AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 29, 2004
NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
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CONSECO, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 6321 75-3108137
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
11825 N. PENNSYLVANIA STREET
CARMEL, INDIANA 46032
(317) 817-6100
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
EUGENE M. BULLIS, EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
WILLIAM S. KIRSCH, EXECUTIVE VICE PRESIDENT, GENERAL COUNSEL AND SECRETARY
CONSECO, INC.
11825 N. PENNSYLVANIA STREET
CARMEL, INDIANA 46032
(317) 817-6100
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
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COPIES OF ALL COMMUNICATIONS, INCLUDING COMMUNICATIONS SENT TO AGENT FOR
SERVICE, SHOULD BE SENT TO:
JAMES S. ROWE VINCENT J. PISANO WILLIAM J. WHELAN, III
KIRKLAND & ELLIS LLP KIRKLAND & ELLIS LLP ANDREW J. PITTS
200 EAST RANDOLPH DRIVE CITIGROUP CENTER CRAVATH, SWAINE & MOORE LLP
CHICAGO, ILLINOIS 60601 153 EAST 53RD STREET WORLDWIDE PLAZA
(312) 861-2000 NEW YORK, NEW YORK 10022 825 EIGHTH AVENUE
(212) 446-4800 NEW YORK, NEW YORK 10019
(212) 474-1000
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
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If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
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PROPOSED MAXIMUM AGGREGATE
TITLE OF EACH CLASS OF SECURITIES TO BE REGISTERED OFFERING PRICE(1)(2) AMOUNT OF REGISTRATION FEE
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Common Stock, par value $0.01 per share..................... $ 800,000,000 $101,360
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Mandatorily Convertible Preferred Stock, Class B, par value
$0.01 per share........................................... $ 350,000,000 $ 44,345
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Total....................................................... $1,150,000,000 $145,705(3)
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(1) Includes amount attributable to shares of common stock and Mandatorily
Convertible Preferred Stock, Class B that may be purchased by the
underwriters under an option to purchase additional shares at the public
offering price less the underwriting discount.
(2) Estimated solely for the purpose of computing the amount of the registration
fee pursuant to Rule 457(o) under the Securities Act of 1933.
(3) The registrant filed a registration statement on Form S-3 (No. 333-110963)
on December 5, 2003 for which the registrant paid a filing fee of $242,700.
The registration statement on Form S-3 (No. 333-110963) was not declared
effective by the Commission, no securities were sold under such registration
statement, and on January 29, 2004, the registrant requested the withdrawal
of such registration statement. Pursuant to Rule 457(p) under the Securities
Act of 1933, the registrant has offset the registration fee of $145,705 due
herewith with a portion of the registration fee paid on December 5, 2003.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
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EXPLANATORY NOTE
This Registration Statement contains alternate sections, paragraphs,
sentences or phrases which will be contained in two forms of prospectus covered
in this Registration Statement, one to be used in connection with an offering of
shares of our common stock and the other to be used in connection with a
concurrent offering of shares of our Mandatorily Convertible Preferred Stock,
Class B. Those sections, paragraphs, sentences or phrases that will appear only
in the common stock prospectus are marked at the beginning of such section,
paragraph, sentence or phrase by the symbol [C] and those that will appear only
in the Mandatorily Convertible Preferred Stock, Class B prospectus are
designated with the symbol [P]. Unless so indicated with a [C] or [P], the
language therein will appear in both forms of prospectus.
THE INFORMATION IN THIS PRELIMINARY PROSPECTUS IS NOT COMPLETE AND MAY BE
CHANGED. THESE SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION STATEMENT FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PRELIMINARY
PROSPECTUS IS NOT AN OFFER TO SELL NOR DOES IT SEEK AN OFFER TO BUY THESE
SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED.
[C] Subject to Completion, Dated January 29, 2004
(CONSECO LOGO)
Shares
CONSECO, INC.
Common Stock
----------------------
We are offering shares of our common stock. Concurrently with this
offering, we are offering shares of our % Class B Mandatorily Convertible
Preferred Stock (the "Class B Preferred Stock"). The closing of this offering is
not conditioned upon the closing of the Class B Preferred Stock offering.
Our common stock is listed on the New York Stock Exchange under the symbol
"CNO." The last reported sale price of our common stock on January 28, 2004 was
$22.94 per share.
Investing in our securities involves risks. See "Risk Factors" beginning on
page 14 to read about factors you should consider before buying our securities.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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Per Share Total
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Initial price to public..................................... $ $
Underwriting discount....................................... $ $
Proceeds, before expenses, to Conseco....................... $ $
To the extent that the underwriters sell more than shares of common
stock, the underwriters have the option to purchase up to an additional
shares from us at the initial price to public less the underwriting discount.
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The underwriters expect to deliver the shares of common stock to purchasers
on , 2004.
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Joint Bookrunning Managers
GOLDMAN, SACHS & CO. MORGAN STANLEY
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BANC OF AMERICA SECURITIES LLC
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Prospectus dated , 2004.
THE INFORMATION IN THIS PRELIMINARY PROSPECTUS IS NOT COMPLETE AND MAY BE
CHANGED. THESE SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION STATEMENT FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PRELIMINARY
PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES NOR DOES IT SEEK AN OFFER TO
BUY THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT
PERMITTED.
[P] Subject to Completion, Dated January 29, 2004
(CONSECO LOGO)
Shares
CONSECO, INC.
% Mandatorily Convertible Preferred Stock, Class B
(liquidation preference $ per share)
----------------------
We are offering shares of our % Mandatorily Convertible Preferred
Stock, Class B (the "Class B Preferred Stock"). Concurrently with this offering,
we are offering shares of our common stock. The closing of this offering is
conditioned upon the closing of the common stock offering.
Dividends on the shares of Class B Preferred Stock will be cumulative from
, 2004 and will be payable , , and
of each year, commencing on , 2004. Accumulated unpaid
dividends will cumulate dividends at the annual rate of %. The dividend
rate is $ per share per annum.
On the mandatory conversion date, each share of Class B Preferred Stock
will automatically convert into shares of our common stock based on the
conversion rates described in this prospectus. Our common stock is listed on the
New York Stock Exchange under the symbol "CNO." The last reported sale price of
our common stock on January 28, 2004 was $22.94 per share.
Prior to this offering there has been no public market for the Class B
Preferred Stock. We intend to list the Class B Preferred Stock on the New York
Stock Exchange under the symbol "CNO PrB."
Investing in our securities involves risks. See "Risk Factors" beginning on
page 14 to read about factors you should consider before buying our securities.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED THESE SECURITIES OR PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
----------------------
Per Share Total
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Initial price to public..................................... $ $
Underwriting discount....................................... $ $
Proceeds, before expenses, to Conseco....................... $ $
To the extent that the underwriters sell more than shares of Class B
Preferred Stock, the underwriters have the option to purchase up to an
additional shares of Class B Preferred Stock from us at the initial price
to public less the underwriting discount.
------------------
The underwriters expect to deliver the shares of Class B Preferred Stock to
purchasers on , 2004.
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Joint Bookrunning Managers
GOLDMAN, SACHS & CO. MORGAN STANLEY
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JPMORGAN
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Prospectus dated , 2004.
TABLE OF CONTENTS
PAGE
----
PROSPECTUS SUMMARY..................... 1
RISK FACTORS........................... 14
OUR RECENT EMERGENCE FROM BANKRUPTCY... 31
[P] RATIOS OF EARNINGS TO FIXED CHARGES
AND EARNINGS TO FIXED CHARGES,
PREFERRED STOCK DIVIDENDS, AND
DISTRIBUTIONS ON COMPANY-OBLIGATED
MANDATORILY REDEEMABLE PREFERRED
SECURITIES OF SUBSIDIARY TRUSTS...... 33
USE OF PROCEEDS........................ 35
PRICE RANGE OF OUR COMMON STOCK........ 35
DIVIDEND POLICY........................ 36
CAPITALIZATION......................... 37
SELECTED CONSOLIDATED FINANCIAL AND
OPERATING DATA....................... 38
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS........................... 40
PAGE
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BUSINESS............................... 93
MANAGEMENT............................. 118
CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS......................... 127
PRINCIPAL STOCKHOLDERS................. 128
[P] DESCRIPTION OF THE MANDATORILY
CONVERTIBLE PREFERRED STOCK.......... 129
[P] CERTAIN U.S. FEDERAL INCOME TAX
CONSIDERATIONS....................... 141
DESCRIPTION OF CAPITAL STOCK........... 146
SHARES ELIGIBLE FOR FUTURE SALE........ 154
[C] UNDERWRITING....................... 157
[P] UNDERWRITING....................... 160
LEGAL MATTERS.......................... 163
EXPERTS................................ 163
WHERE YOU CAN FIND MORE INFORMATION.... 163
INDEX TO FINANCIAL STATEMENTS.......... F-1
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You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with different information. We are not
offering these securities in any state where the offer is not permitted. You
should not assume that the information contained in this prospectus is accurate
as of any date other than the date on the front of this prospectus.
The terms "Conseco," the "Company," "we," "us" and "our" as used in this
prospectus refer to Conseco, Inc., a Delaware corporation, and, unless we state
otherwise or the context otherwise requires, its subsidiaries. Unless we state
otherwise or the context otherwise requires, the terms "Conseco," the "Company,"
"we," "us" and "our" as used in this prospectus also refer to our predecessor,
Conseco, Inc., an Indiana corporation, and its subsidiaries.
PROSPECTUS SUMMARY
The following summary highlights information contained elsewhere in this
prospectus. This summary does not contain all of the information you should
consider before investing in our securities. You should read this entire
prospectus, including "Risk Factors" and our consolidated financial statements
and accompanying notes, before making an investment decision.
OUR COMPANY
We are a holding company for a group of insurance companies operating
throughout the United States that develop, market and administer supplemental
health insurance, annuity, individual life insurance and other insurance
products. We focus on serving the senior and middle-income markets, which we
believe are attractive, high growth markets. We sell our products through three
distribution channels: career agents, professional independent producers (some
of whom sell one or more of our product lines exclusively) and direct marketing.
As of September 30, 2003, we had $2.8 billion of shareholders' equity and $29.9
billion of assets. For the one month ended September 30, 2003, we had $366.3
million of revenues and $24.2 million of net income.
We conduct our business operations through two primary operating segments,
based on method of product distribution, and a third segment comprised of
businesses in run-off:
- BANKERS LIFE, which consists of the businesses of Bankers Life & Casualty
Company ("Bankers Life & Casualty") and Colonial Penn Life Insurance
Company ("Colonial Penn"). Bankers Life & Casualty markets and
distributes Medicare supplement insurance, life insurance, long-term care
insurance and fixed annuities to the senior market through approximately
4,000 exclusive career agents and sales managers. Colonial Penn markets
graded benefit and simplified issue life insurance directly to consumers
through television advertising, direct mail, the internet and
telemarketing. Both Bankers Life & Casualty and Colonial Penn market
their products under their own brand names.
- CONSECO INSURANCE GROUP, which markets and distributes specified disease
insurance, Medicare supplement insurance, and certain life and annuity
products to the senior and middle-income markets through over 500
independent marketing organizations ("IMOs") that represent over 9,100
producing independent agents. This segment markets its products under the
"Conseco" brand.
- OTHER BUSINESS IN RUN-OFF, which includes blocks of business that we no
longer market or underwrite. This segment consists of long-term care
insurance sold through independent agents and major medical insurance.
We also have a corporate segment, which consists of holding company
activities and certain non-insurance company businesses that are not related to
our operating segments.
The following table sets forth information on our segments for the one
month ended September 30, 2003 (dollars in millions):
COLLECTED PREMIUMS
------------------- INCOME BEFORE
$ PERCENTAGE INCOME TAXES
- ---------- -------------
Bankers Life.................................... $172.1 53.0% $ 24.9
Conseco Insurance Group......................... 104.7 32.2 20.2
Other Business In Run-off....................... 48.0 14.8 3.6
Corporate....................................... -- -- (10.9)
------ ----- ------
Total........................................... $324.8 100.0% $ 37.8
====== ===== ======
1
OUR RESTRUCTURING
We are in the process of significantly restructuring our business through a
process which included the bankruptcy of our predecessor company and our
subsequent emergence from bankruptcy on September 10, 2003. None of our
insurance company subsidiaries were a part of the bankruptcy petitions, although
the bankruptcy did cause disruptions to our insurance operations.
We have achieved several critical financial goals as part of our
restructuring, including:
- reducing our debt and other obligations by $5.7 billion,
- disposing of the assets of our predecessor's finance business,
- selling non-core operating subsidiaries such as Conseco Variable
Insurance Company ("CVIC"),
- improving the risk profile of our investment portfolio, and
- improving the financial strength of our insurance companies as measured
by risk-based capital.
We have also recruited and integrated new members into our management team,
and we have a new board of directors. Since our emergence from bankruptcy,
management has continued to take steps in an effort to improve our profitability
and further streamline our business. For example, in September 2003, we sold our
stake in the General Motors building in New York City (the "GM building"), which
increased the statutory capital and surplus of our insurance subsidiaries by
over $350 million.
We have also undertaken several strategic initiatives to streamline our
business lines, focusing on those businesses we believe are most profitable.
These initiatives include emphasizing the sales of Medicare supplement and
specified disease products and de-emphasizing sales of certain annuity and life
products, ceasing sales of long-term care products in Conseco Insurance Group
and attempting to re-price certain lines of business through significant rate
increases.
The next stage of our restructuring, which includes the offering of our
common stock and the offering of the Class B Preferred Stock, is a
recapitalization of our current balance sheet (the "Recapitalization"). The
offering of our Class B Preferred Stock is conditioned upon the offering of our
common stock. The offering of our common stock is not conditioned upon the
offering of our Class B Preferred Stock. Our current capitalization is presented
below:
AS OF
SEPTEMBER 30, 2003
------------------
(IN MILLIONS)
Notes payable............................................... $1,300.0
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Equity:
Preferred Stock, par value $0.01 per share, 265,000,000
authorized; 34,386,740 shares of Class A Senior
Cumulative Convertible Exchangeable Preferred Stock
issued and outstanding................................. 865.0
Common Stock, par value $0.01 per share, 8,000,000,000
authorized; 100,098,119 issued and outstanding......... 1.0
Additional paid-in-capital................................ 1,639.3
Accumulated other comprehensive income.................... 273.2
Retained earnings......................................... 18.9
--------
Total equity........................................... 2,797.4
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Total capitalization................................. $4,097.4
========
The Recapitalization has two components:
- REDEMPTION OF OUR EXISTING PREFERRED STOCK. We plan to use a portion of
the proceeds of the offerings to redeem our outstanding Class A Senior
Cumulative Convertible Exchangeable Preferred Stock (the "Class A
Preferred Stock").
2
- REDUCTION AND REPLACEMENT OR RENEGOTIATION OF OUR EXISTING BANK CREDIT
FACILITY. We intend to reduce our overall senior indebtedness, reduce
our borrowing costs and improve the terms and conditions of our existing
bank credit facility. We believe that we can achieve these goals by using
a portion of the proceeds of the offerings of our common stock and our
Class B Preferred Stock to retire a portion of our existing debt, or by
renegotiating the terms of our existing bank credit facility.
By redeeming all or a part of the Class A Preferred Stock and reducing our
overall indebtedness, our goals are to improve the financial flexibility of our
top-tier holding company and improve the financial strength ratings of our
insurance companies. The completion of the common stock offering is not
conditioned upon completion of the Class B Preferred Stock offering, and if we
complete the common stock offering but not the Class B Preferred Stock offering,
we will have fewer proceeds to apply in this regard.
COMPETITIVE STRENGTHS
We believe our competitive strengths have enabled and will continue to
enable us to capitalize on the opportunities in our target markets. These
strengths include:
- our position as a leading national provider of life and health insurance
products to the senior market,
- our broad-based distribution networks,
- our strong, nationally recognized brand names, and
- our experienced management with a proven track record.
LEADING NATIONAL PROVIDER OF LIFE AND HEALTH INSURANCE PRODUCTS TO THE
SENIOR MARKET. The Bankers Life segment is one of the leading national
providers of life and health insurance products focused primarily on the senior
market. The career agents and direct distribution channels within Bankers Life
provide a number of products that are important to the financial well-being of
seniors: supplemental health coverage, including Medicare supplement and
long-term care insurance, as well as selected life and annuity products.
According to the most recently published study on the Medicare supplement market
by the Life Insurance Marketing Research Association, we were ranked second in
sales of agent-distributed Medicare supplement insurance based on collected
premiums in 2002. Our approximately 4,000 career agents are trained to cater to
the needs of the senior market. Current demographic trends indicate that the
senior market will continue to grow, and we believe our focus on seniors will
provide us with a significant opportunity to increase our share of this market.
BROAD-BASED DISTRIBUTION NETWORKS. Our broad-based distribution networks
provide us with a number of ways to reach our target markets. Our career agents
and direct distribution channels focus on the senior market. We also have
independent agents who focus on senior market products such as Medicare
supplement insurance. Our independent agents also sell certain of our products
that are specifically designed for the under-age-65 middle-income market. These
products include our specified disease insurance coverage, such as cancer and
heart/stroke products, as well as equity-indexed life insurance and
equity-indexed annuities. Despite the bankruptcy, we have retained the majority
of our career agents, including 80 percent of our top 1,000 career agents, who
accounted for over 50 percent of Bankers Life & Casualty's sales during 2003. In
2002, 55 percent of our sales were through independent distributors, 43 percent
were through career agents, and 2 percent were through direct marketing by
Colonial Penn.
STRONG, NATIONALLY RECOGNIZED BRAND NAMES. We believe our brands are
widely recognized by our customers and distributors. We believe we have
successfully developed product-focused consumer recognition in our chosen
markets through three distinct brands -- Conseco, Bankers Life & Casualty and
Colonial Penn. According to Communicus, an independent research firm, we have
increased the awareness of the Conseco brand from 28 percent of consumers in our
target market in 1998 to 50 percent in 2003. Additionally, we believe our
multiple-brand strategy has helped us maintain sales of certain key products,
such as Medicare supplement, and retain business through our reorganization. We
continue to raise the profile of our brands through our "Step Up" campaign and
several national and local community sponsorship arrangements, including the
Indy Racing League and the Conseco Fieldhouse in Indianapolis, home to the
Indiana Pacers
3
NBA basketball team. In addition, we continue to raise the profile of our
Bankers Life brand through our continued relationship with the Alzheimer's
Association and International Longevity Center as well as a renewed relationship
with Paul Harvey, who for many years was the spokesperson for Bankers Life &
Casualty. We believe that our brands give us a key competitive advantage,
allowing us to continue to build and maintain strong relationships with our
customers and distributors.
EXPERIENCED MANAGEMENT WITH A PROVEN TRACK RECORD. Our strong, experienced
senior management team has led us through our restructuring to date. Our
management is led by our President and Chief Executive Officer, William J. Shea,
who has over 25 years of financial services experience and joined Conseco in
2001. Mr. Shea has served as Vice Chairman and Chief Financial Officer of
BankBoston Corporation and as Partner and Vice Chairman of
PricewaterhouseCoopers LLP (formerly Coopers & Lybrand LLP). In addition to our
experienced senior management team, our Non-Executive Chairman, R. Glenn
Hilliard, has over 35 years of insurance experience, having served most recently
as Chairman and CEO of ING Americas. Mr. Hilliard joined our board in September
2003. Our management's knowledge and experience have helped us maintain our
business operations through the restructuring and are expected to provide us
with opportunities to further enhance the Company in the future.
STRATEGY
Our objective is to generate attractive returns on equity while growing a
stable, well capitalized insurance business focused on serving the middle-income
and senior markets. We intend to achieve these objectives by executing the
following strategies:
- focus on the senior and middle-income markets,
- continue to improve our financial condition,
- leverage our distribution network to strengthen market access, and
- continue to improve our operational efficiency.
FOCUS ON THE SENIOR AND MIDDLE-INCOME MARKETS. We are committed to serving
the senior and middle-income markets in the United States. Our customer base
includes approximately 3.8 million policyholders. According to the January 2004
issue of "Journal of Financial Service Professionals," the population of the
United States age 50 or older is projected to increase by approximately 27
percent from 2004 to 2014. We have taken several steps in recent periods to
sharpen our focus on both markets by strengthening our distribution, reducing
our sales of non-core life and annuity products and introducing new and
innovative supplemental health and retirement savings products targeting senior
and middle-income customers.
CONTINUE TO IMPROVE OUR FINANCIAL CONDITION. We seek to continue to
improve our financial condition by reducing leverage at the holding company,
maintaining adequate risk-based capital in our operating subsidiaries and
focusing on marketing profitable products. We took a series of actions in 2002
and 2003 to enhance our financial condition. In addition to reducing our debt
and other obligations at the holding company by $5.7 billion through the
bankruptcy, we improved the risk profile of our investment portfolio and the
financial strength of our insurance companies as measured by risk-based capital.
Our fixed maturity investment portfolio is primarily comprised of government,
investment-grade and structured securities. Below-investment grade securities
comprised 4.1 percent of our fixed maturity portfolio as of September 30, 2003,
down from 6.5 percent as of December 31, 2002. Our insurance companies'
consolidated company action level risk-based capital ratio ("RBC") improved from
166 percent at December 31, 2002 to approximately 250 percent at September 30,
2003. The RBC ratio is one of the tools insurance regulators use to determine
the adequacy of an insurance company's capital. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Statutory
Information" for further information. We intend to continue to manage our
business with a view to improving our capitalization, financial strength and
ratings.
LEVERAGE OUR DISTRIBUTION NETWORK TO STRENGTHEN MARKET ACCESS. We seek to
leverage our broad distribution channels to meet our customers' needs and
enhance our market presence. We believe we have
4
created appropriate incentives focused on persistent and profitable production,
as well as improved monitoring and tracking of production and persistency levels
by distributor. We promote cross-selling of life, supplemental health and
retirement savings products in certain markets to capture a greater share of our
policyholders' coverage needs. In addition, we utilize our independent producers
and career agent network as important sources of information regarding the
evolving needs of our customer base. As a result, our products are tailored to
include the specific features that we believe are most important to our
customers. If we are successful in raising our ratings, we expect to be able to
add new agents to our career and independent agency distribution channels, which
we believe will result in increased sales of our insurance products.
CONTINUE TO IMPROVE OUR OPERATIONAL EFFICIENCY. We have undertaken several
initiatives to improve our operational efficiency and lower costs. We have
simplified our organizational structure by divesting certain businesses and
consolidating several legal entities. We are in the process of integrating
policy administration and claims management systems from previous acquisitions
to lower our operational costs in our Conseco Insurance Group segment. We intend
to reduce the number of policy administration and related support systems by 50
percent over the next 12 to 18 months. We have also reduced our headcount over
the past two years and have focused on improving the productivity of our
employees, career agents and independent distributors. We intend to continue to
work to improve our operational efficiency by rationalizing expenses and systems
in an effort to enhance our service standards and profitability.
CORPORATE INFORMATION
We are a corporation organized under the laws of the State of Delaware, and
the successor to Conseco, Inc., an Indiana corporation. We emerged from
bankruptcy on September 10, 2003. Our principal executive offices are located at
11825 N. Pennsylvania Street, Carmel, Indiana 46032, and our telephone number at
this location is (317) 817-6100. Our website is www.conseco.com. Information on
our website should not be construed to be part of this prospectus.
Our common stock is listed on the New York Stock Exchange ("NYSE") under
the symbol "CNO," and our Series A Warrants are listed on the NYSE under the
symbol "CNOWS." Our Class A Preferred Stock currently trades on the
Over-the-Counter Bulletin Board under the symbol "CNSJP."
5
[C] THE OFFERING
Issuer........................ Conseco, Inc.
Common stock offered.......... shares
Common stock to be outstanding
after this offering........... shares if the underwriters do not
exercise the option to purchase additional
shares.
Over-allotment option......... shares
Initial price................. $ per share
Use of proceeds............... We intend to use the net proceeds of this
offering, together with the net proceeds of the
concurrent Class B Preferred Stock offering, to
redeem shares of our outstanding Class A
Preferred Stock, to repay indebtedness under
our existing senior credit facility, to
contribute capital to our insurance
subsidiaries and/or for general corporate
purposes. See "Use of Proceeds." The completion
of the common stock offering is not conditioned
upon completion of the Class B Preferred Stock
offering.
NYSE symbol................... CNO
The number of shares of our common stock shown above to be outstanding after
this offering is based on 100,115,772 shares, the number of shares of our common
stock outstanding as of December 31, 2003, and excludes:
- 6 million shares of common stock issuable upon the exercise of outstanding
Series A Warrants at an exercise price of $27.60 per share;
- 43.6 million shares of common stock issuable upon the conversion of
outstanding Class A Preferred Stock at a conversion price of $20.35 per
share, which shares are not convertible into common stock until September
30, 2005, and which we intend to redeem with the proceeds of this offering
and the concurrent Class B Preferred Stock offering;
- the shares of common stock issuable upon the conversion of the Class B
Preferred Stock expected to be issued in the concurrent offering;
- 1 million shares of common stock issuable upon the exercise of outstanding
options at a weighted average exercise price per share of $18.01;
- an aggregate of 1 million shares of unvested restricted stock granted to our
President and Chief Executive Officer and to our Non-Executive Chairman;
- approximately 3 million shares of common stock issuable upon the exercise of
options to purchase common stock under our long-term equity incentive plan
that we currently intend to grant to our officers on or shortly after the
date of this prospectus at an exercise price equal to the fair market value
on the date of grant; and
- approximately 5 million shares of common stock reserved for future grants
under our long-term equity incentive plan.
6
[P] THE OFFERING
Issuer........................ Conseco, Inc.
Securities offered............ shares of % Class B
Mandatorily Convertible Preferred Stock, which
we call the Class B Preferred Stock.
Initial price................. $ for each share of Class B Preferred
Stock.
Option to purchase additional
Class B Preferred Stock....... The underwriters have the option to purchase up
to additional shares of Class B
Preferred Stock from us at the public offering
price, less underwriting discounts and
commissions, within 30 days from the date of
this prospectus. If the underwriters exercise
their option to purchase additional shares of
Class B Preferred Stock in full, we will have
million shares of Class B Preferred
Stock outstanding.
Dividends..................... $ for each share of Class B Preferred
Stock per year. Dividends will be cumulative
from the date of issuance, and to the extent
that assets are legally available to pay
dividends and such payments will not result in
a default under our senior credit facility, we
will pay dividends in cash on each dividend
payment date. Accumulated unpaid dividends will
cumulate dividends at the annual rate of
%. The dividend payable on the first
dividend payment date is $ and on each
subsequent dividend payment date will be
$ . See "Description of the
Mandatorily Convertible Preferred
Stock -- Dividends."
Dividend payment dates........ , , and
of each year, commencing on
, 2004.
Redemption.................... The Class B Preferred Stock will not be
redeemable.
Mandatory conversion date..... , , which we call the
mandatory conversion date.
Automatic conversion.......... On the mandatory conversion date, each share of
Class B Preferred Stock will automatically
convert into shares of our common stock, based
on the conversion rate as described below.
The holders of the Class B Preferred Stock on
the mandatory conversion date will have the
right to receive the cash dividends due on such
date (including any accrued and unpaid
dividends on the shares of Class B Preferred
Stock as of the mandatory conversion date),
whether or not declared prior to such date,
provided that we have legally available assets
at such time and such payments will not result
in a default under our senior credit facility.
If we do not have adequate legally available
assets to pay any or all accumulated dividends
in cash on the mandatory conversion date or
such payment would result in a default under
our senior credit facility, then, in respect of
the portion of such dividends which we are
unable to pay in cash, we will deliver to the
holders shares of our common stock as described
under "Description of the Mandatorily
Convertible Preferred Stock -- Mandatory
Conversion."
7
Conversion rate............... The conversion rate for each share of Class B
Preferred Stock will be not more than
shares and not less than
shares of our common stock, depending on the
applicable market value of our common stock, as
described below.
The "applicable market value" of our common
stock is the arithmetic average of the closing
price per share of our common stock on each of
the 20 consecutive trading days ending on the
third trading day immediately preceding the
mandatory conversion date. It will be
calculated as described under "Description of
the Mandatorily Convertible Preferred
Stock -- Mandatory Conversion."
The conversion rate is subject to certain
adjustments, as described under "Description of
the Mandatorily Convertible Preferred
Stock -- Anti-Dilution Adjustments."
The following table illustrates the conversion
rate per share of Class B Preferred Stock,
subject to certain anti-dilution adjustments:
APPLICABLE MARKET
VALUE ON
MANDATORY CONVERSION
CONVERSION DATE RATE
----------------- --------------
less than or equal to $
between $ and $ to
equal to or greater than
$
Optional conversion........... At any time prior to , and
on or after the day immediately following the
issue date of the Class B Preferred Stock, you
may elect to convert each of your shares of
Class B Preferred Stock at the minimum
conversion rate of shares of our
common stock for each share of Class B
Preferred Stock. This conversion rate is
subject to certain adjustments as described
under "Description of the Mandatorily
Convertible Preferred Stock -- Anti-Dilution
Adjustments."
Provisional conversion at our
option........................ If at any time prior to ,
and on or after the day immediately following
the issue date of the Class B Preferred Stock,
the closing price per share of our common stock
exceeds $ (150% of the threshold
appreciation price of $ ), subject to
anti-dilution adjustments, for at least 20
trading days within a period of 30 consecutive
trading days, we may elect to cause the
conversion of all, but not less than all, of
the shares of Class B Preferred Stock then
outstanding at the minimum conversion rate of
shares of our common stock for each
share of Class B Preferred Stock, subject to
certain adjustments as described under
"Description of the Mandatorily Convertible
Preferred Stock -- Anti-Dilution Adjustments,"
only if, in addition to issuing you such shares
of common stock, we pay
8
you in cash the present value of all the
remaining dividend payments through and
including , , on the shares
of Class B Preferred Stock, computed using a
discount rate equal to the treasury yield (as
defined), plus any accrued and unpaid dividend
payments on the shares of Class B Preferred
Stock, whether or not declared, in each case,
out of legally available assets. See
"Description of the Mandatorily Convertible
Preferred Stock -- Provisional Conversion at
Our Option."
Early conversion upon cash
merger........................ Prior to the mandatory conversion date, if we
are involved in a merger in which at least 30%
of the consideration for our common stock
consists of cash or cash equivalents, which we
refer to as a "cash merger," then on the date
specified in our notice to you each holder of
shares of Class B Preferred Stock will have the
right to convert their shares of Class B
Preferred Stock at the conversion rate,
determined in accordance with "Conversion Rate"
above, in effect immediately prior to the cash
merger. See "Description of the Mandatorily
Convertible Preferred Stock -- Early Conversion
upon Cash Merger."
Anti-dilution adjustments..... The formula for determining the conversion rate
on the mandatory conversion date and the number
of shares of our common stock to be delivered
upon an early conversion event may be adjusted
if certain events occur. See "Description of
the Mandatorily Convertible Preferred
Stock -- Anti-Dilution Adjustments."
Liquidation preference........ $ per share of Class B Preferred Stock,
plus an amount equal to the sum of all accrued
and unpaid dividends.
Voting rights................. Holders of shares of Class B Preferred Stock
will not be entitled to any voting rights,
except as required by applicable state law and
as described under "Description of the
Mandatorily Convertible Preferred
Stock -- Voting Rights."
Ranking....................... The Class B Preferred Stock will rank:
- junior to all of our existing and future debt
obligations;
- junior to any class or series of our capital
stock the terms of which provide that such
class or series will rank senior to the Class
B Preferred Stock;
- senior to any class or series of our capital
stock the terms of which provide that such
class or series will rank junior to the Class
B Preferred Stock;
- senior in right of payment to all of our
Class A Preferred Stock and common stock now
outstanding or to be issued in the future;
and
- on a parity with any other class or series of
our capital stock ranking pari passu with the
Class B Preferred Stock as to the payment of
dividends or the distribution of assets upon
distribution, liquidation or winding up.
We will not be entitled to issue any class or
series of our capital stock the terms of which
provide that such class or series will rank
9
senior to the Class B Preferred Stock without
the consent of the holders of at least
two-thirds of the shares of the Class B
Preferred Stock.
As of the date of this prospectus, we are
authorized to issue up to 8,000,000,000 shares
of common stock, $.01 par value per share. As
of December 31, 2003, 100,115,772 shares of
common stock were issued and outstanding. In
addition, as of such date, there were:
- 6 million shares of common stock issuable
upon the exercise of outstanding Series A
Warrants at an exercise price of $27.60 per
share;
- 43.6 million shares of common stock issuable
upon the conversion of outstanding Class A
Preferred Stock at a conversion price of
$20.35 per share, which shares are not
convertible into common stock until September
30, 2005, and which we intend to redeem with
the proceeds of this offering and the
concurrent common stock offering;
- 1 million shares of common stock issuable
upon the exercise of outstanding options at a
weighted average exercise price per share of
$18.01;
- an aggregate of 1 million shares of unvested
restricted stock granted to our President and
Chief Executive Officer and to our
Non-Executive Chairman;
- approximately 3 million shares of common
stock issuable upon the exercise of options
to purchase common stock under our long-term
equity incentive plan that we currently
intend to grant to our officers on or shortly
after the date of this prospectus at an
exercise price equal to the fair market value
on the date of grant; and
- approximately 5 million shares of common
stock reserved for future grants under our
long-term equity incentive plan.
Use of proceeds............... We intend to use the net proceeds of this
offering, together with the net proceeds of the
concurrent common stock offering, to redeem all
outstanding shares of our Class A Preferred
Stock, to repay indebtedness under our existing
senior credit facility, to contribute capital
to our insurance subsidiaries and/or for
general corporate purposes. See "Use of
Proceeds." The completion of this offering is
conditioned upon completion of the common stock
offering.
NYSE symbol................... We intend to list the Class B Preferred Stock
on the New York Stock Exchange under the symbol
"CNO PrB."
10
SUMMARY FINANCIAL DATA
The following table sets forth summary financial data for Conseco, Inc. for
each of the three years ended December 31, 2002, for the eight months ended
August 31, 2003, and as of and for the one month ended September 30, 2003. The
data should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and our consolidated financial
statements and related notes included in this prospectus.
Our predecessor and certain of its subsidiaries emerged from Chapter 11
bankruptcy proceedings on September 10, 2003 (the "Effective Date"). However,
for accounting convenience, the Effective Date of the plan was deemed to have
occurred on August 31, 2003. Fresh start accounting has been implemented as of
August 31, 2003, and accordingly, we restated all of our assets and liabilities
to their current estimated value, reestablished shareholders' equity at the
reorganization value determined in connection with our Sixth Amended Joint Plan
of Reorganization (the "Plan of Reorganization"), and recorded the portion of
the reorganization value which could not be attributed to specific tangible or
identified intangible assets as goodwill. As a result, our financial statements
for periods following August 31, 2003 are not comparable with those prepared
before that date.
For financial reporting purposes, we refer to Conseco and its subsidiaries
on or prior to August 31, 2003 as the predecessor company and after August 31,
2003 as the successor company.
As part of our Chapter 11 reorganization, we sold the assets of our finance
business and exited this line of business effective March 31, 2003. In October
2002, we sold CVIC, our primary writer of variable annuity products. The results
of operations of these former businesses have been reported as discontinued
operations in all periods prior to their sale presented in the summary financial
data. The predecessor's net income (loss) includes amounts related to the
discontinued operations of $(2,216.8) million, $(100.6) million, $(381.9)
million and $16.0 million, for the years ended December 31, 2002, 2001 and 2000
and for the eight months ended August 31, 2003, respectively. The sales of these
businesses further affect the comparability of the summary financial data.
We have derived the summary financial data for the years ended December 31,
2002, 2001 and 2000 from our predecessor's audited consolidated financial
statements included in this prospectus. We have derived the summary statement of
operations data for the one month ended September 30, 2003, and the eight months
ended August 31, 2003 and the summary balance sheet data as of September 30,
2003 from our unaudited interim condensed consolidated financial statements
included in this prospectus.
The unaudited interim consolidated financial data presented in the table
below reflect all adjustments, consisting only of normal, recurring accruals,
that we consider necessary for a fair presentation of our consolidated financial
position and results of operations for such periods and as of such dates. The
results of operations for the interim periods are not necessarily indicative of
the results to be expected for a full year.
We have prepared the summary financial data, other than statutory data, in
conformity with generally accepted accounting principles ("GAAP"). We have
derived the statutory data from the statements filed by our insurance
subsidiaries with regulatory authorities and have prepared the statutory data in
accordance with statutory accounting practices, which vary in certain respects
from GAAP.
The following is a summary, and in order to more fully understand our
historical consolidated financial data, you should read the following in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our consolidated financial statements and notes
thereto included in this prospectus.
11
SUCCESSOR PREDECESSOR
------------ -------------------------------------------------
AS OF OR FOR
THE ONE FOR THE EIGHT
MONTH MONTHS
ENDED ENDED YEAR ENDED DECEMBER 31,
SEPT. 30, AUGUST 31, ---------------------------------
2003 2003 2002 2001 2000
------------ ------------- ---- ---- ----
(AMOUNTS IN MILLIONS,
EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA(a)
Insurance policy income........................ $ 256.2 $ 2,204.3 $ 3,602.3 $3,992.7 $ 4,170.7
Net investment income.......................... 101.2 969.0 1,334.3 1,550.0 1,578.1
Net realized investment gains (losses)......... 6.7 (5.4) (556.3) (340.0) (304.8)
Total revenues................................. 366.3 3,202.2 4,450.4 5,492.0 5,581.4
Interest expense on corporate notes payable and
investment borrowings (contractual interest:
$268.5 for the eight months ended August 31,
2003; and $345.3 for 2002)................... 7.0 202.5 341.9 400.0 454.3
Total benefits and expenses.................... 328.5 1,030.0 6,082.6 5,735.4 6,358.9
Income (loss) before income taxes, minority
interest, discontinued operations and
cumulative effect of accounting change....... 37.8 2,172.2 (1,632.2) (243.4) (777.5)
Cumulative effect of accounting change, net of
income tax................................... -- -- (2,949.2) -- (55.3)
Net income (loss).............................. 24.2 2,201.7 (7,835.7) (405.9) (1,191.2)
Preferred stock dividends...................... 5.3 -- 2.1 12.8 11.0
Net income (loss) applicable to common stock... 18.9 2,201.7 (7,837.8) (418.7) (1,202.2)
PER SHARE DATA
Net income, basic.............................. $ .19
Net income, diluted............................ $ .17
Book value per common share outstanding........ $ 19.31
Weighted average shares outstanding for basic
earnings..................................... 100.1
Weighted average shares outstanding for diluted
earnings..................................... 144.7
Shares outstanding at period end............... 100.1
BALANCE SHEET DATA -- AT PERIOD END
Total investments.............................. $22,415.8
Goodwill....................................... 935.4
Total assets................................... 29,859.9
Corporate notes payable........................ 1,300.0
Total liabilities.............................. 27,062.5
Shareholders' equity........................... 2,797.4
STATUTORY DATA(B)
Statutory capital and surplus.................. $ 1,412.4
Asset valuation reserve ("AVR")................ 78.4
Total statutory capital and surplus and AVR.... 1,490.8
OTHER FINANCIAL DATA
Ratio of earnings to fixed charges(c).......... 1.82x
Ratio of earnings to fixed charges, preferred
stock dividends and distributions on
company-obligated mandatorily redeemable
preferred securities of subsidiary
trusts(d).................................... 1.54x
---------------
(a) Our financial condition and results of operations have been significantly
affected during the periods presented by the discontinued finance
operations. Please refer to note 17 to the audited consolidated financial
statements of our predecessor included elsewhere in this prospectus.
(b) We have derived the statutory data from statements filed by our insurance
subsidiaries with regulatory authorities and have prepared the statutory
data in accordance with statutory accounting principles, which vary in
certain respects from GAAP.
(c) For the purpose of computing the "ratio of earnings to fixed charges",
earnings represent consolidated net income (loss) before income taxes,
minority interest, discontinued operations, extraordinary gain (loss),
cumulative effect of accounting change and the fixed charges described in
the following sentence. Fixed charges consist of: (1) interest
12
expense on corporate debt, including amortization; (2) interest expense on
investment borrowings; (3) interest added to policyholder account balances;
and (4) the portion of rental expense we deem representative of the
interest factor.
(d) For the purpose of computing the "ratio of fixed charges excluding interest
added to policyholder account balances", earnings represent consolidated
net income (loss) before income taxes, minority interest, discontinued
operations, extraordinary gain (loss), cumulative effect of accounting
change and the fixed charges described in the following sentence. Fixed
charges consist of: (1) interest expense on corporate debt, including
amortization; (2) interest expense on investment borrowings; and (3) the
portion of rental expense we deem representative of the interest factor.
We calculate the "ratio of fixed charges excluding interest added to
policyholder account balances" as a measure of our historical ability to
meet our interest obligations related to corporate debt and investment
borrowings, without consideration of insurance policy benefits credited to
policyholders in the form of interest.
13
RISK FACTORS
An investment in our securities involves significant risks. You should
carefully consider the risks described below and the other information in this
prospectus, including our consolidated financial statements and related notes
contained in this prospectus, before you decide to buy our securities. If any of
the following risks actually occur, our business prospects, financial condition
and results of operations could be materially harmed, the market price of our
securities could decline and you could lose all or part of your investment.
RISKS RELATED TO OUR BUSINESS
OUR RECENT BANKRUPTCY AND RELATED PROCEEDINGS MAY CONTINUE TO DISRUPT OUR
OPERATIONS AND THE OPERATIONS OF OUR SUBSIDIARIES.
The announcement of our intention to seek a restructuring of our capital in
August 2002 and the subsequent filing of bankruptcy petitions under Chapter 11
of the United States Bankruptcy Code (the "Bankruptcy Code") in December 2002
caused significant disruptions in our operations. Adverse publicity concerning
our financial condition and the bankruptcy filings caused sales of our insurance
products to decline and policyholder redemptions and lapses to increase. We also
experienced increased agent attrition, which in some cases led us to increase
agents' commissions or sales incentives in order to retain them.
We continue to be involved in various legal proceedings that arose in the
context of our restructuring. For example, since our August 2002 announcement,
we and/or our predecessor and certain of our former, and in some instances
current, officers and directors have been named as defendants in lawsuits,
including class action lawsuits, alleging, among other things, securities fraud
and breaches of fiduciary duties under ERISA. We are also involved with, and
have been subject to subpoena in respect of, federal investigations relating to
certain matters including the accounting for certain interest-only securities of
our predecessor's finance subsidiary, which was sold in connection with the
reorganization. Our business and financial results may be negatively impacted by
resulting adverse publicity and damage to our reputation and brands.
Furthermore, we may be required to indemnify some of these officers and
directors for certain expenses and losses incurred in connection with such
proceedings and investigations. We may also be negatively impacted by adverse
publicity in the context of our ongoing litigation with certain of our former
officers and directors relating to our collection efforts in respect of our
predecessor's 1996-1999 director and officer loan programs. In addition, while
our ultimate financial exposure in respect of some of the litigation in which we
are named as defendants is limited by our discharge in bankruptcy, not all of
the cases relating to periods prior to our bankruptcy are so limited and we
cannot predict with certainty what our ultimate liability in such cases may be.
See "Business -- Legal Proceedings."
We emerged from bankruptcy on September 10, 2003. The full extent to which
our bankruptcy impacted our business operations, reputation and relationships
with our customers, employees, regulators, distributors and agents may not be
known for some time, and there may be ongoing adverse effects associated with
our bankruptcy filing.
A FAILURE TO IMPROVE AND MAINTAIN THE FINANCIAL STRENGTH RATINGS OF OUR
INSURANCE SUBSIDIARIES COULD NEGATIVELY IMPACT OUR OPERATIONS AND FINANCIAL
RESULTS.
An important competitive factor for our insurance subsidiaries is the
ratings they receive from nationally recognized rating organizations, as agents,
insurance brokers and marketing companies who market our products and
prospective purchasers of our products view ratings as an important factor in
determining which insurer's products to market or purchase, particularly with
respect to annuity, interest-sensitive life insurance and long-term care
products. Our insurance companies' financial strength ratings were downgraded by
all of the major rating agencies beginning in July, 2002, in connection with the
financial distress that ultimately led to our predecessor's bankruptcy. The
current financial strength ratings of our insurance subsidiaries (with the
exception of Conseco Senior Health Insurance Company) from A.M. Best Company
("A.M. Best"), Standard & Poors Corporation ("S&P") and Moody's Investors
Services, Inc. ("Moody's") are B (Fair), BB- and Ba3, respectively. The current
financial strength ratings of Conseco Senior Health Insurance
14
Company from A.M. Best, Standard & Poor's and Moody's are B (Fair), CCC and
Caa1, respectively. For a description of the ratings issued by these firms and
additional information on our ratings, see "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Liquidity for Insurance
Operations." Many of our competitors have higher financial strength ratings and
we believe it is critical for us to improve our ratings to be competitive. The
lowered ratings assigned to our insurance subsidiaries were one of the primary
factors causing sales of our insurance products to decline and policyholder
redemptions and lapses to increase during 2002 and 2003. We also experienced
increased agent attrition, which in some cases led us to increase commissions or
sales incentives in an effort to retain them. These events have had a material
adverse effect on our operations, financial results and liquidity.
Our Plan of Reorganization contemplated that our insurance subsidiaries
would achieve an A.M. Best "A" category rating approximately by the end of 2004,
but we cannot assure you that we will be able to either achieve or maintain this
rating. If we fail to achieve and maintain an A.M. Best "A" category rating,
sales of our insurance products could fall further, we may face further
defections among our independent and career sales force, and existing
policyholders may redeem or allow their policies to lapse, adversely affecting
our future operations, financial results and liquidity. If we experience a
ratings downgrade below "B (Fair)" or a downgrade by two or more levels in any
six-month period, a "trigger event" under our existing Class A Preferred Stock
will occur and the holders of such stock will have the right to vote with
holders of our common stock on all matters on an as-converted basis.
Accordingly, our failure to return to our historical ratings levels or further
downgrades by A.M. Best, S&P or Moody's would likely have further material and
adverse effects on our operations, financial results and liquidity.
OUR INDEBTEDNESS MAY LIMIT OUR FINANCING AND OPERATING ACTIVITIES.
We continue to have significant indebtedness after our emergence from
bankruptcy. As of September 30, 2003, our debt to total capital ratio was 32
percent. As adjusted to give effect to the concurrent offerings of our common
stock and Class B Preferred Stock and the use of proceeds thereof as described
under "Use of Proceeds," our debt to total capital ratio as of September 30,
2003 would have been percent. Furthermore, our historical capital
requirements have been significant and our future capital requirements could
vary significantly and may be affected by general economic conditions,
regulatory requirements, industry trends, performance, and many other factors
that are not within our control. We cannot assure you that our substantial
indebtedness will not impair our ability to obtain financing in the future. Our
profitability and ability to generate sufficient cash flow to fund our
operations and service our substantial indebtedness will depend upon our ability
to successfully implement our business strategy. However, we cannot assure you
that we will be able to do so. We may encounter a lack of liquidity, which could
affect our ability to meet our obligations while attempting to meet competitive
pressures or adverse economic conditions.
THE COVENANTS IN OUR SENIOR CREDIT FACILITY AND IN THE CERTIFICATE OF
DESIGNATIONS FOR OUR CLASS A PREFERRED STOCK RESTRICT OUR ACTIVITIES AND REQUIRE
US TO MEET OR MAINTAIN VARIOUS FINANCIAL RATIOS.
Our Senior Credit Facility and the certificate of designations for our
Class A Preferred Stock contain a number of covenants and other provisions that
restrict our ability to engage in various financing transactions and pursue
certain operating activities without obtaining prior consent. We also must meet
or maintain various financial ratios and minimum financial strength ratings for
our insurance subsidiaries. For example, we must have earnings before interest,
taxes, depreciation and amortization (as defined in the credit agreement), of
greater than or equal to $490 million for the two quarters ended March 31, 2004,
and increasing over time to $1,296.0 million for the four quarters ending March
31, 2010. Our ability to meet these financial covenants may be affected by
events beyond our control. These requirements represent significant restrictions
on the manner in which we may operate our business. If we default under any of
the requirements of our Senior Credit Facility, the lenders could declare all
outstanding borrowings, accrued interest and fees to be immediately due and
payable. If that were to occur, we cannot assure you that we would have
sufficient liquidity to repay or refinance this indebtedness or any of our other
debts. If a trigger event occurs under the certificate of designations for our
Class A Preferred Stock, holders of the Class A Preferred Stock will be
15
entitled to vote with the holders of our common stock, as a single class, on all
matters on which holders of common stock are entitled to vote. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources".
CONSECO, INC. AND CDOC, INC. ARE HOLDING COMPANIES AND DEPEND ON THEIR
SUBSIDIARIES FOR CASH.
Conseco, Inc. and CDOC, Inc., our wholly owned subsidiary and a guarantor
under the Senior Credit Facility, are holding companies with no business
operations of their own. As a result, they depend on their operating
subsidiaries for cash to make principal and interest payments on debt, and to
pay administrative expenses and income taxes. The cash they receive from
insurance subsidiaries consists of dividends and distributions, principal and
interest payments on surplus debentures, fees for services, tax-sharing
payments, and from our non-insurance subsidiaries, loans and advances. A
deterioration in the financial condition, earnings or cash flow of the
significant subsidiaries of Conseco or CDOC for any reason could limit their
ability to pay cash dividends or other disbursements to Conseco and CDOC, which,
in turn, would limit the ability of Conseco and CDOC to meet debt service
requirements and satisfy other financial obligations, including payments in
respect of preferred stock.
The ability of our insurance subsidiaries to pay dividends is subject to
state insurance department regulations and is based on the financial statements
of our insurance subsidiaries prepared in accordance with statutory accounting
practices prescribed or permitted by regulatory authorities, which differ from
GAAP. These regulations generally permit dividends to be paid from statutory
earned surplus of the insurance company for any 12-month period in amounts equal
to the greater of (or in a few states, the lesser of):
- statutory net gain from operations or statutory net income for the prior
year; or
- 10 percent of statutory capital and surplus as of the end of the
preceding year.
Any dividends in excess of these levels require the approval of the
director or commissioner of the applicable state insurance department. See Risk
Factors -- "We are Subject to Extensive Regulation."
THE RESULTS OF OPERATIONS OF OUR INSURANCE BUSINESS WILL DECLINE IF OUR PREMIUM
RATES ARE NOT ADEQUATE OR IF WE ARE UNABLE TO OBTAIN REGULATORY APPROVAL TO
INCREASE RATES.
We set the premium rates on our health insurance policies based on facts
and circumstances known at the time we issue the policies and on assumptions
about numerous variables, including the actuarial probability of a policyholder
incurring a claim, the probable size of the claim, maintenance costs to
administer the policies and the interest rate earned on our investment of
premiums. In setting premium rates, we consider historical claims information,
industry statistics, the rates of our competitors and other factors, but we
cannot predict with certainty what the actual claims on our products will be.
This is particularly true in the context of setting premium rates for certain
products, such as long-term care insurance, with respect to which we have
limited historical claims experience. If our actual claims experience proves to
be less favorable than we assumed and we are unable to raise our premium rates,
our financial results may be adversely affected.
Our estimates of insurance liabilities assume we will be able to raise
rates if blocks of our health insurance business are not profitable. The loss
ratios for our long-term care products included in the Other Business in Run-Off
segment have increased in recent periods and exceeded 106 percent during the one
month ended September 30, 2003. We will have to raise rates or take other
actions with respect to certain of these policies or this business will continue
to be unprofitable and our financial results will be adversely affected. We
generally cannot raise our health insurance premiums in any state unless we
first obtain the approval of the insurance regulator in that state. We review
the adequacy of our premium rates regularly and file proposed rate increases on
our products when we believe existing premium rates are too low. It is possible
that we will not be able to obtain approval for premium rate increases from
currently pending requests or requests filed in the future. If we are unable to
raise our premium rates because we fail to obtain approval for a rate increase
in one or more states, our net income may decrease. Moreover, our ability to
exit unprofitable lines of business is subject to regulatory approval, which may
require that we continue to service
16
certain products at a loss for an extended period of time. If we are successful
in obtaining regulatory approval to raise premium rates, the increased premium
rates may reduce the volume of our new sales and cause existing policyholders to
allow their policies to lapse. This could result in anti-selection if healthier
policyholders allow their policies to lapse. This would reduce our premium
income and profitability in future periods. Increased lapse rates also could
require us to expense all or a portion of the value of policies inforce and/or
the cost of policies produced relating to lapsed policies in the period in which
those policies lapse, adversely affecting our financial results in that period.
RECENTLY ENACTED AND PENDING OR FUTURE LEGISLATION COULD ADVERSELY AFFECT THE
FINANCIAL PERFORMANCE OF OUR INSURANCE OPERATIONS.
During recent years, the health insurance industry has experienced
substantial changes, including those caused by healthcare legislation. Recent
federal and state legislation and legislative proposals relating to healthcare
reform contain features that could severely limit or eliminate our ability to
vary our pricing terms or apply medical underwriting standards with respect to
individuals, which could have the effect of increasing our loss ratios and have
an adverse effect on our financial results. In particular, Medicare reform and
legislation concerning prescription drugs could affect our ability to price or
sell our products or maintain our blocks inforce. Federal comprehensive medical
or long-term care programs, if proposed and implemented, could partially or
fully replace some of Conseco's current products.
Proposals currently pending in Congress and some state legislatures may
also affect our financial results. These proposals include the implementation of
minimum consumer protection standards for inclusion in all long-term care
policies, including: guaranteed premium rates; protection against inflation;
limitations on waiting periods for pre-existing conditions; setting standards
for sales practices for long-term care insurance; and guaranteed consumer access
to information about insurers (including lapse and replacement rates for
policies and the percentage of claims denied). Enactment of any of these
proposals could adversely affect our financial results.
In addition, the federal government may seek to directly regulate the
insurance industry, and recent government regulation may increase competition in
the insurance industry and may affect our insurance subsidiaries' current sales
methods. Although the federal government generally does not directly regulate
the insurance industry, federal initiatives often have a direct impact on the
insurance business. Current and proposed measures that may significantly affect
the insurance business generally include limitations on antitrust immunity and
minimum solvency requirements.
TAX LAW CHANGES COULD ADVERSELY AFFECT OUR INSURANCE PRODUCT SALES AND
PROFITABILITY.
We sell deferred annuities and some forms of life insurance products which
we believe are attractive to purchasers, in part, because policyholders
generally are not subject to United States Federal income tax on increases in
policy values until some form of distribution is made. Recently, Congress
enacted legislation to lower marginal tax rates, reduce the federal estate tax
gradually over a ten-year period, with total elimination of the federal estate
tax in 2010, and increase contributions which may be made to individual
retirement accounts and 401(k) accounts. While these tax law changes will expire
at the beginning of 2011 absent future congressional action, they could in the
interim diminish the appeal of our annuity and life insurance products.
Additionally, Congress has considered, from time to time, other possible changes
to the U.S. tax laws, including elimination of the tax deferral on the accretion
of value within certain annuities and life insurance products. There can be no
assurance that further tax legislation will not be enacted which would contain
provisions with possible adverse effects on our insurance products.
WE MAY NOT ACHIEVE THE GOALS OF CERTAIN INITIATIVES WE HAVE UNDERTAKEN WITH
RESPECT TO THE RESTRUCTURING OF OUR PRINCIPAL INSURANCE BUSINESSES.
Our Conseco Insurance Group segment has experienced declining sales and
expense levels that exceed product pricing. We have adopted several initiatives
designed to improve these operations, including focusing sales efforts on higher
margin products; reducing operating expenses by eliminating or reducing the
costs of
17
marketing certain products; personnel reductions and streamlined administrative
procedures; stabilizing the profitability of inforce business, particularly the
long-term care block of business in run-off sold through independent agents; and
combining certain legal insurance entities to reduce burdens associated with
statutory capital requirements and certain other redundancies. Many of the
redundancies present in our business which our current initiatives are intended
to address result from the substantial number of acquisitions undertaken by our
predecessor. Our future performance depends, in part, on our ability to
successfully integrate these prior acquisitions. This process of integration may
involve unforeseen expenses, complications and delays, including, among other
things, further difficulties in integrating the systems and operations of the
acquired companies, and our current initiatives may be inadequate to address
such issues. In addition, certain of our initiatives have only recently been
adopted, and we cannot assure you that they will be successfully implemented.
Our initiatives include the elimination of duplicate processing systems by
converting all similar business currently accounted for on multiple systems to a
single system. We expect to spend over $30 million to complete these initiatives
over the next 2 years, but cannot assure you that such efforts will be
successful. Even if we are able to successfully implement these measures, we
cannot assure you that our results of operations will improve.
OUR INVESTMENTS MAY DECLINE IN VALUE.
The values of the assets in our investment portfolio are subject to
numerous general factors, including, among other things, prevailing economic
conditions, volatility in the securities markets and changes in interest rates,
as well as factors specific to the particular assets. All of these factors are
difficult to predict and are beyond our control. In particular, our actively
managed fixed maturity investments, which comprised 86 percent of our total
investments as of September 30, 2003, are subject to the risk of issuer default.
This risk is significantly greater in respect of below-investment grade
securities, which comprised 4.1 percent of our actively-managed fixed maturity
investments as of September 30, 2003. In 2001 and 2002, a number of large,
highly leveraged issuers experienced significant financial difficulties, which
resulted in our recognition of significant other-than-temporary impairments on
these assets. In addition, our structured-security investments, which comprised
30 percent of our actively-managed fixed maturity investments as of September
30, 2003, are subject to risks relating to variable prepayment and default on
the assets underlying such securities, such as mortgage loans. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Investments."
Accordingly, we are subject to the risk that our investments may decline in
value. We have sustained substantial investment losses in the past and may again
in the future. Because a substantial portion of our net income is derived from
returns on our investment portfolio, significant losses in the portfolio may
have a direct and materially adverse impact on our results of operations. In
addition, losses on our investment portfolio could reduce the investment returns
which we are able to credit to our customers on certain of our products, thereby
impacting our sales and further eroding our financial performance. Further, our
need for liquidity to fund substantial product surrenders or policy claims may
require that we maintain highly liquid, and therefore lower yielding, assets, or
that we sell assets at a loss, thereby further eroding the performance of our
portfolio. Although we have recently reduced our exposure to certain types of
higher risk assets, we cannot assure you that this strategy will prevent or
limit investment losses.
A DECLINE OR INCREASED VOLATILITY IN THE SECURITIES MARKETS, AND OTHER ECONOMIC
FACTORS, MAY ADVERSELY AFFECT OUR BUSINESS, PARTICULARLY CERTAIN OF OUR LIFE
INSURANCE PRODUCTS AND ANNUITIES.
Fluctuations in the securities markets and other economic factors may
adversely affect sales and/or policy surrenders of our annuities and life
insurance policies. For example, we believe that a protracted and/or steep
decline in the capital markets would reduce the popularity of products such as
equity-indexed life and annuity products. In addition, significant or unusual
volatility in the general level of interest rates could negatively impact sales
and/or lapse rates on certain types of insurance products.
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OUR RESERVES FOR FUTURE INSURANCE POLICY BENEFITS AND CLAIMS MAY PROVE TO BE
INADEQUATE, REQUIRING US TO INCREASE LIABILITIES AND RESULTING IN REDUCED NET
INCOME AND SHAREHOLDERS' EQUITY.
We calculate and maintain reserves for the estimated future payment of
claims to our policyholders based on assumptions made by our actuaries. For our
health insurance business, we establish an active life reserve plus a liability
for due and unpaid claims, claims in the course of settlement, and incurred but
not reported claims, as well as a reserve for the present value of amounts on
claims not yet due. For our long-term care insurance business, we establish
reserves based on assumptions and estimates of morbidity rates, policy and claim
termination rates, benefit amounts, investment returns and other factors. Many
factors can affect these reserves and liabilities, such as economic and social
conditions, inflation, hospital and pharmaceutical costs, regulatory actions
(including those related to the pricing of our policies), changes in doctrines
of legal liability and extra-contractual damage awards. Therefore, the reserves
and liabilities we establish are necessarily based on estimates, assumptions and
prior years' statistics. Establishing reserves is an uncertain process, and it
is possible that actual claims will materially exceed our reserves and have a
material adverse effect on our results of operations and financial condition.
This is particularly so with respect to certain products with limited claims
history from which to extrapolate, such as long-term care insurance. We have
recently incurred significant losses as a result of actual claim costs and
persistency of certain long-term care business which have exceeded our
expectations. Our financial performance depends significantly upon the extent to
which our actual claims experience is consistent with the assumptions we used in
setting our reserves and pricing our policies. If our assumptions with respect
to future claims are incorrect, and our reserves are insufficient to cover our
actual losses and expenses, we would be required to increase our liabilities,
resulting in an adverse effect on our financial results and financial position
if we are unable to increase our premium rates.
WE ARE SUBJECT TO FURTHER RISK OF LOSS NOTWITHSTANDING OUR REINSURANCE
AGREEMENTS.
We transfer exposure to certain risks to others through reinsurance
arrangements. Under these arrangements, other insurers assume a portion of our
losses and expenses associated with reported and unreported claims in exchange
for a portion of policy premiums. The availability, amount and cost of
reinsurance depend on general market conditions and may vary significantly.
Furthermore, we face credit risk with respect to reinsurance. When we obtain
reinsurance, we are still liable for those transferred risks if the reinsurer
cannot meet its obligations. Therefore, the inability of our reinsurers to meet
their financial obligations could materially affect our operations and financial
condition.
OUR GOODWILL AND OTHER INTANGIBLE ASSETS ARE SUBJECT TO IMPAIRMENT TESTS.
Upon our emergence from bankruptcy, we revalued our assets and liabilities
to estimated fair value as of August 31, 2003 and established our capital
accounts at the reorganization value determined in conjunction with our
bankruptcy plan. We recorded the $1,102.8 million of reorganization value which
could not be attributed to specific tangible or identified intangible assets as
goodwill.
Under GAAP, we are required to evaluate our goodwill and other intangible
assets for impairment on an annual basis, or more frequently if there is an
indication that an impairment may exist. If certain criteria are met, we are
required to record an impairment charge. We obtained independent appraisals to
determine the value of the Company in conjunction with the preparation of our
bankruptcy plan which indicated no impairments of our goodwill or other
intangible assets existed. However, we cannot assure you that we will not have
to recognize an impairment charge in future periods.
The appraisals prepared to determine the value of our subsidiaries are
based on numerous estimates and assumptions which, though considered reasonable
by management, may not be realized, and are inherently subject to significant
business, economic and competitive uncertainties and contingencies, many of
which are beyond our control. These estimates and assumptions had a significant
effect on the determination of our reorganization value and the amount of
goodwill we recognized. Accordingly, if our actual experience differs from our
estimates and assumptions, it is possible we will have to recognize an
impairment charge in future periods.
19
WE ARE SUBJECT TO EXTENSIVE REGULATION.
Our insurance business is subject to extensive regulation and supervision
in the jurisdictions in which we operate. Our insurance subsidiaries are subject
to state insurance laws that establish supervisory agencies with broad
administrative powers relative to granting and revoking licenses to transact
business, regulating sales and other practices, approving premium rate
increases, licensing agents, approving policy forms, setting reserve and
solvency requirements, determining the form and content of required statutory
financial statements, limiting dividends and prescribing the type and amount of
investments we can make.
We have been operating under heightened scrutiny from state insurance
regulators. For example, our insurance subsidiaries domiciled in Texas, Bankers
National Life Insurance Company and Conseco Life Insurance Company of Texas (on
behalf of itself and its subsidiaries), entered into consent orders with the
Commissioner of Insurance for the State of Texas on October 30, 2002, which were
formally released on November 19, 2003. These consent orders applied to all of
our insurance subsidiaries and, among other things, restricted the ability of
our insurance subsidiaries to pay dividends and other amounts to the parent
company without regulatory consent. Notwithstanding the release of these consent
orders, we have agreed with the Texas Department of Insurance to provide prior
notice of certain transactions, including up to 30 days prior notice for the
payment of dividends by an insurance subsidiary to any non-insurance company
parent, and to provide information periodically concerning our financial
performance and condition. As noted above, state laws generally provide state
insurance regulatory agencies with broad authority to protect policyholders in
their jurisdictions. Accordingly, we cannot assure you that regulators will not
seek to assert greater supervision and control over our insurance subsidiaries'
businesses and financial affairs.
IN CERTAIN CIRCUMSTANCES, REGULATORY AUTHORITIES MAY PLACE OUR INSURANCE
SUBSIDIARIES UNDER REGULATORY CONTROL.
Our insurance subsidiaries are subject to risk-based capital requirements.
These requirements were designed to evaluate the adequacy of statutory capital
and surplus in relation to investment and insurance risks associated with asset
quality, mortality and morbidity, asset and liability matching and other
business factors. The requirements are used by states as an early warning tool
to discover potential weakly-capitalized companies for the purpose of initiating
regulatory action. Generally, if an insurer's RBC falls below specified levels,
the insurer would be subject to different degrees of regulatory action depending
upon the magnitude of the deficiency. See "Business -- Government Regulation."
The National Association of Insurance Commissioner's (the "NAIC") (an
association of state regulators and their staffs) Model Act provides for an
annual trend test if a company's total adjusted capital is between 100 percent
and 125 percent of RBC at the end of the year. Two of our subsidiaries' RBC
ratios were less than 125 percent, based on the capital balances reported in
their 2002 audited statutory financial statements. Although the RBC ratios for
such subsidiaries subsequently exceeded 125 percent, as a result of reserve
strengthening of approximately $85 million and other losses on the long-term
care business within our Other Business in Run-Off segment during the third
quarter of 2003, we will need to contribute additional capital to one subsidiary
to enable its RBC ratio to equal or exceed 125 percent at December 31, 2003.
Furthermore, we cannot assure you that we will be able to maintain the RBC
ratios of our subsidiaries above levels that could give rise to regulatory
action. See the information described under the caption "Statutory Information"
within "Management's Discussion and Analysis of Financial Condition and Results
of Operations."
OUR INSURANCE SUBSIDIARIES MAY BE REQUIRED TO PAY ASSESSMENTS TO FUND
POLICYHOLDER LOSSES OR LIABILITIES AND THIS MAY HAVE A MATERIAL ADVERSE EFFECT
ON OUR RESULTS OF OPERATIONS.
The solvency or guaranty laws of most states in which an insurance company
does business may require that company to pay assessments (up to certain
prescribed limits) to fund policyholder losses or liabilities of other insurance
companies that become insolvent. Insolvencies of insurance companies increase
the possibility that these assessments may be required. These assessments may be
deferred or forgiven under most guaranty laws if they would threaten an
insurer's financial strength and, in certain instances, may be offset against
future premium taxes. We cannot estimate the likelihood and amount of future
assessments. Although past
20
assessments have not been material, if there were a number of large
insolvencies, future assessments could be material and could have a material
adverse effect on our financial results and financial position.
CHANGING INTEREST RATES MAY ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
Our profitability may be directly affected by the level of and fluctuations
in interest rates. While we monitor the interest rate environment and have
previously employed hedging strategies designed to mitigate the impact of
changes in interest rates, our financial results could be adversely affected by
changes in interest rates. Our spread-based insurance and annuity business is
subject to several inherent risks arising from movements in interest rates,
especially if we fail to anticipate or respond to such movements. First,
interest rate changes can cause compression of our net spread between interest
earned on investments and interest credited on customer deposits, thereby
adversely affecting our results. Our ability to adjust for such a compression is
limited by virtue of the guaranteed minimum rates that we must credit to
policyholders on certain of our products, as well as by the fact that we are
able to reduce the crediting rates on most of our products only at limited,
pre-established intervals. Second, if interest rate changes produce an
unanticipated increase in surrenders of our spread-based products, we may be
forced to sell invested assets at a loss in order to fund such surrenders. The
profits from many non-spread-based insurance products, such as long-term care
policies, are adversely affected when interest rates decline because we may be
unable to reinvest the cash flows generated from premiums received and our
investment portfolio at the interest rates anticipated when we sold the
policies. Finally, changes in interest rates can have significant effects on the
performance of our structured securities portfolio, including collateralized
mortgage obligations, as a result of changes in the prepayment rate of the loans
underlying such securities. We follow asset/liability strategies that are
designed to mitigate the effect of interest rate changes on our profitability
but do not currently employ derivative instruments for this purpose. We cannot
assure you that we will be successful in implementing these strategies and
achieving adequate investment spreads.
OUR NET INCOME AND REVENUES WILL SUFFER IF POLICYHOLDER SURRENDER LEVELS DIFFER
SIGNIFICANTLY FROM OUR ASSUMPTIONS.
Surrenders of our annuities and life insurance products can result in
losses and decreased revenues if surrender levels differ significantly from
assumed levels. At December 31, 2002, approximately 20 percent of our total
insurance liabilities (or approximately $4.5 billion) could be surrendered by
the policyholder without penalty. The surrender charges that are imposed on our
fixed rate annuities typically decline during a penalty period which ranges from
five to twelve years after the date the policy is issued. Surrenders and
redemptions could require us to dispose of assets earlier than we had planned,
possibly at a loss. Moreover, surrenders and redemptions require faster
amortization of the acquisition costs or commissions associated with the
original sale of a product, thus reducing our net income. We believe
policyholders are generally more likely to surrender their policies if they
believe the issuer is having financial difficulties, or if they are able to
reinvest the policy's value at a higher rate of return in an alternative
insurance, investment or financial institution product.
LITIGATION AND REGULATORY INVESTIGATIONS ARE INHERENT IN OUR BUSINESS AND MAY
HARM OUR FINANCIAL STRENGTH AND REDUCE OUR PROFITABILITY.
Insurance companies historically have been subject to substantial
litigation resulting from claims, disputes and other matters. In addition to the
traditional policy claims associated with their businesses, insurance companies
typically face policyholder suits and class action suits. The class action and
policyholder suits are often in connection with insurance sales practices,
policy and claims administration practices and other market conduct issues.
State insurance departments focus on sales practices and product issues in their
market conduct examinations. Negotiated settlements of class action and other
lawsuits have had a material adverse effect on the business, financial condition
and results of operations of insurance companies. We are, in the ordinary course
of our business, a plaintiff or defendant in actions arising out of our
insurance business, including class actions and reinsurance disputes, and, from
time to time, are also involved in various governmental and administrative
proceedings and investigations. This litigation and these proceedings and
21
investigations may harm our financial strength and reduce our profitability. We
cannot assure you that such litigation will not adversely affect our future
business, financial condition or results of operations. Because our insurance
subsidiaries were not part of our bankruptcy proceedings, the bankruptcy
proceedings did not result in the discharge of any claims, including claims
asserted in litigation, against our insurance subsidiaries. See
"Business -- Legal Proceedings" below.
THE MARKETS IN WHICH WE OPERATE ARE HIGHLY COMPETITIVE.
Each of the markets in which we operate is highly competitive. Competitors
include other life and accident and health insurers, commercial banks, thrifts,
mutual funds and broker-dealers. Many of our competitors are larger companies
that have greater capital, technological and marketing resources, and have
access to capital at a lower cost. Recent industry consolidation, including
business combinations among insurance and other financial services companies,
has resulted in larger competitors with even greater financial resources.
Furthermore, recent changes in federal law have narrowed the historic separation
between banks and insurance companies, enabling traditional banking institutions
to enter the insurance and annuity markets and further increase competition.
This increasing competition may harm our ability to maintain or increase our
profitability. In addition, because the actual cost of products is unknown when
they are sold, we are subject to competitors who may sell a product at a price
that does not cover its actual cost. There are many life and health insurance
companies in the U.S., most of which currently enjoy higher financial strength
ratings than we do. Some of these companies may pay higher commissions and
charge lower premium rates, and many companies have more substantial resources.
Publicity about our recent financial difficulties, including our bankruptcy,
caused agents to place business with other insurers, and we may not be able to
recapture business from these agents following our emergence from bankruptcy.
We must attract and retain sales representatives to sell our insurance and
annuity products. Strong competition exists among insurance and financial
services companies for sales representatives. We compete with other insurance
and financial services companies for sales representatives primarily on the
basis of our financial position, financial strength ratings, support services
and compensation and product features. Our competitiveness for such agents also
depends upon the relationships we develop with these agents. If we are unable to
attract and retain sufficient numbers of sales representatives to sell our
products, our ability to compete and our revenues would suffer.
WE ARE DEPENDENT ON THIRD PARTIES FOR THE DISTRIBUTION OF PRODUCTS SOLD THROUGH
THE CONSECO INSURANCE GROUP SEGMENT.
Our Conseco Insurance Group segment markets and distributes its products,
including specified disease insurance, Medicare supplement insurance,
equity-indexed life insurance and equity-indexed annuities, exclusively through
independent agents. As a result, our ability to maintain our relationships with
these organizations is critical to our financial performance. This ability is
dependent upon, among other things, the compensation we offer independent
distributors and the overall attractiveness of our products to their customers.
In addition, the distribution of our life insurance and annuity products through
this channel is particularly sensitive to the financial strength ratings of our
insurance subsidiaries. The downgrades of our ratings in 2002, as well as our
bankruptcy, caused significant defections among our independent agents and
increased our costs of retaining them, which had a material adverse effect on
our results of operations and reduced our operating margins. We cannot assure
you that we will be able to restore our relationships with these independent
parties. In the event that we are unable to attract and retain qualified
independent distributors of our products, our operations and financial results
may be materially adversely affected.
WE MAY REQUIRE ADDITIONAL CAPITAL IN THE FUTURE, WHICH MAY NOT BE AVAILABLE OR
MAY ONLY BE AVAILABLE ON UNFAVORABLE TERMS.
Our future capital requirements depend on many factors, including our
ability to write new business successfully and to establish premium rates and
reserves at levels sufficient to cover losses. We may need to raise additional
funds through future financings and, if we are unable to do so, we may need to
curtail our growth and reduce our assets. Any equity or debt financing, if
available at all, may be on terms that are not
22
favorable to us. In the case of equity financings, dilution to our shareholders
could result, and in any case such securities may have rights, preferences and
privileges that are senior to those of the shares offered hereby. If we cannot
obtain adequate capital on favorable terms or at all, our business, operating
results and financial condition could be adversely affected.
A BROAD RANGE OF UNCERTAINTIES ARISING OUT OF WORLD EVENTS MAY ADVERSELY AFFECT
THE INSURANCE INDUSTRY AND FINANCIAL MARKETS.
Terrorist attacks in New York City and Washington, D.C. on September 11,
2001 adversely affected commerce throughout the United States and resulted in
significant disruption to the insurance industry and significant declines and
volatility in financial markets. The continued threat of terrorism within the
United States and abroad, the military action and heightened security measures
in response to that threat and the risk of global outbreaks of illnesses such as
SARS may cause additional disruptions to the insurance industry, reduced
economic activity and continued volatility in markets throughout the world,
which may adversely impact our financial results.
WE ARE SUBJECT TO RESIDUAL LIABILITIES RELATING TO OUR PRIOR DISPOSAL OF
BUSINESSES.
We are subject to retained liabilities and indemnification obligations
related to businesses we have sold. For example, we retained liabilities for
certain purported class action litigation in connection with our disposal of
Manhattan National Life Insurance Company in June 2002. See "Business -- Legal
Proceedings." In addition, the agreements entered into in connection with our
sales of CVIC and Conseco Finance Corp. ("CFC") impose continuing
indemnification obligations in respect of liabilities relating to our period of
ownership of such entities and other matters. We cannot assure you that we will
not be subject to claims in respect of these continuing or residual obligations,
or that any such claims would not be material.
[C] RISKS RELATED TO THE OFFERING
THE PRICE OF OUR COMMON STOCK MAY FLUCTUATE SIGNIFICANTLY, AND YOU COULD LOSE
ALL OR PART OF YOUR INVESTMENT.
Volatility in the market price of our common stock may prevent you from
being able to sell your shares at or above the price you paid for your shares.
The market price of our common stock could fluctuate significantly for various
reasons which include:
- our quarterly or annual earnings or those of other companies in our
industry;
- the public's reaction to our press releases, our other public
announcements and our filings with the Securities and Exchange Commission
("SEC");
- changes in earnings estimates or recommendations by research analysts who
track our common stock or the stocks of other companies in our industry;
- new laws or regulations or new interpretations of laws or regulations
applicable to our business;
- changes in accounting standards, policies, guidance, interpretations or
principles;
- changes in general conditions in the U.S. and global economies or
financial markets, including those resulting from war, incidents of
terrorism or responses to such events; and
- sales of common stock by our directors and executive officers.
In addition, in recent years, the stock market has experienced extreme
price and volume fluctuations. This volatility has had a significant impact on
the market price of securities issued by many companies, including companies in
the insurance industry. The changes frequently appear to occur without regard to
the operating performance of these companies. The price of our common stock
could drop materially based upon factors that have little or nothing to do with
our Company.
23
If our share price is volatile, we may be the target of additional
securities litigation, which is costly and time-consuming to defend. In the
past, following periods of market volatility in the price of a company's
securities, security holders have often instituted class action litigation. If
the market value of our common stock experiences adverse fluctuations and we
become involved in this type of litigation, regardless of the outcome, we could
incur substantial legal costs and our management's attention could be diverted
from the operation of our business, causing our business to suffer.
THERE IS A LIMITED TRADING HISTORY IN OUR COMMON STOCK AND WE CANNOT ASSURE YOU
THAT AN ACTIVE MARKET WILL DEVELOP.
We emerged from bankruptcy, and our common stock was approved for listing
on the NYSE, on September 10, 2003. Accordingly, there is a limited trading
history in our common stock and we cannot predict whether an active market will
continue in shares of our common stock or how illiquid that market might become.
The liquidity of the market for shares of our common stock and the prices at
which the stock trades will depend upon the amount outstanding, the number of
holders thereof, the interest of securities dealers in maintaining a market in
the securities and other factors beyond our control. Consequently, you may not
be able to sell shares of our common stock at prices equal to or greater than
the price you paid in this offering.
ISSUANCE OF ADDITIONAL COMMON STOCK OR PREFERRED STOCK COULD ADVERSELY AFFECT
HOLDERS OF OUR COMMON STOCK.
We may sell additional shares of common stock in subsequent public
offerings. Under certain circumstances, we are authorized to issue, without
stockholder approval, over 7.0 billion additional shares of common stock. After
the completion of this offering, we will have million outstanding
shares of common stock ( shares assuming the underwriters exercise in
full their option to purchase additional shares). This number includes
million shares that we are selling in this offering, which may be
resold immediately in the public market. In addition, shares of our outstanding
Class A Preferred Stock are convertible by holders at any time on or after
September 30, 2005 into shares of our common stock. The Class A Preferred Stock
outstanding as of December 31, 2003 would have been convertible into an
aggregate amount of 43.2 million shares of our common stock as of such date if
it was then convertible. This amount will increase as the holders receive
dividends, payable in additional shares of Class A Preferred Stock, at a rate
per annum equal to 10.5 percent of the liquidation preference per share, payable
semi-annually until September 10, 2005, when the rate increases to 11 percent,
and may increase as a result of anti-dilution adjustments. Holders of our
outstanding Series A Warrants are entitled to purchase one share of our common
stock at a price of $27.60 per share for each such warrant. The Series A
Warrants are exercisable for an aggregate of up to 6,000,000 shares of common
stock and expire on September 10, 2008. Holders of our Class B Preferred Stock
issued in the concurrent offering will be entitled at their option at any time
on or after the day immediately following the issue date of the Class B
Preferred Stock to convert the shares of Class B Preferred Stock into an
aggregate of shares of our common stock and, under specified circumstances,
such shares could be convertible into an aggregate of up to shares of our
common stock. In the event that we are unable to pay all accumulated dividends
on the Class B Preferred Stock in cash on the mandatory conversion date pursuant
to the terms thereof, we are obligated to deliver additional shares of our
common stock in respect of such unpaid dividends. See "Description of Capital
Stock."
In connection with our reorganization, we entered into registration rights
agreements with certain of our predecessor's creditors with respect to our
common stock and Class A Preferred Stock. Under these agreements, these
stockholders have the right, subject to certain limitations, to require us to
effect the registration of their shares upon written demand. In addition,
subject to certain limitations, if we file a registration statement covering our
equity securities for our own account or for the account of any holder of our
equity securities (including the registration statement of which this prospectus
is a part), we must offer to holders of registrable securities the opportunity
to register such number of shares of registrable securities as such holder may
request. See "Description of Capital Stock -- Registration Rights Agreements."
24
In addition, our board of directors is authorized to issue additional
series of shares of preferred stock without any action on the part of our
stockholders. Our board of directors also has the power, without stockholder
approval, to set the terms of any such series of shares of preferred stock that
may be issued, including voting rights, conversion rights, dividend rights,
preferences over our common stock with respect to dividends or if we liquidate,
dissolve or wind up our business and other terms. If we issue preferred stock in
the future that has preference over our common stock with respect to the payment
of dividends or upon our liquidation, dissolution or winding up, or if we issue
preferred stock with voting rights that dilute the voting power of our common
stock, the rights of holders of our common stock or the market price of our
common stock could be adversely affected. We are also authorized to issue,
without stockholder approval, securities convertible into either common stock or
preferred stock.
The issuance of additional common stock or securities convertible into
common stock would result in dilution of existing stockholders' equity interest
in us. We cannot predict the size of future issuances of our common stock or the
effect, if any, that future issuances and sales of shares of our common stock
will have on the market price of our common stock. Sales of substantial amounts
of our common stock, or the perception that such sales could occur, may
adversely affect prevailing market prices for our common stock.
ANTI-TAKEOVER PROVISIONS IN OUR CERTIFICATE OF INCORPORATION, OUR BYLAWS AND
DELAWARE LAW, AS WELL AS IN STATE INSURANCE LAWS, MIGHT DELAY, DETER OR PREVENT
TAKEOVERS AND BUSINESS COMBINATIONS THAT STOCKHOLDERS CONSIDER TO BE IN THEIR
BEST INTERESTS, WHICH COULD NEGATIVELY AFFECT OUR STOCK PRICE.
Provisions in our amended and restated certificate of incorporation and our
second amended and restated bylaws, and applicable provisions of the Delaware
General Corporation Law ("DGCL") may make it more difficult and expensive for a
third party to acquire control of us, even if a change of control would be
beneficial to the interests of our stockholders. These provisions could
discourage potential takeover attempts and could adversely affect the market
price of our common stock . These provisions may also render the removal of the
current board of directors and of management more difficult. These provisions
include:
- a classified board of directors, which could prevent a stockholder, or
group of stockholders, having majority voting power, from obtaining
control of our board of directors until the second annual meeting of
stockholders following September 10, 2003, the effective date of our
emergence from bankruptcy;
- advance notice requirements for stockholder proposals and director
nominations;
- removal of directors only for cause prior to the second annual meeting of
stockholders following September 10, 2003, the effective date of our
emergence from bankruptcy; and
- the authority of our board of directors to issue, without stockholder
approval, series of preferred stock with such terms as the board of
directors may determine.
In addition to the foregoing, state insurance laws include provisions that
may delay, deter or prevent a takeover attempt that may be in the best interests
of stockholders. For instance, state insurance holding company laws and
regulations applicable to us generally provide that no person may acquire
control of a company, and thus indirect control of its insurance subsidiaries,
unless the person has provided required information to, and the acquisition is
approved or not disapproved by, the appropriate insurance regulatory
authorities. Generally, any person acquiring beneficial ownership of 10 percent
or more of the voting power of our capital stock would be presumed to have
acquired control, unless the appropriate insurance regulatory authorities, upon
advance application, determine otherwise. In addition, they may prevent
stockholders from receiving the benefit from any premium over the market price
of our common stock offered by a bidder in a potential takeover. Even in the
absence of a takeover attempt, the existence of these provisions may adversely
affect the prevailing market price of our common stock, Class A Preferred Stock
or Class B Preferred Stock if they are viewed as discouraging takeover attempts
in the future.
25
[P] RISKS RELATED TO THE OFFERING
YOU ASSUME THE RISK THAT THE MARKET VALUE OF OUR COMMON STOCK MAY DECLINE.
The number of shares of our common stock that you will receive upon the
conversion of your shares of Class B Preferred Stock is not fixed but instead
will depend on the average of the closing price per share of our common stock on
each of the 20 consecutive trading days ending on the third trading day
immediately preceding the mandatory conversion date, which we refer to as the
applicable market value. There can be no assurance that the market value of
common stock received by you on the mandatory conversion date will be equal to
or greater than the effective price per share paid by you for our common stock
by buying the shares of Class B Preferred Stock. If the applicable market value
of the common stock is less than the initial price of $ , the market value
of the common stock issued to you pursuant to each share of Class B Preferred
Stock on the mandatory conversion date (assuming that the market value on the
mandatory conversion date is the same as the applicable market value of the
common stock) will be less than the effective price per share paid by you for
the common stock on the date of issuance of the shares of Class B Preferred
Stock. Accordingly, you assume the risk that the market value of the common
stock may decline, and the decline could be substantial.
WE COULD BE PREVENTED FROM PAYING DIVIDENDS ON SHARES OF THE CLASS B PREFERRED
STOCK.
You will only receive cash dividends on shares of the Class B Preferred
Stock if we have funds legally available for the payment of dividends and such
payment will not result in a default under our senior credit facility. Such
funds may not be available to pay cash dividends to you, including upon
mandatory conversion. For the quarter ended December 31, 2003 on an as adjusted
basis to give effect to the concurrent offerings of our common stock and Class B
Preferred Stock and the use of proceeds thereof as described under "Use of
Proceeds," we would have been entitled to pay dividends of up to $ in
compliance with our senior credit facility and in accordance with applicable
law. In addition, because we are a holding company, our ability to pay cash
dividends on shares of the Class B Preferred Stock may be limited by
restrictions on our ability to obtain sufficient funds through dividends from
our subsidiaries. See "Risk Factors -- Conseco, Inc. and CDOC, Inc. are Holding
Companies and Depend on their Subsidiaries for Cash." Accordingly, there is no
guarantee that we will be able to pay any cash dividends on shares of the Class
B Preferred Stock.
We have agreed to deliver shares of our common stock in respect of
accumulated and unpaid dividends on the mandatory conversion date in the event
that we have inadequate legally available assets to pay such dividends in full
in cash on such date or such payment would result in a default under our senior
credit facility. We cannot assure you as to the value of any such shares of our
common stock delivered in those circumstances, or whether such shares will be
able to be sold promptly or at any particular price.
OUR ISSUANCE OF ADDITIONAL COMMON STOCK OR PREFERRED STOCK MAY CAUSE OUR COMMON
STOCK PRICE TO DECLINE, WHICH MAY NEGATIVELY IMPACT YOUR INVESTMENT.
Issuances or sales of substantial numbers of additional shares of our
common or preferred stock, including in connection with future acquisitions, if
any, or the perception that such issuances or sales could occur, may cause
prevailing market prices for our common stock to decline. We may sell additional
shares of common stock in subsequent public offerings. As of the date of this
prospectus, our amended and restated certificate of incorporation provides that
we have authority to issue up to 8.0 billion shares of common stock. As of
December 31, 2003, 100,115,772 shares of common stock were outstanding. Also, as
of such date, there were 43.9 million shares of common stock authorized and
available for issuance, 7.8 billion shares of common stock authorized and
reserved for issuance upon conversion or exchange of our Class A Preferred
Stock, 6.0 million shares of common stock authorized but reserved for issuance
upon exercise of our Series A Warrants, and 10.0 million shares of common stock
authorized and reserved for issuance under our long-term equity incentive plan
(including a total of 2.0 million shares of unvested restricted stock and
unvested options to purchase common stock issued to our Chief Executive Officer
and Non-Executive Chairman). If all of the Class A Preferred Stock is redeemed
with the proceeds of the offerings, the shares of common stock reserved for
issuance upon conversion or exchange of the Class A Preferred Stock will be
available for issuance for
26
other purposes. to shares of common stock will be issuable
upon conversion of the shares of Class B Preferred Stock, assuming that all
dividends on the Class B Preferred Stock are paid in cash (and an additional
to shares of common stock if the underwriters exercise their
option to purchase additional shares of Class B Preferred Stock in full). We
will reserve for issuance the maximum number of shares of our common stock
issuable upon conversion of the shares of Class B Preferred Stock at all times
that the Class B Preferred Stock is convertible. See "Description of the
Mandatorily Convertible Preferred Stock." Holders of our outstanding Series A
Warrants are also entitled to purchase one share of our common stock at a price
of $27.60 per share for each such warrant. The Series A Warrants are exercisable
for an aggregate of up to 6.0 million shares of common stock and expire on
September 10, 2008. See "Description of the Mandatorily Convertible Preferred
Stock" and "Description of Capital Stock." Because the value of the Class B
Preferred Stock is derived in large part from the value of the underlying common
stock into which it is convertible, such declines in the value of our common
stock could negatively impact the value of your investment in the Class B
Preferred Stock.
In connection with our Plan of Reorganization, we entered into registration
rights agreements with certain of our predecessor's creditors with respect to
our common stock and Class A Preferred Stock. Under these agreements, these
stockholders have the right, subject to certain limitations, to require us to
effect the registration of their shares upon written demand. In addition,
subject to certain limitations, if we file a registration statement covering our
equity securities for our own account or for the account of any holder of our
equity securities (including the registration statement of which this prospectus
is a part), we must offer to holders of registrable securities the opportunity
to register such number of shares of registrable securities as such holder may
request. See "Description of Capital Stock -- Registration Rights Agreements."
In addition, our board of directors is authorized to issue additional series of
shares of preferred stock without any action on the part of our stockholders.
Our board of directors also has the power, without stockholder approval, to set
the terms of any such series of shares of preferred stock that may be issued,
including voting rights, conversion rights, dividend rights, preferences over
our common stock with respect to dividends or if we liquidate, dissolve or wind
up our business and other terms. If we issue cumulative preferred stock in the
future that has preference over our common stock with respect to the payment of
dividends or upon our liquidation, dissolution or winding up, or if we issue
preferred stock with voting rights that dilute the voting power of our common
stock, the market price of our common stock could decrease, adversely affecting
the value of our Class B Preferred Stock. We are also authorized to issue,
without stockholder approval, securities convertible into either common stock or
preferred stock.
THE TRADING PRICES FOR THE SHARES OF CLASS B PREFERRED STOCK WILL BE DIRECTLY
AFFECTED BY THE TRADING PRICES OF OUR COMMON STOCK.
The trading prices for the shares of Class B Preferred Stock in the
secondary market will be directly affected by the trading prices of our common
stock, the general level of interest rates and our credit quality. It is
impossible to predict whether the price of the common stock or interest rates
will rise or fall. Trading prices of the common stock will be influenced by our
operating results and prospects and by economic, financial and other factors. In
addition, general market conditions, including the level of, and fluctuations
in, the trading prices of stocks generally, and sales of substantial amounts of
common stock by us in the market after the offering of the Class B Preferred
Stock, or the perception that such sales could occur, could affect the price of
our common stock, and thus the price of our Class B Preferred Stock.
Fluctuations in interest rates may give rise to arbitrage opportunities based
upon changes in the relative value of the common stock underlying the Class B
Preferred Stock. Any such arbitrage could, in turn, affect the trading prices of
the shares of Class B Preferred Stock and our common stock.
We emerged from bankruptcy, and our common stock was approved for listing
on the NYSE, on September 10, 2003. Accordingly, there has been a limited
trading history in our common stock and we cannot predict whether an active
market will continue in shares of our common stock or how illiquid that market
might become. The liquidity of the market for shares of our common stock and the
prices at which the stock trades will depend upon the amount outstanding, the
number of holders thereof, the interest of securities dealers in maintaining a
market in the securities and other factors beyond our control.
27
Consequently, you bear the risk that the value of your investment in the Class B
Preferred Stock will be negatively impacted if shares of our common stock do not
trade at prices equal to or greater than the value of such common stock on the
date you purchased the Class B Preferred Stock.
THE OPPORTUNITY FOR EQUITY APPRECIATION PROVIDED BY AN INVESTMENT IN OUR CLASS B
PREFERRED STOCK IS LESS THAN THAT PROVIDED BY A DIRECT INVESTMENT IN OUR COMMON
STOCK.
Your opportunity for equity appreciation afforded by investing in shares of
our Class B Preferred Stock is less than your opportunity for equity
appreciation if you directly invested in our common stock. This opportunity is
less because the market value of the common stock to be received by you pursuant
to the shares of Class B Preferred Stock on the mandatory conversion date
(assuming that the market value is the same as the applicable market value of
the common stock) will only exceed the effective price per share paid by you for
our common stock on the date of issuance of the Class B Preferred Stock if the
applicable market value of the common stock exceeds the threshold appreciation
price of $ (which represents an appreciation of approximately % over the
initial price of $ ). If the applicable market value of our common stock
exceeds the initial price but falls below the threshold appreciation price, you
realize no equity appreciation of the common stock for the period during which
you own the Class B Preferred Stock. Furthermore, if the applicable market value
of our common stock equals or exceeds the threshold appreciation price, you
would receive on the mandatory conversion date only approximately % of the
value of the shares of common stock you could have purchased with $ at the last
reported sale price of our common stock on the date hereof.
HOLDERS OF THE SHARES OF CLASS B PREFERRED STOCK WILL HAVE NO RIGHTS AS A COMMON
STOCKHOLDER UNTIL THEY ACQUIRE OUR COMMON STOCK.
Until you acquire shares of our common stock upon conversion, you will have
no rights with respect to our common stock, including voting rights (except as
required by applicable state law or our amended and restated certificate of
incorporation, and as described under "Description of the Mandatorily
Convertible Preferred Stock -- Voting Rights"), rights to respond to tender
offers and rights to receive any dividends or other distributions on our common
stock. Upon conversion, you will be entitled to exercise the rights of a holder
of common stock only as to matters for which the record date occurs after the
conversion date. For example, in the event that an amendment is proposed to our
certificate of incorporation or bylaws requiring stockholder approval and the
record date for determining the stockholders of record entitled to vote on the
amendment occurs prior to delivery of the common stock, you will not be entitled
to vote on the amendment, although you will nevertheless be subject to any
changes in the powers, preferences or special rights of our common stock.
OUR CLASS B PREFERRED STOCK HAS NEVER BEEN PUBLICLY TRADED AND AN ACTIVE TRADING
MARKET FOR SUCH STOCK MAY NOT DEVELOP.
Prior to this offering, there has been no public market for the shares of
Class B Preferred Stock. Although we intend to apply to list the shares of Class
B Preferred Stock on the NYSE, we cannot assure you that an active trading
market will develop, or, if developed, will be maintained. Also, the
underwriters have advised us that they intend to facilitate secondary market
trading by making a market in the shares of Class B Preferred Stock. However,
the underwriters are not obligated to make a market in the shares of Class B
Preferred Stock and may discontinue market making activities at any time.
THE SHARES OF CLASS B PREFERRED STOCK WILL RANK JUNIOR TO ALL OF OUR AND OUR
SUBSIDIARIES' LIABILITIES IN THE EVENT OF A BANKRUPTCY, LIQUIDATION OR WINDING
UP OF OUR ASSETS.
In the event of bankruptcy, liquidation or winding up, our assets will be
available to pay obligations on the Class B Preferred Stock only after all of
our liabilities have been paid and only on a pari passu basis with any pari
passu preferred stock we may issue hereafter. In addition, the Class B Preferred
Stock will effectively rank junior to all existing and future liabilities of our
subsidiaries and the capital stock (other than common stock) of our subsidiaries
held by third parties, if any, and thus rights of holders of the shares of
28
Class B Preferred Stock to participate in the assets of our subsidiaries upon
any liquidation or reorganization of any subsidiary will be subject to the prior
claims of that subsidiary's creditors and equity holders. As of September 30,
2003, we had approximately $27.1 billion of total liabilities (excluding
indebtedness to our subsidiaries). In the event of bankruptcy, liquidation or
winding up, there may not be sufficient assets remaining, after paying our and
our subsidiaries' liabilities, to pay amounts due on the Class B Preferred Stock
then outstanding. To the extent we have assets remaining after paying our and
our subsidiaries' liabilities, we are obligated to pay amounts due on any parity
stock then outstanding on a pari passu basis with amounts due on any or all the
shares of Class B Preferred Stock then outstanding.
THE SHARES OF CLASS B PREFERRED STOCK PROVIDE LIMITED CONVERSION RATE
ADJUSTMENTS.
The number of shares of common stock that you are entitled to receive on
the mandatory conversion date, or as a result of early conversion of a share of
Class B Preferred Stock, is subject to adjustment for certain events arising
from stock splits and combinations, stock dividends, cash dividends and certain
other actions by us that modify our capital structure. See "Description of the
Mandatorily Convertible Preferred Stock -- Anti-Dilution Adjustments." We will
not adjust the conversion rate for other events, including offerings of common
stock for cash by us or in connection with acquisitions. We cannot assure you
that an event that adversely affects the value of the shares of Class B
Preferred Stock, but does not result in an adjustment to the conversion rate,
will not occur. Further, we are not restricted from issuing additional common
stock during the term of the Class B Preferred Stock and have no obligation to
consider your interests for any reason. If we issue additional shares of common
stock, it may materially and adversely affect the price of our common stock and,
because of the relationship of the number of shares to be received on the
mandatory date to the price of the common stock, such other events may adversely
affect the trading price of the shares of Class B Preferred Stock.
YOU MAY HAVE TO PAY TAXES WITH RESPECT TO DISTRIBUTIONS ON OUR COMMON STOCK THAT
YOU DO NOT RECEIVE.
The number of shares of common stock that you are entitled to receive on
the mandatory conversion date, or as a result of early conversion of the shares
of Class B Preferred Stock, is subject to adjustment for certain events arising
from stock splits and combinations, stock dividends, certain cash dividends and
certain other actions by us that modify our capital structure. See "Description
of the Mandatorily Convertible Preferred Stock -- Anti-Dilution Adjustments." If
the conversion rate is adjusted as a result of a distribution that is taxable to
our common stockholders, such as a cash dividend, you would be required to
include an amount in income for federal income tax purposes, notwithstanding the
fact that you do not actually receive such distribution. The amount that you
will generally have to include in income would be the fair market value of the
additional common stock to which you would be entitled by reason of the increase
in your proportionate equity interest in the company to the extent of our
current and accumulated earnings and profits. In addition, non-U.S. holders of
shares of Class B Preferred Stock may, in certain circumstances, be deemed to
have received a distribution subject to U.S. federal withholding tax
requirements.
ANTI-TAKEOVER PROVISIONS IN OUR CERTIFICATE OF INCORPORATION, OUR BYLAWS AND
DELAWARE LAW, AS WELL AS IN STATE INSURANCE LAWS, MIGHT DELAY, DETER OR PREVENT
TAKEOVERS AND BUSINESS COMBINATIONS THAT STOCKHOLDERS CONSIDER TO BE IN THEIR
BEST INTERESTS, WHICH COULD NEGATIVELY AFFECT OUR STOCK PRICE.
Provisions in our amended and restated certificate of incorporation and our
second amended and restated bylaws, and applicable provisions of the DGCL may
make it more difficult and expensive for a third party to acquire control of us,
even if a change of control would be beneficial to the interests of our
stockholders. These provisions could discourage potential takeover attempts and
could adversely affect the market price of our common stock, and thus the market
price of the Class B Preferred Stock. These provisions may also render the
removal of the current board of directors and of management more difficult.
These provisions include:
- a classified board of directors, which could prevent a stockholder, or
group of stockholders, having majority voting power, from obtaining
control of our board of directors until the second annual
29
meeting of stockholders following September 10, 2003, the effective date
of our emergence from bankruptcy;
- advance notice requirements for stockholder proposals and director
nominations;
- removal of directors only for cause prior to the second annual meeting of
stockholders following September 10, 2003, the effective date of our
emergence from bankruptcy; and
- the authority of our board of directors to issue, without stockholder
approval, series of preferred stock with such terms as the board of
directors may determine.
In addition to the foregoing, state insurance laws include provisions that
may delay, deter or prevent a takeover attempt that may be in the best interests
of stockholders. For instance, state insurance holding company laws and
regulations applicable to us generally provide that no person may acquire
control of a company, and thus indirect control of its insurance subsidiaries,
unless the person has provided required information to, and the acquisition is
approved or not disapproved by, the appropriate insurance regulatory
authorities. Generally, any person acquiring beneficial ownership of 10 percent
or more of the voting power of our capital stock would be presumed to have
acquired control, unless the appropriate insurance regulatory authorities, upon
advance application, determine otherwise. In addition, they may prevent
stockholders from receiving the benefit from any premium over the market price
of our common stock offered by a bidder in a potential takeover. Even in the
absence of a takeover attempt, the existence of these provisions may adversely
affect the prevailing market price of our common stock and Class B Preferred
Stock if they are viewed as discouraging takeover attempts in the future.
30
OUR RECENT EMERGENCE FROM BANKRUPTCY
On December 17, 2002, our predecessor and certain of its non-insurance
company subsidiaries filed voluntary petitions for relief under Chapter 11 of
the Bankruptcy Code in the United States Bankruptcy Court for the Northern
District of Illinois, Eastern Division (the "Bankruptcy Court"). We emerged from
bankruptcy protection under the Plan of Reorganization, which was confirmed
pursuant to an order of the Bankruptcy Court on September 9, 2003 (the
"Confirmation Date"), and became effective on September 10, 2003. Upon the
confirmation of the Plan of Reorganization, we implemented fresh start
accounting in accordance with Statement of Position 90-7 "Financial Reporting by
Entities in Reorganization under the Bankruptcy Code" ("SOP 90-7"). Our
accounting and actuarial systems and procedures are designed to produce
financial information as of the end of a month. Accordingly, for accounting
convenience purposes, we applied the effects of fresh start accounting on August
31, 2003. The activity of the Company for the period from September 1, 2003
through September 10, 2003 is therefore included in the successor's statement of
operations and excluded from the predecessor's statement of operations. See
"Selected Consolidated Financial and Operating Data" and "Basis of Presentation"
and "Fresh Start Reporting" in our unaudited consolidated financial statements
included elsewhere in this prospectus for more information on fresh start
accounting.
The Plan of Reorganization generally provided for the full payment or
reinstatement of allowed administrative claims, priority claims, fully secured
claims and certain intercompany claims, and the distribution of new equity
securities (including warrants) to partially secured and unsecured creditors of
our predecessor. Holders of claims arising under our predecessor's $1.5 billion
senior bank credit facility also received a pro rata interest in our Senior
Credit Facility. Holders of our predecessor's common stock and preferred stock
did not receive any distribution under the Plan of Reorganization, and these
securities, together with all other prepetition securities and the $1.5 billion
senior bank credit facility of our predecessor, were cancelled on the Effective
Date.
On the Effective Date, under the terms of the Plan of Reorganization, we
emerged from the bankruptcy proceedings with a capital structure consisting of:
- our $1.3 billion Senior Credit Facility;
- approximately 34.4 million shares of Class A Preferred Stock with an
initial aggregate liquidation preference of approximately $859.7 million;
- 100.0 million shares of common stock, excluding shares issued to our new
non-executive chairman upon his appointment and shares issued or to be
issued to directors, officers or employees under a new equity incentive
plan; and
- warrants to purchase 6.0 million shares of our common stock (the "Series
A Warrants").
Under the terms of the Plan of Reorganization, we distributed the equity
securities to the creditors of our predecessor in the amounts outlined below:
- lenders under our predecessor's senior bank credit facility and director
and officer loan program received approximately 34.4 million shares of
our Class A Preferred Stock, with an initial aggregate liquidation
preference of $859.7 million;
- holders of our predecessor's senior notes received approximately 32.3
million shares of our common stock;
- holders of our predecessor's guaranteed senior notes received
approximately 60.6 million shares of our common stock;
- holders of our predecessor's general unsecured claims received
approximately 3.8 million shares of our common stock; and
31
- holders of trust preferred securities issued by our predecessor's
subsidiary trusts received approximately 1.5 million shares of our common
stock and Series A Warrants to purchase 6.0 million shares of our common
stock at an exercise price of $27.60 per share.
The distribution of our common stock summarized above represents
approximately 98 percent of all of the shares of common stock to be distributed
under the Plan of Reorganization. As of December 31, 2003, approximately 1.8
million shares of common stock have been reserved for distribution under the
Plan of Reorganization in respect of disputed claims, the resolution of which is
still pending. If reserved shares remain after resolution of these disputed
claims, then the reserved shares will be reallocated to other general unsecured
creditors of our predecessor as provided for under the Plan of Reorganization.
As part of our Chapter 11 reorganization, we sold substantially all of the
assets of our predecessor's finance business and exited from this line of
business. Our finance business was conducted through our predecessor's indirect
wholly-owned subsidiary, CFC. We accounted for our finance business as a
discontinued operation in 2002 once we formalized our plans to sell it. On April
1, 2003, CFC and 22 of its direct and indirect subsidiaries, which collectively
comprised substantially all of the finance business, filed liquidating plans of
reorganization with the Bankruptcy Court in order to facilitate the sale of this
business. The sale of the finance business was completed in the second quarter
of 2003. We did not receive any proceeds from this sale in respect of our
interest in CFC, nor did any creditors of our predecessor. As of March 31, 2003,
we ceased to include the assets and liabilities of CFC on our predecessor's
consolidated balance sheet.
For a complete discussion of the distributions provided for under the Plan
of Reorganization, you should refer to the complete text of the Plan of
Reorganization confirmed by the Bankruptcy Court, which is filed as an exhibit
to the registration statement of which this prospectus forms a part.
32
[P] RATIOS OF EARNINGS TO FIXED CHARGES AND EARNINGS TO FIXED CHARGES,
PREFERRED STOCK DIVIDENDS, AND DISTRIBUTIONS ON COMPANY-OBLIGATED
MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUSTS
The following table sets forth our ratio of earnings to fixed charges and
our ratio of earnings to fixed charges, preferred stock dividends and
distributions on company-obligated mandatorily redeemable preferred securities
of subsidiary trusts for the periods indicated. For purposes of the table,
"earnings" represent consolidated net income (loss) before income taxes,
minority interest, discontinued operations, extraordinary gain (loss),
cumulative effect of accounting change and fixed charges, as defined below.
"Fixed charges" for the "ratio of earnings to fixed charges as reported"
consist of:
- interest expense on corporate debt, including amortization;
- interest expense on investment borrowings;
- interest added to policyholder account balances; and
- the portion of rental expense we deem representative of the interest
factor.
"Fixed charges" for the "ratio of earnings to fixed charges excluding
interest added to policyholder balances" consist of:
- interest expense on corporate debt, including amortization;
- interest expense on investment borrowings; and
- the portion of rental expense we deem representative of the interest
factor.
We calculate the "ratio of fixed charges excluding interest added to
policyholder account balances" as a measure of our historical ability to meet
our interest obligations related to corporate debt and investment borrowings,
without consideration of insurance policy benefits credited to policyholders in
the form of interest.
"Preferred stock dividends" and "distributions on company-obligated
mandatorily redeemable preferred securities of subsidiary trusts" consist of
income before taxes that is required to pay dividends or distributions on such
securities. For further information with respect to the following table, please
see Exhibit 12.1 to the registration statement of which this prospectus is a
part.
SUCCESSOR PREDECESSOR
------------- -----------------------------------------------
ONE MONTH EIGHT MONTHS
ENDED ENDED YEAR ENDED DECEMBER 31
SEPTEMBER 30, AUGUST 31, --------------------------------
2003 2003(A) 2002 2001 2000 1999 1998
------------- ------------ ---- ---- ---- ---- ----
Ratio of earnings to fixed charges:
As reported........................ 1.82x 4.94x (b) (d) (f) 2.10x 2.13x
Excluding interest added to
policyholder account balances.... 5.61x 10.04x (b) (d) (f) 4.24x 5.10x
Ratio of earnings to fixed charges,
preferred stock dividends and
distributions on company-obligated
mandatorily redeemable preferred
securities of subsidiary trusts:
As reported...................... 1.54x 4.94x (c) (e) (g) 1.72x 1.83x
Excluding interest added to
policyholder account
balances....................... 2.80x 10.04x (c) (e) (g) 2.55x 3.17x
---------------
(a) Earnings for the eight months ended August 31, 2003 included reorganization
items totaling $2,130.5 million. The reorganization items included: (1)
$3,151.4 million related to the gain on the discharge of prepetition
liabilities; (2) $(950.0) million related to fresh start adjustments; and
(3) $(70.9) million related to professional fees. The ratios for
33
the eight months ended August 31, 2003, excluding such reorganization
items, would be as follows: (1) ratio of earnings to fixed
charges -- 1.08x; and (2) ratio of earnings to fixed charges excluding
interest added to policyholder account balances -- 1.17x. There were no
preferred stock dividends or distributions on company-obligated mandatorily
redeemable preferred securities of subsidiary trusts during the eight
months ended August 31, 2003.
(b) For such ratios, earnings were $1,632.2 million less than fixed charges.
Earnings for the year ended December 31, 2002 included: (1) special and
reorganization charges of $110.9 million; (2) goodwill impairment charges
of $500 million; and (3) provision for losses related to loan guarantees of
$240.0 million, as described in greater detail in the notes to the
consolidated financial statements included in this prospectus.
(c) For such ratios, earnings were $1,808.6 million less than fixed charges.
Earnings for the year ended December 31, 2002 included: (1) special and
reorganization charges of $110.9 million; (2) goodwill impairment charges
of $500 million; and (3) provision for losses related to loan guarantees of
$240.0 million, as described in greater detail in the notes to the
consolidated financial statements included in this prospectus.
(d) For such ratios, earnings were $243.4 million less than fixed charges.
Earnings for the year ended December 31, 2001 included: (1) special charges
of $80.4 million; and (2) provision for losses related to loan guarantees
of $169.6 million, as described in greater detail in the notes to the
consolidated financial statements included in this prospectus.
(e) For such ratios, earnings were $447.1 million less than fixed charges.
Earnings for the year ended December 31, 2001 included: (1) special charges
of $80.4 million; and (2) provision for losses related to loan guarantees
of $169.6 million, as described in greater detail in the notes to the
consolidated financial statements included in this prospectus.
(f) For such ratios, earnings were $777.5 million less than fixed charges.
Earnings for the year ended December 31, 2000 included: (1) special charges
of $305.0 million; and (2) provision for losses related to loan guarantees
of $231.5 million, as described in greater detail in the notes to the
consolidated financial statements included in this prospectus.
(g) For such ratios, earnings were $1,018.0 million less than fixed charges.
Earnings for the year ended December 31, 2000 included: (1) special charges
of $305.0 million; and (2) provision for losses related to loan guarantees
of $231.5 million, as described in greater detail in the notes to the
consolidated financial statements included in this prospectus.
34
USE OF PROCEEDS
[C] Net proceeds from the offering of the common stock will be
approximately $ million, or $ million if the underwriters exercise in
full their option to purchase additional shares of common stock in the offering,
assuming a public offering price of $ per share, and after deducting
underwriting discounts and commissions and the estimated expenses of the
offering. Concurrently with the offering of the common stock, we are offering
shares of Class B Preferred Stock. The closing of the common stock
offering is not conditioned upon the closing of the Class B Preferred Stock
offering.
[P] Net proceeds from the offering of the Class B Preferred Stock will be
approximately $ million, or $ million if the underwriters exercise in
full their option to purchase additional shares of Class B Preferred Stock in
the offering, assuming a public offering price of $ per share, and after
deducting underwriting discounts and commissions and the estimated expenses of
the offering. Concurrently with the offering of the Class B Preferred Stock, we
are offering shares of common stock. The closing of the Class B
Preferred Stock offering is conditioned upon the closing of the common stock
offering and upon having sufficient net proceeds from the offerings to redeem
all of our outstanding Class A Preferred Stock.
We expect to use the net proceeds from the offering of the common stock and
the Class B Preferred Stock in one or more of the following ways:
- to redeem shares of our Class A Preferred Stock,
- to repay indebtedness under our Senior Credit Facility, which matures in
2009 and currently has a weighted average interest rate of 7.8 percent,
- to contribute capital to our insurance subsidiaries, and/or
- for general corporate purposes.
PRICE RANGE OF OUR COMMON STOCK
All of our predecessor's common stock was cancelled pursuant to the Plan of
Reorganization, which became effective September 10, 2003. Our common stock has
traded on the NYSE under the symbol "CNO" since September 12, 2003. The high and
low sale prices of our common stock, as reported on the NYSE, for the quarterly
periods (beginning September 12, 2003) are set forth below. On January 28, 2004,
the last reported sale price of our common stock on the NYSE was $22.94. As of
January 21, 2004, there were 100,115,772 shares of our common stock outstanding,
and there were approximately 65,000 holders of our common stock.
CONSECO
COMMON STOCK
---------------
HIGH LOW
------ ------
2003
Third Quarter (beginning September 12).................... $22.50 $17.70
Fourth Quarter............................................ 22.18 18.05
2004
First Quarter (through January 27)........................ $23.89 $20.90
35
DIVIDEND POLICY
We have not declared or paid any cash dividends on our common stock since
our emergence from bankruptcy, nor do we expect to pay any cash dividends on our
common stock for the foreseeable future. We intend to pay cash dividends on our
Class B Preferred Stock in accordance with its terms. We currently intend to
retain any additional future earnings to finance our operations and growth. Any
future determination to pay cash dividends on our common stock will be at the
discretion of our board of directors and will be dependent on our earnings,
financial condition, operating results, capital requirements, any contractual
restrictions, regulatory and other restrictions on the payment of dividends by
our subsidiaries to us, and other factors that our board of directors deems
relevant. In addition, our Senior Credit Facility contains limitations on our
ability to declare and pay cash dividends. Moreover, the payment of dividends on
our common stock is subject to our prior satisfaction of our obligations under
any outstanding shares of preferred stock with preference as to the payment of
dividends, including our existing Class A Preferred Stock and Class B Preferred
Stock.
As an insurance holding company, the assets of which consist primarily of
direct and indirect equity interests in our insurance company subsidiaries, our
ability to pay dividends to our stockholders and meet our other obligations,
including operating expenses and debt service, depends primarily on the receipt
of dividends and other payments from our insurance company subsidiaries. The
payment of dividends by Conseco Life Insurance Company of Texas, our top tier
insurance holding company, is regulated under the insurance laws of the State of
Texas. See "Risk Factors -- Conseco, Inc. and CDOC, Inc. are Holding Companies
and Depend on their Subsidiaries for Cash," and "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
36
CAPITALIZATION
The following table sets forth, as of September 30, 2003, our actual
consolidated capitalization and our capitalization as adjusted to give effect
to:
- the sale of shares of common stock at a public offering price
of $ per share; and
- the sale of shares of Class B Preferred Stock at a public
offering price of $ per share (which sale is conditioned upon the
closing of the common stock offering); and
- the application of the estimated net proceeds from the offerings as set
forth under "Use of Proceeds" as if the offerings had occurred as of
September 30, 2003.
The table should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and our unaudited
consolidated financial statements and the related notes thereto appearing
elsewhere in this prospectus.
AS OF SEPTEMBER 30,
2003
-------------------
ACTUAL AS ADJUSTED
------ -----------
(IN MILLIONS)
Notes payable............................................... $1,300.0 $
-------- --------
Equity:
Preferred Stock, par value $0.01 per share, 265,000,000
authorized:
34,386,740 shares of Class A Preferred Stock issued
and outstanding actual; shares of Class A
Preferred Stock issued and outstanding as
adjusted............................................ 865.0
No shares of Class B Preferred Stock issued and
outstanding actual; shares of Class B
Preferred Stock issued and outstanding as
adjusted............................................ --
Common Stock, par value $0.01 per share, 8,000,000,000
authorized 100,098,119 shares issued and outstanding
actual, shares issued and outstanding as
adjusted............................................... 1.0
Additional paid-in-capital................................ 1,639.3
Accumulated other comprehensive income.................... 273.2
Retained earnings......................................... 18.9
-------- --------
Total equity........................................... 2,797.4
-------- --------
Total capitalization.............................. $4,097.4 $
======== ========
37
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
The following table sets forth selected financial data for Conseco, Inc. as
of and for each of the five years ended December 31, 2002, as of and for the
eight months ended August 31, 2003, and as of and for the one month ended
September 30, 2003. The data should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
our consolidated financial statements and related notes included in this
prospectus.
Our predecessor and certain of its subsidiaries emerged from Chapter 11
bankruptcy proceedings on September 10, 2003. However, for accounting
convenience, the effective date of the plan was deemed to have occurred on
August 31, 2003. Fresh start accounting has been implemented as of August 31,
2003, and accordingly, we restated all of our assets and liabilities to their
current estimated value, reestablished shareholders' equity at the
reorganization value determined in connection with our plan of reorganization,
and recorded the portion of the reorganization value which could not be
attributed to specific tangible or identified intangible assets as goodwill. As
a result, our financial statements for periods following August 31, 2003, are
not comparable with those prepared before that date.
For financial reporting purposes, we refer to Conseco and its subsidiaries
on or prior to August 31, 2003 as the predecessor company and after August 31,
2003 as the successor company.
As part of our Chapter 11 reorganization, we sold the assets of our finance
business and exited this line of business effective March 31, 2003. In October
2002, we sold CVIC, our primary writer of variable annuity products. The results
of operations of these former businesses have been reported as discontinued
operations in all periods presented in the selected financial data prior to
their sale. The predecessor's net income (loss) includes amounts related to the
discontinued operations of $(2,216.8) million, $(100.6) million, $(381.9)
million, $117.3 million, $(53.7) million and $16.0 million for the years ended
December 31, 2002, 2001, 2000, 1999 and 1998 and for the eight months ended
August 31, 2003, respectively. The sales of these businesses further affect the
comparability of the selected financial data.
We have derived the selected financial data for the years ended December
31, 2002, 2001 and 2000 and as of December 31, 2002 and 2001 from the
predecessor's audited consolidated financial statements included in this
prospectus. We have derived the selected financial data for the years ended
December 31, 1999 and 1998 and as of December 31, 2000, 1999 and 1998 from our
audited consolidated financial statements not included in this prospectus. We
have derived the selected statement of operations data for the one month ended
September 30, 2003 and the eight months ended August 31, 2003 and the selected
balance sheet data as of September 30, 2003 and August 31, 2003 from our
unaudited interim condensed consolidated financial statements included in this
prospectus.
The unaudited interim historical consolidated financial data presented in
the table below reflects all adjustments, consisting only of normal, recurring
accruals, that we consider necessary for a fair presentation of our consolidated
financial position and results of operations for such periods and as of such
dates. The results of operations for the interim periods are not necessarily
indicative of the results to be expected for a full year.
We have prepared the selected financial data, other than statutory data, in
conformity with GAAP. We have derived the statutory data from the statements
filed by our insurance subsidiaries with regulatory authorities and have
prepared the statutory data in accordance with statutory accounting practices,
which vary in certain respects from GAAP.
38
You should read the following in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and our
consolidated financial statements and notes thereto included in this prospectus.
