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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, 1997 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 [No Fee Required]
For the transition period from ________ to ________
Commission file number: 1-9250
Conseco, Inc.
Indiana No. 35-1468632
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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.
7% FELINE PRIDES Stock Purchase Contracts New York Stock Exchange, Inc.
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, No Par Value
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days: Yes [ x ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Aggregate market value of common stock held by nonaffiliates (computed as of
March 13, 1998): $9,615,452,117
Shares of common stock outstanding as of March 13, 1998: 185,805,838
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Registrant's definitive
proxy statement for the annual meeting of shareholders to be held May 14, 1998
are incorporated by reference into Part III of this Report.
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PART I
ITEM 1. BUSINESS OF CONSECO.
Conseco, Inc. is a financial services holding company. Conseco develops,
markets and administers supplemental health insurance, annuity, life insurance,
individual and group major medical insurance and other insurance products. As
used in this report, the terms "We," "Conseco" or the "Company" refer to
Conseco, Inc. and its consolidated subsidiaries, unless the context requires
otherwise. Since 1982, Conseco has acquired 19 insurance groups. See "Insurance
Subsidiaries and Recent Acquisitions" for a description of our insurance
subsidiaries and recent acquisitions. Our operating strategy is to grow the
insurance business within our subsidiaries by focusing our resources on the
development and expansion of profitable products and strong distribution
channels. We have supplemented such growth by acquiring companies that have
profitable niche products and strong distribution systems. Once a company has
been acquired, our operating strategy has been to consolidate and streamline
management and administrative functions where appropriate, to realize superior
investment returns through active asset management, to eliminate unprofitable
products and distribution channels, and to expand and develop the profitable
distribution channels and products.
Conseco was organized in 1979 as an Indiana corporation and commenced
operations in 1982. Our executive offices are located at 11825 N. Pennsylvania
Street, Carmel, Indiana 46032, and our telephone number is (317) 817-6100.
MARKETING AND DISTRIBUTION
Conseco seeks to retain the loyalty of its agency force by providing
marketing and sales support; electronic and automated access to account and
commission information; and marketing and training tools. We also have
introduced new products like equity-indexed annuities (1996), indexed universal
life (1997) and multi-year-guarantee annuities (1998). We are also looking for
ways to lighten our agents' administrative burden, increase their productive
sales time and get them the information they need faster and more reliably. In
1997, we introduced the Conseco Online Information System ("COINS"), which
enables agents to track policy and commission information and order materials at
their convenience. Many of our marketing companies and agents are already using
COINS; we expect it to be available to all agents by 1999.
In 1997, Conseco launched a comprehensive effort to transform its name
into a recognized brand. We believe that in a competitive marketplace like
financial services, companies that can differentiate themselves through a
familiar brand can obtain full value for their products; sell more efficiently
and command greater customer loyalty; recruit and retain talent more easily;
better withstand and weather inevitable business crises; and have better access
to the financial markets and the capital they need in order to grow. In 1998,
our advertising campaign is designed to introduce consumers to the Conseco
brand, to our product line and to the benefits of doing business with Conseco.
Our insurance subsidiaries are collectively licensed to market our
insurance products in all fifty states, the District of Columbia, and certain
protectorates of the United States. Sales to residents of the following states
accounted for at least 5 percent of our 1997 collected premiums: Florida (9.4
percent), Illinois (9.0 percent), California (8.4 percent) , Texas (8.1 percent)
and Michigan (5.0 percent).
We believe that people purchase most types of life insurance, accident
and health insurance and annuity products only after being contacted and
solicited by an insurance agent. Accordingly, the success of our distribution
system is largely dependent on our ability to attract and retain agents who are
experienced and highly motivated.
In order to encourage agents to place a high volume of life, accident and
health and annuity business with our subsidiaries, we offer commission rate
bonuses and compensation awards which increase with the volume of new business
written. We formed a subsidiary to focus on the coordination of the marketing,
distribution and cross marketing activities of our products.
A description of our primary distribution channels follows:
Career Agents. This agency force of approximately 4,100 agents working
from 185 branch offices, permits one-on-one contacts with potential
policyholders and promotes strong personal relationships with existing
policyholders. The career agents sell primarily Medicare supplement and
long-term care insurance policies. This distribution channel also includes group
major medical business marketed through a small field force of representatives.
Since December 1, 1997, this segment includes the career agents of WNIC who sell
specialty health insurance products for educators. In 1997, this distribution
channel accounted for $1,593.2 million, or 32 percent, of our total collected
premiums. Most of these agents sell only Conseco policies and typically visit
the prospective policyholder's home to conduct personalized "kitchen-table"
sales presentations. After the sale of an insurance policy, the agent serves as
a contact person for policyholder questions, claims assistance and additional
insurance needs. The personalized marketing and service efforts of the career
field agents, supported by home office persistency programs, have contributed to
a persistency rate of approximately 83 percent on Medicare supplement policies
sold through this channel.
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Professional Independent Producers. This distribution channel consists of
a general agency and insurance brokerage distribution system comprised of
approximately 190,000 independent licensed agents doing business in all fifty
states. In 1997, this channel accounted for $3,433.7 million, or 68 percent, of
our total collected premiums.
Professional independent producers are a diverse network of independent
agents, insurance brokers and marketing organizations. Marketing companies
typically recruit agents for Conseco by advertising our products and commission
structure through direct mail advertising or through seminars for insurance
agents and brokers. These organizations bear most of the costs incurred in
marketing our products. We compensate the marketing organizations by paying them
a percentage of the commissions earned on new sales generated by the agents
recruited by such organizations. Certain of these marketing organizations are
specialty organizations that have a marketing expertise or a distribution system
relating to a particular product, such as flexible-premium annuities for
educators.
A portion of our business is distributed through a "Client Company"
marketing system, whereby agents and other insurance companies have entered into
agreements to market Conseco's products through their professional independent
producer distribution systems. Under the agreements, such groups assume up to 50
percent of the business each writes (through agent owned reinsurance companies
or existing life insurance companies). We retain assets equal to the reserves of
each Client Company and provide substantially all administrative services for a
fee. Of the premiums collected by professional independent producers in 1997,
3.2 percent were collected by groups participating in the Client Company
program.
Direct marketing. This distribution channel was added on September 30,
1997 with the acquisition of Colonial Penn Life Insurance Company ("Colonial
Penn"), which is engaged primarily in the sale of "graded benefit life"
insurance policies through direct marketing. We intend to market other Conseco
products through this distribution channel. In 1997, this channel accounted for
$28.8 million, or less than 1 percent, of our total collected premiums.
OPERATING SEGMENTS
We conduct and manage our business through five segments, reflecting our
major lines of insurance business and target markets: (i) supplemental health
insurance; (ii) annuities; (iii) life insurance; (iv) individual and group major
medical insurance; and (v) other.
Supplemental Health
This segment includes Medicare supplement, long-term care and
specified-disease insurance. For periods prior to January 1, 1997, this segment
consists solely of the Medicare supplement and long-term care products
distributed through a career agency force. For periods after January 1, 1997,
this segment includes the specified-disease products of the former subsidiaries
of Transport Holdings Inc. ("THI") and Capitol American Financial Corporation
("CAF") and the long-term care products of the former subsidiaries of ATC which
are distributed through professional independent producers. For periods after
April 1, 1997, this segment also includes various supplemental health products
of Pioneer Financial Services, Inc. ("PFS") which are distributed through
professional independent producers. During 1997, we collected Medicare
supplement premiums of $796.4 million and long-term care premiums of $663.9
million, up 29 percent and 244 percent, respectively, over 1996. We collected
specified-disease premiums of $383.4 million in 1997.
The following describes the major products of this segment:
Medicare supplement. Medicare supplement products accounted for $796.4
million, or 16 percent, of our total collected premiums in 1997. Medicare is a
two-part federal health insurance program for disabled persons and senior
citizens (age 65 and older). Part A of the program provides protection against
the costs of hospitalization and related hospital and skilled nursing home care,
subject to an initial deductible, related coinsurance amounts and specified
maximum benefit levels. The deductible and coinsurance amounts are subject to
change each year by the federal government. Part B of Medicare covers doctors
bills and a number of other medical costs not covered by Part A, subject to
deductible and coinsurance amounts for "approved" charges.
Medicare supplement policies provide coverage for many of the medical
expenses which the Medicare program does not cover, such as deductibles,
coinsurance costs (in which the insured and Medicare share the costs of medical
expenses) and specified losses which exceed the federal program's maximum
benefits. Our Medicare supplement plans automatically adjust coverage to reflect
changes in Medicare benefits. In marketing these products, we concentrate on
individuals who have recently become eligible for Medicare by reaching the age
of 65. We offer a higher first-year commission for sales to these policyholders
and competitive premium pricing. Approximately one-half of new sales of Medicare
supplement policies are to individuals who are 65 years old.
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Long-term care. Long-term care products accounted for $663.9 million, or
13 percent, of our total collected premiums in 1997. Long-term care products
provide coverage, within prescribed limits, for nursing home, home healthcare,
or a combination of both nursing home and home health care expenses. The
long-term care plans are sold primarily to retirees, and to a lesser degree, to
older self-employed individuals and others in middle-income levels.
Current nursing home care policies cover incurred and daily fixed-dollar
benefits available with an elimination period (which, similar to a deductible,
requires the insured to pay for a certain number of days of nursing home care
before the insurance coverage begins), subject to a maximum benefit. Home
healthcare policies cover the usual and customary charges after a deductible and
are subject to a daily or weekly maximum dollar amount, and an overall benefit
maximum. We monitor the loss experience on our long-term care products and, when
necessary, apply for rate increases in the states in which we sell such
products.
Specified-disease products. Beginning in 1997, the supplemental health
segment includes specified-disease products such as cancer and heart/stroke
insurance. Specified-disease products accounted for $383.4 million, or 7.6
percent, of our total collected premiums in 1997. These policies generally
provide fixed or limited benefits. Cancer insurance and heart/stroke products
are guaranteed renewable individual accident and health insurance policies.
Payments under cancer insurance policies are generally made directly to, or at
the direction of, the policyholder following diagnosis of, or treatment for, a
covered type of cancer. Heart/stroke policies provide for payments directly to
the policyholder for treatment of a covered heart disease, heart attack or
stroke. The benefits provided under the specified-disease policies do not
necessarily reflect the actual cost incurred by the insured as a result of the
illness; benefits are not reduced by any other medical insurance payments made
to or on behalf of the insured.
