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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, 1996 or
[ ] Transition report pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934 [No Fee Required]
For the transition period from ____ to ____
Commission file number: 1-9250
Conseco, Inc.
Indiana No. 35-1468632
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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:
Name of each exchange
Title of each class on which registered
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Common Stock, No Par Value New York Stock Exchange, Inc.
8-1/8% Senior Notes due 2003 New York Stock Exchange, Inc.
10-1/2% Senior Notes due 2004 New York Stock Exchange, Inc.
7% PRIDES Convertible Preferred Stock New York Stock Exchange, Inc.
9.16%Trust Originated Preferred Securities New York Stock Exchange, Inc.
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. [ ]
Aggregate market value of common stock held by nonaffiliates (computed as
of March 14, 1997): $7,326,991,680
Shares of common stock outstanding as of March 14, 1997: 183,174,792
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Registrant's definitive
proxy statement for the annual meeting of shareholders to be held May 13, 1997
are incorporated by reference into Part III of this Report.
PART I
ITEM 1. BUSINESS OF CONSECO.
Background
Conseco, Inc. is a financial services holding company. Conseco develops,
markets and administers annuity, individual health insurance and individual life
insurance products. As used in this report, the terms "Conseco" or the "Company"
refer to Conseco, Inc. and its consolidated subsidiaries, unless the context
requires otherwise. Conseco's operating strategy is to grow the insurance
business within its subsidiaries by focusing its resources on the development
and expansion of profitable products and strong distribution channels. Conseco
has supplemented such growth by acquiring companies that have profitable niche
products, strong distribution systems and progressive management teams who can
work with Conseco to implement Conseco's operating and growth strategies. Once a
company has been acquired, Conseco's operating strategy has been to consolidate
and streamline management and administrative functions, to realize superior
investment returns through active asset management, to eliminate unprofitable
products and distribution channels, and to expand and develop the profitable
distribution channels and products.
Since 1982, Conseco has acquired 15 insurance groups and related
businesses; 10 as wholly owned subsidiaries and five through its acquisition
partnerships. Conseco's first acquisition partnership, Conseco Capital Partners,
L.P. ("Partnership I"), was dissolved in 1993 after distributing to its partners
the securities of the companies it had acquired. Conseco Capital Partners II,
L.P. ("Partnership II"), Conseco's second acquisition partnership, was
liquidated in 1996 after Conseco purchased from the other partners all of the
common shares of American Life Holdings, Inc. ("ALH", formerly The Statesman
Group, Inc.) not already owned by Conseco. Conseco terminated its partnership
activity in 1996 because changes in the regulatory and rating agency environment
had made it difficult to structure leveraged acquisitions of life insurance
companies.
On August 31, 1995, the Company purchased all of the shares of common
stock of CCP Insurance, Inc. ("CCP") it did not previously own (representing 51
percent of CCP's outstanding shares). In the transaction, CCP was merged into
Conseco, with Conseco being the surviving corporation. The merger and the
related transactions are referred to herein as the "CCP Merger". As a result of
the CCP Merger, CCP's subsidiaries -- Great American Reserve Insurance Company
("Great American Reserve") and Beneficial Standard Life Insurance Company
("Beneficial Standard") -- became wholly owned subsidiaries of Conseco. The
accounts of CCP's subsidiaries are consolidated with Conseco's effective January
1, 1995.
On August 2, 1996, Conseco acquired (the "LPG Merger") Life Partners
Group, Inc. ("LPG"). LPG became a wholly owned subsidiary of Conseco. In the LPG
Merger, Conseco issued a total of 32.6 million shares of its common stock (or
common stock equivalents) with a value of $586.8 million. Conseco also assumed
LPG notes payable of $253.1 million. LPG's subsidiaries sell a diverse portfolio
of universal life insurance and, to a lesser extent, annuity products to
individuals.
On September 30, 1996, Conseco acquired the remaining 62 percent of the
common shares of ALH not already owned by Conseco or its affiliates for
approximately $165 million in cash. ALH is a provider of retirement savings
annuities. ALH has been included in Conseco's consolidated financial statements
since ALH's acquisition by Partnership II in September 1994.
On December 17, 1996, Conseco acquired (the "ATC Merger") American
Travellers Corporation ("ATC"). ATC was merged with and into Conseco, with
Conseco being the surviving corporation. In the ATC Merger, Conseco issued a
total of 21.0 million shares of its common stock (or common stock equivalents)
with a value of $630.9 million. In addition, Conseco assumed $102.8 million of
ATC's convertible subordinated debentures, which became convertible into 7.9
million shares of Conseco common stock with a value of $248.3 million. ATC is a
leading marketer and underwriter of long-term care insurance. ATC also markets
and underwrites other supplemental accident and health insurance policies, as
well as life insurance.
On December 23, 1996, Conseco acquired (the "THI Merger") Transport
Holdings Inc. ("THI"). THI was merged with and into Conseco, with Conseco being
the surviving corporation. In the THI Merger, Conseco issued a total of 4.9
million shares of its common stock (or common stock equivalents) with a value of
$121.7 million. In addition, pursuant to an exchange offer, all of THI's
Subordinated Convertible Notes were exchanged for 4.2 million shares of Conseco
common stock with a value of $106.2 million, plus a cash premium of $11.9
million. THI is principally engaged in the underwriting and distribution of
supplemental health insurance.
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On December 31, 1996, Conseco acquired (the "BLH Merger") the 9.6 percent
of the common shares of Bankers Life Holding Corporation ("BLH") not already
owned by Conseco or its affiliates. BLH was merged into a wholly owned
subsidiary of Conseco. In the BLH Merger, Conseco issued a total of 3.9 million
shares of Conseco common stock (or common stock equivalents) with a value of
$123.0 million. BLH is one of the nation's largest writers of individual health
insurance products, based on collected premiums. BLH also markets a variety of
annuity, life and group insurance products. BLH has been included in Conseco's
consolidated financial statements since November 1992, when BLH was acquired by
Partnership I.
Conseco owned the following life insurance companies at December 31,
1996:
- Bankers Life and Casualty Company ("Bankers Life"), Bankers Life
Insurance Company of Illinois and Certified Life Insurance Company,
formerly subsidiaries of BLH;
- Great American Reserve, Beneficial Standard and Jefferson National
Life Insurance Company of Texas, in which Conseco has had an ownership
interest since their acquisition by Partnership I in 1990 and 1991,
respectively, and which became wholly owned subsidiaries in August
1995;
- the subsidiaries of ALH, which are also subsidiaries of Conseco,
including American Life and Casualty Insurance Company ("ALC") and
Vulcan Life Insurance Company;
- the subsidiaries of LPG, which are now subsidiaries of Conseco,
including Philadelphia Life Insurance Company ("Philadelphia Life"),
Massachusetts General Life Insurance Company ("Massachusetts
General"), Lamar Life Insurance Company ("Lamar Life") and Wabash Life
Insurance Company;
- the former subsidiaries of ATC, which are now subsidiaries of Conseco,
including American Travellers Life Insurance Company ("American
Travellers"), United General Life Insurance Company ("United General")
and American Travellers Insurance Company of New York;
- the former subsidiaries of THI, which are now subsidiaries of Conseco,
including TLIC Life Insurance Company ("TLIC Life"), Transport Life
Insurance Company ("Transport Life") and Continental Life Insurance
Company ("Continental Life"); and
- Bankers National Life Insurance Company, National Fidelity Life
Insurance Company and Lincoln American Life Insurance Company, which
have profitable blocks of in-force business, although they are
currently not pursuing new sales.
On March 4, 1997, Conseco acquired (the "CAF Merger") Capitol American
Financial Corporation ("CAF"). CAF was merged with and became a wholly owned
subsidiary of Conseco. In the CAF Merger, each of the approximately 17.7 million
shares of CAF common stock and common stock equivalents were converted into the
right to receive $30.75 in cash plus 0.1647 of a share of Conseco common stock.
Conseco paid $545 million in cash and issued 2.9 million shares of Conseco
common stock with a value of approximately $115.7 million to acquire the CAF
common stock. In addition, Conseco assumed a note payable of CAF of $31.0
million. CAF, through its insurance subsidiaries, underwrites, markets and
distributes individual and group supplemental health and accident insurance.
CAF's principal insurance subsidiary is an Arizona-domiciled company, Capitol
American Life Insurance Company ("CALI"), which accounted for more than 97
percent of CAF's earned premiums over the last five years. CALI is licensed to
sell its products in 47 states, the District of Columbia, Puerto Rico and the
U.S. Virgin Islands, and markets its products through a sales force consisting
of independent agents, agent organizations and brokers. CAF had total assets of
$1.1 billion at December 31, 1996.
Western National Corporation ("WNC"), an NYSE-listed company, and its
wholly owned subsidiary, Western National Life Insurance Company, were wholly
owned subsidiaries until February 15, 1994, when WNC completed an initial public
offering ("IPO"). Conseco sold a 60 percent interest in WNC in connection with
the IPO and sold its remaining 40 percent interest in a separate transaction on
December 23, 1994.
Conseco was organized in 1979 as an Indiana corporation and commenced
operations in 1982. Its executive offices are located at 11825 N. Pennsylvania
Street, Carmel, Indiana 46032, and its telephone number is (317) 817-6100.
Pending Acquisition
On December 15, 1996, Conseco and Pioneer Financial Services, Inc.
