Washington National Insurance Company
Consolidated Financial Statements as of December 31,
1998 and 1997, and for the year ended
December 31, 1998,
the one month ended December 31, 1997,
the eleven months ended November 30, 1997,
and the year ended December 31, 1996
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Washington National Insurance Company
We have audited the accompanying consolidated balance sheet of Washington
National Insurance Company and subsidiaries (the "Company") as of December 31,
1998 and 1997, and the related consolidated statements of operations,
shareholder's equity and cash flows for the year ended December 31, 1998 and the
one month ended December 31, 1997. We have also audited the accompanying
consolidated statements of operations, shareholder's equity and cash flows of
the Company for the eleven months ended November 30, 1997, based on the basis of
accounting applicable to periods prior to the adoption of push down accounting
upon Conseco, Inc.'s purchase of all common shares of Washington National
Corporation, the parent of the Company (see Note 1 of the notes to financial
statements regarding the adoption of push down accounting). These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. The consolidated statements of operations, shareholder's equity and
cash flows of the Company for the year ended December 31, 1996, were audited by
other auditors, whose report dated March 7, 1997 expressed an unqualified
opinion on those financial statements.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Washington
National Insurance Company and subsidiaries at December 31, 1998 and 1997 and
the results of their operations and their cash flows for the year ended December
31, 1998, the month ended December 31, 1997 and the eleven months ended November
30, 1997 in conformity with generally accepted accounting principles.
/s/ PricewaterhouseCoopers LLP
Indianapolis, Indiana
March 30, 1999
1
<PAGE>
<TABLE>
<CAPTION>
WASHINGTON NATIONAL INSURANCE COMPANY
CONSOLIDATED BALANCE SHEET
December 31, 1998 and 1997
(Dollars in millions)
ASSETS
1998 1997
---- ----
<S> <C> <C>
Investments:
Actively managed fixed maturities at fair value (amortized cost:
1998 - $1,789.8; 1997 - $1,874.7)............................................... $1,793.6 $1,887.4
Mortgage loans..................................................................... 126.4 210.8
Policy loans....................................................................... 56.7 58.3
Other invested assets ............................................................. 93.7 17.7
Short-term investments............................................................. 65.8 43.6
Assets held in separate accounts................................................... 52.1 47.2
-------- --------
Total investments............................................................ 2,188.3 2,265.0
Accrued investment income.............................................................. 28.0 29.4
Cost of policies purchased............................................................. 207.2 218.5
Cost of policies produced.............................................................. 22.2 2.7
Reinsurance receivables................................................................ 75.1 101.2
Goodwill (net of accumulated amortization: 1998 - $1.9; 1997 - $.1).................... 62.5 36.8
Other assets........................................................................... 21.0 35.9
--------- --------
Total assets................................................................. $2,604.3 $2,689.5
======== ========
</TABLE>
(continued on next page)
The accompanying notes are an
integral part of the financial
statements.
2
<PAGE>
<TABLE>
<CAPTION>
WASHINGTON NATIONAL INSURANCE COMPANY
CONSOLIDATED BALANCE SHEET (Continued)
December 31, 1998 and 1997
(Dollars in millions, except per share amount)
LIABILITIES AND SHAREHOLDER'S EQUITY
1998 1997
---- ----
<S> <C> <C>
Liabilities:
Insurance liabilities.............................................................. $2,029.4 $2,170.6
Liabilities related to separate accounts........................................... 52.1 47.2
Income tax liabilities............................................................. 9.0 4.5
Investment borrowings.............................................................. 48.1 -
Other liabilities.................................................................. 115.4 128.9
-------- --------
Total liabilities.......................................................... 2,254.0 2,351.2
-------- --------
Minority interest...................................................................... 56.1 56.2
Shareholder's equity:
Common stock and additional paid-in capital (par value $5.00 per share, 5,250,000
shares authorized, 5,007,370 shares issued and outstanding)..................... 273.2 273.2
Accumulated other comprehensive income:
Unrealized gains of fixed maturity securities (net of applicable deferred
income taxes: 1998 - $.6; 1997 - $ -)....................................... .8 6.1
Unrealized gains (losses) of other investments (net of applicable deferred
income taxes: 1998 - $(1.1); 1997 - $ -).................................... (1.7) .5
Retained earnings.................................................................. 21.9 2.3
--------- --------
Total shareholder's equity................................................. 294.2 282.1
-------- --------
Total liabilities and shareholder's equity................................. $2,604.3 $2,689.5
======== ========
</TABLE>
The accompanying notes are an
integral part of the financial
statements.