Approximately 65 percent of our specified-disease policies in force
(based on a count of policies) are sold with return of premium or cash value
riders. The return of premium rider generally provides that after a policy has
been in force for a specified number of years or upon the policyholder reaching
a specified age, the Company will pay to the policyholder, or a beneficiary
under the policy, the aggregate amount of all premiums paid under the policy,
without interest, less the aggregate amount of all claims incurred under the
policy.
Annuities
This segment includes traditional fixed rate annuity products, market
value-adjusted annuity products, equity-indexed annuity products, and variable
annuity products sold through both career agents and professional independent
producers. During 1997, this segment collected total premiums of $1,689.6
million, up 1.2 percent from 1996.
The following describes the major products of this segment:
Traditional fixed rate annuity products. These products include
single-premium deferred annuities ("SPDAs"), flexible-premium deferred annuities
("FPDAs") and single-premium immediate annuities ("SPIAs"). SPDAs (excluding the
equity-indexed and market value-adjusted products described below) accounted for
$366.8 million, or 7.3 percent, of our total collected premiums in 1997. An SPDA
is a savings vehicle in which the policyholder, or annuitant, makes a
single-premium payment to the insurance company; the insurer guarantees the
principal and accrues a stated rate of interest. After a number of years, as
specified in the annuity contract, the annuitant may elect to take the proceeds
of the annuity either in a single payment or in a series of payments for life,
for a fixed number of years, or for a combination thereof. Our SPDAs typically
have an interest rate (the "crediting rate") that is guaranteed by the Company
for the first policy year, after which, we have the discretionary ability to
change the crediting rate to any rate not below a guaranteed minimum rate. The
guaranteed rate recently written on annuities is 3.0 percent, and the rate on
all policies in force ranges from 3.0 percent to 5.5 percent. The initial
crediting rate is largely a function of: (i) the interest rate we can earn on
invested assets acquired with the new annuity fund deposits; and (ii) the rates
offered on similar products by our competitors. For subsequent adjustments to
crediting rates, we take into account the yield on our investment portfolio,
annuity surrender assumptions, competitive industry pricing and the crediting
rate history for particular groups of annuity policies with similar
characteristics.
Approximately 80 percent of our new annuity sales have been "bonus"
products. The initial crediting rate on these products specifies a bonus
crediting rate ranging from 1 percent to 8 percent of the annuity deposit for
the first policy year only. After the first year, the bonus interest portion of
the initial crediting rate is automatically discontinued, and the renewal
crediting rate is established. Commissions to agents are generally reduced by an
amount comparable to the bonus interest to partially compensate the Company for
the higher initial crediting rate on these products. As of December 31, 1997,
crediting rates on our outstanding SPDAs generally ranged from 4.0 percent to
5.5 percent, excluding bonuses guaranteed for the first year of the annuity
contract. The average crediting rate including interest bonuses was 5.0 percent,
and the average rate excluding bonuses was 4.8 percent.
The policyholder is typically permitted to withdraw all or part of the
premium paid plus the accumulated interest credited to his account (the
"accumulation value"), subject in virtually all cases to the assessment of a
surrender charge for withdrawals in excess of specified limits. Most of our
SPDAs provide for penalty-free withdrawals of up to 10 percent of the
accumulation value each year,
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subject to limitations. Withdrawals in excess of allowable penalty-free amounts
are assessed a surrender charge during a penalty period which generally ranges
from five to 12 years after the date a policy is issued. The surrender charge is
initially 6 percent to 12 percent of the accumulation value and generally
decreases by approximately 1 to 2 percentage points per year during the penalty
period. Surrender charges are set at levels to protect the Company from loss on
early terminations and to reduce the likelihood of policyholders terminating
their policies during periods of increasing interest rates. This practice
lengthens the effective duration of policy liabilities and enables the Company
to maintain profitability on such policies.
FPDAs (excluding the equity-indexed and market value-adjusted products
described below) accounted for $362.3 million, or 7.2 percent, of our total
collected premiums in 1997. FPDAs are similar to SPDAs in many respects, except
that FPDAs allow more than one premium payment. Our FPDAs have a crediting rate
that is guaranteed by the Company for the first year. After the first year, the
crediting rate may be changed at least annually, subject to a minimum annual
guaranteed rate. The policyholder is permitted to withdraw all or part of the
accumulation value, less a surrender charge for withdrawals during an initial
penalty period of up to 15 years. The initial surrender charges range from 5
percent to 22 percent of the first-year premium and decline over the penalty
period. Interest rates credited on our outstanding FPDAs at December 31, 1997,
generally ranged from 4.5 percent to 5.5 percent, excluding bonuses guaranteed
for the first year of the annuity contract. The average crediting rate including
interest bonuses was 5.0 percent, and the average rate excluding bonuses was 4.8
percent.
SPIAs accounted for $208.1 million, or 4.1 percent, of our total
collected premiums in 1997. SPIAs are designed to provide a series of periodic
payments for a fixed period of time or for life, according to the policyholder's
choice at the time of issue. Once the payments begin, the amount, frequency and
length of time for which they are payable are fixed. SPIAs often are purchased
by persons at or near retirement age who desire a steady stream of payments over
a future period of years. The single premium is often the payout from a
terminated annuity contract. The implicit interest rate on SPIAs is based on
market conditions when the policy is issued. The implicit interest rate on the
Company's outstanding SPIAs at December 31, 1997, averaged 6.0 percent.
Market value-adjusted annuity products. In September 1995, we began
offering a deferred annuity product with a "market value adjustment" feature.
This feature is designed to provide the Company with additional protection from
early terminations during a period of rising interest rates by reducing the
surrender value payable upon a full or partial surrender of the policy in excess
of the allowable penalty-free withdrawal amount. Conversely, during a period of
declining interest rates, the feature would increase the surrender value payable
to the policyholder. In 1997, we collected premiums of $41.4 million from SPDAs
with this feature. We also offer FPDAs with a "market value adjustment" feature.
In 1997, we collected premiums of $138.1 million from sales of FPDAs with this
feature.
Equity-indexed annuity products. In response to consumers' desire for
alternative investment products with returns linked to those of common stocks,
we introduced an equity-indexed SPDA product in June 1996 and an equity-indexed
FPDA product in January 1997. These products accounted for $387.7 million, or
7.7 percent, of our total premiums collected in 1997. The annuity's contract
value is equal to the premium paid increased for returns based upon a percentage
(the "participation rate") of the change in the S&P 500 Index during each year
of its term, subject to a minimum guaranteed value. The Company has the
discretionary ability to annually change the participation rate (which currently
ranges from 70 percent to 75 percent plus a first-year "bonus", similar to the
bonus previously described, of 25 percent), generally subject to a minimum of 50
percent. The minimum guaranteed values are equal to: (i) 90 percent of premiums
collected for SPDAs (75 percent of first year and 87.5 percent of renewal
premiums collected for FPDAs); plus (ii) interest credited at an annual rate of
3 percent. The annuity provides for penalty-free withdrawals of up to 10 percent
of premium in each year after the first year of the annuity's term. Other
withdrawals from SPDA products are subject to a surrender charge of 9 percent
over the eight year contract term at which time the contract must be renewed or
withdrawn. Other withdrawals from FPDA products are subject to a surrender
charge of 12 percent to 20 percent in the first year, declining 1.2 percent to
1.3 percent each year, to zero over a 10 to 15 year period, depending on issue
age. We purchase Standard & Poor's 500 Index Call Options (the "S&P 500 Call
Options") to hedge potential increases to policyholder benefits resulting from
increases in the S&P 500 Index to which the product's return is linked.
Variable annuity products. Variable annuities accounted for $185.2
million, or 3.7 percent, of our total premiums collected in 1997. Variable
annuities, sold on a single-premium or flexible-premium basis, differ from fixed
annuities in that the original principal value may fluctuate, depending on the
performance of assets allocated pursuant to various investment options chosen by
the contract owner. Variable annuities offer contract owners a fixed or variable
rate of return based upon the specific investment portfolios into which premiums
may be directed.
Life
This segment includes traditional, universal life and other life
insurance products. Beginning with the third quarter of 1996, the largest single
component of this segment is the universal life business of Life Partners Group,
Inc. ("LPG"). This segment's
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products are currently sold through career agents, professional independent
producers and direct response marketing. During 1997, this segment collected
total premiums of $709.0 million, up 76 percent, over premiums collected during
1996.
Interest-sensitive life products. These products include universal life
products that provide whole life insurance with adjustable rates of return
related to current interest rates. They accounted for $450.9 million, or 8.9
percent, of our total collected premiums in 1997 and are marketed through
professional independent producers and to a lesser extent, career agents. The
principal differences between universal life products and other
interest-sensitive life insurance products are policy provisions affecting the
amount and timing of premium payments. Universal life policyholders may vary the
frequency and size of their premium payments, and policy benefits may also
fluctuate according to such payments. Premium payments under other
interest-sensitive policies may not be varied by the policyholders, and as a
result, are designed to reduce the administrative costs typically associated
with monitoring universal life premium payments and policy benefits.
Traditional life. These products accounted for $258.1 million, or 5.1
percent, of our total collected premiums in 1997. Traditional life policies,
including whole life, graded benefit life and term life products, are marketed
through professional independent producers, career agents and direct response
marketing. Under whole life policies, the policyholder generally pays a level
premium over the policyholder's expected lifetime. The annual premium in a whole
life policy is generally higher than the premium for comparable term insurance
coverage in the early years of the policy's life, but is generally lower than
the premium for comparable term insurance coverage in the later years of the
policy's life. These policies, which continue to be marketed by the Company on a
limited basis, combine insurance protection with a savings component that
increases in amount gradually over the life of the policy. The policyholder may
borrow against the savings generally at a rate of interest lower than that
available from other lending sources. The policyholder may also choose to
surrender the policy and receive the accumulated cash value rather than
continuing the insurance protection. Term life products offer pure insurance
protection for a specified period of time -- typically 5, 10 or 20 years.
