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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
[ X ] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 2002 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 [No Fee Required]
For the transition period from to
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Commission file number: 1-9250
Conseco, Inc.
(Debtor-In-Possession as of December 17, 2002)
Indiana No. 35-1468632
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State of Incorporation IRS Employer Identification No.
11825 N. Pennsylvania Street
Carmel, Indiana 46032 (317) 817-6100
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Address of principal executive offices Telephone
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
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Common Stock, No Par Value (a)
8-1/8% Senior Notes due 2003 (a)
10-1/2% Senior Notes due 2004 (a)
9.16% Trust Originated Preferred Securities (a)
8.70% Trust Originated Preferred Securities (a)
9% Trust Originated Preferred Securities (a)
9.44% Trust Originated Preferred Securities (a)
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(a) Prior to August 9, 2002, these securities were listed on the New York Stock
Exchange ("NYSE"). On August 9, 2002, the NYSE suspended trading of these
securities and the securities were subsequently removed from listing and
registration on the NYSE on September 25, 2002.
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, No Par Value
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days: Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No[ ]
At June 28, 2002, the last business day of the Registrant's most recently
completed second fiscal quarter, the aggregate market value of the Registrant's
common equity held by nonaffiliates was approximately $668,600,000. This
calculation of market value has been made for the purposes of this report only
and should not be considered as an admission or conclusion by the Registrant
that any person is in fact an affiliate of the Registrant.
Shares of common stock outstanding as of March 28, 2003: 346,007,133
DOCUMENTS INCORPORATED BY REFERENCE: None.
PART I
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ITEM 1. BUSINESS OF CONSECO.
Conseco, Inc. ("CNC") is the top tier holding company for our two operating
businesses: insurance and finance. Our insurance business is operated through
subsidiaries owned directly and indirectly by CIHC, Incorporated ("CIHC"), an
intermediate holding company that is controlled by CNC. Our finance business has
been historically operated through Conseco Finance Corp. ("CFC"), a wholly-owned
subsidiary of CIHC, and its subsidiaries. Effective December 17, 2002 (the date
CFC filed a petition for relief under the Bankruptcy Code as further described
below), we began to account for our finance business as a discontinued
operation. Our subsidiaries operate throughout the United States. We sometimes
collectively refer to CNC, together with its consolidated subsidiaries, as "we,"
"Conseco" or the "Company."
Our insurance subsidiaries develop, market and administer supplemental
health insurance, annuity, individual life insurance and other insurance
products. Our finance business has historically provided a variety of finance
products including manufactured housing and floor plan loans, home equity
mortgages, home improvement and consumer product loans and private label credit
cards.
PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
On December 17, 2002 (the "Petition Date"), CNC, CIHC, CTIHC, Inc. and
Partners Health Group, Inc. (collectively, the "Debtors") filed voluntary
petitions for reorganization under Chapter 11 of Title 11 of the United States
Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court
(the "Bankruptcy Court") for the Northern District of Illinois. The following
discussion provides general background information regarding the Debtors'
Chapter 11 cases, but is not intended to be a comprehensive summary. For
additional information regarding the effect of these cases on the Debtors,
readers of this report should refer to the Bankruptcy Code, the Second Amended
Joint Plan of Reorganization (the "Plan"), and the Second Amended Disclosure
Statement approved by the Bankruptcy Court on March 18, 2003 (the "Disclosure
Statement"). The Plan and Disclosure Statement were filed with the Securities
and Exchange Commission (the "SEC") on March 21, 2003 as exhibits to CNC's
Current Report on Form 8-K dated March 18, 2003. The Debtors are currently
operating their business as debtors-in-possession pursuant to the Bankruptcy
Code. As debtors-in-possession, the Debtors are authorized to continue to
operate as ongoing businesses, but may not engage in transactions outside the
ordinary course of business without approval of the Bankruptcy Court, after
notice and an opportunity for a hearing. The Company's insurance subsidiaries
are separate legal entities and are not included in the petitions filed by the
Debtors.
CFC and Conseco Finance Servicing Corp. also filed petitions under the
Bankruptcy Code with the Bankruptcy Court on the Petition Date. In addition, on
February 3, 2003, the following subsidiaries of CFC filed petitions under the
Bankruptcy Code with the Bankruptcy Court: Conseco Finance Corp. - Alabama,
Conseco Finance Credit Corp., Conseco Finance Consumer Discount Company, Conseco
Finance Canada Holding Company, Conseco Finance Canada Company, Conseco Finance
Loan Company, Rice Park Properties Corporation, Landmark Manufactured Housing,
Inc., Conseco Finance Net Interest Margin Finance Corp. I, Conseco Finance Net
Interest Margin Finance Corp. II, Green Tree Finance Corp. - Two, Green Tree
Floorplan Funding Corp., Conseco Agency of Nevada, Inc., Conseco Agency of New
York, Inc., Conseco Agency, Inc., Conseco Agency of Alabama, Inc., Conseco
Agency of Kentucky, Inc., Crum-Reed General Agency, Inc. The foregoing entities
are referred to as the "Finance Company Debtors." The Finance Company Debtors
filed a separate plan in connection with their bankruptcy proceedings. The
bankruptcy proceedings of the Debtors and the Finance Company Debtors are
referred to as the "Chapter 11 Cases".
Since commencing operations in 1982, CNC pursued a strategy of growth
through acquisitions. Primarily as a result of these acquisitions and the
funding requirements necessary to operate and expand the acquired businesses,
CNC amassed outstanding indebtedness of approximately $6.0 billion as of June
30, 2002. In 2001 and early 2002, we undertook a series of steps designed to
reduce and extend the maturities of our parent company debt. Notwithstanding
these efforts, the Company's financial position continued to deteriorate,
principally due to our leveraged condition, losses experienced by our finance
business and losses in the value of our investment portfolio.
As a result of these developments, on August 9, 2002, we announced that we
would seek to fundamentally restructure the Company's capital, and announced
that we had retained legal and financial advisors to assist us in these efforts.
We ultimately decided to seek to reorganize under Chapter 11 of the Bankruptcy
Code.
Under the Bankruptcy Code, actions to collect prepetition indebtedness, as
well as most pending litigation, are stayed and other contractual obligations
against the Debtors generally may not be enforced. Absent an order of the
Bankruptcy Court, substantially all prepetition liabilities are subject to
settlement under a plan of reorganization to be voted upon by creditors and
other stakeholders and approved by the Bankruptcy Court. On March 18, 2003, the
Bankruptcy Court approved the Debtors' Plan, as summarized in the Disclosure
Statement, as containing adequate information, as such term is defined in
Section 1125 of the Bankruptcy Code, to permit the solicitation of votes from
creditors on whether or not to accept the Plan. The Debtors commenced
solicitation on April 4, 2003.
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The voting record date has been set as March 19, 2003 and the deadline for
returning completed ballots is May 14, 2003. A hearing to consider confirmation
of the Plan is scheduled to begin on May 28, 2003. The Debtors will emerge from
bankruptcy if and when the Plan receives the requisite stakeholder approval and
is approved by the Bankruptcy Court, and all conditions to the consummation of
the Plan, have been satisfied or waived.
The United States Trustee has appointed a creditors committee representing
the unsecured creditors of the Debtors and a TOPrS committee representing the
claims of the holders of the Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts ("Trust Preferred Securities"). Before the
Petition Date, the Company met with and provided materials to certain
prepetition committees and entered into extensive arms-length negotiations with
committees representing the holders of bank debt and publicly held notes of CNC.
Shortly before the Petition Date, the Company reached a non-binding agreement in
principle with respect to the general terms of a restructuring with certain
prepetition committees. However, there can be no assurance that the appointed
committees will support the Debtors' positions in the bankruptcy proceedings or
approve the Plan. The TOPrS committee has raised certain objections to the Plan
which are summarized in the Disclosure Statement. Disagreements between the
Debtors and the appointed committees could protract the bankruptcy proceedings,
could negatively impact the Company's ability to operate and the results of
those operations during bankruptcy, and could delay the Debtors' emergence from
bankruptcy.
The Debtors previously filed with the Bankruptcy Court schedules of assets
and liabilities of the Debtors as reflected on our books and records. Subject to
certain limited exceptions, the Bankruptcy Court established a bar date of
February 21, 2003, for all prepetition claims against the Debtors. A bar date is
the date by which claims against the Debtors must be filed if the claimants wish
to receive any distribution in the bankruptcy proceedings. The Debtors notified
all known or potential claimants subject to the February 21, 2003 bar date of
their need to file a proof of claim with the Bankruptcy Court. Approximately
9,000 proofs of claim were filed on or before the February 21, 2003 bar date and
the Company has begun objecting to claims and otherwise reconciling claims that
differ from the Debtors' records. Any differences that cannot be resolved
through negotiations between the Debtors and the claimant will be resolved by
the Bankruptcy Court. Certain creditors have filed claims substantially in
excess of amounts reflected in the Debtors' records. Accordingly, the ultimate
number and amount of allowed claims is not presently known. Similarly, the
ultimate distribution with respect to allowed claims is not presently known.
We have filed several motions in the Chapter 11 Cases pursuant to which the
Bankruptcy Court has granted us authority or approval with respect to various
items required by the Bankruptcy Code and/or necessary for our reorganization
efforts. We have obtained orders providing for, among other things: (i) payment
of prepetition and postpetition employee compensation and benefits; (ii)
continuing a key-employee retention plan; (iii) obtaining debtor-in-possession
financing for the Finance Company Debtors; and (iv) increasing the amount of the
servicing fee paid to the Finance Company Debtors as servicers of various
manufactured housing securitization trusts.
Under the priority schedule established by the Bankruptcy Code, certain
postpetition and prepetition liabilities need to be satisfied before unsecured
creditors and holders of CNC's common and preferred stock and Trust Preferred
Securities are entitled to receive any distribution. The Plan (as summarized in
the Disclosure Statement) sets forth the Debtors' proposed treatment of claims
and equity interests. No assurance can be given as to what values, if any, will
be ascribed in the bankruptcy proceedings to each of these constituencies. Our
Plan would result in holders of CNC's common stock and preferred stock (other
than Series F Common-Linked Convertible Preferred Stock ("Series F Preferred
Stock")) receiving no value and the holders of CNC's Trust Preferred Securities
and Series F Preferred Stock receiving little value on account of the
cancellation of their interests. In addition, holders of unsecured claims
against the Debtors would, in most cases, receive less than full recovery for
the cancellation of their interests.
At this time, it is not possible to predict with certainty the effect of
the Chapter 11 Cases on our business or various creditors, or when we will
emerge from Chapter 11. Our future results depend upon our confirming and
successfully implementing, on a timely basis, a plan of reorganization.
The consolidated financial statements included in Item 8. "Financial
Statements and Supplementary Data" have been prepared on a going concern basis
which assumes continuity of operations and realization of assets and
satisfaction of liabilities in the ordinary course of business. Our Plan will
materially change amounts reported in the financial statements, which do not
give effect to all adjustments of the carrying value of assets and liabilities
that will be necessary as a consequence of a reorganization under Chapter 11 of
the Bankruptcy Code. The ability of Conseco to continue as a going concern is
predicated upon many issues, including various bankruptcy considerations and
risks related to our business and financial condition. Please refer to Item 7.
"Management's Discussion and Analysis of Results of Operations and Financial
Condition" and Item 8. "Financial Statements and Supplementary Data" for
additional information.