SUCCESSOR PREDECESSOR
------------ ------------------------------------------------------------------------
AS OF OR FOR AS OF OR FOR
THE ONE THE EIGHT
MONTH MONTHS
ENDED ENDED YEARS ENDED DECEMBER 31,
SEPT. 30, AUGUST 31, ---------------------------------------------------------
2003 2003 2002 2001 2000 1999 1998
------------ ------------ ---- ---- ---- ---- ----
(AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA(a)
Insurance policy income................. $ 256.2 $ 2,204.3 $ 3,602.3 $ 3,992.7 $ 4,170.7 $ 3,990.4 $ 3,875.2
Net investment income................... 101.2 969.0 1,334.3 1,550.0 1,578.1 2,287.7 1,885.0
Net realized investment gains
(losses).............................. 6.7 (5.4) (556.3) (340.0) (304.8) 80.0 189.6
Total revenues.......................... 366.3 3,202.2 4,450.4 5,492.0 5,581.4 6,315.3 6,041.1
Interest expense on corporate notes
payable and investment borrowings
(contractual interest: $268.5 for the
eight months ended August 31, 2003;
and $345.3 for 2002).................. 7.0 202.5 341.9 400.0 454.3 300.2 242.2
Total benefits and expenses............. 328.5 1,030.0 6,082.6 5,735.4 6,358.9 5,301.2 5,011.8
Income (loss) before income taxes,
minority interest, discontinued
operations and cumulative effect of
accounting change..................... 37.8 2,172.2 (1,632.2) (243.4) (777.5) 1,014.1 1,029.3
Cumulative effect of accounting change,
net of income tax..................... -- -- (2,949.2) -- (55.3) -- --
Net income (loss)....................... 24.2 2,201.7 (7,835.7) (405.9) (1,191.2) 595.0 467.1
Preferred stock dividends............... 5.3 -- 2.1 12.8 11.0 1.5 7.8
Net income (loss) applicable to common
stock................................. 18.9 2,201.7 (7,837.8) (418.7) (1,202.2) 593.5 459.3
PER SHARE DATA
Net income, basic....................... $ .19
Net income, diluted..................... $ .17
Book value per common share
outstanding........................... $ 19.31
Weighted average shares outstanding for
basic earnings........................ 100.1
Weighted average shares outstanding for
diluted earnings...................... 144.7
Shares outstanding at period-end........ 100.1
BALANCE SHEET DATA -- AT PERIOD END
Total investments....................... $22,415.8 $22,018.3 $21,783.7 $25,067.1 $25,017.6 $26,431.6 $26,073.0
Goodwill................................ 935.4 99.4 100.0 3,695.4 3,800.8 3,927.8 3,960.2
Total assets............................ 29,859.9 28,318.1 46,509.0 61,432.2 58,589.2 52,185.9 43,599.9
Corporate notes payable and commercial
paper................................. 1,300.0 -- -- 4,085.0 5,055.0 4,624.2 3,809.9
Liabilities subject to compromise....... -- 6,951.4 4,873.3 -- -- -- --
Total liabilities....................... 27,062.5 30,519.5 46,637.9 54,764.7 51,810.9 43,990.6 36,229.4
Company-obligated mandatorily redeemable
preferred securities of subsidiary
trusts................................ -- -- 1,921.5 1,914.5 2,403.9 2,639.1 2,096.9
Shareholders' equity (deficit).......... 2,797.4 (2,201.4) (2,050.4) 4,753.0 4,374.4 5,556.2 5,273.6
STATUTORY DATA(b)
Statutory capital and surplus........... $ 1,412.4 $ 1,064.4 $ 1,649.8 $ 1,881.8 $ 2,170.5 $ 1,850.0
Asset valuation reserve ("AVR")......... 78.4 11.6 105.1 266.8 362.8 336.4
Total statutory capital and surplus and
AVR................................... 1,490.8 1,076.0 1,754.9 2,148.6 2,533.3 2,186.4
---------------
(a) Our financial condition and results of operations have been significantly
affected during the periods presented by the discontinued finance
operations. Please refer to note 17 to the audited consolidated financial
statements of our predecessor included elsewhere in this prospectus.
(b) We have derived the statutory data from statements filed by our insurance
subsidiaries with regulatory authorities and have prepared the statutory
data in accordance with statutory accounting principles, which vary in
certain respects from GAAP.
39
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following analysis of the consolidated results of our operations and
financial condition should be read in conjunction with "Selected Consolidated
Financial and Operating Data," and the consolidated financial statements and the
related notes to the financial statements and the other financial information
included elsewhere in this prospectus.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Our narrative analysis below and elsewhere in this prospectus contains
forward-looking statements within the meaning of the federal securities laws and
the Private Securities Litigation Reform Act of 1995. Forward-looking statements
typically are identified by the use of terms such as "may," "will," "should,"
"expect," "anticipate," "believe," "estimate," "intend" and similar words,
although some forward-looking statements are expressed differently. You should
consider statements that contain these words carefully because they describe our
expectations, plans, strategies and goals and our beliefs concerning future
business conditions, our results of operations, financial position, and our
business outlook or they state other "forward-looking" information based on
currently available information. The "Risk Factors" section of this prospectus
provides examples of risks, uncertainties and events that could cause our actual
results to differ materially from the expectations expressed in our
forward-looking statements. Assumptions and other important factors that could
cause our actual results to differ materially from those anticipated in our
forward-looking statements include, among other things:
- the potential adverse impact of our predecessor's Chapter 11 petition on
our business operations, and relationships with our customers, employees,
regulators, distributors and agents;
- our ability to operate our business under the restrictions imposed by our
senior bank credit facility or future credit facilities;
- our ability to improve the financial strength ratings of our insurance
company subsidiaries and the impact of recent ratings downgrades on our
business;
- general economic conditions and other factors, including prevailing
interest rate levels, stock and credit market performance and health care
inflation, which may affect (among other things) our ability to sell
products and access capital on acceptable terms, the market value of our
investments, and the lapse rate and profitability of policies;
- our ability to achieve anticipated synergies and levels of operational
efficiencies;
- customer response to new products, distribution channels and marketing
initiatives;
- mortality, morbidity, usage of health care services, persistency and
other factors which may affect the profitability of our insurance
products;
- performance of our investments;
- changes in Federal income tax laws and regulations which may affect or
eliminate the relative tax advantages of some of our products;
- increasing competition in the sale of insurance and annuities;
- regulatory changes or actions, including those relating to regulation of
the financial affairs of our insurance companies, including the payment
of dividends to us, regulation of financial services affecting (among
other things) bank sales and underwriting of insurance products,
regulation of the sale, underwriting and pricing of products, and health
care regulation affecting health insurance products;
40
- the ultimate outcome of lawsuits filed against us and other legal and
regulatory proceedings to which we are subject; and
- the risk factors or uncertainties listed from time to time in our filings
with the Securities and Exchange Commission.
Other factors and assumptions not identified above are also relevant to the
forward-looking statements, and if they prove incorrect, could also cause actual
results to differ materially from those projected. The forward-looking
statements made in this prospectus relate only to events as of the date on which
the statements are made. We undertake no obligation to update any
forward-looking statement to reflect events or circumstances after the date on
which the statement is made or to reflect the occurrence of unanticipated
events.
OVERVIEW
We are a holding company for a group of insurance companies operating
throughout the United States that develop, market and administer supplemental
health insurance, annuity, individual life insurance and other insurance
products. We focus on serving the senior and middle-income markets, which we
believe are attractive, high growth markets. We sell our products through three
distribution channels: career agents, professional independent producers (some
of whom sell one or more of our product lines exclusively) and direct marketing.
We conduct our business operations through two primary operating segments,
based on method of product distribution, and a third segment comprised of
businesses in run-off. Prior to September 30, 2003, we conducted our insurance
operations through one segment. In the fourth quarter of 2003, we implemented
changes contemplated in our restructuring plan to conduct our business through
the following segments:
- BANKERS LIFE, which consists of the businesses of Bankers Life & Casualty
and Colonial Penn. Bankers Life & Casualty markets and distributes
Medicare supplement insurance, life insurance, long-term care insurance
and fixed annuities to the senior market through approximately 4,000
exclusive career agents and sales managers. Colonial Penn markets graded
benefit and simplified issue life insurance directly to consumers through
television advertising, direct mail, the internet and telemarketing. Both
Bankers Life & Casualty and Colonial Penn market their products under
their own brand names.
- CONSECO INSURANCE GROUP, which markets and distributes specified disease
insurance, Medicare supplement insurance, and certain life and annuity
products to the senior and middle-income markets through over 500 IMOs
that represent over 9,100 producing independent agents. This segment
markets its products under the "Conseco" brand.
- OTHER BUSINESS IN RUN-OFF, which includes blocks of business that we no
longer market or underwrite. This segment consists of long-term care
insurance sold through independent agents and major medical insurance.
We also have a corporate segment, which consists of holding company
activities and certain non-insurance company businesses that are not related to
our operating segments.
We have restated all historical periods presented in "Management's
Discussion and Analysis of Financial Condition and Results of Operations" to
reflect our new segments.
We emerged from bankruptcy protection under our Plan of Reorganization,
which was confirmed pursuant to an order of the Bankruptcy Court on September 9,
2003, and became effective on September 10, 2003. Upon the confirmation of the
Plan, we implemented fresh start accounting in accordance with SOP 90-7. Our
accounting and actuarial systems and procedures are designed to produce
financial information as of the end of a month. Accordingly, for accounting
convenience purposes, we applied the effects of fresh start accounting on August
31, 2003. The activity of the Company for the period September 1, 2003 through
September 10, 2003 is therefore included in the successor's statement of
41
operations and excluded from the predecessor's statement of operations. We
believe the net income impact of the use of the convenience date is immaterial.
In accordance with SOP 90-7, we restated all of our assets and liabilities
to their current estimated value, reestablished shareholders' equity at the
reorganization value determined in connection with our Plan of Reorganization
and recorded the portion of the reorganization value which could not be
attributed to specific tangible or identified intangible assets as goodwill. As
a result, our financial statements for periods following August 31, 2003, are
not comparable with those prepared before that date.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in accordance with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Management has made estimates in the past
that we believed to be appropriate but were subsequently revised to reflect
actual experience. If our future experience differs materially from these
estimates and assumptions, our results of operations and financial condition
could be affected.
We base our estimates on historical experience and other assumptions that
we believe are reasonable under the circumstances. We continually evaluate the
information used to make these estimates as our business and the economic
environment change. The use of estimates is pervasive throughout our financial
statements. The accounting policies and estimates we consider most critical are
summarized below. Additional information on our accounting policies is included
in the note to our predecessor's consolidated financial statements for the year
ended December 31, 2002 entitled "Summary of Significant Accounting Policies".
INVESTMENTS
At September 30, 2003, the carrying value of our investment portfolio was
$22.4 billion. The accounting risks associated with these assets relate to the
recognition of income, our determination of other-than-temporary impairments and
our estimation of fair values.
We defer any fees received or costs incurred when we originate investments.
We amortize fees, costs, discounts and premiums as yield adjustments over the
contractual lives of the investments. We consider anticipated prepayments on
structured securities in determining estimated yields on such securities.
Adjustments to yields as a result of actual prepayments being different than
anticipated are recognized as investment income (loss).
When we sell a security (other than trading securities or venture capital
investments), we report the difference between the sale proceeds and the
amortized cost (determined based on specific identification) as a realized
investment gain or loss.
We regularly evaluate all of our investments for possible impairment based
on current economic conditions, credit loss experience and other
investee-specific developments. If there is a decline in a security's net
realizable value that is other than temporary, the decline is recognized as a
realized loss and the cost basis of the security is reduced to its estimated
fair value. For 2002, we recorded $556.8 million of writedowns of fixed
maturities, equity securities and other invested assets as a result of
conditions that caused us to conclude a decline in the fair value of the
investments was other than temporary. During the eight months ended August 31,
2003, we recorded writedowns of fixed maturity investments totaling $45.9
million. During the one month ended September 30, 2003, we did not record any
writedowns of fixed maturity investments.
If a decline in value is determined to be other than temporary and the cost
basis of the security is written down to fair value, we review the circumstances
which caused us to believe that the decline was other than temporary with
respect to other investments in our portfolio. If such circumstances exist with
respect to other investments, those investments are also written down to fair
value. Future events may occur, or additional or updated information may become
available, which may necessitate future realized losses of
42
securities in our portfolio. Significant losses in the carrying value of our
investments could have a material adverse effect on our earnings in future
periods.
Our evaluation of investments for impairment requires significant judgments
to be made, including: (1) the identification of potentially impaired
securities; (2) the determination of their estimated fair value; and (3)
assessment of whether any decline in estimated fair value is other than
temporary. Our periodic assessment of whether unrealized losses are "other than
temporary" also requires significant judgment. Factors considered include: (1)
the extent to which market value is less than the cost basis; (2) the length of
time that the market value has been less than cost; (3) whether the unrealized
loss is event driven, credit-driven or a result of changes in market interest
rates; (4) the near-term prospects for improvement in the issuer and/or its
industry; (5) whether the investment is investment grade and our security
analyst's view of the investment's rating and whether the investment has been
downgraded since its purchase; (6) whether the issuer is current on all payments
in accordance with the contractual terms of the investment and is expected to
meet all of its obligations under the terms of the investment; (7) our ability
and intent to hold the investment for a period of time sufficient to allow for
any anticipated recovery; and (8) the underlying asset and enterprise values of
the issuer. If new information becomes available or the financial condition of
the investee changes, our judgments may change resulting in the recognition of a
realized investment loss at that time. At September 30, 2003, our net
accumulated other comprehensive income included gross unrealized losses on
investments of $20.0 million; we consider all such declines in estimated fair
value to be temporary.
Estimated fair values for our investments are determined based on estimates
from nationally recognized pricing services, broker-dealer market makers and
internally developed methods. Our internally developed methods require us to
make judgments about the security's credit quality, liquidity and market spread.
Below-investment grade securities have different characteristics than
investment grade corporate debt securities. Risk of loss upon default by the
borrower is significantly greater with respect to below-investment grade
securities than with other corporate debt securities. Below-investment grade
securities are generally unsecured and are often subordinated to other creditors
of the issuer. Also, issuers of below-investment grade securities usually have
higher levels of debt and are more sensitive to adverse economic conditions,
such as recession or increasing interest rates, than are investment grade
issuers. We attempt to reduce the overall risk in the below-investment grade
portfolio, as in all investments, through careful credit analysis, strict
investment policy guidelines, and diversification by issuer and/or guarantor and
by industry.
During 2002, we sold $11.3 billion of fixed maturity investments which
resulted in gross realized investment losses (before income taxes) of $251.8
million. During the first eight months of 2003, we sold $2.7 billion of fixed
maturity investments which resulted in gross realized investment losses (before
income taxes) of $59.4 million. During the one month ended September 30, 2003,
we sold $50.9 million of fixed maturity investments which resulted in gross
realized investment losses (before income taxes) of $0.8 million. Securities
sold at a loss are sold for a number of reasons including: (1) changes in the
investment environment; (2) expectation that the market value could deteriorate
further; (3) desire to reduce our exposure to an issuer or an industry; (4)
changes in credit quality; and (5) our analysis indicating there is a high
probability that the security is other-than-temporarily impaired.
We seek to closely match the estimated duration of our invested assets to
the expected duration of our insurance liabilities. When the estimated durations
of assets and liabilities are similar, exposure to interest rate risk is
minimized because a change in the value of assets should be largely offset by a
change in the value of liabilities. A mismatch of the durations of invested
assets and insurance liabilities could have a significant impact on our results
of operations and financial position. See "-- Quantitative and Qualitative
Disclosures About Market Risks" for additional discussion of the duration of our
invested assets and insurance liabilities.
VALUE OF POLICIES INFORCE AT THE EFFECTIVE DATE AND COST OF POLICIES PRODUCED
In conjunction with the implementation of fresh start accounting, we
eliminated the historical balances of our predecessor's cost of policies
purchased and cost of policies produced as of the Effective Date and replaced
them with the value of policies inforce.
43
The cost assigned to the right to receive future cash flows from contracts
existing at August 31, 2003 is referred to as the value of policies inforce. We
also defer renewal commissions paid in excess of ultimate commission levels
related to the existing policies in this account. The balance of this account is
amortized, evaluated for recovery, and adjusted for the impact of unrealized
gains (losses) in the same manner as the cost of policies produced described
below. We expect to amortize approximately 2 percent of the September 30, 2003
balance of value of policies inforce during the remainder of 2003, 8 percent in
2004, 9 percent in 2005, 9 percent in 2006 and 8 percent in 2007.
The cost of policies produced are those costs that vary with, and are
primarily related to, producing new insurance business. These amounts are
amortized using the interest rate credited to the underlying policy: (1) in
relation to the estimated gross profits for investment and universal life-type
products or (2) in relation to future anticipated premium revenue for other
products. The amortization for investment and universal life-type products is
adjusted retrospectively when estimates of current or future gross profits and
margins to be realized from a group of products and contracts are revised.
When we realize a gain or loss on investments backing our universal life or
investment-type products, we adjust the amortization to reflect the change in
estimated gross profits from the products due to the gain or loss realized and
the effect of the event on future investment yields. We also adjust the cost of
policies produced for the change in amortization that would have been recorded
if actively managed fixed maturity securities had been sold at their stated
aggregate fair value and the proceeds reinvested at current yields. We include
the impact of this adjustment in accumulated other comprehensive income (loss)
within shareholders' equity.
At September 30, 2003, the combined balance of the value of policies
inforce and cost of policies produced was $2.8 billion. The recovery of these
costs is dependent on the future profitability of the related business.
Each year, we evaluate the recoverability of the unamortized balance of the
value of policies inforce and the cost of policies produced. We consider
estimated future gross profits or future premiums, expected mortality or
morbidity, interest earned and credited rates, persistency and expenses in
determining whether the balance is recoverable. If we determine a portion of the
unamortized balance is not recoverable, it is charged to amortization expense.
The assumptions we use to amortize and evaluate the recoverability of the
value of policies inforce and the cost of policies produced involve significant
judgment. A revision to these assumptions could have a significant adverse
effect on our results of operations and financial position.
GOODWILL
Upon our emergence from bankruptcy, we revalued our assets and liabilities
to current estimated fair value and established our capital accounts at the
reorganization value determined in connection with the Plan of Reorganization.
We recorded the $1,102.8 million of the reorganization value which could not be
attributed to specific tangible or identified intangible assets as goodwill.
Under current accounting rules (which became effective January 1, 2002) goodwill
is not amortized but is subject to an annual impairment test (or more frequently
if there is an indication that an impairment may exist). We obtained an
independent appraisal of our business in connection with the preparation of the
Plan of Reorganization which indicated no impairment of our goodwill existed.
However, we cannot assure you that we will not have to recognize impairment
charges in the future.
Although the goodwill balance will not be subject to amortization, it will
be reduced by future use of our net deferred income tax assets (including the
deferred tax assets associated with tax operating loss carryforwards) existing
at August 31, 2003 (which balance was reduced by $167.4 million in the one month
ended September 30, 2003). A valuation allowance has been provided for the
remaining balance of such net deferred income tax assets due to the
uncertainties regarding their realization. See "-- Income Taxes" below for
further discussion.
44
INCOME TAXES
Our income tax expense includes deferred income taxes arising from
temporary differences between the financial reporting bases of assets and
liabilities, capital loss carryforwards and net operating loss carryforwards. In
assessing the realization of deferred income tax assets, we consider whether it
is more likely than not that the deferred income tax assets will be realized.
The ultimate realization of our deferred income tax assets depends upon
generating future taxable income during the periods in which our temporary
differences become deductible and before our net operating loss carryforwards
expire. In addition, the use of our net operating loss carryforwards is
dependent, in part, on whether the IRS ultimately agrees with the tax position
we plan to take in our current and future tax returns. With respect to the
deferred income tax assets, we assess the need for a valuation allowance on a
quarterly basis.
A valuation allowance has been provided for the entire balance of net
deferred income tax assets at September 30, 2003, as we believe the realization
of such assets in future periods is uncertain. We reached this conclusion after
considering the availability of taxable income in prior carryback years, tax
planning strategies, our recent history of significant losses and the likelihood
of future taxable income exclusive of reversing temporary differences and
carryforwards.
As of September 30, 2003, we had approximately $3.6 billion of net
operating loss carryforwards (after taking into account the reduction in tax
attributes described in the paragraph which follows and the loss resulting from
the worthlessness of our predecessor's investment in CFC discussed below), which
expire as follows: $2.3 million in 2003; $11.2 million in 2004; $4.5 million in
2005; $0.2 million in 2006; $5.7 million in 2007; $6.6 million in 2008; $10.5
million in 2009; $4.2 million in 2010; $2.5 million in 2011; $16.0 million in
2012; $43.4 million in 2013; $6.9 million in 2014; $60.5 million in 2016; $116.7
million in 2017; $3,322.5 million in 2018; $0.2 million in 2019; $12.1 million
in 2020. The timing and manner in which we will utilize the net operating loss
carryforwards in any year or in total may be limited by various provisions of
the Internal Revenue Code (the "Code") (and interpretation thereof) and our
ability to generate sufficient future taxable income in the relevant
carryforward period.
The Code provides that any income realized as a result of the cancellation
of indebtedness (cancellation of debt income or "CODI") in bankruptcy will
reduce certain tax attributes, including net operating loss carryforwards. We
realized an estimated $2.5 billion of CODI when we emerged from bankruptcy.
Accordingly, our net operating loss carryforwards were reduced by $2.5 billion.
The following paragraphs summarize some of the various limitations and
contingencies which exist with respect to the future utilization of the net
operating loss carryforwards.
We realized an estimated $5.4 billion tax loss in 2003 as a result of our
investment in CFC. In consultation with our tax advisors and based on relevant
provisions of the Code, we intend to treat this loss as an ordinary loss,
thereby increasing our net operating loss carryforward. We have requested a
pre-filing examination by the IRS to confirm that this loss should be treated as
an ordinary loss. If the IRS were to disagree with our conclusion and such
determination ultimately prevailed, the loss would be treated as a capital loss,
which would only be available to reduce future capital gains for the next 5
years. The procedures related to the pre-filing examination are in process, but
are not expected to be completed before August 2004.
The Code limits the extent to which losses realized by a non-life entity
(or entities) may offset income from a life insurance company (or companies) to
the lesser of: (1) 35 percent of the income of the life insurance company and
(2) 35 percent of the total loss. There is no limitation with respect to the
ability to utilize net operating losses generated by a life insurance company.
Subsequent to our emergence from bankruptcy, we reorganized certain of our
subsidiaries to improve their capital position and, as a result, the loss
related to CFC was realized by a life insurance company. Accordingly, we believe
the loss should be treated as a life insurance loss and would not be subject to
the limitations described above.
The timing and manner in which we will be able to utilize our net operating
loss carryforward will be limited by Section 382 of the Code. Section 382
imposes limitations on a corporation's ability to use its net operating losses
if the company undergoes an ownership change. Because we underwent an ownership
change pursuant to our reorganization, we have determined that this limitation
applies to us. In order to determine the
45
amount of this limitation we must determine how much of our net operating loss
carryforward relates to the period prior to our emergence from bankruptcy (which
amount will be subject to the Section 382 limitation) and how much relates to
the period after emergence (which amount will not be subject to the Section 382
limitation). Pursuant to the Code, we may (1) allocate the current year tax loss
on a pro rata basis to determine earnings (loss) post- and pre-emergence; or (2)
specifically identify transactions in each period and record them in the period
in which they actually occurred. We intend to elect the latter, which we believe
will result in a substantial portion of the loss related to CFC being treated as
post-emergence and therefore not subject to the Section 382 limitation. Any
losses that are subject to the Section 382 limitation will only be utilized by
us up to approximately $140 million per year, with any unused amounts carried
forward to the following year.
The use of our net deferred income tax assets (including the deferred tax
assets associated with net operating loss carryforwards) existing as of August
31, 2003, will be accounted for as a reduction of goodwill when utilized
pursuant to SOP 90-7. If goodwill is eliminated, any additional use of net
deferred income tax assets existing at August 31, 2003 will be accounted for as
a reduction of other intangible assets until exhausted and thereafter as an
addition to paid-in-capital. Goodwill was reduced by $167.4 million during the
one month ended September 30, 2003 due to a reduction in the valuation allowance
for net deferred income tax assets established at the Effective Date.
LIABILITIES FOR INSURANCE PRODUCTS
At September 30, 2003, the total balance of our liabilities for insurance
and asset accumulation products was $24.5 billion. These liabilities are often
payable over an extended period of time and the profitability of the related
products is dependent on the pricing of the products and other factors.
Differences between our expectations when we sold these products and our actual
experience could result in future losses.
We calculate and maintain reserves for the estimated future payment of
claims to our policyholders based on actuarial assumptions. For our supplemental
health insurance business, we establish an active life reserve plus a liability
for due and unpaid claims, claims in the course of settlement and incurred but
not reported claims, as well as a reserve for the present value of amounts not
yet due on claims. Many factors can affect these reserves and liabilities, such
as economic and social conditions, inflation, hospital and pharmaceutical costs,
changes in doctrines of legal liability and extra-contractual damage awards.
Therefore, the reserves and liabilities we establish are necessarily based on
extensive estimates, assumptions and historical experience. Establishing
reserves is an uncertain process, and it is possible that actual claims will
materially exceed our reserves and have a material adverse effect on our results
of operations and financial condition. Our financial results depend
significantly upon the extent to which our actual claims experience is
consistent with the assumptions we used in determining our reserves and pricing
our products. If our assumptions with respect to future claims are incorrect,
and our reserves are insufficient to cover our actual losses and expenses, we
would be required to increase our liabilities, which would negatively affect our
operating results.
Liabilities for insurance products are calculated using management's best
judgments of mortality, morbidity, lapse rates, investment experience and
expense levels that are based on our past experience and standard actuarial
tables.
46
In accordance with SOP 90-7, the successor established insurance
liabilities and an asset for the value of policies inforce at the effective date
using current assumptions. Adjustments to the predecessor's liabilities for
insurance and asset accumulation products as of August 31, 2003 are summarized
below (dollars in millions):
PREDECESSOR FRESH START SUCCESSOR
BALANCE SHEET ADJUSTMENT BALANCE SHEET
------------- ----------- -------------
Liabilities for insurance and asset accumulation products:
Traditional and limited payment products:
Traditional life insurance products.................. $ 1,817.7 $ 309.3 $ 2,127.0
Limited pay products................................. 758.9 135.2 894.1
Individual accident and health....................... 5,245.8 1,838.4 7,084.2
Group life and health................................ 692.0 136.7 828.7
Unearned premiums.................................... 3.3 -- 3.3
--------- -------- ---------
Total liabilities for traditional and limited
payment products................................ 8,517.7 2,419.6 10,937.3
--------- -------- ---------
Interest sensitive products:
Investment contracts................................. 8,678.5 (66.8) 8,611.7
Universal life-type products......................... 3,994.6 (4.8) 3,989.8
--------- -------- ---------
Total liabilities for interest sensitive
products........................................ 12,673.1 (71.6) 12,601.5
--------- -------- ---------
Other liabilities for insurance and asset accumulation
products:
Separate accounts and investment trusts.............. 87.7 -- 87.7
Claims payable and other policyholder funds.......... 897.1 (10.3) 886.8
--------- -------- ---------
Total other liabilities for insurance and asset
accumulation products........................... 984.8 (10.3) 974.5
--------- -------- ---------
Total liabilities for insurance and asset accumulation
products................................................ $22,175.6 $2,337.7 $24,513.3
========= ======== =========
The following provides explanations for the fresh-start adjustment to
insurance liabilities related to our insurance inforce at the effective date.
TRADITIONAL INSURANCE AND LIMITED PAY PRODUCTS
In accordance with Statement of Financial Accounting Standards No. 60,
"Accounting and Reporting by Insurance Enterprises" and Statement of Financial
Accounting Standards No. 97, "Accounting and Reporting by Insurance Enterprises
for certain Long-Duration Contracts and for Realized Gains and Losses from the
Sale of Investments" ("FAS 97"), the predecessor used the original actuarial
assumptions determined when traditional long-duration and limited payment
insurance contracts were issued in determining liability calculations through
the fresh start date, provided the resulting liabilities were adequate to
provide for future benefits and expenses under the related contracts. This
accounting principle is referred to as the "lock in" principle and is only
applicable to traditional insurance and limited pay products. The use of
assumptions that are locked in at the time of issue means that absent loss
recognition, the same assumptions are used in accounting for a particular block
of business unless the block is subject to purchase or fresh start accounting.
At the Effective Date, the successor established insurance liabilities at
the present value of future benefits and expenses associated with the policies,
by using current best-estimate assumptions with provisions for adverse
deviation. Such assumptions include estimates as to investment yields,
mortality, morbidity, withdrawals, lapses and maintenance expenses. The current
best-estimate assumptions for these blocks of business differ from the original
actuarial assumptions determined when the business was acquired or issued as
further described in the following paragraphs.
Due to the current interest rate environment and the requirement to mark
the value of the investment portfolio to market, we changed our assumptions
related to future investment earnings. The weighted average expected yield on
our investment portfolio decreased to approximately 5.5 percent from 6.5 percent
at
47
December 31, 2002. Approximately $.9 billion of the fresh-start increase to
insurance liabilities is the result of changes in future expected investment
earnings.
The performance of our long-term care business (especially the acquired
block originally sold through independent agents) has generally been unfavorable
to the predecessor's assumptions established when these blocks of business were
acquired. For example, variance in actual versus estimated morbidity, lapses and
expenses have been unfavorable to original assumptions. Approximately $1.3
billion of the increase to insurance liabilities is the result of changes in
non-interest assumptions for our long-term care policies. Our assumption changes
for long-term care business included: (1) changes in morbidity assumptions from
estimates made when the business was acquired to recent Company experience; (2)
changes in mortality assumptions related to certain blocks of this business from
the 1958 and 1980 Commissioners Standard Ordinary Mortality table to the 1983
Group Annuity Mortality table; and (3) changes in ultimate lapse ratios from a
range of approximately 3 percent to 5.5 percent prior to the adoption of fresh
start accounting to a range of 2 percent to 3.5 percent.
INTEREST-SENSITIVE PRODUCTS SUBJECT TO REQUIREMENTS OF FAS 97
The insurance liability for asset accumulation products (such as deferred
annuities and universal life products) are generally equal to current
policyholder account balances. These balances generally do not change as a
result of the adoption of fresh start accounting. The fresh-start adjustment to
insurance liabilities for interest sensitive products primarily results from:
(1) the adoption of SOP 03-01 as of the Effective Date; and (2) certain
predecessor insurance liabilities that exceed the present value of estimated
future benefits as of August 31, 2003.
The adoption of SOP 03-01 as of the effective date required a change in
methodology regarding persistency bonuses provided to policyholders who continue
to keep their policies inforce for a stated period of time. The predecessor
recognized the cost of this benefit over the period prior to the time the
benefit is credited in proportion to estimated gross profits and assumed a
certain number of policies would terminate before the benefit was credited.
Under SOP 03-1, the cost for such benefits is recognized ratably over the period
prior to the time the benefit is credited without assuming policy terminations.
Insurance liabilities increased by approximately $.1 billion as a result of the
adoption of SOP 03-01.
The predecessor had previously established an insurance liability related
to certain business, to recognize the future loss expected to be recognized for
the former practice of reducing the cost of insurance charges to amounts below
the level permitted under the provisions of the policy. The predecessor
amortized this liability into income in proportion to estimated gross profits on
the business, consistent with SFAS 97 requirements for unearned revenues. The
predecessor had previously decided to discontinue the practice of providing this
nonguaranteed benefit. Accordingly, the remaining insurance liability
established for this benefit was no longer required at August 31, 2003,
resulting in a $.1 billion reduction to reserves in conjunction with our
adoption of fresh-start accounting.
LIABILITIES FOR LOSS CONTINGENCIES RELATED TO LAWSUITS
We are involved on an ongoing basis in lawsuits relating to our operations,
including with respect to sales practices, and we and current and former
officers and directors are defendants in pending class action lawsuits asserting
claims under the securities laws and in derivative lawsuits. The ultimate
outcome of these lawsuits cannot be predicted with certainty. We recognize an
estimated loss from these loss contingencies when we believe it is probable that
a loss has been incurred and the amount of the loss can be reasonably estimated.
However, it is difficult to measure the actual loss that might be incurred
related to litigation. The ultimate outcome of these lawsuits could have a
significant impact on our results of operations and financial position.
48
RESULTS OF OPERATIONS
Due to the application of fresh start accounting, the reported historical
financial statements of our predecessor for periods prior to August 31, 2003
generally are not comparable to our financial statements prepared after that
date. Therefore, our results of operations have not been combined with those of
our predecessor. Please read this discussion in conjunction with the
accompanying consolidated financial statements and notes included elsewhere in
this prospectus.
After our emergence from bankruptcy, we began to manage our business
operations through two primary operating segments, based on method of product
distribution, and a third segment comprised of business in run-off. We refer to
these segments as: (1) Bankers Life; (2) Conseco Insurance Group; and (3) Other
Business in Run-Off. Prior to its disposition effective March 31, 2003, we also
had a finance segment. We also have a corporate segment, which consists of
holding company activities and certain non-insurance company businesses that are
not related to our other operating segments. The following tables and narratives
summarize the operating results of our segments for the periods presented as we
currently manage them (dollars in millions):
SUCCESSOR PREDECESSOR
------------- --------------------------------------------------
ONE MONTH EIGHT MONTHS NINE MONTHS YEARS ENDED
ENDED ENDED ENDED DECEMBER 31,
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30, -------------------
2003 2003 2002 2002 2001
------------- ------------ ------------- ---- ----
Earnings (losses) before taxes:
Bankers Life.......................... $ 24.9 $ 159.6 $ 69.1 $ 136.5 $ 289.3
Conseco Insurance Group............... 20.2 299.9 (178.4) (211.5) 186.0
Other business in run-off............. 3.6 (171.3) (161.8) (216.8) (106.0)
Corporate operations.................. (10.9) 1,884.0 (1,154.4) (1,340.4) (612.7)
------ -------- --------- --------- -------
Income (loss) before income taxes,
minority interest, discontinued
operations and cumulative effect of
accounting change................... $ 37.8 $2,172.2 $(1,425.5) $(1,632.2) $(243.4)
====== ======== ========= ========= =======
GENERAL: Conseco, Inc. is the top tier holding company for a group of
insurance companies operating throughout the United States that develop, market
and administer supplemental health insurance, annuity, individual life insurance
and other insurance products. We distribute these products through a career
agency force and direct response marketing (which, together, represent our
Bankers Life segment) and through professional independent producers (which
represent our Conseco Insurance Group segment). Our Other Business in Run-off
segment consists of: (1) long-term care products written in prior years through
independent agents; (2) small group and individual major medical business which
we began to nonrenew in 2001; and (3) other group major medical business which
we no longer actively market. Most of the long-term care business in run-off
relates to business written by certain of our subsidiaries prior to their
acquisitions by Conseco in 1996 and 1997.
49
BANKERS LIFE (DOLLARS IN MILLIONS)
SUCCESSOR PREDECESSOR
------------- --------------------------------------------------
ONE MONTH EIGHT MONTHS NINE MONTHS YEARS ENDED
ENDED ENDED ENDED DECEMBER 31,
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30, -------------------
2003 2003 2002 2002 2001
------------- ------------ ------------- ---- ----
Premiums and asset accumulation
product collections:
Annuities...................... $ 63.5 $ 698.4 $ 496.8 $ 740.9 $ 513.1
Supplemental health............ 96.6 759.6 854.8 1,159.4 1,097.4
Life........................... 12.0 102.7 99.7 139.0 286.3
-------- -------- -------- -------- --------
Total premium collections... $ 172.1 $1,560.7 $1,451.3 $2,039.3 $1,896.8
======== ======== ======== ======== ========
Deposit type contracts......... $ 3.8 $ 39.6 $ 28.0 $ 40.7 $ 23.0
======== ======== ======== ======== ========
Average liabilities for insurance
products:
Annuities:
Mortality based................ $ 94.7 $ 84.9 $ 75.9 $ 75.7 $ 159.4
Equity-linked.................. 214.9 183.2 192.6 187.5 320.8
Deposit based.................. 3,390.2 3,130.9 2,477.9 2,550.1 1,962.5
Health............................. 2,537.3 1,916.3 1,678.2 1,709.6 1,497.6
Life:
Interest sensitive............. 333.3 324.4 309.2 311.0 300.0
Non-interest sensitive......... 755.3 652.4 661.0 657.7 1,083.2
-------- -------- -------- -------- --------
Total average liabilities
for insurance products,
net of reinsurance
ceded..................... $7,325.7 $6,292.1 $5,394.8 $5,491.6 $5,323.5
======== ======== ======== ======== ========
Revenues:
Insurance policy income............ $ 111.7 $ 892.7 $ 962.1 $1,300.1 $1,400.1
Net investment income:
General account invested
assets......................... 32.4 253.4 286.1 382.2 391.9
Equity-indexed products based on
the change in value of the S&P
500 Call Options............... (1.4) 4.8 (14.6) (14.8) (15.5)
Trading account income related to
policyholder and reinsurer
accounts....................... 6.4 -- -- -- --
Change in value of embedded
derivatives related to modified
coinsurance agreements......... (6.4) -- -- -- --
Net realized investment gains
(losses)....................... 2.8 5.5 (131.4) (128.7) (43.5)
Fee revenue and other income....... .4 .2 1.0 1.3 1.2
-------- -------- -------- -------- --------
Total revenues.............. 145.9 1,156.6 1,103.2 1,540.1 1,734.2
-------- -------- -------- -------- --------
Expenses:
Insurance policy benefits.......... 83.6 701.9 710.0 968.3 997.8
Amounts added to policyholder
account balances:
Annuity products and interest-
sensitive life products
other than those listed
below....................... 13.1 93.2 89.5 122.0 110.4
Equity-indexed products based
on S&P 500 Index............ (2.2) -- .6 .6 .6
Amortization related to
operations....................... 15.5 113.4 128.0 171.9 198.4
Amortization related to net
realized investment gains
(losses)......................... -- .5 (3.9) (3.2) (5.0)
Interest expense on investment
borrowings....................... .2 3.4 3.1 4.6 6.1
50
SUCCESSOR PREDECESSOR
------------- --------------------------------------------------
ONE MONTH EIGHT MONTHS NINE MONTHS YEARS ENDED
ENDED ENDED ENDED DECEMBER 31,
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30, -------------------
2003 2003 2002 2002 2001
------------- ------------ ------------- ---- ----
Other operating costs and
expenses......................... 10.8 84.6 63.0 94.4 130.6
Special charges.................... -- -- 43.8 45.0 6.0
-------- -------- -------- -------- --------
Total benefits and
expenses.................. 121.0 997.0 1,034.1 1,403.6 1,444.9
-------- -------- -------- -------- --------
Income before income taxes, minority
interest, discontinued operations
and cumulative effect of accounting
change............................. $ 24.9 $ 159.6 $ 69.1 $ 136.5 $ 289.3
======== ======== ======== ======== ========
Health loss ratios:
All health lines:
Insurance policy benefits........ $ 73.1 $ 578.5 $ 626.5 $ 840.9 $ 770.8
Loss ratio(a).................... 75.73% 75.30% 73.83% 74.06% 70.23%
Medicare Supplement:
Insurance policy benefits........ $ 35.3 $ 283.3 $ 329.7 $ 437.6 $ 443.1
Loss ratio(a).................... 66.50% 66.39% 67.32% 67.15% 66.87%
Long-Term Care:
Insurance policy benefits........ $ 37.3 $ 287.2 $ 290.7 $ 394.3 $ 316.2
Loss ratio(a).................... 87.81% 86.08% 83.24% 83.69% 75.31%
Interest-adjusted loss
ratio(b)....................... 62.37% 69.26% 67.71% 67.95% 60.91%
Other:
Insurance policy benefits........ $ .5 $ 8.0 $ 6.1 $ 9.0 $ 11.5
Loss ratio(a).................... 52.48% 101.05% 63.98% 71.21% 76.45%
---------------
(a) We calculate loss ratios by taking the related product's (1) insurance
policy benefits divided by (2) insurance policy income.
(b) We calculate the interest-adjusted loss ratio for Bankers Life's long-term
care products by taking the product's (1) insurance policy benefits less
interest income on the accumulated assets which back the insurance
liabilities divided by (2) policy income. Interest income is an important
factor in measuring losses on this product. The net cash flows from
long-term care products generally result in the accumulation of amounts in
the early years of a policy (accounted for as reserve increases) which will
be paid out as benefits in later policy years (accounted for as reserve
decreases). Accordingly, as the policies age, the loss ratio will typically
increase, but the increase in the change in reserve will be partially
offset by investment income earned on the assets which have accumulated.
The interest-adjusted loss ratio reflects the effects of the investment
income offset.
PERIODS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2002
TOTAL PREMIUM COLLECTIONS were $172.1 million in the one month ended
September 30, 2003; $1,560.7 million in the eight months ended August 31, 2003;
and $1,451.3 million in the nine months ended September 30, 2002. Bankers Life's
annuity premium collections in 2003 were positively impacted by sales
inducements provided to purchasers of our annuities and sales incentives to our
career agents. These programs ended at various times during the second quarter
of 2003. Premium collections on Bankers Life's other products have been
negatively impacted by the A.M. Best ratings downgrade to "B (Fair)." See
"-- Premium and Asset Accumulation Product Collections" for further analysis.
AVERAGE LIABILITIES FOR INSURANCE PRODUCTS, NET OF REINSURANCE CEDED, were
$7.3 billion in the one month ended September 30, 2003; $6.3 billion in the
eight months ended August 31, 2003; and $5.4 billion in the nine months ended
September 30, 2002. The increase in such liabilities through August 31, 2003 is
primarily due to increases in annuity reserves. As discussed above under
"-- Total premium collections", annuity premium collections in our Bankers Life
segment were positively impacted during 2003 by sales inducements and
incentives. The increase in such liabilities for the one month ended September
30, 2003 reflects the
51
adoption of fresh start accounting as further discussed under "-- Critical
Accounting Policies -- Liabilities for Insurance Products."
INSURANCE POLICY INCOME is comprised of (1) premiums earned on policies
which provide mortality or morbidity coverage and (2) fees and other charges
made against other policies. See "Premium and Asset Accumulation Product
Collections" for further analysis.
NET INVESTMENT INCOME ON GENERAL ACCOUNT INVESTED ASSETS (which excludes
income on policyholder and reinsurer accounts) was $32.4 million in the one
month ended September 30, 2003; $253.4 million in the eight months ended August
31, 2003; and $286.1 million in the nine months ended September 30, 2002. The
average balance of general account invested assets was $6.9 billion in the one
month ended September 30, 2003; $6.6 billion in the eight months ended August
31, 2003; and $6.1 billion in the nine months ended September 30, 2002. The
yield on these assets was 5.6 percent in the one month ended September 30, 2003;
5.7 percent in the eight months ended August 31, 2003; and 6.3 percent in the
nine months ended September 30, 2002. The decrease in yield during 2003 reflects
the lower interest rate environment and the resulting lower rates earned on
invested assets from the 2003 annuity sales.
NET INVESTMENT INCOME RELATED TO EQUITY-INDEXED PRODUCTS BASED ON THE
CHANGE IN VALUE OF THE S&P 500 CALL OPTIONS represents the change in the
estimated fair value of Bankers Life's S&P 500 Index Call Options which are
purchased in an effort to cover certain benefits accruing to the policyholders
of our equity-indexed products. Our equity-indexed products are designed so that
the investment income spread earned on the related insurance liabilities should
be more than adequate to cover the cost of the S&P 500 Call Options and other
costs related to these policies. Option costs that are attributable to benefits
provided were $0.8 million in the one month ended September 30, 2003; $7.7
million in the eight months ended August 31, 2003; and $10.2 million in the nine
months ended September 30, 2002. These costs are reflected in the change in
market value of the S&P 500 Call Options included in the investment income
amounts. Net investment income (loss) related to equity-indexed products before
this expense was $(0.6) million in the one month ended September 30, 2003; $12.5
million in the eight months ended August 31, 2003; and $(4.4) million in the
nine months ended September 30, 2002. Such amounts were partially offset by the
corresponding charge (credit) to AMOUNTS ADDED TO POLICYHOLDER ACCOUNT BALANCES
FOR EQUITY-INDEXED PRODUCTS BASED ON S&P 500 INDEX of $(2.2) million in the one
month ended September 30, 2003; nil in the eight months ended August 31, 2003;
and $0.6 million in the nine months ended September 30, 2002. Such income and
related charge fluctuate based on the value of options embedded in the segment's
equity-indexed annuity policyholder account balances subject to this benefit and
to the performance of the S&P 500 Index to which the returns on such products
are linked.
CHANGE IN VALUE OF EMBEDDED DERIVATIVES RELATED TO MODIFIED COINSURANCE
AGREEMENTS are described in the note to our consolidated financial statements
for the period ended September 30, 2003 entitled "Accounting for Derivatives."
We have transferred the specific block of investments related to these
agreements to our trading securities account, which we carry at estimated fair
value with changes in such value recognized as trading account income. We expect
the change in the value of the embedded derivatives largely to be offset by the
change in value of the trading securities.
NET REALIZED INVESTMENT GAINS (LOSSES) fluctuate from period to period.
During the one month ended September 30, 2003, we recognized net realized
investment gains in our Bankers Life segment of $2.8 million related to the net
gains from the sales of investments (primarily fixed maturities). There were no
writedowns of fixed maturity investments in the one month period. During the
first eight months of 2003, we recognized net investment gains of $5.5 million.
During the first eight months of 2003, the net realized investment gains
included (1) $20.1 million of net gains from the sales of investments (primarily
fixed maturities) net of (2) $14.6 million of writedowns of fixed maturity
investments as a result of conditions which caused us to conclude a decline in
fair value of the investment was other than temporary. The net realized
investment losses during the first nine months of 2002 included (1) $120.9
million of writedowns of fixed maturity investments, equity securities and other
invested assets as a result of conditions which caused us to conclude a decline
in fair value of the investments was other than temporary and (2) $10.5 million
of net losses from the sales of investments (primarily fixed maturities). The
facts and circumstances resulting in the other-than-
52
temporary losses are described in "Investments with Other-Than-Temporary Losses"
included in this "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
INSURANCE POLICY BENEFITS fluctuated as a result of the factors summarized
in the explanations for loss ratios related to specific products which follow.
Loss ratios are calculated by taking the related insurance product's (1)
insurance policy benefits divided by (2) policy income.
The loss ratios on Bankers Life's Medicare supplement products have
generally been within our range of expectations. Governmental regulations
generally require us to attain and maintain a statutory loss ratio, after three
years, of not less than 65 percent on these products.
The loss ratios on Bankers Life's long-term care products have generally
been within our range of expectations. The net cash flows from our long-term
care products generally result in the accumulation of amounts in the early years
of a policy (accounted for as reserve increases) which will be paid out as
benefits in later policy years (accounted for as reserve decreases).
Accordingly, as the policies age, the loss ratio will typically increase, but
the increase in the change in reserve will be partially offset by investment
income earned on the assets which have accumulated. The interest-adjusted loss
ratio for long-term care products is calculated by taking the insurance
product's (1) insurance policy benefits less interest income on the accumulated
assets which back the insurance liabilities divided by (2) policy income.
The loss ratios on our other products fluctuate due to the smaller size of
these blocks of business. The loss ratios on this business have generally been
within our expectations.
AMOUNTS ADDED TO POLICYHOLDER ACCOUNT BALANCES FOR ANNUITY PRODUCTS AND
INTEREST-SENSITIVE LIFE PRODUCTS were $13.1 million in the one month ended
September 30, 2003; $93.2 million in the eight months ended August 31, 2003; and
$89.5 million in the nine months ended September 30, 2002. This increase is
primarily due to increases in annuity reserves. The weighted average crediting
rates for these products were 4.2 percent for the one month ended September 30,
2003; 4.0 percent for the eight months ended August 31, 2003; and 4.3 percent
for the nine months ended September 30, 2002.
AMOUNTS ADDED TO EQUITY-INDEXED PRODUCTS BASED ON S&P 500 INDEX correspond
to the related investment income accounts described above.
AMORTIZATION RELATED TO OPERATIONS includes amortization of the value of
policies inforce at the Effective Date, cost of policies produced and the cost
of policies purchased (such amortization is collectively referred to as
"amortization of insurance intangibles"). Insurance intangibles are amortized:
(1) in relation to the estimated gross profits for universal life-type and
investment-type products; or (2) in relation to future anticipated premium
revenue for other products. Bankers Life's amortization expense in the 2003
periods and the nine months ended September 30, 2002 was generally within our
range of expectations given the related premium revenue and gross profits for
the periods.
AMORTIZATION RELATED TO NET REALIZED INVESTMENT GAINS (LOSSES) represents
the increases or decreases in amortization which result from realized investment
gains or losses. When we sell securities at a gain (loss) and reinvest the
proceeds at a different yield, we increase (reduce) the amortization of
insurance intangibles in order to reflect the change in future expected yields.
Sales of fixed maturity investments resulted in an increase (decrease) in the
amortization of insurance intangibles of nil in the one month ended September
30, 2003; $0.5 million in the eight months ended August 31, 2003; and $(3.9)
million in the nine months ended September 30, 2002.
INTEREST EXPENSE ON INVESTMENT BORROWINGS fluctuates along with our
investment borrowing activities and the interest rates thereon. Average
investment borrowings in our Bankers Life segment (excluding borrowings related
to the GM building) were $208.1 million during the one month ended September 30,
2003; $263.7 million during the eight months ended August 31, 2003; and $465.7
million in the nine months ended September 30, 2002. The weighted average
interest rates on such borrowings (excluding borrowings related to the GM
building) were 1.1 percent during the one month ended September 30, 2003; 1.9
percent during the eight months ended August 31, 2003; and 0.9 percent during
the nine months ended September 30, 2002.
53
OTHER OPERATING COSTS AND EXPENSES in our Bankers Life segment were $10.8
million in the one month ended September 30, 2003; $84.6 million in the eight
months ended August 31, 2003; and $63.0 million in the nine months ended
September 30, 2002. Increases in these expenses in 2003 are primarily related to
increased policy acquisition costs which were non-deferrable.
SPECIAL CHARGES in the nine months ended September 30, 2002 included: (1)
losses of $39.0 million on a reinsurance transaction entered into as part of our
cash raising initiatives; and (2) other items totaling $4.8 million primarily
related to severance benefits.
PREDECESSOR'S YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31,
2001
TOTAL PREMIUM COLLECTIONS in 2002 were $2.0 billion, up 7.5 percent from
2001. See "-- Premium and Asset Accumulation Product Collections" for further
analysis.
AVERAGE LIABILITIES FOR INSURANCE PRODUCTS, NET OF REINSURANCE CEDED were
$5.5 billion in 2002 and $5.3 billion in 2001. Bankers Life's average life
reserves decreased by $414.5 million, or 30 percent, due primarily to a first
quarter 2002 reinsurance transaction which ceded approximately $400 million of
liabilities to the assuming company. See the notes to our consolidated financial
statements for the year ended December 31, 2002, included in this prospectus for
additional discussion of the reinsurance transaction. Bankers Life's average
annuity liabilities increased during 2002 reflecting increased annuity sales.
INSURANCE POLICY INCOME is comprised of: (i) premiums earned on policies
which provide mortality or morbidity coverage; and (ii) fees and other charges
made against other policies. See "Premium and Asset Accumulation Product
Collections" for further analysis.
NET INVESTMENT INCOME ON GENERAL ACCOUNT INVESTED ASSETS (which excludes
the income (loss), cost and change in the fair value of S&P 500 Call Options
related to equity-indexed products) decreased by 2.5 percent, to $382.2 million
in 2002. Bankers Life's average balance of general account invested assets
increased by 7.1 percent in 2002 to $6.1 billion. The yield on these assets was
6.3 percent in 2002 and 6.9 percent in 2001. The decrease in yield reflects
general decreases in market interest rates between 2002 and 2001. Net investment
income and the average balance of general account invested assets both reflect
the transfer of a portion of our investment portfolio to the reinsurer pursuant
to the above-mentioned first quarter 2002 reinsurance transaction. See the notes
to our consolidated financial statements for the year ended December 31, 2002,
included in this prospectus for additional discussion of the reinsurance
transaction.
NET INVESTMENT INCOME RELATED TO EQUITY-INDEXED PRODUCTS BASED ON THE
CHANGE IN VALUE OF THE S&P 500 CALL OPTIONS represents the change in the
estimated fair value of Bankers Life's S&P 500 Call Options which are purchased
in an effort to cover certain benefits accruing to the policyholders of our
equity-indexed products. Our equity-indexed products are designed so that the
investment income spread earned on the related insurance liabilities should be
more than adequate to cover the cost of the S&P 500 Call Options and other costs
related to these policies. Option costs that are attributable to benefits
provided were $15.2 million and $16.0 million in 2002 and 2001, respectively.
These costs are reflected in the change in market value of the S&P 500 Call
Options included in the investment income amounts. Net investment income related
to equity-indexed products before this expense was $.4 million and $.5 million
in 2002 and 2001, respectively. Such amounts were partially offset by the
corresponding charge (credit) to AMOUNTS ADDED TO POLICYHOLDER ACCOUNT BALANCES
FOR EQUITY-INDEXED PRODUCTS BASED ON S&P 500 INDEX of $.6 million in both 2002
and 2001. Such income and related charge fluctuated based on the value of
options embedded in our equity-indexed annuity policyholder account balances
subject to this benefit and to the performance of the S&P 500 Index to which the
returns on such products are linked.
NET REALIZED INVESTMENT GAINS (LOSSES) fluctuate from period to period.
During 2002 and 2001, Bankers Life recognized net realized investment losses of
$128.7 million and $43.5 million, respectively. The net realized investment
losses during 2002 included: (i) $138.5 million to write down certain securities
to fair value due to an other-than-temporary decline in value (including issuers
who have faced significant problems: K-Mart Corp., Amerco, Inc., Global
Crossing, MCI Communications, Mississippi Chemical, United Airlines and
Worldcom, Inc.); and (ii) $9.8 million of net gains from the sales of
investments (primarily fixed
54
maturities). The net realized investment losses during 2001 included writedowns
of $69.4 million related to: (i) the impact of higher default rate assumptions
on certain structured investments; (ii) losses on investments held in our
private equity portfolio; and (iii) the writedown of certain securities to fair
value due to an other-than-temporary decline in value or our plan to sell the
securities in connection with investment restructuring activities (including
issuers who have faced significant problems: Sunbeam Corp., Enron Corp., Crown
Cork & Seal Company Inc., Global Crossing Ltd. and K-Mart Corp.).
INSURANCE POLICY BENEFITS fluctuated in 2002 and 2001 as a result of the
factors summarized in the explanations for loss ratios related to specific
products which follow. Loss ratios are calculated by taking the related
insurance product's: (i) insurance policy benefits; divided by (ii) policy
income.
The loss ratio for Bankers Life's Medicare supplement products was within
the ranges expected during 2002 and 2001. Governmental regulations generally
require us to attain and maintain a statutory loss ratio, after three years, of
not less than 65 percent.
The loss ratio on Bankers Life's long-term care products during 2001
reflected the elimination of reserve redundancies based on the ultimate
development of reserves at December 31, 2000.
The loss ratios on Bankers Life's other products fluctuate due to the
smaller size of these blocks of business. The loss ratios on this business were
generally within our expectations during 2002 and 2001.
AMOUNTS ADDED TO POLICYHOLDER ACCOUNT BALANCES FOR ANNUITY PRODUCTS AND
INTEREST-SENSITIVE LIFE PRODUCTS increased by 11 percent, to $122.0 million, in
2002. The increase in 2002 is primarily due to the above-mentioned increase in
Bankers Life's average annuity liabilities, partially offset by a decrease in
the weighted average crediting rates. The weighted average crediting rates for
these products were 4.3 percent and 4.9 percent in 2002 and 2001, respectively.
AMOUNTS ADDED TO EQUITY-INDEXED PRODUCTS BASED ON S&P 500 INDEX correspond
to the related investment income accounts described above.
AMORTIZATION RELATED TO OPERATIONS includes amortization of insurance
intangibles. Amortization generally fluctuates in relationship to the total
account balances subject to amortization. Bankers Life's amortization expense
for the years ended December 31, 2002 and 2001 was generally within our range of
expectations given the related premium revenue and gross profits for the
periods.
AMORTIZATION RELATED TO NET REALIZED INVESTMENT GAINS (LOSSES) represents
the decreases in amortization which result from realized investment losses. When
we sell securities at a loss and reinvest the proceeds at a different yield, we
reduce the amortization of insurance intangibles in order to reflect the change
in future expected yields. Sales of fixed maturity investments resulted in
reductions in the amortization of insurance intangibles of $3.2 million in 2002
and $5.0 million in 2001.
INTEREST EXPENSE ON INVESTMENT BORROWINGS decreased in 2002 due to lower
interest rates while our investment borrowing activities increased. Average
investment borrowings were $452.2 million during 2002, compared to $222.4
million during 2001. The weighted average interest rate on such borrowings were
1.0 percent and 2.7 percent during 2002 and 2001, respectively.
OTHER OPERATING COSTS AND EXPENSES decreased in 2002 by $36.2 million, or
28 percent compared to 2001, reflecting cost cutting programs implemented in the
Bankers Life segment.
SPECIAL CHARGES in 2002 included: (i) a loss of $39.0 million on a
reinsurance transaction entered into as part of our cash raising initiatives;
and (ii) other items totaling $6.0 million primarily related to severance
benefits and costs incurred with the transfer of certain customer service and
backroom operations to our India subsidiary. Special charges in 2001 were $6.0
million. Such charges primarily related to severance benefits and costs incurred
in conjunction with the transfer of certain customer service and backroom
operations to our former India subsidiary.
55
CONSECO INSURANCE GROUP (DOLLARS IN MILLIONS)
SUCCESSOR PREDECESSOR
------------- ----------------------------------------------------
ONE MONTH EIGHT MONTHS NINE MONTHS YEARS ENDED
ENDED ENDED ENDED DECEMBER 31,
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30, ---------------------
2003 2003 2002 2002 2001
------------- ------------ ------------- ---- ----
Premiums and asset accumulation product
collections:
Annuities.......................... $ 5.2 $ 74.0 $ 307.3 $ 351.9 $ 710.6
Supplemental health................ 65.0 525.3 614.3 830.3 784.1
Life............................... 34.5 280.7 384.1 498.0 553.3
--------- --------- --------- --------- ---------
Collections on insurance products
from continuing lines of
business...................... $ 104.7 $ 880.0 $ 1,305.7 $ 1,680.2 $ 2,048.0
========= ========= ========= ========= =========
Deposit type contracts............. $ 27.0 $ 220.5 $ 209.6 $ 246.9 $ 155.0
========= ========= ========= ========= =========
Average liabilities for insurance and
asset accumulation products:
Annuities:
Mortality based.................. $ 244.1 $ 171.0 $ 174.6 $ 175.0 $ 198.8
Equity-linked.................... 1,354.6 1,514.7 2,065.5 1,983.1 2,311.4
Deposit based.................... 4,057.0 4,245.4 5,520.2 5,352.1 5,993.4
Separate accounts and investment
trust liabilities............. 62.6 401.3 695.9 672.6 738.0
Health............................. 2,284.5 2,046.8 1,968.4 1,981.6 1,969.7
Life:
Interest sensitive............... 3,347.3 3,407.8 3,743.5 3,798.7 3,733.2
Non-interest sensitive........... 1,494.1 1,493.9 1,428.7 1,327.6 1,399.8
--------- --------- --------- --------- ---------
Total average liabilities for
insurance and asset
accumulation products....... $12,844.2 $13,280.9 $15,596.8 $15,290.7 $16,344.3
========= ========= ========= ========= =========
Revenues:
Insurance policy income.............. $ 102.9 $ 892.8 $ 1,089.0 $ 1,454.9 $ 1,377.4
Net investment income:
General account invested assets.... 60.0 562.2 751.4 982.0 1,114.2
Equity-indexed products based on
the change in value of the S&P
500 Call Options................. (6.9) 20.4 (83.2) (85.7) (98.7)
Separate account assets............ -- -- (8.5) -- (5.4)
Trading account income related to
policyholder and reinsurer
accounts......................... 8.4 -- -- -- --
Change in value of embedded
derivatives related to modified
coinsurance agreements........... (2.2) -- -- -- --
Net realized investment gains
(losses)......................... 3.1 (17.1) (314.7) (368.1) (209.1)
Fee revenue and other income......... -- 17.0 19.1 25.4 31.4
--------- --------- --------- --------- ---------
Total revenues................ 165.3 1,475.3 1,453.1 2,008.5 2,209.8
--------- --------- --------- --------- ---------
56
SUCCESSOR PREDECESSOR
------------- ----------------------------------------------------
ONE MONTH EIGHT MONTHS NINE MONTHS YEARS ENDED
ENDED ENDED ENDED DECEMBER 31,
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30, ---------------------
2003 2003 2002 2002 2001
------------- ------------ ------------- ---- ----
Expenses:
Insurance policy benefits............ 83.8 461.3 746.6 998.2 977.5
Amounts added to policyholder account
balances:
Annuity products and
interest-sensitive life
products other than those
listed below.................. 25.0 218.4 287.8 379.7 417.8
Equity-indexed products based on
S&P 500 Index................. (3.0) 66.6 (19.5) (.9) .2
Separate account liabilities....... -- -- (8.5) -- (5.4)
Amortization related to operations... 9.9 202.7 426.0 566.0 356.9
Amortization related to net realized
investment gains (losses).......... -- (.9) (20.7) (24.6) (32.3)
Interest expense on investment
borrowings......................... .4 4.7 7.7 10.2 19.7
Other operating costs and expenses... 29.0 222.6 213.9 292.1 273.9
Special charges...................... -- -- (1.8) (.7) 15.5
--------- --------- --------- --------- ---------
Total benefits and expenses... 145.1 1,175.4 1,631.5 2,220.0 2,023.8
--------- --------- --------- --------- ---------
Income (loss) before income taxes,
minority interest, discontinued
operations and cumulative effect of
accounting change.................... $ 20.2 $ 299.9 $ (178.4) $ (211.5) $ 186.0
========= ========= ========= ========= =========
Health loss ratios:
All health lines:
Insurance policy benefits.......... $ 44.5 $ 381.3 $ 415.3 $ 550.7 $ 533.1
Loss ratio(a)...................... 66.17% 70.95% 66.81% 66.36% 66.97%
Medicare Supplement:
Insurance policy benefits.......... $ 22.0 $ 167.2 $ 162.0 $ 217.6 $ 192.8
Loss ratio(a)...................... 68.24% 65.49% 61.63% 61.28% 61.81%
Specified Disease:
Insurance policy benefits.......... $ 18.3 $ 184.7 $ 192.6 $ 259.5 $ 250.9
Loss ratio(a)...................... 60.68% 75.77% 68.72% 69.61% 67.35%
Interest-adjusted loss ratio(b).... 30.90% 46.33% 41.48% 42.10% 41.70%
Other:
Insurance policy benefits.......... $ 4.2 $ 29.4 $ 60.7 $ 73.6 $ 89.4
Loss ratio(a)...................... 86.89% 76.66% 77.33% 72.22% 80.09%
---------------
(a) We calculate loss ratios by taking the related product's (1) insurance
policy benefits divided by (2) insurance policy income.
(b) We calculate the interest-adjusted loss ratio for Conseco Insurance Group's
specified disease products by taking the product's (1) insurance policy
benefits less interest income on the accumulated assets which back the
insurance liabilities divided by (2) policy income. Interest income is an
important factor in measuring losses on this product. The net cash flows
from specified disease products generally result in the accumulation of
amounts in the early years of a policy (accounted for as reserve increases)
which will be paid out as benefits in later policy years (accounted for as
reserve decreases). Accordingly, as the policies age, the loss ratio will
typically increase, but the increase in the change in reserve will be
partially offset by investment income earned on the assets which have
accumulated. The interest-adjusted loss ratio reflects the effects of the
investment income offset.
57
PERIODS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2002
COLLECTIONS ON INSURANCE PRODUCTS FROM CONTINUING LINES OF BUSINESS were
$104.7 million in the one month ended September 30, 2003; $880.0 million in the
eight months ended August 31, 2003; and $1,305.7 million in the nine months
ended September 30, 2002. Premium collections through the independent agents in
our Conseco Insurance Group segment have been negatively impacted by the A.M.
Best ratings downgrade to "B (Fair)" and our decision to de-emphasize the sale
of certain products. See "Premium and Asset Accumulation Product Collections"
for further analysis.
AVERAGE LIABILITIES FOR INSURANCE AND ASSET ACCUMULATION PRODUCTS were
$12.8 billion in the one month ended September 30, 2003; $13.3 billion in the
eight months ended August 31, 2003; and $15.6 billion in the nine months ended
September 30, 2002. The decrease in such liabilities is primarily due to the
increase in policyholder redemptions and lapses following the downgrade of our
A.M. Best financial strength rating to "B (Fair)". See "-- Liquidity for
insurance and fee-based operations" for additional discussion of the A.M. Best
ratings downgrade.
INSURANCE POLICY INCOME is comprised of (i) premiums earned on policies
which provide mortality or morbidity coverage and (ii) fees and other charges
made against other policies. See "-- Premium and Asset Accumulation Product
Collections" for further analysis.
NET INVESTMENT INCOME ON GENERAL ACCOUNT INVESTED ASSETS (which excludes
income on policyholder and reinsurer accounts) was $60.0 million in the one
month ended September 30, 2003; $562.2 million in the eight months ended August
31, 2003; and $751.4 million in the nine months ended September 30, 2002. The
average balance of general account invested assets was $13.2 billion in the one
month ended September 30, 2003; $13.7 billion in the eight months ended August
31, 2003; and $15.4 billion in the nine months ended September 30, 2002. The
yield on these assets was 5.4 percent in the one month ended September 30, 2003;
6.2 percent in the eight months ended August 31, 2003; and 6.5 percent in the
nine months ended September 30, 2002. The decrease in yield for the one month
ended September 30, 2003 reflects the adoption of fresh start accounting which
effectively reset the yields to market rates at August 31, 2003.
NET INVESTMENT INCOME RELATED TO EQUITY-INDEXED PRODUCTS BASED ON THE
CHANGE IN VALUE OF THE S&P 500 CALL OPTIONS represents the change in the
estimated fair value of Conseco Insurance Group's S&P 500 Index Call Options
which are purchased in an effort to cover certain benefits accruing to the
policyholders of our equity-indexed products. Our equity-indexed products are
designed so that the investment income spread earned on the related insurance
liabilities should be more than adequate to cover the cost of the S&P 500 Call
Options and other costs related to these policies. Option costs that are
attributable to benefits provided were $4.4 million in the one month ended
September 30, 2003; $45.8 million in the eight months ended August 31, 2003; and
$62.7 million in the nine months ended September 30, 2002. These costs are
reflected in the change in market value of the S&P 500 Call Options included in
the investment income amounts. Net investment income (loss) related to
equity-indexed products before this expense was $(2.5) million in the one month
ended September 30, 2003; $66.2 million in the eight months ended August 31,
2003; and $(20.5) million in the nine months ended September 30, 2002. Such
amounts were partially offset by the corresponding charge (credit) to amounts
added to policyholder account balances for equity-indexed products of $(3.0)
million in the one month ended September 30, 2003; $66.6 million in the eight
months ended August 31, 2003; and $(19.5) million in the nine months ended
September 30, 2002. Such income and related charge fluctuate based on the value
of options embedded in the segment's equity-indexed annuity policyholder account
balances subject to this benefit and to the performance of the S&P 500 Index to
which the returns on such products are linked.
NET INVESTMENT INCOME (LOSS) FROM SEPARATE ACCOUNT ASSETS is offset by a
corresponding charge (credit) to amounts added to policyholder account balances
for separate account liabilities. Such income (loss) and related charge (credit)
fluctuated in relationship to total separate account assets and the return
earned on such assets.
TRADING ACCOUNT INCOME RELATED TO POLICYHOLDER AND REINSURER ACCOUNTS
represents the income on trading security accounts established on August 31,
2003, which are designed to act as a hedge for embedded
58
derivatives related to (1) Conseco Insurance Group's equity-indexed products and
(2) certain modified coinsurance agreements. In addition, such income includes
the income on investments backing the market strategies of certain annuity
products which provide for different rates of cash value growth based on the
experience of a particular market strategy. The income on our trading account
securities is designed to substantially offset (1) the change in value of
embedded derivatives related to modified coinsurance agreements described below
and (2) certain amounts included in insurance policy benefits.
CHANGE IN VALUE OF EMBEDDED DERIVATIVES RELATED TO MODIFIED COINSURANCE
AGREEMENTS are described in the note to our consolidated financial statements
for the period ended September 30, 2003 entitled "Accounting for Derivatives."
We have transferred the specific block of investments related to these
agreements to our trading securities account, which we carry at estimated fair
value with changes in such value recognized as trading account income. The
change in the value of the embedded derivatives has largely been offset by the
change in value of the trading securities.
NET REALIZED INVESTMENT GAINS (LOSSES) fluctuate from period to period.
During the one month ended September 30, 2003, we recognized net realized
investment gains in our Conseco Insurance Group segment of $3.1 million related
to the net gains from the sales of investments (primarily fixed maturities).
There were no writedowns of fixed maturity investments in the one month period.
During the first eight months of 2003, we recognized net realized investment
losses of $17.1 million. During the first eight months of 2003, the net realized
investment losses included (1) $12.3 million of net gains from the sales of
investments (primarily fixed maturities) net of (2) $29.4 million of writedowns
of fixed maturity investments as a result of conditions which caused us to
conclude a decline in fair value of the investment was other than temporary. The
net realized investment losses during the first nine months of 2002 included (1)
$321.0 million of writedowns of fixed maturity investments, equity securities
and other invested assets as a result of conditions which caused us to conclude
a decline in fair value of the investments was other than temporary and (2) $6.3
million of net gains from the sales of investments (primarily fixed maturities).
The facts and circumstances resulting in the other-than-temporary losses are
described in "Investments with Other-Than-Temporary Losses" included in this
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
FEE REVENUE AND OTHER INCOME primarily represents income earned by a
subsidiary which was sold in September 2003.
INSURANCE POLICY BENEFITS fluctuated as a result of the factors summarized
in the explanations for loss ratios related to specific products which follow
and, in the eight months ended August 31, 2003, as a result of a change in
estimates of future losses on certain policies, as discussed below in further
detail. Loss ratios are calculated by taking the related insurance product's (1)
insurance policy benefits divided by (2) policy income.
The loss ratios on Conseco Insurance Group's Medicare supplement products
increased slightly in the 2003 periods, although they have generally been within
our range of expectations. Governmental regulations generally require us to
attain and maintain a loss ratio, after three years, of not less than 65 percent
on these products. The lower loss ratio for the nine months ended September 30,
2002 was primarily due to the elimination of reserve redundancies based on the
ultimate development of reserves at December 31, 2001.
The loss ratio on Conseco Insurance Group's specified disease products
reflected higher than expected incurred claims on certain cancer insurance
policies during the first eight months of 2003. These policies generally provide
fixed or limited benefits. 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. We had favorable
claims experience in the one month ended September 30, 2003. Approximately 77
percent of our specified disease policies inforce (based on policy count) are
sold with return of premium or cash value riders. The return of premium rider
generally provides that after a policy has been inforce for a specified number
of years or upon the policyholder reaching a specified age, we 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. Accordingly, the net cash flows from these
products generally result in the accumulation of amounts in the early years of a
policy (accounted for as reserve increases) which will be paid out as benefits
in later policy years (accounted for as reserve
59
decreases). Accordingly, as the policies age, the loss ratio will typically
increase, but the increase in the change in reserve will be partially offset by
investment income earned on the assets which have accumulated. The
interest-adjusted loss ratio for specified disease products is calculated by
taking the insurance product's (1) insurance policy benefits less interest
income on the accumulated assets which back the insurance liabilities; divided
by (2) policy income.
The loss ratios on Conseco Insurance Group's other products fluctuate due
to the smaller size of these blocks of business. The loss ratios on this
business have generally been within our expectations.
In August 2003, we decided to change a non-guaranteed element of certain
Conseco Insurance Group policies. This element was not required by the policy
and the change will eliminate the former practice of reducing the cost of
insurance charges to amounts below the level permitted under the provisions of
the policies. As a result of this decision, our estimates of future expected
gross profits on these products used as a basis for amortization of cost of
policies purchased and cost of policies produced and the establishment of
insurance liabilities has changed. We adjusted the total amortization and
reserve charge we had recorded since the acquisition of these policies as a
result of the change to our earlier estimates in accordance with Statement of
Financial Accounting Standards No. 97, "Accounting and Reporting by Insurance
Enterprises of Certain Long-Duration Contracts and for Realized Gains and Losses
from the Sale of Investments." The effect of the change in estimate was a $220.2
million reduction to insurance policy benefits and a $39.8 million reduction to
amortization recorded in the eight months ended August 31, 2003.
AMOUNTS ADDED TO POLICYHOLDER ACCOUNT BALANCES FOR ANNUITY PRODUCTS AND
INTEREST-SENSITIVE LIFE PRODUCTS were $25.0 million in the one month ended
September 30, 2003; $218.4 million in the eight months ended August 31, 2003;
and $287.8 million in the nine months ended September 30, 2002. The decrease
during 2003 is primarily due to a smaller block of annuity business inforce. The
weighted average crediting rates for these products were 4.2 percent for the one
month ended September 30, 2003; 4.4 percent for the eight months ended August
31, 2003; and 4.3 percent for the nine months ended September 30, 2002.
AMOUNTS ADDED TO EQUITY-INDEXED PRODUCTS BASED ON S&P 500 INDEX correspond
to the related investment income accounts described above.
AMORTIZATION RELATED TO OPERATIONS includes amortization of insurance
intangibles. Conseco Insurance Group's amortization recorded in the eight months
ended August 31, 2003 was affected by the change in estimates of future losses
on certain policies described above under "insurance policy benefits."
Policyholder redemptions of annuity and, to a lesser extent, life products
increased following the downgrade of our A.M. Best financial strength rating to
"B (Fair)" in August of 2002. When redemptions are greater than our previous
assumptions, we are required to accelerate the amortization of insurance
intangibles to write off the balance associated with the redeemed policies.
Amortization in the periods presented has fluctuated as a result of the
acceleration of the amortization of insurance intangibles associated with policy
redemptions and changes in future lapse assumptions with respect to the policies
inforce. In 2002, we changed the lapse assumptions used to determine the
amortization of insurance intangibles related to certain universal life products
and our annuities to reflect our then current estimates of future lapses. For
certain universal life products, we changed the ultimate lapse assumption from
(1) a range of 6 percent to 7 percent to (2) a tiered assumption based on the
level of funding of the policy of a range of 2 percent to 10 percent. We
recorded additional amortization related to higher redemptions and changes to
our lapse assumptions of $162.5 million in the nine months ended September 30,
2002. Policyholder redemptions during the 2003 periods have generally been
consistent with our revised lapse assumptions.
AMORTIZATION RELATED TO NET REALIZED INVESTMENT GAINS (LOSSES) represents
the increases or decreases in amortization which result from realized investment
gains or losses. When we sell securities at a gain (loss) and reinvest the
proceeds at a different yield, we increase (reduce) the amortization of
insurance intangibles in order to reflect the change in future expected yields.
Sales of fixed maturity investments resulted in a decrease in the amortization
of insurance intangibles of nil in the one month ended September 30, 2003; $0.9
million in the eight months ended August 31, 2003; and $20.7 million in the nine
months ended September 30, 2002.
60
INTEREST EXPENSE ON INVESTMENT BORROWINGS fluctuates along with Conseco
Insurance Group's investment borrowing activities and the interest rates
thereon. Average investment borrowings (excluding borrowings related to the GM
building) were $308.4 million during the one month ended September 30, 2003;
$403.4 million during the eight months ended August 31, 2003; and $679.4 million
in the nine months ended September 30, 2002. The weighted average interest rates
on such borrowings (excluding borrowings related to the GM building) were 1.5
percent during the one month ended September 30, 2003; 1.7 percent during the
eight months ended August 31, 2003; and 1.5 percent during the nine months ended
September 30, 2002.
OTHER OPERATING COSTS AND EXPENSES were $29.0 million in the one month
ended September 30, 2003; $222.6 million in the eight months ended August 31,
2003; and $213.9 million in the nine months ended September 30, 2002. Increases
in these expenses in 2003 are primarily related to increased policy acquisition
costs which were non-deferrable.
SPECIAL CHARGES in the nine months ended September 30, 2002 included: (1) a
gain of $4.5 million related to an asset sale transaction entered into as part
of our cash raising initiatives and (2) other expenses totaling $2.7 million
primarily related to severance benefits and costs incurred with the transfer of
certain customer service and backroom operations to our India subsidiary.
PREDECESSOR'S YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31,
2001
COLLECTIONS ON INSURANCE PRODUCTS FROM CONTINUING LINES OF BUSINESS in 2002
were $1.7 billion, down 18 percent from 2001. Sales of Conseco Insurance Group's
insurance products were adversely affected by the declines in our financial
strength ratings during 2002. See "Premium and Asset Accumulation Product
Collections" for further analysis.
AVERAGE LIABILITIES FOR INSURANCE AND ASSET ACCUMULATION PRODUCTS were
$15.3 billion in 2002, down 6.4 percent from 2001. The decrease in such
liabilities is primarily due to policyholder redemptions and lapses following
the downgrade of our A.M. Best financial strength rating to "B (fair)". See
"-- Liquidity for Insurance Operations" for additional discussion of the A.M.
Best ratings downgrade.
INSURANCE POLICY INCOME is comprised of: (i) premiums earned on policies
which provide mortality or morbidity coverage; and (ii) fees and other charges
made against other policies. See "-- Premium and Asset Accumulation Product
Collections" for further analysis.
NET INVESTMENT INCOME ON GENERAL ACCOUNT INVESTED ASSETS (which excludes
income on separate account assets related to variable annuities; and the income
(loss), cost and change in the fair value of S&P 500 Call Options related to
equity-indexed products) decreased by 12 percent, to $982.0 million, in 2002,
compared to $1,114.2 million in 2001. The average balance of general account
invested assets decreased by 6.0 percent in 2002 to $15.0 billion. The yield on
these assets was 6.5 percent in 2002 and 7.0 percent in 2001. The decrease in
yield reflected general decreases in market interest rates between 2002 and
2001.
NET INVESTMENT INCOME RELATED TO EQUITY-INDEXED PRODUCTS BASED ON THE
CHANGE IN VALUE OF THE S&P 500 CALL OPTIONS represents the change in the
estimated fair value of Conseco Insurance Group's S&P 500 Call Options which are
purchased in an effort to cover certain benefits accruing to the policyholders
of our equity-indexed products. Our equity-indexed products are designed so that
the investment income spread earned on the related insurance liabilities should
be more than adequate to cover the cost of the S&P 500 Call Options and other
costs related to these policies. Option costs that are attributable to benefits
provided were $82.3 million and $103.0 million in 2002 and 2001, respectively.
These costs are reflected in the change in market value of the S&P 500 Call
Options included in the investment income amounts. Net investment income (loss)
related to equity-indexed products before this expense was $(3.4) million and
$4.3 million in 2002 and 2001, respectively. Such amounts were partially offset
by the corresponding charge (credit) to amounts added to policyholder account
balances for equity-indexed products of $(.9) million and $.2 million in 2002
and 2001, respectively. Such income and related charge fluctuated based on the
value of options embedded in the Company's equity-indexed annuity policyholder
account balances subject to this benefit and to the performance of the S&P 500
Index to which the returns on such products are linked.
61
NET INVESTMENT INCOME (LOSS) FROM SEPARATE ACCOUNT ASSETS is offset by a
corresponding charge (credit) to amounts added to policyholder account balances
for separate account liabilities. Such income (loss) and related charge (credit)
fluctuated in relationship to total separate account assets and the return
earned on such assets.
NET REALIZED INVESTMENT GAINS (LOSSES) fluctuate from period to period.
During 2002 and 2001, we recognized net realized investment losses of $368.1
million and $209.1 million, respectively, in our Conseco Insurance Group
segment. The net realized investment losses during 2002 included: (1) $365.2
million to write down certain securities to fair value due to an
other-than-temporary decline in value (including issuers who have faced
significant problems: K-Mart Corp., Amerco, Inc., Global Crossing, MCI
Communications, Mississippi Chemical, United Airlines and Worldcom, Inc.); and
(2) $2.9 million of net losses from the sales of investments (primarily fixed
maturities). The net realized investment losses during 2001 included writedowns
of $209.6 million related to: (1) the impact of higher default rate assumptions
on certain structured investments; (2) losses on investments held in our private
equity portfolio; and (3) the writedown of certain securities to fair value due
to an other-than-temporary decline in value, or our plan to sell the securities
in connection with investment restructuring activities (including issuers who
have faced significant problems: Sunbeam Corp., Enron Corp., Crown Cork & Seal
Company Inc., Global Crossing Ltd. and K-Mart Corp.).
FEE REVENUE AND OTHER INCOME primarily represents fees received for
marketing insurance products of other companies. Such amounts decreased in 2002
primarily as a result of the sale, in April 2001, of one of our subsidiaries
which provided such services.
INSURANCE POLICY BENEFITS fluctuated between 2002 and 2001 as a result of
the factors summarized in the explanations for loss ratios related to specific
products which follow. Loss ratios are calculated by taking the related
insurance product's: (1) insurance policy benefits; divided by (2) policy
income.
Loss ratios for Conseco Insurance Group's Medicare supplement products have
generally been within our expected ranges. Governmental regulations generally
require us to attain and maintain a loss ratio, after three years, of not less
than 65 percent. The loss ratios in 2002 and 2001 reflected eliminations of
reserve redundancies based on the ultimate development of reserves at December
31, 2001 and December 31, 2000.
Loss ratios on Conseco Insurance Group's specified disease products were
within our expectations in 2002 and 2001. Our general expectation during these
periods was for the loss ratio for specified disease products to be
approximately 68 percent.
The loss ratios on Conseco Insurance Group's other products fluctuate due
to the smaller size of these blocks of business. The loss ratios on this
business were generally within our expectations in 2002 and 2001.
AMOUNTS ADDED TO POLICYHOLDER ACCOUNT BALANCES FOR ANNUITY PRODUCTS AND
INTEREST-SENSITIVE LIFE PRODUCTS decreased by 9.1 percent, to $379.7 million, in
2002. The decrease was primarily due to the smaller block of annuities inforce.
Average liabilities for these products were $8.8 billion in 2002 and $9.4
billion in 2001. The weighted average crediting rate for these products was 4.3
percent in 2002 and 4.4 percent in 2001.
AMOUNTS ADDED TO EQUITY-INDEXED PRODUCTS BASED ON S&P 500 INDEX AND
SEPARATE ACCOUNT LIABILITIES correspond to the related investment income
accounts described above.
AMORTIZATION RELATED TO OPERATIONS includes amortization of insurance
intangibles. Insurance intangibles are amortized: (1) in relation to the
estimated gross profits for universal life-type and investment-type products; or
(2) in relation to future anticipated premium revenue for other products.
Policyholder redemptions of annuity and, to a lesser extent, life products
increased during 2002 following the downgrade of our A.M. Best financial
strength rating to "B (fair)". When redemptions are greater than our previous
assumptions, we are required to accelerate the amortization of our insurance
intangibles to write off the balance associated with the redeemed policies.
Accordingly, amortization expense increased during 2002. In addition, we changed
the lapse assumptions used to determine the amortization of insurance
intangibles related to certain universal life products and our annuities to
reflect revised estimates of
62
future lapses. For certain universal life products, we changed the ultimate
lapse assumption from: (1) a range of 6 percent to 7 percent; to (2) a tiered
assumption based on the level of funding of the policy of a range of 2 percent
to 10 percent. Policyholder withdrawals in 2002 exceeded our estimates.
Accordingly, we increased the expected future lapse rates on these products to
reflect the expectation that lapses on these policies would continue to be
higher than previously expected for several quarters. We recorded additional
amortization of $203.2 million in 2002 related to higher redemptions and changes
to lapse assumptions.
As a result of economic developments, actual experience of our products and
changes in our expectations, we changed our investment yield assumptions used in
calculating the estimated gross profits to be earned on our annuity products in
2001. Such changes resulted in additional amortization of insurance intangibles
of $27.8 million in 2001.
AMORTIZATION RELATED TO NET REALIZED INVESTMENT GAINS (LOSSES) represents
the increases or decreases in amortization which result from realized investment
gains (losses). When we sell securities at a gain (loss) and reinvest the
proceeds at a different yield, we increase (reduce) the amortization of
insurance intangibles in order to reflect the change in future yields. Sales of
fixed maturity investments resulted in a reduction in the amortization of
insurance intangibles of $24.6 million in 2002 and $32.3 million in 2001.
INTEREST EXPENSE ON INVESTMENT BORROWINGS decreased in 2002 due to lower
interest rates while our investment borrowing activities increased. Average
investment borrowings were $639.1 million during 2002, compared to $618.1
million during 2001. The weighted average interest rate on such borrowings were
1.6 percent and 3.2 percent during 2002 and 2001, respectively.
OTHER OPERATING COSTS AND EXPENSES increased in 2002 primarily as a result
of increased policy acquisition costs which were not deferrable.
SPECIAL CHARGES in 2002 included (i) a gain of $4.0 million on asset sale
transactions entered into as part of our cash raising initiatives; and (ii)
other expenses totaling $3.3 million primarily related to severance benefits and
costs incurred with the transfer of certain customer service and backroom
operations to our India subsidiary. Special charges in 2001 were $15.5 million.
The 2001 charges primarily related to severance benefits and costs incurred in
conjunction with the transfer of certain customer service and backroom
operations to our former India subsidiary.
OTHER BUSINESS IN RUN-OFF (DOLLARS IN MILLIONS)
SUCCESSOR PREDECESSOR
------------- --------------------------------------------------
ONE MONTH EIGHT MONTHS NINE MONTHS YEARS ENDED
ENDED ENDED ENDED DECEMBER 31,
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30, -------------------
2003 2003 2002 2002 2001
------------- ------------ ------------- ---- ----
Premiums and asset accumulation product
collections:
Long-term care....................... $ 30.1 $ 268.0 $ 325.3 $ 434.5 $ 463.0
Major medical........................ 17.9 156.4 337.4 409.5 737.1
-------- -------- -------- -------- --------
Total premium collections.......... $ 48.0 $ 424.4 $ 662.7 $ 844.0 $1,200.1
======== ======== ======== ======== ========
Average liabilities for other business in
run-off:
Long-term care....................... $3,291.1 $1,977.9 $1,729.7 $1,768.7 $1,639.0
Major medical........................ 108.5 120.0 260.6 232.3 407.1
-------- -------- -------- -------- --------
Total average liabilities for other
business in run-off, net of
reinsurance ceded............... $3,399.6 $2,097.9 $1,990.3 $2,001.0 $2,046.1
======== ======== ======== ======== ========
63
SUCCESSOR PREDECESSOR
------------- --------------------------------------------------
ONE MONTH EIGHT MONTHS NINE MONTHS YEARS ENDED
ENDED ENDED ENDED DECEMBER 31,
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30, -------------------
2003 2003 2002 2002 2001
------------- ------------ ------------- ---- ----
Revenues:
Insurance policy income................ $ 41.6 $ 418.8 $ 675.1 $ 847.3 $1,215.2
Net investment income on general
account invested assets.............. 13.5 101.5 117.6 155.8 166.7
Net realized investment gains
(losses)............................. .8 6.3 (45.7) (58.2) (24.6)
Fee revenue and other income........... .3 -- .6 .8 1.2
-------- -------- -------- -------- --------
Total revenues..................... 56.2 526.6 747.6 945.7 1,358.5
-------- -------- -------- -------- --------
Expenses:
Insurance policy benefits.............. 43.0 597.3 663.4 864.6 1,089.6
Amortization related to operations..... 1.5 25.7 105.2 112.2 160.1
Interest expense on investment
borrowings........................... -- .2 .5 .6 2.0
Other operating costs and expenses..... 8.1 74.7 140.3 185.1 212.8
-------- -------- -------- -------- --------
Total benefits and expenses........ 52.6 697.9 909.4 1,162.5 1,464.5
-------- -------- -------- -------- --------
Income (loss) before income
taxes, minority interest,
discontinued operations and
cumulative effect of
accounting change............. $ 3.6 $ (171.3) $ (161.8) $ (216.8) $ (106.0)
======== ======== ======== ======== ========
Health loss ratios:
Long-Term Care:
Insurance policy benefits............ $ 36.4 $ 458.0 $ 450.3 $ 595.9 $ 446.5
Loss ratio(a)........................ 106.28% 169.76% 139.01% 139.11% 96.44%
Interest-adjusted loss ratio(b)...... 71.28% 134.58% 110.95% 110.19% 73.13%
Major medical:
Insurance policy benefits............ $ 6.5 $ 139.2 $ 213.1 $ 268.7 $ 643.2
Loss ratio(a)........................ 88.98% 93.43% 60.70% 64.15% 85.61%
---------------
(a) We calculate loss ratios by taking the related product's (1) insurance
policy benefits divided by (2) insurance policy income.
(b) We calculate the interest-adjusted loss ratio for long-term care products
included in this segment by taking the product's (1) insurance policy
benefits less interest income on the accumulated assets which back the
insurance liabilities divided by (2) policy income. Interest income is an
important factor in measuring losses on this product. The net cash flows
from long-term care products generally result in the accumulation of
amounts in the early years of a policy (accounted for as reserve increases)
which will be paid out as benefits in later policy years (accounted for as
reserve decreases). Accordingly, as the policies age, the loss ratio will
typically increase, but the increase in the change in reserve will be
partially offset by investment income earned on the assets which have
accumulated. The interest-adjusted loss ratio reflects the effects of the
investment income offset.
PERIODS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2002
TOTAL PREMIUM COLLECTIONS in this segment were $48.0 million in the one
month ended September 30, 2003; $424.4 million in the eight months ended August
31, 2003; and $662.7 million in the nine months ended September 30, 2002. We
have ceased marketing the long-term care business included in this segment.
Accordingly, collected premiums will decrease over time. Decreases in long-term
care premium collections are the result of policy lapses, partially offset by
premium rate increases. We have ceased marketing and have not renewed our major
medical business, which has resulted in the significant reduction in major
medical collected premiums. See "-- Premium and Asset Accumulation Product
Collections" for further analysis.
AVERAGE LIABILITIES FOR OTHER BUSINESS IN RUN-OFF, NET OF REINSURANCE CEDED
were $3.4 billion in the one month ended September 30, 2003; $2.1 billion in the
eight months ended August 31, 2003; and $2.0 billion in the nine months ended
September 30, 2002. The increase in the one month ended September 30, 2003
64
reflects the adoption of fresh start accounting as further discussed under
"-- Critical Accounting Policies -- Liabilities for Insurance Products."
INSURANCE POLICY INCOME is comprised of premiums earned on the segment's
long-term care and major medical policies. See "-- Premium and Asset
Accumulation Product Collections" for further analysis.
NET INVESTMENT INCOME ON GENERAL ACCOUNT INVESTED ASSETS was $13.5 million
in the one month ended September 30, 2003; $101.5 million in the eight months
ended August 31, 2003; and $117.6 million in the nine months ended September 30,
2002. The average balance of general account invested assets was $2.8 billion in
the one month ended September 30, 2003; $2.5 billion in the eight months ended
August 31, 2003; and $2.4 billion in the nine months ended September 30, 2002.
The yield on these assets was 5.7 percent in the one month ended September 30,
2003; 6.1 percent in the eight months ended August 31, 2003; and 6.7 percent in
the nine months ended September 30, 2002. The decrease in yield for the one
month ended September 30, 2003 reflects the adoption of fresh start accounting
which effectively re-set the yields to market rates at August 31, 2003.
NET REALIZED INVESTMENT GAINS (LOSSES) fluctuate from period to period.
During the one month ended September 30, 2003, we recognized net realized
investment gains of $.8 million in our Other Business in Run-off segment related
to the net gains from the sales of investments (primarily fixed maturities).
There were no writedowns of fixed maturity investments in the one month period.
During the first eight months of 2003, we recognized net realized investment
gains of $6.3 million. During the first eight months of 2003, the net realized
investment gains included: (1) $8.2 million of net gains from the sales of
investments (primarily fixed maturities); net of (2) $1.9 million of writedowns
of fixed maturity investments as a result of conditions which caused us to
conclude a decline in fair value of the investment was other than temporary. The
net realized investment losses during the first nine months of 2002 included:
(1) $46.7 million of writedowns of fixed maturity investments, equity securities
and other invested assets as a result of conditions which caused us to conclude
a decline in fair value of the investment was other than temporary; and (2) $1.0
million of net gains from the sales of investments (primarily fixed maturities).
The facts and circumstances resulting in the other-than-temporary losses are
described in "Investments with Other-Than-Temporary Losses."
INSURANCE POLICY BENEFITS fluctuated primarily as a result of the factors
summarized below related to loss ratios in the blocks of long-term care business
in this segment. Loss ratios are calculated by taking the product's (1)
insurance policy benefits divided by (2) policy income.
This segment includes long-term care insurance products issued through
independent agents by certain of our subsidiaries prior to their acquisitions by
Conseco in 1996 and 1997. The loss experience on these products has been worse
than we expected. Although we anticipated a higher level of benefits to be paid
out on these products as the policies age, the paid claims have exceeded our
projections. We are experiencing adverse developments on home health care
policies issued in certain areas of Florida and other states. This adverse
experience is reflected in the higher loss ratios in the eight months ended
August 31, 2003. We are aggressively seeking rate increases and pursuing other
actions on certain of these long-term care policies. We hired an actuarial
consulting firm to help evaluate the adequacy of this segment's long-term care
reserves given our recent adverse experience and claim reserve deficiencies.
Based on the results of their study and our internal evaluations, we modified
our claim continuance tables to reflect longer benefit payment periods
consistent with our current estimate of future loss experience. Accordingly,
claim reserves increased by approximately $85 million in the eight months ended
August 31, 2003, most of which was due to the new continuance tables. The
decrease in the long-term care loss ratio for the one month ended September 30,
2003 reflects the adoption of fresh start accounting.
The net cash flows from long-term care products generally result in the
accumulation of amounts in the early years of a policy (accounted for as reserve
increases) which will be paid out as benefits in later policy years (accounted
for as reserve decreases). Accordingly, as the policies age, the loss ratio will
typically increase, but the increase in the change in reserve will be partially
offset by investment income earned on the assets which have accumulated. The
interest-adjusted loss ratio for long-term care products is calculated by taking
the insurance product's (1) insurance policy benefits less interest income on
the accumulated assets which back the insurance liabilities; divided by (2)
policy income.
65
AMORTIZATION RELATED TO OPERATIONS includes amortization of insurance
intangibles. The decrease in amortization expense for the one month ended
September 30, 2003 reflects the adoption of fresh start accounting, and also
reflects the relatively small amount of value of policies inforce associated
with the business comprising this segment.
INTEREST EXPENSE ON INVESTMENT BORROWINGS fluctuates along with our
investment borrowing activities which have not been significant in this segment.
OTHER OPERATING COSTS AND EXPENSES were $8.1 million in the one month ended
September 30, 2003; $74.7 million in the eight months ended August 31, 2003; and
$140.3 million in the nine months ended September 30, 2002. The decrease in 2003
expenses was due primarily to expense cuts in the major medical operations.
Since our decision in 2001 to nonrenew the small group and individual major
medical business, the total number of employees dedicated to major medical has
been reduced by approximately 550 during the period June 30, 2001 through
September 30, 2003.
PREDECESSOR'S YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31,
2001
TOTAL PREMIUM COLLECTIONS in 2002 were $844.0 million, down 30 percent from
2001. The decrease was concentrated primarily in major medical premiums
reflecting our decision to begin nonrenewing major medical business in 2001. See
"-- Premium and Asset Accumulation Product Collections" for further analysis.
AVERAGE LIABILITIES FOR OTHER BUSINESS IN RUN-OFF, NET OF REINSURANCE CEDED
decreased by 2.2 percent to $2,001.0 million in 2002. Average major medical
liabilities decreased by $174.8 million, or 43 percent, reflecting the run-off
of this product line. Average long-term care liabilities increased by $129.7
million or 7.9 percent reflecting the aging of the block of acquired long-term
care business included in this segment and the changes in estimation in
calculating the reserves as described below under INSURANCE POLICY BENEFITS.
INSURANCE POLICY INCOME is comprised of: (i) premiums earned on policies
which provide mortality or morbidity coverage; and (ii) fees and other charges
made against other policies. See "-- Premium and Asset Accumulation Product
Collections" for further analysis.
NET INVESTMENT INCOME ON GENERAL ACCOUNT INVESTED ASSETS in this segment
decreased by 6.5 percent to $155.8 million in 2002 as compared to 2001. The
average balance of general account invested assets increased by 2.0 percent in
2002 to $2.4 billion. The yield on these assets was 6.6 percent in 2002 and 7.2
percent in 2001. The decrease in yield reflected general decreases in market
interest rates between 2002 and 2001.
NET REALIZED INVESTMENT GAINS (LOSSES) fluctuate from period to period.
During 2002 and 2001, we recognized net realized investment losses in the Other
Business in Run-off segment of $58.2 million and $24.6 million, respectively.
The net realized investment losses during 2002 included: (i) $51.8 million to
writedown certain securities to fair value due to an other-than-temporary
decline in value (including issuers who have faced significant problems: K-Mart
Corp., Amerco, Inc., Global Crossing, MCI Communications, Mississippi Chemical,
United Airlines and Worldcom, Inc.); and (ii) $6.4 million of net losses from
the sales of investments (primarily fixed maturities). The net realized
investment losses during 2001 included writedowns of $21.9 million related to:
(i) the impact of higher default rate assumptions on certain structured
investments; (ii) losses on investments held in our private equity portfolio;
and (iii) the writedown of certain securities to fair value due to an
other-than-temporary decline in value or our plan to sell the securities in
connection with investment restructuring activities (including issuers who have
faced significant problems: Sunbeam Corp., Enron Corp., Crown Cork & Seal
Company Inc., Global Crossing Ltd. and K-Mart Corp.).
INSURANCE POLICY BENEFITS fluctuated in 2002 and 2001 as a result of the
factors summarized in the explanations for loss ratios related to specific
products which follow. Loss ratios are calculated by taking the related
insurance product's: (i) insurance policy benefits; divided by (ii) policy
income.
During 2002, we conducted an extensive examination of the assumptions used
to estimate our claim reserves for long-term care products sold through our
independent agent distribution channel. The
66
examination was prompted by the continuing claim reserve deficiencies that we
were experiencing based on the assumptions and estimates made by our actuaries.
We engaged an independent actuarial firm to assist in the examination.
Our prior estimates for long-term care reserves were based on claim
continuance tables using experience for the period from January 1, 1990 through
September 30, 1999. These tables are used to estimate the length of time an
insured will receive covered long-term care for an incurred event. In 2002, we
completed studies which indicated that the average length of time an insured
will receive covered care had increased in recent periods. In addition, we have
experienced significant fluctuations in claim inventories for these products.
Accordingly, our actuaries and the independent actuarial firm concluded that
estimates of future claim payments for incurred claims using the more recent
data reflecting the longer covered care time periods were more appropriate than
estimates based on prior data. The changes in estimation in calculating the
reserves resulted in an increase to insurance policy benefits of $130.0 million
in 2002. Excluding this adjustment related to the change in estimate, insurance
policy benefits on long-term care policies would have been $465.9 million, the
loss ratio for the year ended December 31, 2002 would have been 108.76 percent,
and the interest-adjusted loss ratio for the year ended December 31, 2002 would
have been 79.84 percent.
The loss ratios for long-term care products also increased in 2002 due to
the higher level of benefits paid out on these products as the policies age. The
net cash flows from our long-term care products generally result in the
accumulation of amounts in the early years of a policy (accounted for as reserve
increases) which will be paid out as benefits in later policy years (accounted
for as reserve decreases). Accordingly, as the policies age, the loss ratio will
typically increase, but the increase in the change in reserve will be partially
offset by investment income earned on the assets which have accumulated. The
interest-adjusted loss ratio for long-term care products is calculated by taking
the insurance product's (i) insurance policy benefits less interest income on
the accumulated assets which back the insurance liabilities; divided by (ii)
policy income.
The loss ratio on the major medical business decreased during 2002. This
decrease resulted primarily from lower than expected claims experience as the
business began running off following our decision, in 2001, to begin nonrenewing
major medical business.
AMORTIZATION RELATED TO OPERATIONS includes amortization of insurance
intangibles. Amortization generally fluctuates in relationship to the total
account balances subject to amortization. In 2001, we stopped renewing portions
of our major medical lines of business in several unprofitable states in
accordance with the contractual terms of the policies. As a result, we
determined that approximately $77.4 million of insurance intangibles would not
be recoverable. Such amount is recorded as amortization related to operations.
INTEREST EXPENSE ON INVESTMENT BORROWINGS fluctuates along with our
investment borrowing activities, which were not significant for this segment in
2002 and 2001.
OTHER OPERATING COSTS AND EXPENSES decreased in 2002 by $27.7 million, or
13 percent, primarily as a result of expense reductions in the major medical
operations. As noted above, we began nonrenewing major medical business in 2001.
67
CORPORATE (DOLLARS IN MILLIONS)
SUCCESSOR PREDECESSOR
------------- --------------------------------------------------
ONE MONTH EIGHT MONTHS NINE MONTHS YEARS ENDED
ENDED ENDED ENDED DECEMBER 31,
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30, -------------------
2003 2003 2002 2002 2001
------------- ------------ ------------- ---- ----
Corporate operations:
Interest expense on corporate
debt, net of investment
income on cash and cash
equivalents................ $ (6.3) $ (181.8) $ (228.4) $ (312.4) $(337.0)
Investment income............. -- 3.8 1.0 1.0 7.1
Provision for losses related
to stock purchase plan..... -- (55.6) (199.9) (240.0) (169.6)
Venture capital income (loss)
related to investment in
AT&T Wireless Service, Inc.
("AWE"), net of related
expenses................... (2.7) 10.5 (106.6) (99.3) (23.4)
Fee revenue and other
income..................... 1.5 17.1 49.8 59.2 68.5
Net realized investment
losses..................... -- (.1) (2.1) (1.3) (62.8)
Other items................... (3.4) (40.4) (108.9) (182.8) (137.8)
Goodwill amortization -- -- -- -- (108.2)
Gain on sale of interest in
riverboat.................. -- -- -- -- 192.4
Special charges............... -- -- (61.1) (52.2) (58.9)
Gain on extinguishment of
debt....................... -- -- 1.8 1.8 17.0
Goodwill impairment........... -- -- (500.0) (500.0) --
Reorganization items.......... -- 2,130.5 -- (14.4) --
------ -------- --------- --------- -------
Income (loss) before
income taxes and
minority interest..... $(10.9) $1,884.0 $(1,154.4) $(1,340.4) $(612.7)
====== ======== ========= ========= =======
PERIODS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2002
INTEREST EXPENSE ON CORPORATE DEBT, NET OF INVESTMENT INCOME ON CASH AND
CASH EQUIVALENTS in the one month ended September 30, 2003 includes interest
expense on the Senior Credit Facility. Interest expense decreased in the eight
months ended August 31, 2003 primarily as a result of our ceasing to accrue
interest on notes payable (excluding predecessor's senior credit facility, the
guaranteed senior notes and certain secured senior notes).
PROVISION FOR LOSSES RELATED TO STOCK PURCHASE PLAN represents the non-cash
provision we established in connection with guarantees of bank loans to former
directors and current and former officers and key employees and our related
loans for interest (the "D&O loans"). In connection with our bankruptcy plan,
the D&O loans due to the banks with a principal balance of $481.3 million were
transferred to us. In addition, we hold loans to participants for interest on
the bank loans which total approximately $200 million. We regularly evaluate the
collectibility of these loans in light of the collateral we hold and the
creditworthiness of the participants. At September 30, 2003, we have estimated
that approximately $52.3 million of the D&O loans are collectible. The provision
for losses established in periods prior to August 31, 2003 reduces the recorded
balance of the D&O loans to this balance.
VENTURE CAPITAL INCOME (LOSS) relates to our investment in AT&T Wireless
("AWE"), a company in the wireless communication business. Our investment in AWE
is carried at estimated fair value, with changes in fair value recognized as
investment income (loss). We sold all of our holdings of AWE during the fourth
quarter of 2003.
68
FEE REVENUE AND OTHER INCOME includes (1) revenues we receive for managing
investments for other companies and (2) fees received for marketing insurance
products of other companies. In the nine months ended September 30, 2002, this
amount included $14.5 million of affiliated fee revenue earned by our subsidiary
in India. Such revenue is eliminated in consolidation. Excluding such affiliated
income, fee revenue and other income decreased in the 2003 periods primarily as
a result of a decrease in the market value of investments managed for others,
upon which these fees are based. We sold our India subsidiary in the fourth
quarter of 2002 and have substantially eliminated the customer service and other
operations conducted there.
OTHER ITEMS include general corporate expenses, net of amounts charged to
subsidiaries for services provided by the corporate operations. During the first
eight months of 2003, disputes with certain of our insurance carriers were
resolved and a previously established liability of $40 million was released
which was substantially offset by increases to various litigation reserves of
$30 million. The first nine months of 2002 includes expenses related to our
subsidiary in India which was sold in the fourth quarter of 2002.
SPECIAL CHARGES in corporate operations for 2002 include: (1) an impairment
charge of $20.0 million associated with the value of a subsidiary which we had
entered into an agreement to sell; (2) $17.7 million related to refinancing
transactions; (3) restructuring expenses of $12.1 million; (4) other items
totaling $18.8 million; partially offset by (5) net gains of $7.5 million
related to the sale of certain non-core assets. These charges are described in
greater detail in the note to the accompanying consolidated financial statements
for the period ended September 30, 2003 entitled "Special Charges" included in
this prospectus.
During the first nine months of 2002, we recognized a GAIN ON THE
EXTINGUISHMENT OF DEBT as we repurchased $77.4 million par value of our
predecessor's notes payable (resulting in a gain of $1.8 million).
In the first nine months of 2002, we recognized a GOODWILL IMPAIRMENT of
$500.0 million as discussed in greater detail in the notes to the consolidated
financial statements for the year ended December 31, 2002, included in this
prospectus.
REORGANIZATION ITEMS in the eight months ended August 31, 2003 included:
(1) $3,151.4 million related to the gain on the discharge of prepetition
liabilities; (2) $(950.0) million related to fresh start adjustments; and (3)
$(70.9) million related to professional fees associated with our bankruptcy
proceedings which are expensed as incurred in accordance with SOP 90-7.
PREDECESSOR'S YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31,
2001
INTEREST EXPENSE ON CORPORATE DEBT, NET OF INVESTMENT INCOME ON CASH AND
CASH EQUIVALENTS decreased in 2002 as a result of the repayment of debt and
lower interest rates. The average debt outstanding was $4.1 billion and $4.5
billion in 2002 and 2001, respectively. The average interest rate on such debt
was 8.0 percent and 8.2 percent in 2002 and 2001, respectively.
INVESTMENT INCOME included the income from our investment in a riverboat
casino (prior to its sale in the first quarter of 2001) and miscellaneous other
income.
PROVISION FOR LOSSES AND EXPENSE RELATED TO STOCK PURCHASE PLAN represents
the non-cash provision we established in connection with our guarantees of bank
loans to approximately 155 current and former directors, officers and key
employees and our related loans for interest. The funds from the bank loans were
used by the participants to purchase approximately 18.0 million shares of our
predecessor's common stock. In 2002 and 2001, we established provisions of
$240.0 million and $169.6 million, respectively, in connection with these
guarantees and loans. We determine the reserve based upon the value of the
collateral held by the banks. At December 31, 2002, the reserve for losses on
the loan guarantees totaled $660.0 million. The outstanding principal balance on
the bank loans was $481.3 million. In addition, our predecessor provided loans
to participants for interest on the bank loans totaling $179.2 million. During
2002, our predecessor purchased $55.5 million of loans from the banks utilizing
cash held in a segregated cash account as collateral for our guarantee of the
bank loans (including accrued interest, the balance on these loans was $56.7
million at December 31, 2002). The guarantees of the bank loans are discussed in
greater detail in the notes to our consolidated financial statements for the
year ended December 31, 2002, included in this prospectus.
69
VENTURE CAPITAL LOSS relates to our investment in AWE. Our investment in
AWE is carried at estimated fair value, with changes in fair value recognized as
investment income.
FEE REVENUE AND OTHER INCOME includes: (1) revenues we receive for managing
investments for other companies; and (2) affiliated fee revenue earned by our
subsidiary in India. Such affiliated fee revenue, which is eliminated in
consolidation, totaled $16.7 million and $5.4 million in 2002 and 2001,
respectively. Excluding such affiliated income, fee revenue and other income
decreased primarily as a result of a decrease in the market value of investments
managed for others, upon which these fees are based. We sold our India
subsidiary in the fourth quarter of 2002 and have significantly reduced the
customer service and other operations conducted there.
NET REALIZED INVESTMENT GAINS (LOSSES) often fluctuate from period to
period. During 2002 and 2001, we recorded writedowns in the Corporate segment
totaling $1.3 million and $60.7 million, respectively, on certain securities due
to an other than temporary decline in value.
OTHER ITEMS include general expenses of our corporate segment. Such amount
in 2002 included the establishment of a $40.0 million allowance for a claim
receivable as further discussed in the notes to our consolidated financial
statements for the year ended December 31, 2002, included in this prospectus.
GOODWILL AMORTIZATION in 2001 was $108.2 million. Pursuant to Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142"), intangible assets with an indefinite life are no longer amortized
in periods subsequent to December 31, 2001, but are subject to annual impairment
tests (or more frequently under certain circumstances) effective January 1,
2002.
GAIN ON SALE OF INTEREST IN RIVERBOAT represents the gain recognized in the
first quarter of 2001 as a result of our sale of our 29 percent ownership
interest in the riverboat casino in Lawrenceberg, Indiana, for $260 million.
SPECIAL CHARGES in the Corporate segment for 2002 included: (1) a loss of
$20.0 million associated with the sale of our India subsidiary; (2) $17.7
million related to debt modification and refinancing transactions; (3) other
items totaling $22.0 million; partially offset by (4) net gains of $7.5 million
related to the sale of certain non-core assets. Special charges in this segment
for 2001 included: (1) litigation accrual and expenses of $23.8 million; (2)
severance benefits of $2.9 million; (3) losses related to office closings and
the sale of artwork totaling $6.8 million; (4) losses related to disputed
reinsurance balances totaling $8.5 million; and (5) other losses totaling $16.9
million.
During 2002, we recognized a GAIN ON THE EXTINGUISHMENT OF DEBT as we
repurchased $77.4 million par value of our predecessor's notes payable
(resulting in a gain of $1.8 million).
During 2001, we repurchased: $893.8 million par value of our predecessor's
notes payable (resulting in a gain of $17.0 million).
In 2002, we recognized a GOODWILL IMPAIRMENT of $500.0 million as discussed
in greater detail in the notes to the consolidated financial statements for the
year ended December 31, 2002, included in this prospectus.
REORGANIZATION ITEMS are professional fees associated with our
predecessor's bankruptcy proceedings which are expensed as incurred in
accordance with SOP 90-7.
PREMIUM AND ASSET ACCUMULATION PRODUCT COLLECTIONS
In accordance with GAAP, insurance policy income as shown in our
consolidated statement of operations consists of premiums earned for policies
that have life contingencies or morbidity features. For annuity and universal
life contracts without such features, premiums collected are not reported as
revenues, but as deposits to insurance liabilities. We recognize revenues for
these products over time in the form of investment income and surrender or other
charges.
Agents, insurance brokers and marketing companies who market our products
and prospective purchasers of our products use the ratings of our insurance
subsidiaries as an important factor in determining
70
which insurer's products to market or purchase. Ratings have the most impact on
our annuity and interest-sensitive life insurance products. In July 2002, A.M.
Best downgraded the financial strength ratings of our primary insurance
subsidiaries from "A- (Excellent)" to "B++ (Very Good)" and placed the ratings
"under review with negative implications." On August 14, 2002, A.M. Best lowered
the financial strength ratings of our primary insurance subsidiaries from "B++
(Very Good)" to "B (Fair)". A.M. Best ratings for the industry currently range
from "A++ (Superior)" to "F (In Liquidation)" and some companies are not rated.
An "A++" rating indicates superior overall performance and a superior ability to
meet ongoing obligations to policyholders. The "B" rating is assigned to
companies which have, on balance, fair balance sheet strength, operating
performance and business profile, when compared to the standards established by
A.M. Best, and a fair ability in A.M. Best's opinion to meet their current
obligations to policyholders, but are financially vulnerable to adverse changes
in underwriting and economic conditions. According to a press release issued by
A.M. Best at the time of the downgrade, the rating reflected their view of the
uncertainty surrounding our restructuring initiatives and the potential adverse
financial impact on our subsidiaries. On September 11, 2003, A.M. Best affirmed
its financial strength ratings of our primary insurance companies ("B (Fair)")
and removed the ratings from under review. On October 3, 2003, A.M. Best
assigned a positive outlook to all of our ratings.
On August 2, 2002, S&P downgraded the financial strength rating of our
primary insurance companies from BB+ to B+. On November 19, 2003, S&P assigned a
"BB-" counterparty credit and financial strength rating to our primary insurance
companies, with the exception of Conseco Senior Health Insurance Company, which
was assigned a "CCC" rating. S&P financial strength ratings range from "AAA" to
"R" and some companies are not rated. Rating categories from "BB" to "CCC" are
classified as "vulnerable", and pluses and minuses show the relative standing
within a category. In S&P's view, an insurer rated "BB" has marginal financial
security characteristics and although positive attributes exist, adverse
business conditions could lead to an insufficient ability to meet financial
commitments. In S&P's view, an insurer rated "CCC" has very weak financial
security characteristics and is dependent on favorable business conditions to
meet financial commitments. On July 1, 2003, Moody's downgraded the financial
strength rating of our primary insurance companies from Ba3 to B3. On December
4, 2003, Moody's assigned a "Ba3" rating to our primary insurance companies,
with the exception of Conseco Senior Health Insurance Company, which was
assigned a "Caa1" rating. Moody's financial strength ratings range from "Aaa" to
"C". Rating categories from "Ba" to "C" are classified as "vulnerable" by
Moody's, and may be supplemented with numbers "1", "2", or "3" to show relative
standing within a category. In Moody's view, an insurer rated "Ba" offers
questionable financial security and the ability of the insurer to meet
policyholder obligations may be very moderate and thereby not well-safeguarded
in the future. In Moody's view, an insurer rated "Caa" offers very poor
financial security and may default on its policyholder obligations, or there may
be elements of danger with respect to punctual payment of policyholder
obligations and claims.
The lowered ratings assigned to our insurance subsidiaries caused sales of
our insurance products to decline and policyholder redemptions and lapses to
increase during 2002 and 2003. We also experienced increased agent attrition,
which in some cases led us to increase commissions or sales incentives we must
pay in order to retain them. These events have had a material adverse effect on
our financial results.
We set the premium rates on our health insurance policies based on facts
and circumstances known at the time we issue the policies and on assumptions
about numerous variables, including the actuarial probability of a policyholder
incurring a claim, the probable size of the claim, and the interest rate earned
on our investment of premiums. In setting premium rates, we consider historical
claims information, industry statistics, the rates of our competitors and other
factors. If our actual claims experience proves to be less favorable than we
assumed and we are unable to raise our premium rates, our financial results may
be adversely affected. Our estimates of insurance liabilities assume we will be
able to raise rates if future experience results in blocks of our health
insurance business becoming unprofitable. We generally cannot raise our health
insurance premiums in any state unless we first obtain the approval of the
insurance regulator in that state. We review the adequacy of our premium rates
regularly and file rate increases on our products when we believe existing
premium rates are too low. It is possible that we will not be able to obtain
approval for premium rate increases from currently pending requests or requests
filed in the future. If we are unable to
71
raise our premium rates because we fail to obtain approval for a rate increase
in one or more states, our net income may decrease. If we are successful in
obtaining regulatory approval to raise premium rates due to unfavorable actual
claims experience, the increased premium rates may reduce the volume of our new
sales and cause existing policyholders to allow their policies to lapse. This
could result in anti-selection if healthier policyholders allow their policies
to lapse. This would reduce our premium income and profitability in future
periods. Increased lapse rates also could require us to expense all or a portion
of our insurance intangibles relating to lapsed policies in the period in which
those policies lapse, adversely affecting our financial results in that period.
Our insurance segments sell insurance products through three primary
distribution channels -- career agents and direct marketing (our Bankers Life
segment) and independent producers (our Conseco Insurance Group segment). Our
career agency force in the Bankers Life segment sells primarily Medicare
supplement and long-term care insurance policies, senior life insurance and
annuities. These agents visit the customer's home, which permits one-on-one
contact with potential policyholders and promotes strong personal relationships
with existing policyholders. Bankers Life's direct marketing distribution
channel is engaged primarily in the sale of "graded benefit life" insurance
policies which are sold directly to the policyholder. Our independent producer
distribution channel in the Conseco Insurance Group segment consists of a
general agency and insurance brokerage distribution system comprised of
independent licensed agents doing business in all fifty states, the District of
Columbia, and certain protectorates of the United States. Independent producers
are a diverse network of independent agents, insurance brokers and marketing
organizations.
72
Total premiums and accumulation product collections were as follows:
BANKERS LIFE (DOLLARS IN MILLIONS):
SUCCESSOR PREDECESSOR
------------- --------------------------------------------------
ONE MONTH EIGHT MONTHS NINE MONTHS YEARS ENDED
ENDED ENDED ENDED DECEMBER 31,
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30, ------------
2003 2003 2002 2002 2001
------------- ------------ ------------- ---- ----
Premiums collected:
Annuities:
Equity-indexed
(first-year)............... $ .6 $ 10.0 $ 25.9 $ 30.4 $ 41.4
------ -------- -------- -------- --------
Other fixed (first-year)..... 62.7 685.4 468.5 707.1 469.1
Other fixed (renewal)........ .2 3.0 2.4 3.4 2.6
------ -------- -------- -------- --------
Subtotal -- other fixed
annuities............... 62.9 688.4 470.9 710.5 471.7
------ -------- -------- -------- --------
Total annuities............ 63.5 698.4 496.8 740.9 513.1
------ -------- -------- -------- --------
Supplemental health:
Medicare supplement
(first-year)............... 4.7 37.6 57.0 75.8 74.4
Medicare supplement
(renewal).................. 48.3 381.5 433.2 588.1 582.3
------ -------- -------- -------- --------
Subtotal -- Medicare
supplement.............. 53.0 419.1 490.2 663.9 656.7
------ -------- -------- -------- --------
Long-term care
(first-year)............... 6.0 48.7 66.0 87.7 87.8
Long-term care (renewal)..... 36.6 282.8 289.1 395.2 337.5
------ -------- -------- -------- --------
Subtotal -- long-term
care.................... 42.6 331.5 355.1 482.9 425.3
------ -------- -------- -------- --------
Other health (first-year).... -- .8 .8 1.0 1.2
Other health (renewal)....... 1.0 8.2 8.7 11.6 14.2
------ -------- -------- -------- --------
Subtotal -- other health... 1.0 9.0 9.5 12.6 15.4
------ -------- -------- -------- --------
Total supplemental
health.................. 96.6 759.6 854.8 1,159.4 1,097.4
------ -------- -------- -------- --------
Life insurance:
First-year................... 3.9 25.1 27.4 37.5 50.2
Renewal...................... 8.1 77.6 72.3 101.5 236.1
------ -------- -------- -------- --------
Total life insurance....... 12.0 102.7 99.7 139.0 286.3
------ -------- -------- -------- --------
Collections on insurance products:
Total first-year premium
collections on insurance
products................... 77.9 807.6 645.6 939.5 724.1
Total renewal premium
collections on insurance
products................... 94.2 753.1 805.7 1,099.8 1,172.7
------ -------- -------- -------- --------
Total collections on
insurance products...... $172.1 $1,560.7 $1,451.3 $2,039.3 $1,896.8
====== ======== ======== ======== ========
Deposit type contracts............ $ 3.8 $ 39.6 $ 28.0 $ 40.7 $ 23.0
====== ======== ======== ======== ========
PERIODS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2002
ANNUITIES in the Bankers Life segment include equity-indexed and other
fixed annuities sold to the senior market through our career agents. In order to
maintain our career agency distribution force during the parent company's
Chapter 11 reorganization process, we provided certain sales inducements to
purchasers of annuities and sales incentives to our career agents. These
programs ended at various times during the second quarter of 2003. Annuity
collections from career agents totaled $63.5 million in the one month ended
September 30, 2003; $698.4 million in the eight months ended August 31, 2003;
and $496.8 million in the nine months ended September 30, 2002. Annuity premium
collections in 2003 were favorably impacted by the
73
sales inducements and incentives discussed above. In addition, the minimum
guaranteed crediting rates on certain of our annuity products were very
attractive. We recently introduced new annuity products which have lower minimum
guaranteed crediting rates. As a result of the elimination of the sales
inducements and incentives and the lower minimum guaranteed crediting rates,
sales of fixed rate annuity products have declined.
SUPPLEMENTAL HEALTH products in the Bankers Life segment include Medicare
supplement, long-term care and other insurance products distributed through our
career agency force. Our profits on supplemental health policies depend on the
overall level of sales, the length of time the business remains inforce,
investment yields, claim experience and expense management.
Collected premiums on Medicare supplement policies in the Bankers Life
segment were $53.0 million in the one month ended September 30, 2003; $419.1
million in the eight months ended August 31, 2003; and $490.2 million in the
nine months ended September 30, 2002. Collected premiums have been affected by
new sales levels, which have declined in the Bankers Life segment since our
ratings downgrades.
Premiums collected on Bankers Life's long-term care policies totaled $42.6
million in the one month ended September 30, 2003; $331.5 million in the eight
months ended August 31, 2003; and $355.1 million in the nine months ended
September 30, 2002. New sales of long-term care policies through our career
agents have declined since our ratings downgrades, as reflected in the declines
in first-year collected premiums in 2003.
Other health products include various other health insurance products which
we have not been actively marketing. Premiums collected totaled $1.0 million in
the one month ended September 30, 2003; $9.0 million in the eight months ended
August 31, 2003; and $9.5 million in the nine months ended September 30, 2002.
LIFE products in our Bankers Life segment are sold primarily to the senior
market through our career agents and our direct response distribution channel.
Life premiums collected in this segment totaled $12.0 million in the one month
ended September 30, 2003; $102.7 million in the eight months ended August 31,
2003; and $99.7 million in the nine months ended September 30, 2002. The A.M.