("PFS") entered into an Agreement and Plan of Merger (the "PFS Merger
Agreement") pursuant to which PFS would become a wholly owned subsidiary of
Conseco (the "PFS Merger"). Under the PFS Merger Agreement, each of the
approximately 16.9 million shares of PFS common stock and common stock
3
equivalents would be converted into the right to receive a fraction of a share
of Conseco common stock (rounded to the nearest ten- thousandth) having a value
between $25.00 and $28.00, calculated as follows: (i) if the Conseco/PFS Share
Price (as defined below) is greater than or equal to $28.00 per share and less
than or equal to $31.36 per share, .8928 of a share of Conseco common stock;
(ii) if the Conseco/PFS Share Price is less than $28.00 per share, the fraction
of a share of Conseco common stock determined by dividing $25.00 by the
Conseco/PFS Share Price; or (iii) if the Conseco/PFS Share Price is greater than
$31.36 per share, the fraction of a share of Conseco common stock determined by
dividing $28.00 by the Conseco/PFS Share Price. The "Conseco/PFS Share Price"
shall be equal to the average of the closing prices of the Conseco common stock
on the NYSE Composite Transactions Reporting System for the 10 trading days
immediately preceding the second trading day prior to the date of the PFS
Merger. Based on a Conseco/PFS Share Price which exceeds $28.00 per share (such
price being exceeded on March 14, 1997), Conseco will issue 8.7 million shares
of Conseco common stock with a value of approximately $352.4 million to acquire
the PFS common stock. In addition, Conseco will assume PFS notes payable of
$27.8 million and the PFS 6 1/2% Convertible Subordinated Notes due 2003, which
will be convertible into an assumed 3.0 million shares of Conseco common stock
with a value of approximately $120.7 million.
PFS, through its insurance subsidiaries, underwrites life insurance,
annuities and health insurance in selected niche markets throughout the United
States. PFS had total assets of approximately $1.8 billion at December 31, 1996.
PFS collected $794.2 million of life, annuity and health insurance premiums in
1996.
OPERATING SEGMENTS
Conseco conducts and manages its business through four segments,
reflecting the Company's major lines of insurance business and target markets:
(i) annuities; (ii) supplemental health insurance; (iii) life insurance; and
(iv) other.
Annuities
This segment includes single-premium deferred annuities ("SPDAs"),
flexible-premium deferred annuities ("FPDAs"), single- premium immediate
annuities ("SPIAs") and variable annuities sold through both career agents and
professional independent producers. During 1996, this segment collected total
premiums of $1,542.4 million, down 7.1 percent from 1995. When all currently
consolidated companies are included for all periods, including periods prior to
their acquisition, this segment collected total premiums of $1,612.7 million,
down 8.7 percent from 1995.
The following describes the major products of this segment:
Single-premium deferred annuities. SPDAs accounted for $755.4 million, or
23 percent, of the Company's total collected premiums in 1996. An SPDA is a
savings vehicle in which the policyholder, or annuitant, makes a single-premium
payment to the insurance company; the insurer guarantees the principal and
accrues a stated rate of interest. After a number of years, as specified in the
annuity contract, the annuitant may elect to take the proceeds of the annuity
either in a single payment or in a series of payments for life, for a fixed
number of years, or for a combination thereof. Conseco's SPDAs typically have an
interest rate (the "crediting rate") that is guaranteed by the Company for the
first policy year, after which the Company has the discretionary ability to
change the crediting rate to any rate not below a guaranteed minimum rate, which
generally ranges from 3.0 percent to 5.5 percent. The initial crediting rate is
largely a function of: (i) the interest rate the Company can earn on invested
assets acquired with the new annuity fund deposits; and (ii) the rates offered
on similar products by the Company's competitors. For subsequent adjustments to
crediting rates, the Company takes into account the yield on its investment
portfolio, annuity surrender assumptions, competitive industry pricing and the
crediting rate history for particular groups of annuity policies with similar
characteristics. Since 1992, more than 80 percent of the Company's new annuity
sales have been "bonus" products. The initial crediting rate on these products
specifies a bonus crediting rate ranging from 1 percent to 8 percent of the
annuity deposit for the first policy year only. After the first year, the bonus
interest portion of the initial crediting rate is automatically discontinued and
the renewal crediting rate is established. Commissions to agents are generally
reduced by an amount comparable to the bonus interest to partially compensate
the Company for the higher initial crediting rate on these products. As of
December 31, 1996, crediting rates on the Company's outstanding SPDAs generally
ranged from 4.0 percent to 5.5 percent, excluding bonuses guaranteed for the
first year of the annuity contract. The average crediting rate including
interest bonuses was 5.2 percent and the average rate excluding bonuses was 5.0
percent.
The policyholder is typically permitted to withdraw all or part of the
premium paid plus the accumulated interest credited to his account (the
"accumulation value"), subject in virtually all cases to the assessment of a
surrender charge for withdrawals in excess of specified limits. Most of the
Company's SPDAs 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 was
issued. The surrender charge is initially 6 percent to 12 percent of the
accumulation value and generally decreases by approximately 1 to 2 percentage
points per year during the penalty period. Surrender charges are set at levels
to protect the Company from loss on early terminations and to reduce the
likelihood of policyholders terminating their policies during periods of
increasing interest rates. This practice lengthens the effective
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duration of policy liabilities and enables the Company to maintain profitability
on such policies. In September 1995, the Company began offering a deferred
annuity product with a "market value adjustment" feature. This feature is
designed to provide the Company with additional protection from early
terminations during a period of rising interest rates by reducing the surrender
value payable upon a full or partial surrender of the policy in excess of the
allowable penalty-free withdrawal amount. Conversely, during a period of
declining interest rates, the feature would increase the surrender value payable
to the policyholder. In 1996, the Company collected premiums of $257.7 million
from sales of SPDAs with this feature.
In response to consumers' desire for alternative investment products with
returns linked to those of common stocks, the Company introduced an
equity-linked SPDA in June 1996. This product accounted for $87.1 million of
SPDA premiums collected during 1996. The annuity's accumulation value is
credited with interest at an annual minimum guaranteed rate of 3 percent, but
the annuity provides for higher returns based on a percentage (the
"participation rate") of the change in the S&P 500 Index during each year of its
term. The Company has the discretionary ability to change the participation rate
(which is currently 100 percent), subject to a minimum of 50 percent. The
annuity provides for penalty-free withdrawals of up to 10 percent of the
accumulation value in each year after the first year of the annuity's term. Most
other withdrawals during the first eight years of the annuity's term are subject
to a 9 percent surrender charge. The Company purchases S&P 500 Index Options,
the values of which change as benefits accrue to these annuities as a result of
the equity-linked return feature.
Single-premium immediate annuities. SPIAs accounted for $111.2 million,
or 3.5 percent, of the Company's total collected premiums in 1996. SPIAs are
designed to provide a series of periodic payments for a fixed period of time or
for life, according to the policyholder's choice at the time of issue. Once the
payments begin, the amount, frequency and length of time for which they are
payable are fixed. SPIAs often are purchased by persons at or near retirement
age who desire a steady stream of payments over a future period of years. The
single premium is often the payout from a terminated annuity contract. The
implicit interest rate on SPIAs is based on market conditions when the policy is
issued. The implicit interest rate on the Company's outstanding SPIAs at
December 31, 1996, averaged 6.2 percent.
Flexible-premium deferred annuities. FPDAs accounted for $594.3 million ,
or 18 percent, of the Company's total collected premiums in 1996. FPDAs are
similar to SPDAs in many respects, except that FPDAs allow more than one premium
payment. FPDAs are marketed through professional independent producers.
The Company's FPDAs typically have a guaranteed crediting rate for the
first policy year that exceeds the minimum annual guaranteed rate of at least 3
percent. After the first year, the crediting rate may be changed at least
annually. The policyholder is permitted to withdraw all or part of the
accumulation value, less a surrender charge for withdrawals during an initial
penalty period of up to 15 years. The initial surrender charges range from 5
percent to 19 percent of the first-year premium and decline over the penalty
period. Interest rates credited on the Company's outstanding FPDAs at December
31, 1996, generally ranged from 4.5 percent to 5.5 percent, excluding bonuses
guaranteed for the first year of the annuity contract. The average crediting
rate including interest bonuses was 5.2 percent and the average rate excluding
bonuses was 5.0 percent.
Variable annuities. Variable annuities accounted for $81.5 million, or
2.5 percent, of the Company's total premiums collected in 1996. Variable
annuities, sold on a single- or flexible-premium basis, differ from fixed
annuities in that the original principal value may fluctuate, depending on the
performance of assets allocated pursuant to various investment options chosen by
the contract owner. Variable annuities offer contract owners a fixed interest
option or a variable rate of return based upon the specific investment
portfolios into which premiums may be directed.
Supplemental health
This segment includes Medicare supplement and long-term care insurance.
For periods prior to January 1, 1997, this segment consists solely of the
Medicare supplement and long-term care products distributed through a career
agency force. During 1996, this segment collected Medicare supplement premiums
of $630.9 million and long-term care premiums of $194.2 million, up 5.7 percent
and 22 percent, respectively, over 1995. When all currently consolidated
companies are included for all periods (including periods prior to their
acquisition), this segment collected Medicare supplement premiums of $651.6
million, long-term care premiums of $541.3 million and specified disease
premiums of $90.6 million, up 5.2 percent, up 37 percent and down 2.3 percent,
respectively, from premiums collected during 1995.
Beginning in 1997, this segment will include the specified disease
products of the former subsidiaries of THI and CAF and the long-term care
products of the former subsidiaries of ATC which are distributed through
professional independent producers. Upon completion of the PFS Merger, this
segment will also include various supplemental health products of PFS. These
products are also distributed through professional independent producers.
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The following describes the major products of this segment:
Medicare supplement. Medicare supplement products accounted for $630.9
million, or 20 percent, of the Company's total collected premiums in 1996.
Medicare is a two-part federal health insurance program for disabled persons and
senior citizens (age 65 and older). Part A of the program provides protection
against the costs of hospitalization and related hospital and skilled nursing
home care, subject to an initial deductible, related coinsurance amounts and
specified maximum benefit levels. The deductible and coinsurance amounts are
subject to change each year by the federal government. Part B of Medicare covers
doctors bills and a number of other medical costs not covered by Part A, subject
to deductible and coinsurance amounts for "approved" charges.
Medicare supplement policies provide coverage for many of the medical
expenses which the Medicare program does not cover, such as deductibles and
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. Conseco's Medicare supplement plans automatically adjust coverage to
reflect changes in Medicare benefits. In marketing these products, Conseco
concentrates on individuals who have recently become eligible for Medicare by
reaching the age of 65. Conseco offers a higher first-year commission for sales
to these policyholders and competitive premium pricing. Approximately one-half
of new sales of Medicare supplement policies are to individuals who are 65 years
old.