DISCONTINUED FINANCE BUSINESS - PLANNED SALE OF CFC
In October 2002, we announced that we had engaged financial advisors to
pursue various alternatives with respect to our finance business and that CNC's
board of directors had approved a plan to sell or seek new investors for our
finance business. On
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December 19, 2002, CFC entered into an Asset Purchase Agreement (the "Asset
Purchase Agreement") with CFN Investment Holdings LLC ("CFN"), an affiliate of
Fortress Investment Group LLC, J.C. Flowers & Co. LLC and Cerberus Capital
Management, L.P., pursuant to which CFC would, subject to the satisfaction of
certain conditions, sell all or substantially all of its assets (the "CFC
Assets") in a sale pursuant to Section 363 of the Bankruptcy Code as part of
CFC's Chapter 11 proceedings, subject to the right of CFN to exclude certain
assets from its purchase. In accordance with Section 363 of the Bankruptcy Code
and the terms of the Asset Purchase Agreement, CFC continued to seek alternative
transactions that would provide greater value to CFC and its creditors than the
transactions contemplated by the Asset Purchase Agreement.
As a result of the formalization of the plans to sell the finance business
and the filing of petitions under the Bankruptcy Code by CFC and certain of its
subsidiaries, the finance business is being accounted for as a discontinued
operation.
As part of CFC's efforts to seek alternative transactions that would
provide greater value to CFC, and in accordance with the bidding procedures
order approved by the Bankruptcy Court, CFC conducted an auction for the sale of
its businesses and assets. Potential bidders that submitted bids for the
purchase of the CFC Assets that, by their own terms or aggregated with other
bids, were for more than the purchase price payable under the Asset Purchase
Agreement, plus the amount of the break-up fee of $30 million, plus $5 million
in expense reimbursements, plus the profit sharing rights relating to the
manufactured housing business, were allowed to participate in the auction. The
auction, which commenced on February 28, 2003, promptly adjourned, and was
continued to March 4, 2003, ultimately concluding the morning of March 5, 2003.
At the auction, CFC, with the assistance of its advisors, analyzed each of
the bids presented and determined that CFN's bid of $970 million in cash, plus
the assumption of certain liabilities, represented the highest and best bid. The
terms of the sale included an option for CFC to sell the assets of Mill Creek
Bank, Inc. ("Mill Creek Bank", formerly known as Conseco Bank, Inc.) to General
Electric Capital Corporation ("GE") for approximately $310 million in cash, plus
certain assumed liabilities, which option, if exercised, would provide CFN with
a credit of $270 million to its $970 million bid.
On March 6, 2003, CFC received an offer from Berkadia Equity Holdings,
L.L.C. ("Berkadia") that purported to be a bid in the recently concluded
auction. Concurrently therewith, Berkadia filed an objection to the sale that
the Bankruptcy Court heard, and summarily dismissed, on March 7, 2003. After
further negotiations during the March 7-14, 2003 period, CFN and GE
significantly increased the amount of cash to be paid for the CFC Assets.
Ultimately, each of the major constituencies, including the CFC Committee, the
Ad Hoc Securitization Holders' Committee, U.S. Bank as securitization trustee
for the certificate holders of certain lower-rated securities that are senior in
payment priority to the interest-only securities (the "B-2 securities"), and
Federal National Mortgage Association, as a major B-2 securities certificate
holder, agreed to support the sale of CFC Assets to CFN and GE. The total value
to be received as part of the transactions with CFN and GE upon closing is
expected to be approximately $1.3 billion, representing approximately $1.1
billion in cash and approximately $200 million in assumed liabilities, subject
to certain purchase price adjustments. On March 14, 2003, the Bankruptcy Court
entered orders approving the terms of the sale of the CFC Assets free and clear
of all liens to each of CFN and GE. The closing of the sale of the CFC Assets is
subject to various closing conditions, but is currently expected to occur in the
second quarter of 2003.
Overall, CFC is seeking to maximize the value obtainable from all
restructuring transactions it contemplates as part of its Chapter 11 filing.
However, there can be no assurance that any such transaction will be completed.
Moreover, if such a transaction is completed, no proceeds will be available to
satisfy any creditors, other than creditors of the Finance Company Debtors or
parties with a security interest in the Finance Company Debtors' assets.
OTHER INFORMATION
During the third quarter of 2002, Conseco entered into an agreement to sell
Conseco Variable Insurance Company ("CVIC"), one of its wholly-owned
subsidiaries and the primary writer of its variable annuity products. The sale
was completed in October 2002. The operating results of CVIC have been reported
as a discontinued operation in all periods presented in the accompanying
consolidated statement of operations. See the note to the consolidated financial
statements entitled "Financial Information Regarding CVIC."
During 2001, we stopped renewing a large portion of our major medical lines
of business. These lines of business are in what we refer to as "run-off."
Unless otherwise noted, the collected premium information provided in Item 1
excludes amounts related to the business of CVIC that was sold and the major
medical lines of business that are no longer being sold and are not being
renewed when the contractual terms of the existing insurance policies expire.
CNC was organized in 1979 as an Indiana corporation and commenced
operations in 1982. Our executive offices are located at 11825 N. Pennsylvania
Street, Carmel, Indiana 46032, and our telephone number is (317) 817-6100. Our
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Securities Exchange Act are available free of charge on
our web site at www.conseco.com as soon as
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reasonably practicable after they are electronically filed with, or furnished
to, the SEC. These filings are also available to the public on the SEC's website
at www.sec.gov. In addition, the public may read and copy any document we file
at the SEC's Public Reference Room located at 450 Fifth Street, NW, Washington,
D.C. 20549. The public may obtain information on the operation of the Public
Reference Room by calling the SEC at 1-800-SEC-0330.
Data in Item 1 are provided as of December 31, 2002, or for the year then
ended (as the context implies), unless otherwise indicated.
MARKETING AND DISTRIBUTION
Insurance
Our insurance subsidiaries develop, market and administer supplemental
health insurance, annuity, individual life insurance and other insurance
products. We sell these products through three primary distribution channels:
career agents, professional independent producers (many of whom sell one or more
of our product lines exclusively) and direct marketing. We had over $4.8 billion
of annual premium and asset accumulation product collections during 2002 and
$5.0 billion of collections during 2001.
Our insurance subsidiaries collectively hold licenses to market our
insurance products in all fifty states, the District of Columbia, and certain
protectorates of the United States. Sales to residents of the following states
accounted for at least 5 percent of our 2002 collected premiums: Florida (8.5
percent), California (7.5 percent), Illinois (7.3 percent), Texas (7.1 percent)
and Michigan (5.3 percent).
We believe that people purchase most types of life insurance, accident and
health insurance and annuity products only after being contacted and solicited
by an insurance agent. Accordingly, the success of our distribution system is
largely dependent on our ability to attract and retain agents who are
experienced and highly motivated. A description of the primary distribution
channels is as follows:
Professional Independent Producers. This distribution channel consists of a
general agency and insurance brokerage distribution system comprised of
independent licensed agents doing business in all fifty states, the District of
Columbia, and certain protectorates of the United States. In 2002, this channel
accounted for $2,430.2 million, or 51 percent, of our total collected premiums.
If a significant number of agents changed to other providers, it would have a
material adverse effect on our business.
Professional independent producers are a diverse network of independent
agents, insurance brokers and marketing organizations. Marketing companies
typically recruit agents for Conseco by advertising our products and commission
structure through direct mail advertising or through seminars for insurance
agents and brokers. These organizations bear most of the costs incurred in
marketing our products. We compensate the marketing organizations by paying them
a percentage of the commissions earned on new sales generated by the agents
recruited by such organizations. Certain of these marketing organizations are
specialty organizations that have a marketing expertise or a distribution system
relating to a particular product, such as flexible-premium annuities for
educators. During 1999 and 2000, Conseco purchased four organizations that
specialize in marketing and distributing supplemental health products. In 2002,
these four organizations accounted for $244.9 million, or 5.1 percent, of our
total collected premiums.
We have recently chosen to emphasize the sale of specified disease and
Medicare supplement insurance policies through this distribution channel. We are
de-emphasizing annuity and life insurance sales and eliminating long-term care
insurance sales through this channel of distribution.
Career Agents. This agency force of approximately 3,800 agents working from
149 branch offices, permits one-on-one contacts with potential policyholders and
promotes strong personal relationships with existing policyholders. The career
agents sell primarily Medicare supplement and long-term care insurance policies,
senior life insurance and annuities. In 2002, this distribution channel
accounted for $1,939.1 million, or 41 percent, of our total collected premiums.
These agents sell only Conseco policies and typically visit the prospective
policyholder's home to conduct personalized "kitchen-table" sales presentations.
After the sale of an insurance policy, the agent serves as a contact person for
policyholder questions, claims assistance and additional insurance needs.
Direct Marketing. This distribution channel is engaged primarily in the
sale of "graded benefit life" insurance policies. In 2002, this channel
accounted for $100.3 million, or 2 percent, of our total collected premiums.
During 2000, we reacquired the name "Colonial Penn" (the former brand name these
products were sold under prior to our acquisition of this business), which we
now use to market these products.
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Finance
As a result of the formalization of the plans to sell the finance business
and the filing of petitions under the Bankruptcy Code for CFC and certain of its
subsidiaries, the finance business is being accounted for as a discontinued
operation.
CFC's finance business has historically provided a variety of finance
products to borrowers throughout the United States. These products included
manufactured housing and floor plan loans, home equity mortgages, home
improvement and consumer product loans and private label credit cards. At
December 31, 2002, CFC had managed receivables of $35.3 billion. Originations to
customers in the following states accounted for at least 5 percent of our 2002
originations: California (8.1 percent), Texas (6.9 percent), Minnesota (6.5
percent), Illinois (5.7 percent), Florida (5.5 percent) and North Carolina (5.0
percent). Unless otherwise noted, references to loans CFC has made may include
the purchase by CFC of credit contracts between dealers and buyers.
During 2002, 26 percent of CFC's finance products came indirectly from
customers through intermediary channels such as dealers, contractors, retailers
and correspondents. The remaining products were marketed directly to CFC's
customers through its regional offices and service centers. A description of the
primary distribution channels is as follows:
Dealers, Contractors, Retailers and Correspondents. Manufactured housing,
home improvement and home equity receivables are purchased from and originated
by selected dealers and contractors after being underwritten and analyzed via
one of CFC's automated credit scoring systems at one of its regional service
centers. During 2002, these marketing channels accounted for the following
percentages of total loan originations: 90 percent of manufactured housing, 97
percent of home improvement and 8 percent of home equity.
Regional Service Centers, Retail Satellite Offices and Telemarketing
Center. CFC has historically marketed and originated manufactured housing loans
through 33 regional offices and 3 origination and processing centers. CFC
originated home equity loans through a system of 88 retail satellite offices and
3 regional centers. In March 2003, CFC discontinued the origination of home
equity loans and closed or will be closing all of its facilities that were
dedicated to the home equity business. CFC also marketed private label retail
credit products through selected retailers and processed the contracts through
Mill Creek Bank, a Utah industrial loan company, and through Green Tree Retail
Services Bank, Inc. ("Retail Bank"), a South Dakota limited purpose credit card
bank, both of which are subsidiaries of CFC. CFC also utilized direct mail to
originate home improvement loans and home equity loans. During 2002, these
marketing channels accounted for the following percentages of total loan
originations: 10 percent of manufactured housing, 3 percent of home improvement,
92 percent of home equity and 100 percent of retail credit contracts.