Beginning October 1, 1997, the life insurance segment includes the graded
benefit life insurance products of Colonial Penn. Graded benefit life products
accounted for $28.8 million or .6 percent of our total collected premiums in
1997. Graded benefit life insurance products are offered on an individual basis
primarily to persons age 50 to 80, principally in face amounts of $350 to
$10,000, without medical examination or evidence of insurability. Premiums are
paid as frequently as monthly. Benefits paid are less than the face amount of
the policy during the first two years, except in cases of accidental death.
Graded benefit life policies are marketed using direct response marketing
techniques. New policyholder leads are generated primarily from television and
print advertisements.
Individual and Group Major Medical Insurance
This segment includes individual and group major medical health insurance
products. The size of this segment increased significantly as a result of the
acquisition of PFS. This segment underwrites and markets group and individual
comprehensive major medical products targeted primarily to self-employed
individuals, small business owners and early retirees. Several deductible and
coinsurance options are available, and most policies require certain utilization
review procedures. The profitability of this business depends largely on the
overall persistency of the business in force, claim experience and expense
management. During 1997, this segment collected total premiums of $744.2
million, up 118 percent over premiums collected during 1996.
Insurance premium rates on these products may be adjusted subject to
applicable regulation by class, policy form and state in which the policy is
issued. We monitor the loss experience on these products, and when necessary,
apply for rate increases in the states in which we sell such products.
Other
This segment includes various other health insurance products. The
profitability of this business depends largely on the overall persistency of the
business in force, claim experience and expense management. During 1997, this
segment collected total premium of $69.2 million, up 27 percent over premiums
collected during 1996.
After December 1, 1997, the other segment includes the specialty health
insurance products for educators sold by a subsidiary of WNIC. These products
are sold by career agents and accounted for $9.1 million of Conseco's collected
premiums since the acquisition of WNIC.
This segment also includes fee revenue generated by Conseco's nonlife
subsidiaries, including the investment advisory fees earned by Conseco Capital
Management, Inc. ("CCM") and commissions earned for insurance product marketing
and distribution. Fee revenues and commissions from Conseco's consolidated
subsidiaries are excluded from segment results. CCM had approximately $5.1
billion of assets (at fair value) under management at December 31, 1997, for
unaffiliated parties. Total fees earned from nonaffiliates during 1997 were
$65.8 million, up 32 percent over 1996.
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INSURANCE SUBSIDIARIES AND RECENT ACQUISITIONS
Conseco owned the following life insurance companies at December 31,
1997:
- Bankers Life and Casualty Company ("Bankers Life"), Bankers Life
Insurance Company of Illinois and Certified Life Insurance Company,
formerly subsidiaries of Bankers Life Holding Corporation ("BLH");
- Great American Reserve Insurance Company ("Great American Reserve"),
Beneficial Standard Life Insurance Company ("Beneficial Standard") and
Jefferson National Life Insurance Company of Texas
("Jefferson-Texas"), in which Conseco has had an ownership interest
since 1990 and which became wholly owned subsidiaries in August 1995;
- the subsidiaries of American Life Holdings, Inc. ("ALH", formerly The
Statesman Group, Inc.), including American Life and Casualty Insurance
Company and Vulcan Life Insurance Company;
- the subsidiaries of LPG, including Philadelphia Life Insurance
Company, Conseco Life Insurance Company (formerly Massachusetts
General Life Insurance Company prior to its name change in 1997),
Lamar Life Insurance Company and Wabash Life Insurance Company;
- the former subsidiaries of ATC, including American Travellers Life
Insurance Company ("American Travellers"), United General Life
Insurance Company and Conseco Life Insurance Company of New York
(formerly American Travellers Insurance Company of New York prior to
its name change in 1997);
- the former subsidiaries of THI, including TLIC Life Insurance Company
(which was merged into Jefferson-Texas in 1997), Transport Life
Insurance Company (which was merged into American Travellers in 1997),
and Continental Life Insurance Company;
- the former subsidiaries of CAF, including Capitol American Life
Insurance Company, Capitol National Life Insurance Company and
Frontier National Life Insurance Company;
- the subsidiaries of PFS, including Continental Life and Accident
Insurance Company, Connecticut National Life Insurance Company, Health
and Life Insurance Company of America, Manhattan National Life
Insurance Company, Pioneer Life Insurance Company and National Group
Life Insurance Company;
- certain former subsidiaries of Leucadia National Corporation
("Leucadia"), including Colonial Penn and Providential Life Insurance
Company;
- the subsidiaries of Washington National Corporation ("WNIC"),
including Washington National Insurance Company and United
Presidential Life Insurance Company; and
- Bankers National Life Insurance Company, National Fidelity Life
Insurance Company and Lincoln American Life Insurance Company.
Since 1982, Conseco has acquired 19 insurance groups and related
businesses. We continue to regularly investigate acquisition opportunities in
the insurance industry and other industries in which we operate. We evaluate
potential acquisitions based on a variety of factors, including the operating
results and financial condition of the business to be acquired, its growth
potential, management and personnel and the potential return on such acquisition
in relation to other acquisition opportunities and the internal development of
our existing business operations. No assurances can be given as to when, if at
all, or upon what terms Conseco will make any such acquisition.
Our first acquisition partnership, Conseco Capital Partners, L.P.
("Partnership I"), was dissolved in 1993 after distributing to its partners the
securities of the companies it had acquired. Conseco Capital Partners II, L.P.
("Partnership II"), our second acquisition partnership, was liquidated in 1996
after Conseco purchased from the other partners all of the common shares of ALH
not already owned by Conseco. We terminated its partnership activity in 1996
because changes in the regulatory and rating agency environment made it
difficult to structure leveraged acquisitions of life insurance companies.
On August 31, 1995, we purchased (the "CCP Merger") all of the shares of
common stock of CCP Insurance, Inc. ("CCP") not previously owned (representing
51 percent of CCP's outstanding shares). In the transaction, CCP was merged into
Conseco, with Conseco being the surviving corporation. As a result of the CCP
Merger, CCP's subsidiaries, Great American Reserve and Beneficial
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Standard, became wholly owned subsidiaries of Conseco. The accounts of CCP's
subsidiaries are consolidated with Conseco's accounts effective January 1, 1995.
On August 2, 1996, we acquired LPG (the "LPG Merger"). LPG became a
wholly owned subsidiary of Conseco. In the LPG Merger, we issued a total of 32.6
million shares of Conseco common stock (or common stock equivalents) with a
value of $586.8 million. We also assumed $253.1 million of notes payable of LPG.
LPG's subsidiaries sell a diverse portfolio of universal life insurance and, to
a lesser extent, annuity products to individuals.
On September 30, 1996, we acquired the remaining 62 percent of the common
shares of ALH (the "ALH Stock Purchase") not already owned by Conseco or its
affiliates for approximately $166 million in cash. ALH is a provider of
retirement savings annuities. ALH has been included in our consolidated
financial statements since ALH's acquisition by Partnership II in September
1994.
On December 17, 1996, we acquired ATC (the "ATC Merger"). ATC was merged
with and into Conseco, with Conseco being the surviving corporation. In the ATC
Merger, we issued a total of 21.0 million shares of Conseco common stock (or
common stock equivalents) with a value of $630.9 million. In addition, we
assumed $102.8 million of ATC's convertible subordinated debentures, which
became convertible into 7.9 million shares of Conseco common stock with a value
of $248.3 million. ATC is a leading marketer and underwriter of long-term care
insurance. ATC also markets and underwrites other supplemental accident and
health insurance policies, as well as life insurance.
On December 23, 1996, we acquired THI (the "THI Merger"). THI was merged
with and into Conseco, with Conseco being the surviving corporation. In the THI
Merger, we issued a total of 4.9 million shares of Conseco common stock (or
common stock equivalents) with a value of $121.7 million. In addition, pursuant
to an exchange offer, all of THI's subordinated convertible notes were exchanged
for 4.2 million shares of Conseco common stock with a value of $106.2 million,
plus a cash premium of $11.9 million. THI is principally engaged in the
underwriting and distribution of supplemental health insurance.
On December 31, 1996, we acquired the 9.6 percent of the common shares of
BLH (the "BLH Merger") not already owned by Conseco or its affiliates. BLH was
merged into a wholly owned subsidiary of Conseco. In the BLH Merger, we issued a
total of 3.9 million shares of Conseco common stock (or common stock
equivalents) with a value of $123.0 million. BLH is one of the nation's largest
writers of individual health insurance products, based on collected premiums.
BLH also markets a variety of annuity, life and group insurance products. BLH
has been included in our consolidated financial statements since November 1992,
when BLH was acquired by Partnership I.
On March 4, 1997, we acquired CAF (the "CAF Merger"). CAF became a wholly
owned subsidiary of Conseco. In the CAF Merger, we paid $552.8 million in cash
and issued 3.0 million shares of Conseco common stock (or common stock
equivalents) with a value of $117.4 million. In addition, we assumed a $31.0
million note payable of CAF, which was repaid on the merger date. CAF, through
its insurance subsidiaries, underwrites, markets and distributes individual and
group supplemental health and accident insurance.
On May 30, 1997, we acquired PFS (the "PFS Merger"). PFS became a wholly
owned subsidiary of Conseco. In the PFS Merger, we issued 9.0 million shares of
Conseco common stock (or common stock equivalents) with a value of $354.1
million. In addition, we assumed PFS's convertible subordinated notes, which
became convertible into 3.1 million shares of Conseco common stock, with a value
of $130.6 million. We also assumed a $21.3 million note payable of PFS, which
was repaid on the merger date. PFS, through its insurance subsidiaries,
underwrites, markets and distributes life insurance, annuities and health
insurance in selected niche markets throughout the United States.
On September 30, 1997, we acquired Colonial Penn (the "Colonial Penn
Purchase") and certain other assets (collectively referred to as "Colonial
Penn") from Leucadia. Colonial Penn became a wholly owned subsidiary of Conseco.
In the Colonial Penn Purchase, we paid $60.0 million in cash and issued $400.0
million of notes payable to Leucadia. Colonial Penn is principally engaged in
the underwriting and sale of "graded benefit life" insurance policies through
direct marketing and Medicare supplement insurance through independent agents.
On December 5, 1997, we acquired WNIC (the "WNIC Merger"). WNIC became a
wholly owned subsidiary of Conseco. In the WNIC Merger, we paid $400.6 million
in cash, of which $73.7 million was funded through a dividend to Conseco from
WNIC. WNIC is principally engaged in marketing and underwriting life insurance
and annuities for individuals and specialty health insurance for educators.