Long-term care. Long-term care products accounted for $194.2 million, or
6.0 percent, of the Company's total collected premiums in 1996. Long-term care
products provide coverage, within prescribed limits, for nursing home, home
healthcare, or a combination of both nursing home and home health care expenses.
The long-term care plans are sold primarily to retirees, and to a lesser degree,
to older self-employed individuals and others in middle-income levels.
Current nursing home care policies cover incurred and daily fixed-dollar
benefits available with an elimination period (which, similar to a deductible,
requires the insured to pay for a certain number of days of nursing home care
before the insurance coverage begins), subject to a maximum benefit. Home health
care 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. Conseco monitors the loss experience on its long-term care products
and, when necessary, applies for rate increases in the states in which it sells
such products.
Specified disease products. Beginning in 1997, the supplemental health
segment will include the specified disease products of THI and CAF, such as
cancer and heart/stroke insurance. 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. The benefits provided under the cancer insurance policies of THI and CAF
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. Heart/stroke policies provide for payments
directly to the policyholder for treatment of a covered heart disease, heart
attack or stroke.
Life
This segment includes traditional, universal life and other life
insurance products. Beginning with the third quarter of 1996, the largest single
component of this segment is the universal life business of LPG. This segment's
products are currently sold through both career agents and professional
independent producers.
During 1996, this segment collected total premiums of $453.7 million, up
64 percent, over premiums collected during 1995. When all currently consolidated
companies are included for all periods, including periods prior to their
acquisition, this segment collected total premiums of $665.6 million, up 1.1
percent from 1995.
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 $271.5 million, or 8.4
percent, of the Company's total collected premiums in 1996 and are marketed
primarily through professional independent producers. 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, although 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.
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Traditional life. These products accounted for $182.2 million , or 5.7
percent, of the Company's total collected premiums in 1996. Traditional life
policies, including whole life and term life products, are primarily marketed
through professional independent producers. Under whole life policies, the
policyholder generally pays a level premium over the policyholders' expected
lifetime. The annual premium in a whole life policy is generally higher than the
premium for comparable term insurance coverage in the early years of the
policy's life, but is generally lower than comparable term insurance coverage in
the later years of the policy's life. These policies, which continue to be
marketed by the Company on a limited basis, combine insurance protection with a
savings component that increases in amount gradually over the life of the
policy. The policyholder may borrow against the savings, generally at a rate of
interest lower than that available from other lending sources. The policyholder
may also choose to surrender the policy and receive the accumulated cash value
rather than continuing the insurance protection. Term life products offer pure
insurance protection for a specified period of time -- typically one, five, 10
or 20 years.
Other
This segment includes miscellaneous health products, including Bankers
Life's comprehensive and group products. Bankers Life markets its group
insurance products through a small field force of representatives and
independent insurance brokerage firms. In recent years, Bankers Life has not
emphasized group insurance sales, but does write new business when the potential
new contract carries a high likelihood of profitability and long-term
persistency. During 1996, this segment collected premiums of $389.2 million.
When all currently consolidated companies are included for all periods,
including periods prior to their acquisition, this segment collected premiums of
$420.6 million, down 21 percent from 1995.
This segment also includes fee revenue generated by Conseco's nonlife
subsidiaries, including the investment advisory fees earned by Conseco Capital
Management, Inc. ("CCM") and commissions earned for insurance product marketing
and distribution. Fee revenues from Conseco's consolidated subsidiaries are
excluded. Total fees earned from nonaffiliates during 1996 were $49.8 million,
up 14 percent over 1995.
MARKETING AND DISTRIBUTION
Conseco's insurance subsidiaries are collectively licensed to market the
Company's insurance products in all states and in 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 the Company's 1996 collected
premiums: Illinois (10 percent), Florida (9.1 percent), California (8.7 percent)
, Texas (7.6 percent) and Michigan (6.6 percent).
Conseco believes that people generally purchase life, accident and health
insurance and annuity products only after being contacted and solicited by an
insurance agent. Accordingly, the success of the Company's distribution system
is dependent on its ability to attract and retain agents who are experienced and
highly motivated.
In order to encourage agents to place a high volume of life, accident and
health and annuity business with Conseco's subsidiaries, Conseco offers
commission rate bonuses and compensation awards which increase with the volume
of new business written. Conseco has formed a marketing subsidiary to coordinate
the marketing and distribution of its insurance companies and promote cross
selling of their products.
A description of the Company's primary distribution channels follows:
Career Agents. This agency force of approximately 2,800 agents working
from 200 branch offices, permits one-on-one contacts with potential
policyholders and promotes strong personal relationships with existing
policyholders. In 1996, career agents accounted for $1,263.0 million, or 39
percent, of the Company's total collected premiums. Most of these agents sell
only Conseco policies and typically visit the prospective policyholder's home to
conduct personalized "kitchen-table" sales presentations. After the sale of an
insurance policy, the agent serves as a contact person for policyholder
questions, claims assistance and additional insurance needs. The personalized
marketing and service efforts of the career field agents, supported by home
office persistency programs, have contributed to a persistency rate of
approximately 86 percent on Medicare supplement policies sold through this
channel. Although independent statistics are not available, the Company believes
its persistency rate is one of the highest among the major writers of such
policies.
Professional Independent Producers. This distribution channel consists of
a general agency and insurance brokerage distribution system comprised of
approximately 125,000 independent licensed agents doing business in all states.
In 1996, this channel accounted for $1,947.4 million, or 61 percent, of the
Company's total collected premiums.
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Professional independent producers are a diverse network of independent
agents, insurance brokers and marketing organizations. Marketing companies
typically recruit agents for Conseco by advertising the Company's products and
its commission structure through direct mail advertising, or through seminars
for insurance agents and brokers. These organizations bear most of the costs
incurred in marketing the Company's products. Conseco compensates 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
sales of flexible-premium annuities to educators.
A portion of the Company's business is distributed through a "Client
Company" marketing system, whereby agents and other insurance companies have
entered into agreements to market the Company's products through their
professional independent producer distribution systems. Under the agreements,
such groups assume up to 50 percent of the business each write (through agent
owned reinsurance companies or existing life insurance companies). Conseco
retains assets equal to the reserves of each Client Company and provides
substantially all administrative services for a fee. Of the Company's $3,210.4
million of collected premiums in 1996, 3.1 percent were collected by groups
participating in the Client Company program.
ADMINISTRATION
Conseco minimizes operating expenses by centralizing, standardizing and
more efficiently performing many functions common to most life insurance
companies. These functions include underwriting and policy administration,
accounting and financial reporting, marketing, regulatory compliance, actuarial
services and asset management.
The administration of the Company's individual health insurance products
involves higher volumes of claims, contacts with policyholders and operational
costs, compared to the administration of life insurance or annuity policies. In
1996, the Company processed more than 6.5 million individual health insurance
policyholder claims. Conseco has developed an efficient and highly automated
policyholder administration operation to minimize the costs of such large volume
processing and deliver a high level of service to its policyholders, with
special emphasis on the prompt payment of claims. In most cases, Conseco mails a
check within a week of receiving a claim from a policyholder. Conseco believes
that its promptness in processing policyholder claims is a major reason for its
strong reputation for service and the above-average persistency of its Medicare
supplement products.
INVESTMENTS
CCM, a registered investment adviser wholly owned by Conseco, manages the
investment portfolios of Conseco's subsidiaries. CCM had approximately $31.1
billion of assets (at fair value) under management at December 31, 1996, of
which $18.5 billion were assets of Conseco's subsidiaries and $12.6 billion were
assets of unaffiliated companies. CCM's investment philosophy is to maintain a
largely investment-grade fixed-income portfolio, provide adequate liquidity for
expected liability durations and other requirements and maximize total return
through active investment management.
Investment activities are an integral part of the Company's business;
investment income is a significant component of the Company's total revenues.
Profitability of many of the Company's products is significantly affected by
spreads between interest yields on investments and rates credited on insurance
liabilities. Although substantially all credited rates on SPDAs and FPDAs may be
changed annually, changes in crediting rates may not be sufficient to maintain
targeted investment spreads in all economic and market environments. In
addition, competition and other factors, including the impact of the level of
surrenders and withdrawals, may limit the Company's ability to adjust or to
maintain crediting rates at levels necessary to avoid narrowing of spreads under
certain market conditions. As of December 31, 1996, the average yield, computed
on the cost basis of the Company's investment portfolio, was 7.8 percent and the
average interest rate credited on the Company's interest sensitive products,
excluding interest bonuses guaranteed for the first year of the annuity contract
only, was 5.1 percent.
The Company seeks to balance the duration of its invested assets with the
expected duration of benefit payments arising from its insurance liabilities. At
December 31, 1996, the adjusted modified duration of fixed maturities and
short-term investments was approximately six years and the duration of the
Company's insurance liabilities was approximately seven years.
For information regarding the composition and diversification of the
investment portfolio of Conseco's subsidiaries, see "Management's Discussion and
Analysis of Consolidated Financial Condition and Results of Operations -
Investments" and note 3 to the consolidated financial statements.
8
COMPETITION
Conseco's businesses operate in a highly competitive environment. The
life insurance industry consists of a large number of insurance companies, some
of which are larger and have greater financial resources, broader and more
diversified product lines and larger staffs than those of Conseco. An expanding
number of banks, securities brokerage firms and other financial intermediaries
also market insurance products or offer competing products, such as mutual fund
products, traditional bank investments and other investment and retirement
funding alternatives. Conseco also competes with many of these companies and
others in providing services for fees. In most areas, competition is based on a
number of factors, including pricing, service provided to distributors and
policyholders, and ratings. Conseco's subsidiaries must also compete with other
insurers to attract and retain the allegiance of agents.