Insurance Products
Supplemental Health
Supplemental health products include Medicare supplement, long-term care
and specified-disease insurance products distributed through our career agency
force and professional independent producers. During 2002, we collected Medicare
supplement premiums of $1,033.8 million, long-term care premiums of $917.4
million, specified-disease premiums of $368.7 million and other supplemental
health premiums of $104.3 million. Medicare supplement, long-term care,
specified disease and other supplemental health premiums represented 22 percent,
19 percent, 8 percent and 2 percent, respectively, of our total premiums
collected from continuing lines of business in 2002. Sales of certain
supplemental health products are affected by the financial strength ratings
assigned to our insurance subsidiaries by independent rating agencies. See
"Competition" below.
The following describes the major supplemental health products:
Medicare supplement. Medicare is a two-part federal health insurance
program for disabled persons and senior citizens (age 65 and older). Part A of
the program provides protection against the costs of hospitalization and related
hospital and skilled nursing home care, subject to an initial deductible,
related coinsurance amounts and specified maximum benefit levels. The deductible
and coinsurance amounts are subject to change each year by the federal
government. Part B of Medicare covers doctor's bills and a number of other
medical costs not covered by Part A, subject to deductible and coinsurance
amounts for "approved" charges.
Medicare supplement policies provide coverage for many of the medical
expenses which the Medicare program does not cover, such as deductibles,
coinsurance costs (in which the insured and Medicare share the costs of medical
expenses) and specified losses which exceed the federal program's maximum
benefits. Our Medicare supplement plans automatically adjust coverage to reflect
changes in Medicare benefits. In marketing these products, we concentrate on
individuals who have recently become eligible for Medicare by reaching the age
of 65. We offer a higher first-year commission for sales to these policyholders
and competitive premium pricing. Approximately 26 percent of new sales of
Medicare supplement policies are to individuals who are reaching the age of 65.
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Long-term care. Long-term care products provide coverage, within prescribed
limits, for nursing home, home healthcare, or a combination of both nursing home
and home healthcare expenses. The long-term care plans are sold primarily to
retirees and, to a lesser degree, to older self-employed individuals and others
in middle-income levels.
Current nursing home care policies cover incurred and daily fixed-dollar
benefits available with an elimination period (which, similar to a deductible,
requires the insured to pay for a certain number of days of nursing home care
before the insurance coverage begins), subject to a maximum benefit. Home
healthcare policies cover the usual and customary charges after a deductible and
are subject to a daily or weekly maximum dollar amount, and an overall benefit
maximum. We monitor the loss experience on our long-term care products and, when
necessary, apply for rate increases in the jurisdictions in which we sell such
products. We depend on regulatory approval to increase our premiums on these
products. If we are unable to raise premiums, it would have a material adverse
effect on our business.
We have decided to eliminate the sale of new long-term care insurance
products through our professional independent producer distribution channel. We
will continue to sell these products through Bankers Life and Casualty Company.
Specified-disease products. These policies generally provide fixed or
limited benefits. Cancer insurance and heart/stroke products are guaranteed
renewable individual accident and health insurance policies. Payments under
cancer insurance policies are generally made directly to, or at the direction
of, the policyholder following diagnosis of, or treatment for, a covered type of
cancer. Heart/stroke policies provide for payments directly to the policyholder
for treatment of a covered heart disease, heart attack or stroke. The benefits
provided under the specified-disease policies do not necessarily reflect the
actual cost incurred by the insured as a result of the illness; benefits are not
reduced by any other medical insurance payments made to or on behalf of the
insured.
Approximately 75 percent of our specified-disease policies inforce (based
on a count of policies) are sold with return of premium or cash value riders.
The return of premium rider generally provides that after a policy has been
inforce for a specified number of years or upon the policyholder reaching a
specified age, the Company will pay to the policyholder, or a beneficiary under
the policy, the aggregate amount of all premiums paid under the policy, without
interest, less the aggregate amount of all claims incurred under the policy.
Annuities
Annuity products include equity-indexed annuity, traditional fixed rate
annuity and market value-adjusted annuity products sold through both career
agents and professional independent producers. During 2002, we collected annuity
premiums of $1,092.8 million, or 23 percent of our total premiums collected from
continuing lines of business. We are taking actions to de-emphasize the sale of
annuity products through the professional independent producer distribution
channel. Sales of annuities are affected by the financial strength ratings
assigned to our insurance subsidiaries by independent rating agencies. See
"Competition" below.
The following describes the major annuity products:
Equity-indexed annuity products. These products accounted for $220.1
million, or 5 percent, of our total premiums collected in 2002. The accumulation
value of these annuities is credited with interest at an annual minimum
guaranteed average rate over the term of the contract of 3 percent (or,
including the effect of applicable sales loads, a 1.7 percent compound average
interest rate over the term of the contracts), but the annuities provide for
potentially higher returns based on a percentage (the "participation rate") of
the change in the Standard & Poor's Corporation ("S&P") 500 Index during each
year of their term. The Company has the discretionary ability to annually change
the participation rate which currently ranges from 50 percent to 100 percent and
may include a first-year "bonus", similar to the bonus interest described below
for traditional fixed rate annuity products, which generally ranges from 10
percent to 30 percent. The minimum guaranteed values are equal to: (i) 90
percent of premiums collected for annuities for which premiums are received in a
single payment (single premium deferred annuities "SPDAs"), or 75 percent of
first year and 87.5 percent of renewal premiums collected for annuities which
allow for more than one payment (flexible premium deferred annuities "FPDAs");
plus (ii) interest credited on such percentage of the premiums collected at an
annual rate of 3 percent. The annuity provides for penalty-free withdrawals of
up to 10 percent of premium in each year after the first year of the annuity's
term. Other withdrawals from SPDA products are generally subject to a surrender
charge of 9 percent over the eight year contract term at which time the contract
must be renewed or withdrawn. Other withdrawals from FPDA products are subject
to a surrender charge of 12 percent to 20 percent in the first year, declining
1.2 percent to 1.3 percent each year, to zero over a 10 to 15 year period,
depending on issue age. We purchase S&P 500 Index Call Options ("S&P 500 Call
Options") in an effort to hedge potential increases to policyholder benefits
resulting from increases in the S&P 500 Index to which the product's return is
linked.
Other fixed rate annuity products. These products include SPDAs, FPDAs
(excluding the equity-indexed products) and single-premium immediate annuities
("SPIAs"). These products accounted for $872.7 million, or 18 percent, of our
total collected premiums in 2002. Our SPDAs and FPDAs typically have an interest
rate (the "crediting rate") that is guaranteed by the Company for the first
7
policy year, after which we have the discretionary ability to change the
crediting rate to any rate not below a guaranteed minimum rate. The guaranteed
rate on annuities written recently ranges from 3 percent to 4 percent, and the
rate on all policies inforce ranges from 3 percent to 6 percent. The initial
crediting rate is largely a function of: (i) the interest rate we can earn on
invested assets acquired with the new annuity fund deposits; (ii) the costs
related to marketing and maintaining the annuity products; and (iii) the rates
offered on similar products by our competitors. For subsequent adjustments to
crediting rates, we take into account the yield on our investment portfolio,
annuity surrender assumptions, competitive industry pricing and the crediting
rate history for particular groups of annuity policies with similar
characteristics.
Approximately 77 percent of our new annuity sales have been "bonus"
products. The initial crediting rate on these products specifies a bonus
crediting rate ranging from 1 percent to 6 percent of the annuity deposit for
the first policy year only. After the first year, the bonus interest portion of
the initial crediting rate is automatically discontinued, and the renewal
crediting rate is established. As of December 31, 2002, crediting rates on our
outstanding traditional annuities were at an average rate, excluding bonuses, of
4.3 percent.
The policyholder is typically permitted to withdraw all or part of the
premium paid plus the accumulated interest credited to his or her account (the
"accumulation value"), subject in virtually all cases to the assessment of a
surrender charge for withdrawals in excess of specified limits. Most of our
traditional annuities provide for penalty-free withdrawals of up to 10 percent
of the accumulation value each year, subject to limitations. Withdrawals in
excess of allowable penalty-free amounts are assessed a surrender charge during
a penalty period which generally ranges from five to 12 years after the date a
policy is issued. The initial surrender charge is generally 6 percent to 12
percent of the accumulation value and generally decreases by approximately 1 to
2 percentage points per year during the penalty period. Surrender charges are
set at levels to protect the Company from loss on early terminations and to
reduce the likelihood of policyholders terminating their policies during periods
of increasing interest rates. This practice is intended to lengthen the
effective duration of policy liabilities and enable the Company to maintain
profitability on such policies.
SPIAs accounted for $28.4 million, or .6 percent, of our total collected
premiums in 2002. SPIAs are designed to provide a series of periodic payments
for a fixed period of time or for life, according to the policyholder's choice
at the time of issue. Once the payments begin, the amount, frequency and length
of time for which they are payable are fixed. SPIAs often are purchased by
persons at or near retirement age who desire a steady stream of payments over a
future period of years. The single premium is often the payout from a terminated
annuity contract. The implicit interest rate on SPIAs is based on market
conditions when the policy is issued. The implicit interest rate on the
Company's outstanding SPIAs averaged 6.9 percent at December 31, 2002.
The Company also offers its multibucket annuity product which provides for
different rates of cash value growth based on the experience of a particular
market strategy. Earnings are credited to this product based on the market
activity of a given strategy, less management fees, and funds may be moved
between cash value strategies. Portfolios available include high-yield bond,
investment-grade bond, convertible bond and guaranteed-rate portfolios. During
2002, this product accounted for $40.0 million, or .8 percent, of our total
collected premiums.
As described above in "Other Information", in October 2002, we sold CVIC, a
company engaged in the variable annuity business. We no longer offer variable
annuity products.
Life
Life products include traditional, universal life and other life insurance
products. These products are currently sold through career agents, professional
independent producers and direct response marketing. During 2002, we collected
life insurance premiums of $637.0 million, or 13 percent, of our total collected
premiums from continuing lines of business. We have decided to take actions that
will de-emphasize new sales of life insurance products through professional
independent producers. These actions include eliminating certain products from
those offered by our insurance company subsidiaries. Sales of certain life
products are affected by the financial strength ratings assigned to our
insurance subsidiaries by independent rating agencies. See "Competition" below.
Interest-sensitive life products. These products include universal life
products that provide whole life insurance with adjustable rates of return
related to current interest rates. They accounted for $373.3 million, or 7.8
percent, of our total collected premiums in 2002 and are marketed through
professional independent producers and, to a lesser extent, career agents. The
principal differences between universal life products and other
interest-sensitive life insurance products are policy provisions affecting the
amount and timing of premium payments. Universal life policyholders may vary the
frequency and size of their premium payments, and policy benefits may also
fluctuate according to such payments. Premium payments under other
interest-sensitive policies may not be varied by the policyholders, and as a
result, are designed to reduce the administrative costs typically associated
with monitoring universal life premium payments and policy benefits.
8
Traditional life. These products accounted for $263.7 million, or 5.5
percent, of our total collected premiums in 2002. Traditional life policies,
including whole life, graded benefit life and term life products, are marketed
through professional independent producers, career agents and direct response
marketing. Under whole life policies, the policyholder generally pays a level
premium over an agreed period or the policyholder's lifetime. The annual premium
in a whole life policy is generally higher than the premium for comparable term
insurance coverage in the early years of the policy's life, but is generally
lower than the premium for comparable term insurance coverage in the later years
of the policy's life. These policies, which continue to be marketed by the
Company on a limited basis, combine insurance protection with a savings
component that gradually increases in amount over the life of the policy. The
policyholder may borrow against the savings generally at a rate of interest
lower than that available from other lending sources. The policyholder may also
choose to surrender the policy and receive the accumulated cash value rather
than continuing the insurance protection. Term life products offer pure
insurance protection for a specified period of time - typically 5, 10 or 20
years.