Best ratings downgrade to "B (Fair)" has not had a significant impact on sales
of life products through these channels.
DEPOSIT TYPE CONTRACTS include guaranteed interest contracts, supplemental
contracts without life contingencies and short-term deposit funds. Amounts
collected from deposit type contracts were $3.8 million in the one month ended
September 30, 2003; $39.6 million in the eight months ended August 31, 2003; and
$28.0 million in the nine months ended September 30, 2002. Such amounts often
fluctuate from period-to-period.
PREDECESSOR'S 2002 PREMIUM AND ACCUMULATION PRODUCT COLLECTIONS COMPARED TO
2001
Annuity premiums collected increased by 44 percent, to $740.9 million, in
2002 compared to $513.1 million in 2001. The demand for traditional fixed-rate
annuity contracts increased in 2002 due to the general stock market performance.
Collected premiums on Bankers Life's Medicare supplement policies in 2002
were comparable to 2001.
Premiums collected on Bankers Life's long-term care policies increased by
14 percent, to $482.9 million, in 2002 compared to $425.3 million, in 2001. Such
sales have been affected by increased premium rates.
Premiums collected from other health products in 2002 were $12.6 million,
down 18 percent from 2001. The other health insurance products are generally not
being actively marketed.
Life premiums collected in our Bankers Life segment in 2002 were $139.0
million, down 51 percent from 2001. The decrease was primarily a result of the
reinsurance agreement we entered into during 2002.
74
CONSECO INSURANCE GROUP (DOLLARS IN MILLIONS):
SUCCESSOR PREDECESSOR
------------- --------------------------------------------------
ONE MONTH EIGHT MONTHS NINE MONTHS YEARS ENDED
ENDED ENDED ENDED DECEMBER 31,
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30, -------------------
2003 2003 2002 2002 2001
------------- ------------ ------------- ---- ----
Premiums collected:
Annuities:
Equity-indexed
(first-year)............. $ 1.4 $ 32.8 $ 141.1 $ 162.6 $ 306.2
Equity-indexed (renewal)... .9 12.1 22.2 27.1 33.3
------ ------ -------- -------- --------
Subtotal -- equity-indexed
annuities........... 2.3 44.9 163.3 189.7 339.5
------ ------ -------- -------- --------
Other fixed (first-year)... .6 14.3 123.1 134.9 339.8
Other fixed (renewal)...... 2.3 14.8 20.9 27.3 31.3
------ ------ -------- -------- --------
Subtotal -- other
fixed annuities..... 2.9 29.1 144.0 162.2 371.1
------ ------ -------- -------- --------
Total annuities....... 5.2 74.0 307.3 351.9 710.6
------ ------ -------- -------- --------
Supplemental health:
Medicare supplement
(first-year)............. 4.0 36.5 65.6 90.8 47.0
Medicare supplement
(renewal)................ 25.8 213.9 203.2 279.1 271.4
------ ------ -------- -------- --------
Subtotal -- Medicare
supplement.......... 29.8 250.4 268.8 369.9 318.4
------ ------ -------- -------- --------
Specified disease
(first-year)............. 2.4 19.7 28.0 36.8 42.1
Specified disease
(renewal)................ 27.1 216.7 248.4 331.8 329.7
------ ------ -------- -------- --------
Subtotal -- specified
disease............. 29.5 236.4 276.4 368.6 371.8
------ ------ -------- -------- --------
Other health
(first-year)............. 1.9 9.7 8.5 12.9 10.3
Other health (renewal)..... 3.8 28.8 60.6 78.9 83.6
------ ------ -------- -------- --------
Subtotal -- other
health.............. 5.7 38.5 69.1 91.8 93.9
------ ------ -------- -------- --------
Total supplemental
health.............. 65.0 525.3 614.3 830.3 784.1
------ ------ -------- -------- --------
Life insurance:
First-year................. 1.7 20.6 48.5 59.2 69.9
Renewal.................... 32.8 260.1 335.6 438.8 483.4
------ ------ -------- -------- --------
Total life
insurance........... 34.5 280.7 384.1 498.0 553.3
------ ------ -------- -------- --------
Collections on insurance
products:
Total first-year premium
collections on insurance
products................... 12.0 133.6 414.8 497.2 815.3
Total renewal premium
collections on insurance
products................... 92.7 746.4 890.9 1,183.0 1,232.7
------ ------ -------- -------- --------
Total collections on
insurance products.... $104.7 $880.0 $1,305.7 $1,680.2 $2,048.0
====== ====== ======== ======== ========
Deposit type contracts.......... $ 27.0 $220.5 $ 209.6 $ 246.9 $ 155.0
====== ====== ======== ======== ========
PERIODS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2002
ANNUITIES in our Conseco Insurance Group segment include equity-indexed
annuities and other fixed annuities sold through professional independent
producers. Many professional independent producers discontinued marketing our
annuity products after A.M. Best lowered our financial strength ratings.
Accordingly, we took actions to reduce our expenses related to marketing these
products through this
75
distribution channel, and began to focus instead on the sale of products that
were less ratings sensitive. Total annuity collected premiums in this segment
were $5.2 million in the one month ended September 30, 2003; $74.0 million in
the eight months ended August 31, 2003; and $307.3 million in the nine months
ended September 30, 2002.
We introduced our first equity-indexed annuity product in 1996. The
accumulation value of these annuities is credited with interest at an annual
guaranteed minimum rate of 3 percent (or, including the effect of applicable
sales loads, a 1.7 percent compound average interest rate over the term of the
contracts). These annuities provide for potentially higher returns based on a
percentage of the change in the S&P 500 Index during each year of their term. We
purchase S&P 500 Call Options in an effort to hedge increases to policyholder
benefits resulting from increases in the S&P 500 Index. Total collected premiums
for this product were $2.3 million in the one month ended September 30, 2003;
$44.9 million in the eight months ended August 31, 2003; and $163.3 million in
the nine months ended September 30, 2002. The decreases can be attributed to (i)
the general stock market performance in recent years which has made other
investment products more attractive to certain customers and (ii) the effect of
the A.M. Best ratings downgrade to "B (Fair)."
Other fixed rate annuity products include single-premium deferred annuities
("SPDAs"), flexible-premium deferred annuities ("FPDAs") and single-premium
immediate annuities ("SPIAs"), which are credited with a declared rate. SPDA and
FPDA policies 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. Annuity premiums on
these products were $2.9 million in the one month ended September 30, 2003;
$29.1 million in the eight months ended August 31, 2003; and $144.0 million in
the nine months ended September 30, 2002. The decreases can be attributed to the
effect of the A.M. Best ratings downgrade.
SUPPLEMENTAL HEALTH products in our Conseco Insurance Group segment include
Medicare supplement, specified disease and other insurance products distributed
through professional independent producers. Our profits on supplemental health
policies depend on the overall level of sales, the length of time the business
remains inforce, investment yields, claim experience and expense management.
Collected premiums on Medicare supplement policies in the Conseco Insurance
Group segment were $29.8 million in the one month ended September 30, 2003;
$250.4 million in the eight months ended August 31, 2003; and $268.8 million in
the nine months ended September 30, 2002. Collected premiums have been affected
by the decrease in new Medicare supplement sales since our ratings downgrades.
Premiums collected on specified disease products totaled $29.5 million in
the one month ended September 30, 2003; $236.4 million in the eight months ended
August 31, 2003; and $276.4 million in the nine months ended September 30, 2002.
Collected premiums have been affected by decreases in new sales since our
ratings downgrades.
Other health products include disability income, dental and various other
health insurance products. We no longer actively market many of these products.
The disability income and dental products have been marketed to school systems
located in nearly all states. Premiums collected totaled $5.7 million in the one
month ended September 30, 2003; $38.5 million in the eight months ended August
31, 2003; and $69.1 million in the nine months ended September 30, 2002.
LIFE products in the Conseco Insurance Group segment are sold through
professional independent producers. Life premiums collected totaled $34.5
million in the one month ended September 30, 2003; $280.7 million in the eight
months ended August 31, 2003; and $384.1 million in the nine months ended
September 30, 2002. The A.M. Best ratings downgrade to "B (Fair)" has negatively
affected our sales of life products. We stopped actively marketing many of our
life insurance products sold through the professional independent producer
channel in the second quarter of 2003.
DEPOSIT TYPE CONTRACTS include guaranteed interest contracts, supplemental
contracts without life contingencies and short-term deposit funds. Amounts
collected from deposit type contracts were $27.0 million
76
in the one month ended September 30, 2003; $220.5 million in the eight months
ended August 31, 2003; and $209.6 million in the nine months ended September 30,
2002. Such amounts often fluctuate from period-to-period.
PREDECESSOR'S 2002 PREMIUM AND ACCUMULATION PRODUCT COLLECTIONS COMPARED TO
2001
Total collected premiums for equity-indexed annuities decreased by 44
percent, to $189.7 million, in 2002, compared to $339.5 million, in 2001. The
decrease can be attributed to: (i) the general stock market performance which
has made other investment products more attractive; and (ii) the effect of the
A.M. Best ratings downgrade to "B (fair)".
Fixed rate annuity premiums decreased by 56 percent, to $162.2 million, in
2002, compared to $371.1 million, in 2001, due primarily to the impact of the
A.M. Best ratings downgrades.
Collected premiums on Medicare supplement policies increased by 16 percent,
to $369.9 million, in 2002, compared to $318.4 million, in 2001. The increase
was due to increased premium rates and new sales.
Premiums collected in 2002 on specified disease products were comparable to
2001.
Premiums collected from other health products in 2002 were $91.8 million,
down 2.2 percent from 2001.
Life premiums collected in 2002 were $498.0 million, down 10 percent from
2001. The A.M. Best ratings downgrade to "B (fair)" negatively affected our
sales of life products.
DEPOSIT TYPE CONTRACTS include guaranteed interest contracts, supplemental
contracts without life contingencies and other deposit funds. Amounts collected
from deposit type contracts increased by 59 percent, to $246.9 million, in 2002,
compared to $155.0 million, in 2001. Such amounts often fluctuate from
period-to-period.
OTHER BUSINESS IN RUN-OFF (DOLLARS IN MILLIONS):
SUCCESSOR PREDECESSOR
------------- ------------------------------------------------
ONE MONTH EIGHT MONTHS NINE MONTHS YEARS ENDED
ENDED ENDED ENDED DECEMBER 31,
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30, ------------
2003 2003 2002 2002 2001
------------- ------------ ------------- ---- ----
Premiums collected:
Long-term care:
First-year......................... $ .2 $ 3.2 $ 8.1 $ 10.0 $ 17.4
Renewal............................ 29.9 264.8 317.2 424.5 445.6
----- ------ ------ ------ --------
Total long-term care............. 30.1 268.0 325.3 434.5 463.0
----- ------ ------ ------ --------
Major medical:
Group (first-year)................. -- -- .4 .5 16.4
Group (renewal).................... 17.4 152.4 247.8 315.1 354.5
----- ------ ------ ------ --------
Subtotal -- group major
medical....................... 17.4 152.4 248.2 315.6 370.9
----- ------ ------ ------ --------
Individual (first-year)............ -- -- 15.4 15.6 112.8
Individual (renewal)............... .5 4.0 73.8 78.3 253.4
----- ------ ------ ------ --------
Subtotal -- individual major
medical....................... .5 4.0 89.2 93.9 366.2
----- ------ ------ ------ --------
Total major medical.............. 17.9 156.4 337.4 409.5 737.1
----- ------ ------ ------ --------
Collections on insurance products:
Total first-year premium
collections on insurance
products......................... .2 3.2 23.9 26.1 146.6
Total renewal premium collections
on insurance products............ 47.8 421.2 638.8 817.9 1,053.5
----- ------ ------ ------ --------
Total collections on insurance
products...................... $48.0 $424.4 $662.7 $844.0 $1,200.1
===== ====== ====== ====== ========
77
As described elsewhere, the Other Business in Run-off segment includes (1)
long-term care products written in prior years through independent agents and
(2) group and individual major medical business in run-off.
PERIODS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2002
LONG-TERM CARE premiums collected in this segment totaled $30.1 million in
the one month ended September 30, 2003; $268.0 million in the eight months ended
August 31, 2003; and $325.3 million in the nine months ended September 30, 2002.
Most of the long-term care premiums in this segment relate to business written
by certain of our subsidiaries prior to their acquisitions by Conseco in 1996
and 1997. We ceased selling new long-term care policies through professional
independent producers in the second quarter of 2003. As a result, decreases in
this segment's long-term care collected premiums reflect policy lapses partially
offset by premium rate increases.
GROUP MAJOR MEDICAL premiums totaled $17.4 million in the one month ended
September 30, 2003; $152.4 million in the eight months ended August 31, 2003;
and $248.2 million in the nine months ended September 30, 2002. We no longer
actively market new sales of group products. In early 2002, we decided to stop
renewing all inforce small group business and discontinued new sales.
INDIVIDUAL MAJOR MEDICAL premiums collected were $0.5 million in the one
month ended September 30, 2003; $4.0 million in the eight months ended August
31, 2003; and $89.2 million in the nine months ended September 30, 2002. In the
second half of 2001, we stopped renewing a large portion of our major medical
lines of business. In early 2002, we decided to stop renewing all inforce
individual major medical business and discontinued new sales.
PREDECESSOR'S 2002 PREMIUM AND ACCUMULATION PRODUCT COLLECTIONS COMPARED TO
2001
LONG-TERM CARE premiums collected in this segment totaled $434.5 million in
2002 compared to $463.0 million in 2001. Most of the premiums in this segment
relate to business written by certain of our subsidiaries prior to their
acquisitions by Conseco in 1996 and 1997. The 2002 decrease reflected policy
lapses partially offset by premium rate increases.
GROUP MAJOR MEDICAL premiums totaled $315.6 million in 2002 and $370.9
million in 2001. We no longer actively market these products.
INDIVIDUAL MAJOR MEDICAL premiums collected were $93.9 million in 2002 and
$366.2 million in 2001. In the second half of 2001, we stopped renewing a large
portion of our major medical lines of business. In early 2002, we decided to
stop renewing all inforce individual major medical business and discontinued new
sales. These premiums will continue to decrease in future periods.
LIQUIDITY AND CAPITAL RESOURCES
Changes in our consolidated balance sheet between September 30, 2003 and
December 31, 2002, reflect (1) the reorganization of our capital structure
pursuant to the Plan of Reorganization and (2) the effect of the sale of CFC.
In accordance with GAAP, we record our actively managed fixed maturity
investments, equity securities and certain other invested assets at estimated
fair value with any unrealized gain or loss (excluding impairment losses which
are recognized through earnings), net of tax and related adjustments, recorded
as a component of shareholders' equity. At September 30, 2003, we increased the
carrying value of such investments by $470.6 million as a result of this fair
value adjustment.
Our capital structure was determined in accordance with the terms of the
Plan of Reorganization and consisted of: (1) our $1.3 billion Senior Credit
Facility; (2) Class A Preferred Stock with an aggregate liquidation preference
of $865.0 million as of September 30, 2003; (3) warrants to purchase six million
shares
78
of common stock; and (4) 100 million shares of new common stock. Our capital
structure as of September 30, 2003, is as follows (dollars in millions):
Total capital:
Corporate notes payable................................... $1,300.0
Shareholders' equity:
Class A Preferred stock................................ 865.0
Common stock and additional paid-in capital............ 1,640.3
Accumulated other comprehensive income................. 273.2
Retained earnings...................................... 18.9
--------
Total shareholders' equity........................... 2,797.4
--------
Total capital........................................ $4,097.4
========
The following table summarizes certain financial ratios as of and for the
one month ended September 30, 2003:
Book value per common share................................. $19.31
Ratio of earnings to fixed charges.......................... 1.82x
Ratio of earnings to fixed charges and preferred
dividends................................................. 1.54x
Debt to total capital ratios:
Corporate debt to total capital........................... 32%
Corporate debt and preferred stock to total capital....... 53%
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 any applicable surrender and withdrawal penalty provisions. We seek to
balance the duration of our invested assets with the estimated duration of
benefit payments arising from contract liabilities.
On August 14, 2002, A.M. Best lowered the financial strength ratings of our
primary insurance subsidiaries from "B++ (Very Good)" to "B (Fair)". A.M. Best
ratings for the industry currently range from "A++ (Superior)" to "F (In
Liquidation)" and some companies are not rated. An "A++" rating indicates
superior overall performance and a superior ability to meet ongoing obligations
to policyholders. The "B" rating is assigned to companies which have, on
balance, fair balance sheet strength, operating performance and business
profile, when compared to the standards established by A.M. Best, and a fair
ability in A.M. Best's opinion to meet their current obligations to
policyholders, but are financially vulnerable to adverse changes in underwriting
and economic conditions. The rating reflected A.M. Best's view of the
uncertainty surrounding our restructuring initiatives and the potential adverse
financial impact on our subsidiaries. On September 11, 2003, A.M. Best affirmed
its financial strength ratings of our primary insurance companies ("B (Fair)")
and removed the ratings from under review, indicating that the ratings outlook
is positive. On October 3, 2003, A.M. Best assigned a positive outlook to all of
our ratings. According to a press release issued by A.M. Best, the assignment of
a positive outlook to Conseco's ratings reflects their favorable view of our
bankruptcy reorganization and a number of management initiatives including the
sale of the GM building, sale of CFC, restructuring of our investment
portfolios, expense reductions, merging of certain subsidiaries, stabilization
of surrenders and a commitment in the near-to medium-term to focus on selling
higher margin products with lower capital requirements.
On August 2, 2002, S&P downgraded the financial strength rating of our
primary insurance companies from BB+ to B+. On November 19, 2003, S&P assigned a
"BB-" counterparty credit and financial strength rating to our primary insurance
companies, with the exception of Conseco Senior Health Insurance Company, which
was assigned a "CCC" rating. S&P financial strength ratings range from "AAA" to
"R" and some companies are not rated. Rating categories from "BB" to "CCC" are
classified as "vulnerable", and pluses and minuses show the relative standing
within a category. In S&P's view, an insurer rated "BB" has
79
marginal financial security characteristics and although positive attributes
exist, adverse business conditions could lead to an insufficient ability to meet
financial commitments. In S&P's view, an insurer rated "CCC" has very weak
financial security characteristics and is dependent on favorable business
conditions to meet financial commitments. On July 1, 2003, Moody's downgraded
the financial strength rating of our primary insurance companies from Ba3 to B3.
On December 4, 2003, Moody's assigned a "Ba3" rating to our primary insurance
companies with the exception of Conseco Senior Health Insurance Company, which
was assigned a "Caa1" rating. Moody's financial strength ratings range from
"Aaa" to "C". Rating categories from "Ba" to "C" are classified as "vulnerable"
by Moody's, and may be supplemented with numbers "1", "2", or "3" to show
relative standing within a category. In Moody's view, an insurer rated "Ba"
offers questionable financial security and the ability of the insurer to meet
policyholder obligations may be very moderate and thereby not well safeguarded
in the future. In Moody's view, an insurer rated "Caa" offers very poor
financial security and may default on its policyholder obligations or there may
be elements of danger with respect to punctual payment of policyholder
obligations and claims.
The lowered ratings assigned to our insurance subsidiaries caused sales of
our insurance products to decline and policyholder redemptions and lapses to
increase during 2002 and 2003. We also experienced increased agent attrition,
which in some cases led us to increase commission on sales incentives we must
pay in order to retain them. These events have had a material adverse effect on
our financial results.
As more fully described under the caption "Statutory Information" within
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", our two insurance subsidiaries domiciled in Texas entered into
consent orders with the Texas Department of Insurance, which were formally
released on November 19, 2003. The consent orders applied to all of our
insurance subsidiaries and, among other things, restricted the ability of our
insurance subsidiaries to pay dividends and other amounts to the parent company
without regulatory consent. State laws generally provide state insurance
regulatory agencies with broad authority to protect policyholders in their
jurisdictions. Accordingly, we cannot assure you that the regulators will not
seek to assert greater supervision and control over our insurance subsidiaries'
businesses and financial affairs. We have agreed with the Texas Department of
Insurance to provide prior notice of certain transactions, including up to 30
days prior notice for the payment of dividends by an insurance subsidiary to any
non-insurance company parent, and periodic reporting of information concerning
our financial performance and condition.
Our insurance subsidiaries experienced increased lapse rates on annuity
policies during 2002. Aggregate annuity surrenders have declined in 2003. We
believe that the diversity of the investment portfolios of our insurance
subsidiaries and the concentration of investments in high-quality, liquid
securities provide sufficient liquidity to meet foreseeable cash requirements of
our insurance subsidiaries. We believe our insurance subsidiaries could readily
liquidate sufficient portions of their investments, if lapses were to increase
to the levels experienced in 2002.
80
LIQUIDITY OF THE HOLDING COMPANIES
Pursuant to the Plan of Reorganization, we entered into the Senior Credit
Facility. The Senior Credit Facility consists of two tranches: Tranche A -- $1.0
billion; and Tranche B -- $0.3 billion. See the note to the consolidated
financial statements included in this prospectus for further discussion related
to the Senior Credit Facility. Principal repayments are due as follows (dollars
in millions):
TRANCHE A TRANCHE B
--------- ---------
June 30, 2004............................................... $ 50.0 $ 3.0
June 30, 2005............................................... 50.0 3.0
June 30, 2006............................................... 50.0 1.5
December 31, 2006........................................... 50.0 1.5
June 30, 2007............................................... 75.0 1.5
December 31, 2007........................................... 75.0 1.5
June 30, 2008............................................... 75.0 1.5
December 31, 2008........................................... 75.0 1.5
June 30, 2009............................................... -- 1.5
September 10, 2009.......................................... 500.0 --
December 31, 2009........................................... -- 1.5
September 10, 2010.......................................... -- 282.0
-------- ------
$1,000.0 $300.0
======== ======
At September 30, 2003, Conseco Inc. and CDOC held unrestricted cash of
$12.7 million and additional restricted cash of $22.1 million held in trust for
the payment of bankruptcy-related professional fees. In addition, our other
non-life insurance companies held unrestricted cash of approximately $69.6
million which could be upstreamed to the parent companies if needed.
Conseco Inc. and CDOC are holding companies with no business operations of
their own; they depend on their operating subsidiaries for cash to make
principal and interest payments on debt, and to pay administrative expenses and
income taxes. The cash Conseco and CDOC receive from insurance subsidiaries
consists of dividends and distributions, principal and interest payments on
surplus debentures, fees for services, tax-sharing payments, and from our
non-insurance subsidiaries, loans and advances. A further deterioration in the
financial condition, earnings or cash flow of the material subsidiaries of
Conseco or CDOC for any reason could further limit such subsidiaries' ability to
pay cash dividends or other disbursements to Conseco and/or CDOC, which, in
turn, would limit Conseco's and/or CDOC's ability to meet debt service
requirements and satisfy other financial obligations.
The ability of our insurance subsidiaries to pay dividends is subject to
state insurance department regulations and is based on the financial statements
of our insurance subsidiaries prepared in accordance with statutory accounting
practices prescribed or permitted by regulatory authorities, which differ from
GAAP. These regulations generally permit dividends to be paid from statutory
earned surplus of the insurance company for any 12-month period in amounts equal
to the greater of (or in a few states, the lesser of) (1) statutory net gain
from operations or net income for the prior year and (2) 10 percent of statutory
capital and surplus as of the end of the preceding year. Any dividends in excess
of these levels require the approval of the director or commissioner of the
applicable state insurance department. Also, we have agreed with the Texas
Department of Insurance to provide up to 30 days prior notice of the payment of
dividends by an insurance subsidiary to any non-insurance company parent. As
described under the caption "-- Statutory Information", we recently were subject
to consent orders with the Commissioner of Insurance for the State of Texas
that, among other things, limited the ability of our insurance subsidiaries to
pay dividends. If our financial condition were to deteriorate, we may be
required to enter into similar orders in the future. In addition, we may need to
contribute additional capital to improve the RBC ratios of our insurance
subsidiaries and this could affect the ability of our top tier insurance
subsidiary to pay dividends.
81
Our cash flow may be affected by a variety of factors, many of which are
outside of our control, including insurance and banking regulatory issues,
competition, financial markets and other general business conditions. We cannot
assure you that we will possess sufficient income and liquidity to meet all of
our liquidity requirements and other obligations. Although we believe that
amounts required for us to meet our financial and operating obligations will be
available from our subsidiaries and from funds currently held by, or available
to Conseco and CDOC, our results for future periods are subject to numerous
uncertainties. We may encounter liquidity problems, which could affect our
ability to meet our obligations while attempting to meet competitive pressures
or adverse economic conditions.
If an insurance company subsidiary were to be liquidated, that liquidation
would be conducted under the insurance law of its state of domicile by such
state's insurance regulator as the receiver with respect to such insurer's
property and business. In the event of a default on our debt or our insolvency,
liquidation or other reorganization, our creditors and stockholders will not
have the right to proceed against the assets of our insurance subsidiaries or to
cause their liquidation under federal and state bankruptcy laws.
We have adopted several initiatives designed to reduce the expense levels
that exceed product pricing at our Conseco Insurance Group segment. These
initiatives include the elimination of duplicate processing systems by
converting all similar systems to a single system. We expect to spend over $35
million on capital expenditures in 2004 (including amounts related to the
aforementioned initiatives). We believe we have adequate cash flows from
operations to fund these initiatives.
Under our Senior Credit Facility, we have agreed to a number of covenants
and other provisions that restrict our ability to engage in various financing
transactions and pursue certain operating activities without the prior consent
of the lenders under the Senior Credit Facility. In January 2004, the Senior
Credit Facility was amended to remove requirements that our insurance
subsidiaries maintain minimum A.M. Best financial strength ratings. We have also
agreed to meet or maintain various financial ratios. Our ability to meet these
financial covenants may be affected by events beyond our control. These
requirements represent significant restrictions on the manner in which we may
operate our business. If we default under any of these requirements, the lenders
could declare all outstanding borrowings, accrued interest and fees to be
immediately due and payable. If that were to occur, we cannot assure you that we
would have sufficient liquidity to repay or refinance this indebtedness or any
of our other debts.
INVESTMENTS
At September 30, 2003, our investment portfolio included the following
(dollars in millions):
PERCENTAGE
TOTAL OF TOTAL
--------- ----------
Actively managed fixed maturities........................... $19,352.7 86.3%
Equity securities........................................... 107.5 .5
Mortgage loans.............................................. 1,154.1 5.1
Policy loans................................................ 514.2 2.3
Trading securities.......................................... 944.9 4.2
Venture capital investment in AT&T Wireless Services,
Inc. ..................................................... 33.7 .2
Other invested assets....................................... 308.7 1.4
--------- -----
Total investments......................................... $22,415.8 100.0%
========= =====
82
At September 30, 2003, the amortized cost and estimated fair value of
actively managed fixed maturities and equity securities were as follows (dollars
in millions):
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
Investment grade:
Corporate securities.............. $10,868.2 $345.3 $12.3 $11,201.2
United States Treasury securities
and obligations of United
States government corporations
and agencies................... 812.6 16.4 0.1 828.9
States and political
subdivisions................... 564.5 12.0 0.2 576.3
Debt securities issued by foreign
governments.................... 84.9 2.3 -- 87.2
Structured securities............. 5,767.9 99.2 4.0 5,863.1
Below-investment grade (primarily
corporate securities)............. 787.4 12.0 3.4 796.0
--------- ------ ----- ---------
Total actively managed fixed
maturities..................... $18,885.5 $487.2 $20.0 $19,352.7
========= ====== ===== =========
Equity securities................... $ 104.6 $ 2.9 $ -- $ 107.5
========= ====== ===== =========
CONCENTRATION OF CORPORATE SECURITIES
At September 30, 2003, our corporate securities (including below-investment
grade) were concentrated in the following industries:
PERCENT OF
PERCENT OF ESTIMATED
AMORTIZED FAIR
COST VALUE
---------- ----------
Media and communications.................................... 12.0% 12.1%
Bank/savings and loan....................................... 11.3 11.4
Electric utility............................................ 9.5 9.4
Energy...................................................... 8.2 8.2
Insurance................................................... 7.7 7.7
Real estate and real estate investment trusts............... 7.3 7.3
Financial institutions...................................... 6.2 6.2
With respect to our corporate securities, no other industry accounted for
more than 5.0 percent of amortized cost or estimated fair value.
BELOW-INVESTMENT GRADE SECURITIES
At September 30, 2003, the amortized cost of our below-investment grade
fixed-maturity securities was $787.4 million, or 4.2 percent of our fixed
maturity portfolio. The estimated fair value of the below-investment grade
portfolio was $796.0 million, or 101 percent of the amortized cost. The value of
these securities varies based on the economic terms of the securities,
structural considerations and the creditworthiness of the issuer of the
securities. During 2002 and 2001, a number of large, highly leveraged issuers
have experienced significant financial difficulties, which resulted in our
recognition of significant other-than-temporary impairments.
Below-investment grade securities have different characteristics than
investment grade corporate debt securities. Risk of loss upon default by the
borrower is significantly greater with respect to below-investment grade
securities than with other corporate debt securities. Below-investment grade
securities are generally unsecured and are often subordinated to other creditors
of the issuer. Also, issuers of below-investment grade
83
securities usually have higher levels of debt and are more sensitive to adverse
economic conditions, such as recession or increasing interest rates, than are
investment grade issuers. We attempt to reduce the overall risk in the
below-investment grade portfolio, as in all investments, through careful credit
analysis, strict investment policy guidelines, and diversification by issuer
and/or guarantor and by industry.
NET REALIZED INVESTMENT GAINS (LOSSES)
During the one month ended September 30, 2003, we recognized net realized
investment gains of $6.7 million resulting from the sales of investments
(primarily fixed maturities) which generated proceeds of $2.1 billion. There
were no writedowns of fixed maturity investments as a result of conditions which
caused us to conclude a decline in fair value of the investments was other than
temporary. During the first eight months of 2003, we recognized net realized
investment losses of $5.4 million. The net realized investment losses during the
first eight months of 2003 included (1) $40.5 million of net gains from the
sales of investments (primarily fixed maturities) which generated proceeds of
$5.4 billion net of (2) $45.9 million of writedowns of fixed maturity
investments as a result of conditions which caused us to conclude a decline in
fair value of the investments was other than temporary. At September 30, 2003,
fixed maturity securities in default as to the payment of principal or interest
had an aggregate amortized cost of $21.4 million and a carrying value of $21.5
million. Net realized investment losses during the first nine months of 2002
included (1) $489.8 million of writedowns of fixed maturity investments, equity
securities and other invested assets as a result of conditions which caused us
to conclude a decline in fair value of the investments was other than temporary
and (2) $4.1 million of net losses from the sales of investments (primarily
fixed maturities).
During the one month ended September 30, 2003, we sold $50.9 million of
fixed maturity investments which resulted in gross realized investment losses
(before income taxes) of $0.8 million. During the first eight months of 2003, we
sold $2.7 billion of fixed maturity investments which resulted in gross realized
investment losses (before income taxes) of $59.4 million. Securities sold at a
loss are sold for a number of reasons including: (1) changes in the investment
environment; (2) expectation that the market value could deteriorate further;
(3) desire to reduce our exposure to an issuer or an industry; (4) changes in
credit quality; and (5) our analysis indicating there is a high probability that
the security is other-than-temporarily impaired.
The following summarizes the investments sold at a loss during the first
eight months of 2003 which had been continuously in an unrealized loss position
exceeding 20 percent of the amortized cost basis prior to the sale for the
period indicated (there were no such investments sold at a loss during the one
month ended September 30, 2003) (dollars in millions):
AT DATE OF SALE
---------------
NUMBER AMORTIZED FAIR
PERIOD OF ISSUERS COST VALUE
------ ---------- --------- -----
Less than 6 months prior to sale..................... 16 $32.0 $24.0
Greater than or equal to 6 and less than 12 months
prior to sale...................................... 8 40.6 25.7
Greater than 12 months prior to sale................. 20 39.8 23.7
INVESTMENTS WITH OTHER-THAN-TEMPORARY LOSSES
During the one month ended September 30, 2003, we did not record any
writedowns of fixed maturity investments. During the eight months ended August
31, 2003, we recorded writedowns of fixed maturity investments totaling $45.9
million as further described in the following paragraphs:
During the eight months ended August 31, 2003, we recognized a loss of
$11.1 million to record certain commercial loans at their estimated fair value
as we intended to liquidate them and use the proceeds to repay the senior
financing used to acquire the loans. No additional gain or loss was recognized
upon the ultimate disposition of the loans.
During the eight months ended August 31, 2003, we recorded writedowns of
$8.4 million related to our holdings of fixed maturity investments in a major
airline that has filed for bankruptcy. Although our
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investments are backed by collateral, our analysis of the value of the
underlying collateral indicated that the decline in fair value of the investment
is other than temporary.
During the eight months ended August 31, 2003, we recorded writedowns of
$3.7 million related to our holdings of fixed maturity investments in a
fertilizer company that has filed for bankruptcy. A significant portion of the
issuer's production capacity was rendered unprofitable due to high raw material
costs and was temporarily idled. Accordingly, we concluded that the decline in
fair value was other than temporary.
During the eight months ended August 31, 2003, we recorded writedowns of
$1.8 million related to holdings in a health care company that has had financial
problems due to financial misstatements, substantial regulatory and litigation
exposure and its failure to meet debt service requirements. Accordingly, we
concluded the decline in fair value was other than temporary.
During the eight months ended August 31, 2003, we recorded writedowns of
$1.5 million related to holdings of a fixed income security of a finance company
that has had significant financial and liquidity problems. Accordingly, we
concluded the decline in fair value was other than temporary.
During the eight months ended August 31, 2003, we recorded writedowns of
$9.6 million related to holdings of a fixed income security in a trust which
leases airplanes and related equipment. We believe that the collateral value
supporting these investments has eroded and, therefore, we concluded the decline
in fair value was other than temporary.
In addition to the specific investments discussed above, we recorded $9.8
million of writedowns related to various other fixed maturity investments during
the eight months ended August 31, 2003. No other writedown of a single issuer
exceeded $1.5 million.
RECOGNITION OF LOSSES
We regularly evaluate all of our investments for possible impairment based
on current economic conditions, credit loss experience and other
investee-specific developments. If there is a decline in a security's net
realizable value that is other than temporary, the decline is recognized as a
realized loss and the cost basis of the security is reduced to its estimated
fair value.
Our evaluation of investments for impairment requires significant judgments
to be made including: (1) the identification of potentially impaired securities;
(2) the determination of their estimated fair value; and (3) assessment of
whether any decline in estimated fair value is other than temporary. If new
information becomes available or the financial condition of the investee
changes, our judgments may change resulting in the recognition of an investment
loss at that time.
Our periodic assessment of whether unrealized losses are "other than
temporary" requires significant judgment. Factors considered include: (1) the
extent to which market value is less than the cost basis; (2) the length of time
that the market value has been less than cost; (3) whether the unrealized loss
is event driven, credit-driven or a result of changes in market interest rates;
(4) the near-term prospects for improvement in the issuer and/or its industry;
(5) whether the investment is investment-grade and our view of the investment's
rating and whether the investment has been downgraded since its purchase; (6)
whether the issuer is current on all payments in accordance with the contractual
terms of the investment and is expected to meet all of its obligations under the
terms of the investment; (7) our ability and intent to hold the investment for a
period of time sufficient to allow for any anticipated recovery; and (8) the
underlying current and prospective asset and enterprise values of the issuer and
the extent to which our investment may be affected by changes in such values.
If a decline in value is determined to be other than temporary and the cost
basis of the security is written down to fair value, we review the circumstances
which caused us to believe that the decline was other than temporary with
respect to other investments in our portfolio. If such circumstances exist with
respect to other investments, those investments are also written down to fair
value. Future events may occur, or additional or updated information may become
available, which may necessitate future realized losses related
85
to securities in our portfolio. Significant losses in the carrying value of our
investments could have a material adverse effect on our earnings in future
periods.
The following table sets forth the amortized cost and estimated fair value
of those actively managed fixed maturities with unrealized losses at September
30, 2003, by contractual maturity. Actual maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties. Most of the structured
securities shown below provide for periodic payments throughout their lives.
ESTIMATED
AMORTIZED FAIR
COST VALUE
--------- ---------
(DOLLARS IN MILLIONS)
Due in one year or less..................................... $ 11.3 $ 11.3
Due after one year through five years....................... 119.7 117.6
Due after five years through ten years...................... 165.7 163.6
Due after ten years......................................... 336.5 324.6
-------- --------
Subtotal.................................................. 633.2 617.1
Structured securities....................................... 753.9 750.0
-------- --------
Total..................................................... $1,387.1 $1,367.1
======== ========
Investments in fixed maturities rated below-investment grade or classified
as equity-type securities that were in an unrealized loss position exceeding 20
percent of the cost basis as of September 30, 2003 had a cost basis of $0.2
million.
Our investment strategy is to maximize over a sustained period, and within
acceptable parameters of risk, investment income and total investment return
through active investment management. Accordingly, we may sell securities at a
gain or a loss to enhance the total return of the portfolio as market
opportunities change. While we have both the ability and intent to hold
securities with unrealized losses until they mature or recover in value, we may
sell securities at a loss in the future because of actual or expected changes in
our view of the particular investment, its industry, its type or the general
investment environment.
Based on management's current assessment of securities and other
investments with unrealized losses at September 30, 2003, we believe the issuers
of the securities will continue to meet their obligations (or with respect to
equity-type securities, the investment value will recover to its cost basis). We
have no current plans to sell these securities and, in the case of
fixed-maturity securities, have the ability to hold them to maturity. The
recognition of an other-than-temporary impairment through a charge to earnings
may be recognized in future periods if management later concludes that the
decline in market value below the cost basis is other than temporary.
INVESTMENT IN GENERAL MOTORS BUILDING
During the summer of 2003, we successfully enforced our contractual right
to buy out our 50 percent equity partner in the GM building, a landmark 50-story
office tower in New York City. After obtaining an award in arbitration, and
confirming that award in the New York court system, we finally settled our
differences with our equity partner, thus permitting us to put the building up
for sale. On September 26, 2003, we sold our investment in the GM building. We
received net cash of $636.8 million, which was approximately equal to the net
cash value established upon the adoption of fresh start accounting.
Our investment in the GM building was made through a partnership which
acquired the building in 1998 for $878 million. The initial capital structure of
the partnership consisted of: (1) a $700 million senior mortgage; (2) $200
million of subordinated debt with a stated fixed return of 12.7 percent
payable-in-kind, and the opportunity to earn an additional residual return; and
(3) $30 million of partnership equity, owned 50 percent by Conseco and 50
percent by an affiliate of Donald Trump. A Trump affiliate also served as
general manager of the acquired building. We owned 100 percent of the
subordinated debt.
86
The $30 million of partnership equity represented less than 10 percent of
the total capital of the partnership. In addition, the subordinated debt was
intended to absorb virtually all expected losses and receive a significant
portion of expected residual returns. Based on our 100 percent ownership of the
subordinated debt, we were the primary beneficiary of the GM building. The
partnership was consolidated in our financial statements effective August 31,
2003 in accordance with the requirements of FASB Interpretation No. 46
"Consolidation of Variable Interest Entities", which was implemented in
conjunction with fresh start accounting. The August 31, 2003 fresh start balance
sheet reflected the following balances of the partnership: the GM building at
$1,336.3 million; cash of $28.4 million; and a non-recourse loan of $700 million
(classified as an investment borrowing). Our income statement for the month of
September 2003 reflected investment income of $2.9 million related to this
investment (representing our equity interest in the income from the building for
the 26 days prior to the sale).
STRUCTURED SECURITIES
At September 30, 2003, fixed maturity investments included $5.9 billion of
structured securities (or 30 percent of all fixed maturity securities).
Structured securities include mortgage-backed securities, collateralized
mortgage obligations, asset-backed securities and commercial mortgage-backed
securities. The yield characteristics of structured securities differ from those
of traditional fixed-income securities. Interest and principal payments for
structured securities occur more frequently, often monthly. Structured
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 or
other loans 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 loans and the securities backed
by these loans increase when prevailing interest rates decline significantly
relative to the interest rates on such loans. The yields on structured
securities purchased at a discount to par will increase when the underlying
loans prepay faster than expected. The yields on structured securities purchased
at a premium will decrease when the underlying loans prepay faster than
expected. When interest rates decline, the proceeds from the prepayment of
structured securities may be reinvested at lower rates than we were earning on
the prepaid securities. When interest rates increase, prepayments on structured
securities decrease as fewer underlying loans are refinanced. When this occurs,
the average maturity and duration of the structured securities increase, which
decreases the yield on structured securities purchased at a discount, because
the discount is realized as income at a slower rate, and increases the yield on
those purchased at a premium as a result of a decrease in the annual
amortization of the premium.
Pursuant to fresh start reporting, we were required to mark all of our
investments to market value. The current interest rate environment is much lower
than when most of our investments were purchased. Accordingly, the fresh start
values of our investments generally exceed the par values of such investments.
The amount of value exceeding par is referred to as a "purchase premium" which
is amortized against future income. If prepayments in any period are higher than
expected, premium amortization is increased. In periods of unexpectedly high
prepayment activity, the increased amortization will reduce net investment
income.
87
The following table sets forth the par value, amortized cost and estimated
fair value of structured securities, summarized by interest rates on the
underlying collateral at September 30, 2003 (dollars in millions):
PAR AMORTIZED ESTIMATED
VALUE COST FAIR VALUE
----- --------- ----------
Below 5 percent.................................... $ 798.4 $ 773.7 $ 796.0
5 percent-6 percent................................ 945.3 939.2 964.0
6 percent-7 percent................................ 3,158.5 3,264.9 3,303.2
7 percent-8 percent................................ 658.9 690.9 700.4
8 percent and above................................ 97.2 102.8 103.1
-------- -------- --------
Total structured securities(a)................... $5,658.3 $5,771.5 $5,866.7
======== ======== ========
---------------
(a) Includes below-investment grade structured securities with an amortized
cost and estimated fair value of $3.4 million.
The amortized cost and estimated fair value of structured securities at
September 30, 2003, summarized by type of security, were as follows (dollars in
millions):
ESTIMATED FAIR VALUE
--------------------
PERCENT OF
AMORTIZED FIXED
TYPE COST AMOUNT MATURITIES
---- --------- ------ ----------
Pass-throughs and sequential and targeted
amortization classes............................. $3,816.4 $3,863.0 20%
Planned amortization classes and accretion-directed
bonds............................................ 656.5 673.5 4
Commercial mortgage-backed securities.............. 1,018.7 1,050.5 5
Subordinated classes and mezzanine tranches........ 276.2 276.0 1
Other.............................................. 3.7 3.7 --
-------- -------- --
Total structured securities(a)................... $5,771.5 $5,866.7 30%
======== ======== ==
---------------
(a) Includes below-investment grade structured securities with an amortized
cost and estimated fair value of $3.4 million.
Pass-throughs and sequential and targeted amortization classes have similar
prepayment variability. Pass-throughs historically provide the best liquidity in
the mortgage-backed securities market. Pass-throughs are also used frequently in
the dollar roll market and can be used as the collateral when creating
collateralized mortgage obligations. Sequential classes are a series of tranches
that return principal to the holders in sequence. Targeted amortization classes
offer slightly better structure in return of principal than sequentials when
prepayment speeds are close to the speed at the time of creation.
Planned amortization classes and accretion-directed bonds are some of the
most stable and liquid instruments in the mortgaged-backed securities market.
Planned amortization class bonds adhere to a fixed schedule of principal
payments as long as the underlying mortgage collateral experiences prepayments
within a certain range. Changes in prepayment rates are first absorbed by
support or companion classes. This insulates the planned amortization class from
the consequences of both faster prepayments (average life shortening) and slower
prepayments (average life extension).
Commercial mortgage-backed securities ("CMBS") are bonds secured by
commercial real estate mortgages. Commercial real estate encompasses income
producing properties that are managed for economic profit. Property types
include multi-family dwellings including apartments, retail centers, hotels,
restaurants, hospitals, nursing homes, warehouses and office buildings. The CMBS
market currently offers higher yields, stronger credits, and more favorable call
protection compared to similar-rated corporate bonds. Most CMBS have strong call
protection features where borrowers are locked out from prepaying their
mortgages for a
88
stated period of time. If the borrower does prepay any or all of the loan, they
will be required to pay prepayment penalties.
Subordinated and mezzanine tranches are classes that provide credit
enhancement to the senior tranches. The rating agencies require that this credit
enhancement not deteriorate due to prepayments for a period of time, usually
five years of complete lockout, followed by another period of time where
prepayments are shared pro rata with senior tranches. Subordinated and mezzanine
tranches bear a majority of the risk of loss due to property owner defaults.
Subordinated bonds are generally rated "AA" or lower; we typically do not hold
securities rated lower than "BB".
MORTGAGE LOANS
At September 30, 2003, the mortgage loan balance of $1,154.1 million was
primarily comprised of commercial loans. Less than one percent of the mortgage
loan balance was noncurrent (loans with two or more scheduled payments past due)
at September 30, 2003.
INVESTMENT BORROWINGS
Our investment borrowings (excluding borrowings related to the GM building)
averaged approximately $531.5 million during the one month ended September 30,
2003; $689.1 million during the eight months ended August 31, 2003; and $1,226.4
million during the nine months ended September 30, 2002 and were collateralized
by investment securities with fair values approximately equal to the loan value.
The weighted average interest rates on such borrowings (excluding borrowings
related to the GM building) were 1.3 percent during the one month ended
September 30, 2003; 1.8 percent during the eight months ended August 31, 2003;
and 1.3 percent during the nine months ended September 30, 2002, respectively.
STATUTORY INFORMATION
Statutory accounting practices prescribed or permitted by regulatory
authorities for our insurance subsidiaries differ from GAAP. The statutory net
income (loss) of our insurance subsidiaries was $255.6 million and $(273.3)
million in the first nine months of 2003 and 2002, respectively (including
realized investment gains (losses) of $33.3 million and $(315.4) million,
respectively). Our insurance subsidiaries reported the following amounts to
regulatory agencies at September 30, 2003, after appropriate eliminations of
intercompany accounts among such subsidiaries (dollars in millions):
Statutory capital and surplus............................... $1,412.4
AVR......................................................... 78.4
Interest maintenance reserve................................ 358.5
--------
Total..................................................... $1,849.3
========
The statutory capital and surplus shown above included investments in the
preferred stock of CDOC of $159.0 million, all of which were eliminated in the
consolidated financial statements prepared in accordance with GAAP.
The ability of our insurance subsidiaries to pay dividends is subject to
state insurance department regulations. These regulations generally permit
dividends to be paid from statutory earned surplus of the insurance company for
any 12-month period in amounts equal to the greater of (or in a few states, the
lesser of): (i) statutory net gain from operations or statutory net income for
the prior year; and (ii) 10 percent of statutory capital and surplus as of the
end of the preceding year. Any dividends in excess of these levels require the
approval of the director or commissioner of the applicable state insurance
department.
On October 30, 2002, Bankers National Life Insurance Company and Conseco
Life Insurance Company of Texas (on behalf of itself and all other Conseco
insurance subsidiaries), our insurance subsidiaries domiciled in Texas, each
entered into consent orders with the Commissioner of Insurance for the State of
Texas whereby they agreed: (1) not to request any dividends or other
distributions before January 1, 2003 and, thereafter, not to pay any dividends
or other distributions to parent companies outside of the insurance
89
system without the prior approval of the Texas Insurance Commissioner; (2) to
continue to maintain sufficient capitalization and reserves as required by the
Texas Insurance Code; (3) to request approval from the Texas Insurance
Commissioner before making any disbursements not in the ordinary course of
business; (4) to complete any pending transactions previously reported to the
proper insurance regulatory officials prior to and during Conseco's
restructuring, unless not approved by the Texas Insurance Commissioner; (5) to
obtain a commitment from Conseco to maintain their infrastructure, employees,
systems and physical facilities prior to and during Conseco's restructuring; and
(6) to continue to permit the Texas Insurance Commissioner to examine its books,
papers, accounts, records and affairs. The consent orders were formally released
on November 19, 2003. We have agreed with the Texas Insurance Commissioner to
provide prior notice of certain transactions, including 30 days prior notice of
the payment of dividends by an insurance subsidiary to any non-insurance company
parent, and periodic reporting of information concerning our financial
performance and condition.
The National Association of Insurance Commissioners' Risk-Based Capital for
Life and/or Health Insurers Model Act (the "Model Act") provides a tool for
insurance regulators to determine the levels of statutory capital and surplus an
insurer must maintain in relation to its insurance and investment risks and
whether there is a need for possible regulatory attention. The Model Act
provides four levels of regulatory attention, varying with the ratio of the
insurance company's total adjusted capital (defined as the total of its
statutory capital and surplus, AVR and certain other adjustments) to its RBC:
(1) if a company's total adjusted capital is less than or equal to 100 percent
but greater than 75 percent of its 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; (2) if a company's
total adjusted capital is less than or equal to 75 percent but greater than 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
the corrective actions that must be followed; (3) if a company's total adjusted
capital is less than or equal to 50 percent but greater than 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; and (4) if a company's total adjusted capital is less than or equal to
35 percent of its RBC (the "Mandatory Control Level"), the regulatory authority
must place the company under its control. In addition, the Model Act provides
for an annual trend test if a company's total adjusted capital is between 100
percent and 125 percent of its RBC at the end of the year. The trend test
calculates the greater of the decrease in the margin of total adjusted capital
over RBC: (1) between the current year and the prior year; and (2) for the
average of the last 3 years. It assumes that such decrease could occur again in
the coming year. Any company whose trended total adjusted capital is less than
95 percent of its RBC would trigger a requirement to submit a comprehensive plan
as described above for the Company Action Level.
Two of our subsidiaries' RBC ratios, based on the capital balances reported
in their 2002 audited statutory financial statements, were less than 125
percent. As a result of an additional adjustment made in the amended 2002 annual
statement relating to one such subsidiary's investment in the GM building, its
RBC ratio exceeded 125 percent. As a result of the sale of the GM building, the
RBC ratio for the other such subsidiary has increased to a level above 125
percent. However, as a result of losses on the long-term care business within
the Other Business in Run-off segment during the third quarter of 2003,
including long-term care claim reserve strengthening of $87 million, we will
need to contribute additional capital to one subsidiary to enable its RBC ratio
to equal or exceed 125 at December 31, 2003.
The consolidated RBC ratio for our insurance subsidiaries was approximately
250 percent at September 30, 2003. We calculate the consolidated RBC ratio by
assuming all of the assets, liabilities, capital and surplus and other aspects
of the business of our insurance subsidiaries were combined together in one
insurance subsidiary, with appropriate intercompany eliminations.
Our insurance subsidiaries hold securities of three trusts which invest in
fixed maturities, mortgages, preferred stock, common stock and limited
partnerships. We consolidate the trusts in our financial statements prepared in
accordance with GAAP and at September 30, 2003, the estimated fair value of the
trust investments was approximately equal to their GAAP book value.
90
During the fourth quarter of 2003, the trusts began liquidating their
portfolios, a process which is expected to be completed in 2004. Our September
30, 2003 GAAP book value approximates the expected proceeds from this
liquidation. Statutory accounting practices on this type of investment differ
from GAAP and, as a result, the statutory book value exceeds the expected
proceeds by approximately $150 million. We have been and will be discussing the
appropriate statutory accounting treatment for this difference with its state
insurance regulators. The ultimate outcome of these discussions could result in
a reduction to our statutory capital and surplus and RBC. In any case, we do not
believe the potential outcome will have any effect on our compliance with
applicable risk-based capital requirements.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Our spread-based insurance business is subject to several inherent risks
arising from movements in interest rates, especially if we fail to anticipate or
respond to such movements. First, interest rate changes can cause compression of
our net spread between interest earned on investments and interest credited on
policyholder deposits, thereby adversely affecting our results. Second, if
interest rate changes produce an unanticipated increase in surrenders of our
spread-based products, we may be forced to sell investment assets at a loss in
order to fund such surrenders. At December 31, 2002, approximately 20 percent of
our total insurance liabilities (or approximately $4.5 billion) could be
surrendered by the policyholder without penalty. Finally, changes in interest
rates can have significant effects on the performance of our structured
securities portfolio, including collateralized mortgage obligations, as a result
of changes in the prepayment rate of the loans underlying such securities. We
follow asset/liability strategies that are designed to mitigate the effect of
interest rate changes on our profitability. However, there can be no assurance
that management will be successful in implementing such strategies and achieving
adequate investment spreads.
We seek to invest our available funds in a manner that will fund future
obligations to policyholders, subject to appropriate risk considerations. We
seek to meet this objective through investments that: (1) have similar
characteristics to the liabilities they support; (2) are diversified among
industries, issuers and geographic locations; and (3) make up a predominantly
investment-grade fixed maturity securities portfolio. Many of our products
incorporate surrender charges, market interest rate adjustments or other
features to encourage persistency.
We seek to maximize the total return on our investments through active
investment management. Accordingly, we have determined that our entire portfolio
of fixed maturity securities is available to be sold in response to: (1) changes
in market interest rates; (2) changes in relative values of individual
securities and asset sectors; (3) changes in prepayment risks; (4) changes in
credit quality outlook for certain securities; (5) liquidity needs; and (6)
other factors. From time to time, we invest in securities for trading purposes,
although such investments account for a relatively small portion of our total
portfolio.
The profitability of many of our products depends on the spreads between
the interest yield we earn on investments and the rates we credit on our
insurance liabilities. In addition, changes in competition and other factors,
including the impact of the level of surrenders and withdrawals, may limit our
ability to adjust or to maintain crediting rates at levels necessary to avoid
narrowing of spreads under certain market conditions. Approximately 46 percent
of our insurance liabilities were subject to interest rates that may be reset
annually; 36 percent have a fixed explicit interest rate for the duration of the
contract; 12 percent have credited rates which approximate the income earned by
the Company; and the remainder have no explicit interest rates. As of December
31, 2002, the average yield, computed on the cost basis of our investment
portfolio, was 6.7 percent, and the average interest rate credited or accruing
to our total insurance liabilities (excluding interest rate bonuses for the
first policy year only and excluding the effect of credited rates attributable
to variable or equity-indexed products) was 5.1 percent.
We use computer models to simulate the cash flows expected from our
existing insurance business under various interest rate scenarios. These
simulations help us to measure the potential gain or loss in fair value of our
interest rate-sensitive financial instruments. With such estimates, we seek to
closely match the duration of our assets to the duration of our liabilities.
91
We seek to balance the interest rate risk inherent in our invested assets
with the interest rate characteristics of our insurance liabilities. We attempt
to manage this exposure by measuring the duration of our fixed maturity
investments and insurance liabilities. Duration measures the expected change in
the fair value of assets and liabilities for a given change in interest rates.
For example, if interest rates increase by 1 percent, the fair value of a fixed
maturity security with a duration of 5 years is expected to decrease in value by
approximately 5 percent. 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.
We calculate duration using our estimates of future asset and liability
cash flows. These cash flows are discounted using appropriate interest rates
based on the current yield curve and investment type. Duration is determined by
calculating the present value of the cash flows using different interest rates,
and measuring the change in value. At December 31, 2002, the duration of our
fixed maturity investments (as modified to reflect prepayments and potential
calls) was approximately 6.6 years and the duration of our insurance liabilities
was approximately 6.0 years. The difference between these durations indicates
that our investment portfolio had a longer duration and, consequently, was more
sensitive to interest rate fluctuations than that of our liabilities at that
date. We seek to minimize the gap between asset and liability durations. We
estimate that our fixed maturity securities and short-term investments (net of
corresponding changes in the value of cost of policies purchased, cost of
policies produced and insurance liabilities) would decline in fair value by
approximately $595 million if interest rates were to increase by 10 percent from
their December 31, 2002 levels. This compares to a decline in fair value of $555
million based on amounts and rates at December 31, 2001. The calculations
involved in our computer simulations incorporate numerous assumptions, require
significant estimates and assume an immediate change in interest rates without
any management of the investment portfolio in reaction to such change.
Consequently, potential changes in value of our financial instruments indicated
by the simulations will likely be different from the actual changes experienced
under given interest rate scenarios, and the differences may be material.
Because we actively manage our investments and liabilities, our net exposure to
interest rates can vary over time.
We are subject to the risk that our investments will decline in value. This
has occurred in the past and may occur again. During 2002, we recognized net
realized investment losses of $556.3 million, compared to net realized
investment losses of $340.0 million during 2001. The net realized investment
losses during 2002 included: (1) $556.8 million of writedowns of fixed maturity
investments, equity securities and other invested assets as a result of
conditions which caused us to conclude a decline in fair value of the investment
was other than temporary; and (2) $.5 million of net gains from the sales of
investments (primarily fixed maturities) which generated proceeds of $19.5
billion. During 2002, we recognized other-than-temporary declines in value of
several of our investments, including K-Mart Corp., Amerco, Inc., Global
Crossing, MCI Communications, Mississippi Chemical, United Airlines and
Worldcom, Inc.
Our operations are subject to risk resulting from fluctuations in market
prices of our equity securities and venture-capital investments. In general,
these investments have more year-to-year price variability than our fixed
maturity investments. However, returns over longer time frames have been
consistently higher. We manage this risk by limiting our equity securities and
venture-capital investments to a relatively small portion of our total
investments.
Our investment in S&P 500 Call Options is closely matched with our
obligation to equity-indexed annuity holders. Market value changes associated
with that investment are substantially offset by an increase or decrease in the
amounts added to policyholder account balances for equity-indexed products.
92
BUSINESS
We are a holding company for a group of insurance companies operating
throughout the United States that develop, market and administer supplemental
health insurance, annuity, individual life insurance and other insurance
products. We focus on serving the senior and middle-income markets, which we
believe are attractive, high growth markets. We sell our products through three
distribution channels: career agents, professional independent producers (some
of whom sell one or more of our product lines exclusively) and direct marketing.
As of September 30, 2003, we had $2.8 billion of shareholders' equity and $29.9
billion of assets. For the one month ended September 30, 2003, we had $366.3
million of revenues and $24.2 million of net income.
We are the successor to Conseco, Inc., an Indiana corporation. On December
17, 2002, our predecessor and certain of its non-insurance company subsidiaries
filed voluntary petitions for relief under Chapter 11 of the United States
Bankruptcy Code. We became the successor to our predecessor in connection with
our emergence from bankruptcy on September 10, 2003. As part of our
reorganization, we sold substantially all of the assets of the predecessor's
finance business and exited from this line of business in the second quarter of
2003.
We conduct our business operations through two primary operating segments,
based on method of product distribution, and a third segment comprised of
businesses in run-off:
- BANKERS LIFE, which consists of the businesses of Bankers Life & Casualty
and Colonial Penn. Bankers Life & Casualty markets and distributes
Medicare supplement insurance, life insurance, long-term care insurance
and fixed annuities to the senior market through approximately 4,000
exclusive career agents and sales managers. Colonial Penn markets graded
benefit and simplified issue life insurance directly to consumers through
television advertising, direct mail, the internet and telemarketing. Both
Bankers Life & Casualty and Colonial Penn market their products under
their own brand names.
- CONSECO INSURANCE GROUP, which markets and distributes specified disease
insurance, Medicare supplement insurance, and certain life and annuity
products to the senior and middle-income markets through over 500 IMOs
that represent over 9,100 producing independent agents. This segment
markets its products under the "Conseco" brand.
- OTHER BUSINESS IN RUN-OFF, which includes blocks of business that we no
longer market or underwrite. This segment consists of long-term care
insurance sold through independent agents and major medical insurance.
We also have a corporate segment, which consists of holding company
activities and certain non-insurance company businesses that are not related to
our operating segments.
The following table sets forth information on our segments for the one
month ended September 30, 2003 (dollars in millions):
COLLECTED PREMIUMS
------------------- INCOME BEFORE
$ PERCENTAGE INCOME TAXES
------ ---------- -------------
Bankers Life..................................... $172.1 53.0% $ 24.9
Conseco Insurance Group.......................... 104.7 32.2 20.2
Other Business In Run-off........................ 48.0 14.8 3.6
Corporate........................................ -- -- (10.9)
------ ----- ------
Total............................................ $324.8 100.0% $ 37.8
====== ===== ======
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OUR RESTRUCTURING
We are in the process of significantly restructuring our business through a
process which included the bankruptcy of our predecessor company and our
subsequent emergence from bankruptcy on September 10, 2003. None of our
insurance company subsidiaries were a part of the bankruptcy petitions, although
the bankruptcy did cause disruptions to our insurance operations.
We have achieved several critical financial goals as part of our
restructuring, including:
- reducing our debt and other obligations by $5.7 billion,
- disposing of the assets of our predecessor's finance business,
- selling non-core operating subsidiaries such as CVIC,
- improving the risk profile of our investment portfolio, and
- improving the financial strength of our insurance companies as measured
by risk-based capital.
We have also recruited and integrated new members into our management team,
and we have a new board of directors. Since our emergence from bankruptcy,
management has continued to take steps in an effort to improve our profitability
and further streamline our business. For example, in September 2003, we sold our
stake in the GM building, which increased the statutory capital and surplus of
our insurance subsidiaries by over $350 million.
We have also undertaken several strategic initiatives to streamline our
business lines, focusing on those businesses we believe are most profitable.
These initiatives include emphasizing the sales of Medicare supplement and
specified disease products and de-emphasizing sales of certain annuity and life
products, ceasing sales of long-term care products in Conseco Insurance Group
and attempting to re-price certain lines of business through significant rate
increases.
The next stage of our restructuring, which includes the offering of our
common stock and the offering of the Class B Preferred Stock, is the
Recapitalization. The offering of our Class B Preferred Stock is conditioned
upon the offering of our common stock. The offering of our common stock is not
conditioned upon the offering of our Class B Preferred Stock. Our current
capitalization is presented below:
AS OF
SEPTEMBER 30, 2003
------------------
(IN MILLIONS)
Notes payable............................................... $1,300.0
--------
Equity:
Preferred Stock, par value $0.01 per share, 265,000,000
authorized; 34,386,740 shares of Class A Senior
Cumulative Convertible Exchangeable Preferred Stock
issued and outstanding................................. 865.0
Common Stock, par value $0.01 per share, 8,000,000,000
authorized; 100,098,119 issued and outstanding......... 1.0
Additional paid-in-capital................................ 1,639.3
Accumulated other comprehensive income.................... 273.2
Retained earnings......................................... 18.9
--------
Total equity........................................... 2,797.4
--------
Total capitalization................................. $4,097.4
========
The Recapitalization has two components:
- REDEMPTION OF OUR EXISTING PREFERRED STOCK. We plan to use a portion of
the proceeds of the offerings to redeem our outstanding Class A Preferred
Stock.
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- REDUCTION AND REPLACEMENT OR RENEGOTIATION OF OUR EXISTING BANK CREDIT
FACILITY. We intend to reduce our overall senior indebtedness, reduce our
borrowing costs and improve the terms and conditions of our existing bank
credit facility. We believe that we can achieve these goals by using a portion
of the proceeds of the offerings of our common stock and our Class B Preferred
Stock to retire a portion of our existing debt, or by renegotiating the terms
of our existing bank credit facility.
By redeeming all or a part of the Class A Preferred Stock and reducing our
overall indebtedness, our goals are to improve the financial flexibility of our
top-tier holding company and improve the financial strength ratings of our
insurance companies. The completion of the common stock offering is not
conditioned upon completion of the Class B Preferred Stock offering, and if we
complete the common stock offering but not the Class B Preferred Stock offering,
we will have fewer proceeds to apply in this regard.
COMPETITIVE STRENGTHS
We believe our competitive strengths have enabled and will continue to
enable us to capitalize on the opportunities in our target markets. These
strengths include:
- our position as a leading national provider of life and health insurance
products to the senior market,
- our broad-based distribution networks,
- our strong nationally recognized brand names, and
- our experienced management with a proven track record.
LEADING NATIONAL PROVIDER OF LIFE AND HEALTH INSURANCE PRODUCTS TO THE
SENIOR MARKET. The Bankers Life segment is one of the leading national
providers of life and health insurance products focused primarily on the senior
market. The career agents and direct distribution channels within Bankers Life
provide a number of products that are important to the financial well-being of
seniors: supplemental health coverage, including Medicare supplement and
long-term care insurance, as well as selected life and annuity products.
According to the most recently published study on the Medicare Supplement market
by the Life Insurance Marketing Research Association, we were ranked second in
sales of agent-distributed Medicare supplement insurance based on collected
premiums in 2002. Our approximately 4,000 career agents are trained to cater to
the needs of the senior market. Current demographic trends indicate that the
senior market will continue to grow, and we believe our focus on seniors will
provide us with a significant opportunity to increase our share of this market.
BROAD-BASED DISTRIBUTION NETWORKS. Our broad-based distribution networks
provide us with a number of ways to reach our target market. Our career agents
and direct distribution channels focus on the senior market. We also have
independent agents who focus on senior market products such as Medicare
supplement insurance. Our independent agents also sell certain of our products
that are specifically designed for the under-age-65 middle-income market. These
products include our specified disease insurance coverage, such as cancer and
heart/stroke products, as well as equity-indexed life insurance and
equity-indexed annuities. Despite the bankruptcy, we have retained the majority
of our career agents, including 80 percent of our top 1,000 career agents, who
accounted for over 50 percent of Bankers Life & Casualty's sales during 2003. In
2002, 55 percent of our sales were through independent distributors, 43 percent
were through career agents, and 2 percent were through direct marketing by
Colonial Penn.
STRONG, NATIONALLY RECOGNIZED BRAND NAMES. We believe our brands are
widely recognized by our customers and distributors. We believe we have
successfully developed product-focused consumer recognition in our chosen
markets through three distinct brands -- Conseco, Bankers Life & Casualty and
Colonial Penn. According to Communicus, an independent research firm, we have
increased the awareness of the Conseco brand from 28 percent of consumers in our
target market in 1998 to 50 percent in 2003. Additionally, we believe our
multiple-brand strategy has helped us maintain sales of certain key products,
such as Medicare supplement, and retain business through our reorganization. We
continue to raise the profile of our brands through our "Step Up" campaign and
several national and local community sponsorship arrangements, including Indy
Racing League and the Conseco Fieldhouse in Indianapolis, home to the Indiana
Pacers NBA
95
basketball team. In addition, we continue to raise the profile of our Bankers
Life brand through our continued relationship with the Alzheimer's Association
and International Longevity Center as well as a renewed relationship with Paul
Harvey, who for many years was the spokesperson for Bankers Life & Casualty. We
believe that our brands give us a key competitive advantage, allowing us to
continue to build and maintain strong relationships with our customers and
distributors.
EXPERIENCED MANAGEMENT WITH A PROVEN TRACK RECORD. Our strong, experienced
senior management team has led us through our restructuring to date. Our
management is led by our President and Chief Executive Officer, William J. Shea,
who has over 25 years of financial services experience and joined Conseco in
2001. Mr. Shea has served as Vice Chairman and Chief Financial Officer of
BankBoston Corporation and as Partner and Vice Chairman of
PricewaterhouseCoopers LLP (formerly Coopers & Lybrand LLP). In addition to our
experienced senior management team, our Non-Executive Chairman, R. Glenn
Hilliard, has over 35 years of insurance experience, having served most recently
as Chairman and CEO of ING Americas. Mr. Hilliard joined our board in September
2003. Our management's knowledge and experience have helped us maintain our
business operations through the restructuring and are expected to provide us
with opportunities to further enhance the Company in the future.
STRATEGY
Our objective is to generate attractive returns on equity while growing a
stable, well capitalized insurance business focused on serving the middle-income
and senior markets. We intend to achieve these objectives by executing the
following strategies:
- focus on the senior and middle-income markets,
- continue to improve our financial condition,
- leverage our distribution network to strengthen market access, and
- continue to improve our operational efficiency.
FOCUS ON THE SENIOR AND MIDDLE-INCOME MARKETS. We are committed to serving
the senior and middle-income markets in the United States. Our customer base
includes approximately 3.8 million policyholders. According to the January 2004
issue of "Journal of Financial Service Professionals," the population of the
United States age 50 or older is projected to increase by approximately 27
percent from 2004 to 2014. We have taken several steps in recent periods to
sharpen our focus on both markets by strengthening our distribution, reducing
our sales of non-core life and annuity products and introducing new and
innovative supplemental health and retirement savings products targeting senior
and middle-income customers.
CONTINUE TO IMPROVE OUR FINANCIAL CONDITION. We seek to continue to
improve our financial condition by reducing leverage at the holding company,
maintaining adequate risk-based capital in our operating subsidiaries and
focusing on marketing profitable products. We took a series of actions in 2002
and 2003 to enhance our financial condition. In addition to reducing our debt
and other obligations at the holding company by $5.7 billion through the
bankruptcy, we improved the risk profile of our investment portfolio and the
financial strength of our insurance companies as measured by risk-based capital.
Our fixed maturity investment portfolio is primarily comprised of government,
investment-grade and structured securities. Below-investment grade securities
comprised 4.1 percent of our fixed maturity portfolio as of September 30, 2003,
down from 6.5 percent as of December 31, 2002. Our insurance companies'
consolidated company action level RBC improved from 166 percent at December 31,
2002 to approximately 250 percent at September 30, 2003. The RBC ratio is one of
the tools insurance regulators use to determine the adequacy of an insurance
company's capital. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Statutory Information" for further
information. We intend to continue to manage our business with a view to
improving our capitalization, financial strength and ratings.
LEVERAGE OUR DISTRIBUTION NETWORK TO STRENGTHEN MARKET ACCESS. We seek to
leverage our broad distribution channels to meet our customers' needs and
enhance our market presence. We believe we have
96
created appropriate incentives focused on persistent and profitable production,
as well as improved monitoring and tracking of production and persistency levels
by distributor. We promote cross-selling of life, supplemental health and
retirement savings products in certain markets to capture a greater share of our
policyholders' coverage needs. In addition, we utilize our independent producers
and career agent network as important sources of information regarding the
evolving needs of our customer base. As a result, our products are tailored to
include the specific features that we believe are most important to our
customers. If we are successful in raising our ratings, we expect to be able to
add new agents to our career and independent agency distribution channels, which
we believe will result in increased sales of our insurance products.
CONTINUE TO IMPROVE OUR OPERATIONAL EFFICIENCY. We have undertaken several
initiatives to improve our operational efficiency and lower costs. We have
simplified our organizational structure by divesting certain businesses and
consolidating several legal entities. We are in the process of integrating
policy administration and claims management systems from previous acquisitions
to lower our operational costs in our Conseco Insurance Group Segment. We intend
to reduce the number of policy administration and related support systems by 50
percent over the next 12 to 18 months. We have also reduced our headcount over
the past two years and have focused on improving the productivity of our
employees, career agents and independent distributors. We intend to continue to
work to improve our operational efficiency by rationalizing expenses and systems
in an effort to enhance our service standards and profitability.
PRODUCTS
The following table summarizes premium collections by major category and
distribution channels for the nine month periods ended September 30, 2003 and
2002 and for the years ended December 31, 2002, 2001 and 2000 (dollars in
millions):
TOTAL PREMIUM COLLECTIONS
NINE MONTHS ENDED YEARS ENDED
SEPTEMBER 30, DECEMBER 31,
------------------- -------------------
2003 2002 2002 2001
---- ---- ---- ----
Supplemental health:
Bankers Life............................... $ 856.2 $ 854.8 $1,159.4 $1,097.4
Conseco Insurance Group.................... 590.3 614.3 830.3 784.1
Other Business in Run-off.................. 472.4 662.7 844.0 1,200.1
-------- -------- -------- --------
Total supplemental health............... 1,918.9 2,131.8 2,833.7 3,081.6
-------- -------- -------- --------
Annuities:
Bankers Life............................... 761.9 496.8 740.9 513.1
Conseco Insurance Group.................... 79.2 307.3 351.9 710.6
-------- -------- -------- --------
Total annuities......................... 841.1 804.1 1,092.8 1,223.7
-------- -------- -------- --------
Life:
Bankers Life............................... 114.7 99.7 139.0 286.3
Conseco Insurance Group.................... 315.2 384.1 498.0 553.3
-------- -------- -------- --------
Total................................... 429.9 483.8 637.0 839.6
-------- -------- -------- --------
Total premium collections.................... $3,189.9 $3,419.7 $4,563.5 $5,144.9
======== ======== ======== ========
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Our insurance companies offer the following products:
SUPPLEMENTAL HEALTH
SUPPLEMENTAL HEALTH PREMIUM COLLECTIONS (DOLLARS IN MILLIONS)
NINE MONTHS ENDED YEARS ENDED
SEPTEMBER 30, DECEMBER 31,
------------------- -------------------
2003 2002 2002 2001
---- ---- ---- ----
Medicare Supplement:
Bankers Life....................................... $ 472.1 $ 490.2 $ 663.9 $ 656.7
Conseco Insurance Group............................ 280.2 268.8 369.9 318.4
-------- -------- -------- --------
Total.............................................. 752.3 759.0 1,033.8 975.1
-------- -------- -------- --------
Long-Term Care:
Bankers Life....................................... 374.1 355.1 482.9 425.3
Conseco Insurance Group(1)......................... N/A N/A N/A N/A
Other Business in Run-off.......................... 298.1 325.3 434.5 463.0
-------- -------- -------- --------
Total.............................................. 672.2 680.4 917.4 888.3
-------- -------- -------- --------
Specified-disease products from
Conseco Insurance Group............................ 265.9 276.4 368.6 371.8
-------- -------- -------- --------
Major medical business included in the Other Business
in Run-off......................................... 174.3 337.4 409.5 737.1
-------- -------- -------- --------
Other
Bankers Life....................................... 10.0 9.5 12.6 15.4
Conseco Insurance Group............................ 44.2 69.1 91.8 93.9
-------- -------- -------- --------
Total.............................................. 54.2 78.6 104.4 109.3
-------- -------- -------- --------
Total -- Supplemental Health......................... $1,918.9 $2,131.8 $2,833.7 $3,081.6
======== ======== ======== ========
---------------
(1) We have ceased writing long-term care through Conseco Insurance Group and
all major medical insurance and, as such, classifies associated collected
premiums as part of "Other Business in Run-off."
Supplemental health products include Medicare supplement, long-term care
and specified disease insurance and major medical insurance business in run-off.
During the nine months ended September 30, 2003, we collected supplemental
health premiums of $1,918.9 million or 60 percent of our total premiums
collected. During the nine months ended September 30, 2003, we collected
Medicare supplement premiums of $752.3 million, long-term care premiums of
$672.2 million, specified disease premiums of $265.9 million, major medical
premiums of $174.3 million and other supplemental health premiums of $54.2
million. Medicare supplement, long-term care, specified disease, major medical
and other supplemental health premiums represented 24 percent, 21 percent, 8
percent, 5 percent and 2 percent, respectively, of our total premiums collected
in the first nine months of 2003. Sales of supplemental health products are
affected by the financial strength ratings assigned to our insurance
subsidiaries by independent rating agencies. See "Competition" below.
The following describes our major supplemental health products:
MEDICARE SUPPLEMENT. Medicare supplement collected premiums were $752.3
million during the nine months ended September 30, 2003 or 24 percent of our
total collected premiums. 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
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Medicare covers doctor's bills and a number of other medical costs not covered
by Part A, subject to deductible and coinsurance amounts for "approved" charges.
Medicare supplement policies provide coverage for many of the medical
expenses which the Medicare program does not cover, such as deductibles,
coinsurance costs (in which the insured and Medicare share the costs of medical
expenses) and specified losses which exceed the federal program's maximum
benefits. Our Medicare supplement plans automatically adjust coverage to reflect
changes in Medicare benefits. In marketing these products, we concentrate on
individuals who have recently become eligible for Medicare by reaching the age
of 65. We offer a higher first-year commission to agents for sales to these
policyholders and competitive premium pricing for our policyholders.
Approximately 26 percent of new sales of Medicare supplement policies in 2002
were to individuals who have recently reached the age of 65.
Both Bankers Life and Conseco Insurance Group sell Medicare supplement
insurance.
LONG-TERM CARE. Long-term care collected premiums were $672.2 million
during the nine months ended September 30, 2003 or 21 percent of our total
collected premiums. Long-term care products provide coverage, within prescribed
limits, for nursing home, home healthcare, or a combination of both nursing home
and home healthcare expenses. The long-term care plans are sold primarily to
retirees and, to a lesser degree, to older self-employed individuals and others
in middle-income levels.
Current nursing home care policies cover incurred and daily fixed-dollar
benefits available with an elimination period (which, similar to a deductible,
requires the insured to pay for a certain number of days of nursing home care
before the insurance coverage begins), subject to a maximum benefit. Home
healthcare policies cover the usual and customary charges after a deductible or
elimination period and are subject to a daily or weekly maximum dollar amount,
and an overall benefit maximum. We monitor the loss experience on our long-term
care products and, when necessary, apply for rate increases in the jurisdictions
in which we sell such products. Regulatory approval is required to increase our
premiums on these products.
The long-term care insurance blocks of business sold through the
professional independent producer distribution channel were largely underwritten
by certain of our subsidiaries prior to their acquisition by Conseco in 1996 and
1997. The performance of these blocks of business has been significantly less
favorable than our expectations when the blocks were acquired. As a result, we
ceased selling new long-term care policies through this distribution channel.
We continue to sell long-term care insurance through the career agent
distribution channel. The long-term care business sold through Bankers Life's
career agents was underwritten using stricter underwriting and pricing standards
than our acquired blocks of long-term care business included in the Other
Business in Run-off segment. In addition, Bankers Life's claim management
procedures are more advanced than those of our other subsidiaries. The
performance of this block has been better and more predictable than the acquired
business.
SPECIFIED DISEASE PRODUCTS. Specified disease collected premiums were
$265.9 million during the nine months ended September 30, 2003 or 8 percent of
our total collected premiums. 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 and benefits are
not reduced by any other medical insurance payments made to or on behalf of the
insured.
Approximately 77 percent of our specified disease policies inforce (based
on a count of policies) are sold with return of premium or cash value riders.
The return of premium rider generally provides that after a policy has been in
force for a specified number of years or upon the policyholder reaching a
specified age, we 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.
99
Our specified disease products are sold through the independent
distribution network of Conseco Insurance Group.
MAJOR MEDICAL. Our major medical business is included in our Other
Business in Run-off segment. Sales of our major medical health insurance
products were targeted to self-employed individuals, small business owners,
large employers and early retirees. Various deductible and coinsurance options
are available, and most policies require certain utilization review procedures.
The profitability of this business depends largely on the overall persistency of
the business inforce, claim experience and expense management. During 2001, we
decided to discontinue a large block of major medical business by not renewing
these policies because this business was not profitable. During the nine months
ended September 30, 2003, we collected major medical premiums of $174.3 million,
or 5.5 percent of our total collected premiums.
OTHER SUPPLEMENTAL HEALTH PRODUCTS. Other supplemental health product
collected premiums were $54.2 million, or 1.7 percent of our total collected
premiums. These products include various other products such as disability
income insurance. We no longer actively market these products.
ANNUITIES
ANNUITY PREMIUM COLLECTIONS (DOLLARS IN MILLIONS)
NINE MONTHS
ENDED YEARS ENDED
SEPTEMBER 30, DECEMBER 31,
--------------- ---------------------
2003 2002 2002 2001
---- ---- ---- ----
Equity-indexed annuity
Bankers Life........................................ $ 10.6 $ 25.9 $ 30.4 $ 41.4
Conseco Insurance Group............................. 47.2 163.3 189.7 339.5
------ ------ --------- ---------
Total equity-indexed annuity premium
collections.................................... 57.8 189.2 220.1 380.9
------ ------ --------- ---------
Other fixed annuity
Bankers Life........................................ 751.3 470.9 710.5 471.7
Conseco Insurance Group............................. 32.0 144.0 162.2 371.1
------ ------ --------- ---------
Total fixed annuity premium collections.......... 783.3 614.9 872.7 842.8
------ ------ --------- ---------
Total annuity collections............................. $841.1 $804.1 $1,092.80 $1,223.70
====== ====== ========= =========
During the nine months ended September 30, 2003, we collected annuity
premiums of $841.1 million or 26 percent of our total premiums collected.
Annuity products include equity-indexed annuity, traditional fixed rate annuity
and market value-adjusted annuity products sold through both Bankers Life and
Conseco Insurance Group. Annuities offer a tax-deferred means of accumulating
savings for retirement needs, and provide a tax-efficient source of income in
the payout period. Our major source of income from annuities is the spread
between the investment income earned on the underlying general account assets
and the interest credited to contractholders' accounts.
More than our other products, annuities are affected by the financial
strength ratings assigned to our insurance subsidiaries by independent rating
agencies. Many of our professional independent agents discontinued marketing our
annuity products after A.M. Best lowered the financial strength ratings assigned
to our insurance subsidiaries. In addition, the annuity business we were selling
through this distribution channel required more statutory capital and surplus
than our other insurance products. Accordingly, we took actions in our Conseco
Insurance Group Segment to reduce expenses by eliminating the marketing expenses
related to annuity products sold through professional independent producers and
instead focused on the sale of products that are less ratings sensitive and
capital intensive. Our career agents, in our Bankers Life segment who sell
annuity products are less sensitive in the near-term to A.M. Best ratings, since
these agents only sell our products. Accordingly, we continue to actively market
annuities through Bankers Life. In order to maintain
100
Bankers Life's career agency distribution force during the bankruptcy process,
we provided certain sales inducements to purchasers of annuities and sales
incentives to our career agents.
The following describes the major annuity products:
EQUITY-INDEXED ANNUITIES. These products accounted for $57.8 million, or
1.8 percent, of our total premium collections during the nine months ended
September 30, 2003. The accumulation value of these annuities is credited with
interest at an annual minimum guaranteed average rate over the term of the
contract of 3 percent (or, including the effect of applicable sales loads, a 1.7
percent compound average interest rate over the term of the contracts), but the
annuities provide for potentially higher returns based on a percentage (the
"participation rate") of the change in the S&P 500 Index during each year of
their term. We have the discretionary ability to annually change the
participation rate, which currently ranges from 50 percent to 100 percent, and
may include a first-year "bonus" participation rate, similar to the bonus
interest described below for traditional fixed rate annuity products, which
generally ranges from an additional 10 percent to 30 percent. The minimum
guaranteed values are equal to:
- 90 percent of premiums collected for annuities for which premiums are
received in a single payment (single-premium deferred annuities "SPDAs"),
or 75 percent of first year and 87.5 percent of renewal premiums
collected for annuities which allow for more than one payment (flexible
premium deferred annuities "FPDAs"); plus
- interest credited on such percentage of the premiums collected at an
annual rate of 3 percent. The annuity provides for penalty-free
withdrawals of up to 10 percent of premiums in each year after the first
year of the annuity's term.
Other withdrawals from SPDA products are generally subject to a surrender charge
of 9 percent over the eight year contract term at the end of which the contract
must be renewed or withdrawn. Other withdrawals from FPDA products are subject
to a surrender charge of 12 percent to 20 percent in the first year, declining
1.2 percent to 1.3 percent each year, to zero over a 10 to 15 year period,
depending on issue age. We purchase S&P 500 Index call options in an effort to
offset, or "hedge," potential increases to policyholder benefits resulting from
increases in the S&P 500 Index to which the product's return is linked.
OTHER FIXED RATE ANNUITIES. These products include fixed rate SPDAs, FPDAs
and single-premium immediate annuities ("SPIAs"). These products accounted for
$783.3 million, or 24 percent, of our total premium collections during the nine
months ended September 30, 2003. Our fixed rate SPDAs and FPDAs 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 on annuities written recently ranges from 3 percent to 4
percent, and the rate on all policies inforce ranges from 3 percent to 6
percent. The initial crediting rate is largely a function of:
- the interest rate we can earn on invested assets acquired with the new
annuity fund deposits;
- the costs related to marketing and maintaining the annuity products; and
- the rates offered on similar products by our competitors.
For subsequent adjustments to crediting rates, we take into account current and
prospective yields on investments, annuity surrender assumptions, competitive
industry pricing and the crediting rate history for particular groups of annuity
policies with similar characteristics.
In 2002, approximately 77 percent of our new annuity sales have been
"bonus" products. The initial crediting rate on these products specifies a bonus
crediting rate ranging from 1 percent to 6 percent of the annuity deposit for
the first policy year only. After the first year, the bonus interest portion of
the initial crediting rate is automatically discontinued, and the renewal
crediting rate is established. As of December 31, 2002, crediting rates on our
outstanding traditional annuities were at an average rate of 4.3 percent.
The policyholder is typically permitted to withdraw all or part of the
premium paid plus the accumulated interest credited to his or her account (the
"accumulation value"), subject in virtually all cases
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to the assessment of a surrender charge for withdrawals in excess of specified
limits. Most of our traditional annuities provide for penalty-free withdrawals
of up to 10 percent of the accumulation value each year, subject to limitations.
Withdrawals in excess of allowable penalty-free amounts are assessed a surrender
charge during a penalty period which generally ranges from five to 12 years
after the date a policy is issued. The initial surrender charge is generally 6
percent to 12 percent of the accumulation value and generally decreases by
approximately 1 to 2 percentage points per year during the penalty period.
Surrender charges are set at levels intended to protect us from loss on early
terminations and to reduce the likelihood of policyholders terminating their
policies during periods of increasing interest rates. This practice is intended
to lengthen the effective duration of policy liabilities and enable us to
maintain profitability on such policies.
SPIAs accounted for $21.1 million, or 0.7 percent, of our total premiums
collected in the nine months ended September 30, 2003. 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 our outstanding SPIAs averaged 6.9 percent at December 31,
2002.
We also offered a multibucket annuity product which provides for different
rates of cash value growth based on the experience of a particular market
strategy. Earnings are credited to this product based on the market activity of
a given strategy, less management fees, and funds may be moved between cash
value strategies. Portfolios available include high-yield bond, investment-grade
bond, convertible bond and guaranteed-rate portfolios. During the nine months
ended September 30, 2003, this product accounted for $3.4 million, or .1
percent, of our total premiums collected. Sales of this product were
discontinued in 2003.
In October 2002, we sold Conseco Variable Insurance Company, a company
engaged in the variable annuity business. In connection with that sale, we
agreed with the buyer not to engage in the variable annuity business for a
period of three years. We no longer offer variable annuity products.
LIFE
LIFE INSURANCE PREMIUM COLLECTIONS (DOLLARS IN MILLIONS)
Nine months
ended Years ended
September 30, December 31,
--------------- ---------------
2003 2002 2002 2001
---- ---- ---- ----
Bankers Life
First year............................................... $ 29.0 $ 27.4 $ 37.5 $ 50.2
Renewal.................................................. 85.7 72.3 101.5 236.1
Total life insurance -- Bankers Life.................. 114.7 99.7 139.0 286.3
------ ------ ------ ------
Conseco Insurance Group
First year............................................... 22.3 48.5 59.2 69.9
Renewal.................................................. 292.9 335.6 438.8 483.4
Total life insurance -- Conseco Insurance Group....... 315.2 384.1 498.0 553.3
------ ------ ------ ------
Total life insurance premium collections................... $429.9 $483.8 $637.0 $839.6
====== ====== ====== ======
Life products include traditional, interest-sensitive and other life
insurance products. These products are currently sold through both Bankers Life
and Conseco Insurance Group. During the nine months ended September 30, 2003, we
collected life insurance premiums of $429.9 million, or 14 percent, of our total
collected premiums. In April 2003, we took actions to de-emphasize new sales of
several of our life insurance products through Conseco Insurance Group's
professional independent producers. Sales of life products are
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affected by the financial strength ratings assigned to our insurance
subsidiaries by independent rating agencies. See "Competition" below.
INTEREST-SENSITIVE LIFE PRODUCTS. These products include universal life
products that provide whole life insurance with adjustable rates of return
related to current interest rates. They accounted for $228.7 million, or 7.2
percent of our total collected premiums in the nine months ended September 30,
2003. These products 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.
TRADITIONAL LIFE. These products accounted for $201.2 million, or 6.3
percent, of our total collected premiums in the nine months ended September 30,
2003. Traditional life policies, including whole life, graded benefit life and
term life products, are marketed through professional independent producers,
career agents and direct response marketing. Under whole life policies, the
policyholder generally pays a level premium over an agreed period or the
policyholder's lifetime. The annual premium in a whole life policy is generally
higher than the premium for comparable term insurance coverage in the early
years of the policy's life, but is generally lower than the premium for
comparable term insurance coverage in the later years of the policy's life.
These policies, which we continue to market on a limited basis, combine
insurance protection with a savings component that gradually increases in amount
over the life of the policy. The policyholder may borrow against the savings
generally at a rate of interest lower than that available from other lending
sources. The policyholder may also choose to surrender the policy and receive
the accumulated cash value rather than continuing the insurance protection. Term
life products offer pure insurance protection for a specified period of
time -- typically five, 10 or 20 years. We stopped selling most term life
products through the professional independent producer distribution channel
during the second quarter of 2003.
Traditional life products also include graded benefit life insurance
products. Graded benefit life products accounted for $83 million, or 2.6
percent, of our total collected premiums in the nine months ended September 30,
2003. 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. Our
Bankers Life segment markets graded benefit life policies under the Colonial
Penn brand name using direct response marketing techniques. New policyholder
leads are generated primarily from television and print advertisements.
MARKETING AND DISTRIBUTION
Our insurance subsidiaries develop, market and administer supplemental
health insurance, annuity, individual life insurance and other insurance
products. We sell these products through three primary distribution channels:
career agents, professional independent producers (some of whom sell one or more
of our product lines exclusively) and direct marketing. We had over $324 million
of premium and asset accumulation product collections during the one month ended
September 30, 2003, $2.9 billion in the eight month period ended August 31,
2003, and $4.6 billion during 2002.
Our insurance subsidiaries collectively hold licenses to market our
insurance products in all fifty states, the District of Columbia, and certain
protectorates of the United States. Sales to residents of the following states
accounted for at least 5 percent of our 2002 collected premiums: Florida (8.5
percent), California (7.5 percent), Illinois (7.3 percent), Texas (7.1 percent)
and Michigan (5.3 percent).
We believe that people purchase most types of life insurance, accident and
health insurance and annuity products only after being contacted and solicited
by an insurance agent. Accordingly, we believe the success
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of our distribution system is largely dependent on our ability to attract and
retain agents who are experienced and highly motivated. A description of our
primary distribution channels is as follows:
CAREER AGENTS. This agency force of approximately 4,000 agents working
from 140 branch offices, permits one-on-one contacts with potential
policyholders and promotes strong personal relationships with existing
policyholders. The career agents sell primarily Medicare supplement and
long-term care insurance policies, senior life insurance and annuities. During
the nine months ended September 30, 2003, this distribution channel accounted
for $1,649.8 million, or 52 percent, of our total collected premiums. These
agents sell only Bankers Life & Casualty's 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.
PROFESSIONAL INDEPENDENT PRODUCERS. This distribution channel consists of
a general agency and insurance brokerage distribution system comprised of
independent licensed agents doing business in all fifty states, the District of
Columbia, and certain protectorates of the United States. During the nine months
ended September 30, 2003, this distribution channel accounted for $984.7
million, or 31 percent, of our total collected premiums. The collected premium
amounts summarized in the preceding two sentences exclude the collected premiums
in our Other Business in Run-off segment which was originally sold through
professional independent producers. During the nine months ended September 30,
2003, premiums collected attributed to that segment were $472.4 million, or 15
percent, of total collected premiums.
Professional independent producers are a diverse network of independent
agents, insurance brokers and marketing organizations. Marketing companies
typically recruit agents for the Conseco Insurance Group segment by advertising
our products and commission structure through direct mail advertising or through
seminars for insurance agents and brokers. These organizations bear most of the
costs incurred in marketing our products. We compensate the marketing
organizations by paying them a percentage of the commissions earned on new sales
generated by the agents recruited by such organizations. Certain of these
marketing organizations are specialty organizations that have a marketing
expertise or a distribution system relating to a particular product, such as
flexible-premium annuities for educators. During 1999 and 2000, the Conseco
Insurance Group segment purchased four organizations that specialize in
marketing and distributing supplemental health products. In 2002, these four
organizations accounted for $244.9 million, or 5.4 percent, of our total
collected premiums.
During the second quarter of 2003, we decided to emphasize the sale of
specified disease and Medicare supplement insurance policies through this
distribution channel. We also decided to de-emphasize annuity and life insurance
sales and eliminate long-term care insurance sales through this channel of
distribution.
DIRECT MARKETING. This distribution channel is engaged primarily in the
sale of "graded benefit life" insurance policies. During the nine months ended
September 30, 2003, this distribution channel accounted for $83.0 million, or
2.6 percent, of our total collected premiums.
INSURANCE UNDERWRITING
Under regulations promulgated by the NAIC (an association of state
regulators and their staffs) and adopted as a result of the Omnibus Budget
Reconciliation Act of 1990, we are prohibited from underwriting our Medicare
supplement policies for certain first-time purchasers. If a person applies for
insurance within six months after becoming eligible by reason of age, or
disability in certain limited circumstances, the application may not be rejected
due to medical conditions. Some states prohibit underwriting of all Medicare
supplement policies. For other prospective Medicare supplement policyholders,
such as senior citizens who are transferring to our products, the underwriting
procedures are relatively limited, except for policies providing prescription
drug coverage.
Before issuing long-term care or comprehensive major medical products to
individuals and groups, we generally apply detailed underwriting procedures
designed to assess and quantify the insurance risks. We require medical
examinations of applicants (including blood and urine tests, where permitted)
for certain health insurance products and for life insurance products which
exceed prescribed policy amounts. These
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requirements vary according to the applicant's age and may vary by type of
policy or product. We also rely on medical records and the potential
policyholder's written application. In recent years, there have been significant
regulatory changes with respect to underwriting certain types of health
insurance. 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 the products we market and where we market them.
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:
- approves the policy as applied for, or with an extra premium charge
because of unfavorable factors; or
- 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.
LIABILITIES FOR INSURANCE AND ASSET ACCUMULATION PRODUCTS
At September 30, 2003, the total balance of our liabilities for insurance
and asset accumulation products was $24.5 billion. These liabilities are often
payable over an extended period of time and the profitability of the related
products is dependent on the pricing of the products and other factors.
Differences between our expectations when we sold these products and our actual
experience could result in future losses.
We calculate and maintain reserves for the estimated future payment of
claims to our policyholders based on actuarial assumptions. For our supplemental
health insurance business, we establish an active life reserve plus a liability
for due and unpaid claims, claims in the course of settlement and incurred but
not reported claims, as well as a reserve for the present value of amounts not
yet due on claims. Many factors can affect these reserves and liabilities, such
as economic and social conditions, inflation, hospital and pharmaceutical costs,
changes in doctrines of legal liability and extra-contractual damage awards.
Therefore, the reserves and liabilities we establish are necessarily based on
extensive estimates, assumptions and historical experience. Establishing
reserves is an uncertain process, and it is possible that actual claims will
materially exceed our reserves and have a material adverse effect on our results
of operations and financial condition. Our financial results depend
significantly upon the extent to which our actual claims experience is
consistent with the assumptions we used in determining our reserves and pricing
our products. If our assumptions with respect to future claims are incorrect,
and our reserves are insufficient to cover our actual losses and expenses, we
would be required to increase our liabilities, which would negatively affect our
operating results.
Liabilities for insurance products are calculated using management's best
judgments of mortality, morbidity, lapse rates, investment experience and
expense levels that are based on our past experience and standard actuarial
tables.
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. Our reinsured
business is ceded to numerous reinsurers. We believe the assuming companies are
able to honor all
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contractual commitments, based on our periodic review of their financial
statements, insurance industry reports and reports filed with state insurance
departments.
As of December 31, 2002, the individual policy risk retention limit was
generally $0.8 million or less on the policies of our subsidiaries. Reinsurance
ceded by Conseco represented 27 percent of gross combined life insurance inforce
and reinsurance assumed represented 4.8 percent of net combined life insurance
inforce. At December 31, 2002, the total ceded business inforce of $26.4 billion
was primarily ceded to insurance companies rated "A- (Excellent)" or better by
A.M. Best. Our principal reinsurers at December 31, 2002 were American Founders
Life Insurance Company, General & Cologne Life Re of America, Lincoln National
Life Insurance Company, Munich American Reassurance Company, Reassure America
Life Insurance Company, RGA Reinsurance Company, Security Life of Denver Life
Insurance Company and Swiss Re Life and Health America Inc. No other single
reinsurer assumes greater than 4 percent of the total ceded business inforce.
In the first quarter of 2002, we completed a reinsurance agreement pursuant
to which we ceded 80 percent of the inforce traditional life business of our
subsidiary, Bankers Life, to Reassure America Life Insurance Company (rated A++
by A.M. Best). The total insurance liabilities ceded pursuant to the contract
were approximately $400 million.
During the second quarter of 2002, one of our subsidiaries, Colonial Penn,
ceded a block of graded benefit life insurance policies to an unaffiliated
company pursuant to a modified coinsurance agreement.
INVESTMENTS
40Y86 Advisors, Inc., a registered investment adviser and wholly-owned
subsidiary of Conseco, Inc., manages the investment portfolios of our insurance
subsidiaries. 40Y86 Advisors had approximately $27.3 billion of assets (at fair
value) under management at September 30, 2003, of which $23.1 billion were
assets of our subsidiaries and $4.2 billion were assets we manage for third
parties. Our general account investment philosophy is to maintain a largely
investment-grade diversified fixed-income portfolio, maximize the spread between
the investment income we earn and the yields we pay on investment products
within acceptable levels of risk, provide adequate liquidity for expected
liability durations and other requirements and maximize total return through
active investment management. During 2002, we recognized net realized investment
losses of $556.3 million, compared to net realized investment losses of $340.0
million during 2001. The net realized investment losses during 2002 included:
- $556.8 million of writedowns of fixed maturity investments, equity
securities and other invested assets as a result of conditions which
caused us to conclude a decline in fair value of the investment was other
than temporary; and
- $.5 million of net gains from the sales of investments (primarily fixed
maturities) which generated proceeds of $19.5 billion.
During 2002, we recognized other-than-temporary declines in value of several of
our investments, including K-Mart Corp., Amerco, Inc., Global Crossing, MCI
Communications, Mississippi Chemical, United Airlines and Worldcom, Inc.
Investment activities are an integral part of our business as investment
income is a significant component of our total revenues. Profitability of many
of our insurance products is significantly affected by spreads between interest
yields on investments and rates credited on insurance liabilities. Although
substantially all credited rates on SPDAs and FPDAs may be changed annually
(subject to minimum guaranteed rates), changes in crediting rates may not be
sufficient to maintain targeted investment spreads in all economic and market
environments. In addition, competition, minimum guaranteed rates and other
factors, including the impact of the level of surrenders and withdrawals, may
limit our ability to adjust or to maintain crediting rates at levels necessary
to avoid narrowing of spreads under certain market conditions. As of December
31, 2002, the average yield, computed on the cost basis of our investment
portfolio, was 6.7 percent, and the average interest rate credited or accruing
to our total insurance liabilities was 5.1 percent.
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We manage the equity-based risk component of our equity-indexed annuity
products by:
- purchasing S&P 500 call options in an effort to hedge such risk; and
- adjusting the participation rate to reflect the change in the cost of
such options (such cost varies based on market conditions).
Accordingly, we are able to focus on managing the interest rate spread component
of these products.
We seek to balance the interest rate risk inherent in our invested assets
with the interest rate characteristics of our insurance liabilities. We attempt
to manage this exposure by measuring the duration of our fixed maturity
investments and insurance liabilities. Duration measures the expected change in
the fair value of assets and liabilities for a given change in interest rates.
For example, if interest rates increase by 1 percent, the fair value of a fixed
maturity security with a duration of 5 years is expected to decrease in value by
approximately 5 percent 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.
We calculate duration using our estimates of future asset and liability
cash flows. These cash flows are discounted using appropriate interest rates
based on the current yield curve and investment type. Duration is determined by
calculating the present value of the cash flows using different interest rates,
and measuring the change in value. At December 31, 2002, the duration of our
fixed maturity investments (as modified to reflect prepayments and potential
calls) was approximately 6.6 years and the duration of our insurance liabilities
was approximately 6.0 years. The difference between these durations indicates
that our investment portfolio had a longer duration and, consequently, was more
sensitive to interest rate fluctuations than that of our liabilities at that
date. We seek to minimize the gap between asset and liability durations.
For information regarding the composition and diversification of the
investment portfolio of our subsidiaries, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Investments."
COMPETITION
Each of the markets in which we operate is highly competitive, and our
highly leveraged capitalization, our ratings downgrades and our recent
bankruptcy proceedings have had a material adverse impact on our ability to
compete in these markets. The financial services industry consists of a large
number of companies, many of which are larger and have greater capital,
technological and marketing resources, access to capital and other sources of
liquidity at a lower cost, broader and more diversified product lines and larger
staffs than those of Conseco. An expanding number of banks, securities brokerage
firms and other financial intermediaries also market insurance products or offer
competing products, such as mutual fund products, traditional bank investments
and other investment and retirement funding alternatives. We also compete with
many of these companies and others in providing services for fees. In most
areas, competition is based on a number of factors, including pricing, service
provided to distributors and policyholders and ratings. Conseco's subsidiaries
must also compete with their competitors to attract and retain the allegiance of
agents, insurance brokers and marketing companies.
In the individual health insurance business, insurance companies compete
primarily on the basis of marketing, service and price. Pursuant to federal
regulations, the Medicare supplement products offered by all companies have
standardized policy features. This increases the comparability of such policies
and has intensified competition based on factors other than product features.
See "Insurance Underwriting" and "-- Government Regulation." In addition to
competing with the products of other insurance companies, commercial banks,
thrifts, mutual funds and broker-dealers, our insurance products compete with
health maintenance organizations, preferred provider organizations and other
health care-related institutions which provide medical benefits based on
contractual agreements.
An important competitive factor for life insurance companies is the ratings
they receive from nationally recognized rating organizations. Agents, insurance
brokers and marketing companies who market our products
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and prospective purchasers of our products use the ratings of our insurance
subsidiaries as one factor in determining which insurer's products to market or
purchase. Ratings have the most impact on our annuity and interest-sensitive
life insurance products. Insurance financial strength ratings are opinions
regarding an insurance company's financial capacity to meet the obligations of
its insurance policies in accordance with their terms. They are not directed
toward the protection of investors, and such ratings are not recommendations to
buy, sell or hold securities.
RATINGS
In July 2002, A.M. Best Company downgraded the financial strength ratings
of our primary insurance subsidiaries from "A- (Excellent)" to "B++ (Very good)"
and placed the ratings "under review with negative implications." On August 14,
2002, A.M. Best again lowered the financial strength ratings of our primary
insurance subsidiaries from "B++ (Very good)" to "B (Fair)". A.M. Best ratings
for the industry currently range from "A++ (Superior)" to "F (In Liquidation)"
and some companies are not rated. An "A++" rating indicates superior overall
performance and a superior ability to meet ongoing obligations to policyholders.
The "B" rating is assigned to companies which have, on balance, fair balance
sheet strength, operating performance and business profile, when compared to the
standards established by A.M. Best, and a fair ability in A.M. Best's opinion to
meet their current obligations to policyholders, but are financially vulnerable
to adverse changes in underwriting and economic conditions. The rating reflected
A.M. Best's view of the uncertainty surrounding our restructuring initiatives
and the potential adverse financial impact on our subsidiaries. On September 11,
2003, A.M. Best affirmed its financial strength ratings of our primary insurance
companies ("B (Fair)") and removed the ratings from under review. On October 3,
2003, A.M. Best assigned a positive outlook to all of our ratings. According to
A.M. Best's press release, the assignment of a positive outlook to our ratings
reflects its favorable view of our bankruptcy reorganization and a number of
management initiatives, including the sale of the GM building, restructuring of
our investment portfolios, expense reductions, merging of certain subsidiaries,
stabilization of surrenders and a commitment in the near-to-medium-term to focus
on selling higher margin products with lower capital requirements.
On August 2, 2002, S&P downgraded the financial strength rating of our
primary insurance companies from BB+ to B+. On November 19, 2003, S&P assigned a
"BB-" counterparty credit and financial strength rating to our primary insurance
companies, with the exception of Conseco Senior Health Insurance Company, which
was assigned a "CCC" rating. S&P financial strength ratings range from "AAA" to
"R" and some companies are not rated. Rating categories from "BB" to "CCC" are
classified as "vulnerable", and pluses and minuses show the relative standing
within a category. In S&P's view, an insurer rated "BB" has marginal financial
security characteristics and although positive attributes exist, adverse
business conditions could lead to an insufficient ability to meet financial
commitments. In S&P's view, an insurer rated "CCC" has very weak financial
security characteristics and is dependent on favorable business conditions to
meet financial commitments. On July 1, 2003, Moody's downgraded the financial
strength rating of our primary insurance companies from Ba3 to B3. On December
4, 2003, Moody's assigned a "Ba3" rating to our primary insurance companies,
with the exception of Conseco Senior Health Insurance Company, which was
assigned a "Caa1" rating. Moody's financial strength ratings range from "Aaa" to
"C". Rating categories from "Ba" to "C" are classified as "vulnerable" by
Moody's, and may be supplemented with numbers "1", "2", or "3" to show relative
standing within a category. In Moody's view, an insurer rated "Ba" offers
questionable financial security and the ability of the insurer to meet
policyholder obligations may be very moderate and thereby not well-safeguarded
in the future. In Moody's view, an insurer rated "Caa" offers very poor
financial security and may default on its policyholder obligations, or there may
be elements of danger with respect to punctual payment of policyholder
obligations and claims.
The ratings downgrades have generally caused sales of our insurance
products to decline and policyholder redemptions and lapses to increase. In some
cases, the downgrades have also caused defections among our independent agent
sales force and increases in the commissions we must pay in order to retain
them. These events have had a material adverse effect on our financial results.
Further downgrades by
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A.M. Best or S&P would likely have further material and adverse effects on our
financial results and liquidity.
A.M. Best, S&P and Moody's each reviews its ratings from time to time. We
cannot provide any assurance that the ratings of our insurance subsidiaries will
remain at their current levels or predict the impact any downgrades could have
on our business.
EMPLOYEES
At December 31, 2003, we had approximately 4,350 employees, of which 4,200
are full time employees, including 1,900 employees supporting our Bankers Life
segment and 2,300 employees supporting both our Conseco Insurance Group segment
and our Other Business in Run-off segment. None of our employees are covered by
a collective bargaining agreement. We believe that we have good relations with
our employees.
GOVERNMENT REGULATION
Our insurance businesses are subject to extensive regulation and
supervision in the jurisdictions in which they operate. This regulation and
supervision is primarily for the benefit and protection of customers, and not
for the benefit of investors or creditors.
Our insurance subsidiaries are subject to regulation and supervision by the
insurance regulatory agencies of the jurisdictions in which they transact
business. State laws generally establish supervisory agencies with broad
regulatory authority, including the power to:
- grant and revoke business licenses;
- regulate and supervise trade practices and market conduct;
- establish guaranty associations;
- license agents;
- approve policy forms;
- approve premium rates for some lines of business;
- establish reserve requirements;
- prescribe the form and content of required financial statements and
reports;
- determine the reasonableness and adequacy of statutory capital and
surplus;
- perform financial, market conduct and other examinations;
- define acceptable accounting principles;
- regulate the type and amount of permitted investments; and
- limit the amount of dividends and of surplus debenture payments that can
be paid without obtaining regulatory approval.
Because of limits on the payment of dividends and surplus debenture
payments from our insurance subsidiaries, not all of our consolidated cash flows
from operations are available to the parent company to service our debt. Our
insurance subsidiaries are subject to periodic examinations by state regulatory
authorities.
We recently were subject to consent orders with the Commissioner of
Insurance for the State of Texas that, among other things, limited the ability
of our insurance subsidiaries to pay dividends. The Texas Department of
Insurance formally released the consent orders on November 19, 2003. We have
agreed with the Commissioner of Insurance for the State of Texas to provide
prior notice of certain transactions, including
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up to 30 days prior notice for the payment of dividends to any non-insurance
company parent, and periodic reporting of information concerning our financial
performance and operations.
In addition to the limitations imposed by the laws described above, most
states have also enacted laws or regulations with respect to the activities of
insurance holding company systems, including acquisitions, the payment of
ordinary and extraordinary dividends by insurance companies, the terms of
surplus debentures, the terms of transactions between insurance companies and
their affiliates and other related matters. Various notice and reporting
requirements generally apply to transactions between insurance companies and
their affiliates within an insurance holding company system, depending on the
size and nature of the transactions. These requirements may include prior
regulatory approval or prior notice for certain material transactions.
Currently, the Company and its insurance subsidiaries have registered as holding
company systems pursuant to such laws and regulations in the domiciliary states
of the insurance subsidiaries, and they routinely report to other jurisdictions.
Most states have also enacted legislation or adopted administrative
regulations that affect the acquisition (or sale) of control of insurance
companies. The nature and extent of such legislation and regulations vary from
state to state. Generally, these regulations require an acquirer of control to
file detailed information concerning such acquirer and the plan of acquisition,
and to obtain administrative approval prior to the acquisition of control.
"Control" is generally defined as the direct or indirect power to direct or
cause the direction of the management and policies of a person and is rebuttably
presumed to exist if a person or group of affiliated persons directly or
indirectly owns or controls 10 percent or more of the voting securities of
another person.
On the basis of statutory statements filed with state regulators annually,
the NAIC calculates certain financial ratios to assist state regulators in
monitoring the financial condition of insurance companies. A "usual range" of
results for each ratio is used as a benchmark. In the past, variances in certain
ratios of our insurance subsidiaries have resulted in inquiries from insurance
departments, to which we have responded. These inquiries have not led to any
restrictions affecting our operations.
In addition, the NAIC issues model laws and regulations, many of which have
been adopted by state insurance regulators, relating to:
- investment reserve requirements;
- RBC standards;
- codification of insurance accounting principles;
- additional investment restrictions;
- restrictions on an insurance company's ability to pay dividends; and
- product illustrations.
The Model Act provides a tool for insurance regulators to determine the
levels of statutory capital and surplus an insurer must maintain in relation to
its insurance and investment risks and whether there is a need for possible
regulatory attention. The Model Act provides four levels of regulatory
attention, varying with the ratio of the insurance company's total adjusted
capital (defined as the total of its statutory capital and surplus, AVR and
certain other adjustments) to its RBC:
- if a company's total adjusted capital is less than or equal to 100
percent but greater than 75 percent of its 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 or equal to 75 percent
but greater than 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 the corrective actions that must be
followed;
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- if a company's total adjusted capital is less than or equal to 50 percent
but greater than 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; and
- if a company's total adjusted capital is less than or equal to 35 percent
of its RBC (the "Mandatory Control Level"), the regulatory authority must
place the company under its control.
In addition, the Model Law provides for an annual trend test if a company's
total adjusted capital is between 100 percent and 125 percent of its RBC at the
end of the year.
The trend test calculates the greater of the decrease in the margin of
total adjusted capital over CALRBC:
- between the current year and the prior year; and
- for the average of the last 3 years.
It assumes that such decrease could occur again in the coming year. Any
company whose trended total adjusted capital is less than 95 percent of its RBC
would trigger a requirement to submit a comprehensive plan as described above
for the Company Action Level.
Refer to the section entitled "Statutory Information" within "Management's
Discussion and Analysis of Financial Condition and Results of Operations" for
more information on our RBC ratios.
The NAIC has adopted a revised manual of statutory accounting principles in
a process referred to as codification. These principles are summarized in the
Accounting Practices and Procedures Manual. The revised manual was effective
January 1, 2001. The domiciliary states of our insurance subsidiaries have
adopted the provisions of the revised manual or, with respect to some states,
adopted the manual with certain modifications. The revised manual has changed,
to some extent, prescribed statutory accounting practices which resulted in
changes to the accounting practices that our insurance subsidiaries use to
prepare their statutory-basis financial statements. These changes increased our
insurance subsidiaries' statutory-based capital and surplus by approximately
$198 million as of January 1, 2001.
The NAIC has adopted model long-term care policy language providing
nonforfeiture benefits and has proposed a rate stabilization standard for
long-term care policies. Various bills are proposed from time to time in the
U.S. Congress which would provide for the implementation of certain minimum
consumer protection standards for inclusion in all long-term care policies,
including guaranteed renewability, protection against inflation and limitations
on waiting periods for pre-existing conditions. Federal legislation permits
premiums paid for qualified long-term care insurance to be treated as
tax-deductible medical expenses and for benefits received on such policies to be
excluded from taxable income.
Our insurance subsidiaries are required under guaranty fund laws of most
states in which we transact business to pay assessments up to prescribed limits
to fund policyholder losses or liabilities of insolvent insurance companies.
Assessments can be partially recovered through a reduction in future premium
taxes in some states.
Most states mandate minimum benefit standards and loss ratios for accident
and health insurance policies. We are generally required to maintain, with
respect to our individual long-term care policies, minimum anticipated loss
ratios over the entire period of coverage of not less than 60 percent. With
respect to our Medicare supplement policies, we are generally required to attain
and maintain an actual loss ratio, after three years, of not less than 65
percent. We provide to the insurance departments of all states in which we
conduct business annual calculations that demonstrate compliance with required
minimum loss ratios for both long-term care and Medicare supplement insurance.
These calculations are prepared utilizing statutory lapse and interest rate
assumptions. In the event that we fail to maintain minimum mandated loss ratios,
our insurance subsidiaries could be required to provide retrospective refunds
and/or prospective rate reductions. We believe that our insurance subsidiaries
currently comply with all applicable mandated minimum loss ratios.
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NAIC model regulations, adopted in substantially all states, created 10
standard Medicare supplement plans (Plans A through J). Plan A provides the
least extensive coverage, while Plan J provides the most extensive coverage.
Under NAIC regulations, Medicare insurers must offer Plan A, but may offer any
of the other plans at their option. Our insurance subsidiaries currently offer
nine of the model plans. We have declined to offer Plan J, due in part to its
high benefit levels and, consequently, high costs to the consumer.
The federal government does not directly regulate the insurance business.
However, federal legislation and administrative policies in several areas,
including pension regulation, age and sex discrimination, financial services
regulation, securities regulation, privacy laws and federal taxation, do affect
the insurance business. Legislation has been introduced from time to time in
Congress that could result in the federal government assuming some role.
Numerous proposals to reform the current health care system (including
Medicare) have been introduced in Congress and in various state legislatures.
Proposals have included, among other things, modifications to the existing
employer-based insurance system, a quasi-regulated system of "managed
competition" among health plans, and a single-payer, public program. Changes in
health care policy could significantly affect our business. For example, Federal
comprehensive major medical or long-term care programs, if proposed and
implemented, could partially or fully replace some of Conseco's current
products.
During recent years, the health insurance industry has experienced
substantial changes, including those caused by healthcare legislation. Recent
federal and state legislation and legislative proposals relating to healthcare
reform contain features that could severely limit or eliminate our ability to
vary our pricing terms or apply medical underwriting standards with respect to
individuals which could have the effect of increasing our loss ratios and
adversely affecting our financial results. In particular, Medicare reform and
legislation concerning prescription drugs could affect our ability to price or
sell our products.
The United States Department of Health and Human Services has issued
regulations under the Health Insurance Portability and Accountability Act
("HIPAA") relating to standardized electronic transaction formats, code sets and
the privacy of member health information. These regulations, and any
corresponding state legislation, will affect our administration of health
insurance.
A number of states have passed or are considering legislation that would
limit the differentials in rates that insurers could charge for health care
coverages between new business and renewal business for similar demographic
groups. State legislation has also been adopted or is being considered that
would make health insurance available to all small groups by requiring coverage
of all employees and their dependents, by limiting the applicability of
pre-existing conditions exclusions, by requiring insurers to offer a basic plan
exempt from certain benefits as well as a standard plan, or by establishing a
mechanism to spread the risk of high risk employees to all small group insurers.
Congress and various state legislators have from time to time proposed changes
to the health care system that could affect the relationship between health
insurers and their customers, including external review. We cannot predict with
certainty the effect that any proposals, if adopted, or legislative developments
could have on our insurance businesses and operation.
The asset management activities of 40Y86 Advisors are subject to federal
and state securities, fiduciary (including the Employee Retirement Income
Security Act of 1974, as amended) and other laws and regulations. The SEC, the
National Association of Securities Dealers, state securities commissions and the
Department of Labor are the principal regulators of our asset management
operations.
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 generally 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
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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 Code, and is
generally followed in all states and other United States taxing jurisdictions.
Recently, Congress enacted legislation to lower marginal tax rates, reduce
the federal estate tax gradually over a ten-year period, with total elimination
of the federal estate tax in 2010, and increase contributions that may be made
to individual retirement accounts and 401(k) accounts. While these tax law
changes will sunset at the beginning of 2011 absent future congressional action,
they could in the interim diminish the appeal of our annuity and life insurance
products. Additionally, Congress has considered, from time to time, other
possible changes to the U.S. tax laws, including elimination of the tax deferral
on the accretion of value within certain annuities and life insurance products.
It is possible that further tax legislation will be enacted which would contain
provisions with possible adverse effects on our annuity and life insurance
products.
PROPERTIES
Our headquarters and the administrative operations of our Conseco Insurance
Group segment are located on a Company-owned 146-acre corporate campus in
Carmel, Indiana, immediately north of Indianapolis. The ten buildings on the
campus contain approximately 854,500 square feet of space and house Conseco's
executive offices and certain administrative operations of its subsidiaries.
Management believes that Conseco's offices are adequate for its current needs.
Our Bankers Life distribution segment is primarily administered from two
facilities in Chicago. Bankers Life has 177,000 square feet in downtown Chicago,
Illinois, leased under an agreement whereby 107,000 square feet are leased until
2018 and 70,000 square feet are leased until 2008. We also lease approximately
130,000 square feet of space in a second Chicago facility. This lease expires in
October 2004, at which time the operations of this facility will be moved to a
new location (with approximately 222,000 square feet) in downtown Chicago under
a lease with a life of approximately 10 years. We own an office building in
Philadelphia, Pennsylvania (127,000 square feet), which serves as the
administrative center for the direct marketing operation of our Bankers Life
segment. We occupy approximately 60 percent of this space, with the remainder
leased to tenants. We also lease 206 sales offices in various states totaling
approximately 507,000 square feet. These leases are short-term in length, with
remaining lease terms expiring between 2004 and 2009.
LEGAL PROCEEDINGS
We are involved on an ongoing basis in lawsuits (including purported class
actions) relating to our operations, including with respect to sales practices,
and we and current and former officers and former directors are defendants in a
pending class action lawsuit asserting claims under the securities laws. The
ultimate outcome of these lawsuits cannot be predicted with certainty and we
have estimated the potential exposure for each of the matters and have recorded
a liability if a loss is deemed probable.
SECURITIES LITIGATION
Since we announced our intention to restructure our capital on August 9,
2002, a total of eight purported securities fraud class action lawsuits have
been filed in the United States District Court for the Southern District of
Indiana. The complaints name us as a defendant, along with certain of our
current and former officers. These lawsuits were filed on behalf of persons or
entities who purchased our predecessor's common stock on various dates between
October 24, 2001 and August 9, 2002. In each case the plaintiffs allege claims
under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as
amended (the "Exchange Act") and allege material omissions and dissemination of
materially misleading statements regarding, among other things, the liquidity of
Conseco and alleged problems in CFC's manufactured housing division, allegedly
resulting in the artificial inflation of our predecessor's stock price. On March
13, 2003, all of these cases were consolidated into one case in the United
States District Court for the Southern District of Indiana, captioned Franz
Schleicher, et al. v. Conseco, Inc., et al., File No. 02-CV-1332 DFH-TAB. The
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lawsuits were stayed as to all defendants by order of the United States
Bankruptcy Court for the Northern District of Illinois. The stay was lifted on
October 15, 2003. The plaintiffs have filed a consolidated class action
complaint with respect to the individual defendants. Our liability with respect
to these lawsuits was discharged in the Plan of Reorganization and our
obligation to indemnify individual defendants who were not serving one of our
officers or directors on the Effective Date is limited to $3 million in the
aggregate under the Plan of Reorganization. Our liability to indemnify
individual defendants who were serving as an officer or director on the
Effective Date, of which there is one such defendant, is not limited by the Plan
of Reorganization. We believe these lawsuits are without merit and intend to
defend them vigorously. The ultimate outcome of these lawsuits cannot be
predicted with certainty.