Financial institutions, school districts, marketing companies, agents who
market insurance products and policyholders use the financial strength ratings
assigned to an insurer by independent rating agencies as one factor in
determining which insurer's products to market or purchase. The following table
summarizes the ratings of the Company's primary life insurance companies:
Duffs & Phelps Standard &
A.M. Best Credit Rating Poor's
Company rating Company Corporation
- ------- ------ ------- -----------
ALC............................................................. A - A -
American Travellers............................................. A - BBB +
Bankers Life.................................................... A AA - BBBq
Beneficial Standard............................................. A A + BBBq
Great American Reserve.......................................... A A + BBBq
Lamar Life...................................................... A A + BBBq
Massachusetts General........................................... A A + BBq
Philadelphia Life............................................... A A + Aq
Transport Life.................................................. A - BBBq
A.M. Best Company ("A.M. Best") insurance company ratings for the
industry currently range from "A++ (Superior)" to "F (In Liquidation)".
Publications of A.M. Best indicate that the "A" and "A-" ratings are assigned to
those companies that, in A.M. Best's opinion, have demonstrated excellent
overall performance when compared to the standards established by A.M. Best and
have demonstrated a strong ability to meet their obligations to policyholders
over a long period of time. A.M. Best's rating procedure includes quantitative
and qualitative evaluations of a company's financial condition and operating
performance. Its quantitative evaluation is based on an analysis of a company's
financial performance in the areas of profitability, leverage/capitalization and
liquidity. A.M. Best's review also includes a qualitative evaluation of a
company's spread of risk, quality and appropriateness of the reinsurance
program, quality and diversification of assets, adequacy of policy or loss
reserves, management experience and objectives, market presence and
policyholders' confidence.
After the LPG Merger in August 1996, A.M. Best upgraded the ratings of
Bankers Life, Great American Reserve and Beneficial Standard to "A" (Excellent)
from "A-" (Excellent). In addition, A.M. Best affirmed the "A" (Excellent)
ratings of Philadelphia Life, Massachusetts General and Lamar Life and affirmed
the "A-" (Excellent) rating of ALC. Among the reasons A.M. Best cited for the
ratings upgrades and reaffirmations were the benefits Conseco will derive as a
result of the LPG Merger including: (i) improved unit costs arising from the
integration of administrative, financial, investment, marketing and underwriting
functions; (ii) expanded distribution capacity and increased cross-selling
opportunities; and (iii) a more diversifed product portfolio that should
generate more balanced and predictable revenue and earnings sources. A.M. Best
also views favorably the continuing improvement in Conseco's financial leverage
and Conseco's commitment to maintain debt/total capital at or below 35 percent.
Duff & Phelps' Credit Rating Company claims-paying ability ratings range
from "AAA (Highest claims-paying ability)" to "DD (Company is under an order of
liquidation)." An "AA-" rating represents "Very high claims paying ability."
Publications of Duff & Phelps indicate that the "A+" rating represents "High
claims-paying ability". A plus or minus sign attached to a Duff & Phelps claims
paying rating shows relative standing within a ratings category.
9
Standard & Poor's Corporation ("Standard & Poor's") claims-paying ability
ratings range from "AAA (Superior)" to "R (Regulatory Action)". An "A" is
assigned by Standard & Poor's to those companies which, in its opinion, have a
secure claims-paying ability and whose financial capacity to meet policyholder
obligations is viewed on balance as sound, but their capacity to meet such
policyholder obligations is somewhat more susceptible to adverse changes in
economic or underwriting conditions than more highly rated insurers. A "BBB" is
assigned by Standard & Poor's to those companies which, in its opinion, have
adequate financial security, but their capacity to meet policyholder obligations
is susceptible to adverse economic and underwriting conditions. A "BB" is
assigned by Standard & Poor's to those companies which, in its opinion, have
adequate financial security, but their capacity to meet policyholder
obligations, particularly with respect to long-term or "long-tail" policies, is
vulnerable to adverse economic and underwriting conditions. According to
Standard & Poor's, a minus sign attached to a Standard & Poor's claims-paying
rating shows relative standing within a ratings category. A "q" subscript
indicates that the rating is based solely on quantitative analysis of publicly
available financial data.
Generally, rating agencies base their ratings upon information furnished
to them by the insurer and upon their own investigations, studies and
assumptions. A.M. Best's ratings, Duff & Phelps' claims-paying ratings and
Standard & Poor's claims-paying ratings are principally based upon factors of
concern to policyholders, agents and intermediaries and are not directed toward
the protection of investors. Given the competitive nature of the Company's
business and the increasing focus placed on the aforementioned ratings, the
Company manages its business with the objective of preserving existing ratings
and, where possible, achieving more favorable ratings. There can be no assurance
that any particular rating will continue for any given period of time, or that
it will not be changed or withdrawn entirely if, in the judgement of the rating
agency, circumstances so warrant. If the Company's ratings were downgraded from
their current levels, sales of its products and the persistency of its in-force
policies could be adversely affected in a material way.
In the individual health insurance business, insurance companies compete
primarily on the basis of marketing, service and price. The provisions of the
Omnibus Budget Reconciliation Act of 1984 and the work of the National
Association of Insurance Commissioners ("NAIC") (an association of state
regulators and their staffs) have resulted in standardized policy features for
Medicare supplement products. This increases the comparability of such policies
and may intensify competition based on factors other than product features. See
"Underwriting" and "Government Regulation." In addition to the products of other
insurance companies, the Company's health insurance products compete with health
maintenance organizations, preferred provider organizations, and other health
care-related institutions which provide medical benefits based on contractual
agreements.
The Company believes that its insurance companies are able to compete
effectively because: (i) they emphasize specialized distribution channels, where
the ability to respond rapidly to changing customer needs yields a competitive
edge; (ii) they are experienced in establishing and cultivating relationships
with the unique distribution networks and the independent marketing companies
operating in these specialized markets; (iii) they can offer competitive rates
as a result of their lower-than-average operating costs and higher-than-average
investment yields achieved by applying active investment portfolio management
techniques; and (iv) they have reliable policyholder administrative services,
supported by customized information technology systems.
UNDERWRITING
Under regulations promulgated by the NAIC and adopted as a result of the
Omnibus Budget Reconciliation Act of 1990, the Company is prohibited from
underwriting its 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. 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, Conseco generally applies detailed underwriting
procedures designed to assess and quantify the insurance risks. Conseco requires
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.
Conseco also relies on medical records and the potential policyholder's written
application.
Substantially all the life insurance policies issued by Conseco are
underwritten individually, although standardized underwriting procedures have
been adopted for certain low face-amount life insurance coverages. After initial
processing, insurance underwriters review each file and obtain the information
needed to make an underwriting decision (such as medical examinations, doctors'
statements and special medical tests). After collecting and reviewing the
information, the underwriter either: (i) approves the policy as applied for, or
with an extra premium charge because of unfavorable factors; or (ii) rejects the
application. Conseco underwrites group insurance policies based on the
characteristics of the group and its past claim experience. There is minimal
underwriting on SPDAs and FPDAs.
10
REINSURANCE
Consistent with the general practice of the life insurance industry, the
Company's 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 their 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. The
Company believes the assuming companies are able to honor all contractual
commitments, based on the Company's periodic reviews of their financial
statements, insurance industry reports and reports filed with state insurance
departments.
As of December 31, 1996, the policy risk retention limit was $.8 million
or less on all of the policies of the Company's subsidiaries. Reinsurance ceded
by Conseco represented 23 percent of gross combined life insurance in force and
reinsurance assumed represented 4.6 percent of net combined life insurance in
force. At December 31,1996, the total ceded business inforce of $22.3 billion
included: (i) $5.5 billion ceded to Client Companies for which Conseco retains
assets equal to the reserves on the business ceded; (ii) $13.0 billion ceded to
insurance companies rated "A (Excellent)" or better by A.M. Best, and (iii) $2.9
billion ceded to American Equity Investment Life Insurance Company, which is not
rated because, according to A.M. Best, it did not have sufficient operating
history to evaluate its performance. The Company's principal reinsurers at
December 31, 1996 (which assume approximately 60 percent of the total ceded
business inforce, excluding business ceded to the Client Companies) were
American Equity Investment Life Insurance Company, Connecticut General Life
Insurance Company, Life Reassurance Corporation of America, Lincoln National
Life Insurance Company, Reliance Standard Life Insurance Company and Mercantile
and General Life Reassurance Company. No other single reinsurer assumes greater
than 5 percent of the total ceded business inforce.
EMPLOYEES
At December 31, 1996, Conseco had approximately 3,700 employees,
including: (i) 1,850 home office employees; (ii) 1,250 employees in the Chicago
office (primarily involved with the Company's supplemental health operations);
and (iii) 600 employees in branch offices (primarily supporting the Company's
career agency force). None of the Company's employees are covered by a
collective bargaining agreement. Conseco believes that it has excellent
relations with its employees.
GOVERNMENTAL REGULATION
General
Conseco's insurance subsidiaries are subject to regulation and
supervision by the states in which they transact business. State laws generally
establish supervisory agencies with broad regulatory authority, including the
power to: (i) grant and revoke business licenses; (ii) regulate and supervise
trade practices and market conduct; (iii) establish guaranty associations; (iv)
license agents; (v) approve policy forms; (vi) approve premium rates for some
lines of business; (vii) establish reserve requirements; (viii) prescribe the
form and content of required financial statements and reports; (ix) determine
the reasonableness and adequacy of statutory capital and surplus; and (x)
regulate the type and amount of permitted investments. The Company's insurance
subsidiaries are subject to periodic examinations by state regulatory
authorities. Management does not expect the results of any on-going examinations
to have a material effect on the financial condition of the Company.