8
ADMINISTRATION
We minimize operating expenses by centralizing, standardizing and more
efficiently performing many functions common to most life insurance companies.
These functions include underwriting and policy administration, accounting and
financial reporting, marketing, regulatory compliance, actuarial services and
asset management.
The administration of our individual and group health insurance products
involves higher volumes of claims, contacts with policyholders and operational
costs, compared to the administration of life insurance or annuity policies. We
have developed an efficient and highly automated policyholder administration
operation to minimize the costs of such large volume processing and deliver a
high level of service to our policyholders, with special emphasis on the prompt
payment of claims. In many cases, we mail a check within a week of receiving a
claim from a policyholder.
INVESTMENTS
CCM, a registered investment adviser wholly owned by Conseco, manages the
investment portfolios of Conseco's subsidiaries. CCM had approximately $32.1
billion of assets (at fair value) under management at December 31, 1997, of
which $27.0 billion were assets of Conseco's subsidiaries and $5.1 billion were
assets of unaffiliated parties. CCM's investment philosophy is to maintain a
largely investment-grade fixed-income portfolio, provide adequate liquidity for
expected liability durations and other requirements and maximize total return
through active investment management.
Investment activities are an integral part of our business; investment
income is a significant component of our total revenues. Profitability of many
of our products is significantly affected by spreads between interest yields on
investments and rates credited on insurance liabilities. Although substantially
all credited rates on SPDAs and FPDAs may be changed annually, changes in
crediting rates may not be sufficient to maintain targeted investment spreads in
all economic and market environments. In addition, competition and other
factors, including the impact of the level of surrenders and withdrawals, may
limit our ability to adjust or to maintain crediting rates at levels necessary
to avoid narrowing of spreads under certain market conditions. As of December
31, 1997, the average yield, computed on the cost basis of our investment
portfolio, was 7.5 percent, and the average interest rate credited or accruing
to our total insurance liabilities, excluding interest bonuses guaranteed for
the first year of the annuity contract only, was 5.2 percent.
We seek to balance the duration of our invested assets with the expected
duration of benefit payments arising from our insurance liabilities. At December
31, 1997, the adjusted modified duration of fixed maturities and short-term
investments was approximately 5.8 years and the duration of our insurance
liabilities was approximately 6.7 years.
For information regarding the composition and diversification of the
investment portfolio of our subsidiaries, see "Management's Discussion and
Analysis of Consolidated Financial Condition and Results of Operations -
Investments" and note 3 to the consolidated financial statements.
COMPETITION
Our businesses operate in a highly competitive environment. The financial
services industry consists of a large number of companies, some of which are
larger and have greater financial resources, broader and more diversified
product lines and larger staffs than those of Conseco. An expanding number of
banks, securities brokerage firms and other financial intermediaries also market
insurance products or offer competing products, such as mutual fund products,
traditional bank investments and other investment and retirement funding
alternatives. We also compete with many of these companies and others in
providing services for fees. In most areas, competition is based on a number of
factors, including pricing, service provided to distributors and policyholders,
and ratings. Conseco's subsidiaries must also compete with other insurers to
attract and retain the allegiance of agents.
Marketing companies, agents who market insurance products, school
districts, financial institutions and policyholders use the financial strength
ratings assigned to an insurer by independent rating agencies as one factor in
determining which insurer's products to market or purchase. Substantially all of
our primary life insurance companies have received: (i) an "A" (Excellent)
insurance company rating by A.M. Best Company ("A.M. Best"); (ii) an "AA-"
claims-paying ability rating from Duff & Phelps' Credit Rating Company ("Duff &
Phelps"); and (iii) an "A+" claims-paying ability rating from Standard & Poor's
Corporation ("Standard & Poor's").
A.M. Best insurance company ratings for the industry currently range from
"A++ (Superior)" to "F (In Liquidation)". Publications of A.M. Best indicate
that the "A" and "A-" ratings are assigned to those companies that, in A.M.
Best's opinion, have demonstrated excellent overall performance when compared to
the standards established by A.M. Best and have demonstrated a strong
9
ability to meet their obligations to policyholders over a long period of time.
A.M. Best's rating procedure includes quantitative and qualitative evaluations
of a company's financial condition and operating performance. Its quantitative
evaluation is based on an analysis of a company's financial performance in the
areas of profitability, leverage/capitalization and liquidity. A.M. Best's
review also includes a qualitative evaluation of a company's spread of risk,
quality and appropriateness of reinsurance programs, quality and diversification
of assets, adequacy of policy or loss reserves, management experience and
objectives, market presence and policyholders' confidence.
In recent years, A.M. Best upgraded the ratings of several of our
subsidiaries to "A" (Excellent) from "A-" (Excellent). Among the reasons A.M.
Best cited for the ratings upgrades and reaffirmations were the benefits Conseco
will derive as a result of recent acquisitions including: (i) improved unit
costs arising from the integration of administrative, financial, investment,
marketing and underwriting functions; (ii) expanded distribution capacity and
increased cross-selling opportunities; and (iii) a more diversified product
portfolio that should generate more balanced and predictable revenue and
earnings sources. A.M. Best also views favorably the continuing improvement in
Conseco's financial leverage and our target ratio of debt to total capital of
not more than 35 percent.
Duff & Phelps' claims-paying ability ratings range from "AAA (Highest
claims-paying ability)" to "DD (Company is under an order of liquidation)." An
"AA-" rating represents "Very high claims-paying ability." A plus or minus sign
attached to a Duff & Phelps claims paying rating shows relative standing within
a ratings category.
Standard & Poor's claims-paying ability ratings range from "AAA
(Superior)" to "R (Regulatory Action)". An "A" is assigned by Standard & Poor's
to those companies which, in its opinion, have a secure claims-paying ability
and whose financial capacity to meet policyholder obligations is viewed on
balance as sound, but their capacity to meet such policyholder obligations is
somewhat more susceptible to adverse changes in economic or underwriting
conditions than more highly rated insurers. According to Standard & Poor's, a
plus or minus sign attached to a Standard & Poor's claims-paying rating shows
relative standing within a ratings category. A "q" subscript indicates that the
rating is based solely on quantitative analysis of publicly available financial
data.
Generally, rating agencies base their ratings upon information furnished
to them by the insurer and upon their own investigations, studies and
assumptions. A.M. Best's ratings, Duff & Phelps' claims-paying ratings and
Standard & Poor's claims-paying ratings are principally based upon factors of
concern to policyholders, agents and intermediaries and are not directed toward
the protection of investors. Given the competitive nature of our business and
the increasing focus placed on the aforementioned ratings, we manage our
business with the objective of preserving existing ratings and, where possible,
achieving more favorable ratings. There can be no assurance that any particular
rating will continue for any given period of time, or that it will not be
changed or withdrawn entirely if, in the judgement of the rating agency,
circumstances so warrant. If our ratings were downgraded from their current
levels, sales of our products and the persistency of our in-force policies could
be adversely affected in a material way.
In the individual health insurance business, insurance companies compete
primarily on the basis of marketing, service and price. The provisions of the
Omnibus Budget Reconciliation Act of 1984 and the work of the National
Association of Insurance Commissioners ("NAIC") (an association of state
regulators and their staffs) have resulted in standardized policy features for
Medicare supplement products. This increases the comparability of such policies
and may intensify competition based on factors other than product features. See
"Underwriting" and "Governmental Regulation." In addition to the products of
other insurance companies, our health insurance products compete with health
maintenance organizations, preferred provider organizations and other health
care- related institutions which provide medical benefits based on contractual
agreements.
We believe that we are able to compete effectively because: (i) we
emphasize a number of specialized distribution channels, where the ability to
respond rapidly to changing customer needs yields a competitive edge; (ii) we
are experienced in establishing and cultivating relationships with the unique
distribution networks and the independent marketing companies operating in these
specialized markets; (iii) we can offer competitive rates as a result of our
lower-than-average operating costs and higher-than-average investment yields
achieved by applying active investment portfolio management techniques; and (iv)
we have reliable policyholder administrative services, supported by customized
information technology systems.
UNDERWRITING
Under regulations promulgated by the NAIC and adopted as a result of the
Omnibus Budget Reconciliation Act of 1990, we are prohibited from underwriting
our Medicare supplement policies for certain first-time purchasers. If a person
applies for insurance within six months after becoming eligible by reason of
age, or disability in certain limited circumstances, the application may not be
rejected due to medical conditions. Some states prohibit underwriting of all
Medicare supplement policies. For other prospective Medicare supplement
policyholders, such as senior citizens who are transferring to Conseco's
products, the underwriting procedures are relatively limited, except for
policies providing prescription drug coverage.
10
Before issuing long-term care or comprehensive major medical products to
individuals and groups, we generally apply detailed underwriting procedures
designed to assess and quantify the insurance risks. We require medical
examinations of applicants (including blood and urine tests, where permitted)
for certain health insurance products and for life insurance products which
exceed prescribed policy amounts. These requirements are graduated according to
the applicant's age and may vary by type of policy or product. We also rely on
medical records and the potential policyholder's written application. In recent
years, there has been significant regulatory changes with respect to
underwriting individual and group major medical plans. An increasing number of
states prohibit underwriting and/or charging higher premiums for substandard
risks. We monitor changes in state regulation that affect our products, and
consider these regulatory developments in determining where we market our
products.
Most of our life insurance policies are underwritten individually,
although standardized underwriting procedures have been adopted for certain low
face-amount life insurance coverages. After initial processing, insurance
underwriters review each file and obtain the information needed to make an
underwriting decision (such as medical examinations, doctors' statements and
special medical tests). After collecting and reviewing the information, the
underwriter either: (i) approves the policy as applied for, or with an extra
premium charge because of unfavorable factors; or (ii) rejects the application.
We underwrite group insurance policies based on the characteristics of the group
and its past claim experience. Graded benefit life insurance policies are issued
without medical examination or evidence of insurability. There is minimal
underwriting on annuities.