DERIVATIVE LITIGATION
Nine shareholder derivative suits were filed in 2000 in the United States
District Court for the Southern District of Indiana. The complaints named as
defendants the then current directors, certain former directors, certain
non-director officers of our predecessor (in one case), and, alleging aiding and
abetting liability, certain banks that made loans in relation to our
predecessor's "Stock Purchase Plan" (in three cases). Our predecessor was also
named as a nominal defendant in each complaint. Plaintiffs alleged that the
defendants breached their fiduciary duties by, among other things, intentionally
disseminating false and misleading statements concerning the acquisition,
performance and proposed sale of CFC, and engaged in corporate waste by causing
our predecessor to guarantee loans that certain officers, directors and key
employees of our predecessor used to purchase stock under the Stock Purchase
Plan. These cases have now been consolidated into one case in the United States
District Court for the Southern District of Indiana, captioned: In Re Conseco,
Inc. Derivative Litigation, Case Number IP00655-C-Y/S. An amended complaint was
filed on April 12, 2001, making generally the same allegations and allegations
of violation of the Federal Reserve Board's margin rules. Three similar cases
were filed in the Hamilton County Superior Court in Indiana. Schweitzer v.
Hilbert, et al., Case No. 29D01-0004CP251; Evans v. Hilbert, et al., Case No.
29D01-0005CP308 (both Schweitzer and Evans name as defendants certain
non-director officers); and Gintel v. Hilbert, et al., Case No. 29003-0006CP393
(naming as defendants, and alleging aiding and abetting liability as to, banks
that allegedly made loans in relation to the Stock Purchase Plan). All of these
cases have been dismissed.
OTHER LITIGATION
Collection efforts by the Company and Conseco Services, LLC related to the
1996-1999 director and officer loan programs have been commenced against various
past board members and executives with outstanding loan balances. In addition,
certain former officers and directors have sued the companies for declaratory
relief concerning their liability for the loans. Currently, we are involved in
litigation with Stephen C. Hilbert, James D. Massey, Dennis E. Murray, Sr.,
Rollin M. Dick, James S. Adams, Maxwell E. Bublitz, Ngaire E. Cuneo, David R.
Decatur, Donald F. Gongaware and Bruce A. Crittenden. The specific lawsuits
include: Hilbert v. Conseco, Case No. 03A 04283 (Bankr. N.D. Ill.); Conseco
Services v. Hilbert, Case No. 29C01-0310 MF 1296 (Cir. Ct. Hamilton Cty, Ind.);
Murray and Massey v. Conseco, Case No. 1:03-CV-1482 LJM-WTL (S.D. Ind.); Conseco
Services v. Adams, et al, Case No. 29DO2-0312-CC-1035(Cir. Ct. Hamilton Cty.
Ind.); Conseco v. Adams, et al, Case No. 03A 04545, (Bankr. N.D. Ill.) Dick v.
Conseco Services, Case No. 29 D01-0207-PL-549 (Sup. Ct. Hamilton Cty, Ind.);
Conseco Services v. Dick, et al., Case No. 06C01-0311-CC-356 (Cir. Ct. Boone Ct.
Ind.) and Crittenden v. Conseco, Case No.IP02-1823-C B/S (S.D. Ind.). The
Company and Conseco Services, LLC believe that all amounts due under the
director and officer loan programs, including all applicable interest, are valid
obligations owed to the companies. As part of the Plan of reorganization, we
have agreed to pay 45 percent of any net proceeds recovered in connection with
these lawsuits, in an aggregate amount not to exceed $30 million, to former
holders of our predecessor's trust preferred securities that opted out of a
settlement reached with the committee representing holders of these securities.
We are required to use the balance of any net proceeds recovered in connection
with these lawsuits to pay down our Senior Credit Facility. Any remaining
proceeds will be used to contribute capital to our insurance subsidiaries. We
intend to prosecute these claims to obtain the maximum recovery possible.
Further, with regard to the various claims brought against the Company and
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Conseco Services, LLC by certain former directors and officers, we believe that
these claims are without merit and intend to defend them vigorously. The
ultimate outcome of the lawsuits cannot be predicted with certainty.
In October 2002, Roderick Russell, on behalf of himself and a class of
persons similarly situated, and on behalf of the ConsecoSave Plan, filed an
action in the United States District Court for the Southern District of Indiana
against our predecessor, Conseco Services, LLC and certain of our current and
former officers (Roderick Russell, et al. v Conseco, Inc., et al., Case No.
1:02-CV-1639 LJM). The purported class action consists of all individuals whose
401(k) accounts held common stock of our predecessor at any time since April 28,
1999. The complaint alleges, among other things, breaches of fiduciary duties
under ERISA by continuing to permit employees to invest in our predecessor's
common stock without full disclosure of the Company's true financial condition.
We filed a motion to dismiss the complaint in December 2002. This lawsuit was
stayed as to all defendants by order of the Bankruptcy Court. The stay was
lifted on October 15, 2003. It is expected that there will be a ruling on the
motion to dismiss before further proceedings occur in this matter. We believe
the lawsuit is without merit and intend to defend it vigorously. The ultimate
outcome of the lawsuit cannot be predicted with certainty.
On June 24, 2002, the heirs of a former officer, Lawrence Inlow, commenced
an action against our predecessor, Conseco Services, LLC and two former officers
in the Boone Circuit Court (Inlow et al. v. Conseco, Inc., et al., Cause No.
06C01-0206-CT-244). The heirs assert that unvested options to purchase 756,248
shares of our predecessor's common stock should have been vested at Mr. Inlow's
death. The heirs further claim that if such options had been vested, they would
have been exercised, and that the resulting shares of common stock would have
been sold for a gain of approximately $30 million based upon a stock price of
$58.125 per share, the highest stock price during the alleged exercise period of
the options. We believe the heirs' claims are without merit and will defend the
action vigorously. The maximum exposure to the Company for this lawsuit is
estimated to be $33 million. The heirs did not file a proof of claim with the
Bankruptcy Court. Subject to dispositive motions which are yet to be filed, the
matter will continue to trial against Conseco Services, LLC and the other
co-defendants on September 13, 2004. The ultimate outcome cannot be predicted
with certainty.
On June 27, 2001, two suits against the Company's subsidiary, Philadelphia
Life Insurance Company (now known as Conseco Life Insurance Company), both
purported nationwide class actions seeking unspecified damages, were
consolidated in the U.S. District Court, Middle District of Florida (In Re PLI
Sales Litigation, Cause No. 01-MDL-1404), alleging among other things,
fraudulent sales and a "vanishing premium" scheme. Philadelphia Life filed a
motion for summary judgment against both named plaintiffs, which motion was
granted in June 2002. Plaintiffs appealed to the 11th Circuit. The 11th Circuit,
in July 2003, affirmed in part and reversed in part, allowing two fraud counts
with respect to one plaintiff to survive. The plaintiffs' request for a
rehearing with respect to this decision has been denied. Philadelphia Life has
filed a summary judgment motion with respect to the remaining claims.
Philadelphia Life believes this lawsuit is without merit and intends to defend
it vigorously. The ultimate outcome of the lawsuit cannot be predicted with
certainty.
On December 1, 2000, the Company's former subsidiary, Manhattan National
Life Insurance Company, was named in a purported nationwide class action seeking
unspecified damages in the First Judicial District Court of Santa Fe, New Mexico
(Robert Atencio and Theresa Atencio, for themselves and all other similarly
situated v. Manhattan National Life Insurance Company, an Ohio corporation,
Cause No. D-0101-CV-2000-2817), alleging among other things fraud by
non-disclosure of additional charges for those policyholders wishing to pay
premium modes other than annual. We retained liability for this litigation in
connection with the sale of Manhattan National Life in June 2002. We believe
this lawsuit is without merit and intend to defend it vigorously. The ultimate
outcome of the lawsuit cannot be predicted with certainty.
On December 19, 2001, four of the Company's subsidiaries were named in a
purported nationwide class action seeking unspecified damages in the District
Court of Adams County, Colorado (Jose Medina and others similarly situated v.
Conseco Annuity Assurance Company, Conseco Life Insurance Company, Bankers
National Life Insurance Company and Bankers Life and Casualty Company, Cause No.
01-CV-2465), alleging
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among other things breach of contract regarding alleged non-disclosure of
additional charges for those policy holders wishing to pay premium modes other
than annual. On July 14 and 15, 2003 the plaintiff's motion for class
certification was heard and the Court took the matter under advisement. On
November 10, 2003, the Court denied the motion for class certification. The
plaintiff has indicated he will appeal trial court's ruling denying class
certification. All further proceedings have been stayed pending the outcome of
the appeal. The defendants believe this lawsuit is without merit and intend to
defend it vigorously. The ultimate outcome of the lawsuit cannot be predicted
with certainty.
On July 31, 2001, the Company's subsidiary, Conseco Senior Health Insurance
Company, was named in an action filed by the State of Texas in the District
Court of Travis County, Texas (State of Texas v. Conseco Senior Health Insurance
Company, Cause No. GV102103), alleging among other things a violation of the
Deceptive Trade Practices Act related to allegations of failure to adequately
notify policyholders that premium rates could increase. Conseco Senior has
reached a settlement with the State of Texas.
On December 30, 2002 and December 31, 2002, five suits were filed in
various Mississippi counties against the Company's subsidiary, Conseco Life
Insurance Company (Kathie Allen, et al. v. Conseco Life Insurance Company, et
al., Circuit Court of Jones County, Mississippi, Cause No. 2002-448-CV12;
Malcolm Bailey, et al. v. Conseco Life Insurance Company, et al., Circuit Court
of Claiborne County, Mississippi, Cause No. CV-2002-371; Anthony Cascio, et al.
v. Conseco Life Insurance Company, et al, Circuit Court of LeFlore County,
Mississippi, Cause No. CV-2002-0242-CICI; William Garrard, et al. v. Conseco
Life insurance Company, et al., Circuit Court of Sunflower County, Mississippi,
Cause No. CV-2002-0753-CRL; and William Weaver, et al. v. Conseco Life Insurance
Company, et al., Circuit Court of LeFlore County, Mississippi, Cause No.
CV-2002-0238-CICI) alleging, among other things, a "vanishing premium" scheme.
Conseco Life removed all of the cases to the U.S. District Courts in
Mississippi. In September 2003, plaintiffs' Motion to Remand was denied in the
Garrard and Weaver matters, but granted in the Cascio matter. In November 2003,
Conseco Life again removed the Cascio matter to U.S. District Court. Conseco
Life awaits the court's ruling on Plaintiff's Motion to Remand in the Allen
matter. In Bailey the parties have agreed to stay in Federal court and the
plaintiffs are attempting to amend their complaint to include class action
allegations. Conseco Life believes the lawsuits are without merit and intends to
defend them vigorously. The ultimate outcome of the lawsuits cannot be predicted
with certainty.
In addition, the Company and its subsidiaries are involved on an ongoing
basis in other lawsuits and arbitrations (including purported class actions)
related to their operations. The ultimate outcome of all of these other legal
matters pending against the Company or its subsidiaries cannot be predicted,
and, although such lawsuits are not expected individually to have a material
adverse effect on the Company, such lawsuits could have, in the aggregate, a
material adverse effect on the Company's consolidated financial condition, cash
flows or results of operations.
OTHER PROCEEDINGS
The Company has been notified that the staff of the SEC has obtained a
formal order of investigation in connection with an inquiry that relates to
events in and before the spring of 2000, including CFC's accounting for its
interest-only securities and servicing rights. These issues were among those
addressed in the Company's writedown and restatement in the spring of 2000, and
were the subject of shareholder class action litigation, which was settled in
the second quarter of 2003. The Company is cooperating fully with the SEC staff
in this matter.
The deadline to file administrative claims in the bankruptcy proceeding was
October 9, 2003. The Plan provides that all such claims must be paid in full, in
cash. We are reviewing all timely filed administrative claims and may resolve
disputes regarding allowance of such claims in the Bankruptcy Court. If
significant administrative claims are allowed, our cash flow would be negatively
affected.
On September 18, 2003, the Company received a grand jury subpoena from the
U.S. District Court for the Southern District of Indiana in connection with a
Department of Justice investigation requiring production of documents relating
to the valuation of interest-only securities held by CFC, our predecessor's
former finance subsidiary, contemporaneous earnings estimates for the
predecessor, certain personnel records and
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other accounting and financial disclosure records for the period June 1, 1998 to
June 30, 2000. The Company has subsequently received follow-up grand jury
document subpoenas concerning other matters. All of these follow-up requests
have been limited to the time period prior to the December 17, 2002 bankruptcy
filing. The Company has been advised by the Department of Justice that neither
it nor any of its current directors or employees are subjects or targets of this
investigation. The Company is cooperating fully with the Department of Justice
investigation.
On October 29, 2003, the New York Attorney General served Conseco Life
Insurance Company of Texas ("Conseco Life") with a document subpoena concerning
customer transfers between mutual fund sub-accounts offered by CVIC, a former
wholly-owned subsidiary of Conseco Life, that occurred prior to the sale of CVIC
to an unrelated third party in October 2002. The SEC served the Company with a
similar subpoena shortly after we received the Attorney General's subpoena.
Certain of our employees have also received subpoenas regarding duties they
previously performed in respect of annuity sales by CVIC. The purchase agreement
pursuant to which CVIC was sold contains indemnification provisions with respect
to certain liabilities relating to Conseco Life's period of ownership, including
provisions concerning certain business activities (including marketing
activities) of CVIC. Conseco Life and the Company have cooperated with the
Attorney General and the SEC in producing documents responsive to their
subpoenas. In January 2004, the Company received telephonic notification of a
potential enforcement action by the Attorney General and a Wells notification
from the SEC regarding alleged market timing on the part of holders of variable
annuity policies issued by CVIC. The Company and its affiliates have not issued
any variable annuity policies since the sale of CVIC. The Company and Conseco
Life believe, based on the information obtained and supplied to the
investigators to date, that CVIC violated no federal or state law prior to the
October 2002 sale. The investigations are in a preliminary stage and their
outcome cannot be predicted with certainty. The Company and Conseco Life are
cooperating fully with the Attorney General and the SEC in these investigations.
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MANAGEMENT
EXECUTIVE OFFICERS
Our executive officers are as follows:
NAME AGE POSITION
---- --- --------
Edward M. Berube...................... 55 President and Chief Executive Officer,
Bankers Life and Casualty Company
Eugene M. Bullis...................... 58 Executive Vice President and Chief
Financial Officer
Eric R. Johnson....................... 43 President, 40Y86 Advisors, Inc.
William S. Kirsch..................... 47 Executive Vice President, General
Counsel and Secretary
John R. Kline......................... 46 Senior Vice President and Chief
Accounting Officer
William J. Shea....................... 56 Director, President and Chief
Executive Officer
EDWARD M. BERUBE joined Conseco in 1999 and has been president and chief
executive officer of Bankers Life & Casualty since 2000. From 1998 to 1999 he
was president and chief operating officer of American Life Insurance Company.
From 1975 to 1997 Mr. Berube held various positions with CIGNA.
EUGENE M. BULLIS has been executive vice president and chief financial
officer since November 2002. From 2000 until 2002, Mr. Bullis served as chief
financial officer of Managed Ops.Com, Inc. From 1999 until 2000 he was executive
vice president and chief financial officer of Manufacturers Services, Ltd. and
from 1998 to 1999 he served as senior vice president and chief financial officer
of Physicians Quality Care.
ERIC R. JOHNSON has been president and chief executive officer of 40Y86
Advisors, Inc. (formerly Conseco Capital Management, Inc.), Conseco's
wholly-owned registered investment advisor, since September 2003 and has held
various positions since joining Conseco Capital Management, Inc. in 1997.
JOHN R. KLINE has been senior vice president and chief accounting officer
since July 2002. Mr. Kline has served in various accounting and finance
capacities with Conseco since 1990.
WILLIAM S. KIRSCH has been executive vice president, general counsel and
secretary since September 2003. His professional corporation, William S. Kirsch,
P.C., is a partner in the law firm Kirkland & Ellis LLP. Mr. Kirsch has been
with Kirkland & Ellis LLP since 1981.
WILLIAM J. SHEA has served as a director of Conseco and its predecessor
since September 2002. He has served as president and chief executive officer of
Conseco since October 2002 and was president and chief operating officer from
September 2001 until October 2002. Before joining Conseco, Mr. Shea served as
CEO of View Tech, Inc. (integrated video-conferencing solutions) from 1999 until
2000. From 1993 to 1998, he was vice chairman and chief financial officer of
Bank Boston Corporation. Mr. Shea is also a director of the AIG/Sunamerica
Mutual Funds.
Messrs. Shea, Bullis, Berube and Kline served as officers, and Mr. Shea
served as a director, of our predecessor company, which filed a bankruptcy
petition on December 17, 2002. Mr. Shea and Mr. Bullis also served as directors
and/or officers of several subsidiaries of our predecessor that also filed
bankruptcy petitions on December 17, 2002.
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DIRECTORS
Our directors are as follows:
NAME AGE POSITION
---- --- --------
R. Glenn Hilliard(2)(3)(5)................ 61 Non-Executive Chairman
Philip R. Roberts(1)(4)................... 62 Director
Neal Schneider(1)(4)...................... 59 Director
Michael S. Shannon(2)(3).................. 45 Director
William J. Shea(4)(5)..................... 56 Director, President and Chief Executive
Officer
Michael T. Tokarz(2)(3)................... 53 Director
John G. Turner(1)(4)(5)................... 64 Director
---------------
(1) Member of the Audit and Enterprise Risk Committee
(2) Member of the Governance and Strategy Committee
(3) Member of the Human Resources and Compensation Committee
(4) Member of the Investment Committee
(5) Member of the Executive Committee
R. GLENN HILLIARD became the non-executive chairman of our board of
directors in September 2003. Mr. Hilliard has been Chairman and CEO of Hilliard
Group, LLC, an investment and consulting firm, since June 2003. From 1999 until
his retirement in April 2003, Mr. Hilliard served as chairman and CEO of ING
Americas. From 1994 to 1999 he was chairman and CEO of ING North America.
PHILIP R. ROBERTS joined our board of directors in September 2003. Mr.
Roberts is principal of Roberts Ventures L.L.C., consultant for merger and
acquisition and product development for investment management firms. From 1996
until 2000, Mr. Roberts served as chief investment officer of trust business for
Mellon Financial Corporation and headed its institutional asset management
businesses from 1990 to 1996.
NEAL SCHNEIDER joined our board of directors in September 2003. Since June
2002, Mr. Schneider has been a partner of Smart and Associates, LLP, a business
advisory and accounting firm. Between August 2000 and June 2002, he was an
independent consultant. Until his retirement in August 2000, Mr. Schneider spent
34 years with Arthur Andersen & Co., including service as partner in charge of
the Worldwide Insurance Industry Practice and the North American Financial
Service Practice. Mr. Schneider is a director of PMA Capital Corporation.
MICHAEL S. SHANNON joined our board of directors in September 2003. Mr.
Shannon is co-founder and current president and chief executive officer of KSL
Recreation Corporation (owner and operator of golf courses and destination
resorts in the U.S.). Mr. Shannon was lead director of ING Americas before
joining our board. Mr. Shannon is a director of Startek, Inc.
MICHAEL T. TOKARZ joined our board of directors in September 2003. Mr.
Tokarz is managing member of the Tokarz Group, LLC (venture capital
investments). He was a general partner with Kohlberg Kravis Roberts & Co. until
he retired in 2002. Mr. Tokarz is also a director of Walter Industries, Inc,
Idex Corp. and MEVC Draper Fisher Jurvetson Fund I Inc.
JOHN G. TURNER joined our board of directors in September 2003. Mr. Turner
is chairman of Hillcrest Capital Partners, a private equity investment firm. Mr.
Turner served as chairman and CEO of ReliaStar Financial Corp. from 1991 until
it was acquired by ING in 2000. After the acquisition he became vice chairman
and a member of the executive committee for ING Americas until his retirement in
2002. Mr. Turner is a director of Hormel Foods Corporation, Shopko Stores, Inc.
and ING Funds.
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BOARD OF DIRECTORS
Our board of directors is currently comprised of seven members, divided
into two classes as follows: Messrs. Shea, Roberts and Tokarz are Class I
directors, and Messrs. Hilliard, Schneider, Shannon and Turner are Class II
directors. The term of office of the Class I directors expires at our 2004
annual meeting of stockholders and the term of office of the initial Class II
directors expires at our 2005 annual meeting of stockholders. Other than the
term of office of the initial Class II directors, the term of office of each
Class of directors will expire at the next succeeding annual meeting of
stockholders. Accordingly, the term of office of the Class I directors expires
at the 2004 annual meeting of stockholders, at which time three new directors
will be elected for a one year term, and the term of office of the Class II
directors, as well as the Class I directors elected at the 2004 annual meeting
of stockholders, will expire at the 2005 annual meeting of stockholders, at
which time seven new directors will be elected.
The initial Class I and Class II directors are those directors elected in
connection with the adoption of our certificate of incorporation on September
10, 2003. At each annual meeting of stockholders, directors to replace those of
a class or classes whose terms expire at such annual meeting will be elected to
hold office until the next succeeding annual meeting and until their respective
successors have been duly elected and qualified. If the number of directors is
changed, any newly created directorships or decrease in directorships will be so
apportioned among the classes as to make all classes as nearly equal in number
as practicable.
BOARD COMMITTEES
AUDIT AND ENTERPRISE RISK COMMITTEE. The Audit and Enterprise Risk
Committee's functions, among others, are to recommend the appointment of
independent accountants; review the arrangements for and scope of the audit by
independent accountants; review the independence of the independent accountants;
consider the adequacy of the system of internal accounting controls and review
any proposed corrective actions; review and monitor the Company's compliance
with legal and regulatory requirements; and discuss with management and the
independent accountants our draft annual and quarterly financial statements and
key accounting and/or reporting matters. The audit committee currently consists
of Messrs. Schneider, Roberts and Turner, with Mr. Schneider serving as chairman
of the committee and as "audit committee financial expert," as defined under SEC
rules promulgated under the Sarbanes-Oxley Act. All current members of the Audit
and Enterprise Risk Committee are "independent" within the meaning of the new
regulations adopted by the SEC and the listing requirements adopted by the NYSE
regarding audit committee membership. A copy of the Audit and Enterprise Risk
Committee's charter is available on our website at www.conseco.com.
GOVERNANCE AND STRATEGY COMMITTEE. The Governance and Strategy Committee
is responsible for, among other things, establishing criteria for board
membership; considering, recommending and recruiting candidates to fill new
positions on the board; reviewing candidates recommended by shareholders;
considering questions of possible conflicts of interest involving board members,
executive officers and key employees. It is also responsible for developing
principles of corporate governance and recommending them to the board for its
approval and adoption, reviewing periodically these principles of corporate
governance to insure that they remain relevant and are being complied with. The
Governance and Strategy Committee currently consists of Messrs. Hilliard, Tokarz
and Shannon, with Mr. Tokarz serving as chairman of the committee. All current
members of the Governance and Strategy Committee are "independent" within the
meaning of the new listing requirements adopted by the NYSE regarding nominating
committee membership. A copy of the Governance and Strategy Committee's charter
is available on our website at www.conseco.com.
HUMAN RESOURCES AND COMPENSATION COMMITTEE. The Human Resources and
Compensation Committee is responsible for, among other things, approving overall
compensation policy; recommending to the board the compensation of the Chief
Executive Officer and other senior officers; and reviewing and administering our
incentive compensation and equity award plans. The Human Resources and
Compensation Committee currently consists of Messrs. Hilliard, Tokarz and
Shannon, with Mr. Shannon serving as chairman of the committee. All current
members of the Human Resources and Compensation Committee are "independent"
within the meaning of the new listing requirements adopted by the NYSE regarding
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compensation committee membership. A copy of the Human Resources and
Compensation Committee's charter is available on our website at www.conseco.com.
INVESTMENT COMMITTEE. The Investment Committee is responsible for, among
other things, reviewing investment policies, strategies and programs; overseeing
the investment of funds in accordance with policies and limits approved by it;
and reviewing the quality and performance of our investment portfolios and the
alignment of asset duration to liabilities. The Investment Committee currently
consists of Messrs. Shea, Schneider, Roberts and Turner, with Mr. Roberts
serving as chairman of the committee. A copy of the Investment Committee's
charter is available on our website at www.conseco.com.
EXECUTIVE COMMITTEE. Subject to the requirements of applicable law,
including our certificate of incorporation and bylaws, the Executive Committee
is responsible for exercising, as necessary, the authority of the board of
directors in the management of our business affairs during intervals between
board meetings. The Executive Committee currently consists of Messrs. Hilliard,
Shea and Turner, with Mr. Turner serving as chairman of the committee. A copy of
the Executive Committee's charter is available on our website at
www.conseco.com.
COMPENSATION COMMITTEE INTERLOCKS
None of the members of the Human Resources and Compensation Committee is or
has been an officer or employee of our Company. None of our executive officers
serves, or served during 2003, as a member of the board of directors or
compensation committee of any entity that has one or more executive officers
serving on our board of directors or Human Resources and Compensation Committee.
DIRECTOR COMPENSATION
Our non-employee directors (other than our non-executive chairman) receive
an annual cash retainer of $70,000. The chairman of the Audit and Enterprise
Risk Committee receives an additional annual cash fee of $30,000, and directors
who serve as chairman of one of our other board committees receive an additional
annual cash fee of $20,000. Each member of the Audit and Enterprise Risk
Committee also receives an annual cash retainer of $30,000. Directors are also
entitled to receive $70,000 in annual equity awards under the Conseco, Inc. 2003
Long-Term Equity Incentive Plan. Directors are reimbursed for out-of-pocket
expenses incurred in connection with the performance of their responsibilities
as directors.
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EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following Summary Compensation Table sets forth the cash compensation
and certain other compensation paid to each person who served as chief executive
officer and the other five most highly compensated individuals who served as
executive officers of Conseco in 2003 (collectively, the "named executive
officers") for services rendered during 2003.
LONG-TERM COMPENSATION
AWARDS
--------------------------------
NUMBER OF
SECURITIES
ANNUAL COMPENSATION UNDERLYING
---------------------------------- RESTRICTED OPTIONS/SARS ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS(1) OTHER(2) STOCK AWARDS(3) (IN SHARES)(4) COMPENSATION(5)
--------------------------- ---- ------ -------- -------- --------------- -------------- ---------------
William J. Shea.................. 2003 $1,026,122 $1,000,000 $9,195,000 500,000 $ 68,379
President and Chief Executive
Officer 2002 774,038 1,100,000 $87,625 -- -- 3,677
2001 147,756 250,000 340,000 450,000 92
Edward M. Berube................. 2003 660,000 660,000 -- -- 774
President, Bankers Life and
Casualty 2002 660,000 660,000 -- -- 5,500
2001 660,000 693,000 -- 100,000 269,778
Maxwell E. Bublitz(6)............ 2003 497,372 762,375 -- -- 703,031
Senior Vice President,
Investments 2002 700,000 450,000 -- -- 6,790
2001 625,000 450,000 -- 25,000 6,750
Eugene M. Bullis(7)(8)........... 2003 609,135 1,800,000 -- -- 162,090
Executive Vice President and 2002 243,590 600,000 -- -- --
Chief Financial Officer
Eric R. Johnson(7)(9)............ 2003 505,961 1,100,000 -- -- 180
President, 40Y86 Advisors, Inc.
John R. Kline(7)(10)............. 2003 275,000 68,750 -- -- 270
Senior Vice President and 2002 214,571 1,052,500 -- -- 6,310
Chief Accounting Officer
---------------
(1) Bonus amounts shown for 2003 include payments approved by the Bankruptcy
Court but do not include performance bonuses to be paid with respect to
2003, the amounts of which bonuses have not yet been determined.
(2) Includes for Mr. Shea $68,541 relating to his personal use of Company
aircraft in 2002.
(3) The amount shown in this column for Mr. Shea in 2003 represents the value
of the award of 500,000 shares of restricted stock based on the closing
price of the common stock on the date of grant, September 29, 2003. The
amount shown in this column for Mr. Shea in 2001 represents the value of
the award of 50,000 shares of restricted common stock of our predecessor
company. Those shares were cancelled in the Reorganization and Mr. Shea
received no payment for them.
(4) No stock appreciation rights have been granted.
(5) For 2003, the amounts reported in this column represent the following
amounts paid for the named executive officers: (i) severance payment (Mr.
Bublitz, $650,000); (ii) accrued vacation payment (Mr. Bublitz, $51,538);
(iii) amounts imputed as income for accommodation and business commuting
expenses (Mr. Shea, $65,170 and Mr. Bullis, $130,337); (iv) relocation
expenses (Mr. Bullis, $30,979); (v) individual life insurance premiums (Mr.
Shea, $2,435 and Mr. Bublitz, $1,290); and (vi) group life insurance
premiums (Mr. Shea, $774, Mr. Berube, $774, Mr. Bublitz, $203, Mr. Bullis,
$774, Mr. Johnson, $180 and Mr. Kline, $270).
(6) Mr. Bublitz' employment was terminated in September 2003.
(7) No compensation information is reported for years prior to the year in
which the named executive officer became an executive officer of the
Company.
(8) Mr. Bullis' employment commenced in July 2002.
(9) Mr. Johnson became an executive officer in September 2003.
(10) Mr. Kline became an executive officer in July 2002.
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STOCK OPTIONS
The following table sets forth certain information concerning the exercise
in 2003 of options to purchase common stock by the named executive officers and
the unexercised options to purchase common stock held by such individuals as of
December 31, 2003.
AGGREGATED OPTION EXERCISES IN 2003 AND YEAR-END OPTION VALUES
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS (IN SHARES) AT IN-THE-MONEY OPTIONS AT
NUMBER OF DECEMBER 31, 2003 DECEMBER 31, 2003(1)
SHARES ACQUIRED VALUE --------------------------- ---------------------------
NAME ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- --------------- -------- ----------- ------------- ----------- -------------
William J. Shea........................ 0 0 0 500,000 0 $2,700,000
Edward M. Berube....................... 0 0 0 0 0 0
Maxwell E. Bublitz..................... 0 0 0 0 0 0
Eugene M. Bullis....................... 0 0 0 0 0 0
Eric R. Johnson........................ 0 0 0 0 0 0
John R. Kline.......................... 0 0 0 0 0 0
---------------
(1) The value is calculated based on the aggregate amount of the excess of
$21.80 (the last sale prices of the Common Stock as reported by the NYSE for
the last business day of 2003) over the relevant exercise prices.
The following table sets forth certain information concerning options to
purchase common stock granted in 2003 to the named executive officers.
OPTION GRANTS IN 2003
INDIVIDUAL GRANTS
------------------------------------------------------------------------------------------------
POTENTIAL REALIZABLE VALUE AT
ASSUMED ANNUAL RATES OF
% OF TOTAL STOCK PRICE APPRECIATION FOR
NUMBER OF OPTIONS GRANTED PER SHARE OPTIONS TERM
SECURITIES UNDERLYING TO EMPLOYEES IN EXERCISE EXPIRATION -----------------------------
NAME OPTIONS GRANTED 2003 PRICE DATE 5% 10%
---- --------------------- --------------- --------- ---------- ----------- ------------
William J. Shea(1)........... 500,000 100% $16.40 9/29/13 $6,777,686 $15,649,462
Edward M. Berube............. 0 -- -- -- -- --
Maxwell E. Bublitz........... 0 -- -- -- -- --
Eugene M. Bullis............. 0 -- -- -- -- --
Eric R. Johnson.............. 0 -- -- -- -- --
John R. Kline................ 0 -- -- -- -- --
---------------
(1) The options reported are non-qualified stock options which vest in four
equal annual installments beginning September 29, 2004.
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EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth information about our common stock that may
be issued under the Conseco, Inc. 2003 Long-Term Equity Incentive Plan.
NUMBER OF
SECURITIES
REMAINING AVAILABLE
FOR FUTURE ISSUANCE
NUMBER OF SECURITIES UNDER EQUITY
TO BE ISSUED UPON WEIGHTED-AVERAGE COMPENSATION PLANS
EXERCISE OF EXERCISE PRICE OF (EXCLUDING
OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, SECURITIES REFLECTED
PLAN CATEGORY WARRANTS OR RIGHTS(A) WARRANTS OR RIGHTS(B) IN COLUMN (A))(C)
------------- --------------------- --------------------- --------------------
Equity compensation plans approved
by security holders............... 1,000,000 $18.01 7,982,370
Equity compensation plans not
approved by security holders...... -- -- --
Total............................... 1,000,000 $18.01 7,982,370
As described immediately below under "Non-Executive Chairman Agreement," we
granted Mr. Hilliard a signing bonus of 98,119 shares of common stock. These
shares were not issued under the Conseco, Inc. 2003 Long-Term Equity Incentive
Plan.
NON-EXECUTIVE CHAIRMAN AGREEMENT
On June 18, 2003, our predecessor entered into an agreement with R. Glenn
Hilliard pursuant to which Mr. Hilliard provided consulting services to our
predecessor during the pendency of the Chapter 11 cases and agreed to serve as
our non-executive chairman for an initial term of four years following our
emergence from bankruptcy. This agreement, which became effective upon our
emergence from bankruptcy, was negotiated with our predecessor's creditors
committee and was approved by the Bankruptcy Court in connection with the
approval of the Plan of Reorganization. The agreement provides for (i) an annual
director's fee of $1,000,000 for the first two years of the term, and director's
fees similar to those paid to similarly situated non-executive chairmen for the
latter two years of the term; (ii) a signing bonus of 98,119 shares of common
stock, which were issued shortly after our emergence from bankruptcy; and (iii)
a retention bonus of $1,500,000, payable as soon as practicable following the
first anniversary of our emergence from bankruptcy, and a retention bonus of
$750,000, payable as soon as practicable following the second anniversary of our
emergence from bankruptcy. Under the agreement, we also issued Mr. Hilliard
options to purchase 500,000 shares of common stock and 500,000 shares of
restricted stock, all of which are subject to vesting, pursuant to the Conseco,
Inc. 2003 Long-Term Equity Incentive Plan. The agreement also provides that Mr.
Hilliard will receive a grant of options to purchase 0.25% of our
then-outstanding common stock and a restricted stock grant of 0.25% of our
then-outstanding common stock, all of which will be subject to vesting, as soon
as practicable following the first anniversary of our emergence from bankruptcy.
After the second anniversary of our emergence from bankruptcy, the agreement
provides that Mr. Hilliard will receive the same equity-based compensation as
other non-employee members of our board of directors. Under the agreement, Mr.
Hilliard is entitled to a gross-up for excise tax payments under Section 280G of
the Internal Revenue Code. Mr. Hilliard also receives a monthly allowance of
$3,000 per month for office space and related expenses in connection with the
maintenance of an office in Atlanta, Georgia. If Mr. Hilliard's service as
non-executive chairman ends as a result of his death, disability, removal other
than for cause or failure to be re-elected (each a "qualifying termination")
before the first anniversary of our emergence from bankruptcy, he is entitled to
receive the prorated portion of his first-year retention bonus. If Mr.
Hilliard's service as non-executive chairman ends as a result of a qualifying
termination after the first anniversary but before the second anniversary of our
emergence from bankruptcy, he is entitled to receive the prorated portion of his
second-year retention bonus. In addition, upon a qualifying termination, vesting
of previously granted options and restricted stock will
124
occur as if Mr. Hilliard continued to serve through the next anniversary of our
emergence from bankruptcy following his separation. Mr. Hilliard has agreed not
to commence full-time employment with any other company during the 18-month
period following our emergence from bankruptcy, and Mr. Hilliard is subject to a
non-competition clause under the agreement in the event his service with us
terminates prior to the end of the term. On December 30, 2003, Mr. Hilliard, who
serves as one of our independent directors, agreed to irrevocably waive his
right to receive compensation with respect to services rendered by him to our
predecessor prior to our emergence from bankruptcy.
EMPLOYMENT AGREEMENTS
CHIEF EXECUTIVE OFFICER. On May 27, 2003, our predecessor entered into an
employment agreement with William J. Shea pursuant to which he would serve as
our President and Chief Executive Officer for an initial term of three years.
This agreement, which became effective upon our emergence from bankruptcy, was
negotiated with our predecessor's creditors committee and was approved by the
Bankruptcy Court in connection with the approval of the Plan of Reorganization.
The agreement provides for an annual base salary of $1,000,000, an annual
performance-based bonus with a target of 100% of base salary, and an emergence
bonus of $1,000,000, which was paid shortly after our emergence from bankruptcy.
Under the agreement, we issued Mr. Shea options to purchase 500,000 shares of
common stock and 500,000 shares of restricted stock, all of which are subject to
vesting, pursuant to the Conseco, Inc. 2003 Long-Term Equity Incentive Plan. The
agreement also provides that Mr. Shea will receive a retirement benefit of
$500,000 per year and term life insurance with a face amount of $1,500,000. Mr.
Shea's retirement benefit is guaranteed by our subsidiaries, Conseco Services
LLC and Conseco Life Insurance Company of Texas. Mr. Shea is also entitled to a
gross-up for excise tax payments under Section 280G of the Internal Revenue
Code. If Mr. Shea is terminated by the Company without just cause or resigns for
good reason, he will be entitled to a payment of $6,250,000 and a pro rata
portion of the greater of (i) his annual bonus for the year in which the
separation occurs or (ii) $500,000. In addition, vesting of previously granted
options and restricted stock will occur as if Mr. Shea were employed through the
next anniversary of our emergence from bankruptcy following his separation. Mr.
Shea is subject to a non-competition clause under the agreement in the event his
service with the Company terminates prior to the end of the term.
CHIEF FINANCIAL OFFICER. We have entered into an employment agreement,
effective September 10, 2003, with Eugene M. Bullis pursuant to which he would
serve as our Executive Vice President and Chief Financial Officer for a term of
three years. The agreement provides for an annual base salary of $600,000, an
annual performance-based bonus with a target of 100% of base salary and
emergence bonus of $1,200,000, which was paid shortly after our emergence from
bankruptcy. Mr. Bullis is also entitled to a future success bonus of $1,200,000
to be paid on the third anniversary of the agreement, subject to acceleration
triggers under which one-third of the $1,200,000 future success bonus would be
paid upon the occurrence of each of: (i) the first refinancing of our Class A
Preferred Stock and Senior Credit Facility, (ii) our obtaining a financial
strength rating from A.M. Best of "A-" or higher, and (iii) achievement of
agreed upon expense reductions. Under the agreement, we will provide Mr. Bullis
with an initial equity award comprised of options to purchase 250,000 shares of
common stock with an exercise price equal to fair market value on the date of
grant and 250,000 shares or restricted stock, all of which will be subject to
vesting, pursuant to the Conseco, Inc. 2003 Long-Term Equity Incentive Plan. The
agreement also provides that Mr. Bullis will receive a supplemental retirement
benefit of $250,000 per year, one-third of which will vest each anniversary of
the agreement. We will provide Mr. Bullis a life insurance policy with a face
value of $600,000 and cover the cost of certain relocation expenses. If Mr.
Bullis is terminated by the Company without just cause, the unpaid amount of his
supplemental retirement benefit will vest and any unpaid portion of the
$1,200,000 future success bonus will become due and payable. In addition,
vesting of previously granted options and restricted stock will occur as if Mr.
Bullis were employed through the next anniversary of our emergence from
bankruptcy following his separation. In the event of a change of control of the
Company, all previously granted options and restricted stock will vest. In the
event that Mr. Bullis' employment is terminated 6 months prior to or within 2
years after a change of control, the unvested amount of his supplemental
retirement benefit will vest and any unpaid portion of the $1,200,000 future
success bonus will become due and payable. In addition, if Mr. Bullis'
employment is terminated 6 months prior to a change of control, all
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of his unvested options and restricted stock will vest, retroactive to the date
of termination, upon the occurrence of the change of control. Mr. Bullis is
subject to a non-competition clause under the agreement in the event his service
with the Company terminates prior to the end of the term.
CHIEF ACCOUNTING OFFICER. Effective July 15, 2002, our predecessor entered
into an employment agreement with John R. Kline pursuant to which he would serve
as our Senior Vice President and Chief Accounting Officer for an initial term of
two years. The agreement provides for an annual salary of at least $275,000,
bonuses at the discretion of Conseco, a signing bonus of $865,000 subject to
payment to Conseco in a pro rata amount in the event Mr. Kline voluntarily
leaves Conseco (based on the portion of the two year period remaining after the
date of such voluntary termination of employment), a severance allowance upon
termination of employment and other fringe benefits.
PRESIDENT, 40Y86 ADVISORS, INC. 40Y86 Advisors, Inc., a wholly-owned
investment management subsidiary of Conseco, Inc. that manages the investment
portfolios of our insurance subsidiaries, has entered into an employment
agreement, effective September 10, 2003, with Eric R. Johnson pursuant to which
he would serve as 40Y86 Advisor's President for a term of three years. The
agreement provides for an annual base salary of $500,000, an annual
performance-based bonus with a target of 100% of base salary and a bonus of
$950,000 that was paid in January 2004. Mr. Johnson is also entitled to a future
success bonus of $950,000 to be paid on the third anniversary of the agreement,
subject to acceleration triggers under which one-third of the $950,000 future
success bonus would be paid upon the occurrence of each of: (i) the first
refinancing of our Class A Preferred Stock and Senior Credit Facility, (ii) our
obtaining a financial strength rating from A.M. Best of "A-" or higher, and
(iii) the achievement of mutually agreed-upon improvements in investment return
and quality. Under the agreement, we will provide Mr. Johnson with an initial
equity award comprised of options to purchase 150,000 shares of common stock
with an exercise price equal to fair market value on the date of grant and
75,000 shares or restricted stock, all of which will be subject to vesting,
pursuant to the Conseco, Inc. 2003 Long-Term Equity Incentive Plan. We will
provide Mr. Johnson a life insurance policy with a face value of $500,000. If
Mr. Johnson is terminated by 40Y86 Advisors without just cause, any unvested
portion of the $950,000 future success bonus will become due and payable. In the
event of a change of control of the Company, all previously granted options and
restricted stock will vest. In the event that Mr. Johnson's employment is
terminated 6 months prior to or within 2 years after a change of control, any
unvested portion of the $950,000 future success bonus will become due and
payable. In addition, if Mr. Johnson's employment is terminated 6 months prior
to a change of control, all of his unvested options and restricted stock will
vest, retroactive to the date of termination, upon the occurrence of the change
of control. Mr. Johnson is subject to a non-competition clause under the
agreement in the event his service with 40Y86 Advisors terminates prior to the
end of the term.
PRESIDENT AND CHIEF EXECUTIVE OFFICER, BANKERS LIFE AND CASUALTY
COMPANY. Edward M. Berube has an agreement with Conseco Services, LLC, a
subsidiary of Conseco, which provides for a base salary of $660,000 per year,
annual bonuses based on the achievement of performance parameters and certain
other benefits. Pursuant to this agreement, it was agreed that Mr. Berube would
be entitled to additional compensation to the extent his accumulated incentive
compensation from our predecessor company did not exceed $1,234,000 (he received
no such incentive compensation from stock options granted by our predecessor
company). This provision was designed to compensate Mr. Berube for the loss of
certain incentive compensation that would have been available from his prior
employer otherwise. Under the terms of his agreement, Mr. Berube is entitled to
a severance payment equal to two years of total cash compensation, but in no
case less than $2,320,000 in the event of a change of control, a major change in
strategy resulting in the elimination of his role, a material reduction in his
responsibilities or termination of employment for other than cause. Upon any
such event, Mr. Berube is also entitled to receive a payment of $1,234,000.
CONSECO, INC. 2003 LONG-TERM EQUITY INCENTIVE PLAN
OVERVIEW. As of the effective date of the Plan of Reorganization, the
Bankruptcy Court, pursuant to the confirmation order approving the Plan of
Reorganization, approved, and our board of directors adopted, the Conseco, Inc.
2003 Long-Term Equity Incentive Plan. The purpose of the plan is to promote our
long-term growth and profitability by providing selected directors, officers and
employees of the Company and its
126
subsidiaries, as well as other persons who provide services to us, with
incentives to maximize stockholder value and otherwise contribute to our
success, and enable us to attract, retain and reward the best available persons
for positions of responsibility.
TYPES OF AWARDS. The plan provides for the grant of stock options and
restricted stock to eligible participants.
ELIGIBILITY. Directors, officers and employees of the Company and its
subsidiaries, as well as other individuals performing significant services for
us, or to whom we have extended an offer of employment, will be eligible to
receive awards under the plan. In each case, the Human Resources and
Compensation Committee of the board of directors will select the actual
participants and determine the amounts and terms of their awards.
SHARE RESERVE/LIMITATIONS. 10,000,000 shares of our common stock are
available for issuance under the plan. Of these 10,000,000 shares, only
3,333,333 may be granted in the form of restricted stock.
ADMINISTRATION. The Human Resources and Compensation Committee of our
board of directors administers the plan. Our board of directors also has the
authority to administer the plan and to take all actions that the Human
Resources and Compensation Committee is otherwise authorized to take under the
plan.
TERMS OF AWARDS. The exercise price of an option issued under the plan may
not be less than 100% of the fair market value of our common stock on the date
the option is granted. The Human Resources and Compensation Committee
determines, in connection with each grant under the plan, when options become
exercisable and when they expire. The Human Resources and Compensation Committee
also determines the vesting periods of restricted stock granted under the plan.
CHANGE IN CONTROL. The Human Resources and Compensation Committee may
provide, in award agreements, for appropriate adjustments to option and
restricted stock awards, including the acceleration of vesting, if a change in
control of the Company occurs.
AMENDMENT AND TERMINATION. The Human Resources and Compensation Committee
or our board of directors may amend or terminate the plan at any time, as long
as the amendment or termination does not negatively affect any options or
restricted stock that have been previously granted under the plan without the
consent of the holders, but cannot increase the number of shares available for
issuance under the plan, materially modify the requirements for eligibility
under the plan, or materially increase the benefits to participants under the
plan without the approval of a majority of stockholders. Unless earlier
terminated by the board of directors, the plan will terminate on September 10,
2013.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Beginning in 1996, our predecessor adopted stock purchase plans (the
"Purchase Plans") to encourage direct, long-term ownership of its common stock
by directors, executive officers and certain key employees. Purchases of common
stock under the Purchase Plans were financed by personal loans made to the
participants from banks. These loans were collateralized by the common stock
purchased. Approximately 170 directors, officers and key employees of our
predecessor and its subsidiaries participated in the Purchase Plans and
purchased an aggregate of approximately 19.0 million shares of our predecessor's
common stock offered under the Purchase Plans. Our predecessor guaranteed the
loans but had recourse to the participants if it incurred a loss under the
guarantees. As a result of the Reorganization, Conseco acquired the right to
collect these loans from the participants. The only current director or
executive officer that had an outstanding Purchase Plan loan during 2003 was Mr.
Johnson, who had borrowed $205,903, relating to his purchase of 5,000 shares
under the Purchase Plans. Mr. Johnson repaid this loan in full in 2003.
In addition, our predecessor provided loans to the participants for the
interest payments payable on the guaranteed bank loans. The largest amount owed
during 2003 by Mr. Johnson on the loan to cover interest was $58,912. Mr.
Johnson repaid his interest payment loan in full in January 2004. The interest
payment loans bore interest at a variable annual rate equal to the lowest annual
rate our predecessor paid under its most recent senior credit facility.
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PRINCIPAL STOCKHOLDERS
The following table sets forth certain information concerning the
beneficial ownership of our common stock as of December 31, 2003 by each person
known to us who beneficially owns more than 5% of the outstanding shares of our
common stock, each of our directors, each of our named executive officers and
all of our directors and named executive officers as a group.
SHARES SHARES
BENEFICIALLY OWNED BENEFICIALLY OWNED
PRIOR TO THE OFFERING AFTER THE OFFERING
---------------------- ----------------------
NAME AND ADDRESS NUMBER PERCENTAGE NUMBER PERCENTAGE
---------------- ------ ---------- ------ ----------
David A. Tepper(1)............................ 7,321,550 7.3% 7,321,550
Angelo, Gordon & Co., L.P.(2)................. 5,716,487 5.7 5,716,487
R. Glenn Hilliard............................. 598,119 * 598,119 *
William J. Shea............................... 500,000 * 500,000 *
Neal Schneider................................ 3,526 * 3,526 *
Philip R. Roberts............................. 3,526 * 3,526 *
John G. Turner................................ 3,526 * 3,526 *
Michael T. Tokarz............................. 3,526 * 3,526 *
Michael S. Shannon............................ 3,526 * 3,526 *
Eugene M. Bullis.............................. 0 0 0 0
Edward M. Berube.............................. 0 0 0 0
Eric R. Johnson............................... 0 0 0 0
John R. Kline................................. 0 0 0 0
All directors and named executive officers as
a group (12 persons)........................ 1,115,749 1.1% 1,115,749
---------------
* Less than 1%.
(1) Based solely on the Schedule 13D/A filed with the SEC on October 7, 2003,
and the Schedule 13G filed with the SEC on October 8, 2003, by and on behalf
of Appaloosa Investment Limited Partnership I ("AILP"), Palamino Fund Ltd.
("Palamino"), Appaloosa Management L.P. ("AMLP"), Appaloosa Partners Inc.
("API") and David A. Tepper (collectively, the "Reporting Persons"). The
business address of each of the Reporting Persons is c/o Appaloosa
Management L.P., 26 Main Street, Chatham, New Jersey 07928. Of the shares
reported in this table: 2,928,644 shares may be deemed to be beneficially
owned by AILP; 2,565,998 shares may be deemed to be owned beneficially by
Palamino; 5,494,642 shares may be deemed beneficially owned by AMLP;
5,494,642 may be deemed to be beneficially owned by API; and 7,321,550 may
be deemed to be owned beneficially by Mr. Tepper. Of the shares reported in
this table: AILP may be deemed to have shared voting and dispositive power
with respect to 2,928,644 shares; Palomino may be deemed to have shared
voting and dispositive power with respect to 2,565,998 shares; AMLP may be
deemed to have shared voting and dispositive power with respect to 5,494,642
shares; API may be deemed to have shared voting and dispositive power with
respect to 5,494,642 shares; Mr. Tepper may be deemed to have shared voting
and dispositive power with respect to 5,494,642 shares and sole voting and
dispositive power with respect to 1,826,908 shares.
(2) Based solely on the Schedule 13G filed with the SEC on September 22, 2003 by
and on behalf of Angelo, Gordon & Co., L.P. ("Angelo, Gordon"); John M.
Angelo, in his capacities as general partner of AG Partners, L.P., the sole
general partner of Angelo, Gordon, and as the chief executive officer of
Angelo, Gordon; and Michael L. Gordon, in his capacities as the other
general partner of AG Partners, L.P., the sole general partner of Angelo,
Gordon, and as the operating officer of Angelo, Gordon. The business address
of each of Angelo, Gordon, Mr. Angelo and Mr. Gordon is 245 Park Avenue, New
York, New York 10167.
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[P] DESCRIPTION OF THE MANDATORILY CONVERTIBLE PREFERRED STOCK
The description in this prospectus of the terms of the Class B Mandatorily
Convertible Preferred Stock (the "Class B Preferred Stock") is only a summary.
The terms of the Class B Preferred Stock are contained in a certificate of
designations that will amend our amended and restated certificate of
incorporation. We have previously filed with the SEC copies of our amended and
restated certificate of incorporation. See "Where You Can Find More
Information." The form of certificate of designations is filed as an exhibit to
the registration statement of which this prospectus is a part.
GENERAL
Our amended and restated certificate of incorporation authorizes the
issuance of 265,000,000 shares of preferred stock, par value $.01 per share, of
which 34,386,740 shares of Class A Preferred Stock were issued and outstanding
as of September 30, 2003. The Class A Preferred Stock will be redeemed in full
with a portion of the combined net proceeds of the Class B Preferred Stock and
the concurrent offering of common stock. The Class B Preferred Stock constitutes
a new series of our preferred stock. See "Description of Capital Stock" in this
prospectus for a description of our other classes of capital stock, as well as
the Series A Warrants referred to below.
The Class B Preferred Stock is a single series consisting of
shares of Class B Preferred Stock (or shares of Class B Preferred
Stock if the underwriters exercise their option to purchase additional shares of
Class B Preferred Stock in full in accordance with the procedures set forth in
"Underwriting"). The holders of the shares of Class B Preferred Stock will have
no preemptive rights. Upon issuance, all of the shares of Class B Preferred
Stock will be fully paid and non-assessable.
The Class B Preferred Stock will rank:
- junior to all of our existing and future debt obligations;
- junior to any class or series of our capital stock the terms of which
provide that such class or series will rank senior to the Class B
Preferred Stock (any such stock being referred to herein as "Senior
Stock");
- senior to any class or series of our capital stock the terms of which
provide that such class or series will rank junior to the Class B
Preferred Stock;
- senior in right of payment to all of our Class A Preferred Stock and
common stock now outstanding or to be issued in the future; and
- on a parity with any other class or series of our capital stock ranking
pari passu with the Class B Preferred Stock as to the payment of
dividends or the distribution of assets upon dissolution, liquidation or
winding up (any such stock being herein referred to as "Parity Stock").
We will not be entitled to issue any class or series of our capital stock
the terms of which provide that such class or series will rank senior to the
Class B Preferred Stock without the consent of the holders of at least
two-thirds of the shares of the Class B Preferred Stock. See "-- Voting Rights."
As of the date of this prospectus, we are authorized to issue up to
8,000,000,000 shares of common stock, $.01 par value per share (the "common
stock"). As of September 30, 2003, 100,098,119 shares of common stock were
issued and outstanding. In addition, as of such date, there were outstanding
Series A Warrants exercisable for an aggregate of 6,000,000 shares of our common
stock at an exercise price of $27.60 per share, subject to certain anti-dilution
provisions. As of September 30, 2003, there were 34,386,740 shares of our Class
A Preferred Stock outstanding, with an aggregate liquidation preference amount
of approximately $865 million.
Under Delaware law, we may declare or pay dividends on the Class B
Preferred Stock solely out of legally available assets for the payment of
dividends. Under Delaware law, legally available assets means the amount of our
surplus. If there is no surplus, legally available assets also means, in the
case of a dividend,
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the amount of our net profits for the fiscal year in which the payment occurs
and/or the preceding fiscal year. Our surplus is the amount by which our total
assets exceeds the sum of
- our total liabilities, including our contingent liabilities, and
- the amount of our capital.
When the need to make a determination of legally available assets arises,
the amount of our total assets and total liabilities and the amount of our
capital will be determined by our board of directors in accordance with Delaware
law.
DIVIDENDS
GENERAL
Dividends on the shares of Class B Preferred Stock will be payable
quarterly in cash on the March 1, June 1, September 1 and December 1 of each
year (or the following business day if such day is not a business day) (each, a
"Dividend Payment Date") at the annual rate of $ per share. The initial
dividend on the Class B Preferred Stock, for the first dividend period, assuming
the issue date is , 2004, will be $ per share of Class B Preferred
Stock, and will be payable on , 2004. Each subsequent quarterly
dividend on the shares of Class B Preferred Stock will be $ per share of
Class B Preferred Stock.
The amount of dividends payable on each share of Class B Preferred Stock
for each full quarterly period will be computed by dividing the annual dividend
rate by four. The amount of dividends payable for any other period that is
shorter or longer than a full quarterly dividend period will be computed on the
basis of a 360-day year consisting of twelve 30-day months.
A dividend period is the period ending on the day before a Dividend Payment
Date and beginning on the preceding Dividend Payment Date or, if none, the date
of issue. Dividends payable on a Dividend Payment Date will be payable to
holders of record on the February 15, May 15, August 15 or November 15, as the
case may be, immediately preceding the relevant Dividend Payment Date, as fixed
for the purpose by our board of directors in advance of payment of the relevant
dividend. The shares of Class B Preferred Stock are entitled to receive payment
of dividends on a parity with any class or series of our capital stock the terms
of which provide that such class or series will rank on a parity with the Class
B Preferred Stock.
We will pay dividends in cash on the Class B Preferred Stock on each
Dividend Payment Date unless (1) we do not have legally available assets for
such payment or (2) such dividend payment would result in a default under our
Senior Credit Agreement. "Senior Credit Agreement" means the Credit Agreement
dated as of September 10, 2003, among Conseco, Inc., Bank of America, N.A. and
the other financial institutions party thereto, as in effect on the issue date
of the Class B Preferred Stock (the "Issue Date"), as the same may be amended,
modified or replaced following the Issue Date. Notwithstanding the foregoing,
the right of holders of the Class B Preferred Stock to receive payments of
dividends on the Class B Preferred Stock is subject to the rights of any Senior
Stock and Parity Stock issued in accordance with the terms of the Class B
Preferred Stock. For the quarter ended December 31, 2003, we would have been
able to pay dividends of up to $ in accordance with the terms of our Senior
Credit Agreement on an as adjusted basis to give effect to the concurrent
offerings of our common stock and Class B Preferred Stock and the use of
proceeds thereof as described under "Use of Proceeds."
Dividends on the Class B Preferred Stock will be cumulative, whether or not
there are assets legally available for the payment of such dividends. This means
that, if our board of directors does not declare a dividend for any reason, the
dividend will accumulate until declared and paid. Accumulated unpaid dividends
will cumulate dividends at the annual rate of % and are payable in the manner
provided above. We will undertake to disclose in our quarterly and annual
reports filed with the SEC the amount of any accumulated and unpaid dividends on
the shares of the Class B Preferred Stock as of the date of such reports,
including any dividends cumulated thereon.
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We are not obligated to pay holders of Class B Preferred Stock any dividend
in excess of the full dividends on the shares of Class B Preferred Stock that
are payable as described above.
PAYMENT RESTRICTIONS
Unless all dividends on the Class B Preferred Stock for all past quarterly
dividend periods shall have been paid in full, we will not:
- declare or pay any dividend or make any distribution of assets on any of
our capital stock now or hereafter authorized that ranks junior to the
Class B Preferred Stock as to the payment of dividends or the
distribution of assets upon our liquidation, dissolution or winding up,
including our common stock, which we call junior stock, other than
dividends or distributions in the form of junior stock;
- redeem, purchase or otherwise acquire any junior stock other than Class A
Preferred Stock, except upon conversion or exchange for other junior
stock, or
- redeem, purchase or otherwise acquire any of our capital stock now or
hereafter authorized that ranks equally with the Class B Preferred Stock
as to payment of dividends or the distribution of assets upon our
liquidation, dissolution or winding up, except upon conversion or
exchange for junior stock.
REDEMPTION
The Class B Preferred Stock will not be redeemable.
MANDATORY CONVERSION
Each of the shares of Class B Preferred Stock, unless previously converted,
will automatically convert on , which we call the mandatory conversion
date, into a number of newly issued shares of our common stock equal to the
conversion rate described below.
Subject to the immediately following paragraph, the conversion rate, which
is the number of newly issued shares of our common stock issuable upon
conversion of each share of Class B Preferred Stock on the applicable conversion
date, will, subject to adjustment under certain circumstances as described under
"-- Anti-Dilution Adjustments" below, be as follows:
- If the Applicable Market Value of our common stock is equal to or greater
than $ , which we call the threshold appreciation price, then the
conversion rate will be shares of our common stock per share of
Class B Preferred Stock (the "minimum conversion rate").
- If the Applicable Market Value of our common stock is less than the
threshold appreciation price but greater than $ , which we call the
initial price, the conversion rate will be equal to $ divided by
the applicable market value of our common stock per share of Class B
Preferred Stock.
- If the Applicable Market Value of our common stock is less than or equal
to the initial price, the conversion rate will be shares of our
common stock per share of Class B Preferred Stock (the "maximum
conversion rate").
We refer to the minimum conversion rate and the maximum conversion rate
collectively as the fixed conversion rates.
Accordingly, assuming that the market price of our common stock on the
mandatory conversion date is the same as the applicable market value, the
aggregate market value of the shares you receive upon conversion will be
- greater than the liquidation preference of the shares of Class B
Preferred Stock if the Applicable Market Value is greater than the
threshold appreciation price,
131
- equal to the liquidation preference if the Applicable Market Value is
less than or equal to the threshold appreciation price and greater than
or equal to the initial price, and
- less than the liquidation preference if the Applicable Market Value is
less than the initial price.
In addition to the number of newly issued shares of our common stock
issuable upon conversion of each share of Class B Preferred Stock on the
conversion date determined as provided above, holders will receive on the
mandatory conversion date an amount in cash equal to any accrued and unpaid
dividends on the shares of Class B Preferred Stock due on the mandatory
conversion date, whether or not declared prior to that date, provided that we
have legally available assets at such time and paying such dividend in cash
would not result in a default under our Senior Credit Agreement. If on the
mandatory conversion date we do not have adequate legally available assets to
pay in cash all or any portion of the accrued and unpaid dividends payable in
cash on such date as provided in this paragraph, or if such payment would result
in a default under our Senior Credit Agreement, then, in either such case, with
respect to the portion of such dividends which we are unable to pay in cash, we
shall deliver to the holders a number of common shares per share of Class B
Preferred Stock equal to (1) the aggregate amount of such portion per share of
Class B Preferred Stock divided by (2) the greater of (A) the Applicable Market
Value of our common stock and (B) $0.15. We will use our reasonable best efforts
to cause any such shares of common stock delivered in respect of dividends on
the mandatory conversion date to be freely transferable by the recipients
thereof, including, if necessary, the filing of a registration statement in
respect of such common shares.
"Applicable Market Value" means the average of the closing price per share
of our common stock on each of the twenty consecutive trading days ending on the
third trading day immediately preceding the mandatory conversion date. The
initial price is the closing price of our common stock on the New York Stock
Exchange on , 2004. The threshold appreciation price represents an
approximately % appreciation over the initial price.
The closing price of our common stock on any date of determination means
the closing sale price or, if no closing sale price is reported, the last
reported sale price of our common stock on the New York Stock Exchange on that
date. If our common stock is not listed on the New York Stock Exchange on any
date, the closing price of our common stock on any date of determination means
the closing sales price as reported in the composite transactions for the
principal U.S. securities exchange on which our common stock is so listed or
quoted, or if our common stock is not so listed or quoted on a U.S. national or
regional securities exchange, as reported by the Nasdaq National Market, or, if
our common stock is not so reported, the last quoted bid price for our common
stock in the over-the-counter market as reported by the National Quotation
Bureau or similar organization or, if that bid price is not available, the
market price of our common stock on that date as determined by a nationally
recognized independent investment banking firm retained by us for this purpose.
A trading day is a day on which our common stock:
- is not suspended from trading on any national or regional securities
exchange or association or over-the-counter market at the close of
business; and
- has traded at least once on the national or regional securities exchange
or association or over-the-counter market that is the primary market for
the trading of our common stock.
CONVERSION
Conversion into common stock will occur on the mandatory conversion date,
unless:
- we have caused the conversion of the shares of Class B Preferred Stock
prior to the mandatory conversion date in the manner described in
"-- Provisional Conversion at Our Option";
- you have converted your shares of Class B Preferred Stock prior to the
mandatory conversion date in the manner described in "-- Conversion at
the Option of the Holder"; or
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- we are involved in a merger prior to the mandatory conversion date in
which at least 30% of the consideration for our common stock consists of
cash or cash equivalents, and you have converted your shares of Class B
Preferred Stock through an exercise of the merger early conversion right
as described in "-- Early Conversion upon Cash Merger."
On the applicable conversion date, or as soon as practicable thereafter,
certificates representing our common stock will be issued and delivered to you
or your designee, upon presentation and surrender of the certificate evidencing
the shares of Class B Preferred Stock, if the shares of Class B Preferred Stock
are held in certificated form.
Prior to the date on which shares of common stock are issued upon
conversion, our common stock underlying the shares of Class B Preferred Stock
will not be deemed to be outstanding for any purpose and you will have no rights
with respect to our common stock, including voting rights, rights to respond to
tender offers and rights to receive any dividends or other distributions on our
common stock, by virtue of holding the Class B Preferred Stock.
PROVISIONAL CONVERSION AT OUR OPTION
Prior to the mandatory conversion date and on or after the first day
immediately following the Issue Date, we may at our option cause the conversion
of all, but not less than all, of the shares of Class B Preferred Stock then
outstanding into shares of our common stock at the minimum conversion rate of
shares of our common stock for each share of Class B Preferred Stock, subject to
adjustment under certain circumstances as described under "-- Anti-Dilution
Adjustments" below; provided that the closing price per share of our common
stock has exceeded 150% of the threshold appreciation price, initially $ ,
subject to anti-dilution adjustments, for at least 20 trading days within a
period of 30 consecutive trading days ending on the trading day prior to the
date that we notify you of the optional conversion. We will provide each holder
of Class B Preferred Stock notice of the option by mail and issue a press
release and publish such information on our website on the World Wide Web. The
date specified in such notice for the optional conversion shall be at least 30
days but no more than 60 days from the date of such notice. We will be able to
cause this conversion only if, in addition to issuing you shares of our common
stock as described above, we pay you in cash (1) an amount equal to any accrued
and unpaid dividends on your shares of Class B Preferred Stock, whether or not
declared, and (2) the present value of all remaining dividend payments on your
shares of Class B Preferred Stock through and including , in each
case, out of legally available assets. The present value of the remaining
dividend payments will be computed using a discount rate equal to the Treasury
Yield. "Treasury Yield" means the yield to maturity at the time of computation
of United States Treasury securities with a constant maturity (as compiled and
published in the most recent Federal Reserve Statistical Release H.15 (519) that
has become publicly available at least two business days prior to the date fixed
for conversion (or, if such Statistical Release is no longer published, any
publicly available source for similar market data)) most nearly equal to the
then remaining term to , provided, however, that if the then remaining
term to is not equal to the constant maturity of a U.S. Treasury
security for which a weekly average yield is given, the Treasury Rate shall be
obtained by linear interpolation (calculated to the nearest one-twelfth of a
year) from the weekly average yields of U.S. Treasury securities for which such
yields are given, except that if the then remaining term to is less
than one year, the weekly average yield on actually traded U.S. Treasury
securities adjusted to a constant maturity of one year shall be used.
CONVERSION AT THE OPTION OF THE HOLDER
The holders of shares of Class B Preferred Stock have the right to convert
them, in whole or in part, at any time prior to the mandatory conversion date
and on or after the first day immediately following the Issue Date, into shares
of our common stock at the minimum conversion rate of shares of our
common stock for each share of Class B Preferred Stock, subject to adjustment
under certain circumstances as described under "-- Anti-Dilution Adjustments"
below.
133
Assuming a dividend is declared, holders of shares of Class B Preferred
Stock at the close of business on the record date for the payment of such
dividend will be entitled to receive such dividend on the corresponding Dividend
Payment Date even if optional conversion of the shares of Class B Preferred
Stock occurs between that record date and the corresponding Dividend Payment
Date.
Except as described above, upon any optional conversion of shares of Class
B Preferred Stock, we will make no payment or allowance for unpaid dividends,
whether or not in arrears, on the shares of Class B Preferred Stock, or for
prior dividends or distributions on the shares of our common stock issued upon
conversion.
EARLY CONVERSION UPON CASH MERGER
Prior to the mandatory conversion date, if we are involved in a merger in
which at least 30% of the consideration for our common stock consists of cash or
cash equivalents, which we refer to as a cash merger, then on or after the date
of the cash merger, each holder of shares of Class B Preferred Stock will have
the right to convert their shares of Class B Preferred Stock at the conversion
rate determined as set forth under "-- Mandatory Conversion" assuming that the
trading day immediately before the cash merger is the mandatory conversion date.
We refer to this right as the "merger early conversion right." We will provide
each of the holders with a notice of the completion of a cash merger within five
business days thereof. The notice will specify the conversion date, which shall
be not less than 20 nor more than 35 days after the date of the notice, on which
the merger early conversion will occur and a date by which each holder's merger
early conversion right must be exercised. The notice will set forth, among other
things, the applicable conversion rate and the amount of the cash, securities
and other consideration receivable by the holder upon conversion. To exercise
the merger early conversion right, a holder must deliver to us, on or before the
date specified in the notice, the certificate evidencing such holder's shares of
Class B Preferred Stock, if the shares of Class B Preferred Stock are held in
certificated form. If a holder exercises the merger early conversion right, we
will deliver to such holder on the merger early conversion date the kind and
amount of securities, cash or other property that such holder would have been
entitled to receive if it had converted its shares of Class B Preferred Stock
immediately before the cash merger at the conversion rate (determined as set
forth under "-- Mandatory Conversion") in effect at such time. If a holder does
not elect to exercise the merger early conversion right, such holder's shares of
Class B Preferred Stock will remain outstanding and subject to mandatory
conversion on the mandatory conversion date.
ANTI-DILUTION ADJUSTMENTS
Each fixed conversion rate and the number of shares of common stock to be
delivered as a result of the conversion described under "-- Mandatory
Conversion", "-- Provisional Conversion at Our Option", "-- Conversion at the
Option of the Holder" and "-- Early Conversion upon Cash Merger" will be
adjusted if the following events occur:
(1) We pay dividends (and other distributions) on our common stock in
shares of our common stock.
(2) We issue to all holders of our common stock rights or warrants
entitling them, for a period of up to 45 days, to subscribe for or purchase
our common stock at less than the "current market price," as defined below,
of our common stock.
(3) We subdivide, split or combine our common stock.
(4) We distribute to all holders of our common stock evidences of our
indebtedness, shares of capital stock, securities, cash or property
(excluding any dividend or distribution covered by clauses (1) or (2) above
and, with respect to any dividend or distribution paid exclusively in cash,
excluding any dividend or distribution in connection with our liquidation,
dissolution or termination), in which event each fixed conversion rate will
be multiplied by a fraction,
- the numerator of which is the current market price of our common
stock, and
134
- the denominator of which is the current market price of our common
stock minus the fair market value, as determined by our board of
directors, except as described in the following paragraph, of the
portion of the assets or evidences of indebtedness, shares,
securities, cash or property so distributed applicable to one share of
common stock.
In the event that we make a distribution to all holders of our common stock
consisting of capital stock of, or similar equity interests in, a
subsidiary or other business unit of ours, each fixed conversion rate will
be adjusted based on the market value of the securities being distributed
relative to the market value of our common stock, in each case based on the
average of the closing sale prices of those securities for the 10 trading
days commencing on and including the fifth trading day after the "ex-date"
for such distribution.
(5) We or any of our subsidiaries successfully completes a tender or
exchange offer for our common stock to the extent that the cash and the
value of any other consideration included in the payment per share of our
common stock exceeds the closing price of our common stock on the trading
day next succeeding the last date on which tenders or exchanges may be made
pursuant to such tender or exchange offer, in which event each fixed
conversion rate will be divided by a fraction,
- the numerator of which shall be equal to (A) the product of (I) the
closing price per share of our common stock on the first trading day
after the date of expiration of the tender or exchange offer
multiplied by (II) the number of shares of common stock outstanding
(including any purchased shares) at such time less (B) the amount of
cash plus the fair market value, as determined by our board of
directors, of the aggregate consideration payable for all the shares
of our common stock we purchased in such tender or exchange offer; and
- the denominator of which will be the product of the number of shares
of our common stock outstanding less any such purchased shares and the
closing price of our common stock on the first trading day after the
date of expiration of the tender or exchange offer.
(6) Someone other than us or one of our subsidiaries makes a payment in
respect of a tender offer or exchange offer in which, as of the closing
date of the offer, our board of directors is not recommending rejection of
the offer, in which event each fixed conversion rate will be multiplied by
a fraction,
- the numerator of which will be the sum of (x) the fair market value,
as determined by our board of directors, of the aggregate
consideration payable to our stockholders based on the acceptance (up
to any maximum specified in the terms of the tender or exchange offer)
of all shares validly tendered or exchanged and not withdrawn as of
the expiration of the offer and (y) the product of the number of
shares of our common stock outstanding less any such purchased shares
and the closing price of our common stock on the trading day next
succeeding the expiration of the tender or exchange offer; and
- the denominator of which will be the product of the number of shares
of our common stock outstanding, including any such purchased shares,
and the closing price of our common stock on the trading day next
succeeding the expiration of the tender or exchange offer.
The adjustment referred to in this clause (6) will only be made if:
- the tender offer or exchange offer is for an amount that increases the
offeror's ownership of common stock to more than 25% of the total
shares of common stock outstanding; and
- the cash and value of any other consideration included in the payment
per share of common stock exceeds the closing sale price per share of
common stock on the trading day next succeeding the last date on which
tenders or exchanges may be made pursuant to the tender or exchange
offer.
However, the adjustment referred to in this clause will generally not be
made if as of the closing of the offer, the offering documents disclose a
plan or an intention to cause us to engage in a consolidation or merger or
a sale of all or substantially all of our assets.
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The "current market price" is the average of the daily closing prices for
the five consecutive trading days preceding the earlier of the day preceding the
day in question and the day before the "ex-date" with respect to the issuance or
distribution requiring such computation. For purposes of this paragraph, the
term "ex-date," when used with respect to any such issuance or distribution,
means the first date on which our common stock trades on the applicable exchange
or in the applicable market, regular way, without the right to receive such
issuance or distribution.
To the extent that we have a rights plan in effect with respect to our
common stock, upon conversion of any share of Class B Preferred Stock, you will
receive, in addition to the common stock, the rights under the rights plan,
unless, prior to such conversion, the rights have separated from the common
stock, in which case each fixed conversion rate will be adjusted at the time of
separation as if we made a distribution to all holders of our common stock as
described in clause (4) above, subject to readjustment in the event of the
expiration, termination or redemption of such rights.
In the case of certain reclassifications, consolidations, mergers, sales or
transfers of assets or other transactions that cause our common stock to be
converted into the right to receive other securities, cash or property, each
share of Class B Preferred Stock that thereafter remains outstanding would,
without the consent of the holders of the Class B Preferred Stock, become
convertible into such other securities, cash or property instead of our common
stock. In such event, on the applicable conversion date, the conversion rate
then in effect will be applied to the value on the applicable conversion date of
the securities, cash or property a holder of one share of our common stock would
have received in such transaction. Holders have the right to convert their
shares of Class B Preferred Stock early in the event of certain cash mergers as
described under "-- Early Conversion upon Cash Merger."
In addition, we may make such increases in each fixed conversion rate as we
deem advisable for any reason. We may only make such a discretionary adjustment
if we make the same proportionate adjustment to each fixed conversion rate.
In the event of a taxable distribution to holders of shares of our common
stock that results in an adjustment of each fixed conversion rate or an increase
in each fixed conversion rate in our discretion, holders of shares of Class B
Preferred Stock may, in certain circumstances, be deemed to have received a
distribution subject to U.S. federal income tax as a dividend. In addition,
non-U.S. holders of Class B Preferred Stock may, in certain circumstances, be
deemed to have received a distribution subject to U.S. federal withholding tax
requirements. See "Certain United States Federal Income Tax
Considerations -- Adjustment of Conversion Rate" in this prospectus.
Adjustments to each fixed conversion rate will be calculated to the nearest
1/10,000th of a share. We will be required, as soon as practicable following the
occurrence of an event that requires or permits an adjustment in each fixed
conversion rate, to provide written notice to the holders of Class B Preferred
Stock of the occurrence of that event. We will also be required to deliver a
statement setting forth in reasonable detail the method by which the adjustment
to each fixed conversion rate was determined and setting forth each revised
fixed conversion rate.
If an adjustment is made to the fixed conversion rates, an adjustment also
will be made to the threshold appreciation price and the initial price.
FRACTIONAL SHARES
No fractional shares of our common stock will be issued to holders of Class
B Preferred Stock. In lieu of any fractional share otherwise issuable in respect
of the aggregate number of shares of Class B Preferred Stock of any holder that
are converted upon mandatory conversion or any optional conversion, that holder
will be entitled to receive an amount in cash equal to the same fraction of:
- in the case of mandatory conversion, an early conversion at our option or
a merger early conversion, the current market price of a share of common
stock; or
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- in the case of an optional conversion by a holder, the closing price per
share of our common stock determined as of the trading day immediately
preceding the effective date of conversion.
COMMON STOCK RIGHTS
Reference is made to the "Description of Capital Stock" for a description
of the rights of holders of common stock to be delivered upon conversion of
Class B Preferred Stock.
LIQUIDATION RIGHTS
In the event of our liquidation, dissolution or winding up, the holders of
Class B Preferred Stock will be entitled to receive out of our assets available
for distribution to shareholders, before any distribution or payment is made on
any junior stock as to the distribution of assets upon our voluntary or
involuntary liquidation, our dissolution or the winding up of our affairs, a
liquidating distribution in the amount of $ per share, plus an amount equal
to the sum of all accrued and unpaid dividends, whether or not declared, for the
then-current dividend period and all prior dividend periods.
For the purpose of the preceding paragraph, none of the following will
constitute a voluntary or involuntary liquidation, dissolution or winding up of
our affairs:
- the sale, lease or conveyance of all or substantially all of our property
or business;
- the consolidation or merger of Conseco, Inc. with or into any other
corporation; or
- the consolidation or merger of any other corporation with or into
Conseco, Inc.
If, upon any voluntary or involuntary liquidation, dissolution or winding
up, the amounts payable with respect to the shares of Class B Preferred Stock
then outstanding are not paid in full as provided above, no distribution may be
made on account of any Parity Stock unless a pro rata distribution is made on
the Class B Preferred Stock. The holders of the Class B Preferred Stock then
outstanding and the holders of any Parity Stock then outstanding will share
ratably in any distribution of assets upon such liquidation, dissolution or
winding up. The amount allocable to the Class B Preferred Stock and each series
of Parity Stock then outstanding will be based on the proportion of their full
respective liquidation preference to the aggregate liquidation preference of the
outstanding shares of each such series.
After the payment to the holders of Class B Preferred Stock of the full
preferential amounts provided above, the holders of Class B Preferred Stock will
have no right or claim to any of our remaining assets.
VOTING RIGHTS
The holders of the shares of Class B Preferred Stock are not entitled to
any voting rights, except as required by applicable state law, our amended and
restated certificate of incorporation and as described below.
Unless the approval of a greater number of shares of Class B Preferred
Stock is required by law, we will not, without the approval of the holders of at
least two-thirds of the shares of Class B Preferred Stock then outstanding,
voting together as a single class:
- amend, alter or repeal any provisions of our amended and restated
certificate of incorporation or by-laws by way of merger, consolidation
or otherwise, that would affect adversely any right, preference,
privilege or voting power of the Class B Preferred Stock;
- reclassify any of our authorized stock into any stock of any class, or
any obligation or security convertible into or evidencing a right to
purchase such stock, ranking senior to the Class B Preferred Stock;
- issue, authorize or increase the authorized amount of, or issue or
authorize any obligation or security convertible into or evidencing a
right to purchase, stock ranking senior to the Class B Preferred Stock;
provided, that we may issue, authorize or increase the authorized amount
of, or issue or
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authorize any obligation or security convertible into or evidencing a
right to purchase, stock ranking on a parity with or junior to the Class
B Preferred Stock without the vote of the holders of the Class B
Preferred Stock; or
- voluntarily liquidate, dissolve or wind up our affairs, or sell, lease or
convey (other than by mortgage) all or substantially all of our property
or business, or consolidate or merge with or into any other corporation,
except any such consolidation or merger wherein none of the rights,
preferences, privileges or voting powers of the Class B Preferred Stock
or the holders thereof are adversely affected.
In addition, we will not, without the approval of each holder of shares of
Class B Preferred Stock affected thereby, amend our amended and restated
certificate of incorporation in a manner that:
- adversely changes the dividends payable on the Class B Preferred Stock;
- adversely changes the liquidation preference of the Class B Preferred
Stock; or
- adversely affects the conversion provisions of the Class B Preferred
Stock.
If and whenever six full quarterly dividends, whether or not consecutive,
payable on the Class B Preferred Stock or any Parity Stock are not paid, the
number of directors constituting our board of directors will be increased by two
and the holders of the Class B Preferred Stock and any Parity Stock, voting
together as a single class (such vote being in proportion to the relative
liquidation values of the voting shares), will be entitled to elect those
additional directors. In the event of such a non-payment, any holder of such
preferred stock, including the Class B Preferred Stock, may request that we call
a special meeting of the holders of such preferred stock for the purpose of
electing the additional directors and we must call such meeting within 30 days
of such request. If we fail to call such a meeting within 30 days of such
request, then holders of 10% of such outstanding preferred stock (determined by
liquidation value), including the Class B Preferred Stock, taken as a single
class, can call a meeting. If all accumulated dividends on such preferred stock,
including the Class B Preferred Stock, have been paid in full or set apart for
payment and dividends for the current quarterly dividend period shall have been
paid or set apart for payment, the holders of the Class B Preferred Stock and
such other preferred stock will no longer have the right to vote on directors
and the term of office of each director so elected will terminate and the number
of our directors will, without further action, be reduced by two.
In addition to the requirements set forth above, under Delaware law any
amendment of our amended and restated certificate of incorporation, including
any amendment related solely to the terms of the Class B Preferred Stock, must
be approved by a majority of all of our capital stock, including our common
stock.
MISCELLANEOUS
We will at all times on and after the first business day immediately
following the Issue Date reserve and keep available out of our authorized and
unissued common stock, solely for issuance upon the conversion of the shares of
Class B Preferred Stock, that number of shares of common stock as shall from
time to time be issuable upon the conversion of all the shares of Class B
Preferred Stock then outstanding. Any shares of Class B Preferred Stock
converted into our common stock or otherwise reacquired by us shall resume the
status of authorized and unissued shares of our preferred stock, undesignated as
to series, and shall be available for subsequent issuance.
TRANSFER AGENT, REGISTRAR AND PAYING AGENT
will act as transfer agent, registrar, and paying agent for the
payment of dividends for the Class B Preferred Stock.
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TITLE
We, the transfer agent, registrar and paying agent may treat the registered
holder of shares of Class B Preferred Stock as the absolute owner of such shares
of Class B Preferred Stock for the purpose of making payment and settling the
related conversions and for all other purposes.
BOOK-ENTRY, DELIVERY AND FORM
The Depository Trust Company, or DTC, will act as securities depositary for
the Class B Preferred Stock. The shares of Class B Preferred Stock will be
issued only as fully-registered securities registered in the name of Cede & Co.,
the depositary's nominee. One or more fully-registered global security
certificates, representing the total aggregate number of shares of Class B
Preferred Stock, will be issued and deposited with the depositary and will bear
a legend regarding the restrictions on exchanges and registration of transfer
referred to below.
The laws of some jurisdictions require that some purchasers of securities
take physical delivery of securities in definitive form. Those laws may impair
the ability to transfer beneficial interests in shares of Class B Preferred
Stock so long as shares of Class B Preferred Stock are represented by global
security certificates.
The depositary is a limited-purpose trust company organized under the New
York Banking Law, a "banking organization" within the meaning of the New York
Banking Law, a member of the Federal Reserve System, a "clearing corporation"
within the meaning of the New York Uniform Commercial Code and a "clearing
agency" registered pursuant to the provisions of Section 17A of the Securities
Exchange Act of 1934.
The depositary holds securities that its participants deposit with the
depositary. The depositary also facilitates the settlement among participants of
securities transactions, including transfers and pledges, in deposited
securities through electronic computerized book-entry changes in participants'
accounts, thus eliminating the need for physical movement of securities
certificates. Direct participants include securities brokers and dealers, banks,
trust companies, clearing corporations and certain other organizations. The
depositary is owned by a number of its direct participants and by the New York
Stock Exchange, the American Stock Exchange, Inc. and the National Association
of Securities Dealers, Inc., collectively referred to as participants. Access to
the depositary system is also available to others, including securities brokers
and dealers, bank and trust companies that clear transactions through or
maintain a direct or indirect custodial relationship with a direct participant,
collectively referred to as indirect participants. The rules applicable to the
depositary and its participants are on file with the SEC.
Except as otherwise required by applicable law, no shares of Class B
Preferred Stock represented by global security certificates may be exchanged in
whole or in part for shares of Class B Preferred Stock registered, and no
transfer of global security certificates will be made in whole or in part for
shares of Class B Preferred Stock registered, and no transfer of global security
certificates in whole or in part may be registered, in the name of any person
other than the depositary or any nominee of the depositary, unless, however, the
depositary has notified us that it is unwilling or unable to continue as
depositary for the global security certificates, has ceased to be qualified to
act or we decide to discontinue the use of book-entry transfer through the
depositary. All of the shares of Class B Preferred Stock represented by one or
more global security certificates or any portion of them will be registered in
those names as the depositary may direct.
As long as the depositary or its nominee is the registered owner of the
global security certificates, the depositary or that nominee will be considered
the sole owner and holder of the global security certificates and all of the
shares of Class B Preferred Stock represented by those certificates for all
purposes under the Class B Preferred Stock. Except in the limited circumstances
referred to above or as otherwise required by applicable law, owners of
beneficial interests in global security certificates will not be entitled to
have the global security certificates or the shares of Class B Preferred Stock
represented by those certificates registered in their names, will not receive or
be entitled to receive physical delivery of certificates representing the
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shares of Class B Preferred Stock in exchange and will not be considered to be
owners or holders of the global security certificates or any of the shares of
Class B Preferred Stock represented by those certificates for any purpose under
the Class B Preferred Stock. All payments on the shares of Class B Preferred
Stock represented by the global security certificates and all related transfers
and deliveries of common stock will be made to the depositary or its nominee as
their holder.
Ownership of beneficial interests in the global security certificates will
be limited to participants or persons that may hold beneficial interests through
institutions that have accounts with the depositary or its nominee. Ownership of
beneficial interests in global security certificates will be shown only on, and
the transfer of those ownership interests will be effected only through, records
maintained by the depositary or its nominee with respect to participants'
interests or by the participant with respect to interests of persons held by the
participants on their behalf.
Procedures for conversion on the conversion date or upon early conversion
will be governed by arrangements among the depositary, participants and persons
that may hold beneficial interests through participants designed to permit the
settlement without the physical movement of certificates. Payments, transfers,
deliveries, exchanges and other matters relating to beneficial interests in
global security certificates may be subject to various policies and procedures
adopted by the depositary from time to time.
Neither we nor any of our agents will have any responsibility or liability
for any aspect of the depositary's or any participant's records relating to, or
for payments made on account of, beneficial interests in global security
certificates, or for maintaining, supervising or reviewing any of the
depositary's records or any participant's records relating to those beneficial
ownership interests.
The information in this section concerning the depositary and its
book-entry system has been obtained from sources that we believe to be reliable,
but we do not take responsibility for its accuracy.
REPLACEMENT OF CLASS B PREFERRED STOCK CERTIFICATES
If physical certificates are issued, we will replace any mutilated
certificate at your expense upon surrender of that certificate to the transfer
agent. We will replace certificates that become destroyed or lost at your
expense upon delivery to us and the transfer agent of satisfactory evidence that
the certificate has been destroyed or lost, together with any indemnity that may
be required by the transfer agent and us.
We, however, are not required to issue any certificates representing shares
of Class B Preferred Stock on or after the applicable conversion date. In place
of the delivery of a replacement certificate following the applicable conversion
date, the transfer agent, upon delivery of the evidence and indemnity described
above, will deliver the shares of our common stock issuable pursuant to the
terms of the Class B Preferred Stock formerly evidenced by the certificate.
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[P] CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of certain U.S. federal income tax
considerations relating to the purchase, ownership and disposition of our Class
B Preferred Stock and the common stock acquired upon the conversion thereof, but
does not purport to be a complete analysis of all the potential tax
considerations. This summary is based on the provisions of the Internal Revenue
Code of 1986, as amended (the "Code"), the Treasury regulations promulgated or
proposed thereunder, judicial authority, published administrative positions of
the Internal Revenue Service (the "IRS") and other applicable authorities, all
as in effect on the date of this document. These authorities may be changed,
possibly on a retroactive basis, so as to result in U.S. federal income tax
consequences different from those set forth below. We have not sought any ruling
from the Internal Revenue Service (the "IRS") with respect to the statements
made and the conclusions reached in the following summary, and there can be no
assurance that the IRS will agree with our statements and conclusions. This
summary deals only with holders that will hold our Class B Preferred Stock or
any of our common stock received upon conversion thereof as a "capital asset"
(within the meaning of Section 1221 of the Code). This summary does not purport
to deal with all aspects of U.S. federal income taxation that might be relevant
to particular holders in light of their personal investment circumstances or
status, nor does it address tax considerations applicable to investors that may
be subject to special tax rules, such as banks, certain financial institutions,
tax-exempt organizations, S Corporations, partnerships or other pass-through
entities, insurance companies, broker-dealers, dealers or traders in securities
or currencies, expatriates subject to Code Section 877 and taxpayers subject to
the alternative minimum tax. This summary also does not discuss our Class B
Preferred Stock held as part of a hedge, straddle, synthetic security or
conversion transaction, or situations in which the "functional currency" of a
U.S. holder (as defined below) is not the U.S. dollar. Moreover, the effect of
any applicable estate, state, local or non-U.S. tax laws is not discussed.
THE FOLLOWING DISCUSSION IS FOR INFORMATIONAL PURPOSES ONLY AND IS NOT A
SUBSTITUTE FOR CAREFUL TAX PLANNING AND ADVICE. INVESTORS CONSIDERING THE
PURCHASE OF OUR CLASS B PREFERRED STOCK SHOULD CONSULT THEIR OWN TAX ADVISORS
WITH RESPECT TO THE APPLICATION OF THE U.S. FEDERAL INCOME TAX LAWS TO THEIR
PARTICULAR SITUATIONS AS WELL AS ANY TAX CONSEQUENCES ARISING UNDER THE ESTATE
TAX LAWS OR THE LAWS OF ANY STATE, LOCAL OR NON-U.S. TAXING JURISDICTION OR
UNDER ANY APPLICABLE TAX TREATY.
The term "U.S. holder" means a holder of our Class B Preferred Stock (or
common stock received upon conversion thereof) that is, for U.S. federal income
tax purposes:
(1) a citizen or resident of the United States;
(2) a corporation or other entity taxable as a corporation for U.S.
federal income tax purposes, created or organized under the laws of the
United States or of any political subdivision thereof;
(3) an estate, the income of which is subject to U.S. federal income
taxation regardless of source; or
(4) a trust, if (i) a court within the United States is able to
exercise primary jurisdiction over its administration and one or more U.S.
persons has the authority to control all of its substantial decisions, or
(ii) in the case of a trust that was treated as a domestic trust under the
law in effect before 1997, a valid election is in place under applicable
Treasury regulations to treat such trust as a domestic trust.
The term "non-U.S. holder" means a holder of our Class B Preferred Stock
(or common stock received upon conversion thereof) that is neither a U.S. holder
nor a partnership for U.S. federal income tax purposes.
A holder of our Class B Preferred Stock (or common stock received upon
conversion thereof) that is a partnership for U.S. federal income tax purposes
is not subject to income tax on income or gain derived from our Class B
Preferred Stock (or common stock received upon conversion thereof). A partner of
the partnership may be subject to tax on such income under rules similar to the
rules for U.S. holders or
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non-U.S. holders depending on whether (i) the partner is a U.S. or a non-U.S.
person, and (ii) the partnership is or is not engaged in a U.S. trade or
business to which the income or gain is effectively connected. If you are a
partner of a partnership holding our Class B Preferred Stock, you should consult
your tax advisor regarding the tax consequences of the ownership and disposition
of our Class B Preferred Stock (or common stock received upon conversion
thereof).
U.S. HOLDERS
DISTRIBUTIONS. Distributions of cash on our Class B Preferred Stock (or
common stock received upon conversion thereof) will be taxed as dividends to the
extent they are paid out of our current or accumulated earnings and profits (as
calculated for U.S. federal income tax purposes). To the extent that the amount
of any distribution paid on our Class B Preferred Stock (or common stock
received upon conversion thereof) exceeds our current and accumulated earnings
and profits, it will be treated first as a tax-free return of the U.S. holder's
adjusted tax basis in the Class B Preferred Stock (or common stock received upon
conversion thereof) and thereafter as capital gain, which will be long-term
capital gain if the holder has held such stock for more than one year.
Dividends received by non-corporate U.S. holders on or before December 31,
2008 will be "qualified dividends," taxed at the rates applicable to long-term
capital gains if (i) the holder has held the stock for more than 60 days during
the 120-day period beginning 60 days before the ex-dividend date and ending 60
days after the ex-dividend date and (ii) the holder is not obligated to make
related payments with respect to those positions in substantially similar or
related property. Non-corporate U.S. holders should consult their own tax
advisors regarding their eligibility for such lower tax rates.
Corporate U.S. holders of our Class B Preferred Stock (or common stock
received upon conversion thereof) generally should be eligible for the 70%
dividends received deduction with respect to the portion of any distribution
which is taxed as a dividend for U.S. federal income tax purposes. However,
corporate U.S. holders should consider the possible effect on them of (i)
section 1059 of the Code, which reduces a corporate shareholder's basis in stock
(and may result in the recognition of gain) by the nontaxed portion of an
"extraordinary dividend" where such holder has not held the stock for more than
two years before the dividend announcement date, (ii) section 246A of the Code,
which reduces the dividends received deduction allowed to a corporate
shareholder that has incurred indebtedness that is "directly attributable" to an
investment in "portfolio stock," (iii) section 246(b) of the Code, which limits
the amount of the dividends received deduction to a percentage of the
shareholder's taxable income, and (iv) section 246(c) of the Code, which, among
other things, disallows the dividends received deduction in respect of any
dividend on a share of stock that has been held for 45 days or less during the
90-day period beginning on the date which is 45 days before the ex-dividend date
with respect to such dividend (or held 90 days or less during a 180-day period,
in the case of certain preferred dividends attributable to periods aggregating
in excess of 366 days). For this purpose, any period in which a holder of our
Class B Preferred Stock (or common stock received upon conversion thereof) (i)
has an option to sell, (ii) is under a contractual obligation to sell, has made
(and not closed) a short sale of, or has granted certain options to buy
substantially identical stock or securities, or (iii) holds one or more other
positions with respect to substantially similar or related property that
diminish the risk of loss of holding such stock, will not be counted toward the
45-day (or 90-day) holding period. Corporate U.S. holders should also consider
the effect of the corporate alternative minimum tax, which imposes a maximum tax
rate of 20% on a corporation's alternative minimum taxable income for the tax
year and which is calculated without regard to the dividends received deduction.
Corporate U.S. holders should consult their own tax advisors regarding the
availability of, and limitations on, the dividends received deduction.
SALE OR EXCHANGE. A U.S. holder generally will recognize gain or loss on
the sale or other taxable disposition of our Class B Preferred Stock (or common
stock received upon conversion thereof) equal to the difference between the
amount of cash and the fair market value of property received and the U.S.
Holder's adjusted tax basis in the stock sold or exchanged. Such gain or loss
will be capital gain or loss and will be long-term capital gain or loss if the
stock was held for a period exceeding one year. The deductibility of
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capital losses is subject to certain limitations; U.S. holders should consult
their tax advisors regarding these limitations.
CONVERSION. A U.S. holder generally will not recognize gain or loss upon
the conversion of our Class B Preferred stock into shares of our common stock
except with respect to any cash the U.S. holder receives in lieu of fractional
shares of our common stock. However, a U.S. holder may recognize dividend income
to the extent that it receives cash or common stock in respect of dividends in
arrears on the Class B Preferred Stock at the time of its conversion into common
stock.
A U.S. holder that receives cash in lieu of fractional shares will be
treated as receiving a "dividend" subject to tax in accordance with the
principles described above in "Distributions" if such receipt of cash has "the
effect of the distribution of a dividend" (as described below) for U.S. federal
income tax purposes. In such a case, the portion of the U.S. holder's tax basis
(reduced for amounts, if any, treated as a return of capital) in the Class B
Preferred Stock allocable to the fractional share will be transferred to the
common stock received upon conversion, subject, in the case of a corporate
holder, to reduction or possible gain recognition under Section 1059 of the
Code. If the receipt of cash in lieu of fractional shares does not have "the
effect of the distribution of a dividend," a U.S. holder that receives cash in
lieu of fractional shares will recognize gain or loss in an amount equal to the
difference between the portion of such holder's tax basis in our Class B
Preferred Stock allocable to the fractional share and the cash payment received
in lieu thereof. Such gain or loss would be capital gain and would be long-term
capital gain if the holding period for such stock exceeded one year.
If there is a Provisional Conversion, the income tax consequences regarding
the receipt of the additional cash amount equal to the present value of all
remaining dividend payments (see "Description of the Mandatorily Convertible
Preferred Stock -- Provisional Conversion") are unclear. The additional cash
amount could be treated as a distribution, subject to tax as a dividend to the
extent of our current and accumulated earnings and profits, as described above
under "Distributions." Alternatively, the additional cash amount could be
treated as an additional payment received in connection with the conversion of
our Class B Preferred Stock into common stock, in which case any gain realized
by a holder on such conversion (i.e., the excess (if any) of the amount of cash
and the fair market value of common stock received over the adjusted tax basis
of Class B Preferred Stock relinquished) would be recognized to the extent of
the additional cash amount. This recognized gain would be subject to tax as a
dividend, to the extent of our current and accumulated earnings and profits, if
the receipt of the additional cash amount is treated as the distribution of a
dividend under section 302(a) of the Code. Gain recognized in excess of a
holder's ratable share of our current and accumulated earnings and profits would
be capital gain. If the receipt of the additional cash amount is not treated as
the distribution of a dividend under section 302(a) of the Code, the gain
recognized by a U.S. holder would be capital gain and would be long-term capital
gain if the holding period exceeded one year.
To determine if the receipt of the cash paid in lieu of fractional shares
or of the additional cash amount is treated as the distribution of a dividend
for U.S. federal income tax purposes, a U.S. holder would be treated as if it
received solely our common stock upon conversion of our Class B Preferred Stock
and then exchanged the extra shares of common stock for the cash received. The
receipt of the additional cash will be treated as the distribution of a dividend
under section 302(a) of the Code unless the deemed redemption of the common
stock meets one of the tests set forth in section 302(b) of the Code. Under one
of these tests, the deemed purchase of such extra shares by the Company for cash
will be treated as "not essentially equivalent to a dividend" if the reduction
in the U.S. holder's proportionate interest in the Company as a result of the
purchase constitutes a "meaningful reduction" given the U.S. holder's particular
circumstances. The IRS has indicated in a published revenue ruling that even a
small reduction in the percentage interest of a stockholder whose relative stock
interest in a publicly held corporation is minimal (for example, an interest of
less than 1%) and who exercises no control over corporate affairs should
constitute a "meaningful reduction." Prospective investors are advised to
consult their tax advisors to determine the tax treatment of the receipt of cash
paid in lieu of fractional shares or of the additional cash.
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The tax basis of the common stock received upon conversion of shares of our
Class B Preferred Stock will generally be equal to the tax basis of the shares
of Class B Preferred Stock so converted and the holding period of the common
stock will generally include the holding period of the shares of Class B
Preferred Stock converted. The tax basis of any common stock received on
conversion and treated as a dividend will be equal to its fair market value on
the date of the distribution and the holding period of such common stock will
commence on the day after its receipt.
Holders of our Class B Preferred Stock may not receive fewer shares of
common stock upon conversion than the number they would receive by application
of the minimum conversion rate nor more shares than the number they would
receive by application of the maximum conversion rate, depending on when the
shares are converted and, if converted on the mandatory conversion date, the
market value of our common stock on such date. A holder's right to receive a
greater number of shares of our common stock at the mandatory conversion date
than they would receive by application of the minimum conversion rate could be
viewed as a constructive distribution of stock to such holder under section 305
of the Code, which, if so treated, would be subject to tax as a dividend to the
extent of our current and accumulated earnings and profits. While the matter is
not free from doubt due to a lack of authority directly on point, such a right
on the part of a holder of our Class B Preferred Stock should not result in a
constructive distribution of stock. Accordingly, absent a change of law or a
differing interpretation by the IRS after the date hereof, the Company will
consistently treat the receipt of shares in a number greater than the number the
shareholder would receive using the minimum conversion rate as other than a
dividend. Prospective investors are urged to consult their tax advisors to
determine the tax treatment of the additional common stock.
ADJUSTMENT OF CONVERSION RATE. U.S. holders of our Class B Preferred Stock
may be deemed to have received a constructive distribution of stock that is
subject to tax as a dividend when the conversion rate is adjusted as described
under "Description of the Mandatorily Convertible Preferred
Stock -- Anti-dilution Adjustments." An adjustment to the conversion rate made
pursuant to a bona fide reasonable adjustment formula that has the effect of
preventing the dilution of the interest of the U.S. holders generally will not
be considered to result in a constructive distribution of stock. Certain of the
possible adjustments provided for in our Class B Preferred Stock (e.g., to take
account of distributions of cash or property with respect to other classes of
stock) will not qualify as being pursuant to a bona fide reasonable adjustment
formula. If such a non-qualifying adjustment were made (or if adjustments were
not made in certain cases), U.S. holders of our Class B Preferred Stock would be
deemed to have received a taxable stock distribution. In such case, the amount
of the taxable stock distribution to be included in income would be the fair
market value of the additional common stock to which U.S. holders of our Class B
Preferred Stock would be entitled by reason of the increase in such holders'
proportionate equity interest in the Company to the extent of our current and
accumulated earnings and profits. The taxable stock distribution would be
taxable in the same manner as a cash distribution of an equal amount would be
taxed (as explained above in "Dividends"). U.S. holders of our Class B Preferred
Stock would be required to include their allocable share of that constructive
dividend in gross income but would not receive any cash related to it.
INFORMATION REPORTING AND BACKUP WITHHOLDING. In general, a payor must
report certain information to the IRS with respect to payments of dividends on,
and payments of the proceeds of the sale or redemption of, our Class B Preferred
Stock to certain non-corporate U.S. holders. The payor (which may be us or an
intermediate payor) will be required to withhold backup withholding tax,
currently at a rate of 28%, if (i) the payee fails to furnish a taxpayer
identification number ("TIN") to the payor or establish an exemption from backup
withholding, (ii) the IRS notifies the payor that the TIN furnished by the payee
is incorrect, (iii) there has been a notified payee underreporting described in
Section 3406(c) of the Code or (iv) the payee has not certified under penalties
of perjury that it has furnished a correct TIN and that the IRS has not notified
the payee that it is subject to backup withholding under the Code. Any amounts
withheld under the backup withholding rules from a payment to a U.S. holder will
be allowed as a credit against that holder's U.S. federal income tax liability
and may entitle the holder to a refund, provided that the required information
is furnished to the IRS on a timely basis.
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NON-U.S. HOLDERS
DIVIDENDS. In general, distributions treated as dividends (possibly
including certain constructive distributions described above in "Adjustment of
Conversion Rate") received by non-U.S. holders on our Class B Preferred Stock
(or common stock received upon conversion thereof) will be subject to a 30% U.S.
federal withholding tax, subject to reduction if the holder is eligible for the
benefits of an applicable income tax treaty. Dividends that are effectively
connected with such non-U.S. holder's conduct of a trade or business within the
United States (or if a tax treaty applies, dividends that are attributable to a
U.S. permanent establishment of such holder) are generally subject to U.S.
federal income tax on a net income basis and are exempt from the 30% withholding
tax (assuming compliance with certain certification requirements described
below). Any such effectively connected dividends received by a non-U.S. holder
that is a corporation may also, under certain circumstances, be subject to an
additional "branch profits tax" at a 30% rate or such lower rate as may be
applicable under an income tax treaty.
For purposes of obtaining a reduced rate of withholding under an income tax
treaty or to establish an exemption from withholding on effectively connected
dividends, a non-U.S. holder should provide a properly executed Form W-8BEN (if
the holder is claiming the benefits of an income tax treaty) or Form W-8ECI (if
the dividends are effectively connected with a trade or business in the United
States) or suitable substitute form to us or our paying agent.
SALE OR OTHER TAXABLE DISPOSITION. Non-U.S. holders will generally not be
subject to U.S. federal income taxes, including withholding taxes, on gain
recognized on a disposition of our Class B Preferred Stock (or common stock
received upon conversion thereof) as long as (i) the gain is not effectively
connected with the conduct by the non-U.S. holder of a trade or business within
the United States (or if a tax treaty applies, attributable to a U.S. permanent
establishment maintained by such non-U.S. holder); (ii) in the case of a
non-U.S. holder who is an individual, such non-U.S. holder is not present in the
United States for 183 days or more in the taxable year of disposition and
certain other requirements are met; and (iii) we are not and have not been a
"United States real property holding corporation," within the meaning of section
897 of the Code for U.S. federal income tax purposes at any time within the
shorter of the five-year period preceding such disposition or such non-U.S.
holder's holding period. We do not believe that we are currently, nor do we
anticipate becoming, a United States real property holding corporation.
CONVERSION. Non-U.S. holders generally will not recognize any gain or loss
for United States federal income tax purposes upon the conversion of our Class B
Preferred Stock into our common stock. However a non-U.S. holder (i) receiving
cash in lieu of fractional shares, (ii) receiving additional cash amounts
pursuant to a Provisional Conversion or (iii) receiving dividends in arrears in
the form of cash or additional common stock on conversion will be treated as
described in the discussion above pertaining to U.S. holders with respect to
those distributions. If any of those distributions are treated as dividends for
U.S. federal income tax purposes, we must withhold 30% of such distribution as
described above in "Non-U.S. Holders -- Dividends" unless we receive the forms
and certifications described in that section. If we withhold tax from any
payment of such amounts and such payment were determined not to be subject to
tax in the United States, a non-U.S. holder would be entitled to a refund of any
tax withheld.
BACKUP WITHHOLDING AND INFORMATION REPORTING. United States information
reporting requirements and backup withholding tax generally will not apply to
payments made on, and payments of the proceeds of the sale or redemption of, our
Class B Preferred Stock (or common stock received upon conversion thereof) to a
non-U.S. holder if the statement described in "Non-U.S. holders -- Dividends" is
duly provided by such holder, provided that the payor does not have actual
knowledge or reason to know that the holder is a U.S. person. If a non-U.S.
holder holds our Class B Preferred Stock through a financial institution or
other agent acting on the holder's behalf, the holder may be required to provide
appropriate certifications to the agent. The holder's agent will then generally
be required to provide appropriate certifications to us.
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DESCRIPTION OF CAPITAL STOCK
GENERAL
The following description of our capital stock is a summary. It summarizes
only those aspects of our capital stock that we believe will be most important
to your decision to invest in our capital stock. You should keep in mind,
however, that it is our certificate of incorporation, including any certificates
of designations that are a part of our certificate of incorporation, and our
bylaws and the DGCL, and not this summary, which define your rights as a
securityholder. There may be other provisions in these documents that are also
important to you. You should read these documents for a full description of the
terms of our capital stock. Our certificate of incorporation, including any
certificates of designations, and our bylaws are filed as exhibits to the
registration statement of which this prospectus forms a part.
Our certificate of incorporation authorizes us to issue 8,000,000,000
shares of common stock, par value $0.01 per share, and 265,000,000 shares of
preferred stock, par value $0.01 per share. As of December 31, 2003 there were
100,115,749 shares of our common stock outstanding and 34,386,740 shares of our
Class A Preferred Stock outstanding. We have also issued Series A Warrants to
purchase shares of our common stock. The Series A Warrants are exercisable for
an aggregate of 6,000,000 shares of our common stock at an exercise price of
$27.60 per share, subject to certain anti-dilution provisions, and expire on
September 10, 2008.
CLASS A PREFERRED STOCK
In connection with our predecessor's Plan of Reorganization, we issued
34,386,740 shares of Class A Preferred Stock to holders of our predecessor's
senior bank debt.
RANKING. The shares of Class A Preferred Stock have preference over the
shares of common stock with respect to payment of dividends and the distribution
of assets in the event of our liquidation, winding up or dissolution.
LIQUIDATION. Upon our liquidation, dissolution or winding up, no
distribution shall be made:
- to the holders of stock ranking junior to the Class A Preferred Stock
unless, prior thereto, the holders of Class A Preferred Stock shall have
received $25.00 per share (the "liquidation preference"), plus an amount
equal to accrued but unpaid dividends thereon, whether or not declared,
through the date of such payment, or
- to the holders of stock ranking on a parity with the Class A Preferred
Stock, except distributions made ratably on the Class A Preferred Stock
and all other such parity stock in proportion to the total amounts to
which the holders of all such shares are entitled upon such liquidation,
dissolution or winding up.
DIVIDENDS. Holders of shares of Class A Preferred Stock are initially
entitled to receive dividends at a rate per annum equal to 10.5% of the
liquidation preference per share. The dividend rate per annum increases to 11%
on September 10, 2005, the second anniversary of the issue date. These dividends
are cumulative and are payable semi-annually in additional shares of Class A
Preferred Stock until the later of:
- September 10, 2005, the second anniversary of the issue date; and
- the next fiscal quarter after the date that our principal insurance
subsidiaries achieve at least an "A-" category financial strength rating
by A.M. Best.
Thereafter, such dividends are payable semi-annually in cash out of funds
legally available for the payment of dividends or, at our option, in additional
shares of Class A Preferred Stock.
We may not declare, pay or set apart for payment any dividends or other
distributions on parity securities or junior securities or make any payment on
account of, or set apart for payment money for a sinking or other similar fund
for, the purchase, redemption or other retirement of any parity securities or
junior securities, and will not permit any corporation or other entity we
directly or indirectly control to
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purchase or redeem any parity securities or junior securities, unless full
cumulative dividends have been paid on the Class A Preferred Stock.
VOTING. Holders of Class A Preferred Stock vote as a class on each of the
following events or transactions, unless all of the Class A Preferred Stock is
redeemed concurrently with such event or transaction:
- sale of all or substantially all of our assets;
- our merger or consolidation;
- our liquidation or dissolution;
- issuances of subsidiary preferred stock to a third party;
- issuances of debt (with certain exceptions) or senior equity securities
unless the proceeds are used to pay down debt under our Senior Credit
Facility;
- issuances of pari passu securities unless the proceeds are used to pay
down debt under our Senior Credit Facility or to redeem Class A Preferred
Stock (subject to certain limitations);
- amendments to our certificate of incorporation or Class A Preferred Stock
certificate of designations that adversely change the rights or
preferences of the Class A Preferred Stock; and
- redemptions of and payment of cash dividends on pari passu and junior
securities (subject to an exception for any bona fide plan for the
benefit of our directors, officers or employees).
Following the occurrence of a "trigger event," the holders of Class A
Preferred Stock will have the right to vote on an as-converted basis on all
corporate matters on which holders of common stock have the right to vote and
will have the right to call a shareholders meeting for the election of directors
and nominate directors to serve on the board of directors (subject to our right
to cure certain trigger events until September 10, 2004, the first anniversary
of the issue date). For purposes of the preceding sentence, a "trigger event" is
defined to include:
- reduction in certain A.M. Best ratings;
- any payment default under our Senior Credit Facility;
- any material adverse regulatory event affecting any material insurance
subsidiary;
- conversion rights under the Class A Preferred Stock becoming exercisable;
- failure to comply with the minimum EBITDA requirements as set forth on
Schedule A to the Class A Preferred Stock certificate of designations;
and
- failure to maintain certain minimum risk-based capital ratios as set
forth on Schedules B and C to the Class A Preferred Stock certificate of
designations.
REDEMPTION. Subject to the limitations contained in our Senior Credit
Facility, the availability of cash, and the limitations under applicable
insurance laws, if any, we may, in our sole discretion, redeem any or all of the
shares of Class A Preferred Stock, at a redemption price equal to the
liquidation preference, plus all accrued but unpaid dividends, whether or not
declared, for each share as of the redemption date. In the event of a redemption
of only a portion of the then outstanding shares of Class A Preferred Stock, we
will effect such redemption on a pro rata basis according to the number of
shares held by each holder of Class A Preferred Stock, provided that we may
redeem any or all such shares held by any holder of fewer than 100 shares (or
shares held by any holder who would hold less than 100 shares as a result of
such redemption), as we may determine.
CONVERSION. Shares of Class A Preferred Stock are convertible by holders
at any time on or after September 30, 2005 into shares of common stock at a
conversion price of $20.35 per share, subject to adjustment upon the occurrence
of certain events.
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EXCHANGE. On and after September 10, 2013, the tenth anniversary of the
effective date of our predecessor's Plan of Reorganization, shares of Class A
Preferred Stock are exchangeable, at the holder's option, into shares of common
stock having a fair market value on the exchange date equal to the liquidation
preference, plus accrued and unpaid dividends, whether declared or not, subject
to a maximum number of shares of common stock issuable upon exchange. At our
option, we may pay cash in an amount equal to the liquidation preference, plus
accrued and unpaid dividends, whether declared or not, in lieu of delivering
shares of common stock upon exchange.
OTHER. Our Class A Preferred Stock currently is quoted on the
Over-the-Counter Bulletin Board under the symbol "CNSJP." Wachovia Bank, N.A. is
the transfer agent and registrar for our Class A Preferred Stock.
[C] CLASS B PREFERRED STOCK
Concurrently with this offering of common stock, we plan to issue
shares of Class B Preferred Stock.
RANKING. The shares of Class B Preferred Stock have preference over the
shares of common stock with respect to the payment of dividends and the
distribution of assets in the event of our liquidation, winding up or
dissolution.
LIQUIDATION. Upon our liquidation, dissolution or winding up, no
distribution shall be made:
- to the holders of stock ranking junior to the Class B Preferred Stock
unless, prior thereto, the holders of Class B Preferred Stock shall have
received $ per share (the "liquidation preference"), plus an amount
equal to accrued but unpaid dividends thereon, whether or not declared,
through the date of such payment, or
- to the holders of stock ranking on a parity with the Class B Preferred
Stock, unless such distributions are made ratably on the Class B
Preferred Stock in proportion to the total amounts to which the holders
of all such shares are entitled upon such liquidation, dissolution or
winding up.
DIVIDENDS. Holders of shares of Class B Preferred Stock are entitled to
receive dividends in cash at a rate per annum equal to $ per share. The
initial dividend on the Class B Preferred Stock, for the first dividend period,
assuming the issue date is , 2004, will be $ per share of Class B
Preferred Stock. Each subsequent quarterly dividend on the shares of Class B
Preferred Stock will be $ per share of Class B Preferred Stock. Accumulated
unpaid dividends will cumulate dividends at the annual rate of %.
We are obligated to pay a dividend on the Class B Preferred Stock unless
prohibited by the terms of our senior credit facility or applicable law. The
shares of Class B Preferred Stock are entitled to receive payment of dividends
pro rata with any other class or series of our capital stock the terms of which
provide that such class or series will rank on a parity with the Class B
Preferred Stock.
PAYMENT RESTRICTIONS. Unless all dividends on the Class B Preferred Stock
have been paid, we may not declare or pay any dividend or make any distribution
of assets on any of our junior securities now or hereafter authorized, including
our common stock, which we call junior stock, other than dividends or
distributions in the form of junior stock. We may not redeem, purchase or
otherwise acquire any junior stock, except upon conversion or exchange for other
junior stock other than the Class A Preferred Stock, or redeem, purchase or
otherwise acquire any parity securities now or hereafter authorized, except upon
conversion or exchange for junior stock.
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VOTING. Unless the approval of a greater number of shares of Class B
Preferred Stock is required by law, we will not, without the approval of the
holders of at least two-thirds of the shares of Class B Preferred Stock then
outstanding, voting together as a single class:
- sell, lease or convey all or substantially all of our assets;
- merge or consolidate with or into any other corporation, except any such
consolidation or merger wherein none of the rights, preferences,
privileges or voting powers of the Class B Preferred Stock or the holders
thereof are adversely affected;
- voluntarily liquidate, dissolve or wind up our affairs;
- amend, alter or repeal any provisions of our amended and restated
certificate of incorporation or by-laws by way of merger, consolidation
or otherwise, that would affect adversely any right, preference,
privilege or voting power of the Class B Preferred Stock;
- reclassify any of our authorized stock into any stock of any class, or
any obligation or security convertible into or evidencing a right to
purchase such stock, ranking senior to the Class B Preferred Stock; or
- issue, authorize or increase the authorized amount of, or issue or
authorize any obligation or security convertible into or evidencing a
right to purchase, stock ranking senior to the Class B Preferred Stock;
provided, that we may issue, authorize or increase the authorized amount
of, or issue or authorize any obligation or security convertible into or
evidencing a right to purchase, stock ranking on a parity with or junior
to the Class B Preferred Stock without the vote of the holders of the
Class B Preferred Stock;
In addition, we will not, without the approval of each holder of shares of
Class B Preferred Stock affected thereby, amend our amended and restated
certificate of incorporation in a manner that:
- adversely changes the dividends payable on the Class B Preferred Stock;
- adversely changes the liquidation preference of the Class B Preferred
Stock; or
- adversely affects the conversion provisions of the Class B Preferred
Stock.
If and whenever six full quarterly dividends, whether or not consecutive,
payable on the Class B Preferred Stock or any Parity Stock are not paid, the
number of directors constituting our board of directors will be increased by two
and the holders of our Class B Preferred Stock and any Parity Stock, voting
together as a single class, will be entitled to elect those additional
directors. In the event of such a non-payment, any holder of such preferred
stock, including the Class B Preferred Stock, may request that we call a special
meeting of the holders of such preferred stock for the purpose of electing the
additional directors and we must call such meeting within 30 days of such
request. If we fail to call such a meeting within 30 days of such request, then
holders of 10% of such outstanding preferred stock, including the Class B
Preferred Stock, taken as a single class, can call a meeting. If all accumulated
dividends on such preferred stock, including the Class B Preferred Stock, have
been paid in full or set apart for payment and dividends for the current
quarterly dividend period shall have been paid or set apart for payment, the
holders of the Class B Preferred Stock and such other preferred stock will no
longer have the right to vote on directors and the term of office of each
director so elected will terminate and the number of our directors will, without
further action, be reduced by two.
REDEMPTION. The Class B Preferred Stock is not redeemable.
MANDATORY CONVERSION. Each of the shares of Class B Preferred Stock,
unless previously converted, will automatically convert on ,
, which we call the mandatory conversion date, into a number of newly
issued shares of our common stock at the conversion rate described below:
- If the applicable market value of our common stock is equal to or greater
than $ , which we call the threshold appreciation price, then the
conversion rate will be shares of our common stock per share of
Class B Preferred Stock (the "minimum conversion rate").
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- If the applicable market value of our common stock is less than the
threshold appreciation price but greater than $ , which we call the
initial price, the conversion rate will be equal to $ divided by
the applicable market value of our common stock per share of Class B
Preferred Stock.
- If the applicable market value of our common stock is less than or equal
to the initial price, the conversion rate will be shares of our
common stock per share of Class B Preferred Stock (the "maximum
conversion rate").
In addition to the number of newly issued shares of our common stock
issuable upon conversion of each share of Class B Preferred Stock on the
mandatory conversion date as provided above, holders will receive on the
mandatory conversion date a payment in cash equal to all accumulated and unpaid
dividends on the Class B Preferred Stock, to the extent not prohibited by the
terms of our senior credit facility or applicable law. In the event that
applicable law or our senior credit facility prohibit us from paying such
accumulated and unpaid dividends in cash on the mandatory conversion date, we
are obligated to deliver shares of our common stock in respect of such unpaid
dividends.
PROVISIONAL CONVERSION. Prior to the mandatory conversion date and on or
after the day following the issue date of the Class B Preferred Stock, we may at
our option cause the conversion of all, but not less than all, of the shares of
Class B Preferred Stock then outstanding into shares of our common stock at the
minimum conversion rate of shares of our common stock for each share of
Class B Preferred Stock; provided that the closing price per share of our common
stock has exceeded 150% of the threshold appreciation price, initially $ ,
for at least 20 trading days within a period of 30 consecutive trading days
ending on the trading day prior to the date that we give notice of the optional
conversion. We will be able to cause this conversion only if, in addition to
issuing holders shares of our common stock as described above, we pay in cash
(1) an amount equal to any accrued and unpaid dividends on the shares of Class B
Preferred Stock, whether or not declared, and (2) the present value of all
remaining dividend payments on the shares of Class B Preferred Stock through and
including , in each case, out of legally available assets.
CONVERSION AT THE OPTION OF THE HOLDER. The holders of shares of Class B
Preferred Stock have the right to convert them, in whole or in part, at any time
prior to the mandatory conversion date and on or after the day following the
issue date of the Class B Preferred Stock, into shares of our common stock at
the minimum conversion rate of shares of our common stock for each share of
Class B Preferred Stock.
MANDATORY CONVERSION UPON CASH MERGER. Prior to the mandatory conversion
date, if we are involved in a merger in which at least 30% of the consideration
for our common stock consists of cash or cash equivalents, which we refer to as
a cash merger, then on or after the date of the cash merger, each holder of
shares of Class B Preferred Stock will have the right to convert their shares of
Class B Preferred Stock at the applicable mandatory conversion rate assuming
that the trading day immediately before the cash merger is the mandatory
conversion date.
