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, 1997 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.
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:
Name of each exchange
Title of each class on which registered
------------------- -------------------
Common Stock, No Par Value New York Stock Exchange, Inc.
8-1/8% Senior Notes due 2003 New York Stock Exchange, Inc.
10-1/2% Senior Notes due 2004 New York Stock Exchange, Inc.
7% PRIDES Convertible Preferred Stock New York Stock Exchange, Inc.
9.16% Trust Originated Preferred Securities New York Stock Exchange, Inc.
7% FELINE PRIDES Stock Purchase Contracts New York Stock Exchange, Inc.
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. [X]
Aggregate market value of common stock held by nonaffiliates (computed as of
March 13, 1998): $9,615,452,117
Shares of common stock outstanding as of March 13, 1998: 185,805,838
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Registrant's definitive
proxy statement for the annual meeting of shareholders to be held May 14, 1998
are incorporated by reference into Part III of this Report.
- --------------------------------------------------------------------------------
PART I
ITEM 1. BUSINESS OF CONSECO.
Conseco, Inc. is a financial services holding company. Conseco develops,
markets and administers supplemental health insurance, annuity, life insurance,
individual and group major medical insurance and other insurance products. As
used in this report, the terms "We," "Conseco" or the "Company" refer to
Conseco, Inc. and its consolidated subsidiaries, unless the context requires
otherwise. Since 1982, Conseco has acquired 19 insurance groups. See "Insurance
Subsidiaries and Recent Acquisitions" for a description of our insurance
subsidiaries and recent acquisitions. Our operating strategy is to grow the
insurance business within our subsidiaries by focusing our resources on the
development and expansion of profitable products and strong distribution
channels. We have supplemented such growth by acquiring companies that have
profitable niche products and strong distribution systems. Once a company has
been acquired, our operating strategy has been to consolidate and streamline
management and administrative functions where appropriate, to realize superior
investment returns through active asset management, to eliminate unprofitable
products and distribution channels, and to expand and develop the profitable
distribution channels and products.
Conseco 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.
MARKETING AND DISTRIBUTION
Conseco seeks to retain the loyalty of its agency force by providing
marketing and sales support; electronic and automated access to account and
commission information; and marketing and training tools. We also have
introduced new products like equity-indexed annuities (1996), indexed universal
life (1997) and multi-year-guarantee annuities (1998). We are also looking for
ways to lighten our agents' administrative burden, increase their productive
sales time and get them the information they need faster and more reliably. In
1997, we introduced the Conseco Online Information System ("COINS"), which
enables agents to track policy and commission information and order materials at
their convenience. Many of our marketing companies and agents are already using
COINS; we expect it to be available to all agents by 1999.
In 1997, Conseco launched a comprehensive effort to transform its name
into a recognized brand. We believe that in a competitive marketplace like
financial services, companies that can differentiate themselves through a
familiar brand can obtain full value for their products; sell more efficiently
and command greater customer loyalty; recruit and retain talent more easily;
better withstand and weather inevitable business crises; and have better access
to the financial markets and the capital they need in order to grow. In 1998,
our advertising campaign is designed to introduce consumers to the Conseco
brand, to our product line and to the benefits of doing business with Conseco.
Our insurance subsidiaries are collectively licensed 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 1997 collected premiums: Florida (9.4
percent), Illinois (9.0 percent), California (8.4 percent) , Texas (8.1 percent)
and Michigan (5.0 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.
In order to encourage agents to place a high volume of life, accident and
health and annuity business with our subsidiaries, we offer commission rate
bonuses and compensation awards which increase with the volume of new business
written. We formed a subsidiary to focus on the coordination of the marketing,
distribution and cross marketing activities of our products.
A description of our primary distribution channels follows:
Career Agents. This agency force of approximately 4,100 agents working
from 185 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. This distribution channel also includes group
major medical business marketed through a small field force of representatives.
Since December 1, 1997, this segment includes the career agents of WNIC who sell
specialty health insurance products for educators. In 1997, this distribution
channel accounted for $1,593.2 million, or 32 percent, of our total collected
premiums. Most of 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. The personalized marketing and service efforts of the career
field agents, supported by home office persistency programs, have contributed to
a persistency rate of approximately 83 percent on Medicare supplement policies
sold through this channel.
2
Professional Independent Producers. This distribution channel consists of
a general agency and insurance brokerage distribution system comprised of
approximately 190,000 independent licensed agents doing business in all fifty
states. In 1997, this channel accounted for $3,433.7 million, or 68 percent, of
our total collected premiums.
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.
A portion of our business is distributed through a "Client Company"
marketing system, whereby agents and other insurance companies have entered into
agreements to market Conseco's products through their professional independent
producer distribution systems. Under the agreements, such groups assume up to 50
percent of the business each writes (through agent owned reinsurance companies
or existing life insurance companies). We retain assets equal to the reserves of
each Client Company and provide substantially all administrative services for a
fee. Of the premiums collected by professional independent producers in 1997,
3.2 percent were collected by groups participating in the Client Company
program.
Direct marketing. This distribution channel was added on September 30,
1997 with the acquisition of Colonial Penn Life Insurance Company ("Colonial
Penn"), which is engaged primarily in the sale of "graded benefit life"
insurance policies through direct marketing. We intend to market other Conseco
products through this distribution channel. In 1997, this channel accounted for
$28.8 million, or less than 1 percent, of our total collected premiums.
OPERATING SEGMENTS
We conduct and manage our business through five segments, reflecting our
major lines of insurance business and target markets: (i) supplemental health
insurance; (ii) annuities; (iii) life insurance; (iv) individual and group major
medical insurance; and (v) other.
Supplemental Health
This segment includes Medicare supplement, long-term care and
specified-disease insurance. For periods prior to January 1, 1997, this segment
consists solely of the Medicare supplement and long-term care products
distributed through a career agency force. For periods after January 1, 1997,
this segment includes the specified-disease products of the former subsidiaries
of Transport Holdings Inc. ("THI") and Capitol American Financial Corporation
("CAF") and the long-term care products of the former subsidiaries of ATC which
are distributed through professional independent producers. For periods after
April 1, 1997, this segment also includes various supplemental health products
of Pioneer Financial Services, Inc. ("PFS") which are distributed through
professional independent producers. During 1997, we collected Medicare
supplement premiums of $796.4 million and long-term care premiums of $663.9
million, up 29 percent and 244 percent, respectively, over 1996. We collected
specified-disease premiums of $383.4 million in 1997.
The following describes the major products of this segment:
Medicare supplement. Medicare supplement products accounted for $796.4
million, or 16 percent, of our total collected premiums in 1997. 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 doctors
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 one-half of new sales of Medicare
supplement policies are to individuals who are 65 years old.
3
Long-term care. Long-term care products accounted for $663.9 million, or
13 percent, of our total collected premiums in 1997. Long-term care products
provide coverage, within prescribed limits, for nursing home, home healthcare,
or a combination of both nursing home and home health care 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 states in which we sell such
products.
Specified-disease products. Beginning in 1997, the supplemental health
segment includes specified-disease products such as cancer and heart/stroke
insurance. Specified-disease products accounted for $383.4 million, or 7.6
percent, of our total collected premiums in 1997. 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 65 percent of our specified-disease policies in force
(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 in force 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
This segment includes traditional fixed rate annuity products, market
value-adjusted annuity products, equity-indexed annuity products, and variable
annuity products sold through both career agents and professional independent
producers. During 1997, this segment collected total premiums of $1,689.6
million, up 1.2 percent from 1996.
The following describes the major products of this segment:
Traditional fixed rate annuity products. These products include
single-premium deferred annuities ("SPDAs"), flexible-premium deferred annuities
("FPDAs") and single-premium immediate annuities ("SPIAs"). SPDAs (excluding the
equity-indexed and market value-adjusted products described below) accounted for
$366.8 million, or 7.3 percent, of our total collected premiums in 1997. An SPDA
is a savings vehicle in which the policyholder, or annuitant, makes a
single-premium payment to the insurance company; the insurer guarantees the
principal and accrues a stated rate of interest. After a number of years, as
specified in the annuity contract, the annuitant may elect to take the proceeds
of the annuity either in a single payment or in a series of payments for life,
for a fixed number of years, or for a combination thereof. Our SPDAs typically
have an interest rate (the "crediting rate") that is guaranteed by the Company
for the first 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 recently written on annuities is 3.0 percent, and the rate on
all policies in force ranges from 3.0 percent to 5.5 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; and (ii) 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 80 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 8 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. Commissions to agents are generally reduced by an
amount comparable to the bonus interest to partially compensate the Company for
the higher initial crediting rate on these products. As of December 31, 1997,
crediting rates on our outstanding SPDAs generally ranged from 4.0 percent to
5.5 percent, excluding bonuses guaranteed for the first year of the annuity
contract. The average crediting rate including interest bonuses was 5.0 percent,
and the average rate excluding bonuses was 4.8 percent.
The policyholder is typically permitted to withdraw all or part of the
premium paid plus the accumulated interest credited to his 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
SPDAs provide for penalty-free withdrawals of up to 10 percent of the
accumulation value each year,
4
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 surrender charge is
initially 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
lengthens the effective duration of policy liabilities and enables the Company
to maintain profitability on such policies.
FPDAs (excluding the equity-indexed and market value-adjusted products
described below) accounted for $362.3 million, or 7.2 percent, of our total
collected premiums in 1997. FPDAs are similar to SPDAs in many respects, except
that FPDAs allow more than one premium payment. Our FPDAs have a crediting rate
that is guaranteed by the Company for the first year. After the first year, the
crediting rate may be changed at least annually, subject to a minimum annual
guaranteed rate. The policyholder is permitted to withdraw all or part of the
accumulation value, less a surrender charge for withdrawals during an initial
penalty period of up to 15 years. The initial surrender charges range from 5
percent to 22 percent of the first-year premium and decline over the penalty
period. Interest rates credited on our outstanding FPDAs at December 31, 1997,
generally ranged from 4.5 percent to 5.5 percent, excluding bonuses guaranteed
for the first year of the annuity contract. The average crediting rate including
interest bonuses was 5.0 percent, and the average rate excluding bonuses was 4.8
percent.
SPIAs accounted for $208.1 million, or 4.1 percent, of our total
collected premiums in 1997. 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 at December 31, 1997, averaged 6.0 percent.
Market value-adjusted annuity products. In September 1995, we began
offering a deferred annuity product with a "market value adjustment" feature.
This feature is designed to provide the Company with additional protection from
early terminations during a period of rising interest rates by reducing the
surrender value payable upon a full or partial surrender of the policy in excess
of the allowable penalty-free withdrawal amount. Conversely, during a period of
declining interest rates, the feature would increase the surrender value payable
to the policyholder. In 1997, we collected premiums of $41.4 million from SPDAs
with this feature. We also offer FPDAs with a "market value adjustment" feature.
In 1997, we collected premiums of $138.1 million from sales of FPDAs with this
feature.
Equity-indexed annuity products. In response to consumers' desire for
alternative investment products with returns linked to those of common stocks,
we introduced an equity-indexed SPDA product in June 1996 and an equity-indexed
FPDA product in January 1997. These products accounted for $387.7 million, or
7.7 percent, of our total premiums collected in 1997. The annuity's contract
value is equal to the premium paid increased for returns based upon a percentage
(the "participation rate") of the change in the S&P 500 Index during each year
of its term, subject to a minimum guaranteed value. The Company has the
discretionary ability to annually change the participation rate (which currently
ranges from 70 percent to 75 percent plus a first-year "bonus", similar to the
bonus previously described, of 25 percent), generally subject to a minimum of 50
percent. The minimum guaranteed values are equal to: (i) 90 percent of premiums
collected for SPDAs (75 percent of first year and 87.5 percent of renewal
premiums collected for FPDAs); plus (ii) interest credited 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 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 Standard & Poor's 500 Index Call Options (the "S&P 500 Call
Options") to hedge potential increases to policyholder benefits resulting from
increases in the S&P 500 Index to which the product's return is linked.
Variable annuity products. Variable annuities accounted for $185.2
million, or 3.7 percent, of our total premiums collected in 1997. Variable
annuities, sold on a single-premium or flexible-premium basis, differ from fixed
annuities in that the original principal value may fluctuate, depending on the
performance of assets allocated pursuant to various investment options chosen by
the contract owner. Variable annuities offer contract owners a fixed or variable
rate of return based upon the specific investment portfolios into which premiums
may be directed.
Life
This segment includes traditional, universal life and other life
insurance products. Beginning with the third quarter of 1996, the largest single
component of this segment is the universal life business of Life Partners Group,
Inc. ("LPG"). This segment's
5
products are currently sold through career agents, professional independent
producers and direct response marketing. During 1997, this segment collected
total premiums of $709.0 million, up 76 percent, over premiums collected during
1996.
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 $450.9 million, or 8.9
percent, of our total collected premiums in 1997 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.
Traditional life. These products accounted for $258.1 million, or 5.1
percent, of our total collected premiums in 1997. 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 the policyholder's expected 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
increases in amount gradually 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.
Beginning October 1, 1997, the life insurance segment includes the graded
benefit life insurance products of Colonial Penn. Graded benefit life products
accounted for $28.8 million or .6 percent of our total collected premiums in
1997. 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.
Individual and Group Major Medical Insurance
This segment includes individual and group major medical health insurance
products. The size of this segment increased significantly as a result of the
acquisition of PFS. This segment underwrites and markets group and individual
comprehensive major medical products targeted primarily to self-employed
individuals, small business owners and early retirees. Several 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 in force, claim experience and expense
management. During 1997, this segment collected total premiums of $744.2
million, up 118 percent over premiums collected during 1996.
Insurance premium rates on these products may be adjusted subject to
applicable regulation by class, policy form and state in which the policy is
issued. We monitor the loss experience on these products, and when necessary,
apply for rate increases in the states in which we sell such products.
Other
This segment includes various other health insurance products. The
profitability of this business depends largely on the overall persistency of the
business in force, claim experience and expense management. During 1997, this
segment collected total premium of $69.2 million, up 27 percent over premiums
collected during 1996.
After December 1, 1997, the other segment includes the specialty health
insurance products for educators sold by a subsidiary of WNIC. These products
are sold by career agents and accounted for $9.1 million of Conseco's collected
premiums since the acquisition of WNIC.
This segment also includes fee revenue generated by Conseco's nonlife
subsidiaries, including the investment advisory fees earned by Conseco Capital
Management, Inc. ("CCM") and commissions earned for insurance product marketing
and distribution. Fee revenues and commissions from Conseco's consolidated
subsidiaries are excluded from segment results. CCM had approximately $5.1
billion of assets (at fair value) under management at December 31, 1997, for
unaffiliated parties. Total fees earned from nonaffiliates during 1997 were
$65.8 million, up 32 percent over 1996.
6
INSURANCE SUBSIDIARIES AND RECENT ACQUISITIONS
Conseco owned the following life insurance companies at December 31,
1997:
- Bankers Life and Casualty Company ("Bankers Life"), Bankers Life
Insurance Company of Illinois and Certified Life Insurance Company,
formerly subsidiaries of Bankers Life Holding Corporation ("BLH");
- Great American Reserve Insurance Company ("Great American Reserve"),
Beneficial Standard Life Insurance Company ("Beneficial Standard") and
Jefferson National Life Insurance Company of Texas
("Jefferson-Texas"), in which Conseco has had an ownership interest
since 1990 and which became wholly owned subsidiaries in August 1995;
- the subsidiaries of American Life Holdings, Inc. ("ALH", formerly The
Statesman Group, Inc.), including American Life and Casualty Insurance
Company and Vulcan Life Insurance Company;
- the subsidiaries of LPG, including Philadelphia Life Insurance
Company, Conseco Life Insurance Company (formerly Massachusetts
General Life Insurance Company prior to its name change in 1997),
Lamar Life Insurance Company and Wabash Life Insurance Company;
- the former subsidiaries of ATC, including American Travellers Life
Insurance Company ("American Travellers"), United General Life
Insurance Company and Conseco Life Insurance Company of New York
(formerly American Travellers Insurance Company of New York prior to
its name change in 1997);
- the former subsidiaries of THI, including TLIC Life Insurance Company
(which was merged into Jefferson-Texas in 1997), Transport Life
Insurance Company (which was merged into American Travellers in 1997),
and Continental Life Insurance Company;
- the former subsidiaries of CAF, including Capitol American Life
Insurance Company, Capitol National Life Insurance Company and
Frontier National Life Insurance Company;
- the subsidiaries of PFS, including Continental Life and Accident
Insurance Company, Connecticut National Life Insurance Company, Health
and Life Insurance Company of America, Manhattan National Life
Insurance Company, Pioneer Life Insurance Company and National Group
Life Insurance Company;
- certain former subsidiaries of Leucadia National Corporation
("Leucadia"), including Colonial Penn and Providential Life Insurance
Company;
- the subsidiaries of Washington National Corporation ("WNIC"),
including Washington National Insurance Company and United
Presidential Life Insurance Company; and
- Bankers National Life Insurance Company, National Fidelity Life
Insurance Company and Lincoln American Life Insurance Company.
Since 1982, Conseco has acquired 19 insurance groups and related
businesses. We continue to regularly investigate acquisition opportunities in
the insurance industry and other industries in which we operate. We evaluate
potential acquisitions based on a variety of factors, including the operating
results and financial condition of the business to be acquired, its growth
potential, management and personnel and the potential return on such acquisition
in relation to other acquisition opportunities and the internal development of
our existing business operations. No assurances can be given as to when, if at
all, or upon what terms Conseco will make any such acquisition.
Our first acquisition partnership, Conseco Capital Partners, L.P.
("Partnership I"), was dissolved in 1993 after distributing to its partners the
securities of the companies it had acquired. Conseco Capital Partners II, L.P.
("Partnership II"), our second acquisition partnership, was liquidated in 1996
after Conseco purchased from the other partners all of the common shares of ALH
not already owned by Conseco. We terminated its partnership activity in 1996
because changes in the regulatory and rating agency environment made it
difficult to structure leveraged acquisitions of life insurance companies.
On August 31, 1995, we purchased (the "CCP Merger") all of the shares of
common stock of CCP Insurance, Inc. ("CCP") not previously owned (representing
51 percent of CCP's outstanding shares). In the transaction, CCP was merged into
Conseco, with Conseco being the surviving corporation. As a result of the CCP
Merger, CCP's subsidiaries, Great American Reserve and Beneficial
7
Standard, became wholly owned subsidiaries of Conseco. The accounts of CCP's
subsidiaries are consolidated with Conseco's accounts effective January 1, 1995.
On August 2, 1996, we acquired LPG (the "LPG Merger"). LPG became a
wholly owned subsidiary of Conseco. In the LPG Merger, we issued a total of 32.6
million shares of Conseco common stock (or common stock equivalents) with a
value of $586.8 million. We also assumed $253.1 million of notes payable of LPG.
LPG's subsidiaries sell a diverse portfolio of universal life insurance and, to
a lesser extent, annuity products to individuals.
On September 30, 1996, we acquired the remaining 62 percent of the common
shares of ALH (the "ALH Stock Purchase") not already owned by Conseco or its
affiliates for approximately $166 million in cash. ALH is a provider of
retirement savings annuities. ALH has been included in our consolidated
financial statements since ALH's acquisition by Partnership II in September
1994.
On December 17, 1996, we acquired ATC (the "ATC Merger"). ATC was merged
with and into Conseco, with Conseco being the surviving corporation. In the ATC
Merger, we issued a total of 21.0 million shares of Conseco common stock (or
common stock equivalents) with a value of $630.9 million. In addition, we
assumed $102.8 million of ATC's convertible subordinated debentures, which
became convertible into 7.9 million shares of Conseco common stock with a value
of $248.3 million. ATC is a leading marketer and underwriter of long-term care
insurance. ATC also markets and underwrites other supplemental accident and
health insurance policies, as well as life insurance.
On December 23, 1996, we acquired THI (the "THI Merger"). THI was merged
with and into Conseco, with Conseco being the surviving corporation. In the THI
Merger, we issued a total of 4.9 million shares of Conseco common stock (or
common stock equivalents) with a value of $121.7 million. In addition, pursuant
to an exchange offer, all of THI's subordinated convertible notes were exchanged
for 4.2 million shares of Conseco common stock with a value of $106.2 million,
plus a cash premium of $11.9 million. THI is principally engaged in the
underwriting and distribution of supplemental health insurance.
On December 31, 1996, we acquired the 9.6 percent of the common shares of
BLH (the "BLH Merger") not already owned by Conseco or its affiliates. BLH was
merged into a wholly owned subsidiary of Conseco. In the BLH Merger, we issued a
total of 3.9 million shares of Conseco common stock (or common stock
equivalents) with a value of $123.0 million. BLH is one of the nation's largest
writers of individual health insurance products, based on collected premiums.
BLH also markets a variety of annuity, life and group insurance products. BLH
has been included in our consolidated financial statements since November 1992,
when BLH was acquired by Partnership I.
On March 4, 1997, we acquired CAF (the "CAF Merger"). CAF became a wholly
owned subsidiary of Conseco. In the CAF Merger, we paid $552.8 million in cash
and issued 3.0 million shares of Conseco common stock (or common stock
equivalents) with a value of $117.4 million. In addition, we assumed a $31.0
million note payable of CAF, which was repaid on the merger date. CAF, through
its insurance subsidiaries, underwrites, markets and distributes individual and
group supplemental health and accident insurance.
On May 30, 1997, we acquired PFS (the "PFS Merger"). PFS became a wholly
owned subsidiary of Conseco. In the PFS Merger, we issued 9.0 million shares of
Conseco common stock (or common stock equivalents) with a value of $354.1
million. In addition, we assumed PFS's convertible subordinated notes, which
became convertible into 3.1 million shares of Conseco common stock, with a value
of $130.6 million. We also assumed a $21.3 million note payable of PFS, which
was repaid on the merger date. PFS, through its insurance subsidiaries,
underwrites, markets and distributes life insurance, annuities and health
insurance in selected niche markets throughout the United States.
On September 30, 1997, we acquired Colonial Penn (the "Colonial Penn
Purchase") and certain other assets (collectively referred to as "Colonial
Penn") from Leucadia. Colonial Penn became a wholly owned subsidiary of Conseco.
In the Colonial Penn Purchase, we paid $60.0 million in cash and issued $400.0
million of notes payable to Leucadia. Colonial Penn is principally engaged in
the underwriting and sale of "graded benefit life" insurance policies through
direct marketing and Medicare supplement insurance through independent agents.
On December 5, 1997, we acquired WNIC (the "WNIC Merger"). WNIC became a
wholly owned subsidiary of Conseco. In the WNIC Merger, we paid $400.6 million
in cash, of which $73.7 million was funded through a dividend to Conseco from
WNIC. WNIC is principally engaged in marketing and underwriting life insurance
and annuities for individuals and specialty health insurance for educators.
8
ADMINISTRATION
We minimize operating expenses by centralizing, standardizing and more
efficiently performing many functions common to most life insurance companies.
These functions include underwriting and policy administration, accounting and
financial reporting, marketing, regulatory compliance, actuarial services and
asset management.
The administration of our individual and group health insurance products
involves higher volumes of claims, contacts with policyholders and operational
costs, compared to the administration of life insurance or annuity policies. We
have developed an efficient and highly automated policyholder administration
operation to minimize the costs of such large volume processing and deliver a
high level of service to our policyholders, with special emphasis on the prompt
payment of claims. In many cases, we mail a check within a week of receiving a
claim from a policyholder.
INVESTMENTS
CCM, a registered investment adviser wholly owned by Conseco, manages the
investment portfolios of Conseco's subsidiaries. CCM had approximately $32.1
billion of assets (at fair value) under management at December 31, 1997, of
which $27.0 billion were assets of Conseco's subsidiaries and $5.1 billion were
assets of unaffiliated parties. CCM's 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.
Investment activities are an integral part of our business; investment
income is a significant component of our total revenues. Profitability of many
of our 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, 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, 1997, the average yield, computed on the cost basis of our investment
portfolio, was 7.5 percent, and the average interest rate credited or accruing
to our total insurance liabilities, excluding interest bonuses guaranteed for
the first year of the annuity contract only, was 5.2 percent.
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, 1997, the adjusted modified duration of fixed maturities and short-term
investments was approximately 5.8 years and the duration of our insurance
liabilities was approximately 6.7 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 note 3 to the consolidated financial statements.
COMPETITION
Our businesses operate in a highly competitive environment. The financial
services industry consists of a large number of companies, some of which are
larger and have greater financial resources, 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 other insurers to
attract and retain the allegiance of agents.
Marketing companies, agents who market insurance products, school
districts, financial institutions and policyholders use the financial strength
ratings assigned to an insurer by independent rating agencies as one factor in
determining which insurer's products to market or purchase. Substantially all of
our primary life insurance companies have received: (i) an "A" (Excellent)
insurance company rating by A.M. Best Company ("A.M. Best"); (ii) an "AA-"
claims-paying ability rating from Duff & Phelps' Credit Rating Company ("Duff &
Phelps"); and (iii) an "A+" claims-paying ability rating from Standard & Poor's
Corporation ("Standard & Poor's").
A.M. Best insurance company ratings for the industry currently range from
"A++ (Superior)" to "F (In Liquidation)". Publications of A.M. Best indicate
that the "A" and "A-" ratings are assigned to those companies that, in A.M.
Best's opinion, have demonstrated excellent overall performance when compared to
the standards established by A.M. Best and have demonstrated a strong
9
ability to meet their obligations to policyholders over a long period of time.
A.M. Best's rating procedure includes quantitative and qualitative evaluations
of a company's financial condition and operating performance. Its quantitative
evaluation is based on an analysis of a company's financial performance in the
areas of profitability, leverage/capitalization and liquidity. A.M. Best's
review also includes a qualitative evaluation of a company's spread of risk,
quality and appropriateness of reinsurance programs, quality and diversification
of assets, adequacy of policy or loss reserves, management experience and
objectives, market presence and policyholders' confidence.
In recent years, A.M. Best upgraded the ratings of several of our
subsidiaries to "A" (Excellent) from "A-" (Excellent). Among the reasons A.M.
Best cited for the ratings upgrades and reaffirmations were the benefits Conseco
will derive as a result of recent acquisitions including: (i) improved unit
costs arising from the integration of administrative, financial, investment,
marketing and underwriting functions; (ii) expanded distribution capacity and
increased cross-selling opportunities; and (iii) a more diversified product
portfolio that should generate more balanced and predictable revenue and
earnings sources. A.M. Best also views favorably the continuing improvement in
Conseco's financial leverage and our target ratio of debt to total capital of
not more than 35 percent.
Duff & Phelps' claims-paying ability ratings range from "AAA (Highest
claims-paying ability)" to "DD (Company is under an order of liquidation)." An
"AA-" rating represents "Very high claims-paying ability." A plus or minus sign
attached to a Duff & Phelps claims paying rating shows relative standing within
a ratings category.
Standard & Poor's claims-paying ability ratings range from "AAA
(Superior)" to "R (Regulatory Action)". An "A" is assigned by Standard & Poor's
to those companies which, in its opinion, have a secure claims-paying ability
and whose financial capacity to meet policyholder obligations is viewed on
balance as sound, but their capacity to meet such policyholder obligations is
somewhat more susceptible to adverse changes in economic or underwriting
conditions than more highly rated insurers. According to Standard & Poor's, a
plus or minus sign attached to a Standard & Poor's claims-paying rating shows
relative standing within a ratings category. A "q" subscript indicates that the
rating is based solely on quantitative analysis of publicly available financial
data.
Generally, rating agencies base their ratings upon information furnished
to them by the insurer and upon their own investigations, studies and
assumptions. A.M. Best's ratings, Duff & Phelps' claims-paying ratings and
Standard & Poor's claims-paying ratings are principally based upon factors of
concern to policyholders, agents and intermediaries and are not directed toward
the protection of investors. Given the competitive nature of our business and
the increasing focus placed on the aforementioned ratings, we manage our
business with the objective of preserving existing ratings and, where possible,
achieving more favorable ratings. There can be no assurance that any particular
rating will continue for any given period of time, or that it will not be
changed or withdrawn entirely if, in the judgement of the rating agency,
circumstances so warrant. If our ratings were downgraded from their current
levels, sales of our products and the persistency of our in-force policies could
be adversely affected in a material way.
In the individual health insurance business, insurance companies compete
primarily on the basis of marketing, service and price. The provisions of the
Omnibus Budget Reconciliation Act of 1984 and the work of the National
Association of Insurance Commissioners ("NAIC") (an association of state
regulators and their staffs) have resulted in standardized policy features for
Medicare supplement products. This increases the comparability of such policies
and may intensify competition based on factors other than product features. See
"Underwriting" and "Governmental Regulation." In addition to the products of
other insurance companies, our health insurance products compete with health
maintenance organizations, preferred provider organizations and other health
care- related institutions which provide medical benefits based on contractual
agreements.
We believe that we are able to compete effectively because: (i) we
emphasize a number of specialized distribution channels, where the ability to
respond rapidly to changing customer needs yields a competitive edge; (ii) we
are experienced in establishing and cultivating relationships with the unique
distribution networks and the independent marketing companies operating in these
specialized markets; (iii) we can offer competitive rates as a result of our
lower-than-average operating costs and higher-than-average investment yields
achieved by applying active investment portfolio management techniques; and (iv)
we have reliable policyholder administrative services, supported by customized
information technology systems.
UNDERWRITING
Under regulations promulgated by the NAIC 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.
10
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 has 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 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, 1997, the policy risk retention limit was $.8 million
or less on all of the policies of our subsidiaries. Reinsurance ceded by Conseco
represented 27 percent of gross combined life insurance in force and reinsurance
assumed represented 4.0 percent of net combined life insurance in force. At
December 31,1997, the total ceded business in force of $36.7 billion included:
(i) $5.3 billion ceded to Client Companies for which we retain assets equal to
the reserves on the business ceded; and (ii) $25.8 billion ceded to insurance
companies rated "A- (Excellent)" or better by A.M. Best. Our principal
reinsurers at December 31, 1997 (which assume approximately 65 percent of the
total ceded business in force, excluding business ceded to the Client Companies)
were American Equity Investment Life Insurance Company, Cologne Life,
Connecticut General Life Insurance Company, Employers Re, Life Reassurance
Corporation of America, Lincoln National Life Insurance Company, RGA Reinsurance
Company, Security Life of Denver and Swiss Re Life and Health America. No other
single reinsurer assumes greater than 5 percent of the total ceded business in
force.
EMPLOYEES
At December 31, 1997, Conseco had approximately 6,800 employees,
including: (i) 3,000 home office employees; (ii) 1,400 employees in our Chicago
office (primarily involved with our supplemental health operations); (iii) 1,900
employees in various locations serving as administrative centers for its
insurance operations; and (iv) 500 employees in branch offices (primarily
supporting our career agency force). None of our employees is covered by a
collective bargaining agreement. We believe that we have excellent relations
with our employees.
GOVERNMENTAL REGULATION
General
Our insurance subsidiaries are subject to regulation and supervision by
the states 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 surplus debenture
payments that can be paid without obtaining regulatory approval. Our insurance
subsidiaries are subject to periodic examinations by state regulatory
authorities. We do not expect the results of any ongoing examinations to have a
material effect on the Company's financial condition.
11
Most states have also enacted regulations on the activities of insurance
holding company systems, including acquisitions, extraordinary dividends, the
terms of surplus debentures, the terms of affiliate transactions and other
related matters. Currently, the Company and its insurance subsidiaries have
registered as holding company systems pursuant to such legislation in the
domiciliary states of the insurance subsidiaries (Alabama, Arizona, Arkansas,
California, Illinois, Indiana, Kentucky, Mississippi, Missouri, New York, Ohio,
Pennsylvania, Tennessee and Texas), and they routinely report to other
jurisdictions. Recently, a number of state legislatures have considered or have
enacted legislative proposals that alter, and in many cases increase, the
authority of state agencies to regulate insurance companies and holding company
systems. For further information on state laws regulating the payment of
dividends by insurance company subsidiaries, see "Management's Discussion and
Analysis of Consolidated Financial Position and Results of Operations -
Consolidated Financial Condition" and note 12 to Conseco's consolidated
financial statements.
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 and federal taxation, do affect the insurance
business. In recent years, the Office of the Comptroller of the currency has
issued a number of rulings which have expanded the ability of banks to sell
certain insurance products. The United States House of Representatives is
currently considering the Financial Services Act (H.R.10), which would (among
other things) eliminate existing restrictions on affiliations between insurance
companies, banks and securities firms. This proposed legislation in its current
form would allow insurance companies and securities firms to directly own banks
and each other while banks could own insurance companies and securities firms
indirectly through a holding company. Other provisions of the act would define
insurance products and retain jurisdiction over their regulation in the states.
Such legislation, if enacted, could result in increased competition, as well as
new opportunities, for the Company. In addition, legislation has been introduced
from time to time in recent years which, if enacted, could result in the federal
government assuming a more direct role in the regulation of the insurance
industry.
The Securities and Exchange Commission has requested comments as to
whether equity-indexed annuities, such as those sold by the Company, should be
treated as securities under the Federal securities laws rather than as insurance
products. Treatment of these products as securities would likely require
additional registration and licensing of these products and the agents selling
them, as well as cause the Company to seek additional marketing relationships
for these products.
The Risk-Based Capital for Life and/or Health Insurers Model Act (the
"Model Act") adopted by the NAIC provides a tool for insurance regulators to
determine the levels of 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 (or similar legislation or regulation) has
been adopted in states where our insurance subsidiaries are domiciled.
The Model Act provides for four levels of regulatory attention, varying
with the ratio of the company's total adjusted capital (defined as the total of
its statutory capital, surplus, asset valuation reserve and certain other
adjustments) to its risk-based capital ("RBC"). If a company's total adjusted
capital is less than 100 percent but greater than or equal to 75 percent of its
RBC, or if a negative trend (as defined by the regulators) has occurred and
total adjusted capital is less than 125 percent of RBC (the "Company Action
Level"), the company must submit a comprehensive plan to the regulatory
authority proposing corrective actions aimed at improving its capital position.
If a company's total adjusted capital is less than 75 percent but greater than
or equal to 50 percent of its RBC (the "Regulatory Action Level") , the
regulatory authority will perform a special examination of the company and issue
an order specifying corrective actions that must be followed. If a company's
total adjusted capital is less than 50 percent but greater than or equal to 35
percent of its RBC (the "Authorized Control Level"), the regulatory authority
may take any action it deems necessary, including placing the company under
regulatory control. If a company's total adjusted capital is less than 35
percent of its RBC (the "Mandatory Control Level") the regulatory authority must
place the company under its control. At December 31, 1997, the average ratio of
total adjusted capital to RBC for our insurance subsidiaries was greater than
twice the levels at which regulatory attention is triggered.
The Texas Insurance Department has adopted its own RBC requirements, the
stated purpose of which is to require a minimum level of capital and surplus to
absorb the financial, underwriting, and investment risks assumed by an insurer.
Texas' RBC requirements differ from those adopted by the NAIC in two principal
respects: (i) they use different elements to determine minimum RBC levels in
their calculation formulas; and (ii) they do not stipulate "Action Levels" (like
those described in the previous paragraph) where corrective actions are
required. However, the Commissioner of the Texas Insurance Department does have
the power to take similar corrective actions if a company does not maintain the
required minimum level of capital and surplus. Under the Texas Regulations, an
insurer also meets RBC requirements if its admitted assets exceed its
liabilities by at least 6 percent. Five of our insurance subsidiaries are
domiciled in Texas and all of them were in compliance with Texas RBC
requirements at December 31, 1997.
Most states have either enacted legislation or adopted administrative
regulations which affect the acquisition of control of insurance companies as
well as transactions between insurance companies and persons controlling them.
The nature and extent of such legislation and regulations vary from state to
state. Most states, however, require administrative approval of: (i) the
acquisition
12
of 10 percent or more of the outstanding shares of an insurance company
domiciled in the state; or (ii) the acquisition of 10 percent or more of the
outstanding stock of an insurance holding company whose insurance subsidiary is
domiciled in the state. The acquisition of 10 percent of such shares is
generally deemed to be the acquisition of control for the purpose of the holding
company statutes. These regulations require the acquirer to file detailed
information concerning the acquiring parties and the plan of acquisition, and to
obtain administrative approval prior to the acquisition. In many states,
however, an insurance authority may determine that control does not exist, even
in circumstances in which a person owns or controls 10 percent or a greater
amount of securities.
On the basis of statutory statements filed with state regulators
annually, the NAIC calculates eleven 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. Such inquiries did not lead to any
restrictions affecting our operations.
Under the solvency or guaranty laws of most states in which we do
business, our insurance subsidiaries may be required to pay guaranty fund
assessments (up to certain prescribed limits). Guaranty funds are established by
various states to fund policyholder losses or the liabilities of insolvent or
rehabilitated insurance companies. These assessments may be deferred or forgiven
under most guaranty laws if they would threaten an insurer's financial strength.
In certain instances, the assessments may be offset against future premium
taxes. We establish a reserve to provide for assessments related to known
insolvencies. This reserve is based upon our current expectation of the
availability of the right of offset and state guaranty fund assessment bases.
However, changes in the basis whereby assessments are charged to individual
companies or changes to the availability of the right to offset assessments
against premium tax payments could materially affect our results of operations.
Our insurance subsidiaries' statutory financial statements for the year ended
December 31, 1997, include $7.2 million of expenses as a result of such
assessments.
Health Care
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 we have failed 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. Conseco currently offers 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 Health Insurance Portability and Accountability Act of 1996 ("HIPAA")
was enacted in 1996. HIPAA sets forth minimum federal standards for group and
individual health insurance, including requirements relating to the
availability, portability and renewability of health coverage.
Numerous proposals to reform the current health care system have been
introduced in Congress and the 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. Federal comprehensive major medical or
long-term care programs, if proposed and implemented, could partially or fully
replace some of Conseco's current products, for example.
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.
The NAIC recently adopted model long-term care policy language providing
nonforfeiture benefits and has proposed a rate stabilization standard for
long-term care policies. Various bills proposed in the U.S. Congress would
provide for the implementation of certain minimum consumer protection standards
for inclusion in all long-term care policies, including guaranteed renewability,
13
protection against inflation and limitations on waiting periods for pre-existing
conditions. Other recently adopted 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.