REINSURANCE
Consistent with the general practice of the life insurance industry, our
subsidiaries enter into both facultative and treaty agreements of indemnity
reinsurance with other insurance companies in order to reinsure portions of the
coverage provided by our insurance products. Indemnity reinsurance agreements
are intended to limit a life insurer's maximum loss on a large or unusually
hazardous risk or to diversify its risk. Indemnity reinsurance does not
discharge the original insurer's primary liability to the insured. The Company's
reinsured business is ceded to numerous reinsurers. We believe the assuming
companies are able to honor all contractual commitments, based on our periodic
review of their financial statements, insurance industry reports and reports
filed with state insurance departments.
As of December 31, 1997, the policy risk retention limit was $.8 million
or less on all of the policies of our subsidiaries. Reinsurance ceded by Conseco
represented 27 percent of gross combined life insurance in force and reinsurance
assumed represented 4.0 percent of net combined life insurance in force. At
December 31,1997, the total ceded business in force of $36.7 billion included:
(i) $5.3 billion ceded to Client Companies for which we retain assets equal to
the reserves on the business ceded; and (ii) $25.8 billion ceded to insurance
companies rated "A- (Excellent)" or better by A.M. Best. Our principal
reinsurers at December 31, 1997 (which assume approximately 65 percent of the
total ceded business in force, excluding business ceded to the Client Companies)
were American Equity Investment Life Insurance Company, Cologne Life,
Connecticut General Life Insurance Company, Employers Re, Life Reassurance
Corporation of America, Lincoln National Life Insurance Company, RGA Reinsurance
Company, Security Life of Denver and Swiss Re Life and Health America. No other
single reinsurer assumes greater than 5 percent of the total ceded business in
force.
EMPLOYEES
At December 31, 1997, Conseco had approximately 6,800 employees,
including: (i) 3,000 home office employees; (ii) 1,400 employees in our Chicago
office (primarily involved with our supplemental health operations); (iii) 1,900
employees in various locations serving as administrative centers for its
insurance operations; and (iv) 500 employees in branch offices (primarily
supporting our career agency force). None of our employees is covered by a
collective bargaining agreement. We believe that we have excellent relations
with our employees.
GOVERNMENTAL REGULATION
General
Our insurance subsidiaries are subject to regulation and supervision by
the states in which they transact business. State laws generally establish
supervisory agencies with broad regulatory authority, including the power to:
(i) grant and revoke business licenses; (ii) regulate and supervise trade
practices and market conduct; (iii) establish guaranty associations; (iv)
license agents; (v) approve policy forms; (vi) approve premium rates for some
lines of business; (vii) establish reserve requirements; (viii) prescribe the
form and content of required financial statements and reports; (ix) determine
the reasonableness and adequacy of statutory capital and surplus; (x) perform
financial, market conduct and other examinations; (xi) define acceptable
accounting principles; (xii) regulate the type and amount of permitted
investments; and (xiii) limit the amount of dividends and surplus debenture
payments that can be paid without obtaining regulatory approval. Our insurance
subsidiaries are subject to periodic examinations by state regulatory
authorities. We do not expect the results of any ongoing examinations to have a
material effect on the Company's financial condition.
11
Most states have also enacted regulations on the activities of insurance
holding company systems, including acquisitions, extraordinary dividends, the
terms of surplus debentures, the terms of affiliate transactions and other
related matters. Currently, the Company and its insurance subsidiaries have
registered as holding company systems pursuant to such legislation in the
domiciliary states of the insurance subsidiaries (Alabama, Arizona, Arkansas,
California, Illinois, Indiana, Kentucky, Mississippi, Missouri, New York, Ohio,
Pennsylvania, Tennessee and Texas), and they routinely report to other
jurisdictions. Recently, a number of state legislatures have considered or have
enacted legislative proposals that alter, and in many cases increase, the
authority of state agencies to regulate insurance companies and holding company
systems. For further information on state laws regulating the payment of
dividends by insurance company subsidiaries, see "Management's Discussion and
Analysis of Consolidated Financial Position and Results of Operations -
Consolidated Financial Condition" and note 12 to Conseco's consolidated
financial statements.
The federal government does not directly regulate the insurance business.
However, federal legislation and administrative policies in several areas,
including pension regulation, age and sex discrimination, financial services
regulation, securities regulation and federal taxation, do affect the insurance
business. In recent years, the Office of the Comptroller of the currency has
issued a number of rulings which have expanded the ability of banks to sell
certain insurance products. The United States House of Representatives is
currently considering the Financial Services Act (H.R.10), which would (among
other things) eliminate existing restrictions on affiliations between insurance
companies, banks and securities firms. This proposed legislation in its current
form would allow insurance companies and securities firms to directly own banks
and each other while banks could own insurance companies and securities firms
indirectly through a holding company. Other provisions of the act would define
insurance products and retain jurisdiction over their regulation in the states.
Such legislation, if enacted, could result in increased competition, as well as
new opportunities, for the Company. In addition, legislation has been introduced
from time to time in recent years which, if enacted, could result in the federal
government assuming a more direct role in the regulation of the insurance
industry.
The Securities and Exchange Commission has requested comments as to
whether equity-indexed annuities, such as those sold by the Company, should be
treated as securities under the Federal securities laws rather than as insurance
products. Treatment of these products as securities would likely require
additional registration and licensing of these products and the agents selling
them, as well as cause the Company to seek additional marketing relationships
for these products.
The Risk-Based Capital for Life and/or Health Insurers Model Act (the
"Model Act") adopted by the NAIC provides a tool for insurance regulators to
determine the levels of capital and surplus an insurer must maintain in relation
to its insurance and investment risks and whether there is a need for possible
regulatory attention. The Model Act (or similar legislation or regulation) has
been adopted in states where our insurance subsidiaries are domiciled.
The Model Act provides for four levels of regulatory attention, varying
with the ratio of the company's total adjusted capital (defined as the total of
its statutory capital, surplus, asset valuation reserve and certain other
adjustments) to its risk-based capital ("RBC"). If a company's total adjusted
capital is less than 100 percent but greater than or equal to 75 percent of its
RBC, or if a negative trend (as defined by the regulators) has occurred and
total adjusted capital is less than 125 percent of RBC (the "Company Action
Level"), the company must submit a comprehensive plan to the regulatory
authority proposing corrective actions aimed at improving its capital position.
If a company's total adjusted capital is less than 75 percent but greater than
or equal to 50 percent of its RBC (the "Regulatory Action Level") , the
regulatory authority will perform a special examination of the company and issue
an order specifying corrective actions that must be followed. If a company's
total adjusted capital is less than 50 percent but greater than or equal to 35
percent of its RBC (the "Authorized Control Level"), the regulatory authority
may take any action it deems necessary, including placing the company under
regulatory control. If a company's total adjusted capital is less than 35
percent of its RBC (the "Mandatory Control Level") the regulatory authority must
place the company under its control. At December 31, 1997, the average ratio of
total adjusted capital to RBC for our insurance subsidiaries was greater than
twice the levels at which regulatory attention is triggered.
The Texas Insurance Department has adopted its own RBC requirements, the
stated purpose of which is to require a minimum level of capital and surplus to
absorb the financial, underwriting, and investment risks assumed by an insurer.
Texas' RBC requirements differ from those adopted by the NAIC in two principal
respects: (i) they use different elements to determine minimum RBC levels in
their calculation formulas; and (ii) they do not stipulate "Action Levels" (like
those described in the previous paragraph) where corrective actions are
required. However, the Commissioner of the Texas Insurance Department does have
the power to take similar corrective actions if a company does not maintain the
required minimum level of capital and surplus. Under the Texas Regulations, an
insurer also meets RBC requirements if its admitted assets exceed its
liabilities by at least 6 percent. Five of our insurance subsidiaries are
domiciled in Texas and all of them were in compliance with Texas RBC
requirements at December 31, 1997.
Most states have either enacted legislation or adopted administrative
regulations which affect the acquisition of control of insurance companies as
well as transactions between insurance companies and persons controlling them.
The nature and extent of such legislation and regulations vary from state to
state. Most states, however, require administrative approval of: (i) the
acquisition
12
of 10 percent or more of the outstanding shares of an insurance company
domiciled in the state; or (ii) the acquisition of 10 percent or more of the
outstanding stock of an insurance holding company whose insurance subsidiary is
domiciled in the state. The acquisition of 10 percent of such shares is
generally deemed to be the acquisition of control for the purpose of the holding
company statutes. These regulations require the acquirer to file detailed
information concerning the acquiring parties and the plan of acquisition, and to
obtain administrative approval prior to the acquisition. In many states,
however, an insurance authority may determine that control does not exist, even
in circumstances in which a person owns or controls 10 percent or a greater
amount of securities.
On the basis of statutory statements filed with state regulators
annually, the NAIC calculates eleven financial ratios to assist state regulators
in monitoring the financial condition of insurance companies. A "usual range" of
results for each ratio is used as a benchmark. In the past, variances in certain
ratios of our insurance subsidiaries have resulted in inquiries from insurance
departments to which we have responded. Such inquiries did not lead to any
restrictions affecting our operations.
Under the solvency or guaranty laws of most states in which we do
business, our insurance subsidiaries may be required to pay guaranty fund
assessments (up to certain prescribed limits). Guaranty funds are established by
various states to fund policyholder losses or the liabilities of insolvent or
rehabilitated insurance companies. These assessments may be deferred or forgiven
under most guaranty laws if they would threaten an insurer's financial strength.
In certain instances, the assessments may be offset against future premium
taxes. We establish a reserve to provide for assessments related to known
insolvencies. This reserve is based upon our current expectation of the
availability of the right of offset and state guaranty fund assessment bases.
However, changes in the basis whereby assessments are charged to individual
companies or changes to the availability of the right to offset assessments
against premium tax payments could materially affect our results of operations.
Our insurance subsidiaries' statutory financial statements for the year ended
December 31, 1997, include $7.2 million of expenses as a result of such
assessments.
Health Care
Most states mandate minimum benefit standards and loss ratios for
accident and health insurance policies. We are generally required to maintain,
with respect to our individual long-term care policies, minimum anticipated loss
ratios over the entire period of coverage of not less than 60 percent. With
respect to our Medicare supplement policies, we are generally required to attain
and maintain an actual loss ratio, after three years, of not less than 65
percent. We provide, to the insurance departments of all states in which we
conduct business, annual calculations that demonstrate compliance with required
minimum loss ratios for both long-term care and Medicare supplement insurance.