ANTI-DILUTION ADJUSTMENTS. The formula for determining the conversion rate
on the mandatory conversion date and the number of shares of our common stock to
be delivered upon an early conversion event may be adjusted if certain events
occur, including if:
- we pay dividends (and other distributions) on our common stock in shares
of our common stock;
- we issue to all holders of our common stock rights or warrants entitling
them, for a period of up to 45 days, to subscribe for or purchase our
common stock at less than the "current market price" of our common stock;
- we subdivide, split or combine our common stock;
- we distribute to all holders of our common stock evidences of our
indebtedness, shares of capital stock, securities, cash or property;
- we or any of our subsidiaries successfully completes a tender or exchange
offer for our common stock to the extent that the cash and the value of
any other consideration included in the payment per share of our common
stock exceeds the closing price of our common stock on the trading day
next
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succeeding the last date on which tenders or exchanges may be made
pursuant to such tender or exchange offer; or
- someone other than us or one of our subsidiaries makes a payment in
respect of a tender offer or exchange offer in which, as of the closing
date of the offer, our board of directors is not recommending rejection
of the offer, the tender offer or exchange offer is for an amount that
increases the offeror's ownership of common stock to more than 25% of the
total shares of common stock outstanding, and the cash and value of any
other consideration included in the payment per share of common stock
exceeds the closing sale price per share of common stock on the trading
day next succeeding the last date on which tenders or exchanges may be
made pursuant to the tender or exchange offer.
OTHER. On or after the day immediately following the issue date of the
Class B Preferred Stock, we will at all times reserve and keep available out of
our authorized and unissued common stock, solely for issuance upon the
conversion of the shares of Class B Preferred Stock, that number of shares of
common stock as shall from time to time be issuable upon the conversion of all
the shares of Class B Preferred Stock then outstanding.
COMMON STOCK
Our common stock is listed on the NYSE under the symbol "CNO." Wachovia
Bank, N.A. is the transfer agent and registrar for our common stock. All
outstanding shares of common stock are, and the shares of common stock issued
under this prospectus will be, fully paid and non-assessable.
DIVIDENDS. Except as otherwise provided by the DGCL or our certificate of
incorporation, and subject to all rights and preferences of holders of any
outstanding shares of preferred stock, holders of common stock share ratably in
all dividends and distributions, whether upon liquidation or dissolution or
otherwise.
VOTING. Except as otherwise provided by the DGCL or our certificate of
incorporation and subject to the rights of holders of any outstanding shares of
preferred stock, all of the voting power of our stockholders is vested in the
holders of our common stock, and each holder of common stock has one vote for
each share held by such holder on all matters voted upon by our stockholders.
Notwithstanding the voting rights granted to holders of common stock and
preferred stock in our certificate of incorporation or in any certificate of
designations relating to any preferred stock, the voting rights of any common
stock or preferred stock held by any holder as of September 10, 2003, the
effective date of our predecessor's Plan of Reorganization, is automatically
reduced with respect to any particular stockholder vote or action by written
consent to the extent, if any, required to avoid a presumption of control
arising from the beneficial ownership of voting securities under the insurance
statutes or regulations applicable to any of our direct or indirect insurance
company subsidiaries, provided that no such reduction reduces (without such
holder's written consent) such voting rights:
- by more than the minimum amount required to reduce such voting rights to
less than 10% of the aggregate voting rights of all stock entitled to
vote or consent with respect to such vote or action, or
- to the extent that such holder's acquisition of control or deemed
acquisition of control of our direct and indirect insurance company
subsidiaries has been approved under, or is exempt from the approval
requirements of, all insurance statutes and regulations applicable to our
direct and indirect insurance company subsidiaries.
BOARD OF DIRECTORS; CLASSIFICATION OF DIRECTORS. Except as otherwise
provided in our certificate of incorporation or any duly authorized certificate
of designations of any series of preferred stock, directors are elected by a
plurality of the votes of the shares present in person or represented by proxy
at the meeting of the stockholders at which directors are elected and entitled
to vote in the election of directors or pursuant to a valid written consent in
lieu of a meeting.
At each annual meeting of stockholders, directors are elected to hold
office until the expiration of the term for which they are elected, and until
their successors have been duly elected and qualified; except that if
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any such election is not so held, such election will take place at a
stockholders' meeting called and held in accordance with the DGCL. Our directors
are initially divided into two classes as nearly equal in size as is
practicable, designated Class I and Class II. The term of office of the initial
Class I directors expires at the next succeeding annual meeting of stockholders
and the term of office of the initial Class II directors expires at the second
succeeding annual meeting of stockholders. Other than the term of office of the
initial Class II directors, the term of office of each Class of directors
expires at the next succeeding annual meeting of stockholders. The initial Class
I and Class II directors are those directors elected in connection with the
adoption of our certificate of incorporation on September 10, 2003. At each
annual meeting of stockholders, directors to replace those of a class or classes
whose terms expire at such annual meeting will be elected to hold office until
the next succeeding annual meeting and until their respective successors have
been duly elected and qualified. If the number of directors is changed, any
newly created directorships or decrease in directorships will be so apportioned
among the classes as to make all classes as nearly equal in number as
practicable.
OTHER. Our common stock is not convertible into, or exchangeable for, any
other class or series of our capital stock. Holders of common stock have no
preemptive or other rights to subscribe for or purchase additional securities of
Conseco. Shares of common stock are not subject to calls or assessments.
SERIES A WARRANTS
In connection with our predecessor's Plan of Reorganization, we issued
Series A Warrants to purchase shares of our common stock to holders of our
predecessor's trust preferred securities.
GENERAL. Each Series A Warrant entitles its holder to purchase one share
of common stock at a price of $27.60 per share. The Series A Warrants are
exercisable for an aggregate of 6,000,000 shares of common stock and expire on
September 10, 2008.
ANTIDILUTION PROVISIONS. If we:
- pay a dividend or make a distribution on our common stock in shares of
common stock,
- subdivide the outstanding shares of common stock into a greater number of
shares,
- combine the outstanding shares of our common stock into a smaller number
of shares, or
- issue by reclassification of our common stock any shares of our capital
stock,
then the exercise price of the Series A Warrants in effect immediately
prior to such action will be proportionately adjusted so that the holder of any
Series A Warrant thereafter exercised may receive the aggregate number and kind
of shares of our capital stock that such holder would have owned immediately
following such action if such Series A Warrant had been exercised immediately
prior to such action.
The exercise price of the Series A Warrants will be adjusted if we issue
any rights, options, warrants or other securities exercisable for, or
convertible into, shares of our common stock to all holders of our common stock
entitling them to purchase shares of common stock at a price per share less than
the market price per share on the record date applicable to such distribution.
No adjustment in the exercise price will be made unless the adjustment
would require an increase or decrease of at least 1% in the exercise price. Any
adjustments that are not made will be carried forward and taken into account in
any subsequent adjustment.
Upon each adjustment of the exercise price, each Series A Warrant
outstanding prior to the making of the adjustment in the exercise price will
thereafter evidence the right to receive upon payment of the adjusted exercise
price a number of shares of common stock proportionately adjusted to reflect the
adjustment in the exercise price.
REORGANIZATION, MERGER OR SALE. If we consolidate or merge with or into,
or transfer or lease all or substantially all our assets to, any person, upon
consummation of such transaction the Series A Warrants shall automatically
become exercisable for the kind and amount of securities, cash or other assets
which the holder
152
of a Series A Warrant would have owned immediately after the consolidation,
merger, transfer or lease if the holder had exercised the Series A Warrant
immediately before the effective date of the transaction.
ANTI-TAKEOVER PROVISIONS OF OUR CERTIFICATE OF INCORPORATION AND BYLAWS
Our certificate of incorporation and bylaws contain certain provisions that
are intended to enhance the likelihood of continuity and stability in the
composition of our Board of Directors and which may have the effect of delaying,
deferring or preventing our future takeover or change of control unless the
takeover or change of control is approved by our Board of Directors. These
provisions may also render the removal of the current Board of Directors and of
management more difficult. These provisions include:
- a classified Board of Directors, which could prevent a stockholder, or
group of stockholders, having majority voting power, from obtaining
control of our Board of Directors until the second annual meeting of
stockholders following September 10, 2003, the effective date of our
predecessor's Plan of Reorganization;
- advance notice requirements for stockholder proposals and nominations;
- removal of directors only for cause prior to the second annual meeting of
stockholders following September 10, 2003, the effective date of our
predecessor's Plan of Reorganization; and
- the authority of our Board of Directors to issue, without stockholder
approval, certain series of preferred stock with such terms as the Board
of Directors may determine.
ANTI-TAKEOVER EFFECTS OF CERTAIN INSURANCE LAWS
The insurance laws and regulations of the jurisdictions in which we or our
insurance subsidiaries do business may impede or delay a business combination
involving us. State insurance holding company laws and regulations applicable to
us generally provide that no person may acquire control of a company, and thus
indirect control of its insurance subsidiaries, unless the person has provided
required information to, and the acquisition is approved or not disapproved by,
the appropriate insurance regulatory authorities. Generally, any person
acquiring beneficial ownership of 10% or more of the voting power of our capital
stock would be presumed to have acquired control, unless the appropriate
insurance regulatory authorities upon advance application determine otherwise.
REGISTRATION RIGHTS AGREEMENTS
In connection with the Plan of Reorganization, we entered into registration
rights agreements with certain of our predecessor's creditors who, upon our
emergence from bankruptcy:
- would be holders of 5% or more of a class of our equity securities,
- notified us in writing that they are members of a "group" (as defined
under the Exchange Act) owning 5% or more of a class of our equity
securities, or
- notified us in writing that they are "underwriters" within the meaning of
Section 1145 of the Bankruptcy Code.
The registration rights agreements cover our common stock and Class A
Preferred Stock, and contain similar material terms and conditions. The
following summary of our registration rights agreements describes some of their
more important provisions. The complete agreements, which contain precise legal
terms and conditions and other information summarized here, are filed as
exhibits to the registration statement of which this prospectus forms a part.
SHELF REGISTRATION. As soon as practicable after our emergence from
bankruptcy, but in no event later than December 9, 2003, we were required to
file a shelf registration statement covering the resale of registrable
securities of the holders, and use reasonable best efforts to cause the
registration statement to be declared effective by the SEC as soon as
practicable. Subject to customary blackouts referred to below, we
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are required to use reasonable best efforts to keep the shelf registration
statement continuously effective until the earliest of:
- the date the registrable securities could be sold free of any volume
limitations imposed by Rule 144,
- the date all holders of registrable securities have disposed of all
registrable securities, or
- three years from the date on which the shelf registration statement was
declared effective.
All parties to the registration rights agreements declined to be included
in any shelf registration statement. Accordingly, we did not file this shelf
registration statement.
DEMAND REGISTRATION. Any holder of registrable securities may make a
written request for registration under the Securities Act of all or part of its
registrable securities. We, however, are not obligated to effect:
- any demand registration, except for the first demand registration under
the agreement, unless the aggregate market value of the registrable
securities covered by the request is at least $50,000,000,
- more than one demand registration in any six-month period,
- more than three demand registrations requested by any holder of
registrable securities,
- any demand registration within three months of a previous registration in
which holders of registrable securities were given piggy-back rights
(described below) and in which there was no reduction in the number of
registrable securities included in such registration, or
- any demand registration by holders of common stock that would be
inconsistent with certain registration rights of holders of Class A
Preferred Stock.
The registration rights agreements contain customary provisions limiting,
under certain circumstances, the number of registrable securities a holder may
offer in a demand registration.
PIGGY-BACK REGISTRATION. If we file a registration statement covering our
equity securities for our own account or for the account of any holder of our
equity securities (other than registration statements on Form S-4 or Form S-8),
we must offer to holders of registrable securities the opportunity to register
such number of shares of registrable securities as such holder may request. The
registration rights agreements contain customary provisions limiting, under
certain circumstances, the number of registrable securities a holder may offer
in a piggy-back registration.
EXPENSES. We have agreed to pay all customary costs and expenses
associated with each registration, including for each registration statement
prepared, the reasonable fees and expenses of one firm of attorneys for the
holders of registrable securities.
SHARES ELIGIBLE FOR FUTURE SALE
Based on the confirmation order we received from the Bankruptcy Court on
September 9, 2003, we relied on Section 1145(a)(1) of the Bankruptcy Code to
exempt the offer and sale of our common stock, Class A Preferred Stock and
Series A Warrants, which may have been deemed to have occurred through the
solicitation of acceptances of the Plan of Reorganization, from the registration
requirements of the Securities Act of 1933, as amended.
Section 1145(a)(1) exempts the offer or sale of securities pursuant to a
plan of reorganization from the registration requirements of the Securities Act
and from registration under state securities laws if the following conditions
are satisfied:
- the securities are issued by a company (a "debtor" under the Bankruptcy
Code), or its affiliates or successors, under a plan of reorganization;
- the recipients of the securities hold a claim against, an interest in, or
a claim for an administrative expense against the debtor; and
154
- the securities are issued in exchange for the recipients' claim against
or interest in the debtor, or principally in such exchange and partly for
cash or property.
In general, offers and sales of securities made in reliance on the exemption
afforded under section 1145(a)(1) of the Bankruptcy Code are deemed to be made
in a public offering, so that the recipients thereof, other than "underwriters,"
are free to resell such securities without registration under the Securities
Act. In addition, such securities generally may be resold without registration
under state securities laws pursuant to various exemptions provided by the
respective laws of the several states. However, recipients of common stock,
Class A Preferred Stock and Series A Warrants issued under the Plan of
Reorganization were advised to consult with their own legal counsel as to the
availability of any such exemption from registration under state law in any
given instance and as to any applicable requirements or conditions to such
availability. It was a condition to consummation of the Plan of Reorganization
that the Section 1145 exemption apply to the common stock, Class A Preferred
Stock and Series A Warrants.
The exemption from the registration requirements of the Securities Act for
resales provided by section 1145(a) was not available to a recipient of common
stock, Class A Preferred Stock or Series A Warrants if such individual or entity
was deemed to be an "underwriter" with respect to such securities, as that term
is defined in section 1145(b) of the Bankruptcy Code. Section 1145(b) of the
Bankruptcy Code defines the term "underwriter" as one who
- purchases a claim with a view toward distribution of any security to be
received in exchange for the claim,
- offers to sell securities issued under a plan for the holders of such
securities,
- offers to buy securities issued under a plan from persons receiving such
securities, if the offer to buy is made with a view toward distribution,
or
- is a control person of the issuer of the securities.
Notwithstanding the foregoing, statutory underwriters may be able to sell
securities without registration pursuant to Rule 144 under the Securities Act
(subject, however, to any resale limitations contained therein) which, in
effect, permits the resale of securities (including those securities received by
statutory underwriters pursuant to a Chapter 11 plan), subject to applicable
volume limitations, notice and manner of sale requirements and certain other
conditions. Recipients of common stock, Class A Preferred Stock and Series A
Warrants under the Plan of Reorganization who believed they may have been
statutory underwriters as defined by Section 1145 of the Bankruptcy Code were
advised to consult with their own counsel as to the availability of the
exemption provided by Rule 144. These holders also have rights to have their
shares registered for resale under the Securities Act. See "Description of
Capital Stock -- Registration Rights" above.
On September 16, 2003, we filed a registration statement on Form S-8 under
the Securities Act to register all of the shares of common stock issued and
reserved for future issuance under the Conseco, Inc. 2003 Long-Term Equity
Incentive Plan. The registration statement, which covers 10,000,000 shares,
became effective upon filing. Accordingly, shares of restricted stock and shares
issued upon the exercise of stock options granted under the Conseco, Inc. 2003
Long-Term Equity Incentive Plan are eligible for resale in the public market
from time to time, subject to vesting restrictions.
[C] After the completion of this offering, [P] After the completion of the
concurrent common stock offering, we will have shares of common stock
outstanding. This number includes million shares that we are selling
[C] in this offering [P] in the concurrent common stock offering, which may be
resold immediately in the public market. In addition, shares of our outstanding
Class A Preferred Stock are convertible by holders at any time on or after
September 30, 2005 into shares of our common stock. The Class A Preferred Stock
is convertible into an aggregate amount of approximately 42.5 million shares of
our common stock, determined as of September 30, 2003. This amount will increase
as the holders receive dividends, payable in additional shares of Class A
Preferred Stock, at a rate per annum equal to 10.5% of the liquidation
preference per share, semi-annually until September 10, 2005, when the rate
increases to 11%, and may increase as a result of anti-dilution adjustments.
Holders of our outstanding Series A Warrants are entitled to purchase one share
of our common stock at a price of $27.60 per share for each such warrant. The
Series A Warrants are exercisable for an aggregate of up to 6.0 million shares
of common stock and expire
155
on September 10, 2008. [C] Holders of our Class B Preferred Stock issued in the
concurrent offering will be entitled at their option at any time on or after the
first day after issuance of the Class B Preferred Stock to convert the shares of
Class B Preferred Stock into an aggregate of shares of our common
stock and, under specified circumstances, such shares could be convertible into
an aggregate of up to shares of our common stock. In the event that we
are unable to pay all accumulated dividends on the Class B Preferred Stock in
cash on the mandatory conversion date pursuant to the terms thereof, we are
obligated to deliver additional shares of our common stock in respect of such
unpaid dividends. [P] Holders of our Class B Preferred Stock issued in this
offering will be entitled at their option at any time on or after the first day
after issuance of the Class B Preferred Stock to convert the shares of Class B
Preferred Stock into an aggregate of shares of our common stock and,
under specified circumstances, such shares could be convertible into an
aggregate of up to shares of our common stock. In the event that we
are unable to pay all accumulated dividends on the Class B Preferred Stock in
cash on the mandatory conversion date pursuant to the terms thereof, we are
obligated to deliver additional shares of our common stock in respect of such
unpaid dividends. See "Description of Capital Stock" [P] and "Description of the
Mandatory Convertible Preferred Stock, Class B."
156
[C] UNDERWRITING
We and Goldman, Sachs & Co., Morgan Stanley & Co. Incorporated and the
underwriters named below have entered into an underwriting agreement with
respect to the shares being offered. Subject to certain conditions, each
underwriter has severally agreed to purchase the number of shares indicated in
the following table. Goldman, Sachs & Co. and Morgan Stanley & Co. Incorporated
are the representatives of the underwriters.
Number of
Underwriters Shares
------------ ---------
Goldman, Sachs & Co.........................................
Morgan Stanley & Co. Incorporated...........................
Banc of America Securities LLC..............................
Total.....................................................
The underwriters are committed to take and pay for all of the shares being
offered, if any are taken, other than the shares covered by the option described
below unless and until this option is exercised.
If the underwriters sell more shares than the total number set forth in the
table above, the underwriters have an option to buy up to an additional
shares from us to cover such sales. They may exercise that option for 30 days.
If any shares are purchased pursuant to this option, the underwriters will
severally purchase shares in approximately the same proportion as set forth in
the table above.
The following table shows the per share and total underwriting discounts
and commissions to be paid by us to the underwriters. Such amounts are shown
assuming both no exercise and full exercise of the underwriters' option to
purchase additional shares.
Paid by Conseco
---------------------------
No Exercise Full Exercise
----------- -------------
Per Share................................................ $ $
Total.................................................... $ $
Shares sold by the underwriters to the public will initially be offered at
the initial price to public set forth on the cover of this prospectus. Any
shares sold by the underwriters to securities dealers may be sold at a discount
of up to $ per share from the initial price to public. Any such securities
dealers may resell any shares purchased from the underwriters to other brokers
or dealers at a discount of up to $ per share from the initial price to
public. If all the shares are not sold at the initial price to public, the
underwriters may change the offering price and the other selling terms.
We and our executive officers and directors have agreed with the
underwriters not to dispose of or hedge any of our common stock or securities
convertible into or exchangeable for shares of common stock during the period
from the date of this prospectus continuing through the date days after the
date of this prospectus, except with the prior written consent of Goldman, Sachs
& Co. and Morgan Stanley & Co. Incorporated. This agreement does not apply to
any transfers (i) under our existing employee benefit plans or (ii) by gift or
for estate planning purposes, so long as in each case the transferee agrees to
be bound in writing by the restrictions for the remaining period, (iii) to any
trust for the direct or indirect benefit of the undersigned or the immediate
family of the undersigned or (iv) by us in the concurrent offering of our Class
B Preferred Stock.
In connection with this offering, the underwriters may purchase and sell
shares of our common stock in the open market. These transactions may include
short sales, stabilizing transactions and purchases to cover positions created
by short sales. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in this offering. "Covered"
short sales are sales made in an amount not greater than the underwriters'
option to purchase additional shares from us in the offering. The underwriters
may close out any covered short position by either exercising their option to
purchase additional shares or purchasing shares in the open market. In
determining the source of shares to close out the covered short
157
position, the underwriters will consider, among other things, the price of
shares available for purchase in the open market as compared to the price at
which they purchase additional shares pursuant to the option granted to them.
"Naked" short sales are any sales in excess of such option. The underwriters
must close out any naked short position by purchasing shares in the open market.
A naked short position is more likely to be created if the underwriters are
concerned that there may be downward pressure on the price of our common stock
in the open market after pricing that could adversely affect investors who
purchase in the offering. Stabilizing transactions consist of various bids for
or purchases of common stock made by the underwriters in the open market prior
to the completion of the offering.
The underwriters may also impose a penalty bid. This occurs when a
particular underwriter repays to the underwriters a portion of the underwriting
discount received by it because the underwriter effecting a stabilizing
transaction has repurchased shares sold by or for the account of such
underwriter in stabilizing or short covering transactions.
Purchases to cover a short position and stabilizing transactions may have
the effect of preventing or retarding a decline in the market price of our
stock, and together with the imposition of the penalty bid, may stabilize,
maintain or otherwise affect the market price of our common stock. As a result,
the price of our common stock may be higher than the price that otherwise might
exist in the open market. If these activities are commenced, they may be
discontinued at any time. These transactions may be effected on the NYSE, in the
over-the-counter market or otherwise.
Each underwriter has represented, warranted and agreed that: (i) it will
have not offered or sold and, prior to the expiry of a period of six months from
the closing date, will not offer or sell any shares to persons in the United
Kingdom except to persons whose ordinary activities involve them in acquiring,
holding, managing or disposing of investments (as principal or agent) for the
purposes of their businesses or otherwise in circumstances which have not
resulted and will not result in an offer to the public in the United Kingdom
within the meaning of the Public Offers of Securities Regulations 1995; (ii) it
has only communicated or caused to be communicated and will only communicate or
cause to be communicated any invitation or inducement to engage in investment
activity (within the meaning of section 21 of the Financial Services and Markets
Act 2000 ("FSMA")) received by it in connection with the issue or sale of any
shares in circumstances in which section 21(1) of the FSMA does not apply to the
issuer; and (iii) it has complied and will comply with all applicable provisions
of the FSMA with respect to anything done by it in relation to the shares in,
from or otherwise involving the United Kingdom.
The shares may not be offered or sold, transferred or delivered, as part of
their initial distribution or at any time thereafter, directly or indirectly, to
any individual or legal entity in the Netherlands other than to individuals or
legal entities who or which trade or invest in securities in the conduct of
their profession or trade, which includes banks, securities intermediaries,
insurance companies, pension funds, other institutional investors and commercial
enterprises which, as an ancillary activity, regularly trade or invest in
securities.
The shares may not be offered or sold by means of any document other than
to persons whose ordinary business is to buy or sell shares or debentures,
whether as principal or agent, or in circumstances which do not constitute an
offer to the public within the meaning of the Companies Ordinance (Cap. 32) of
Hong Kong, and no advertisement, invitation or document relating to the shares
may be issued, whether in Hong Kong or elsewhere, which is directed at, or the
contents of which are likely to be accessed or read by, the public in Hong Kong
(except if permitted to do so under the securities laws of Hong Kong) other than
with respect to shares which are or are intended to be disposed of only to
persons outside Hong Kong or only to "professional investors" within the meaning
of the Securities and Futures Ordinance (Cap. 571) of Hong Kong and any rules
made thereunder.
The prospectus has not been and will not be registered as a prospectus with
the Monetary Authority of Singapore. Accordingly, each underwriter acknowledges
that the shares may not be offered or sold, or be made the subject of an
invitation for subscription or purchase, nor may the prospectus and any other
document or material in connection with the offer or sale, or invitation for
subscription or purchase, of the shares be circulated or distributed, whether
directly or indirectly, to the public or any member of the public in Singapore
other than (i) to an institutional investor or other person specified in Section
274 of the Securities
158
and Futures Act, Chapter 289 of Singapore (the "Securities and Futures Act")
(ii) to a sophisticated investor, and in accordance with the conditions,
specified in Section 275 of the Securities and Futures Act, or (iii) otherwise
pursuant to, and in accordance with the conditions of, any other applicable
provision of the Securities and Futures Act.
Each underwriter has acknowledged and agreed that the shares have not been
registered under the Securities and Exchange Law of Japan and are not being
offered or sold and may not be offered or sold, directly or indirectly, in Japan
or to or for the account of any resident of Japan, except (i) pursuant to an
exemption from the registration requirements of the Securities and Exchange Law
of Japan and (ii) in compliance with any other applicable requirements of
Japanese law.
We estimate that our total out-of-pocket expenses of the offering,
excluding underwriting discounts and commissions, will be approximately $ .
A prospectus in electronic format will be made available on Internet web
sites maintained by one or more of the lead or co-managers of this offering and
may also be made available on web sites maintained by other underwriters.
We have agreed to indemnify the several underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as amended.
Certain of the underwriters and their respective affiliates have, from time
to time, performed, and may in the future perform, various financial advisory
and investment banking services for us, for which they received or will receive
customary fees and expenses. Goldman, Sachs & Co. and Morgan Stanley & Co.
Incorporated are acting as underwriters in the concurrent public offering of our
Class B Preferred Stock. Furthermore, Banc of America Securities LLC is joint
lead arranger and joint bookrunner under our existing credit facility.
159
[P] UNDERWRITING
We and Goldman, Sachs & Co., Morgan Stanley & Co. Incorporated and the
underwriters named below have entered into an underwriting agreement with
respect to the shares of Class B Preferred Stock being offered. The closing of
the offering of the Class B Preferred Stock is conditioned upon the closing of
the concurrent offering of common stock. Subject to certain conditions, each
underwriter has severally agreed to purchase the number of shares indicated in
the following table. Goldman, Sachs & Co. and Morgan Stanley & Co. Incorporated
are the representatives of the underwriters.
Number of
Underwriters Shares
------------ ---------
Goldman, Sachs & Co.........................................
Morgan Stanley & Co. Incorporated...........................
J.P. Morgan Securities Inc. ................................
Total.....................................................
The underwriters are committed to take and pay for all of the shares being
offered, if any are taken, other than the shares covered by the option described
below unless and until this option is exercised.
If the underwriters sell more shares than the total number set forth in the
table above, the underwriters have an option to buy up to an additional
shares from us to cover such sales. They may exercise that option for
30 days. If any shares are purchased pursuant to this option, the underwriters
will severally purchase shares in approximately the same proportion as set forth
in the table above.
The following table shows the per share and total underwriting discounts
and commissions to be paid by us to the underwriters. Such amounts are shown
assuming both no exercise and full exercise of the underwriters' option to
purchase additional shares.
Paid by Conseco
---------------------------
No Exercise Full Exercise
----------- -------------
Per Share................................................ $ $
Total.................................................... $ $
Shares sold by the underwriters to the public will initially be offered at
the initial price to public set forth on the cover of this prospectus. Any
shares sold by the underwriters to securities dealers may be sold at a discount
of up to $ per share from the initial price to public. Any such securities
dealers may resell any shares purchased from the underwriters to other brokers
or dealers at a discount of up to $ per share from the initial price to
public. If all the shares are not sold at the initial price to public, the
underwriters may change the offering price and the other selling terms.
We and our executive officers and directors have agreed with the
underwriters not to dispose of or hedge any of our common stock or securities
convertible into or exchangeable for shares of common stock during the period
from the date of this prospectus continuing through the date days after the
date of this prospectus, except with the prior written consent of Goldman, Sachs
& Co. and Morgan Stanley & Co. Incorporated. This agreement does not apply to
any transfers (i) under our existing employee benefit plans or (ii) by gift or
for estate planning purposes, so long as in each case the transferee agrees to
be bound in writing by the restrictions for the remaining period, (iii) to any
trust for the direct or indirect benefit of the undersigned or the immediate
family of the undersigned or (iv) by us in the concurrent offering of our common
stock.
In connection with this offering, the underwriters may purchase and sell
shares of our Class B Preferred Stock in the open market. These transactions may
include short sales, stabilizing transactions and purchases to cover positions
created by short sales. Short sales involve the sale by the underwriters of a
greater number of shares than they are required to purchase in this offering.
"Covered" short sales are sales made in an amount not greater than the
underwriters' option to purchase additional shares from us in the offering. The
underwriters may close out any covered short position by either their option to
purchase additional shares or purchasing shares in the open market. In
determining the source of shares to close out the covered short
160
position, the underwriters will consider, among other things, the price of
shares available for purchase in the open market as compared to the price at
which they purchase additional shares pursuant to the option granted to them.
"Naked" short sales are any sales in excess of such option. The underwriters
must close out any naked short position by purchasing shares in the open market.
A naked short position is more likely to be created if the underwriters are
concerned that there may be downward pressure on the price of our Class B
Preferred Stock in the open market after pricing that could adversely affect
investors who purchase in the offering. Stabilizing transactions consist of
various bids for or purchases of Class B Preferred Stock made by the
underwriters in the open market prior to the completion of the offering.
The underwriters may also impose a penalty bid. This occurs when a
particular underwriter repays to the underwriters a portion of the underwriting
discount received by it because the underwriter effecting a stabilizing
transaction has repurchased shares sold by or for the account of such
underwriter in stabilizing or short covering transactions.
Purchases to cover a short position and stabilizing transactions may have
the effect of preventing or retarding a decline in the market price of our Class
B Preferred Stock, and together with the imposition of the penalty bid, may
stabilize, maintain or otherwise affect the market price of our Class B
Preferred Stock. As a result, the price of our Class B Preferred Stock may be
higher than the price that otherwise might exist in the open market. If these
activities are commenced, they may be discontinued at any time. These
transactions may be effected on the NYSE, in the over-the-counter market or
otherwise.
Each underwriter has represented, warranted and agreed that: (i) it will
have not offered or sold and, prior to the expiry of a period of six months from
the closing date, will not offer or sell any shares to persons in the United
Kingdom except to persons whose ordinary activities involve them in acquiring,
holding, managing or disposing of investments (as principal or agent) for the
purposes of their businesses or otherwise in circumstances which have not
resulted and will not result in an offer to the public in the United Kingdom
within the meaning of the Public Offers of Securities Regulations 1995; (ii) it
has only communicated or caused to be communicated and will only communicate or
cause to be communicated any invitation or inducement to engage in investment
activity (within the meaning of section 21 of the FSMA) received by it in
connection with the issue or sale of any shares in circumstances in which
section 21(1) of the FSMA does not apply to the issuer; and (iii) it has
complied and will comply with all applicable provisions of the FSMA with respect
to anything done by it in relation to the shares in, from or otherwise involving
the United Kingdom.
The shares may not be offered or sold, transferred or delivered, as part of
their initial distribution or at any time thereafter, directly or indirectly, to
any individual or legal entity in the Netherlands other than to individuals or
legal entities who or which trade or invest in securities in the conduct of
their profession or trade, which includes banks, securities intermediaries,
insurance companies, pension funds, other institutional investors and commercial
enterprises which, as an ancillary activity, regularly trade or invest in
securities.
The shares may not be offered or sold by means of any document other than
to persons whose ordinary business is to buy or sell shares or debentures,
whether as principal or agent, or in circumstances which do not constitute an
offer to the public within the meaning of the Companies Ordinance (Cap. 32) of
Hong Kong, and no advertisement, invitation or document relating to the shares
may be issued, whether in Hong Kong or elsewhere, which is directed at, or the
contents of which are likely to be accessed or read by, the public in Hong Kong
(except if permitted to do so under the securities laws of Hong Kong) other than
with respect to shares which are or are intended to be disposed of only to
persons outside Hong Kong or only to "professional investors" within the meaning
of the Securities and Futures Ordinance (Cap. 571) of Hong Kong and any rules
made thereunder.
The prospectus has not been and will not be registered as a prospectus with
the Monetary Authority of Singapore. Accordingly, each underwriter acknowledges
that the shares may not be offered or sold, or be made the subject of an
invitation for subscription or purchase, nor may the prospectus and any other
document or material in connection with the offer or sale, or invitation for
subscription or purchase, of the shares be circulated or distributed, whether
directly or indirectly, to the public or any member of the public in Singapore
other than (i) to an institutional investor or other person specified in Section
274 of the Securities
161
and Futures Act (ii) to a sophisticated investor, and in accordance with the
conditions, specified in Section 275 of the Securities and Futures Act, or (iii)
otherwise pursuant to, and in accordance with the conditions of, any other
applicable provision of the Securities and Futures Act.
Each underwriter has acknowledged and agreed that the shares have not been
registered under the Securities and Exchange Law of Japan and are not being
offered or sold and may not be offered or sold, directly or indirectly, in Japan
or to or for the account of any resident of Japan, except (i) pursuant to an
exemption from the registration requirements of the Securities and Exchange Law
of Japan and (ii) in compliance with any other applicable requirements of
Japanese law.
We estimate that our total out-of-pocket expenses of the offering,
excluding underwriting discounts and commissions, will be approximately $ .
A prospectus in electronic format will be made available on Internet web
sites maintained by one or more of the lead or co-managers of this offering and
may also be made available on web sites maintained by other underwriters.
We have agreed to indemnify the several underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as amended.
Certain of the underwriters and their respective affiliates have, from time
to time, performed, and may in the future perform, various financial advisory
and investment banking services for us, for which they received or will receive
customary fees and expenses. Goldman, Sachs & Co. and Morgan Stanley & Co.
Incorporated are acting as underwriters in the concurrent public offering of our
common stock. Furthermore, J.P. Morgan Securities Inc. is joint lead arranger
and joint bookrunner under our existing credit facility.
162
LEGAL MATTERS
[C] The validity of the shares of common stock offered hereby will be
passed upon by Kirkland & Ellis LLP, Chicago, Illinois. William S. Kirsch has
served as Executive Vice President, General Counsel and Corporate Secretary of
Conseco, Inc. since September 2003. Mr. Kirsch's professional corporation,
William S. Kirsch, P.C., is a partner of Kirkland & Ellis LLP. The underwriters
have been represented by Cravath, Swaine & Moore LLP, New York, New York.
[P] The validity of the shares of Class B Preferred Stock offered hereby
will be passed upon by Kirkland & Ellis LLP, Chicago, Illinois. William S.
Kirsch has served as Executive Vice President, General Counsel and Corporate
Secretary of Conseco, Inc. since September 2003. Mr. Kirsch's professional
corporation, William S. Kirsch, P.C., is a partner of Kirkland & Ellis LLP. The
underwriters have been represented by Cravath, Swaine & Moore LLP, New York, New
York.
EXPERTS
The predecessor financial statements included in this prospectus as of
December 31, 2001 and 2002 and for the years ended December 31, 2000, 2001 and
2002 have been so included in reliance on the report (which contains an
explanatory paragraph related to the predecessor filing voluntary petitions for
reorganization under Chapter 11 of the United States Bankruptcy Code) of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 with respect to the securities offered in this prospectus.
This prospectus is a part of the registration statement and, as permitted by the
Securities and Exchange Commission's rules, does not contain all of the
information presented in the registration statement. Whenever one of our
contracts or other documents is described, summarized or referred to in this
prospectus, please be aware that this description, summary or reference is not
necessarily complete and that you should refer to the exhibits that are a part
of the registration statement for a copy of the contract or other document. You
may review a copy of the registration statement, including exhibits to the
registration statement, at the Securities and Exchange Commission's public
reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call
the Securities and Exchange Commission at 1-800-SEC-0330 for further information
on the operation of the public reference room. Our filings with the Securities
and Exchange Commission are also available to the public through the Securities
and Exchange Commission's website at http://www.sec.gov.
We are subject to the informational requirements of the Exchange Act, and
in accordance with the Exchange Act, we and our predecessor have filed annual,
quarterly and current reports and other information with the Securities and
Exchange Commission. You may read and copy any documents at the address set
forth above.
You may request copies of the filings, at no cost, by writing to the
following address or calling the following telephone number:
Investor Relations
Conseco, Inc.
11825 N. Pennsylvania Street
Carmel, Indiana 46032
(317) 817-2893.
163
CONSECO, INC.
INDEX TO FINANCIAL STATEMENTS
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS OF CONSECO, INC.,
A DELAWARE CORPORATION (THE "SUCCESSOR"),
AS OF AND FOR THE PERIOD ENDED SEPTEMBER 30, 2003
Consolidated Balance Sheet.................................. F-2
Consolidated Statement of Operations........................ F-3
Consolidated Statement of Shareholders' Equity (Deficit).... F-5
Consolidated Statement of Cash Flows........................ F-6
Notes to Consolidated Financial Statements.................. F-7
AUDITED FINANCIAL STATEMENTS OF CONSECO, INC.,
AN INDIANA CORPORATION (THE "PREDECESSOR"),
AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Report of Independent Accountants........................... F-42
Consolidated Balance Sheet.................................. F-43
Consolidated Statement of Operations........................ F-45
Consolidated Statement of Shareholders' Equity (Deficit).... F-47
Consolidated Statement of Cash Flows........................ F-50
Notes to Consolidated Financial Statements.................. F-51
F-1
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
SUCCESSOR PREDECESSOR
-------------------------- ------------
SEPTEMBER 30, AUGUST 31, DECEMBER 31,
2003 2003 2002
------------- ---------- ------------
(UNAUDITED)
(DOLLARS IN MILLIONS)
ASSETS
Investments:
Actively managed fixed maturities at fair value (amortized
cost:
September 30, 2003 -- $18,885.5; August 31,
2003 -- $18,701.0; December 31, 2002 -- $18,989.8).... $19,352.7 $18,701.0 $19,417.4
Equity securities at fair value (cost: September 30,
2003, -- $104.6; August 31, 2003 -- $101.4; December 31,
2002 -- $161.4)......................................... 107.5 101.4 156.0
Mortgage loans............................................ 1,154.1 1,159.7 1,308.3
Policy loans.............................................. 514.2 515.8 536.2
General Motors building................................... -- 1,336.3 --
Trading securities........................................ 944.9 952.1 --
Venture capital investment in AT&T Wireless Services, Inc.
at fair value (cost: September 30, 2003 -- $36.4; August
31, 2003 -- $36.4; December 31, 2002 -- $14.2).......... 33.7 36.4 25.0
Other invested assets..................................... 308.7 321.5 340.8
--------- --------- ---------
Total investments..................................... 22,415.8 23,124.2 21,783.7
Cash and cash equivalents:
Unrestricted.............................................. 1,724.3 1,215.9 1,268.9
Restricted................................................ 22.1 -- --
Accrued investment income................................... 316.0 304.6 389.8
Value of policies inforce at the Effective Date............. 2,770.4 2,836.9 --
Cost of policies purchased.................................. -- -- 1,170.0
Cost of policies produced................................... 23.2 -- 2,014.4
Reinsurance receivables..................................... 933.6 932.3 934.2
Income tax assets........................................... 86.7 88.0 101.5
Goodwill.................................................... 935.4 1,102.8 100.0
Other tangible assets....................................... 173.8 174.8 --
Assets held in separate accounts and investment trust....... 37.5 87.7 447.0
Assets of discontinued operations........................... -- -- 17,624.3
Other assets................................................ 421.1 545.7 675.2
--------- --------- ---------
Total assets............................................ $29,859.9 $30,412.9 $46,509.0
========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Liabilities:
Liabilities for insurance and asset accumulation products:
Interest-sensitive products............................. $12,851.5 $12,837.9 $13,469.5
Traditional products.................................... 10,727.5 10,701.0 7,971.4
Claims payable and other policyholder funds............. 873.1 886.7 909.2
Liabilities related to separate accounts and investment
trust................................................. 37.5 87.7 447.0
Other liabilities......................................... 748.5 875.2 673.5
Liabilities of discontinued operations.................... -- -- 17,624.3
Investment borrowings..................................... 524.4 1,224.4 669.7
Notes payable -- direct corporate obligations............. 1,300.0 1,300.0 --
--------- --------- ---------
Total liabilities not subject to compromise........... 27,062.5 27,912.9 41,764.6
--------- --------- ---------
Liabilities subject to compromise......................... -- -- 4,873.3
--------- --------- ---------
Total liabilities..................................... 27,062.5 27,912.9 46,637.9
--------- --------- ---------
Minority interest:
Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts......................... -- -- 1,921.5
Shareholders' equity (deficit):
Preferred stock........................................... 865.0 859.7 501.7
Common stock and additional paid-in capital ($0.01 par
value, 8,000,000,000 shares authorized, shares issued
and outstanding: September 30, 2003 -- 100,098,119;
August 31, 2003 -- 100,098,119; no par value,
1,000,000,000 shares authorized, shares issued and
outstanding at December 31, 2002 -- 346,007,133)........ 1,640.3 1,640.3 3,497.0
Accumulated other comprehensive income.................... 273.2 -- 580.6
Retained earnings (deficit)............................... 18.9 -- (6,629.7)
--------- --------- ---------
Total shareholders' equity (deficit).................. 2,797.4 2,500.0 (2,050.4)
--------- --------- ---------
Total liabilities and shareholders' equity
(deficit)........................................... $29,859.9 $30,412.9 $46,509.0
========= ========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
F-2
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
SUCCESSOR PREDECESSOR
-------------- ----------------------------
ONE MONTH TWO MONTHS THREE MONTHS
ENDED ENDED ENDED
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30,
2003 2003 2002
------------- ---------- -------------
(UNAUDITED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
Revenues:
Insurance policy income................................... $ 256.2 $ 516.8 $ 902.6
Net investment income:
General account assets.................................. 106.0 237.3 373.0
Policyholder and reinsurer accounts..................... (2.1) 6.8 (32.6)
Venture capital income (loss) related to investment in
AT&T Wireless Services, Inc........................... (2.7) 2.0 (6.6)
Net realized investment gains (losses).................. 6.7 (35.8) (261.1)
Fee revenue and other income.............................. 2.2 7.8 15.5
------------ --------- ---------
Total revenues........................................ 366.3 734.9 990.8
------------ --------- ---------
Benefits and expenses:
Insurance policy benefits................................. 243.3 407.4 883.4
Provision for losses...................................... -- 24.5 59.9
Interest expense (contractual interest of $73.7 for the
two months ended August 31, 2003)....................... 7.0 55.4 84.5
Amortization.............................................. 26.9 44.8 200.2
Other operating costs and expenses........................ 51.3 106.8 180.8
Goodwill impairment....................................... -- -- 500.0
Special charges........................................... -- -- 34.9
Reorganization items...................................... -- (2,163.0) --
------------ --------- ---------
Total benefits and expenses........................... 328.5 (1,524.1) 1,943.7
------------ --------- ---------
Income (loss) before income taxes, minority interest
and discontinued operations........................ 37.8 2,259.0 (952.9)
Income tax expense (benefit):
Tax expense (benefit) on period income (losses)........... 13.6 17.7 (154.8)
Valuation allowance for deferred tax assets............... -- -- 311.4
------------ --------- ---------
Income (loss) before minority interest and
discontinued operations............................ 24.2 2,241.3 (1,109.5)
Minority interest:
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, net of income
taxes................................................... -- -- 29.2
------------ --------- ---------
Income (loss) before discontinued operations.......... 24.2 2,241.3 (1,138.7)
Discontinued operations, net of income taxes.............. -- -- (630.3)
------------ --------- ---------
Net income (loss)..................................... 24.2 2,241.3 (1,769.0)
Preferred stock dividends................................. 5.3 -- .2
------------ --------- ---------
Net income (loss) applicable to common stock.......... $ 18.9 $ 2,241.3 $(1,769.2)
============ ========= =========
Earnings per common share:
Basic:
Weighted average shares outstanding..................... 100,098,000
============
Net income.............................................. $ .19
============
Diluted:
Weighted average shares outstanding..................... 144,671,000
============
Net income.............................................. $ .17
============
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS -- (CONTINUED)
SUCCESSOR PREDECESSOR
------------- ----------------------------
ONE MONTH EIGHT MONTHS NINE MONTHS
ENDED ENDED ENDED
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30,
2003 2003 2002
------------- ------------ -------------
(UNAUDITED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
Revenues:
Insurance policy income.................................. $ 256.2 $ 2,204.3 $ 2,726.2
Net investment income:
General account assets................................. 106.0 933.3 1,164.2
Policyholder and reinsurer accounts.................... (2.1) 25.2 (106.3)
Venture capital income (loss) related to investment in
AT&T Wireless Services, Inc.......................... (2.7) 10.5 (106.6)
Net realized investment gains (losses)................. 6.7 (5.4) (493.9)
Fee revenue and other income............................. 2.2 34.3 56.1
------------ --------- ---------
Total revenues:...................................... 366.3 3,202.2 3,239.7
------------ --------- ---------
Benefits and expenses:
Insurance policy benefits................................ 243.3 2,138.7 2,469.9
Provision for losses..................................... -- 55.6 199.9
Interest expense (contractual interest of $268.5 for the
eight months ended August 31, 2003).................... 7.0 202.5 248.8
Amortization............................................. 26.9 341.4 635.2
Other operating costs and expenses....................... 51.3 422.3 510.1
Goodwill impairment...................................... -- -- 500.0
Special charges.......................................... -- -- 103.1
Extraordinary gain on extinguishment of debt............. -- -- (1.8)
Reorganization items..................................... -- (2,130.5) --
------------ --------- ---------
Total benefits and expenses.......................... 328.5 1,030.0 4,665.2
------------ --------- ---------
Income (loss) before income taxes, minority interest,
discontinued operations and cumulative effect of
accounting change................................. 37.8 2,172.2 (1,425.5)
Income tax expense (benefit):
Tax expense (benefit) on period income (losses).......... 13.6 (13.5) (316.1)
Valuation allowance for deferred tax assets.............. -- -- 1,314.4
------------ --------- ---------
Income (loss) before minority interest, discontinued
operations and cumulative effect of accounting
change............................................ 24.2 2,185.7 (2,423.8)
Minority interest:
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, net of
income taxes........................................... -- -- 87.6
------------ --------- ---------
Income (loss) before discontinued operations and
cumulative effect of accounting change............ 24.2 2,185.7 (2,511.4)
Discontinued operations, net of income taxes............... -- 16.0 (686.6)
Cumulative effect of accounting change for goodwill
impairment, net of income taxes.......................... -- -- (2,949.2)
------------ --------- ---------
Net income (loss).................................... 24.2 2,201.7 (6,147.2)
Preferred stock dividends.................................. 5.3 -- 2.1
------------ --------- ---------
Net income (loss) applicable to common stock......... $ 18.9 $ 2,201.7 $(6,149.3)
============ ========= =========
Earnings per common share:
Basic:
Weighted average shares outstanding.................... 100,098,000
============
Net income............................................. $ .19
============
Diluted:
Weighted average shares outstanding.................... 144,671,000
============
Net income............................................. $ .17
============
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)
COMMON STOCK ACCUMULATED
AND ADDITIONAL OTHER RETAINED
PREFERRED PAID-IN COMPREHENSIVE EARNINGS
TOTAL STOCK CAPITAL INCOME (LOSS) (DEFICIT)
----- --------- -------------- ------------- ---------
(UNAUDITED)
(DOLLARS IN MILLIONS)
Predecessor balance, January 1, 2003.................. $(2,050.4) $ 501.7 $ 3,497.0 $ 580.6 $(6,629.7)
Comprehensive income, net of tax:
Net income........................................ 2,201.7 -- -- -- 2,201.7
Change in unrealized appreciation of investments
(net of applicable income tax benefit of nil)... (151.6) -- -- (151.6) --
---------
Total comprehensive income.................... 2,050.1
Change in shares for employee benefit plans......... .3 -- .3 -- --
--------- ------- --------- ------- ---------
Predecessor balance, August 31, 2003.................. -- 501.7 3,497.3 429.0 (4,428.0)
Elimination of Predecessor's equity securities........ (3,999.0) (501.7) (3,497.3) -- --
Issuance of Successor's equity securities............. 2,500.0 859.7 1,640.3 -- --
Fresh start adjustments............................... 3,999.0 -- -- (429.0) 4,428.0
--------- ------- --------- ------- ---------
Successor balance, August 31, 2003.................... 2,500.0 859.7 1,640.3 -- --
Comprehensive income, net of tax:
Net income........................................ 24.2 -- -- -- 24.2
Change in unrealized appreciation of investments
(net of applicable income tax expense of
$154.4)......................................... 273.2 -- -- 273.2 --
---------
Total comprehensive income.................... 297.4
Payment-in-kind dividends on convertible
exchangeable preferred stock.................... 5.3 5.3 -- -- --
Dividends on preferred stock...................... (5.3) -- -- -- (5.3)
--------- ------- --------- ------- ---------
Successor balance, September 30, 2003................. $ 2,797.4 $ 865.0 $ 1,640.3 $ 273.2 $ 18.9
========= ======= ========= ======= =========
Predecessor balance, January 1, 2002.................. $ 4,753.0 $ 499.6 $ 3,484.3 $(439.0) $ 1,208.1
Comprehensive loss, net of tax:
Net loss.......................................... (6,147.2) -- -- -- (6,147.2)
Change in unrealized depreciation of investments
(net of applicable income tax expense of
$324.0)......................................... 569.4 -- -- 569.4 --
---------
Total comprehensive loss...................... (5,577.8)
Issuance of shares for stock options and for
employee benefit plans............................ 13.0 -- 13.0 -- --
Payment-in-kind dividends on convertible preferred
stock............................................. 2.1 2.1 -- -- --
Dividends on preferred stock........................ (2.1) -- -- -- (2.1)
--------- ------- --------- ------- ---------
Predecessor balance, September 30, 2002............... $ (811.8) $ 501.7 $ 3,497.3 $ 130.4 $(4,941.2)
========= ======= ========= ======= =========
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
SUCCESSOR PREDECESSOR
------------- ----------------------------
ONE MONTH EIGHT MONTHS NINE MONTHS
ENDED ENDED ENDED
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30,
2003 2003 2002
------------- ------------ -------------
(UNAUDITED)
(DOLLARS IN MILLIONS)
Cash flows from operating activities:
Insurance policy income................................ $ 223.7 $ 1,876.2 $ 2,313.1
Net investment income.................................. 103.6 933.5 2,723.6
Fee revenue and other income........................... 2.2 34.3 236.6
Insurance policy benefits.............................. (178.1) (1,466.1) (1,810.4)
Interest expense....................................... -- -- (1,013.1)
Policy acquisition costs............................... (25.6) (287.5) (391.4)
Special charges........................................ -- -- (46.7)
Reorganization items................................... -- (26.5) --
Other operating costs.................................. (73.6) (360.8) (1,143.9)
Taxes.................................................. .3 44.2 (130.4)
--------- --------- ----------
Net cash provided by operating activities.......... 52.5 747.3 737.4
--------- --------- ----------
Cash flows from investing activities:
Sales of investments................................... 2,121.9 5,378.9 15,592.4
Maturities and redemptions of investments.............. 288.7 1,854.7 1,143.9
Purchases of investments............................... (1,225.6) (7,385.9) (15,771.7)
Cash received from the sale of finance receivables, net
of expenses.......................................... -- -- 1,450.6
Finance receivables originated......................... -- -- (6,401.8)
Consolidation of partnership which holds General Motors
building............................................. 28.4 -- --
Principal payments received on finance receivables..... -- -- 6,196.6
Charge in restricted cash.............................. (22.1) -- --
Other.................................................. 4.3 (19.6) (139.2)
--------- --------- ----------
Net cash provided (used) by investing activities... 1,195.6 (171.9) 2,070.8
--------- --------- ----------
Cash flows from financing activities:
Amounts received for deposit products.................. 121.8 1,272.7 3,465.0
Withdrawals from deposit products...................... (133.1) (1,784.2) (4,228.6)
Issuance of notes payable.............................. -- -- 6,034.3
Payments on notes payable.............................. -- -- (7,918.0)
Ceding commission received on reinsurance
transaction.......................................... -- -- 83.0
Change in cash held in restricted accounts for
settlement of borrowings............................. -- -- (210.7)
Investment borrowings.................................. (700.0) (145.3) (1,399.6)
Dividends on preferred shares and distributions on
Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts...................... -- -- (86.2)
--------- --------- ----------
Net cash used by financing activities.............. (711.3) (656.8) (4,260.8)
--------- --------- ----------
Net increase (decrease) in cash and cash
equivalents..................................... 536.8 (81.4) (1,452.6)
Cash and cash equivalents, beginning of period........... 1,187.5 1,268.9 3,060.8
--------- --------- ----------
Cash and cash equivalents, end of period................. $ 1,724.3 $ 1,187.5 $ 1,608.2
========= ========= ==========
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following notes should be read together with the notes to the
consolidated financial statements included in the 2002 Form 10-K of our
predecessor, Conseco, Inc., an Indiana corporation ("Old Conseco").
Conseco, Inc., a Delaware corporation ("CNO"), is the top tier holding
company for our insurance subsidiaries that develop, market and administer
supplemental health insurance, annuity, individual life insurance and other
products. CNO became the successor to Old Conseco in connection with our
bankruptcy reorganization. The terms "Conseco," the "Company," "we," "us," and
"our" as used in this report refer to CNO and its subsidiaries and, unless the
context requires otherwise, Old Conseco and its subsidiaries.
PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
On December 17, 2002 (the "Petition Date"), Old Conseco and three of its
non-insurance company subsidiaries (collectively, the "Filing Entities") filed
voluntary petitions for relief under Chapter 11 of the United States Bankruptcy
Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the
Northern District of Illinois, Eastern Division (the "Bankruptcy Court"). During
the pendency of the Chapter 11 cases, the Filing Entities continued to operate
their businesses as debtors-in-possession under the jurisdiction of the
Bankruptcy Court and in accordance with the applicable provisions of the
Bankruptcy Code and orders of the Bankruptcy Court.
We emerged from bankruptcy protection under the Sixth Amended Joint Plan of
Reorganization (the "Plan"), which was confirmed pursuant to an order of the
Bankruptcy Court on September 9, 2003 (the "Confirmation Date"), and became
effective on September 10, 2003 (the "Effective Date"). In accordance with
Statement of Position 90-7, "Financial Reporting by Entities in Reorganization
under the Bankruptcy Code," ("SOP 90-7"), we adopted fresh start accounting on
the Effective Date. However, in light of the proximity of such date to the
August month end, for accounting convenience purposes, the effects of fresh
start accounting have generally been reported "as if" they occurred on August
31, 2003. See the note entitled "Fresh Start Reporting" for more information
relating to fresh start accounting.
The Plan generally provided for the full payment or reinstatement of
allowed administrative claims, priority claims, fully secured claims and certain
intercompany claims, and the distribution of new equity securities (including
warrants) of CNO to partially secured and unsecured creditors of the Filing
Entities. Holders of claims arising under Old Conseco's $1.5 billion senior bank
credit facility also received a pro rata interest in a new $1.3 billion senior
bank credit facility. Holders of Old Conseco's common stock and preferred stock
did not receive any distribution under the Plan, and these securities, together
with all other prepetition securities and the $1.5 billion senior bank credit
facility of Old Conseco, were cancelled on the Effective Date.
On the Effective Date, under the terms of the Plan, we emerged from the
bankruptcy proceedings with a capital structure consisting of: (i) a new $1.3
billion senior bank credit facility; (ii) approximately 34.4 million shares of
Class A Senior Cumulative Convertible Exchangeable Preferred Stock of CNO (the
"Preferred Stock") with an initial aggregate liquidation preference of $859.7
million; (iii) 100 million shares of common stock of CNO, excluding shares
issued to our new non-executive chairman upon his appointment and shares issued
or to be issued to directors, officers, or employees under a new equity
incentive plan; and (iv) warrants to purchase 6.0 million shares of CNO common
stock. Under the terms of the Plan, we distributed CNO equity securities to the
creditors of Old Conseco in the amounts outlined below:
- lenders under Old Conseco's senior bank credit facility and director and
officer loan program received approximately 34.4 million shares of our
Preferred Stock with an initial aggregate liquidation preference of
$859.7 million;
- holders of Old Conseco's senior notes received approximately 32.3 million
shares of our common stock;
F-7
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
- holders of Old Conseco's guaranteed senior notes received approximately
60.6 million shares of our common stock;
- holders of Old Conseco's general unsecured claims received approximately
2.9 million shares of our common stock; and
- holders of trust preferred securities issued by Old Conseco's subsidiary
trusts received approximately 1.5 million shares of our common stock and
warrants to purchase 6.0 million shares of our common stock at an
exercise price of $27.60 per share.
The distribution of our common stock summarized above represents
approximately 97 percent of all of the shares of common stock to be distributed
under the Plan. Approximately 2.7 million shares of common stock have been
reserved for distribution under the Plan in respect of disputed claims, the
resolution of which is still pending. If reserved shares remain after resolution
of these disputed claims, then the reserved shares will be reallocated to other
general unsecured creditors of Old Conseco as provided for under the Plan.
For a complete discussion of the distributions provided for under the Plan,
investors should refer to the complete text of the Plan confirmed by the
Bankruptcy Court on September 9, 2003, and filed with the Securities and
Exchange Commission on September 15, 2003 with our Current Report on Form 8-K.
Our common stock is listed on the New York Stock Exchange ("NYSE") under
the symbol "CNO," and our warrants are listed on the NYSE under the symbol "CNO
WS." Our Preferred Stock currently trades on the Over-the-Counter Bulletin Board
under the symbol "CNSJP."
DISCONTINUED FINANCE BUSINESS -- SALE OF CFC
As part of our Chapter 11 reorganization, we sold substantially all of the
assets of our finance business and exited from this line of business. Our
finance business was conducted through our indirect wholly-owned subsidiary,
Conseco Finance Corp. ("CFC"). We accounted for our finance business as a
discontinued operation in 2002 once we formalized plans to sell it. On April 1,
2003, CFC and 22 of its direct and indirect subsidiaries, which collectively
comprised substantially all of our finance business, filed liquidating plans of
reorganization with the Bankruptcy Court in order to facilitate the sale of this
business. The sale of the finance business was completed in the second quarter
of 2003. We did not receive any proceeds from this sale in respect of our
interest in CFC, nor did any creditors of Old Conseco. As of March 31, 2003, we
ceased to include the assets and liabilities of CFC on our consolidated balance
sheet.
BASIS OF PRESENTATION
References in these consolidated financial statements to "Predecessor"
refer to Old Conseco prior to August 31, 2003. References to "Successor" refer
to the Company on and after August 31, 2003, after giving effect to the
implementation of fresh start reporting. The accompanying consolidated financial
statements have been prepared in accordance with SOP 90-7. Accordingly, all
prepetition liabilities subject to compromise have been segregated in the
Predecessor's consolidated balance sheet and classified as "liabilities subject
to compromise" at the estimated amount of allowable claims.
Pursuant to SOP 90-7, professional fees associated with the Chapter 11
cases are expensed as incurred and reported as reorganization items. Interest
expense is reported only to the extent that it was paid during the Chapter 11
cases. During the period January 1, 2003 through August 31, 2003, the Company
recognized a charge of $70.9 million associated with the Chapter 11 cases for
fees payable to professionals to assist with the Chapter 11 cases.
Upon our emergence from bankruptcy, we implemented fresh start reporting in
accordance with SOP 90-7. These rules required the Company to revalue its assets
and liabilities to current estimated fair value, re-establish shareholders'
equity at the reorganization value determined in connection with the Plan,
F-8
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and record any portion of the reorganization value which cannot be attributed to
specific tangible or identified intangible assets as goodwill. As a result, the
Company's financial statements for periods following August 31, 2003, will not
be comparable with those of Old Conseco prepared before that date.
Our unaudited consolidated financial statements reflect normal recurring
adjustments that are necessary to present fairly our financial position and
results of operations on a basis consistent with that of our prior audited
consolidated financial statements. As permitted by rules and regulations of the
Securities and Exchange Commission, applicable to quarterly reports on Form
10-Q, we have condensed or omitted certain information and disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles ("GAAP"). We have also reclassified certain amounts from
the prior periods to conform to the 2003 presentation. These reclassifications
have no effect on net income or shareholders' equity. Results for interim
periods are not necessarily indicative of the results that may be expected for a
full year.
During the third quarter of 2002, Old Conseco entered into an agreement to
sell Conseco Variable Insurance Company ("CVIC"), its wholly owned subsidiary
and the primary writer of its variable annuity products. The sale was completed
in October 2002. The operating results of CVIC have been reported as
discontinued operations in all periods presented in the accompanying
consolidated statement of operations. See the note to the consolidated financial
statements entitled "Discontinued Operations."
During 2001, we stopped renewing a large portion of our major medical lines
of business. These lines of business are referred to herein as the "major
medical business in run-off".
When we prepare financial statements in conformity with GAAP, we are
required to make estimates and assumptions that significantly affect various
reported amounts of assets and liabilities, and the disclosure of contingent
assets and liabilities at the date of the financial statements and revenues and
expenses during the reporting periods. For example, we use significant estimates
and assumptions in calculating values for the cost of policies produced, the
cost of policies purchased, the value of policies inforce at the Effective Date,
certain investments, assets and liabilities related to income taxes, goodwill,
liabilities for insurance and asset accumulation products, liabilities related
to litigation, guaranty fund assessment accruals and liabilities related to
guarantees of bank loans and the related interest loans to certain former
directors and to certain current and former officers and key employees. If our
future experience differs from these estimates and assumptions, our financial
statements would be materially affected.
Our consolidated financial statements exclude the results of material
transactions between us and our consolidated affiliates, or among our
consolidated affiliates.
FRESH START REPORTING
Upon the confirmation of the Plan on September 9, 2003, we implemented
fresh start reporting in accordance with SOP 90-7. However, in light of the
proximity of this date to the August month end, for accounting convenience
purposes, we have reported the effects of fresh start accounting as if they
occurred on August 31, 2003. We engaged an independent financial advisor to
assist in the determination of our reorganization value as defined in SOP 90-7.
We determined a reorganization value, together with our financial advisor, using
various valuation methods, including: (i) selected comparable companies
analysis; and (ii) actuarial valuation analysis. These analyses are necessarily
based on a variety of estimates and assumptions which, though considered
reasonable by management, may not be realized, and are inherently subject to
significant business, economic and competitive uncertainties and contingencies,
many of which are beyond our control. Changes in these estimates and assumptions
may have had a significant effect on the determination of our reorganization
value. The estimated reorganization value of the Company was calculated to be
approximately $3.7 billion to $3.9 billion. We selected the midpoint of the
range, $3.8 billion, as the reorganization value. Such value was confirmed by
the Bankruptcy Court on the Confirmation Date.
F-9
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Under fresh start reporting, a new reporting entity is considered to be
created and the Company is required to revalue its assets and liabilities to
current estimated fair value, re-establish shareholders' equity at the
reorganization value determined in connection with the Plan, and record any
portion of the reorganization value which can not be attributed to specific
tangible or identified intangible assets as goodwill. In addition, all
accounting standards that are required to be adopted in the financial statements
within twelve months following the adoption of fresh start accounting were
adopted as of August 31, 2003. Adjustments to the Predecessor's consolidated
balance sheet as of August 31, 2003, to reflect the discharge of debt, change in
capital structure and the fair value of our assets and liabilities are presented
in the following table (dollars in millions):
PREDECESSOR DEBT DISCHARGE
BALANCE AND FRESH START SUCCESSOR
SHEET(A) REORGANIZATION(B) ADJUSTMENTS BALANCE SHEET
----------- ----------------- ----------- -------------
Assets:
Investments............................... $22,018.3 $ -- $ 1,043.5 (c) $23,124.2
62.4 (d)
Cash and cash equivalents................. 1,187.5 -- 28.4 (c) 1,215.9
Accrued investment income................. 304.6 -- -- 304.6
Value of policies inforce at the Effective
Date.................................... -- -- 2,836.9 (e) 2,836.9
Cost of policies purchased................ 1,099.2 -- (1,099.2)(e) --
Cost of policies produced................. 2,019.5 -- (2,019.5)(e) --
Reinsurance receivables................... 878.3 -- 54.0 (f) 932.3
Goodwill.................................. 99.4 -- 1,003.4 (f) 1,102.8
Other intangible assets................... -- -- 174.8 (f) 174.8
Income tax assets......................... 88.0 -- -- 88.0
Assets held in separate accounts and
investment trust........................ 87.7 -- -- 87.7
Other assets.............................. 535.6 -- 10.1 (f) 545.7
--------- --------- --------- ---------
Total assets.......................... $28,318.1 $ -- $ 2,094.8 $30,412.9
========= ========= ========= =========
Liabilities:
Liabilities for insurance and asset
accumulation products................... $22,175.6 $ -- $ 2,337.7 (g) $24,513.3
Other liabilities......................... 868.1 -- (23.7)(f) 875.2
30.8 (c)
Investment borrowings..................... 524.4 -- 700.0 (c) 1,224.4
Notes payable -- direct corporate
obligations............................. -- 1,300.0 -- 1,300.0
--------- --------- --------- ---------
Total liabilities not subject to
compromise......................... 23,568.1 1,300.0 3,044.8 27,912.9
Liabilities subject to compromise......... 6,951.4 (6,951.4) -- --
--------- --------- --------- ---------
Total liabilities..................... 30,519.5 (5,651.4) 3,044.8 27,912.9
--------- --------- --------- ---------
Shareholders' equity (deficit):
Convertible preferred stock............... 501.7 -- (501.7) --
Convertible exchangeable preferred
stock................................... -- 859.7 -- 859.7
Common stock and additional paid-in
capital................................. 3,497.3 1,640.3 (3,497.3) 1,640.3
Retained earnings (accumulated deficit)... (6,629.4) 3,151.4 3,478.0 --
Accumulated other comprehensive income.... 429.0 -- (429.0) --
--------- --------- --------- ---------
Total shareholders' equity
(deficit).......................... (2,201.4) 5,651.4 (950.0) 2,500.0
--------- --------- --------- ---------
Total liabilities and shareholders'
equity (deficit)................... $28,318.1 $ -- $ 2,094.8 $30,412.9
========= ========= ========= =========
F-10
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
---------------
(a) Predecessor balance sheet as of August 31, 2003, prior to the recording of
the discharge of prepetition liabilities and the effects of the fresh start
adjustments.
(b) The fresh start balance sheet reflects the reorganization value for Conseco
of $3,800.0 million. After deducting from Conseco's reorganization value
the long-term indebtedness of Conseco at the Effective Date, consisting of
$1,300 million of indebtedness under the new senior secured bank credit
facility, the total equity of Conseco is $2,500 million. After deducting
from Conseco's total equity the value of the new Preferred Stock of $859.7
million, the value of the new common stock is $1,640.3 million. These
adjustments also reflect the gain on the discharge of prepetition
liabilities.
(c) In accordance with a new accounting pronouncement, the Company was required
to consolidate the assets and liabilities of the partnership which owned
the General Motors building into its balance sheet. As a result of the
consolidation and the adoption of fresh start accounting we increased our
investment in the General Motors building by $1,043.5 million and
recognized the following other assets and liabilities held by the
partnership which owns the General Motors building: (i) cash of $28.4
million; (ii) other liabilities of $30.8 million; and (iii) a note payable
of $700 million. We sold the General Motors building in September 2003 at a
value that was approximately equal to the fresh start value. The note
payable of the partnership was paid in full and the net proceeds from the
sale were distributed to the partners.
(d) The values of our mortgage loans, policy loans and other invested assets
were adjusted to market value at the Effective Date. In addition, the cost
basis of our actively managed fixed maturities was increased by $436.6
million to recognize all of the unrealized appreciation based on the
Predecessor cost basis at the Effective Date.
(e) The Company's historical cost of policies purchased and cost of policies
produced are eliminated and replaced with the value of policies inforce at
the Effective Date. The value of policies inforce reflects the estimated
fair value of the Company's business inforce and represents the portion of
the estimated reorganization value allocated to the value of the right to
receive future cash flows from the policies inforce on the Effective Date.
A discount rate of 12 percent was used to determine the value of policies
inforce and is the rate of return which management of the Company (with
assistance from an independent actuarial firm) believes would be required by
a purchaser of the business based on conditions existing as of the Effective
Date. In determining such rate of return, the following factors, among
others, are considered.
- The magnitude of the risks associated with each of the actuarial
assumptions used in determining the expected cash flows.
- Market rates of interest that would be applicable to an acquisition of
the business.
- The perceived likelihood of changes in insurance regulations and tax
laws.
- The complexity of the business.
- Prices paid for similar blocks of business.
(f) Assets and liabilities are adjusted to reflect their estimated fair market
value. The portion of the reorganization value that could not be attributed
to specific tangible or identified intangible assets has been recorded as
goodwill.
(g) The Company establishes reserves for insurance policy benefits based on
assumptions as to investment yields, mortality, morbidity, withdrawals and
lapses. These reserves include amounts for estimated future payment of
claims based on actuarial assumptions. Many factors can affect these
reserves, such as economic conditions, inflation, hospital and
pharmaceutical costs, changes in doctrines of legal liability and extra
contractual damage awards. The balance is based on the Company's best
estimate (with assistance from an independent actuarial firm) of the future
performance of this business, given recent and expected future changes in
experience.
F-11
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
REORGANIZATION ITEMS
Reorganization items represent amounts the Predecessor incurred as a result
of its Chapter 11 reorganization, and are presented separately in the
consolidated statement of operations. These items consist of the following
(dollars in millions):
TWO MONTHS EIGHT MONTHS
ENDED ENDED
AUGUST 31, 2003 AUGUST 31, 2003
--------------- ---------------
Gain on discharge of prepetition liabilities....... $3,151.4 $3,151.4
Fresh start adjustments............................ (950.0) (950.0)
Professional fees.................................. (38.4) (70.9)
-------- --------
Total reorganization items....................... $2,163.0 $2,130.5
======== ========
LIABILITIES SUBJECT TO COMPROMISE
Under the Bankruptcy Code, actions by creditors to collect indebtedness
owed prior to the Petition Date were stayed and certain other prepetition
contractual obligations could not be enforced against the Filing Entities. The
Filing Entities received approval from the Bankruptcy Court to pay certain
prepetition liabilities including employee salaries and wages, benefits and
other employee obligations. All other prepetition liabilities were classified as
"liabilities subject to compromise" in the accompanying consolidated balance
sheet.
The following table summarizes the components of the liabilities included
in the line "liabilities subject to compromise" in our consolidated balance
sheet at December 31, 2002 (dollars in millions):
Other liabilities:
Liability for guarantee of bank loans to former directors
and current and former officers and key employees of
Old Conseco to purchase common stock of Old Conseco.... $ 480.8
Interest payable.......................................... 171.6
Accrual of distributions on Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts of
Old Conseco............................................ 90.1
Liability for retirement benefits pursuant to executive
employment agreements.................................. 22.6
Liability for deferred compensation....................... 2.3
Other liabilities......................................... 48.8
--------
Total other liabilities subject to compromise........ 816.2
Notes payable -- direct corporate obligations............... 4,057.1
--------
Total liabilities subject to compromise.............. $4,873.3
========
GOODWILL
Upon our emergence from bankruptcy, we revalued our assets and liabilities
to current estimated fair value and established our capital accounts at the
reorganization value determined in connection with the Plan. We recorded the
$1,102.8 million of the reorganization value which could not be attributed to
specific tangible or identified intangible assets as goodwill. Under current
accounting rules (which became effective January 1, 2002) goodwill is not
amortized but is subject to an annual impairment test (or more frequent under
certain circumstances). We obtained an independent appraisal of our business in
connection with the preparation of the Plan and our implementation of fresh
start accounting.
F-12
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Although the goodwill balance will not be subject to amortization, it will
be reduced by future use of the Company's net deferred income tax assets
(including the tax operating loss carryforwards) existing at August 31, 2003
(such balance was reduced by $167.4 million in the one month ended September 30,
2003). A valuation allowance has been provided for the remaining balance of such
net deferred income tax assets due to the uncertainties regarding their
realization. See the note entitled "Income Taxes" for further discussion.
Changes in the carrying amount of goodwill are as follows (dollars in
millions):
SUCCESSOR
------------------
ONE MONTH ENDED
SEPTEMBER 30, 2003
------------------
Goodwill balance, beginning of period....................... $1,102.8
Recognition of tax valuation reserve established at the
Effective Date............................................ (167.4)
--------
Goodwill balance, end of period............................. $ 935.4
========
OTHER INTANGIBLE ASSETS
In conjunction with our adoption of fresh start accounting, we identified
certain intangible assets other than goodwill. We determined the value of these
assets with assistance from an independent valuation firm. In accordance with
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"), other intangible assets with indefinite lives
are not amortized, but are subject to impairment tests on an annual basis (or
more frequent under certain circumstances). SFAS 142 requires intangible assets
with finite useful lives to be amortized over their estimated useful lives and
to be reviewed for impairment in accordance with Statement of Financial
Accounting Standards No. 144, "Accounting for Impairment or Disposal of
Long-Lived Assets" ("SFAS 144").
The following summarizes other identifiable intangible assets as of
September 30, 2003 (dollars in millions):
Indefinite lived other intangible assets:
Trademarks and tradenames................................. $ 25.1
State licenses and charters............................... 34.0
------
Total indefinite lived other intangible assets......... 59.1
------
Finite lived other intangible assets:
Career agency force....................................... 64.7
Independent agency force.................................. 49.8
Other..................................................... 1.2
Less accumulated amortization............................. (1.0)
------
Total finite lived other intangible assets............. 114.7
------
Total other intangible assets............................... $173.8
======
CUMULATIVE EFFECT OF ACCOUNTING CHANGE AND GOODWILL IMPAIRMENT RELATED TO
PREDECESSOR
The Financial Accounting Standards Board ("FASB") issued SFAS 142, in June
2001. Under the new rule, intangible assets with an indefinite life are no
longer amortized in periods subsequent to December 31, 2001, but are subject to
annual impairment tests (or more frequent under certain circumstances),
effective January 1, 2002. The Company determined that all of its goodwill had
an indefinite life and was therefore subject to the new rules. The Company
adopted SFAS 142 on January 1, 2002.
F-13
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Pursuant to the transitional rules of SFAS 142, we completed the two-step
impairment test during 2002 and, as a result of that test, we recorded the
cumulative effect of the accounting change for the goodwill impairment charge of
$2,949.2 million. The impairment charge is reflected as the cumulative effect of
an accounting change in the accompanying consolidated statement of operations
for the nine months ended September 30, 2002. Subsequent impairment tests will
be performed on an annual basis, or more frequently if circumstances indicate a
possible impairment. Subsequent impairment charges are classified as an
operating expense. As described below, the Company performed an impairment test
in the quarter ended September 30, 2002, as a result of circumstances which
indicated a possible impairment.
The significant factors used to determine the amount of the initial
impairment included analyses of industry market valuations, historical and
projected performance of our insurance segment, discounted cash flow analyses
and the market value of our capital. The valuation utilized the best available
information, including assumptions and projections we considered reasonable and
supportable. The assumptions we used to determine the discounted cash flows
involve significant judgments regarding the best estimate of future premiums,
expected mortality and morbidity, interest earned and credited rates,
persistency and expenses. The discount rate used was based on an analysis of the
weighted average cost of capital for several insurance companies and considered
the specific risk factors related to Conseco. Pursuant to the guidance in SFAS
142, quoted market prices in active markets are the best evidence of fair value
and shall be used as the basis for measurement, if available.
On August 14, 2002, our insurance subsidiaries' financial strength ratings
were downgraded by A.M. Best to "B (fair)" and on September 8, 2002, the Company
defaulted on its public debt. These developments caused sales of our insurance
products to fall and policyholder redemptions and lapses to increase. The
adverse impact on our insurance subsidiaries resulting from the ratings
downgrade and parent company default required that an additional impairment test
be performed as of September 30, 2002, in accordance with SFAS 142.
In connection with the preparation of the Plan, we retained an outside
actuarial consulting firm to assist in valuing our insurance subsidiaries. That
valuation work and our internal evaluation were used in performing the
additional impairment tests that resulted in an impairment charge to goodwill in
the third quarter of 2002 of $500.0 million. The charge is reflected in the line
item entitled "Goodwill impairment" in our consolidated statement of operations
for the three and nine months ended September 30, 2002. The most significant
changes made to the January 1, 2002 valuation that resulted in the additional
impairment charge were: (i) reduced estimates of projected future sales of
insurance products; (ii) increased estimates of future policyholder redemptions
and lapses; and (iii) a higher discount rate to reflect the current rates used
by the market to value life insurance companies. Management believes that the
assumptions and estimates used were reasonable given all available facts and
circumstances at the time made.
Prior to the adoption of SFAS 142, we determined whether goodwill was
recoverable from projected undiscounted net cash flows for the earnings of our
subsidiaries over the remaining amortization period. If we determined that
undiscounted projected cash flows were not sufficient to recover the goodwill
balance, we would reduce its carrying value with a corresponding charge to
expense or shorten the amortization period. Cash flows considered in such an
analysis were those of the business acquired, if separately identifiable, or the
product line that acquired the business, if such earnings were not separately
identifiable.
F-14
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Changes in the carrying amount of Predecessor's goodwill are as follows
(dollars in millions):
PREDECESSOR
---------------------------------------
EIGHT MONTHS ENDED NINE MONTHS ENDED
AUGUST 31, 2003 SEPTEMBER 30, 2002
------------------ ------------------
Goodwill balance, beginning of period...... $100.0 $ 3,695.4
Cumulative effect of accounting change..... -- (2,949.2)
Impairment charge.......................... -- (500.0)
Reduction of tax valuation contingencies
established at acquisition date for
acquired companies....................... (.6) (146.2)
------ ---------
Goodwill balance, end of period............ $ 99.4 $ 100.0
====== =========
ACCOUNTING FOR INVESTMENTS
We classify our fixed maturity securities into three categories: (i)
"actively managed" (which we carry at estimated fair value with any unrealized
gain or loss, net of tax and related adjustments, recorded as a component of
shareholders' equity (deficit)); (ii) "trading" (which we carry at estimated
fair value with changes in such value recognized as trading income); and (iii)
"held to maturity" (which we carry at amortized cost). We had no fixed maturity
securities classified as held to maturity during the periods presented in these
financial statements.
At August 31, 2003, we established trading security accounts which are
designed to act as a hedge for embedded derivatives related to: (i) our
equity-indexed annuity products; and (ii) certain modified coinsurance
agreements. See the note entitled "Accounting for Derivatives" for further
discussion regarding the embedded derivatives and the trading accounts. In
addition, the trading account includes the investments backing the market
strategies of our multibucket annuity products. The change in market value of
these securities is substantially offset by the change in insurance policy
benefits for these products. All of our trading securities totaled $944.9
million at September 30, 2003. The change in the market value of these
securities is recognized currently in investment income (classified as income
from policyholder and reinsurer accounts).
Accumulated other comprehensive income is primarily comprised of unrealized
gains on actively managed fixed maturity investments. These amounts, included in
shareholders' equity (deficit) as of September 30, 2003, and December 31, 2002,
were as follows (dollars in millions):
SUCCESSOR PREDECESSOR
------------- ------------
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
Unrealized gains on investments....................... $ 470.6 $448.1
Adjustments to value of policies inforce at the
Effective Date...................................... (43.0) --
Adjustments to cost of policies purchased and cost of
policies produced................................... -- (95.3)
Deferred income tax asset (liability)................. (154.4) 249.6
Other................................................. -- (21.8)
------- ------
Accumulated other comprehensive income.............. $ 273.2 $580.6
======= ======
F-15
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
VENTURE CAPITAL INVESTMENT IN AT&T WIRELESS SERVICES, INC.
At September 30, 2003, our venture capital investments consisted of 4.1
million shares of AT&T Wireless Services, Inc. ("AWE") with a value of $33.7
million. Our investment in AWE is carried at fair value, with changes in fair
value recognized as investment income (loss). We recognized venture capital
investment income (losses) of $(2.7) million in the one month ended September
30, 2003; $2.0 million in the two months ended August 31, 2003; and $10.5
million in the eight months ended August 31, 2003, related to this investment.
Our venture capital investment losses related to this investment were $6.6
million and $106.6 million in the three and nine months ended September 30,
2002, respectively.
COST OF POLICIES PRODUCED
In conjunction with the implementation of fresh start accounting, we
eliminated the historical balance of Old Conseco's cost of policies produced as
of August 31, 2003 and replaced it with the value of policies inforce at the
Effective Date.
The costs that vary with, and are primarily related to, producing new
insurance business in the period after August 31, 2003 are referred to as cost
of policies produced. We amortize these costs (using the interest rate credited
to the underlying policy for universal life or investment-type products and the
projected investment earnings rate for other products): (i) in relation to the
estimated gross profits for universal life-type and investment-type products; or
(ii) in relation to future anticipated premium revenue for other products.
When we realize a gain or loss on investments backing our universal life or
investment-type products, we adjust the amortization to reflect the change in
estimated gross profits from the products due to the gain or loss realized and
the effect of the event on future investment yields. We also adjust the cost of
policies produced for the change in amortization that would have been recorded
if actively managed fixed maturity securities had been sold at their stated
aggregate fair value and the proceeds reinvested at current yields. We include
the impact of this adjustment in accumulated other comprehensive income (loss)
within shareholders' equity (deficit).
When we replace an existing insurance contract with another insurance
contract with substantially different terms, all unamortized cost of policies
produced related to the replaced contract is immediately written off. When we
replace an existing insurance contract with another insurance contract with
substantially similar terms, we continue to defer the cost of policies produced
associated with the replaced contract.
We regularly evaluate the recoverability of the unamortized balance of the
cost of policies produced. We consider estimated future gross profits or future
premiums, expected mortality or morbidity, interest earned and credited rates,
persistency and expenses in determining whether the balance is recoverable. If
we determine a portion of the unamortized balance is not recoverable, it is
charged to amortization expense.
VALUE OF POLICIES INFORCE AT THE EFFECTIVE DATE
In conjunction with the implementation of fresh start accounting, we
eliminated the historical balances of Old Conseco's cost of policies purchased
and cost of policies produced as of the Effective Date and replaced them with
the value of policies inforce as of the Effective Date.
The cost assigned to the right to receive future cash flows from contracts
existing at August 31, 2003 is referred to as the value of policies inforce as
of the Effective Date. We also defer renewal commissions paid in excess of
ultimate commission levels related to the existing policies in this account. The
balance of this account is amortized, evaluated for recovery, and adjusted for
the impact of unrealized gains (losses) in the same manner as the cost of
policies produced described above.
The discount rate we used to determine the value of policies inforce as of
the Effective Date is the rate of return we need to earn in order to invest in
the business. In determining this required rate of return, we
F-16
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
consider many factors including: (i) the magnitude of the risks associated with
each of the actuarial assumptions used in determining expected future cash
flows; (ii) the cost of our capital; (iii) the likelihood of changes in
projected future cash flows that might occur if there are changes in insurance
regulations and tax laws; (iv) the compatibility of the business with our future
business plans that may favorably affect future cash flows; (v) the complexity
of the business; and (vi) recent prices (i.e., discount rates used in
determining valuations) paid by others to acquire similar blocks of business.
The weighted average discount rate we used to determine the value of business
inforce as of the Effective Date was 12 percent.
The Company expects to amortize approximately 2 percent of the August 31,
2003 balance of cost of policies inforce during the remainder of 2003, 8 percent
in 2004, 9 percent in 2005, 9 percent in 2006 and 8 percent in 2007.
EARNINGS PER SHARE
A reconciliation of net income and shares used to calculate basic and
diluted earnings per share is as follows:
ONE MONTH ENDED
SEPTEMBER 30, 2003
------------------
(DOLLARS IN MILLIONS AND
SHARES IN THOUSANDS)
Net income.................................................. $ 24.2
Preferred stock dividends................................... (5.3)
--------
Income applicable to common stock for basic earnings per
share.................................................. 18.9
Effect of dilutive securities:
Preferred stock dividends................................. 5.3
--------
Income applicable to common stock and assumed conversions
for diluted earnings per share............................ $ 24.2
========
Shares:
Weighted average shares outstanding for basic earnings per
share.................................................. 100,098
--------
Effect of dilutive securities on weighted average shares:
Preferred Stock(a)..................................... 44,566
Stock options and employee benefit plans............... 7
--------
Dilutive potential common shares..................... 44,573
--------
Weighted average shares outstanding for diluted earnings per
share..................................................... 144,671
========
---------------
(a) The dilutive effect is determined under the treasury stock method using the
average market price during the period.
On the Effective Date, the Successor adopted a new long-term incentive
plan, which permits the grant of CNO incentive or non-qualified stock options
and restricted stock awards to certain directors, officers and employees of CNO
and certain other individuals who perform services for the Company. A maximum of
10 million shares may be issued under the plan. Restricted share grants are
limited to 3.3 million shares. During September 2003, the Company granted
options to purchase 500,000 shares of CNO common stock at $16.40 per share and
500,000 restricted shares of CNO common stock to the Chief Executive Officer in
accordance with his employment agreement. These options and restricted stock
vest over the next four years. In addition, the Company granted options to
purchase 500,000 shares of CNO common stock at $19.61 per share and 500,000
restricted shares of CNO common stock to the non-executive Chairman of the Board
of Directors in accordance with his agreement. These options and restricted
shares vest over the next three years.
F-17
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Basic earnings per common share ("EPS") is computed by dividing income
applicable to common stock by the weighted average number of common shares
outstanding for the period. Restricted shares are not included in basic EPS
until vested. Diluted EPS reflects the potential dilution that could occur if
the Preferred Stock were converted into common stock, the options were exercised
and the restricted stock was vested. The dilution from options and restricted
shares are calculated using the treasury stock method.
STOCK-BASED COMPENSATION
In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation -- Transition and
Disclosure", an Amendment of FASB Statement No. 123 ("SFAS 148"), which provides
three alternative methods of transition to the fair value method of accounting
for stock options. SFAS 148 also amends the disclosure requirements of Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123").
We apply Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" and related interpretations in accounting for our stock
option plans. Since the amount an employee must pay to acquire the stock is
equal to the market price of the stock on the grant date, no compensation cost
has been recognized for our stock option plans. Had compensation cost been
determined based on the fair value at the grant dates consistent with the method
of SFAS 123, the Company's pro forma net income (loss) and pro forma earnings
(loss) per share would have been as follows (dollars in millions, except per
share amounts):
SUCCESSOR PREDECESSOR
--------- -----------------------------------------------
ONE TWO THREE EIGHT NINE
MONTH MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED ENDED
SEPT. 30, AUGUST 31, SEPT. 30, AUGUST 31, SEPT. 30,
2003 2003 2002 2003 2002
--------- ---------- --------- ---------- ---------
Net income (loss), as reported................ $24.2 $2,241.3 $(1,769.0) $2,201.7 $(6,147.2)
Less stock-based employee compensation expense
determined under the fair value based method
for all awards, net of income taxes......... -- (2.0) 2.5 7.2 10.5
----- -------- --------- -------- ---------
Pro forma net income (loss)................... $24.2 $2,243.3 $(1,771.5) $2,194.5 $(6,157.7)
===== ======== ========= ======== =========
Earnings per share:
Basic, as reported.......................... $ .19
=====
Basic, pro forma............................ $ .19
=====
Diluted, as reported........................ $ .17
=====
Diluted, pro forma.......................... $ .17
=====
All outstanding stock options of the Predecessor were cancelled pursuant to
the Plan. Pro forma compensation expense in the two and eight months ended
August 31, 2003, has been reduced by $5.0 million due to the reversal of expense
for options that were not vested upon cancellation of the outstanding stock
options of the Predecessor.
BUSINESS SEGMENTS
We have historically managed our business operations through two segments,
based on the products offered, in addition to the corporate segment. We are
reorganizing our business and plan to manage them through three segments in the
future: (i) products marketed through career agents and direct marketing; (ii)
products marketed through professional independent producers; and (iii) the
long-term care products
F-18
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
which were sold through professional independent producers but are no longer
being marketed. The Company is currently modifying its accounting and reporting
systems to provide information consistent with this structure.
Insurance and fee-based segment. Our insurance and fee-based segment
provides supplemental health, annuity and life insurance products to a broad
spectrum of customers through multiple distribution channels, each focused on a
specific market segment. These products are primarily marketed through career
agents, professional independent producers and direct marketing. Fee-based
activities include services performed for other companies, including investment
management and insurance product marketing.
Finance segment. CFC historically provided a variety of finance products
including: (i) loans for the purchase of manufactured housing, home improvements
and various consumer products; (ii) home equity loans; and (iii) private label
credit card programs. As a result of the formalization of the plan to sell the
finance business and the filing of petitions under the Bankruptcy Code by CFC
and several of its subsidiaries, we accounted for the finance business as a
discontinued business in our consolidated financial statements in 2002. As of
March 31, 2003, we no longer included the assets and liabilities of CFC in our
consolidated financial statements.
Corporate and other segment. Our corporate segment includes certain
investment activities, such as our venture capital investment in AWE. In
addition, the corporate segment includes interest expense related to the
Company's corporate debt, special corporate charges, income (loss) from the
major medical business in run-off and other income and expenses. Corporate
expenses are net of charges to our subsidiaries for services provided by the
corporate operations.
F-19
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Operating information regarding the insurance and corporate segments was as
follows (dollars in millions):
SUCCESSOR PREDECESSOR
------------- ----------------------------------------------------------
ONE MONTH TWO MONTHS THREE MONTHS EIGHT MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED ENDED
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30, AUGUST 31, SEPTEMBER 30,
2003 2003 2002 2003 2002
------------- ---------- ------------- ------------- -------------
Revenues:
Insurance and fee-based
segment:
Insurance policy income:
Annuities................. $ 7.3 $ 16.0 $ 48.1 $ 84.5 $ 111.3
Supplemental health....... 192.2 380.3 568.6 1,529.2 1,705.9
Life...................... 43.6 94.9 155.0 395.4 469.8
Other..................... 5.8 8.5 28.8 46.2 88.1
Net investment income(a).... 103.2 239.5 332.5 938.6 1,034.7
Fee revenue and other
income(a)................. 1.9 8.2 19.9 34.4 69.9
Net realized investment
gains (losses)(a)......... 6.7 (35.8) (261.1) (5.4) (493.9)
------ ------ -------- -------- --------
Total insurance and
fee-based segment
revenues............. 360.7 711.6 891.8 3,022.9 2,985.8
------ ------ -------- -------- --------
Corporate and other:
Net investment income......... .1 3.2 3.5 12.4 8.8
Venture capital gain (loss)
related to investment in
AWE......................... (2.7) 2.0 (6.6) 10.5 (106.6)
Revenue from the major medical
business in run-off......... 8.2 18.1 107.0 156.4 366.8
------ ------ -------- -------- --------
Total corporate segment
revenues............. 5.6 23.3 103.9 179.3 269.0
Eliminations.................... -- -- (4.9) -- (15.1)
------ ------ -------- -------- --------
Total revenues......... 366.3 734.9 990.8 3,202.2 3,239.7
------ ------ -------- -------- --------
Expenses:
Insurance and fee-based
segment:
Insurance policy benefits... 236.8 380.1(b) 841.1 1,999.5 2,256.9
Amortization................ 27.0 58.4(b) 160.1 337.6 555.1
Interest expense on
investment borrowings..... .6 1.9 2.1 8.3 12.4
Other operating costs and
expenses.................. 47.0 100.7 133.6 380.6 378.7
Goodwill impairment......... -- -- 500.0 -- 500.0
Special charges............. -- -- 2.3 -- 42.0
------ ------ -------- -------- --------
Total insurance and
fee-based segment
expenses............. 311.4 541.1 1,639.2 2,726.0 3,745.1
------ ------ -------- -------- --------
F-20
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SUCCESSOR PREDECESSOR
------------- ---------------------------------------------------------
ONE MONTH TWO MONTHS THREE MONTHS EIGHT MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED ENDED
SEPTEMBER 30, AUGUST 31, SEPTEMBER 31, AUGUST 31, SEPTEMBER 30,
2003 2003 2002 2003 2002
------------- ---------- ------------- ------------ -------------
Corporate and other:
Interest expense on corporate debt... 6.4 53.5 82.5 194.1 236.5
Provision for losses and interest
expense related to stock purchase
plan............................... -- 24.5 59.9 55.6 199.9
Expenses from the major medical
business in run-off................ 8.2 18.1 107.0 156.4 366.8
Other corporate expenses, less
charges to subsidiaries for
services provided.................. 2.5 1.7 27.4 28.4 72.7
Extraordinary gain on extinguishment
of debt............................ -- -- -- -- (1.8)
Reorganization items................. -- (2,163.0) -- (2,130.5) --
Special charges...................... -- -- 32.6 -- 61.1
------ --------- -------- --------- ---------
Total corporate segment expenses... 17.1 (2,065.2) 309.4 (1,696.0) 935.2
Eliminations........................... -- -- (4.9) -- (15.1)
------ --------- -------- --------- ---------
Total expenses..................... 328.5 (1,524.1) 1,943.7 1,030.0 4,665.2
------ --------- -------- --------- ---------
Income (loss) before income taxes,
minority interest, discontinued
operations and cumulative effect of
accounting change:
Insurance and fee-based
operations....................... 49.3 170.5 (747.4) 296.9 (759.3)
Corporate operations............... (11.5) 2,088.5 (205.5) 1,875.3 (666.2)
------ --------- -------- --------- ---------
Income (loss) before income
taxes, minority interest,
discontinued operations and
cumulative effect of accounting
change......................... $ 37.8 $ 2,259.0 $ (952.9) $ 2,172.2 $(1,425.5)
====== ========= ======== ========= =========
---------------
(a) It is not practicable to provide additional components of revenue by product
or service.
(b) In August 2003, the Company decided to change a non-guaranteed element of
certain policies. This element was not required by the policy and the change
will eliminate the former practice of reducing the cost of insurance charges
to amounts below the level permitted under the provisions of the policies.
As a result of this decision, our estimates of future expected gross profits
on these products used as a basis for amortization of cost of policies
purchased and cost of policies produced and the establishment of insurance
liabilities has changed. We adjusted the total amortization and reserve
charge we had recorded since the acquisitions of these policies as a result
of the change to our earlier estimates in accordance with Statement of
Financial Accounting Standards No. 97, "Accounting and Reporting by
Insurance Enterprises of Certain Long-Duration Contracts and for Realized
Gains and Losses from the Sale of Investments." The effect of the change in
estimate was a $220.2 million reduction to insurance policy benefits and a
$39.8 million reduction in amortization recorded in the two months ended
August 31, 2003.
ACCOUNTING FOR DERIVATIVES
Our equity-indexed annuity products provide a guaranteed base rate of
return and a higher potential return linked to the performance of the S&P 500
Index based on a percentage (the participation rate) over an annual period. At
the beginning of each policy year, a new index period begins. We are able to
change the participation rate at the beginning of each index period, subject to
contractual minimums. We buy S&P 500 Call Options in an effort to hedge
potential increases to policyholder benefits resulting from increases in the S&P
500 Index to which the product's return is linked. We include the cost of the
S&P 500 Call Options in
F-21
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the pricing of these products. Policyholder account balances for these annuities
fluctuate in relation to changes in the values of these options. We reflect
changes in the estimated market value of these options in net investment income.
Option costs that are attributable to benefits provided were $5.2 million in the
one month ended September 30, 2003; $53.5 million in the eight months ended
August 31, 2003; and $72.9 million in the first nine months of 2002. These costs
are reflected in the change in market value of the S&P 500 Call Options included
in investment income. Net investment income (loss) related to equity-indexed
products before this expense was $(3.1) million in the one month ended September
30, 2003; $78.7 million in the eight months ended August 31, 2003; and $(24.9)
million in the first nine months of 2002. These amounts were substantially
offset by the corresponding charge to insurance policy benefits. The estimated
fair value of the S&P 500 Call Options was $83.7 million and $32.8 million at
September 30, 2003 and December 31, 2002, respectively. We classify these
instruments as other invested assets. The Company accounts for the options
attributed to the policyholder for the estimated life of the annuity contract as
embedded derivatives as defined by Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities", as
amended by Statement of Financial Accounting Standards No. 137, "Deferral of the
Effective Date of FASB Statement No. 133" and Statement of Financial Accounting
Standards No. 138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activities". We record the change in the fair values of the embedded
derivatives in current earnings as a component of policyholder benefits. The
fair value of these derivatives, which are classified as "liabilities for
interest-sensitive products", was $243.7 million and $301.9 million at September
30, 2003 and December 31, 2002, respectively. We have transferred a specified
block of investments which are equal to the balance of these liabilities to our
trading securities account, which we carry at estimated fair value with changes
in such value recognized as investment income (classified as investment income
from policyholder accounts). The change in value of these trading securities
should largely offset the portion of the change in the value of the embedded
derivative which is caused by interest rate fluctuations.
If the counterparties for the derivatives we hold fail to meet their
obligations, we may have to recognize a loss. We limit our exposure to such a
loss by diversifying among several counterparties believed to be strong and
creditworthy. At September 30, 2003, all of the counterparties were rated "A" or
higher by Standard & Poor's Corporation.
The FASB's Derivative Implementation Group issued SFAS No. 133
Implementation Issue No. B36, "Embedded Derivatives: Modified Coinsurance
Arrangements and Debt Instruments that Incorporate Credit Risk Exposures that
are Unrelated or Only Partially Related to the Creditworthiness of the Obligor
of Those Instruments" ("DIG B36") in April 2003. DIG B36 addresses specific
circumstances under which bifurcation of an instrument into a host contract and
an embedded derivative is required. DIG B36 requires the bifurcation of a
derivative from the receivable or payable related to a modified coinsurance
agreement, where the yield on the receivable and payable is based on a return of
a specified block of assets rather than the creditworthiness of the ceding
company. We implemented this guidance on August 31, 2003, in conjunction with
our adoption of fresh start accounting. We have determined that certain of our
reinsurance payable balances contain embedded derivatives. Such derivatives had
an estimated fair value of $20.9 million and $29.5 million at August 31, 2003
and September 30, 2003, respectively. We record the change in the fair value of
these derivatives as a component of investment income (classified as investment
income from policyholder and reinsurer accounts). We have transferred the
specific block of investments related to these agreements to our trading
securities account, which we carry at estimated fair value with changes in such
value recognized as investment income (also classified as investment income from
reinsurer accounts). The change in value of these trading securities should
largely offset the change in value of the embedded derivatives.
F-22
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
GUARANTEES
In conjunction with the Plan, $481.3 million principal amount of bank loans
made to certain former directors and certain current and former officers and key
employees to enable them to purchase common stock of Old Conseco were
transferred to the Company. These loans had been guaranteed by Old Conseco. We
received all rights to collect the balances due pursuant to the original terms
of these loans. In addition, we hold loans to participants for interest on the
bank loans which total approximately $200 million. The former bank loans and the
interest loans are collectively referred to as the "D&O loans." We regularly
evaluate the collectibility of these loans in light of the collateral we hold
and the credit worthiness of the participants. At August 31, 2003 and September
30, 2003, we have estimated that approximately $52.3 million of the D&O balance
(which is included in other assets) is collectible (net of the cost of
collection). An allowance has been established to reduce the recorded balance of
the D&O loans to this balance.
Pursuant to the settlement that was reached with the Official Committee of
the Trust Originated Preferred Securities ("TOPrS") Holders and the Official
Committee of Unsecured Creditors in the Plan, the former holders of TOPrS
(issued by Old Conseco's subsidiary trusts and eliminated in our reorganization)
who did not opt out of the bankruptcy settlement, will be entitled to receive 45
percent of any proceeds from the collection of certain D&O loans in an aggregate
amount not to exceed $30 million. We have established a liability of $23.5
million (which is included in other liabilities), representing our estimate of
the amount which will be paid to the former holders of TOPrS pursuant to the
settlement.
In accordance with the terms of the Company's former Chief Executive
Officer's employment agreement, Bankers Life and Casualty Company, a
wholly-owned subsidiary of the Company, is the guarantor of the former
executive's nonqualified supplemental retirement benefit. The liability for such
benefit at September 30, 2003 was $15.4 million and is included in the caption
"Other liabilities" in the liability section of the consolidated balance sheet.
REINSURANCE
The cost of reinsurance ceded totaled $25.0 million in the one month ended
September 30, 2003; $199.1 million in the eight months ended August 31, 2003;
and $258.9 million in the first nine months of 2002. We deducted this cost from
insurance policy income. In each case, the ceding Conseco subsidiary is
contingently liable for claims reinsured if the assuming company is unable to
pay. Reinsurance recoveries netted against insurance policy benefits totaled
$24.9 million in the one month ended September 30, 2003; $183.4 million in the
eight months ended August 31, 2003; and $232.8 million in the first nine months
of 2002. Reinsurance premiums assumed totaled $10.6 million in the one month
ended September 30, 2003; $57.3 million in the eight months ended August 31,
2003; and $56.3 million in the first nine months of 2002. See the note entitled
"Accounting for Derivatives" for a discussion of the derivative embedded in the
payable related to certain modified coinsurance agreements.
F-23
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
INCOME TAXES
The components of income tax expense (benefit) are as follows (dollars in
millions):
SUCCESSOR PREDECESSOR
------------- ----------------------------
ONE MONTH EIGHT MONTHS NINE MONTHS
ENDED ENDED ENDED
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30,
2003 2003 2002
------------- ------------ -------------
Current tax provision.................. $ .6 $(13.5) $ 127.7
Deferred tax provision (benefit)....... 13.0 -- (443.8)
----- ------ --------
Income tax expense (benefit) on
period income..................... 13.6 (13.5) (316.1)
Valuation allowance.................... -- -- 1,314.4
----- ------ --------
Total income tax expense (benefit)... $13.6 $(13.5) $ 998.3
===== ====== ========
A reconciliation of the U.S. statutory corporate tax rate to the effective
rate reflected in the consolidated statement of operations is as follows:
SUCCESSOR PREDECESSOR
------------- ----------------------------
ONE MONTH EIGHT MONTHS NINE MONTHS
ENDED ENDED ENDED
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30,
2003 2003 2002
------------- ------------ -------------
U.S. statutory corporate rate.......... 35.0% 35.0% (35.0)%
Valuation allowance.................... -- 25.8 92.2
Gain on debt restructuring............. -- (39.7) --
Subsidiary stock basis adjustment...... -- (21.8) --
Nondeductible goodwill amortization and
impairment........................... -- -- 12.2
Other nondeductible expenses........... .1 (.1) --
State taxes............................ .9 .2 (.1)
Provision for tax issues and other..... -- -- .7
---- ----- -----
Effective tax rate................... 36.0% (.6)% 70.0%
==== ===== =====
Conseco and its affiliates are currently under examination by the Internal
Revenue Service (the "IRS") for tax years ending December 31, 1999 through
December 31, 2001. The outcome of the examination is not expected to result in
material adverse deficiencies, but may result in utilization or adjustment to
the income tax loss carryforwards reported below.
F-24
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of the Company's income tax assets and liabilities were as
follows (dollars in millions):
SUCCESSOR PREDECESSOR
------------- ------------
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
Deferred tax assets:
Net operating loss carryforwards:
Portion attributable to CFC worthless
investment.................................... $ 1,133.9 $ --
Other........................................... 135.2 615.0
Deductible temporary differences:
Actively managed fixed maturities............... -- 196.0
Capital loss carryforwards...................... 406.8 112.8
Interest-only securities........................ -- 536.3
Insurance liabilities........................... 1,258.5 750.4
Allowance for loan losses....................... -- 252.2
Reserve for loss on loan guarantees............. 221.5 229.2
Venture capital income.......................... 26.6 --
Unrealized depreciation......................... -- --
Debt obligations................................ -- 39.4
Other........................................... 75.4 14.0
--------- ---------
Gross deferred tax assets..................... 3,257.9 2,745.3
--------- ---------
Deferred tax liabilities:
Actively managed fixed maturities.................. (9.3) --
Cost of policies purchased and cost of policies
produced........................................ (613.6) (773.8)
Unrealized appreciation............................ (154.4) (126.2)
Other.............................................. (60.8) (125.7)
--------- ---------
Gross deferred tax liabilities................ (838.1) (1,025.7)
--------- ---------
Valuation allowance................................ (2,419.8) (1,719.6)
--------- ---------
Net deferred tax assets....................... -- --
--------- ---------
Current income taxes prepaid......................... 86.7 66.9
Income tax liabilities classified as liabilities of
discontinued operations............................ -- 34.6
--------- ---------
Net income tax assets......................... $ 86.7 $ 101.5
========= =========
Our income tax expense includes deferred income taxes arising from
temporary differences between the financial reporting bases of assets and
liabilities, capital loss carryforwards and net operating loss carryforwards. In
assessing the realization of deferred income tax assets, we consider whether it
is more likely than not that the deferred income tax assets will be realized.
The ultimate realization of our deferred income tax assets depends upon
generating future taxable income during the periods in which our temporary
differences become deductible and before our net operating loss carryforwards
expire. In addition, the use of the Company's net ordinary loss carryforwards is
dependent, in part, on whether the IRS ultimately agrees with the tax position
we plan to take in our current and future tax returns. We evaluate the
realizability of our deferred income tax assets by assessing the need for a
valuation allowance on a quarterly basis.
A valuation allowance has been provided for the entire balance of net
deferred income tax assets at September 30, 2003, as we believe the realization
of such assets in future periods is uncertain. We reached this conclusion after
considering the availability of taxable income in prior carryback years, tax
planning
F-25
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
strategies, our recent history of significant losses and the likelihood of
future taxable income exclusive of reversing temporary differences and
carryforwards.
As of September 30, 2003, we had about $3.6 billion of net operating loss
carryforwards (after taking into account the reduction in tax attributes
described in the paragraph which follows and the loss resulting from the
worthlessness of CFC discussed below), which expire as follows: $2.3 million in
2003; $11.2 million in 2004; $4.5 million in 2005; $0.2 million in 2006; $5.7
million in 2007; $6.6 million in 2008; $10.5 million in 2009; $4.2 million in
2010; $2.5 million in 2011; $16.0 million in 2012; $43.4 million in 2013; $6.9
million in 2014; $60.5 million in 2016; $116.7 million in 2017; $3,322.5 million
in 2018; $.2 million in 2019; $12.1 million in 2020. The timing and manner in
which we will utilize the net operating loss carryforwards in any year or in
total may be limited by various provisions of the Internal Revenue Code (the
"Code") (and interpretation thereof) and our ability to generate sufficient
future taxable income in the relevant carryforward period.
The Code provides that any income realized as a result of the cancellation
of indebtedness (cancellation of debt income or "CODI") in bankruptcy, will
reduce certain tax attributes including net operating loss carryforwards. We
realized an estimated $2.5 billion of CODI when we emerged from bankruptcy.
Accordingly, our net operating loss carryforwards were reduced by $2.5 billion.
The following paragraphs summarize some of the various limitations and
contingencies which exist with respect to the future utilization of the net
operating loss carryforwards.
The Company realized an estimated $5.4 billion tax loss in 2003 as a result
of its investment in CFC. In consultation with our tax advisors and based on
relevant provisions of the Code, the Company intends to treat this loss as an
ordinary loss, thereby increasing the Company's net operating loss carryforward.
The Company has requested a pre-filing examination by the IRS to confirm that
this loss should be treated as an ordinary loss. If the IRS were to disagree
with our conclusion and such determination ultimately prevailed, the loss would
be treated as a capital loss, which would only be available to reduce future
capital gains for the next 5 years. The procedures related to the pre-filing
examination are in process, but are not expected to be completed before August
2004.
The Code limits the extent to which losses realized by a non-life entity
(or entities) may offset income from a life insurance company (or companies) to
the lesser of: (i) 35 percent of the income of the life insurance company; or
(ii) 35 percent of the total loss. There is no limitation with respect to the
ability to utilize net operating losses generated by a life insurance company.
Subsequent to our emergence from bankruptcy, we reorganized certain of our
subsidiaries to improve their capital position. As a result of the
reorganization, the loss related to CFC was realized by a life insurance
company. Accordingly, we believe the loss should be treated as a life insurance
loss and would not be subject to the limitations described above.
The timing and manner in which the Company will be able to utilize its net
operating loss carryforward will be limited by Section 382 of the Code. Section
382 imposes on a corporation's ability to use its net operating losses if the
company undergoes an ownership change. Because the Company underwent an
ownership change pursuant to its reorganization, we have determined that this
limitation applies to the Company. In order to determine the amount of this
limitation we must determine how much of our net operating loss carryforward
relates to the period prior to our emergence from bankruptcy (such amount will
be subject to the 382 limitation) and how much relates to the period after
emergence (such amount will not be subject to the 382 limitation). Pursuant to
the Code, we may: (i) allocate the current year tax loss on a pro rata basis to
determine earnings (loss) post- and pre-emergence; or (ii) specifically identify
transactions in each period and record it in the period it actually occurred. We
intend to elect the latter, which we believe will result in a substantial
portion of the loss related to CFC being treated as post emergence and therefore
not subject to the Section 382 limitation. Any losses that are subject to the
Section 382 limitation will only
F-26
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
be utilized by the Company up to approximately $140 million per year with any
unused amounts carried forward to the following year.
The use of the Company's net deferred income tax assets (including the net
operating loss carryforwards) existing as of August 31, 2003, will be accounted
for as a reduction of goodwill when utilized pursuant to SOP 90-7. If goodwill
is eliminated, any additional use of net deferred income tax assets existing at
August 31, 2003 will be accounted for as a reduction of other intangible assets
until exhausted and thereafter as an addition to paid-in-capital. Goodwill was
reduced by $167.4 million during the one month ended September 30, 2003, due to
a reduction in the valuation allowance for net deferred income tax assets
established at the Effective Date.
CHANGES IN DIRECT CORPORATE OBLIGATIONS
This note contains information regarding the following notes payable that
were direct corporate obligations of the Company as of September 30, 2003 and
December 31, 2002 (dollars in millions):
SUCCESSOR PREDECESSOR
------------- ------------
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
$1.3 billion credit agreement........................ $1,300.0 $ --
$1.5 billion senior credit facility.................. -- 1,531.4
8.5% senior notes due 2002........................... -- 224.9
8.5% guaranteed senior notes due 2003................ -- 1.0
8.125% senior notes due 2003......................... -- 63.5
6.4% senior notes due 2003........................... -- 234.1
6.4% guaranteed senior notes due 2004................ -- 14.9
10.5% senior notes due 2004.......................... -- 24.5
8.75% senior notes due 2004.......................... -- 423.7
8.75% guaranteed senior notes due 2006............... -- 364.3
6.8% senior notes due 2005........................... -- 99.2
6.8% guaranteed senior notes due 2007................ -- 150.8
9.0% senior notes due 2006........................... -- 150.8
9.0% guaranteed senior notes due 2008................ -- 399.2
10.75% senior notes due 2008......................... -- 37.6
10.75% guaranteed senior notes due 2009.............. -- 362.4
-------- ---------
Total principal amount.......................... 1,300.0 4,082.3
Unamortized net discount related to issuance of notes
payable............................................ -- (34.0)
Unamortized fair market value of terminated interest
rate swap agreements............................... -- 8.8
-------- ---------
Less amounts subject to compromise................... -- (4,057.1)
-------- ---------
Direct corporate obligations.................... $1,300.0 $ --
======== =========
F-27
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Pursuant to the Plan, we entered into a senior secured bank credit facility
with a principal balance of $1.3 billion (the "New Credit Facility"). The New
Credit Facility consists of two tranches: Tranche A -- $1.0 billion; and Tranche
B -- $.3 billion. Principal repayments are due as follows (dollars in millions):
TRANCHE A TRANCHE B
--------- ---------
June 30, 2004.............................................. $ 50.0 $ 3.0
June 30, 2005.............................................. 50.0 3.0
June 30, 2006.............................................. 50.0 1.5
December 31, 2006.......................................... 50.0 1.5
June 30, 2007.............................................. 75.0 1.5
December 31, 2007.......................................... 75.0 1.5
June 30, 2008.............................................. 75.0 1.5
December 31, 2008.......................................... 75.0 1.5
June 30, 2009.............................................. -- 1.5
September 10, 2009......................................... 500.0 --
December 31, 2009.......................................... -- 1.5
September 10, 2010......................................... -- 282.0
-------- ------
$1,000.0 $300.0
======== ======
Tranche A and Tranche B borrowings bear interest, payable monthly, based on
either an offshore rate or a base rate. Offshore rates are equal to LIBOR plus
an applicable margin based on the rating of the Company's senior secured
long-term debt securities by Moody's Investors Service, Inc. ("Moody's") or
Standard & Poor's Ratings Group ("S&P"). Base rates are equal to: (i) the
greater of: (a) the Federal funds rate plus .50 percent; or (b) Bank of
America's prime rate; plus (ii) an applicable margin based on the rating of the
Company's senior secured long-term debt securities by Moody's or S&P. With
respect to Tranche A, the LIBOR rate may not be less than 2.0 percent through
September 30, 2004, or less than 2.50 percent thereafter. With respect to
Tranche B, the LIBOR rate may not be less than 2.25 percent through September
30, 2004, or less than 2.75 percent thereafter. The range of applicable margins
are summarized in the following table:
OFFSHORE BASE
RATE MARGIN RATE MARGIN
----------- -----------
Tranche A........................................... 3.75% - 5.25% 1.75% - 3.25%
Tranche B........................................... 5.75% - 7.25% 3.75% - 5.25%
On September 30, 2003, the interest rates on our Tranche A and Tranche B
borrowings were 7.25 percent and 9.50 percent, respectively.
Pursuant to the New Credit Facility, the Company is required to make
mandatory prepayments with all or a portion of the proceeds from the following
transactions or events including: (i) the issuance of certain indebtedness; (ii)
equity issuances; (iii) certain asset sales or casualty events; (iv) a certain
percentage of amounts received or recovered with respect to the D&O loans; and
(v) excess cash flow as defined in the credit agreement. Proceeds not used to
prepay indebtedness must generally be: (i) used to redeem a portion of our
Preferred Stock; or (ii) contributed to the capital of our insurance
subsidiaries.
The New Credit Facility requires the Company to maintain various financial
ratios and balances, as defined in the agreement including: (i) a debt-to-total
capitalization ratio of less than .358:1.0 or less at September 30, 2003, and
decreasing over time to .200:1.0 at June 30, 2008 (such ratio was .341:1.0 at
September 30, 2003); (ii) an interest coverage ratio greater than or equal to
1.00:1.0 for the quarter ending December 31, 2003, and increasing over time to
4.50:1.0 for the year ending December 31, 2009;
F-28
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(iii) EBITDA, as defined in the credit agreement, greater than or equal to
$490.0 million for the two quarters ended March 31, 2004, and increasing over
time to $1,296.0 million for the four quarters ending March 31, 2010; (iv) an
aggregate risk-based capital ratio, as defined in the credit agreement, greater
than or equal to 158 percent at September 30, 2003, and increasing over time to
225 percent at March 31, 2006 (such ratio was 257 percent at September 30,
2003); (v) minimum individual risk-based capital ratios for certain insurance
companies as of the end of each fiscal year; (vi) minimum levels of statutory
capital and surplus, as defined in the credit agreement (statutory capital and
surplus at September 30, 2003 exceeded such requirements); and (vii) minimum
investment portfolio requirements (such minimum investment portfolio
requirements were met at September 30, 2003). In addition, if we experience a
ratings downgrade, or if we fail to achieve an A.M. Best "A-" rating by August
15, 2005 (or December 31, 2005 if we meet certain financial ratios), we will
suffer an event of default under the New Credit Facility. If we experience a
ratings downgrade below "B (Fair)" or a downgrade by two or more levels in any
six-month period, a "trigger event" will also occur and holders of our Preferred
Stock will have the right to vote with holders of our common stock on all
matters on an as-converted basis.
The New Credit Facility prohibits or restricts, among other things: (i) the
payment of cash dividends on the Company's common or preferred stock; (ii) the
repurchase of our common stock; (iii) the issuance of additional debt or capital
stock; (iv) liens; (v) asset dispositions; (vi) affiliate transactions; (vii)
certain investment activities; (viii) change in business; and (ix) prepayment of
indebtedness (other than the New Credit Facility). The obligations under our New
Credit Facility are guaranteed by Conseco's current and future domestic
subsidiaries, other than: (i) its insurance companies; (ii) subsidiaries of the
insurance companies; or (iii) certain immaterial subsidiaries as defined in the
credit agreement. This guarantee was secured by granting liens on substantially
all the assets of the guarantors including the capital stock of our top tier
insurance company, Conseco Life Insurance Company of Texas.
Pursuant to the New Credit Facility, the Company is required to pay a fee
of $6.5 million on June 30, 2004, unless all borrowings under the credit
agreement have been repaid.
The outstanding notes payable that were direct corporate obligations of Old
Conseco prior to our emergence from bankruptcy and the $1.5 billion senior
credit facility were discharged in accordance with the Plan.
PREFERRED STOCK
Pursuant to the Plan, CNO issued 34.4 million shares of Preferred Stock
with an aggregate liquidation preference of approximately $859.7 million. The
Preferred Stock has a par value of $.01 per share and a liquidation preference
of $25 per share. Dividends are payable at a rate equal to 10.5 percent of the
liquidation preference per share, payable semi-annually on March 1 and September
1. This rate will increase to 11 percent beginning September 11, 2005. These
dividends are payable in additional shares of Preferred Stock until the later
of: (i) September 10, 2005; or (ii) the beginning of the first fiscal quarter
after which our primary insurance companies have received a financial strength
rating of at least "A-" by A.M. Best Company ("A.M. Best"). Thereafter,
dividends are payable, at our option, in cash or additional shares of Preferred
Stock. The Preferred Stock may be redeemed by CNO, in whole or in part, at any
time in cash equal to the liquidation preference plus cumulative unpaid
dividends thereon.
The Preferred Stock is convertible, at the option of the holder, into
common stock of CNO at any time on or after September 30, 2005. The conversion
rate is equal to the total liquidation preference plus cumulative unpaid
dividends thereon divided by the greater of: (i) the average price of CNO's
common stock, as defined, for each of the trading days in the 60 calendar day
period immediately preceding January 8, 2004; or (ii) $.15 per share of common
stock.
F-29
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Preferred Stock is exchangeable, at the option of the holder, into
common stock of CNO at any time on or after September 10, 2013. The exchange
rate is equal to the total liquidation preference plus cumulative unpaid
dividends thereon divided by the average market price of CNO's common stock, as
defined, for the ten trading days ending on the date of exchange. The maximum
number of common shares that can be issued shall not exceed the greater of: (i)
7.84 billion shares of common stock; or (ii) the number of authorized but
unissued shares of CNO's common stock. In addition, CNO, at its option, may pay
cash in an amount equal to the liquidation preference in lieu of delivering the
exchanged common stock.
The holders of the Preferred Stock will be entitled to voting rights
beginning September 30, 2005 or earlier if there is: (i) a reduction in the
financial strength rating assigned to any of our active material insurance
subsidiaries (as defined) by A.M. Best; (ii) an event of default under our
credit agreement; (iii) the occurrence of a material adverse regulatory event,
as defined, with respect to any of our material insurance subsidiaries (as
defined); or (iv) a failure to maintain various financial ratios and balances
(none of which are more restrictive than the covenants contained in our credit
agreement).
WARRANTS
Pursuant to the Plan, we issued 6.0 million Series A Warrants (the
"Warrants") entitling the holders to purchase shares of CNO common stock at a
price of $27.60 per share. The Warrants expire on September 10, 2008. The
exercise price and number of common shares issuable are subject to adjustment
based on the occurrence of certain events, including: (i) stock dividends; (ii)
stock splits; and (iii) the issuance of instruments or securities which are
exercisable for or convertible into shares of common stock entitling the holders
to purchase shares of common stock at a price per share that is less than the
market price on the date of issuance.
SALE OF THE GENERAL MOTORS BUILDING
During the summer of 2003, we successfully enforced our contractual right
to buy out our 50 percent equity partner in the General Motors building ("GM
building"), a landmark 50-story office tower in New York City. After obtaining
an award in arbitration, and confirming that award in the New York court system,
we finally settled our differences with our equity partner, thus permitting us
to put the building up for sale. On September 26, 2003, we sold our investment
in the GM building. We received cash of $636.8 million, which was approximately
equal to the value established upon the adoption of fresh start accounting.
Our investment in the GM building was made through a partnership which
acquired the building in 1998 for $878 million. The initial capital structure of
the partnership consisted of: (i) a $700 million senior mortgage; (ii) $200
million of subordinated debt with a stated fixed return of 12.7 percent
payable-in-kind, and the opportunity to earn an additional residual return; and
(iii) $30 million of partnership equity, owned 50 percent by Conseco and 50
percent by an affiliate of Donald Trump. A Trump affiliate also served as
general manager of the acquired building. We owned 100 percent of the
subordinated debt.
The $30 million of partnership equity represented less than 10 percent of
the total capital of the partnership. In addition, the subordinated debt was
intended to absorb virtually all expected losses and receive a significant
portion of expected residual returns. Based on our 100 percent ownership of the
subordinated debt, we were the primary beneficiary of the GM building. The
partnership was consolidated in our financial statements effective August 31,
2003 in accordance with the requirements of FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"), which was implemented
in conjunction with fresh start accounting. The August 31, 2003 fresh start
balance sheet reflected the following balances of the partnership: the GM
building at $1,336.3 million; cash of $28.4 million; and a non-recourse loan of
$700 million (classified as an investment borrowing). Our income statement for
the one month ended
F-30
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
September 30, 2003, reflected investment income of $2.9 million related to this
investment (representing our equity interest in the income from the building for
the 26 days prior to the sale).