We cannot predict with certainty the effect that any proposals, if
adopted, or legislative developments could have on our business and operations.
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.
Accordingly, the tax advantage is subject to change by Congress and by the
legislatures of the respective taxing jurisdictions.
In February of 1998, President Clinton released various revenue proposals
and tax changes to be considered in the current federal budget. Such proposals
contained numerous tax increases directed at the insurance industry, of which
the more significant ones were as follows: taxing asset reallocations within
variable annuities and exchanges of variable annuities, reducing the tax basis
of insurance and annuity contracts for mortality charges and modifying tax
reserving rules for annuity contracts. We have joined the insurance industry and
other groups opposing these taxes upon savings, and we expect that these
proposed changes will not be enacted into legislation.
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
surplus and, accordingly, decreases the amount of cash dividends that may be
paid by the life insurance subsidiaries. As of December 31, 1997, the cumulative
taxes paid by our insurance subsidiaries as a result of this provision were
$327.8 million.
The Company had tax loss carryforwards at December 31, 1997, of
approximately $737.1 million, portions of which begin expiring in 1999. However,
the amount of such loss that may be offset against current taxable income is
subject to the following limitations: (i) losses may be offset against income of
other corporate entities only if such entities are included in the same
consolidated tax return (insurance companies are currently not eligible for
inclusion in Conseco's consolidated tax return until five years after they are
acquired); (ii) losses incurred in non-life companies (which comprise most of
the loss carryforwards) may offset only a portion of income from life companies
in the same consolidated tax return; and (iii) some loss carryforwards may not
be used to offset taxable income of entities acquired after the loss was
incurred. We, however, believe we will be able to utilize all current loss
carryforwards before they expire.
ITEM 2. PROPERTIES.
Our principal operations are located on a 170-acre corporate campus in
Carmel, Indiana, immediately north of Indianapolis. The 11 buildings on the
campus (all but one of which are owned) contain approximately 810,000 square
feet of space and house Conseco's executive offices and certain administrative
operations of its subsidiaries. The campus has ample room for additional
buildings to support future growth.
Our supplemental health products are primarily administered from a single
facility of 300,000 square feet in downtown Chicago, Illinois, leased under an
agreement having a remaining life of 10 years. We also lease approximately
130,000 square feet of warehouse space in a second Chicago facility; this lease
has a remaining life of five years. Conseco owns an office building in Kokomo,
Indiana (100,000 square feet), and two office buildings in Rockford, Illinois
(total of 169,000 square feet), which serve as administrative centers for
portions of our insurance operations. Conseco owns one 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 leases 24,000 square feet of office space
in Bensalem, Pennsylvania, and 4,000 square feet of office space in Sarasota,
Florida, for use by our long-term care insurance marketing operations; these
leases expire in 2000 and 1998, respectively. Conseco leases 22,000 square feet
of office space in Schaumburg, Illinois, for use by our major medical marketing
and certain information technology operations. Conseco also leases
14
210 sales offices in various states totaling approximately 363,000 square feet;
these leases are short-term in length, with remaining lease terms ranging from
one to five years.
ITEM 3. LEGAL PROCEEDINGS.
Conseco and its subsidiaries are involved in lawsuits primarily related
to their operations. Most of these lawsuits involve claims under insurance
policies or other contracts of the Company. None of the lawsuits currently
pending, either individually or in the aggregate, is expected to have a material
adverse effect on Conseco's consolidated financial condition or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
15
OPTIONAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT.
Officer Positions with Conseco, principal
name and age (a) Since occupation and business experience (b)
------------ ----- ----------------------------------
Stephen C. Hilbert, 52......... 1979 Since 1979, Chairman of the Board and Chief Executive Officer and, since
1988, President of Conseco.
Ngaire E. Cuneo, 47 ........... 1992 Since 1992, Executive Vice President, Corporate Development and, since
1994, Director of Conseco; from 1986 to 1992, Senior Vice President and
Corporate Officer of General Electric Capital Corporation.
Rollin M. Dick, 66............. 1986 Since 1986, Executive Vice President, Chief Financial Officer and Director of
Conseco.
Donald F. Gongaware, 62........ 1985 Since 1985, Executive Vice President and Director of Conseco; since 1989,
Chief Operations Officer of Conseco; and, since 1996, President of Conseco
Marketing, LLC. Mr. Gongaware is resigning from these positions (other than
as director of Conseco) effective March 31, 1998.
John J. Sabl, 46............... 1997 Since 1997, Executive Vice President, General Counsel and Secretary of
Conseco; from 1983 to 1997 Partner in the law firm of Sidley & Austin.
James S. Adams, 38............. 1997 Since 1997, Senior Vice President, Chief Accounting Officer and Treasurer of
Conseco; from 1989 to present, Senior Vice President and Treasurer of various
Conseco subsidiaries.
Thomas J. Kilian, 47........... 1998 Effective March 31, 1998, Executive Vice President and Chief Operations Officer
of Conseco and President of Conseco Marketing, LLC; from 1996 to March 31,
1998, President of Conseco Services, LLC (responsible for insurance operations,
data processing, human resources and administrative services for various
Conseco subsidiaries); from 1989 to 1996, Senior Vice President of data
processing for various Conseco subsidiaries.
- -------------------
(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.
16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
MARKET INFORMATION
The common stock of Conseco (trading symbol "CNC") has been listed for
trading on the New York Stock Exchange (the "NYSE") since 1986. The following
table sets forth the quarterly dividends paid per share and the ranges of high
and low sales prices per share on the NYSE for the last two fiscal years, based
upon information supplied by the NYSE. All applicable per share data have been
adjusted for the two-for-one stock splits distributed April 1, 1996, and
February 11, 1997.
Market price
Period ------------ Dividend
------ High Low paid
---- --- ----
1996:
First Quarter.................................. $18-5/32 $14-15/16 $.00500
Second Quarter................................. 20-3/8 17-3/8 .01000
Third Quarter.................................. 24-11/16 17-5/8 .01000
Fourth Quarter................................. 33-1/8 24-7/16 .03125
1997:
First Quarter.................................. $43-7/8 $30-3/4 $.03125
Second Quarter................................. 42-7/8 34-1/4 .03125
Third Quarter.................................. 50 35-1/8 .03125
Fourth Quarter................................. 50-1/16 39-7/8 .12500
As of March 13, 1998, there were approximately 74,000 holders of the
outstanding shares of common stock, including individual participants in
securities position listings.
DIVIDENDS
Cash dividends are paid quarterly at an amount determined by our Board of
Directors. Our general policy is to retain most of our earnings. Retained
earnings have been used: (i) to finance the growth and development of the
Company's business through acquisitions or otherwise; (ii) to pay preferred
stock dividends; (iii) to pay distributions on the Company-obligated mandatorily
redeemable preferred stock of subsidiary trusts; (iv) to repurchase common stock
on those occasions when we have determined that our shares were undervalued in
the market and that the use of funds for stock repurchases would not interfere
with other cash needs; and (v) to pay dividends on common stock.
We have paid all cumulative dividends on our preferred stock and
distributions on our Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts when due. We are prohibited from paying common
stock dividends if such payments are not current. Certain Conseco financing
agreements require the Company to maintain financial ratios which could also
limit its ability to pay dividends.
Our ability to pay dividends depends primarily on the receipt of cash
dividends and other cash payments from our subsidiaries. The principal operating
subsidiaries of Conseco are life insurance companies organized under state laws
and subject to regulation by state insurance departments. These laws and
regulations limit the ability of insurance subsidiaries to make cash dividends,
loans or advances to a holding company such as Conseco. However, these laws
generally permit the payment, without prior approval, of annual dividends which
in the aggregate do not exceed the greater of (or in a few states, the lesser
of): (i) the subsidiary's prior year net gain from operations; or (ii) 10
percent of surplus attributable to policyholders at the prior year-end, both
computed on the statutory basis of accounting prescribed for insurance
companies. See "Management's Discussion and Analysis of Consolidated Financial
Condition and Results of Operations -- Liquidity of Conseco (Parent Company)."
17
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA (a).
Years ended December 31,
----------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Amounts in millions, except per share data)
STATEMENT OF OPERATIONS DATA
Insurance policy income..................................... $3,410.8 $1,654.2 $1,465.0 $1,285.6 $1,293.8
Net investment income....................................... 1,825.3 1,302.5 1,142.6 385.7 896.2
Net investment gains (losses) .............................. 266.5 60.8 204.1 (30.5) 242.6
Total revenues.............................................. 5,568.4 3,067.3 2,855.3 1,862.0 2,636.0
Interest expense on notes payable........................... 109.4 108.1 119.4 59.3 58.0
Total benefits and expenses................................. 4,565.3 2,573.7 2,436.8 1,537.6 2,025.8
Income before income taxes, minority interest and
extraordinary charge...................................... 1,003.1 493.6 418.5 324.4 610.2
Extraordinary charge on extinguishment of debt, net of tax.. 6.9 26.5 2.1 4.0 11.9
Net income.................................................. 567.3 252.4 220.4 150.4 297.0
Preferred stock dividends and charge related to induced
conversions of convertible preferred stock................ 21.9 27.4 18.4 18.6 20.6
Net income applicable to common stock....................... 545.4 225.0 202.0 131.8 276.4
PER SHARE DATA (b)
Net income, basic........................................... $2.94 $2.15 $ 2.48 $ 1.31 $ 2.74
Net income, diluted......................................... 2.64 1.82 2.12 1.22 2.20
Dividends declared per common share......................... .313 .083 .046 .125 .075
Book value per common share outstanding..................... 20.22 16.86 10.22 5.22 8.45
Shares outstanding at year-end.............................. 186.7 167.1 81.0 88.7 101.2
Weighted average shares outstanding for diluted earnings.... 210.2 138.9 103.9 123.4 133.8
BALANCE SHEET DATA - PERIOD END
Total assets................................................ $35,914.8 $25,612.7 $17,297.5 $10,811.9 $13,749.3
Notes payable for which Conseco is directly liable.......... 1,906.7 1,094.9 871.4 191.8 413.0
Notes payable of affiliates, not direct
obligations of Conseco.................................... - - 584.7 611.1 290.3
Commercial paper............................................ 448.2 - - - -
Total liabilities........................................... 30,640.1 21,829.7 15,782.5 9,743.2 12,382.9
Minority interests in consolidated subsidiaries:
Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts.............. 1,383.9 600.0 - - -
Preferred stock........................................... - 97.0 110.7 130.1 -
Common stock.............................................. .7 .7 292.6 191.6 223.8
Shareholders' equity ....................................... 3,890.1 3,085.3 1,111.7 747.0 1,142.6
OTHER FINANCIAL DATA (b) (c)
Premiums collected (d)...................................... $5,055.7 $3,280.2 $3,106.5 $1,879.1 $2,140.1
Operating earnings (e)...................................... 574.9 267.7 131.3 151.7 162.0
Operating earnings per diluted common share (e)............. 2.74 1.93 1.26 1.23 1.20
Shareholders' equity excluding unrealized appreciation
(depreciation) of fixed maturity securities (f)........... 3,712.9 3,045.5 999.1 884.7 1,055.2
Book value per common share outstanding, excluding
unrealized appreciation (depreciation) of fixed
maturity securities (f)................................... 19.27 16.62 8.83 6.77 7.58
(a) Comparison of selected consolidated financial data in the table above is
significantly affected by: (i) the acquisitions consummated by
Partnership I and Partnership II; (ii) the sale of Western National Life
Insurance Company ("Western National") in 1994; (iii) the transactions
affecting Conseco's ownership interest in BLH and CCP during 1993 through
1996; (iv) the LPG Merger (completed effective July 1, 1996); (v) the ATC
Merger (December 31, 1996); (vi) the THI Merger (December 31, 1996);
(vii) the CAF Merger (January 1, 1997); (viii) the PFS Merger (April 1,
1997); (ix) the Colonial Penn Purchase (September 30, 1997); and (x) the
WNIC Merger (December 1, 1997). For periods beginning with their
acquisitions by
18
Partnership I and ending June 30, 1992, Partnership I and its
subsidiaries were consolidated with the financial statements of Conseco.
Following the completion of the initial public offering by CCP in July
1992, Conseco did not have unilateral control to direct all of CCP's
activities and, therefore, did not consolidate the financial statements
of CCP with the financial statements of Conseco. As a result of the CCP
Merger, the financial statements of CCP's subsidiaries were consolidated
with the financial statements of Conseco, effective January 1, 1995.
Conseco has included BLH in its financial statements since November 1,
1992. Through December 31, 1993, the financial statements of Western
National were consolidated with the financial statements of Conseco.
Following the completion of the initial public offering of Western
National in early 1994 (and subsequent disposition of Conseco's remaining
equity interest in Western National), the financial statements of Western
National were no longer consolidated with the financial statements of
Conseco. As of September 29, 1994, Conseco began to include in its
financial statements the newly acquired Partnership II subsidiary, ALH.
On September 30, 1996, Conseco acquired all of the common stock of ALH
which Conseco did not already own from Partnership II. Business
combinations completed in 1997 and 1996 are included in Conseco's
financial statements on the effective date of the acquisition and are
described in the notes to the consolidated financial statements.
(b) All share and per-share amounts have been restated to reflect the
two-for-one stock splits paid on February 11, 1997 and April 1, 1996.
Prior period earnings per share amounts have been restated to comply with
the new reporting standards as described in note 1 to the consolidated
financial statements.
(c) Amounts under this heading are included to assist the reader in analyzing
the Company's financial position and results of operations. Such amounts
are not intended to, and do not, represent insurance policy income, net
income, net income per share, shareholders' equity or book value per
share prepared in accordance with generally accepted accounting
principles ("GAAP").
(d) Includes premiums received from universal life products and products
without mortality or morbidity risk. Such premiums are not reported as
revenues under GAAP and were $2,099.4 million in 1997; $1,881.3 million
in 1996; $1,757.5 million in 1995; $634.6 million in 1994; and $891.9
million in 1993.
(e) Represents income before extraordinary charge, excluding net investment
gains (losses) (less that portion of change in future policy benefits,
amortization of cost of policies purchased and cost of policies produced
and income taxes relating to such gains (losses)) and nonrecurring
charges (net of income taxes).
(f) Excludes the effects of reporting fixed maturities at fair value and
recording the unrealized gain or loss on such securities as a component
of shareholders' equity, net of tax and other adjustments. Such
adjustments are in accordance with Statement of Financial Accounting
Standards No. 115 "Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS 115"), as described in note 1 to the consolidated
financial statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
Management's discussion and analysis reviews the consolidated financial
condition of Conseco at December 31, 1997 and 1996, the consolidated results of
operations for the three years ended December 31, 1997, and where appropriate,
factors that may affect future financial performance. This discussion should be
read in conjunction with the accompanying consolidated financial statements,
notes thereto and selected consolidated financial data.
All statements, trend analyses and other information contained in this
report and elsewhere (such as in other filings by the Company with the
Securities and Exchange Commission, press releases, presentations by the Company
or its management or oral statements) relative to markets for the Company's
products and trends in the Company's operations or financial results, as well as
other statements including words such as "anticipate," "believe," "plan,"
"estimate," "expect," "intend," and other similar expressions, constitute
forward-looking statements under the Private Securities Litigation Reform Act of
1995. These forward-looking statements are subject to known and unknown risks,
uncertainties and other factors that may cause actual results to be materially
different from those contemplated by the forward-looking statements. Such
factors include, among other things: (i) general economic conditions and other
factors, including prevailing interest rate levels, stock market performance and
health care inflation, which may affect the ability of the Company to sell its
products, the market value of the Company's investments and the lapse rate and
profitability of the Company's policies; (ii) the Company's ability to achieve
anticipated levels of operational efficiencies at recently acquired companies,
as well as through other cost-saving initiatives; (iii) customer response to new
products, distribution channels and marketing initiatives; (iv) mortality,
morbidity, use of health care services and other factors that may affect the
profitability of the Company's insurance products; (v) changes in the federal
income tax laws and regulations that may affect the relative tax advantages of
some of the Company's products; (vi) increasing competition in the sale of the
Company's products; (vii) regulatory changes or actions, including those
relating to regulation of financial services affecting (among other things) bank
sales and underwriting of insurance products, regulation of the sale,
underwriting and pricing of insurance products, and health care regulation
affecting the Company's health insurance products; (viii)
19
the availability and terms of future acquisitions; and (ix) the risk factors or
uncertainties listed from time to time in the Company's other filings with the
Securities and Exchange Commission.
Consolidated results and analysis
Our 1997 operating earnings were $574.9 million, or $2.74 per diluted
share, up 115 percent and 42 percent, respectively, over 1996. Operating
earnings increased as a result of the LPG Merger (completed effective July 1,
1996), the ALH Stock Purchase (September 30, 1996), the ATC Merger (December 31,
1996), the THI Merger (December 31, 1996), the BLH Merger (December 31, 1996),
the CAF Merger (January 1, 1997), the PFS Merger (April 1, 1997), the Colonial
Penn Purchase (September 30, 1997) and the WNIC Merger (December 1, 1997) and as
a result of the increased business in force of these acquired companies and
companies previously owned. The percentage increase in operating earnings was
greater than the percentage increase in operating earnings per diluted share
primarily because of the 51 percent increase in weighted average diluted common
shares or equivalents outstanding during 1997. The increase in weighted average
diluted shares resulted from shares issued in certain 1997 and 1996 acquisitions
(the LPG Merger, the ATC Merger, the THI Merger, the BLH Merger, the CAF Merger
and the PFS Merger), partially offset by repurchases of Conseco common stock.
Our 1996 operating earnings were $267.7 million, or $1.93 per diluted
share, up 104 percent and 53 percent, respectively, over 1995. Operating
earnings increased as a result of the LPG Merger, the ALH Stock Purchase, the
effect of increased ownership of BLH as a result of purchases of BLH common
stock during 1995 and 1996, and profit improvements in each of our segments.
Operating earnings for 1996 were not affected by the ATC Merger, the THI Merger
or the BLH Merger, all of which were recorded as of December 31, 1996. The
percentage increase in operating earnings was greater than the increase in
operating earnings per diluted share primarily because of the additional common
shares or equivalents outstanding in 1996 resulting from: (i) the LPG Merger;
and (ii) the Company's January 1996 offering of Preferred Redeemable Increased
Dividend Equity Securities, 7% PRIDES Convertible Preferred Stock ("PRIDES"),
which are mandatorily convertible into shares of Conseco common stock.
Net income of $567.3 million in 1997, or $2.64 per diluted share,
included: (i) net investment gains (net of related costs, amortization and
taxes) of $44.1 million, or 21 cents per diluted share; (ii) an extraordinary
charge of $6.9 million, or 3 cents per share, related to early retirement of
debt; (iii) a charge of 7 cents per share related to the induced conversion of
preferred stock (treated as a preferred stock dividend); and (iv) nonrecurring
charges totaling $44.8 million, or 21 cents per share. Nonrecurring charges
include: (i) $40.5 million related to our Medicare supplement business in
Massachusetts; and (ii) $4.3 million related to the death of an executive
officer. Regulators in Massachusetts have not allowed premium increases for
Medicare supplement products necessary to avoid losses on the business. We are
currently seeking rate increases. We are no longer writing new Medicare
supplement business in Massachusetts. We have written off the cost of policies
purchased and produced and accrued additional claim reserves related to our
in-force Massachusetts Medicare supplement business due to the estimated premium
deficiencies.
Net income of $252.4 million in 1996, or $1.82 per diluted share,
included: (i) net investment gains (net of related costs, amortization and
taxes) of $11.2 million, or 8 cents per diluted share; and (ii) an extraordinary
charge of $26.5 million, or 19 cents per share, related to early retirement of
debt. Net income of $220.4 million in 1995, or $2.12 per diluted share,
included: (i) net investment gains (net of related costs, amortization and
taxes) of $16.3 million, or 16 cents per share; (ii) restructuring income of
$74.9 million, or 72 cents per share, arising from the release of deferred
income taxes previously accrued on income related to CCP and BLH (such deferred
tax was no longer required when Conseco's ownership of these companies exceeded
80 percent); and (iii) an extraordinary charge of $2.1 million, or 2 cents per
share, related to early retirement of debt.
Total revenues include net investment gains of $266.5 million in 1997,
$60.8 million in 1996 and $204.1 million in 1995. Excluding net investment
gains, total revenues were $5.3 billion in 1997, up 76 percent from $3.0 billion
in 1996. Total revenues in 1997 include a full year of activity for acquisitions
completed in 1996 and the revenues of CAF, PFS, Colonial Penn and WNIC in the
periods subsequent to their acquisitions. Total revenues in 1996 include LPG
revenues after July 1, 1996. Total revenues, excluding net investment gains,
were up 13 percent in 1996 from $2.7 billion in 1995.
20
Results of operations by segment for the three years ended December 31,
1997:
The following tables and narratives summarize the results of our
operations by business segment. All amounts reported in these summaries relate
solely to periods after the companies were included in our consolidated
financial statements.
1997 1996 1995
---- ---- ----
(Dollars in millions)
Income before income taxes, minority interest and extraordinary charge:
Supplemental health:
Operating income...........................................................$ 408.0 $ 136.6 $ 96.0
Net investment gains, net of related costs................................. 26.3 .1 1.1
Nonrecurring charges....................................................... (62.4) - -
--------- --------- --------
Income before income taxes, minority interest and extraordinary charge 371.9 136.7 97.1
--------- -------- --------
Annuities:
Operating income .......................................................... 305.1 255.0 244.1
Net investment gains (losses), net of related costs and amortization ...... 53.2 (.7) 72.0
--------- -------- --------
Income before income taxes, minority interest and extraordinary charge 358.3 254.3 316.1
--------- -------- --------
Life insurance:
Operating income........................................................... 304.7 126.8 74.8
Net investment gains (losses), net of related costs and amortization....... 2.4 (2.0) (4.6)
--------- -------- ---------
Income before income taxes, minority interest and extraordinary charge 307.1 124.8 70.2
--------- -------- --------
Individual and group major medical:
Operating income........................................................... 40.2 32.1 35.1
Net investment gains, net of related costs................................. .1 - .1
--------- -------- --------
Income before income taxes, minority interest and extraordinary charge 40.3 32.1 35.2
--------- -------- ---------
Other:
Operating income........................................................... 58.3 30.7 31.5
Net investment gains (losses), net of related costs........................ 3.3 27.4 (6.3)
--------- -------- --------
Income before income taxes, minority interest and extraordinary charge 61.6 58.1 25.2
--------- -------- --------
Corporate:
Interest and other corporate expenses...................................... (126.8) (112.4) (140.5)
Nonrecurring charges....................................................... (9.3) - -
Net investment gains, net of related costs................................. - - 15.2
--------- -------- --------
Net corporate expenses................................................. (136.1) (112.4) (125.3)
--------- -------- --------
Consolidated:
Operating income........................................................... 989.5 468.8 341.0
Net investment gains, net of related costs and amortization ............... 85.3 24.8 77.5
Nonrecurring charges....................................................... (71.7) - -
--------- -------- --------
Income before income taxes, minority interest and extraordinary charge 1,003.1 493.6 418.5
Income tax expense.............................................................. 376.6 179.8 87.0
--------- -------- --------
Income before minority interest and extraordinary charge............... 626.5 313.8 331.5
Minority interest in consolidated subsidiaries:
Distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts............................................ 49.0 3.6 -
Dividends on preferred stock of subsidiaries................................. 3.3 8.9 11.9
Equity in earnings of subsidiaries........................................... - 22.4 97.1
--------- -------- --------
Income before extraordinary charge.................................... 574.2 278.9 222.5
Extraordinary charge on extinguishment of debt, net of taxes and
minority interest............................................................ 6.9 26.5 2.1
--------- -------- --------
Net income.............................................................$ 567.3 $ 252.4 $ 220.4
========= ======== ========
21
Supplemental health:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Premiums collected:
Medicare supplement (first-year)............................. $ 101.9 $ 72.5 $ 81.1
Medicare supplement (renewal)................................ 694.5 545.4 515.6
--------- ------- -------
Subtotal - Medicare supplement........................... 796.4 617.9 596.7
--------- ------- -------
Long-term care (first-year).................................. 143.4 51.6 44.4
Long-term care (renewal)..................................... 520.5 141.3 97.7
--------- ------- -------
Subtotal - long-term care................................ 663.9 192.9 142.1
--------- ------- -------
Specified-disease (first-year)............................... 44.7 - -
Specified-disease (renewal).................................. 338.7 - -
--------- ------- --------
Subtotal - specified-disease............................. 383.4 - -
--------- ------- -------
Total supplemental health premiums collected............. $1,843.7 $ 810.8 $738.8
======== ======= ======
Insurance policy income......................................... $1,858.1 $ 805.9 $756.9
Net investment income........................................... 273.8 66.6 66.9
-------- ------- -------
Total revenues (a)......................................... 2,131.9 872.5 823.8
--------- ------- -------
Insurance policy benefits and change in future policy benefits.. 1,217.5 531.8 525.6
Amortization related to operations.............................. 232.1 87.8 81.6
Interest expense on investment borrowings....................... 6.3 1.1 1.4
Other operating costs and expenses.............................. 268.0 115.2 119.2
--------- ------- -------
Total benefits and expenses................................ 1,723.9 735.9 727.8
--------- ------- -------
Operating income before income taxes,
minority interest and extraordinary
charge................................................... 408.0 136.6 96.0
Net investment gains, net of related costs...................... 26.3 .1 1.1
Nonrecurring charges............................................ (62.4) - -
--------- ------- -------
Income before income taxes, minority
interest and extraordinary charge...................... $ 371.9 $136.7 $97.1
========= ====== =====
Loss ratios:
Medicare supplement products................................. 69.1% 68.2% 71.7%
Long-term care products...................................... 63.6 58.7 60.5
Specified-disease products................................... 61.6 - -
(a) Revenues exclude net investment gains.
General: This segment includes Medicare supplement and long-term care
insurance products, primarily sold to senior citizens, and effective January 1,
1997 (as a result of the acquisitions of CAF and THI), specified-disease
products. Through December 31, 1996, the supplemental health operations consist
solely of Bankers Life's Medicare supplement and long-term care products,
distributed through a career agency force. The segment's 1997 results of
operations are significantly affected by recent acquisitions (ATC, THI and CAF,
effective January 1, 1997; PFS, effective April 1, 1997; and Colonial Penn,
effective September 30, 1997). The supplemental health products of THI, CAF,
ATC, PFS and Colonial Penn are all distributed through professional independent
producers. The profitability of this segment largely depends on the overall
level of sales, persistency of in-force business, claim experience and expense
management.
22
Premiums collected by this segment in 1997 were $1,843.7 million, up 127
percent from 1996. Premiums collected in 1996 increased to $810.8 million, up
9.7 percent.
Medicare supplement policies accounted for 43 percent of this segment's
collected premiums in 1997, compared with more than 75 percent of this segment's
collected premiums in 1996 and 1995. The change in the mix of premiums collected
reflects the more diverse supplemental health lines sold by Conseco as a result
of the recent acquisitions. Collected premiums on Medicare supplement policies
increased 29 percent in 1997, to $796.4 million, and increased 3.6 percent in
1996, to $617.9 million. Such increases primarily reflect the recent
acquisitions and a larger base of premiums due to rate increases. The sales of
Medicare supplement policies have been affected by: (i) steps taken to improve
profitability by increasing premium rates and changing both the commission
structure and the underwriting criteria for these policies; and (ii) increased
competition from alternative providers, including HMOs.
Premiums collected on long-term care policies increased 244 percent in
1997, to $663.9 million, and 36 percent in 1996, to $192.9 million. First-year
collected premiums in 1997, 1996 and 1995 were $143.4 million, $51.6 million and
$44.4 million, respectively. The increase in long-term care premiums collected
primarily reflects the acquisition of recently acquired companies.
Premiums collected on specified-disease policies were $383.4 million in
1997, substantially all of which were collected by recently acquired companies.
Insurance policy income comprises premiums earned on the segment's
policies and has increased over the last three years consistent with the
explanations provided above for premiums collected.
Net investment income increased 311 percent in 1997, to $273.8 million,
and did not change materially in 1996 compared with 1995. Such investment income
fluctuates when changes occur in: (i) the amount of average invested assets
supporting insurance liabilities; and (ii) the yield earned on invested assets.
During 1997, the segment's average invested assets increased approximately 278
percent, to $3.4 billion, and the net yield on invested assets increased to 8.0
percent from 7.6 percent. During 1996, the segment's average invested assets
increased approximately 5.0 percent, to $.9 billion, and the net yield on
invested assets decreased from 8.0 percent to 7.6 percent. Invested assets grew
as a result of the growth in insurance liabilities related to the segment's
business.
Insurance policy benefits and change in future policy benefits increased
in 1997, reflecting recent acquisitions, the larger amount of business in force
on which benefits are incurred, and a higher incidence of claims. This account
increased in 1996 as a result of the larger amount of business in force on which
benefits are incurred, net of the lower incidence of claims. In 1997, the ratio
of policy benefits to insurance policy income for the Medicare supplement
policies increased to 69.1 percent from 68.2 percent, reflecting the different
characteristics of such policies in recently acquired companies as well as
fluctuations in claim experience. In 1996, the ratio of policy benefits to
insurance policy income for Medicare supplement policies fell 3.5 percentage
points to 68.2 percent, reflecting the premium rate increases implemented in
1996 and 1995.
Changes in the ratio of policy benefits to insurance policy income for
long-term care policies reflect different characteristics of such policies in
recently acquired companies as well as fluctuations in claim experience and
reserve development. In 1997, the long-term care loss ratio increased by 4.9
percentage points, to 63.6 percent. In 1996, the long-term care loss ratio fell
by 1.8 percentage points, to 58.7 percent.
The ratio of policy benefits to insurance policy income for
specified-disease policies was 61.6 percent in 1997. Such products were not sold
by Conseco prior to the acquisitions of THI and CAF.
Amortization related to operations includes amortization of: (i) the cost
of policies produced; (ii) the cost of policies purchased; and (iii) goodwill
related to this segment's business. The amount of amortization increased
primarily because of the increase in balances subject to amortization as a
result of recent acquisitions.
Interest expense on investment borrowings was affected by changes in
investment borrowing activities during the last three years and the changes in
interest rates paid on such borrowings.
Other operating costs and expenses increased in 1997 from the increased
business of recently acquired companies. Such expenses did not change materially
in 1996 compared with 1995.
23
Net investment gains, net of related costs, often fluctuate from period
to period.
Nonrecurring charges for 1997 represent an increase to claim reserves of
$41.5 million and the write-off of cost of policies produced and cost of
policies purchased of $20.9 million related to Medicare supplement business in
the state of Massachusetts. Regulators in that state have not allowed premium
increases for Medicare supplement products necessary to avoid losses on the
business. We are currently seeking rate increases. We are no longer writing new
Medicare supplement business in Massachusetts.
24
Annuities:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Annuity premiums collected:
Traditional fixed (first-year)................................ $ 857.8 $1,148.6 $1,536.4
Traditional fixed (renewal)................................... 79.4 92.7 62.8
--------- -------- --------
Subtotal - traditional fixed.............................. 937.2 1,241.3 1,599.2
--------- -------- --------
Market value - adjusted (first-year).......................... 165.7 237.2 27.7
Market value - adjusted (renewal)............................. 13.8 20.5 3.1
--------- -------- --------
Subtotal - market value - adjusted........................ 179.5 257.7 30.8
--------- -------- --------
Equity-indexed (all first-year)............................... 387.7 80.4 -
--------- -------- --------
Variable annuities (first-year)............................... 127.4 37.9 17.2
Variable annuities (renewal).................................. 57.8 53.0 46.7
--------- -------- --------
Subtotal - variable annuities............................. 185.2 90.9 63.9
--------- -------- --------
Total annuity premiums collected.......................... $1,689.6 $1,670.3 $1,693.9
======== ======== ========
Insurance policy income.......................................... $ 96.8 $ 77.6 $ 68.4
Net investment income:
General account invested assets............................... 960.9 891.2 851.5
Change in fair value of S&P 500 Call Options.................. 39.4 - -
Separate account assets....................................... 70.3 48.4 28.8
--------- -------- --------
Total revenues (a)...................................... 1,167.4 1,017.2 948.7
--------- -------- --------
Insurance policy benefits and change in future policy benefits... 74.1 67.3 61.8
Amounts added to policyholder account balances:
Annuity products other than those listed below................ 542.2 523.2 505.0
Equity-indexed products based on S&P 500 Index................ 39.3 - -
Variable annuity products..................................... 70.3 48.4 28.8
Amortization related to operations............................... 84.8 76.9 64.9
Interest expense on investment borrowings........................ 23.2 14.3 16.9
Other operating costs and expenses............................... 28.4 32.1 27.2
--------- -------- --------
Total benefits and expenses (a)......................... 862.3 762.2 704.6
--------- -------- --------
Operating income before income taxes, minority
interest and extraordinary charge..................... 305.1 255.0 244.1
Net investment gains (losses), net of related costs and
amortization.................................................. 53.2 (.7) 72.0
--------- -------- --------
Income before income taxes, minority interest
and extraordinary charge.............................. $ 358.3 $ 254.3 $ 316.1
========= ========= ========
Weighted average gross interest spread on annuity products (b)... 2.8% 2.9% 3.1%
=== === ===
Total traditional fixed and market value-adjusted annuity
product insurance liabilities at end of period................ $13,007.4 $11,998.6 $10,169.1
========= ========= =========
Total annuity product insurance liabilities at end of period..... $14,150.8 $12,421.8 $10,396.1
========= ========= =========
(a) Revenues exclude net investment gains (losses); benefits and expenses
exclude amortization related to net investment gains (losses).
(b) Excludes variable annuity products where the credited amount is based on
investment income from segregated investments.
General: This segment includes traditional fixed rate annuity products
(SPDAs, FPDAs and SPIAs), market value-adjusted annuity products, equity-indexed
annuity products and variable annuities sold through both career agents and
professional independent producers. The profitability of this segment largely
depends on the investment spread earned (i.e., the excess of investment earnings
25
over interest credited on annuity deposits), the persistency of in-force
business, and expense management. In addition, comparability between periods is
affected by: (i) the LPG Merger, effective July 1, 1996; and (ii) the ALH Stock
Purchase, effective September 30, 1996.
Premiums collected by this segment in 1997 were $1,689.6 million, up 1.2
percent over 1996. Premiums collected in 1996 were $1,670.3 million, down 1.4
percent from 1995. Increased competition from products such as mutual funds,
traditional bank investments, variable annuities and other investment and
retirement funding alternatives was a significant factor in the modest increase
in annuity premiums collected, despite the full-year impact of the former LPG
subsidiaries.
Traditional fixed rate annuity products include SPDAs, FPDAs and SPIAs,
which are credited with a guaranteed rate. SPDA and FPDA policies (which make up
78 percent, 84 percent and 90 percent of traditional fixed rate annuity premiums
collected in 1997, 1996 and 1995, respectively) typically have an interest rate
that is 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 minimum 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. The demand for traditional fixed rate annuity contracts has
decreased in recent years, as relatively low interest rates have made other
investment products more attractive. Annuity premiums on these products
decreased 24 percent in 1997, to $937.2 million, and decreased 22 percent in
1996, to $1,241.3 million.
We offer deferred annuity products with a "market value adjustment"
feature designed to provide additional protection from early terminations during
a period of rising interest rates by reducing the surrender value payable upon a
full surrender of the policy in excess of the allowable penalty-free withdrawal
amount. Conversely, during a period of declining interest rates, the market
value adjustment feature would increase the surrender value payable to the
policyholder. Annuity premiums collected with this feature represent 11 percent
and 16 percent of total annuity premiums collected during 1997 and 1996,
respectively.
In response to consumers' desire for alternative investment products with
returns linked to equities, we introduced an equity- indexed annuity product in
June 1996. The accumulation value of these annuities is credited with interest
at an annual minimum guaranteed rate of 3 percent, but the annuities provide for
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
potential increases to policyholder benefits resulting from increases in the S&P
500 Index to which the product's return is linked. Total collected premiums for
this product were $387.7 million in 1997 compared with $80.4 million in 1996.
Variable annuities offer contract holders a rate of return based on the
specific investment portfolios into which premiums may be directed. The
popularity of such annuities has increased recently as a result of the desire of
investors to invest in common stocks. In addition, in 1996, we began to offer
more investment options for variable annuity deposits, and we expanded our
marketing efforts, which resulted in increased collected premiums. Profits on
variable annuities are derived from the fees charged to contract holders rather
than from the investment spread. Variable annuity collected premiums increased
104 percent in 1997, to $185.2 million, and increased 42 percent in 1996, to
$90.9 million.
Insurance policy income includes: (i) premiums received on SPIA policies
that incorporate significant mortality features; (ii) cost of insurance and
expenses charged to annuity policies; and (iii) surrender charges earned on
annuity policy withdrawals. In accordance with GAAP, premiums on annuity
contracts without mortality features are not reported as revenues, but rather
are reported as deposits to insurance liabilities. Insurance policy income
increased in 1997 and 1996 primarily because of increased surrender charges
collected (changes in premiums received on policies with mortality features and
cost of insurance and expenses charged to annuity policies were not
significant). Surrender charges were $64.0 million in 1997, $41.2 million in
1996 and $28.6 million in 1995. Annuity policy withdrawals were $1.8 billion in
1997, compared with $1.7 billion in 1996 and $1.5 billion in 1995. The increase
in policy withdrawals and surrender charges generally corresponds to the aging
and the growth of our annuity business in force. In addition, policyholders are
using the systematic withdrawal features available in several of our annuity
policies, and more policyholders are surrendering in order to invest in
alternative investments. Total withdrawals and surrenders were 15 percent, 16
percent and 16 percent of insurance liabilities related to surrenderable
policies in 1997, 1996 and 1995, respectively.
Net investment income on general account invested assets (excluding
income on separate account assets related to variable annuities and the change
in the fair value of S&P 500 Call Options related to equity-indexed products)
increased 7.8 percent in 1997, to $960.9 million, and increased 4.7 percent in
1996, to $891.2 million. These increases primarily reflect the increase in
general account invested assets acquired in conjunction with the recent
acquisitions. The segment's average invested assets increased 11 percent to
$12.8 billion in 1997, compared with 1996, and the annualized yield earned on
average invested assets decreased from 7.9 percent to 7.5 percent in 1997. The
segment's average invested assets increased 10 percent to $11.2 billion in 1996,
and the annualized yield earned on average invested assets decreased from 8.4
percent to 7.9 percent in 1996. Cash flows received during 1997 and 1996
(including cash flows from the sales of investments) were invested in lower
yielding securities due to a general decline in interest rates.