Most states have also enacted regulations on the activities of insurance
holding company systems, including acquisitions, extraordinary dividends, the
terms of surplus debentures, the terms of affiliate transactions, and other
related matters. Currently, the Company and its insurance subsidiaries have
registered as holding company systems pursuant to such legislation in the
domiciliary states of the insurance subsidiaries (Alabama, California, Illinois,
Iowa, Kentucky, Massachusetts, Missouri, New York, Pennsylvania, Tennessee and
Texas) and they routinely report to other jurisdictions. Recently, a number of
state legislatures have considered or have enacted legislative proposals that
alter, and in many cases increase, the authority of state agencies to regulate
insurance companies and holding company systems. For further information on
state laws regulating the payment of dividends by insurance company
subsidiaries, see "Management's Discussion and Analysis of Consolidated
Financial Position and Results of Operations - Consolidated Financial Condition"
and note 13 to Conseco's consolidated financial statements.
The federal government does not directly regulate the insurance business.
However, federal legislation and administrative policies in several areas,
including pension regulation, age and sex discrimination, financial services
regulation and federal taxation, do affect the insurance business. In addition,
legislation has been introduced from time to time in recent years which, if
enacted, could result in the federal government assuming a more direct role in
the regulation of the insurance industry.
11
In December 1992, the NAIC adopted the Risk-Based Capital for Life and/or
Health Insurers Model Act (the "Model Act"). The Model Act provides a tool for
insurance regulators to determine the levels of capital and surplus an insurer
must maintain in relation to its insurance and investment risks and whether
there is a need for possible regulatory attention. The Model Act (or similar
legislation or regulation) has been adopted in states where the Company's
insurance subsidiaries are domiciled.
The Model Act provides for four levels of regulatory attention, varying
with the ratio of the company's total adjusted capital (defined as the total of
its statutory capital, surplus, asset valuation reserve and certain other
adjustments) to its risk-based capital ("RBC"). If a company's total adjusted
capital is less than 100 percent but greater than or equal to 75 percent of its
RBC, or if a negative trend (as defined by the regulators) has occurred and
total adjusted capital is less than 125 percent of RBC (the "Company Action
Level"), the company must submit a comprehensive plan to the regulatory
authority proposing corrective actions aimed at improving its capital position.
If a company's total adjusted capital is less than 75 percent but greater than
or equal to 50 percent of its RBC (the "Regulatory Action Level") , the
regulatory authority will perform a special examination of the company and issue
an order specifying corrective actions that must be followed. If a company's
total adjusted capital is less than 50 percent but greater than or equal to 35
percent of its RBC (the "Authorized Control Level"), the regulatory authority
may take any action it deems necessary, including placing the company under
regulatory control. If a company's total adjusted capital is less than 35
percent of its RBC (the "Mandatory Control Level") the regulatory authority must
place the company under its control. At December 31, 1996, the total adjusted
capital for each of Conseco's principal insurance subsidiaries was approximately
equal to or greater than twice the respective Company Action Levels.
The Texas Insurance Department has adopted its own RBC requirements, the
stated purpose of which is to require a minimum level of capital and surplus to
absorb the financial, underwriting, and investment risks assumed by an insurer.
Texas' RBC requirements differ from those adopted by the NAIC in two principal
respects: (i) they use different elements to determine minimum RBC levels in
their calculation formulas; and (ii) they do not stipulate "Action Levels" (like
those adopted by the NAIC) where corrective actions are required. However, the
Commissioner of the Texas Insurance Department does have the power to take
similar corrective actions if a company does not maintain the required minimum
level of capital and surplus. Under the Texas Regulations, an insurer has met
RBC requirements if its admitted assets exceed its liabilities by at least 3
percent. Bankers National, Great American Reserve, United General, TLIC Life,
Transport Life and Continental Life are domiciled in Texas and must comply with
Texas RBC requirements. At December 31, 1996, the admitted assets of these
companies exceeded liabilities by more than twice the required 3 percent level.
Most states have either enacted legislation or adopted administrative
regulations which affect the acquisition of control of insurance companies as
well as transactions between insurance companies and persons controlling them.
The nature and extent of such legislation and regulations vary from state to
state. Most states, however, require administrative approval of: (i) the
acquisition of 10 percent or more of the outstanding shares of an insurance
company incorporated in the state; or (ii) the acquisition of 10 percent or more
of the outstanding stock of an insurance holding company whose insurance
subsidiary is incorporated in the state. The acquisition of 10 percent of such
shares is generally deemed to be the acquisition of control for the purpose of
the holding company statutes. These regulations require the acquirer to file
detailed information concerning the acquiring parties and the plan of
acquisition, and to obtain administrative approval prior to the acquisition. In
many states, however, an insurance authority may determine that control does not
exist, even in circumstances in which a person owns or controls 10 percent or a
greater amount of securities.
On the basis of statutory statements filed with state regulators
annually, the NAIC calculates twelve 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 the Company's insurance subsidiaries have resulted in inquiries from
insurance departments to which the Company has responded. Such inquiries did not
lead to any restrictions affecting the Company's operations.
Under the solvency or guaranty laws of most states in which they do
business, Conseco's insurance subsidiaries may be required to pay guaranty fund
assessments (up to certain prescribed limits). Guaranty funds are established by
various states to fund policyholder losses or the liabilities of insolvent or
rehabilitated insurance companies. These assessments may be deferred or forgiven
under most guaranty laws if they would threaten an insurer's financial strength.
In certain instances, the assessments may be offset against future premium
taxes. The Company believes that the liability established at December 31, 1996,
is sufficient to provide for assessments related to known insolvencies. This
reserve is based upon management's current expectation of the availability of
this right of offset and state guaranty fund assessment bases. However, changes
in the basis whereby assessments are charged to individual companies or changes
to the availability of the right to offset assessments against premium tax
payments could materially affect the Company's results. The Company's insurance
subsidiaries statutory financial statements for the year ended December 31,
1996, include $11.3 million of expenses as a result of such assessments.
12
Health Care
Most states mandate minimum benefit standards and loss ratios for
accident and health insurance policies. The Company is generally required to
maintain, with respect to its individual long term care policies, minimum
anticipated loss ratios over the entire period of coverage of not less than 60
percent. With respect to its Medicare supplement policies, the Company is
generally required to attain and maintain an actual loss ratio, after three
years, of not less than 65 percent. The Company provides, to the insurance
departments of all states in which it conducts 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 the
Company has failed to maintain minimum mandated loss ratios, it could be
required to provide retrospective refunds and/or prospective rate reductions.
The Company believes that it currently complies with all applicable mandated
minimum loss ratios.
NAIC model regulations, adopted by all states, created 10 standard
Medicare supplement plans (Plans A through J). Plan A provides the least
extensive coverage, while Plan J provides the most extensive coverage. Under
NAIC regulations, Medicare insurers must offer Plan A, but may offer any of the
other plans at their option. Conseco currently offers nine of the model plans.
Conseco has declined to offer Plan J, due in part to its high benefit levels and
consequently high costs to the consumer.
Numerous proposals to reform the current health care system have been
introduced in Congress and the state legislatures. Proposals have included,
among other things, modifications to the existing employer-based insurance
system, a quasi-regulated system of "managed competition" among health plans,
and a single-payer, public program. Changes in health care policy could
significantly affect Conseco's business. Federal comprehensive major medical or
long-term care programs, if proposed and implemented, could partially or fully
replace some of Conseco's current products, for example.
A number of states have passed or are considering legislation that would
limit the differentials in rates that insurers could charge for health care
coverages between new business and renewal business for similar demographic
groups. State legislation has also been adopted or is being considered that
would make health insurance available to all small groups by requiring coverage
of all employees and their dependents, by limiting the applicability of
pre-existing conditions exclusions, by requiring insurers to offer a basic plan
exempt from certain benefits as well as a standard plan, or by establishing a
mechanism to spread the risk of high risk employees to all small group insurers.
The NAIC recently adopted model long-term care policy language providing
nonforfeiture benefits and has proposed a rate stabilization standard for
long-term care policies. Various bills proposed in the U.S. Congress would
provide for the implementation of certain minimum consumer protection standards
for inclusion in all long-term care policies, including guaranteed renewability,
protection against inflation and limitations on waiting periods for pre-existing
conditions. Other recently adopted legislation permits premiums paid for
long-term care insurance to be treated as tax-deductible medical expenses.
The Company cannot predict with certainty the effect that any proposals,
if adopted, or legislative developments could have on its business and
operations.
FEDERAL INCOME TAXATION
The annuity and life insurance products marketed and issued by Conseco's
subsidiaries generally provide the policyholder with an income tax advantage, as
compared to other saving investments such as certificates of deposit and bonds,
in that income taxation on the increase in value of the product is deferred
until it is received by the policyholder. With other savings investments, the
increase in value is taxed as earned. Annuity benefits, and life insurance
benefits which accrue prior to the death of the policyholder, are generally not
taxable until paid. Life insurance death benefits are generally exempt from
income tax. Also, benefits received on immediate annuities (other than
structured settlements) are recognized as taxable income ratably, as opposed to
the methods used for some other investments which tend to accelerate taxable
income into earlier years. The tax advantage for annuities and life insurance is
provided in the Internal Revenue Code (the "Code"), and is generally followed in
all states and other United States taxing jurisdictions. Accordingly, the tax
advantage is subject to change by Congress and by the legislatures of the
respective taxing jurisdictions.
13
Conseco's insurance company subsidiaries are taxed under the life
insurance company provisions of the Code. Provisions in the Code require a
portion of the expenses incurred in selling insurance products to be deducted
over a period of years, as opposed to immediate deduction in the year incurred.
This provision increases the tax for statutory accounting purposes, which
reduces statutory surplus and, accordingly, decreases the amount of cash
dividends that may be paid by the life insurance subsidiaries. As of December
31, 1996, the cumulative taxes paid as a result of this provision were $175.2
million.
The Company had tax loss carryforwards at December 31, 1996, of
approximately $441.1 million, portions of which begin expiring in 1999. However,
the amount of such loss that may be offset against current taxable income is
subject to the following limitations: (i) losses may be offset against income of
other corporate entities only if such entities are included in the same
consolidated tax return (insurance companies are currently not eligible for
inclusion in Conseco's consolidated tax return until five years after they are
acquired); (ii) losses incurred in non-life companies (which comprise most of
the loss carryforwards) may offset only a portion of income from life companies
in the same consolidated tax return; and (iii) some loss carryforwards may not
be used to offset taxable income of entities acquired after the loss was
incurred. The Company, however, believes it will be able to utilize all current
loss carryforwards before they expire.