RECENTLY ISSUED ACCOUNTING STANDARDS
Pursuant to SOP 90-7, we have implemented the provisions of accounting
principles required to be adopted within twelve months of the adoption of fresh
start accounting. The following summarizes the new accounting pronouncements we
have recently adopted:
The FASB's Derivative Implementation Group issued DIG B36 in April 2003.
DIG B36 addresses specific circumstances under which bifurcation of an
instrument into a host contract and an embedded derivative is required. DIG B36
requires the bifurcation of a derivative from the receivable or payable related
to a modified coinsurance agreement, where the yield on the receivable and
payable is based on a return of a specified block of assets rather than the
creditworthiness of the ceding company. We implemented this guidance on August
31, 2003, in conjunction with our adoption of fresh start accounting. See the
note entitled "Accounting for Derivatives" for a discussion of the impact of
implementing this guidance.
The FASB issued Financial Accounting Standards No. 149 "Amendment of SFAS
No. 133 on Derivative Instruments and Hedging Activities" ("SFAS 149") in April
2003. SFAS 149 amends and clarifies accounting for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities under Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities." Except for
certain implementation guidance included in SFAS 149 which is already effective,
the new guidance is effective for: (i) contracts entered into or modified after
June 30, 2003; and (ii) hedging relationships designated after June 30, 2003.
The adoption of SFAS 149 did not have a material impact on the Company's
consolidated financial statements.
The FASB issued Financial Accounting Standards No. 150, "Accounting for
Certain Financial Instruments with Characteristics of Both Liabilities and
Equity" ("SFAS 150") in May 2003. SFAS 150 establishes standards for classifying
and measuring certain financial instruments that embody obligations of the
issuer and have characteristics of both liabilities and equity. For example,
mandatorily redeemable preferred stock is required to be classified as a
liability pursuant to SFAS 150. SFAS 150 is effective immediately for financial
instruments entered into or modified after May 31, 2003, and for all other
financial instruments beginning with the third quarter of 2003. Effective July
1, 2003, Old Conseco's Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts, or TOPrS, with an aggregate carrying value of
$1,921.5 million, were reclassified to liabilities pursuant to the provisions of
SFAS 150. The adoption of SFAS 150 does not impact the financial statements of
Conseco subsequent to the Effective Date since the Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts are no longer outstanding.
The Accounting Standards Executive Committee of the American Institute of
Certified Public Accountants issued Statement of Position 03-1 "Accounting and
Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration
Contracts and for Separate Accounts" ("SOP 03-01") in July 2003. SOP 03-01
provides guidance on several insurance company disclosure and accounting matters
including the appropriate accounting for: (i) separate accounts; (ii) additional
interest (for example, persistency bonus) accruing to the investment contract
holder; (iii) the liability for contracts where the amounts assessed against the
contract holder each period are assessed in a manner that is expected to result
in profits in earlier years and losses in subsequent years; (iv) potential
benefits to annuity holders in addition to their account balance; (v) sales
inducements to contract holders; and (vi) other provisions. The Company recently
sold most of its separate account business. Accordingly, the new guidance
related to separate accounts will have no impact on the Company's consolidated
financial position, results of operations or cash flows. As a result of our
adoption of fresh start accounting, we were required to revalue our insurance
product liabilities and record them at their estimated fair market value. In
calculating the value of the liabilities for insurance and asset
F-31
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
accumulation products, we followed the guidance of SOP 03-01. We have changed
the way we classify the costs related to sales inducements in accordance with
the new guidance. However, such change was not material. Our reserve for sales
inducement persistency bonus benefits was $280.0 million at September 30, 2003,
and $278.6 million at August 31, 2003.
In January 2003, the FASB issued FIN 46, which requires expanded
disclosures for and, in some cases, consolidation of significant investments in
variable interest entities ("VIE"). A VIE is an entity in which the equity
investors do not have the characteristics of a controlling financial interest,
or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties.
Under FIN 46, a company is required to consolidate a VIE if it is the primary
beneficiary of the VIE. FIN 46 defines primary beneficiary as the party which
will absorb a majority of the VIE's expected losses or receive a majority of the
VIE's expected residual returns, or both.
The Company has investments in various types of VIEs, some of which require
additional disclosure under FIN 46, and several of which will require
consolidation under FIN 46. As further discussed in the note to the consolidated
financial statements entitled "Investments in Variable Interest Entities", we
have consolidated all of our investments in VIEs. The adoption of the
consolidation requirements of FIN 46 did not have a material impact on our
financial condition or results of operations. The note entitled "Investments in
Variable Interest Entities" includes the expanded disclosures required by FIN
46.
The FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45") in November 2002. FIN 45 requires certain
guarantees to be recognized as liabilities at fair value. In addition, it
requires a guarantor to make new disclosures regarding its obligations. We
implemented the new disclosure requirements as of December 31, 2002. FIN 45's
liability recognition requirement is effective on a prospective basis for
guarantees issued or modified after December 31, 2002. The adoption of FIN 45
did not impact the Company's results of operations or financial condition.
The FASB issued Statement of Financial Accounting Standards No. 146,
"Accounting for Exit or Disposal Activities" ("SFAS 146") in June 2002. SFAS 146
addresses financial accounting and reporting for costs that are associated with
exit and disposal activities and supersedes Emerging Issues Task Force Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)"
("EITF 94-3"). SFAS 146 is required to be used to account for exit or disposal
activities that are initiated after December 31, 2002. The provisions of EITF
94-3 shall continue to apply for an exit activity initiated prior to the
adoption of SFAS 146. SFAS 146 requires companies to recognize costs associated
with exit or disposal activities when they are incurred rather than at the date
of commitment to an exit or disposal plan. The Company adopted the provisions of
SFAS 146 on January 1, 2003. The initial adoption of SFAS 146 did not have an
impact on the Company's consolidated financial statements.
The FASB issued Statement of Financial Accounting Standards No. 145,
"Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No.
13, and Technical Corrections" ("SFAS 145") in April 2002. Under previous
guidance all gains and losses resulting from the extinguishment of debt were
required to be aggregated and, if material, classified as an extraordinary item,
net of related income tax effect. SFAS 145 rescinds that guidance and requires
that gains and losses from extinguishments of debt be classified as
extraordinary items only if they are both unusual and infrequent in occurrence.
SFAS 145 also amends previous guidance to require certain lease modifications
that have economic effects similar to sale-leaseback transactions to be
accounted for in the same manner as sale-leaseback transactions. The Company
adopted SFAS 145 on January 1, 2003. Prior period amounts related to
extraordinary gains on the extinguishment of debt have been reclassified in
accordance with the new guidance.
F-32
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The FASB issued SFAS 144 in August 2001. This standard addresses the
measurement and reporting for impairment of all long-lived assets. It also
broadens the definition of what may be presented as a discontinued operation in
the consolidated statement of operations to include components of a company's
business segments. SFAS 144 requires that long-lived assets currently in use be
written down to fair value when considered impaired. Long-lived assets to be
disposed of are written down to the lower of cost or fair value less the
estimated cost to sell. The Company adopted this standard on January 1, 2002. We
followed this standard in determining when it was appropriate to recognize
impairments on assets we decided to sell as part of our efforts to raise cash.
We also followed this standard in determining that our variable annuity business
line and CFC should be presented as discontinued operations in our consolidated
financial statements (see the note to the consolidated financial statements
entitled "Discontinued Operations").
DISCONTINUED OPERATIONS
As previously described in the notes to the consolidated financial
statements entitled "Discontinued Finance Business -- Sale of CFC" and "Basis of
Presentation", the operations of CFC and CVIC were classified as discontinued
operations in the 2002 consolidated statement of operations. The following
summarizes selected financial information of CFC and CVIC:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2002
----------------------------- ------------------------------
CFC CVIC TOTAL CFC CVIC TOTAL
--- ---- ----- --- ---- -----
(DOLLARS IN MILLIONS)
Insurance policy income........... $ -- $ 12.4 $ 12.4 $ -- $ 30.5 $ 30.5
Net investment income (loss)...... 533.3 (120.6) 412.7 1,647.2 (217.3) 1,429.9
Impairment charge................. (701.3) -- (701.3) (701.3) -- (701.3)
Fee revenue and other income...... 70.1 -- 70.1 201.3 .2 201.5
Total revenues.................... (129.2) (128.3) (257.5) 1,133.3 (244.4) 888.9
Provision for losses.............. 234.2 -- 234.2 550.9 -- 550.9
Insurance policy benefits......... -- (125.9) (125.9) -- (234.7) (234.7)
Interest expense.................. 282.2 .1 282.3 852.4 1.0 853.4
Amortization...................... -- 132.8 132.8 -- 224.6 224.6
Other operating costs and
expenses........................ 174.0 4.6 178.6 472.1 15.5 487.6
Special charges................... 53.4 -- 53.4 109.9 -- 109.9
Extraordinary gain on
extinguishment of debt.......... -- -- -- (6.2) -- (6.2)
Total expenses.................... 743.8 11.6 755.4 1,979.1 6.4 1,985.5
Pre-tax loss...................... (873.0) (139.9) (1,012.9) (845.8) (250.8) (1,096.6)
Income tax benefit................ (331.6) (51.0) (382.6) (321.3) (88.7) (410.0)
------- ------- --------- -------- ------- ---------
Amount classified as discontinued
operations...................... $(541.4) $ (88.9) $ (630.3) $ (524.5) $(162.1) $ (686.6)
======= ======= ========= ======== ======= =========
In addition, in the nine months ended September 30, 2002, CVIC recognized a
$43.8 million cumulative effect of accounting change for goodwill impairment
pursuant to the adoption of SFAS 142.
During 2002, we recognized estimated losses related to the ultimate sale
and disposition of the aforementioned discontinued businesses, including
estimated costs to sell and costs related to the resolution of contingencies.
During the eight months ended August 31, 2003, we reduced the accrual for such
estimated costs by $16.0 million (after income taxes of $.7 million) to reflect
our current estimate. We recorded the reduction of such accrual as income from
discontinued operations.
F-33
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
LITIGATION AND OTHER LEGAL PROCEEDINGS
We are involved on an ongoing basis in lawsuits (including purported class
actions) relating to our operations, including with respect to sales practices,
and we and current and former officers and former directors are defendants in
pending class action lawsuits asserting claims under the securities laws and
derivative lawsuits. The ultimate outcome of these lawsuits cannot be predicted
with certainty and we have estimated the potential exposure for each of the
matters and have recorded a liability if a loss is deemed probable.
SECURITIES LITIGATION
Since we announced our intention to restructure our capital on August 9,
2002, a total of eight purported securities fraud class action lawsuits have
been filed in the United States District Court for the Southern District of
Indiana. The complaints name us as a defendant, along with certain current and
former officers of Old Conseco. These lawsuits were filed on behalf of persons
or entities who purchased Old Conseco's common stock on various dates between
October 24, 2001 and August 9, 2002. In each case Plaintiffs allege claims under
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and allege
material omissions and dissemination of materially misleading statements
regarding, among other things, the liquidity of Conseco and alleged problems in
CFC's manufactured housing division, allegedly resulting in the artificial
inflation of Old Conseco's stock price. On March 13, 2003, all of these cases
were consolidated into one case in the United States District Court for the
Southern District of Indiana, captioned Franz Schleicher, et al. v. Conseco,
Inc., et al., File No. 02-CV-1332 DFH-TAB. The lawsuits were stayed as to all
defendants by order of the United States Bankruptcy Court for the Northern
District of Illinois. The stay was lifted on October 15, 2003. It is expected
that plaintiffs will file a consolidated class action complaint with respect to
the individual defendants in November 2003. Our liability with respect to these
lawsuits was discharged in the Plan and our obligation to indemnify certain
individual defendants is limited by the Plan. We believe these lawsuits are
without merit and intend to defend them vigorously. The ultimate outcome of
these lawsuits cannot be predicted with certainty.
DERIVATIVE LITIGATION
Nine shareholder derivative suits were filed in 2000 in the United States
District Court for the Southern District of Indiana. The complaints named as
defendants the then current directors, certain former directors, certain
non-director officers of Old Conseco (in one case), and, alleging aiding and
abetting liability, certain banks that made loans in relation to Old Conseco's
"Stock Purchase Plan" (in three cases). Old Conseco is also named as a nominal
defendant in each complaint. Plaintiffs allege that the defendants breached
their fiduciary duties by, among other things, intentionally disseminating false
and misleading statements concerning the acquisition, performance and proposed
sale of CFC, and engaged in corporate waste by causing Old Conseco to guarantee
loans that certain officers, directors and key employees of Old Conseco used to
purchase stock under the Stock Purchase Plan. These cases have now been
consolidated into one case in the United States District Court for the Southern
District of Indiana, captioned: In Re Conseco, Inc. Derivative Litigation, Case
Number IP00655-C-Y/S. An amended complaint was filed on April 12, 2001, making
generally the same allegations and allegations of violation of the Federal
Reserve Board's margin rules. Three similar cases have been filed in the
Hamilton County Superior Court in Indiana. Schweitzer v. Hilbert, et al., Case
No. 29D01-0004CP251; Evans v. Hilbert, et al., Case No. 29D01-0005CP308 (both
Schweitzer and Evans name as defendants certain non-director officers); Gintel
v. Hilbert, et al., Case No. 29003-0006CP393 (naming as defendants, and alleging
aiding and abetting liability as to, banks that allegedly made loans in relation
to the Stock Purchase Plan). We believe that these lawsuits are without merit
and intend to defend them vigorously. The cases filed in Hamilton County have
been stayed pending resolution of the derivative suits filed in the United
States District Court. We have asserted that these lawsuits are assets of the
estate pursuant to section 541(a) of the Bankruptcy Code and do not intend to
pursue them
F-34
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
following emergence from bankruptcy because they are meritless. In October and
November 2003, CNO filed motions to dismiss all the pending derivative matters.
The ultimate outcome of these lawsuits cannot be predicted with certainty.
OTHER LITIGATION
Collection efforts by the Company and Conseco Services, LLC related to the
1996-1999 director and officer loan programs have been commenced against various
past board members and executives/officers with outstanding loan balances. In
addition, certain former officers and directors have sued the companies for
declaratory relief concerning their liability for the loans. Currently, we are
involved in litigation with Stephen C. Hilbert, James D. Massey, Dennis E.
Murray, Sr., Rollin Dick and Bruce Crittenden. The specific lawsuits include:
Hilbert v. Conseco, Case No. 03A 04283 (Bankr. N.D. Ill.); Conseco Services v.
Hilbert, Case No. 29C01-0310 MF 1296 (Cir. Ct. Hamilton Cty, Ind.); Murray and
Massey v. Conseco, Case No. 1:03-CV-1482 LJM-WTL (S.D. Ind.); Dick v. Conseco
Services, Case No. 29 D01-0207-PL-549 (Sup. Ct. Hamilton Cty, Ind.); and
Crittenden v. Conseco, Case No.IP02-1823-C B/S (S.D. Ind.). The Company and
Conseco Services, LLC believe that all amounts due under the director and
officer loan programs, including all applicable interest, are valid obligations
owed to the companies. We intend to prosecute these claims to obtain the maximum
recovery possible. Further, with regard to the various claims brought against
the Company and Conseco Services, LLC by certain former directors and officers,
we believe that these claims are without merit and intend to defend them
vigorously. The ultimate outcome of the lawsuit cannot be predicted with
certainty.
In October 2002, Roderick Russell, on behalf of himself and a class of
persons similarly situated, and on behalf of the ConsecoSave Plan filed an
action in the United States District Court for the Southern District of Indiana
against Old Conseco, Conseco Services, LLC and certain current and former
officers of Old Conseco (Roderick Russell, et al. v Conseco, Inc., et al., Case
No. 1:02-CV-1639 LJM). The purported class action consists of all individuals
whose 401(k) accounts held common stock of Old Conseco at any time since April
28, 1999. The complaint alleges, among other things, breaches of fiduciary
duties under ERISA by continuing to permit employees to invest in Old Conseco's
common stock without full disclosure of the Company's true financial condition.
Old Conseco filed a motion to dismiss the complaint in December 2002. This
lawsuit was stayed as to all defendants by order of the Bankruptcy Court. The
stay was lifted on October 15, 2003. It is expected that there will be a ruling
on the motion to dismiss before further proceedings occur in this matter. We
believe the lawsuit is without merit and intend to defend it vigorously. The
ultimate outcome of the lawsuit cannot be predicted with certainty.
On June 24, 2002, the heirs of a former officer, Lawrence Inlow, commenced
an action against Old Conseco, Conseco Services, LLC, and two former officers in
the Boone Circuit Court (Inlow et al. v. Conseco, Inc., et al., Cause No.
06C01-0206-CT-244). The heirs assert that unvested options to purchase 756,248
shares of Old Conseco common stock should have been vested at Mr. Inlow's death.
The heirs further claim that if such options had been vested, they would have
been exercised, and that the resulting shares of common stock would have been
sold for a gain of approximately $30 million based upon a stock price of $58.125
per share, the highest stock price during the alleged exercise period of the
options. We believe the heirs' claims are without merit and will defend the
action vigorously. The maximum exposure to the Company for this lawsuit is
estimated to be $33 million. The heirs did not file a proof of claim with the
Bankruptcy Court. Subject to dispositive motions which are yet to be filed, the
matter will continue to trial against Conseco Services, LLC and the other
co-defendants on September 13, 2004. The ultimate outcome cannot be predicted
with certainty.
On June 27, 2001, two suits against the Company's subsidiary, Philadelphia
Life Insurance Company (now known as Conseco Life Insurance Company), both
purported nationwide class actions seeking unspecified damages, were
consolidated in the U.S. District Court, Middle District of Florida (In Re PLI
F-35
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Sales Litigation, Cause No. 01-MDL-1404), alleging among other things,
fraudulent sales and a "vanishing premium" scheme. Philadelphia Life filed a
motion for summary judgment against both named plaintiffs, which motion was
granted in June 2002. Plaintiffs appealed to the 11th Circuit. The 11th Circuit,
in July 2003, affirmed in part and reversed in part, allowing two fraud counts
with respect to one plaintiff to survive. The plaintiffs' request for a
rehearing with respect to this decision has been denied. Philadelphia Life has
filed a summary judgment motion with respect to the remaining claims.
Philadelphia Life believes this lawsuit is without merit and intends to defend
it vigorously. The ultimate outcome of the lawsuit cannot be predicted with
certainty.
On December 1, 2000, the Company's former subsidiary, Manhattan National
Life Insurance Company, was named in a purported nationwide class action seeking
unspecified damages in the First Judicial District Court of Santa Fe, New Mexico
(Robert Atencio and Theresa Atencio, for themselves and all other similarly
situated v. Manhattan National Life Insurance Company, an Ohio corporation,
Cause No. D-0101-CV-2000-2817), alleging among other things fraud by
non-disclosure of additional charges for those policyholders wishing to pay
premium modes other than annual. We retained liability for this litigation in
connection with the sale of Manhattan National Life in June 2002. We believe
this lawsuit is without merit and intend to defend it vigorously. The ultimate
outcome of the lawsuit cannot be predicted with certainty.
On December 19, 2001, four of the Company's subsidiaries were named in a
purported nationwide class action seeking unspecified damages in the District
Court of Adams County, Colorado (Jose Medina and others similarly situated v.
Conseco Annuity Assurance Company, Conseco Life Insurance Company, Bankers
National Life Insurance Company and Bankers Life and Casualty Company, Cause No.
01-CV-2465), alleging among other things breach of contract regarding alleged
non-disclosure of additional charges for those policy holders wishing to pay
premium modes other than annual. On July 14 and 15, 2003 the plaintiff's motion
for class certification was heard and the Court took the matter under
advisement. On November 10, 2003, the Court denied the motion for class
certification. The defendants believe this lawsuit is without merit and intend
to defend it vigorously. The ultimate outcome of the lawsuit cannot be predicted
with certainty.
On July 31, 2001, the Company's subsidiary, Conseco Senior Health Insurance
Company, was named in an action filed by the State of Texas in the District
Court of Travis County, Texas (State of Texas v. Conseco Senior Health Insurance
Company, Cause No. GV102103), alleging among other things a violation of the
Deceptive Trade Practices Act related to allegations of failure to adequately
notify policyholders that premium rates could increase. Conseco Senior has
reached a tentative settlement with the State of Texas, however in the event a
settlement is not consummated, Conseco Senior intends to defend this matter
vigorously as it believes the lawsuit is without merit. The ultimate outcome of
this lawsuit cannot be predicted with certainty.
On December 30, 2002 and December 31, 2002, five suits were filed in
various Mississippi counties against the Company's subsidiary, Conseco Life
Insurance Company (Kathie Allen, et al. v. Conseco Life Insurance Company, et
al., Circuit Court of Jones County, Mississippi, Cause No. 2002-448-CV12;
Malcolm Bailey, et al. v. Conseco Life Insurance Company, et al., Circuit Court
of Claiborne County, Mississippi, Cause No. CV-2002-371; Anthony Cascio, et al.
v. Conseco Life Insurance Company, et al, Circuit Court of LeFlore County,
Mississippi, Cause No. CV-2002-0242-CICI; William Garrard, et al. v. Conseco
Life insurance Company, et al., Circuit Court of Sunflower County, Mississippi,
Cause No. CV-2002-0753-CRL; and William Weaver, et al. v. Conseco Life Insurance
Company, et al., Circuit Court of LeFlore County, Mississippi, Cause No.
CV-2002-0238 -CICI), alleging among other things, a "vanishing premium" scheme.
Conseco Life removed all of the cases to the U.S. District Courts in
Mississippi. In September 2003, plaintiffs' Motion to Remand was denied in the
Garrard and Weaver matters, but granted in the Cascio matter. Conseco Life
awaits the court's ruling on Plaintiff's Motion to Remand in the Allen matter.
In Bailey the parties have agreed to stay in Federal court. Conseco Life
believes the lawsuits are without merit and intends to defend them vigorously.
The ultimate outcome of the lawsuits cannot be predicted with certainty.
F-36
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In addition, the Company and its subsidiaries are involved on an ongoing
basis in other lawsuits and arbitrations (including purported class actions)
related to their operations. The ultimate outcome of all of these other legal
matters pending against the Company or its subsidiaries cannot be predicted,
and, although such lawsuits are not expected individually to have a material
adverse effect on the Company, such lawsuits could have, in the aggregate, a
material adverse effect on the Company's consolidated financial condition, cash
flows or results of operations.
OTHER PROCEEDINGS
The Company has been notified that the staff of the SEC has obtained a
formal order of investigation in connection with an inquiry that relates to
events in and before the spring of 2000, including CFC's accounting for its
interest-only securities and servicing rights. These issues were among those
addressed in the Company's write-down and restatement in the spring of 2000, and
were the subject of shareholder class action litigation, which was settled in
the second quarter of 2003. The Company is cooperating fully with the SEC staff
in this matter.
The deadline to file administrative claims in the bankruptcy proceeding was
October 9, 2003. The Plan provides that all such claims must be paid in full, in
cash. We are reviewing all timely filed administrative claims and may resolve
disputes regarding allowance of such claims in the Bankruptcy Court. If
significant administrative claims are allowed, our cash flow would be negatively
affected.
F-37
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONSOLIDATED STATEMENT OF CASH FLOWS
The following disclosures supplement our consolidated statement of cash
flows (dollars in millions):
SUCCESSOR PREDECESSOR
------------- ----------------------------
ONE MONTH EIGHT MONTHS NINE MONTHS
ENDED ENDED ENDED
SEPTEMBER 30, AUGUST 31, SEPTEMBER 30,
2003 2003 2002
------------- ------------ -------------
Cash flows from operating activities:
Net income (loss).............................. $ 24.2 $ 2,201.7 $(6,147.2)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Interest-only securities investment
income.................................. -- -- (15.8)
Cash received from interest-only
securities, net......................... -- -- (54.2)
Servicing income........................... -- -- (54.5)
Cash received from servicing activities.... -- -- 33.7
Provision for losses....................... -- 55.6 735.2
Gain on sale of finance receivables........ -- -- 13.9
Amortization and depreciation.............. 30.3 369.8 800.3
Income taxes............................... 13.9 31.4 410.7
Insurance liabilities...................... 35.8 265.8 279.9
Accrual and amortization of investment
income.................................. (.7) 43.2 162.8
Deferral of cost of policies produced and
purchased............................... (25.6) (287.5) (391.4)
Impairment charges......................... -- -- 701.3
Goodwill impairment........................ -- -- 500.0
Special charges............................ -- -- 166.3
Reorganization items....................... -- (2,157.0) --
Cumulative effect of accounting change..... -- -- 2,949.2
Minority interest.......................... -- -- 134.8
Net realized investment (gains) losses..... (6.7) 5.4 551.7
Discontinued operations.................... -- (16.7) 109.3
Extraordinary gain on extinguishment of
debt.................................... -- -- (8.1)
Other...................................... (18.7) 235.6 (140.5)
------ --------- ---------
Net cash provided by operating
activities............................ $ 52.5 $ 747.3 $ 737.4
====== ========= =========
Non-cash items not reflected in the investing and
financing activities sections of the
consolidated statement of cash flows:
Issuance of common stock under stock option
and employee benefit plans................. $ -- $ .3 $ 13.0
Issuance of convertible preferred shares..... 5.3 -- 2.1
At September 30, 2003, we held restricted cash of $22.1 million in trust
for the payment of bankruptcy-related professional fees.
F-38
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
INVESTMENTS IN VARIABLE INTEREST ENTITIES
The Company has investments in various types of special purpose entities
and other entities, some of which are VIEs under FIN 46. The following are
descriptions of our significant investments in VIEs:
BRICKYARD TRUST
We liquidated and distributed all the assets of the Brickyard Loan Trust
("Brickyard") during the third quarter of 2003. We recognized a loss of $11.1
million during the second quarter of 2003 to record our investment at its
estimated fair value as we intended to liquidate it. No additional gain or loss
was recognized upon the ultimate disposition of Brickyard.
Brickyard was a collateralized debt obligation trust which participated in
an underlying pool of commercial loans. The initial capital structure of
Brickyard consisted of $575 million of senior financing provided by unrelated
third party investors and $127 million of notes and subordinated certificates
owned by the Company and others. As a result of our 85 percent ownership
interest in the subordinated certificates, we were the primary beneficiary of
Brickyard. In accordance with ARB 51 "Consolidated Financial Statements",
Brickyard was consolidated in our financial statements because: (i) our
investment management subsidiary, 40Y86 Advisors, Inc. was the investment
manager; and (ii) we owned a significant interest in the subordinated
certificates. Included in "Assets held in separate accounts and investment
trust" at December 31, 2002 were $410.2 million of assets which served as
collateral for Brickyard's obligations. These amounts were offset by a
corresponding liability account, the value of which fluctuated in relation to
changes in the values of the investments. The senior note obligations had no
recourse to the general credit of the Company.
OTHER INVESTMENT TRUSTS
In December 1998, Old Conseco formed three investment trusts which were
special purpose entities formed to hold various fixed maturity, limited
partnership and other types of investments. The initial capital structure of
each of the trusts consisted of: (i) approximately 96 percent
principal-protected senior notes; (ii) approximately 3 percent subordinated
junior notes; and (iii) 1 percent equity. The senior principal-protected notes
are collateralized by zero coupon treasury notes with par values and maturities
matching the par values and maturities of the principal-protected senior notes.
Conseco's life insurance subsidiaries own 100 percent of the senior
principal-protected notes. Certain of Conseco's non-life insurance subsidiaries
own all of the subordinated junior notes, which have a preferred return equal to
the total return on the trusts' assets in excess of principal and interest on
the senior notes. The equity of the trusts is owned by unrelated third parties.
The three investment trusts are VIEs under FIN 46 because the trusts'
equity represents significantly less than 10 percent of total capital and the
subordinated junior notes were intended to absorb expected losses and receive
virtually all expected residual returns. Based on our 100 percent ownership of
the subordinated junior notes, we are the primary beneficiary of the investment
trusts. All three trusts are consolidated in our financial statements. The
carrying value of the total invested assets in the three trusts was
approximately $397 million and $382 million at September 30, 2003 and December
31, 2002, respectively, which also represents Conseco's maximum exposure to loss
as a result of our ownership interests in the trusts. The trusts have no
obligations or debt to outside parties.
F-39
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
INVESTMENT IN GENERAL MOTORS BUILDING
See the note entitled "Sale of the General Motors Building" for a
discussion of this investment.
SPECIAL CHARGES
2002
The following table summarizes the special charges incurred by the Company
during the three and nine months ended September 30, 2002, which are further
described in the paragraphs which follow (dollars in millions):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2002
------------------ ------------------
Loss related to reinsurance transaction and
businesses sold to raise cash............ $20.0 $ 47.0
Costs related to debt modification and
refinancing transactions................. .3 17.7
Restructuring costs........................ 12.1 12.1
Expenses related to the termination of the
former chief financial officer........... -- 6.5
Other items................................ 2.5 19.8
----- ------
Special charges before income tax
benefit............................... $34.9 $103.1
===== ======
LOSS RELATED TO DEBT MODIFICATION AND REINSURANCE TRANSACTION AND BUSINESSES
SOLD TO RAISE CASH
We completed various asset sales and reinsurance transactions to raise cash
which resulted in net losses of $47.0 million during the first nine months of
2002. These amounts included: (i) a loss of $39.0 million related to the
reinsurance of a portion of our life insurance business; (ii) a loss of $20.0
million associated with the sale of our subsidiary in India; partially offset by
(iii) asset sales resulting in a net gain of $12.0 million.
COSTS RELATED TO DEBT MODIFICATION AND REFINANCING TRANSACTIONS
In conjunction with the various modifications to borrowing arrangements
(including the debt exchange offer completed in April 2002) entered into in the
first nine months of 2002, we incurred costs of $17.7 million which are not
permitted to be deferred pursuant to GAAP.
RESTRUCTURING COSTS
We incurred expenses totaling $12.1 million in the three and nine months
ended September 30, 2002, related to professional and advisory fees incurred
related to the restructuring of our capital.
EXPENSES RELATED TO TERMINATION OF THE FORMER CHIEF FINANCIAL OFFICER
The employment of Old Conseco's chief financial officer was terminated in
the first quarter of 2002. As a result, the vesting provisions associated with
the restricted stock issued to the chief financial officer pursuant to his
employment agreement were accelerated. We recognized a charge of $5.1 million
related to the immediate vesting of such restricted stock in the first quarter
of 2002. In addition, we recognized severance benefits of $1.4 million
associated with the termination.
F-40
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OTHER ITEMS
Other items include expenses incurred: (i) in conjunction with the transfer
of certain customer service and backroom operations to our India subsidiary;
(ii) for severance benefits related to the transfer of such operations; and
(iii) for other items which are not individually significant. The Company sold
its India subsidiary in the fourth quarter of 2002 and has significantly reduced
the customer service and backroom operations conducted there.
F-41
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors
Conseco, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, shareholders' equity (deficit) and cash
flows present fairly, in all material respects, the financial position of
Conseco, Inc. and subsidiaries at December 31, 2002 and 2001, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States of America. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
The accompanying consolidated financial statements have been prepared
assuming that Conseco, Inc. will continue as a going concern, which contemplates
continuity of Conseco's operations and realization of its assets and payments of
its liabilities in the ordinary course of business. As more fully described in
the notes to the consolidated financial statements, on December 17, 2002,
Conseco, Inc. and several of its wholly-owned subsidiaries filed voluntary
petitions for reorganization under Chapter 11 of the United States Bankruptcy
Code. The uncertainties inherent in the bankruptcy process and Conseco's
recurring losses from operations raise substantial doubt about Conseco's ability
to continue as a going concern. Conseco, Inc. is currently operating its
business as a Debtor-in-Possession under the jurisdiction of the Bankruptcy
Court, and continuation of Conseco as a going concern is contingent upon, among
other things, the confirmation of Conseco's Plan of Reorganization and Conseco's
ability to generate sufficient cash from operations and obtain financing sources
to meet its future obligations. If no reorganization plan is approved, it is
possible that Conseco's assets may be liquidated. The consolidated financial
statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amount and
classification of liabilities that may result from the outcome of these
uncertainties.
As discussed in note 4 to the consolidated financial statements, the
Company adopted Emerging Issues Task Force Issue No. 99-20, "Recognition of
Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets" in 2000 and Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" in 2002.
/s/ PricewaterhouseCoopers LLP
----------------------------------
PricewaterhouseCoopers LLP
Indianapolis, Indiana
April 11, 2003
F - 42
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED BALANCE SHEET
December 31, 2002 and 2001
(Dollars in millions)
ASSETS
2002 2001
---- ----
Investments:
Actively managed fixed maturities at fair value (amortized cost:
2002 - $18,989.8; 2001 - $22,422.8)............................................. $19,417.4 $21,818.5
Retained interests in securitization trusts at fair value (amortized cost:
2001 - $876.1).................................................................. - 710.1
Equity securities at fair value (cost: 2002 - $161.4; 2001 - $257.3)............... 156.0 227.0
Mortgage loans..................................................................... 1,308.3 1,228.0
Policy loans....................................................................... 536.2 635.8
Venture capital investment in AT&T Wireless Services, Inc. at fair value
(cost: 2002 - $14.2; 2001 - $39.0).............................................. 25.0 155.3
Other invested assets ............................................................. 340.8 292.4
--------- ---------
Total investments............................................................ 21,783.7 25,067.1
Cash and cash equivalents:
Held by the parent company......................................................... 41.9 152.2
Held by the parent company in segregated accounts.................................. - 54.7
Held by subsidiaries............................................................... 1,227.0 2,853.9
Accrued investment income.............................................................. 389.8 688.6
Finance receivables.................................................................... - 3,810.7
Finance receivables - securitized...................................................... - 14,198.5
Cost of policies purchased............................................................. 1,170.0 1,657.8
Cost of policies produced.............................................................. 2,014.4 2,570.2
Reinsurance receivables................................................................ 934.2 663.0
Income tax assets...................................................................... 101.5 678.1
Goodwill ............................................................................. 100.0 3,695.4
Assets held in separate accounts and investment trust.................................. 447.0 2,376.3
Cash held in segregated accounts for investors......................................... - 550.2
Cash held in segregated accounts related to servicing agreements and
securitization transactions........................................................ - 994.6
Assets of discontinued operations...................................................... 17,624.3 -
Other assets........................................................................... 675.2 1,420.9
--------- ---------
Total assets................................................................. $46,509.0 $61,432.2
========= =========
(continued on next page)
The accompanying notes are an integral part
of the consolidated financial statements.
F - 43
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED BALANCE SHEET (Continued)
December 31, 2002 and 2001
(Dollars in millions)
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
2002 2001
---- ----
Liabilities:
Liabilities for insurance and asset accumulation products:
Interest-sensitive products..................................................... $13,469.5 $15,787.7
Traditional products............................................................ 7,971.4 8,172.8
Claims payable and other policyholder funds..................................... 909.2 1,005.5
Liabilities related to separate accounts and investment trust................... 447.0 2,376.3
Liabilities related to certificates of deposit.................................. - 1,790.3
Investor payables.................................................................. - 550.2
Guarantee liability related to interests in securitization trusts held by others... - 39.9
Other liabilities.................................................................. 673.5 1,701.9
Liabilities of discontinued operations............................................. 17,624.3 -
Investment borrowings.............................................................. 669.7 2,242.7
Notes payable:
Direct corporate obligations.................................................... - 4,085.0
Direct finance obligations:
Master repurchase agreements................................................. - 1,670.8
Credit facility collateralized by retained interests in securitizations...... - 507.3
Other borrowings............................................................. - 349.8
Related to securitized finance receivables structured as collateralized
borrowings................................................................... - 14,484.5
--------- ---------
Total liabilities not subject to compromise................................ 41,764.6 54,764.7
Liabilities subject to compromise.................................................. 4,873.3 -
--------- ---------
Total liabilities............................................................ 46,637.9 54,764.7
--------- ---------
Minority interest:
Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts............................................................ 1,921.5 1,914.5
Shareholders' equity (deficit):
Preferred stock.................................................................... 501.7 499.6
Common stock and additional paid-in capital (no par value, 1,000,000,000 shares
authorized, shares issued and outstanding: 2002 - 346,007,133;
2001 - 344,743,196)............................................................. 3,497.0 3,484.3
Accumulated other comprehensive income (loss)...................................... 580.6 (439.0)
Retained earnings (deficit)........................................................ (6,629.7) 1,208.1
--------- ---------
Total shareholders' equity (deficit)....................................... (2,050.4) 4,753.0
--------- ---------
Total liabilities and shareholders' equity (deficit)....................... $46,509.0 $61,432.2
========= =========
The accompanying notes are an integral part
of the consolidated financial statements.
F - 44
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED STATEMENT OF OPERATIONS
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions, except per share data)
2002 2001 2000
---- ---- ----
Revenues:
Insurance policy income....................................................... $ 3,602.3 $3,992.7 $ 4,170.7
Net investment income:
Insurance and fee-based segment general account assets..................... 1,528.0 1,706.1 1,800.8
Equity-indexed and separate account products............................... (100.5) (119.6) (56.1)
Venture capital loss related to investment in AT&T Wireless Services, Inc.. (99.3) (42.9) (199.5)
Other ..................................................................... 14.7 20.9 51.8
Gain on sale of interest in riverboat......................................... - 192.4 -
Net realized investment losses................................................ (597.0) (379.4) (346.5)
Fee revenue and other income.................................................. 70.1 96.9 137.4
--------- -------- ---------
Total revenues............................................................. 4,418.3 5,467.1 5,558.6
--------- -------- ---------
Benefits and expenses:
Insurance policy benefits..................................................... 3,332.5 3,588.5 3,807.6
Provision for losses.......................................................... 210.8 169.6 231.5
Interest expense (contractual interest for 2002 of $366.5).................... 363.1 400.0 454.3
Amortization.................................................................. 822.9 766.8 657.2
Other operating costs and expenses............................................ 712.1 722.2 872.9
Goodwill impairment........................................................... 500.0 - -
Special charges............................................................... 96.5 80.4 305.0
Reorganization items.......................................................... 14.4 - -
--------- -------- ---------
Total benefits and expenses................................................ 6,052.3 5,727.5 6,328.5
--------- -------- ---------
Loss before income taxes, minority interest, discontinued operations,
extraordinary gain (loss) and cumulative effect of accounting change..... (1,634.0) (260.4) (769.9)
Income tax expense (benefit):
Tax expense (benefit) on period income..................................... 53.1 (63.5) (166.2)
Valuation allowance for deferred tax assets................................ 811.2 - -
--------- -------- ---------
Loss before minority interest, discontinued operations,
extraordinary gain (loss) and cumulative effect of accounting change..... (2,498.3) (196.9) (603.7)
Minority interest:
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, net of income taxes
(contractual distributions for 2002 of $179.8)............................. 173.2 119.5 145.3
--------- -------- ---------
Loss before discontinued operations, extraordinary gain (loss)
and cumulative effect of accounting change .............................. (2,671.5) (316.4) (749.0)
Discontinued operations, net of income taxes...................................... (2,223.1) (106.7) (381.9)
Extraordinary gain (loss) on extinguishment of debt, net of income taxes.......... 8.1 17.2 (5.0)
Cumulative effect of accounting change, net of income taxes....................... (2,949.2) - (55.3)
--------- -------- ---------
Net loss................................................................... (7,835.7) (405.9) (1,191.2)
Preferred stock dividends (contractual distributions for 2002 of $2.1)............ 2.1 12.8 11.0
--------- -------- ---------
Net loss applicable to common stock........................................ $(7,837.8) $ (418.7) $(1,202.2)
========= ======== =========
(continued)
The accompanying notes are an integral part
of the consolidated financial statements.
F - 45
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED STATEMENT OF OPERATIONS (Continued)
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions, except per share data)
2002 2001 2000
---- ---- ----
Loss per common share:
Basic:
Weighted average shares outstanding......................... 345,807,000 338,145,000 325,953,000
Loss before discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change ... $ (7.73) $ (.97) $(2.34)
Discontinued operations..................................... (6.43) (.32) (1.17)
Extraordinary gain (loss) on extinguishment of debt......... .02 .05 (.01)
Cumulative effect of accounting change...................... (8.53) - (.17)
------- ------ ------
Net loss.................................................. $(22.67) $ (1.24) $(3.69)
======= ======= ======
Diluted:
Weighted average shares outstanding......................... 345,807,000 338,145,000 325,953,000
Loss before discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change.... $ (7.73) $ (.97) $(2.34)
Discontinued operations..................................... (6.43) (.32) (1.17)
Extraordinary gain (loss) on extinguishment of debt ........ .02 .05 (.01)
Cumulative effect of accounting change...................... (8.53) - (.17)
------- ------ ------
Net loss.................................................. $(22.67) $(1.24) $(3.69)
======= ====== ======
The accompanying notes are an integral part
of the consolidated financial statements.
F - 46
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions)
Common stock Accumulated other
Preferred and additional comprehensive Retained
Total stock paid-in capital loss earnings
----- ----- --------------- ---- --------
Balance, December 31,1999................................$ 5,556.2 $478.4 $2,987.1 $(771.6) $2,862.3
Comprehensive loss, net of tax:
Net loss............................................. (1,191.2) - - - (1,191.2)
Change in unrealized depreciation
of investments (net of applicable income tax
expense of $72.0).................................. 120.6 - - 120.6 -
---------
Total comprehensive loss......................... (1,070.6)
Issuance of common shares for stock options and for
employee benefit plans............................... 6.6 - 6.6 - -
Issuance of convertible preferred shares............... 8.4 8.4 - - -
Issuance of warrants................................... 21.0 - 21.0 - -
Settlement of forward contract......................... (90.5) - (90.5) - -
Cost of shares acquired................................ (12.4) - (12.4) - -
Dividends on preferred stock........................... (11.0) - - - (11.0)
Dividends on common stock.............................. (33.3) - - - (33.3)
--------- ------ -------- ------- --------
Balance, December 31, 2000................................$ 4,374.4 $486.8 $2,911.8 $(651.0) $1,626.8
(continued on following page)
The accompanying notes are an integral part
of the consolidated financial statements.
F - 47
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT) (Continued)
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions)
Common stock Accumulated other
Preferred and additional comprehensive Retained
Total stock paid-in capital loss earnings
----- ----- --------------- ---- --------
Balance, December 31, 2000 (carried forward
from prior page).............................. $4,374.4 $486.8 $2,911.8 $(651.0) $1,626.8
Comprehensive loss, net of tax:
Net loss........................................ (405.9) - - - (405.9)
Change in unrealized depreciation of
investments (net of applicable income tax
expense of $121.8)............................ 212.0 - - 212.0 -
--------
Total comprehensive loss.................... (193.9)
Issuance of shares pursuant to stock purchase
contracts related to FELINE PRIDES.............. 496.6 - 496.6 - -
Issuance of shares pursuant to acquisition of
ExlService.com, Inc............................. 52.1 - 52.1 -
Issuance of shares for stock options and for
employee benefit plans.......................... 23.8 - 23.8 - -
Payment-in-kind dividends on convertible
preferred stock................................. 12.8 12.8 - - -
Dividends on preferred stock...................... (12.8) - - - (12.8)
-------- ------ -------- ------- --------
Balance, December 31, 2001........................... $4,753.0 $499.6 $3,484.3 $(439.0) $1,208.1
(continued on following page)
The accompanying notes are an integral part
of the consolidated financial statements.
F - 48
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT) (Continued)
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions)
Common stock Accumulated other
Preferred and additional comprehensive Retained
Total stock paid-in capital income (loss) earnings (deficit)
----- ----- --------------- ------------ ------------------
Balance, December 31, 2001 (carried forward
from prior page) .................................. $ 4,753.0 $499.6 $3,484.3 $(439.0) $ 1,208.1
Comprehensive loss, net of tax:
Net loss......................................... (7,835.7) - - - (7,835.7)
Change in unrealized depreciation
of investments and other (net of applicable
income tax expense of nil)..................... 1,019.6 - - 1,019.6 -
--------
Total comprehensive loss..................... (6,816.1)
Issuance of shares for stock options and for
employee benefit plans........................... 12.7 - 12.7 - -
Payment-in-kind dividends on convertible
preferred stock.................................. 2.1 2.1 - - -
Dividends on preferred stock....................... (2.1) - - - (2.1)
-------- ------ -------- ------- ---------
Balance, December 31, 2002............................ $(2,050.4) $501.7 $3,497.0 $ 580.6 $(6,629.7)
========= ====== ======== ======= =========
The accompanying notes are an integral part
of the consolidated financial statements.
F - 49
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED STATEMENT OF CASH FLOWS
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions)
2002 2001 2000
---- ---- ----
Cash flows from operating activities:
Insurance policy income............................................................. $ 3,041.3 $ 3,518.8 $ 3,634.4
Net investment income............................................................... 3,323.9 3,913.6 3,864.1
Fee revenue and other income........................................................ 307.1 389.1 518.7
Insurance policy benefits........................................................... (1,996.9) (2,792.8) (2,686.5)
Interest expense.................................................................... (1,279.6) (1,570.5) (1,331.6)
Policy acquisition costs............................................................ (509.2) (667.0) (794.2)
Special charges..................................................................... (47.2) (29.5) (216.3)
Reorganization items, net........................................................... (31.7) - -
Other operating costs............................................................... (1,406.1) (1,466.8) (1,741.7)
Taxes............................................................................... (105.9) 29.8 (41.6)
--------- --------- ----------
Net cash provided by operating activities....................................... 1,295.7 1,324.7 1,205.3
--------- --------- ----------
Cash flows from investing activities:
Sales of investments................................................................ 19,465.4 24,179.7 6,987.5
Maturities and redemptions of investments........................................... 1,623.9 1,381.4 825.5
Purchases of investments............................................................ (19,879.4) (25,509.5) (7,952.6)
Cash received from the sale of finance receivables, net of expenses................. 2,372.9 867.2 2,501.2
Principal payments received on finance receivables.................................. 8,294.0 8,611.3 8,490.1
Finance receivables originated...................................................... (7,877.9) (12,320.3) (18,515.9)
Cash held by Conseco Finance Corp. and classified as assets held by
discontinued operations........................................................... (562.3) - -
Other............................................................................... (27.6) (136.7) (165.2)
--------- --------- ----------
Net cash provided (used) by investing activities ............................... 3,409.0 (2,926.9) (7,829.4)
--------- --------- ----------
Cash flows from financing activities:
Amounts received for deposit products............................................... 4,584.8 4,204.8 4,966.7
Withdrawals from deposit products................................................... (5,682.8) (4,489.4) (4,545.9)
Issuance of notes payable........................................................... 6,671.9 12,160.5 22,548.9
Payments on notes payable........................................................... (10,481.3) (10,480.5) (14,416.2)
Ceding commission received on reinsurance transaction............................... 83.0 - -
Change in cash held in restricted accounts for settlement of borrowings............. (13.0) (241.8) (689.7)
Investment borrowings............................................................... (1,573.0) 2,022.9 (609.1)
Repurchase of Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts................................................... - - (250.0)
Issuance of common and convertible preferred shares................................. - 4.1 .8
Payments for settlement of forward contract and to repurchase equity securities..... - - (102.6)
Dividends on common and preferred shares and distributions on
Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts......................................... (86.2) (181.2) (302.1)
--------- --------- ----------
Net cash provided (used) by financing activities................................ (6,496.6) 2,999.4 6,600.8
--------- --------- ----------
Net increase (decrease) in cash and cash equivalents............................ (1,791.9) 1,397.2 (23.3)
Cash and cash equivalents, beginning of year........................................... 3,060.8 1,663.6 1,686.9
--------- --------- ----------
Cash and cash equivalents, end of year................................................. $ 1,268.9 $ 3,060.8 $ 1,663.6
========= ========= ==========
The accompanying notes are an integral part
of the consolidated financial statements.
F - 50
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
1. PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
Conseco, Inc. ("CNC") is the top tier holding company for our two
operating businesses: insurance and finance. Our insurance business is operated
through subsidiaries owned directly and indirectly by CIHC, Incorporated
("CIHC"), an intermediate holding company that is controlled by CNC. Our finance
business has been historically operated through Conseco Finance Corp. ("CFC"), a
wholly-owned subsidiary of CIHC, and its subsidiaries. Effective December 17,
2002 (the date CFC filed a petition for relief under the Bankruptcy Code as
further described below), we began to account for our finance business as a
discontinued operation. Our subsidiaries operate throughout the United States.
We sometimes collectively refer to CNC, together with its consolidated
subsidiaries, as "we," "Conseco" or the "Company."
Our insurance subsidiaries develop, market and administer supplemental
health insurance, annuity, individual life insurance and other insurance
products. Our finance business has historically provided a variety of finance
products including manufactured housing and floor plan loans, home equity
mortgages, home improvement and consumer product loans and private label credit
cards.
On December 17, 2002 (the "Petition Date"), CNC, CIHC, CTIHC, Inc. and
Partners Health Group, Inc. (collectively, the "Debtors") filed voluntary
petitions for reorganization under Chapter 11 of Title 11 of the United States
Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court
(the "Bankruptcy Court") for the Northern District of Illinois. The following
discussion provides general background information regarding the Debtors'
Chapter 11 cases, but is not intended to be a comprehensive summary. The Debtors
are currently operating their business as debtors-in-possession pursuant to the
Bankruptcy Code. As debtors-in-possession, the Debtors are authorized to
continue to operate as ongoing businesses, but may not engage in transactions
outside the ordinary course of business without approval of the Bankruptcy
Court, after notice and an opportunity for a hearing. The Company's insurance
subsidiaries are separate legal entities and are not included in the petitions
filed by the Debtors. On March 18, 2003, the Bankruptcy Court approved the
Debtor's Second Amended Joint Plan of Reorganization (the "Plan"), and the
Second Amended Disclosure Statement (the "Disclosure Statement").
CFC and Conseco Finance Servicing Corp. also filed petitions under the
Bankruptcy Code with the Bankruptcy Court on the Petition Date. In addition, on
February 3, 2003, the following subsidiaries of CFC filed petitions under the
Bankruptcy Code with the Bankruptcy Court: Conseco Finance Corp. - Alabama,
Conseco Finance Credit Corp., Conseco Finance Consumer Discount Company, Conseco
Finance Canada Holding Company, Conseco Finance Canada Company, Conseco Finance
Loan Company, Rice Park Properties Corporation, Landmark Manufactured Housing,
Inc., Conseco Finance Net Interest Margin Finance Corp. I, Conseco Finance Net
Interest Margin Finance Corp. II, Green Tree Finance Corp. - Two, Green Tree
Floorplan Funding Corp., Conseco Agency of Nevada, Inc., Conseco Agency of New
York, Inc., Conseco Agency, Inc., Conseco Agency of Alabama, Inc., Conseco
Agency of Kentucky, Inc., Crum-Reed General Agency, Inc. The foregoing entities
are referred to as the "Finance Company Debtors." The Finance Company Debtors
filed a separate plan in connection with their bankruptcy proceedings. The
bankruptcy proceedings of the Debtors and the Finance Company Debtors are
referred to as the "Chapter 11 Cases".
Since commencing operations in 1982, CNC pursued a strategy of growth
through acquisitions. Primarily as a result of these acquisitions and the
funding requirements necessary to operate and expand the acquired businesses,
CNC amassed outstanding indebtedness of approximately $6.0 billion as of June
30, 2002. In 2001 and early 2002, we undertook a series of steps designed to
reduce and extend the maturities of our parent company debt. Notwithstanding
these efforts, the Company's financial position continued to deteriorate,
principally due to our leveraged condition, losses experienced by our finance
business and losses in the value of our investment portfolio.
As a result of these developments, on August 9, 2002, we announced that
we would seek to fundamentally restructure the Company's capital, and announced
that we had retained legal and financial advisors to assist us in these efforts.
We ultimately decided to seek to reorganize under Chapter 11 of the Bankruptcy
Code.
Under the Bankruptcy Code, actions to collect prepetition indebtedness,
as well as most pending litigation, are stayed and other contractual obligations
against the Debtors generally may not be enforced. Absent an order of the
Bankruptcy Court, substantially all prepetition liabilities are subject to
settlement under a plan of reorganization to be voted upon by creditors and
other stakeholders and approved by the Bankruptcy Court. On March 18, 2003, the
Bankruptcy Court approved the Debtors' Plan, as summarized in the Disclosure
Statement, as containing adequate information, as such term is defined in
Section 1125 of the Bankruptcy Code, to permit the solicitation of votes from
creditors on whether or not to accept the Plan. The Debtors commenced
solicitation on April 4, 2003. The voting record date has been set as March 19,
2003 and the deadline for returning completed ballots is May 14, 2003. A hearing
to consider confirmation of the Plan is scheduled to begin on May 28, 2003. The
Debtors will emerge from bankruptcy if and when
F - 51
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
the Plan receives the requisite stakeholder approval and is approved by the
Bankruptcy Court, and all conditions to the consummation of the Plan, have been
satisfied or waived.
The United States Trustee has appointed a creditors committee
representing the unsecured creditors of the Debtors and a TOPrS committee
representing the claims of the holders of the Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts ("Trust Preferred
Securities"). Before the Petition Date, the Company met with and provided
materials to certain prepetition committees and entered into extensive
arms-length negotiations with committees representing the holders of bank debt
and publicly held notes of CNC. Shortly before the Petition Date, the Company
reached a non-binding agreement in principle with respect to the general terms
of a restructuring with certain prepetition committees. However, there can be no
assurance that the appointed committees will support the Debtors' positions in
the bankruptcy proceedings or approve the Plan. The TOPrS committee has raised
certain objections to the Plan which are summarized in the Disclosure Statement.
Disagreements between the Debtors and the appointed committees could protract
the bankruptcy proceedings, could negatively impact the Company's ability to
operate and the results of those operations during bankruptcy, and could delay
the Debtors' emergence from bankruptcy.
The Debtors previously filed with the Bankruptcy Court schedules of
assets and liabilities of the Debtors as reflected on our books and records.
Subject to certain limited exceptions, the Bankruptcy Court established a bar
date of February 21, 2003, for all prepetition claims against the Debtors. A bar
date is the date by which claims against the Debtors must be filed if the
claimants wish to receive any distribution in the bankruptcy proceedings. The
Debtors notified all known or potential claimants subject to the February 21,
2003 bar date of their need to file a proof of claim with the Bankruptcy Court.
Approximately 9,000 proofs of claim were filed on or before the February 21,
2003 bar date and the Company has begun objecting to claims and otherwise
reconciling claims that differ from the Debtors' records. Any differences that
cannot be resolved through negotiations between the Debtors and the claimant
will be resolved by the Bankruptcy Court. Certain creditors have filed claims
substantially in excess of amounts reflected in the Debtors' records.
Accordingly, the ultimate number and amount of allowed claims is not presently
known. Similarly, the ultimate distribution with respect to allowed claims is
not presently known.
We have filed several motions in the Chapter 11 Cases pursuant to which
the Bankruptcy Court has granted us authority or approval with respect to
various items required by the Bankruptcy Code and/or necessary for our
reorganization efforts. We have obtained orders providing for, among other
things: (i) payment of prepetition and postpetition employee compensation and
benefits; (ii) continuing a key-employee retention plan; (iii) obtaining
debtor-in-possession financing for the Finance Company Debtors; and (iv)
increasing the amount of the servicing fee paid to the Finance Company Debtors
as servicers of various manufactured housing securitization trusts.
Under the priority schedule established by the Bankruptcy Code, certain
postpetition and prepetition liabilities need to be satisfied before unsecured
creditors and holders of CNC's common and preferred stock and Trust Preferred
Securities are entitled to receive any distribution. The Plan (as summarized in
the Disclosure Statement) sets forth the Debtors' proposed treatment of claims
and equity interests. No assurance can be given as to what values, if any, will
be ascribed in the bankruptcy proceedings to each of these constituencies. Our
Plan would result in holders of CNC's common stock and preferred stock (other
than Series F Common-Linked Convertible Preferred Stock ("Series F Preferred
Stock")) receiving no value and the holders of CNC's Trust Preferred Securities
and Series F Preferred Stock receiving little value on account of the
cancellation of their interests. In addition, holders of unsecured claims
against the Debtors would, in most cases, receive less than full recovery for
the cancellation of their interests.
At this time, it is not possible to predict with certainty the effect of
the Chapter 11 cases on our business or various creditors, or when we will
emerge from Chapter 11. Our future results depend upon our confirming and
successfully implementing, on a timely basis, a plan of reorganization.
2. DISCONTINUED FINANCE BUSINESS - PLANNED SALE OF CFC
In October 2002, we announced that we had engaged financial advisors to
pursue various alternatives with respect to our finance business and that CNC's
board of directors had approved a plan to sell or seek new investors for our
finance business. On December 19, 2002, CFC entered into an Asset Purchase
Agreement (the "Asset Purchase Agreement") with CFN Investment Holdings LLC
("CFN"), an affiliate of Fortress Investment Group LLC, J.C. Flowers & Co. LLC
and Cerberus Capital Management, L.P., pursuant to which CFC would, subject to
the satisfaction of certain conditions, sell all or substantially all of its
assets (the "CFC Assets") in a sale pursuant to Section 363 of the Bankruptcy
Code as part of CFC's Chapter 11 proceedings, subject to the right of CFN to
exclude certain assets from its purchase. In accordance with Section 363 of the
Bankruptcy Code and the terms of the Asset Purchase Agreement, CFC continued to
seek alternative transactions that would provide greater value to CFC and its
creditors than the
F - 52
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
transactions contemplated by the Asset Purchase Agreement.
As a result of the formalization of the plans to sell the finance
business and the filing of petitions under the Bankruptcy Code by CFC and
certain of its subsidiaries, the finance business is being accounted for as a
discontinued operation. See the note to the consolidated financial statements
entitled "Financial Information Regarding CFC" for information regarding this
discontinued operation.
As part of CFC's efforts to seek alternative transactions that would
provide greater value to CFC, and in accordance with the bidding procedures
order approved by the Bankruptcy Court, CFC conducted an auction for the sale of
its businesses and assets. Potential bidders that submitted bids for the
purchase of the CFC Assets that, by their own terms or aggregated with other
bids, were for more than the purchase price payable under the Asset Purchase
Agreement, plus the amount of the break-up fee of $30 million, plus $5 million
in expense reimbursements, plus the profit sharing rights relating to the
manufactured housing business, were allowed to participate in the auction. The
auction, which commenced on February 28, 2003, promptly adjourned, and was
continued to March 4, 2003, ultimately concluding the morning of March 5, 2003.
At the auction, CFC, with the assistance of its advisors, analyzed each
of the bids presented and determined that CFN's bid of $970 million in cash,
plus the assumption of certain liabilities, represented the highest and best
bid. The terms of the sale included an option for CFC to sell the assets of Mill
Creek Bank, Inc. ("Mill Creek Bank", formerly known as Conseco Bank, Inc.) to
General Electric Capital Corporation ("GE") for approximately $310 million in
cash, plus certain assumed liabilities, which option, if exercised, would
provide CFN with a credit of $270 million to its $970 million bid.
On March 6, 2003, CFC received an offer from Berkadia Equity Holdings,
L.L.C. ("Berkadia") that purported to be a bid in the recently concluded
auction. Concurrently therewith, Berkadia filed an objection to the sale that
the Bankruptcy Court heard, and summarily dismissed, on March 7, 2003. After
further negotiations during the March 7-14, 2003 period, CFN and GE
significantly increased the amount of cash to be paid for the CFC Assets.
Ultimately, each of the major constituencies, including the CFC Committee, the
Ad Hoc Securitization Holders' Committee, U.S. Bank as securitization trustee
for the certificate holders of certain lower-rated securities that are senior in
payment priority to the interest-only securities (the "B-2 securities"), and
Federal National Mortgage Association, as a major B-2 securities certificate
holder, agreed to support the sale of CFC Assets to CFN and GE. The total value
to be received as part of the transactions with CFN and GE upon closing is
expected to be approximately $1.3 billion, representing approximately $1.1
billion in cash and approximately $200 million in assumed liabilities, subject
to certain purchase price adjustments. On March 14, 2003, the Bankruptcy Court
entered orders approving the terms of the sale of the CFC Assets free and clear
of all liens to each of CFN and GE. The closing of the sale of the CFC Assets is
subject to various closing conditions, but is currently expected to occur in the
second quarter of 2003.
Overall, CFC is seeking to maximize the value obtainable from all
restructuring transactions it contemplates as part of its Chapter 11 filing.
However, there can be no assurance that any such transaction will be completed.
Moreover, if such a transaction is completed, no proceeds resulting therefrom
will be available to satisfy any creditors, other than creditors, of CFC or
parties with a security interest in CFC's assets.
3. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared on
a going concern basis, which assumes continuity of operations and realization of
assets and liabilities in the ordinary course of business, and in accordance
with Statement of Position 90-7 "Financial Reporting by Entities in
Reorganization under the Bankruptcy Code" ("SOP 90-7"). Accordingly, all
prepetition liabilities subject to compromise have been segregated in the
consolidated balance sheet and classified as "liabilities subject to compromise"
at the estimated amount of allowable claims.
Pursuant to SOP 90-7, professional fees associated with the Chapter 11
Cases are expensed as incurred and reported as reorganizational items. Interest
expense is reported only to the extent that it will be paid during the Chapter
11 Cases or when it is probable that it will be an allowed claim. During 2002,
the Company recognized a charge of $14.4 million associated with the Chapter 11
Cases for fees payable to professionals to assist with the filing of the Chapter
11 Cases.
The Company is currently operating under the jurisdiction of Chapter 11
of the Bankruptcy Code and the Bankruptcy Court, and continuation of Conseco as
a going concern is contingent upon our ability to obtain confirmation of the
Plan, our ability to return to profitability, generate sufficient cash flows
from operations, obtain financing sources to meet our future obligations and
many other
F - 53
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
issues, ongoing other bankruptcy considerations and risks related to our
business and financial condition. These matters raise substantial doubt about
Conseco's ability to continue as a going concern. The accompanying consolidated
financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities that might result from the outcome of these
uncertainties. Additionally, our Plan will materially change amounts reported in
the consolidated financial statements, which do not give effect to all
adjustments of the carrying value of assets and liabilities that are necessary
as a consequence of a reorganization under Chapter 11 of the Bankruptcy Code.
As described in the note entitled "Discontinued Finance Business -
Planned Sale of CFC", CFC is being accounted for as a discontinued operation.
During the third quarter of 2002, Conseco entered into an agreement to
sell Conseco Variable Insurance Company ("CVIC"), its wholly owned subsidiary
and the primary writer of its variable annuity products. The sale was completed
in October 2002. The operating results of CVIC have been reported as
discontinued operations in all periods presented in the accompanying
consolidated statement of operations. See the note to the consolidated financial
statements entitled "Financial Information Regarding CVIC."
During 2001, we stopped renewing a large portion of our major medical
lines of business. These lines of business are referred to herein as the "major
medical business in run-off". These actions had a significant effect on the
Company's operating results during 2001 and 2000. These lines had pre-tax losses
of $130.3 million in 2001 (including a write off of $77.4 million of the cost of
policies produced and the cost of policies purchased related to this business
that is not recoverable) and $51.3 million in 2000.
On July 31, 2001, we completed the acquisition of ExlService.com, Inc.
("Ex1"), a firm that specializes in customer service and backroom outsourcing
with operations in India. We issued 3.4 million shares of our common stock in
exchange for Ex1's common stock. The total value of the transaction was $52.1
million. The Conseco Board of Directors (without Gary C. Wendt, the Company's
former Chief Executive Officer, voting) approved the transaction, after
receiving the recommendation of a special committee of outside directors. Mr.
Wendt was one of the founders of Exl. Mr. Wendt and his wife owned 20.3 percent
of Exl and his other relatives owned an additional 9.4 percent. Mr. Wendt and
his wife received 692,567 shares of Conseco common stock in the transaction
(worth approximately $9.7 million at the time the agreement was negotiated).
However, these shares were restricted until Conseco recovered its $52.1 million
acquisition price through cost savings achieved by transferring work to Exl
and/or pre-tax profits from services provided to third parties by Exl. The
shares also become unrestricted upon a change of control of 51 percent of the
outstanding shares of Conseco common stock. In November 2002, the Company
completed the sale of Exl and recognized a loss of $20.0 million on the
transaction. The Company had previously written off a significant portion of the
value of this investment in conjunction with the impairment charge related to
goodwill pursuant to the Company's adoption of SFAS 142 (as defined in the
following paragraph). Since Conseco did not recover the acquisition price prior
to its sale of Exl, the shares held by Mr. Wendt and his wife remain restricted.
Statement of Financial Accounting Standards No. 141, "Business
Combinations" ("SFAS 141") eliminated the pooling-of-interests method of
accounting for business combinations initiated after July 1, 2001 and also
changed the criteria used to recognize intangible assets apart from goodwill. We
were required to apply these rules in accounting for the Exl acquisition.
Pursuant to these rules, in the Exl acquisition Conseco acquired: (i) goodwill
with a value of $38.6 million, which had an indeterminate life; and (ii) other
intangible assets with a value of $7.5 million, which were expected to have an
average life of approximately 5 years. Pursuant to SFAS 141 and Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142") described below under "Recently Issued Accounting Standards", this
goodwill was not amortized but was subject to annual impairment tests, effective
January 1, 2002.
The accompanying financial statements include the accounts of the Company
and all of its wholly owned insurance subsidiaries. Our consolidated financial
statements exclude the results of material transactions between us and our
consolidated affiliates, or among our consolidated affiliates. We reclassified
certain amounts in our 2001 and 2000 consolidated financial statements and notes
to conform with the 2002 presentation. These reclassifications have no effect on
net income (loss) or shareholders' equity (deficit).
For certain other special purpose entities related to our investment
portfolio, we consider the requirements of Emerging Issues Task Force Issue
Topic D-14, "Transactions Involving Special-Purpose Entities" ("EITF D-14") in
determining whether to consolidate such entities. We consolidate such entities
if: (i) an independent third party has not made a substantial capital investment
in the entity; (ii) such independent third party does not control the activities
of the entity; and (iii) the independent party does not retain substantial risks
and rewards of the special purpose entity's assets. See the note to the
consolidated financial statements entitled "Investments in Variable Interest
Entities" for additional information.
F - 54
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following summary explains the significant accounting policies we use
to prepare our financial statements. We prepare our financial statements in
accordance with generally accepted accounting principles ("GAAP"). We follow the
accounting standards established by the Financial Accounting Standards Board
("FASB"), the American Institute of Certified Public Accountants ("AICPA") and
the Securities and Exchange Commission (the "SEC").
Investments
Fixed maturities are securities that mature more than one year after
issuance and include bonds, certain notes receivable and redeemable preferred
stock. Fixed maturities that we may sell prior to maturity are classified as
actively managed and are carried at estimated fair value, with any unrealized
gain or loss, net of tax and related adjustments, recorded as a component of
shareholders' equity (deficit). Fixed maturity securities that we intend to sell
in the near term are classified as trading and included in other invested
assets. We include any unrealized gain or loss on trading securities in net
realized investment losses.
Retained interests in securitization trusts represent the right to
receive certain future cash flows from securitization transactions structured
prior to our September 8, 1999 announcement (see "Revenue Recognition for Sales
of Finance Receivables and Amortization of Servicing Rights" below). Such cash
flows generally are equal to the value of the principal and interest to be
collected on the underlying financial contracts of each securitization in excess
of the sum of the principal and interest to be paid on the securities sold and
contractual servicing fees. We carry retained interests at estimated fair value.
We determine fair value by discounting the projected cash flows over the
expected life of the receivables sold using current prepayment, default, loss
and interest rate assumptions. We determine the appropriate discount rate to
value these securities based on our estimates of current market rates of
interest for securities with similar yield, credit quality and maturity
characteristics. The discount rate was 16 percent at December 31, 2002 and
December 31, 2001. We record any unrealized gain or loss determined to be
temporary, net of tax, as a component of shareholders' equity. Declines in value
are considered to be other than temporary when: (i) the fair value of the
security is less than its carrying value; and (ii) the timing and/or amount of
cash expected to be received from the security has changed adversely from the
previous valuation which determined the carrying value of the security. When
declines in value considered to be other than temporary occur, we reduce the
amortized cost to estimated fair value and recognize a loss in the statement of
operations. The assumptions used to determine new values are based on our
internal evaluations. See the note to the consolidated financial statements
entitled "Financial Information Regarding CFC" for additional discussion of gain
on sale of receivables and interest-only securities.
Equity securities include investments in common stocks and non-redeemable
preferred stock. We carry these investments at estimated fair value. We record
any unrealized gain or loss, net of tax and related adjustments, as a component
of shareholders' equity. When declines in value considered to be other than
temporary occur, we reduce the amortized cost to estimated fair value and
recognize a loss in the statement of operations.
Mortgage loans held in our investment portfolio are carried at amortized
unpaid balances, net of provisions for estimated losses.
Policy loans are stated at their current unpaid principal balances.
Venture capital investment in AT&T Wireless Services, Inc. ("AWE") is
carried at fair value, with changes in such value recognized as venture capital
investment income (loss). In 2002, we sold 10.3 million shares of AWE common
stock which generated proceeds of $75.7 million. At December 31, 2002, we held
4.1 million shares of AWE common stock with a value of $25 million. The market
values of AWE common stock and other companies in AWE's business sector have
declined significantly in recent periods. We recognized venture capital
investment losses of $99.3 million, $42.9 million and $199.5 million in 2002,
2001 and 2000, respectively, related to this investment.
Other invested assets include: (i) trading securities; (ii) Standard &
Poor's 500 Index Call Options ("S&P 500 Call Options"); and (iii) certain
non-traditional investments. Trading securities are carried at market value with
the change in value recognized as a charge to net income (loss). These
securities are expected to be sold in the near term or relate to our multibucket
annuity products as described under "Multibucket Annuity Product" below. We
carry the S&P 500 Call Options at estimated fair value as further described
below under "Accounting for Derivatives". Non-traditional investments include
investments in certain limited partnerships and promissory notes; we account for
them using either the cost method, or for investments in partnerships, the
equity method.
F - 55
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
We defer any fees received or costs incurred when we originate
investments. We amortize fees, costs, discounts and premiums as yield
adjustments over the contractual lives of the investments. We consider
anticipated prepayments on mortgage-backed securities in determining estimated
future yields on such securities.
When we sell a security (other than trading securities or venture capital
investments), we report the difference between the sale proceeds and amortized
cost (determined based on specific identification) as an investment gain or
loss.
We regularly evaluate all of our investments based on current economic
conditions, credit loss experience and other investee-specific developments. If
there is a decline in a security's fair value that is other than temporary, we
treat it as a realized loss and reduce the cost basis of the security to its
estimated fair value.
Cash and Cash Equivalents
Cash and cash equivalents include commercial paper, invested cash and
other investments purchased with original maturities of less than three months.
We carry them at amortized cost, which approximates estimated fair value.
Finance Receivables
Finance receivables relate to the business of CFC and include
manufactured housing, home equity, home improvement, retail credit and floor
plan loans. CFC carries finance receivables at amortized cost, net of an
allowance for credit losses.
CFC defers fees received and costs incurred when it originates finance
receivables. CFC amortizes deferred fees, costs, discounts and premiums over the
estimated lives of the receivables. CFC includes such deferred fees or costs in
the amortized cost of finance receivables.
CFC generally stops accruing investment income on finance receivables
after three consecutive months of contractual delinquency.
Finance receivables transferred to securitization trusts in transactions
structured as securitized borrowings are classified as finance receivables -
securitized. These receivables are held as collateral for the notes issued to
investors in the securitization trusts. Finance receivables held by CFC that
have not been securitized are classified as finance receivables.
Provision for Losses
The provision for credit losses charged to expense is related to the
business of CFC. This expense is based upon an assessment of current and
historical loss experience, loan portfolio trends, prevailing economic and
business conditions, and other relevant factors. In management's opinion, the
provision is sufficient to maintain the allowance for credit losses at a level
that adequately provides for losses inherent in the portfolio.
CFC reduces the carrying value of finance receivables to net realizable
value at the earlier of: (i) six months of contractual delinquency; or (ii) when
it takes possession of the property securing the finance receivable.
In addition, during 2002, 2001 and 2000, we established additional
provisions for losses related to our guarantees of bank loans and the related
interest loans to approximately 155 current and former directors, officers and
key employees for the purchase of Conseco common stock (see the note to the
consolidated financial statements entitled "Other Disclosures" for additional
information on this provision).
F - 56
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Cost of Policies Produced
The costs that vary with, and are primarily related to, producing new
insurance business are referred to as cost of policies produced. We amortize
these costs using the interest rate credited to the underlying policy: (i) in
relation to the estimated gross profits for universal life-type and
investment-type products; or (ii) in relation to future anticipated premium
revenue for other products.
When we realize a gain or loss on investments backing our universal life
or investment-type products, we adjust the amortization to reflect the change in
estimated gross profits from the products due to the gain or loss realized and
the effect of the event on future investment yields. We also adjust the cost of
policies produced for the change in amortization that would have been recorded
if actively managed fixed maturity securities had been sold at their stated
aggregate fair value and the proceeds reinvested at current yields. We include
the impact of this adjustment in accumulated other comprehensive income (loss)
within shareholders' equity.
When we replace an existing insurance contract with another insurance
contract with substantially different terms, all unamortized cost of policies
produced related to the replaced contract is immediately written off. When we
replace an existing insurance contract with another insurance contract with
substantially similar terms, we continue to defer the cost of policies produced
associated with the replaced contract. Such costs related to the replaced
contracts which continue to be deferred were $7.6 million, $10.0 million and
$5.6 million in 2002, 2001 and 2000, respectively.
Each year, we evaluate the recoverability of the unamortized balance of
the cost of policies produced. We consider estimated future gross profits or
future premiums, expected mortality or morbidity, interest earned and credited
rates, persistency and expenses in determining whether the balance is
recoverable. If we determine a portion of the unamortized balance is not
recoverable, it is charged to amortization expense.
Cost of Policies Purchased
The cost assigned to the right to receive future cash flows from
contracts existing at the date of an acquisition is referred to as the cost of
policies purchased. We also defer renewal commissions paid in excess of ultimate
commission levels related to the purchased policies in this account. The balance
of this account is amortized, evaluated for recovery, and adjusted for the
impact of unrealized gains (losses) in the same manner as the cost of policies
produced described above.
The discount rate we use to determine the value of the cost of policies
purchased is the rate of return we need to earn in order to invest in the
business being acquired. In determining this required rate of return, we
consider many factors including: (i) the magnitude of the risks associated with
each of the actuarial assumptions used in determining expected future cash
flows; (ii) the cost of our capital required to fund the acquisition; (iii) the
likelihood of changes in projected future cash flows that might occur if there
are changes in insurance regulations and tax laws; (iv) the acquired company's
compatibility with other Conseco activities that may favorably affect future
cash flows; (v) the complexity of the acquired company; and (vi) recent prices
(i.e., discount rates used in determining valuations) paid by others to acquire
similar blocks of business.
Goodwill
Goodwill is the excess of the amount we paid to acquire a company over
the fair value of its net assets. We adopted SFAS 142 effective January 1, 2002,
as further described under the caption "Cumulative Effect of Accounting Change
and Goodwill Impairment". Prior to the adoption of SFAS 142, our analysis of
acquired businesses indicated that the anticipated ongoing cash flows from the
earnings of the purchased businesses extended beyond the maximum 40-year period
allowed for goodwill amortization. Accordingly, for periods prior to 2002, we
amortized goodwill on a straight-line basis generally over a 40-year period.
Pursuant to GAAP in effect at December 31, 2001, we had determined that goodwill
was fully recoverable from projected undiscounted net cash flows from earnings
of the subsidiaries over the remaining amortization period. If we had determined
that the undiscounted projected cash flows no longer supported the
recoverability of goodwill over the remaining amortization period, we would have
reduced its carrying value with a corresponding charge to expense or shortened
the amortization period. Cash flows considered in such an analysis were those of
the business acquired, if separately identifiable, or the product line that
acquired the business, if such earnings were not separately identifiable.
F - 57
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Assets Held in Separate Accounts and Investment Trust
Separate accounts are funds on which investment income and gains or
losses accrue directly to certain policyholders. The assets of these accounts
are legally segregated. They are not subject to the claims that may arise out of
any other business of Conseco. We report separate account assets at market
value; the underlying investment risks are assumed by the contractholders. We
record the related liabilities at amounts equal to the market value of the
underlying assets. We record the fees earned for administrative and
contractholder services performed for the separate accounts in insurance policy
income.
In addition, we hold investments in a trust for the benefit of the
purchasers of certain products of our asset management subsidiary; this amount
is offset by a corresponding liability account, the value of which fluctuates in
relation to changes in the values of these investments. Because we hold the
residual interests in the cash flows from the trust and actively manage its
investments, we are required to include the accounts of the trust in our
consolidated financial statements. We record the fees earned for investment
management and other services provided to the trust as fee revenue. See the
caption "Brickyard Trust" in the note to the consolidated financial statements
entitled "Investments in Variable Interest Entities" for further information on
these investments.
Recognition of Insurance Policy Income and Related Benefits and Expenses
on Insurance Contracts
Generally, we recognize insurance premiums for traditional life and
accident and health contracts as earned over the premium-paying periods. We
establish reserves for future benefits on a net-level premium method based upon
assumptions as to investment yields, mortality, morbidity, withdrawals and
dividends. We record premiums for universal life-type and investment-type
contracts that do not involve significant mortality or morbidity risk as
deposits to insurance liabilities. Revenues for these contracts consist of
mortality, morbidity, expense and surrender charges. We establish reserves for
the estimated present value of the remaining net costs of all reported and
unreported claims.
Liabilities Related to Certificates of Deposit
These liabilities relate to the certificates of deposits issued by the
bank subsidiaries of CFC. The liability and interest expense account are also
increased for the interest which accrues on the deposits. At December 31, 2002
and 2001, the weighted average interest crediting rate on these deposits was 3.5
percent and 4.7 percent, respectively.
Reinsurance
In the first quarter of 2002, we completed a reinsurance agreement
pursuant to which we ceded 80 percent of the inforce traditional life business
of our subsidiary, Bankers Life & Casualty Company, to Reassure America Life
Insurance Company (rated A++ by A.M. Best). The total insurance liabilities
ceded pursuant to the contract were approximately $400 million. The reinsurance
agreement and the related dividends of $110.5 million were approved by the
appropriate state insurance departments and the dividends were paid to CNC. The
ceding commission approximated the amount of the cost of policies purchased and
cost of policies produced related to the ceded business.
On June 28, 2002, we completed a reinsurance transaction pursuant to
which we ceded 100 percent of the traditional life and interest-sensitive life
insurance business of our subsidiary, Conseco Variable Insurance Company, to
Protective Life Insurance Company (rated A+ by A.M. Best). The total insurance
liabilities ceded pursuant to the contract were approximately $470 million. Our
insurance subsidiary received a ceding commission of $49.5 million.
During the second quarter of 2002, one of our subsidiaries, Colonial Penn
Life Insurance Company (formerly known as Conseco Direct Life Insurance
Company), ceded a block of graded benefit life insurance policies to an
unaffiliated company pursuant to a modified coinsurance agreement. Our
subsidiary received a ceding commission of $83.0 million. The cost of policies
purchased and the cost of policies produced were reduced by $123.0 million and
we recognized a loss of $39.0 million related to the transaction.
In the normal course of business, we seek to limit our exposure to loss
on any single insured or to certain groups of policies by ceding reinsurance to
other insurance enterprises. We currently retain no more than $.8 million of
mortality risk on any one policy. We diversify the risk of reinsurance loss by
using a number of reinsurers that have strong claims-paying ratings. If any
reinsurer could not meet its obligations, the Company would assume the
liability. The likelihood of a material loss being incurred as a result of the
failure of one of our reinsurers is considered remote. The cost of reinsurance
is recognized over the life of the reinsured policies using assumptions
consistent with those used to account for the underlying policy. The cost of
reinsurance ceded totaled $327.8 million,
F - 58
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
$249.4 million and $237.2 million in 2002, 2001 and 2000, respectively. A
receivable is recorded for the reinsured portion of insurance policy benefits
paid and liabilities for insurance products. Reinsurance recoveries netted
against insurance policy benefits totaled $323.6 million, $201.3 million and
$273.2 million in 2002, 2001 and 2000, respectively.
From time-to-time, we assume insurance from other companies. Any costs
associated with the assumption of insurance are amortized consistent with the
method used to amortize the cost of policies produced described above.
Reinsurance premiums assumed totaled $78.7 million, $146.0 million and $300.5
million in 2002, 2001 and 2000, respectively.
Income Taxes
Our income tax expense includes deferred income taxes arising from
temporary differences between the tax and financial reporting bases of assets
and liabilities and net operating loss carryforwards. In assessing the
realization of deferred income tax assets, we consider whether it is more likely
than not that the deferred income tax assets will be realized. The ultimate
realization of deferred income tax assets depends upon generating future taxable
income during the periods in which temporary differences become deductible and
net operating loss carryforwards expire. As of December 31, 2002, a valuation
reserve of $1.7 billion has been provided as the realization of the net deferred
tax asset is uncertain.
Investment Borrowings
As part of our investment strategy, we may enter into reverse repurchase
agreements and dollar-roll transactions to increase our investment return or to
improve our liquidity. We account for these transactions as collateral
borrowings, where the amount borrowed is equal to the sales price of the
underlying securities. Reverse repurchase agreements involve a sale of
securities and an agreement to repurchase the same securities at a later date at
an agreed-upon price. Dollar rolls are similar to reverse repurchase agreements
except that, with dollar rolls, the repurchase involves securities that are
substantially the same as the securities sold (rather than being the same
security). Such borrowings averaged $1,155.8 million during 2002 and $927.0
million during 2001. These borrowings were collateralized by investment
securities with fair values approximately equal to the loan value. The weighted
average interest rate on short-term collateralized borrowings was 1.3 percent
and 3.3 percent in 2002 and 2001, respectively. The primary risk associated with
short-term collateralized borrowings is that a counterparty will be unable to
perform under the terms of the contract. Our exposure is limited to the excess
of the net replacement cost of the securities over the value of the short-term
investments (such excess was not material at December 31, 2002). We believe the
counterparties to our reverse repurchase and dollar-roll agreements are
financially responsible and that the counterparty risk is minimal.
Liabilities Subject to Compromise
Under the Bankruptcy Code, actions by creditors to collect indebtedness
we owe prior to the Petition Date are stayed and certain other prepetition
contractual obligations may not be enforced against the Debtors. We have
received approval from the Court to pay certain prepetition liabilities
including employee salaries and wages, benefits and other employee obligations.
All other prepetition liabilities have been classified as "liabilities subject
to compromise" in the December 31, 2002 consolidated balance sheet.
F - 59
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The following table summarizes the components of the liabilities included
in the line "liabilities subject to compromise" in our consolidated balance
sheet as of December 31, 2002 (dollars in millions):
Other liabilities
Liability for guarantee of bank loans to current and former
directors, officers and key employees to purchase
CNC common stock................................................ $ 480.8
Interest payable................................................... 171.6
Accrual for distributions on Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts............ 90.1
Liability for litigation........................................... 41.8
Liability for retirement benefits pursuant to executive
employment agreements........................................... 22.6
Liability for deferred compensation................................ 2.3
Other payables..................................................... 7.0
--------
Total other liabilities subject to compromise................... 816.2
Notes payable - direct corporate obligations........................... 4,057.1
--------
Total liabilities subject to compromise......................... $4,873.3
========
F - 60
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The following table summarizes condensed consolidating financial
information segregating such information between the Debtors and non-Debtor
subsidiaries.
Condensed Consolidating Balance Sheet as of December 31, 2002
(Dollars in millions)
Conseco and Subsidiaries Conseco, Inc.
subsidiaries in not in and subsidiaries
reorganization reorganization Eliminations consolidated
-------------- -------------- ------------ ------------
ASSETS
Cash and cash equivalents....................................... $ 41.5 $ 1,227.4 $ - $ 1,268.9
Investments..................................................... 5.9 21,777.8 - 21,783.7
Investment in wholly-owned subsidiaries
(eliminated in consolidation)............................... 5,521.5 1,239.0 (6,760.5) -
Receivable from affiliates
(eliminated in consolidation)............................... 1,280.3 1,153.7 (2,434.0) -
Income tax assets............................................... 77.8 23.7 - 101.5
Other assets.................................................... 66.8 5,663.8 - 5,730.6
Assets of discontinued operations............................... 17,624.3 - - 17,624.3
--------- --------- --------- ---------
Total assets.......................................... $24,618.1 $31,085.4 $(9,194.5) $46,509.0
========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Liabilities:
Liabilities for insurance and asset accumulation products... $ - $22,797.1 $ - $22,797.1
Payables to subsidiaries (eliminated in consolidation)...... 4.8 1,298.3 (1,303.1) -
Other liabilities........................................... - 1,343.2 1,343.2
Liabilities of discontinued operations...................... 17,624.3 - - 17,624.3
Liabilities subject to compromise........................... 4,873.3 - - 4,873.3
Affiliated liabilities subject to compromise................ 1,177.4 - (1,177.4) -
--------- --------- --------- ---------
Total liabilities..................................... 23,679.8 25,438.6 (2,480.5) 46,637.9
--------- --------- --------- ---------
Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts....................................... 1,921.5 - - 1,921.5
Shareholders' equity (deficit):
Preferred stock............................................. 1,644.7 - (1,143.0) 501.7
Common stock and additional paid-in capital (no par value,
1,000,000,000 shares authorized, shares issued and
outstanding: 2002 - 346,007,133; 2001 - 344,743,196)..... 3,497.3 6,393.4 (6,393.7) 3,497.0
Accumulated other comprehensive income (loss)............... 580.6 470.0 (470.0) 580.6
Retained earnings (deficit)................................. (6,705.8) (1,216.6) 1,292.7 (6,629.7)
---------- --------- --------- ---------
Total shareholders' equity (deficit).................. (983.2) 5,646.8 (6,714.0) (2,050.4)
--------- --------- --------- ---------
Total liabilities and shareholders' equity (deficit).. $24,618.1 $31,085.4 $(9,194.5) $46,509.0
========= ========= ========= =========
F - 61
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Condensed Consolidating Statement of Operations
for the year ended December 31, 2002
(Dollars in millions)
Conseco and Subsidiaries Conseco, Inc.
subsidiaries in not in and subsidiaries
reorganization reorganization Eliminations consolidated
-------------- -------------- ------------ ------------
Revenues:
Insurance policy income....................................... $ - $3,602.3 $ - $ 3,602.3
Net investment income......................................... 2.4 1,439.8 - 1,442.2
Net investment income from venture capital investments........ (67.1) (32.2) - (99.3)
Dividends from subsidiaries................................... 276.0 - (276.0) -
Fee and interest income - affiliated.......................... 65.5 58.5 (124.0) -
Net investment losses......................................... - (597.0) - (597.0)
Fee revenue and other income.................................. 1.5 68.6 - 70.1
-------- -------- -------- ---------
Total revenue........................................... 278.3 4,540.0 (400.0) 4,418.3
-------- -------- -------- ---------
Expenses:
Insurance policy benefits..................................... - 3,332.5 - 3,332.5
Interest expense on notes payable............................. 326.2 36.9 - 363.1
Interest expense on notes payable - affiliated................ 8.4 48.8 (57.2) -
Provision for loss............................................ 147.2 63.6 - 210.8
Amortization.................................................. - 822.9 - 822.9
Operating costs and expenses - affiliated..................... 17.5 32.2 (49.7) -
Operating costs and expenses.................................. 74.2 637.9 - 712.1
Goodwill impairment........................................... - 500.0 - 500.0
Special charges............................................... 30.5 66.0 - 96.5
Reorganization items, net..................................... 14.4 - - 14.4
-------- -------- -------- ---------
Total expenses.......................................... 618.4 5,540.8 (106.9) 6,052.3
-------- -------- -------- ---------
Loss before income taxes, equity in undistributed
earnings of subsidiaries, distributions on Company-
obligated mandatorily redeemable preferred securities
of subsidiary trusts, discontinued operations,
extraordinary gain and cumulative effect of
accounting change.................................... (340.1) (1,000.8) (293.1) (1,634.0)
Income tax expense expense (benefit):
Tax (benefit) expense on period income .................... (49.3) 102.4 - 53.1
Valuation allowance for deferred tax assets................ 811.2 - - 811.2
-------- -------- -------- ---------
Loss before equity in undistributed earnings of
subsidiaries, distributions on Company-obligated
mandatorily redeemable preferred securities of
subsidiary trusts, discontinued operations,
extraordinary gain and cumulative effect of
accounting change (eliminated in consolidation)...... (1,102.0) (1,103.2) (293.1) (2,498.3)
Equity in undistributed earnings of subsidiaries before
discontinued operations, extraordinary charge and
cumulative effect of accounting change
(eliminated in consolidation)........................... (4,298.2) - 4,298.2 -
-------- -------- -------- ---------
F - 62
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Condensed Consolidating Statement of Operations
for the year ended December 31, 2002 (Continued)
(Dollars in millions)
Conseco and Subsidiaries Conseco, Inc.
subsidiaries in not in and subsidiaries
reorganization reorganization Eliminations consolidated
-------------- -------------- ------------ ------------
Loss before distributions on Company-obligated
mandatorily redeemable preferred securities of
subsidiary trusts, discontinued operations,
extraordinary gain and cumulative effect
of accounting change............................... (5,400.2) (1,103.2) 4,005.1 (2,498.3)
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts.................. 173.2 - - 173.2
--------- --------- -------- ---------
Loss before discontinued operations, extraordinary gain
and cumulative effect of accounting change............... (5,573.4) (1,103.2) 4,005.1 (2,671.5)
Discontinued operations of subsidiaries, net of income tax.... (1,961.6) (253.5) (8.0) (2,223.1)
Extraordinary gain on extinguishment of debt,
net of income taxes:
Parent company........................................... 1.8 - - 1.8
Subsidiary............................................... 6.3 - - 6.3
Cumulative effect of accounting change of subsidiaries, net of
income taxes............................................... (0.8) (2,948.4) - (2,949.2)
--------- --------- -------- ----------
Net loss................................................. (7,527.7) (4,305.1) 3,997.1 (7,835.7)
Preferred stock dividends..................................... 2.1 - - 2.1
Preferred stock dividends - affiliated........................ 60.7 - (60.7) -
--------- --------- -------- ---------
Loss applicable to common stock.......................... $(7,590.5) $(4,305.1) $4,057.8 $(7,837.8)
========= ========= ======== =========
F - 63
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Condensed Consolidating Statement of Cash Flows
for the year ended December 31, 2002
(Dollars in millions)
Conseco and Subsidiaries Conseco, Inc.
subsidiaries in not in and subsidiaries
reorganization reorganization Eliminations consolidated
-------------- -------------- ------------ ------------
Net cash provided (used) by operating activities.............. $ 395.2 $ 982.3 $(81.8) $1,295.7
Net cash provided by investing activities..................... 2,555.7 1,119.5 (266.2) 3,409.0
Net cash used by financing activities......................... (3,455.1) (3,389.5) 348.0 (6,496.6)
--------- -------- ------ --------
Net increase (decrease) in cash and cash equivalents.......... (504.2) (1,287.7) - (1,791.9)
Cash and cash equivalents, beginning of year.................. 545.7 2,515.1 - 3,060.8
--------- -------- ------ --------
Cash and cash equivalents, end of year..................... $ 41.5 $1,227.4 $ - $1,268.9
========= ======== ====== ========
F - 64
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Subject to certain limited exceptions, the Bankruptcy Court established a
bar date of February 21, 2003, for all prepetition claims against the Debtors. A
bar date is the date by which claims against the Debtors must be filed if the
claimants wish to receive any distribution in the Chapter 11 Cases. The Debtors
have notified all known or potential claimants subject to the February 21, 2003,
bar date of their need to file a proof of claim with the Bankruptcy Court.
Approximately 9,000 proofs of claim have been filed in connection with
the February 21, 2003, bar date, and the Debtors have begun reconciling claims
that differ from their records. Any remaining differences that cannot be
resolved by negotiated agreement between the Debtors and the claimants will be
resolved by the Bankruptcy Court.
Certain creditors have filed claims substantially in excess of amounts
reflected in the Debtors' records. Consequently, the amount included in the
consolidated balance sheet at December 31, 2002, as liabilities subject to
compromise may be adjusted.
Use of Estimates
When we prepare financial statements in conformity with GAAP, we are
required to make estimates and assumptions that significantly affect various
reported amounts of assets and liabilities, and the disclosure of contingent
assets and liabilities at the date of the financial statements and revenues and
expenses during the reporting periods. For example, we use significant estimates
and assumptions in calculating values for the cost of policies produced, the
cost of policies purchased, retained interest in securitization trusts
(including interest-only securities and B-2 securities), certain investments,
servicing rights, assets and liabilities related to income taxes, goodwill,
liabilities for insurance and asset accumulation products, the guarantee
liability related to interests in securitizations, liabilities related to
litigation, guaranty fund assessment accruals, liabilities related to guarantees
of securitized debt issued in conjunction with certain sales of finance
receivables and liabilities related to guarantees of bank loans and the related
interest loans to certain current and former directors, officers and key
employees, gain on sale of finance receivables and allowance for credit losses
on finance receivables. If our future experience differs from these estimates
and assumptions, our financial statements would be materially affected.
Accounting for Derivatives
Our equity-indexed annuity products provide a guaranteed base rate of
return and a higher potential return linked to the performance of the Standard &
Poor's 500 Index ("S&P 500 Index") based on a percentage (the participation
rate) over an annual period. At the beginning of each policy year, a new index
period begins. The Company is able to change the participation rate at the
beginning of each index period, subject to contractual minimums. We buy S&P 500
Call Options in an effort to hedge potential increases to policyholder benefits
resulting from increases in the S&P 500 Index to which the product's return is
linked. We include the cost of the S&P 500 Call Options in the pricing of these
products. Policyholder account balances for these annuities fluctuate in
relation to changes in the values of these options. We reflect changes in the
estimated market value of these options in net investment income. Option costs
that are attributable to benefits provided were $97.5 million, $119.0 million
and $123.9 million during 2002, 2001 and 2000, respectively. These costs are
reflected in the change in market value of the S&P 500 Call Options included in
investment income. Net investment income (loss) related to equity-indexed
products before this expense was $(3.0) million, $4.8 million and $12.9 million
in 2002, 2001 and 2000, respectively. Such amounts were substantially offset by
the corresponding charge to insurance policy benefits. The estimated fair value
of the S&P 500 Call Options was $32.8 million and $49.8 million at December 31,
2002 and 2001, respectively. We classify such instruments as other invested
assets. The Company accounts for the options attributed to the policyholder for
the estimated life of the annuity contract as embedded derivatives as defined by
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities", as amended by Statement of Financial
Accounting Standards No. 137, "Deferral of the Effective Date of FASB Statement
No. 133" and Statement of Financial Accounting Standards No. 138, "Accounting
for Certain Derivative Instruments and Certain Hedging Activities" (collectively
referred to as "SFAS 138"). The Company records the change in the fair values of
the embedded derivatives in current earnings as a component of policyholder
benefits. The fair value of these derivatives, which are classified as
"liabilities for interest-sensitive products" was $274.0 million and $491.2
million at December 31, 2002 and 2001, respectively.
On June 29, 2001, we entered into interest rate swap agreements to
convert the fixed rate on our senior notes (10.75 percent) to a variable rate
based on LIBOR plus 4.75 percent. In accordance with the requirements of SFAS
138, the change in the fair value of the interest rate swap and the gain or loss
on the hedged senior notes attributable to the hedged interest rate risk were
recorded in current-period earnings. Because the terms of the interest rate swap
agreements substantially matched the terms of the senior notes, the gain or loss
on the swap and the senior notes was generally equal and offsetting (although
the effective interest rate on our debt was affected).
F - 65
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
In early October 2001, we terminated these interest rate swap agreements
for cash proceeds of $19.0 million (the value of the terminated swap
agreements). No gain was recognized upon the termination of the interest rate
swap agreements. Instead, the change in the fair value of the senior notes
recorded while the interest rate swaps were outstanding will be amortized as a
reduction to interest expense over the remaining life of our senior notes.
In October 2001, we also entered into new interest rate swap agreements
to replace the terminated agreements which convert the fixed rate on our 10.75%
senior notes to a variable rate based on LIBOR plus 5.7525 percent. At December
31, 2001, "notes payable-direct corporate obligations" was decreased by $13.5
million to reflect the estimated fair value of such interest rate swap
agreements. Such interest rate swap agreements were terminated in April 2002
generating cash proceeds of $3.5 million. Such amount represented $11.9 million
of cash due to the Company pursuant to the terms of the swaps, net of $8.4
million which represented the fair value of the interest rate swaps on the date
of termination. The $8.4 million will be amortized as additional interest
expense over the remaining life of our senior notes.
In the past, we have used interest-rate swaps to hedge the interest rate
risk associated with our borrowed capital. These agreements were terminated
during 2000. We realized a net investment loss of $38.6 million (net of an
income tax benefit of $20.6 million) related to such terminations during 2000.
The Company entered into a forward sale contract related to a portion of
its venture capital investment in AWE. Such contract was carried at market
value, with the change in such value being recognized as venture capital income
(loss). The value of the derivative fluctuated in relation to the AWE common
stock it related to. In the third quarter of 2002, we agreed with the
counterparties to unwind the forward sale contract. The net effect of unwinding
the forward purchase contract resulted in a small gain.
If the counterparties for the derivatives we hold fail to meet their
obligations, Conseco may have to recognize a loss. Conseco limits its exposure
to such a loss by diversifying among several counterparties believed to be
strong and creditworthy. At December 31, 2002, all of the counterparties were
rated "A" or higher by Standard & Poor's Corporation ("S&P").
Multibucket Annuity Product
The Company's multibucket annuity is a fixed annuity product that credits
interest based on the experience of a particular market strategy. Policyholders
allocate their annuity premium payments to several different market strategies
based on different asset classes within the Company's investment portfolio.
Interest is credited to this product based on the market return of the given
strategy, less management fees, and funds may be moved between different
strategies. The Company guarantees a minimum return of premium plus
approximately 3 percent per annum over the life of the contract. The investments
backing the market strategies of these products are designated by the Company as
trading securities. The change in the fair value of these securities is included
in investment income which is substantially offset by the change in insurance
policy benefits for these products.
Revenue Recognition for Sales of Finance Receivables and Amortization of
Servicing Rights
Subsequent to September 8, 1999, CFC generally structured its
securitizations in a manner that required them to be accounted for under the
portfolio method, whereby the loans and securitization debt remain on CFC's
balance sheet pursuant to Financial Accounting Standards Board Statement No.
140, "Accounting for the Transfer and Servicing of Financial Assets and
Extinguishments of Liabilities" ("SFAS 140"). The ratings downgrades and other
events that followed the Company's August 9, 2002, announcement, eliminated
CFC's access to the securitization markets.
For securitizations structured prior to September 8, 1999, CFC accounted
for the transfer of finance receivables as sales. In accordance with GAAP, CFC
recognized a gain, representing the difference between the proceeds from the
sale (net of related sale costs) and the carrying value of the component of the
finance receivable sold. CFC determined such carrying value by allocating the
carrying value of the finance receivables between the portion sold and the
interests retained (generally interest-only securities, servicing rights and, in
some instances, other subordinated securities), based on each portion's relative
fair values on the date of the sale.
CFC amortizes the servicing rights it retains after the sale of finance
receivables in proportion to, and over the estimated period of, net servicing
income.
CFC evaluates servicing rights for impairment on an ongoing basis,
stratified by product type and securitization period. To the extent that the
recorded amount exceeds the fair value for any strata, CFC establishes a
valuation allowance through a charge to
F - 66
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
earnings. If CFC determines, upon subsequent measurement of the fair value of
these servicing rights, that the fair value equals or exceeds the amortized
cost, any previously recorded valuation allowance would be deemed unnecessary
and restored to earnings.
Fair Values of Financial Instruments
We use the following methods and assumptions to determine the estimated
fair values of financial instruments:
Investment securities. For fixed maturity securities (including
redeemable preferred stocks) and for equity and trading securities, we
use quotes from independent pricing services, where available. For
investment securities for which such quotes are not available, we use
values obtained from broker-dealer market makers or by discounting
expected future cash flows using a current market rate appropriate for
the yield, credit quality, and (for fixed maturity securities) the
maturity of the investment being priced.
Retained interests in securitization trusts. These assets relate to the
business of CFC. Management of CFC discounts future expected cash flows
over the expected life of the receivables sold using current estimates of
future prepayment, default, loss severity and interest rates. They
consider any potential payments related to the guarantees of certain
lower-rated securities issued by the securitization trusts in the
projected cash flows used to determine the value of CFC's retained
interests in securitization trusts.
Venture capital investment in AWE. We carry this investment at estimated
fair value based on quoted market prices.
Cash and cash equivalents. The carrying amount for these instruments
approximates their estimated fair value.
Mortgage loans and policy loans. We discount future expected cash flows
for loans included in our investment portfolio based on interest rates
currently being offered for similar loans to borrowers with similar
credit ratings. We aggregate loans with similar characteristics in our
calculations. The market value of policy loans approximates their
carrying value.
Other invested assets. We use quoted market prices, where available. When
quotes are not available, we estimate the fair value based on: (i)
discounted future expected cash flows; or (ii) independent transactions
which establish a value for our investment. When we are unable to
estimate a fair value, we assume a market value equal to carrying value.
Finance receivables. These assets relate to the business of CFC. The
estimated fair value of finance receivables, including those that have
been securitized, is determined based on general market transactions
which establish values for similar loans.
Insurance liabilities for interest-sensitive products. We discount future
expected cash flows based on interest rates currently being offered for
similar contracts with similar maturities.
Liabilities related to certificates of deposit. These assets relate to
the business of CFC. Management of CFC estimates the fair value of these
liabilities using discounted cash flow analyses based on current
crediting rates. Since crediting rates are generally not guaranteed
beyond one year, market value approximates carrying value.
Investment borrowings and notes payable. For publicly traded debt, we use
current market values. For other notes, we use discounted cash flow
analyses based on our current incremental borrowing rates for similar
types of borrowing arrangements.
Trust Preferred Securities. We use quoted market prices.
F - 67
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Here are the estimated fair values of our financial instruments:
2002 2001
----------------------- --------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
(Dollars in millions)
Financial assets:
Actively managed fixed maturities.......................... $19,417.4 $19,417.4 $21,818.5 $21,818.5
Retained interests in securitization trusts (a)............ - - 710.1 710.1
Equity securities ......................................... 156.0 156.0 227.0 227.0
Mortgage loans............................................. 1,308.3 1,335.7 1,228.0 1,210.7
Policy loans............................................... 536.2 536.2 635.8 635.8
Venture capital investment in AT&T Wireless
Services, Inc............................................ 25.0 25.0 155.3 155.3
Other invested assets...................................... 340.8 340.8 292.4 292.4
Cash and cash equivalents.................................. 1,268.9 1,268.9 3,060.8 3,060.8
Finance receivables (including finance
receivables-securitized) (a)............................. - - 18,009.2 18,376.7
Financial liabilities:
Insurance liabilities for interest-sensitive products (b).. 13,469.5 13,469.5 15,787.7 15,787.7
Liabilities related to certificates of deposit (a)......... - - 1,790.3 1,790.3
Guarantee liability related to interests in securitization
trusts held by others (a)................................ - - 39.9 39.9
Investment borrowings...................................... 669.7 669.7 2,242.7 2,242.7
Notes payable:
Corporate (c)............................................ - - 4,085.0 2,863.5
Finance (a).............................................. - - 2,527.9 2,455.2
Related to securitized finance receivables structured
as collateralized borrowings (a)....................... - - 14,484.5 14,774.3
Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts................ 1,921.5 9.7 1,914.5 1,206.5
--------------------
(a) These accounts relate to the business of CFC, which are classified as
discontinued operations at December 31, 2002. See "Basis of Presentation"
above.
(b) The estimated fair value of the liabilities for interest-sensitive
products was approximately equal to its carrying value at December 31,
2002 and 2001. This was because interest rates credited on the vast
majority of account balances approximate current rates paid on similar
products and because these rates are not generally guaranteed beyond one
year. We are not required to disclose fair values for insurance
liabilities, other than those for interest-sensitive products. However,
we take into consideration the estimated fair values of all insurance
liabilities in our overall management of interest rate risk. We attempt
to minimize exposure to changing interest rates by matching investment
maturities with amounts due under insurance contracts.
(c) At December 31, 2002, corporate notes payable are classified as
liabilities subject to compromise as such amounts may be subject to
adjustment.
Cumulative Effect of Accounting Change and Goodwill Impairment
The FASB issued SFAS 142, in June 2001. Under the new rule, intangible
assets with an indefinite life are no longer amortized in periods subsequent to
December 31, 2001, but are subject to annual impairment tests (or more
frequently under certain circumstances), effective January 1, 2002. The Company
has determined that all of its goodwill has an indefinite life and is therefore
subject to the new rules.
Pursuant to SFAS 142, the goodwill impairment test has two steps. For
Conseco, the first step consisted of comparing the estimated fair value of each
of the business units comprising our insurance segment to the unit's book value.
Since all of our goodwill relates to the insurance segment (which is also a
reportable segment), the goodwill impairment test is not relevant to the finance
F - 68
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
business. If the estimated fair value exceeds the book value, the test is
complete and goodwill is not impaired. If the fair value is less than the book
value, the second step of the impairment test must be performed, which compares
the implied fair value of the applicable business unit's goodwill with the book
value of that goodwill to measure the amount of goodwill impairment, if any.
Pursuant to the transitional rules of SFAS 142, we completed the two-step
impairment test during 2002 and, as a result of that test, we recorded the
cumulative effect of the accounting change for the goodwill impairment charge of
$2,949.2 million. The impairment charge is reflected in the cumulative effect of
an accounting change in the accompanying consolidated statement of operations
for the year ended December 31, 2002. Subsequent impairment tests will be
performed on an annual basis, or more frequently if circumstances indicate a
possible impairment. Subsequent impairment charges are classified as an
operating expense. As described below, the Company performed additional
impairment tests in 2002, as a result of circumstances which indicated a
possible impairment.
The significant factors used to determine the amount of the initial
impairment included analyses of industry market valuations, historical and
projected performance of our insurance segment, discounted cash flow analyses
and the market value of our capital. The valuation utilized the best available
information, including assumptions and projections we considered reasonable and
supportable. The assumptions we used to determine the discounted cash flows
involve significant judgments regarding the best estimate of future premiums,
expected mortality and morbidity, interest earned and credited rates,
persistency and expenses. The discount rate used was based on an analysis of the
weighted average cost of capital for several insurance companies and considered
the specific risk factors related to Conseco. Pursuant to the guidance in SFAS
142, quoted market prices in active markets are the best evidence of fair value
and shall be used as the basis for measurement, if available.
On August 14, 2002, our insurance subsidiaries' financial strength
ratings were downgraded by A.M. Best to "B (fair)" and on September 8, 2002, the
Company defaulted on its public debt. These developments caused sales of our
insurance products to fall and policyholder redemptions and lapses to increase.
The adverse impact on our insurance subsidiaries resulting from the ratings
downgrade and parent company default required that an additional impairment test
be performed as of September 30, 2002, in accordance with SFAS 142.
In connection with our negotiations with debt holders, we retained an
outside actuarial consulting firm to assist in valuing our insurance
subsidiaries. That valuation work and our internal evaluation were used in
performing the additional impairment tests that resulted in an impairment charge
to goodwill of $500.0 million. The charge is reflected in the line item entitled
"Goodwill impairment" in our consolidated statement of operations for the year
ended December 31, 2002. The most significant changes made to the January 1,
2002 valuation that resulted in the additional impairment charge were: (i)
reduced estimates of projected future sales of insurance products; (ii)
increased estimates of future policyholder redemptions and lapses; and (iii) a
higher discount rate to reflect the current rates used by the market to value
life insurance companies. Management believes that the assumptions and estimates
used are reasonable given all available facts and circumstances. However, if
projected cash flows are not realized in the future, we may be required to
recognize additional impairments.
Prior to the adoption of SFAS 142, we determined whether goodwill was
recoverable from projected undiscounted net cash flows for the earnings of our
subsidiaries over the remaining amortization period. If we determined that
undiscounted projected cash flows were not sufficient to recover the goodwill
balance, we would reduce its carrying value with a corresponding charge to
expense or shorten the amortization period. Cash flows considered in such an
analysis were those of the business acquired, if separately identifiable, or the
product line that acquired the business, if such earnings were not separately
identifiable.
F - 69
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Changes in the carrying amount of goodwill for the years ended December
31, 2002 and 2001, are as follows:
2002 2001
---- ----
(Dollars in millions)
Goodwill balance, beginning of year......................................... $ 3,695.4 $3,800.8
Amortization expense........................................................ - (109.6)
Cumulative effect of accounting change...................................... (2,949.2) -
Impairment charge........................................................... (500.0) -
Reduction of tax valuation contingencies established at acquisition date
for acquired companies.................................................. (146.2) -
Goodwill related to the acquisition of ExlServices, Inc..................... - 46.1
Goodwill related to businesses sold......................................... - (41.9)
--------- --------
Goodwill balance, end of year............................................... $ 100.0 $3,695.4
========= ========
F - 70
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
In accordance with SFAS 142, we discontinued the amortization of goodwill
expense effective January 1, 2002. The following information summarizes the
impact of goodwill amortization on income before discontinued operations,
extraordinary gain (loss) and cumulative effect of accounting change; net
income; and the respective earnings per share amounts for the periods presented
in our consolidated statement of operations for periods prior to January 1,
2002:
2001 2000
----- ----
(Dollars in millions, except per share data)
Reported loss before discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change................................... $(316.4) $ (749.0)
Add back: goodwill amortization.............................................................. 108.2 108.5
------- ---------
Adjusted loss before discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change.................................... $(208.2) $ (640.5)
======= =========
Reported net loss applicable to common stock................................................. $(418.7) $(1,202.2)
Add back: goodwill amortization.............................................................. 109.6 112.5
----- ---------
Adjusted net loss applicable to common stock.................................................. $(309.1) $(1,089.7)
======= =========
Basic earnings per share:
Reported loss before discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change.................................... $ (.97) $ (2.34)
Add back: goodwill amortization.............................................................. .32 .33
------- ---------
Adjusted loss before discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change.................................... $ (.65) $ (2.01)
======= =========
Reported net loss applicable to common stock.................................................. $ (1.24) $ (3.69)
Add back: goodwill amortization.............................................................. .32 .35
------- ---------
Adjusted net loss applicable to common stock.................................................. $ (.92) $ (3.34)
======= =========
Diluted earnings per share:
Reported loss before discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change................................... $ (.97) $ (2.34)
Add back: goodwill amortization............................................................. .32 .33
------- ---------
Adjusted loss before discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change.................................... $ (.65) $ (2.01)
======= =========
Reported net loss applicable to common stock................................................. $ (1.24) $ (3.69)
Add back: goodwill amortization.............................................................. .32 .35
------- ---------
Adjusted net loss applicable to common stock.................................................. $ (.92) $ (3.34)
======= =========
F - 71
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Pursuant to the transitional rules of SFAS 142, the cumulative effect of
the accounting change for goodwill impairment is reflected in the consolidated
financial statements for the quarter ended March 31, 2002. Accordingly, the
consolidated statement of operations for the three months ended March 31, 2002,
has been restated to reflect the change as summarized below (dollars in
millions, except per share data):
Net loss applicable to common stock, as reported................ $ (96.9)
Cumulative effect of accounting change.......................... (2,949.2)
-----------
Net loss applicable to common stock, as adjusted................ $ (3,046.1)
===========
Net loss per common share:
Basic:
Net loss, as reported........................................ $ (.28)
Cumulative effect of accounting change....................... (8.54)
------
Net loss, as adjusted........................................ $(8.82)
======
Diluted:
Net loss, as reported........................................ $ (.28)
Cumulative effect of accounting change....................... (8.54)
------
Net loss, as adjusted........................................ $(8.82)
======
During the third quarter of 2000, the Emerging Issues Task Force of the
Financial Accounting Standards Board issued EITF 99-20, "Recognition of Interest
Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets" ("EITF 99-20").
Under the prior accounting rule, declines in the value of our
interest-only securities and other retained beneficial interests in securitized
financial assets were recognized in the statement of operations when the present
value of estimated cash flows discounted at a risk-free rate using current
assumptions was less than the carrying value of the interest-only security.
Under the new accounting rule, declines in value are recognized when: (i)
the fair value of the retained beneficial interests are less than their carrying
value; and (ii) the timing and/or amount of cash expected to be received from
the retained beneficial interests have changed adversely from the previous
valuation which determined the carrying value of the retained beneficial
interests. When both occur, the retained beneficial interests are written down
to fair value.
F - 72
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
We adopted the new accounting rule on July 1, 2000. The cumulative effect
of the accounting change for periods prior to July 1, 2000 was a charge to the
statement of operations of $55.3 million (net of an income tax benefit of $29.9
million), or $.17 per diluted share. The cumulative effect of the accounting
change includes: (i) $45.5 million (net of an income tax benefit of $24.7
million) related to interest-only securities held by CFC; and (ii) $9.8 million
(net of an income tax benefit of $5.2 million) related to other retained
beneficial interests in securitized financial assets held by our insurance
segment.
Impairment Charge
During 2002, 2001 and 2000, the retained interests held by CFC did not
perform as well as anticipated. In addition, CFC's expectations regarding future
economic conditions changed. Accordingly, CFC changed various underlying
assumptions (including default, severity, credit loss, discount rate and
servicing cost assumptions) related to the future performance of the underlying
loans to be consistent with management's expectations. As a result, the expected
future cash flows (including any potential payments related to the guarantees of
certain lower-rated securities issued by the securitization trusts) from
interest-only securities changed adversely from previous estimates. Pursuant to
the requirements of EITF 99-20, the effect of these changes was reflected
immediately in earnings as an impairment charge. In 2002, CFC recognized an
impairment charge of $1,077.2 million related to its retained interests. CFC
also recognized a $336.5 million increase in the valuation allowance related to
its servicing rights as a result of the changes in assumptions in 2002. The
valuation allowance related to the servicing rights increased as a result of
changes to the expected future cost of servicing the finance receivables. The
levels of delinquent and defaulting loans have caused servicing costs to
increase. In addition, future servicing costs are expected to increase as the
portfolio ages. In addition, CFC recognized impairment charges of: (i) $29.3
million to establish a valuation allowance for advances CFC was required to make
to the securitization trusts which are potentially uncollectible; and (ii) $6.9
million to establish a liability of guarantee payments due to certain holders of
lower-rated securities issued by the securitization trusts which CFC was unable
to pay. In 2001, CFC recognized an impairment charge of $264.8 million ($171.3
million after the income tax benefit) related to its retained interests. CFC
also recognized a $122.1 million ($79.1 million after the income tax benefit)
increase in the valuation allowance related to its servicing rights as a result
of the changes in assumptions in 2001. In 2000, the effect of the impairment
charge and adjustments to the value of its retained interests totaled $515.7
million ($324.9 million after the income tax benefit) in addition to the
cumulative effect of adopting EITF 99-20 of $70.2 million ($45.5 million after
the income tax benefit).
Recently Issued Accounting Standards
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which requires expanded disclosures for
and, in some cases, consolidation of significant investments in variable
interest entities ("VIE"). A VIE is an entity in which the equity investors do
not have the characteristics of a controlling financial interest, or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. Under FIN 46, a
company is required to consolidate a VIE if it is the primary beneficiary of the
VIE. FIN 46 defines primary beneficiary as the party which will absorb a
majority of the VIE's expected losses or receive a majority of the VIE's
expected residual returns, or both. FIN 46 is effective immediately for VIEs
created after January 31, 2003. For VIEs acquired before February 1, 2003, the
additional disclosure requirements are effective for financial statements issued
after January 31, 2003 and the consolidation requirements must be applied not
later than the fiscal year or interim period beginning after June 15, 2003.
The Company has investments in various types of VIEs, some of which
require additional disclosure under FIN 46, and several of which that will
require consolidation under FIN 46. As further discussed in the note to the
consolidated financial statements entitled "Investments in Variable Interest
Entities", certain of our investments in VIEs are already consolidated in our
financial statements. We have identified one additional VIE investment in which
we are the primary beneficiary and, accordingly, will require consolidation in
our financial statements beginning with our September 30, 2003 financial
statements. The additional liabilities, which will be recognized as a result of
consolidating the VIE, do not represent claims on the general assets of the
Company. Likewise, the additional assets, which will be recognized upon
consolidation, are collateral for the additional recognized liabilities.
Consequently, the adoption of the consolidation requirements of FIN 46 is not
expected to have a material impact on our financial condition or results of
operations. The note entitled "Investments in Variable Interest Entities"
includes the expanded disclosures required by FIN 46.
The FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45") in November 2002. FIN 45 requires certain
guarantees to be recognized as liabilities at fair value. In addition, it
requires a guarantor to make new disclosures regarding its obligations. We
implemented the new disclosure requirements as of December 31, 2002; see the
note to the consolidated financial statements entitled "Other Disclosures." FIN
45's liability recognition requirement is effective on a prospective basis for
guarantees issued or modified after December 31, 2002.
F - 73
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
We do not expect that FIN 45 will materially impact the Company's results of
operations or financial condition.
The FASB issued Statement of Financial Accounting Standards No. 146,
"Accounting for Exit or Disposal Activities" ("SFAS 146") in June 2002. SFAS 146
addresses financial accounting and reporting for costs that are associated with
exit and disposal activities and supersedes Emerging Issues Task Force Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)"
("EITF 94-3"). SFAS 146 is required to be used to account for exit or disposal
activities that are initiated after December 31, 2002. The provisions of EITF
94-3 shall continue to apply for an exit activity initiated prior to the
adoption of SFAS 146. SFAS 146 requires companies to recognize costs associated
with exit or disposal activities when they are incurred rather than at the date
of commitment to an exit or disposal plan. The Company plans to adopt the
provisions of SFAS 146 on January 1, 2003. We do not expect the initial adoption
of SFAS 146 to have a material impact on the Company's consolidated financial
statements.
The FASB issued Statement of Financial Accounting Standards No. 145,
"Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No.
13, and Technical Corrections" ("SFAS 145") in April 2002. Under previous
guidance all gains and losses resulting from the extinguishment of debt were
required to be aggregated and, if material, classified as an extraordinary item,
net of related income tax effect. SFAS 145 rescinds that guidance and requires
that gains and losses from extinguishments of debt be classified as
extraordinary items only if they are both unusual and infrequent in occurrence.
SFAS 145 also amends previous guidance to require certain lease modifications
that have economic effects similar to sale-leaseback transactions be accounted
for in the same manner as sale-leaseback transactions. This new guidance is
effective for fiscal years beginning after May 15, 2002. We do not expect SFAS
145 to materially impact the Company's results of operations and financial
position.
The FASB issued Statement of Financial Accounting Standards No. 144,
"Accounting for the Impairment of Long-Lived Assets" ("SFAS 144") in August
2001. This standard addresses the measurement and reporting for impairment of
all long-lived assets. It also broadens the definition of what may be presented
as a discontinued operation in the consolidated statement of operations to
include components of a company's business segments. SFAS 144 requires that
long-lived assets currently in use be written down to fair value when considered
impaired. Long-lived assets to be disposed of are written down to the lower of
cost or fair value less the estimated cost to sell. The Company adopted this
standard on January 1, 2002. We have followed this standard in determining when
it is appropriate to recognize impairments on assets we have decided to sell as
part of our efforts to raise cash. We have also followed this standard in
determining that our variable annuity business line and CFC should be presented
as discontinued operations in our consolidated financial statements (see the
notes to the consolidated financial statements entitled "Financial Information
Regarding CFC" and "Financial Information Regarding CVIC").
The FASB issued SFAS 141 and SFAS 142 in June 2001. Under the new rules,
intangible assets with an indefinite life are no longer amortized in periods
subsequent to December 31, 2001, but are subject to annual impairment tests (or
more frequently under certain circumstances), effective January 1, 2002. The
Company adopted SFAS 141 and SFAS 142 effective January 1, 2002 (see the note to
the consolidated financial statements entitled "Summary of Significant
Accounting Policies" for additional discussion).
The FASB issued SFAS 140 (which is a replacement for Statement of
Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities") and a related
implementation guide in September 2000. SFAS 140 and the implementation guide
have changed the criteria that must be met for securitization transactions to be
recorded under the portfolio method. We did not need to make any significant
changes to our securitization structures to meet the new criteria which are
effective for securitization transactions completed after March 31, 2001. We
first adopted the SFAS 140 requirement for additional disclosures on
securitization in our December 31, 2000, consolidated financial statements.