These calculations are prepared utilizing statutory lapse and interest rate
assumptions. In the event we have failed to maintain minimum mandated loss
ratios, our insurance subsidiaries could be required to provide retrospective
refunds and/or prospective rate reductions. We believe that our insurance
subsidiaries currently comply with all applicable mandated minimum loss ratios.
NAIC model regulations, adopted in substantially all states, created 10
standard Medicare supplement plans (Plans A through J). Plan A provides the
least extensive coverage, while Plan J provides the most extensive coverage.
Under NAIC regulations, Medicare insurers must offer Plan A, but may offer any
of the other plans at their option. Conseco currently offers nine of the model
plans. We have declined to offer Plan J, due in part to its high benefit levels
and, consequently, high costs to the consumer.
The Health Insurance Portability and Accountability Act of 1996 ("HIPAA")
was enacted in 1996. HIPAA sets forth minimum federal standards for group and
individual health insurance, including requirements relating to the
availability, portability and renewability of health coverage.
Numerous proposals to reform the current health care system have been
introduced in Congress and the state legislatures. Proposals have included,
among other things, modifications to the existing employer-based insurance
system, a quasi-regulated system of "managed competition" among health plans,
and a single-payer, public program. Changes in health care policy could
significantly affect our business. Federal comprehensive major medical or
long-term care programs, if proposed and implemented, could partially or fully
replace some of Conseco's current products, for example.
A number of states have passed or are considering legislation that would
limit the differentials in rates that insurers could charge for health care
coverages between new business and renewal business for similar demographic
groups. State legislation has also been adopted or is being considered that
would make health insurance available to all small groups by requiring coverage
of all employees and their dependents, by limiting the applicability of
pre-existing conditions exclusions, by requiring insurers to offer a basic plan
exempt from certain benefits as well as a standard plan, or by establishing a
mechanism to spread the risk of high risk employees to all small group insurers.
The NAIC recently adopted model long-term care policy language providing
nonforfeiture benefits and has proposed a rate stabilization standard for
long-term care policies. Various bills proposed in the U.S. Congress would
provide for the implementation of certain minimum consumer protection standards
for inclusion in all long-term care policies, including guaranteed renewability,
13
protection against inflation and limitations on waiting periods for pre-existing
conditions. Other recently adopted legislation permits premiums paid for
qualified long-term care insurance to be treated as tax-deductible medical
expenses and for benefits received on such policies to be excluded from taxable
income.
We cannot predict with certainty the effect that any proposals, if
adopted, or legislative developments could have on our business and operations.
FEDERAL INCOME TAXATION
The annuity and life insurance products marketed and issued by our
insurance subsidiaries generally provide the policyholder with an income tax
advantage, as compared to other savings investments such as certificates of
deposit and bonds, in that income taxation on the increase in value of the
product is deferred until it is received by the policyholder. With other savings
investments, the increase in value is taxed as earned. Annuity benefits and life
insurance benefits, which accrue prior to the death of the policyholder, are
generally not taxable until paid. Life insurance death benefits are generally
exempt from income tax. Also, benefits received on immediate annuities (other
than structured settlements) are recognized as taxable income ratably, as
opposed to the methods used for some other investments which tend to accelerate
taxable income into earlier years. The tax advantage for annuities and life
insurance is provided in the Internal Revenue Code (the "Code"), and is
generally followed in all states and other United States taxing jurisdictions.
Accordingly, the tax advantage is subject to change by Congress and by the
legislatures of the respective taxing jurisdictions.
In February of 1998, President Clinton released various revenue proposals
and tax changes to be considered in the current federal budget. Such proposals
contained numerous tax increases directed at the insurance industry, of which
the more significant ones were as follows: taxing asset reallocations within
variable annuities and exchanges of variable annuities, reducing the tax basis
of insurance and annuity contracts for mortality charges and modifying tax
reserving rules for annuity contracts. We have joined the insurance industry and
other groups opposing these taxes upon savings, and we expect that these
proposed changes will not be enacted into legislation.
Our insurance company subsidiaries are taxed under the life insurance
company provisions of the Code. Provisions in the Code require a portion of the
expenses incurred in selling insurance products to be deducted over a period of
years, as opposed to immediate deduction in the year incurred. This provision
increases the tax for statutory accounting purposes, which reduces statutory
surplus and, accordingly, decreases the amount of cash dividends that may be
paid by the life insurance subsidiaries. As of December 31, 1997, the cumulative
taxes paid by our insurance subsidiaries as a result of this provision were
$327.8 million.
The Company had tax loss carryforwards at December 31, 1997, of
approximately $737.1 million, portions of which begin expiring in 1999. However,
the amount of such loss that may be offset against current taxable income is
subject to the following limitations: (i) losses may be offset against income of
other corporate entities only if such entities are included in the same
consolidated tax return (insurance companies are currently not eligible for
inclusion in Conseco's consolidated tax return until five years after they are
acquired); (ii) losses incurred in non-life companies (which comprise most of
the loss carryforwards) may offset only a portion of income from life companies
in the same consolidated tax return; and (iii) some loss carryforwards may not
be used to offset taxable income of entities acquired after the loss was
incurred. We, however, believe we will be able to utilize all current loss
carryforwards before they expire.
ITEM 2. PROPERTIES.
Our principal operations are located on a 170-acre corporate campus in
Carmel, Indiana, immediately north of Indianapolis. The 11 buildings on the
campus (all but one of which are owned) contain approximately 810,000 square
feet of space and house Conseco's executive offices and certain administrative
operations of its subsidiaries. The campus has ample room for additional
buildings to support future growth.
Our supplemental health products are primarily administered from a single
facility of 300,000 square feet in downtown Chicago, Illinois, leased under an
agreement having a remaining life of 10 years. We also lease approximately
130,000 square feet of warehouse space in a second Chicago facility; this lease
has a remaining life of five years. Conseco owns an office building in Kokomo,
Indiana (100,000 square feet), and two office buildings in Rockford, Illinois
(total of 169,000 square feet), which serve as administrative centers for
portions of our insurance operations. Conseco owns one office building in
Philadelphia, Pennsylvania (127,000 square feet), which serves as the
administrative center for our direct response life insurance operations;
approximately 60 percent of this space is occupied by the Company, with the
remainder leased to tenants. Conseco leases 24,000 square feet of office space
in Bensalem, Pennsylvania, and 4,000 square feet of office space in Sarasota,
Florida, for use by our long-term care insurance marketing operations; these
leases expire in 2000 and 1998, respectively. Conseco leases 22,000 square feet
of office space in Schaumburg, Illinois, for use by our major medical marketing
and certain information technology operations. Conseco also leases
14
210 sales offices in various states totaling approximately 363,000 square feet;
these leases are short-term in length, with remaining lease terms ranging from
one to five years.
ITEM 3. LEGAL PROCEEDINGS.
Conseco and its subsidiaries are involved in lawsuits primarily related
to their operations. Most of these lawsuits involve claims under insurance
policies or other contracts of the Company. None of the lawsuits currently
pending, either individually or in the aggregate, is expected to have a material
adverse effect on Conseco's consolidated financial condition or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
15
OPTIONAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT.
Officer Positions with Conseco, principal
name and age (a) Since occupation and business experience (b)
------------ ----- ----------------------------------
Stephen C. Hilbert, 52......... 1979 Since 1979, Chairman of the Board and Chief Executive Officer and, since
1988, President of Conseco.
Ngaire E. Cuneo, 47 ........... 1992 Since 1992, Executive Vice President, Corporate Development and, since
1994, Director of Conseco; from 1986 to 1992, Senior Vice President and
Corporate Officer of General Electric Capital Corporation.
Rollin M. Dick, 66............. 1986 Since 1986, Executive Vice President, Chief Financial Officer and Director of
Conseco.
Donald F. Gongaware, 62........ 1985 Since 1985, Executive Vice President and Director of Conseco; since 1989,
Chief Operations Officer of Conseco; and, since 1996, President of Conseco
Marketing, LLC. Mr. Gongaware is resigning from these positions (other than
as director of Conseco) effective March 31, 1998.
John J. Sabl, 46............... 1997 Since 1997, Executive Vice President, General Counsel and Secretary of
Conseco; from 1983 to 1997 Partner in the law firm of Sidley & Austin.
James S. Adams, 38............. 1997 Since 1997, Senior Vice President, Chief Accounting Officer and Treasurer of
Conseco; from 1989 to present, Senior Vice President and Treasurer of various
Conseco subsidiaries.
Thomas J. Kilian, 47........... 1998 Effective March 31, 1998, Executive Vice President and Chief Operations Officer
of Conseco and President of Conseco Marketing, LLC; from 1996 to March 31,
1998, President of Conseco Services, LLC (responsible for insurance operations,
data processing, human resources and administrative services for various
Conseco subsidiaries); from 1989 to 1996, Senior Vice President of data
processing for various Conseco subsidiaries.
- -------------------
(a) The executive officers serve as such at the discretion of the Board of
Directors and are elected annually.
(b) Business experience is given for at least the last five years.
16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
MARKET INFORMATION
The common stock of Conseco (trading symbol "CNC") has been listed for
trading on the New York Stock Exchange (the "NYSE") since 1986. The following
table sets forth the quarterly dividends paid per share and the ranges of high
and low sales prices per share on the NYSE for the last two fiscal years, based
upon information supplied by the NYSE. All applicable per share data have been
adjusted for the two-for-one stock splits distributed April 1, 1996, and
February 11, 1997.
Market price
Period ------------ Dividend
------ High Low paid
---- --- ----
1996:
First Quarter.................................. $18-5/32 $14-15/16 $.00500
Second Quarter................................. 20-3/8 17-3/8 .01000
Third Quarter.................................. 24-11/16 17-5/8 .01000
Fourth Quarter................................. 33-1/8 24-7/16 .03125
1997:
First Quarter.................................. $43-7/8 $30-3/4 $.03125
Second Quarter................................. 42-7/8 34-1/4 .03125
Third Quarter.................................. 50 35-1/8 .03125
Fourth Quarter................................. 50-1/16 39-7/8 .12500
As of March 13, 1998, there were approximately 74,000 holders of the
outstanding shares of common stock, including individual participants in
securities position listings.