Traditional life products also include graded benefit life insurance
products. Graded benefit life products accounted for $152.4 million, or 3.2
percent, of our total collected premiums in 2002. Graded benefit life insurance
products are offered on an individual basis primarily to persons age 50 to 80,
principally in face amounts of $350 to $10,000, without medical examination or
evidence of insurability. Premiums are paid as frequently as monthly. Benefits
paid are less than the face amount of the policy during the first two years,
except in cases of accidental death. Graded benefit life policies are marketed
using direct response marketing techniques. New policyholder leads are generated
primarily from television and print advertisements.
Group Major Medical
Sales of our group major medical health insurance products are targeted to
self-employed individuals, small business owners, large employers and early
retirees. Various deductible and coinsurance options are available, and most
policies require certain utilization review procedures. The profitability of
this business depends largely on the overall persistency of the business
inforce, claim experience and expense management. During 2001, we decided to
discontinue a large block of major medical business by not renewing these
policies because this business was not profitable. During 2002, we collected
group major medical premiums of $315.6 million.
Finance Products
As described in Item 1. "Business of Conseco," we have agreed to sell our
finance business and it is being accounted for as a discontinued operation.
Manufactured Housing. CFC has historically provided financing for consumer
purchases of manufactured housing. During 2002, CFC originated $1.0 billion of
contracts for manufactured housing purchases, or 14 percent of its total
originations. A manufactured home is a structure, transportable in one or more
sections, designed to be a dwelling with or without a permanent foundation.
Manufactured housing does not include either modular housing (which typically
involves more sections, greater assembly and a separate means of transporting
the sections) or recreational vehicles. At December 31, 2002, CFC's managed
receivables included $23.0 billion of contracts for manufactured housing
purchases, or 65 percent of total managed receivables. On November 25, 2002, CFC
discontinued the origination of manufactured housing loans as a result of
funding constraints and the unprofitable nature of these loans in light of its
financial condition and prevailing market conditions at that time.
CFC had previously purchased manufactured housing contracts from dealers
located throughout the United States through its regional service centers.
Regional service center personnel solicited dealers in their region. If the
dealer wished to utilize CFC's financing, the dealer completed an application.
Upon approval, a dealer agreement was executed. CFC also originated manufactured
housing installment loan agreements directly with customers. For the year ended
December 31, 2002, 90 percent of CFC's manufactured housing loan originations
were purchased from dealers and 10 percent were originated directly by CFC.
CFC's manufactured housing contracts are secured by either the manufactured
home or, in the case of land-and-home contracts, by a lien on the manufactured
home and a lien on the real estate where the manufactured home is permanently
affixed. In 2002, approximately 25 percent of CFC's manufactured housing
originations were for land-and-home contracts. Customers who financed their
homes with CFC were required to make a minimum down payment of 5 percent. For
manufactured housing originations, the average loan-to-value ratio was
approximately 90 percent in 2002.
Customers' credit applications for new manufactured homes were reviewed in
CFC's service centers. If the application met CFC's guidelines, CFC generally
purchased the contract after the customer had moved into the manufactured home.
CFC used a proprietary automated credit scoring system to evaluate manufactured
housing credit applications. The scoring system is statistically based,
quantifying information using variables obtained from customer credit
applications and credit reports. CFC performed monthly audits on samples of new
loan originations to measure adherence to its underwriting policies and
procedures.
9
Mortgage Services. Products within this category include home equity and
home improvement loans. During 2002, CFC originated $2.5 billion of contracts
for these products, or 35 percent of its total originations. At December 31,
2002, CFC's managed receivables included $8.8 billion of contracts for home
equity and home improvement loans, or 25 percent of total managed receivables.
CFC originates home equity loans through 88 retail satellite offices and 3
regional centers, and through a network of correspondent and broker originators
throughout the United States. The retail offices are responsible for
originating, processing and funding the loan transaction. Underwriting of the
application is handled through central locations. Subsequently, loans are
re-underwritten on a test basis by a third party to ensure compliance with CFC's
credit policy. After the loan has closed, the loan documents are forwarded to
CFC's loan servicing center. The servicing center is responsible for handling
customer service and performing document handling, custodial, quality control,
collection and other servicing functions.
During 2002, approximately 92 percent of CFC's home equity finance loans
were originated directly with the borrower. The remaining finance volume was
originated through a few correspondent lenders. CFC has decreased the volume of
loans originated through the correspondent channel in recent years.
Typically, home equity loans are secured by first or second liens. Homes
used for collateral in securing home equity loans may be either residential or
investor owned, one-to-four-family properties. During 2002, approximately 83
percent of the loans originated were secured by first liens. The average loan to
value for loans originated in 2002 was approximately 88 percent. Approximately
70 percent of CFC's home equity loan originations during 2002 were fixed rate
closed-end loans. In March 2003, CFC discontinued the origination of home equity
loans and closed or will be closing all of its facilities that were dedicated to
the home equity business.
CFC originates the majority of its home improvement loan contracts
indirectly through a network of home improvement contractors located throughout
the United States. CFC reviews the financial condition, business experience and
qualifications of all contractors through which it obtains loans.
CFC finances conventional home improvement contracts generally secured by
first, second or, to a lesser extent, third liens on the improved real estate.
On a limited basis, CFC has also financed unsecured conventional home
improvement loans (generally from $2,500 to $15,000).
Typically, an approved contractor submits the customer's credit application
and construction contract to CFC's centralized service center where an analysis
of the creditworthiness of the customer is made using a proprietary credit
scoring system. If it is determined that the application meets CFC's
underwriting guidelines, CFC typically purchases the contract from the
contractor when the customer verifies satisfactory completion of the work.
CFC also originates home improvement loans directly with borrowers. After
receiving a mail solicitation, the customer calls CFC's telemarketing center and
a CFC sales representative explains the available financing plans, terms and
rates depending on the customer's needs. The majority of the loans are secured
by a second or third lien on the real estate of the customer. Direct
distribution accounted for approximately 3 percent of the home improvement loan
originations during 2002.
The types of home improvements CFC finances include exterior renovations
(such as windows, siding and roofing); pools and spas; kitchen and bath
remodeling; and room additions and garages. CFC may also extend additional
credit beyond the purchase price of the home improvement for the purpose of debt
consolidation.
Private Label Credit Card. During 2002, CFC originated $3.2 billion of
private label credit card receivables primarily through its bank subsidiaries,
or 44 percent of its total originations. At December 31, 2002, CFC's managed
receivables included $2.3 billion of contracts for credit card loans, or 6.4
percent of total managed receivables.
CFC originates private label credit card receivables through contractual
relationships with selected retailer and dealer partners. CFC's core
relationships are with retailers and dealers of home improvement products,
powersport vehicles (motorcycles, all-terrain-vehicles, snowmobiles and personal
watercraft) and outdoor power equipment.
CFC performs an initial review on all retailer and dealer partners as well
as periodic monitoring of their financial condition. Credit card applications
are generated primarily through retail and dealer outlets and the internet. CFC
utilizes a proprietary automated credit scoring system to review the credit of
individual customers seeking credit cards. CFC periodically monitors payment
behavior trends within its credit card portfolio through the use of automated
portfolio management tools. If CFC makes poor credit decisions with respect to
its partners and borrowers, it could have a material adverse effect on its
business.
10
ACQUISITIONS
Since 1982, Conseco has acquired 19 insurance groups and related businesses
and Green Tree Financial Corporation (renamed "Conseco Finance Corp.") These
acquisitions were responsible for the Company's growth in recent years. The
Company does not anticipate making additional acquisitions in the foreseeable
future, and is currently prohibited from doing so.
INVESTMENTS
Conseco Capital Management, Inc. ("CCM"), a registered investment adviser
and wholly-owned subsidiary of CNC, manages the investment portfolios of our
insurance subsidiaries. CCM had approximately $27.7 billion of assets (at fair
value) under management at December 31, 2002, of which $22.0 billion were assets
of CNC's subsidiaries, $3.8 billion were assets held by registered and
structured products and $1.9 billion were assets owned by other parties. Our
investment philosophy is to maintain a largely investment-grade fixed-income
portfolio, provide adequate liquidity for expected liability durations and other
requirements and maximize total return through active investment management. We
are subject to the risk that our investments will decline in value. This has
occurred in the past and may occur again. During 2002, we recognized net
realized investment losses of $597.0 million, compared to net realized
investment losses of $379.4 million during 2001. The net realized investment
losses during 2002 included: (i) $556.8 million of writedowns of fixed maturity
investments, equity securities and other invested assets as a result of
conditions which caused us to conclude a decline in fair value of the investment
was other than temporary; and (ii) $40.2 million of net losses from the sales of
investments (primarily fixed maturities) which generated proceeds of $19.5
billion. During 2002, we recognized other-than-temporary declines in value of
several of our investments including K-Mart Corp., Amerco, Inc., Global
Crossing, MCI Communications, Mississippi Chemical, United Airlines and
Worldcom, Inc.
Investment activities are an integral part of our business; investment
income is a significant component of our total revenues. Profitability of many
of our insurance products is significantly affected by spreads between interest
yields on investments and rates credited on insurance liabilities. Although
substantially all credited rates on SPDAs and FPDAs may be changed annually
(subject to minimum guaranteed rates), changes in crediting rates may not be
sufficient to maintain targeted investment spreads in all economic and market
environments. In addition, competition and other factors, including the impact
of the level of surrenders and withdrawals, may limit our ability to adjust or
to maintain crediting rates at levels necessary to avoid narrowing of spreads
under certain market conditions. As of December 31, 2002, the average yield,
computed on the cost basis of our investment portfolio, was 6.7 percent, and the
average interest rate credited or accruing to our total insurance liabilities
(excluding interest rate bonuses for the first policy year only and excluding
the effect of credited rates attributable to multi-bucket or equity-indexed
products) was 5.1 percent.
We manage the equity-based risk component of our equity-indexed annuity
products by: (i) purchasing S&P 500 Call Options in an effort to hedge such
risk; and (ii) adjusting the participation rate to reflect the change in the
cost of such options (such cost varies based on market conditions). Accordingly,
we are able to focus on managing the interest rate spread component of these
products.
We seek to balance the duration of our invested assets with the expected
duration of benefit payments arising from our insurance liabilities. At December
31, 2002, the adjusted modified duration of fixed maturities and short-term
investments was approximately 6.6 years and the duration of our insurance
liabilities was approximately 6.0 years.
For information regarding the composition and diversification of the
investment portfolio of our subsidiaries, see "Management's Discussion and
Analysis of Consolidated Financial Condition and Results of Operations -
Investments" and the notes to our consolidated financial statements.
COMPETITION
Each of the markets in which we operate is highly competitive, and our
highly leveraged position and our recent bankruptcy filings have had a material
adverse impact on our ability to compete in these markets. The financial
services industry consists of a large number of companies, some of which are
larger and have greater capital, technological and marketing resources, access
to capital and other sources of liquidity at a lower cost, broader and more
diversified product lines and larger staffs than those of Conseco. An expanding
number of banks, securities brokerage firms and other financial intermediaries
also market insurance products or offer competing products, such as mutual fund
products, traditional bank investments and other investment and retirement
funding alternatives. We also compete with many of these companies and others in
providing services for fees. In most areas, competition is based on a number of
factors, including pricing, service provided to distributors and policyholders
and ratings. Conseco's subsidiaries must also compete with their competitors to
attract and retain the allegiance of dealers, vendors, contractors,
manufacturers, retailers and agents.