ITEM 2. PROPERTIES.
The Company's principal operations are located on a 170-acre corporate
campus in Carmel, Indiana, immediately north of Indianapolis. These facilities
contain approximately 525,000 square feet of space in eight buildings which
contain Conseco's executive offices and certain administrative operations of its
subsidiaries. These facilities include sufficient capacity for future growth.
Conseco's supplemental health products are primarily administered from a
single facility of 300,000 square feet in downtown Chicago leased under
agreement with a remaining life of 11 years. Conseco also leases approximately
130,000 square feet of warehouse space in a second Chicago facility with a
remaining life of six years. Conseco leases 210 sales offices totaling
approximately 363,000 square feet. All of the sales office leases are short-term
in length, with remaining lease terms ranging from one to five years.
ITEM 3. LEGAL PROCEEDINGS.
Conseco and its subsidiaries are involved in lawsuits primarily related
to their operations. Most of these lawsuits involve claims under insurance
policies or other contracts of the Company. Even though Conseco may be
contesting the validity or extent of its liability in response to such lawsuits,
the Company has established reserves in its consolidated financial statements
for its estimated potential liability and cost of defense. Accordingly, none of
the lawsuits currently pending, either individually or in the aggregate, is
expected to have a material adverse effect on the Company's consolidated
financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On November 26, 1996, Conseco held a special meeting of shareholders to
approve and adopt an Agreement and Plan of Merger dated as of August 25, 1996
between Conseco and American Travellers Corporation. Shareholders cast
52,395,561 votes for and 77,148 votes against the ATC Merger, and there were
345,620 abstentions.
14
OPTIONAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT.
Officer Positions with Conseco, principal
name and age (a) Since occupation and business experience (b)
---------------- ----- --------------------------------------
Stephen C. Hilbert, 51......... 1979 Since 1979, Chairman of the Board and Chief Executive Officer and, since
1988, President of Conseco.
Ngaire E. Cuneo, 46 ........... 1992 Since 1992, Executive Vice President, Corporate Development and, since
1994, Director of Conseco; from 1986 to 1992, Senior Vice President and
Corporate Officer of General Electric Capital Corporation.
Rollin M. Dick, 65............. 1986 Since 1986, Executive Vice President, Chief Financial Officer and Director of
Conseco.
Donald F. Gongaware, 61........ 1985 Since 1985, Executive Vice President and Director of Conseco; since 1989,
Chief Operations Officer of Conseco; and, since 1996, President of Conseco
Marketing, LLC.
Lawrence W. Inlow, 46.......... 1986 Since 1986, Executive Vice President and General Counsel of Conseco.
- -------------------
(a) The executive officers serve as such at the discretion of the Board of
Directors and are elected at the annual meeting of the Board.
(b) Business experience is given for at least the last five years.
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
MARKET INFORMATION
The common stock of Conseco (trading symbol "CNC") has been listed for
trading on the New York Stock Exchange (the "NYSE") since 1986. The following
table sets forth the quarterly dividends paid per share and the ranges of high
and low sales prices per share on the NYSE for the last two fiscal years, based
upon information supplied by the NYSE. All applicable per share data have been
adjusted for the two-for-one stock splits distributed April 1, 1996, and
February 11, 1997.
Period Market price
------ ------------ Dividend
High Low paid
---- --- ----
1995:
First Quarter...................................... $12-5/32 $ 8-1/8 $.03125
Second Quarter..................................... 11-21/32 9-25/32 .03125
Third Quarter...................................... 13-5/16 11-3/8 .005
Fourth Quarter..................................... 15-25/32 12-23/32 .005
1996:
First Quarter...................................... $18-5/32 $14-15/16 $.005
Second Quarter..................................... 20-3/8 17-3/8 .01
Third Quarter...................................... 24-11/16 17-5/8 .01
Fourth Quarter..................................... 33-1/8 24-7/16 .03125
As of March 14, 1997, there were approximately 72,000 holders of the
outstanding shares of common stock, including individual participants in
securities position listings.
DIVIDENDS
Cash dividends are paid quarterly, at an amount determined by Conseco's
Board of Directors. The Company's general policy is to retain most of its
earnings. Retained earnings have been used: (i) to finance the growth and
development of the Company's business through acquisitions or otherwise; (ii) to
pay preferred stock dividends; (iii) to pay distributions on the
Company-obligated mandatorily redeemable preferred stock of subsidiary trusts;
and (iv) to repurchase common stock on those occasions when the Company has
determined that its shares were undervalued in the market and that the use of
funds for stock repurchases would not interfere with other cash needs.
Conseco has paid all cumulative dividends on its preferred stock and
distributions on its Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts when due. The Company is prohibited from paying
common stock dividends if such payments are not current.
Conseco's ability to pay dividends depends primarily on the receipt of
cash dividends and other cash payments from its subsidiaries. The principal
operating subsidiaries of Conseco are life insurance companies organized under
state laws and subject to regulation by state insurance departments. These laws
and regulations limit the ability of insurance subsidiaries to make cash
dividends, loans or advances to a holding company such as Conseco. However,
these laws generally permit the payment, without prior approval, of annual
dividends which in the aggregate do not exceed the greater of (or in a few
states, the lesser of): (i) the subsidiary's prior year net gain from
operations; or (ii) 10 percent of surplus attributable to policyholders at the
prior year-end, both computed on the statutory basis of accounting prescribed
for insurance companies. Certain Conseco notes payable require the Company to
maintain financial ratios which could also limit its ability to pay dividends.
See "Management's Discussion and Analysis of Results of Operations and Financial
Condition -- Liquidity and Capital Resources."
16
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA (a).
Years ended December 31,
------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(Amounts in millions, except per share data)
STATEMENT OF OPERATIONS DATA
Insurance policy income..................................... $1,654.2 $1,465.0 $1,285.6 $1,293.8 $378.7
Net investment income....................................... 1,302.5 1,142.6 385.7 896.2 888.6
Net investment gains (losses) .............................. 30.4 188.9 (30.5) 242.6 160.2
Total revenues.............................................. 3,067.3 2,855.3 1,862.0 2,636.0 1,523.9
Interest expense on notes payable........................... 108.1 119.4 59.3 58.0 46.2
Total benefits and expenses................................. 2,573.7 2,436.8 1,537.6 2,025.8 1,193.9
Income before income taxes, minority interest and
extraordinary charge...................................... 493.6 418.5 324.4 610.2 330.0
Extraordinary charge on extinguishment of debt, net of tax.. 26.5 2.1 4.0 11.9 5.3
Net income.................................................. 252.4 220.4 150.4 297.0 169.5
Preferred dividends......................................... 27.4 18.4 18.6 20.6 5.5
Net income applicable to common stock....................... 225.0 202.0 131.8 276.4 164.0
PER SHARE DATA (b)
Net income, primary......................................... $1.91 $ 2.35 $ 1.25 $ 2.36 $ 1.36
Net income, fully diluted................................... 1.77 2.11 1.22 2.19 1.35
Dividends declared per common share......................... .083 .046 .125 .075 .021
Book value per common share outstanding..................... 16.86 10.22 5.22 8.45 5.46
Shares outstanding at year-end.............................. 167.1 81.0 88.7 101.2 99.6
Average fully diluted shares outstanding.................... 142.5 104.5 123.4 134.0 118.4
BALANCE SHEET DATA - PERIOD END
Total assets................................................ $25,612.7 $17,297.5 $10,811.9 $13,749.3 $11,772.7
Notes payable for which Conseco is directly liable.......... 1,094.9 871.4 191.8 413.0 163.2
Notes payable of affiliates, not direct
obligations of Conseco................................... - 584.7 611.1 290.3 392.0
Total liabilities........................................... 21,829.7 15,782.5 9,743.2 12,382.9 11,154.4
Minority interests in consolidated subsidiaries:
Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts.............. 600.0 - - - -
Preferred stock........................................... 97.0 110.7 130.1 - -
Common stock.............................................. .7 292.6 191.6 223.8 24.0
Shareholders' equity ....................................... 3,085.3 1,111.7 747.0 1,142.6 594.3
OTHER FINANCIAL DATA (b) (c)
Premiums collected (d)...................................... $3,210.4 $3,106.4 $1,879.1 $2,140.1 $1,464.9
Operating earnings (e)...................................... 267.7 131.3 151.7 162.0 114.8
Operating earnings per fully diluted common share (e)....... 1.89 1.26 1.23 1.19 .90
Shareholders' equity excluding unrealized appreciation
(depreciation) of fixed maturity securities (f)........... 3,045.5 999.1 884.7 1,055.2 560.3
Book value per common share outstanding, excluding
unrealized appreciation (depreciation) of fixed
maturity securities (f)................................... 16.62 8.83 6.77 7.58 5.12
(a) Comparison of selected consolidated financial data in the table above is
significantly affected by: (i) the acquisitions consummated by Partnership I
and Partnership II; (ii) the sale of WNC; (iii) the transactions affecting
Conseco's ownership interest in BLH and CCP; (iv) the LPG Merger; (v) the
ATC Merger; and (vi) the THI Merger. For periods beginning with their
acquisitions by Partnership I and ending June 30, 1992, Partnership I and
its subsidiaries were consolidated with the financial statements of Conseco.