SFAS 138 requires all derivative instruments to be recorded on the
balance sheet at estimated fair value. Changes in the fair value of derivative
instruments are to be recorded each period either in current earnings or other
comprehensive income (loss), depending on whether a derivative is designated as
part of a hedge transaction and, if it is, on the type of hedge transaction. We
adopted SFAS 138 on January 1, 2001. The initial adoption of the new standard
did not have a material impact on the Company's financial position or results of
operations and there was no cumulative effect of an accounting change related to
its adoption.
Statement of Position No. 98-7, "Accounting for Insurance and Reinsurance
Contracts That Do Not Transfer Insurance Risk" ("SOP 98-7") provides guidance on
the method of accounting for insurance and reinsurance contracts that do not
transfer risk. We adopted SOP 98-7 on January 1, 2000. The adoption did not have
a material impact on the Company's consolidated financial condition or results
of operations.
F - 74
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
5. INVESTMENTS:
At December 31, 2002, the amortized cost and estimated fair value of
actively managed fixed maturities and equity securities were as follows:
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
(Dollars in millions)
Investment grade:
Corporate securities........................................................... $10,529.0 $517.5 $293.9 $10,752.6
United States Treasury securities and obligations of
United States government corporations and agencies........................... 442.4 25.2 9.0 458.6
States and political subdivisions.............................................. 418.0 23.2 .9 440.3
Debt securities issued by foreign governments.................................. 83.3 7.3 - 90.6
Mortgage-backed securities .................................................... 6,082.0 336.3 4.2 6,414.1
Below-investment grade (primarily corporate securities)........................... 1,435.1 17.1 191.0 1,261.2
--------- ------ ------ ---------
Total actively managed fixed maturities...................................... $18,989.8 $926.6 $499.0 $19,417.4
========= ====== ====== =========
Equity securities................................................................. $161.4 $4.5 $9.9 $156.0
====== ==== ==== ======
At December 31, 2001, the amortized cost and estimated fair value of
actively managed fixed maturities and equity securities were as follows:
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
(Dollars in millions)
Investment grade:
Corporate securities........................................................... $12,827.2 $121.5 $501.1 $12,447.6
United States Treasury securities and obligations of
United States government corporations and agencies........................... 240.9 11.8 1.0 251.7
States and political subdivisions.............................................. 225.7 5.0 2.0 228.7
Debt securities issued by foreign governments.................................. 103.9 3.8 .9 106.8
Mortgage-backed securities .................................................... 7,488.1 82.8 74.3 7,496.6
Below-investment grade (primarily corporate securities)........................... 1,537.0 15.2 265.1 1,287.1
--------- ------- ------ ----------
Total actively managed fixed maturities...................................... $22,422.8 $240.1 $844.4 $21,818.5
========= ====== ====== =========
Equity securities................................................................. $257.3 $6.0 $36.3 $227.0
====== ==== ===== ======
Accumulated other comprehensive income (loss) is primarily comprised of
unrealized gains (losses) on actively managed fixed maturity investments. Such
amounts, included in shareholders' equity (deficit) as of December 31, 2002 and
2001, were as follows:
2002 2001
---- ----
(Dollars in millions)
Unrealized gains (losses) on investments........................................................... $448.1 $(816.0)
Adjustments to cost of policies purchased and cost of policies produced............................ (95.3) 133.9
Deferred income tax benefit........................................................................ 249.6 249.6
Other.............................................................................................. (21.8) (6.5)
------ -------
Accumulated other comprehensive income (loss)............................................... $580.6 $(439.0)
====== =======
F - 75
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Concentration of Corporate Securities
At December 31, 2002, our corporate securities (including
below-investment grade) were concentrated in the following industries:
Percent of Percent of
amortized estimated
cost fair value
-------------- ----------
Media and communications......................................................... 13.7% 13.5%
Financial institutions........................................................... 10.5 10.5
Bank/savings and loan............................................................ 10.2 10.7
Electric utility................................................................. 9.0 9.0
Energy........................................................................... 8.2 8.8
Insurance ....................................................................... 4.7 5.5
With respect to our corporate securities, no other industry accounted for
more than 5.0 percent of amortized cost or estimated fair value.
Below-Investment Grade Securities
At December 31, 2002, the amortized cost of the Company's fixed maturity
securities in below-investment grade securities was $1,435.1 million, or 7.6
percent of the Company's fixed maturity portfolio. The estimated fair value of
the below-investment grade portfolio was $1,261.2 million, or 88 percent of the
amortized cost. The value of these securities varies based on the economic terms
of the securities, structural considerations and the credit worthiness of the
issuer of the securities. Recently a number of large highly leveraged issuers
have experienced significant financial difficulties, which resulted in our
recognition of other-than-temporary impairments. These impairments have had a
material adverse effect on us.
Below-investment grade securities have different characteristics than
investment grade corporate debt securities. Risk of loss upon default by the
borrower is significantly greater with respect to below-investment grade
securities than with other corporate debt securities. Below-investment grade
securities are generally unsecured and are often subordinated to other creditors
of the issuer. Also, issuers of below-investment grade securities usually have
higher levels of debt and are more sensitive to adverse economic conditions,
such as recession or increasing interest rates, than are investment grade
issuers. The Company attempts to reduce the overall risk in the below-investment
grade portfolio, as in all investments, through careful credit analysis, strict
investment policy guidelines, and diversification by issuer and/or guarantor and
by industry.
Contractual Maturity
The following table sets forth the amortized cost and estimated fair
value of actively managed fixed maturities at December 31, 2002, by contractual
maturity. Actual maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties. Most of the mortgage-backed securities shown below
provide for periodic payments throughout their lives.
F - 76
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Estimated
Amortized fair
cost value
---- -----
(Dollars in millions)
Due in one year or less...................................................................... $ 160.0 $ 162.0
Due after one year through five years........................................................ 1,147.8 1,189.6
Due after five years through ten years....................................................... 4,094.7 4,228.8
Due after ten years.......................................................................... 7,498.4 7,420.8
--------- ---------
Subtotal................................................................................. 12,900.9 13,001.2
Mortgage-backed securities (a)............................................................... 6,088.9 6,416.2
--------- ---------
Total actively managed fixed maturities ............................................. $18,989.8 $19,417.4
========= =========
--------------------
(a) Includes below-investment grade mortgage-backed securities with an
amortized cost and estimated fair value of $6.9 million and $2.1 million,
respectively.
Net Investment Income
Net investment income consisted of the following:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Fixed maturities................................................................. $1,375.2 $1,510.7 $1,550.5
Venture capital investment loss.................................................. (99.3) (42.9) (199.5)
Equity securities................................................................ 13.2 17.8 35.2
Mortgage loans................................................................... 99.0 90.2 96.4
Policy loans..................................................................... 32.6 35.9 33.7
Change in value of S&P 500 Call Options related to equity-indexed products....... (100.5) (114.2) (111.0)
Other invested assets............................................................ 7.7 24.6 91.9
Cash and cash equivalents........................................................ 27.6 60.5 58.0
Separate accounts................................................................ - (5.4) 54.9
-------- -------- --------
Gross investment income....................................................... 1,355.5 1,577.2 1,610.1
Less investment expenses......................................................... 12.6 12.7 13.1
-------- -------- --------
Net investment income......................................................... $1,342.9 $1,564.5 $1,597.0
======== ======== ========
The carrying value of fixed maturity investments and mortgage loans not
accruing investment income totaled $169.6 million, $140.2 million and $98.0
million at December 31, 2002, 2001 and 2000, respectively.
F - 77
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Net Realized Investment Losses
Investment losses, net of related investment expenses, were included in
revenue as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Fixed maturities:
Gross gains...................................................................... $ 260.8 $ 295.8 $ 83.6
Gross losses..................................................................... (251.8) (260.3) (154.4)
Other-than-temporary decline in fair value....................................... (500.6) (293.2) (139.4)
------- ------- -------
Net investment losses from fixed maturities before expenses................. (491.6) (257.7) (210.2)
Equity securities.................................................................... (7.5) (1.8) 11.5
Mortgages............................................................................ (1.4) (1.9) (3.2)
Other-than-temporary decline in fair value of equity securities and
other invested assets............................................................ (56.2) (68.5) (41.2)
Loss related to termination of interest rate swap agreements......................... - - (59.2)
Other ............................................................................... .4 (10.1) (2.4)
------- ------- -------
Net investment losses before expenses....................................... (556.3) (340.0) (304.7)
Investment expenses.................................................................. 40.7 39.4 41.8
------- ------- -------
Net investment losses....................................................... $(597.0) $(379.4) $(346.5)
======= ======= =======
Net realized investment losses during 2002 included: (i) $556.8 million
of writedowns of fixed maturity investments, equity securities and other
invested assets as a result of conditions which caused us to conclude a decline
in fair value of the investment was other than temporary; and (ii) $40.2 million
of net losses from the sales of investments (primarily fixed maturities) which
generated proceeds of $19.5 billion. At December 31, 2002, fixed maturity
securities in default as to the payment of principal or interest had an
aggregate amortized cost of $203.9 million and a carrying value of $174.8
million. Net realized investment losses during 2001 included: (i) $361.7 million
of writedowns of fixed maturity investments, equity securities and other
invested assets as a result of conditions which caused us to conclude a decline
in fair value of the investment was other than temporary; and (ii) $17.7 million
of net losses from the sales of investments (primarily fixed maturities).
During 2002, we sold $11.3 billion of fixed maturity investments which
resulted in gross investment losses (before income taxes) of $251.8 million.
Securities sold at a loss are sold for a number of reasons including: (i)
changes in the investment environment; (ii) expectation that the market value
could deteriorate further; (iii) desire to reduce our exposure to an issuer or
an industry; (iv) changes in credit quality; and (v) our analysis indicating
there is a high probability that the security is other-than-temporarily
impaired.
The following summarizes the investments sold at a loss during 2002 which
had been continuously in an unrealized loss position exceeding 20 percent of the
amortized cost basis prior to the sale for the period indicated:
At date of sale
-----------------
Number of Amortized Estimated Fair
Period issuers cost value
------ ------- ---- -----
(Dollars in millions)
Less than 6 months prior to sale....................... 90 $231.3 $130.4
Greater than or equal to 6 and less than 12 months
prior to sale....................................... 28 79.2 43.1
Greater than 12 months
prior to sale....................................... 24 79.3 48.8
F - 78
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Investments with Other-Than-Temporary Losses
During 2002, we recorded writedowns of fixed maturity investments, equity
securities and other invested assets totaling $556.8 million. The following is a
brief description of the facts and circumstances that resulted in the
other-than-temporary losses.
During 2002, we recorded writedowns totaling $130.1 million on
securitized investments backed by various debt securities and/or commercial
loans (referred to herein as "collateralized debt obligations" or "CDOs").
Principal and interest payments on CDOs are made from cash flows from underlying
loans held by the trusts. The current value of these investments are influenced
by a number of factors, such as the performance of the underlying loans, the
current and future expected economic environment, and the payment priority of
our investment in the securitization structure. In recent periods, general rates
of defaults on commercial loans have increased. In addition, the ratings of
several CDOs which we hold have been downgraded by nationally recognized
statistical rating organizations. Accordingly, we reviewed our CDO portfolio for
potential other-than-temporary impairments in accordance with EITF 99-20.
During 2002, we recorded writedowns totaling $73.7 million related to
fixed maturity investments issued by a merchant energy company rated B3/B-. The
issuer's operating results and liquidity have deteriorated due to lower energy
prices, diminished energy trading profits and higher working capital demands.
Although the issuer has successfully executed certain cash raising activities
and has remained in compliance with the terms of all of its debt securities, its
earnings have significantly declined and its debt service requirements are
significant. We concluded the decline in fair value was other than temporary.
During 2002, we recorded writedowns totaling $67.8 million on certain
lower-rated securities issued by the non-consolidated securitization trusts
which hold loans to purchase manufactured housing originated and managed by CFC.
These securities were acquired by our insurance subsidiaries prior to our
acquisition of CFC. Due to the performance of the underlying portfolios, the
payments on lower-priority securities are dependent on the guarantees of CFC.
Given the current financial condition of CFC, there can be no assurance it will
be able to honor its commitments with respect to such guarantees. Accordingly,
we wrote these investments down to estimated fair value.
During 2002, we recorded writedowns totaling $29.9 million related to
investments in a large capitalization stock fund, a balanced fund, and a
diversified science and technology fund. The events of September 11, 2001 caused
a decline in the value of most equity securities, including net assets in these
funds. Based on the belief that the economy was improving at year-end 2001,
combined with the general equity market improvement in late 2001, we concluded
that the unrealized loss at December 31, 2001 was temporary. However, the equity
markets in the first half of 2002 suffered additional significant losses due to
a combination of corporate restatements, fears over a double-dip recession and
decreased corporate capital spending. We changed our intent to hold these funds
once we concluded that the loss was other than temporary. All of our holdings in
such funds were sold by August 5, 2002.
During 2002, we recorded writedowns totaling $30.2 million related to an
investment in a telecommunications company that was rated investment grade at
the time of purchase and was subsequently downgraded to below-investment grade.
The issuer faced significant financial difficulties and accounting
irregularities that resulted in sequential and material restatements of its
financial statements. The issuer defaulted and filed for Chapter 11 Bankruptcy
protection in July 2002.
During 2002, we recorded writedowns totaling $24.5 million related to
holdings of fixed maturity investments in a retail chain that defaulted in early
2002. A writedown was taken as of December 31, 2001 based upon the estimated
fair value of the investment at that time. Given the subsequent decrease in the
estimated fair value of our investment, subsequent writedowns were taken in
2002.
During 2002, we recorded writedowns totaling $26.5 million based upon our
analysis of the value of the underlying collateral of various investments in the
airline sector. Many major airlines are facing significant liquidity issues and
we believe the current market value of the collateral backing these loans is
less than the book value of our investment. We believe that the decline in fair
value of these investments is other than temporary.
During 2002, we recorded writedowns totaling $10.8 million on a fixed
maturity investment in an Australian nickel mining company. The construction
costs of the processing plant at this start-up nickel project were higher than
anticipated and the plant's ultimate production capacity did not meet projected
levels. Initially, the project's equity sponsors supported this project through
additional equity and cash infusions. However, during the first six months of
2002, the equity sponsors notified bond investors that they were no longer
willing to support the project without a restructuring of the issuer's debt. As
a result, we believe the decline in market value of this security is other than
temporary.
F - 79
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
During 2002, we recorded writedowns totaling $9.4 million of fixed
maturity investments issued by a global energy services company. The issuer is
suffering from reduced profitability due to declining energy prices in key
markets plus the effect of above market purchase contracts. Due to very high
financial leverage related to several acquisitions at high prices and diminished
cash flows, we believe that the decline in fair value is other than temporary.
During 2002, we recorded writedowns totaling $8.5 million related to
investments issued by a moving and storage company. The issuer failed to make a
scheduled principal payment on a public debt security. The issuer recently
cancelled a proposed offering of long-term notes. While the issuer has publicly
expressed its intention and belief that a successful refinancing can be
completed, we believe that the decline in market value of this security is other
than temporary.
During 2002, we recorded writedowns of $8.1 million of fixed maturity
investments issued by a copper producer. The financial condition of this issuer
is significantly affected by the price of copper, which has dropped from as high
as $0.80 per pound earlier this year to a low of $0.68 near the end of the
second quarter. In addition, the issuer was downgraded by a national rating
agency during the first six months of 2002. Despite the fact that the issuer was
still making the coupon payments on this issue, we believed that the decline in
market value of this security was other than temporary. All of our holdings in
this issuer were sold by August 8, 2002.
During 2002, in addition to the specific securities discussed above, we
recorded $105.3 million of writedowns related to various other investments. In
accordance with GAAP, we are required to recognize an impairment charge when we
no longer have an intent to hold an investment with unrealized loss for a period
of time sufficient to allow for any anticipated recovery. In early 2003, we sold
certain securities at a loss in conjunction with decisions made in 2003 to
restructure our portfolio by reducing our exposure to certain credits. We
recorded $32.0 million of investment writedowns in 2002 related to such sales.
No other writedowns of a single issuer exceeded $7.0 million.
Recognition of Losses
We regularly evaluate all of our investments for possible impairment
based on current economic conditions, credit loss experience and other
investee-specific developments. If there is a decline in a security's net
realizable value that is other than temporary, the decline is recognized as a
realized loss and the cost basis of the security is reduced to its estimated
fair value.
Our evaluation of investments for impairment requires significant
judgments to be made including: (i) the identification of potentially impaired
securities; (ii) the determination of their estimated fair value; and (iii)
assessment of whether any decline in estimated fair value is other than
temporary. If new information becomes available or the financial condition of
the investee changes, our judgments may change resulting in the recognition of
an investment loss at that time.
Our periodic assessment of whether unrealized losses are "other than
temporary" requires significant judgment. Factors considered include: (i) the
extent to which market value is less than the cost basis; (ii) the length of
time that the market value has been less than cost; (iii) whether the unrealized
loss is event driven, credit-driven or a result of changes in market interest
rates; (iv) the near-term prospects for improvement in the issuer and/or its
industry; (v) whether the investment is investment-grade and our security
analyst's view of the investment's rating and whether the investment has been
downgraded since its purchase; (vi) whether the issuer is current on all
payments in accordance with the contractual terms of the investment and is
expected to meet all of its obligations under the terms of the investment; (vii)
our ability and intent to hold the investment for a period of time sufficient to
allow for any anticipated recovery; and (viii) the underlying asset and
enterprise values of the issuer.
If a decline in value is determined to be other than temporary and the
cost basis of the security is written down to fair value, we review the
circumstances which caused us to believe that the decline was other than
temporary with respect to other investments in our portfolio. If such
circumstances exist with respect to other investments, those investments are
also written down to fair value. Future events may occur, or additional or
updated information may become available, which may necessitate future realized
losses of securities in our portfolio. Significant losses in the carrying value
of our investments could have a material adverse effect on our earnings in
future periods.
The following table sets forth the amortized cost and estimated fair
value of those actively managed fixed maturities with unrealized losses at
December 31, 2002, by contractual maturity. Actual maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties. Most of the
mortgage-backed securities shown below provide for periodic payments throughout
their lives.
F - 80
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Estimated
Amortized fair
cost value
--------- ---------
(Dollars in millions)
Due in one year or less................................................................... $ 57.3 $ 56.9
Due after one year through five years..................................................... 259.7 241.0
Due after five years through ten years.................................................... 864.4 786.4
Due after ten years....................................................................... 3,108.9 2,716.0
-------- --------
Subtotal............................................................................... 4,290.3 3,800.3
Mortgage-backed securities (a)............................................................ 127.1 118.1
-------- --------
Total.................................................................................. $4,417.4 $3,918.4
======== ========
--------------------
(a) Includes below-investment grade mortgage-backed securities with an
amortized cost and estimated fair value of $6.8 million and $2.1 million,
respectively.
The following summarizes the investments in our portfolio rated
below-investment grade or classified as equity-type securities which have been
continuously in an unrealized loss position exceeding 20 percent of the cost
basis for the period indicated as of December 31, 2002:
Number Cost Unrealized Estimated
Period of issuers basis loss fair value
------ ---------- ----- ---- ----------
(Dollars in millions)
Less than 6 months(1)............................... 25 $190.2 $59.7 $130.5
Greater than or equal to
6 months and less
than 12 months(2)........................... 10 97.4 37.5 59.9
Greater than 12 months(3)........................... 21 238.4 76.4 162.0
-----------------------
(1) These investments include fixed maturity investments in three
commercial airlines with a cost basis of $35.2 million and an
estimated fair value of $20.0 million. See "Investments with
Unrealized Losses" for additional information. No other single
issuer in this category had an unrealized loss exceeding $7.0
million.
(2) These investments include: (i) an investment in an oil-related
production facility with a cost basis of $50.4 million and an
estimated fair value of $33.0; and (ii) an investment in a
telecommunications company with a cost basis of $19.7 million and
an estimated fair value of $10.6 million. See "Investments with
Unrealized Losses" for additional information. No other single
issuer in this category had an unrealized loss exceeding $7.0
million.
(3) These investments include: (i) a fixed maturity investment issued
by a commercial property and casualty insurance company with a
cost basis of $31.6 million and an estimated fair value of $24.1
million; and (ii) a fixed maturity investment in a
telecommunications company with a cost basis of $34.4 million and
an estimated fair value of $21.9 million; and (iii) a fixed
maturity investment issued by a regional retail chain with an
amortized cost basis of $28.8 million and an estimated fair value
of $20.1 million. See "Investments with Unrealized Losses" for
additional information. No other single issuer in this category
had an unrealized loss exceeding $7.0 million.
F - 81
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Our investment strategy is to maximize investment income and total
investment return through active investment management. Accordingly, we may sell
securities at a gain or a loss to enhance the total return of the portfolio as
market opportunities change. While we have both the ability and intent to hold
securities with unrealized losses until they mature or recover in value, we may
sell securities at a loss in the future because of actual or expected changes in
our view of the particular investment, its industry, its type or the general
investment environment.
Based on management's current assessment of these securities and other
investments with unrealized losses at December 31, 2002, the Company believes
the issuers of the securities will continue to meet their obligations (or with
respect to equity-type securities, the investment value will recover to its cost
basis). The Company has no current plans to sell these securities and has the
ability to hold them to maturity. The recognition of an other-than-temporary
impairment through a charge to earnings may be recognized in future periods if
management later concludes that the decline in market value below the cost basis
is other than temporary.
Investments with Unrealized Losses
The following is a brief description of our assessment of the potential
other-than-temporary losses related to investments in our below-investment grade
portfolio (or equity-type securities) with significant unrealized losses at
December 31, 2002 (unrealized losses which exceed $7.0 million and 20 percent of
the cost basis of the securities by the same issuer):
At December 31, 2002, we held fixed maturity investments issued by a
telecommunications company with ratings of Ba3/B- and Caa1/C with an amortized
cost basis of $54.1 million and an estimated fair value of $32.6 million. The
issuer reduced total debt in the fourth quarter of 2002 by $4.6 billion due to
the closing of a sales transaction and a debt exchange offer. The issuer also
expects to receive regulatory approval to close a $4.3 billion transaction in
mid-2003, the proceeds of which will be used to further reduce debt. We believe
that the issuer has sufficient liquidity and the underlying value of the
issuer's customer base provides sufficient value to cover the existing debt.
Therefore, we concluded that the unrealized loss at December 31, 2002 is
temporary.
At December 31, 2002, we held fixed maturity investments in an
oil-related production facility rated Ba1 with an amortized cost basis of $53.9
million and an estimated fair value of $35.5 million. Proceeds from the sale of
the oil produced are used to service the debt. This joint venture includes
purchase guarantees from investment grade companies that will provide sufficient
liquidity to service the debt. Therefore, we concluded that the unrealized loss
at December 31, 2002 is temporary.
At December 31, 2002, we held fixed maturity investments issued by a
commercial property and casualty insurance company rated Ba2/BB+ with an
amortized cost basis of $32.1 million and an estimated fair value of $24.5
million. We believe this issuer currently has sufficient liquidity to cover its
debt service through 2005. They believe the underwriting cycle will improve
before then (consistent with prior cycles), allowing the issuer to continue to
service its debt beyond 2005. In addition, this issuer recently completed the
public issuance of equity securities, which further improves its liquidity and
demonstrates the ability to access the capital market, if needed, to service its
future debt obligations. Therefore, we concluded that the unrealized loss at
December 31, 2002 is temporary.
At December 31, 2002, we held secured fixed maturity investments issued
by a commercial airline rated Ba2/BB+ with an amortized cost of $17.2 million
and an estimated fair value of $10.5 million. The issuer is facing financial
challenges that affect the entire industry, but is implementing a plan to
increase liquidity, reduce debt and reduce costs. Given that the issuer has
demonstrated that it has sufficient cash flows and liquidity to meet its
obligations, we concluded that the unrealized loss at December 31, 2002 is
temporary.
At December 31, 2002, we held fixed maturity investments issued by a
commercial airline rated Ba3/B+ and Caa1/CCC+ with an amortized cost of $29.8
million and an estimated fair value of $14.4 million. We previously recorded
writedowns related to these securities. We believe the collateral supporting
these investments is sufficient and, therefore, concluded that the unrealized
loss at December 31, 2002 is temporary.
At December 31, 2002, we held fixed maturity investments issued by a
regional retail chain rated B2/B+ with an amortized cost basis of $28.8 million,
a par amount of $24.2 million and an estimated fair value of $20.1 million. We
have observed that this issuer has improving fundamentals including its
liquidity position, leverage and operating performance. This fixed maturity has
a long duration and was purchased at a price in excess of par as an investment
grade credit. The market value of this security has increased significantly
during 2002 (from 70 percent of par at December 31, 2001 to 83 percent of par at
December 31, 2002). We believe that
F - 82
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
we will recover full value from this investment and we intend to hold the
security to maturity. Therefore, we concluded that the unrealized loss at
December 31, 2002 is temporary.
At December 31, 2002 we held fixed maturity investments in a reinsurance
company rated Ba2/BB+ with an amortized cost of $23.1 million and an estimated
fair value of $16.0 million. The reinsurance on the books of the issuer is high
quality, with counter parties rated AA or better. The issuer recently received a
capital infusion and is seeing strong price increases across most product lines.
The issuer appears to have sufficient cash flow to retire existing debt. We
concluded that the unrealized loss at December 31, 2002 is temporary.
Investment in General Motors Building
At December 31, 2002, Conseco holds $292.9 million of investments related
to a 50 story office building in New York City known as the General Motors
Building. Such investments are primarily held in our fixed maturity investment
portfolio. In January 2002, Conseco exercised its right to purchase the interest
of the other investor in the building.
Pursuant to GAAP, Conseco's future earnings on these investments are
limited to amounts which are based on the actual earnings related to the
operation of the building (including adjustments to reflect Conseco's actual
cost basis). These earnings were not material in 2002 and are not expected to be
material in 2003; accordingly, our income from these investments will be less
than the stated return on the investment of 12.7 percent.
The other investor in the building has filed a lawsuit against Conseco
which is described in the note to the consolidated financial statements entitled
"Other Disclosures". See the caption "Investment in General Motors Building" in
the note to the consolidated financial statements entitled "Investments in
Variable Interest Entities" for further information on this investment.
Mortgage-Backed Securities
At December 31, 2002, fixed maturity investments included $6.4 billion of
mortgage-backed securities (or 33 percent of all fixed maturity securities). The
yield characteristics of mortgage-backed securities differ from those of
traditional fixed-income securities. Interest and principal payments for
mortgage-backed securities occur more frequently, often monthly. Mortgage-backed
securities are subject to risks associated with variable prepayments. Prepayment
rates are influenced by a number of factors that cannot be predicted with
certainty, including: the relative sensitivity of the underlying mortgages
backing the assets to changes in interest rates; a variety of economic,
geographic and other factors; and the repayment priority of the securities in
the overall securitization structures.
In general, prepayments on the underlying mortgage loans and the
securities backed by these loans increase when prevailing interest rates decline
significantly relative to the interest rates on such loans. The yields on
mortgage-backed securities purchased at a discount to par will increase when the
underlying mortgages prepay faster than expected. The yields on mortgage-backed
securities purchased at a premium will decrease when they prepay faster than
expected. When interest rates decline, the proceeds from the prepayment of
mortgage-backed securities are likely to be reinvested at lower rates than we
were earning on the prepaid securities. When interest rates increase,
prepayments on mortgage-backed securities decrease as fewer underlying mortgages
are refinanced. When this occurs, the average maturity and duration of the
mortgage-backed securities increase, which decreases the yield on
mortgage-backed securities purchased at a discount, because the discount is
realized as income at a slower rate, and increases the yield on those purchased
at a premium as a result of a decrease in the annual amortization of the
premium.
F - 83
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The following table sets forth the par value, amortized cost and
estimated fair value of mortgage-backed securities, summarized by interest rates
on the underlying collateral at December 31, 2002:
Par Amortized Estimated
value cost fair value
----- ---- ----------
(Dollars in millions)
Below 7 percent..................................................................... $4,895.4 $4,857.3 $5,125.2
7 percent - 8 percent............................................................... 1,000.4 1,007.6 1,059.1
8 percent - 9 percent............................................................... 171.9 179.8 187.1
9 percent and above................................................................. 42.1 44.2 44.8
-------- -------- --------
Total mortgage-backed securities (a)......................................... $6,109.8 $6,088.9 $6,416.2
======== ======== ========
-------------------
(a) Includes below-investment grade mortgage-backed securities with an
amortized cost and estimated fair value of $6.9 million and $2.1 million,
respectively.
The amortized cost and estimated fair value of mortgage-backed securities
at December 31, 2002, summarized by type of security, were as follows:
Estimated fair value
--------------------
Percent
Amortized of fixed
Type cost Amount maturities
---- ---- ------ ----------
(Dollars in millions)
Pass-throughs and sequential and targeted amortization classes............ $2,849.5 $3,000.8 16%
Planned amortization classes and accretion-directed bonds................. 2,439.8 2,580.6 13
Commercial mortgage-backed securities..................................... 441.3 461.4 2
Subordinated classes and mezzanine tranches............................... 348.7 365.7 2
Other..................................................................... 9.6 7.7 -
-------- -------- --
Total mortgage-backed securities (a)............................... $6,088.9 $6,416.2 33%
======== ======== ==
-------------------------
(a) Includes below-investment grade mortgage-backed securities with an
amortized cost and estimated fair value of $6.9 million and $2.1 million,
respectively.
Pass-throughs and sequential and targeted amortization classes have
similar prepayment variability. Pass-throughs historically provide the best
liquidity in the mortgage-backed securities market. Pass-throughs are also used
frequently in the dollar roll market and can be used as the collateral when
creating collateralized mortgage obligations. Sequential classes are a series of
tranches that return principal to the holders in sequence. Targeted amortization
classes offer slightly better structure in return of principal than sequentials
when prepayment speeds are close to the speed at the time of creation.
Planned amortization classes and accretion-directed bonds are some of the
most stable and liquid instruments in the mortgage-backed securities market.
Planned amortization class bonds adhere to a fixed schedule of principal
payments as long as the underlying mortgage collateral experiences prepayments
within a certain range. Changes in prepayment rates are first absorbed by
support or companion classes. This insulates the planned amortization class from
the consequences of both faster prepayments (average life shortening) and slower
prepayments (average life extension).
Commercial mortgage-backed securities ("CMBS") are bonds secured by
commercial real estate mortgages. Commercial real estate encompasses income
producing properties that are managed for economic profit. Property types
include multi-family dwellings including apartments, retail centers, hotels,
restaurants, hospitals, nursing homes, warehouses, and office buildings. The
CMBS market currently offers high yields, strong credits, and call protection
compared to similar-rated corporate bonds. Most CMBS have strong call protection
features where borrowers are locked out from prepaying their mortgages for a
stated period of time. If the
F - 84
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
borrower does prepay any or all of the loan, he or she will be required to pay
prepayment penalties.
Subordinated and mezzanine tranches are classes that provide credit
enhancement to the senior tranches. The rating agencies require that this credit
enhancement not deteriorate due to prepayments for a period of time, usually
five years of complete lockout, followed by another period of time where
prepayments are shared pro rata with senior tranches. The credit risk of
subordinated and mezzanine tranches is derived from owning a small percentage of
the mortgage collateral, while bearing a majority of the risk of loss due to
property owner defaults. Subordinated bonds can be rated "AA" or lower; we
typically do not buy anything rated lower than "BB".
Mortgage Loans
At December 31, 2002, the mortgage loan balance was primarily comprised
of commercial loans. Approximately 9 percent, 8 percent, 7 percent, 6 percent, 6
percent and 6 percent of the mortgage loan balance were on properties located in
New York, Massachusetts, Florida, California, Ohio and Pennsylvania,
respectively. No other state comprised greater than 5 percent of the mortgage
loan balance. Less than one percent of the mortgage loan balance was noncurrent
at December 31, 2002. Our allowance for loss on mortgage loans was $3.5 million
and $3.8 million at December 31, 2002 and 2001, respectively.
Investment Borrowings
Our investment borrowings averaged approximately $1,155.8 million during
2002, compared with approximately $927.0 million during 2001 and were
collateralized by investment securities with fair values approximately equal to
the loan value. The weighted average interest rates on such borrowings were 1.3
percent and 3.3 percent during 2002 and 2001, respectively.
Other Investment Disclosures
Life insurance companies are required to maintain certain investments on
deposit with state regulatory authorities. Such assets had an aggregate carrying
value of $144.5 million at December 31, 2002.
Conseco had two investments in excess of 10 percent of the absolute
dollar amount of shareholders' deficit at December 31, 2002, (other than
investments issued or guaranteed by the United States government or a United
States government agency) which are summarized below:
Amortized Estimated
Issuer cost fair value
------ ---- ----------
(Dollars in millions)
Investors Guaranty Assurance........... $305.0 $283.7
Carmel Fifth, LLC...................... 212.7 212.5
F - 85
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
6. LIABILITIES FOR INSURANCE AND ASSET ACCUMULATION PRODUCTS:
These liabilities consisted of the following:
Interest
Withdrawal Mortality rate
assumption assumption assumption 2002 2001
---------- ---------- ---------- ---- ----
(Dollars in millions)
Future policy benefits:
Interest-sensitive products:
Investment contracts............................ N/A N/A (c) $ 9,203.6 $11,117.1
Universal life-type contracts................... N/A N/A N/A 4,265.9 4,670.6
--------- ---------
Total interest-sensitive products............. 13,469.5 15,787.7
--------- ---------
Traditional products:
Traditional life insurance contracts............ Company (a) 6% 1,821.3 2,091.5
experience
Limited-payment contracts....................... Company (b) 7% 569.7 869.9
experience,
if applicable
Individual and group accident and health ....... Company Company 6% 5,580.4 5,211.4
experience experience --------- ---------
Total traditional products.................... 7,971.4 8,172.8
--------- ---------
Claims payable and other policyholder funds ........ N/A N/A N/A 909.2 1,005.5
Liabilities related to separate accounts and
investment trust.................................. N/A N/A N/A 447.0 2,376.3
--------- ---------
Total........................................... $22,797.1 $27,342.3
========= =========
--------------------
(a) Principally, modifications of the 1965 - 70 and 1975 - 80 Basic, Select
and Ultimate Tables.
(b) Principally, the 1984 United States Population Table and the NAIC 1983
Individual Annuitant Mortality Table.
(c) In both 2002 and 2001: (i) approximately 96 percent of this liability
represented account balances where future benefits are not guaranteed;
and (ii) approximately 4 percent represented the present value of
guaranteed future benefits determined using an average interest rate of
approximately 6 percent.
F - 86
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Changes in the unpaid claims reserve and liabilities related to accident
and health insurance were as follows:
2002 2001 2000
---- ---- -----
(Dollars in millions)
Balance, beginning of year............................. $1,324.2 $1,324.9 $1,224.7
Less reinsurance ceded.............................. (132.7) (89.7) (85.5)
-------- -------- --------
1,191.5 1,235.2 1,139.2
-------- -------- --------
Incurred claims related to:
Current year........................................ 1,906.5 1,986.4 2,053.1
Prior year (a)...................................... 73.1 (19.5) 55.0
-------- -------- --------
Total incurred................................... 1,979.6 1,966.9 2,108.1
-------- -------- --------
Paid claims related to:
Current year........................................ 1,137.9 1,232.4 1,277.4
Prior year.......................................... 699.3 778.2 734.7
-------- -------- --------
Total paid....................................... 1,837.2 2,010.6 2,012.1
-------- -------- --------
Balance, end of year................................... 1,333.9 1,191.5 1,235.2
Reinsurance ceded................................... 107.5 132.7 89.7
-------- -------- --------
$1,441.4 $1,324.2 $1,324.9
======== ======== ========
-------------
(a) Such amounts will fluctuate based upon the estimation procedures used to
determine the amount of unpaid losses. Such estimates are the result of
ongoing analysis related to recent loss development trends.
F - 87
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
7. INCOME TAXES:
Our income tax expense includes deferred income taxes arising from
temporary differences between the financial reporting and tax bases of assets
and liabilities, capital loss carryforwards and net operating loss
carryforwards. The net deferred tax assets totaled $1,719.6 million at December
31, 2002 (including $925.7 million of deferred tax assets related to CFC which
are classified as discontinued operations). In assessing the realization of our
deferred income tax assets, we consider whether it is more likely than not that
the deferred income tax assets will be realized. The ultimate realization of our
deferred income tax assets depends upon generating future taxable income during
the periods in which our temporary differences become deductible and before our
net operating loss carryforwards expire. We evaluate the realizability of our
deferred income tax assets by assessing the need for a valuation allowance on a
quarterly basis. A valuation allowance of $1,719.6 million (of which $925.7
million relates to discontinued operations) has been provided for the entire
balance of net deferred income tax assets at December 31, 2002, as we believe
the realization of such assets in future periods is uncertain. We reached this
conclusion after considering the availability of taxable income in prior
carryback years, tax planning strategies, and the likelihood of future taxable
income exclusive of reversing temporary differences and carryforwards. This
conclusion was greatly influenced by recent unfavorable developments affecting
the Company such as rating downgrades that decrease the Company's likelihood to
generate adequate future taxable income to realize the tax benefits.
F - 88
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The Company established valuation contingencies related to certain tax
uncertainties of the insurance companies we acquired on the date of their
acquisition. We have determined that $146.2 million of such valuation
contingencies are no longer necessary because the tax uncertainties no longer
exist. Pursuant to Statement of Financial Accounting Standards Statement No.
109, "Accounting for Income Taxes", the benefit for the reduction of such
valuation contingencies shall be first applied to reduce the goodwill balance
related to the acquisition. Accordingly, in the second quarter of 2002, we
reduced such valuation contingencies (increasing deferred tax asset) and reduced
goodwill by $146.2 million. The components of the Company's income tax assets
and liabilities were as follows:
2002 2001
---- ----
(Dollars in millions)
Deferred tax assets:
Net operating loss carryforwards.................................................. $ 615.0 $ 411.7
Deductible temporary differences:
Actively managed fixed maturities.............................................. 196.0 124.9
Capital loss carryforwards..................................................... 112.8 -
Interest-only securities....................................................... 536.3 -
Insurance liabilities.......................................................... 750.4 827.5
Allowance for loan losses...................................................... 252.2 148.2
Reserve for loss on loan guarantees............................................ 229.2 147.0
Unrealized depreciation........................................................ - 247.1
Debt obligations............................................................... 39.4 -
Other.......................................................................... 14.0 -
-------- --------
Total deferred tax assets.................................................... 2,745.3 1,906.4
Valuation allowance............................................................ 1,719.6 -
-------- --------
Net deferred tax assets...................................................... 1,025.7 1,906.4
-------- --------
Deferred tax liabilities:
Venture capital income (loss).................................................. - (36.7)
Interest-only securities....................................................... - (75.2)
Cost of policies purchased and cost of policies produced....................... (773.8) (1,075.6)
Unrealized appreciation........................................................ (126.2) -
Other.......................................................................... (125.7) (56.2)
-------- --------
Total deferred tax liabilities............................................... (1,025.7) (1,243.7)
-------- --------
Current income taxes prepaid.......................................................... 66.9 15.4
Income tax liabilities classified as liabilities of discontinued operations........... 34.6 -
-------- --------
Net income tax assets........................................................ $ 101.5 $ 678.1
======== ========
Included in the components of the consolidated net deferred tax asset are
$925.7 million of net deferred tax assets related to CFC (see the note entitled
"Financial Information Regarding CFC" for further detail). These assets are
offset by a $925.7 million valuation reserve. The CFC deferred taxes are
presented assuming a continuation of its business. The actual realization of
CFC's deferred items may be materially different as the result of the conclusion
of bankruptcy proceedings and the disposition of certain businesses.
At December 31, 2002, Conseco had federal income tax loss carryforwards
of $1,757.4 million available (subject to various statutory restrictions) for
use on future tax returns (including $552.4 million of federal income tax
carryforwards attributable to discontinued operations). These carryforwards will
expire as follows: $2.3 million in 2003; $11.2 million in 2004; $4.9 million in
2005; $.6 million in 2006; $7.9 million in 2007; $7.5 million in 2008; $14.7
million in 2009; $30.7 million in 2010; $6.2 million in 2011; $10.1 million in
2012; $43.9 million in 2013; $6.9 million in 2014; $60.5 million in 2016; $90.0
million in 2017; $244.6 million in 2018; $159.1 million in 2019; $594.3 million
in 2020; and $462.0 million in 2022.
F - 89
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
At December 31, 2002, Conseco had $322.4 million of capital loss
carryforwards. These carryforwards will expire as follows: $23.2 million in
2006; and $299.2 million in 2007.
Income tax expense (benefit) was as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Current tax provision..................................................................... $ 53.1 $ 132.2 $ 65.9
Deferred tax provision (benefit).......................................................... - (195.7) (232.1)
------ ------- -------
Income tax expense (benefit) on period income.................................... 53.1 (63.5) (166.2)
Valuation allowance....................................................................... 811.2 - -
------ ------- -------
Total income tax expense (benefit)............................................... $864.3 $ (63.5) $(166.2)
====== ======= =======
The income tax expense (benefit) recorded in 2002 has been allocated
entirely to continuing operations before the following items: minority interest,
discontinued operations, extraordinary gain, cumulative effect of accounting
change and other comprehensive income. This accounting treatment is required
because the calculation of income tax expense is the same, both "with and
without" the items other than continuing operations discussed above.
A reconciliation of the U.S. statutory corporate tax rate to the
effective rate reflected in the consolidated statement of operations is as
follows:
2002 2001 2000
---- ---- ----
U.S. statutory corporate rate............................................................. (35.0)% (35.0)% (35.0)%
Valuation allowance....................................................................... 49.6 - -
Net deferred benefits not recognized in the current period................................ 27.7 - -
Nondeductible goodwill amortization and impairment........................................ 10.9 15.9 5.1
Other nondeductible expenses.............................................................. (.1) (1.6) 3.8
State taxes............................................................................... (.2) 3.0 1.2
Provision for tax issues and other........................................................ - (6.7) 3.3
----- ----- -----
Effective tax rate............................................................... 52.9% (24.4)% (21.6)%
===== ===== =====
Conseco and its affiliates are currently under examination by the
Internal Revenue Service for tax years ending June 30, 1998 through December 31,
1999. The outcome of the examination is not expected to result in material
adverse deficiencies, but may result in utilization or adjustment to the income
tax loss carryforwards reported above.
F - 90
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
8. NOTES PAYABLE:
Direct Corporate Obligations of CNC
This note contains information regarding notes payable that were direct
corporate obligations of CNC as of December 31, 2002 and 2001. As a result of
the filing of the Chapter 11 Cases previously described, no payments have been
made by CNC on these prepetition notes payable:
December 31, December 31,
2002 2001
---- ----
(Dollars in millions)
$1.5 billion Senior Credit Facility.......................................... $1,531.4 $1,493.3
8.5% senior notes due 2002................................................... 224.9 302.3
8.5% guaranteed senior notes due 2003........................................ 1.0 -
8.125% senior notes due 2003................................................. 63.5 63.5
6.4% senior notes due 2003................................................... 234.1 250.0
6.4% guaranteed senior notes due 2004........................................ 14.9 -
10.5% senior notes due 2004.................................................. 24.5 24.5
8.75% senior notes due 2004.................................................. 423.7 788.0
8.75% guaranteed senior notes due 2006....................................... 364.3 -
6.8% senior notes due 2005................................................... 99.2 250.0
6.8% guaranteed senior notes due 2007........................................ 150.8 -
9.0% senior notes due 2006................................................... 150.8 550.0
9.0% guaranteed senior notes due 2008........................................ 399.2 -
10.75% senior notes due 2008................................................. 37.6 400.0
10.75% guaranteed senior notes due 2009...................................... 362.4 -
-------- --------
Total principal amount.................................................. 4,082.3 4,121.6
Unamortized net discount related to issuance of notes payable ............... (34.0) (42.1)
Mark-to-market adjustment related to hedging transactions (as described in
the note entitled "Summary of Significant Accounting Policies")....... - 5.5
Unamortized fair market value of terminated interest rate swap
agreements (as described in the note entitled "Summary of
Significant Accounting Policies")..................................... 8.8 -
-------- --------
Less amounts subject to compromise........................................... (4,057.1) -
-------- --------
Direct corporate obligations............................................ $ - $4,085.0
======== ========
CNC has not made any interest or principal payments on any of its direct
corporate obligations since its August 9, 2002 announcement that it intends to
effectuate a fundamental restructuring of the Company's capital structure. As a
result of its failure to make such payments and the filing of the Chapter 11
Cases, CNC has defaulted on its debt obligations, $481.3 million of principal
amount of the guaranteed D&O loans and approximately $1.9 billion of trust
preferred securities through cross-default provisions contained in the governing
instruments. CNC is also not in compliance with certain covenants under its bank
credit agreement and the guarantees of the D&O loans. During the reorganization
proceedings the Debtors are not subject to the restrictions contained in the
bank credit agreement and the guarantees of the D&O loans.
CNC has a $1.5 billion credit facility (the "Senior Credit Facility")
with Bank of America, N.A., as administrative agent, and various other lending
institutions. The Senior Credit Facility was scheduled to mature on December 31,
2003. Approximately $38 million of accrued and unpaid interest was added to the
outstanding principal amount of the Senior Credit Facility pursuant to a waiver
dated September 8, 2002.
In 1993, CNC issued $200 million of 8.125% senior notes due February 15,
2003 (the "93 Notes"). In 1994, CCP Insurance, Inc. ("CCP") issued $200 million
of 10.5% senior notes due December 15, 2004 (the "94 Notes"). CNC acquired CCP
by merger on
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CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
August 31, 1995 and assumed CCP's obligations under the 94 Notes in connection
with the merger.
We sometimes refer to the 93 Notes and the 94 Notes collectively as the
"93/94 Notes." The 93/94 Notes are secured by the stock of CIHC, Conseco Capital
Management, Inc. (a registered investment advisor and wholly-owned subsidiary of
CNC), CFC and certain of its subsidiaries and certain intercompany notes. It is
anticipated that substantially all of CFC's assets will be sold in connection
with the Company's reorganization. If certain of these assets have been pledged
to the holders of the 93/94 Notes, and if proceeds of these pledged assets are
used to pay the 93/94 Notes, then CFC may assert, by subrogation, the rights of
such holders against the Debtors.
The collateral that secures the 93/94 Notes was pledged pursuant to an
"equal and ratable" clause in the indentures governing the 93/94 Notes. The
indentures of the 93/94 Notes provide that if another creditor obtains a
security interest in certain property of CNC or any of its significant
subsidiaries, then the 93/94 Notes will automatically obtain an "equal and
ratable" security interest in such property. Certain parties have alleged that
the legal mechanism by which the 93/94 Notes obtained a security interest
somehow impairs that security interest. Such parties allege that because the
holders of the 93/94 Notes did not provide consideration for the security
interest that they received simply because another party received that security
interest, the 93/94 Notes' security interest may be voided under a theory of
unjust enrichment, fraudulent conveyance or lack of consideration. Wilmington
Trust Company, the indenture trustee under the 93/94 Notes, maintains that any
and all claims with respect to the avoidability of the 93/94 Notes are frivolous
and wholly without merit.
Between 1998 and 2001, CNC issued the following series of senior notes:
(i) $450,000,000 of 8.5% senior notes due October 15, 2002 (the "8.5% Original
Notes"); (ii) $250,000,000 of 6.4% senior notes due February 10, 2003 (the "6.4%
Original Notes"); (iii) $800,000,000 of 8.75% senior notes due February 9, 2004
(the "8.75% Original Notes"); (iv) $250,000,000 of 6.8% senior notes due June
15, 2005 (the "6.8% Original Notes"); (v) $550,000,000 of 9.0% senior notes due
October 15, 2006 (the "9.0% Original Notes"); and (vi) $400,000,000 of 10.75%
senior notes due June 15, 2008 (the "10.75% Original Notes").
In April 2002, CNC completed an exchange of approximately $1.3 billion
aggregate principal amount of newly issued guaranteed notes for its senior
unsecured notes held by "qualified institutional buyers," institutional
"accredited investors", or non-U.S. persons in transactions outside the United
States. The bonds which were exchanged have identical principal and interest
components, but the new bonds have extended maturities in exchange for an
enhanced ranking in the Company's capital structure. The purpose of the exchange
offer was to extend the maturity profile of the existing notes in an effort to
improve the Company's financial flexibility and to enhance its future ability to
refinance public debt. The new notes are guaranteed on a senior subordinated
basis by CIHC. As a result, the new notes are structurally senior to the
existing notes. The new notes were not registered under the Securities Act of
1933, as amended, and may not be offered or sold in the United States absent
registration or an exemption from registration. CNC entered into a registration
rights agreement for the benefit of each exchange participant in which we agreed
to file, and did file, an exchange offer registration statement with the SEC
with respect to the new notes. However, as a result of the decision to
restructure the Company's capital, CNC does not intend to make the registered
exchange offer. Accordingly, the affected notes will accrue additional interest
as liquidated damages under the registration rights agreement.
In connection with the exchange offer CNC issued: (i) $991,000 of 8.5%
senior notes due October 15, 2003, in exchange for an equal amount of 8.5%
Original Notes due October 15, 2002 (the "8.5% Exchange Notes"); (ii)
$14,936,000 of 6.4% senior notes due February 10, 2004 in exchange for an equal
amount of 6.4% Original Notes due February 10, 2003 (the "6.4% Exchange Notes");
(iii) $364,294,000 of 8.75% senior notes due August 9, 2006 in exchange for an
equal amount of 8.75% Original Notes due February 9, 2004 (the "8.75% Exchange
Notes"); (iv) $150,783,000 of 6.8% senior notes due June 15, 2007 in exchange
for an equal amount of 6.8% Original Notes due June 15, 2005 (the "6.8% Exchange
Notes"); (v) $399,200,000 of 9.0% senior notes due April 15, 2008 in exchange
for an equal amount of 9.0% Original Notes due October 15, 2006 (the "9.0%
Exchange Notes"); and (vi) $362,433,000 of 10.75% senior notes due June 15, 2009
in exchange for an equal amount of 10.75% Original Notes due June 15, 2008 (the
"10.75% Exchange Notes").
Effective March 20, 2002, CNC reached agreement with the participating
banks in its bank credit facility to modify certain terms and conditions within
the $1.5 billion Senior Credit Facility. The most significant changes in the
amended facility include (i) a change in financial covenant requirements; (ii) a
change in the distribution of proceeds on asset sales; (iii) a reduction in the
minimum liquidity requirement at the holding company necessary to pay trust
preferred dividends; and (iv) a provision permitting the Company to exchange up
to $2.54 billion aggregate principal amount of newly issued notes guaranteed by
CIHC. As noted above, the new notes are structurally senior to the existing
notes, but subordinated to the CIHC guarantee of the Senior Credit Facility.
Absent the default described above, the amended facility would have been due on
December 31, 2003, and could have been extended to March
F - 92
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
31, 2005, subject to the satisfaction of a number of conditions.
Our Senior Credit Facility requires the Company to maintain various
financial ratios and balances, as defined in the agreement. At December 31,
2002, we were not in compliance with these covenants in our Senior Credit
Facility. We were in violation of the following financial covenants we agreed to
maintain at December 31, 2002: (i) a debt to capitalization ratio of less than
..375:1.0 at December 31, 2002 and decreasing over time, as defined in the
agreement, to 0.300:1.0 at March 31, 2004 and thereafter (such ratio was
..567:1.0 at December 31, 2002); (ii) an interest coverage ratio greater than
1.10:1.0 for the four quarters ending December 31, 2002 and changing over time,
as defined in the agreement, to 2.50:1.0 for the four quarters ending June 30,
2004 and thereafter (such ratio was .11:1.0 for the four quarters ended December
31, 2002); (iii) adjusted earnings, as defined in the agreement, of at least
$1,300.0 million for the four quarters ending December 31, 2002 and increasing
over time, as defined in the agreement, to $1,700.0 million for the four
quarters ending September 30, 2004 (the adjusted earnings for the four quarters
ended December 31, 2002 were $926.7 million); and (iv) CFC tangible net worth,
as defined in the agreement, of at least $1.2 billion at December 31, 2002; and
$1.6 billion at March 31, 2005 (such tangible net worth was less than zero at
December 31, 2002). We also agreed to maintain the ratio of aggregate total
adjusted capital to aggregate authorized control level risk-based capital (as
defined by the National Association of Insurance Commissioners) with respect to
our insurance subsidiaries of at least 250 percent (such ratio was greater than
250 percent at December 31, 2002). Our amended credit facility provides that any
charges taken to write off goodwill to the extent required by SFAS 142 will be
excluded from the various financial ratios and covenants that we are required to
meet or maintain.
The Senior Credit Facility reduces the 90-day moving average cash balance
we must maintain at the parent company from $100 million to $50 million. The
Company is required to have at least $50 million of cash on hand immediately
after making a trust preferred dividend payment in addition to the 90-day moving
average requirement. The parent company had less than $50 million in cash at
December 31, 2002. The Senior Credit Facility also states that in the event one
of Conseco's significant insurance subsidiaries is rated "B" or below by A.M.
Best, the Company must take certain actions to generate liquidity and accelerate
the repayment of the amended credit facility. All of our significant insurance
subsidiaries are rated "B" by A.M. Best.
The Senior Credit Facility prohibits the payment of cash dividends on our
common stock until the Company has received investment grade ratings on its
outstanding public debt. Such agreement also prohibits the repurchase of our
common stock. The Senior Credit Facility limits the issuance of additional debt,
contingent obligations, liens, asset dispositions, other restrictive agreements,
affiliate transactions, change in business and modification of terms of debt or
preferred stock, all as defined in the agreements. The obligations under our
credit facility are also guaranteed by CIHC.
Effective September 9, 2002, we were subject to the default interest rate
on the Senior Credit Facility. Such rate is based on the prime rate plus a
margin of 3.75 percent. Prior to September 9, 2002, the interest rate on the
amended credit facility was based on an IBOR rate plus a margin of 3.25 percent.
Borrowings under our Senior Credit Facility averaged $1,499.2 million during
2002, at a weighted average interest rate of 6.0 percent. The interest rate on
the Senior Credit Facility was 8.0 percent at December 31, 2002.
On June 29, 2001, the Company completed the public offering of $400.0
million of senior notes with a stated rate of 10.75 percent (the "10.75%
Original Notes") due June 15, 2008. We entered into interest rate swap
agreements to convert the fixed rate on these notes to a weighted average
variable rate based on LIBOR plus approximately 5.75 percent. Such interest rate
swap agreements were terminated in 2002. See the note to the consolidated
financial statements entitled "Summary of Significant Accounting Policies" for
additional information on these interest rate swap agreements. The indenture for
the 10.75% Original Notes limits our ability to, among other things (all as
described in the indenture): (i) incur additional debt and issue preferred
stock; (ii) make loans and investments; (iii) pay dividends; (iv) create
additional loans on our assets; (v) engage in transactions with our affiliates;
(vi) consolidate, merge or transfer all or substantially all our assets; or
(vii) change lines of business. Most of the foregoing restrictions will expire
if the 10.75% Original Notes have been rated as investment grade securities by
either S & P or Moody's. The 10.75% Original Notes are unsecured and rank
equally with all other unsecured senior indebtedness of CNC. Proceeds from the
offering of approximately $385.9 million (after underwriting discounts and
estimated offering expenses) were used to reduce amounts outstanding under our
credit facilities. As a result, we recognized an extraordinary charge of $.4
million (net of an income tax benefit of $.2 million) in 2001.
During 2002, we repurchased: (i) $76.4 million par value of the 8.5%
Original Notes (resulting in an extraordinary gain of $1.7 million); and (ii)
$1.0 million of the 6.4% Original Notes (resulting in an extraordinary gain of
$.2 million).
During 2001, we repurchased: (i) $64.6 million par value of the 7.6%
senior notes due June 2001 (resulting in an extraordinary gain of $.3 million,
net of income taxes of $.2 million); and (ii) $147.7 million par value of the
8.5% Original Notes (resulting in an
F - 93
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
extraordinary gain of $15.8 million, net of income taxes of $8.5 million).
Pursuant to the terms of the Mandatory Par Put Remarketed Securities, the
Company elected to redeem the notes at a redemption price defined in the
remarketing agreement. As a result, the Company recognized an extraordinary
charge of $4.6 million (net of an income tax benefit of $2.5 million) in the
second quarter of 2001.
During 2000, we repurchased: (i) $18.5 million par value of the 7.875
percent notes due 2000 for $16.7 million; and (ii) $12 million par value of the
8.75% Original Notes for $8.7 million. We recognized an extraordinary gain of
$3.2 million (net of income taxes of $1.7 million) related to these repurchases.
In addition, during 2000, the Company repurchased $250 million of notes payable
due 2003. We recognized an extraordinary loss of $4.9 million (net of an income
tax benefit of $2.6 million) related to this repurchase.
9. OTHER DISCLOSURES:
Leases
The Company rents office space, equipment and computer software under
noncancellable operating leases. Rental expense was $41.5 million in 2002, $45.3
million in 2001 and $42.4 million in 2000. Future required minimum rental
payments as of December 31, 2002, were as follows (dollars in millions):
2003 ...................................................................... $ 33.5
2004 ...................................................................... 19.5
2005 ...................................................................... 15.9
2006 ...................................................................... 11.2
2007 ...................................................................... 9.5
Thereafter................................................................... 10.8
------
Total................................................................ $100.4
======
Postretirement Plans
One of our insurance subsidiaries has a noncontributory, unfunded
deferred compensation plan for qualifying members of its career agency force.
Benefits are based on years of service and career earnings. The liability
recognized in the consolidated balance sheet for the agents' deferred
compensation plan was $54.2 million and $48.4 million at December 31, 2002 and
2001, respectively. Included as an adjustment to accumulated other comprehensive
income (loss) is a $9.1 million adjustment representing the additional minimum
liability associated with this plan. Substantially all of this liability
represents vested benefits. Costs incurred on this plan, primarily representing
interest on unfunded benefit costs, were $5.1 million, $4.9 million and $4.4
million during 2002, 2001 and 2000, respectively.
F - 94
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The Company provides certain health care and life insurance benefits for
certain eligible retired employees under partially funded and unfunded plans in
existence at the date on which certain subsidiaries were acquired. Certain
postretirement benefit plans are contributory, with participants' contributions
adjusted annually. Amounts related to the postretirement benefit plans were as
follows:
Postretirement
benefits
--------------
2002 2001
---- ----
(Dollars in millions)
Benefit obligation, beginning of year........................................ $ 24.5 $ 21.1
Interest cost............................................................ 1.6 1.5
Plan participants' contributions......................................... 1.1 1.1
Actuarial loss (gain).................................................... .4 3.1
Benefits paid............................................................ (3.0) (2.3)
------ ------
Benefit obligation, end of year.............................................. $ 24.6 $ 24.5
====== ======
Fair value of plan assets, beginning of year................................. $ 2.0 $ 3.0
Actual return on plan assets............................................. - .3
Employer contributions................................................... 2.1 1.0
Benefits paid............................................................ (3.0) (2.3)
------ ------
Fair value of plan assets, end of year....................................... $ 1.1 $ 2.0
====== ======
Funded status................................................................ $(23.5) $(22.5)
Unrecognized net actuarial loss (gain)....................................... (7.1) (7.6)
Unrecognized prior service cost.............................................. (1.4) (1.6)
------ ------
Prepaid (accrued) benefit cost........................................ $(32.0) $(31.7)
====== ======
We used the following weighted average assumptions to calculate benefit
obligations for our 2002 and 2001 valuations: discount rate of approximately 6.5
percent and 7.0 percent, respectively; an expected return on plan assets of
approximately 4.6 percent and 4.6 percent, respectively. Beginning in 2000, as a
result of plan amendments, no assumption for compensation increases was
required. For measurement purposes, we assumed an 11.5 percent annual rate of
increase in the per capita cost of covered health care benefits for 2003,
decreasing gradually to 5 percent in 2015 and remaining level thereafter.
Components of the cost we recognized related to postretirement plans were
as follows:
Postretirement
benefits
----------------------------
2002 2001 2000
---- ---- ----
(Dollars in millions)
Interest cost........................................................................ $1.6 $ 1.5 $1.5
Expected return of plan assets....................................................... (.1) (.1) (.2)
Amortization of prior service cost................................................... (.2) (1.0) (.9)
Recognized net actuarial loss........................................................ (.5) (.1) -
---- ----- ----
Net periodic cost (benefit)................................................... $ .8 $ .3 $ .4
==== ===== ====
A one-percentage-point change in the assumed health care cost trend rates
would have an insignificant effect on the net periodic benefit cost of our
postretirement benefit obligation.
The Company has qualified defined contribution plans for which
substantially all employees are eligible. Company contributions, which match
certain voluntary employee contributions to the plan, totaled $6.6 million in
2002, $4.7 million in 2001, and $9.1 million in 2000. Prior to 2002, employer
matching contributions were made in CNC common stock. For the first nine months
of 2002, employer matching
F - 95
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
contributions were made in cash. In September 2002, the plans were amended to
make future employer matching contributions discretionary. Subsequently, the
Company determined that no additional employer matching contributions will be
made until the Plan of Reorganization has been confirmed.
Litigation
As described in the note to the consolidated financial statements
entitled "Proceedings under Chapter 11 of the Bankruptcy Code", CNC and several
of its subsidiaries filed voluntary petitions for reorganization under Chapter
11 of the Bankruptcy Code in the Bankruptcy Court. The Company's insurance
subsidiaries and other subsidiaries who did not file petitions are separate
legal entities and are not included in the petitions filed by the parent. The
Debtors retain control of the insurance subsidiaries and related subsidiaries
and are authorized to operate these businesses as debtors-in-possession while
being subject to the jurisdiction of the Bankruptcy Court. The Finance Company
Debtors filed a separate plan in connection with their Chapter 11 Cases on April
2, 2003. As of the Petition Date, pending litigation against the Debtors or the
Finance Company Debtors is stayed, and absent further order of the Bankruptcy
Court, substantially all prepetition liabilities of the Debtors and the Finance
Company Debtors are subject to settlement under a plan of reorganization. Based
on the Plan of the Debtors, liabilities subject to compromise exceed the fair
value of the Debtors' assets, and unsecured claims will be satisfied at less
than 100 percent of their fair value.
We and our subsidiaries are involved on an ongoing basis in lawsuits
(including purported class actions) relating to our operations, including with
respect to sales practices, and we and current and former officers and directors
are defendants in pending class action lawsuits asserting claims under the
securities laws and derivative lawsuits. The ultimate outcome of these lawsuits
cannot be predicted with certainty.
Legal Proceedings Related to CFC Only
CFC was served with various related lawsuits filed in the United States
District Court for the District of Minnesota. These lawsuits were generally
filed as purported class actions on behalf of persons or entities who purchased
common stock or options to purchase common stock of CFC during alleged class
periods that generally run from July 1995 to January 1998. One action (Florida
State Board of Admin. v. Green Tree Financial Corp., et. al, Case No. 98-1162)
was brought not on behalf of a class, but by the Florida State Board of
Administration, which invests and reinvests retirement funds for the benefit of
state employees. In addition to CFC, certain former officers and directors of
CFC are named as defendants in one or more of the lawsuits. CFC and other
defendants obtained an order consolidating the lawsuits seeking class action
status into two actions, one of which pertains to a purported class of common
stockholders (In re Green Tree Financial Corp. Stock Litig., Case No. 97-2666)
and the other of which pertains to a purported class of stock option traders (In
re Green Tree Financial Corp. Options Litig., Case No. 97-2679). Plaintiffs in
the lawsuits assert claims under Sections 10(b) (and Rule 10b-5 promulgated
thereunder) and 20(a) of the Securities Exchange Act of 1934. In each case,
plaintiffs allege that CFC and the other defendants violated federal securities
laws by, among other things, making false and misleading statements about the
current state and future prospects of CFC (particularly with respect to
prepayment assumptions and performance of certain loan portfolios of CFC), which
allegedly rendered CFC's financial statements false and misleading. On August
24, 1999, the United States District Court for the District of Minnesota issued
an order dismissing with prejudice all claims alleged in the lawsuits. The
plaintiffs subsequently appealed the decision to the U.S. Court of Appeals for
the 8th Circuit. A three judge panel issued an opinion on October 25, 2001,
reversing the United States District Court's dismissal order and remanding the
actions to the United States District Court. The parties to these lawsuits have
entered into a stipulation of settlement, which is subject only to review and
approval by the court.
CFC is a defendant in two arbitration proceedings in South Carolina
(Lackey v. Green Tree Financial Corporation, n/k/a Conseco Finance Corp. and
Bazzle v. Green Tree Financial Corporation, n/k/a Conseco Finance Corp.) where
the arbitrator, over CFC's objection, allowed the plaintiffs to pursue purported
class action claims in arbitration. The two purported arbitration classes
consist of South Carolina residents who obtained real estate secured credit from
CFC's Manufactured Housing Division (Lackey) and Home Improvement Division
(Bazzle) in the early and mid 1990s, and did not receive a South Carolina
specific disclosure form relating to selection of attorneys and insurance agents
in connection with the credit transactions. The arbitrator, in separate awards
issued on July 24, 2000, awarded a total of $26.8 million in penalties and
attorneys' fees. The awards were confirmed as judgments in both Lackey and
Bazzle. These cases were consolidated into one case, and CFC appealed them to
the South Carolina Supreme Court. Oral argument was heard on March 21, 2002. On
August 26, 2002 the South Carolina Supreme Court affirmed the arbitration
judgments, and CFC filed a petition for writ of certiorari with the U.S. Supreme
Court on October 23, 2002. CFC's petition was granted in January 2003, and the
U.S. Supreme Court will hear oral argument on April 22, 2003. CFC has posted
appellate bonds, including $23 million of cash, for these cases. CFC intends to
challenge the awards vigorously and believes that the arbitrator erred by, among
other things, conducting class action arbitrations without the authority to do
so. The ultimate outcome of this proceeding
F - 96
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
cannot be predicted with certainty.
Securities Litigation
A total of forty-five suits were filed in 2000 against CNC in the United
States District Court for the Southern District of Indiana. Nineteen of these
cases were putative class actions on behalf of persons or entities that
purchased CNC's common stock during alleged class periods that generally run
from April 1999 through April 2000. Two cases were putative class actions on
behalf of persons or entities that purchased CNC's bonds during the same alleged
class periods. Three cases were putative class actions on behalf of persons or
entities that purchased or sold option contracts, not issued by CNC, on CNC's
common stock during the same alleged class periods. One case was a putative
class action on behalf of persons or entities that purchased CNC's "FELINE
PRIDES" convertible preferred stock instruments during the same alleged class
periods. With four exceptions, in each of these twenty-five cases two former
officers/directors of CNC were named as defendants. In each case, the plaintiffs
asserted claims under Sections 10(b) (and Rule 10b-5 promulgated thereunder) and
20(a) of the Securities Exchange Act of 1934. In each case, plaintiffs alleged
that CNC and the individual defendants violated the federal securities laws by,
among other things, making false and misleading statements about the current
state and future prospects of CFC (particularly with respect to performance of
certain loan portfolios of CFC) which allegedly rendered CNC's financial
statements false and misleading.
Eleven of the cases in the United States District Court for the Southern
District of Indiana were filed as purported class actions on behalf of persons
or entities that purchased preferred securities issued by various Conseco
Financing Trusts, including Conseco Financing Trust V, Conseco Financing Trust
VI, and Conseco Financing Trust VII. Each of these complaints named as
defendants CNC, the relevant trust (with two exceptions), two former
officers/directors of CNC, and underwriters for the particular issuance (with
one exception). One complaint also named an officer and all of CNC's directors
at the time of issuance of the preferred securities by Conseco Financing Trust
VII. In each case, plaintiffs asserted claims under Section 11 and Section 15 of
the Securities Act of 1933, and eight complaints also asserted claims under
Section 12(a)(2) of that Act. Two complaints also asserted claims under Sections
10(b) and 20(a) of the Securities Exchange Act of 1934, and one complaint also
asserted a claim under Section 10(b) of that Act. In each case, plaintiffs
alleged that the defendants violated the federal securities laws by, among other
things, making false and misleading statements in Prospectuses and/or
Registration Statements related to the issuance of preferred securities by the
Trust involved regarding the current state and future prospects of CFC
(particularly with respect to performance of certain loan portfolios of CFC)
which allegedly rendered the disclosure documents false and misleading.
All of the CNC securities cases were consolidated into one case in the
United States District Court for the Southern District of Indiana, captioned:
"In Re Conseco, Inc. Securities Litigation", Case number IP00-C585-Y/S (the
"securities litigation"). An amended complaint was filed on January 12, 2001,
which asserted claims under Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934, and Sections 11, 12(a)(2), and 15 of the Securities Act of 1933,
with respect to common stock and various other securities issued by CNC and
Conseco Financing Trust VII. The Company filed a motion to dismiss the amended
complaint on April 27, 2001. On January 10, 2002, CNC entered into a Memorandum
of Understanding (the "MOU") to settle the litigation for $120 million subject
to court approval. Under the MOU, as amended on February 12, 2002, $106 million
was required to be placed in escrow by March 8, 2002; the remaining $14 million
was to be paid in two installments: $6 million by April 1, 2002, and $8 million
by October 1, 2002 (all payments with interest from January 25, 2002). The $106
million due on March 8, 2002, was not paid, for reasons set forth in the
following paragraph, and the MOU was terminated by the plaintiffs. On April 15,
2002, a new MOU was executed (the "April 15 MOU"). Pursuant to the April 15 MOU,
$95 million was funded on April 25, 2002, with the remaining $25 million to
await the outcome of the coverage litigation between CNC and certain of its
directors' and officers' liability insurance carriers as described in the next
paragraph. Court approval of the settlement was received on August 7, 2002.
We maintained certain directors' and officers' liability insurance that
was in force at the time the Indiana securities and derivative litigation (the
derivative litigation is described below) was commenced and which, in our view,
applies to the claims asserted in that litigation. The insurers denied coverage
for those claims, so we commenced a lawsuit against them on June 13, 2001, in
Marion County Circuit Court in Indianapolis, Indiana (Conseco, Inc., et al. v.
National Union Fire Insurance Company of Pittsburgh, PA, Royal & SunAlliance,
Westchester Fire Insurance Company, RLI Insurance Company, Greenwich Insurance
Company and Certain Underwriters at Lloyd's of London, Case No.
49C010106CP001467) (the "coverage litigation") seeking, among other things, a
judicial declaration that coverage for those claims exists. The primary
insurance carrier, National Union Fire Insurance Co. of Pittsburgh, PA, has paid
its full $10 million in policy proceeds toward the settlement of the securities
litigation; in return, National Union has been released from the coverage
litigation. The first excess insurance carrier, Royal & SunAlliance ("Royal"),
has paid its full $15 million in policy proceeds toward the settlement, but
reserved rights to continue to litigate coverage. Royal subsequently asserted
counterclaims seeking repayment of the $15 million it previously provided to CNC
as part of the
F - 97
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
settlement. The second excess insurance carrier, Westchester Fire
Insurance Company, has paid its full $15 million in policy proceeds toward the
settlement without a reservation of rights and has been released from the
coverage litigation. The third excess insurance carrier, RLI Insurance Company
("RLI"), has paid its full $10 million in policy proceeds toward the settlement,
but initially reserved rights to continue to litigate coverage. RLI has
subsequently settled (for $50,000 paid by certain of the individual insureds as
partial payment of RLI's attorneys' fees incurred in the coverage litigation),
and RLI is no longer continuing to dispute coverage. The fourth excess insurance
carrier, Greenwich Insurance Company ("Greenwich"), has paid its full $25
million in policy proceeds toward the settlement without a reservation of rights
and has been released from the coverage litigation. The final excess carrier,
Certain Underwriters at Lloyd's of London ("Lloyd's"), refused to pay or to
escrow its $25 million in policy proceeds toward the settlement and is
continuing to litigate coverage. Under the April 15 MOU, the settlement of the
securities litigation will proceed notwithstanding the continuing coverage
litigation between CNC, Royal and Lloyd's. Since the United States District
Court for the Southern District of Indiana has approved the settlement of the
securities litigation prior to resolution of the coverage litigation, $90
million plus accrued interest is available for distribution to the putative
class. The remaining funds, with interest, will be distributed at the conclusion
of the coverage litigation (or, in the case of the $25 million at issue in the
litigation with Lloyd's, on December 31, 2005, if the litigation with Lloyd's
has not been resolved by that date), with such funds coming either from Lloyd's
(if CNC prevails in the coverage litigation) or from CNC (if CNC does not
prevail). We intend to pursue our coverage rights vigorously. Because the
directors' and officers' liability insurance that was in force at the time the
litigation commenced provides for coverage of $100 million, CNC believes its
exposure in the litigation should be $20 million (i.e., the excess of the $100
million in coverage). CNC believes that the insurance applies to the claims in
the securities litigation and that the two insurers who are continuing to
litigate the coverage issue were obligated to pay their policy limits to fund
the settlement, as the other four carriers have done. We recorded $20 million as
our best estimate of a probable loss in 2001. Such amount has been placed in
escrow. We also previously established the estimated remaining liability of $40
million and a claim receivable of $40 million. Such amount includes: (i) $15
million related to Royal who paid its portion of the settlement into a fund but
reserved its rights to continue to litigate coverage (which litigation is
proceeding); and (ii) $25 million related to Lloyd's who has refused to pay.
Following the filing of our Chapter 11 Case, the trial court granted Lloyd's
motion to dismiss our lawsuit resulting in our decision to establish an
allowance for the entire $40 million claim receivable CNC believes is due from
Royal and Lloyd's. We intend to appeal the decision to dismiss in part because
we believe the decision violates the stay in the Chapter 11 Case. CNC believes
that the coverage litigation should result in a determination that the insurer
that paid under a reservation of rights has no right to recoup the payment that
it made, and that the insurer that refused to pay is obligated to do so under
its policy. We believe the latter insurer should pay its portion of the coverage
once such determination is made. The ultimate outcome cannot be predicted with
certainty. CNC is also pursuing settlement discussions with Royal and Lloyd's.
In the event that CNC does not reach settlement and does not prevail in the
coverage litigation, it will seek to subordinate the securities plaintiffs'
claims under section 510 of the Bankruptcy Code, or disallow such claims under
sections 502(d) and 547 of the Bankruptcy Code, in which case CNC may not be
required to pay the portion of the settlement not covered by its directors' and
officers' liability insurance. CNC has asked the Bankruptcy Court to stay the
Indiana state court action, and the Bankruptcy Court is scheduled to hear that
motion on May 19, 2003.
Since we announced our intention to restructure our capital on August 9,
2002, a total of eight purported securities fraud class action lawsuits have
been filed in the United States District Court for the Southern District of
Indiana. The complaints name CNC as a defendant, along with certain current and
former officers of CNC. These lawsuits were filed on behalf of persons or
entities who purchased CNC's common stock on various dates between October 24,
2001 and August 9, 2002. In each case Plaintiffs allege claims under Sections
10(b) and 20(a) of the Securities Exchange Act of 1934, and allege material
omissions and dissemination of materially misleading statements regarding, among
other things, the liquidity of CNC and alleged problems in CFC's manufactured
housing division, allegedly resulting in the artificial inflation of CNC's stock
price. Plaintiffs in one of these lawsuits have filed an uncontested
consolidation and lead plaintiff motion, which, if granted, would result in the
consolidation of these eight cases into one. On March 13, 2003, all of these
cases were consolidated into one case in the United States District Court for
the Southern District of Indiana, captioned "Franz Schleicher, et al. v.
Conseco, Inc., et al.," File No. 02-CV-1332 DFH-TAB. CNC believes these lawsuits
are without merit and intends to defend them vigorously. The ultimate outcome of
these lawsuits cannot be predicted with certainty. CNC has filed an adversary
proceeding to extend the automatic stay provided for by the Bankruptcy Code to
this litigation as it pertains to current and former officers and directors of
CNC.
In October 2002, Roderick Russell, on behalf of himself and a class of
persons similarly situated, and on behalf of the ConsecoSave Plan filed an
action in the United States District Court for the Southern District of Indiana
against CNC, Conseco Services LLC and certain current and former officers of CNC
(Roderick Russell, et al. v Conseco, Inc., et al., Case No. 1:02-CV-1639 LJM).
The purported class action consists of all individuals whose 401(k) accounts
held common stock of CNC at any time from April 28, 1999 through the present.
The complaint alleges, among other things, breaches of fiduciary duties under
ERISA by continuing to permit employees to invest in CNC's common stock without
full disclosure of the Company's true financial condition. CNC believes
F - 98
the lawsuit is without merit and intends to defend it vigorously. The ultimate
outcome of the lawsuit cannot be predicted with certainty. CNC has filed an
adversary proceeding to extend the automatic stay provided for by the Bankruptcy
Code to this litigation as it pertains to current and former officers and
directors of CNC.
Derivative Litigation
Nine shareholder derivative suits were filed in 2000 in the United States
District Court for the Southern District of Indiana. The complaints named as
defendants the current directors, certain former directors, certain non-director
officers of CNC (in one case), and, alleging aiding and abetting liability,
certain banks that allegedly made loans in relation to CNC's "Stock Purchase
Plan" (in three cases). CNC is also named as a nominal defendant in each
complaint. Plaintiffs allege that the defendants breached their fiduciary duties
by, among other things, intentionally disseminating false and misleading
statements concerning the acquisition, performance and proposed sale of CFC, and
engaged in corporate waste by causing CNC to guarantee loans that certain
officers, directors and key employees of CNC used to purchase stock under the
Stock Purchase Plan. These cases have now been consolidated into one case in the
United States District Court for the Southern District of Indiana, captioned:
"In Re Conseco, Inc. Derivative Litigation", Case Number IP00655-C-Y/S. An
amended complaint was filed on April 12, 2001, making generally the same
allegations and allegations of violation of the Federal Reserve Board's margin
rules. Three similar cases have been filed in the Hamilton County Superior Court
in Indiana. Schweitzer v. Hilbert, et al., Case No. 29D01-0004CP251; Evans v.
Hilbert, et al., Case No. 29D01-0005CP308 (both Schweitzer and Evans name as
defendants certain non-director officers); Gintel v. Hilbert, et al., Case No.
29003-0006CP393 (naming as defendants, and alleging aiding and abetting
liability as to, banks that allegedly made loans in relation to the Stock
Purchase Plan). CNC believes that these lawsuits are without merit and intends
to defend them vigorously. The cases filed in Hamilton County have been stayed
pending resolution of the derivative suits filed in the United States District
Court. CNC asserts that these lawsuits are assets of the estate pursuant to
section 541(a) of the Bankruptcy Code and does not currently intend to pursue
them postpetition because they are meritless. The ultimate outcome of these
lawsuits cannot be predicted with certainty.
Other Litigation
On January 15, 2002, Carmel Fifth, LLC ("Carmel"), an indirect,
wholly-owned subsidiary of CNC, exercised its rights to require 767 Manager, LLC
("Manager"), an affiliate of Donald J. Trump, to elect within 60 days, either to
acquire Carmel's interests in 767 LLC for $499.4 million, or to sell its
interests in 767 LLC to Carmel for $15.6 million (the "Buy/Sell Right"). Such
rights were exercised pursuant to the Limited Liability Company Agreement of 767
LLC. 767 LLC is a Delaware limited liability company that indirectly owns the
General Motors Building, a 50-story office building in New York, New York (the
"GM Building"). 767 LLC is owned by Carmel and Manager. On February 6, 2002, Mr.
Trump commenced a civil action against CNC, Carmel and 767 LLC in New York State
Supreme Court, entitled Donald J. Trump v. Conseco, Inc., et al. (the "State
Court Action"). Plaintiff claims that CNC and Carmel breached an agreement,
dated July 3, 2001, to sell Carmel's interests to plaintiff for $295 million on
or before September 15, 2001 (the "July 3rd Agreement"). Specifically, plaintiff
claims that CNC and Carmel improperly refused to accept a reasonable guaranty of
plaintiff's payment obligations, refused to complete the sale of Carmel's
interest before the September 15, 2001 deadline, repudiated an oral promise to
extend the September 15 deadline indefinitely and repudiated the July 3rd
Agreement by exercising Carmel's Buy/Sell Right. Plaintiff asserts claims for
breach of contract, breach of the implied covenant of good faith and fair
dealing, promissory estoppel, unjust enrichment and breach of fiduciary duty.
Plaintiff is seeking compensatory and punitive damages of approximately $1
billion and declaratory and injunctive relief blocking Carmel's Buy/Sell Right.
On March 25, 2002, Carmel filed a Demand for Arbitration and Petition and
Statement of Claim with the American Arbitration Association ("AAA") to have the
issues relating to the Buy/Sell Right resolved by arbitration (the
"Arbitration"). Manager and Mr. Trump requested the New York State Supreme Court
to stay that arbitration, but the Court denied Manager's and Trump's request on
May 2, 2002, allowing the arbitration to proceed. In addition, CNC and Carmel
filed a Motion to Dismiss Mr. Trump's lawsuit on March 25, 2002. By Stipulation
and Order, dated June 14, 2002, the State Court Action was stayed, pending
resolution of the Arbitration. CNC plans to vigorously pursue its options to
compel prompt resolution of this dispute. CNC believes that Mr. Trump's lawsuit
is without merit and intends to vigorously pursue its own rights to acquire the
GM Building. The ultimate outcome cannot be predicted with certainty. On
February 21, 2003, the Trump entities filed a proof of claim asserting a general
unsecured claim of $1 billion against CNC. On March 3, 2003, CNC and Carmel
Fifth initiated an adversary proceeding against the Trump entities. CNC and
Carmel Fifth's adversary complaint seeks declaratory and injunctive relief
against the Trump entities. CNC and Carmel Fifth's adversary action requests
that the court find (1) that the July 3rd Agreement terminated due to Trump's
failure to comply with the terms of that agreement, and (2) that the Trump
entities are required to convey their interest in 767 LLC to Carmel Fifth
pursuant to Carmel Fifth's rights under the LLC Agreement. On March 5, 2003, CNC
and Carmel Fifth, in the adversary proceeding, filed an emergency motion for
preliminary injunction and an emergency motion for expedited hearing. Through
those motions, CNC and Carmel Fifth sought: an accelerated schedule for
resolution of their claims against the Trump entities, removal of Mr. Trump from
management of the GM Building, and
F - 99
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
an order restraining Mr. Trump and the Trump entities from interference with CNC
and Carmel Fifth's efforts to market the GM Building. The Bankruptcy Court has
assumed jurisdiction of the matters related to the July 3rd Agreement and has
denied jurisdiction with respect to Carmel Fifth's rights under the LLC
Agreement and ordered that the arbitration of the LLC Agreement matters be
completed or nearly completed by May 19, 2003. After such time, the Bankruptcy
Court will set the July 3rd Agreement matters for trial. In connection with the
Bankruptcy Court's ruling on the jurisdictional issues, the parties stipulated
that they would appear before the Bankruptcy Court to provide updates with
respect to the pending arbitration in order to keep the arbitration process on
schedule for resolution or near resolution by May 19, 2003. The Court also
ordered the Trump entities to stipulate that they would take no actions that
would delay completion or near completion of arbitration by May 19, 2003.
On June 24, 2002, the heirs of a former officer, Lawrence Inlow,
commenced an action against CNC, Conseco Services, LLC, and two former officers
in the Boone Circuit Court (Inlow et al. v. Conseco, Inc., et al., Cause No.
06C01-0206-CT-244). The heirs assert that unvested options to purchase 756,248
shares of CNC common stock should have been vested at Mr. Inlow's death. The
heirs further claim that if such options had been vested, they would have been
exercised, and that the resulting shares of common stock would have been sold
for a gain of approximately $30 million based upon a stock price of $58.125 per
share, the highest stock price during the alleged exercise period of the
options. CNC believes the heirs' claims are without merit and will defend the
action vigorously. The maximum exposure to the Company for this lawsuit is
estimated to be $33 million. The ultimate outcome cannot be predicted with
certainty.
CNC is also a party to litigation related to the death of Lawrence Inlow
with the manufacturer of a corporate helicopter and other parties. This
litigation was consolidated in the United States District Court for the Southern
District of Indiana (In re: Inlow Accident Litigation, Cause No.
IP99-0830-C-H/G) and is currently on appeal to the Seventh Circuit Court of
Appeals. The maximum exposure for this litigation is estimated to be $25
million, although CNC believes that the claims against it are without merit. The
ultimate outcome cannot be predicted with certainty. CNC is also party to
litigation with Associated Aviation Underwriters, Inc. in Hamilton County
Superior Court (Associated Aviation Underwriters, Inc. v. Conseco Inc., et al,
Cause No. 29C01-9909-CP588) relating to Associated Aviation Underwriters'
obligation to defend and/or indemnify CNC in the aforementioned litigation. If
CNC prevails in this lawsuit, Associated Underwriters may be obligated to
indemnify CNC for all or part of its liability in the aforementioned litigation.
This litigation has been stayed until final judgments are rendered in the former
litigation.
In addition, the Company and its subsidiaries are involved on an ongoing
basis in other lawsuits and arbitrations (including purported class actions)
related to their operations. These actions include one action brought by the
Texas Attorney General regarding long-term care policies, two purported
nationwide class actions involving claims related to "vanishing premiums," and
two purported nationwide class actions involving claims related to "modal
premiums" (the alleged imposition and collection of insurance premium surcharges
in excess of stated annual premiums. The ultimate outcome of all of these other
legal matters pending against the Company or its subsidiaries cannot be
predicted, and, although such lawsuits are not expected individually to have a
material adverse effect on the Company, such lawsuits could have, in the
aggregate, a material adverse effect on the Company's consolidated financial
condition, cash flows or results of operations.
Other Proceedings
The Company has been notified that the staff of the SEC has obtained a
formal order of investigation in connection with an inquiry that relates to
events in and before the spring of 2000, including CFC's accounting for its
interest-only securities and servicing rights. These issues were among those
addressed in the Company's write-down and restatement in the spring of 2000, and
were the subject of shareholder class action litigation, which has recently been
settled as described above. The Company is cooperating with the SEC staff in
this matter.
The Company has been notified that the Alabama Securities Commission is
examining the Company's 1998 Directors/Officers & Key Employees Stock Purchase
Program and the 2000 Employee Stock Purchase Program Work-Down Plan. The Company
is cooperating with the Commission's staff in this matter.
Guaranty Fund Assessments
The balance sheet at December 31, 2002, includes: (i) accruals of $11.5
million, representing our estimate of all known assessments that will be levied
against the Company's insurance subsidiaries by various state guaranty
associations based on premiums written through December 31, 2002; and (ii)
receivables of $7.5 million that we estimate will be recovered through a
reduction in future premium taxes as a result of such assessments. At December
31, 2001, such guaranty fund assessment related accruals were $18.7
F - 100
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
million and such receivables were $8.0 million. These estimates are subject to
change when the associations determine more precisely the losses that have
occurred and how such losses will be allocated among the insurance companies. We
recognized expense (benefit) for such assessments of $(1.7) million in 2002,
$6.5 million in 2001 and $7.6 million in 2000.
Guarantees
We have guaranteed D&O loans totaling $481.3 million. As previously
described, Conseco has defaulted on certain notes, which has resulted in the
immediate maturity of the D&O loans through cross-acceleration and cross-default
provisions contained in the governing instruments. The proceeds of the bank
loans were used by the participants to purchase approximately 18.0 million
shares of Conseco common stock in open market or negotiated transactions with
independent parties. Such shares have been held by the D&O lenders as collateral
for the loans. In addition, Conseco has provided loans to participants for
interest on the D&O loans totaling $179.2 million.
The Company is exploring a number of alternatives to reduce the balance
of certain participants' D&O loans. The plan currently being considered would
reduce the D&O loan balance of certain participants who collectively owe less
than 10 percent of the entire amount due under the stock purchase program.
Conseco also granted a security interest in most of its assets in conjunction
with the guarantee of a portion of the bank loans. In 2002, 2001, and 2000, we
established a noncash provision in connection with these guarantees and loans of
$240.0 million, $169.6 million and $231.5 million, respectively. Such provision
is included as a component of the provision for losses. At December 31, 2002,
the reserve for losses on the loan guarantees and on the loans held by Conseco
totaled $660.0 million. During 2002, Conseco purchased $55.5 million of loans
from the banks utilizing cash held in a segregated cash account as collateral
for our guarantee of the bank loans (including accrued interest, the balance on
these loans was $56.7 million at December 31, 2002). At December 31, 2002, the
guaranteed bank loans and interest loans exceeded the value of the collateral
held and the reserve for losses by approximately $50 million. All participants
have agreed to indemnify Conseco for any loss incurred on their loans. We
regularly evaluate these guarantees and loans in light of the collateral and the
creditworthiness of the participants.
CIHC is the guarantor of an aggregate principal amount of $125 million with
respect to CFC's residual and warehouse lines of credit with Lehman Brothers,
Inc. and its affiliates ("Lehman"). Such facilities are collectively referred to
as the "CFC Lehman Facilities". In addition, CIHC is the guarantor of: (i) the
term portion of the Secured Super-Priority Debtor in Possession Credit
Agreement, dated as of December 19, 2002, among CFC, various subsidiaries of
CFC, CIHC and FPS DIP, LLC (the "FPS DIP"); and (ii) a cash management facility
with U.S. Bank National Association (the "U.S. Bank Facility"). The term portion
of the FPS DIP provides for funding in a maximum aggregate amount of $60 million
and is fully drawn. The guarantee obligations of CIHC under the FPS DIP and the
U.S. Bank Facility are limited to an aggregate of $125 million. The December 31,
2002 balances outstanding on the CFC Lehman Facilities and CFC's
debtor-in-possession facility are included in the caption "Liabilities of
discontinued operations" in the liability section of the consolidated balance
sheet. Also, see the note to the consolidated financial statement entitled
"Financial Information Regarding CFC." Assuming the sale of CFC's assets is
completed and CFC receives the proceeds from the sale of such assets as
contemplated by the CFN and GE transactions, Conseco believes the proceeds will
be sufficient to satisfy CFC's obligations pursuant to the Lehman and CFC's
debtor-in-possession facility and all claims senior to such facilities. CFC's
unsecured creditors have indicated that they intend to challenge Lehman's
security position and otherwise attempt to prevent Lehman from being paid in
full out of the proceeds from the sale of CFC's assets. If Lehman were not paid
in full from the proceeds, Lehman would likely pursue its claim on the CIHC
guarantee which, if successful, could impact the ability of the Debtors to
complete their proposed Plan.
In accordance with the terms of the Company's former Chief Executive
Officer's employment agreement, Bankers Life & Casualty Company, a wholly-owned
subsidiary of the Company, is the guarantor of the former executive's
nonqualified supplemental retirement benefit. The liability for such benefit at
December 31, 2002 was $14.8 million and is included in the caption "Other
liabilities" in the liability section of the consolidated balance sheet.
Trust Preferred Securities
Certain wholly-owned subsidiary trusts have issued preferred securities
in public offerings. The trusts used the proceeds from these offerings to
purchase subordinated debentures from Conseco. The terms of the preferred
securities parallel the terms of the debentures, which account for substantially
all trust assets. The preferred securities are to be redeemed on a pro rata
basis, to the same extent as the debentures are repaid. Under certain
circumstances involving a change in law or legal interpretation, the debentures
may be distributed to the holders of the preferred securities. Our obligations
under the debentures and related agreements, taken together, provide a full and
unconditional guarantee of payments due on the preferred securities. The
debentures issued to the subsidiary trusts
F - 101
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
and the common securities purchased by Conseco from the subsidiary trusts are
eliminated in the consolidated financial statements.
On February 16, 2001, the trust preferred securities component of the
FELINE PRIDES were retained by the Company (and subsequently retired) as payment
under the stock purchase contract in accordance with their terms and, as a
result, we issued 11.4 million shares of Conseco common stock to the holders of
the FELINE PRIDES. The $496.6 million carrying value of the FELINE PRIDES that
were retired (and used for payment pursuant to the stock purchase contracts) was
transferred from minority interest to common stock and additional paid-in
capital.
In April 2000, the Company and the holder of the Redeemable Hybrid Income
Overnight Shares ("RHINOS") issued in 1999 agreed to the repurchase by the
Company of the RHINOS at their $250 million par value. The Company recognized an
extraordinary loss of $3.3 million (net of income taxes of $1.8 million) in the
second quarter of 2000 related to the redemption.
Trust Preferred Securities at December 31, 2002, were as follows:
Year Carrying Distribution Earliest/mandatory
issued Par value value rate redemption dates
------ --------- ----- ---- ----------------
(Dollars in millions)
Trust Originated Preferred Securities................ 1999 $ 300.0 $ 296.5 9.44% 2004/2029 (b)
Trust Originated Preferred Securities ............... 1998 500.0 496.9 8.70 2003/2028 (b)
Trust Originated Preferred Securities................ 1998 230.0 228.1 9.00 2003/2028 (b)
Capital Securities (a)............................... 1997 300.0 300.0 8.80 2027
Trust Originated Preferred Securities................ 1996 275.0 275.0 9.16 2001/2026 (b)
Capital Trust Pass-through Securities (a)............ 1996 325.0 325.0 8.70 2026
--------- --------
$ 1,930.0 $1,921.5
========= ========
---------------
(a) These securities may be redeemed anytime at: (i) the principal balance;
plus (ii) a premium equal to the excess, if any, of the sum of the
discounted present value of the remaining scheduled payments of principal
and interest using a current market interest rate over the principal
amount of securities to be redeemed.
(b) The mandatory redemption dates of these securities may be extended for up
to 19 years.
So long as no event of default under the debentures has occurred and is
continuing, Conseco has the right to defer interest payments on the subordinated
debentures for up to 20 consecutive quarters, but not beyond the maturity date
of the subordinated debentures. If Conseco defers interest payments on the
subordinated debentures, the trust will also defer distributions on the Trust
Preferred Securities. During the deferral period, distributions continue to
accumulate on the par amount plus any unpaid distributions at the stated
distribution rate. Since the third quarter of 2002, Conseco has not paid certain
interest and principal payments on its notes payable which resulted in defaults
with respect to the Trust Preferred Securities through cross-default provisions.
F - 102
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Reclassification Adjustments Included in Comprehensive Income
The changes in unrealized appreciation (depreciation) included in
comprehensive income are net of reclassification adjustments for after-tax net
gains (losses) from the sale of investments included in net income (loss) of
approximately $545 million, $240 million and $220 million for the years ended
December 31, 2002, 2001 and 2000, respectively.
Sale of Interest in Riverboat
In the first quarter of 2001, the Company sold its 29 percent ownership
interest in the riverboat casino in Lawrenceberg, Indiana, for $260 million. We
recognized a net gain on the sale of $192.4 million.
10. SPECIAL CHARGES
2002
The following table summarizes the special charges incurred by the
Company during 2002, which are further described in the paragraphs which follow
(dollars in millions):
Loss related to reinsurance transactions and businesses sold to raise cash..... $47.5
Costs related to debt modification and refinancing transactions................ 17.7
Other items.................................................................... 31.3
-----
Special charges before income tax benefit.................................. $96.5
=====
Loss related to reinsurance transactions and businesses sold to raise
cash
We completed various asset sales and reinsurance transactions to raise
cash which resulted in net losses of $47.5 million in 2002. Such amounts
included: (i) a loss of $39.0 million related to the reinsurance of a portion of
our life insurance business; (ii) a loss of $20.0 million associated with the
sale of Exl; partially offset by (iii) asset sales resulting in a net gain of
$11.5 million.
Costs related to debt modification and refinancing transactions
In conjunction with the various modifications to borrowing arrangements
(including the debt exchange offer completed in April 2002), we incurred costs
of $17.7 million in 2002 which are not permitted to be deferred pursuant to
GAAP.
Other items
Other items include expenses incurred: (i) as a result of the termination
of our chief financial officer; (ii) in conjunction with the transfer of certain
customer service and backroom operations to our India subsidiary; (iii) for
severance benefits; and (iv) for other items which are not individually
significant. The Company sold its India subsidiary in the fourth quarter of 2002
and has significantly reduced the customer service and backroom operations
conducted there.
F - 103
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
2001
The following table summarizes the special charges incurred by the
Company during 2001, which are further described in the paragraphs which follow
(dollars in millions):
Organizational restructuring:
Severance benefits.................................................................... $12.4
Office closings and sale of artwork................................................... 7.9
Transfer of certain customer service and backroom operations to our
India subsidiary.................................................................... 10.6
Amounts related to disputed reinsurance balances......................................... 8.5
Litigation expenses...................................................................... 23.8
Other items.............................................................................. 17.2
-----
Special charges before income tax benefit............................................. $80.4
=====
Severance benefits
During 2001, Conseco undertook several restructuring actions in an effort
to improve the Company's operations and profitability. The planned changes
included moving a significant number of jobs to India. Pursuant to GAAP, the
Company is required to recognize the costs associated with most restructuring
activities as the costs are incurred. However, costs associated with severance
benefits are required to be recognized when the costs are: (i) attributable to
employees' services that have already been rendered; (ii) relate to obligations
that accumulate; and (iii) are probable and can be reasonably estimated. Since
the severance costs associated with our planned activities met these
requirements, we recognized a charge of $12.4 million in 2001.
Office closings and sale of artwork
In conjunction with our restructuring activities, we closed certain
offices, which resulted in the abandonment of certain leasehold improvements.
Further, certain antiques and artwork, formerly displayed in the Company's
executive offices were sold. We recognized losses of $7.9 million related to
these actions in 2001.
Amounts related to disputed reinsurance balances
During 2001, we discontinued marketing certain medical insurance
products. Several reinsurers who assumed most of the risks associated with these
products disputed the reinsurance receivables due to us. We established an
allowance of $8.5 million for disputed balances that were ultimately written off
due to their uncollectibility.
Litigation expenses
Litigation expenses primarily include the cost and proposed settlement
related to our securities litigation class action lawsuit. Such lawsuit is
further discussed in the note to the consolidated financial statements entitled
"Other Disclosures".
Other items
Other items include expenses incurred: (i) for consulting fees with
respect to services provided related to various debt and organizational
restructuring transactions; (ii) pursuant to the terms of the employment
agreement for our chief executive officer; and (iii) for other items which are
not individually significant.
F - 104
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
2000
The Company incurred significant special charges during 2000, primarily
related to the restructuring of our debt, asset sales to raise cash and payments
made pursuant to employment contracts. The following table summarizes the
special charges, which are further described in the paragraphs which follow
(dollars in millions):
Advisory and professional fees related to debt restructuring................ $ 9.9
Restructuring of finance business:
Loss on sale of asset-based loans...................................... 15.2
Loss on sale of subprime automobile business........................... 71.6
Advisory fees paid to Lehman and other investment banks................ 44.0
Executive contracts:
Executive termination payment ......................................... 72.5
Chief Executive Officer signing payment................................ 45.0
Warrants issued to General Electric Company............................ 21.0
Other items................................................................. 25.8
------
Special charges before income tax benefit.......................... $305.0
======
Advisory and professional fees related to debt restructuring
During 2000, we incurred $9.9 million of non-deferrable advisory and
professional fees primarily related to the restructuring of our bank credit
facilities.
Loss on sale of asset-based loans
During the third quarter of 2000, we sold asset-based loans with a
carrying value of $63.9 million in whole loan sale transactions. We recognized a
loss of $15.2 million on these sales.
Loss on sale of subprime automobile business
During the second quarter of 2000, we sold all of the finance receivables
of our subprime automobile financing and servicing companies and terminated
their operations. We recognized a net loss on these sales of $71.6 million.
Advisory fees paid to Lehman and other investment banks
We paid Lehman $20.0 million in fees for its efforts to form an investor
group to purchase Conseco Finance. In addition, the Company paid other
investment banks and financial institutions $24.0 million in advisory fees
related to the potential sale of Conseco Finance and consultation regarding
various other transactions.
Executive Terminations
On April 28, 2000, Conseco and Stephen C. Hilbert, the Company's former
Chairman and Chief Executive Officer, entered into an agreement pursuant to
which Mr. Hilbert's employment was terminated. As contemplated by the terms of
his employment agreement, Mr. Hilbert received: (i) $72.5 million (prior to
required withholdings for taxes), an amount equal to five times his salary and
the non-discretionary bonus amount (as defined in his employment agreement) for
2000; less (ii) the amount due under a secured loan of $23 million, plus accrued
interest, made to Mr. Hilbert on April 6, 2000. Mr. Hilbert also received the
bonus of $3,375,000 payable under his employment agreement for the first quarter
of 2000. Conseco agreed to continue to treat Mr. Hilbert as though he were an
employee/participant for purposes of the guaranteed bank loans and the loans for
interest on such loans pursuant to the stock purchase program. Conseco also
entered into a consulting agreement with Mr. Hilbert pursuant to which Mr.
Hilbert agreed to provide consulting services up to an average of 25 hours per
month for a period of three years. Mr. Hilbert also agreed not to compete with
Conseco during the term of the consulting agreement. On April 27, 2000, Mr.
Hilbert was granted options to purchase an aggregate of 2,000,000 shares of
Conseco common stock at a price of $5.75 per share (the average of the high and
low sales prices on the New York Stock Exchange on such date). The options
expire on April 26, 2003.
F - 105
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
On April 28, 2000, Conseco and Rollin M. Dick, the Company's former Chief
Financial Officer, entered into an agreement pursuant to which Mr. Dick's
employment was terminated. As contemplated by the terms of his employment
agreement, Conseco agreed to pay Mr. Dick his salary of $250,000 per year
through December 31, 2001, and he also received the bonus of $187,500 payable
under his employment agreement for the first quarter of 2000. Conseco also
agreed to continue to treat Mr. Dick as though he were an employee/participant
for purposes of the guaranteed bank loans and the loans for interest on such
loans pursuant to the stock purchase program. Conseco also entered into a
consulting agreement with Mr. Dick pursuant to which Mr. Dick agreed to provide
consulting services up to an average of 25 hours per month for a period of three
years. Mr. Dick also agreed not to compete with Conseco during the term of the
consulting agreement. On April 27, 2000, Mr. Dick was granted options to
purchase an aggregate of 600,000 shares of Conseco common stock at a price of
$5.75 per share. The options expire on April 26, 2003.
Executive Hiring
On June 28, 2000, the Company hired Gary C. Wendt as its Chief Executive
Officer. Pursuant to the terms of his employment agreement, Mr. Wendt received a
payment of $45 million (prior to required withholdings for taxes) and was
granted options to purchase an aggregate of 10,000,000 shares of Conseco common
stock at a price of $5.875 per share (the average of the high and low sales
price on the New York Stock Exchange on the date on which the substantial terms
of Mr. Wendt's employment were agreed to). The options vest over five years and
expire on June 28, 2010. The Company also issued 3,200,000 shares of restricted
stock to Mr. Wendt. The restrictions on the stock lapse if Mr. Wendt remains
employed by Conseco through June 30, 2002, or upon a "change in control" of the
Company. The value of the restricted shares ($18.8 million) was recognized as an
expense to the Company over the two year period ending June 30, 2002. In 2002,
Mr. Wendt's restricted stock agreement was amended to extend the date that the
restrictions on the stock would lapse. Prior to the date that the restrictions
would lapse, Mr. Wendt resigned his position of Chief Executive Officer
(although he remains Chairman of the Board of Conseco) and the shares were
canceled. Mr. Wendt is also being provided certain supplemental retirement,
insurance and other benefits under the terms of his employment agreement.
In conjunction with Mr. Wendt's hiring and his release from noncompete
provisions of a prior agreement, the Company issued a warrant to a subsidiary of
General Electric Company to purchase 10,500,000 shares of Conseco common stock
at a purchase price of $5.75 per share. The estimated value of the warrant
($21.0 million) was recognized as a special charge.
11. SHAREHOLDERS' EQUITY:
We are authorized to issue up to 20 million shares of preferred stock. On
December 15, 1999, we issued $500.0 million (2.6 million shares) of Series F
Preferred Stock to Thomas H. Lee Company and affiliated investors. The Series F
Preferred Stock is convertible into Conseco common stock at a common equivalent
rate of $19.25 per share. The Series F Preferred Stock pays a 4 percent
dividend, of which an amount at least equal to the common dividend will be
payable in cash, and the remainder may be paid in additional Series F shares
valued at a common equivalent rate of $19.25 per share. In September 2000, we
suspended the payment of common stock dividends and, as a result, all dividend
payments since that date have been paid in additional Series F shares (the
carrying value of such additional shares is determined based on the fair value
of the equivalent number of Conseco common shares that such shares are
convertible into as of the date the dividend is paid). The Series F Preferred
Stock ranks senior to the common stock outstanding and has a liquidation
preference of $192.50 per share plus all declared and unpaid dividends.
F - 106
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Changes in the number of shares of common stock outstanding during the
years ended December 31, 2002, 2001 and 2000 were as follows:
2002 2001 2000
---- ---- ----
(Shares in thousands)
Balance, beginning of year.......................................................... 344,743 325,318 327,679
Stock options exercised......................................................... 6 432 95
Stock warrants exercised........................................................ - 3,327 -
Shares issued in conjunction with the acquisition of Exl........................ - 3,411 -
Shares issued pursuant to stock purchase contracts related to the
FELINE PRIDES................................................................ - 11,351 -
Shares issued under employee benefit compensation plans......................... 1,258 904 1,791
Settlement of forward contract and common stock acquired........................ - - (4,247)
------- ------- -------
Balance, end of year................................................................ 346,007 344,743 325,318
======= ======= =======
In February 2001, the Company issued 11.4 million shares of Conseco
common stock pursuant to stock purchase contracts related to the FELINE PRIDES.
This transaction is discussed in further detail in the note to the consolidated
financial statements entitled "Other Disclosures".
Dividends declared on common stock for 2000, were $.10 per common share.
No dividends were declared in 2002 or 2001.
During 1999, we sold 3.6 million shares of our common stock to an
unaffiliated party (the "Buyer"). Simultaneous with the issuance of the common
stock, we entered into a forward transaction with the Buyer to be settled at
$29.0625 per share in a method of our choosing (i.e., cash settlement, transfer
of net shares to or from the Buyer, or transfer of net cash to or from the
Buyer). We settled the contract in March 2000 by repurchasing 3.6 million shares
held by the Buyer.
Conseco's 1994 Stock and Incentive Plan authorizes the granting of
options to employees and directors of the Company to purchase up to 24 million
shares of Conseco common stock at a price not less than its market value on the
date the option is granted. In 1997, the Company adopted the 1997 Non-qualified
Stock Option Plan, which authorizes the granting of non-qualified options to
employees of the Company to purchase shares of Conseco common stock. The
aggregate number of shares of common stock for which options may be granted
under the 1997 plan, when added to all outstanding, unexpired options under the
Company's employee benefit plans, shall not exceed 20 percent of the total of
shares of common stock outstanding plus the number of shares issuable upon
conversion of any outstanding convertible security on the date of grant
(calculated in the manner set forth in the 1997 plan). The options may become
exercisable immediately or over a period of time. The 1994 plan also permits
granting of restricted stock, stock appreciation rights and certain other
awards.
F - 107
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
A summary of the Company's stock option activity and related information
for the years ended December 31, 2002, 2001 and 2000, is presented below (shares
in thousands):
2002 2001 2000
----------------------- --------------------- ----------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Shares price Shares price Shares price
------ ----- ------ ----- ------ -----
Outstanding at the beginning of year.... 40,292 $15.01 36,107 $18.38 33,750 $32.15
Options granted......................... 2,572 3.57 8,609 6.32 18,404 7.10
Exercised............................... (6) 1.51 (432) 9.88 (95) 8.15
Forfeited or terminated................. (19,338) 12.35 (3,992) 27.27 (15,952) 34.56
------- ------ -------
Outstanding at the end of the year...... 23,520 15.95 40,292 15.01 36,107 18.38
======= ====== =======
Options exercisable at year-end......... 13,593 13,591 13,905
======= ====== =======
Available for future grant.............. 52,668 34,903 34,853
======= ====== =======
The following table summarizes information about stock options
outstanding at December 31, 2002 (shares in thousands):
Options outstanding Options exercisable
---------------------------------------- ------------------------
Weighted Weighted Weighted
average average average
Range of Number remaining exercise Number exercise
exercise prices outstanding life (in years) price exercisable price
--------------- ----------- --------------- ----- ----------- -----
$ 1.51 - 4.24................... 6,781 8.9 $ 3.70 1,432 $ 3.61
5.75 - 8.87................... 3,587 2.3 6.20 2,852 5.92
9.19 - 14.73................... 3,520 4.7 11.41 1,659 13.49
15.03 - 16.57................... 162 6.4 15.25 73 15.43
17.63 - 26.19................... 3,510 5.5 22.67 2,668 22.83
27.19 - 30.41................... 1,606 10.5 30.11 963 29.92
30.81 - 45.44................... 3,964 3.5 34.72 3,700 34.88
46.71 - 51.28................... 390 5.3 50.51 246 50.44
------ ------
23,520 13,593
====== ======
F - 108
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
We apply Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" and related interpretations in accounting for our
stock option plans. Since the amount an employee must pay to acquire the stock
is equal to the market price of the stock on the grant date, no compensation
cost has been recognized for our stock option plans. Had compensation cost been
determined based on the fair value at the grant dates for awards granted after
January 1, 1995, consistent with the method of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation", the Company's pro
forma net income (loss) and pro forma earnings (loss) per share for the years
ended December 31, 2002, 2001 and 2000 would have been as follows:
2002 2001 2000
------------------------- ------------------------- ------------------------
As reported Pro forma As reported Pro forma As reported Pro forma
----------- --------- ----------- --------- ----------- ---------
(Dollars in millions, except per share amounts)
Net loss.............................. $(7,835.7) $(7,848.1) $(405.9) $(434.1) $(1,191.2) $(1,218.3)
Basic loss per share.................. (22.67) (22.70) (1.24) (1.32) (3.69) (3.77)
Diluted loss per share................ (22.67) (22.70) (1.24) (1.32) (3.69) (3.77)
We estimated the fair value of each option grant used to determine the
pro forma amounts summarized above using the Black-Scholes option valuation
model with the following weighted average assumptions for 2002, 2001 and 2000:
2002 Grants 2001 Grants 2000 Grants
----------- ----------- -----------
Weighted average risk-free interest rates...... 4.7% 4.8% 6.3%
Weighted average dividend yields............... 0.0% 0.0% 2.4%
Volatility factors............................. 40% 40% 40%
Weighted average expected life................. 6.4 years 6.4 years 6.1 years
Weighted average fair value per share.......... $1.73 $3.04 $2.84
At December 31, 2002, a total of 115 million shares of common stock were
reserved for issuance under stock options, stock bonus and deferred compensation
plans, Series F Preferred Stock, warrants to buy 700,000 shares of Conseco
common stock for $19.71 per share at anytime through September 29, 2006 and
warrants to buy 5,250,000 shares of Conseco common stock for $5.75 at any time
through June 2005.
At December 31, 2002, a total of 50,000 shares of restricted common
shares issued pursuant to employment agreements were outstanding. The
restrictions on such shares will expire in September 2004.
F - 109
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
A reconciliation of net income (loss) and shares used to calculate basic
and diluted earnings per share is as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions and shares in thousands)
Net loss:
Net loss............................................................ $(7,835.7) $(405.9) $(1,191.2)
Preferred stock dividends........................................... 2.1 12.8 11.0
--------- ------- ---------
Loss applicable to common ownership for basic and diluted
earnings per share.............................................. $(7,837.8) $(418.7) $(1,202.2)
========= ======= =========
Shares:
Weighted average shares outstanding for basic and diluted earnings
per share......................................................... 345,807 338,145 325,953
======= ======= =======
There were no dilutive common stock equivalents during 2002, 2001 and
2000 because of the net loss realized by the Company.
The following summarizes the equivalent common shares for securities that
were not included in the computation of diluted earnings per share during 2002,
2001 and 2000 because doing so would have been antidilutive in the periods
presented:
2002 2001 2000
---- ---- ----
(Shares in thousands)
Equivalent common shares that were antidilutive during the period:
Stock options....................................................... 75 9,117 2,798
Employee benefit plans.............................................. 3,080 2,786 1,438
Assumed conversion of convertible preferred stock................... 28,557 27,443 26,405
Forward contract.................................................... - - 476
------ ------ ------
Antidilutive equivalent common shares............................. 31,712 39,346 31,117
====== ====== ======
F - 110
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
12. OTHER OPERATING STATEMENT DATA:
Insurance policy income consisted of the following:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Traditional products:
Direct premiums collected......................................................... $5,100.2 $5,426.3 $5,389.3
Reinsurance assumed............................................................... 78.7 146.0 300.5
Reinsurance ceded................................................................. (327.8) (249.4) (237.2)
-------- -------- --------
Premiums collected, net of reinsurance...................................... 4,851.1 5,322.9 5,452.6
Change in unearned premiums....................................................... (19.7) 1.9 1.1
Less premiums on universal life and products
without mortality and morbidity risk which are
recorded as additions to insurance liabilities ................................ (1,792.7) (1,828.2) (1,833.5)
-------- -------- --------
Premiums on traditional products with mortality or morbidity risk,
recorded as insurance policy income...................................... 3,038.7 3,496.6 3,620.2
Fees and surrender charges on interest-sensitive products............................. 563.6 496.1 550.5
-------- -------- --------
Insurance policy income..................................................... $3,602.3 $3,992.7 $4,170.7
======== ======== ========
The five states with the largest shares of 2002 collected premiums were
Florida (8.5 percent), California (7.5 percent), Illinois (7.3 percent), Texas
(7.1 percent), and Michigan (5.3 percent). No other state accounted for more
than 5 percent of total collected premiums.
Other operating costs and expenses were as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Commission expense.................................................................... $195.1 $218.6 $270.9
Salaries and wages.................................................................... 215.1 206.0 240.0
Other................................................................................. 301.9 297.6 362.0
------ ------ ------
Total other operating costs and expenses....................................... $712.1 $722.2 $872.9
====== ====== ======
F - 111
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Changes in the cost of policies purchased were as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Balance, beginning of year............................................................ $1,657.8 $1,954.8 $2,258.5
Additional acquisition expense on acquired policies............................... 11.3 12.5 14.6
Amortization...................................................................... (215.5) (242.0) (266.0)
Amounts related to fair value adjustment of actively managed fixed maturities..... (81.9) (49.0) (68.1)
Reinsurance transactions.......................................................... (73.4) - -
Net amounts related to discontinued operations ................................... (66.6) (13.9) (20.2)
Amounts related to sales of subsidiaries.......................................... (60.0) - -
Other ............................................................................ (1.7) (4.6) 36.0
-------- -------- --------
Balance, end of year.................................................................. $1,170.0 $1,657.8 $1,954.8
======== ======== ========
Based on current conditions and assumptions as to future events on all
policies inforce, the Company expects to amortize approximately 12 percent of
the December 31, 2002 balance of cost of policies purchased in 2003, 11 percent
in 2004, 9 percent in 2005, 8 percent in 2006 and 7 percent in 2007. The
discount rates used to determine the amortization of the cost of policies
purchased averaged 7 percent in 2002, 6 percent in 2001 and 7 percent in 2000.
Changes in the cost of policies produced were as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Balance, beginning of year............................................................ $2,570.2 $2,480.5 $2,087.4
Additions.......................................................................... 486.0 612.8 695.6
Amortization....................................................................... (544.3) (396.3) (269.6)
Amounts related to fair value adjustment of actively managed fixed maturities...... (121.0) (28.2) 7.5
Reinsurance transactions........................................................... (134.6) - -
Net amounts related to discontinued operations..................................... (103.3) 15.0 66.8
Amounts related to sales of subsidiaries........................................... (140.8) - -
Other.............................................................................. 2.2 (113.6) (107.2)
-------- -------- --------
Balance, end of year.................................................................. $2,014.4 $2,570.2 $2,480.5
======== ======== ========
In 2001, the Company stopped renewing portions of our major medical lines
of business in several unprofitable states in accordance with the contractual
terms of the policies. As a result, we determined that approximately $77.4
million of the cost of policies produced and the cost of policies purchased
would not be recoverable. Such amount is recorded as amortization in the
accompanying statement of operations.
Policyholder redemptions of annuity and, to a lesser extent, life
products have increased in recent periods. We have experienced additional
redemptions following the downgrade of our A.M. Best financial strength rating
to "B (fair)". When redemptions are greater than our previous assumptions, we
are required to accelerate the amortization of our cost of policies produced and
cost of policies purchased to write off the balance associated with the redeemed
policies. Accordingly, amortization expense has increased. We have changed the
lapse assumptions used to determine the amortization of the cost of policies
produced and the cost of policies purchased related to certain universal life
products and our annuities to reflect our current estimates of future lapses.
For certain universal life products, we changed the ultimate lapse assumption
from: (i) a range of 6 percent to 7 percent; to (ii) a tiered assumption based
on the level of funding of the policy of a range of 2 percent to 10 percent.
Policyholder withdrawals in recent periods have exceeded our estimates. Such
withdrawals were $3,708.3 million in 2002 and $2,528.3 million in 2001.
Accordingly, we increased the expected future lapse rates on these products to
reflect our current belief that lapses on these policies will continue to be
higher than previously expected for the next several quarters. These changes
resulted in additional amortization of the cost of policies produced and the
cost of policies purchased of $203.2 million in 2002.
The cost of policies produced and the cost of policies purchased are
amortized in relation to the estimated gross profits to be earned
F - 112
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
over the life of our annuity products. As a result of economic developments,
actual experience of our products and changes in our expectations, we changed
our investment yield assumptions used in calculating the estimated gross profits
to be earned on our annuity products. Such changes resulted in additional
amortization of the cost of policies produced and the cost of policies purchased
of $35.0 million (of which $7.2 million related to discontinued operations) and
$25.6 million in 2001 and 2000, respectively.
13. CONSOLIDATED STATEMENT OF CASH FLOWS:
The following disclosures supplement our consolidated statement of cash
flows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Non-cash items not reflected in the investing and financing activities section
of the consolidated statement of cash flows:
Issuance of common stock under stock option and employee benefit plans............. $12.7 $ 19.7 $ 5.8
Issuance of convertible preferred shares........................................... 2.1 12.8 8.4
Value of FELINE PRIDES retired and transferred from minority interest to
common stock and additional paid-in capital...................................... - 496.6 -
Issuance of common stock in connection with the acquisition of Exl................. - 52.1 -
Decrease in notes payable-direct corporate obligations and increase in other
liabilities reflecting the estimated fair value of interest rate swap agreements. - 13.5 -
Issuance of warrants to Lehman..................................................... - - 48.1
Issuance of warrants to General Electric Company................................... - - 21.0
The following reconciles net loss to net cash provided by operating
activities:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Cash flows from operating activities:
Net loss............................................................................ $(7,835.7) $ (405.9) $(1,191.2)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Interest-only securities investment income...................................... (10.6) (51.5) (106.6)
Cash received from interest-only securities, net................................ (73.3) 14.3 187.6
Servicing income................................................................ (83.9) (115.3) (108.2)
Cash received from servicing activities......................................... 46.9 71.7 123.8
Provision for losses............................................................ 1,160.8 707.2 576.2
(Gain) loss on sale of finance receivables...................................... 49.5 (26.9) (7.5)
Amortization and depreciation................................................... 1,017.8 848.0 745.9
Income taxes.................................................................... 758.3 (140.7) (531.1)
Insurance liabilities........................................................... 509.5 334.4 539.7
Accrual and amortization of investment income................................... 227.9 97.2 174.6
Deferral of cost of policies produced and purchased............................. (509.2) (667.0) (794.3)
Gain on sale of interest in riverboat........................................... - (192.4) -
Impairment charges.............................................................. 1,514.4 386.9 515.7
Goodwill impairment............................................................. 500.0 - -
Special charges................................................................. 171.2 72.4 483.1
Cumulative effect of accounting change.......................................... 2,949.2 - 85.2
Minority interest............................................................... 173.2 183.9 223.5
Net investment losses........................................................... 673.7 413.7 358.3
Loss on CVIC sale............................................................... 93.1 - -
Extraordinary (gain) loss on extinguishment of debt............................. (8.1) (26.9) 7.7
Other........................................................................... (29.0) (178.4) (77.1)
-------- -------- ---------
Net cash provided by operating activities..................................... $ 1,295.7 $1,324.7 $ 1,205.3
========= ======== =========
F - 113
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
14. STATUTORY INFORMATION:
Statutory accounting practices prescribed or permitted by regulatory
authorities for the Company's insurance subsidiaries differ from GAAP. Our
insurance subsidiaries reported the following amounts to regulatory agencies,
after appropriate elimination of intercompany accounts:
2002 2001
---- ----
(Dollars in millions)
Statutory capital and surplus.................................................................... $1,063.4 $1,649.8
Asset valuation reserve.......................................................................... 11.6 105.1
Interest maintenance reserve..................................................................... 311.3 379.3
-------- --------
Total...................................................................................... $1,386.3 $2,134.2
======== ========
The statutory capital and surplus shown above included investments in
up-stream affiliates, all of which were eliminated in the consolidated financial
statements prepared in accordance with GAAP, as follows:
2002 2001
---- ----
(Dollars in millions)
Securitization debt issued by special purpose entities and guaranteed by our
finance subsidiary, all of which was purchased by our insurance subsidiaries
prior to the acquisition of Conseco Finance (a)................................................. $ 2.0 $ 71.7
Preferred and common stock of intermediate holding company......................................... 146.4 145.9
Common stock of Conseco (39.8 million shares)...................................................... - 14.9
Other ............................................................................................. 2.5 2.5
------ ------
Total........................................................................................ $150.9 $235.0
====== ======
--------------------
(a) Total par value, amortized cost and fair value of securities issued by
special purpose entities which hold loans originated by our finance
subsidiary (including the securities that are not guaranteed by Conseco
Finance, and therefore are not considered affiliated investments) were
$269.3 million, $197.1 million and $177.7 million, respectively.