26
Net investment income from the change in fair value of S&P 500 Call
Options is substantially offset by a corresponding charge to amounts added to
policyholder account balances for equity-indexed products. Such income and
related charge fluctuate based on the performance of the S&P 500 Index to which
the returns on such products are linked.
Net investment income on separate account assets is offset by a
corresponding charge to amounts added to policyholder account balances for
variable annuity products. Such income and related charge fluctuate in
relationship to total separate account assets and the return earned on such
assets.
Insurance policy benefits and change in future policy benefits relate
solely to annuity policies that incorporate significant mortality features. The
increase corresponds to the increase in the in-force block of such policies.
Amounts added to policyholder account balances for interest expense on
annuity products increased 3.6 percent in 1997 and 3.6 percent in 1996,
primarily due to a larger block of annuity business in force in 1997, partially
offset by a reduction in crediting rates. The weighted average crediting rates
for these annuity liabilities were 4.8 percent in 1997, 5.0 percent in 1996 and
5.3 percent in 1995.
Amortization related to operations increased 10 percent in 1997 and 18
percent in 1996. Amortization related to operations includes amortization of:
(i) the cost of policies produced; (ii) the cost of policies purchased; and
(iii) goodwill related to this segment's business. The amount of amortization
increased primarily because of the increase in balances subject to amortization
as a result of recent acquisitions.
Interest expense on investment borrowings is affected by changes in
investment borrowing activities during the last three years and the changes in
interest rates paid on such borrowings.
Other operating costs and expenses decreased 12 percent in 1997 and
increased 18 percent in 1996. Other operating costs and expenses were favorably
affected in 1997 by the consolidation of all annuity operations in Conseco's
Carmel, Indiana facilities. The increase in 1996 corresponds to the increases in
the total business in force primarily related to acquisition transactions
described above under "General."
Net investment gains (losses), net of related costs and amortization,
often fluctuate from period to period. Selling securities at a gain and
reinvesting the proceeds at lower yields may, absent other management action,
tend to decrease future investment yields. We believe, however, that the
following factors mitigate the adverse effect of such decreases on net income:
(i) we recognized additional amortization of cost of policies purchased and cost
of policies produced in order to reflect reduced future yields (thereby reducing
such amortization in future periods); (ii) we can reduce interest rates credited
to some products, thereby diminishing the effect of the yield decrease on the
investment spread; and (iii) the investment portfolio grows as a result of
reinvesting the realized gains. As a result of the sales of fixed maturity
investments, the amortization of the cost of policies produced and the cost of
policies purchased increased $132.0 million in 1997, $31.6 million in 1996 and
$117.3 million in 1995.
27
Life insurance:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Premiums collected:
Universal life (first-year).......................................$ 96.6 $ 62.2 $ 15.7
Universal life (renewal).......................................... 354.3 208.9 97.4
---------- ------- ---------
Subtotal - universal life..................................... 450.9 271.1 113.1
---------- ------- ---------
Traditional life (first-year)..................................... 49.0 17.0 16.1
Traditional life (renewal)........................................ 209.1 115.5 124.4
---------- ------- ---------
Subtotal - traditional life................................... 258.1 132.5 140.5
---------- ------- ---------
Total life premiums collected.............................$ 709.0 $ 403.6 $ 253.6
========== ======= =========
Insurance policy income:
Premiums earned on traditional life products......................$ 258.6 $ 141.1 $ 143.5
Mortality charges and administrative fees......................... 357.8 211.2 73.8
Surrender charges................................................. 14.1 8.2 5.1
---------- ------- ---------
Total insurance policy income................................... 630.5 360.5 222.4
Net investment income................................................ 448.2 279.7 176.9
---------- ------- ---------
Total revenues (a)........................................ 1,078.7 640.2 399.3
---------- ------- ---------
Insurance policy benefits and change in future policy benefits....... 456.9 270.5 182.5
Interest added to financial product policyholder account balances.... 154.9 97.0 51.6
Amortization related to operations................................... 61.3 48.1 33.4
Interest expense on investment borrowings............................ 11.6 6.3 3.5
Other operating costs and expenses................................... 89.3 91.5 53.5
---------- ------- ---------
Total benefits and expenses (a)........................... 774.0 513.4 324.5
---------- ------- ---------
Operating income before income taxes,
minority interest and extraordinary
charge................................................. 304.7 126.8 74.8
Net investment gains (losses), net of related costs
and amortization.................................................. 2.4 (2.0) (4.6)
---------- ------- ---------
Income before income taxes, minority
interest and extraordinary charge......................$ 307.1 $ 124.8 $ 70.2
========== ======= =========
Total life product insurance liabilities.............................$ 7,075.0 $4,992.7 $ 2,102.2
========== ======== =========
Life insurance in force..............................................$104,144.5 $80,149.5 $33,783.2
========== ========= =========
(a) Revenues exclude net investment gains (losses); benefits and expenses
exclude amortization related to net investment gains (losses).
General: This segment includes traditional life and universal life
products sold through career agents, professional independent producers and
direct response distribution channels. This segment's operations were
significantly affected by recent acquisitions (LPG effective July 1, 1996; PFS
effective April 1, 1997; Colonial Penn effective September 30, 1997; and WNIC
effective December 1, 1997). The profitability of this segment largely depends
on the investment spread earned (for universal life), the persistency of
in-force business, claim experience and expense management.
28
Premiums collected by this segment were up 76 percent in 1997, to $709.0
million. Premiums collected in 1996 were up 59 percent in 1996, to $403.6
million. Such increases relate primarily to premiums collected by recently
acquired companies in periods after their acquisition.
Universal life product collected premiums increased 66 percent in 1997,
to $450.9 million, and increased 140 percent in 1996, to $271.1 million.
Traditional life product collected premiums increased 95 percent in 1997,
to $258.1 million, and decreased 5.7 percent in 1996, to $132.5 million.
Insurance policy income includes: (i) premiums received on traditional
life products; (ii) the mortality charges and administrative fees earned on
universal life insurance; and (iii) surrender charges on terminated universal
life insurance policies. In accordance with GAAP, premiums on universal life
products are accounted for as deposits to insurance liabilities. Revenues are
earned over time in the form of investment income on policyholder account
balances, surrender charges, and mortality and other charges deducted from
policyholders' account balances.
All three components of insurance policy income have increased over the
last three years primarily as a result of the acquisition transactions described
above under "General."
Net investment income increased 60 percent in 1997, to $448.2 million,
and 58 percent in 1996, to $279.7 million. Investment income fluctuates with
changes in: (i) the amount of average invested assets supporting insurance
liabilities; and (ii) the yield earned on invested assets. During 1997, the
segment's average invested assets increased 71 percent, to $6.0 billion, and the
net yield on invested assets decreased from 7.9 percent to 7.5 percent. During
1996, the segment's average invested assets increased 66 percent, to $3.5
billion, and the net yield on invested assets decreased from 8.4 percent to 7.9
percent. Invested assets grew primarily as a result of the growth in insurance
liabilities from the acquisition transactions described above under "General."
Insurance policy benefits and change in future policy benefits increased
in 1997 and 1996, reflecting the larger amount of business in force on which
benefits are incurred as a result of the acquisition transactions described
above under "General." There were no unusual fluctuations in claim experience
during the periods.
Interest added to financial product policyholder account balances
increased 60 percent in 1997, to $154.9 million, and 88 percent in 1996, to
$97.0 million. Such expense fluctuates with changes in: (i) the amount of
insurance liabilities for universal life products; and (ii) the interest rate
credited to such products. During 1997, such average liabilities increased 66
percent, to $3.3 billion, and the rate credited decreased from 5.0 percent to
4.8 percent. During 1996, such average liabilities increased 98 percent, to $2.0
billion, and the rate credited decreased from 5.2 percent to 5.0 percent.
Universal life product liabilities increased primarily as a result of the
acquisition transactions described above under "General."
Amortization related to operations increased 27 percent in 1997, to $61.3
million, and 44 percent in 1996, to $48.1 million. Amortization related to
operations includes amortization of: (i) the cost of policies produced; (ii) the
cost of policies purchased; and (iii) goodwill related to this segment's
business. The amount of amortization was primarily affected by the increases in
balances subject to amortization as a result of the recent acquisitions, net of
the effect of reductions in the balances of the cost of policies purchased and
cost of policies produced resulting from net investment gains recognized during
1997 and 1996 (see "Net investment gains (losses)" below).
Interest expense on investment borrowings is affected by changes in
investment borrowing activities during the last three years and the changes in
interest rates paid on such borrowings.
Other operating costs and expenses decreased 2.4 percent in 1997, to
$89.3 million, and increased 71 percent in 1996, to $91.5 million. The
fluctuations correspond to the increases in this segment's business as a result
of recent acquisitions, offset in 1997 by expense reductions realized as a
result of the consolidation of certain operations.
Net investment gains (losses), net of related costs and amortization,
often fluctuate from period to period. Net investment gains (losses) affect the
timing of the amortization of costs of policies purchased and the cost of
policies produced. As a result of net investment gains (losses) from the sales
of fixed maturity investments, amortization of cost of policies purchased and
cost of policies produced increased $49.2 million in 1997, $4.4 million in 1996
and $9.3 million in 1995.
29
Individual and group major medical:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Premiums collected:
Individual (first-year)...............................................$ 70.3 $ 6.0 $ 8.4
Individual (renewal).................................................. 147.4 44.9 56.1
------- -------- --------
Subtotal - individual............................................. 217.7 50.9 64.5
------- -------- --------
Group (first-year).................................................... 63.6 - -
Group (renewal)....................................................... 462.9 290.1 289.1
------- -------- --------
Subtotal - group.................................................. 526.5 290.1 289.1
------- -------- --------
Total individual and group major medical premiums collected.......$ 744.2 $ 341.0 $ 353.6
======= ======== ========
Insurance policy income..................................................$ 758.1 $ 357.0 $ 352.0
Net investment income.................................................... 17.3 8.8 9.5
------- -------- --------
Total revenues (a)................................................ 775.4 365.8 361.5
------- -------- --------
Insurance policy benefits and changes in future policy benefits.......... 579.5 300.3 300.8
Amortization related to operations....................................... 21.2 16.0 13.6
Interest expense on investment borrowings................................ .6 .1 .2
Other operating costs and expenses....................................... 133.9 17.3 11.8
------- -------- --------
Total benefits and expenses....................................... 735.2 333.7 326.4
------- -------- --------
Operating income before income taxes, minority interest and
extraordinary charge............................................ 40.2 32.1 35.1
Net investment gains, net of related costs............................... .1 - .1
------- -------- --------
Income before income taxes, minority interest and extraordinary
charge..........................................................$ 40.3 $ 32.1 $ 35.2
======= ======== ========
Benefit ratio ........................................................... 78.0% 85.7% 85.4%
(a) Revenues exclude net investment gains.
General: This segment includes individual and group major medical health
insurance products. The segment's operations were significantly affected by the
PFS Merger, effective April 1, 1997, and to a lesser extent, by the LPG Merger,
effective July 1, 1996. The profitability of this business depends largely on
the overall persistency of the business in force, as well as claim experience
and expense management.
Premiums collected by this segment increased 118 percent in 1997, to
$744.2 million, and decreased 3.6 percent in 1996, to $341.0 million. Individual
health premiums increased 328 percent in 1997, to $217.7 million, and decreased
21 percent in 1996, to $50.9 million. Group premiums increased 81 percent in
1997, to $526.5 million, and did not change materially between 1995 and 1996.
The recently acquired companies accounted for all of the 1997 increases.
Insurance policy income comprises premiums earned on the segment's
policies and fee income earned for group medical risk management services.
Fluctuations in premiums earned have been consistent with the fluctuations in
premiums collected described above. Fee income (which is earned by a subsidiary
acquired in the LPG Merger) was $15.0 million in 1997 and $7.0 million in 1996.
Net investment income increased 97 percent in 1997, to $17.3 million, and
decreased 7.4 percent in 1996, to $8.8 million. Investment income fluctuates
when changes occur in: (i) the amount of average invested assets supporting
insurance liabilities; and (ii) the yield earned on invested assets. During
1997, the segment's average invested assets increased approximately 111 percent,
to $244.0 million, and the net yield on invested assets decreased from 7.6
percent to 7.1 percent. During 1996, the segment's average
30
invested assets did not change significantly and the net yield on invested
assets decreased from 7.9 percent to 7.6 percent. Average invested assets
increased in 1997 as a result of the PFS Merger.
Insurance policy benefits and change in future policy benefits increased
in 1997, primarily as a result of the larger amount of segment business in
force. In 1997, the ratio of policy benefits to insurance policy income
decreased 7.7 percentage points, to 78.0 percent. In 1996, the ratio of policy
benefits to insurance policy income increased from 85.4 percent to 85.7 percent.
The lower benefit ratio in 1997 reflects: (i) the lower incidence of claims
experienced on business written by the acquired companies compared with the
business of other Conseco subsidiaries; and (ii) favorable claim developments.
Amortization related to operations includes amortization of: (i) the cost
of policies produced; (ii) the cost of policies purchased; and (iii) goodwill
related to this segment's business. Amortization expense increased 33 percent in
1997, to $21.2 million, and 18 percent in 1996, to $16.0 million. The amount of
amortization was primarily affected by the increase in balances subject to
amortization as a result of the recent acquisitions.
Interest expense on investment borrowings is affected by changes in
investment borrowing activities during the last three years and the changes in
interest rates paid on such borrowings.
Other operating costs and expenses increased 674 percent in 1997, to
$133.9 million, and 47 percent in 1996, to $17.3 million. Such increases
correspond to the increases in the total business in force related primarily to
the recently acquired companies.
Net investment gains, net of related costs, realized by this segment were
not material in 1997, 1996 or 1995.
31
Other:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Premiums collected:
Other (first-year)................................................ $ 3.9 $ 2.2 $ 2.6
Other (renewal)................................................... 65.3 52.3 64.0
-------- -------- ---------
Total other premiums collected................................ $ 69.2 $ 54.5 $ 66.6
======== ======== =========
Insurance policy income.............................................. $ 67.3 $ 53.2 $ 65.3
Net investment income................................................ 15.4 7.8 9.0
Fee revenue and other income......................................... 65.8 49.8 43.6
-------- -------- ---------
Total revenues (a)............................................ 148.5 110.8 117.9
-------- -------- ---------
Insurance policy benefits and changes in future policy benefits...... 40.3 25.1 36.8
Amortization related to operations................................... 9.4 11.2 10.1
Interest expense on investment borrowings............................ .3 .2 .2
Other operating costs and expenses................................... 40.2 43.6 39.3
-------- -------- ---------
Total benefits and expenses .................................. 90.2 80.1 86.4
-------- -------- ---------
Operating income before income taxes,
minority interest and extraordinary
charge...................................................... 58.3 30.7 31.5
Net investment gains (losses), net of related costs and amortization. 3.3 27.4 (6.3)
-------- -------- --------
Income before income taxes, minority
interest and extraordinary charge........................... $ 61.6 $ 58.1 $ 25.2
======== ======== =========
(a) Revenues exclude net investment gains (losses).
General: This segment includes: (i) various other health insurance
products that are not currently being actively marketed; and (ii) beginning
December 1, 1997, the specialty health insurance products of WNIC marketed to
educators through career agents. The segment's operations were significantly
affected by recent acquisitions (THI, effective January 1, 1997, and WNIC,
effective December 1, 1997). The profitability of this business depends largely
on the overall persistency of the business in force, claim experience and
expense management.
This segment also includes the fee revenue generated by our non-life
subsidiaries, including the investment advisory fees earned by CCM and
commissions earned for insurance and investment product marketing and
distribution. Such amounts exclude the fees and commissions we charge to our
consolidated subsidiaries. The profitability of the fee-based business depends
on the total fees generated and on expense management.
Premiums collected by this segment increased 27 percent in 1997, to $69.2
million, and decreased 18 percent in 1996, to $54.5 million. The increase in
premiums collected in 1997 primarily relates to recent acquisitions.
We do not emphasize the sale of many of the products in this segment,
andcollected premiums are expected to decrease in future years. However, the
in-force business continues to be profitable.
Insurance policy income comprises premiums earned on the segment's
policies, and has fluctuated over the last three years consistent with the
explanations provided above for premiums collected.
Net investment income increased 97 percent in 1997, to $15.4 million, and
decreased 13 percent in 1996, to $7.8 million. Such investment income fluctuated
primarily in relationship to the amount of average invested assets supporting
this segment's insurance liabilities. During 1997, the segment's average
invested assets increased 96 percent, to $199.5 million, and the net yield on
invested assets did not change materially. During 1996, the segment's average
invested assets decreased approximately 8.6 percent, to $101.6 million, and the
net yield on invested assets decreased from 8.1 percent to 7.7 percent.
32
Fee revenue and other income includes: (i) fees for investment management
and for mortgage origination and servicing; and (ii) commissions earned for
insurance and investment product marketing and distribution. Such amounts
exclude the fees and commissions we charge our consolidated subsidiaries. Fee
revenue and other income increased 32 percent in 1997, to $65.8 million,
primarily due to increased investment management fees. Fee revenue and other
income increased 14 percent in 1996, to $49.8 million, primarily as a result of
the acquisition of certain property and casualty insurance brokerage businesses.
Insurance policy benefits and change in future policy benefits fluctuate
in relationship to the amount of segment business in force and the incidence of
claims.
Amortization related to operations decreased 16 percent in 1997, to $9.4
million, and increased 11 percent in 1996, to $11.2 million. Amortization
related to operations includes amortization of: (i) the cost of policies
produced; (ii) the cost of policies purchased; and (iii) goodwill related to
this segment's business. The decrease in amortization in 1997 is consistent with
the declining balance of cost of policies purchased and cost of policies
produced associated with the business included in this segment. The increase in
1996 was primarily due to the increases in such balances as a result of our
purchase of additional shares of BLH common stock in 1995 and 1996. The
acquisitions of THI and WNIC did not materially increase the balance of goodwill
and cost of policies purchased of this segment (valuations of the acquired
blocks indicated that such amounts were insignificant).
Other components of income before income taxes, minority interest and
extraordinary charge:
In addition to the income of the five operating segments, income before
income taxes, minority interest and extraordinary charge is affected by interest
and other corporate expenses, nonrecurring charges and net investment gains not
attributable to the operating segments.
Interest and other corporate expenses were $126.8 million in 1997, $112.4
million in 1996, and $140.5 million in 1995. Interest expense included therein
was $109.4 million in 1997, $108.1 million in 1996, and $119.4 million in 1995.
Such expense fluctuates in relationship to the average debt outstanding during
each period and the interest rate thereon.
Nonrecurring charges of $9.3 million in 1997 represent expenses incurred
related to the death of an executive officer.
Net investment gains, net of related costs, of $15.2 million in 1995
primarily arose from the gain realized on the sale of Conseco's investment in
Eagle Credit (a finance subsidiary of Harley-Davidson).
SALES
In accordance with GAAP, insurance policy income shown in our
consolidated statement of operations consists of premiums received 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 rather are reported as deposits to insurance liabilities. Revenues
for these products are recognized over time in the form of investment income and
surrender or other charges assessed to the policy.
33
Total premiums collected by our business segments during the last three
years were as follows:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Supplemental health:
First-year....................................................................... $ 290.0 $ 124.1 $ 125.5
Renewal.......................................................................... 1,553.7 686.7 613.3
--------- --------- ---------
Total supplemental health.................................................... 1,843.7 810.8 738.8
--------- --------- ---------
Annuities:
First-year ...................................................................... 1,538.6 1,504.1 1,581.3
Renewal.......................................................................... 151.0 166.2 112.6
--------- --------- ---------
Total annuities.............................................................. 1,689.6 1,670.3 1,693.9
--------- --------- ---------
Life insurance:
First-year....................................................................... 145.6 79.2 31.8
Renewal.......................................................................... 563.4 324.4 221.8
--------- --------- ---------
Total life insurance......................................................... 709.0 403.6 253.6
--------- --------- ---------
Individual and group major medical:
First-year....................................................................... 133.9 6.0 8.4
Renewal.......................................................................... 610.3 335.0 345.2
--------- --------- ---------
Total individual and group major medical..................................... 744.2 341.0 353.6
--------- --------- ---------
Other:
First-year....................................................................... 3.9 2.2 2.6
Renewal.......................................................................... 65.3 52.3 64.0
--------- --------- ---------
Total other.................................................................. 69.2 54.5 66.6
--------- --------- ---------
Total:
First-year....................................................................... 2,112.0 1,715.6 1,749.6
Renewal.......................................................................... 2,943.7 1,564.6 1,356.9
--------- --------- ---------
Total collected premiums...................................................... $ 5,055.7 $ 3,280.2 $ 3,106.5
========= ========= =========
34
Fluctuations in premiums collected are discussed above under "Results of
operations by segment for the three years ended December 31, 1997." Our recent
acquisitions will have a significant effect on future premiums collected. Total
premiums collected for all currently consolidated companies (except subsidiaries
of WNIC, which were acquired on December 1, 1997) for all periods (including
periods prior to ownership by Conseco) are provided below:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Supplemental health:
First-year....................................................................... $ 303.7 $ 306.0 $ 296.6
Renewal.......................................................................... 1,631.7 1,521.1 1,417.3
--------- --------- ---------
Total supplemental health.................................................... 1,935.4 1,827.1 1,713.9
--------- --------- ---------
Annuities:
First-year....................................................................... 1,540.9 1,549.1 1,613.1
Renewal.......................................................................... 138.8 182.9 177.3
--------- --------- ---------
Total annuities.............................................................. 1,679.7 1,732.0 1,790.4
--------- --------- ---------
Life insurance:
First-year....................................................................... 165.1 185.9 136.0
Renewal.......................................................................... 647.3 620.9 681.5
--------- --------- ---------
Total life insurance......................................................... 812.4 806.8 817.5
--------- --------- ---------
Individual and group major medical:
First-year....................................................................... 172.4 145.6 137.0
Renewal.......................................................................... 691.4 630.8 652.3
--------- --------- ---------
Total individual and group major medical..................................... 863.8 776.4 789.3
--------- --------- ---------
Other:
First-year....................................................................... 1.7 2.3 2.6
Renewal.......................................................................... 89.9 112.5 144.1
--------- --------- ---------
Total other.................................................................. 91.6 114.8 146.7
--------- --------- ---------
Total:
First-year....................................................................... 2,183.8 2,188.9 2,185.3
Renewal.......................................................................... 3,199.1 3,068.2 3,072.5
--------- --------- ---------
Total collected premiums..................................................... $ 5,382.9 $ 5,257.1 $ 5,257.8
========= ========= =========
INVESTMENTS
Our investment strategy is to: (i) maintain a predominately
investment-grade fixed income portfolio; (ii) provide adequate liquidity to meet
the cash flow requirements of policyholders and other obligations; and (iii)
maximize current income and total investment return through active investment
management. Consistent with this strategy, investments in fixed maturity
securities, mortgage loans, credit-tenant loans, policy loans, separate accounts
and short-term investments made up 97 percent of our $27.0 billion investment
portfolio at December 31, 1997. The remainder of the invested assets were equity
securities and other invested assets.
Our insurance subsidiaries are regulated by insurance statutes and
regulations as to the type of investments that they are permitted to make and
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, Conseco
generally seeks to invest in United States government and government-agency
securities and corporate securities rated investment grade by established
nationally recognized rating organizations or, if not rated, in securities of
comparable investment quality.
35
The following table summarizes investment yields earned over the past
three years:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Weighted average invested assets:
As reported ................................................................. $23,288.8 $16,356.3 $13,769.3
Excluding unrealized appreciation (depreciation) (a)......................... 23,177.7 16,278.8 13,690.6
Net investment income............................................................... 1,825.3 1,302.5 1,142.6
Yields earned:
As reported.................................................................. 7.8% 8.0% 8.3%
Excluding unrealized appreciation (depreciation) (a) ........................ 7.9% 8.0% 8.3%
(a) Excludes the effect of reporting fixed maturities at fair value as
described in note 1 to the consolidated financial statements.
Although investment income is a significant component of total revenues,
the profitability of a portion of our insurance products is determined primarily
by spreads between interest rates earned and rates credited or accruing to our
insurance liabilities. At December 31, 1997, the average yield, computed on the
cost basis of our investment portfolio, was 7.5 percent, and the average
interest rate credited or accruing to our total insurance liabilities was 5.2
percent, excluding interest bonuses guaranteed only for the first year of the
contract.
Actively managed fixed maturities
Our actively managed fixed maturity portfolio at December 31, 1997,
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, 1997, our fixed maturity portfolio had net unrealized
gains of $484.4 million (equal to approximately 2.1 percent of the portfolio's
carrying value), consisting of $611.5 million of unrealized gains and $127.1
million of unrealized losses. Estimated fair values for fixed maturity
investments were determined based on: (i) estimates from nationally recognized
pricing services (82 percent of the portfolio); (ii) broker-dealer market makers
(8 percent of the portfolio); and (iii) internally developed methods (10 percent
of the portfolio).
As discussed in the notes to the consolidated financial statements, when
we adjust carrying values of actively managed fixed maturity securities for
changes in fair value, we also adjust the cost of policies purchased, cost of
policies produced and liabilities. These adjustments are made in order to
reflect the change in amortization and liability accruals that would be needed
if those fixed maturity investments had actually been sold at their fair values
and the proceeds reinvested at current interest rates.
At December 31, 1997, approximately 5.5 percent of our invested assets
and 6.6 percent of fixed maturity investments were 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 high 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, 1997, our below-
investment-grade fixed maturity investments had an amortized cost of $1,525.1
million and an estimated fair value of $1,496.2 million.
We periodically evaluate the creditworthiness of each issuer whose
securities the Company holds. Special attention is paid to those securities
whose market values have declined materially for reasons other than changes in
interest rates or other general market conditions. We consider available
information to 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,
recent press releases and other information. Conseco employs a staff of
experienced securities analysts in a variety of specialty areas. Among its other
responsibilities, this staff is charged with compiling and reviewing such
information. 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 net realizable value, which becomes the new cost basis; the amount of the
reduction is reported 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. We recorded writedowns of fixed maturity
investments and other invested assets totaling $1.2 million
36
in 1997, primarily as a result of: (i) changes in the financial condition of a
private company in which we had an indirect equity investment; and (ii) changes
in the value of the underlying collateral associated with certain notes. These
changes caused us to conclude that the decline in fair value of such investments
was other than temporary. 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, 1997, fixed maturity investments in substantive
default (i.e., in default due to nonpayment of interest or principal) had an
amortized cost and carrying value of $2.1 million and $1.2 million,
respectively. Fixed maturity investments in technical (but not substantive)
default (i.e., in default, but not as to the payment of interest or principal)
had an amortized cost and carrying value of $.3 million. There were no other
fixed maturity investments about which we had serious doubts as to the ability
of the issuer to comply on a timely basis with the material terms of the
instruments.
Our policy is to discontinue the accrual of interest and eliminate all
previous interest accruals for defaulted securities, if it is determined that
such amounts will not be ultimately realized in full. Investment income forgone
due to defaulted securities was $.2 million in 1997, $3.8 million in 1996 and
$1.6 million in 1995.
At December 31, 1997, fixed maturity investments included $6.9 billion of
mortgage-backed securities (or 30 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 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 the level of prevailing interest
rates declines significantly relative to the interest rates on such loans.
Mortgage-backed securities purchased at a discount to par will experience an
increase in yield when the underlying mortgages prepay faster than expected.
These securities purchased at a premium that prepay faster than expected will
incur a reduction in yield. 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, because 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 annual amortization of the premium.
CMOs are securities backed by pools of pass-through securities and/or
mortgages that are segregated into sections or "tranches" that provide for
sequential retirement of principal, rather than the pro rata share of principal
return that occurs through regular monthly principal payments on pass-through
securities.
All mortgage-backed securities are subject to risks associated with
variable prepayments. As a result, these securities may have a different actual
maturity than planned at the time of purchase. When securities having a cost
greater than par are backed by mortgages that prepay faster than expected, we
record a charge to investment income. When securities having a cost less than
par prepay faster than expected, we record investment income.
The degree to which a mortgage-backed security is susceptible to income
fluctuations is influenced by: (i) the difference between its cost and par; (ii)
the relative sensitivity of the underlying mortgages backing the security to
prepayment in a changing interest rate environment; and (iii) the repayment
priority of the security in the overall securitization structure. The Company
seeks to limit the extent of these risks by: (i) purchasing securities that are
backed by collateral with lower prepayment sensitivity (such as mortgages priced
at a discount to par value and mortgages that are extremely seasoned); (ii)
avoiding securities whose values are heavily influenced by changes in
prepayments (such as interest-only and principal-only securities); (iii)
investing in securities structured to reduce prepayment risk (such as planned
amortization class ("PAC") and targeted amortization class ("TAC") CMOs); and
(iv) actively managing the entire portfolio of mortgage-backed securities to
dispose of those which are deemed more likely to be prepaid. PAC and TAC
instruments represented approximately 24 percent of our mortgage-backed
securities at December 31, 1997. The call-adjusted modified duration of our
mortgage-backed securities at December 31, 1997, was 5.2 years.
37
The following table sets forth the par value, amortized cost and
estimated fair value of mortgage-backed securities at December 31, 1997,
summarized by interest rates on the underlying collateral:
Par Amortized Estimated
value cost fair value
----- ---- ----------
(Dollars in millions)
Below 7 percent............................................................ $2,025.5 $1,980.4 $2,014.7
7 percent - 8 percent...................................................... 3,568.0 3,546.5 3,638.2
8 percent - 9 percent...................................................... 712.9 716.1 730.5
9 percent and above........................................................ 445.1 455.5 467.0
-------- -------- --------
Total mortgage-backed securities............................... $6,751.5 $6,698.5 $6,850.4
======== ======== ========
The amortized cost and estimated fair value of mortgage-backed securities
at December 31, 1997, summarized by type of security, were as follows:
Estimated fair value
--------------------
% of
Amortized fixed
Type cost Amount maturities
- ---- ---- ------ ----------
(Dollars in millions)
Pass-throughs and sequential and targeted amortization classes............ $4,599.7 $4,697.5 21%
Planned amortization classes and accretion-directed bonds.................. 1,515.9 1,547.6 7
Support classes............................................................ 36.0 36.9 -
Accrual (Z tranche) bonds.................................................. 27.9 28.8 -
Subordinated classes....................................................... 519.0 539.6 2
-------- -------- --
$6,698.5 $6,850.4 30%
======== ======== ==
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 and provide the best
price/performance ratio in a highly volatile interest rate environment. This
type of security is also frequently used as collateral in the dollar-roll
market. Sequential classes pay in a strict sequence; all principal payments
received by the CMO are paid to the sequential tranches in order of priority.
Targeted amortization classes provide a modest amount of prepayment protection
when prepayments on the underlying collateral increase from those assumed at
pricing. Thus, they offer slightly better call protection than sequential
classes and pass-throughs.
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 classes. This insulates the planned amortization classes from the
consequences of both faster prepayments (average life shortening) and slower
prepayments (average life extension).
Support classes absorb the prepayment risk from which planned
amortization and targeted amortization classes are protected. As such, they are
usually extremely sensitive to prepayments. Most of our support classes are
higher-average-life instruments that generally will not lengthen if interest
rates rise further, and will have a tendency to shorten if interest rates
decline. However, since these bonds have costs below their par values, higher
prepayments will have the effect of increasing yields.
Accrual bonds are CMOs structured such that the payment of coupon
interest is deferred until principal payments begin. On each accrual date, the
principal balance is increased by the amount of the interest (based on the
stated coupon rate) that otherwise would have been payable. As such, these
securities act much the same as zero-coupon bonds until cash payments begin.
Cash payments typically do not commence until earlier classes in the CMO
structure have been retired, which can be significantly influenced by the
prepayment experience of the underlying mortgage loan collateral in the CMO
structure. Because of the zero-coupon element of these securities and the
potential uncertainty as to the timing of cash payments, their market values and
yields are more sensitive to changing interest rates than are other CMOs,
pass-through securities and coupon bonds.
Subordinated CMO classes have both prepayment and credit risk. The
subordinated classes are used to enhance the credit quality of the senior
securities, and as such, rating agencies require that this support not
deteriorate due to the prepayment of the subordinated securities. The credit
risk of subordinated classes is derived from the negative leverage of owning a
small percentage of the underlying mortgage loan collateral while bearing a
majority of the risk of loss due to homeowner defaults.
38
If we determine that an investment held in the actively managed fixed
maturity category will be sold, we will either sell the security or transfer it
to the trading account at its fair value and recognize the gain or loss
immediately. There were no material transfers in 1997. During 1997, we sold
actively managed fixed maturity securities with a $17.8 billion book value,
resulting in $342.6 million of investment gains and $41.4 million of investment
losses (both before related expenses, amortization and taxes). Such securities
were sold in response to changes in the investment environment, which created
opportunities to enhance the total return of the investment portfolio without
adversely affecting the quality of the portfolio or the matching of expected
maturities of assets and liabilities. The realization of gains and losses
affects the timing of the amortization of the cost of policies produced and the
cost of policies purchased, as explained in note 10 to the consolidated
financial statements.
Other investments
Credit-tenant loans are loans on commercial properties where the lease of
the principal tenant is assigned to the lender. The principal tenant, or any
guarantor of such tenant's obligations, must have a credit rating at the time of
origination of the loan of at least BBB- or its equivalent. The underwriting
guidelines consider such factors as: (i) the lease term of the property; (ii)
the mortgagee's management ability, including business experience, property
management capabilities and financial soundness; and (iii) economic, demographic
or other factors that may affect the income generated by the property or its
value. The underwriting guidelines also generally require a loan-to-value ratio
of 75 percent or less. Credit-tenant loans are carried at amortized cost and
totaled $558.6 million at December 31, 1997, or 2.1 percent of total invested
assets. The total estimated fair value of credit-tenant loans was $587.2 million
at December 31, 1997.
At December 31, 1997, we held mortgage loan investments with a carrying
value of $516.2 million (or 1.9 percent of total invested assets) and a fair
value of $551.0 million. The balance of mortgage loans included 96 percent
commercial loans, 2 percent residential loans and 2 percent residual interests
in CMOs. The residual interests in CMOs entitle the Company to the excess cash
flows arising from the difference between: (i) the cash flows required to make
principal and interest payments on the related senior interests in the CMOs; and
(ii) the actual cash flows received on the mortgage loan assets included in the
CMO portfolios. If prepayments vary from projections on the mortgage loan assets
included in such CMO portfolios, the total cash flows to the Company from such
junior and residual interests could change from projected cash flows, resulting
in a gain or loss.
Noncurrent mortgage loans were insignificant at December 31, 1997. We
recognized realized losses of $.8 million on mortgage loans for the year ended
December 31, 1997. At December 31, 1997, we had a loan loss reserve of $9.0
million. Approximately 20 percent of the mortgage loans were on properties
located in California, 11 percent in Texas and 9 percent in Florida. No other
state accounted for more than 7 percent of the mortgage loan balance.
At December 31, 1997, we held $64.8 million of trading securities that
are included in other invested assets. Trading securities are investments that
are held with the intent to be traded prior to their maturity, or are believed
likely to be disposed of in the foreseeable future as a result of market or
issuer developments. Trading securities are carried at estimated fair value,
with the changes in fair value reflected in the statement of operations.
Other invested assets include: (i) trading securities; (ii) S&P 500 Call
Options; and (iii) certain nontraditional investments, including investments in
venture capital funds, limited partnerships, mineral rights and promissory
notes.
Short-term investments totaled $990.5 million, or 3.7 percent of invested
assets at December 31, 1997, and consisted primarily of commercial paper and
repurchase agreements relating to government securities.
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. Such investment borrowings averaged $719.3 million
during 1997 and 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 5.8 percent in 1997. The primary risk
associated with short-term collateralized borrowings is that the 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 (which was not material at December 31,
1997). We believe that the counterparties to our reverse repurchase and
dollar-roll agreements are financially responsible and that the counterparty
risk is minimal.
39
CONSOLIDATED FINANCIAL CONDITION
Changes in the consolidated balance sheet of 1997 compared with 1996
Our consolidated balance sheet at December 31, 1997, compared with 1996,
reflects growth through operations, changes in the fair value of actively
managed fixed maturity securities, and the following capital and financing
transactions described in the notes to the consolidated financial statements:
(i) the CAF Merger; (ii) the issuance of $800 million of Company-obligated
mandatorily redeemable preferred securities of subsidiary trusts; (iii) the
repurchase of senior subordinated notes and senior notes with a par value of
$130.1 million; (iv) the conversion of convertible debentures acquired in the
ATC Merger into Conseco common stock; (v) the conversion of PRIDES into Conseco
common stock; (vi) the repurchase of mandatorily redeemable preferred stock of a
subsidiary; (vii) the PFS Merger; (viii) the Colonial Penn Purchase; (ix) the
WNIC Merger; (x) common stock repurchases; and (xi) the issuance of commercial
paper and notes payable.
Our total capital at December 31, 1997 and 1996, was as follows:
1997 1996
---- ----
(Dollars in millions)
Notes payable...................................................... $1,906.7 $1,094.9
Commercial paper................................................... 448.2 -
Minority interest:
Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts............................. 1,383.9 600.0
Mandatorily redeemable preferred stock of subsidiary........... - 97.0
Common stock of subsidiary..................................... .7 .7
Shareholders' equity:
Preferred stock................................................ 115.8 267.1
Common stock and additional paid-in capital.................... 2,382.0 2,029.6
Accumulated other comprehensive income......................... 182.0 38.9
Retained earnings.............................................. 1,210.3 749.7
-------- --------
Total shareholders' equity.................................. 3,890.1 3,085.3
--------- --------
Total capital of Conseco.................................... $7,629.6 $4,877.9
======== ========
Notes payable increased during 1997 primarily as a result of: (i) debt
issued or assumed in connection with the acquisitions of CAF, PFS, Colonial Penn
and WNIC; (ii) debt used to finance common stock repurchases; and (iii) the
redemption of mandatorily redeemable preferred stock of a subsidiary of ALH. The
increase in notes payable was partially offset by the repayment of debt using
the proceeds from the issuance of Company-obligated mandatorily redeemable
preferred securities.