DIVIDENDS
Cash dividends are paid quarterly at an amount determined by our Board of
Directors. Our general policy is to retain most of our earnings. Retained
earnings have been used: (i) to finance the growth and development of the
Company's business through acquisitions or otherwise; (ii) to pay preferred
stock dividends; (iii) to pay distributions on the Company-obligated mandatorily
redeemable preferred stock of subsidiary trusts; (iv) to repurchase common stock
on those occasions when we have determined that our shares were undervalued in
the market and that the use of funds for stock repurchases would not interfere
with other cash needs; and (v) to pay dividends on common stock.
We have paid all cumulative dividends on our preferred stock and
distributions on our Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts when due. We are prohibited from paying common
stock dividends if such payments are not current. Certain Conseco financing
agreements require the Company to maintain financial ratios which could also
limit its ability to pay dividends.
Our ability to pay dividends depends primarily on the receipt of cash
dividends and other cash payments from our subsidiaries. The principal operating
subsidiaries of Conseco are life insurance companies organized under state laws
and subject to regulation by state insurance departments. These laws and
regulations limit the ability of insurance subsidiaries to make cash dividends,
loans or advances to a holding company such as Conseco. However, these laws
generally permit the payment, without prior approval, of annual dividends which
in the aggregate do not exceed the greater of (or in a few states, the lesser
of): (i) the subsidiary's prior year net gain from operations; or (ii) 10
percent of surplus attributable to policyholders at the prior year-end, both
computed on the statutory basis of accounting prescribed for insurance
companies. See "Management's Discussion and Analysis of Consolidated Financial
Condition and Results of Operations -- Liquidity of Conseco (Parent Company)."
17
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA (a).
Years ended December 31,
----------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Amounts in millions, except per share data)
STATEMENT OF OPERATIONS DATA
Insurance policy income..................................... $3,410.8 $1,654.2 $1,465.0 $1,285.6 $1,293.8
Net investment income....................................... 1,825.3 1,302.5 1,142.6 385.7 896.2
Net investment gains (losses) .............................. 266.5 60.8 204.1 (30.5) 242.6
Total revenues.............................................. 5,568.4 3,067.3 2,855.3 1,862.0 2,636.0
Interest expense on notes payable........................... 109.4 108.1 119.4 59.3 58.0
Total benefits and expenses................................. 4,565.3 2,573.7 2,436.8 1,537.6 2,025.8
Income before income taxes, minority interest and
extraordinary charge...................................... 1,003.1 493.6 418.5 324.4 610.2
Extraordinary charge on extinguishment of debt, net of tax.. 6.9 26.5 2.1 4.0 11.9
Net income.................................................. 567.3 252.4 220.4 150.4 297.0
Preferred stock dividends and charge related to induced
conversions of convertible preferred stock................ 21.9 27.4 18.4 18.6 20.6
Net income applicable to common stock....................... 545.4 225.0 202.0 131.8 276.4
PER SHARE DATA (b)
Net income, basic........................................... $2.94 $2.15 $ 2.48 $ 1.31 $ 2.74
Net income, diluted......................................... 2.64 1.82 2.12 1.22 2.20
Dividends declared per common share......................... .313 .083 .046 .125 .075
Book value per common share outstanding..................... 20.22 16.86 10.22 5.22 8.45
Shares outstanding at year-end.............................. 186.7 167.1 81.0 88.7 101.2
Weighted average shares outstanding for diluted earnings.... 210.2 138.9 103.9 123.4 133.8
BALANCE SHEET DATA - PERIOD END
Total assets................................................ $35,914.8 $25,612.7 $17,297.5 $10,811.9 $13,749.3
Notes payable for which Conseco is directly liable.......... 1,906.7 1,094.9 871.4 191.8 413.0
Notes payable of affiliates, not direct
obligations of Conseco.................................... - - 584.7 611.1 290.3
Commercial paper............................................ 448.2 - - - -
Total liabilities........................................... 30,640.1 21,829.7 15,782.5 9,743.2 12,382.9
Minority interests in consolidated subsidiaries:
Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts.............. 1,383.9 600.0 - - -
Preferred stock........................................... - 97.0 110.7 130.1 -
Common stock.............................................. .7 .7 292.6 191.6 223.8
Shareholders' equity ....................................... 3,890.1 3,085.3 1,111.7 747.0 1,142.6
OTHER FINANCIAL DATA (b) (c)
Premiums collected (d)...................................... $5,055.7 $3,280.2 $3,106.5 $1,879.1 $2,140.1
Operating earnings (e)...................................... 574.9 267.7 131.3 151.7 162.0
Operating earnings per diluted common share (e)............. 2.74 1.93 1.26 1.23 1.20
Shareholders' equity excluding unrealized appreciation
(depreciation) of fixed maturity securities (f)........... 3,712.9 3,045.5 999.1 884.7 1,055.2
Book value per common share outstanding, excluding
unrealized appreciation (depreciation) of fixed
maturity securities (f)................................... 19.27 16.62 8.83 6.77 7.58
(a) Comparison of selected consolidated financial data in the table above is
significantly affected by: (i) the acquisitions consummated by
Partnership I and Partnership II; (ii) the sale of Western National Life
Insurance Company ("Western National") in 1994; (iii) the transactions
affecting Conseco's ownership interest in BLH and CCP during 1993 through
1996; (iv) the LPG Merger (completed effective July 1, 1996); (v) the ATC
Merger (December 31, 1996); (vi) the THI Merger (December 31, 1996);
(vii) the CAF Merger (January 1, 1997); (viii) the PFS Merger (April 1,
1997); (ix) the Colonial Penn Purchase (September 30, 1997); and (x) the
WNIC Merger (December 1, 1997). For periods beginning with their
acquisitions by
18
Partnership I and ending June 30, 1992, Partnership I and its
subsidiaries were consolidated with the financial statements of Conseco.
Following the completion of the initial public offering by CCP in July
1992, Conseco did not have unilateral control to direct all of CCP's
activities and, therefore, did not consolidate the financial statements
of CCP with the financial statements of Conseco. As a result of the CCP
Merger, the financial statements of CCP's subsidiaries were consolidated
with the financial statements of Conseco, effective January 1, 1995.
Conseco has included BLH in its financial statements since November 1,
1992. Through December 31, 1993, the financial statements of Western
National were consolidated with the financial statements of Conseco.
Following the completion of the initial public offering of Western
National in early 1994 (and subsequent disposition of Conseco's remaining
equity interest in Western National), the financial statements of Western
National were no longer consolidated with the financial statements of
Conseco. As of September 29, 1994, Conseco began to include in its
financial statements the newly acquired Partnership II subsidiary, ALH.
On September 30, 1996, Conseco acquired all of the common stock of ALH
which Conseco did not already own from Partnership II. Business
combinations completed in 1997 and 1996 are included in Conseco's
financial statements on the effective date of the acquisition and are
described in the notes to the consolidated financial statements.
(b) All share and per-share amounts have been restated to reflect the
two-for-one stock splits paid on February 11, 1997 and April 1, 1996.
Prior period earnings per share amounts have been restated to comply with
the new reporting standards as described in note 1 to the consolidated
financial statements.
(c) Amounts under this heading are included to assist the reader in analyzing
the Company's financial position and results of operations. Such amounts
are not intended to, and do not, represent insurance policy income, net
income, net income per share, shareholders' equity or book value per
share prepared in accordance with generally accepted accounting
principles ("GAAP").
(d) Includes premiums received from universal life products and products
without mortality or morbidity risk. Such premiums are not reported as
revenues under GAAP and were $2,099.4 million in 1997; $1,881.3 million
in 1996; $1,757.5 million in 1995; $634.6 million in 1994; and $891.9
million in 1993.
(e) Represents income before extraordinary charge, excluding net investment
gains (losses) (less that portion of change in future policy benefits,
amortization of cost of policies purchased and cost of policies produced
and income taxes relating to such gains (losses)) and nonrecurring
charges (net of income taxes).
(f) Excludes the effects of reporting fixed maturities at fair value and
recording the unrealized gain or loss on such securities as a component
of shareholders' equity, net of tax and other adjustments. Such
adjustments are in accordance with Statement of Financial Accounting
Standards No. 115 "Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS 115"), as described in note 1 to the consolidated
financial statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
Management's discussion and analysis reviews the consolidated financial
condition of Conseco at December 31, 1997 and 1996, the consolidated results of
operations for the three years ended December 31, 1997, and where appropriate,
factors that may affect future financial performance. This discussion should be
read in conjunction with the accompanying consolidated financial statements,
notes thereto and selected consolidated financial data.
All statements, trend analyses and other information contained in this
report and elsewhere (such as in other filings by the Company with the
Securities and Exchange Commission, press releases, presentations by the Company
or its management or oral statements) relative to markets for the Company's
products and trends in the Company's operations or financial results, as well as
other statements including words such as "anticipate," "believe," "plan,"
"estimate," "expect," "intend," and other similar expressions, constitute
forward-looking statements under the Private Securities Litigation Reform Act of
1995. These forward-looking statements are subject to known and unknown risks,
uncertainties and other factors that may cause actual results to be materially
different from those contemplated by the forward-looking statements. Such
factors include, among other things: (i) general economic conditions and other
factors, including prevailing interest rate levels, stock market performance and
health care inflation, which may affect the ability of the Company to sell its
products, the market value of the Company's investments and the lapse rate and
profitability of the Company's policies; (ii) the Company's ability to achieve
anticipated levels of operational efficiencies at recently acquired companies,
as well as through other cost-saving initiatives; (iii) customer response to new
products, distribution channels and marketing initiatives; (iv) mortality,
morbidity, use of health care services and other factors that may affect the
profitability of the Company's insurance products; (v) changes in the federal
income tax laws and regulations that may affect the relative tax advantages of
some of the Company's products; (vi) increasing competition in the sale of the
Company's products; (vii) regulatory changes or actions, including those
relating to regulation of financial services affecting (among other things) bank
sales and underwriting of insurance products, regulation of the sale,
underwriting and pricing of insurance products, and health care regulation
affecting the Company's health insurance products; (viii)
19
the availability and terms of future acquisitions; and (ix) the risk factors or
uncertainties listed from time to time in the Company's other filings with the
Securities and Exchange Commission.