3
<PAGE>
<TABLE>
<CAPTION>
WASHINGTON NATIONAL INSURANCE COMPANY
CONSOLIDATED STATEMENT OF OPERATIONS
(Dollars in millions)
Prior basis
----------------------------
One month Eleven months
Year ended ended ended Year ended
December 31, December 31, November 30, December 31,
1998 1997 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Insurance policy income....................... $161.1 $14.2 $149.1 $157.6
Net investment income......................... 148.5 12.0 146.1 165.7
Net investment gains (losses)................. 9.9 (.1) 4.3 .6
Other ........................................ 6.2 - 8.0 4.4
------ ----- ------ ------
Total revenues............................ 325.7 26.1 307.5 328.3
------ ----- ------ ------
Benefits and expenses:
Insurance policy benefits..................... 205.1 17.3 193.8 214.3
Amortization of cost of policies produced
and purchased .............................. 29.8 1.2 24.2 22.7
Other operating costs and expenses............ 27.7 3.1 44.3 42.4
------ ----- ------ ------
Total benefits and expenses............... 262.6 21.6 262.3 279.4
------ ----- ------ ------
Income before income taxes, minority
interest and discontinued operations.... 63.1 4.5 45.2 48.9
Income tax expense............................... 23.2 1.6 16.6 16.8
------ ----- ------ ------
Income before minority interest and
discontinued operations................. 39.9 2.9 28.6 32.1
Minority interest................................ 6.3 .6 4.6 4.5
------ ----- ------ ------
Income from continuing operations......... 33.6 2.3 24.0 27.6
Income (loss) from discontinued operations,
net of income taxes........................... - - 1.8 (26.0)
------ ----- ------ ------
Net income................................ $ 33.6 $ 2.3 $ 25.8 $ 1.6
====== ===== ====== ======
</TABLE>
The accompanying notes are an
integral part of the financial
statements.
4
<PAGE>
<TABLE>
<CAPTION>
WASHINGTON NATIONAL INSURANCE COMPANY
CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY
(Dollars in millions)
Common stock Accumulated other
and additional comprehensive Retained
Total paid-in capital income (loss) earnings
----- --------------- ------------- --------
<S> <C> <C> <C> <C>
Balance, December 31, 1995 (a).............................. $381.4 $ 68.3 $ 45.2 $ 267.9
Comprehensive loss, net of tax:
Net income (a)......................................... 1.6 - - 1.6
Change in unrealized appreciation (depreciation) of
securities (net of applicable income tax benefit
of $12.0) (a)........................................ (30.8) - (30.8) -
------
Total comprehensive loss (a)....................... (29.2)
Other (a)................................................ 3.5 - - 3.5
Dividends on common stock (a)............................ (8.1) - - (8.1)
------ ------ ------- -------
Balance, December 31, 1996 (a).............................. 347.6 68.3 14.4 264.9
Comprehensive income, net of tax:
Net income (a)......................................... 25.8 - - 25.8
Change in unrealized appreciation (depreciation) of
securities (net of applicable income taxes
of $1.2) (a)......................................... 10.2 - 10.2 -
------
Total comprehensive income (a)..................... 36.0 - - -
Dividends on common stock (a)............................ (28.0) - - (28.0)
------ ------ -------- -------
Balance, November 30, 1997 (a).............................. 355.6 68.3 24.6 262.7
Comprehensive income, net of tax:
Net income............................................. 2.3 - - 2.3
Change in unrealized appreciation (depreciation) of
securities (net of applicable income taxes of $ - ) . 6.6 - 6.6 -
------
Total comprehensive income......................... 8.9
Dividends on common stock................................ (73.7) - - (73.7)
Adjustment of balance due to new accounting basis........ (8.7) 204.9 (24.6) (189.0)
------ ------ ------- -------
Balance, December 31, 1997.................................. 282.1 273.2 6.6 2.3
Comprehensive income, net of tax:
Net income............................................... 33.6 - - 33.6
Change in unrealized appreciation (depreciation) of
securities (net of applicable income tax
benefit of $.5)........................................ (7.5) - (7.5) -
-------
Total comprehensive income......................... 26.1
Dividends on common stock................................ (14.0) - - (14.0)
------ ------ ------- -------
Balance, December 31, 1998.................................. $294.2 $273.2 $ (.9) $ 21.9
====== ====== ======= =======
<FN>
- --------------------
(a) Prior basis.