We instituted a commercial paper program in April 1997 to lower our
borrowing costs and improve our liquidity. Borrowings under our commercial paper
program averaged approximately $525.9 million during the period of April 24,
1997 through December 31, 1997. The weighted average interest rate on such
borrowings was 5.8 percent during 1997.
Company-obligated mandatorily redeemable preferred securities of
subsidiary trusts are classified as minority interest in accordance with GAAP.
During 1997, we issued $300 million of Capital Securities and $500 million of
FELINE PRIDES. See note 8 to the consolidated financial statements for a
description of these securities.
Minority interest, excluding the Company-obligated mandatorily redeemable
preferred securities, at December 31, 1997, included a $.7 million interest in
common stock of a subsidiary of ALH. At December 31, 1996, minority interest
included: (i) $97.0 million of mandatorily redeemable preferred stock of a
subsidiary of ALH; and (ii) $.7 million interest in the common stock of a
subsidiary of ALH.
During 1997, we repurchased all of the mandatorily redeemable preferred
stock of a subsidiary of ALH formerly held by minority interests. As a result,
gains of $3.7 million were realized from the sale of securities having an
amortized cost of $47.7 million; such securities had been held in a segregated
account to ensure the redemption of such preferred stock.
40
Shareholders' equity increased by $804.8 million in 1997, to $3.9
billion. Significant components of the increase included: (i) Conseco common
stock issued in the CAF Merger with a value of $117.4 million; (ii) Conseco
common stock issued in the PFS Merger with a value of $354.1 million; (iii) net
income of $567.3 million; (iv) the conversion of convertible debentures into
Conseco common stock with a value of $150.0 million; (v) the issuance of common
stock related to stock options and employee benefit plans (including the tax
benefit thereon) of $276.1 million; and (vi) the increase in net unrealized
appreciation of $143.1 million. These increases were partially offset by: (i)
repurchases of common stock for $711.7 million; and (ii) common and preferred
stock dividends totaling $80.6 million.
Book value per common share outstanding increased to $20.22 at December
31, 1997, from $16.86 at December 31, 1996. Such increase was primarily
attributable to the factors discussed in the previous paragraph. Excluding
unrealized appreciation of fixed maturity securities in accordance with SFAS
115, book value per common share outstanding was $19.27 at December 31, 1997,
compared with $16.62 at December 31, 1996.
Total assets increased by $10.3 billion in 1997, to $35.9 billion,
primarily due to the assets acquired in the CAF Merger, the PFS Merger, the
Colonial Penn Purchase and the WNIC Merger.
In accordance with SFAS 115, Conseco records its actively managed fixed
maturity investments at estimated fair value. At December 31, 1997 and 1996,
such investments were increased by $484.4 million and $103.8 million,
respectively, as a result of the SFAS 115 adjustment.
Financial ratios
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Ratio of earnings to fixed charges:
As reported........................................................ 2.04X 1.61X 1.57X 2.26X 2.19X
Excluding interest on annuities and financial products(a).......... 7.21X 4.55X 3.80X 4.55X 8.85X
Ratio of earnings to fixed charges and preferred dividends:
As reported........................................................ 1.95X 1.50X 1.50X 1.95X 2.04X
Excluding interest on annuities and financial products(a).......... 5.77X 3.14X 3.06X 3.14X 6.00X
Ratio of earnings to fixed charges, preferred dividends and
distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts:
As reported..................................................... 1.82X 1.49X 1.50X 1.95X 2.04X
Excluding interest on annuities and financial products(a)....... 4.20X 3.06X 3.06X 3.14X 6.00X
Ratio of debt to total capital: (b)
As reported........................................................ .31X .22X .49X .43X .34X
Excluding unrealized appreciation (depreciation)(c)................ .32X .23X .53X .39X .36X
Ratio of debt and Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts to total capital:(b) (d)
As reported..................................................... .49X .35X .49X .43X .34X
Excluding unrealized appreciation (depreciation) (c)............ .50X .35X .53X .39X .36X
Rating agency ratios: (c) (e) (f) (g)
Debt to total capital.............................................. .28X .17X .37X .02X .20X
Debt and preferred stock to total capital (h)...................... .47X .30X .37X .02X .20X
(a) These ratios are included to assist the reader in analyzing the impact of
interest on annuities and financial products (which is not generally
required to be paid in cash in the period in which it is recognized). Such
ratios are not intended to, and do not, represent the following ratios
prepared in accordance with GAAP: the ratio of earnings to fixed charges;
the ratio of earnings to fixed charges and preferred dividends; and the
ratio of earnings to fixed charges, preferred dividends and distributions
on Company-obligated mandatorily redeemable preferred securities of
subsidiary trusts.
(b) For periods prior to 1996, debt includes obligations for which Conseco was
not directly liable.
(c) Excludes the effect of reporting fixed maturities at fair value.
41
(d) Represents the ratio of debt and the Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts to the sum of
shareholders' equity, debt, minority interest and the Company-obligated
mandatorily redeemable preferred securities of subsidiary trusts.
(e) Consistent with our discussions with rating agencies, the Company has
targeted: (i) the ratio of debt to total capital to be at or below 35
percent; and (ii) the ratio of debt and preferred stock to total capital to
be at or below 49 percent. These ratios are calculated in a manner
discussed with rating agencies.
(f) Debt is reduced by cash and investments held by non-life companies and
excludes, for periods prior to 1996, obligations for which Conseco was not
directly liable.
(g) Assumes conversion of all convertible debentures.
(h) Assumes purchase of common shares under purchase contracts.
Liquidity for insurance 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 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.
Of our total insurance liabilities at December 31, 1997, approximately 17
percent could be surrendered by the policyholder without a penalty.
Approximately 59 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 24 percent are not subject to surrender. Payment
characteristics of the insurance liabilities at December 31, 1997, were as
follows (dollars in millions):
Payments under contracts containing fixed payment dates:
Due in one year or less.............................................. $ 339.6
Due after one year through five years................................ 819.0
Due after five years through ten years............................... 415.9
Due after ten years.................................................. 852.4
---------
Total gross payments whose payment dates are fixed by contract.. 2,426.9
Less amounts representing future interest on such contracts.......... 879.0
---------
Insurance liabilities whose payment dates are fixed by contract 1,547.9
Insurance liabilities whose payment dates are not fixed by contract....... 24,352.2
---------
Total insurance liabilities..................................... $25,900.1
=========
Of the above insurance liabilities under contracts containing fixed
payment dates, approximately 59 percent relate to payments that will be made for
the lifetime of the contract holder. We consider expected mortality in
determining the amount of this liability. The remaining insurance liabilities
having fixed payment dates are payable regardless of the contract holder's
survival.
Approximately 30 percent of insurance liabilities were contracts subject
to a fixed interest rate for the life of the contract. The remaining liabilities
generally were subject to interest rates that could be reset annually.
The following summarizes insurance liabilities for investment contracts
by credited rate (excluding interest rate bonuses for the first policy year
only) at December 31, 1997 (dollars in millions):
Below 4.75 percent......................................................... $ 2,627.0
4.75 percent - 5.00 percent................................................ 2,533.0
5.00 percent - 5.25 percent................................................ 3,588.0
5.25 percent - 5.50 percent................................................ 1,703.0
5.50 percent - 5.75 percent................................................ 676.0
5.75 percent and above..................................................... 1,597.0
---------
Total insurance liabilities on investment contracts.................. $12,724.0
=========
42
We believe that the diversity of our investment portfolio and the
concentration of investments in high quality liquid securities provide
sufficient liquidity to meet foreseeable cash requirements. Our investment
portfolio at December 31, 1997, included $1.0 billion of short-term investments
and $19.2 billion of publicly traded investment grade bonds, including $.6
billion of United States government and agency securities. Although there is no
present need or intent to dispose of such investments, our life insurance
subsidiaries could readily liquidate portions of their investments, if such a
need arose. In addition, investments could be used to facilitate borrowings
under reverse repurchase agreements or dollar-roll transactions. Such borrowings
have been used by the life companies from time to time to increase their return
on investments and to improve liquidity. At December 31, 1997, our portfolio of
bonds and redeemable preferred stocks had an aggregate unrealized gain of $484.4
million.
Liquidity of Conseco (parent company)
The parent company is a legal entity, separate and distinct from its
subsidiaries, and has no business operations. The parent company needs cash for:
(i) principal and interest on debt; (ii) dividends on preferred and common
stock; (iii) distributions on the Company-obligated mandatorily redeemable
preferred stock of subsidiary trusts; (iv) holding company administrative
expenses; (v) income taxes; and (vi) investments in subsidiaries. The primary
sources of cash to meet these obligations include statutorily permitted payments
from our life insurance subsidiaries, including: (i) dividend payments; (ii)
surplus debenture interest and principal payments; (iii) tax sharing payments;
and (iv) fees for services provided. The parent company may also obtain cash by:
(i) issuing debt or equity securities; (ii) borrowing additional amounts under
its revolving credit agreement, as described in note 7 to the consolidated
financial statements; or (iii) selling all or a portion of its subsidiaries.
These sources have historically provided adequate cash flow to fund: (i) the
needs of the parent company's normal operations; (ii) internal expansion,
acquisitions and investment opportunities; and (iii) the retirement of debt and
equity. In 1997, we also issued new shares of Conseco common stock for a portion
of the cost to acquire CAF and the entire cost to acquire PFS.
43
The following table shows the cash flow activity of the parent company
and its wholly owned non-life subsidiaries:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Items relating to operations:
Dividends and surplus debenture interest payments from life subsidiaries..... $ 166.1 $109.9 $ 80.6
Tax sharing payments from life subsidiaries.................................. 9.3 4.6 2.7
Fees from life subsidiaries.................................................. 89.1 74.8 34.7
Fees from unaffiliated companies............................................. 35.2 39.3 39.0
Parent and non-life subsidiary costs......................................... (74.1) (39.8) (64.5)
Interest on debt of Conseco, including direct and indirect obligations....... (117.4) (71.3) (41.6)
Interest on amounts due to life subsidiaries................................. (26.5) (7.3) (8.8)
Income taxes................................................................. (2.3) 2.2 (7.7)
Other........................................................................ 8.9 (4.7) -
------- ------ ------
Total items relating to operations....................................... 88.3 107.7 34.4
------- ------ ------
Items relating to investing:
Purchase of investments...................................................... (140.7) (71.1) (70.8)
Sales and maturities of investments.......................................... 70.2 45.3 125.6
Cash held by non-life subsidiaries prior to acquisition...................... 4.1 40.9 17.0
Investment in consolidated subsidiaries...................................... (939.7) (226.1) (552.3)
Surplus debenture principal payments......................................... 73.9 36.5 -
Expense incurred in terminated merger........................................ - - (5.5)
------- ------ ------
Total items relating to investing......................................... (932.2) (174.5) (486.0)
------- ------ ------
Items relating to financing:
Proceeds from issuance of Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, net of issuance costs.......... 780.4 587.7 -
Proceeds from the issuance of equity securities.............................. 52.3 20.6 1.8
Proceeds from the issuance of debt, net of issuance costs.................... 2,578.8 856.0 827.2
Commercial paper, net........................................................ 448.2 - -
Common and preferred dividends............................................... (76.8) (34.3) (24.6)
Dividends on stock held by subsidiaries...................................... (53.8) (38.1) (38.7)
Distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts........................................... (65.7) (2.9) -
Payments on debt, including prepayments and acquired debt.................... (2,218.8) (1,467.2) (330.0)
Payments to retire redeemable preferred stock of a non-life subsidiary....... (72.4) (.3) -
Repurchases of Conseco common stock ......................................... (593.3) (21.5) (92.4)
Proceeds from the issuance of convertible preferred stock, net of issuance
costs..................................................................... - 257.7 -
------- ------ ------
Total items relating to financing......................................... 778.9 157.7 343.3
------- ------ ------
Change in short-term investments of parent
and its non-life subsidiaries......................................... (65.0) 90.9 (108.3)
Short-term investments, beginning of year................................. 115.1 24.2 132.5
------- ------ ------
Short-term investments, end of year....................................... $ 50.1 $115.1 $ 24.2
======= ====== ======
44
At December 31, 1997, the parent company and its non-life subsidiaries
had short-term investments of $50.1 million, of which $28.7 million was expended
in January 1998 for accrued interest and dividends. The parent company and its
non-life subsidiaries had additional investments in fixed maturities, equity
securities and other invested assets of $155.0 million at December 31, 1997,
which, if needed, could be liquidated or contributed to the insurance
subsidiaries.
The ability of our insurance subsidiaries to pay dividends is subject to
state insurance department regulations. These regulations generally permit
dividends to be paid 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 for the prior
year; or (ii) 10 percent of 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. The amount of
dividends that our insurance subsidiaries could pay to non-life parent companies
in 1998 without prior approval is approximately $165.1 million.
Statutory operating results and statutory surplus are determined
according to accounting practices prescribed or permitted by each state in which
the subsidiaries do business. Statutory surplus bears no direct relationship to
equity as determined under GAAP. With respect to new business, statutory
accounting practices require acquisition costs and reserves for future
guaranteed benefit payments and interest in excess of statutory rates to be
expensed as the new business is written. These items cause a statutory loss
("surplus strain") on many insurance policies in the year in which they are
issued. We manage the effect of such statutory surplus strain by designing our
products to minimize such first-year losses, and by controlling the amount of
new premiums written.
Note 12 to the consolidated financial statements shows the difference
between pretax income reported using statutory accounting practices and GAAP.
Insurance departments in the states where our life insurance subsidiaries
are domiciled or do business require insurance companies to make annual and
quarterly filings. The interest maintenance reserve ("IMR") and the asset
valuation reserve ("AVR") are required to be appropriated and reported as
liabilities. The IMR captures all investment gains and losses resulting from
changes in interest rates and provides for such amounts to be amortized into
statutory net income on a basis reflecting the remaining lives of the assets
sold. The AVR captures investment gains and losses related to changes in
creditworthiness; it is also adjusted each year based on a formula related to
the quality and loss experience of the Company's investment portfolio. These
reserves affect the ability of our insurance subsidiaries to reflect investment
gains and losses in statutory earnings and surplus.
Our debt agreements require the Company to maintain minimum working
capital and RBC ratios and limit the Company's ability to incur additional
indebtedness. They also restrict the amount of retained earnings that is
available for dividends and require Conseco to maintain certain minimum ratings
at its insurance subsidiaries.
INFLATION
Inflation does not have a significant effect on Conseco's balance sheet;
we have minimal investments in property, equipment or inventories.
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. Before Medicare supplement plans were standardized, approximately
two-thirds of the states permitted rate plans with automatic escalation clauses.
This permitted Conseco, in periods following initial approval, to adjust premium
rates for changes in Medicare deductibles and increases in medical cost
inflation without refiling with the regulators. Currently, rate changes for all
Medicare supplement plans must be individually approved by each state. 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.
YEAR 2000 CONVERSION COSTS
We have initiated a corporate-wide program designed to ensure that our
computer systems will function properly in the year 2000. For some of our
operations, the most effective solution will be to ensure timely completion of
the previously planned conversions of their older systems to more modern, year
2000 - compliant systems used in other areas of the Company. In some cases, our
most effective solution will be to purchase new, more modern systems; these
costs will be capitalized as assets and amortized over their expected useful
lives. In other cases, we will modify existing systems, thereby incurring costs
that will be charged to operating expense. To date, we have incurred $11.6
million in costs related to year 2000 projects. We expect to spend approximately
an additional $35 million on these projects over the next two years. We began to
incur expenses related to this program several years ago. We expect our year
2000 program to be completed on a timely basis.
45
MARKET-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT
We seek to invest our available funds in a manner that will maximize
shareholder value and fund future obligations to policyholders and debtors,
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.
Approximately 59 percent of our total insurance liabilities at December 31,
1997, had surrender penalties or other restrictions and approximately 24 percent
are not subject to surrender.
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.
Profitability of many of our products is significantly affected by the
spreads between interest yields on investments and rates credited on insurance
liabilities. Although substantially all credited rates on our annuity products
may be changed annually (subject to minimum guaranteed rates), 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. As of December 31, 1997, the average yield, computed on the cost
basis of our investment portfolio, was 7.5 percent, and the average interest
rate credited or accruing to our total insurance liabilities was 5.2 percent,
excluding interest bonuses guaranteed for the first year of the annuity contract
only.
We use computer models to perform simulations of the cash flows generated
from our existing business under various interest rate scenarios. These
simulations enable 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, 1997,
the adjusted modified duration of our fixed maturity securities and short-term
investments was approximately 5.8 years and the duration of our insurance
liabilities was approximately 6.7 years.
If interest rates were to increase by 10 percent from their December 31,
1997 levels, 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 $545 million. 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, actual losses could be less than those estimated
above.
We manage the composition of our borrowed capital by considering
factors such as the ratio of borrowed capital to total capital, the portion of
our outstanding capital subject to fixed and variable rates, the current
interest rate environment and other market conditions. Our borrowed capital at
December 31, 1997, includes commercial paper, notes payable and
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts totaling $3.7 billion ($1.8 billion of which is at floating rates and
$1.9 billion of which is at fixed rates). Based on the interest rate exposure
and prevalent rates at December 31, 1997, a relative 10 percent decrease in
interest rates would increase the fair value of our fixed-rate borrowed capital
by approximately $75 million. Our interest expense on floating-rate debt will
fluctuate as prevailing interest rates change.
We periodically use options and interest rate swaps to hedge interest
rate risk associated with our investments and borrowed capital. Although we had
no such agreements outstanding at December 31, 1997, we entered into four
interest rate swap agreements in March 1998. The Company entered into such
agreements to create a hedge that effectively converts a portion of its
fixed-rate borrowed capital into floating-rate instruments for the period during
which the agreements are outstanding. Such interest rate swap agreements have an
aggregate notional principal amount of $1.0 billion, mature in various years
through 2008, and have an average remaining life of seven years. If the
counterparties of these interest rate swaps do not meet their obligations,
Conseco could have a loss. Conseco limits its exposure to such a loss by
diversifying among several counterparties believed to be financially sound and
creditworthy. At March 13, 1998, all of the counterparties were rated "A" or
higher by Standard & Poor's Corporation. These swap agreements, if in existence
when the assumed 10 percent decrease in interest rates occurred (see
46
preceding paragraph), would cause the increase in the fair value of our borrowed
capital to be $55.0 million, or $20.0 million less than indicated in the
preceding paragraph.
OUTLOOK
As indicated in this report, Conseco intends to continue to grow its life
and health insurance operations.
Conseco's operations in 1998 and in future years will be significantly
affected by its recently completed acquisitions. After completing an
acquisition, Conseco generally seeks to improve results of operations by
centralizing, standardizing and more efficiently performing many functions
common to most life insurance companies and by focusing on the sale of
profitable products. In the case of Colonial Penn, which is engaged primarily in
the sale of life insurance through direct marketing, many activities remain at
its Philadelphia facility.
Conseco believes that a number of life insurance companies will become
available for acquisition in the next 10 years as a result of strategic
restructuring and industry consolidation. The Company may participate in those
acquisitions which fit Conseco's strategic growth plan. We evaluate a potential
acquisition based on a variety of factors, including its operating results and
financial condition, growth potential, management and personnel, potential
return on the acquisition in relation to other investment opportunities and
internal development of our existing business operations. Conseco's ability to
complete acquisitions that achieve those objectives depends on a number of
external factors, including: (i) the attitudes of rating agencies toward
Conseco's strategic plan and capital structure; (ii) the availability and cost
of both debt and equity capital; (iii) pressures that motivate companies to seek
to be acquired at a reasonable cost; and (iv) competition from other acquirers,
which affects the cost of acquisitions.
Conseco believes it has the resources and capabilities to continue being
a successful acquirer of life insurance companies. It also believes that its
past record of successfully acquiring, financing and operating life insurance
companies will be an advantage compared with others who may attempt to acquire
available candidates. However, many acquisition targets that have been available
recently did not appear to provide significant strategic benefits and their
asking prices were high relative to their expected value. Management believes it
is more beneficial to use Conseco's resources to improve the value of its
products, distribution capabilities and operating systems rather than to
complete acquisitions that do not offer comparable potential returns on its
investment.
Conseco continually reviews its capital structure, including the need and
desirability of restructuring the existing debt and equity of the Company.
As a result of its recent acquisitions, Conseco has significant in-force
business and marketing activity in multiple segments of the life insurance
industry, including universal life, whole life, term life, single-premium and
flexible-premium deferred and immediate annuities (including variable, indexed
and fixed), Medicare supplement insurance, long-term care coverage, specified-
disease coverage, and individual and group health insurance. Conseco will
continue to concentrate on opportunities to improve the effectiveness of its
distribution systems in marketing these products.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information included under the caption "Market-Sensitive Instruments
and Risk Management" in "Item 7. Management's Discussion and Analysis of
Consolidated Financial Condition and Results of Operations" is incorporated
herein by reference.
47
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Index to Consolidated Financial Statements
Page
----
Report of Management...................................................................................................49
Report of Independent Accountants......................................................................................50
Consolidated Balance Sheet at December 31, 1997 and 1996...............................................................51
Consolidated Statement of Operations for the years ended
December 31, 1997, 1996 and 1995...................................................................................53
Consolidated Statement of Shareholders' Equity
for the years ended December 31, 1997, 1996 and 1995...............................................................55
Consolidated Statement of Cash Flows for the years ended
December 31, 1997, 1996 and 1995...................................................................................57
Notes to Consolidated Financial Statements.............................................................................59
48
REPORT OF MANAGEMENT
To Our Shareholders
Management of Conseco, Inc. is responsible for the reliability of the
financial information in this annual report. The financial statements are
prepared in accordance with generally accepted accounting principles, and the
other financial information in this annual report is consistent with that of the
financial statements (except for such information described as being in
accordance with regulatory or statutory accounting requirements).
The integrity of the financial information relies in large part on
maintaining a system of internal control that is established by management to
provide reasonable assurance that assets are safeguarded and transactions are
properly authorized, recorded and reported. Reasonable assurance is based upon
the premise that the cost of controls should not exceed the benefits derived
from them. The Company's internal auditors continually evaluate the adequacy and
effectiveness of this system of internal control and actions are taken to
correct deficiencies as they are identified.
Certain financial information presented depends upon management's
estimates and judgments regarding the ultimate outcome of transactions which are
not yet complete. Management believes these estimates and judgments are fair and
reasonable in view of present conditions and available information.
The Company engages independent accountants to audit its financial
statements and express their opinion thereon. They have full access to each
member of management in conducting their audits. Such audits are conducted in
accordance with generally accepted auditing standards and include a review of
internal controls, tests of the accounting records, and such other auditing
procedures as they consider necessary to express an opinion on the Company's
financial statements.
The Audit Committee of the Board of Directors, composed solely of
nonmanagement directors, meets periodically with management, internal auditors
and the independent accountants to review internal accounting control, audit
activities and financial reporting matters. The internal auditors and the
independent accountants have full and free access to the Audit Committee.
Stephen C. Hilbert Rollin M. Dick
Chairman of the Board, Executive Vice President and
President and Chief Financial Officer
Chief Executive Officer
49
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Shareholders
Conseco, Inc.
We have audited the accompanying consolidated balance sheet of Conseco,
Inc. and Subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the three years in the period ended December 31, 1997. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Conseco, Inc. and Subsidiaries as of December 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
/S/ COOPERS & LYBRAND L.L.P.
----------------------------
COOPERS & LYBRAND L.L.P.
Indianapolis, Indiana
March 23, 1998
50
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
December 31, 1997 and 1996
(Dollars in millions)
ASSETS
1997 1996
---- ----
Investments:
Actively managed fixed maturities at fair value (amortized cost:
1997 - $22,289.3; 1996 - $17,203.3)............................................. $22,773.7 $17,307.1
Equity securities at fair value (cost: 1997 - $227.6; 1996 - $97.6)................ 228.9 99.7
Mortgage loans..................................................................... 516.2 356.0
Credit-tenant loans................................................................ 558.6 447.1
Policy loans....................................................................... 692.4 542.4
Other invested assets ............................................................. 518.1 259.6
Short-term investments............................................................. 990.5 281.6
Assets held in separate accounts................................................... 682.8 337.6
--------- ---------
Total investments............................................................ 26,961.2 19,631.1
Accrued investment income.............................................................. 379.3 296.9
Cost of policies purchased............................................................. 2,466.4 2,015.0
Cost of policies produced.............................................................. 915.2 544.3
Reinsurance receivables................................................................ 849.1 504.2
Income tax assets...................................................................... 85.6 8.8
Goodwill (net of accumulated amortization: 1997 - $167.7; 1996 - $83.2)............... 3,637.3 2,200.8
Property and equipment (net of accumulated depreciation: 1997 - $83.8; 1996 - $69.7)... 171.6 110.5
Other assets........................................................................... 449.1 301.1
--------- ---------
Total assets................................................................. $35,914.8 $25,612.7
========= =========
(continued on next page)
The accompanying notes are an integral
part of the consolidated financial
statements.
51
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (Continued)
December 31, 1997 and 1996
(Dollars in millions)
LIABILITIES AND SHAREHOLDERS' EQUITY
1997 1996
---- ----
Liabilities:
Insurance liabilities:
Interest sensitive products..................................................... $17,357.6 $14,795.5
Traditional products............................................................ 5,784.8 3,251.5
Claims payable and other policyholder funds..................................... 1,668.8 984.9
Unearned premiums............................................................... 406.1 272.4
Liabilities related to separate accounts ....................................... 682.8 337.6
Investment borrowings.............................................................. 1,389.5 383.4
Other liabilities.................................................................. 995.6 709.5
Commercial paper................................................................... 448.2 -
Notes payable...................................................................... 1,906.7 1,094.9
--------- ---------
Total liabilities.......................................................... 30,640.1 21,829.7
--------- ---------
Minority interest:
Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts............................................................ 1,383.9 600.0
Mandatorily redeemable preferred stock of subsidiary............................... - 97.0
Common stock of subsidiary......................................................... .7 .7
Shareholders' equity:
Preferred stock.................................................................... 115.8 267.1
Common stock and additional paid-in capital (no par value, 1,000,000,000 shares
authorized, shares issued and outstanding: 1997 - 186,665,591;
1996 - 167,128,228)............................................................. 2,382.0 2,029.6
Accumulated other comprehensive income:
Unrealized appreciation of fixed maturity securities (net of applicable deferred
income taxes: 1997 - $95.5; 1996 - $21.5)................................... 177.2 39.8
Unrealized appreciation (depreciation) of other investments (net of applicable
deferred income taxes: 1997 - $2.6; 1996 - $(.5))........................... 4.8 (.9)
Retained earnings.................................................................. 1,210.3 749.7
--------- ---------
Total shareholders' equity................................................. 3,890.1 3,085.3
--------- ---------
Total liabilities and shareholders' equity................................. $35,914.8 $25,612.7
========= =========
The accompanying notes are an integral
part of the consolidated financial
statements.
52
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
for the years ended December 31, 1997, 1996 and 1995
(Dollars in millions, except per share data)
1997 1996 1995
---- ---- ----
Revenues:
Insurance policy income:
Traditional products............................................. $2,954.1 $1,384.3 $1,355.6
Interest sensitive products...................................... 456.7 269.9 109.4
Net investment income............................................... 1,825.3 1,302.5 1,142.6
Net investment gains................................................ 266.5 60.8 204.1
Fee revenue and other income........................................ 65.8 49.8 43.6
-------- -------- --------
Total revenues.............................................. 5,568.4 3,067.3 2,855.3
-------- -------- --------
Benefits and expenses:
Insurance policy benefits........................................... 2,185.7 1,173.3 1,075.5
Change in future policy benefits.................................... 182.6 21.7 32.0
Amounts added to annuity and financial product policyholder account
balances:
Interest...................................................... 697.1 620.2 556.6
Other amounts added to variable and equity-indexed
annuity products........................................... 109.6 48.4 28.8
Interest expense on notes payable................................... 109.4 108.1 119.4
Interest expense on short-term investment borrowings................ 42.0 22.0 22.2
Amortization related to operations.................................. 408.8 240.0 203.6
Amortization related to investment gains............................ 181.2 36.0 126.6
Nonrecurring charges................................................ 71.7 - -
Other operating costs and expenses.................................. 577.2 304.0 272.1
-------- -------- --------
Total benefits and expenses................................... 4,565.3 2,573.7 2,436.8
-------- -------- --------
Income before income taxes, minority interest
and extraordinary charge ................................. 1,003.1 493.6 418.5
Income tax expense...................................................... 376.6 179.8 87.0
-------- -------- --------
Income before minority interest and
extraordinary charge ..................................... 626.5 313.8 331.5
Minority interest:
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, net of income taxes... 49.0 3.6 -
Dividends on preferred stock of subsidiaries........................ 3.3 8.9 11.9
Equity in earnings of subsidiaries.................................. - 22.4 97.1
-------- -------- -------
Income before extraordinary charge ......................... 574.2 278.9 222.5
Extraordinary charge on extinguishment of
debt, net of taxes and minority interest............................ 6.9 26.5 2.1
-------- -------- -------
Net income.................................................. 567.3 252.4 220.4
Less amounts applicable to preferred stock:
Charge related to induced conversions............................... 13.2 - -
Preferred stock dividends........................................... 8.7 27.4 18.4
-------- -------- -------
Net income applicable to common stock....................... $ 545.4 $ 225.0 $ 202.0
======== ======== =======
(continued on next page)
The accompanying notes are an integral
part of the consolidated financial
statements.
53
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS (Continued)
for the years ended December 31, 1997, 1996 and 1995
(Dollars in millions, except per share data)
1997 1996 1995
---- ---- ----
Earnings per common share:
Basic:
Weighted average shares outstanding............................ 185,751,000 104,584,000 81,405,000
Net income before extraordinary charge ........................ $2.98 $2.40 $2.51
Extraordinary charge .......................................... .04 .25 .03
----- ----- -----
Net income................................................ $2.94 $2.15 $2.48
===== ===== =====
Diluted:
Weighted average shares outstanding............................ 210,179,000 138,860,000 103,881,000
Net income before extraordinary charge ........................ $2.67 $2.01 $2.14
Extraordinary charge........................................... .03 .19 .02
----- ----- -----
Net income................................................ $2.64 $1.82 $2.12
===== ===== =====
The accompanying notes are an integral
part of the consolidated financial
statements.
54
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
for the years ended December 31, 1997, 1996 and 1995
(Dollars in millions)
Common stock Accumulated other
Preferred and additional comprehensive Retained
Total stock paid-in capital income earnings
----- ----- --------------- ------ --------
Balance, January 1, 1995.................................. $ 747.0 $ 283.5 $ 165.8 $(139.7) $ 437.4
Comprehensive income, net of tax:
Net income........................................... 220.4 - - - 220.4
Change in unrealized appreciation (depreciation) of
securities (net of applicable income taxes of
$132.8 million).................................... 252.4 - - 252.4 -
---------
Total comprehensive income....................... 472.8
Issuance of shares for stock options and employee
benefit plans........................................ 6.0 - 6.0 - -
Tax benefit related to issuance of shares under stock
option plans......................................... .4 - .4 - -
Cost of shares acquired................................ (92.4) - (15.0) - (77.4)
Dividends on preferred stock........................... (18.4) - - - (18.4)
Dividends on common stock.............................. (3.7) - - - (3.7)
---------- ------- -------- ------- ---------
Balance, December 31, 1995................................ 1,111.7 283.5 157.2 112.7 558.3
Comprehensive income, net of tax:
Net income........................................... 252.4 - - - 252.4
Change in unrealized appreciation (depreciation) of
securities (net of applicable income tax benefit of
$45.9 million)..................................... (73.8) - - (73.8) -
---------
Total comprehensive income....................... 178.6
Issuance of convertible preferred stock................ 267.1 267.1 - - -
Conversion of preferred stock into common shares....... - (283.2) 283.2 - -
Redemption of preferred stock for cash................. (.3) (.3) - - -
Issuance of shares in merger transactions.............. 1,568.6 - 1,568.6 - -
Issuance of shares for stock options and employee
benefit plans........................................ 29.5 - 29.5 - -
Tax benefit related to issuance of shares under stock
option plans......................................... 15.9 - 15.9 - -
Cost of issuance of preferred stock.................... (21.7) - (21.7) - -
Cost of shares acquired................................ (26.0) - (3.1) - (22.9)
Dividends on preferred stock........................... (27.4) - - - (27.4)
Dividends on common stock.............................. (10.7) - - - (10.7)
--------- ------- -------- ------- ---------
Balance, December 31, 1996................................ 3,085.3 267.1 2,029.6 38.9 749.7
(continued on following page)
The accompanying notes are an integral
part of the consolidated financial
statements.
55
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY, continued
for the years ended December 31, 1997, 1996 and 1995
(Dollars in millions)
Common stock Accumulated other
Preferred and additional comprehensive Retained
Total stock paid-in capital income earnings
----- ----- --------------- ------ --------
Balance, December 31, 1996 (carried forward from
prior page)............................................$3,085.3 $ 267.1 $2,029.6 $ 38.9 $ 749.7
Comprehensive income, net of tax:
Net income........................................... 567.3 - - - 567.3
Change in unrealized appreciation (depreciation) of
securities (net of applicable income taxes of
$77.1 million)..................................... 143.1 - - 143.1 -
--------
Total comprehensive income....................... 710.4
Conversion of preferred stock into common shares....... - (151.3) 151.3 - -
Issuance of shares in merger transactions.............. 471.5 - 471.5 - -
Issuance of shares for stock options and agent and
employee benefit plans............................... 190.9 - 190.9 - -
Tax benefit related to issuance of shares under stock
option plans......................................... 85.2 - 85.2 - -
Conversion of convertible debentures into common
shares............................................... 150.0 - 150.0 - -
Cost of shares acquired................................ (711.7) - (685.6) - (26.1)
Value of stock purchase contracts, a component of the
FELINE PRIDES........................................ (3.4) - (3.4) - -
Other.................................................. (7.5) - (7.5) - -
Amounts applicable to preferred stock:
Charge related to induced conversion of convertible
preferred stock.................................... (13.2) - - - (13.2)
Dividends on preferred stock......................... (8.7) - - - (8.7)
Dividends on common stock.............................. (58.7) - - - (58.7)
-------- --------- -------- ------- --------
Balance, December 31, 1997................................$3,890.1 $ 115.8 $2,382.0 $ 182.0 $1,210.3
======== ========= ======== ======= ========
The accompanying notes are an integral
part of the consolidated financial
statements.
56
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
for the years ended December 31, 1997, 1996 and 1995
(Dollars in millions)
1997 1996 1995
---- ---- ----
Cash flows from operating activities:
Net income......................................................... $ 567.3 $ 252.4 $ 220.4
Adjustments to reconcile net income to net
cash provided by operating activities:
Amortization and depreciation................................ 604.1 336.3 339.4
Income taxes................................................. 181.0 13.6 (34.7)
Insurance liabilities........................................ (344.4) (123.8) (3.0)
Amounts added to annuity and financial product policyholder
account balances........................................... 806.7 668.6 585.4
Fees charged to insurance liabilities........................ (456.7) (269.9) (109.4)
Accrual and amortization of investment income................ (70.5) (29.5) (71.8)
Deferral of cost of policies produced........................ (602.6) (308.4) (282.1)
Nonrecurring charges......................................... 71.7 - -
Minority interest............................................ 75.4 26.8 91.9
Extraordinary charge on extinguishment of debt............... 10.6 36.9 3.7
Net investment gains......................................... (266.5) (60.8) (204.1)
Other........................................................ (15.6) (73.9) (28.9)
--------- --------- --------
Net cash provided by operating activities.................. 560.5 468.3 506.8
--------- --------- --------
Cash flows from investing activities:
Sales of investments............................................... 18,459.4 8,394.1 7,900.9
Maturities and redemptions......................................... 750.7 614.3 417.1
Purchases of investments........................................... (20,043.8) (9,409.7) (9,112.3)
Acquisition of subsidiaries, net of cash held at the date of the
mergers......................................................... (759.7) (21.7) (586.3)
Short-term investments held by CCP Insurance, Inc. before
consolidation at January 1, 1995................................ - - 123.0
Repurchase of equity securities by CCP Insurance, Inc.............. - - (44.5)
Cash paid in reinsurance transactions.............................. - - (71.1)
Other.............................................................. - (.7) (3.3)
--------- --------- --------
Net cash used by investing activities...................... (1,593.4) (423.7) (1,376.5)
--------- --------- --------
(continued on next page)
The accompanying notes are an integral
part of the consolidated financial
statements.
57
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
for the years ended December 31, 1997, 1996 and 1995
(Dollars in millions)
1997 1996 1995
---- ---- ----
Cash flows from financing activities:
Issuance of notes payable of Conseco, net.......................... $ 2,578.8 $ 856.0 $ 795.2
Issuance of Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts....................... 780.4 587.7 -
Issuance of commercial paper, net.................................. 448.2 - -
Investment borrowings.............................................. 962.5 30.6 298.1
Issuance of notes payable of affiliates, net - not direct
obligations of Conseco ......................................... - 459.4 233.4
Payments on notes payable of Conseco............................... (2,273.3) (1,207.9) (330.0)
Payments on notes payable of affiliates - not direct
obligations of Conseco.......................................... - (926.4) (269.0)
Purchase of preferred stock of a subsidiary........................ (98.4) (12.6) -
Deposits to insurance liabilities.................................. 2,099.4 1,881.3 1,757.5
Withdrawals from insurance liabilities............................. (2,072.3) (1,842.5) (1,622.6)
Issuance of shares for employee benefit plans...................... 52.3 20.6 1.8
Issuance of convertible preferred stock............................ - 257.7 -
Issuance of equity interests in subsidiaries, net.................. - 2.2 16.8
Payments to repurchase equity securities of Conseco ............... (593.3) (21.5) (92.4)
Payments related to the induced conversion of convertible
preferred stock................................................. (13.2) - -
Redemption of preferred stock...................................... - (.3) -
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts....................... (65.7) (2.9) -
Dividends paid..................................................... (63.6) (34.3) (24.6)
--------- -------- --------
Net cash provided by financing activities.................. 1,741.8 47.1 764.2
--------- -------- --------
Net increase (decrease) in short-term investments.......... 708.9 91.7 (105.5)
Short-term investments, beginning of year.............................. 281.6 189.9 295.4
--------- -------- --------
Short-term investments, end of year.................................... $ 990.5 $ 281.6 $ 189.9
========= ======== ========
The accompanying notes are an integral
part of the consolidated financial
statements.