Following the completion of the initial public offering by CCP in July 1992,
Conseco did not have unilateral control to direct all of CCP's activities
and, therefore, did not consolidate the financial statements of CCP with the
financial statements of Conseco. As a result of the purchase by Conseco of
all the shares of common stock of CCP it did not already own on August 31,
1995 (the "CCP Merger"), the financial statements of CCP's subsidiaries are
consolidated with the
17
financial statements of Conseco, effective January 1, 1995. Conseco has
included BLH in its financial statements since November 1, 1992. Through
December 31, 1993, the financial statements of WNC were consolidated with
the financial statements of Conseco. Following the completion of the initial
public offering of WNC in early 1994 (and subsequent disposition of
Conseco's remaining equity interest in WNC), the financial statements of WNC
were no longer consolidated with the financial statements of Conseco. As of
September 29, 1994, Conseco began to include in its financial statements the
newly acquired Partnership II subsidiary, ALH. On September 30, 1996,
Conseco acquired all of the common stock of ALH which Conseco did not
already own from Partnership II. As of July 1, 1996, Conseco began to
include in its financial statements its newly acquired subsidiary, LPG.
Effective December 31, 1996, Conseco began to include in its balance sheet
the subsidiaries acquired in the ATC Merger and the THI Merger. Such
business combinations are described in the notes to the consolidated
financial statements.
(b) All share and per-share amounts have been restated to reflect the
two-for-one stock splits paid on April 1, 1996 and February 11, 1997.
(c) Amounts under this heading are included to assist the reader in analyzing
the Company's financial position and results of operations. Such amounts are
not intended to, and do not, represent insurance policy income, net income,
net income per share, shareholders' equity or book value per share prepared
in accordance with generally accepted accounting principles ("GAAP").
(d) Includes premiums received from universal life and products without
mortality or morbidity risk. Such premiums are not reported as revenues
under GAAP and were $1,811.5 million in 1996; $1,757.4 million in 1995;
$634.6 million in 1994; $891.9 million in 1993; and $1,131.8 million in
1992.
(e) Represents income before extraordinary charge, excluding net investment
gains (losses) (less that portion of change in future policy benefits,
amortization of cost of policies purchased and cost of policies produced and
income taxes relating to such gains) and restructuring activities (net of
income taxes).
(f) Excludes the effects of reporting fixed maturities at fair value and
recording the unrealized gain or loss on such securities as a component of
shareholders' equity, net of tax and other adjustments. Such adjustments,
which the Company began to do in 1992, are in accordance with Statement of
Financial Accounting Standards No. 115 "Accounting for Certain Investments
in Debt and Equity Securities" ("SFAS 115"), as described in note 1 to the
consolidated financial statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
Management's discussion and analysis reviews the consolidated financial
condition of Conseco at December 31, 1996 and 1995, the consolidated results of
operations for the three years ended December 31, 1996, and, where appropriate,
factors that may affect future financial performance. This discussion should be
read in conjunction with the accompanying consolidated financial statements,
notes thereto and selected financial data.
The Company cautions readers regarding certain forward-looking statements
contained in the following discussion and elsewhere in this report and in any
other statements made by, or on behalf of, the Company, whether or not in future
filings with the Securities and Exchange Commission ("SEC"). Forward-looking
statements are statements not based on historical information. They relate to
future operations, strategies, financial results or other developments. In
particular, statements using verbs such as "expect," "anticipate," "believe" or
similar words generally involve forward-looking statements. Forward-looking
statements include statements that represent the Company's beliefs concerning
future or projected levels of sales of the Company's products, investment
spreads or yields, or the earnings or profitability of the Company's activities.
Forward-looking statements are based upon estimates and assumptions that
are subject to significant business, economic and competitive uncertainties,
many of which are beyond the Company's control and are subject to change. These
uncertainties can affect actual results and could cause actual results to differ
materially from those expressed in any forward-looking statements made by, or on
behalf of, the Company. Whether or not actual results differ materially from
forward-looking statements may depend on numerous foreseeable and unforeseeable
events or developments, some of which may be national in scope, such as general
economic conditions and interest rates. Some of these events may be related to
the insurance industry generally, such as pricing competition, regulatory
developments and industry consolidation. Others may relate to Conseco
specifically, such as credit, volatility and other risks associated with the
Company's investment portfolio, and other factors. Investors are also directed
to consider other risks and uncertainties discussed in documents filed with the
SEC. Conseco disclaims any obligation to update forward-looking information.
18
Consolidated Results and Analysis
Conseco's 1996 operating earnings were $267.7 million, or $1.89 per fully
diluted share, up 104 percent and 50 percent, respectively, over 1995. Operating
earnings increased as a result of the LPG Merger, the ALH Stock Purchase, the
full-year effect of the CCP Merger, the effect of increased ownership of BLH as
a result of purchases of BLH common stock during 1995 and 1996, and profit
improvements in each of the Company's segments. Operating earnings for 1996 were
not affected by the ATC Merger, the THI Merger or the BLH Merger, all of which
were recorded as of December 31, 1996. The percentage increase in operating
earnings was greater than the increase in operating earnings per fully diluted
share primarily because of the additional common shares or equivalents
outstanding in 1996 resulting from: (i) the LPG Merger; and (ii) the Company's
January 1996 offering of PRIDES, which are mandatorily convertible into shares
of Conseco common stock.
Conseco's 1995 operating earnings were $131.3 million, or $1.26 per fully
diluted share, down 13 percent and up 2 percent, respectively, from 1994.
Operating earnings decreased primarily because capital was used to repurchase
shares of common stock during 1994 and 1995 (Conseco repurchased 21.6 million of
its shares at a cost of $267 million from March 31, 1994 to February 1, 1995).
This decrease was partially offset by increased earnings from the CCP Merger and
the increased ownership of BLH as a result of purchases of BLH common stock
during 1995. Operating earnings per fully diluted share increased despite the
decline in operating earnings because of the smaller number of weighted average
common shares outstanding in 1995.
Net income of $252.4 million in 1996, or $1.77 per fully diluted share,
included: (i) net investment losses (net of related costs, amortization and
taxes) of $6.2 million, or 5 cents per fully diluted share; (ii) restructuring
income totaling $17.4 million, or 12 cents per share, primarily arising from the
sale of Conseco's investment in Noble Broadcast Group, Inc.; and (iii) an
extraordinary charge of $26.5 million, or 19 cents per share, related to early
retirement of debt. Net income of $220.4 million in 1995, or $2.11 per fully
diluted share, included: (i) net investment gains (net of related costs,
amortization and taxes) of $4.1 million, or 4 cents per share; (ii)
restructuring income of $87.1 million, or 83 cents per share, primarily arising
from the release of deferred income taxes previously accrued on income related
to CCP and BLH (such deferred tax was no longer required when Conseco reached 80
percent ownership of these companies) and the sale of Conseco's investment in
Eagle Credit (a finance subsidiary of Harley-Davidson); and (iii) an
extraordinary charge of $2.1 million, or 2 cents per share, related to early
retirement of debt. Net income of $150.4 million in 1994, or $1.22 per fully
diluted share, included: (i) net investment losses (net of related costs,
amortization and taxes) of $20.5 million, or 17 cents per share; (ii)
restructuring income of $23.2 million, or 19 cents per share, resulting from the
sale of WNC, net of expenses incurred in conjunction with a terminated merger;
and (iii) an extraordinary charge of $4.0 million, or 3 cents per share, related
to early retirement of debt.
Total revenues include net investment gains (losses) of $30.4 million in
1996, $188.9 million in 1995 and ($30.5) million in 1994. Excluding net
investment gains (losses), total revenues were $3.0 billion in 1996, up 11
percent from $2.7 billion in 1995. Total revenues in 1996 include: (i) LPG
revenues after July 1, 1996, the effective date of the LPG Merger; and (ii)
restructuring income of $30.4 million, primarily arising from the sale of
Conseco's investment in Noble Broadcast Group, Inc. Total revenues excluding net
investment gains (losses) were up 42 percent in 1995, from $1.9 billion in 1994.
Total revenues in 1995 include: (i) a full year of revenues from ALH, which was
acquired on September 29, 1994; (ii) a full year of the revenues of CCP's
subsidiaries, which Conseco began to consolidate effective January 1, 1995; and
(iii) restructuring income of $15.2 million. Total revenues in 1994 include
restructuring income of $80.8 million and equity in earnings of WNC and CCP of
$64.9 million.
19
Results of Operations by Segment for the Three Years ended December 31,
1996:
The following tables and narratives summarize the Company's results of
operations by business segment.