</FN>
</TABLE>
The accompanying notes are an
integral part of the financial
statements.
5
<PAGE>
<TABLE>
<CAPTION>
WASHINGTON NATIONAL INSURANCE COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in millions)
Prior basis
-----------------------------
One month Eleven months
Year ended ended ended Year ended
December 31, December 31, November 30, December 31,
1998 1997 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income.................................. $ 33.6 $ 2.3 $ 25.8 $ 1.6
Adjustments to reconcile net income to net..
cash provided by operating activities:
Amortization and depreciation........... 34.3 1.2 26.3 38.8
Income taxes............................ 5.8 10.5 (4.3) 6.0
Insurance liabilities................... (28.1) (.4) (14.0) 17.3
Accrual and amortization of investment
income................................ 9.4 1.2 1.7 1.2
Deferral of cost of policies produced
and purchased......................... (28.1) (2.7) (30.5) (48.3)
Income (loss) from discontinued
operations, net of tax................ - - (1.8) 25.1
Investment gains (losses)............... (9.9) .1 (4.3) (.6)
Other................................... (18.9) (29.7) 10.3 (24.5)
--------- ------ ------- -------
Net cash provided (used) by
operating activities............... (1.9) (17.5) 9.2 16.6
--------- ------ ------- -------
Cash flows from investing activities:
Sales of investments.......................... 1,568.2 26.8 64.0 240.3
Maturities and redemptions.................... 283.3 2.0 205.5 142.4
Purchases of investments...................... (1,748.5) - (139.2) (239.4)
Net payments on sale of discontinued
operations.................................. - - (24.0) (11.7)
--------- ------ ------- -------
Net cash provided by
investing activities............... 103.0 28.8 106.3 131.6
--------- ------ ------- -------
Cash flows from financing activities:
Deposits to insurance liabilities............. 119.8 12.7 134.7 149.9
Investment borrowings......................... 48.1 - - -
Withdrawals from insurance liabilities........ (232.8) (18.8) (215.8) (234.0)
Dividends paid on common stock................ (14.0) (73.7) (28.0) (11.2)
--------- ------ ------- -------
Net cash used by financing activities. (78.9) (79.8) (109.1) (95.3)
--------- ------ ------- -------
Net increase (decrease) in short-term
investments........................ 22.2 (68.5) 6.4 52.9
Short-term investments, beginning of period...... 43.6 112.1 105.7 52.8
--------- ------ ------- --------
Short-term investments, end of period............ $ 65.8 $ 43.6 $ 112.1 $ 105.7
========= ====== ======= =======
</TABLE>
The accompanying notes are an
integral part of the financial
statements.
6
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY
Notes to Financial Statements
------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Washington National Insurance Company ("we" or the "Company") is a wholly
owned subsidiary of Washington National Corporation ("WNC"). Effective December
5, 1997, WNC became a wholly owned subsidiary of Conseco, Inc. ("Conseco").
Conseco is a financial services holding company operating throughout the United
States. Conseco's life insurance subsidiaries develop, market and administer
supplemental health insurance, annuity, individual life insurance, individual
and group major medical insurance and other insurance products. Conseco's
finance subsidiaries originate, purchase, sell and service consumer and
commercial finance loans.