58
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Basis of Presentation
The following summary explains the accounting policies we use to arrive
at the more significant numbers in our financial statements. We have restated
all share and per-share amounts for the two-for-one stock splits distributed
February 11, 1997 and April 1, 1996. 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,
the American Institute of Certified Public Accountants and the Securities and
Exchange Commission.
Conseco, Inc. ("We," "Conseco" or "the Company" ) is a financial services
holding company. The Company develops, markets and administers supplemental
health insurance, annuity, individual life insurance, individual and group major
medical insurance and other insurance products. Conseco's operating strategy is
to grow the insurance business within its subsidiaries by focusing its resources
on the development and expansion of profitable products and strong distribution
channels. Conseco has supplemented such growth by acquiring companies that have
profitable niche products and strong distribution systems. Once a company is
acquired, our operating strategy has been to consolidate and streamline
management and administrative functions where appropriate, to realize superior
investment returns through active asset management, to eliminate unprofitable
products and distribution channels and to expand and develop the profitable
distribution channels and products.
Consolidation issues. Conseco Capital Partners, L.P. ("Partnership I"),
an investment partnership formed by Conseco with other investors, was the
Company's vehicle for acquiring four insurance companies: Great American Reserve
Insurance Company ("Great American Reserve") in June 1990, Jefferson National
Life Insurance Company in November 1990 (it was merged with Great American
Reserve in 1994), Beneficial Standard Life Insurance Company ("Beneficial
Standard") in March 1991 and Bankers Life and Casualty Company ("Bankers Life")
in November 1992. CCP Insurance, Inc. ("CCP"), a newly organized holding company
for Partnership I's first three acquisitions, completed an initial public
offering ("IPO") in July 1992. In August 1995, we completed the purchase of all
the shares of CCP common stock we did not previously own in a transaction
pursuant to which CCP was merged with Conseco, with Conseco being the surviving
corporation (the merger and related transactions are referred to herein as the
"CCP Merger"). As a result, CCP's subsidiaries (Great American Reserve and
Beneficial Standard) became wholly owned subsidiaries of the Company. The
accounts of CCP are consolidated with Conseco's for all periods in the
accompanying financial statements.
We were required to use step-basis accounting when we acquired the shares
of CCP common stock in various transactions. As a result, the assets and
liabilities of CCP included in our consolidated balance sheet represent the
following combination of values: (i) the portion of CCP's net assets acquired by
Conseco in the initial acquisitions of CCP's subsidiaries made by Partnership I
is valued as of those respective acquisition dates; and (ii) the portion of
CCP's net assets acquired in the CCP Merger is valued as of August 31, 1995.
Bankers Life Holding Corporation ("BLH"), a company formed by Partnership
I to acquire Bankers Life, completed an IPO in March 1993. As a result of the
IPO and the acquisition of additional BLH common shares in September 1993, we
owned 56 percent of BLH at January 1, 1995. In June 1995, we purchased
additional common shares of BLH, increasing the Company's ownership of BLH to 85
percent. Conseco's ownership of BLH increased to 88 percent at December 31,
1995, and 90.5 percent at March 5, 1996, as a result of share repurchases by
BLH. On December 31, 1996, we completed the purchase of all of the shares of BLH
common stock we did not already own in a transaction pursuant to which BLH
merged with a wholly owned subsidiary of Conseco (the "BLH Merger"). The
accounts of BLH are consolidated with Conseco's accounts for all periods in the
accompanying consolidated financial statements.
We were required to use step-basis accounting when we acquired the BLH
common shares at the various acquisition dates. The assets and liabilities of
BLH included in our consolidated balance sheet represent the following
combination of values: (i) the portion of BLH's net assets acquired by Conseco
in the November 1992 acquisition made by Partnership I is valued as of that
acquisition date; (ii) the portion of BLH's net assets acquired in 1993, 1995
and the first quarter of 1996 is valued as of the dates of their purchase; and
(iii) the portion of BLH's net assets acquired in the BLH Merger is valued as of
December 31, 1996.
Conseco Capital Partners II, L.P. ("Partnership II"), Conseco's second
investment partnership, acquired American Life Holdings, Inc. ("ALH" and the
parent of American Life and Casualty Insurance Company) on September 29, 1994.
Because Conseco was the sole general partner of Partnership II, Conseco
controlled Partnership II and ALH even though our ownership interest was
59
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
less than 50 percent. Because of this control, Conseco's consolidated financial
statements were required to include the accounts of ALH.
On January 1, 1995, Conseco had a 27 percent ownership interest in ALH.
On November 30, 1995, ALH issued 2,142,857 shares of its common stock for $30.0
million (including $13.2 million paid by Conseco and its subsidiaries) in a
private placement transaction. Conseco's ownership interest in ALH increased to
36 percent at December 31, 1995, as a result of this transaction and changes in
our ownership of affiliated companies with ownership interests in ALH.
On September 30, 1996, we purchased all of the common shares of ALH we
did not previously own from Partnership II for $166.0 million in cash (the "ALH
Stock Purchase") and Partnership II was terminated. We were required to use
step-basis accounting when we acquired the shares of ALH common stock in the ALH
Stock Purchase and for our previous acquisitions. As a result, the assets and
liabilities of ALH included in the December 31, 1996, consolidated balance sheet
represent the following combination of values: (i) the portion of ALH's net
assets acquired by Conseco in the initial acquisition of ALH made by Partnership
II is valued as of September 29, 1994; (ii) the portion of ALH's net assets
acquired on November 30, 1995 is valued as of that date; and (iii) the portion
of ALH's net assets acquired in the ALH Stock Purchase is valued as of September
30, 1996.
On August 2, 1996, we completed the acquisition (the "LPG Merger") of
Life Partners Group, Inc. ("LPG") and LPG became a wholly owned subsidiary of
Conseco. On December 17, 1996, we completed the acquisition (the "ATC Merger")
of American Travellers Corporation ("ATC") and ATC was merged with and into
Conseco, with Conseco being the surviving corporation. On December 23, 1996, we
completed the acquisition (the "THI Merger") of Transport Holdings Inc. ("THI")
and THI was merged with and into Conseco, with Conseco being the surviving
corporation. On March 4, 1997, we completed the acquisition (the "CAF Merger")
of Capitol American Financial Corporation ("CAF") and CAF became a wholly owned
subsidiary of Conseco. On May 30, 1997, we completed the acquisition (the "PFS
Merger") of Pioneer Financial Services, Inc. ("PFS") and PFS became a wholly
owned subsidiary of Conseco. On September 30, 1997, we completed the acquisition
(the "Colonial Penn Purchase") of Colonial Penn Life Insurance Company and
Providential Life Insurance Company and certain other assets (collectively
referred to as "Colonial Penn"). Colonial Penn became a wholly owned subsidiary
of Conseco. On December 5, 1997, we completed the acquisition (the "WNIC
Merger") of Washington National Corporation ("WNIC") and WNIC became a wholly
owned subsidiary of Conseco. The accounts of LPG are consolidated with Conseco
effective July 1, 1996; the accounts of ATC and THI are consolidated effective
December 31, 1996; the accounts of CAF are consolidated effective January 1,
1997; the accounts of PFS are consolidated effective April 1, 1997; the accounts
of Colonial Penn are consolidated effective September 30, 1997; and the accounts
of WNIC are consolidated effective December 1, 1997.
Neither "consolidation" nor "non-consolidation" methods of accounting for
partially owned subsidiaries affect our reported net income or shareholders'
equity. Our consolidated financial statements do not include the results of
material transactions between us and our consolidated affiliates, or among our
consolidated affiliates. We reclassified some amounts in our 1996 and 1995
consolidated financial statements and notes to conform with the 1997
presentation.
60
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
Investments
Fixed maturities are securities that mature more than one year after
issuance. They include bonds, notes receivable and preferred stocks with
mandatory redemption features and are classified as follows:
Actively managed - fixed maturity securities that we may sell prior
to maturity in response to changes in interest rates, issuer credit
quality or our liquidity requirements. We carry actively managed
securities at estimated fair value. We record any unrealized gain
or loss, net of tax and the related adjustments described below, as
a component of shareholders' equity.
Trading - fixed maturity securities that we buy principally for the
purpose of selling in the near term. We carry trading securities at
estimated fair value. We include any unrealized gain or loss in net
investment gains (losses). We held $64.8 million of trading
securities at December 31, 1997, which are included in other
invested assets. We did not hold any trading securities at December
31, 1996 or 1995.
Held to maturity - fixed maturity securities that we have the
ability and positive intent to hold to maturity. When we own such
securities, we carry them at amortized cost. We may dispose of
these securities if the credit quality of the issuer deteriorates,
if regulatory requirements change or under other unforeseen
circumstances. We have not held any held to maturity securities
since implementing SFAS 115 in 1993.
We consider the anticipated returns from investing policyholder balances,
including investment gains and losses, in determining the amortization of the
cost of policies purchased and the cost of policies produced. When we state
actively managed fixed maturities at fair value, we also adjust the cost of
policies purchased and the cost of policies produced to reflect the change in
cumulative amortization that we would have recorded if we had sold these
securities at their fair value and reinvested the proceeds at current yields. If
future yields on such securities decline, it may be necessary to increase
certain of our insurance liabilities. We are required to adjust such liabilities
when their balances and future net cash flows (including investment income) are
insufficient to cover future benefits and expenses.
The unrealized gains and losses and the related adjustments described
above have no effect on our earnings. We record them, net of tax and other
adjustments, to shareholders' equity. The following table summarizes the effect
of these adjustments on the related balance sheet accounts as of December 31,
1997:
Effect of fair value
adjustment to
Balance actively managed
before fixed maturity Reported
adjustment securities amount
---------- ---------- ------
(Dollars in millions)
Actively managed fixed maturity securities.................... $22,289.3 $ 484.4 $22,773.7
Other balance sheet items:
Cost of policies purchased................................. 2,639.0 (172.6) 2,466.4
Cost of policies produced.................................. 949.9 (34.7) 915.2
Other...................................................... - (4.4) (4.4)
Income tax assets.......................................... 181.1 (95.5) 85.6
-------
Unrealized appreciation of fixed maturity securities,
net................................................. $ 177.2
=======
When there are changes in conditions that cause us to transfer a fixed
maturity investment to a different category (i.e., actively managed, trading or
held to maturity), we transfer it at its fair value on that date. We account for
the security's unrealized gain or loss (such amounts were immaterial in 1997) as
follows:
For a transfer to the trading category - we recognize the unrealized
gain or loss immediately in earnings.
For a transfer from the trading category - we do not reverse the
unrealized gain or loss already recognized in earnings.
61
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
For a transfer to actively managed from held to maturity - we
recognize the unrealized gain or loss immediately in shareholders'
equity.
For a transfer to held to maturity from actively managed - we continue
to report the unrealized gain or loss at the date of transfer in
shareholders' equity, but we amortize the gain or loss over the
remaining life of the security as an adjustment of yield.
Equity securities include investments in common stocks and non-redeemable
preferred stock. We treat them like actively managed fixed maturities (as
described above).
Credit-tenant loans ("CTLs") are loans for commercial properties. When we
make these loans: (i) the lease of the principal tenant must be assigned to
Conseco; (ii) the lease must produce adequate cash flow to fund substantially
all the requirements of the loan; and (iii) the principal tenant or the
guarantor of such tenant's obligations must have an investment-grade credit
rating when the loan is made. These loans also must be collateralized by the
value of the related property. Our underwriting guidelines take into account
such factors as: (i) the lease term of the property; (ii) the borrower's
management ability, including business experience, property management
capabilities and financial soundness; and (iii) such economic, demographic or
other factors that may affect the income generated by the property, or its
value. The underwriting guidelines generally require a loan-to-value ratio of 75
percent or less. We carry both CTLs and traditional mortgage loans at amortized
cost.
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.
Other invested assets include: (i) trading securities; (ii) Standard &
Poor's 500 Call Options ("S&P 500 Call Options"); and (iii) certain
non-traditional investments. Trading securities are carried at estimated fair
value as described above. The S&P 500 Call Options are also carried at estimated
fair value and are further described below under "Financial Instruments."
Non-traditional investments include investments in venture capital funds,
limited partnerships, mineral rights and promissory notes and are accounted for
using either the cost method, or for investments in partnerships over whose
operations the Company exercises significant influence, the equity method.
Policy loans are stated at their current unpaid principal balances.
Short-term investments include commercial paper, invested cash and other
investments purchased with maturities of less than three months. We carry them
at amortized cost, which approximates their estimated fair value. We consider
all short-term investments to be cash equivalents.
We defer any fees received or costs incurred when we originate
investments--principally CTLs and mortgages. 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 a trading security), we report the
difference between our sale proceeds and its amortized cost as an investment
gain or loss.
We regularly evaluate all of our CTLs, mortgage loans and other
investments 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, we treat it as a realized loss
and we reduce our cost basis of the security to its estimated fair value.
Separate Accounts
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 contract holders. We
record the related liabilities at amounts equal to the underlying assets; the
fair value of these liabilities equals their carrying amount.
62
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
Cost of Policies Purchased
When we acquire an insurance company, we assign a portion of its cost to
the right to receive future cash flows from insurance contracts existing at the
date of the acquisition. This cost of policies purchased represents the
actuarially determined present value of the projected future cash flows from the
acquired policies. To determine this value, we use a method that is consistent
with methods commonly used to value blocks of insurance business and with the
basic methodology generally used to value assets. It can be summarized as
follows:
- Identify the expected future cash flows from the blocks of business.
- Identify the risks to realizing those cash flows (i.e., assess the
probability that the cash flows will be realized).
- Identify the rate of return that we must earn in order to accept these
risks, based on consideration of the factors summarized below.
- Determine the value of the policies purchased by discounting the
expected future cash flows by the discount rate we need to earn.
The expected future cash flows we use in determining such value are based
on actuarially determined projections of future premium collections, mortality,
surrenders, operating expenses, changes in insurance liabilities, investment
yields on the assets held to back the policy liabilities and other factors.
These projections take into account all factors known or expected at the
valuation date, based on the collective judgment of Conseco's management. Our
actual experience on purchased business may vary from projections due to
differences in renewal premiums collected, investment spread, investment gains
or losses, mortality and morbidity costs and other factors.
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 the following factors:
- The magnitude of the risks associated with each of the actuarial
assumptions used in determining expected future cash flows
(as described above).
- The cost of our capital required to fund the acquisition.
- The likelihood of changes in projected future cash flows that might
occur if there are changes in insurance regulations and tax laws.
- The acquired company's compatibility with other Conseco activities
that may favorably affect future cash flows.
- The complexity of the acquired company.
- Recent prices (i.e., discount rates used in determining valuations)
paid by others to acquire similar blocks of business.
After we determine the cost of policies purchased, we amortize that
amount and evaluate recoverability in the same manner as cost of policies
produced as described below.
The cost of policies purchased related to acquisitions completed prior to
November 19, 1992 (representing 8 percent of the balance of cost of policies
purchased at December 31, 1997) is amortized under a slightly different method
than that described above. However, the effect of the different method on 1997
net income was insignificant.
63
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
Cost of Policies Produced
The costs that vary with and are primarily related to producing new
business are referred to as cost of policies produced. They consist primarily of
commissions, first-year bonus interest and certain costs of policy issuance and
underwriting, net of fees charged to the policy in excess of ultimate fees
charged. To the extent that they are recoverable from future profits, we defer
these costs and amortize them, using the interest rate credited to the
underlying policies, as follows:
- For universal life-type contracts and investment-type contracts, in
relation to the present value of expected gross profits from the
contracts.
- For immediate annuities with mortality risks, in relation to the
present value of benefits to be paid.
- For traditional life and accident and health products, in relation to
future anticipated premium revenue, using the same assumptions that
are used in calculating the insurance liabilities.
Each year, we evaluate the recoverability of the unamortized balance of
the cost of policies produced. For universal life-type contracts and
investment-type contracts, we increase or decrease the accumulated amortization
whenever there is a material change in the estimated gross profits expected over
the life of a block of business. We do this in order to maintain a constant
relationship between the cumulative amortization and the present value
(discounted at the rate of interest that accrues to the policies) of expected
gross profits. For most other contracts, we reduce the unamortized asset balance
(by a charge to income) only when the present value of future cash flows, net of
the policy liabilities, is insufficient to recover the asset balance.
Goodwill
Goodwill is the excess of the amount we paid to acquire a company over
the fair value of its net assets. We amortize goodwill on the straight-line
basis over a 40-year period. We continually monitor the value of our goodwill
based on our estimates of future earnings. We determine whether goodwill is
fully recoverable from projected undiscounted net cash flows from earnings of
the subsidiaries over the remaining amortization period. If we were to determine
that changes in such projected cash flows no longer supported the recoverability
of goodwill over the remaining amortization period, we would reduce its carrying
value with a corresponding charge to expense or shorten the amortization period
(no such changes have occurred). Cash flows considered in such an analysis are
those of the business acquired, if separately identifiable, or the business
segment that acquired the business if such earnings are not separately
identifiable.
Property and Equipment
We carry property and equipment at depreciated cost. We depreciate
property and equipment on a straight-line basis over the estimated useful lives
of the assets, which average approximately 13 years. Our depreciation expense
was $19.2 million in 1997, $11.9 million in 1996 and $9.3 million in 1995.
Insurance Liabilities, Recognition of Insurance Policy Income and Related
Benefits and Expenses
Our reserves for universal life-type and investment-type contracts are
based either on the contract account balance (if future benefit payments in
excess of the account balance are not guaranteed) or on the present value of
future benefit payments (if such payments are guaranteed). We make additions to
insurance liabilities if we determine that future cash flows (including
investment income) are insufficient to cover future benefits and expenses.
For investment contracts without mortality risk (such as deferred
annuities and immediate annuities with benefits paid for a period certain) and
for contracts that permit either Conseco or the insured to make changes in the
contract terms (such as single- premium whole life and universal life), we are
required to record premium deposits and benefit payments as increases or
decreases in a liability account, rather than as revenue and expense. We record
as revenue any amounts charged against the liability account for the cost of
insurance, policy administration and surrender penalties. We record as expense
any interest credited to the liability account and any benefit payments that
exceed the contract liability account balance.
64
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
We calculate our reserves for traditional and limited-payment life
contracts generally using the net-level-premium method, based on assumptions as
to investment yields, mortality, withdrawals and dividends. We make these
assumptions at the time we issue the contract or, in the case of contracts
acquired by purchase, at the purchase date. We base these assumptions on
projections from past experience, modified as necessary to reflect anticipated
trends and making allowance for possible unfavorable deviation.
For traditional life insurance contracts, we recognize premiums as income
when due or, for short-duration contracts, over the period to which the premiums
relate. We recognize benefits and expenses as a level percentage of earned
premiums. We accomplish this by providing for future policy benefits and by
amortizing deferred policy acquisition costs.
For contracts with mortality risk, but with premiums paid for only a
limited period (such as single-premium immediate annuities with benefits paid
for the life of the annuitant), we use an accounting treatment similar to that
used for traditional contracts. An exception is that we defer the excess of the
gross premium over the net premium and recognize it in relation to the present
value of expected future benefit payments (when accounting for annuity
contracts) or in relation to insurance in force (when accounting for life
insurance contracts).
We establish reserves for the estimated present value of the remaining
net cost of all reported and unreported claims. We base our estimates on past
experience and on published tables for disabled lives. We believe that the
reserves we have established are adequate. Final claim payments, however, may
differ from the established reserves, particularly when those payments may not
occur for several years. Any adjustments we make to reserves are reflected in
the results for the year during which the adjustments are made.
The liability for future policy benefits for accident and health policies
consists of active life reserves and the estimated present value of the
remaining ultimate net cost of incurred claims. Active life reserves include
unearned premiums and additional reserves. The additional reserves are computed
on the net level premium method using assumptions for future investment yield,
mortality and morbidity experience. Our assumptions are based on projections of
past experience and include provisions for possible adverse deviation.
For participating policies, we determine annually the amount of dividends
to be paid. We include as an insurance liability the portion of the earnings
allocated to participating policyholders.
Reinsurance
In the normal course of business, Conseco seeks to limit its exposure to
loss on any single insured and to recover a portion of the benefits paid over
such limits. We do this by ceding reinsurance to other insurance enterprises or
reinsurers under excess coverage and coinsurance contracts. We limit how much
risk per policy we will retain. We currently retain no more than $.8 million of
risk on any one policy.
We report assets and liabilities related to insurance contracts before
the effects of reinsurance. We report reinsurance receivables and prepaid
reinsurance premiums (including amounts related to insurance liabilities) as
assets. We recognize estimated reinsurance receivables in a manner consistent
with the liabilities related to the underlying reinsured contracts.
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. This liability method of accounting for income taxes also
requires us to reflect in income the effect of a tax-rate change on accumulated
deferred income taxes in the period in which the change is enacted.
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. If future income is not generated as expected,
deferred income tax assets may need to be written off.
65
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
Minority Interest
Our consolidated financial statements for 1995 and 1996 include all of
the assets, liabilities, revenues and expenses of BLH and ALH, even though we
did not own all of the common stock of these subsidiaries until December 1996.
We make a charge against consolidated income for: (i) the share of earnings
allocable to minority interests; (ii) dividends on preferred stock of
subsidiaries; and (iii) distributions on the Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts. We show the shareholders'
equity of such entities allocable to the minority interests separately on our
consolidated balance sheet.
We report Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts at their book value under minority interest. We charge the
distributions on these securities against consolidated income.
Earnings Per Share
As of December 31, 1997, we adopted Statement of Financial Accounting
Standards No. 128, "Earnings Per Share"("SFAS 128"). SFAS 128 provides new
accounting and reporting standards for earnings per share. It replaces primary
and fully diluted earnings per share with basic and diluted earnings per share.
Basic earnings per share excludes dilution and is computed by dividing income
available to common shareholders by the weighted average number of common shares
outstanding for the period. Diluted earnings per share represents the potential
dilution that could occur if all convertible securities, warrants and stock
options were exercised and converted into common stock if their effect is
dilutive. The diluted earnings per share calculation assumes that the proceeds
received upon the conversion of all dilutive options and warrants are used to
repurchase the Company's common shares at the average market price of such
shares during the period. Prior period earnings per share amounts have been
restated. We have also restated all share and per-share amounts for the
two-for-one stock splits distributed February 11, 1997 and April 1, 1996.
Comprehensive Income
As of December 31, 1997, we adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130
establishes standards for reporting and presentation of comprehensive income and
its components in a full set of financial statements. Comprehensive income
includes all changes in shareholders' equity (except those arising from
transactions with shareholders) and includes net income and net unrealized gains
(losses) on securities. The new standard requires only additional disclosures in
the consolidated financial statements; it does not affect our financial position
or results of operations.
Comprehensive income excludes net investment gains (losses) included in
net income of: (i) $42.1 million (after income taxes of $22.6 million) in 1997;
(ii) $(2.0) million (after income tax benefit of $1.0 million) in 1996; and
(iii) $48.1 million (net of income taxes of $25.9 million) in 1995.
Use of Estimates
Our financial statements have been prepared in accordance with GAAP. As
such, they include amounts based on our informed estimates and judgment, with
consideration given to materiality. We use many estimates and assumptions
calculating amortized value and recoverability of securities, cost of policies
produced, cost of policies purchased, goodwill, insurance liabilities, guaranty
fund assessment accruals, liabilities for litigation, and deferred income taxes.
Actual results could differ from reported results using those estimates.
Financial Instruments
In 1996, we introduced equity-indexed annuity products, which provide a
guaranteed base rate of return with a higher potential return linked to the
performance of a broad-based equity index. 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 the
equity-indexed annuity products. We reflect changes in the values of the S&P 500
Call Options, which fluctuate in relation to changes in policyholder account
balances for these annuities, in net investment income. Premiums paid to
purchase these instruments are deferred and amortized over their term.
During the year ended December 31, 1997, net investment income increased
by $39.4 million as a result of changes in the value of the S&P 500 Call
Options. Such investment income was substantially offset by amounts added to
policyholder account balances
66
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
for annuities and financial products. The value of the S&P 500 Call Options was
$41.4 million at December 31, 1997. We classify such instruments as other
invested assets.
If the counterparties of the aforementioned financial instruments do not
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, 1997, all of the counterparties were
rated "A"or higher by Standard & Poor's Corporation.
In conjunction with its investment in a consumer financing company,
Conseco has guaranteed up to $10.0 million of the financing company's
indebtedness to its primary lender through 1998. Conseco believes the likelihood
of a significant loss from the guarantee is remote.
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.
Short-term investments. We use quoted market prices. The carrying amount
reported on our consolidated balance sheet for these instruments
approximates their estimated fair value.
Mortgage loans, credit-tenant loans and policy loans. We discount future
expected cash flows 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.
Other invested assets. We use quoted market prices, where available. For
other invested assets, which are not material, we have assumed a market
value equal to carrying value.
Other assets. The portion of other assets in 1996 representing the value
attributable to the U.S. Treasury securities held in escrow for the
future redemption of mandatorily redeemable preferred stock of a
subsidiary of ALH are based on quoted market prices. In 1997, the
redeemable preferred stock was redeemed and the securities held in escrow
were released.
Insurance liabilities for investment contracts. We use discounted cash
flow calculations based on interest rates currently being offered for
similar contracts having maturities consistent with the contracts being
valued.
Investment borrowings and notes payable. We use either: (i) discounted
cash flow analyses based on our current incremental borrowing rates for
similar types of borrowing arrangements; or (ii) current market values
for publicly traded debt.
Other liabilities. The portion of other liabilities representing the
value attributable to the conversion features of subordinated convertible
debentures acquired in conjunction with the ATC Merger and the PFS Merger
are valued at estimated fair value.
Company-obligated mandatorily redeemable preferred securities of
subsidiary trusts. We use quoted market prices.
Mandatorily redeemable preferred stock of a subsidiary of ALH (a
component of minority interest). The estimated fair value of redeemable
preferred stock which is publicly-traded is based on quoted market
prices. The estimated fair value of the privately placed redeemable
preferred stock is determined by discounting expected future cash flows
using assumed incremental dividend rates for similar duration securities.
These securities were redeemed in 1997.
67
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
Here are the estimated fair values of our financial instruments:
1997 1996
------------------------ -------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
(Dollars in millions)
Financial assets held for purposes other than trading:
Actively managed fixed maturities...................... $22,773.7 $22,773.7 $17,307.1 $17,307.1
Equity securities ..................................... 228.9 228.9 99.7 99.7
Mortgage loans......................................... 516.2 551.0 356.0 356.1
Credit-tenant loans.................................... 558.6 587.2 447.1 446.3
Policy loans........................................... 692.4 692.4 542.4 542.4
Other invested assets.................................. 453.3 453.3 259.6 259.6
Short-term investments................................. 990.5 990.5 281.6 281.6
Other assets........................................... - - 45.6 49.1
Financial liabilities held for purposes other than trading:
Insurance liabilities for investment contracts (1)..... 12,724.0 12,724.0 11,491.6 11,491.6
Investment borrowings.................................. 1,389.5 1,389.5 383.4 383.4
Other liabilities...................................... 72.6 95.1 145.5 145.5
Commercial paper....................................... 448.2 448.2 - -
Notes payable.......................................... 1,906.7 1,950.6 1,094.9 1,140.8
Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts........... 1,383.9 1,491.6 600.0 604.3
Mandatorily redeemable preferred stock of a subsidiary
(a component of minority interest).................. - - 97.0 97.0
(1) The estimated fair value of the liabilities for investment contracts
was approximately equal to its carrying value at December 31, 1997 and
1996. This was because interest rates credited on the vast majority of
account balances approximate current rates paid on similar investments
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 investment contracts. 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.
Recently Issued Accounting Standards
Statement of Financial Accounting Standards No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"
("SFAS 125") was issued in June 1996 and provides accounting and reporting
standards for transfers of financial assets and extinguishments of liabilities.
SFAS 125 is effective for 1997 financial statements; however, certain provisions
relating to accounting for repurchase agreements and securities lending are not
effective until January 1, 1998. Provisions effective in 1997 did not have any
effect on our financial position or results of operations. The adoption of
provisions effective in 1998 are not expected to have a material effect on our
financial position or results of operations.
Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS 131") establishes new
standards for reporting about operating segments and products and services,
geographic areas and major customers. Under SFAS 131, segments are to be defined
consistent with the basis management uses internally to assess performance and
allocate resources. Implementing SFAS 131 will have no impact on the
consolidated amounts we report, and we do not expect any significant changes to
our segment disclosures. SFAS 131 is effective for our December 31, 1998
financial statements.
Statement of Financial Accounting Standards No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits" ("SFAS 132") was
issued in February 1998 and revises current disclosure requirements for
employers' pensions and other
68
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
retiree benefits. SFAS 132 will have no effect on our financial position or
results of operations. SFAS 132 is effective for our December 31, 1998 financial
statements.
Statement of Position 97-3, "Accounting by Insurance and Other
Enterprises for Insurance-Related Assessments" ("SOP 97-3") was issued by the
American Institute of Certified Public Accountants in December 1997 and provides
guidance for determining when an insurance company or other enterprise should
recognize a liability for guaranty-fund assessments and guidance for measuring
the liability. The statement is effective for 1999 financial statements with
early adoption permitted. The adoption of this statement is not expected to have
a material effect on our financial position or results of operations.
2. ACQUISITIONS/DISPOSITIONS:
CCP Insurance, Inc.
At January 1, 1995, we owned 45 percent of the common stock of CCP, which
was acquired through several separate transactions beginning in 1990. In early
1995, CCP repurchased an additional 2.2 million shares under this program
increasing our ownership interest to 49 percent.
In August 1995, we completed the purchase of all of the shares of common
stock of CCP that we did not previously own. A total of 11.8 million shares were
purchased for $281.8 million (including transaction costs and the cost to settle
outstanding stock options of CCP) in a transaction pursuant to which CCP was
merged with Conseco, with Conseco being the surviving corporation. Income tax
expense was reduced by $8.4 million in the third quarter of 1995 as a result of
the release of deferred income taxes previously accrued on income related to
CCP. Such deferred tax is no longer required because the CCP Merger was
completed without incurring additional tax. We funded the CCP Merger with
available cash and borrowings from our credit facility.
Bankers Life Holding Corporation
At January 1, 1995, we owned 58 percent of the common stock of BLH, which
was acquired in various transactions beginning in 1992. During 1995, we acquired
12.8 million shares of BLH common stock for $262.4 million in open market and
negotiated transactions, increasing our ownership of BLH to 85 percent. Income
tax expense was reduced by $66.5 million in the second quarter of 1995 as a
result of the release of deferred income taxes previously accrued on income
related to BLH. Such deferred tax was no longer required since we were permitted
to file a consolidated tax return with BLH. In addition, BLH repurchased 2.2
million shares of its common stock during 1995 at a cost of $42.1 million,
increasing our ownership interest in BLH to 88 percent as of December 31, 1995.
During the first three months of 1996, BLH repurchased 1.3 million shares of its
common stock at a cost of $27.7 million. As a result of such repurchases,
Conseco's ownership interest in BLH increased to 90.5 percent.
On December 31, 1996, we completed the BLH Merger. Each outstanding share
of BLH common stock not already owned by Conseco was exchanged for 0.7966 of a
share of Conseco common stock. We issued 3.9 million shares of common stock
(including .1 million common equivalent shares in exchange for BLH's outstanding
options) with a value of $123.0 million.
American Life Holdings, Inc.
At January 1, 1995, we owned 27 percent of ALH through our direct
investment and through our investment in Partnership II. On November 30, 1995,
ALH issued 2,142,857 shares of its common stock for $30.0 million (including
$13.2 million paid by Conseco and its subsidiaries) in a private placement
transaction. Eighty percent of the shares were purchased by Partnership II and
the remainder were purchased by the other holders of ALH common stock. The
proceeds from the sale were used to reduce the amount of ALH's outstanding debt.
In accordance with the Partnership II agreement, Conseco earned fees of $.2
million (net of taxes of $.1 million) for services in connection with such
transaction. On September 30, 1996, we repurchased all of the common shares of
ALH we did not already own for $166.0 million in cash in the ALH Stock Purchase.
The Partnership II agreement provided that an additional ownership
interest in ALH would be allocated to Conseco if returns to the limited partners
were in excess of prescribed targets. Upon termination of Partnership II, such
targets were exceeded and the additional ownership interest allocated to Conseco
was recognized as follows: (i) $10.2 million, which represents Conseco's
increased ownership interest in the previously reported net income of
Partnership II, was recorded as a reduction of amounts that would otherwise be
charged to the minority interest; and (ii) $16.6 million was recorded as net
investment gains. Such income of Conseco
69
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
was offset by $16.2 million of expenses incurred in connection with the
realization of the investment gains.
Life Partners Group, Inc.
Effective July 1, 1996, we completed the LPG Merger. Each of the issued
and outstanding shares of LPG common stock was converted into 1.1666 shares of
Conseco common stock. We issued 32.6 million shares of common stock (including
.4 million common equivalent shares issued in exchange for LPG's outstanding
options) with a value of $586.8 million. In connection with the LPG Merger, we
also assumed notes payable of $253.1 million.
The LPG Merger was accounted for under the purchase method of accounting.
Under this method, we allocated the cost to acquire LPG to the assets and
liabilities acquired based on their fair values as of July 1, 1996, and recorded
the excess of the total purchase cost over the fair value of the liabilities we
assumed as goodwill. The LPG Merger did not qualify to be accounted for under
the pooling of interest method in accordance with Accounting Principles Board
Opinion No. 16, Business Combinations ("APB No.16"), because of Conseco's
significant common stock repurchases.
American Travellers Corporation
On December 17, 1996, we completed the ATC Merger. Each outstanding share
of ATC common stock was exchanged for 1.1672 shares of Conseco common stock. We
issued 21.0 million shares of common stock (including .9 million common
equivalent shares issued in exchange for ATC's outstanding options) with a value
of $630.9 million. We also assumed ATC's convertible subordinated debentures,
which are convertible into 7.9 million shares of Conseco common stock with a
value of $248.3 million (of which $102.8 million, representing the principal
amount outstanding, was classified as notes payable and $145.5 million,
representing the additional value attributable to the conversion feature, was
classified as other liabilities).
The ATC Merger was accounted for under the purchase method of accounting
effective December 31, 1996. Under this method, we allocated the cost to acquire
ATC to the assets and liabilities acquired based on fair values as of the date
of the ATC Merger, and reported the excess of the total purchase cost over the
fair value of the assets acquired less the fair value of the liabilities assumed
as goodwill. The ATC Merger did not qualify to be accounted for under the
pooling of interests method in accordance with APB No. 16 because an affiliate
of ATC sold a portion of the Conseco common stock received in the ATC Merger
shortly after the consummation of the ATC Merger.
Transport Holdings Inc.
On December 23, 1996, we completed the THI Merger. Each outstanding share
of THI common stock was exchanged for 2.8 shares of Conseco common stock. We
issued 4.9 million shares of common stock (including .4 million common
equivalent shares issued in exchange for THI's outstanding options and warrants)
with a value of $121.7 million. In addition, pursuant to an exchange offer, all
of THI's convertible notes were exchanged for 4.2 million shares of Conseco
common stock with a value of $106.2 million plus a cash premium of $11.9
million.
The THI Merger was accounted for under the purchase method of accounting
effective December 31, 1996. Under this method, we allocated the cost to acquire
THI to the assets and liabilities acquired based on fair values as of the date
of the THI Merger. There was no goodwill acquired with the THI Merger. The THI
Merger did not qualify to be accounted for under the pooling of interests method
in accordance with APB No. 16 because THI was a subsidiary of another
corporation within two years of the transaction.
Capitol American Financial Corporation
On March 4, 1997, we completed the CAF Merger. Each outstanding share of
CAF common stock was exchanged for $30.75 in cash plus 0.1647 of a share of
Conseco common stock. We paid $552.8 million (including acquisition expenses of
$14.2 million) in cash and issued 3.0 million shares of common stock (including
.1 million common equivalent shares issued in exchange for CAF's outstanding
options) with a value of $117.4 million. In addition, we assumed a $31.0 million
note payable of CAF, which we repaid on the merger date.
The CAF Merger was accounted for under the purchase method of accounting
effective January 1, 1997. Under this method, we allocated the cost to acquire
CAF to the assets and liabilities acquired based on fair values as of the date
of the CAF Merger, and
70
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
reported the excess of the total purchase cost over the fair value of the assets
acquired less the fair value of the liabilities assumed as goodwill.
Pioneer Financial Services, Inc.
On May 30, 1997, we completed the PFS Merger. Each outstanding share of
PFS common stock was exchanged for .7077 of a share of Conseco common stock. We
issued 9.0 million shares of common stock (including .6 million common
equivalent shares issued in exchange for PFS's outstanding options) with a value
of $354.1 million. We also assumed PFS's convertible subordinated notes, which
are convertible into 3.1 million shares of Conseco common stock, with a value of
$130.6 million (of which $86.3 million, representing the principal amount
outstanding, was classified as notes payable and $44.3 million, representing the
additional value attributable to the conversion feature, was classified as other
liabilities). In addition, we assumed a $21.3 million note payable of PFS, which
we repaid on the merger date.
The PFS Merger was accounted for under the purchase method of accounting
effective April 1, 1997. Under this method, we allocated the cost to acquire PFS
to the assets and liabilities acquired based on fair values as of the date of
the PFS Merger, and reported the excess of the total purchase cost over the fair
value of the assets acquired less the fair value of the liabilities assumed as
goodwill. The PFS Merger did not qualify to be accounted for under the pooling
of interests method in accordance with APB No. 16 because an affiliate of PFS
sold a portion of his holdings of PFS common stock after the PFS Merger was
announced.
Colonial Penn
On September 30, 1997, we completed the Colonial Penn Purchase from
Leucadia National Corporation ("Leucadia") for $460.0 million in cash and notes
payable. The Colonial Penn Purchase was funded with: (i) $60.0 million in cash
which was borrowed under our bank credit facility; and (ii) notes payable to
Leucadia (the "Leucadia Notes") totaling $400.0 million.