The statutory net loss of our life insurance subsidiaries was $466.0
million, $137.8 million and $70.8 million in 2002, 2001 and 2000, respectively.
Included in such net loss are net realized capital losses, net of income taxes,
of $514.7 million, $188.0 million and $200.8 million in 2002, 2001 and 2000,
respectively. In addition, the insurance subsidiaries incur fees and interest to
Conseco or its non-life subsidiaries; such amounts totaled $194.8 million,
$279.2 million and $264.4 million in 2002, 2001 and 2000, respectively.
The ability of our insurance subsidiaries to pay dividends is subject to
state insurance department regulations. These regulations generally permit
dividends to be paid from earned surplus of the insurance company for any
12-month period in amounts equal to the greater of (or in a few states, the
lesser of): (i) net gain from operations or net income for the prior year; or
(ii) 10 percent of capital and surplus as of the end of the preceding year. Any
dividends in excess of these levels require the approval of the director or
commissioner of the applicable state insurance department. During 2002, our
insurance subsidiaries paid dividends to Conseco totaling $240.0 million.
On October 30, 2002, Bankers National Life Insurance Company and Conseco
Life Insurance Company of Texas (on behalf of itself and its insurance
subsidiaries), our insurance subsidiaries domiciled in Texas, each entered into
consent orders with the Commissioner of Insurance for the State of Texas whereby
they agreed: (i) not to request any dividends or other distributions before
January 1, 2003 and, thereafter, not to pay any dividends or other distributions
to parent companies outside of the insurance system without the prior approval
of the Texas Insurance Commissioner; (ii) to continue to maintain sufficient
capitalization and reserves as required by the Texas Insurance Code; (iii) to
request approval from the Texas Insurance Commissioner before making any
disbursements not in the ordinary course of business; (iv) to complete any
pending transactions previously reported to the proper insurance regulatory
officials prior to and during Conseco's restructuring, unless not approved by
the Texas Insurance Commissioner; (v) to obtain a commitment from Conseco and
CIHC to maintain their infrastructure, employees, systems and physical
facilities prior
F - 114
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
to and during Conseco's restructuring; and (vi) to continue to permit the Texas
Insurance Commissioner to examine its books, papers, accounts, records and
affairs. Conseco Life Insurance Company of Texas is the parent of all of the
Company's insurance subsidiaries, except for Bankers National Life Insurance
Company. The consent orders do not prohibit the payment of fees in the ordinary
course of business pursuant to existing administrative, investment management
and marketing agreements with our non-insurance subsidiaries.
The National Association of Insurance Commissioners ("NAIC") adopted
codified statutory accounting principles in a process referred to as
codification. Such principles are summarized in the Accounting Practices and
Procedures Manual. The revised manual was effective January 1, 2001. The
domiciliary states of our insurance subsidiaries have adopted the provisions of
the revised manual or, with respect to some states, adopted the manual with
certain modifications. The revised manual has changed, to some extent,
prescribed statutory accounting practices and resulted in changes to the
accounting practices that our insurance subsidiaries use to prepare their
statutory-basis financial statements. The impact of these changes increased our
insurance subsidiaries' statutory-based capital and surplus as of January 1,
2001, by approximately $198 million.
The NAIC's Risk-Based Capital for Life and/or Health Insurers Model Act
(the "Model Act") provides a tool for insurance regulators to determine the
levels of statutory capital and surplus an insurer must maintain in relation to
its insurance and investment risks and whether there is a need for possible
regulatory attention. The Model Act provides four levels of regulatory
attention, varying with the ratio of the insurance company's total adjusted
capital (defined as the total of its statutory capital and surplus, asset
valuation reserve and certain other adjustments) to its authorized control level
risk based capital ("ACLRBC"): (i) if a company's total adjusted capital is less
than or equal to 200 percent but greater than 150 percent of its ACLRBC (the
"Company Action Level"), the company must submit a comprehensive plan to the
regulatory authority proposing corrective actions aimed at improving its capital
position; (ii) if a company's total adjusted capital is less than or equal to
150 percent but greater than 100 percent of its ACLRBC (the "Regulatory Action
Level"), the regulatory authority will perform a special examination of the
company and issue an order specifying the corrective actions that must be
followed; (iii) if a company's total adjusted capital is less than or equal to
100 percent but greater than 70 percent of its ACLRBC (the "Authorized Control
Level"), the regulatory authority may take any action it deems necessary,
including placing the company under regulatory control; and (iv) if a company's
total adjusted capital is less than or equal to 70 percent of its ACLRBC (the
"Mandatory Control Level"), the regulatory authority must place the company
under its control. In addition the Model Law provides for an annual trend test
if a company's total adjusted capital is between 200 percent and 250 percent of
its ACLRBC at the end of the year. The trend test calculates the greater of the
decrease in the margin of total adjusted capital over ACLRBC: (i) between the
current year and the prior year; and (ii) for the average of the last 3 years.
It assumes that such decrease could occur again in the coming year. Any company
whose trended total adjusted capital is less than 190 percent of its ACLRBC
would trigger a requirement to submit a comprehensive plan as described above
for the Company Action Level.
The 2002 statutory annual statements filed with the state insurance
regulators of each of our insurance subsidiaries reflected total adjusted
capital in excess of the levels subjecting the subsidiary to any regulatory
action. However, our ACLRBC ratios have declined significantly over the last
year and some of our subsidiaries are near the level which would require them to
submit a comprehensive plan aimed at improving their capital position.
The aggregate ACLRBC ratio for our insurance subsidiaries was 332 percent
at December 31, 2002, compared to 480 percent at December 31, 2001. The ratios
for our insurance subsidiaries that are subject to the four levels of regulatory
attention described above ranged from 250 percent (just above the trend test
level) to 563 percent. We are taking actions intended to improve the ACLRBC
ratios of our insurance subsidiaries. Such actions include: (i) discontinuing or
reducing sales of products that create initial reductions in statutory surplus
because of the costs of selling the products; (ii) reducing operating expenses;
(iii) merging some of our insurance subsidiaries with other insurance
subsidiaries; and (iv) restructuring our investment portfolio to better match
the risk profile of the portfolio with the insurance subsidiary's earnings and
capital requirements. We have discussed these actions with insurance regulators
in each of the states in which our insurance subsidiaries are domiciled. The
audited financial statements of our insurance subsidiaries generally are not
completed until around June 1 of each year (the date such audited financial
statements are generally required to be filed with state insurance departments).
Any significant audit adjustments to the financial statements of our insurance
subsidiaries resulting in a reduction in capital could cause the ACLRBC ratio of
one or more of our insurance subsidiaries to fall below the trend test level
requiring the trended total adjusted capital to be calculated. In addition, the
Company has been and will be discussing the appropriate statutory accounting
treatment for certain investments with the state insurance regulators. If the
ultimate outcome of these discussions resulted in adjustments to the December
31, 2002 statutory financial statements of our insurance subsidiaries, some of
our subsidiaries could be required to complete the trend test. If a trend test
were required for any of our subsidiaries, such a test would likely result in
trended total adjusted capital which is less than 190 percent of ACLRBC.
Our internal actuaries must annually render opinions concerning the
adequacy of our insurance reserves. Our actuaries
F - 115
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
rendered unqualified opinions at December 31, 2002. Such opinions reference the
Chapter 11 Cases and recent downgrades of our insurance company ratings as being
outside the scope of the actuarial opinion, meaning that the actuaries did not
believe it was appropriate to calculate what impact, if any, such events would
have on the life insurance reserves. Regulators have raised the question as to
whether or not such references result in the actuarial opinions becoming
qualified opinions. We continue to believe the actuarial opinions are
unqualified opinions. If the actuarial opinions were qualified opinions, more
stringent rules would apply for calculating ACLRBC which we believe would result
in the ACLRBC for several of our insurance subsidiaries falling below the trend
test level.
15. BUSINESS SEGMENTS:
We have historically managed our business operations through two
segments, based on the products offered, in addition to the corporate segment.
Insurance and fee-based segment. Our insurance and fee-based segment
provides supplemental health, annuity and life insurance products to a broad
spectrum of customers through multiple distribution channels, each focused on a
specific market segment. These products are primarily marketed through career
agents, professional independent producers and direct marketing. Fee-based
activities include services performed for other companies, including investment
management and insurance product marketing.
Finance segment. CFC has historically provided a variety of finance
products including: (i) loans for the purchase of manufactured housing, home
improvements and various consumer products; (ii) home equity loans; and (iii)
private label credit card programs. As a result of the formalization of the plan
to sell the finance business and the filing of petitions under the Bankruptcy
Code by the Finance Company Debtors, the finance business is being accounted for
as a discontinued business in Conseco's consolidated financial statements. See
the note to our consolidated financial statements entitled "Discontinued Finance
Business - Planned Sale of CFC" for additional information on this segment.
Corporate and other segment. Our corporate segment includes certain
investment activities, such as our venture capital investment in AWE, and, prior
to its sale, our ownership interest in the riverboat casino in Lawrenceberg,
Indiana. In addition, the corporate segment includes interest expense related to
the Company's corporate debt, special corporate charges, income (loss) from the
major medical business in run-off and other income and expenses. Corporate
expenses are net of charges to our subsidiaries for services provided by the
corporate operations.
F - 116
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Operating information regarding the insurance and corporate segments was
as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Revenues:
Insurance and fee-based segment:
Insurance policy income:
Annuities............................................................. $ 160.9 $ 88.2 $ 125.5
Supplemental health................................................... 2,279.1 2,229.9 2,136.6
Life ................................................................ 628.9 795.7 855.2
Other ................................................................ 114.6 126.7 148.1
Net investment income (a)............................................... 1,416.2 1,564.0 1,707.7
Fee and other revenue (a)............................................... 85.8 100.2 128.9
Net realized investment losses (a)...................................... (597.0) (379.4) (346.5)
--------- --------- ---------
Total insurance and fee-based segment revenues........................ 4,088.5 4,525.3 4,755.5
--------- --------- ---------
Corporate and other:
Net investment income................................................... 13.6 19.2 50.1
Venture capital loss related to investment in AWE....................... (99.3) (42.9) (199.5)
Gain on sale of interest in riverboat................................... - 192.4 -
Revenue from the major medical business in run-off...................... 439.2 777.7 946.3
Other income............................................................ - .9 6.7
--------- --------- ---------
Total corporate segment revenues...................................... 353.5 947.3 803.6
--------- --------- ---------
Eliminations.............................................................. (23.7) (5.5) (.5)
--------- --------- ---------
Total revenues........................................................ 4,418.3 5,467.1 5,558.6
--------- --------- ---------
Expenses:
Insurance and fee-based segment:
Insurance policy benefits............................................... 3,063.8 2,945.4 3,050.1
Amortization............................................................ 745.3 665.7 646.5
Interest expense on investment borrowings............................... 15.4 30.5 15.8
Other operating costs and expenses...................................... 548.6 556.1 663.9
Goodwill impairment..................................................... 500.0 - -
Special charges......................................................... 44.3 21.5 -
--------- --------- ---------
Total insurance and fee-based segment expenses........................ 4,917.4 4,219.2 4,376.3
--------- --------- ---------
(continued on following page)
F - 117
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
2002 2001 2000
---- ---- ----
(Dollars in millions)
(continued from previous page)
Corporate and other:
Interest expense on corporate debt........................................ 325.6 369.5 438.4
Provision for losses and expenses related to stock purchase plan.......... 240.0 169.6 231.5
Expenses from the major medical business in run-off....................... 439.2 908.0 997.6
Special charges and other corporate expenses, less charges to
subsidiaries for services provided.................................... 153.8 66.7 285.2
--------- --------- ---------
Total corporate segment expenses...................................... 1,158.6 1,513.8 1,952.7
-------- --------- ---------
Eliminations.............................................................. (23.7) (5.5) (.5)
--------- --------- ---------
Total expenses........................................................ 6,052.3 5,727.5 6,328.5
--------- --------- ---------
Income (loss) before income taxes, minority interest, extraordinary gain (loss)
and cumulative effect of accounting change:
Insurance and fee-based operations...................................... (828.9) 306.1 379.2
Corporate interest expense and other items.............................. (805.1) (566.5) (1,149.1)
--------- --------- ---------
Loss before income taxes, minority interest,
extraordinary gain (loss) and cumulative
effect of accounting change......................................... $(1,634.0) $ (260.4) $ (769.9)
========= ========= =========
Segment balance sheet information was as follows:
2002 2001
---- ----
(Dollars in millions)
Assets:
Insurance and fee-based................................................... $28,649.1 $38,768.2
Discontinued operations................................................... 17,964.9 22,267.9
Corporate................................................................. 5,343.7 12,175.8
Eliminate intercompany amounts............................................ (5,448.7) (11,779.7)
--------- ---------
Total assets......................................................... $46,509.0 $61,432.2
========= =========
Liabilities:
Insurance and fee-based................................................... $24,118.5 $30,128.5
Discontinued operations................................................... 18,051.1 20,318.4
Corporate................................................................. 5,472.6 5,508.3
Eliminate intercompany amounts............................................ (1,004.3) (1,190.5)
--------- ---------
Total liabilities.................................................... $46,637.9 $54,764.7
========= =========
-------------------
(a) It is not practicable to provide additional components of revenue by
product or services.
F - 118
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
16. QUARTERLY FINANCIAL DATA (UNAUDITED):
We compute earnings per common share for each quarter independently of
earnings per share for the year. The sum of the quarterly earnings per share may
not equal the earnings per share for the year because of: (i) transactions
affecting the weighted average number of shares outstanding in each quarter; and
(ii) the uneven distribution of earnings during the year.
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
-------- -------- -------- --------
(Dollars in millions, except per share data)
2002
----
Revenues................................................................ $ 1,253.0 $ 981.8 $ 982.3 $ 1,201.2
Loss before income taxes, minority interest, discontinued operations,
extraordinary gain (loss) and cumulative effect of accounting change . (85.7) (275.7) (846.1) (426.5)
Net loss................................................................ (3,045.1) (1,333.1) (1,769.0) (1,688.5)
Income (loss) per common share:
Basic:
Loss before discontinued operations, extraordinary gain (loss)
and cumulative effect of accounting change ....................... $ (.26) $(3.39) $(2.98) $(1.10)
Discontinued operations.............................................. (.03) (.47) (2.13) (3.79)
Extraordinary gain (loss)............................................ .01 - - .01
Cumulative effect of accounting change............................... (8.54) - - -
----- ------ ------ ------
Net loss.......................................................... $(8.82) $(3.86) $(5.11) $(4.88)
====== ====== ====== ======
Diluted:
Loss before discontinued operations, extraordinary gain (loss) and
cumulative effect of accounting change............................ $ (.26) $(3.39) $(2.98) $(1.10)
Discontinued operations.............................................. (.03) (.47) (2.13) (3.79)
Extraordinary gain (loss)............................................ .01 - - .01
Cumulative effect of accounting change............................... (8.54) - - -
------- ------ ------ ------
Net loss.......................................................... $(8.82) $(3.86) $(5.11) $(4.88)
====== ====== ====== ======
F - 119
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
-------- -------- -------- --------
(Dollars in millions, except per share data)
2001
----
Revenues................................................................. $1,485.2 $1,456.8 $1,168.3 $1,356.8
Income (loss) before income taxes, minority interest, discontinued
operations and extraordinary gain (loss)............................... 124.6 .6 (280.2) (105.4)
Net income (loss)........................................................ 84.1 (25.7) (407.5) (56.8)
Income (loss) per common share:
Basic:
Income (loss) before discontinued operations and extraordinary
gain (loss)....................................................... $.14 $(.14) $(.67) $(.30)
Discontinued operations................................................ .10 .06 (.54) .07
Extraordinary gain (loss) on extinguishment of debt.................... - (.01) - .06
---- ----- ----- -----
Net income (loss)................................................. $.24 $(.09) $(1.21) $(.17)
==== ===== ====== =====
Diluted:
Income (loss) before discontinued operations and extraordinary
gain (loss)....................................................... $.14 $(.14) $(.67) $(.30)
Discontinued operations.............................................. .09 .06 (.54) .07
Extraordinary gain (loss) on extinguishment of debt.................. - (.01) - .06
---- ----- ------ -----
Net income (loss)................................................. $.23 $(.09) $(1.21) $(.17)
==== ===== ====== =====
F - 120
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
17. FINANCIAL INFORMATION REGARDING CFC
As previously described, CFC filed a petition for relief under the
Bankruptcy Code in the United States Bankruptcy Court on December 17, 2002. On
March 14, 2003, the Bankruptcy Court entered orders approving the terms of the
sale of substantially all of CFC's assets. The closing of the sale of the CFC
assets is subject to various closing conditions, but is currently expected to
occur in the second quarter of 2003. As a result of the formalization of the
plan to sell the finance business and the filing of petitions for relief under
the Bankruptcy Code by the Finance Company Debtors, the finance business is
being accounted for as a discontinued business in our consolidated financial
statements. The consolidated statement of operations reflects the operations of
the discontinued finance business in the caption "Discontinued operations" for
all periods. Our December 31, 2002 consolidated balance sheet includes the total
assets of the finance segment in the caption "Assets of discontinued operations"
and the total liabilities of the finance segment in the caption "Liabilities of
discontinued operations". We currently believe that it is unlikely that the
Company will receive any net proceeds from the ultimate disposition of CFC
beyond the extinguishment of CFC's liabilities and the release of related
Company guarantees on CFC's debt. Accordingly, we wrote off our entire remaining
investment in CFC of $64.5 million on December 31, 2002.
F - 121
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The following summarizes selected balance sheet information of CFC as of
December 31, 2002 and 2001:
CFC
CONSOLIDATED BALANCE SHEET INFORMATION
December 31, 2002 and 2001
(Dollars in millions)
2002 2001
---- ----
ASSETS
Retained interests in securitization trusts at fair value (amortized cost:
2002 - $189.1; 2001 - $876.1)............................................................. $ 252.6 $ 710.1
Cash and cash equivalents..................................................................... 562.3 394.5
Cash held in segregated accounts for investors in securitizations............................. 394.7 550.2
Cash held in segregated accounts related to servicing agreements and
securitization transactions................................................................ 998.4 994.6
Finance receivables........................................................................... 2,023.1 3,810.7
Finance receivables - securitized............................................................. 12,460.0 14,198.5
Receivables due from Conseco, Inc.(a)......................................................... 276.1 358.0
Income tax assets............................................................................. - 267.2
Other assets.................................................................................. 997.7 984.1
--------- ---------
Total assets........................................................................... $17,964.9 $22,267.9
========= =========
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Investor payables.......................................................................... $ 394.7 $ 550.2
Guarantee liability related to interests in securitization trusts held by others........... 326.7 39.9
Liabilities related to certificates of deposit............................................. 2,326.0 1,790.3
Servicing liability........................................................................ 333.4 17.8
Income tax liability....................................................................... 34.6 -
Other liabilities.......................................................................... 279.1 548.5
Preferred stock dividends payable to Conseco, Inc.(a)...................................... - 86.1
Notes payable:
Related to securitized finance receivables structured as collateralized borrowings....... 13,069.7 14,484.5
Debtor in possession facilities.......................................................... 82.0 -
Master repurchase agreements............................................................. - 1,691.8
Credit facility collateralized by retained interests in securitizations.................. - 507.3
Due to Conseco, Inc.(a).................................................................. - 249.5
Other borrowings......................................................................... - 352.5
--------- ---------
Total liabilities not subject to compromise......................................... 16,846.2 20,318.4
--------- ---------
Liabilities subject to compromise ............................................................ 1,204.9 -
--------- ---------
Total Liabilities................................................................... 18,051.1 20,318.4
--------- ---------
Shareholder's equity (deficit):
Preferred stock (a)........................................................................ 750.0 750.0
Common stock and additional paid-in capital (a)............................................ 1,209.4 1,209.4
Accumulated other comprehensive income (loss) (net of applicable deferred
income tax benefit: 2002 - $(63.8); 2001 - $(63.8)) (a)................................. 110.6 (108.6)
Retained earnings (deficit) (a)............................................................ (2,156.2) 98.7
--------- ---------
Total shareholder's equity (deficit)................................................ (86.2) 1,949.5
--------- ---------
Total liabilities and shareholder's equity (deficit)................................ $17,964.9 $22,267.9
========= =========
-------------
(a) Intercompany accounts were eliminated when consolidated with Conseco and
its other wholly-owned subsidiaries.
F - 122
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The following summarizes selected statement of operations information of
CFC for the years ended December 31, 2002, 2001 and 2000:
CFC
CONSOLIDATED STATEMENT OF OPERATIONS INFORMATION (a)
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions)
2002 2001 2000
---- ---- ----
Revenues:
Net investment income:
Finance receivables and other.......................................... $ 2,062.4 $2,150.1 $1,826.7
Retained interests..................................................... 75.0 125.3 180.7
Affiliated (b)......................................................... 11.8 19.6 26.9
Gain (loss) on sale of finance receivables............................... (49.5) 26.9 7.5
Servicing income......................................................... 83.9 115.3 108.2
Impairment charges....................................................... (1,449.9) (386.9) (515.7)
Fee revenue and other income............................................. 189.9 220.5 257.4
--------- -------- --------
Total revenues..................................................... 923.6 2,270.8 1,891.7
--------- -------- --------
Expenses:
Provision for losses..................................................... 950.0 537.7 344.7
Interest expense - affiliated (b)........................................ 10.3 28.5 156.3
Interest expense......................................................... 1,119.7 1,205.9 996.1
Other operating costs and expenses....................................... 608.0 639.4 750.0
Other operating costs and expenses - affiliated (b)...................... 8.0 3.0 3.5
Special charges.......................................................... 121.9 21.5 394.3
Reorganization items..................................................... 17.3 - -
--------- -------- --------
Total expenses..................................................... 2,835.2 2,436.0 2,644.9
--------- -------- --------
Loss before income taxes, cumulative effect of accounting change
and extraordinary gain (loss) on extinguishment of debt.......... (1,911.6) (165.2) (753.2)
Income tax expense (benefit):
Tax (benefit) expense on period income................................... 34.4 (56.4) (262.8)
Valuation allowance for deferred tax assets.............................. 245.3 - -
--------- -------- --------
Loss before cumulative effect of accounting change and
extraordinary gain (loss) on extinguishment of debt.............. (2,191.3) (108.8) (490.4)
Extraordinary gain (loss) on extinguishment of debt, net of income taxes.. 3.9 6.1 -
Cumulative effect of accounting change, net of income taxes................. - - (45.5)
--------- -------- ---------
Net loss........................................................... (2,187.4) (102.7) (535.9)
Preferred stock dividends payable to Conseco (b)............................ 67.5 67.5 18.6
--------- -------- --------
Net loss applicable to common stock................................ $(2,254.9) $ (170.2) $ (554.5)
========= ======== ========
F - 123
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
----------------
(a) CFC's statement of operations information has been presented as a
discontinued operation in Conseco's consolidated financial statements for
the periods summarized.
(b) Intercompany accounts were eliminated when consolidated with Conseco and
its other wholly-owned subsidiaries.
The following table reconciles CFC's loss before extraordinary gain (loss)
and cumulative effect of accounting change as presented on the previous page to
the amount included in discontinued operations in the accompanying consolidated
statement of operations:
2002 2001 2000
---- ---- ----
(dollars in millions)
Loss before extraordinary gain (loss) and cumulative
effect of accounting change........................ $(2,191.3) $(108.8) $(490.4)
Income taxes(a)....................................... 279.7 - -
Net expenses eliminated in consolidation, net of
income tax......................................... 6.5 7.7 90.8
Impairment charge related to investment in CFC........ (64.5) - -
--------- ------- -------
Loss recognized as discontinued operations............ $(1,969.6) $(101.1) $(399.6)
========= ======= =======
-------------
(a) Amount is considered in determining the income tax expense in the
consolidated statement of operations.
Refer to the note to the consolidated financial statements entitled
"Summary of Significant Accounting Policies" for disclosures related to the
accounting policies of CFC. Disclosures related to the significant accounts of
CFC are summarized below:
Liabilities Subject to Compromise
Under the Bankruptcy Code, actions by creditors to collect indebtedness CFC
owes prior to the Petition Date are stayed and certain other prepetition
contractual obligations may not be enforced against the Finance Company Debtors.
CFC has received approval from the Bankruptcy Court to pay certain prepetition
liabilities including employee salaries and wages, benefits, and other employee
obligations. All other prepetition liabilities have been classified as
"liabilities subject to compromise" in CFC's December 31, 2002 consolidated
balance sheet.
F - 124
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The following table summarizes the components of the liabilities included
in the line "liabilities subject to compromise" in CFC's consolidated balance
sheet as of December, 2002 (dollars in millions):
Other liabilities:
Liability for litigation................................................... $ 38.8
Accounts payable and accrued expenses...................................... 65.8
--------
Total other liabilities subject to compromise.......................... 104.6
--------
Preferred stock dividends payable to Conseco, Inc............................. 153.6
--------
Notes payable:
Master repurchase agreements (a)........................................... 174.4
Credit facility collateralized by retained
interests in securitizations (a) ........................................ 497.7
Due to Conseco, Inc........................................................ 273.2
Other borrowings........................................................... 1.4
--------
Total notes payable subject to compromise.............................. 946.7
--------
Total liabilities subject to compromise................................ $1,204.9
========
----------------
(a) The Finance Company Debtors have guaranteed these facilities.
Finance Receivables and Retained Interests in Securitization Trusts
During 2002, CFC completed six securitization transactions, securitizing
$2.7 billion of finance receivables. These securitizations were structured in a
manner that requires them to be accounted for as secured borrowings, whereby the
loans and securitization debt remain on our balance sheet, rather than as sales,
pursuant to SFAS 140. Such accounting method is referred to as the "portfolio
method".
CFC classifies the finance receivables transferred to the securitization
trusts and held as collateral for the notes issued to investors as "finance
receivables-securitized". The average interest rate on these receivables was
approximately 12.4 percent and 12.5 percent at December 31, 2002 and 2001,
respectively. We classify the notes issued to investors in the securitization
trusts as "notes payable related to securitized finance receivables structured
as collateralized borrowings".
Conseco's leveraged condition and liquidity difficulties eliminated CFC's
ability to access the securitization markets. This has required CFC to pursue
whole loan sales to maintain availability under its warehouse facilities for new
originations. Accordingly, CFC has classified its unsecuritized finance
receivables as held for sale which requires the assets to be carried at the
lower of cost or market. At December 31, 2002, CFC has an allowance of $47.1
million for certain finance receivables with current estimated market values
below cost.
During 2002 and 2001, CFC completed various loan sale transactions. During
2002, CFC sold $2.1 billion of finance receivables which generated net losses of
$49.5 million. CFC also recognized a loss of $96.0 million related to the sale
of $.5 billion of certain finance receivables sold as part of its cash raising
initiatives in order to meet its debt obligations. See "Special Charges"
elsewhere in the notes to the consolidated financial statements. In 2001, CFC
sold $1.6 billion of receivables including: (i) $802.3 million vendor services
loan portfolio (which was marked-to-market in the fourth quarter of 2000 and no
additional gain or loss was recognized in 2001); (ii) $568.4 million of
high-loan-to-value mortgage loans; and (iii) $269.0 million of other loans.
These sales resulted in net gains of $26.9 million in 2001.
F - 125
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The following table summarizes CFC's finance receivables - securitized by
business line and categorized as either part of CFC's primary lines or part of
other lines (discontinued in previous periods):
December 31,
---------------------
2002 2001
---- ----
(Dollars in millions)
Primary lines:
Manufactured housing............................................................. $ 6,965.3 $ 6,940.4
Mortgage services................................................................ 5,005.9 5,658.2
Retail credit.................................................................... 641.5 878.9
Consumer finance - closed-end.................................................... 407.7 580.8
--------- ---------
13,020.4 14,058.3
Less allowance for credit losses................................................. 560.4 288.5
--------- ---------
Net other finance receivables for primary lines................................ 12,460.0 13,769.8
--------- ---------
Other lines (discontinued in previous periods)...................................... - 436.9
Less allowance for credit losses................................................. - 8.2
--------- ---------
Net other finance receivables for other lines.................................. - 428.7
--------- ---------
Total finance receivables - securitized........................................ $12,460.0 $14,198.5
========= =========
The following table summarizes CFC's other finance receivables by business
line and categorized as either a part of CFC's primary lines or a part of other
lines (discontinued in previous periods):
December 31,
---------------------
2002 2001
---- ----
(Dollars in millions)
Primary lines:
Manufactured housing............................................................... $ 159.5 $ 609.3
Mortgage services.................................................................. 260.7 1,128.9
Retail credit...................................................................... 1,599.1 1,811.1
Consumer finance closed-end........................................................ 35.8 6.3
-------- --------
2,055.1 3,555.6
Less allowance for credit losses................................................... 86.5 111.6
-------- --------
Net other finance receivables for primary lines.................................. 1,968.6 3,444.0
-------- --------
Other lines (discontinued in previous periods)........................................ 71.4 379.7
Less allowance for credit losses................................................... 16.9 13.0
-------- --------
Net other finance receivables for other lines.................................... 54.5 366.7
-------- --------
Total other finance receivables.................................................. $2,023.1 $3,810.7
======== ========
F - 126
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The changes in CFC's allowance for credit losses included in finance
receivables (both securitized and other portfolios) were as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Allowance for credit losses, beginning of year................................... $ 421.3 $ 306.8 $ 88.4
Additions to the allowance:
Provision for losses.......................................................... 950.0 537.7 344.7
Provision for losses related to discontinued lines (further discussed
under the caption "Special Charges" below).................................. - - 45.9
Provision for losses related to regulatory changes related to CFC's bank
subsidiary (further discussed under the caption "Special Charges" below).... - - 48.0
Change in allowance due to purchases and sales of certain
finance receivables......................................................... (21.3) (.1) 24.7
Credit losses.................................................................... (686.2) (423.1) (244.9)
------- ------- -------
Allowance for credit losses, end of year......................................... $ 663.8 $ 421.3 $ 306.8
======= ======= =======
F - 127
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The securitizations structured prior to September 8, 1999, met the
applicable criteria to be accounted for as sales. At the time the loans were
securitized and sold, CFC recognized a gain and recorded its retained interest
represented by the interest-only security and servicing rights. The
interest-only security represents the right to receive, over the life of the
pool of receivables: (i) the excess of the principal and interest received on
the receivables transferred to the special purpose entity over the principal and
interest paid to the holders of other interests in the securitization; and (ii)
contractual servicing fees. In some of those securitizations, CFC also retained
B-2 securities. CFC's net retained interests in securitization trusts at
December 31, 2002 and 2001 are summarized below:
December 31, 2002 December 31, 2001
------------------------- ----------------------
Amortized Estimated Amortized Estimated
cost fair value cost fair value
---- ---------- ---- ----------
(Dollars in millions)
Retained interests in securitization trusts:
Interests securitized in the form of B-2 securities............. $ 548.0 $ 611.5 $704.9 $528.5
Interest-only securities........................................ (358.9) (358.9) 171.2 181.6
------- ------- ------ ------
Total retained interests, excluding guarantee liabilities... 189.1 252.6 876.1 710.1
Guarantee liability related to interests in securitization
trusts held by others........................................... (326.7) (326.7) (39.9) (39.9)
------- ------- ------ ------
Total retained interests, net of guarantee liabilities...... $(137.6) $ (74.1) $836.2 $670.2
======= ======= ====== ======
During 2002 and 2001, CFC recognized no gain on sale related to securitized
transactions.
The retained interests in securitization trusts on CFC's balance sheet
represent an allocated portion of the cost basis of the finance receivables in
the securitization transactions accounted for as sales. CFC's retained interests
in those securitization transactions are subordinate to the interests of other
investors. Their values are subject to credit, prepayment, and interest rate
risk on the securitized finance receivables. Management of CFC determines the
discount rate to value these securities based on our estimates of current market
rates of interest for securities with similar yield, credit quality and maturity
characteristics. CFC includes the difference between estimated fair value and
the amortized cost of the retained interests (after adjustments for impairments
required to be recognized in earnings) in "accumulated other comprehensive
income (loss), net of taxes."
The determination of the value of CFC's retained interests in
securitization trusts requires significant judgment. CFC has recognized
significant charges when the interest-only securities did not perform as well as
anticipated based on its assumptions and expectations. CFC's current valuation
of retained interests may prove inaccurate in future periods. In securitizations
to which these retained interests relate, CFC has retained certain contingent
risks in the form of guarantees of certain lower-rated securities issued by the
securitization trusts. As of December 31, 2002, the total nominal amount of
these guarantees was approximately $1.4 billion. CFC considers any potential
payments related to these guarantees in the projected cash flows used to
determine the value of its retained interests. The discounted present value of
the expected future payments related to the guarantees are classified as the
"Guarantee liability related to interests in securitization trusts held by
others" in CFC's balance sheet. If CFC would have to make more payments on these
guarantees than anticipated, or if CFC experienced higher than anticipated rates
of repayment, including due to foreclosure or charge-offs, or any adverse
changes in its assumptions used for valuation, CFC would be required to
recognize additional impairment charges. The $1.4 billion nominal amount of
these guarantees represents the par value of the guaranteed lower-rated
securities. The maximum potential amount of undiscounted future payments which
CFC could be required to make on these guarantees would include both the par
value and interest. Because the guaranteed securities do not have fixed maturity
dates, such maximum potential amount is not possible to calculate. During 2002,
2001 and 2000, interest and principal payments related to such guarantees
totaled $45.5 million, $32.7 million and $22.3 million, respectively. CFC
suspended guarantee payments in the fourth quarter of 2002 and without
additional liquidity in the near future, CFC will be unable to make these
guarantee payments when such payments are required to be made.
Together, the interest-only securities and the B-2 securities, represent
CFC's retained interests in these securitization trusts.
During 2002, CFC's ability to access the securitization markets was
eliminated. The securitization markets are CFC's main source of funding for
loans made to purchasers of repossessed manufactured homes. CFC believes that
its loss severity rates were
F - 128
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
positively impacted when it used retail channels to dispose of repossessed
inventory (where the repossessed units are sold through company-owned sales lots
or its dealer network). Since CFC is no longer able to fund the loans made on
repossessed homes sold through these channels, sales through these channels have
decreased and CFC must use the wholesale channel to dispose of repossessed
manufactured housing units, through which recovery rates are significantly
lower. Accordingly, CFC changed the loss severity assumptions used to value its
retained interests to reflect the higher loss severity expected to be
experienced in the future. In addition, CFC's previous assumptions reflected its
belief that the adverse manufactured housing default experience in recent
periods would continue through the first half of 2002 and then improve over
time. Given recent circumstances, default experience is not expected to improve
as previously expected. Accordingly, CFC increased the default assumptions it
used to value its retained interests to reflect its future expectations. CFC's
home equity/home improvement assumptions have also been adjusted to reflect
recent default experience as well as CFC's future expectations.
As described in the note to the consolidated financial statements entitled
"Summary of Significant Accounting Policies", the Company adopted the
requirements of EITF 99-20 effective July 1, 2000. Under EITF 99-20, declines in
the value of CFC's retained interests in securitization trusts are recognized
when: (i) the fair value of the retained beneficial interests are less than
their carrying value; and (ii) the timing and/or amount of cash expected to be
received from the retained beneficial interests have changed adversely from the
previous valuation which determined the carrying value of the retained
beneficial interests. When both occur, the retained beneficial interests are
written down to fair value as an other-than-temporary impairment.
As a result of the requirements of EITF 99-20 and the assumption changes
described above, CFC recognized an impairment charge of $1,077.2 million in 2002
for the retained beneficial interests. CFC also recognized a $336.5 million
increase in the valuation allowance as a result of changes to the expected
future cost of servicing the finance receivables. The levels of delinquent and
defaulting loans have caused servicing costs to increase. In addition, future
servicing costs are expected to increase as the portfolio ages.
CFC recognized impairment charges of $386.9 million and $515.7 million in
2001 and 2000, respectively, for the interest-only securities that were not
performing as well as expected based on its previous valuation estimates.
The following table summarizes certain cash flows received from and paid to
the securitization trusts during 2002 and 2001 (dollars in millions):
2002 2001
--------- ---------
Servicing fees received......................................................... $ 46.9 $ 71.7
Cash flows from retained interests, net of guarantee payments................... 22.3 71.3
Servicing advances paid......................................................... (275.9) (677.0)
Repayment of servicing advances................................................. 257.1 665.2
During the third quarter and again in the fourth quarter of 2002, CFC
changed the assumptions used to estimate the value of its retained interests to:
(i) project higher severity losses related to the defaults, reflecting CFC's
inability to finance the sale of repossessed manufactured homes resulting in
reliance on the wholesale disposition channel for repossessed manufactured
homes; and (ii) project higher rates of default in the future, based on its
current expectations. As a result of these assumptions, CFC projects that
payments related to guarantees issued in conjunction with the sales of certain
finance receivables will exceed the gross cash flows from the retained interests
by approximately $225 million in 2003, $100 million in 2004, $60 million in 2005
and $10 million in 2006. These projected payments are considered in the
projected cash flows CFC used to value its retained interests. Without
additional liquidity in the near future, CFC will be unable to make these
projected guarantee payments when such payments are required to be made. CFC
projects the gross cash flows from the retained interests will exceed the
payments related to guarantees issued in conjunction with the sales of certain
finance receivables by approximately $175 million in all years thereafter.
Effective September 30, 2001, CFC transferred substantially all of its
interest-only securities into a securitization trust. The transaction provided a
means to finance a portion of the value of its interest-only securities by
selling some of the cash flows to Lehman. The transfer was accounted for as a
sale in accordance with SFAS 140. However, no gain or loss was recognized
because the aggregate fair value of the interest retained by CFC and the cash
received from the sale were equal to the carrying value of the interest-only
securities prior to their transfer to the trust. The trust is a qualifying
special purpose entity and is not consolidated pursuant to SFAS 140. CFC
received a trust security representing an interest in the trust equal to 85
percent of the estimated future
F - 129
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
cash flows of the interest-only securities held in the trust. Lehman purchased
the remaining 15 percent interest. The value of the interest purchased by Lehman
was $20.4 million at December 31, 2002. CFC continues to be the servicer of the
finance receivables underlying the interest-only securities transferred to the
trust. Lehman has the ability to accelerate the principal payments related to
their interest after a stated period. Until such time, Lehman is required to
maintain a 15 percent interest in the estimated future cash flows of the trust.
By aggregating the interest-only securities into one structure, the impairment
tests for these securities are conducted on a single set of cash flows
representing CFC's 85 percent interest in the trust. Accordingly, adverse
changes in cash flows from one interest-only security are offset by positive
changes in another. The new structure does not avoid an impairment charge if
sufficient positive cash flows in the aggregate are not available (such as was
the case at December 31, 2002).
On December 2, 2002, Conseco Finance elected not to make approximately $4.7
million in guarantee payments of which $.6 million was owed to outside third
parties. Upon filing for protection under Chapter 11 of the United States
Bankruptcy Code on December 17, 2002, Conseco Finance has not made any
additional guarantee payments. The continued payment of guarantee payments
depends on the restructuring results of Conseco Finance Corp. as approved by the
Bankruptcy Court. There can be no guarantee that the Court will uphold the
continuation of the required guarantee fees (refer to the caption entitled
"Subsequent events related to CFC" for further discussion regarding the
guarantee payments).
F - 130
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
At December 31, 2002, key economic assumptions used to determine the
estimated fair value of CFC's retained interests in securitizations and the
sensitivity of the current fair value of residual cash flows to immediate 10
percent and 20 percent changes in those assumptions are as follows:
Home equity/ Interests Interests
Manufactured home Consumer/ held by held by
housing improvement equipment Total others Conseco
------- ------------ --------- ----- ------ -------
(Dollars in millions)
Carrying amount/fair value of retained interests:
Retained interests..................................... $ 24.6 $ 234.4 $ 14.0 $ 273.0 $(20.4) $ 252.6
Guarantee liability.................................... (299.7) (5.8) (21.2) (326.7) - (326.7)
Servicing liabilities.................................. (320.1) (5.9) (7.4) (333.4) - (333.4)
------- -------- ------ --------- ------ -------
Total retained interests........................... $ (595.2) $ 222.7 $(14.6) $ (387.1) $(20.4) $(407.5)
========= ======== ====== ========= ====== =======
Cumulative principal balance of sold finance
receivables at December 31, 2002....................... $15,429.6 $3,723.2 $787.2 $19,940.0
Weighted average life in years.............................. 6.9 3.6 2.5 6.1
Weighted average stated customer interest rate
on sold finance receivables............................ 9.7% 11.9% 10.5% 10.2%
Assumptions to determine estimated fair value
of retained interests at December 31, 2002:
Expected prepayment speed as a percentage
of principal balance of sold finance receivables (a)... 7.1% 18.9% 18.0% 9.8%
Impact on fair value of 10 percent decrease............ $(6.7) $2.0 $(.6) $(5.3)
Impact on fair value of 20 percent decrease............ (18.1) 5.9 (1.1) (13.3)
Impact on fair value of 10 percent increase............ 8.0 (1.3) .4 7.1
Impact on fair value of 20 percent increase............ 15.8 (1.9) .9 14.8
Expected nondiscounted credit losses as a percentage of
principal balance of related finance receivables (a)... 20.3% 9.0% 11.7% 17.9%
Impact on fair value of 10 percent decrease............ $26.8 $17.4 $2.2 $46.4
Impact on fair value of 20 percent decrease............ 115.3 37.6 5.2 158.1
Impact on fair value of 10 percent increase............ (6.3) (15.8) (2.0) (24.1)
Impact on fair value of 20 percent increase............ (30.3) (30.3) (3.5) (64.1)
Weighted average discount rate.............................. 16.0% 16.0% 16.0% 16.0%
Impact on fair value of 10 percent decrease............ $(11.8) $20.3 $.9 $9.4
Impact on fair value of 20 percent decrease............ (24.4) 43.6 2.0 21.2
Impact on fair value of 10 percent increase............ 11.2 (17.8) (1.0) (7.6)
Impact on fair value of 20 percent increase............ 21.6 (33.5) (1.8) (13.7)
F - 131
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
-----------------
(a) The valuation of retained interests in securitization trusts is affected
not only by the projected level of prepayments of principal and net credit
losses, but also by the projected timing of such prepayments and net credit
losses. Should such timing differ materially from CFC's projections, it
could have a material effect on the valuation of its retained interests.
Additionally, such valuation is determined by discounting cash flows over
the entire expected life of the receivables sold.
These sensitivities are hypothetical and should be used with caution. As
the figures indicate, changes in fair value based on a 10 percent variation in
assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, in
this table, the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in another
(for example, increases in market interest rates may result in lower prepayments
and increased credit losses), which might magnify or counteract the
sensitivities.
The following table summarizes quantitative information about
delinquencies, net credit losses, and components of managed finance receivables:
Principal balance
60 days or more Net credit
Principal balance past due losses
--------------------- ----------------- ------
for the year ended
at December 31, December 31,
---------------------------------------------- --------------------
2002 2001 2002 2001 2002 2001
---- ---- ---- ---- ---- ----
(Dollars in millions)
Type of finance receivables
Manufactured housing...................... $23,022.4 $25,575.1 $ 803.3 $610.5 $ 756.3 $ 555.5
Home equity/home improvement.............. 8,842.8 11,851.4 122.6 139.9 282.7 244.4
Consumer.................................. 3,334.6 4,198.8 83.8 112.6 219.3 199.5
Commercial................................ 82.7 1,377.0 6.5 16.2 17.7 38.3
--------- --------- -------- ------ -------- --------
Total managed receivables................. 35,282.5 43,002.3 1,016.2 879.2 1,276.0 1,037.7
Less finance receivables securitized
and repossessed assets................. 19,908.8 24,297.3 528.5 464.9 589.8 614.7
--------- --------- -------- ------ -------- --------
Finance receivables held on balance sheet
before allowance for credit losses and
deferred points and other, net......... 15,373.7 18,705.0 $ 487.7 $414.3 $ 686.2 $ 423.0
======== ====== ======== ========
Less allowance for credit losses.......... 663.8 421.3
Less deferred points and other, net....... 226.8 274.5
--------- ---------
Finance receivables held on
balance sheet.......................... $14,483.1 $18,009.2
========= =========
F - 132
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The following schedule reconciles CFC's retained interests, net of
guarantee liabilities, from the beginning to the end of the years presented:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Balance, beginning of year......................................................... $ 670.2 $ 927.5 $1,599.3
Investment income............................................................... 75.0 125.3 180.7
Cash paid (received):
Gross cash received........................................................... (67.8) (132.6) (279.9)
Guarantee payments related to clean-up calls (a).............................. - 45.3 100.3
Guarantee payments related to interests held by others........................ 45.5 32.7 22.3
Impairment charge to reduce carrying value...................................... (1,077.2) (264.8) (434.1)
Sale of securities related to a discontinued line and other..................... 15.9 (12.4) -
Change in interest purchased by Lehman in conjunction with
securitization transaction.................................................... 34.8 (55.2) -
Transfer to servicing rights in conjunction with securitization transaction..... - (50.0) -
Cumulative effect of change in accounting principle............................. - - (70.2)
Change in unrealized appreciation (depreciation) recorded in shareholders'
equity (deficit).............................................................. 229.5 54.4 (190.9)
--------- ------- --------
Balance, end of year............................................................... $ (74.1) $ 670.2 $ 927.5
========= ======= ========
-----------------------
(a) During 2001 and 2000, clean-up calls were exercised for certain
securitizations that were previously recognized as sales. The interest-only
securities related to these securitizations had previously been separately
securitized with other interest-only securities in transactions recognized
as sales. CFC holds the residual interests issued by the securitization
trusts. The terms of the residual interests require the holder to make
payments to the securitization trust when a clean-up call related to an
underlying trust (a trust which issued interest-only securities held by the
securitization trust) occurs. These payments are used to accelerate
principal payments to the holders of the other securities issued by the
securitization trusts. During 2001, CFC was required to make payments to
the securitization trusts. These payments increased our basis in the
retained interests, as the related liability assumed by CFC (and reflected
in the value of the retained interest) was extinguished.
F - 133
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Income Taxes
CFC's income tax expense includes deferred income taxes arising from
temporary differences between the financial reporting and tax bases of assets
and liabilities. These amounts are reflected in the balance of deferred income
tax assets which totaled $925.7 million at December 31, 2002. In assessing the
realization of deferred income tax assets, CFC considers whether it is more
likely than not that the deferred income tax assets will be realized. The
ultimate realization of deferred income tax assets depends upon generating
future taxable income during the periods in which temporary differences become
deductible. CFC evaluates the realizability of its deferred income tax assets by
assessing the need for a valuation allowance on a quarterly basis. A valuation
allowance of $925.7 million has been provided for the entire net deferred tax
asset balance as of December 31, 2002, as CFC believes that the realization of
such assets in future periods is uncertain. The components of CFC's income tax
assets and liabilities were as follows:
2002 2001
---- ----
(Dollars in millions)
Deferred tax assets (liabilities):
Net operating loss carryforwards................................................................. $ 193.3 $ -
Deductible timing differences:
Interest-only securities...................................................................... 536.3 (75.2)
Unrealized (appreciation) depreciation........................................................ (22.4) 61.5
Allowance for loan losses..................................................................... 252.2 148.2
Other......................................................................................... (33.7) 110.8
-------- ------
Total deferred tax assets................................................................ 925.7 245.3
Valuation allowance....................................................................... (925.7) -
-------- ------
Net deferred tax asset (liability)........................................................ - 245.3
Current income taxes prepaid (payable)............................................................. (34.6) 21.9
------- ------
Net income tax assets (liabilities)....................................................... $ (34.6) $267.2
======= ======
Income tax expense (benefit) was as follows:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Current tax provision.............................................................................. $ 34.4 $ 59.5 $ 60.6
Deferred tax provision (benefit)................................................................... - (115.9) (323.4)
------ ------ -------
Income tax expense (benefit).......................................................... 34.4 (56.4) (262.8)
Valuation allowance................................................................................ 245.3 - -
------ ------ -------
Net income tax expense (benefit)........................................................ $279.7 $(56.4) $(262.8)
====== ====== =======
The income tax benefit differed from that computed at the applicable
federal statutory rate (35 percent) for the following reasons:
2002 2001 2000
---- ---- ----
(Dollars in millions)
Tax expense (benefit) on income (loss) before income taxes at statutory rate....................... $(669.1) $(57.8) $(259.9)
Valuation allowance................................................................................ 245.3 .2 1.6
Net deferred benefits not recognized in the current period......................................... 760.9 - -
State taxes, net................................................................................... (57.4) 1.2 (4.5)
------- ------ -------
Income tax benefit.......................................................................... $279.7 $(56.4) $(262.8)
====== ====== =======
F - 134
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
At December 31, 2002, CFC had $552.4 million of net operating loss
carryforwards. The carryforwards will expire as follows: $54.7 in 2018; $273.6
in 2020; and $224.1 in 2022.
CFC is under examination by the Internal Revenue Service for the periods
ending June 30, 1998 through December 31, 1999. No material deficiencies are
known at this time; however, the net operating losses may be reduced, utilized
or reattributed as a result of the examinations.
The above deferred income tax assets are scheduled assuming a continuation
of business. The actual realization of CFC's deferred items may be materially
different as the result of the conclusion of bankruptcy proceedings and the
disposition of certain businesses.
Pension Plan of CFC
CFC provided certain pension benefits for certain eligible retired
employees under a partially funded plan. Amounts related to the pension plan
were as follows:
Pension benefits
----------------
2002 2001
---- ----
(Dollars in millions)
Benefit obligation, beginning of year............................. $14.8 $17.9
Interest cost................................................. .9 1.1
Actuarial loss................................................ 7.1 .6
Benefits paid................................................. (4.6) (4.8)
----- -----
Benefit obligation, end of year................................... $18.2 $14.8
===== =====
Fair value of plan assets, beginning of year...................... $14.2 $19.9
Actual return on plan assets.................................. (1.1) (1.4)
Employer contributions........................................ .4 .5
Benefits paid................................................. (4.6) (4.8)
----- -----
Fair value of plan assets, end of year............................ $ 8.9 $14.2
===== =====
Funded status..................................................... $(9.3) $ (.6)
Unrecognized net actuarial loss................................... 12.9 6.5
----- -----
Prepaid benefit cost....................................... $ 3.6 $ 5.9
===== =====
CFC used the following weighted average assumptions to calculate benefit
obligations for its 2002 and 2001 valuations: postretirement discount rate of
approximately 5.0 percent and 6.5 percent, respectively; preretirement discount
rate of approximately 6.0 percent and 7.0 percent, respectively; and an expected
return on plan assets of approximately 9.0 percent and 9.0 percent,
respectively. Beginning in 2000, as a result of plan amendments, no assumption
for compensation increases was required. Included as an adjustment to
accumulated other comprehensive income (loss) is a $12.7 million adjustment
representing the additional minimum liability associated with this plan.
F - 135
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Components of the cost CFC recognized related to its pension plan were as
follows:
Pension benefits
--------------------------
2002 2001 2000
---- ---- ----
(Dollars in millions)
Interest cost.................................................... $ .9 $ 1.1 $ 1.4
Expected return of plan assets................................... (1.1) (1.5) (1.7)
Settlement (gain) loss........................................... 2.2 1.3 (.3)
Recognized net actuarial loss.................................... .6 .3 -
----- ----- -----
Net periodic cost (benefit)............................... $ 2.6 $ 1.2 $ (.6)
===== ===== ======
Notes Payable, Representing Direct Finance Obligations (Excluding Notes
Payable Related to Securitized Finance Receivables Structured as
Collateralized Borrowings)
Notes payable (excluding notes payable related to securitized finance
receivables structured as collateralized borrowings) of CFC at December 31, 2002
and 2001, were as follows (interest rates as of December 31, 2002):
2002 2001
---- ----
(Dollars in millions)
Master repurchase agreements ("Warehouse Facilities") due on various
dates in 2003 (3.10%)..................................................... $ 176.3 $1,679.0
Residual facility collateralized by retained interests in securitizations
due 2004 ("Residual Facility") (3.88%).................................... 497.7 507.3
Debtor in possession facility due May 2003 (10.0%)........................... 82.0 -
Medium term notes due September 2002 and April 2003.......................... - 189.7
10.25% senior subordinated notes due June 2002............................... - 161.9 (a)
Bank credit facility due December 2002 ("U.S. Bank Facility")................ - 21.0
Note payable to Conseco (2.91%).............................................. 273.2 249.5
Other........................................................................ 1.4 1.5
-------- --------
Total principal amount.................................................. 1,030.6 2,809.9
Unamortized net discount and deferred fees................................... (1.9) (8.8)
-------- --------
Direct finance obligations.............................................. $1,028.7 $2,801.1
======== ========
-----------------
(a) Includes $23.7 million held by Conseco.
As of the Petition Date, CFC's remaining liquidity sources were a warehouse
facility (the "Warehouse Facility") and a residual facility ("Residual
Facility") with Lehman and a bank credit facility with U.S. Bank and together
with the Warehouse Facility and Residual Facility, the "CFC Facilities". The
direct borrower under (i) the Warehouse Facility is CFC's non-debtor subsidiary
Green Tree Finance Corp. - Five ("GTFC"), and (ii) the Residual Facility is
CFC's non-debtor subsidiary Green Tree Residual Finance Corp. I ("GTRFC"). The
Warehouse Facility and the Residual Facility are fully guaranteed by CFC and, up
to an aggregate of $125 million, by CIHC. CFC was the direct borrower under the
U.S. Bank Facility, which was also guaranteed by CIHC up to an aggregate of $125
million.
Prior to the Petition Date, CFC was in default under the CFC Facilities as
a result of (i) cross-defaults triggered by CNC's defaulting on its debt
obligations, (ii) cross-defaults among the U.S. Bank Facility, the Warehouse
Facility and the Residual Facility, (iii) failure to make payments required by
CFC's guarantees of payments on B-2 securities, which were issued to investors
in certain finance receivable securitization transactions; and (iv) breaches of
several financial covenants under the CFC Facilities. CFC entered into
forbearance agreements with Lehman with respect to the Warehouse Facility and
Residual Facility and with U.S. Bank with
F - 136
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
respect to U.S. Bank Facility, pursuant to which Lehman and U.S. Bank agreed to
temporarily refrain from exercising any rights arising from events of default
that occurred under each CFC Facility prior to the Petition Date.
The Warehouse Facility is a repurchase facility under which primarily newly
originated manufactured housing, home equity, home improvement and recreational
vehicle loans originated by CFC or affiliates of CFC and transferred to GTFC are
sold by GTFC to Lehman with an agreement to repurchase those loans at a later
date and at a higher price. The price differential reflects the cost of
financing. The Warehouse Facility provides funding to CFC for new loan
origination. The Warehouse Facility and the Residual Facility are
cross-collateralized.
The Residual Facility is collateralized by retained interests in
securitizations. CFC is required to maintain collateral based on current
estimated fair values in accordance with the terms of such facility. Due to the
decrease in the estimated fair value of its retained interests, CFC's collateral
was deficient at December 31, 2002 (as calculated in accordance with the
relevant transaction documents, which provide that Lehman calculates the value
of CFC's collateral within its sole discretion). Pursuant to the forbearance
agreement entered into with Lehman on December 20, 2002, Lehman agreed not to
accelerate the repayment of the Residual Facility based on the collateral
deficiency through June 1, 2003. Under the terms of this forbearance agreement,
Lehman retains the cash flows from CFC's retained interests pledged under this
facility and applies those cash flows to the margin deficit. As mentioned above,
this forbearance agreement is subject to a number of conditions that may cause
it to terminate prior to June 1, 2003. The filing by CNC, CIHC and CFC of a
Chapter 11 petition triggered additional defaults under the CFC Facilities.
On December 19, 2002, shortly after the filing of the Chapter 11 Cases, CFC
obtained the FPS DIP provided by U.S. Bank and FPS DIP LLC, an affiliate of
Fortress Investment Group LLC ("Fortress"), J.C. Flowers & Co. LLC. ("Flowers")
and Cerberus Capital Management, L.P. ("Cerberus"). The DIP financing is for up
to $125,000,000. The DIP financing motion was granted by the Bankruptcy Court on
January 14, 2003.
From time to time, CFC has failed to comply with certain covenants
regarding the maximum permissible variance of the budgets provided to the FPS
DIP lenders in connection with the FPS DIP. In each instance, CFC has obtained
appropriate waivers. The occurrence of events of default under the FPS DIP, may
cause events of default under the Lehman December 20 Agreements (as defined
below).
On December 20, 2002, CFC, GTFC, and GTRFC, entered into several agreements
with Lehman: (the "Lehman December 20 Agreements") (i) providing that Lehman
temporarily refrain from exercising any rights arising from events of default
that occurred under each relevant CFC Facility (including, but not limited to,
those arising out of CNC, CIHC and CFC filing for Chapter 11 relief) until June
1, 2003; (ii) indirectly providing CFC with up to $25,000,000 in postpetition
financing by allowing GTFC to provide intercompany loans to CFC with cash flows
obtained from the Warehouse Facility; (iii) decreasing the capacity of the
Warehouse Facility to a maximum of $250,000,000; and (iv) otherwise amending the
Warehouse Facility and the Residual Facility. These agreements are subject to a
number of conditions that may cause them to terminate prior to June 1, 2003.
As a result of CFC's defaults and the Lehman December 20 Agreements, CFC
may not draw funds from the Residual Facility.
During 2002, CFC repurchased $46.9 million par value of its senior
subordinated notes and medium term notes resulting in an extraordinary gain of
$3.9 million (net of income taxes). In March 2002, CFC completed a tender offer
pursuant to which it purchased $75.8 million par value of its senior
subordinated notes due June 2002. The purchase price was equal to 100 percent of
the principal amount of the notes plus accrued interest. The remaining principal
amount outstanding of $58.5 million (including $23.7 million held by Conseco) of
the senior subordinated notes was retired at maturity on June 3, 2002.
In April 2002, CFC completed a tender offer pursuant to which it purchased
$158.5 million par value of its medium term notes due September 2002 and $3.7
million par value of its medium term notes due April 2003. The purchase price
was equal to 100 percent of the principal amount of the notes plus accrued
interest. In June 2002, CFC tendered for the remaining $8.2 million par value of
its medium term notes due September 2002. Pursuant to the tender offer $5.5
million par value of the notes was tendered in July. The purchase price was
equal to 101 percent of the principal amount of the notes plus accrued interest.
The remaining principal amount outstanding of the medium term notes after giving
effect to both tender offers and other debt repurchases completed prior to the
tender offers of $2.7 million was retired at maturity on September 26, 2002.
During 2001, CFC repurchased $55.4 million par value of its 10.25% senior
subordinated notes due June 2002 for $51.9 million (resulting in an
extraordinary gain of $2.1 million, net of income taxes of $1.3 million). Also
during 2001, CFC repurchased $34.0
F - 137
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
million par value of its 6.5% medium term notes due September 2002 for $27.5
million (resulting in an extraordinary gain of $4.0 million, net of income taxes
of $2.5 million).
Notes Payable Related to Securitized Finance Receivables Structured as
Collateralized Borrowings
Notes payable related to securitized finance receivables structured as
collateralized borrowings were $13,069.7 million and $14,484.5 million at
December 31, 2002 and 2001, respectively. The principal and interest on these
notes are paid using the cash flows from the underlying finance receivables
which serve as collateral for the notes. Accordingly, the timing of the
principal payments on these notes is dependent on the payments received on the
underlying finance receivables which back the notes. In some instances, CFC is
required to advance principal and interest payments even though the payments on
the underlying finance receivables which back the notes have not yet been
received. The average interest rate on these notes was 6.7 percent and 6.4
percent at December 31, 2002 and 2001, respectively. The notes payable balance
also includes amounts related to financing transactions securitized by: (i)
capitalized expenses related to the refurbishment of repossessed assets; and
(ii) principal and interest advances. The outstanding liability on these
facilities at December 31, 2002 was $85 million.
Special Charges
2002
The following table summarizes the special charges incurred by CFC during
2002, which are further described in the paragraphs which follow (dollars in
millions):
Loss related to assets sold to raise cash...................................... $ 97.6
Costs related to debt modification and refinancing transactions................ 39.4
Reduction in value of Lehman warrant........................................... (38.1)
Abandonment of computer processing system...................................... 16.3
Other items.................................................................... 6.7
------
Special charges before income tax benefit.................................. $121.9
======
Loss related to assets sold to raise cash
CFC completed various asset sales which resulted in net losses of $97.6
million in 2002. Such amounts included the loss of $96.0 million related to the
sales of $463 million of certain finance receivables and $1.6 million of
additional loss related to receivables required to be repurchased from the
purchaser of the vendor services receivables pursuant to the repurchase clauses
in the agreements.
Costs related to debt modification and refinancing transactions
In conjunction with the various modifications to borrowing arrangements and
refinancing transactions and the recognition of deferred expenses for terminated
financing arrangements, CFC incurred costs of $39.4 million in 2002 which are
not permitted to be deferred pursuant to GAAP.
Reduction in value of Lehman warrant
As partial consideration for a financing transaction, Conseco Finance
issued a warrant to Lehman which permits the holder to purchase 5 percent of
Conseco Finance at a nominal price. The holder of the warrant or Conseco Finance
may cause the warrant and any stock issued upon its exercise to be purchased for
cash at an appraised value in May 2003. Additionally, until May 2003, the holder
has the right (subject to certain terms and conditions) to convert the warrant
into convertible preferred stock of Conseco. Since the warrant permits cash
settlement at fair value at the option of the holder of the warrant, it has been
included in other liabilities and is measured at fair value, with changes in its
value reported in earnings. The estimated fair value of the warrant at December
31, 2002 was nil based on current valuations of Conseco Finance. Accordingly,
CFC recorded a $38.1 million reduction in the value of the warrant during 2002.
F - 138
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Abandonment of computer processing systems
In 2002, CFC incurred a $16.3 million charge for the abandonment of certain
computer processing systems. CFC is abandoning such systems given the recent
changes to its business and its decision to no longer originate certain types of
loans.
F - 139
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
2001
The following table summarizes the special charges incurred by CFC during
2001, which are further described in the paragraphs which follow (dollars in
millions):
Severance benefits, litigation reserves and other restructuring charges................... $ 20.3
Loss related to sale of certain finance receivables....................................... 11.2
Change in value of warrant................................................................ (10.0)
-----
Special charges before income tax benefit............................................ $ 21.5
======
Severance benefits, litigation reserves and other restructuring charges
During 2001, Conseco developed plans to change the way it operates. Such
changes were undertaken in an effort to improve CFC's operations and
profitability. The planned changes included moving a significant number of jobs
to India, where a highly-educated, low-cost, English-speaking labor force is
available. Pursuant to GAAP, CFC was required to recognize the costs associated
with most restructuring activities as the costs were incurred. However, costs
associated with severance benefits are required to be recognized when the costs
are: (i) attributable to employees' services that have already been rendered;
(ii) relate to obligations that accumulate; and (iii) are probable and can be
reasonably estimated. Since the severance costs associated with their planned
activities met these requirements, CFC recognized a charge of $6.2 million in
2001 related to severance benefits and other restructuring charges. CFC also
recognized charges of: (i) $7.5 million related to its decision to discontinue
the sale of certain types of life insurance in conjunction with lending
transactions; and (ii) $6.6 million related to certain litigation matters.
Loss related to the sale of certain finance receivables
During 2001, CFC recognized a loss of $2.2 million on the sale of $11.2
million of finance receivables. Also, during 2001, the purchaser of certain
credit card receivables returned certain receivables pursuant to a return of
accounts provision included in the sales agreement. Such returns and the
associated losses exceeded the amounts CFC initially anticipated when the
receivables were sold. CFC recognized a loss of $9.0 million related to the
returned receivables.
Change in value of warrant
As partial consideration for a financing transaction, CFC issued a warrant
which permits the holder to purchase 5 percent of Conseco Finance at a nominal
price. The holder of the warrant or CFC may cause the warrant and any stock
issued upon its exercise to be purchased for cash at an appraised value in May
2003. Additionally, until May 2003, the holder has the right (subject to certain
terms and conditions) to convert the warrant into preferred stock of Conseco.
Since the warrant permits cash settlement at fair value at the option of the
holder of the warrant, it has been included in other liabilities and is measured
at fair value, with changes in its value reported in earnings. The estimated
fair value of the warrant at December 31, 2001 was $38.1 million. The estimated
value was determined based on discounted cash flow and market multiple valuation
techniques. During 2001, CFC recognized a $10.0 million benefit as a result of
the decreased value of the warrant (which was classified as a reduction to
special charges).
F - 140
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
2000
CFC incurred significant special charges during 2000, primarily related to
the restructuring of its debt and its business. The following table summarizes
the special charges, which are further described in the paragraphs which follow
(dollars in millions):
Lower of cost or market adjustment for finance receivables
identified for sale.................................................... $103.3
Loss on sale of transportation loans and vendor services
financing business..................................................... 51.0
Loss on sale of asset-based loans........................................... 53.0
Costs related to closing offices and streamlining businesses................ 29.5
Abandonment of computer processing systems.................................. 35.8
Transaction fees paid and warrant issued.................................... 78.4
Reserve methodology change at bank subsidiary............................... 48.0
Net gain on sale of certain loans and other items........................... (4.7)
------
Special charges before income tax benefit.......................... $394.3
======
Lower of cost or market adjustment for finance receivables identified for
sale
On July 27, 2000, CFC announced several courses of action to restructure
its business, including the sale or runoff of the finance receivables of several
business lines. The carrying value of the loans held for sale was reduced to the
lower of cost or market, consistent with CFC's accounting policy for such loans.
The reduction in value of these loans of $103.3 million (including a $45.9
million increase to the allowance for credit losses) primarily related to
transportation finance receivables (primarily loans for the purchase of trucks
and buses). These loans had experienced a significant decrease in value as a
result of the adverse economic effect that increases in oil prices and
competition had on borrowers in the transportation business during 2000.
Loss on sale of transportation loans and vendor service financing business
During the fourth quarter of 2000, CFC sold transportation loans with a
carrying value of $566.0 million (after the market adjustment described above)
in whole loan sale transactions. CFC recognized an additional loss of $30.7
million on the sale. During 2000, CFC recognized a special charge and reduced
goodwill by $20.3 million, representing the difference between: (i) the carrying
value of the net assets of the vendor services financing business; and (ii) the
anticipated proceeds from the sale of such business, which was completed in the
first quarter of 2001.
Loss on sale of asset-based loans
During the third quarter of 2000, CFC sold asset-based loans with a
carrying value of $152.2 million in whole loan sale transactions. CFC recognized
a loss of $53.0 million on these sales.
Costs related to closing offices and streamlining businesses
CFC's restructuring activities included the closing of several branch
offices and streamlining its businesses. These activities included a reduction
in the work force of approximately 1,700 employees. CFC incurred a charge of
$6.9 million related to severance costs paid to terminated employees in 2000.
CFC also incurred lease termination and direct closing costs of $12.3 million
associated with the branch offices closed in conjunction with the restructuring
activities. In addition, fixed assets and leasehold improvements of $10.3
million were abandoned when the branch offices were closed.
Abandonment of computer processing systems
CFC recorded a $35.8 million charge in 2000 to write off the carrying value
of capitalized computer software costs for projects that have been abandoned in
conjunction with its restructuring. These costs are primarily associated with:
(i) computer processing systems under development that would require significant
additional expenditures to complete and that were inconsistent with its business
plan; and (ii) computer systems related to the lines of business discontinued by
CFC and therefore were no longer required.
F - 141
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Advisory fees and warrant paid and/or issued to Lehman and other investment
banks
In May 2000, CFC sold approximately $1.3 billion of finance receivables to
Lehman and its affiliates for cash and a right to share in future profits from a
subsequent sale or securitization of the assets sold. CFC paid a $25.0 million
transaction fee to Lehman in conjunction with the sale, which was included in
special charges. Such loans were sold to Lehman at a value which approximated
net book value, less the fee paid to Lehman.
During the second and third quarters of 2000, CFC repurchased a significant
portion of the finance receivables sold to Lehman. These finance receivables
were subsequently included in securitization transactions structured as
financings. The cost of the finance receivables purchased from Lehman did not
differ materially from the book value of the loans prior to their sale to
Lehman.
Lehman has also amended its master repurchase financing facilities to
expand the types of assets financed. As partial consideration for the financing
transaction, Lehman received a warrant, with a nominal exercise price, for five
percent of the common stock of CFC. The initial $48.1 million estimated value of
the warrant was recognized as an expense during the second quarter of 2000. The
estimated fair value of the warrant did not change materially during 2000.
CFC also paid Lehman $5.3 million in advisory fees related to the business
and debt restructuring.
Reserve Methodology Change at Bank Subsidiary
During the fourth quarter of 2000, CFC increased the allowance for credit
losses related to credit card receivables held by its bank subsidiary. CFC
implemented a more conservative approach pursuant to a regulatory examination,
which resulted in this special charge.
Gain on sale of certain loans and other items
During 2000, CFC sold substantially all of the finance receivables related
to its bankcard (Visa and Mastercard) portfolio. CFC recognized a gain of $9.7
million on the sale.
During 2000, CFC recognized $5.0 million of other costs related to its
restructuring.
Reorganization Items
During 2002, CFC incurred professional fees associated with its bankruptcy
proceedings which totaled $17.3 million. Such items are expensed and classified
in accordance with SOP 90-7.
Subsequent events related to CFC
On March 14, 2003, the Bankruptcy Court approved a new servicing agreement
which was agreed upon by CFC and the securitization bondholders. Pursuant to the
agreement the servicing fee for the manufactured housing securitization trusts
will increase to 125 bps for the first 12 months subsequent to the closing of
the sale of CFC's assets to CFN and 115 bps thereafter. This is an increase from
the original servicing fee of 50 bps. This agreement also moves the payment of
the servicing fee to the top of the cash flow streams before distributions to
the bondholders. Previously, this servicing fee was distributed after all
principal and interest payments were made to all bondholders. The modifications
to the servicing agreements will have a favorable impact on the cash flow and
valuation of CFC's servicing rights. Under the new servicing assumptions, CFC's
servicing rights would have been valued at $180.8 million as of December 31,
2002, an increase in value of $514.2 million. The change adversely affects the
valuation of our retained interests and guarantee liability related to interests
in securitization trusts held by others by $10.3 million and $216.1 million,
respectively. The valuations for the retained interests and the guarantee
liability related to interests in securitization trusts held by others as of
December 31, 2002 under the new assumptions would have been $242.2 million and
$(542.8) million, respectively.
Through April 1, 2003, CFC has failed to make $254.2 million in guarantee
payments of which $91.8 million was owed to outside third parties. These amounts
are contemplated in the above mentioned valuations using the new servicing
agreement and related assumptions.
On April 14, 2003, the Bankruptcy Court approved an amendment to the FPS
DIP to increase the maximum permitted borrowings thereunder, from $125 million
to $150 million.
F - 142
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
18. FINANCIAL INFORMATION REGARDING CVIC
In October 2002, Conseco Life Insurance Company of Texas (a wholly-owned
subsidiary of the Company) completed the sale of CVIC to Inviva, Inc.
("Inviva"), a holding company that owns The American Life Insurance Company of
New York. CVIC marketed tax qualified annuities and certain employee
benefit-related insurance products through professional independent agents.
Pursuant to SFAS 144, CVIC is accounted for as a discontinued operation. Our
consolidated statement of operations reflects the operations of CVIC in the
caption "Discontinued operations" for all periods. The consideration received
from Inviva at closing (subject to adjustment based upon the adjusted statutory
balance sheet of CVIC at September 30, 2002) totaled $83.7 million, of which
$35.0 million was in the form of Series D Preferred Shares (the "Preferred
Shares") issued by Inviva and the remainder was in cash. Under the terms of the
purchase agreement, if the adjusted statutory book value of CVIC at September
30, 2002, is less than a specified value, the purchase price shall be reduced by
the amount that such specified value exceeds the adjusted statutory book value.
In addition, Conseco Life Insurance Company of Texas received a dividend of
approximately $75 million from CVIC immediately prior to the closing. We
recognized a loss on the sale of $93.1 million. There was no income tax benefit
recognized on the transaction.
The Preferred Shares accrue dividends (in-kind) at an annual rate of 19
percent. On or after December 31, 2002, our insurance subsidiary that holds
these shares may elect to exchange the Preferred Shares for non-voting common
stock of JNF Holding Company, Inc., a wholly-owned subsidiary of Inviva, ("JNF")
that now owns all of the stock of CVIC. If not previously exchanged, on October
15, 2003, the Preferred Shares will be mandatorily exchanged into the common
stock of JNF and our insurance subsidiary that holds the Preferred Shares will
be entitled to receive a $1.67 million cash fee upon the occurrence of such
exchange. After the exchange has occurred, such JNF common stock may be
repurchased by JNF at any time at 115 percent of the stated value of the
Preferred Shares plus accrued and unpaid dividends thereon immediately prior to
the exchange.
In connection with the sale of CVIC, we agreed to provide, for a fee,
various administrative and technical services in order to allow CVIC to continue
to operate and to facilitate the transition of CVIC to Inviva. Such services are
being provided pursuant to an Administrative and Transition Services Agreement
(the "Transition Agreement"). The term of the Transition Agreement is nine
months subject to extension or early termination. As part of the CVIC sale,
Conseco agreed that it would not engage in the variable annuity or variable
insurance business for a period of three years after the closing.
The following summarizes selected financial information of CVIC:
December 31,
2001
-----------
(Dollars in millions)
Total investments.......................................................................... $1,399.6
Cost of policies purchased................................................................. 100.7
Cost of policies produced.................................................................. 228.0
Assets held in separate accounts........................................................ 1,649.1
Total assets............................................................................... 3,631.1
Insurance liabilities...................................................................... 1,382.9
Liabilities related to separate accounts................................................... 1,649.1
Investment borrowings...................................................................... 151.8
Total liabilities.......................................................................... 3,242.6
Net assets of discontinued operations.................................................... 388.5
F - 143
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Year ended
December 31,
---------------------------------
2002 2001 2000
---- ---- ----
(Dollars in millions)
Insurance policy income..................................................... $ 30.5 $ 73.0 $ 49.6
Net investment income....................................................... (217.3) (61.7) 309.9
Net realized investment losses.............................................. (76.7) (34.3) (11.8)
Total revenues.............................................................. (263.3) (23.0) 347.9
Insurance policy benefits................................................... (234.7) (81.7) 263.4
Amortization................................................................ 117.4 33.7 27.3
Total expenses.............................................................. (102.9) (17.4) 319.5
Pre-tax income (loss)....................................................... (160.4) (5.6) 28.4
Net income (loss)........................................................... $(101.6) $ (5.6) $17.7
Income taxes................................................................ (58.8)(a) - -
Loss on sale of CVIC........................................................ (93.1) - -
----- ------ -----
Amount classified as discontinued operations............................ $(253.5) $ (5.6) $17.7
======= ====== =====
---------------
(a) Amount is considered in determining the income tax expense in the
consolidated statement of operations.
F - 144
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
19. INVESTMENTS IN VARIABLE INTEREST ENTITIES
The Company has investments in various types of special purpose entities
and other entities, some of which are VIEs under FIN 46, as described in the
note to the consolidated financial statements entitled "Summary of Significant
Accounting Policies". The following are descriptions of our significant
investments in VIEs:
Brickyard Trust
In 1998, the Company invested in an investment trust known as the Brickyard
Loan Trust ("Brickyard"). Brickyard is a collateralized debt obligation trust
which participates in an underlying pool of commercial loans. The initial
capital structure of Brickyard consisted of $575 million of senior financing
provided by unrelated third party investors and $127 million of notes and
certificates owned by the Company and others. As a result of our 85 percent
ownership interest in the subordinated certificates, we are the primary
beneficiary of Brickyard. In accordance with ARB 51 "Consolidated Financial
Statements", Brickyard is consolidated in our financial statements, because of:
(i) our investment management subsidiary, Conseco Capital Management, Inc. was
the investment manager; and (ii) our significant ownership of the subordinated
certificates. Included in "Assets held in separate accounts and investment
trust" were $410.2 million and $481.1 million at December 31, 2002 and 2001,
respectively, of assets which serve as collateral for Brickyard's obligations.
These amounts are offset by a corresponding liability account, the value of
which fluctuates in relation to changes in the values of the investments. At
December 31, 2002 the net carrying value of our investment was $66.7 million,
which is also the maximum loss we could recognize if the loans held in the trust
experiences significant defaults. The senior note obligations have no recourse
to the general credit of the Company.
Other Investment Trusts
In December 1998, the Company formed three investment trusts which were
special purpose entities formed to hold various fixed maturity, limited
partnership and other types of investments. The initial capital structure of
each of the trusts consisted of: (i) approximately 96 percent
principal-protected senior notes; (ii) approximately 3 percent subordinated
junior notes; and (iii) 1 percent equity. The senior principal-protected notes
are collateralized by zero coupon treasury notes with par values and maturities
matching the par values and maturities of the principal-protected senior notes.
Conseco's life insurance subsidiaries own 100 percent of the senior
principal-protected notes. Certain of Conseco's non-life insurance subsidiaries
own all of the subordinated junior notes, which have a preferred return equal to
the total return on the trusts' assets in excess of principal and interest on
the senior notes. The equity of the trusts is owned by unrelated third parties.
The three investment trusts are VIEs under FIN 46 because the trusts'
equity represents significantly less than 10 percent of total capital and the
subordinated junior notes were intended to absorb expected losses and receive
virtually all expected residual returns. Based on our 100 percent ownership of
the subordinated junior notes, we are the primary beneficiary of the investment
trusts. All three trusts are consolidated in our financial statements at
December 31, 2002. The carrying value of the total invested assets in the three
trusts were approximately $382 million at December 31, 2002, which also
represents Conseco's maximum exposure to loss as a result of our ownership
interests in the trusts. The trusts have no obligations or debt to outside
parties.
Investment in General Motors Building
In 1998, Conseco invested in a partnership which was formed to acquire and
own the 50 story office building in New York City known as the General Motors
Building (the "GM Building"). The partnership acquired the GM Building for
approximately $878 million. The initial capital structure of the partnership
consisted of: (i) a $700 million senior mortgage; (ii) $200 million of
subordinated debt with a stated fixed return of 12.7 percent payable-in-kind,
and the opportunity to earn an additional residual return; and (iii) $30 million
of partnership equity, owned 50 percent by Conseco and 50 percent by an
affiliate of Donald Trump. A Trump affiliate also served as general manager of
the acquired building. We own 100 percent of the subordinated debt. The
partnership is a VIE under FIN 46 because the $30 million of equity represents
significantly less than 10 percent of total partnership capital and the
subordinated debt was intended to absorb virtually all expected losses and
receive a significant portion of expected residual returns. Based on our 100
percent ownership of the subordinated debt, we are the primary beneficiary of
the GM Building partnership. Accordingly, the partnership will be consolidated
in our financial statements beginning in the third quarter 2003. We do not
expect the consolidation of the GM Building partnership to have a material
impact on our financial condition or results of operations. The real estate
asset, which will be added to our balance sheet as a result of consolidation,
collateralizes the partnership's senior mortgage obligation. The existing senior
mortgage obligation, which would also be added to our balance sheet as a result
of consolidation, is not guaranteed by Conseco and does not have recourse
against Conseco's general credit. The existing senior mortgage obligation
matures
F - 145
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
on August 1, 2003.
At December 31, 2002, actively managed fixed maturities at fair value
included $277.8 million of subordinated debt and accrued interest in the GM
Building partnership. Other invested assets included our $15 million equity
investment at December 31, 2002. The investments in subordinated debt and equity
represent our maximum exposure to investment loss as a result of our involvement
in the partnership. As more fully described in the note to the consolidated
financial statements entitled "Other Disclosures", the other investor in the
partnership has filed a lawsuit against Conseco.
Other Investments in Variable Interest Entities
Certain limited partnerships and other entities, which are part of our
non-traditional investment portfolio, are VIEs. However, our investments in each
of those entities are not significant and, therefore, the disclosure and
consolidation requirements of FIN 46 are not applicable. In each case, the
carrying value included in other invested assets represents the Company's
maximum exposure to loss as a result of its involvement with the entity.
F - 146
[C]
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
Shares
(CONSECO LOGO)
Common Stock
----------------------
GOLDMAN, SACHS & CO.
MORGAN STANLEY
----------------------
BANC OF AMERICA SECURITIES LLC
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
[P]
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
Shares
(CONSECO LOGO)
% Mandatorily Convertible Preferred Stock, Class B
----------------------
GOLDMAN, SACHS & CO.
MORGAN STANLEY
----------------------
JPMORGAN
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
Set forth below is an estimate (except in the case of the registration fee)
of the amount of fees and expenses to be paid by Conseco in connection in
connection with the issuance and distribution of the offered securities,
excluding underwriting discounts and commissions.
Securities and Exchange Commission registration fee......... $145,705
NASD filing fee............................................. 30,500
New York Stock Exchange listing fee......................... *
Blue Sky fees and expenses (including attorneys' fees and
expenses)................................................. *
Printing expenses........................................... *
Accounting fees and expenses................................ *
Transfer agent's fees and expenses.......................... *
Legal fees and expenses..................................... *
Miscellaneous fees and expenses............................. *
--------
Total..................................................... $ *
========
---------------
* To be provided by amendment.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
We are incorporated under the laws of the State of Delaware. Our Amended
and Restated Certificate of Incorporation provides, as authorized by Section
102(b)(7) of the Delaware General Corporation Law (the "DGCL"), that our
directors will not be personally liable to us or our stockholders for monetary
damages for breach of fiduciary duty as a director, except for liability: (i)
for any transaction from which the director derives an improper personal
benefit; (ii) for any act or omission not in good faith or that involves
intentional misconduct or a knowing violation of law; (iii) for any improper
payment of dividends or redemption of shares; or (iv) for any breach of the
director's duty of loyalty to us or our stockholders.
Our Amended and Restated Certificate of Incorporation and Second Amended
and Restated Bylaws further provide, as permitted by Section 145 of the DGCL,
that each person who was, is or is threatened to be made a party to or is
otherwise involved with any action, suit or proceeding, whether civil, criminal,
administrative or investigative, by reason of the fact that he or she is or was
a director or officer or, while a director or officer, is or was serving at the
request of the Company as a director, officer, employee or agent of another
company or enterprise (an "indemnitee"), will be indemnified and held harmless
by us to the fullest extent authorized by the DGCL, against all expense,
liability and loss (including attorneys' fees), reasonably incurred or suffered
by such indemnitee in connection therewith. This right of indemnification
includes our obligation to provide an advance of expenses, although the
indemnitee may be required to repay such an advance if there is a judicial
determination that the indemnitee was not entitled to the indemnification.
The foregoing statements are subject to the detailed provisions of the DGCL
and our Amended and Restated Certificate of Incorporation and our Second Amended
and Restated Bylaws.
Our directors and officers are covered under directors' and officers'
liability insurance policies maintained by us.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
(1) On September 10, 2003, the effective date of our Plan of
Reorganization, we issued 100,000,000 shares of our common stock, 34,386,740
shares of our Class A Preferred Stock and 6,000,000 Series A Warrants to our
predecessor's pre-bankruptcy creditors pursuant to the Plan of Reorganization.
II-1
Based upon the exemption from the registration requirements under the Securities
Act provided by Section 1145 of the Bankruptcy Code, which we relied on pursuant
to an order from the Bankruptcy Court, we believe that none of these securities
were required to be registered under the Securities Act or under any state or
local law requiring registration for offer or sale of a security or registration
of licensing of an issuer of, underwriter of, or broker or dealer in, such
securities, in connection with their issuance and distribution pursuant to the
Plan of Reorganization.
(2) On September 29, 2003, we issued R. Glenn Hilliard, our non-executive
chairman, 98,119 shares of our common stock in reliance on the exemption from
registration provided by Section 4(2) of the Securities Act. Mr. Hilliard
received these shares in connection with a Bankruptcy Court-approved agreement
whereby Mr. Hilliard agreed to serve as our non-executive chairman upon our
emergence from bankruptcy.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits.
Reference is made to the attached Exhibit Index.
(b) Financial Statement Schedules.
The following financial statement schedules are listed as part of this
Registration Statement immediately following the signature pages.
Schedule II -- Condensed Financial Information of Registrant (Parent
Company)
Schedule IV -- Reinsurance
ITEM 17. UNDERTAKINGS.
The undersigned registrant hereby undertakes:
1. For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
2. For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions or otherwise, the registrant has
been advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of their counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed by
the final adjudication of such issue.
II-2
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, Conseco, Inc.
certifies that it has duly caused this Registration Statement on Form S-1 to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Carmel and State of Indiana on January 28, 2004.
CONSECO, INC.
By: /s/ EUGENE M. BULLIS
------------------------------------
Eugene M. Bullis
Executive Vice President and
Chief Financial Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints William J. Shea, Eugene M. Bullis, John R. Kline
and William S. Kirsch and each of them, his or her true and lawful
attorneys-in-fact and agents, with full power of substitution and
resubstitution, for him or her and in his or her name, place and stead, in any
and all capacities, to sign any or all amendments (including post-effective
amendments) to this Registration Statement (and any registration statement filed
pursuant to Rule 462(b) under the Securities Act of 1933, as amended, for the
offering which this Registration Statement relates), and to file the same, with
all exhibits thereto, and other documents in connection therewith, with the SEC,
granting unto said attorneys-in-fact and agents, and each of them, full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and
purposes as he or she might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents or any of them, or their
or his or her substitute or substitutes, may lawfully do or cause to be done by
virtue hereof.
* * * *
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement on Form S-1 and Power of Attorney have been signed by the
following persons in the capacities and on the dates indicated:
SIGNATURES CAPACITY DATE
---------- -------- ----
/s/ WILLIAM J. SHEA President, Chief Executive January 28, 2004
-------------------------------------- Officer and Director (Principal
William J. Shea Executive Officer)
/s/ EUGENE M. BULLIS Executive Vice President and January 28, 2004
-------------------------------------- Chief Financial Officer
Eugene M. Bullis (Principal Financial Officer)
/s/ JOHN R. KLINE Senior Vice President and Chief January 28, 2004
-------------------------------------- Accounting Officer (Principal
John R. Kline Accounting Officer)
/s/ R. GLENN HILLIARD Chairman of the Board January 28, 2004
--------------------------------------
R. Glenn Hilliard
II-3
SIGNATURES CAPACITY DATE
---------- -------- ----
/s/ NEAL SCHNEIDER Director January 28, 2004
--------------------------------------
Neal Schneider
/s/ PHILIP R. ROBERTS Director January 28, 2004
--------------------------------------
Philip R. Roberts
/s/ JOHN G. TURNER Director January 28, 2004
--------------------------------------
John G. Turner
/s/ MICHAEL T. TOKARZ Director January 28, 2004
--------------------------------------
Michael T. Tokarz
/s/ MICHAEL S. SHANNON Director January 28, 2004
--------------------------------------
Michael S. Shannon
II-4
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 F-42 of this Form S-1. In connection with our
audits of such financial statements, we have also audited the related financial
statement schedules listed in the index on page II-2 of this Form S-1. In our
opinion, the financial statement schedules referred to above, present fairly, in
all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements.
The accompanying consolidated financial statements have been prepared
assuming that Conseco, Inc. will continue as a going concern, which contemplates
continuity of Conseco's operations and realization of its assets and payments of
its liabilities in the ordinary course of business. As more fully described in
the notes to the consolidated financial statements, on December 17, 2002,
Conseco, Inc. and several of its wholly-owned subsidiaries filed voluntary
petitions for reorganization under Chapter 11 of the United States Bankruptcy
Code. The uncertainties inherent in the bankruptcy process and Conseco's
recurring losses from operations raise substantial doubt about Conseco's ability
to continue as a going concern. Conseco, Inc. is currently operating its
business as a Debtor-in-Possession under the jurisdiction of the Bankruptcy
Court, and continuation of Conseco as a going concern is contingent upon, among
other things, the confirmation of Conseco's Plan of Reorganization and Conseco's
ability to generate sufficient cash from operations and obtain financing sources
to meet its future obligations. If no reorganization plan is approved, it is
possible that Conseco's assets may be liquidated. The consolidated financial
statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amount and
classification of liabilities that may result from the outcome of these
uncertainties.
As discussed in note 4 to the consolidated financial statements, the
Company adopted Emerging Issues Task Force Issue No. 99-20, "Recognition of
Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets" in 2000 and Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" in 2002.
/s/ PricewaterhouseCoopers LLP
--------------------------------
PricewaterhouseCoopers LLP
Indianapolis, Indiana
April 11, 2003
S-1
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Condensed Financial Information of Registrant (Parent Company)
Balance Sheet
as of December 31, 2002 and 2001
(Dollars in millions)
ASSETS
2002 2001
------------ ------------
Cash and cash equivalents ............................................................ $ 41.9 $ 152.2
Cash held in segregated accounts for the payment of debt ............................. -- 54.7
Other invested assets ................................................................ 8.0 15.3
Investment in wholly-owned subsidiaries (eliminated in consolidation) ................ 3,899.7 9,528.5
Notes receivable from Conseco Finance (eliminated in consolidation) .................. -- 249.5
Receivable from subsidiaries (eliminated in consolidation) ........................... 1,272.9 1,643.7
Income tax assets .................................................................... 54.3 521.2
Other assets ......................................................................... 66.9 10.7
------------ ------------
Total assets ............................................................... $ 5,343.7 $ 12,175.8
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable .................................................................... $ -- $ 4,085.0
Notes payable to subsidiaries (eliminated in consolidation) ...................... -- 353.5
Payable to subsidiaries (eliminated in consolidation) ............................ 5.1 477.7
Liabilities subject to compromise ................................................ 4,873.3 --
Affiliated liabilities subject to compromise ..................................... 572.4 --
Other liabilities ................................................................ 21.8 592.1
------------ ------------
Total liabilities .......................................................... 5,472.6 5,508.3
------------ ------------
Company-obligated mandatorily redeemable preferred securities of subsidiary trusts ... 1,921.5 1,914.5
Shareholders' equity (deficit):
Preferred stock .................................................................. 501.7 499.6
Common stock and additional paid-in capital (no par value, 1,000,000,000
shares authorized, shares issued and outstanding: 2002 - 346,007,133;
2001 - 344,743,196) .......................................................... 3,497.0 3,484.3
Accumulated other comprehensive income (loss) .................................... 580.6 (439.0)
Retained earnings (deficit) ...................................................... (6,629.7) 1,208.1
------------ ------------
Total shareholders' equity (deficit) ....................................... (2,050.4) 4,753.0
------------ ------------
Total liabilities and shareholders' equity (deficit) ....................... $ 5,343.7 $ 12,175.8
============ ============
The accompanying notes are an integral part
of the condensed financial information.
S-2
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Condensed Financial Information of Registrant (Parent Company)
Statement of Operations
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions)
2002 2001 2000
----------- ----------- -----------
Revenues:
Net investment income ........................................................... $ 3.3 $ 29.9 $ 77.3
Dividends from subsidiaries (eliminated in consolidation) ....................... 276.0 216.3 178.0
Fee and interest income from subsidiaries (eliminated in consolidation) ......... 68.6 170.2 347.3
Net investment losses ........................................................... (2.1) (53.5) (66.8)
Gain on sale of interest in riverboat ........................................... -- 192.4 --
Other income .................................................................... 1.5 1.6 7.6
----------- ----------- -----------
Total revenues .............................................................. 347.3 556.9 543.4
----------- ----------- -----------
Expenses:
Interest expense on notes payable (contractual interest for 2002 of $328.7) ..... 325.3 369.5 438.4
Provision for loss .............................................................. 147.2 169.6 231.5
Intercompany expenses (eliminated in consolidation) ............................. -- 21.0 28.0
Operating costs and expenses .................................................... 91.9 53.8 37.0
Special charges ................................................................. 30.5 49.6 281.6
Reorganization items, net ....................................................... 14.4 -- --
----------- ----------- -----------
Total expenses .............................................................. 609.3 663.5 1,016.5
----------- ----------- -----------
Loss before income taxes, equity in undistributed earnings of
subsidiaries, distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, discontinued operations,
extraordinary gain (loss) and cumulative effect of accounting change ...... (262.0) (106.6) (473.1)
Income tax expense (benefit):
Tax benefit on period income .................................................... (50.5) (115.6) (185.7)
Valuation allowance for deferred tax assets ..................................... 811.2 -- --
----------- ----------- -----------
Income (loss) before equity in undistributed earnings of subsidiaries,
distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts, discontinued operations, extraordinary
gain (loss) and cumulative effect of accounting change .................... (1,022.7) 9.0 (287.4)
Equity in undistributed loss of subsidiaries before discontinued operations,
extraordinary gain (loss) and cumulative effect of accounting change
(eliminated in consolidation) ................................................... (1,475.6) (205.9) (316.3)
----------- ----------- -----------
Loss before distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, discontinued operations,
extraordinary gain (loss) and cumulative effect of
accounting change ......................................................... (2,498.3) (196.9) (603.7)
Distributions on Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts (contractual distributions for 2002 of $179.8) ............. 173.2 119.5 145.3
----------- ----------- -----------
Loss before discontinued operations, extraordinary gain (loss)
and cumulative effect of accounting change ................................ (2,671.5) (316.4) (749.0)
Discontinued operations of subsidiaries, net of income taxes ....................... (2,223.1) (106.7) (381.9)
Extraordinary gain (loss) on extinguishment of debt, net of income taxes:
Parent company .................................................................. 1.9 11.1 (5.0)
Subsidiary ...................................................................... 6.2 6.1 --
Cumulative effect of accounting change of subsidiaries, net of income taxes ........ (2,949.2) -- (55.3)
----------- ----------- -----------
Net loss .................................................................... (7,835.7) (405.9) (1,191.2)
Preferred stock dividends (contractual distributions for 2002 of $2.1) ............. 2.1 12.8 11.0
----------- ----------- -----------
Loss applicable to common stock ............................................. $ (7,837.8) $ (418.7) $ (1,202.2)
=========== =========== ===========
The accompanying notes are an integral part
of the condensed financial information.
S-3
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Condensed Financial Information of Registrant (Parent Company)
Statement of Cash Flows
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions)
2002 2001 2000
----------- ----------- -----------
Cash flows from operating activities:
Net loss .................................................................. $ (7,835.7) $ (405.9) $ (1,191.2)
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed earnings of consolidated subsidiaries * ....... 1,475.6 205.9 316.3
Discontinued operations of subsidiaries ............................... 2,223.1 106.7 381.9
Cumulative effect of accounting change of subsidiaries ................ 2,949.2 -- --
Provision for loss on loan guarantees ................................. 147.2 169.6 231.5
Net investment losses ................................................. 2.1 53.5 66.8
Income taxes .......................................................... 723.4 (80.1) (351.7)
Extraordinary charge on extinguishment of debt ........................ (8.1) (26.9) 7.7
Cumulative effect of change in accounting ............................. -- -- 85.2
Distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts ..................................... 173.2 183.9 223.5
Special charges ....................................................... 10.2 41.9 112.1
Gain on sale of interest in riverboat ................................. -- (192.4)
Other ................................................................. 272.7 71.8 (19.9)
----------- ----------- -----------
Net cash provided (used) by operating activities ...................... 132.9 128.0 (137.8)
----------- ----------- -----------
Cash flows from investing activities:
Sales and maturities of investments ......................................... 16.7 375.9 228.2
Investments and advances to consolidated subsidiaries* ...................... (72.2) -- (1,427.2)
Purchases of investments .................................................... (59.2) (50.1) (220.0)
Payments from subsidiaries* ................................................. 21.5 535.9 2,218.0
----------- ----------- -----------
Net cash provided by investing activities ............................. (93.2) 861.7 799.0
----------- ----------- -----------
Cash flows from financing activities:
Issuance of common and convertible preferred shares ......................... -- 4.1 .8
Repurchase of Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts ........................................... -- -- (250.0)
Issuance of notes payable and commercial paper .............................. -- 410.8 3,537.2
Payments on notes payable ................................................... (75.5) (1,349.4) (3,114.6)
Payments on notes payable to affiliates* .................................... -- -- (3.1)
Payments to repurchase equity securities of Conseco, Inc. ................... -- -- (102.6)
Dividends to subsidiaries* .................................................. (43.0) (43.0) (52.8)
Dividends and distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts ................................. (86.2) (181.2) (302.1)
----------- ----------- -----------
Net cash used by financing activities ................................. (204.7) (1,158.7) (287.2)
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents .................. (165.0) (169.0) 374.0
Cash and cash equivalents, beginning of year ................................ 206.9 375.9 1.9
----------- ----------- -----------
Cash and cash equivalents, end of year ...................................... $ 41.9 $ 206.9 $ 375.9
=========== =========== ===========
* Eliminated in consolidation
The accompanying notes are an integral part
of the condensed financial information.
S-4
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Notes to Condensed Financial Information
1. Basis of Presentation
The condensed financial information should be read in conjunction with the
consolidated financial statements of Conseco, Inc. ("Conseco" or "CNC"). The
condensed financial information includes the accounts and activity of the parent
company and its wholly-owned non-insurance subsidiaries which act as the holding
companies for Conseco's life insurance subsidiaries.
2. Condensed Consolidating Financial Information
The obligations under our current bank credit facilities, which had a
principal balance of $1,531.4 million at December 31, 2002, are guaranteed by
CIHC, Incorporated, ("CIHC") a wholly-owned subsidiary of Conseco, and the
ultimate holding company for Conseco's principal operating subsidiaries. In
addition, CIHC has guaranteed up to $250.0 million of debt of Conseco Finance
Corp. ("CFC"), and up to $481.3 million of bank loans to certain of our current
and former directors, officers and key employees which were used to purchase
shares of our common stock.
As described in the note to the consolidated financial statements entitled
"Notes Payable", Conseco completed an exchange of approximately $1.3 billion
aggregate principal amount of newly issued guaranteed notes for its senior
unsecured notes held by "qualified institutional buyers," institutional
"accredited investors," or non U.S. persons in transactions outside the United
States. The bonds which were exchanged have identical principal and interest
amounts, but the new bonds have extended maturities and are guaranteed on a
senior subordinated basis by CIHC. Such guarantee is subordinated to the
guarantees of CIHC summarized in the preceding paragraph. The guarantee is on
parity with CIHC's senior subordinated debt including a $177.4 million note to
CFIHC, Inc. CFIHC, Inc. is a subsidiary of CIHC.
The following condensed consolidating financial information as of December
31, 2002 and 2001, and for the three years ended December 31, 2002, summarizes
the accounts of CIHC, Conseco and other holding companies which comprise the
parent company. Such condensed consolidating financial information should be
read in conjunction with the consolidated financial statements of Conseco.
S-5
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Notes to Condensed Financial Information
Condensed Consolidating Financial Information of Registrant (Parent Company)
Balance Sheet
as of December 31, 2002
(Dollars in millions)
ASSETS
Conseco, Inc. Total
CIHC, and other Conseco, Inc.
Incorporated holding (parent
(holding company) companies Eliminations company)
----------------- ----------- ------------ --------------
Cash and cash equivalents ....................................... $ 25.9 $ 16.0 $ -- $ 41.9
Other invested assets ........................................... 5.8 2.2 -- 8.0
Investment in wholly-owned subsidiaries
(eliminated in consolidation) ............................... 4,440.3 5,360.9 (5,901.5) 3,899.7
Receivable from subsidiaries (eliminated in consolidation) ...... 1,278.7 1,007.8 (1,013.6) 1,272.9
Income tax assets ............................................... (4.7) 59.0 -- 54.3
Other assets .................................................... .1 66.8 -- 66.9
------------- ----------- ----------- -----------
Total assets .......................................... $ 5,746.1 $ 6,512.7 $ (6,915.1) $ 5,343.7
============= =========== =========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Payable to subsidiaries (eliminated in consolidation) ....... $ 4.8 $ 71.3 $ (71.0) $ 5.1
Liabilities subject to compromise ........................... 7.4 4,865.9 -- 4,873.3
Affiliated liabilities subject to compromise ................ 1,030.3 558.1 (1,016.0) 572.4
Other liabilities ........................................... -- 21.8 -- 21.8
------------- ----------- ----------- -----------
Total liabilities ..................................... 1,042.5 5,517.1 (1,087.0) 5,472.6
------------- ----------- ----------- -----------
Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts ....................................... -- 1,921.5 -- 1,921.5
Shareholders' equity (deficit):
Preferred stock ............................................. 268.8 1,401.7 (1,168.8) 501.7
Common stock and additional paid-in capital ................. 8,718.8 3,800.0 (9,021.8) 3,497.0
Accumulated other comprehensive income ...................... 585.6 580.6 (585.6) 580.6
Retained earnings (deficit) ................................. (4,869.6) (6,708.2) 4,948.1 (6,629.7)
------------- ----------- ----------- -----------
Total shareholders' equity (deficit) .................. 4,703.6 (925.9) (5,828.1) (2,050.4)
------------- ----------- ----------- -----------
Total liabilities and shareholders' equity (deficit) .. $ 5,746.1 $ 6,512.7 $ (6,915.1) $ 5,343.7
============= =========== =========== ===========
S-6
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Notes to Condensed Financial Information
Condensed Consolidating Financial Information of Registrant (Parent Company)
Balance Sheet
as of December 31, 2001
(Dollars in millions)
ASSETS
Conseco, Inc. Total
CIHC, and other Conseco, Inc.
Incorporated holding (parent
(holding company) companies Eliminations company)
--------------- ------------- ------------ -------------
Cash and cash equivalents ...................................... $ 1.0 $ 151.2 $ -- $ 152.2
Cash held in segregated accounts for the payment of debt ....... -- 54.7 -- 54.7
Other invested assets .......................................... 3.5 11.8 -- 15.3
Investment in wholly-owned subsidiaries
(eliminated in consolidation) .............................. 10,240.6 10,166.6 (10,878.7) 9,528.5
Notes receivable from Conseco Finance
(eliminated in consolidation) .............................. 249.5 -- -- 249.5
Receivable from subsidiaries (eliminated in consolidation) ..... 1,535.8 2,685.1 (2,577.2) 1,643.7
Income taxes ................................................... (210.8) 648.8 83.2 521.2
Other assets ................................................... 1.0 9.7 -- 10.7
--------------- ------------- ----------- -------------
Total assets ......................................... $ 11,820.6 $ 13,727.9 $ (13,372.7) $ 12,175.8
=============== ============= =========== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable .............................................. $ -- $ 4,085.0 $ -- $ 4,085.0
Notes payable to subsidiaries (eliminated in
consolidation) ....................................... 1,279.8 77.0 (1,003.3) 353.5
Payable to subsidiaries (eliminated in consolidation) ...... 313.3 1,094.0 (929.6) 477.7
Other liabilities .......................................... 35.7 556.4 -- 592.1
--------------- ------------- ----------- -------------
Total liabilities .................................... 1,628.8 5,812.4 (1,932.9) 5,508.3
--------------- ------------- ----------- -------------
Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts ...................................... -- 1,914.5 -- 1,914.5
Shareholders' equity:
Preferred stock ............................................ 250.8 1,399.6 (1,150.8) 499.6
Common stock and additional paid-in capital ................ 8,763.4 3,789.0 (9,068.1) 3,484.3
Accumulated other comprehensive loss ....................... (478.2) (438.9) 478.1 (439.0)
Retained earnings .......................................... 1,655.8 1,251.3 (1,699.0) 1,208.1
--------------- ------------- ----------- -------------
Total shareholders' equity ........................... 10,191.8 6,001.0 (11,439.8) 4,753.0
--------------- ------------- ----------- -------------
Total liabilities and shareholders' equity ........... $ 11,820.6 $ 13,727.9 $ (13,372.7) $ 12,175.8
=============== ============= =========== =============
S-7
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Notes to Condensed Financial Information
Condensed Consolidating Financial Information of Registrant (Parent Company)
Statement of Operations
for the year ended December 31, 2002
(Dollars in millions)
Conseco, Inc. Total
CIHC, and other Conseco, Inc.
Incorporated holding (parent
(holding company) companies Eliminations company)
---------------- ------------- ------------ ------------
Revenues:
Net investment income ......................................... $ .1 $ 3.2 $ -- $ 3.3
Dividends from subsidiaries (eliminated in consolidation) ..... 276.0 -- -- 276.0
Fee and interest income from subsidiaries
(eliminated in consolidation) .............................. 67.3 39.6 (38.3) 68.6
Net investment gains (losses) ................................. -- (2.1) -- (2.1)
Other income .................................................. -- 1.5 -- 1.5
-------------- ------------ ------------ -----------
Total revenues .......................................... 343.4 42.2 (38.3) 347.3
-------------- ------------ ------------ -----------
Expenses:
Interest expense on notes payable ............................. -- 325.3 -- 325.3
Provision for loss ............................................ -- 147.2 -- 147.2
Intercompany expenses (eliminated in consolidation) ........... 32.5 1.2 (33.7) --
Operating costs and expenses .................................. 4.7 89.6 (2.4) 91.9
Special charges ............................................... .1 30.4 -- 30.5
Reorganization items, net ..................................... -- 14.4 -- 14.4
-------------- ------------ ------------ -----------
Total expenses .......................................... 37.3 608.1 (36.1) 609.3
-------------- ------------ ------------ -----------
Income (loss) before income taxes, equity in
undistributed earnings ofsubsidiaries, distributions
on Company-obligated mandatorilyredeemable preferred
securities of subsidiary trusts, discontinued
operations, extraordinary gain and cumulative effect
of accounting change ................................. 306.1 (565.9) (2.2) (262.0)
Income tax expense (benefit):
Tax benefit on period income ............................... 37.0 (87.5) -- (50.5)
Valuation allowance for deferred tax assets ................ -- 811.2 -- 811.2
-------------- ------------ ------------ -----------
Income (loss) before equity in undistributed earnings of
subsidiaries,distributions on Company-obligated
mandatorily redeemable preferredsecurities of
subsidiary trusts, discontinued operations,
extraordinary gain and cumulative effectof
accounting change .................................... 269.1 (1,289.6) (2.2) (1,022.7)
Equity in undistributed earnings of subsidiaries before
discontinued operations,extraordinary gain and cumulative
effect of accounting change(eliminated in consolidation) ...... (1,664.1) (6,274.1) 6,462.6 (1,475.6)
-------------- ------------ ------------ -----------
Income (loss) before distributions on Company-obligated
mandatorily redeemable preferred securities of
subsidiary trusts, discontinued operations,
extraordinary gain and cumulative effect
of accounting change ................................. (1,395.0) (7,563.7) 6,460.4 (2,498.3)
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts ..................... -- 173.2 -- 173.2
-------------- ------------ ------------ -----------
Income (loss) before discontinued operations,
extraordinary gain and cumulative effect of
accounting change .......................................... (1,395.0) (7,736.9) 6,460.4 (2,671.5)
Discontinued operations of subsidiaries, net of tax ............... (2,223.1) -- -- (2,223.1)
Extraordinary gain on extinguishment of debt, net of tax
Parent company ................................................ -- 1.9 -- 1.9
Subsidiary .................................................... 6.2 -- -- 6.2
Cumulative effect of accounting change of subsidiaries,
net of tax .................................................... (2,857.1) (92.1) -- (2,949.2)
-------------- ------------ ------------ -----------
Net income (loss) .......................................... (6,469.0) (7,827.1) 6,460.4 (7,835.7)
Preferred stock dividends ......................................... 27.1 38.1 (63.1) 2.1
-------------- ------------ ------------ -----------
Income (loss) applicable to common stock ................... $ (6,496.1) $ (7,865.2) $ 6,523.5 $ (7,837.8)
============== ============ ============ ===========
S-8
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Notes to Condensed Financial Information
Condensed Consolidating Financial Information of Registrant (Parent Company)
Statement of Operations
for the year ended December 31, 2001
(Dollars in millions)
Conseco, Inc. Total
CIHC, and other Conseco, Inc.
Incorporated holding (parent
(holding company) companies Eliminations company)
--------------- ------------- ------------ -------------
Revenues:
Net investment income .......................................... $ .7 $ 29.2 $ -- $ 29.9
Dividends from subsidiaries (eliminated in consolidation) ...... 192.3 24.0 -- 216.3
Fee and interest income from subsidiaries
(eliminated in consolidation) ............................... 172.5 180.4 (182.7) 170.2
Net investment gains (losses) .................................. 4.3 (57.8) -- (53.5)
Gain on sale of interest in riverboat .......................... -- 192.4 -- 192.4
Other income ................................................... -- 1.6 -- 1.6
-------------- ------------- ------------ -------------
Total revenues ........................................... 369.8 369.8 (182.7) 556.9
-------------- ------------- ------------ -------------
Expenses:
Interest expense on notes payable .............................. 2.6 369.2 (2.3) 369.5
Provision for loss ............................................. -- 169.6 -- 169.6
Intercompany expenses (eliminated in consolidation) ............ 122.0 5.3 (106.3) 21.0
Operating costs and expenses ................................... 2.5 70.4 (19.1) 53.8
Special charges ................................................ .2 36.9 12.5 49.6
-------------- ------------- ------------ -------------
Total expenses ........................................... 127.3 651.4 (115.2) 663.5
-------------- ------------- ------------ -------------
Income (loss) before income taxes, equity in
undistributed earnings ofsubsidiaries, distributions
on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts, discontinued
operations, extraordinary gain and cumulative effect
of accounting change .................................. 242.5 (281.6) (67.5) (106.6)
Income tax expense (benefit) ....................................... 16.3 (107.5) (24.4) (115.6)
-------------- ------------- ------------ -------------
Income (loss) before equity in undistributed earnings of
subsidiaries, distributions on Company-obligated
mandatorily redeemable preferred securities of
subsidiary trusts, discontinued operations,
extraordinary gain and cumulative effect of
accounting change ..................................... 226.2 (174.1) (43.1) 9.0
Equity in undistributed earnings of subsidiaries before
discontinued operations, extraordinary gain and cumulative
effect of accounting change (eliminated in consolidation) ...... (193.9) (78.3) 66.3 (205.9)
-------------- ------------- ------------ -------------
Income (loss) before distributions on Company-obligated
redeemable mandatorily preferred securities of
subsidiary trusts, discontinued operations,
extraordinary gain and cumulative effect of
accounting change ..................................... 32.3 (252.4) 23.2 (196.9)
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts ...................... -- 119.5 -- 119.5
-------------- ------------- ------------ -------------
Income (loss) before discontinued operations, extraordinary
gain and cumulative effect of accounting change ............. 32.3 (371.9) 23.2 (316.4)
Discontinued operations of subsidiaries, net of tax ................ (106.7) -- -- (106.7)
Extraordinary gain on extinguishment of debt, net of tax:
Parent company ................................................. -- 11.1 -- 11.1
Subsidiary ..................................................... 6.1 -- -- 6.1
-------------- ------------- ------------ -------------
Net income (loss) ........................................... (68.3) (360.8) 23.2 (405.9)
Preferred stock dividends .......................................... -- 12.8 -- 12.8
-------------- ------------- ------------ -------------
Income (loss) applicable to common stock .................... $ (68.3) $ (373.6) $ 23.2 $ (418.7)
============== ============= ============ =============
S-9
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
SCHEDULE II
Notes to Condensed Financial Information
Condensed Consolidating Financial Information of Registrant (Parent Company)
Statement of Operations
for the year ended December 31, 2000
(Dollars in millions)
Conseco, Inc. Total
CIHC, and other Conseco, Inc.
Incorporated holding (parent
(holding company) companies Eliminations company)
----------------- ------------ ------------ -------------
Revenues:
Net investment income ........................................... $ -- $ 77.3 $ -- $ 77.3
Dividends from subsidiaries (eliminated in consolidation) ....... 178.0 -- -- 178.0
Fee and interest income from subsidiaries
(eliminated in consolidation) ................................ 197.4 335.3 (185.4) 347.3
Net investment gains (losses) ................................... 2.7 (69.5) -- (66.8)
Other income .................................................... -- 7.6 -- 7.6
------------- ------------ ------------ -------------
Total revenues ............................................ 378.1 350.7 (185.4) 543.4
------------- ------------ ------------ -------------
Expenses:
Interest expense on notes payable ............................... 12.5 425.9 -- 438.4
Provision for loss .............................................. -- 231.5 -- 231.5
Intercompany expenses (eliminated in consolidation) ............. 198.9 11.6 (182.5) 28.0
Operating costs and expenses .................................... 6.9 30.1 -- 37.0
Special charges ................................................. -- 281.6 -- 281.6
------------- ------------ ------------ -------------
Total expenses ............................................ 218.3 980.7 (182.5) 1,016.5
------------- ------------ ------------ -------------
Income (loss) before income taxes, equity in undistributed
earnings of subsidiaries, distributions on Company-
obligated mandatorily redeemable preferred securities
of subsidiary trusts, discontinued operations,
extraordinary charge and cumulative effect of
accounting change ...................................... 159.8 (630.0) (2.9) (473.1)
Income tax expense (benefit) ........................................ (2.6) (182.1) (1.0) (185.7)
------------- ------------ ------------ -------------
Income (loss) before equity in undistributed earnings of
subsidiaries, distributions on Company-obligated
mandatorily redeemable preferred securities of
subsidiary trusts, discontinued operations,extraordinary
charge and cumulative effect of accounting change ...... 162.4 (447.9) (1.9) (287.4)
Equity in undistributed earnings of subsidiaries before discontinued
operations, extraordinary charge and cumulative effect of
accounting change (eliminated in consolidation) ................. (321.1) (584.4) 589.2 (316.3)
------------- ------------ ------------ -------------
Loss before distributions on Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts,
discontinued operations, extraordinary charge and
cumulative effect of accounting change ................. (158.7) (1,032.3) 587.3 (603.7)
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts ....................... -- 145.3 -- 145.3
------------- ------------ ------------ -------------
Loss before discontinued operations, extraordinary charge
and cumulative effect of accounting change ................... (158.7) (1,177.6) 587.3 (749.0)
Discontinued operations of subsidiaries, net of tax ................. (381.9) -- -- (381.9)
Extraordinary charge on extinguishment of debt, net of tax .......... (4.9) (.1) -- (5.0)
Cumulative effect of accounting change, net of tax, of
subsidiaries .................................................... (55.3) -- -- (55.3)
------------- ------------ ------------ -------------
Net loss ..................................................... (600.8) (1,177.7) 587.3 (1,191.2)
Preferred stock dividends ........................................... -- 11.0 -- 11.0
------------- ------------ ------------ -------------
Loss applicable to common stock .............................. $ (600.8) $ (1,188.7) $ 587.3 $ (1,202.2)
============= ============ ============ =============
S-10
CONSECO, INC. AND SUBSIDIARIES
SCHEDULE IV
Reinsurance
for the years ended December 31, 2002, 2001 and 2000
(Dollars in millions)
2002 2001 2000
------------ ------------ ------------
Life insurance inforce:
Direct ............................................. $ 94,098.3 $ 116,075.0 $ 117,556.2
Assumed ............................................ 3,380.7 1,996.5 4,878.0
Ceded .............................................. (26,368.9) (26,088.6) (27,106.3)
------------ ------------ ------------
Net insurance inforce ........................ $ 71,110.1 $ 91,982.9 $ 95,327.9
============ ============ ============
Percentage of assumed to net ................. 4.8% 2.2% 5.1%
============ ============ ============
Premiums recorded as revenue for generally accepted
accounting principles:
Direct ........................................... $ 3,287.8 $ 3,600.0 $ 3,556.7
Assumed .......................................... 78.7 146.0 300.5
Ceded ............................................ (327.8) (249.4) (237.1)
------------ ------------ ------------
Net premiums ................................. $ 3,038.7 $ 3,496.6 $ 3,620.1
============ ============ ============
Percentage of assumed to net ................. 2.6% 4.2% 8.3%
============ ============ ============
S-11
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
------- -----------
1.1* Form of Underwriting Agreement.
2.1 Sixth Amended Joint Plan of Reorganization of Conseco, Inc.
and affiliated Debtors, incorporated by reference to Exhibit
2.2 of our Current Report on Form 8-K filed September 15,
2003.
2.2 Order Confirming Reorganizing Debtors' Sixth Amended Joint
Plan of Reorganization, incorporated by reference to Exhibit
2.3 of our Current Report on Form 8-K filed September 15,
2003.
3.1 Amended and Restated Certificate of Incorporation of
Conseco, Inc., incorporated by reference to Exhibit 3.1 of
our Current Report on Form 8-K filed September 15, 2003.
3.2 Second Amended and Restated Bylaws of Conseco, Inc.
4.1 Certificate of Designations relating to Class A Senior
Cumulative Convertible Exchangeable Preferred Stock of
Conseco, Inc., incorporated by reference to Exhibit 4.1 of
our Current Report on Form 8-K filed September 15, 2003.
4.2 Series A Warrant Agreement between Conseco, Inc. and
Wachovia Bank, N.A., as Warrant Agent, incorporated by
reference to Exhibit 4.2 of our Current Report on Form 8-K
filed September 15, 2003.
4.3* Certificate of Designations relating to Mandatorily
Convertible Preferred Stock, Class B.
5.1* Opinion of Kirkland & Ellis LLP.
10.1 Credit Agreement dated as of September 10, 2003 among
Conseco, Inc., Bank of America, N.A., as Agent, and other
financial institutions, incorporated by reference to Exhibit
10.1 of our Current Report on Form 8-K filed September 15,
2003.
10.2 Amendment No. 1 to Credit Agreement dated as of January 15,
2004 among Conseco, Inc., Bank of America, N.A., as Agent,
and other financial institutions.
10.3 Guarantee and Security Agreement dated as of September 10,
2003 among Conseco, Inc., the Subsidiary Guarantors Party
Thereto and Bank of America, N.A., as Agent, incorporated by
reference to Exhibit 10.4 of our Quarterly Report on Form
10-Q for the quarter ended September 30, 2003.
10.4 Common Stock Registration Rights Agreement dated as of
September 10, 2003, incorporated by reference to Exhibit
10.2 of our Current Report on Form 8-K filed September 15,
2003.
10.5 Preferred Stock Registration Rights Agreement dated as of
September 10, 2003, incorporated by reference to Exhibit
10.3 of our Current Report on Form 8-K filed September 15,
2003.
10.6 Employment Agreement dated as of May 27, 2003 between
Conseco, Inc. and William J. Shea, incorporated by reference
to Exhibit 10.5 of our Quarterly Report on Form 10-Q for the
quarter ended September 30, 2003.
10.7 Agreement dated as of June 18, 2003 between Conseco, Inc.
and R. Glenn Hilliard, incorporated by reference to Exhibit
10.6 of our Quarterly Report on Form 10-Q for the quarter
ended September 30, 2003.
10.8 Amendment dated as of December 30, 2003 to Agreement dated
as of June 18, 2003 between Conseco, Inc. and R. Glenn
Hilliard.
10.9 Employment Agreement dated as of September 10, 2003 between
Conseco, Inc. and Eugene M. Bullis.
10.10 Employment Agreement dated as of July 15, 2002 between
Conseco, Inc. and John R. Kline.
10.11 Employment Agreement dated as of September 10, 2003 between
40Y86 Advisors, Inc. and Eric R. Johnson.
10.12 Conseco, Inc. 2003 Long-Term Equity Incentive Plan,
incorporated by reference to Exhibit 4 of our Registration
Statement on Form S-8 (No. 333-108835).
EXHIBIT
NO. DESCRIPTION
------- -----------
12.1 Computation of Ratio of Earnings to Fixed Charges, Preferred
Stock Dividends and Distributions on Company-obligated
Mandatorily Redeemable Preferred Securities of Subsidiary
Trusts.
21.1 Subsidiaries of Conseco, Inc.
23.1 Consent of PricewaterhouseCoopers LLP.
23.2* Consent of Kirkland & Ellis LLP (included in Exhibit 5.1).
24.1 Powers of Attorney (included in Part II to the Registration
Statement).
---------------
* To be filed by amendment.