1996 1995 1994
---- ---- ----
(Dollars in millions)
Income before income taxes, minority interest and extraordinary charge:
Annuities:
Operating income .......................................................... $ 255.0 $ 244.1 $ 67.1
Net investment gains (losses), net of related costs and amortization ...... (.7) 72.0 (7.3)
------- ------- -------
Income before income taxes, minority interest and extraordinary charge 254.3 316.1 59.8
------- ------- -------
Supplemental health:
Operating income........................................................... 136.7 96.1 107.8
Net investment gains, net of related costs and amortization................ .2 1.1 -
------- ------- -------
Income before income taxes, minority interest and extraordinary charge 136.9 97.2 107.8
------- ------- -------
Life insurance:
Operating income........................................................... 131.2 81.9 52.2
Net investment losses, net of related costs and amortization............... (1.9) (4.8) (13.1)
------- ------- -------
Income before income taxes, minority interest and extraordinary charge 129.3 77.1 39.1
------- ------- -------
Other:
Operating income........................................................... 58.3 59.4 100.6
Net investment losses, net of related costs and amortization............... (3.2) (6.0) (4.8)
------- ------- -------
Income before income taxes, minority interest and extraordinary charge 55.1 53.4 95.8
------- ------- -------
Interest and other corporate expenses........................................ (112.4) (140.5) (88.0)
------- ------- -------
Equity in earnings of CCP and WNC............................................ - - 64.9
------- ------- -------
Restructuring income......................................................... 30.4 15.2 45.0
------- ------- -------
Consolidated earnings:
Operating income........................................................... 468.8 341.0 239.7
Net investment gains (losses), net of related costs and amortization ...... (5.6) 62.3 (25.2)
Equity in earnings of CCP and WNC.......................................... - - 64.9
Restructuring activities................................................... 30.4 15.2 45.0
------- ------- -------
Income before income taxes, minority interest and extraordinary charge 493.6 418.5 324.4
Income tax expense.............................................................. 179.8 87.0 111.0
------- ------- -------
Income before minority interest and extraordinary charge............... 313.8 331.5 213.4
Minority interest in consolidated subsidiaries:
Distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts............................................ 3.6 - -
Dividends on preferred stock................................................. 8.9 11.9 3.3
Equity in earnings........................................................... 22.4 97.1 55.7
------- ------- -------
Income before extraordinary charge..................................... 278.9 222.5 154.4
Extraordinary charge on extinguishment of debt, net of taxes and
minority interest............................................................ 26.5 2.1 4.0
------- ------- -------
Net income............................................................. $ 252.4 $ 220.4 $150.4
======= ======= ======
20
Annuities:
1996 1995 1994
---- ---- ----
(Dollars in millions)
Premiums collected:
Single-premium immediate annuities........................... $ 111.2 $ 145.0 $ 10.5
Single-premium deferred annuities............................ 755.4 1,004.5 444.5
-------- -------- -------
Subtotal - single-premium annuities...................... 866.6 1,149.5 455.0
-------- -------- -------
Flexible-premium deferred annuities (first-year)............. 500.5 386.8 103.9
Flexible-premium deferred annuities (renewal)................ 93.8 65.9 12.9
-------- -------- -------
Subtotal - flexible-premium deferred annuities........... 594.3 452.7 116.8
-------- -------- -------
Variable annuities (first-year).............................. 37.9 17.2 -
Variable annuities (renewal)................................. 43.6 40.1 -
-------- -------- -------
Subtotal - variable annuities............................ 81.5 57.3 -
-------- -------- -------
Total annuity premiums collected....................... $1,542.4 $1,659.5 $ 571.8
======== ======== =======
Insurance policy income......................................... $ 77.6 $ 68.4 $ 31.0
Net investment income:
General account invested assets.............................. 891.2 851.2 220.4
Separate account assets...................................... 48.4 28.7 2.6
-------- -------- -------
Total revenues (a)..................................... 1,017.2 948.3 254.0
-------- -------- -------
Insurance policy benefits and change in future policy benefits.. 67.3 61.6 45.5
Interest expense on:
All annuity products, except variable annuities.............. 523.2 505.1 116.8
Variable annuity products.................................... 48.4 28.7 2.6
Amortization related to operations.............................. 76.9 64.8 11.1
Interest expense on investment borrowings....................... 14.3 16.9 4.4
Other operating costs and expenses.............................. 32.1 27.1 6.5
-------- -------- -------
Total benefits and expenses (a)........................ 762.2 704.2 186.9
-------- -------- -------
Operating income before income taxes, minority
interest and extraordinary charge.................... 255.0 244.1 67.1
Net investment gains (losses), net of related costs and
amortization................................................. (.7) 72.0 (7.3)
-------- -------- -------
Income before income taxes, minority interest
and extraordinary charge............................. $ 254.3 $ 316.1 $ 59.8
======== ======== =======
Weighted average gross interest spread on annuity products (b).. 2.9% 3.0% 2.8%
=== === ===
(a) Revenues exclude net investment gains (losses); benefits and expenses
exclude amortization related to net investment gains (losses).
(b) Excludes variable annuity products where the credited amount is based on
investment income from segregated investments.
General: This segment includes SPDAs, FPDAs, SPIAs and variable annuities
sold through both career agents and professional independent producers. For
periods prior to September 30, 1994, this segment consists solely of the annuity
operations of: (i) BLH, whose products are primarily marketed to seniors; and
(ii) various Conseco subsidiaries whose products are not currently being
actively marketed. The segment's operations were significantly affected by: (i)
the acquisition of ALH by Partnership II on September 30, 1994; (ii) the
consolidation of the CCP subsidiaries effective January 1, 1995, as a result of
the CCP Merger; and (iii) the LPG Merger,
21
effective July 1, 1996. The profitability of this segment largely depends on the
investment spread earned (i.e., the excess of investment earnings over interest
credited on annuity deposits), persistency of inforce business, and expense
control.
Premiums collected by this segment in 1996 were $1,542.4 million, down
7.1 percent from 1995. Increased competition from products such as mutual funds,
traditional bank investments, variable annuities and other investment and
retirement funding alternatives was a significant factor in the decrease.
Premiums collected in 1995 were $1,659.5 million, up 190 percent over 1994, due
to the acquisition transactions described above under "General."
SPDA collected premiums decreased 25 percent to $755.4 million, in 1996.
The demand for SPDA products offered by all insurance companies decreased during
1996, when relatively low interest rates made other investment products more
attractive. The Company introduced an equity-linked SPDA in June 1996 to appeal
to consumers' desire for alternative investment products with returns linked to
equities. The accumulation value of these annuities is credited with interest at
an annual minimum guaranteed rate of 3 percent, but the annuities provide for
higher returns based on a percentage of the change in the S&P 500 Index during
each year of their term. The Company purchases S&P 500 Index Options, the values
of which change as the benefits accrue to these annuities as a result of the
equity-linked return feature. Total collected premiums for this product were
$87.1 million in 1996.
FPDA collected premiums increased 31 percent to $594.3 million, in 1996.
FPDA premiums collected by LPG after the LPG Merger accounted for $30.4 million
of such premiums collected during 1996. FPDAs are similar to SPDAs in many
respects, except FPDAs allow more than one premium payment.
Variable annuity collected premiums increased 42 percent to $81.5
million, in 1996. Variable annuities offer contract holders a rate of return
based upon the specific investment portfolios into which premiums may be
directed. The popularity of such annuities has increased recently as a result of
the desire of investors to invest in common stocks. In addition, in 1996 Conseco
began to offer more investment options for variable annuity deposits and
expanded its marketing efforts, which resulted in increased collected premiums.
Profits on variable annuities are derived from the fees charged to contract
holders, rather than from the investment spread.
Insurance policy income includes: (i) premiums received on annuity
policies that incorporate significant mortality features; (ii) cost of insurance
and expenses charged to annuity policies; and (iii) surrender charges earned on
annuity policy withdrawals. In accordance with GAAP, premiums on annuity
contracts without mortality features are not reported as revenues, but rather
are reported as deposits to insurance liabilities. Insurance policy income
increased in 1996 primarily because of increased surrender charges (changes in
premiums and other policy charges were not significant). Surrender charges were
$41.2 million in 1996 and $28.6 million in 1995. Annuity policy withdrawals were
$1.7 billion in 1996, compared with $1.5 billion in 1995. The increase in policy
withdrawals and surrender charges generally corresponds to the aging and the
growth of the Company's annuity business in force. In addition, policyholders
are using the systematic withdrawal features available in several of the
Company's annuity policies, and more policyholders are surrendering in order to
invest in alternative investments. Total withdrawals and surrenders were 16
percent of insurance liabilities related to surrenderable policies in 1996 and
1995.
Insurance policy income increased in 1995 over 1994, primarily as a
result of the acquisition transactions described above under "General."
Net investment income on general account invested assets (excluding
income on separate account assets related to variable annuities) increased 4.7
percent in 1996, to $891.2 million, and increased 286 percent in 1995, to $851.2
million. The yield earned on average invested assets declined to 7.9 percent in
1996 from 8.4 percent in 1995. Cash flows received during 1995 and 1996
(including cash flows from the sales of investments) were invested in lower
yielding securities due to a general decline in interest rates.
Net investment income on separate account assets is offset by a
corresponding charge to interest credited on variable annuity products. Such
income fluctuates in relationship to total separate account assets and the
return earned on such assets.
Insurance policy benefits and change in future policy benefits relate
solely to annuity policies that incorporate significant mortality features. The
increase corresponds to the increase in the in-force block of such policies.
Interest expense on all annuity products, except variable annuities
increased 3.6 percent in 1996, primarily due to a larger block of annuity
business inforce in 1996, partially offset by a reduction in crediting rates.
The weighted average crediting rates for these annuity liabilities were 5.0
percent in 1996 and 5.3 percent in 1995. The increase in interest expense on
annuities in 1995 was primarily the result of the acquisition transactions
described above under "General."
22
Interest expense on variable annuity products is equal to the net
investment income on separate account assets.
Amortization related to operations increased 19 percent in 1996 and 484
percent in 1995. Such increases reflect a larger balance subject to amortization
as a result of the acquisition transactions described above under "General."
Interest expense on investment borrowings is affected by changes in
investment borrowing activities during the last three years and the higher
interest rates paid on such borrowings during 1996 and 1995.
Other operating costs and expenses increased 18 percent in 1996 and 317
percent in 1995. Such increases correspond to the increases in the total
business inforce primarily related to acquisition transactions described above
under "General."
Net investment gains (losses), net of related costs and amortization
often fluctuate from period to period. In 1995, this segment's level of sales of
securities (principally fixed maturities) in a recently acquired subsidiary
increased to accomplish planned changes in that subsidiary's fixed maturity
investment portfolio in order to reduce its duration and exposure to more
volatile CMO investments. Net investment gains (net of related costs and
amortization) were $72.0 million in 1995.
Selling securities at a gain and reinvesting the proceeds at lower yields
may, absent other management action, tend to decrease future investment yields.
The Company believes, however, that the following factors mitigate the adverse
effect of such decreases on net income: (i) the Company recognized additional
amortization of cost of policies purchased and cost of policies produced in
order to reflect reduced future yields (thereby reducing such amortization in
future periods); (ii) the Company can reduce interest rates credited to some
products, thereby diminishing the effect of the yield decrease on the investment
spread; and (iii) the investment portfolio grows as a result of reinvesting the
realized gains. As a result of the sales of fixed maturity investments, the
amortization of the cost of policies produced and the cost of policies purchased
increased $30.9 million in 1996, increased $114.8 million in 1995 and decreased
$3.0 million in 1994.
23
Supplemental health:
1996 1995 1994
---- ---- ----
(Dollars in millions)
Premiums collected:
Medicare supplement (first year)............................. $ 74.3 $ 81.2 $ 99.1
Medicare supplement (renewal)................................ 556.6 515.8 492.7
------ ------ ------
Subtotal - Medicare supplement........................... 630.9 597.0 591.8