In the finance industry, operations are affected by consumer demand which
is influenced by regional trends, economic conditions and personal preferences.
Competition in the finance industry is primarily among finance companies,
commercial banks,
11
thrifts, other financial institutions, mortgage brokers, credit unions and
manufacturers and vendors. Competition is based on a number of factors,
including service, the credit review process, the integration of financing
programs and the ability to manage the servicing portfolio in changing economic
environments.
In the individual health insurance business, insurance companies compete
primarily on the basis of marketing, service and price. Pursuant to federal
regulations, the Medicare supplement products offered by all companies have
standardized policy features. This increases the comparability of such policies
and has intensified competition based on factors other than product features.
See "Insurance Underwriting" and "Governmental Regulation." In addition to the
products of other insurance companies, commercial banks, thrifts, mutual funds
and broker dealers, our insurance products compete with health maintenance
organizations, preferred provider organizations and other health care-related
institutions which provide medical benefits based on contractual agreements.
An important competitive factor for life insurance companies is the ratings
they receive from nationally recognized rating organizations. Agents, insurance
brokers and marketing companies who market our products and prospective
purchasers of our products use the ratings of our insurance subsidiaries as one
factor in determining which insurer's products to market or purchase. Ratings
have the most impact on our annuity and interest-sensitive life insurance
products. Insurance financial strength ratings are opinions regarding an
insurance company's financial capacity to meet the obligations of its insurance
policies in accordance with their terms. They are not directed toward the
protection of investors, and such ratings are not recommendations to buy, sell
or hold securities.
In July 2002, A.M. Best Company, a nationally recognized insurance company
ratings organization, lowered the financial strength ratings of our primary
insurance subsidiaries from "A- (Excellent)" to "B++ (Very good)" and placed the
ratings "under review with negative implications." In August 2002, A.M. Best
further downgraded the financial strength ratings of our primary insurance
subsidiaries to "B (Fair)". A.M. Best ratings for the industry currently range
from "A++ (Superior)" to "F (In Liquidation)" and some companies are not rated.
S&P has given our principal insurance subsidiaries a claims-paying ability
rating of "BB+ (Marginal)." These ratings have caused sales of our insurance
products to decline and policyholder redemptions and lapses to increase, which
has had a material adverse impact on our financial results. In some cases, the
ratings downgrades also caused defections among our sales force of agents and/or
increases in the commissions we had to pay to retain them. The effect of these
ratings downgrades is further discussed in the section of Management's
Discussion and Analysis of Financial Condition and Results of Operations
entitled "Consolidated Financial Condition."
A.M. Best and S&P each reviews its ratings from time to time. We cannot
provide any assurance that the ratings of our insurance subsidiaries will remain
at their current levels or predict the impact additional downgrades could have
on our business.
Conseco's leveraged condition and liquidity difficulties also severely
impacted the operations of CFC, which we have agreed to sell. For a more
complete discussion of the effect of our leveraged condition and liquidity
difficulties on CFC, see the section of Management's Discussion and Analysis of
Financial Condition and Results of Operations entitled "Results of the
Discontinued Finance Operations."
INSURANCE UNDERWRITING
Under regulations promulgated by the National Association of Insurance
Commissioners ("NAIC") (an association of state regulators and their staffs) and
adopted as a result of the Omnibus Budget Reconciliation Act of 1990, we are
prohibited from underwriting our Medicare supplement policies for certain
first-time purchasers. If a person applies for insurance within six months after
becoming eligible by reason of age, or disability in certain limited
circumstances, the application may not be rejected due to medical conditions.
Some states prohibit underwriting of all Medicare supplement policies. For other
prospective Medicare supplement policyholders, such as senior citizens who are
transferring to Conseco's products, the underwriting procedures are relatively
limited, except for policies providing prescription drug coverage.
Before issuing long-term care or comprehensive major medical products to
individuals and groups, we generally apply detailed underwriting procedures
designed to assess and quantify the insurance risks. We require medical
examinations of applicants (including blood and urine tests, where permitted)
for certain health insurance products and for life insurance products which
exceed prescribed policy amounts. These requirements are graduated according to
the applicant's age and may vary by type of policy or product. We also rely on
medical records and the potential policyholder's written application. In recent
years, there have been significant regulatory changes with respect to
underwriting individual and group major medical plans. An increasing number of
states prohibit underwriting and/or charging higher premiums for substandard
risks. We monitor changes in state regulation that affect our products, and
consider these regulatory developments in determining where we market our
products.
Most of our life insurance policies are underwritten individually, although
standardized underwriting procedures have been adopted for certain low
face-amount life insurance coverages. After initial processing, insurance
underwriters review each file and obtain the information needed to make an
underwriting decision (such as medical examinations, doctors' statements and
special
12
medical tests). After collecting and reviewing the information, the underwriter
either: (i) approves the policy as applied for, or with an extra premium charge
because of unfavorable factors; or (ii) rejects the application. We underwrite
group insurance policies based on the characteristics of the group and its past
claim experience. Graded benefit life insurance policies are issued without
medical examination or evidence of insurability. There is minimal underwriting
on annuities.
REINSURANCE
Consistent with the general practice of the life insurance industry, our
subsidiaries enter into both facultative and treaty agreements of indemnity
reinsurance with other insurance companies in order to reinsure portions of the
coverage provided by our insurance products. Indemnity reinsurance agreements
are intended to limit a life insurer's maximum loss on a large or unusually
hazardous risk or to diversify its risk. Indemnity reinsurance does not
discharge the original insurer's primary liability to the insured. The Company's
reinsured business is ceded to numerous reinsurers. We believe the assuming
companies are able to honor all contractual commitments, based on our periodic
review of their financial statements, insurance industry reports and reports
filed with state insurance departments.
As of December 31, 2002, the policy risk retention limit was generally $.8
million or less on the policies of our subsidiaries. Reinsurance ceded by
Conseco represented 27 percent of gross combined life insurance inforce and
reinsurance assumed represented 4.8 percent of net combined life insurance
inforce. At December 31, 2002, the total ceded business inforce of $26.4 billion
was primarily ceded to insurance companies rated "A- (Excellent)" or better by
A.M. Best. Our principal reinsurers at December 31, 2002 were American Founders
Life Insurance Company, General & Cologne Life Re of America, Lincoln National
Life Insurance Company, Munich American Reassurance Company, Reassure America
Life Insurance Company, RGA Reinsurance Company, Security Life of Denver Life
Insurance Company and Swiss Re Life and Health America Inc. No other single
reinsurer assumes greater than 4 percent of the total ceded business inforce.
In the first quarter of 2002, we completed a reinsurance agreement pursuant
to which we ceded 80 percent of the inforce traditional life business of our
subsidiary, Bankers Life & Casualty Company, to Reassure America Life Insurance
Company (rated A++ by A.M. Best). The total insurance liabilities ceded pursuant
to the contract were approximately $400 million. The reinsurance agreement and
the related dividends of $110.5 million were approved by the appropriate state
insurance departments and were paid to CNC. The ceding commission approximated
the amount of the cost of policies purchased and cost of policies produced
related to the ceded business.
On June 28, 2002, we completed a reinsurance transaction pursuant to which
we ceded 100 percent of the traditional life and interest-sensitive life
insurance business of our former subsidiary, CVIC, to Protective Life Insurance
Company (rated A+ by A.M. Best). The total insurance liabilities ceded pursuant
to the contract were approximately $470 million. CVIC, which was sold in the
fourth quarter of 2002, received a ceding commission of $49.5 million.
During the second quarter of 2002, one of our subsidiaries, Colonial Penn
Life Insurance Company (formerly known as Conseco Direct Life Insurance
Company), ceded a block of graded benefit life insurance policies to an
unaffiliated company pursuant to a modified coinsurance agreement. Our
subsidiary received a ceding commission of $83.0 million. The cost of policies
purchased and the cost of policies produced were reduced by $123.0 million and
we recognized a loss of $39.0 million related to the transaction.
EMPLOYEES
At December 31, 2002, Conseco, Inc. and its subsidiaries had approximately
10,400 employees, of which 10,100 are full time employees, including: (i) 4,300
employees supporting our insurance operations; (ii) 5,400 employees of CFC (a
discontinued operation we are in the process of selling); and (iii) 400
employees supporting our holding company and shared services. None of our
employees is covered by a collective bargaining agreement. We believe that we
have satisfactory relations with our employees.
GOVERNMENTAL REGULATION
Our insurance businesses and CFC's finance business are subject to
extensive regulation and supervision in the jurisdictions in which they operate.
This regulation and supervision is primarily for the benefit and protection of
customers, and not for the benefit of investors or creditors.
13
Insurance
Our insurance subsidiaries are subject to regulation and supervision by the
insurance regulatory agencies of the jurisdictions in which they transact
business. State laws generally establish supervisory agencies with broad
regulatory authority, including the power to: (i) grant and revoke business
licenses; (ii) regulate and supervise trade practices and market conduct; (iii)
establish guaranty associations; (iv) license agents; (v) approve policy forms;
(vi) approve premium rates for some lines of business; (vii) establish reserve
requirements; (viii) prescribe the form and content of required financial
statements and reports; (ix) determine the reasonableness and adequacy of
statutory capital and surplus; (x) perform financial, market conduct and other
examinations; (xi) define acceptable accounting principles; (xii) regulate the
type and amount of permitted investments; and (xiii) limit the amount of
dividends and of surplus debenture payments that can be paid without obtaining
regulatory approval. Because of limits on the payment of dividends and surplus
debenture payments from our insurance subsidiaries, not all of our consolidated
cash flows from operations are available to the parent company to service our
debt. Our insurance subsidiaries are subject to periodic examinations by state
regulatory authorities.
Since the announcement of our restructuring efforts on August 9, 2002, we
have been working closely with insurance regulators in each of the states in
which our insurance subsidiaries are domiciled (Arizona, Illinois, Indiana, New
York, Pennsylvania and Texas) in connection with their monitoring of the
operations and financial position of our insurance subsidiaries. The
Commissioner of Insurance for the State of Texas has acted as the lead regulator
among these states and has principally coordinated the oversight and monitoring
efforts associated with our financial restructuring.
On October 30, 2002, Bankers National Life Insurance Company and Conseco
Life Insurance Company of Texas (on behalf of itself and its subsidiaries), our
two insurance subsidiaries domiciled in Texas, each entered into consent orders
with the Commissioner of Insurance for the State of Texas whereby they agreed:
(i) not to request any dividends or other distributions before January 1, 2003
and, thereafter, not to pay any dividends or other distributions to parent
companies outside of the insurance system without the prior approval of the
Texas Insurance Commissioner; (ii) to continue to maintain sufficient
capitalization and reserves as required by the Texas Insurance Code; (iii) to
request approval from the Texas Insurance Commissioner before making any
disbursements not in the ordinary course of business; (iv) to complete any
pending transactions previously reported to the proper insurance regulatory
officials prior to and during Conseco's restructuring, unless not approved by
the Texas Insurance Commissioner; (v) to obtain a commitment from CNC and CIHC
to maintain their infrastructure, employees, systems and physical facilities
prior to and during Conseco's restructuring; and (vi) to continue to permit the
Texas Insurance Commissioner to examine its books, papers, accounts, records and
affairs. The consent orders do not prohibit the payment of fees in the ordinary
course of business pursuant to existing administrative, investment management
and marketing agreements with our non-insurance subsidiaries.