The Company owns a 71.3% interest in United Presidential Corporation
("UPC"), the parent company of United Presidential Life Insurance Company
("UPI"), a life insurance company domiciled in Indiana. The remaining 28.7% is
owned by WNC. The operations of UPC are consolidated in the accompanying
financial statements, with WNC's ownership of UPC recorded as minority interest.
On December 5, 1997, Conseco, an Indiana company, completed the acquisition
of WNC. All former WNC shareholders received $33.25 in cash per common share.
The acquisition was accounted for using the push-down purchase method of
accounting with an effective date of December 1, 1997. Under this method, the
total cost to acquire the Company was allocated to the assets and liabilities
based on their fair value, with the excess of the total purchase cost over the
fair value of the net assets acquired recorded as goodwill.
The consolidated balance sheet as of December 31, 1998 and 1997, and the
consolidated statement of operations, shareholder's equity and cash flows for
the year ended December 31, 1998 and the one month ended December 31, 1997, are
reported under the push-down purchase method of accounting. The consolidated
statements of operations, shareholder's equity and cash flows for the eleven
months ended November 30, 1997, and the year ended December 31, 1996, are the
historical financial data of the Company ("prior basis").
The following summary explains the accounting policies we use to arrive at
the more significant numbers in our financial statements. We prepare our
financial statements in accordance with generally accepted accounting principles
("GAAP"). We follow the accounting standards established by the Financial
Accounting Standards Board, the American Institute of Certified Public
Accountants and the Securities and Exchange Commission. Significant intercompany
transactions have been eliminated. We reclassified certain amounts in our 1997
and 1996 financial statements and notes to conform with the 1998 presentation.
Investments
Fixed maturities are securities that mature more than one year after
issuance and include bonds, notes receivable and redeemable preferred stock.
Fixed maturities that we may sell prior to maturity are classified as actively
managed and are carried at estimated fair value, with any unrealized gain or
loss, net of tax and related adjustments, recorded as a component of
shareholder's equity. Fixed maturity securities that we intend to sell in the
near term are classified as trading and included in other invested assets. We
include any unrealized gain or loss on trading securities in net investment
gains.
Equity securities include investments in common stocks and non-redeemable
preferred stock. We carry these investments at estimated fair value. We record
any unrealized gain or loss, net of tax and related adjustments, as a component
of shareholder's equity.
Mortgage loans held in our investment portfolio are carried at amortized
unpaid balances, net of provisions for estimated losses.
Policy loans are stated at their current unpaid principal balances.
Other invested assets include trading securities and certain
non-traditional investments. Non-traditional investments include
7
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY
Notes to Financial Statements
------------------------------
investments in venture capital funds, limited partnerships, mineral rights and
promissory notes; we account for them using either the cost method, or for
investments in partnerships over whose operations the Company exercises
significant influence, the equity method.
Short-term investments include commercial paper, invested cash and other
investments purchased with maturities of less than three months. We carry them
at amortized cost, which approximates their estimated fair value. We consider
all short-term investments to be cash equivalents.
We defer any fees received or costs incurred when we originate investments
(primarily mortgage loans). We amortize fees, costs, discounts and premiums as
yield adjustments over the contractual lives of the investments. We consider
anticipated prepayments on mortgage-backed securities in determining estimated
future yields on such securities.
When we sell a security (other than a trading security), we report the
difference between our sale proceeds and its amortized cost (determined based on
specific identification) as an investment gain or loss.
We regularly evaluate all of our investments based on current economic
conditions, credit loss experience and other investee- specific developments. If
there is a decline in a security's net realizable value that is other than
temporary, we treat it as a realized loss and reduce our cost basis of the
security to its estimated fair value.
Separate Accounts
Separate accounts are funds on which investment income and gains or losses
accrue directly to certain policyholders. The assets of these accounts are
legally segregated. They are not subject to the claims that may arise out of any
other business of the Company. We report separate account assets at market
value; the underlying investment risks are assumed by the contract holders. We
record the related liabilities at amounts equal to the market value of the
underlying assets.