The Colonial Penn Purchase was accounted for under the purchase method of
accounting effective September 30, 1997. Under this method, we allocated the
cost to acquire Colonial Penn to the assets and liabilities acquired based on
fair values as of the date of the Colonial Penn Purchase, and reported the
excess of the total purchase cost over the fair value of the assets acquired
less the fair value of the liabilities assumed as goodwill.
Washington National Corporation
On December 5, 1997, we completed the WNIC Merger. In the merger, each
share of WNIC common stock was converted into the right to receive $33.25 in
cash. We paid $400.6 million in cash, of which $73.7 million was funded through
a dividend to Conseco from WNIC. The remaining purchase price was funded with
amounts borrowed under our bank credit facilities.
We accounted for the WNIC Merger under the purchase method of accounting
effective December 1, 1997. Under this method, we allocated the cost to acquire
WNIC to the assets and liabilities acquired based on fair values as of the date
of the WNIC Merger, and reported the excess of the total purchase cost over the
fair value of the assets acquired less the fair value of the liabilities assumed
as goodwill.
Effect of Merger Transactions on Consolidated Financial Statements
We used purchase accounting to account for all our acquisitions during
1997, 1996 and 1995. We allocated the total purchase cost of acquisitions
completed in 1997 to the assets and liabilities acquired, based on a preliminary
determination of their fair values. We may adjust this allocation when we make a
final determination of such values (within one year of the acquisition date). We
don't expect any adjustment to be material, however.
The following unaudited pro forma results of operations of the Company
are presented as if the following had occurred as of January 1, 1995: (i) the
LPG Merger; (ii) the call for redemption of Conseco's Series D Convertible
Preferred Stock (the "Series D Call") completed on September 26, 1996; (iii) the
ALH Stock Purchase; (iv) the issuance of $600.0 million of Company-obligated
mandatorily redeemable preferred securities of subsidiary trusts (see note 8);
(v) the ATC Merger; (vi) the THI Merger; (vii) the BLH Merger; (viii) the CCP
Merger; (ix) the increase of Conseco's ownership in BLH to 90.4 percent, as a
result of purchases of BLH common shares in 1995 and 1996; (x) the issuance of
4.37 million shares of Preferred Redeemable Increased Dividend Equity
71
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
Securities, 7% PRIDES Convertible Preferred Stock ("PRIDES") in January 1996;
(xi) the BLH tender offer for and repurchase of its 13 percent senior
subordinated notes due 2002 and related financing transactions completed in
March 1996; and (xii) the debt restructuring of ALH in the fourth quarter of
1995. The pro forma data are not necessarily indicative of the results of
Conseco's operations had these transactions occurred on January 1, 1995, nor the
results of future operations. We have not presented pro forma data for the 1997
acquisitions because, in accordance with the disclosure requirements of the
Securities and Exchange Commission, such acquisitions are not significant
individually or in the aggregate.
1996 1995(1)
---- -------
(Dollars in millions,
except per share data)
Revenues...................................................................................... $3,967.8 $4,031.6
Income before extraordinary charge............................................................ 352.7 314.1
Income before extraordinary charge per common share:
Basic.................................................................................... $2.10 $1.80
Diluted.................................................................................. 1.79 1.63
(1) We have excluded $74.9 million from pro forma income before extraordinary
charge and $.39 from income before extraordinary charge per diluted
common share. These amounts related to the release of deferred income
taxes that are no longer required to be accrued as a result of the CCP
Merger and the purchase of additional BLH common shares in 1995.
3. INVESTMENTS:
At December 31, 1997, the amortized cost and estimated fair value of
actively managed fixed maturities were as follows:
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
(Dollars in millions)
United States Treasury securities and obligations of
United States government corporations and agencies.................. $ 541.4 $ 20.9 $ .1 $ 562.2
Obligations of states and political subdivisions........................ 277.1 8.3 .8 284.6
Debt securities issued by foreign governments........................... 204.3 4.4 9.6 199.1
Public utility securities............................................... 2,267.5 69.0 26.0 2,310.5
Other corporate securities.............................................. 12,300.5 352.9 86.5 12,566.9
Mortgage-backed securities ............................................. 6,698.5 156.0 4.1 6,850.4
--------- ------ ------ ---------
Total actively managed fixed maturities.......................... $22,289.3 $611.5 $127.1 $22,773.7
========= ====== ====== =========
At December 31, 1996, the amortized cost and estimated fair value of
actively managed fixed maturities were as follows:
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
(Dollars in millions)
United States Treasury securities and obligations of
United States government corporations and agencies.................. $ 509.9 $ 5.1 $ 1.2 $ 513.8
Obligations of states and political subdivisions........................ 103.5 2.8 .2 106.1
Debt securities issued by foreign governments........................... 144.4 1.4 2.2 143.6
Public utility securities............................................... 2,148.8 42.8 35.4 2,156.2
Other corporate securities.............................................. 8,808.3 145.1 81.2 8,872.2
Mortgage-backed securities ............................................. 5,488.4 64.5 37.7 5,515.2
--------- ------ ------ ---------
Total actively managed fixed maturities.......................... $17,203.3 $261.7 $157.9 $17,307.1
========= ====== ====== =========
72
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
At December 31, 1997, the amortized cost and estimated fair value of
actively managed fixed maturities based upon the pricing source used to
determine estimated fair value were as follows:
Estimated
Amortized fair
cost value
---- -----
(Dollars in millions)
Nationally recognized pricing services............................................................ $18,272.9 $18,703.7
Broker-dealer market makers....................................................................... 1,808.9 1,831.8
Internally developed methods (calculated based on a weighted-average
current market yield of 7.0 percent)........................................................... 2,207.5 2,238.2
--------- ---------
Total actively managed fixed maturities.................................................... $22,289.3 $22,773.7
========= =========
The following table sets forth fixed maturity investments at December 31,
1997, classified by rating categories. The category assigned is the highest
rating by a nationally recognized statistical rating organization or, as to
$651.2 million fair value of fixed maturities not rated by such firms, the
rating assigned by the National Association of Insurance Commissioners ("NAIC").
For purposes of the table, NAIC Class 1 is included in the "A" rating; Class 2,
"BBB-"; Class 3, "BB-"; and Classes 4-6, "B+ and below."
Percent of Percent of
Investment rating fixed maturities total investments
----------------- ---------------- -----------------
AAA.................................. 35% 29%
AA................................... 8 7
A.................................... 24 20
BBB+................................. 8 7
BBB.................................. 11 9
BBB- ................................ 7 6
----- ---
Investment grade................. 93 78
----- ---
BB+.................................. 2 2
BB................................... 1 1
BB-.................................. 1 1
B+ and below......................... 3 2
----- ---
Below-investment grade............ 7 6
----- ---
Total fixed maturities........ 100% 84%
=== ==
The following table sets forth below-investment-grade fixed maturity
investments as of December 31, 1997, summarized by the amount their amortized
cost exceeds fair value:
Estimated
Amortized fair
cost value
---- -----
(Dollars in millions)
Amortized cost exceeds fair value by 30% or more.................................................$ 9.5 $ 4.7
Amortized cost exceeds fair value by 15%, but less than 30%...................................... 141.3 110.0
Amortized cost exceeds fair value by 5%, but less than 15%....................................... 158.7 142.3
All others....................................................................................... 1,215.6 1,239.2
-------- --------
Total below-investment-grade fixed maturity investments................................... $1,525.1 $1,496.2
======== ========
73
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
The following table sets forth the amortized cost and estimated fair
value of actively managed fixed maturities at December 31, 1997, 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 and because most mortgage-backed securities provide for
periodic payments throughout their lives.
Estimated
Amortized fair
cost value
---- -----
(Dollars in millions)
Due in one year or less......................................................................... $ 238.9 $ 239.8
Due after one year through five years........................................................... 2,243.1 2,264.7
Due after five years through ten years.......................................................... 5,481.4 5,539.5
Due after ten years............................................................................. 7,627.4 7,879.3
--------- ---------
Subtotal................................................................................... 15,590.8 15,923.3
Mortgage-backed securities...................................................................... 6,698.5 6,850.4
--------- ---------
Total actively managed fixed maturities ................................................ $22,289.3 $22,773.7
========= =========
Equity securities consisted of the following:
December 31, 1997 December 31, 1996
-------------------- --------------------
Estimated Estimated
fair fair
Cost value Cost value
---- ----- ---- -----
(Dollars in millions)
Preferred stock, non-redeemable.......................................... $149.3 $152.5 $64.7 $66.3
Common stock............................................................. 78.3 76.4 32.9 33.4
------ ------ ------ -----
Total equity securities........................................... $227.6 $228.9 $97.6 $99.7
====== ====== ===== =====
Net investment income consisted of the following:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Fixed maturities..................................................................... $1,467.5 $1,109.5 $ 988.6
Equity securities.................................................................... 23.6 6.5 2.8
Mortgage loans....................................................................... 39.5 42.6 43.3
Credit-tenant loans.................................................................. 44.5 28.8 19.7
Policy loans......................................................................... 38.6 25.9 19.4
Equity-indexed products.............................................................. 39.4 - -
Other invested assets................................................................ 74.8 27.8 17.5
Short-term investments............................................................... 39.6 15.6 26.4
Separate accounts.................................................................... 70.3 48.4 28.8
-------- -------- --------
Gross investment income........................................................ 1,837.8 1,305.1 1,146.5
Investment expenses.................................................................. 12.5 2.6 3.9
-------- -------- --------
Net investment income.......................................................... $1,825.3 $1,302.5 $1,142.6
======== ======== ========
The carrying value of fixed maturity investments and mortgage loans not
accruing investment income totaled $3.1 million, $2.1 million and $1.5 million
at December 31, 1997, 1996 and 1995, respectively.
74
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
The proceeds from sales of fixed maturity investments were $18.1 billion
in 1997, $8.2 billion in 1996, and $7.9 billion in 1995.
Investment gains (losses), net of investment gain expenses, were included
in revenue as follows:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Fixed maturities:
Gross gains......................................................................... $342.6 $126.8 $270.8
Gross losses........................................................................ (41.4) (52.5) (17.5)
Other than temporary decline in fair value.......................................... (1.2) (.6) (21.9)
------ ------ ------
Net investment gains from fixed maturities before expenses..................... 300.0 73.7 231.4
Equity securities....................................................................... 13.2 2.6 .4
Mortgages............................................................................... (.8) (.4) (2.1)
Other than temporary decline in fair value of other invested assets..................... - (8.3) (3.0)
Other................................................................................... (1.2) 29.9 13.9
------ ------ ------
Net investment gains before expenses........................................... 311.2 97.5 240.6
Investment gain expenses................................................................ 44.7 36.7 36.5
------ ------ ------
Net investment gains........................................................... $266.5 $ 60.8 $204.1
====== ======= ======
Changes in unrealized appreciation (depreciation) on investments were as
follows:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Investments carried at fair value:
Actively managed fixed maturities .................................................. $380.6 $(504.4) $981.6
Equity securities................................................................... (.8) .1 5.4
Other investments................................................................... 9.6 (2.2) (2.7)
------ ------- -------
389.4 (506.5) 984.3
Equity in unrealized appreciation of CCP's investments.................................. - - 46.2
Adjustment for effect on other balance sheet accounts:
Cost of policies purchased ......................................................... (128.4) 141.6 (269.6)
Cost of policies produced........................................................... (36.4) 45.4 (56.7)
Other............................................................................... (4.4) - -
Income taxes........................................................................ (77.1) 116.4 (246.5)
Minority interest................................................................... - 129.3 (205.3)
------ ------- -------
Change in unrealized appreciation (depreciation) of investments ............... $143.1 $ (73.8) $ 252.4
====== ======= =======
At December 31, 1997, net appreciation of equity securities (before
income tax) was $1.3 million, consisting of $7.3 million of appreciation and
$6.0 million of depreciation.
At December 31, 1997, the amortized cost and fair value of fixed maturity
investments in default as to the payment of principal and interest totaled $2.4
million and $1.5 million, respectively. Conseco recorded writedowns of fixed
maturity investments and other invested assets of $1.2 million in 1997, $8.9
million in 1996 and $24.9 million in 1995. These writedowns were the result of
changes in conditions that caused the Company to conclude that the decline in
fair value of the investment was other than temporary. Investment income forgone
due to defaulted securities was $.2 million in 1997, $3.8 million in 1996 and
$1.6 million in 1995.
75
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
Investments in mortgage-backed securities at December 31, 1997, included
collateralized mortgage obligations ("CMOs") of $3,210.2 million and
mortgage-backed pass-through securities of $3,640.2 million. CMOs are securities
backed by pools of pass-through securities and/or mortgages that are segregated
into sections or "tranches." These securities provide for sequential retirement
of principal, rather than the pro rata share of principal return that occurs
through regular monthly principal payments on pass-through securities.
The following table sets forth the par value, amortized cost and
estimated fair value of investments in mortgage-backed securities including CMOs
at December 31, 1997, summarized by interest rates on the underlying collateral:
Par Amortized Estimated
value cost fair value
----- ---- ----------
(Dollars in millions)
Below 7 percent .................................................................... $2,025.5 $1,980.4 $2,014.7
7 percent - 8 percent............................................................... 3,568.0 3,546.5 3,638.2
8 percent - 9 percent............................................................... 712.9 716.1 730.5
9 percent and above................................................................. 445.1 455.5 467.0
-------- -------- --------
Total mortgage-backed securities.................................. $6,751.5 $6,698.5 $6,850.4
======== ======== ========
The amortized cost and estimated fair value of mortgage-backed securities
including CMOs at December 31, 1997, 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................ $4,599.7 $4,697.5 21%
Planned amortization classes and accretion directed bonds..................... 1,515.9 1,547.6 7
Support classes............................................................... 36.0 36.9 -
Accrual (Z tranche) bonds..................................................... 27.9 28.8 -
Subordinated classes ......................................................... 519.0 539.6 2
-------- -------- --
Total mortgage-backed securities............................. $6,698.5 $6,850.4 30%
======== ======== ==
At December 31, 1997, approximately 73 percent of the estimated fair
value of Conseco's mortgage-backed securities was determined by nationally
recognized pricing services, 8 percent was determined by broker-dealer market
makers, and 19 percent was determined by internally developed methods. The
call-adjusted modified duration of our mortgage-backed securities was 5.2 years
at December 31, 1997.
At December 31, 1997, the mortgage loan balance was primarily comprised
of commercial loans, including multifamily residential loans. Approximately 20
percent, 11 percent and 9 percent of the mortgage loan balance were on
properties located in California, Texas and Florida, respectively. No other
state comprised greater than 7 percent of the mortgage loan balance. Less than 2
percent of the mortgage loan balance was noncurrent at December 31, 1997. At
December 31, 1997, the Company had an allowance for loss on mortgage loans of
$9.0 million.
At December 31, 1997, we held $558.6 million of CTLs. CTLs are mortgage
loans for commercial properties that we make based on the underwriting
guidelines described in note 1. We classify CTLs as a separate class of
securities because they are principally underwritten based on the
creditworthiness of the tenant rather than the value of the underlying property.
As with commercial mortgages, CTLs are additionally collateralized by liens on
the underlying property.
As part of its investment strategy, the Company enters into reverse
repurchase agreements and dollar-roll transactions to increase its return on
investments and improve its liquidity. Reverse repurchase agreements involve a
sale of securities and an
76
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
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 only
substantially the same as the securities sold. These transactions are accounted
for as short-term collateralized borrowings. Such borrowings averaged
approximately $719.3 million during 1997 (compared with an average of $424.7
million during 1996) and 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 5.8 percent in 1997 and 5.2 percent
in 1996. The primary risk associated with short-term collateralized borrowings
is that the counterparty will be unable to perform under the terms of the
contract. The Company's 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, 1997). The Company believes that the counterparties
to its reverse repurchase and dollar-roll agreements are financially responsible
and that the counterparty risk is minimal.
Other invested assets include: (i) trading securities of $64.8 million;
(ii) S&P 500 Call Options issued in conjunction with equity-indexed annuities
described in note 1 of $41.4 million; and (iii) certain non-traditional
investments, including investments in venture capital funds, limited
partnerships, mineral rights and promissory notes of $411.9 million. During
1996, Conseco sold its non-traditional investment in Noble Broadcast Group, Inc.
and realized a gain of $30.0 million. During 1995, Conseco sold its
non-traditional investment in Eagle Credit (a finance subsidiary of
Harley-Davidson) and realized a gain of $20.6 million.
Life insurance companies are required to maintain certain investments on
deposit with state regulatory authorities. Such assets had an aggregate carrying
value of $202.5 million at December 31, 1997.
Conseco had no investments in any single entity in excess of 10 percent
of shareholders' equity at December 31, 1997, other than investments issued or
guaranteed by the United States government or a United States government agency.
4. INSURANCE LIABILITIES:
Insurance liabilities consisted of the following:
Interest
Withdrawal Mortality rate
assumption assumption assumption 1997 1996
---------- ---------- ---------- ---- ----
(Dollars in millions)
Future policy benefits:
Interest-sensitive products:
Investment contracts............................ N/A N/A (c) $12,724.0 $11,491.6
Universal life-type contracts................... N/A N/A 5% 4,633.6 3,303.9
--------- ---------
Total interest-sensitive products............. 17,357.6 14,795.5
--------- ---------
Traditional products:
Traditional life insurance contracts............ Company (a) 4% 1,925.0 1,234.7
experience
Limited-payment contracts....................... None (b) 6% 968.4 761.5
Individual accident and health ................. Company Company 6% 2,820.4 1,184.0
experience experience
Group life and health........................... N/A N/A N/A 71.0 71.3
--------- ---------
Total traditional products.................... 5,784.8 3,251.5
--------- ---------
Claims payable and other policyholder funds ........ N/A N/A N/A 1,668.8 984.9
Unearned premiums................................... N/A N/A N/A 406.1 272.4
Liabilities related to separate accounts............ N/A N/A N/A 682.8 337.6
--------- ---------
Total insurance liabilities..................... $25,900.1 $19,641.9
========= =========
(a) Principally modifications of the 1965 - 70 and 1975 - 80 Basic, Select
and Ultimate Tables.
77
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
(b) Principally the 1984 United States Population Table and the NAIC 1983
Individual Annuitant Mortality Table.
(c) In both 1997 and 1996: (i) approximately 95 percent of this liability
represented account balances where future benefits are not guaranteed;
and (ii) 5 percent represented the present value of guaranteed future
benefits determined using an average interest rate of approximately 5
percent.
Participating policies represented approximately 2 percent, 2 percent and
12 percent of total life insurance in force at December 31, 1997, 1996 and 1995,
respectively. Participating policies represented approximately 2 percent, 1
percent and 1 percent of premium income for the years ended December 31, 1997,
1996 and 1995, respectively. Dividends on participating policies amounted to
$13.0 million, $13.4 million and $12.3 million in 1997, 1996 and 1995,
respectively.
5. REINSURANCE:
Cost of reinsurance ceded where the reinsured policy contains mortality
risks totaled $499.0 million, $313.8 million and $72.6 million in 1997, 1996 and
1995, respectively. This cost was deducted from insurance premium revenue.
Conseco is contingently liable for claims reinsured if the assuming company is
unable to pay. Reinsurance recoveries netted against insurance policy benefits
totaled $587.5 million, $281.4 million, and $59.8 million in 1997, 1996 and
1995, respectively.
The Company has ceded certain policy liabilities under assumption
reinsurance agreements. Since all of Conseco's obligations under these insurance
contracts have been ceded to another company, insurance liabilities related to
such policies were not reported in the balance sheet. We believe the assuming
companies are able to honor all contractual commitments under the assumption
reinsurance agreements, based on our periodic reviews of financial statements,
insurance industry reports and reports filed with state insurance departments.
The Company's reinsurance receivable at December 31, 1997, relates to
approximately 181 reinsurers. Two major United States insurance companies rated
"A (Excellent)" or better by A.M. Best Company, a recognized insurance rating
agency, account for approximately 19 percent of such balance. Each of our other
reinsurers (the majority of which are rated "A- (Excellent)" or better) accounts
individually for less than 4 percent of reinsurance receivables.
6. INCOME TAXES:
Income tax assets (liabilities) were comprised of the following:
1997 1996
---- ----
(Dollars in millions)
Deferred income tax assets (liabilities):
Investments................................................................................... $ (95.9) $ 52.2
Cost of policies purchased and cost of policies produced...................................... (750.5) (573.7)
Insurance liabilities......................................................................... 898.9 474.0
Unrealized appreciation....................................................................... (98.1) (21.0)
Net operating loss carryforward............................................................... 258.0 154.4
Other......................................................................................... (136.6) (87.6)
-------- --------
Deferred income tax assets (liabilities)................................................ 75.8 (1.7)
Current income tax assets ........................................................................ 9.8 10.5
-------- --------
Income tax assets....................................................................... $ 85.6 $ 8.8
======== ========
Income tax expense was as follows:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Current tax provision......................................................................... $174.0 $110.5 $121.0
Deferred tax provision (benefit).............................................................. 202.6 69.3 (34.0)
------ ------ ------
Income tax expense................................................................ $376.6 $179.8 $ 87.0
====== ====== ======
78
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
Income tax expense differed from that computed at the applicable federal
statutory rate (35 percent) for the following reasons:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Tax on income before income taxes at statutory rate........................................... $351.1 $172.8 $146.5
Goodwill ............................................................................... 29.6 12.3 7.9
State taxes................................................................................... 12.4 7.3 .3
Other......................................................................................... (16.5) (12.6) 7.2
Reversal of deferred tax liabilities as a result of increased ownership
in certain subsidiaries...................................................................... - - (74.9)
------ ------ -------
Income tax expense................................................................ $376.6 $179.8 $ 87.0
====== ====== =======
At December 31, 1997, Conseco had federal income tax loss carryforwards
of $737.1 million available (subject to various statutory restrictions) for use
on future tax returns. Portions of these carryforwards begin expiring in 1999.
Of the loss carryforwards: (i) $25.3 million may be used only to offset income
from the non-life insurance companies and, under certain circumstances, a
portion of the income of life insurance companies; and (ii) $77.5 million are
attributable to acquired companies and may be used only to offset the income
from those companies. None of the carryforwards are available to reduce the tax
provision for financial reporting purposes. With respect to determining that the
Company's net operating loss carryforwards will be fully utilized, the Company
is relying upon its past history of earnings.
The IRS has completed its examination of Conseco's consolidated tax
returns for years through 1994 and is currently conducting an examination for
years 1995 through 1996. Certain companies acquired in the LPG Merger have been
audited by the IRS through 1994. Colonial Penn Life Insurance Company is
currently being examined for the tax years 1992 and 1993. Conseco believes the
adjustment, if any, related to these audits will not be significant.
7. NOTES PAYABLE AND COMMERCIAL PAPER:
Notes payable and commercial paper of the Company at December 31, 1997
and 1996, were as follows:
Interest rate 1997 1996
------------- ---- ----
(Dollars in millions)
Bank debt............................................................ 6.23% (1) $1,000.0 (2) $ 465.0
Leucadia Notes....................................................... 6.44% (1) 400.0 -
Senior notes due 2003................................................ 8.125% 168.5 170.0
Senior notes due 2004................................................ 10.5% 184.9 200.0
Subordinated notes due 2004.......................................... 11.25% 10.9 98.1
Convertible subordinated notes due 2003.............................. 6.5% 86.1 -
Convertible subordinated debentures due 2005......................... 6.5% 29.1 102.8
Other................................................................Various 21.3 45.2
-------- --------
Total principal amount.......................................... 1,900.8 1,081.1
Unamortized net premium.............................................. 5.9 13.8
-------- --------
Total........................................................... $1,906.7 $1,094.9
======== ========
Commercial paper..................................................... 5.8% (3) $ 448.2 -
======== ========
(1) Current rate at December 31, 1997.
(2) See note 15 for description of $248.0 million repayment in 1998 using
proceeds from the offering of 6.4 percent notes due February 10, 2003.
(3) Weighted average rate during 1997.
79
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
Maturities of notes payable at December 31, 1997, were as follows:
Maturity date Amount
------------- ------
(Dollars in millions)
1998....................................................................... $ 601.1 (1)
1999....................................................................... 1.1
2000....................................................................... 1.1
2001....................................................................... 401.1
2002....................................................................... 2.0
Thereafter................................................................. 894.4
--------
Total par value at December 31, 1997.................................. $1,900.8
========
(1) See note 15 for description of $248.0 million repayment in 1998 using
proceeds from the offering of 6.4 percent notes due February 10, 2003.
Bank debt. Bank debt is comprised of our revolving bank credit facility
and various bank loans described below.
The Company's current revolving credit agreement (the "Credit Facility"),
executed in November 1996, permits borrowings up to $1.4 billion. Maximum
permitted borrowings under the Credit Facility are reduced by any aggregate
outstanding commercial paper of Conseco. At December 31, 1997, outstanding
borrowings under the Credit Facility totaled $400.0 million. Borrowings bear
interest at the bank's base rate, a Eurodollar rate or a rate determined based
on a solicitation of bids from lenders. Eurodollar rates are equal to the
reserve-adjusted LIBOR rate plus a margin of .225 percent to .75 percent, based
on the credit rating of Conseco's senior notes. The current margin of .35
percent will increase by .125 percent after December 31, 1997, if Conseco's debt
to total capitalization ratio exceeds 35 percent. Borrowings at December 31,
1997, bore interest at a weighted average rate of 6.21 percent. The Credit
Facility also permits revolving Swingline loans up to $50.0 million. Such loans
are due within 7 days and bear interest at the bank's base rate or a reserve
adjusted three-month CD rate plus the Eurodollar rate margin and an assessment
rate.
Borrowings are due in November 2001. Mandatory prepayments, which reduce
the maximum permitted borrowings, are required under the Credit Facility upon
the sale or disposition of any significant assets other than in the ordinary
course of business. The Credit Facility contains various restrictive covenants
that primarily pertain to levels of indebtedness, limitations on payment of
dividends, limitations on the quality and types of investments, and capital
expenditures. Additionally, the Company must comply with several financial
covenant restrictions, including maintaining: (i) shareholders' equity and
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts in excess of $2.4 billion in 1997 and 1998 and $3.5 billion thereafter;
(ii) the interest coverage ratio in excess of 2.5:1 through December 1997
(escalating to 2.75:1 during the period January 1, 1998 through December 31,
1999; and 3.0:1 thereafter); and (iii) the debt to total capital ratio less than
.45:1. As of December 31, 1997 the Company was in compliance with all covenants
under its debt agreements.
On the last day of each quarter, we pay a commitment fee that ranges from
.08 percent to .25 percent per annum (depending on the credit rating of
Conseco's senior debt) on the average daily unused commitments during the
quarter. This fee was .125 percent per annum during 1997.
During 1997, Conseco entered into various unsecured bank loans totaling
$600 million. The proceeds from such bank loans were used: (i) to finance the
WNIC Merger; (ii) to finance a portion of the Colonial Penn Purchase; (iii) to
redeem all of the $2.16 Redeemable Cumulative Preferred Stock of a subsidiary
formerly held by minority interest; and (iv) for general corporate purposes. The
interest rates on these bank loans are based on LIBOR and averaged 6.25 percent
at December 31, 1997. These bank loans mature at various dates through September
1998.
We recognized an extraordinary loss of $12.9 million during 1996 (net of
a $7.0 million tax benefit) as a result of prepaying our prior bank credit
agreements and the bank credit agreements of BLH and ALH.
Leucadia Notes. Conseco entered into these notes in conjunction with the
Colonial Penn Purchase. The notes bear interest
80
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
at the one month LIBOR rate plus a margin of .50 percent payable semi-annually
on March 31 and September 30. Such rate was 6.44 percent at December 31, 1997.
The notes mature on January 2, 2003 and may be put back to Conseco by the holder
at any time after December 31, 1997, in the event that: (i) all or substantially
all of Leucadia's assets are sold; or (ii) there is an acquisition of beneficial
ownership of 20 percent or more of Leucadia's voting securities. In addition,
the notes are putable (in whole or in increments of $10 million of par value) at
any time on or after September 30, 1999, at a discount to par. The discount rate
is equal to (i) 3 percent of the then outstanding principal balance during the
period September 30, 1999, through September 29, 2000; (ii) 2 percent of the
then outstanding principal balance during the period September 30, 2000, through
September 29, 2001; and (iii) 1 percent of the then outstanding principal
balance thereafter prior to maturity. The notes and accrued interest thereon are
secured by standby letters of credit totaling $420.0 million which Conseco may
use to fund redemption of the notes. Such letters of credit expire on September
30, 1998, but may be extended in one-year increments through 2003. The Company
pays a fee on the letters of credit based upon the credit rating of Conseco's
senior debt. At December 31, 1997, such fee was .20 percent per annum on the
$420.0 million of outstanding letters of credit.
8.125% senior notes due 2003 were issued to the public in 1993, are
unsecured and rank pari passu with all other unsecured and unsubordinated
indebtedness of the Company. The notes are not redeemable prior to maturity. We
recognized an extraordinary charge of $.1 million during 1997 as a result of
repurchasing $1.5 million par value of these notes.
10.5% senior notes due 2004 were issued to the public by CCP in 1994, are
unsecured and rank pari passu with all other unsecured and unsubordinated
indebtedness of Conseco. The notes are not redeemable prior to maturity. We
recognized an extraordinary charge of $1.2 million (net of a $.6 million tax
benefit) during 1997 as a result of repurchasing $15.1 million par value of
these notes.
11.25% senior subordinated notes due 2004 were issued to the public by
ALH in conjunction with its acquisition by Partnership II. Such notes are
unsecured and will be subordinated in the right of payment to the prior payment
in full of all senior indebtedness. The notes are redeemable at the Company's
option, in whole or in part, at any time on or after September 15, 1999,
initially at 105.625 percent of their principal amount, plus accrued interest,
declining to 100 percent of their principal amount, plus accrued interest, on
and after September 15, 2001. We recognized an extraordinary charge of $5.6
million (net of a $3.0 million tax benefit) during 1997 as a result of
repurchasing $87.2 million par value of these notes. We recognized an
extraordinary charge of $4.2 million (net of a $2.3 million tax benefit) during
1996 as a result of repurchasing $51.9 million par value of these notes.
6.5% convertible subordinated notes due 2003 were acquired in conjunction
with the PFS Merger and bear interest at 6.5 percent payable semi-annually on
April 1 and October 1. The notes are redeemable by Conseco, under certain
conditions, at 103.3 percent of par value after April 1999 under certain
conditions. The notes are convertible into Conseco common stock any time prior
to maturity at a conversion rate of 35.38 Conseco common shares per $1,000
principal amount of notes. During 1997, $.2 million par value of the notes were
converted into 6,613 shares of Conseco common stock. At December 31, 1997, the
value of the remaining debentures in excess of the principal balance (the value
attributable to the conversion feature) of $34.4 million is included in other
liabilities.
6.5% convertible subordinated debentures due 2005 were acquired in
conjunction with the ATC Merger and are convertible into Conseco common stock at
any time prior to maturity, at a conversion ratio of 76.96 shares of Conseco
common stock for each $1,000 principal amount of debentures. The convertible
debentures may be redeemed at Conseco's option at a price equal to 103.25
percent after October 1998, declining to 100 percent after October 2001. During
1997, we induced the conversion of $64.8 million par value of the debentures
into 5.0 million shares of Conseco common stock. Conseco paid $4.4 million to
induce the holders to convert. In addition, during 1997, Conseco repurchased
$7.5 million par value of the debentures for $24.8 million. An additional $1.4
million par value of the debentures was converted into .1 million shares of
Conseco common stock at the option of the holders during 1997. At December 31,
1997, the value of the remaining debentures in excess of the principal balance
(the value attributable to the conversion feature) of $38.2 million is included
in other liabilities.
Other debt. During the third quarter of 1997, we repurchased or called
for redemption the remaining $23.2 million par value of 12.75 percent senior
subordinated notes due 2002. Such notes had been assumed in connection with the
LPG Merger.
81
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
In March 1996, BLH completed a tender offer in which it repurchased
$148.3 million principal balance of its senior subordinated notes. In addition,
Conseco repurchased $28.5 million of such notes during 1996. Conseco recognized
an extraordinary charge of $9.0 million (net of a $4.9 million tax benefit)
related to such repurchases.
In conjunction with the LPG Merger and the THI Merger, Conseco repaid
acquired debt in 1996 of $214.5 million and $78.5 million, respectively. Conseco
also repurchased other debt of $65.8 million during 1996. Conseco recognized an
extraordinary charge of $.4 million (net of $.2 million tax benefit) related to
such repurchases.
Conseco recognized extraordinary charges of $2.1 million (net of a $1.5
million tax benefit) in 1995 related to the repayment of notes payable.
Commercial paper. We instituted a commercial paper program in April 1997
to lower our borrowing costs and improve our liquidity. Borrowings under our
commercial paper program averaged approximately $525.9 million during the period
April 24, 1997 through December 31, 1997. The weighted average interest rate on
such borrowings was 5.8 percent during 1997. Conseco's commercial paper has
maturities ranging from 2 to 37 days. However, the Company has the ability to
refinance such obligations through its bank credit facility.
8. OTHER DISCLOSURES:
Leases
The Company rents office space, equipment and computer software under
noncancellable operating leases. Rental expense was $35.1 million in 1997, $21.3
million in 1996 and $20.8 million in 1995. Future required minimum rental
payments as of December 31, 1997, were as follows (dollars in millions):
1998.......................... $ 24.3
1999.......................... 21.1
2000.......................... 19.2
2001.......................... 17.7
2002.......................... 16.3
Thereafter.................... 55.5
------
Total................... $154.1
======
Employment Arrangements
Some officers of the Company are employed under long-term employment
agreements. One of these agreements provides for a base salary plus an annual
bonus equal to 3 percent of the Company's consolidated defined pretax profits.
This contract was modified to permit a reduction in such bonus amount for 1997.
This agreement renews annually for a five-year period unless either party
notifies the other, in which case the agreement expires five years from the last
renewal date. In addition, a $1.9 million interest-free loan has been granted to
the officer. Repayment is due two years after termination of the officer's
employment contract.
The agreements described above also include provisions under which the
employees may elect to receive, in the event of a termination of the agreement
following a change in control of the Company (as defined), a severance allowance
equal to 60 months' salary, bonus and other benefits. The employee also may
elect to have the Company purchase all Conseco stock and all options to purchase
Conseco stock, without deduction of the applicable exercise prices, held by such
person at a price per share equal to the highest market price in the preceding
six months.
The Company has qualified defined contribution plans in which
substantially all employees are eligible to participate. Company contributions,
which match certain voluntary employee contributions to the plan, totaled $3.8
million in 1997, $2.0 million in 1996, and $2.2 million in 1995. These
contributions may be made either in cash or in Conseco common stock.
The Company also has a stock bonus and deferred compensation program for
certain officers and directors. Company contributions vary based on the
profitability of the Company. Each year's contribution, which is fully funded in
the form of Conseco
82
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
common stock, vests five years later or upon certain other events. The cost of
the program is charged to expense over the vesting period and amounted to $14.4
million in 1997 ($10.3 million of which is a nonrecurring charge due to the
death of an executive officer), $3.9 million in 1996 and $3.7 million in 1995.
The market value of Conseco common stock held under the program (included in
other assets and other liabilities) was $158.0 million and $101.7 million at
December 31, 1997 and 1996, respectively.
The Company has a noncontributory, unfunded deferred compensation plan
for qualifying members of Bankers Life's 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 $37.3
million and $34.5 million at December 31, 1997 and 1996, respectively.
Substantially all of this liability represents vested benefits. Costs incurred
on this plan, primarily representing interest on unfunded benefit costs, were
$3.4 million, $3.2 million and $2.8 million during 1997, 1996 and 1995,
respectively.
The Company also provides certain health care and life insurance benefits
for eligible retired employees of certain subsidiaries under partially funded
and unfunded plans in existence at the date on which such subsidiaries were
acquired. Benefits under the plans are provided on a contributory basis. Some of
the benefits provided are subject to cost-sharing features determined at the
discretion of management. Amounts related to the postretirement benefit plans
(which increased in 1997 as a result of acquisitions) are as follows:
1997 1996
---- ----
(Dollars in millions)
Accumulated postretirement benefit obligations:
Retirees, dependents and disabled participants.................... $23.1 $ 1.9
Fully eligible active plan participants........................... 2.1 4.6
Other active participants......................................... .5 .6
----- ----
Total accumulated postretirement benefit obligations............ 25.7 7.1
Unrecognized net reduction in prior service cost.................... 1.6 2.8
Fair value of assets held for partially funded plan................. (5.9) -
----- ----
Accrued liability included in other liabilities................. $21.4 $9.9
===== ====
The weighted average rate used in determining the accumulated
postretirement benefit obligations under the plans was 7.25 percent. The
weighted average after-tax expected rate of return on plan assets was 4.60
percent. The health care cost trend rate in 1997 was 11.1 percent for pre-age 65
and 9.3 percent for post-age 65 participants, graded evenly to 5.0 percent in 13
years. Increasing the trend rate by 1 percent would increase the accumulated
postretirement benefit obligation by $1.5 million at December 31, 1997 (for
plans without employer's maximum cost sharing provisions).
Litigation
The Company and its subsidiaries are involved in lawsuits related to their
operations. In most cases, such lawsuits involve claims under insurance policies
or other contracts of the Company. None of the lawsuits currently pending,
either individually or in the aggregate, is expected to have a material effect
on the Company's consolidated financial condition, cash flows or results of
operations.
Guaranty Fund Assessments
From time to time, mandatory assessments are levied on the Company's
insurance subsidiaries by life and health guaranty associations of most states
in which these subsidiaries are licensed. These assessments are to cover losses
to policyholders of insolvent or rehabilitated insurance companies. The
associations levy assessments (up to prescribed limits) on all insurers in a
particular state in order to pay claims on the basis of the proportionate share
of premiums written by insurers in the lines of business in which the insolvent
or rehabilitated insurer is engaged. These assessments may be deferred or
forgiven in certain states if they would threaten an insurer's financial
strength and, in some states, these assessments can be partially recovered
through a reduction in future premium taxes. The balance sheet at December 31,
1997, includes accruals of $16.9 million, which approximate the Company's
estimate of: (i) all known assessments that will be levied against the Company's
insurance subsidiaries by various state guaranty associations based
83
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
on premiums that have been written through December 31, 1997; less (ii) amounts
that would be recoverable through a reduction in future premium taxes as a
result of such assessments. Such estimate is subject to change as the
associations determine more precisely the losses that have occurred and how such
losses will be allocated to insurance companies. The Company's cost for such
assessments incurred by its insurance company subsidiaries was $3.7 million in
1997, $4.0 million in 1996 and $3.2 million in 1995.