In addition to the limitations imposed by the laws described above and the
Texas consent orders, most states have also enacted laws or regulations with
respect to the activities of insurance holding company systems, including
acquisitions, the payment of ordinary and extraordinary dividends by insurance
companies, the terms of surplus debentures, the terms of transactions between
insurance companies and their affiliates and other related matters. Various
notice and reporting requirements generally apply to transactions between
insurance companies and their affiliates within an insurance holding company
system, depending on the size and nature of the transactions. These requirements
may include prior regulatory approval or prior notice for certain material
transactions. Currently, the Company and its insurance subsidiaries have
registered as holding company systems pursuant to such laws and regulations in
the domiciliary states of the insurance subsidiaries, and they routinely report
to other jurisdictions.
Most states have also enacted legislation or adopted administrative
regulations that affect the acquisition (or sale) of control of insurance
companies. The nature and extent of such legislation and regulations vary from
state to state. Generally, these regulations require an acquirer of control to
file detailed information concerning such acquirer and the plan of acquisition,
and to obtain administrative approval prior to the acquisition of control.
"Control" is generally defined as the direct or indirect power to direct or
cause the direction of the management and policies of a person and is rebuttably
presumed to exist if a person or group of affiliated persons directly or
indirectly owns or controls 10% or more of the voting securities of another
person.
The affiliated party transaction and change of control laws and regulations
described in the preceding two paragraphs may require notices to and/or prior
approvals by certain of our insurance regulators before our plan of
reorganization pursuant to Chapter 11 of the Bankruptcy Code may be consummated.
The regulators for Texas and Pennsylvania are requiring the Company to request
an exemption from the change of control laws and regulations. The Illinois
Department of Insurance, the New York Department of Insurance and the Indiana
Department of Insurance have each indicated that they are requiring an
application of a change in control. Such requests and filings have been or soon
will be made and the exemptions or required approvals are expected to be
obtained for all states concurrently with the other voting and confirmation
procedures required for our plan of reorganization. Arizona has not indicated
whether or not an exemption from the change in control application requirement
or a change of control application is required.
14
On the basis of statutory statements filed with state regulators annually,
the NAIC calculates certain financial ratios to assist state regulators in
monitoring the financial condition of insurance companies. A "usual range" of
results for each ratio is used as a benchmark. In the past, variances in certain
ratios of our insurance subsidiaries have resulted in inquiries from insurance
departments, to which we have responded. These inquiries have not led to any
restrictions affecting our operations.
In addition, the NAIC issues model laws and regulations, many of which have
been adopted by state insurance regulators, relating to: (i) investment reserve
requirements; (ii) risk-based capital ("RBC") standards; (iii) codification of
insurance accounting principles; (iv) additional investment restrictions; (v)
restrictions on an insurance company's ability to pay dividends; and (vi)
product illustrations.
The NAIC's Risk-Based Capital for Life and/or Health Insurers Model Act
(the "Model Act") provides a tool for insurance regulators to determine the
levels of statutory capital and surplus an insurer must maintain in relation to
its insurance and investment risks and whether there is a need for possible
regulatory attention. The Model Act provides four levels of regulatory
attention, varying with the ratio of the insurance company's total adjusted
capital (defined as the total of its statutory capital and surplus, asset
valuation reserve and certain other adjustments) to its authorized control level
RBC ("ACLRBC"): (i) if a company's total adjusted capital is less than or equal
to 200 percent but greater than 150 percent of its ACLRBC (the "Company Action
Level"), the company must submit a comprehensive plan to the regulatory
authority proposing corrective actions aimed at improving its capital position;
(ii) if a company's total adjusted capital is less than or equal to 150 percent
but greater than 100 percent of its ACLRBC (the "Regulatory Action Level"), the
regulatory authority will perform a special examination of the company and issue
an order specifying the corrective actions that must be followed; (iii) if a
company's total adjusted capital is less than or equal to 100 percent but
greater than 70 percent of its ACLRBC (the "Authorized Control Level"), the
regulatory authority may take any action it deems necessary, including placing
the company under regulatory control; and (iv) if a company's total adjusted
capital is less than or equal to 70 percent of its ACLRBC (the "Mandatory
Control Level"), the regulatory authority must place the company under its
control. In addition the Model Law provides for an annual trend test if a
company's total adjusted capital is between 200 percent and 250 percent of its
ACLRBC at the end of the year. The trend test calculates the greater of the
decrease in the margin of total adjusted capital over ACLRBC: (i) between the
current year and the prior year; and (ii) for the average of the last 3 years.
It assumes that such decrease could occur again in the coming year. Any company
whose trended total adjusted capital is less than 190 percent of its ACLRBC
would trigger a requirement to submit a comprehensive plan as described above
for the Company Action Level.
The 2002 statutory annual statements filed with the state insurance
regulators of each of our insurance subsidiaries reflected total adjusted
capital in excess of the levels subjecting the subsidiary to any regulatory
action. However, our ACLRBC ratios have declined significantly over the last
year and some of our subsidiaries are near the level which would require them to
submit a comprehensive plan aimed at improving their capital position.
The aggregate ACLRBC ratio for our insurance subsidiaries was 332 percent
at December 31, 2002, compared to 480 percent at December 31, 2001. The ratios
for our insurance subsidiaries that are subject to the four levels of regulatory
attention described above ranged from 250 percent (just above the trend test
level) to 563 percent. We are taking actions intended to improve the ACLRBC
ratios of our insurance subsidiaries. Such actions include: (i) discontinuing or
reducing sales of products that create initial reductions in statutory surplus
because of the costs of selling the products; (ii) reducing operating expenses;
(iii) merging some of our insurance subsidiaries with other insurance
subsidiaries; and (iv) restructuring our investment portfolio to better match
the risk profile of the portfolio with the insurance subsidiary's earnings and
capital requirements. We have discussed these actions with insurance regulators
in each of the states in which our insurance subsidiaries are domiciled. The
audited financial statements of our insurance subsidiaries generally are not
completed until around June 1 of each year (the date such audited financial
statements are generally required to be filed with state insurance departments).
Any significant audit adjustments to the financial statements of our insurance
subsidiaries resulting in a reduction in capital could cause the ACLRBC ratio of
one or more of our insurance subsidiaries to fall below the trend test level
requiring the trended total adjusted capital to be calculated. In addition, the
Company has been and will be discussing the appropriate statutory accounting
treatment for certain investments with the state insurance regulators. If the
ultimate outcome of these discussions resulted in adjustments to the December
31, 2002 statutory financial statements of our insurance subsidiaries, some of
our subsidiaries could be required to complete the trend test. If a trend test
were required for any of our subsidiaries, such a test would likely result in
trended total adjusted capital which is less than 190 percent of ACLRBC.
Our internal actuaries must annually render opinions concerning the
adequacy of our insurance reserves. Our actuaries rendered unqualified opinions
at December 31, 2002. Such opinions reference the Chapter 11 Cases and recent
downgrades of our insurance company ratings as being outside the scope of the
actuarial opinion, meaning that the actuaries did not believe it was appropriate
to calculate what impact, if any, such events would have on the life insurance
reserves. Regulators have raised the question as to whether or not such
references result in the actuarial opinions becoming qualified opinions. We
continue to believe the actuarial opinions are qualified opinions. If the
actuarial opinions were qualified opinions, more stringent rules would apply for
calculating ACLRBC which we believe would result in the ACLRBC for several of
our insurance subsidiaries falling below the trend test level.
15
The NAIC has adopted a revised manual of statutory accounting principles in
a process referred to as codification. These principles are summarized in the
Accounting Practices and Procedures Manual. The revised manual was effective
January 1, 2001. The domiciliary states of our insurance subsidiaries have
adopted the provisions of the revised manual or, with respect to some states,
adopted the manual with certain modifications. The revised manual has changed,
to some extent, prescribed statutory accounting practices and resulted in
changes to the accounting practices that our insurance subsidiaries use to
prepare their statutory-basis financial statements. The impact of these changes
increased our insurance subsidiaries' statutory-based capital and surplus by
approximately $198 million as of January 1, 2001.
The NAIC has adopted model long-term care policy language providing
nonforfeiture benefits and has proposed a rate stabilization standard for
long-term care policies. Various bills are proposed from time to time in the
U.S. Congress which would provide for the implementation of certain minimum
consumer protection standards for inclusion in all long-term care policies,
including guaranteed renewability, protection against inflation and limitations
on waiting periods for pre-existing conditions. Federal legislation permits
premiums paid for qualified long-term care insurance to be treated as
tax-deductible medical expenses and for benefits received on such policies to be
excluded from taxable income.
Our insurance subsidiaries are required under guaranty fund laws of most
states in which we transact business, to pay assessments up to prescribed limits
to fund policyholder losses or liabilities of insolvent insurance companies.
Assessments can be partially recovered through a reduction in future premium
taxes in some states.
Most states mandate minimum benefit standards and loss ratios for accident
and health insurance policies. We are generally required to maintain, with
respect to our individual long-term care policies, minimum anticipated loss
ratios over the entire period of coverage of not less than 60 percent. With
respect to our Medicare supplement policies, we are generally required to attain
and maintain an actual loss ratio, after three years, of not less than 65
percent. We provide to the insurance departments of all states in which we
conduct business annual calculations that demonstrate compliance with required
minimum loss ratios for both long-term care and Medicare supplement insurance.
These calculations are prepared utilizing statutory lapse and interest rate
assumptions. In the event that we fail to maintain minimum mandated loss ratios,
our insurance subsidiaries could be required to provide retrospective refunds
and/or prospective rate reductions. We believe that our insurance subsidiaries
currently comply with all applicable mandated minimum loss ratios.
NAIC model regulations, adopted in substantially all states, created 10
standard Medicare supplement plans (Plans A through J). Plan A provides the
least extensive coverage, while Plan J provides the most extensive coverage.
Under NAIC regulations, Medicare insurers must offer Plan A, but may offer any
of the other plans at their option. Our insurance subsidiaries currently offer
nine of the model plans. We have declined to offer Plan J, due in part to its
high benefit levels and, consequently, high costs to the consumer.
The federal government does not directly regulate the insurance business.
However, federal legislation and administrative policies in several areas,
including pension regulation, age and sex discrimination, financial services
regulation, securities regulation, privacy laws and federal taxation, do affect
the insurance business. Legislation has been introduced from time to time in
Congress that could result in the federal government assuming some role in
regulating the companies or allowing combinations between insurance companies,
banks and other entities.
Numerous proposals to reform the current health care system (including
Medicare) have been introduced in Congress and in various state legislatures.
Proposals have included, among other things, modifications to the existing
employer-based insurance system, a quasi-regulated system of "managed
competition" among health plans, and a single-payer, public program. Changes in
health care policy could significantly affect our business. For example, Federal
comprehensive major medical or long-term care programs, if proposed and
implemented, could partially or fully replace some of Conseco's current
products.
During recent years, the health insurance industry has experienced
substantial changes, including those caused by healthcare legislation. Recent
federal and state legislation and legislative proposals relating to healthcare
reform contain features that could severely limit or eliminate our ability to
vary our pricing terms or apply medical underwriting standards with respect to
individuals which could have the effect of increasing our loss ratios and
adversely affecting our financial results. In particular, Medicare reform and
legislation concerning prescription drugs could affect our ability to price or
sell our products.
In addition, proposals currently pending in Congress and some state
legislatures may also affect our financial results. These proposals include the
implementation of minimum consumer protection standards for inclusion in all
long-term care policies, including: guaranteed premium rates; protection against
inflation; limitations on waiting periods for pre-existing conditions; setting
standards for sales practices for long-term care insurance; and guaranteed
consumer access to information about insurers, including lapse and replacement
rates for policies and the percentage of claims denied. Enactment of any of
these proposals could affect our financial results.