Cost of Policies Produced
The costs that vary with, and are primarily related to, producing new
insurance business are referred to as cost of policies produced. We amortize
these costs using the interest rate credited to the underlying policy; (i) in
relation to the estimated gross profits for universal life-type and
investment-type products; or (ii) in relation to future anticipated premium
revenue for other products.
When we sell investments backing our universal life or investment-type
product business at a gain or loss, we adjust the amortization to reflect the
change in future investment yields resulting from the sale (thereby changing the
future amortization to offset the change in yield). We also adjust the cost of
policies produced for the change in amortization that would have been recorded
if actively managed fixed maturity securities had been sold at their stated
aggregate fair value and the proceeds reinvested at current yields. We include
the impact of this adjustment in net unrealized appreciation (depreciation)
within shareholder's equity.
Each year, we evaluate the recoverability of the unamortized balance of the
cost of policies produced. We consider estimated future gross profits or future
premiums, expected mortality or morbidity, interest earned and credited rates,
persistency and expenses in determining whether the balance is recoverable.
Cost of Policies Purchased
The cost assigned to the right to receive future cash flows from contracts
existing at the date of an acquisition is referred to as cost of policies
purchased. This balance is amortized, evaluated for recoverability, and adjusted
for the impact of realized and unrealized gains (losses) in the same manner as
the cost of policies produced described above.
8
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY
Notes to Financial Statements
------------------------------
Goodwill
Goodwill is the excess of the amount paid to acquire the Company over the
fair value of its net assets. We amortize goodwill on the straight-line basis
over a 40-year period. We continually monitor the value of our goodwill based on
our estimates of future earnings. We determine whether goodwill is fully
recoverable from projected undiscounted net cash flows over the remaining
amortization period. If we were to determine that changes in such projected cash
flows no longer support the recoverability of goodwill over the remaining
amortization period, we would reduce its carrying value with a corresponding
charge to expense or shorten the amortization period (no such changes have
occurred).
Recognition of Insurance Policy Income and Related Benefits and Expenses on
Insurance Contracts
Generally, we recognize insurance premiums for traditional life and
accident and health contracts as earned over the premium-paying periods. We
establish reserves for future benefits on a net-level premium method based upon
assumptions as to investment yields, mortality, morbidity, withdrawals and
dividends. We record premiums for universal life-type and investment-type
contracts that do not involve significant mortality or morbidity risk as
deposits to insurance liabilities. Revenues for these contracts consist of
mortality, morbidity, expense and surrender charges. We establish reserves for
the estimated present value of the remaining net costs of all reported and
unreported claims.
Reinsurance
In the normal course of business, we seek to limit our exposure to loss on
any single insured or to certain groups of policies by ceding reinsurance to
other insurance enterprises. We currently retain no more than $.3 million of
mortality risk on any one policy. We diversify the risk of reinsurance loss by
using a number of reinsurers that have strong claims-paying ratings. If any
reinsurer could not meet its obligations, the Company would assume the
liability. The likelihood of a material loss being incurred as the result of the
failure of one of our reinsurers is considered remote. The cost of reinsurance
ceded totaled $41.7 million, $8.9 million, $37.7 million and $49.1 million for
the year ended December 31, 1998, the one month ended December 31, 1997, the
eleven months ended November 30, 1997, and the year ended December 31, 1996,
respectively. Reinsurance recoveries netted against insurance policy benefits
totaled $29.5 million, $3.6 million, $18.7 million and $19.8 million, for the
year ended December 31, 1998, the one month ended December 31, 1997, the eleven
months ended November 30, 1997, and the year ended December 31, 1996,
respectively.
At December 31, 1998 and 1997, approximately 51 percent and 58 percent,
respectively of our total reinsurance recoverables related to our sale of the
health business to a subsidiary of Conseco.