Minority Interest
Minority interest represents the interest of investors other than Conseco
in its subsidiaries. Minority interest at December 31, 1997, includes: (i)
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts with a carrying value of $1,383.9 million; and (ii) $.7 million interest
in the common stock of a subsidiary of ALH. Minority interest at December 31,
1996, included: (i) $600.0 million par value of Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts; (ii) $97.0 million
interest in the redeemable preferred stock of a subsidiary of ALH; and (iii) $.7
million interest in the common stock of a subsidiary of ALH.
Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary
Trusts
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts at December 31, 1997, were as follows :
Estimated
Amount Carrying fair
outstanding value value
----------- ----- -----
(Dollars in millions)
9.16% Trust Originated Preferred Securities ("TOPrS")................. $ 275.0 $ 275.0 $ 284.6
8.70% Capital Trust Pass-through Securities ("TruPS")................. 325.0 325.0 359.2
8.796% Capital Securities............................................. 300.0 300.0 335.3
FELINE PRIDES......................................................... 500.0 483.9 512.5
-------- -------- --------
$1,400.0 $1,383.9 $1,491.6
======== ======== ========
On November 19, 1996, Conseco Financing Trust I ("Trust I"), a wholly
owned subsidiary of Conseco, issued 11 million of the TOPrS at $25 per security.
Each TOPrS security pays cumulative cash distributions at the annual rate of
9.16 percent of the stated $25 liquidation amount per security, payable
quarterly. The TOPrS are fully and unconditionally guaranteed by Conseco.
Proceeds from the offering of $266.1 million (after underwriting and associated
costs) were used by the trust to purchase a subordinated debenture from Conseco.
Conseco then used the net proceeds to repay bank debt. Conseco has the right to
redeem the securities at any time, in whole or in part, on or after November 19,
2001, at the principal amount plus accrued and unpaid interest. The securities
are subordinated to all senior indebtedness of Conseco and mature on November
30, 2026. Conseco may extend the maturity date by one or more periods, but in no
event later than November 30, 2045. The terms of the TOPrS parallel the terms of
Conseco's debentures held by Trust I, which debentures account for substantially
all of the assets of Trust I.
On November 27, 1996, Conseco Financing Trust II ("Trust II"), a wholly
owned subsidiary of Conseco, issued 325,000 of the TruPS at $1,000 per security.
Each TruPS security pays cumulative cash distributions at the annual rate of
8.70 percent of the stated $1,000 liquidation amount per security, payable
semi-annually. The TruPS are fully and unconditionally guaranteed by Conseco.
Proceeds from the offering of $321.6 million (after underwriting and associated
costs) were used by the trust to purchase a subordinated debenture from Conseco.
Conseco then used the net proceeds to repay bank debt. Conseco has the right to
redeem the securities at the principal amount plus a premium equal to the
excess, if any, of the sum of the discounted present values of the remaining
scheduled payments of principal and interest over the principal amount of
securities to be redeemed. The securities are subordinated to all senior
indebtedness of Conseco and mature on November 15, 2026. The terms of the TruPS
parallel the terms of Conseco's debentures held by Trust II, which debentures
account for substantially all of the assets of Trust II.
On March 31, 1997, Conseco Financing Trust III ("Trust III"), a wholly
owned subsidiary of Conseco, issued 300,000 Capital Securities at $1,000 per
security. Each Capital Security pays cumulative cash distributions at the annual
rate of 8.796 percent of the stated $1,000 liquidation amount per security,
payable semi-annually. The Capital Securities are fully and unconditionally
guaranteed by Conseco. Proceeds from the offering of $296.7 million (after
underwriting and associated costs) were used by the trust to purchase
84
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
a subordinated debenture from Conseco. Conseco then used the net proceeds to
repay bank debt. Conseco has the right to redeem the securities at the principal
amount plus a premium equal to the excess, if any, of the sum of the discounted
present values of the remaining scheduled payments of principal and interest
over the principal amount of securities to be redeemed. The securities are
subordinated to all senior indebtedness of Conseco and mature on April 1, 2027.
The terms of the Capital Securities parallel the terms of Conseco's debentures
held by Trust III, which debentures account for substantially all of the assets
of Trust III.
On December 12, 1997, Conseco Financing Trust IV ("Trust IV"), a wholly
owned subsidiary of Conseco, issued 10,000,000 FELINE PRIDES at $50 per
security. Each FELINE PRIDES includes: (a) a stock purchase contract under which
(i) the holder will purchase a number of shares of Conseco common stock on
February 16, 2001 (ranging from .9363 and 1.1268 shares per FELINE PRIDES) under
the terms specified in the stock purchase contract; and (ii) will receive a
contract adjustment payment equal to .25 percent of the value of the security;
and (b) a beneficial ownership of a 6.75 percent trust originated preferred
security. Each holder will receive aggregate cumulative cash distributions at
the annual rate of 7 percent of the $50 stated amount per security, payable
quarterly. The applicable distribution rate on the trust originated preferred
securities that remain outstanding during the period February 16, 2001 through
February 16, 2003, will be reset so that the market value of the trust
originated preferred securities will be equal to 100.5 percent of the par value.
Conseco may limit the market rate reset to be no higher than the rate on the
2-year benchmark Treasury plus 200 basis points. The trust originated preferred
securities are fully and unconditionally guaranteed by Conseco. Proceeds from
the offering of approximately $483.7 million (after underwriting and associated
costs) were used by the trust to purchase a subordinated debenture from Conseco.
Conseco then used the net proceeds to repay bank debt and for other corporate
purposes. The trust originated preferred securities are subordinated to all
senior indebtedness of Conseco and mature on February 16, 2001. The terms of the
trust originated preferred security parallel the terms of Conseco's debentures
held by Trust IV, which debentures account for substantially all of the assets
of Trust IV.
Common Stock
At December 31, 1997 and 1996, minority interest in common stock of
Conseco's subsidiaries includes only the $.7 million interest in the common
stock of a subsidiary.
Changes in minority interest in common and preferred stock of
consolidated subsidiaries during 1997 and 1996 are summarized below:
1997 1996
---- ----
(Dollars in millions)
Minority interest, beginning of year........................................................... $ 97.7 $ 403.3
Changes in investments held by minority interest:
Repurchase of mandatorily redeemable preferred stock of a subsidiary.................... (93.4) -
Mandatorily redeemable preferred stock of a subsidiary held by PFS prior to the
PFS Merger........................................................................... (2.7) -
Transactions resulting from ALH Stock Purchase, BLH Merger and related events........... - (224.9)
Equity of minority interest in the change in financial position of the
Company's subsidiaries:
Dividends............................................................................... (3.3) (10.0)
Amortization of value in excess of par of mandatorily redeemable preferred stock........ (.9) -
Net income before extraordinary charge.................................................. 3.3 31.3
Extraordinary charge.................................................................... - (1.7)
Unrealized depreciation of securities .................................................. - (100.3)
------ -------
Minority interest, end of year ................................................................ $ .7 $ 97.7
====== =======
During 1997, we completed the purchase of all of the mandatorily
redeemable preferred stock of a subsidiary formerly held by minority interests.
85
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
9. SHAREHOLDERS' EQUITY:
Authorized preferred stock is 20 million shares. On January 23, 1996,
Conseco completed the offering of 4.37 million shares of PRIDES. Proceeds from
the offering of $257.7 million (after underwriting and other associated costs)
were used to repay notes payable of Conseco. Each share of PRIDES pays quarterly
dividends at the annual rate of 7 percent of the $61.125 liquidation preference
per share (equivalent to an annual amount of $4.279 per share). On February 1,
2000, unless either previously redeemed by Conseco or converted at the option of
the holder, each share of PRIDES will mandatorily convert into four shares of
Conseco common stock, subject to adjustment in certain events. Shares of PRIDES
are not redeemable prior to February 1, 1999. From February 1, 1999 through
February 1, 2000, the Company may redeem any or all of the outstanding shares of
PRIDES. Upon such redemption, each holder will receive, in exchange for each
share of PRIDES, the number of shares of Conseco common stock equal to (i) the
sum of (a) $62.195, declining to $61.125; and (b) accrued and unpaid dividends
divided by (ii) the market price of Conseco common stock at such date. In no
event will a holder receive less than 3.42 shares of Conseco common stock.
During 1996, 400 shares of PRIDES were converted by holders of such shares into
1,368 shares of Conseco common stock. In 1997, the holders of 2,374,300 shares
of PRIDES converted such shares into 8.1 million shares of common stock. We paid
$13.2 million to induce these conversions. We recorded this payment in the
consolidated financial statements as a dividend paid to such holders. In
addition, during 1997, 100,050 shares of PRIDES were converted by holders of
such shares into 342,171 shares of Conseco common stock.
Conseco issued 5.75 million shares of Series D Cumulative Convertible
Preferred Stock ("Series D preferred stock") with annual dividends of $3.25 per
share and with a total stated value of $287.5 million ($50 per share) in January
1993 in a public offering. Prior to January 1, 1995, Conseco had repurchased or
the holders had converted 80,275 Series D preferred shares. In 1996, the Company
exercised its right to redeem all outstanding Series D preferred stock. A total
of 6,358 Series D shares were redeemed at $52.916 per share including $.641 per
share of accrued and unpaid dividends. Holders of the remaining 5,666,559 Series
D shares elected to convert their shares into 17,766,864 shares of Conseco
common stock.
Changes in the number of shares of common stock outstanding during the
years ended December 31, 1997, 1996 and 1995 were as follows:
1997 1996 1995
---- ---- ----
(Shares in thousands)
Balance, beginning of year...................................................... 167,128 81,032 88,739
Stock options exercised..................................................... 12,341 4,893 366
Shares issued in conjunction with acquired companies........................ 11,264 60,560 -
Common shares converted from convertible subordinated debentures............ 5,138 4,250 -
Common shares converted from Series D preferred shares...................... - 17,767 -
Common shares converted from PRIDES......................................... 8,463 1 -
Shares issued under employee and agent benefit compensation plans........... 321 282 17
Treasury stock purchased.................................................... (17,989) (1,657) (8,090)
------- -------- ------
Balance, end of year............................................................ 186,666 167,128 81,032
======= ======== ======
Dividends declared on common stock for 1997, 1996 and 1995, were $.313,
$.083 and $.046 per common share, respectively. A liability was accrued for
dividends declared but unpaid at December 31, 1997, totaling $23.5 million. Such
dividends were paid in January 1998.
The Company was authorized under its 1983 employee stock option plan to
grant options to purchase up to 48 million shares of Conseco common stock at a
price not less than its market value on the date the option was granted. The
1983 stock option plan continues to govern options granted thereunder, but
expired in all other respects in December 1993. The 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. The options
may become exercisable immediately or over a period of time. The plan also
permits granting of stock appreciation rights and certain other awards. 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 other employee benefit
86
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
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).
Conseco implemented two option exercise programs under which its chief
executive officer and four of its executive vice presidents exercised
outstanding options to purchase 9.1 million shares of Conseco common stock under
the 1997 program (the "1997 Program") and 3.1 million shares under the 1996
program (the "1996 Program"). The options exercised would otherwise have
remained exercisable until various dates through 2006 with respect to the 1997
Program and until the years 2000 through 2002 with respect to the 1996 Program.
We implemented these programs in order to accelerate the recording of tax
benefits we derived from the exercise of the options and to better manage our
capital structure. With respect to both programs, no cash was exchanged as the
executives paid for the exercise price of the options by tendering previously
owned shares. The Company withheld shares or the executives tendered previously
held shares to cover federal and state taxes owed by the executives as a result
of the exercise transactions. The 1997 Program resulted in the following changes
to common stock and additional paid-in capital: (i) an increase for a tax
benefit of $81.9 million (net of payroll taxes incurred of $3.5 million); (ii)
an increase for the exercise price of $120.0 million; and (iii) a decrease of
$229.9 million related to shares withheld or tendered by the executives for the
exercise price and for federal and state taxes. The 1996 Program resulted in the
following changes to common stock and additional paid-in capital: (i) an
increase for a tax benefit of $15.1 million (net of payroll taxes incurred of
$.7 million); (ii) an increase for the exercise proceeds of $5.2 million; and
(iii) a decrease of $20.8 million related to shares withheld or tendered by the
executives for federal and state taxes. Net of shares withheld or tendered, the
Company issued approximately 3.3 million and 1.6 million shares of common stock
to the executives under the 1997 Program and the 1996 Program, respectively. As
an inducement to encourage the exercise of options prior to their expiration
date, we granted to the executive officers new options to purchase a total of
5.8 million shares at an average price of $39.52 per share and 1.6 million
shares at $16.22 per share (in each case equal to the market price per share on
the grant date) to replace the shares surrendered for taxes and the exercise
price in connection with the 1997 and 1996 Programs, respectively.
In 1997, 1996 and 1995, we repurchased approximately 17.9 million, 1.7
million and 8.1 million shares of our common stock for $711.7 million, $26.0
million and $92.4 million, respectively, in connection with our stock repurchase
programs and shares withheld or tendered for the exercise price of options and
for federal and state taxes. The cost of the common stock we repurchased in
connection with these programs was allocated to the shareholders' equity
accounts in 1997, 1996 and 1995 as follows: (i) $685.6 million, $3.1 million and
$15.0 million, respectively, to common stock and additional paid-in capital
(such allocation was based on the average common stock and paid-in capital
balance per share) and (ii) $26.1 million, $22.9 million and $77.4 million,
respectively, to retained earnings (representing the purchase price in excess of
such average).
Conseco's Director, Executive and Senior Officer Stock Purchase Plan was
implemented to encourage direct, long-term ownership of Conseco stock by Board
members, executive officers and certain senior officers. Under the program, 8
million shares of Conseco common stock have been purchased in open market or
negotiated transactions with independent parties. Purchases are financed by
personal loans to the participants from a bank. Such loans are collateralized by
the Conseco stock purchased. Conseco has guaranteed the loans, but has recourse
to the participants if we incur a loss under the guarantee. In addition, we
provide loans to the participants for interest payments under the bank loans. A
total of 39 directors and officers of Conseco participated in the plan. At
December 31, 1997, the bank loans guaranteed by us totaled $247.4 million, and
the loans provided by us for interest totaled $9.3 million. The common stock
that collateralizes the loans had a fair value of $343.5 million on December 31,
1997.
In December 1996, we granted options to selected key managers to purchase
1.1 million shares at a price of $30.41 per share (the "Key Manager Program").
These options contain lengthy vesting and non-compete requirements designed to
encourage continuity of employment with these individuals. The options will
become fully vested normally only upon both: (i) eleven years of continuous
employment; and (ii) the earlier of: (a) two years following termination of
employment during which time the individual is not in competition with the
Company; (b) the grantee reaching age 65; or (c) death or disability of the
grantee. In certain cases, the options remain exercisable throughout the
lifetime of the grantee.
We apply Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" and related interpretations in accounting for our
stock option plans. Accordingly, no compensation cost has been recognized for
such 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" ("SFAS 123"), the Company's pro forma net income and
pro forma earnings per share for the years ended December 31, 1997, 1996 and
1995 would have been as follows:
87
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
1997 1996 1995
------------------------- ------------------------- ------------------------
As reported Pro forma As reported Pro forma As reported Pro forma
----------- --------- ----------- --------- ----------- ---------
(Dollars in millions, except per share amounts)
Net income........................ $567.3 $521.2 $252.4 $245.4 $220.4 $211.9
Basic earnings per share.......... 2.94 2.69 2.15 2.08 2.48 2.38
Diluted earnings per share........ 2.64 2.42 1.82 1.77 2.12 2.04
The fair value of each option grant used to determine the pro forma
amounts summarized above is estimated on the date of grant using the
Black-Scholes option valuation model with the following weighted average
assumptions for 1997, 1996 and 1995:
1997 Grants 1996 Grants 1995 Grants
--------------------- ------------------------------------ -----------
Option Option Key
Traditional exercise Traditional exercise Manager Traditional
grants program grants program Program grants
------ ------- ------ ------- ------- ------
Weighted average risk-free interest rates.. 6.0% 6.5% 6.1% 6.0% 6.8% 6.2%
Weighted average dividend yields........... .9% .9% .1% .1% .1% .2%
Volatility factors......................... .28 .28 .28 .28 .28 .43
Weighted average expected life............. 6 years 4 years 5 years 5 years 25 years 5 years
Weighted average fair value per share...... $13.13 $11.95 $10.17 $5.54 $24.50 $5.53
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferrable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because our employee stock options have characteristics
significantly different from those of traded options, and because changes in
subjective assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not provide a reliable single
measure of the fair value of our employee stock options. Because SFAS 123 is
effective only for awards granted after January 1, 1995, the pro forma
disclosures provided above may not be representative of the effects on reported
net income for future years.
88
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
In conjunction with the CAF Merger and the PFS Merger in 1997 and the LPG
Merger, the ATC Merger, the THI Merger and the BLH Merger in 1996, outstanding
options to purchase common stock of the acquired companies were converted into
options to purchase Conseco stock. These options, which were immediately
exercisable, were for the number of shares and the price per share equal to what
holders would have been entitled to receive at the dates of the mergers had the
former options been exercised at that time and exchanged for Conseco shares in
the mergers. The fair value of these options is included in the cost to acquire
the companies (see note 2). A summary of options issued in connection with the
mergers and, together with related information, is presented below:
Weighted
Total value average
at merger exercise price
Shares date per share
------ ---- ---------
(Shares in (Dollars in millions, except
thousands) per share amounts)
Options issued in 1997 in connection with the:
CAF Merger............................................... 226 $ 3.5 $23.96
PFS Merger............................................... 1,132 22.4 19.78
----- ------
1,358 $25.9 20.48
===== =====
Options issued in 1996 in connection with the:
LPG Merger............................................... 1,133 $ 7.7 11.18
ATC Merger............................................... 2,049 26.9 16.87
THI Merger............................................... 644 6.5 14.90
BLH Merger............................................... 609 2.6 27.18
----- -----
4,435 $43.7 16.54
===== =====
89
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
A summary of the Company's stock option activity and related information
for the years ended December 31, 1997, 1996 and 1995, is presented below (shares
in thousands):
1997 1996 1995
----------------------- ---------------------- ----------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Shares price Shares price Shares price
------ ----- ------ ----- ------ -----
Outstanding at the beginning of year.. 28,720 $15.38 25,487 $11.76 22,029 $11.43
Granted or assumed in connection with:
Traditional grants................. 1,212 40.02 1,206 28.54 4,117 12.60
Option exercise program............ 5,818 39.52 1,605 16.22 - -
Key Manager Program................ - - 1,100 30.41 - -
Mergers............................ 1,358 20.48 4,435 16.54 - -
------- ------ ------
Total granted................ 8,388 36.51 8,346 20.04 4,117 12.60
------- ------ ------
Exercised............................. (12,341) 13.71 (4,893) 4.75 (366) 3.06
Forfeited............................. (339) 17.58 (220) 11.62 (293) 9.98
------- ------ ------
Outstanding at the end of the year.... 24,428 23.45 28,720 15.38 25,487 11.76
======= ====== ======
Options exercisable at year-end....... 9,765 9,554 7,352
======= ====== ======
Available for future grant............ 17,206 2,933 8,399
======= ======= =======
The following table summarizes information about fixed stock options
outstanding at December 31, 1997 (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
- --------------- ----------- --------------- ----- ----------- -----
$ 1.36-1.56........................... 50 .6 $ 1.51 50 $ 1.51
2.61................................ 35 1.6 2.61 35 2.61
4.57-6.72........................... 190 1.6 6.01 190 6.01
6.91-10.28.......................... 109 1.9 8.20 109 8.20
10.47-15.47.......................... 13,210 5.3 14.27 1,637 13.22
16.06-23.67.......................... 995 6.5 19.53 963 19.55
25.11-30.41.......................... 1,890 5.6 29.17 903 28.62
30.41 (Key Manager Program)......... 1,100 24.0 30.41 - -
30.73-45.84.......................... 6,822 7.5 39.91 5,878 39.36
48.38................................ 27 9.9 48.38 - -
------ -----
24,428 9,765
====== =====
90
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
In connection with the THI Merger, the outstanding warrants to purchase
shares of THI common stock were converted into warrants to purchase the same
number of shares of Conseco common stock at the same total cost that the holders
would have been entitled to receive if such warrants were exercised immediately
prior to the THI Merger. Such warrants may be exercised to buy 700,000 shares of
Conseco common stock for $13.8 million at anytime through September 29, 2005.
Accordingly, 700,000 shares of common stock are reserved for issuance under the
warrants. The value of the warrants on the THI Merger date of $3.8 million is
included in the total cost to acquire THI (see note 2).
A total of 69.0 million shares of common stock are reserved for issuance
under the previously described convertible subordinated debentures, PRIDES,
FELINE PRIDES, stock options granted and available for future grant, warrants,
and stock bonus and deferred compensation plans.
A reconciliation of income and shares used to calculate basic and diluted
earnings per share is as follows:
1997 1996 1995
---- ---- ----
(Dollars in millions and shares in thousands)
Income:
Net income before extraordinary charge.................................. $574.2 $278.9 $222.5
Preferred stock dividends............................................... 21.9 27.4 18.4
------ ------ ------
Income before extraordinary charge applicable to common ownership
for basic earnings per share........................................ 552.3 251.5 204.1
Effect of dilutive securities:
Preferred stock dividends............................................. 8.7 27.4 18.4
------ ------ ------
Income before extraordinary charge applicable to common ownership
and assumed conversions for diluted earnings per share.............. $561.0 $278.9 $222.5
====== ====== ======
Shares:
Weighted average shares outstanding for basic earnings per share........ 185,751 104,584 81,405
Effect of dilutive securities on weighted average shares:
Stock options......................................................... 9,767 6,013 2,921
Employee stock plans.................................................. 2,268 2,172 1,768
PRIDES................................................................ 6,936 14,042 -
Convertible preferred stock........................................... - 12,049 17,787
Convertible debentures................................................ 5,457 - -
------- ------- -------
Dilutive potential common shares.................................. 24,428 34,276 22,476
------- ------- -------
Weighted average shares outstanding for diluted earnings
per share.................................................... 210,179 138,860 103,881
======= ======= =======
91
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
10. OTHER OPERATING STATEMENT DATA:
Insurance policy income consisted of the following:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Traditional products:
Direct premiums collected......................................................... $5,264.4 $3,528.2 $3,173.0
Reinsurance assumed............................................................... 290.3 65.8 6.1
Reinsurance ceded................................................................. (499.0) (313.8) (72.6)
-------- -------- --------
Premiums collected, net of reinsurance...................................... 5,055.7 3,280.2 3,106.5
Change in unearned premiums....................................................... (2.2) (14.6) 6.6
Less premiums on universal life and products
without mortality and morbidity risk which are
recorded as additions to insurance liabilities ................................ 2,099.4 1,881.3 1,757.5
-------- -------- --------
Premiums on traditional products with mortality or morbidity risk,
recorded as insurance policy income...................................... 2,954.1 1,384.3 1,355.6
Fees and surrender charges on interest sensitive products............................. 456.7 269.9 109.4
-------- -------- --------
Insurance policy income..................................................... $3,410.8 $1,654.2 $1,465.0
======== ======== ========
The five states with the largest shares of premiums collected in 1997
were Florida (9.4 percent), Illinois (9.0 percent), California (8.4 percent),
Texas (8.1 percent) and Michigan (5.0 percent). No other state accounted for
more than 5 percent of total collected premiums.
Other operating costs and expenses were as follows:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Commission expense.................................................................... $201.2 $ 72.5 $ 47.7
Other................................................................................. 376.0 231.5 224.4
------ ------ ------
Other operating costs and expenses........................................... $577.2 $304.0 $272.1
====== ====== ======
Conseco considers anticipated returns from the investment of policyholder
balances in determining the amortization of the cost of policies purchased and
cost of policies produced for universal life-type and investment-type contracts.
Sales of fixed maturity investments change the incidence of profits on such
policies because gains (losses) are recognized currently and, if the sale
proceeds are reinvested at the current market yields, the expected future yields
on the investment of policyholder balances are reduced (increased). Accordingly,
amortization of the cost of policies purchased was increased by $151.4 million,
$31.1 million and $106.4 million in the years ended December 31, 1997, 1996 and
1995, respectively. Amortization of the cost of policies produced was increased
by $29.8 million, $4.9 million and $20.2 million in the years ended December 31,
1997, 1996 and 1995, respectively.
92
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
The changes in the cost of policies purchased were as follows:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Balance, beginning of year............................................................ $2,015.0 $1,030.7 $1,021.6
Additional acquisition expense on acquired policies............................... 93.9 - -
Amortization related to operations:
Cash flow realized............................................................. (436.5) (285.1) (252.0)
Interest added................................................................. 174.7 127.6 133.2
Amortization related to sales of investments...................................... (151.4) (31.1) (106.4)
Amounts related to fair value adjustment
of actively managed fixed maturities........................................... (128.4) 141.6 (395.6)
Transferred to cost of policies produced related to
exchanged health policies...................................................... (16.1) (13.4) (13.5)
Amounts acquired in mergers and acquisitions...................................... 914.2 1,042.0 643.4
Nonrecurring charge............................................................... (8.8) - -
Reinsurance and other ............................................................ 9.8 2.7 -
-------- -------- --------
Balance, end of year.................................................................. $2,466.4 $2,015.0 $1,030.7
======== ======== ========
Based on current conditions and assumptions as to future events on all
policies in force, the Company expects to amortize approximately 9 percent of
the December 31, 1997, balance of cost of policies purchased in 1998, 9 percent
in 1999, 8 percent in 2000, 7 percent in 2001, and 7 percent in 2002. The
discount rates used to determine the cost of policies purchased ranged from 18
percent to 20 percent during the three-year period ended December 31, 1997. The
discount rates used to determine the amortization of the cost of policies
purchased averaged 7 percent in 1997, 10 percent in 1996, and 12 percent in
1995.
The changes in the cost of policies produced were as follows:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Balance, beginning of year............................................................ $544.3 $391.0 $ 300.7
Additions......................................................................... 550.7 331.5 302.9
Amortization related to operations................................................ (110.4) (72.9) (62.0)
Amortization of deferred revenue.................................................. 5.4 1.4 1.3
Amortization related to sales of investments...................................... (29.8) (4.9) (20.2)
Amounts related to fair value adjustment of
actively managed fixed maturities.............................................. (36.4) 45.4 (74.9)
Transferred from cost of policies purchased related to
exchanged health policies, net of related reserves............................. 3.5 4.0 1.6
Amounts related to BLH Merger and share repurchases............................... - (54.7) (107.5)
Amounts related to ALH Stock Purchase............................................. - (96.5) -
Amounts related to CCP Merger..................................................... - - (62.8)
Consolidation of CCP, effective January 1, 1995................................... - - 111.9
Nonrecurring charge............................................................... (12.1) - -
------ ------ -------
Balance, end of year.................................................................. $915.2 $544.3 $ 391.0
====== ====== =======
Nonrecurring charges in 1997 include an increase to claim reserves of
$41.5 million and the write-off of cost of policies produced and cost of
policies purchased of $20.9 million related to premium deficiencies on our
Medicare supplement business in the state of Massachusetts. Regulators in that
state have not allowed premium increases for Medicare supplement products
necessary to avoid losses on the business. We are currently seeking rate
increases. We are no longer writing new Medicare supplement business in
Massachusetts.
Nonrecurring charges in 1997 also include expenses of $9.3 million (net
of proceeds from a life insurance policy) related to the death of an executive
officer.
93
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
11. CONSOLIDATED STATEMENT OF CASH FLOWS:
The following disclosures are provided to support and/or supplement our
consolidated statement of cash flows:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Impact of acquisition transactions (described in note 2) on the consolidated statement
of cash flows:
Total investments................................................................ $ 4,716.6 $ 5,022.8 $ 4,528.4
Cost of policies purchased....................................................... 914.2 1,046.4 493.7
Goodwill......................................................................... 1,133.9 1,747.2 241.6
Income taxes..................................................................... 6.4 134.9 (114.9)
Insurance liabilities............................................................ (5,193.8) (5,943.6) (4,405.8)
Notes payable.................................................................... (540.6) (448.2) (213.7)
Minority interest................................................................ - 210.4 225.4
Common stock and additional paid-in capital...................................... (471.5) (1,568.6) -
Other............................................................................ 194.5 (179.6) (168.4)
--------- --------- ---------
Net cash used.................................................................. $ 759.7 $ 21.7 $ 586.3
========= ========= =========
Additional non-cash items not reflected in the consolidated statement of cash
flows:
Issuance of common stock under stock option and employee benefit plans............. $ 20.2 $ 12.2 $ 4.2
Tax benefit related to the issuance of common stock under employee benefit plans... 85.2 15.9 .4
Conversion of preferred stock into common stock.................................... 151.3 283.2 -
Conversion of convertible debentures into common stock............................. 150.0 - -
Redemption of convertible subordinated debentures of a subsidiary using
segregated cash.................................................................. - - 9.2
Cash paid for:
Interest expense on debt and commercial paper...................................... 117.4 111.3 112.0
Income taxes....................................................................... 200.0 122.5 90.3
12. STATUTORY INFORMATION:
Statutory accounting practices prescribed or permitted for the Company's
insurance subsidiaries by regulatory authorities differ from GAAP. The Company's
life insurance subsidiaries reported the following amounts to regulatory
agencies, after appropriate eliminations of intercompany accounts among such
subsidiaries:
1997 1996
---- ----
(Dollars in millions)
Statutory capital and surplus.................................................................... $1,662.4 $1,170.8
Asset valuation reserve.......................................................................... 329.2 232.9
Interest maintenance reserve..................................................................... 414.9 272.6
Portion of surplus debenture carried as a liability ............................................. 99.2 98.8
-------- --------
Total...................................................................................... $2,505.7 $1,775.1
======== ========
Combined statutory net income of the Company's life insurance
subsidiaries for the periods during which such subsidiaries were included in our
consolidated financial statements was $243.4 million, $215.0 million and $183.8
million in 1997, 1996 and 1995, respectively, after appropriate eliminations of
intercompany amounts among such subsidiaries, but before elimination of
intercompany amounts between such subsidiaries and non-life insurance
subsidiaries and the parent company.
The statutory capital and surplus of the insurance subsidiaries include
surplus debentures issued to the parent holding companies totaling $793.4
million. Payments of interest and principal on such debentures are generally
subject to the approval of the insurance
94
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
department of the subsidiary's state of domicile.
Statutory accounting practices require the asset valuation reserve
("AVR") and the interest maintenance reserve ("IMR") be reported as liabilities.
The purpose of these reserves is to stabilize statutory surplus against
fluctuations in the market value of investments. The IMR captures all realized
investment gains and losses, net of income taxes, on debt instruments resulting
from changes in interest rates, and provides for subsequent amortization of such
amounts into statutory net income on a basis reflecting the remaining lives of
the assets sold. The AVR captures all realized and unrealized investment gains
(losses), net of income taxes, related to equity investments and to changes in
creditworthiness of debt instruments. AVR is also adjusted each year based on a
formula related to the quality and loss experience of the Company's investment
portfolio.
Included in statutory capital and surplus shown above are the following
investments in non-life insurance affiliates, all of which are eliminated in the
consolidated financial statements prepared in accordance with GAAP:
1997 1996
-------------------- --------------------
Admitted Admitted
asset asset
Cost value Cost value
---- ----- ---- -----
(Dollars in millions)
Common stock of Conseco purchased in open market
transactions (1997 includes 39,823,149 shares and 1996
includes 39,021,822 shares)......................................... $ 99.8 $152.4 $ 89.6 $ 80.9
Notes payable of Conseco and its non-life subsidiaries................. 275.0 275.7 261.3 245.2
Common stock of ALH (463,649 shares in 1997 and 614,057
shares in 1996) .................................................... 2.4 6.3 5.8 9.8
Preferred stock of a non-life subsidiary............................... 900.0 - 900.0 -
Investment in ALH 1994 Series PIK Preferred Stock...................... 72.2 72.2 62.8 62.8
Preferred stock of American Life Holding Company....................... 6.5 6.5 6.5 6.5
95
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
The following table compares the consolidated pretax income determined on a
statutory accounting basis with such income reported in accordance with GAAP:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Life insurance subsidiaries:
Pretax income as reported on a statutory
accounting basis before deduction of
investment management fees paid to affiliates and
transfers to and from and amortization
of the IMR......................................................................... $ 606.3 $332.2 $370.4
GAAP adjustments:
Change in difference in carrying values of investments............................. 111.7 51.9 185.9
Changes in cost of policies purchased and produced and insurance liabilities....... 256.2 70.1 (52.0)
Other adjustments, net............................................................. (7.9) (.1) (7.7)
-------- ------ ------
GAAP pretax income of life insurance subsidiaries.......................... 966.3 454.1 496.6
Non-life companies:
Interest expense..................................................................... (109.4) (108.1) (119.4)
All other income and expense, net
(excluding investment management fees received from affiliates).................... 146.2 147.6 41.3
-------- ------ ------
GAAP consolidated pretax income............................................ $1,003.1 $493.6 $418.5
======== ====== ======
State insurance laws generally restrict the ability of insurance
companies to pay dividends or make other distributions. Net assets of the
Company's wholly owned life insurance subsidiaries, determined in accordance
with GAAP, aggregated approximately $7.8 billion at December 31, 1997, of which
approximately $165.1 million is available for distribution to Conseco in 1998
without the permission of state regulatory authorities.
Most states have adopted risk-based capital ("RBC") rules to evaluate the
adequacy of statutory capital and surplus in relation to investment and
insurance risks. The RBC formula is designed as an early warning tool to help
state regulators identify possible weakly capitalized companies for the purpose
of initiating regulatory action. At December 31, 1997, the average ratio of
total adjusted capital to RBC (as defined by the rules) for our principal
insurance subsidiaries was greater than twice the level at which regulatory
attention is triggered.
13. BUSINESS SEGMENT AND DISTRIBUTION CHANNELS:
Conseco conducts and manages its business through five segments,
reflecting the Company's major lines of insurance business and target markets:
(i) supplemental health; (ii) annuities; (iii) life insurance; (iv) individual
and group major medical insurance; and (v) other. Summarized data for the
Company's business segments follows:
96
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
Income before
Amortization income taxes,
of cost of minority
policies produced interest and
Premiums Total and cost of policies extraordinary Total
collected revenues purchased (a) charge assets
--------- -------- ------------- ------ ------
(Dollars in millions)
1997
Supplemental health...................... $1,843.7 $2,160.2 $194.9 $ 371.9 $ 7,522.5
Annuities................................ 1,689.6 1,350.5 198.9 358.3 16,535.6
Life insurance........................... 709.0 1,130.3 87.8 307.1 9,771.1
Individual and group major medical....... 744.2 775.5 16.8 40.3 896.8
Other ................................... 69.2 151.9 7.3 61.6 577.4
Corporate................................ - - - (136.1) 611.4
-------- -------- ------ -------- ---------
Total.................................. $5,055.7 $5,568.4 $505.7 $1,003.1 $35,914.8
======== ======== ====== ======== =========
1996
Supplemental health...................... $ 810.8 $ 873.2 $ 81.2 $ 136.7 $ 3,841.1
Annuities................................ 1,670.3 1,047.4 95.1 254.3 14,186.5
Life insurance........................... 403.6 642.6 41.5 124.8 6,512.4
Individual and group major medical....... 341.0 365.8 15.1 32.1 418.2
Other ................................... 54.5 138.3 7.9 58.1 170.0
Corporate ............................... - - - (112.4) 484.5
-------- -------- ------ -------- ---------
Total.................................. $3,280.2 $3,067.3 $240.8 $ 493.6 $25,612.7
======== ======== ====== ======= =========
1995
Supplemental health...................... $ 738.8 $ 827.2 $ 78.3 $ 97.1 $ 1,759.6
Annuities................................ 1,693.9 1,135.5 169.9 316.1 12,152.8
Life insurance........................... 253.6 404.0 38.6 70.2 2,667.6
Individual and group major medical....... 353.6 361.7 13.1 35.2 269.4
Other ................................... 66.6 111.7 7.6 25.2 193.8
Corporate................................ - 15.2 - (125.3) 254.3
-------- -------- ------ ------- ---------
Total.................................. $3,106.5 $2,855.3 $307.5 $ 418.5 $17,297.5
======== ======== ====== ======= =========
(a) Includes additional amortization related to gains on sales of investments.
97
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
14. 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.
1997
----------------------------------------------
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
-------- -------- -------- --------
(Dollars in millions, except per share data)
Insurance policy income................................................... $ 670.1 $ 885.0 $ 885.8 $ 969.9
Revenues.................................................................. 1,099.0 1,360.5 1,483.5 1,625.4
Income before income taxes, minority interest
and extraordinary charge .............................................. 195.4 231.2 275.2 301.3
Net income................................................................ 111.5 130.6 153.8 171.4
Net income per common share:
Basic:
Income before extraordinary charge .................................. $.57 $.68 $.81 $.91
Extraordinary charge................................................. .02 .01 - .01
---- ---- ---- ----
Net income......................................................... $.55 $.67 $.81 $.90
==== ==== ==== ====
Diluted:
Income before extraordinary charge .................................. $.51 $.62 $.73 $.81
Extraordinary charge................................................. .02 .01 - -
---- ---- ---- ----
Net income......................................................... $.49 $.61 $.73 $.81
==== ==== ==== ====
98
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
------------------------------------
1996
-----------------------------------------------
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
-------- -------- -------- --------
(Dollars in millions, except per share data)
Insurance policy income..................................................... $369.8 $371.6 $451.8 $461.0
Revenues.................................................................... 691.8 672.5 834.3 868.7
Income before income taxes, minority interest
and extraordinary charge ................................................ 120.2 101.3 131.5 140.6
Net income.................................................................. 46.3 50.1 78.1 77.9
Net income per common share:
Basic:
Income before extraordinary charge .................................... $.68 $.49 $.62 $.61
Extraordinary charge................................................... .21 - .01 .06
----- ---- ---- ----
Net income........................................................... $.47 $.49 $.61 $.55
==== ==== ==== ====
Diluted:
Income before extraordinary charge .................................... $.55 $.41 $.51 $.54
Extraordinary charge................................................... .15 - .01 .05
---- ---- ---- ----
Net income........................................................... $.40 $.41 $.50 $.49
==== ==== ==== ====
Our quarterly results of operations are based on numerous estimates,
principally related to policy reserves, amortization of cost of policies
purchased, amortization of cost of policies produced and income taxes. We revise
all such estimates each quarter and we ultimately adjust them to year-end
amounts. When we determine revisions are necessary, we report them as part of
operations of the current quarter.