16
The United States Department of Health and Human Services has issued
regulations under the Health Insurance Portability and Accountability Act
("HIPAA") relating to standardized electronic transaction formats, code sets and
the privacy of member health information. These regulations and any
corresponding state legislation, will affect the Company's administration of
health insurance.
A number of states have passed or are considering legislation that would
limit the differentials in rates that insurers could charge for health care
coverages between new business and renewal business for similar demographic
groups. State legislation has also been adopted or is being considered that
would make health insurance available to all small groups by requiring coverage
of all employees and their dependents, by limiting the applicability of
pre-existing conditions exclusions, by requiring insurers to offer a basic plan
exempt from certain benefits as well as a standard plan, or by establishing a
mechanism to spread the risk of high risk employees to all small group insurers.
Congress and various state legislators have from time to time proposed changes
to the health care system that could affect the relationship between health
insurers and their customers, including external review. We cannot predict with
certainty the effect that any proposals, if adopted, or legislative developments
could have on our insurance businesses and operations.
The asset management activities of CCM are subject to federal and state
securities, fiduciary (including the Employee Retirement Income Security Act of
1974, as amended) and other laws and regulations. The SEC, the National
Association of Securities Dealers, state securities commissions and the
Department of Labor are the principal regulators of our asset management
operations.
Finance
CFC's finance operations are subject to regulation by certain federal and
state regulatory authorities. A substantial portion of CFC's consumer loans and
assigned sales contracts are originated or purchased by finance subsidiaries
licensed under applicable state law. The licensed entities are subject to
examination by and reporting requirements of the state administrative agencies
issuing such licenses. CFC's subsidiaries are subject to state laws and
regulations, which in certain states: (i) limit the amount, duration and charges
for such loans and contracts; (ii) require disclosure of certain loan terms and
regulate the content of documentation; (iii) place limitations on collection
practices; and (iv) govern creditor remedies. The licenses granted are renewable
and may be subject to revocation by the respective issuing authority for
violation of such state's laws and regulations. Some states have adopted or are
considering the adoption of consumer protection laws or regulations that impose
requirements or restrictions on lenders who make certain types of loans secured
by real estate.
In addition to the subsidiaries of CFC licensed under state law, Mill Creek
Bank and Retail Bank (both of which are wholly-owned subsidiaries of CFC), are
regulated and subject to examination by the Federal Deposit Insurance
Corporation. Mill Creek Bank is also regulated and examined by the Utah
Department of Financial Institutions. Retail Bank is regulated and examined by
the South Dakota Department of Banking. The ownership of these entities does not
subject CFC to regulation by the Federal Reserve Board as a bank holding
company. Mill Creek Bank has the authority to engage generally in the banking
business and may accept all types of deposits, other than demand deposits.
Retail Bank is limited by its charter to engage in the credit card business and
may issue only certificates of deposit in denominations of $100,000 or greater.
Mill Creek Bank and Retail Bank are subject to regulations relating to capital
adequacy, leverage, loans, loss reserves, deposits, consumer protection,
community reinvestment, payment of dividends and transactions with affiliates.
A number of states have usury and other consumer protection laws which may
place limitations on the amount of interest and other charges and fees charged
on loans originated in such state. Generally, state law has been preempted by
federal law under the Depositary Institutions Deregulation and Monetary Control
Act of 1980 ("DIDA") which deregulates the rate of interest, discount points and
finance charges with respect to first lien residential loans, including
manufactured home loans and real estate secured mortgage loans. As permitted
under DIDA, a number of states enacted legislation timely opting out of coverage
of either or both of the interest rate and/or finance charge provisions of the
DIDA. States may no longer opt out of the interest rate provisions of the DIDA,
but could in the future opt out of the finance charge provisions. To be eligible
for federal preemption for manufactured home loans, CFC's licensed finance
subsidiaries must comply with certain restrictions providing protection to
consumers. In addition, another provision of DIDA applicable to state-chartered
insured depository institutions permits both Mill Creek Bank and Retail Bank to
export interest, finance charges and certain fees from the states where they are
located to all other states, with the exception of Iowa which opted out of the
DIDA during the permitted time period. Interest, finance charges and fees in
Utah and South Dakota are, for the most part, unregulated.
CFC's operations are subject to regulation under other applicable federal
laws and regulations, the more significant of which include: the Truth in
Lending Act ("TILA"); the Equal Credit Opportunity Act ("ECOA"); the Fair Credit
Reporting Act ("FCRA"); the Real Estate Settlement and Procedures Act ("RESPA");
the Home Mortgage Disclosure Act ("HMDA"); the Home Owner Equity Protection Act
("HOEPA"); and certain rules and regulations of the Federal Trade Commission
("FTC Rules").
17
The TILA and related regulations require certain disclosures designed to
provide consumers with uniform, understandable information with respect to the
terms and conditions of extensions of credit and the ability to compare credit
terms. The TILA also provides consumers with certain substantive protection such
as a three day right to cancel certain credit transactions, including certain of
the loans originated by CFC.
The ECOA requires certain disclosures to applicants for credit regarding
information that is used as a basis for denial of credit and prohibits
discrimination against applicants on the basis of sex, race, color, religion,
national origin, age, marital status, derivation of income from a public
assistance program or the good faith exercise of a right under the TILA. The
ECOA also requires that notices be given to applicants who are denied credit.
The FCRA regulates the process of obtaining, using and reporting of credit
information on consumers. The FCRA also regulates the use of credit information
among affiliates.
The RESPA regulates the disclosure of information to consumers on loans
involving a mortgage on real estate. The RESPA and related regulations also
govern payment for and disclosure of payments for settlement services in
connection with mortgage loans and prohibits the payment of fees for the
referral of a loan.
The HMDA requires reporting of certain information to the Department of
Housing and Urban Development, including the race and sex of applicants in
connection with mortgage loan applications. A lender is required to obtain and
report such information if the application is made in person, but is not
required to obtain such information if the application is taken over the
telephone.
The HOEPA provides for additional disclosure and regulation of certain
consumer mortgage loans which are defined as "covered loans". A covered loan is
a mortgage loan (other than a mortgage loan to finance the initial purchase of a
dwelling, a reverse mortgage transaction, or an open-end credit plan) which: (i)
has total origination fees in excess of the greater of eight percent of the loan
amount, or $488; or (ii) has an annual percentage interest rate that is more
than ten percent higher than comparably maturing United States treasury
obligations for second mortgage loans or has an annual percentage interest rate
that is more than eight percent higher than comparably maturing United States
treasury obligations for first mortgage loans. A number of CFC's home equity and
home improvement loans meet the requirements to be considered covered loans.
The FTC Rules provide, among other things, that in connection with the
purchase of consumer sales finance contracts from dealers, the holder of the
contract is subject to all claims and defenses which the consumer could assert
against the dealer. However, the consumer's recovery under such provisions
cannot exceed the amount paid under the sales contract.
In the judgment of the management of CFC, existing federal and state law
and regulations have not had a material adverse effect on CFC's operations. It
is possible that more restrictive laws, rules or regulations will be adopted in
the future and will place additional burdens on CFC.
CFC's commercial lending operations are not subject to material regulation
in most states, although certain states do require licensing. In addition,
certain provisions of the ECOA apply to commercial loans to small businesses.
CFC has designed internal controls to manage the risks associated with its
finance activities. However, there is a risk that one or more employees will
circumvent these controls, as has occurred at other financial institutions.
FEDERAL INCOME TAXATION
The annuity and life insurance products marketed and issued by our
insurance subsidiaries generally provide the policyholder with an income tax
advantage, as compared to other savings investments such as certificates of
deposit and bonds, in that income taxation on the increase in value of the
product is deferred until it is received by the policyholder. With other savings
investments, the increase in value is taxed as earned. Annuity benefits and life
insurance benefits, which accrue prior to the death of the policyholder, are
generally not taxable until paid. Life insurance death benefits are generally
exempt from income tax. Also, benefits received on immediate annuities (other
than structured settlements) are recognized as taxable income ratably, as
opposed to the methods used for some other investments which tend to accelerate
taxable income into earlier years. The tax advantage for annuities and life
insurance is provided in the Internal Revenue Code (the "Code"), and is
generally followed in all states and other United States taxing jurisdictions.
In addition, the interest paid on home equity and home improvement loans by
customers of CFC are generally tax deductible for individuals who itemize their
tax deductions.
Recently, Congress enacted legislation to lower marginal tax rates, reduce
the federal estate tax gradually over a ten-year period, with total elimination
of the federal estate tax in 2010, and increase contributions that may be made
to individual retirement accounts and 401(k) accounts. While these tax law
changes will sunset at the beginning of 2011 absent future congressional action,
they could in the interim diminish the appeal of our annuity and life insurance
products. Additionally, Congress has considered, from
18
time to time, other possible changes to the U.S. tax laws, including elimination
of the tax deferral on the accretion of value within certain annuities and life
insurance products. It is possible that further tax legislation will be enacted
which would contain provisions with possible adverse effects on our annuity and
life insurance products.
Our insurance company subsidiaries are taxed under the life insurance
company provisions of the Code. Provisions in the Code require a portion of the
expenses incurred in selling insurance products to be deducted over a period of
years, as opposed to immediate deduction in the year incurred. This provision
increases the tax for statutory accounting purposes, which reduces statutory
earnings and surplus and, accordingly, decreases the amount of cash dividends
that may be paid by the life insurance subsidiaries.
In certain securitization transactions historically used by CFC, a special
tax structure was used referred to as a Real Estate Mortgage Investment Conduit
("REMIC"). When this tax structure was used, CFC was required to account for the
transfer of the finance receivables into the securitization trust as a sale
(even when such transfers were accounted for as collateralized borrowings
pursuant to generally accepted accounting principles ("GAAP")). Additionally,
since CFC retained the residual interests of the REMIC, the REMIC tax rules
require CFC to pay a minimum amount of tax each year based on the taxable income
of the retained residual interest.
At December 31, 2002, Conseco had net federal income tax loss carryforwards
of $1,757.4 million available (subject to various statutory restrictions) for
use on future tax returns (including $552.4 million of federal income tax
carryforwards attributable to discontinued operations). These carryforwards will
expire as follows: $2.3 million in 2003; $11.2 million in 2004, $4.9 million in
2005; $.6 million in 2006; $7.9 million in 2007; $7.5 million in 2008; $14.7
million in 2009; $30.7 million in 2010; $6.2 million in 2011; $10.1 million in
2012; $43.9 million in 2013; $6.9 million in 2014; $60.5 million in 2016; $90.0
million in 2017; $244.6 million in 2018; $159.1 million in 2019; $594.3 million
in 2020; and $462.0 million in 2022. The following restrictions exist with
respect to the utilization of portions of the loss carryforwards: (i) $145.2
million attributable to certain acquired companies may be used only to offset
the taxable income of those companies; and (ii) $1,612.2 million is available to
offset income from certain life insurance subsidiaries and other non-life
insurance subsidiaries.
The Company is currently in bankruptcy and expects to restructure and
emerge from bankruptcy. As a result of the restructuring that is expected to
occur upon the anticipated emergence from bankruptcy, the aggregate outstanding
indebtedness will be substantially reduced. The cancellation of the indebtedness
is expected to result in the realization of cancellation of indebtedness income
("COD Income"). The COD Income will not be recognized as taxable income because
the Company is under the jurisdiction of a court in a Title 11 bankruptcy
proceeding. Instead, as a consequence of such exclusion from taxable income, the
Company must reduce its tax attributes by the amount of COD Income, which it
excluded from taxable income. Tax attributes are reduced in the following order:
(i) net operating loss carryforwards ("NOLs"); (ii) tax credits and capital loss
carryforwards; and (iii) tax basis in assets. Although it is expected that a
reduction of tax attributes will be required, because the determination of the
COD Income is dependent upon the fair market value of the various debt and
capital instruments at the Effective Date, the exact amount of the reduction
cannot be predicted.