Consolidated results and analysis
Our 1997 operating earnings were $574.9 million, or $2.74 per diluted
share, up 115 percent and 42 percent, respectively, over 1996. Operating
earnings increased as a result of the LPG Merger (completed effective July 1,
1996), the ALH Stock Purchase (September 30, 1996), the ATC Merger (December 31,
1996), the THI Merger (December 31, 1996), the BLH Merger (December 31, 1996),
the CAF Merger (January 1, 1997), the PFS Merger (April 1, 1997), the Colonial
Penn Purchase (September 30, 1997) and the WNIC Merger (December 1, 1997) and as
a result of the increased business in force of these acquired companies and
companies previously owned. The percentage increase in operating earnings was
greater than the percentage increase in operating earnings per diluted share
primarily because of the 51 percent increase in weighted average diluted common
shares or equivalents outstanding during 1997. The increase in weighted average
diluted shares resulted from shares issued in certain 1997 and 1996 acquisitions
(the LPG Merger, the ATC Merger, the THI Merger, the BLH Merger, the CAF Merger
and the PFS Merger), partially offset by repurchases of Conseco common stock.
Our 1996 operating earnings were $267.7 million, or $1.93 per diluted
share, up 104 percent and 53 percent, respectively, over 1995. Operating
earnings increased as a result of the LPG Merger, the ALH Stock Purchase, the
effect of increased ownership of BLH as a result of purchases of BLH common
stock during 1995 and 1996, and profit improvements in each of our segments.
Operating earnings for 1996 were not affected by the ATC Merger, the THI Merger
or the BLH Merger, all of which were recorded as of December 31, 1996. The
percentage increase in operating earnings was greater than the increase in
operating earnings per diluted share primarily because of the additional common
shares or equivalents outstanding in 1996 resulting from: (i) the LPG Merger;
and (ii) the Company's January 1996 offering of Preferred Redeemable Increased
Dividend Equity Securities, 7% PRIDES Convertible Preferred Stock ("PRIDES"),
which are mandatorily convertible into shares of Conseco common stock.
Net income of $567.3 million in 1997, or $2.64 per diluted share,
included: (i) net investment gains (net of related costs, amortization and
taxes) of $44.1 million, or 21 cents per diluted share; (ii) an extraordinary
charge of $6.9 million, or 3 cents per share, related to early retirement of
debt; (iii) a charge of 7 cents per share related to the induced conversion of
preferred stock (treated as a preferred stock dividend); and (iv) nonrecurring
charges totaling $44.8 million, or 21 cents per share. Nonrecurring charges
include: (i) $40.5 million related to our Medicare supplement business in
Massachusetts; and (ii) $4.3 million related to the death of an executive
officer. Regulators in Massachusetts have not allowed premium increases for
Medicare supplement products necessary to avoid losses on the business. We are
currently seeking rate increases. We are no longer writing new Medicare
supplement business in Massachusetts. We have written off the cost of policies
purchased and produced and accrued additional claim reserves related to our
in-force Massachusetts Medicare supplement business due to the estimated premium
deficiencies.
Net income of $252.4 million in 1996, or $1.82 per diluted share,
included: (i) net investment gains (net of related costs, amortization and
taxes) of $11.2 million, or 8 cents per diluted share; and (ii) an extraordinary
charge of $26.5 million, or 19 cents per share, related to early retirement of
debt. Net income of $220.4 million in 1995, or $2.12 per diluted share,
included: (i) net investment gains (net of related costs, amortization and
taxes) of $16.3 million, or 16 cents per share; (ii) restructuring income of
$74.9 million, or 72 cents per share, arising from the release of deferred
income taxes previously accrued on income related to CCP and BLH (such deferred
tax was no longer required when Conseco's ownership of these companies exceeded
80 percent); and (iii) an extraordinary charge of $2.1 million, or 2 cents per
share, related to early retirement of debt.
Total revenues include net investment gains of $266.5 million in 1997,
$60.8 million in 1996 and $204.1 million in 1995. Excluding net investment
gains, total revenues were $5.3 billion in 1997, up 76 percent from $3.0 billion
in 1996. Total revenues in 1997 include a full year of activity for acquisitions
completed in 1996 and the revenues of CAF, PFS, Colonial Penn and WNIC in the
periods subsequent to their acquisitions. Total revenues in 1996 include LPG
revenues after July 1, 1996. Total revenues, excluding net investment gains,
were up 13 percent in 1996 from $2.7 billion in 1995.
20
Results of operations by segment for the three years ended December 31,
1997:
The following tables and narratives summarize the results of our
operations by business segment. All amounts reported in these summaries relate
solely to periods after the companies were included in our consolidated
financial statements.
1997 1996 1995
---- ---- ----
(Dollars in millions)
Income before income taxes, minority interest and extraordinary charge:
Supplemental health:
Operating income...........................................................$ 408.0 $ 136.6 $ 96.0
Net investment gains, net of related costs................................. 26.3 .1 1.1
Nonrecurring charges....................................................... (62.4) - -
--------- --------- --------
Income before income taxes, minority interest and extraordinary charge 371.9 136.7 97.1
--------- -------- --------
Annuities:
Operating income .......................................................... 305.1 255.0 244.1
Net investment gains (losses), net of related costs and amortization ...... 53.2 (.7) 72.0
--------- -------- --------
Income before income taxes, minority interest and extraordinary charge 358.3 254.3 316.1
--------- -------- --------
Life insurance:
Operating income........................................................... 304.7 126.8 74.8
Net investment gains (losses), net of related costs and amortization....... 2.4 (2.0) (4.6)
--------- -------- ---------
Income before income taxes, minority interest and extraordinary charge 307.1 124.8 70.2
--------- -------- --------
Individual and group major medical:
Operating income........................................................... 40.2 32.1 35.1
Net investment gains, net of related costs................................. .1 - .1
--------- -------- --------
Income before income taxes, minority interest and extraordinary charge 40.3 32.1 35.2
--------- -------- ---------
Other:
Operating income........................................................... 58.3 30.7 31.5
Net investment gains (losses), net of related costs........................ 3.3 27.4 (6.3)
--------- -------- --------
Income before income taxes, minority interest and extraordinary charge 61.6 58.1 25.2
--------- -------- --------
Corporate:
Interest and other corporate expenses...................................... (126.8) (112.4) (140.5)
Nonrecurring charges....................................................... (9.3) - -
Net investment gains, net of related costs................................. - - 15.2
--------- -------- --------
Net corporate expenses................................................. (136.1) (112.4) (125.3)
--------- -------- --------
Consolidated:
Operating income........................................................... 989.5 468.8 341.0
Net investment gains, net of related costs and amortization ............... 85.3 24.8 77.5
Nonrecurring charges....................................................... (71.7) - -
--------- -------- --------
Income before income taxes, minority interest and extraordinary charge 1,003.1 493.6 418.5
Income tax expense.............................................................. 376.6 179.8 87.0
--------- -------- --------
Income before minority interest and extraordinary charge............... 626.5 313.8 331.5
Minority interest in consolidated subsidiaries:
Distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts............................................ 49.0 3.6 -
Dividends on preferred stock of subsidiaries................................. 3.3 8.9 11.9
Equity in earnings of subsidiaries........................................... - 22.4 97.1
--------- -------- --------
Income before extraordinary charge.................................... 574.2 278.9 222.5
Extraordinary charge on extinguishment of debt, net of taxes and
minority interest............................................................ 6.9 26.5 2.1
--------- -------- --------
Net income.............................................................$ 567.3 $ 252.4 $ 220.4
========= ======== ========
21
Supplemental health:
1997 1996 1995
---- ---- ----
(Dollars in millions)
Premiums collected:
Medicare supplement (first-year)............................. $ 101.9 $ 72.5 $ 81.1
Medicare supplement (renewal)................................ 694.5 545.4 515.6
--------- ------- -------
Subtotal - Medicare supplement........................... 796.4 617.9 596.7
--------- ------- -------
Long-term care (first-year).................................. 143.4 51.6 44.4
Long-term care (renewal)..................................... 520.5 141.3 97.7
--------- ------- -------
Subtotal - long-term care................................ 663.9 192.9 142.1
--------- ------- -------
Specified-disease (first-year)............................... 44.7 - -
Specified-disease (renewal).................................. 338.7 - -
--------- ------- --------
Subtotal - specified-disease............................. 383.4 - -
--------- ------- -------
Total supplemental health premiums collected............. $1,843.7 $ 810.8 $738.8
======== ======= ======
Insurance policy income......................................... $1,858.1 $ 805.9 $756.9
Net investment income........................................... 273.8 66.6 66.9
-------- ------- -------
Total revenues (a)......................................... 2,131.9 872.5 823.8
--------- ------- -------
Insurance policy benefits and change in future policy benefits.. 1,217.5 531.8 525.6
Amortization related to operations.............................. 232.1 87.8 81.6
Interest expense on investment borrowings....................... 6.3 1.1 1.4
Other operating costs and expenses.............................. 268.0 115.2 119.2
--------- ------- -------
Total benefits and expenses................................ 1,723.9 735.9 727.8
--------- ------- -------
Operating income before income taxes,
minority interest and extraordinary
charge................................................... 408.0 136.6 96.0
Net investment gains, net of related costs...................... 26.3 .1 1.1
Nonrecurring charges............................................ (62.4) - -
--------- ------- -------
Income before income taxes, minority
interest and extraordinary charge...................... $ 371.9 $136.7 $97.1
========= ====== =====
Loss ratios:
Medicare supplement products................................. 69.1% 68.2% 71.7%
Long-term care products...................................... 63.6 58.7 60.5
Specified-disease products................................... 61.6 - -
(a) Revenues exclude net investment gains.
General: This segment includes Medicare supplement and long-term care
insurance products, primarily sold to senior citizens, and effective January 1,
1997 (as a result of the acquisitions of CAF and THI), specified-disease
products. Through December 31, 1996, the supplemental health operations consist
solely of Bankers Life's Medicare supplement and long-term care products,
distributed through a career agency force. The segment's 1997 results of
operations are significantly affected by recent acquisitions (ATC, THI and CAF,
effective January 1, 1997; PFS, effective April 1, 1997; and Colonial Penn,
effective September 30, 1997). The supplemental health products of THI, CAF,
ATC, PFS and Colonial Penn are all distributed through professional independent
producers. The profitability of this segment largely depends on the overall
level of sales, persistency of in-force business, claim experience and expense