15. SUBSEQUENT EVENTS (UNAUDITED):
On February 9, 1998, we completed the offering of $250.0 million of 6.4
percent Notes (the "Notes") due February 10, 2003. Proceeds from the offering of
approximately $248.0 million (after original issue discount and other associated
costs) were used to retire bank debt. Interest is paid semi-annually on February
10 and August 10 of each year. The Notes are redeemable in whole or in part at
the option of Conseco at any time, at a redemption price equal to the sum of (a)
the greater of: (i) 100 percent of the principal amount; and (ii) the sum of the
present values of the remaining scheduled payments of principal and interest
thereon from the redemption date to the maturity date, computed by discounting
such payments, in each case, to the redemption date on a semi-annual basis at
the Treasury rate (as defined in the Notes) plus 25 basis points, plus (b)
accrued and unpaid interest on the principal amount thereof to the date of
redemption. The Notes are unsecured and rank pari passu with all other unsecured
and unsubordinated obligations of Conseco.
We periodically use options and interest rate swaps to hedge interest
rate risk associated with our investments and borrowed capital. Although we had
no such agreements outstanding at December 31, 1997, we entered into four
interest rate swap agreements in March 1998. The Company entered into such
agreements to create a hedge that effectively converts a portion of its
fixed-rate borrowed capital into floating-rate instruments for the period during
which the agreements are outstanding. Such interest rate swap agreements have an
aggregate notional principal amount of $1.0 billion, mature in various years
through 2008 and have an average remaining life of 7 years. If the
counterparties of these interest rate swaps do not meet their obligations,
Conseco could have a loss. Conseco limits its exposure to such a loss by
diversifying among several counterparties believed to be financially sound and
creditworthy. At March 13, 1998, all of the counterparties were rated A or
higher by Standard & Poor's Corporation.
On March 3, 1998, we commenced a new program to repurchase up to 5
million Conseco common shares in open market or negotiated transactions. The
timing and terms of the purchases are to be determined based on market
conditions and other considerations. As of March 17, 1998, we had repurchased .5
million shares under the program for $26.4 million.
In March 1998, we repurchased $139 million par value of our 10.5 percent
senior notes due 2004 for $171 million. We will recognize an extraordinary
charge of approximately $15.6 million (net of an $8.3 million tax benefit)
related to the repurchases in the quarter ended March 31, 1998.
99
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
The information required by Part III is hereby incorporated by reference
from the Registrant's definitive proxy statement to be filed with the Commission
pursuant to Regulation 14A within 120 days after December 31, 1997, except that
the information required by Item 10 regarding Executive Officers is included
herein under a separate caption at the end of Part I.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. Financial Statements. See Index to Consolidated Financial
Statements on page 48 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 III -- Supplementary Insurance Information
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. - None
100
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 27th day of March, 1998.
CONSECO, INC.
By: /s/ STEPHEN C. HILBERT
-----------------------------
Stephen C. Hilbert, President
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/ STEPHEN C. HILBERT Chairman of the Board, March 27, 1998
- ---------------------- President and Director
Stephen C. Hilbert (Principal Executive Officer)
/s/ ROLLIN M. DICK Executive Vice President and Director March 27, 1998
- ------------------------- (Principal Financial Officer)
Rollin M. Dick
/s/JAMES S. ADAMS Senior Vice President and Treasurer March 27, 1998
- ------------------------- (Principal Accounting Officer)
James S. Adams
/s/ NGAIRE CUNEO Director March 27, 1998
- -------------------------
Ngaire Cuneo
/s/ DAVID R. DECATUR Director March 27, 1998
- -------------------------
David R. Decatur
/s/ JOHN M. MUTZ Director March 27, 1998
- -------------------------
John M. Mutz
/s/ DONALD F. GONGAWARE Director March 27, 1998
- -------------------------
Donald F. Gongaware
/s/ M. PHIL HATHAWAY Director March 27, 1998
- -------------------------
M. Phil Hathaway
/s/ DENNIS E. MURRAY, SR. Director March 27, 1998
- -------------------------
Dennis E. Murray, Sr.
/s/ JAMES D. MASSEY Director March 27, 1998
- -------------------------
James D. Massey
101
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 50 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 100 of this Form 10-K.
In our opinion, the financial statement schedules referred to above, when
considered in relation to the basic financial statements taken as a whole,
present fairly, in all material respects, the information required to be
included therein.
/s/COOPERS & LYBRAND L.L.P.
---------------------------
COOPERS & LYBRAND L.L.P.
Indianapolis, Indiana
March 23, 1998
102
CONSECO, INC. AND SUBSIDIARIES
SCHEDULE II
Condensed Financial Information of Registrant (Parent Company)
Balance Sheet
as of December 31, 1997 and 1996
(Dollars in millions)
ASSETS
1997 1996
---- ----
Short-term investments......................................................................... $ 17.4 $ 74.9
Actively managed fixed maturities ............................................................. 12.9 2.1
Equity securities.............................................................................. 14.0 7.9
Other invested assets.......................................................................... 128.1 55.3
Investment in wholly owned subsidiaries (eliminated in consolidation).......................... 6,734.6 3,811.9
Receivable from subsidiaries (eliminated in consolidation)..................................... 949.9 871.5
Income taxes................................................................................... 207.1 155.7
Other assets................................................................................... 231.9 188.6
-------- --------
Total assets............................................................................ $8,295.9 $5,167.9
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable............................................................................... $1,906.7 $1,094.9
Commercial paper............................................................................ 448.2 -
Notes payable to subsidiaries (eliminated in consolidation)................................. 213.1 101.6
Other liabilities due to subsidiaries (eliminated in consolidation)......................... 210.5 93.5
Other liabilities........................................................................... 243.4 192.6
-------- --------
Total liabilities....................................................................... 3,021.9 1,482.6
-------- --------
Company-obligated mandatorily redeemable preferred securities of subsidiary trusts............. 1,383.9 600.0
Shareholders' equity:
Preferred stock............................................................................. 115.8 267.1
Common stock and additional paid-in capital (no par value, 1,000,000,000
shares authorized, shares issued and outstanding: 1997 - 186,665,591
1996 - 167,128,228)....................................................................... 2,382.0 2,029.6
Accumulated other comprehensive income:
Unrealized appreciation of fixed maturity securities (net of applicable
deferred income taxes: 1997 - $95.5; 1996 - $21.5)...................................... 177.2 39.8
Unrealized appreciation (depreciation) of other investments (net of applicable deferred
income taxes: 1997 - $2.6; 1996 - $(.5))................................................ 4.8 (.9)
Retained earnings........................................................................... 1,210.3 749.7
-------- --------
Total shareholders' equity.............................................................. 3,890.1 3,085.3
-------- --------
Total liabilities and shareholders' equity.............................................. $8,295.9 $5,167.9
======== ========
The accompanying note is an integral
part of the condensed financial
information.
103
CONSECO, INC. AND SUBSIDIARIES
SCHEDULE II
Condensed Financial Information of Registrant (Parent Company)
Statement of Operations
for the years ended December 31, 1997, 1996 and 1995
(Dollars in millions)
1997 1996 1995
---- ---- ----
Revenues:
Net investment income.............................................................. $ 46.5 $ 5.5 $ 8.5
Dividends from subsidiaries (eliminated in consolidation).......................... 185.2 146.9 106.5
Fee and interest income from subsidiaries (eliminated in consolidation)............ 93.9 30.9 12.9
Net investment gains............................................................... - 30.1 20.6
Other income (losses).............................................................. 2.5 1.1 (6.4)
------ ------- -------
Total revenues................................................................. 328.1 214.5 142.1
------ ------- -------
Expenses:
Interest expense on notes payable.................................................. 109.1 69.2 42.6
Interest expense to subsidiaries (eliminated in consolidation)..................... 31.2 7.2 7.5
Operating costs and expenses....................................................... 24.7 10.2 27.8
------ ------- -------
Total expenses................................................................. 165.0 86.6 77.9
------ ------- -------
Income before income taxes, equity in undistributed earnings of
subsidiaries, distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts
and extraordinary charge..................................................... 163.1 127.9 64.2
Income tax expense (benefit).......................................................... (5.5) 1.2 (93.2)
------ ------- -------
Income before equity in undistributed earnings of subsidiaries,
distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts
and extraordinary charge..................................................... 168.6 126.7 157.4
Equity in undistributed earnings of subsidiaries (eliminated in consolidation)........ 454.6 155.8 65.1
------- ------- -------
Income before distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts and extraordinary charge........... 623.2 282.5 222.5
Distributions on Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts............................................................... 49.0 3.6 -
------- ------- ------
Income before extraordinary charge............................................. 574.2 278.9 222.5
Extraordinary charge on extinguishment of debt, net of tax............................ 6.9 26.5 2.1
------- ------- ------
Net income..................................................................... 567.3 252.4 220.4
Less amounts applicable to preferred stock:
Charge related to induced conversions.............................................. 13.2 - -
Preferred stock dividends.......................................................... 8.7 27.4 18.4
------- ------- ------
Earnings applicable to common stock............................................ $545.4 $ 225.0 $202.0
====== ======= ======
The accompanying note is an
integral part of the condensed
financial information.
104
CONSECO, INC. AND SUBSIDIARIES
SCHEDULE II
Condensed Financial Information of Registrant (Parent Company)
Statement of Cash Flows
for the years ended December 31, 1997, 1996 and 1995
(Dollars in millions)
1997 1996 1995
---- ---- ----
Cash flows from operating activities:
Net income........................................................................... $ 567.3 $ 252.4 $ 220.4
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed earnings of consolidated subsidiaries.................... (454.6) (155.8) (65.1)
Net investment gains............................................................. - (30.1) (20.6)
Income taxes .................................................................... (62.0) (3.2) (101.3)
Extraordinary charge on extinguishment of debt................................... 10.6 36.9 3.7
Distributions on Company-obligated mandatorily redeemable preferred securities of
subsidiary trusts.............................................................. 75.4 5.5 -
Other............................................................................ 7.0 (21.4) 10.8
-------- -------- -------
Net cash provided by operating activities...................................... 143.7 84.3 47.9
-------- -------- -------
Cash flows from investing activities:
Sales and maturities of investments.................................................. 70.0 45.0 125.6
Investments in consolidated subsidiaries............................................. (983.1) (226.1) (556.9)
Purchases of investments............................................................. (143.3) (66.0) (70.8)
Investment in Conseco Capital Partners II, L.P....................................... - - (7.1)
Expenses incurred in conjunction with terminated merger.............................. - - (5.5)
Cash held by subsidiaries prior to acquisition....................................... 4.1 38.9 17.0
Payments from subsidiaries........................................................... 72.9 36.5 -
-------- -------- -------
Net cash used by investing activities.......................................... (979.4) (171.7) (497.7)
-------- -------- -------
Cash flows from financing activities:
Issuance of equity securities, net................................................... 52.3 20.6 1.8
Issuance of convertible preferred stock.............................................. - 257.7 -
Issuance of Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts............................................................... 780.4 587.7 -
Issuance of notes payable, net....................................................... 2,577.0 856.0 827.2
Issuance of commercial paper......................................................... 448.2 - -
Payments on notes payable............................................................ (2,217.7) (1,467.2) (330.0)
Payments to repurchase equity securities of Conseco.................................. (593.3) (21.5) (92.4)
Dividends paid ...................................................................... (76.8) (34.3) (24.6)
Dividends on stock held by subsidiaries.............................................. (53.8) (38.1) (38.7)
Distributions on Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts............................................................... (65.7) (2.9) -
Payments to retire preferred stock................................................... (72.4) (.3) -
-------- -------- -------
Net cash provided by financing activities...................................... 778.2 157.7 343.3
-------- -------- -------
Net increase (decrease) in short-term investments.............................. (57.5) 70.3 (106.5)
Short term investments, beginning of year............................................ 74.9 4.6 111.1
-------- -------- -------
Short term investments, end of year.................................................. $ 17.4 $ 74.9 $ 4.6
======== ======== =======
The accompanying note is an
integral part of the condensed financial
information.
105
CONSECO, INC. AND SUBSIDIARIES
SCHEDULE II
Note to Condensed Financial Information
Basis of Presentation
The condensed financial information should be read in conjunction with the
consolidated financial statements of Conseco, Inc. 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
the Company's life insurance subsidiaries.
106
CONSECO, INC. AND SUBSIDIARIES
SCHEDULE III
Supplementary Insurance Information
(Dollars in millions)
Amortization
of
Cost of policies Insurance cost of policies
produced and Insurance Net policy benefits produced and Other
cost of policies Insurance policy investment and cost of policies operating
Segment purchased liabilities income income expenses(1) purchased(2) expenses(3)
- ------- --------- ----------- ------ ------ ----------- ------------ -----------
1997
Supplemental health
operations.................. $1,527.8 $ 3,759.6 $1,858.1 $ 273.8 $1,217.5 $194.9 $313.5
Annuity operations............ 828.0 14,150.8 96.8 1,070.6 725.9 198.9 67.3
Life operations............... 921.7 7,075.0 630.5 448.2 611.8 87.8 123.6
Individual and group
major medical............... 44.1 577.2 758.1 17.3 579.5 16.8 139.0
Other......................... 60.0 337.5 67.3 15.4 40.3 7.3 42.7
Corporate..................... - - - - - - 126.8
-------- --------- -------- -------- -------- ------ ------
Total..................... $3,381.6 $25,900.1 $3,410.8 $1,825.3 $3,175.0 $505.7 $812.9
======== ========= ======== ======== ======== ====== ======
1996
Supplemental health
operations.................. $ 990.8 $ 1,891.9 $ 805.9 $ 66.6 $ 531.8 $ 81.2 $123.5
Annuity operations............ 858.6 12,421.8 77.6 939.6 638.9 95.1 59.1
Life operations............... 626.5 4,992.7 360.5 279.7 367.5 41.5 108.9
Individual and group
major medical............... 49.4 227.4 357.0 8.8 300.3 15.1 18.3
Other......................... 34.0 108.1 53.2 7.8 25.1 7.9 47.1
Corporate..................... - - - - - - 112.4
-------- --------- -------- -------- -------- ------ ------
Total..................... $2,559.3 $19,641.9 $1,654.2 $1,302.5 $1,863.6 $240.8 $469.3
======== ========= ======== ======== ======== ====== ======
1995
Supplemental health
operations.................. $ 571.9 $ 842.6 $ 756.9 $ 66.9 $ 525.6 $ 78.3 $126.2
Annuity operations............ 535.9 10,396.1 68.4 880.3 595.6 169.9 53.9
Life operations............... 220.9 2,102.2 222.4 176.9 234.1 38.6 61.1
Individual and group
major medical............... 54.7 144.2 352.0 9.5 300.8 13.1 12.6
Other......................... 38.3 120.3 65.3 9.0 36.8 7.6 42.1
Corporate..................... - - - - - - 140.5
-------- --------- -------- -------- -------- ------ ------
Total..................... $1,421.7 $13,605.4 $1,465.0 $1,142.6 $1,692.9 $307.5 $436.4
======== ========= ======== ======== ======== ====== ======
(1) Includes insurance policy benefits, change in future policy benefits and
amounts added to annuity and financial product policyholder account
balances.
(2) Includes additional amortization related to gains on sales of investments.
(3) Includes interest expense on notes payable, interest expense on short-term
investment borrowings, change in future policy benefits related to realized
gains, amortization of goodwill and other operating costs and expenses.
107
CONSECO, INC. AND SUBSIDIARIES
SCHEDULE IV
Reinsurance
for the years ended December 31, 1997, 1996 and 1995
(Dollars in millions)
1997 1996 1995
---- ---- ----
Life insurance in force:
Direct............................................................ $136,711.4 $98,835.5 $36,040.7
Assumed........................................................... 4,198.7 3,659.3 562.8
Ceded............................................................. (36,765.6) (22,345.3) (2,820.3)
---------- ---------- ---------
Net insurance in force...................................... $104,144.5 $80,149.5 $33,783.2
========== ========= =========
Percentage of assumed to net................................ 4.0% 4.6% 1.7%
=== === ===
Premiums recorded as revenue for generally accepted accounting principles:
Direct............................................................ $3,162.8 $1,632.3 $1,422.1
Assumed........................................................... 290.3 65.8 6.1
Ceded............................................................. (499.0) (313.8) (72.6)
-------- -------- --------
Net premiums................................................ $2,954.1 $1,384.3 $1,355.6
======== ======== ========
Percentage of assumed to net................................ 9.8% 4.7% .4%
=== === ==
108
EXHIBIT INDEX
Annual Report on Form 10-K
of Conseco, Inc.
Exhibit
No. Document
2.4 Agreement and Plan of Merger dated as of May 19, 1995, by and
between CCP Insurance, Inc. and Conseco, Inc. was filed with
the Commission as Exhibit 2.4 to the Registrant's Report on
Form 8-K dated August 31, 1995, and is incorporated herein by
this reference.
2.5 Agreement and Plan of Merger dated as of March 11, 1996, by
and among Conseco, Inc., LPG Acquisition Company and Life
Partners Group, Inc. was filed with the Commission as Exhibit
2.5 to the Registrant's Report on Form 8-K dated March 11,
1996, and is incorporated herein by this reference.
2.6 Agreement and Plan of Merger dated as of August 25, 1996, by
and between the Registrant and American Travellers Corporation
was filed with the Commission as Exhibit 2.6 to the
Registrant's Report on Form 8-K dated August 25, 1996, and is
incorporated herein by this reference.
2.7 Agreement and Plan of Merger dated August 25, 1996, by and
among the Registrant, CAF Acquisition Company and Capitol
American Financial Corporation was filed with the Commission
as Exhibit 2.7 to the Registrant's Report on Form 8-K dated
August 25, 1996, and is incorporated herein by this reference.
2.8 Agreement and Plan of Merger dated as of September 25, 1996,
by and between the Registrant and Transport Holdings Inc. was
filed with the Commission as Exhibit 2.8 to the Registrant's
Report on Form 8-K dated September 25, 1996, and is
incorporated herein by this reference.
2.8.1 First Amendment to Agreement and Plan of Merger dated as of
November 7, 1996, by and between the Registrant and Transport
Holdings Inc. was filed with the Commission as Exhibit 2.8.1
to its Registration Statement on Form S-4, No. 333-14377 and
is incorporated herein by this reference.
2.9 Agreement and Plan of Merger dated as of December 15, 1996, by
and among the Registrant, Rock Acquisition Company and Pioneer
Financial Services, Inc. was filed with the Commission as
Exhibit 2.9 to the Registrant's Report on Form 8-K dated
December 15, 1996, and is incorporated herein by this
reference.
*3.1 Amended and Restated Articles of Incorporation of the
Registrant.
*3.2 Amended and Restated By-Laws of the Registrant.
4.8 Indenture dated as of February 18, 1993, between the
Registrant and Shawmut Bank Connecticut, National Association,
as Trustee, for the 8 1/8 percent Senior Notes due 2003, was
filed with the Commission as Exhibit 4.8 to the Registrant's
Annual Report on Form 10-K for 1992, and is incorporated
herein by this reference.
Exhibit
No. Document
4.12 Indenture dated as of September 29, 1994 between ALHC Merger
Corporation and LTCB Trust Company and First Supplemental
Indenture dated as of September 29, 1994 between American Life
Holding Company and the Trustee for the 11 1/4% Senior
Subordinated Notes due 2004 were filed with the Commission as
Exhibit 4.12 to the Registrant's Report on Form 8-K dated
September 29, 1994, and are incorporated herein by this
reference.
4.13 Indenture dated as of December 15, 1994, between CCP
Insurance, Inc., and LTCB Trust Company, as Trustee, for the
$200,000,000 aggregate principal amount of 10 1/2% Senior
Notes due 2004 was filed with the Commission as Exhibit 4.13
to the Registrant's Annual Report on Form 10-K for 1995, and
is incorporated herein by this reference.
4.13.1 First Supplemental Indenture between Conseco, Inc., as Issuer,
and LTCB Trust Company as Trustee, dated as of August 31,
1995, was filed with the Commission as Exhibit 4.13.1 to the
Registrant's Report on Form 10-Q for the quarter ended
September 30, 1995, and is incorporated herein by this
reference.
4.14 Credit Agreement among the Registrant, Bank of America
National Trust and Savings Association, First Union National
Bank of North Carolina and Nationsbank, N.A. dated November
22, 1996 ("Credit Agreement"), was filed with the Commission
as Exhibit 4.17 to the Registrant's Report on Form 8-K dated
December 17, 1996, and is incorporated herein by this
reference.
4.14.1 First Amendment dated as of March 10, 1997 to Credit Agreement
was filed with the Commission as Exhibit 4.14.1 to the
Registrant's Report on Form 8-K dated April 1, 1997, and
is incorporated herein by this reference.
4.17.1 Subordinated Indenture, dated as of November 14, 1996, between
the Registrant and Fleet National Bank, as Trustee, was filed
with the Commission as Exhibit 4.17.1 to the Registrant's
Report on Form 8-K dated November 19, 1996, and is
incorporated herein by this reference.
4.17.2 First Supplemental Indenture, dated as of November 14, 1996,
between the Registrant and Fleet National Bank, as Trustee,
was filed with the Commission as Exhibit 4.17.2 to the
Registrant's Report on Form 8-K dated November 19, 1996, and
is incorporated herein by this reference.
4.17.3 9.16% Subordinated Deferrable Interest Debenture due 2006 was
filed with the Commission as Exhibit 4.17.3 to the
Registrant's Report on Form 8-K dated November 19, 1996, and
is incorporated herein by this reference.
4.17.4 Second Supplemental Indenture, dated as of November 22, 1996,
between Conseco, Inc. and Fleet National Bank, as Trustee was
filed with the Commission as Exhibit 4.17.1 to the
Registrant's Report on Form 8-K dated November 27, 1996, and
is incorporated herein by this reference.
4.17.5 8.70% Subordinated Deferrable Interest Debenture due 2026 was
filed with the Commission as Exhibit 4.17.4 to the
Registrant's Report on Form 8-K dated November 27, 1996, and
is incorporated herein by this reference.
4.17.6 Third Supplemental Indenture, dated as of March 26, 1997
between the Registrant and Fleet National Bank, as Trustee,
was filed with the Commission as Exhibit 4.17.6 to the
Registrant's Report on Form 8-K dated April 1, 1997, and is
incorporated herein by this reference.
4.17.7 8.796% Subordinated Deferrable Interest Debenture due 2027 was
filed with the Commission as Exhibit 4.17.7 to the
Registrant's Report on Form 8-K dated April 1, 1997, and
is incorporated herein by this reference.
Exhibit
No. Document
4.18.1 Amended and Restated Declaration of Trust of Conseco Financing
Trust I, dated as of November 14, 1996, among Conseco, Inc.,
as sponsor, the Trustees named therein and the holders from
time to time of undivided beneficial interests in the assets
of Conseco Financing Trust I was filed with the Commission
as Exhibit 4.18.1 to the Registrant's Report on Form 8-K dated
November 19, 1996, and is incorporated herein by this
reference.
4.18.2 Global Certificate for Preferred Security of Conseco Financing
Trust I was filed with the Commission as Exhibit 4.18.2 to the
Registrant's Report on Form 8-K dated November 19, 1996, and
is incorporated herein by this reference.
4.18.3 Preferred Securities Guarantee Agreement, dated as of
November 19, 1996, between the Registrant and Fleet National
Bank was filed with the Commission as Exhibit 4.18.3 to the
Registrant's Report on Form 8-K dated November 19, 1996, and
is incorporated herein by this reference.
4.19.1 Amended and Restated Declaration of Trust of Conseco Financing
Trust II, dated as of November 22, 1996, among Conseco, Inc.,
as sponsor, the Trustees named therein and the holders from
time to time of undivided beneficial interests in the assets
of Conseco Financing Trust II was filed with the Commission as
Exhibit 4.19.1 to the Registrant's Report on Form 8-K dated
November 27, 1996, and is incorporated herein by this
reference.
4.19.2 Global Certificate for Preferred Security of Conseco Financing
Trust II was filed with the Commission as Exhibit 4.19.2 to
the Registrant's Report on Form 8-K dated November 27, 1996,
and is incorporated herein by this reference.
4.19.3 Preferred Securities Guarantee Agreement, dated as of November
27, 1996, between Conseco, Inc. and Fleet National Bank was
filed with the Commission as Exhibit 4.19.3 to the
Registrant's Report on Form 8-K dated November 27, 1996, and
is incorporated herein by this reference.
4.20 Indenture relating to the 6.5% Convertible Subordinated
Debentures due October 1, 2005 issued by American Travellers
Corporation was filed with the Commission as Exhibit 4(c) to
the Annual Report on Form 10-K of American Travellers
Corporation for the year ended December 31, 1995, and is
incorporated herein by this reference.
4.20.1 First Supplemental Indenture between the Registrant and
Firstar Bank of Minnesota, N.A. Trustee, as Trustee, relating
to the 6.5% Convertible Subordinated Debentures due October 1,
2005 was filed with the Commission as Exhibit 4.20.1 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1996, and is incorporated herein by this
reference.
4.21.1 Amended and Restated Declaration of Trust of Conseco Financing
Trust III, dated as of March 26, 1997, among the Registrant,
as sponsor, the trustees named therein and the holders from
time to time of undivided beneficial interests in the assets
of Conseco Financing Trust III was filed with the Commission
as Exhibit 4.20.1 to the Registrant's Report on Form 8-K dated
April 1, 1997, and is incorporated herein by this reference.
4.21.2 Global Certificate for Capital Security of Conseco Financing
Trust III was filed with the Commission as Exhibit 4.20.2 to
the Registrant's Report on Form 8-K dated April 1, 1997, and
is incorporated herein by this reference.
Exhibit
No. Document
4.21.3 Capital Securities Guarantee Agreement, dated as of April 1,
1997 between the Registrant and Fleet National Bank was filed
with the Commission as Exhibit 4.20.3 to the Registrant's
Report on Form 8-K dated April 1, 1997, and is incorporated
herein by this reference.
4.22.1 Senior Indenture, dated November 13, 1997, by and between the
Registrant and 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.
*4.22.2 6.4% Note due February 10, 2003 issued under the Senior
Indenture (one of several identical notes aggregating $250
million).
4.23.1 Subordinated Indenture between the Registrant and The First
National Bank of Chicago, as Trustee, was filed with the
Commission as Exhibit 4.2 to the Registrant's Registration
Statement on Form S-3, No. 333-40423, and is incorporated
herein by this reference.
4.24.1 Amended and Restated Declaration of Trust of Conseco Financing
Trust IV was filed with the Commission as Exhibit 4.12 to the
Registrant's Registration Statement on Form S-3, No.
333-40423, and is incorporated herein by this reference.
4.24.2 Preferred Securities Guarantee of the Registrant for the
benefit of the holders of trust preferred securities of
Conseco Financing Trust IV was filed with the Commission as
Exhibit 4.13 to the Registrant's Registration Statement on
Form S-3, No. 333-40423, and is incorporated herein by
reference.
4.24.3 Purchase Contract Agreement between the Registrant and The
First National Bank of Chicago, as Purchase Contract Agent,
was filed with the Commission as Exhibit 4.20 to the
Registrant's Registration Statement on Form S-3, No.
333-40423, and is incorporated herein by reference.
4.24.4 Pledge Agreement among the Registrant, The Chase Manhattan
Bank, as Collateral Agent, and The First National Bank of
Chicago, as Purchase Contract Agent, was filed with the
Commission as Exhibit 4.21 to the Registrant's Registration
Statement on Form S-3, No. 333-40423, and is incorporated
herein by reference.
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.
Exhibit
No. Document
10.1.2 Employment Agreement dated January 1, 1987, between the
Registrant and Stephen C. Hilbert was filed with the
Commission as Exhibit 10.1.2 to the Registrant's Annual Report
on Form 10-K for 1986, and Amendment No. 1 thereto were filed
with the Commission as Exhibit 10.1.2 to the Registrant's
Annual Report on Form 10-K for 1987; and are incorporated
herein by this reference.
10.1.3 Employment Agreement dated July 1, 1991, between the
Registrant and Rollin M. Dick was filed with the Commission as
Exhibit 10.1.3 to the Registrant's Report on Form 10-Q for the
quarter ended June 30, 1991, and is incorporated herein by
this reference.
10.1.3(a) Amendment No. 1 to Employment Agreement between the Registrant
and Rollin M. Dick was filed with the Commission as Exhibit
10.1.3(a) to the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1996, and is incorporated herein
by this reference.
10.1.3(b) Amendment No.2 to Employment Agreement between the Registrant
and Rollin M. Dick was filed with the Commission as Exhibit
10.1.3(b) to the Registrant's Report on Form 10-Q for the
quarter ended September 30, 1997, and is incorporated herein
by this reference.
10.1.4 Employment Agreement dated July 1, 1991, between the
Registrant and Donald F. Gongaware was filed with the
Commission as Exhibit 10.1.4 to the Registrant's Report on
Form 10-Q for the quarter ended June 30, 1991, and is
incorporated herein by this reference.
10.1.4(a) Amendment No. 1 to Employment Agreement between the Registrant
and Donald F. Gongaware was filed with the Commission as
Exhibit 10.1.4(a) to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1996, and is incorporated
herein by this reference.
10.1.4(b) Amendment No. 2 to Employment Agreement between the Registrant
and Donald F. Gongaware was filed with the Commission as
Exhibit 10.1.4(b) to the Registrant's Report on Form 10-Q for
the quarter ended September 30, 1997, and is incorporated
herein by this reference.
10.1.9 Unsecured Promissory Note of Stephen C. Hilbert dated May 13,
1996 was filed with the Commission as Exhibit 10.1.9 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1996, and is incorporated herein by this
reference.
10.1.10 Employment Agreement dated August 17, 1992, between the
Registrant and Ngaire E. Cuneo was filed with the Commission
as Exhibit 10.1.10 to the Registrant's Report on Form 10-Q for
the quarter ended September 30, 1992, and is incorporated
herein by this reference.
10.1.10(a) Amendment No. 1 to Employment Agreement between the Registrant
and Ngaire E. Cuneo was filed with the Commission as Exhibit
10.1.10(a) to the Registrant's Report on Form 10-K for the
year ended December 31, 1996, and is incorporated herein by
this reference.
10.1.10(b) Amendment No. 2 to Employment Agreement between the Registrant
and Ngaire E. Cuneo was filed with the Commission as Exhibit
10.1.10(b) to the Registrant's Report on Form 10-Q for the
quarter ended September 30, 1997, and is incorporated herein
by this reference.
Exhibit
No. Document
10.1.11 Employment Agreement dated September 8, 1997 between the
Registrant and John J. Sabl was filed with the Commission as
Exhibit 10.1.11 to the Registrant's Report on Form 10-Q for
the quarter ended September 30, 1997, and is incorporated
herein by this reference.
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.
10.8.3 The Registrant's Cash Bonus Plan was filed with the Commission
as Exhibit 10.8.3 to the Registrant's Report on Form 10-Q for
the quarter ended March 31, 1989, and is 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 Bonus Plan for
Executive Vice Presidents was filed with the Commission as
Exhibit B to the Registrant's definitive Proxy Statement dated
April 29, 1994, 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 1994 Stock and Incentive Plan was filed as Exhibit A
to the Registrant's definitive Proxy Statement dated April 29,
1994 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, Executive and Senior Officer
Stock Purchase Plan.
10.8.12 Guaranty regarding Director, Executive and Senior Officer
Stock Purchase Plan was filed with the Commission as Exhibit
10.8.12 to the Registrant's Report on Form 10-Q for the
quarter ended June 30, 1996, and is incorporated herein by
this reference.
10.8.13 Form of Promissory Note payable to the Registrant relating to
the Registrant's Director, Executive and Senior Officer Stock
Purchase Plan was filed with the Commission as Exhibit 10.8.13
to the Registrant's Report on Form 10-Q for the quarter ended
September 30, 1996, and is incorporated herein by this
reference.
*10.8.14 Conseco, Inc. Amended And Restated 1997 Non-qualified Stock
Option Plan.
Exhibit
No. Document
10.23 Aircraft Lease Agreement dated December 22, 1988, between
General Electrical Capital Corporation and Conseco Investment
Holding Company was filed with the Commission as Exhibit 10.23
to the Registrant's Annual Report on Form 10-K for 1988, and
is incorporated herein by this reference.
10.23.1 Amendment to Aircraft Lease Agreement dated December 22, 1988,
between General Electric Capital Corporation and Conseco
Investment Holding Company was filed with the Commission as
Exhibit 10.23.1 to the Registrant's Annual Report on Form 10-K
for 1993, and is incorporated herein by this reference.
10.24 Aircraft Lease Agreement dated April 26, 1991 between General
Electric Capital Corporation and Conseco Investment Holding
Company was filed with the Commission as Exhibit 10.29 to the
Registrant's Report on Form 10-Q for the quarter ended
September 30, 1991, and is incorporated herein by this
reference.
10.24.1 Amendment to Aircraft Lease Agreement dated April 26, 1991,
between General Electric Capital Corporation and Conseco
Investment Holding Company was filed with the Commission as
Exhibit 10.24.1 to the Registrant's Annual Report on Form 10-K
for 1993, and is incorporated herein by this reference.
10.25 Aircraft Lease Purchase Agreement dated December 28, 1993,
between MetLife Capital Corporation and Conseco Investment
Holding Company was filed with the Commission as Exhibit 10.25
to the Registrant's Annual Report on Form 10-K for 1993, and
is incorporated herein by this reference.
10.31 Helicopter Lease Agreement dated April 9, 1992 between General
Electric Capital Corporation and Conseco Investment Holding
Company was filed with the Commission as Exhibit 10.31 to the
Registrant's Report on Form 10-Q for the quarter ended June
30, 1992, and is incorporated herein by this reference.
10.32 Aircraft Lease Agreement dated October 6, 1993, between
General Electric Capital Corporation and Conseco Investment
Holding Company and the associated Assignment Agreement dated
October 25, 1993, between General Electric Capital Corporation
and Nationsbanc Leasing Corporation were filed with the
Commission as Exhibit 10.32 to the Registrant's Annual Report
on Form 10-K for 1993, and are incorporated herein by this
reference.
10.36 Lease dated as of December 18, 1992 between LaSalle National
Trust, N.A. as trustee and Bankers Life and Casualty Company
relating to the lease of executive office and administration
space by BLH was filed with the Commission as Exhibit 10.17 to
Amendment No. 1 to BLH's Registration Statement on Form S-1,
No. 33-55026, and is incorporated herein by this reference.
10.37 Lease dated as of August 20, 1993 between REO Holding
Corporation and Bankers Life and Casualty Company relating the
lease of warehouse space by BLH was filed with the Commission
as Exhibit 10.14 to BLH's Report on Form 10-K for 1994, 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.
Exhibit
No. Document
*23 Consent of Independent Accountants.
*27 Financial data schedule for Conseco, Inc. dated December 31,
1997
*Filed herewith
Compensation Plans and Arrangements
10.1.2 Employment Agreement dated January 1, 1987, between the
Registrant and Stephen C. Hilbert and Amendment No. 1 thereto.
10.1.3 Employment Agreement dated July 1, 1991, between the
Registrant and Rollin M. Dick.
10.1.3(a) Amendment No. 1 to Employment Agreement between the Registrant
and Rollin M. Dick.
10.1.3(b) Amendment No. 2 to Employment Agreement between the Registrant
and Rollin M. Dick.
10.1.4 Employment Agreement dated July 1, 1991, between the
Registrant and Donald F. Gongaware.
10.1.4(a) Amendment No. 1 to Employment Agreement between the Registrant
and Donald F. Gongaware.
10.1.4(b) Amendment No. 2 to Employment Agreement between the Registrant
and Donald F. Gongaware.
10.1.9 Unsecured Promissory Note of Stephen C. Hilbert.
10.1.10 Employment Agreement dated August 17, 1992, between the
Registrant and Ngaire E. Cuneo.
10.1.10(a) Amendment No. 1 to Employment Agreement between the Registrant
and Ngaire E. Cuneo.
10.1.10(b) Amendment No. 2 to Employment Agreement between the Registrant
and Ngaire E. Cuneo.
10.11 Employment Agreement between the Registrant and John J. Sabl.
10.8 The Registrant's Stock Option Plan; Amendment No. 1 thereto;
Amendment No. 2 thereto; Amendment No. 3 thereto; Amendment
No. 4 thereto; and Amendment No. 5 thereto.
10.8.3 The Registrant's Cash Bonus Plan.
10.8.4 Amended and Restated Conseco Stock Bonus and Deferred
Compensation Program.
10.8.6 Conseco Performance - Based Compensation Bonus Plan for
Executive Vice Presidents.
10.8.7 Conseco, Inc. Amended and Restated Deferred Compensation Plan.
10.8.8 Amendment to the Amended and Restated Conseco Stock Bonus and
Deferred Compensation Program.
10.8.9 Conseco 1994 Stock and Incentive Plan.
10.8.10 Amendment No. 2 to the Amended and Restated Stock Bonus and
Deferred Compensation Program.
*10.8.11 Amended and Restated Director, Executive and Senior Officer
Stock Purchase Plan.
10.8.12 Guaranty regarding Director, Executive and Senior Officer
Stock Purchase Plan.
10.8.13 Form of Promissory Note Payable to the Registrant relating to
the Registrant's Director, Executive and Senior Officer Stock
Purchase Plan.
*10.8.14 Conseco, Inc. Amended and Restated 1997 Non-qualified Stock
Option Plan.