The restructuring will be accomplished by the formation of a new company
("New Conseco"), which will issue new debt, preferred stock and common stock, in
exchange for substantially all of the assets of the Company. The Company intends
to accomplish this transaction as a reorganization described in Code Section 368
(a)(1)(G) ("G Reorganization"). Assuming that the restructuring constitutes a G
Reorganization, the Company will recognize no gain or loss with respect to such
transactions to effect the G Reorganization, the Company's taxable year will
close on the date the Company emerges from bankruptcy (the "Effective Date") and
New Conseco will begin a new taxable year on the day after the Effective Date,
and all of the Company's tax attributes existing on the Effective Date,
including NOLs and other loss and credit carryovers will be transferred to New
Conseco as of the close of the Effective Date.
Any NOLs and other loss and credit carryovers transferred to New Conseco
will be limited under the Code to a maximum amount in any one year. This amount
is equal to the product of the fair market value of the loss corporation's
outstanding stock immediately before the ownership change and the long term
tax-exempt rate (which is published monthly by the Treasury Department and most
recently was approximately 4.61 percent) in effect for the month in which the
ownership change occurs. This amount will not be known until the Effective Date.
Our income tax expense includes deferred income taxes arising from
temporary differences between the financial reporting and tax bases of assets
and liabilities and NOLs. In assessing the realization of our deferred income
tax assets, we consider whether it is more likely than not that the deferred
income tax assets will be realized. The ultimate realization of our deferred
income tax assets depends upon generating future taxable income during the
periods in which our temporary differences become deductible and before our NOLs
expire.
A valuation allowance of $1.7 billion (of which $.9 billion relates to
discontinued operations) has been provided for the entire balance of net
deferred income tax assets at December 31, 2002, as we believe the realization
of such assets in future periods is
19
uncertain. We reached this conclusion after considering the availability of
taxable income in prior carryback years, tax planning strategies, and the
likelihood of future taxable income exclusive of reversing temporary differences
and carryforwards.
ITEM 2. PROPERTIES.
Headquarters. Our headquarters is located on a Company-owned 168-acre
corporate campus in Carmel, Indiana, immediately north of Indianapolis. The ten
buildings on the campus contain approximately 854,500 square feet of space and
house Conseco's executive offices and certain administrative operations of its
subsidiaries. Management believes that Conseco's offices are adequate for its
current needs. Some of our properties are or soon may be available for sale or
lease.
Insurance operations. Our professional independent producer distribution
channel operations are administered from our Carmel, Indiana headquarters. Our
career agent operations are primarily administered from a single facility of
300,000 square feet in downtown Chicago, Illinois, leased under an agreement
whereby 107,000 square feet is leased until 2018; 70,000 square feet is leased
until 2008; and the remaining 123,000 square feet is leased through November
2003. We also lease approximately 130,000 square feet of warehouse space in a
second Chicago facility; this lease has a remaining life of approximately 11
months. Conseco owns an office building (currently listed for sale) in Rockford,
Illinois (total of 44,400 square feet), which served as an administrative center
for portions of our insurance operations. Conseco owns an office building in
Philadelphia, Pennsylvania (127,000 square feet), which serves as the
administrative center for our direct response life insurance operations;
approximately 60 percent of this space is occupied by the Company, with the
remainder leased to tenants. Conseco also leases 215 sales offices in various
states totaling approximately 507,000 square feet; these leases are short-term
in length, with remaining lease terms ranging from six months to five years.
Finance operations. CFC is headquartered in St. Paul, Minnesota in a
CFC-owned building (110,000 square feet of which is occupied by CFC). CFC leases
additional space in downtown St. Paul (185,000 square feet), which is used by
its mortgage services, manufactured housing and private credit card divisions.
CFC owns a building in Rapid City, South Dakota (137,000 square feet), which is
used by its manufactured housing, private label credit card and retail bank
servicing units. CFC also leases buildings in Tempe, Arizona (200,000 square
feet) and Atlanta, Georgia (48,000 square feet) which serve as collection and
service centers. CFC had previously leased an additional 75,000 square feet in
Rapid City, South Dakota, and 48,000 square feet in Atlanta, Georgia, however
CFC rejected these leases in its bankruptcy proceedings in January 2003. CFC
leases 31 regional manufactured housing division offices and 88 mortgage
services branch offices across the United States; the lease terms generally
range from one to five years.
ITEM 3. LEGAL PROCEEDINGS.
As described in Item 1. "Business of Conseco", CNC and several of its
subsidiaries filed voluntary petitions for reorganization under Chapter 11 of
the Bankruptcy Code in the Bankruptcy Court. The Company's insurance
subsidiaries and other subsidiaries who did not file petitions are separate
legal entities and are not included in the petitions filed by the parent. The
Debtors retain control of the insurance subsidiaries and related subsidiaries
and are authorized to operate these businesses as debtors-in-possession while
being subject to the jurisdiction of the Bankruptcy Court. The Finance Company
Debtors filed a separate plan in connection with their Chapter 11 Cases on April
2, 2003. As of the Petition Date, pending litigation against the Debtors or the
Finance Company Debtors is stayed, and absent further order of the Bankruptcy
Court, substantially all prepetition liabilities of the Debtors and the Finance
Company Debtors are subject to settlement under a plan of reorganization. Based
on the Plan of the Debtors, liabilities subject to compromise exceed the fair
value of the Debtors' assets, and most unsecured claims will be satisfied at
less than 100 percent of their fair value.
We and our subsidiaries are involved on an ongoing basis in lawsuits
(including purported class actions) relating to our operations, including with
respect to sales practices, and we and current and former officers and directors
are defendants in pending class action lawsuits asserting claims under the
securities laws and derivative lawsuits. The ultimate outcome of these lawsuits
cannot be predicted with certainty.
Legal Proceedings Related to CFC Only
CFC was served with various related lawsuits filed in the United States
District Court for the District of Minnesota. These lawsuits were generally
filed as purported class actions on behalf of persons or entities who purchased
common stock or options to purchase common stock of CFC during alleged class
periods that generally run from July 1995 to January 1998. One action (Florida
State Board of Admin. v. Green Tree Financial Corp., et. al, Case No. 98-1162)
was brought not on behalf of a class, but by the Florida State Board of
Administration, which invests and reinvests retirement funds for the benefit of
state employees. In addition to CFC, certain former officers and directors of
CFC are named as defendants in one or more of the lawsuits. CFC and other
defendants obtained an order consolidating the lawsuits seeking class action
status into two actions, one of which pertains to a purported class of common
stockholders (In re Green Tree Financial Corp. Stock Litig., Case No. 97-2666)
and the other of which pertains to a purported class of stock option traders (In
re Green Tree Financial Corp. Options Litig., Case No. 97-2679). Plaintiffs in
the lawsuits
20
assert claims under Sections 10(b) (and Rule 10b-5 promulgated thereunder) and
20(a) of the Securities Exchange Act of 1934. In each case, plaintiffs allege
that CFC and the other defendants violated federal securities laws by, among
other things, making false and misleading statements about the current state and
future prospects of CFC (particularly with respect to prepayment assumptions and
performance of certain loan portfolios of CFC), which allegedly rendered CFC's
financial statements false and misleading. On August 24, 1999, the United States
District Court for the District of Minnesota issued an order dismissing with
prejudice all claims alleged in the lawsuits. The plaintiffs subsequently
appealed the decision to the U.S. Court of Appeals for the 8th Circuit. A three
judge panel issued an opinion on October 25, 2001, reversing the United States
District Court's dismissal order and remanding the actions to the United States
District Court. The parties to these lawsuits have entered into a stipulation of
settlement, which is subject only to review and approval by the court.
CFC is a defendant in two arbitration proceedings in South Carolina (Lackey
v. Green Tree Financial Corporation, n/k/a Conseco Finance Corp. and Bazzle v.
Green Tree Financial Corporation, n/k/a Conseco Finance Corp.) where the
arbitrator, over CFC's objection, allowed the plaintiffs to pursue purported
class action claims in arbitration. The two purported arbitration classes
consist of South Carolina residents who obtained real estate secured credit from
CFC's Manufactured Housing Division (Lackey) and Home Improvement Division
(Bazzle) in the early and mid 1990s, and did not receive a South Carolina
specific disclosure form relating to selection of attorneys and insurance agents
in connection with the credit transactions. The arbitrator, in separate awards
issued on July 24, 2000, awarded a total of $26.8 million in penalties and
attorneys' fees. The awards were confirmed as judgments in both Lackey and
Bazzle. These cases were consolidated into one case, and CFC appealed them to
the South Carolina Supreme Court. Oral argument was heard on March 21, 2002. On
August 26, 2002 the South Carolina Supreme Court affirmed the arbitration
judgments, and CFC filed a petition for writ of certiorari with the U.S. Supreme
Court on October 23, 2002. CFC's petition was granted in January 2003, and the
U.S. Supreme Court will hear oral argument on April 22, 2003. CFC has posted
appellate bonds, including $23 million of cash, for these cases. CFC intends to
challenge the awards vigorously and believes that the arbitrator erred by, among
other things, conducting class action arbitrations without the authority to do
so. The ultimate outcome of this proceeding cannot be predicted with certainty.
Securities Litigation
A total of forty-five suits were filed in 2000 against CNC in the United
States District Court for the Southern District of Indiana. Nineteen of these
cases were putative class actions on behalf of persons or entities that
purchased CNC's common stock during alleged class periods that generally run
from April 1999 through April 2000. Two cases were putative class actions on
behalf of persons or entities that purchased CNC's bonds during the same alleged
class periods. Three cases were putative class actions on behalf of persons or
entities that purchased or sold option contracts, not issued by CNC, on CNC's
common stock during the same alleged class periods. One case was a putative
class action on behalf of persons or entities that purchased CNC's "FELINE
PRIDES" convertible preferred stock instruments during the same alleged class
periods. With four exceptions, in each of these twenty-five cases two former
officers/directors of CNC were named as defendants. In each case, the plaintiffs
asserted claims under Sections 10(b) (and Rule 10b-5 promulgated thereunder) and
20(a) of the Securities Exchange Act of 1934. In each case, plaintiffs alleged
that CNC and the individual defendants violated the federal securities laws by,
among other things, making false and misleading statements about the current
state and future prospects of CFC (particularly with respect to performance of
certain loan portfolios of CFC) which allegedly rendered CNC's financial
statements false and misleading.
Eleven of the cases in the United States District Court for the Southern
District of Indiana were filed as purported class actions on behalf of persons
or entities that purchased preferred securities issued by various Conseco
Financing Trusts, including Conseco Financing Trust V, Conseco Financing Trust
VI, and Conseco Financing Trust VII. Each of these complaints named as
defendants CNC, the relevant trust (with two exceptions), two former
officers/directors of CNC, and underwriters for the particular issuance (with
one exception). One complaint also named an officer and all of CNC's directors
at the time of issuance of the preferred securities by Conseco Financing Trust
VII. In each case, plaintiffs asserted claims under Section 11 and Section 15 of
the Securities Act of 1933, and eight complaints also asserted claims under
Section 12(a)(2) of that Act. Two complaints also asserted claims under Sections
10(b) and 20(a) of the Securities Exchange Act of 1934, and on