Yearly renewable term reinsurance is used at UPI to maintain statutory
profitability and other statutory financial requirements while sustaining
growth. The cumulative contribution to statutory basis capital and surplus from
this reinsurance was $5.5 million, $6.1 million and $8.0 million for the years
ended December 31, 1998, 1997 and 1996, respectively. These transactions do not
materially impact the Company's GAAP financial statements.
Income Taxes
Our income tax expense includes deferred income taxes arising from
temporary differences between the tax and financial reporting bases of assets
and liabilities. In assessing the realization of deferred income tax assets, we
consider whether it is more likely than not that the deferred income tax assets
will be realized. The ultimate realization of deferred income tax assets depends
upon generating future taxable income during the periods in which temporary
differences become deductible. If future income is not generated as expected,
deferred income tax assets may need to be written off (no such write-offs have
occurred).
Minority Interest
Our consolidated financial statements include all of the assets,
liabilities, revenues and expenses of UPC, even though we did not own all of
UPC's common stock. We make a charge against consolidated income for the share
of earnings allocable to minority interests. We show the equity of UPC allocable
to the minority interest separately on our consolidated balance sheet.
9
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY
Notes to Financial Statements
------------------------------
Investment Borrowings
As part of our investment strategy, we may enter into reverse repurchase
agreements and dollar-roll transactions to increase our investment return or to
improve our liquidity. We account for these transactions as collateral
borrowings, where the amount borrowed is equal to the sales price of the
underlying securities. Reverse repurchase agreements involve a sale of
securities and an agreement to repurchase the same securities at a later date at
an agreed-upon price. Dollar rolls are similar to reverse repurchase agreements
except that, with dollar rolls, the repurchase involves securities that are only
substantially the same as the securities sold. We account for these transactions
as short-term collateralized borrowings. Such borrowings averaged approximately
$12.4 million during 1998 and were collateralized by investment securities with
fair values approximately equal to the loan value. The weighted average interest
rate on short-term collateralized borrowings was 4.8 percent in 1998. There were
no such borrowings in 1997. The primary risk associated with short-term
collateralized borrowings is that a counterparty will be unable to perform under
the terms of the contract. Our exposure is limited to the excess of the net
replacement cost of the securities over the value of the short-term investments
(such excess was not material at December 31, 1998). We believe the
counterparties to our reverse repurchase and dollar-roll agreements are
financially responsible and that the counterparty risk is minimal.
Use of Estimates
When we prepare financial statements in conformity with GAAP, we are
required to make estimates and assumptions that significantly affect various
reported amounts of assets and liabilities, and the disclosure of contingent
assets and liabilities at the date of the financial statements and revenues and
expenses during the reporting periods. For example, we use significant estimates
and assumptions in calculating values for the cost of policies produced, the
cost of policies purchased, goodwill, liabilities for insurance and deposit
products, liabilities related to litigation, guaranty fund assessment accruals,
gain on sale of finance receivables and deferred income taxes. If our future
experience differs materially from these estimates and assumptions, our
financial statements could be affected.
Fair Values of Financial Instruments
We use the following methods and assumptions to determine the estimated
fair values of financial instruments:
Investment securities. For fixed maturity securities (including redeemable
preferred stocks) and for equity and trading securities, we use quotes from
independent pricing services, where available. For investment securities
for which such quotes are not available, we use values obtained from
broker-dealer market makers or by discounting expected future cash flows
using a current market rate appropriate for the yield, credit quality, and
(for fixed maturity securities) the maturity of the investment being
priced.
Short-term investments. We use quoted market prices. The carrying amount
for these instruments approximates their estimated fair value.
Mortgage loans and policy loans. We discount future expected cash flows for
loans included in our investment portfolio based on interest rates
currently being offered for similar loans to borrowers with similar credit
ratings. We aggregate loans with similar characteristics in our
calculations.
Other invested assets. We use quoted market prices, where available. When
quotes are not available, we assume a market value equal to carrying value.
Insurance liabilities for investment contracts. We discount future expected
cash flows based on interest rates currently being offered for similar
contracts with similar maturities.
Investment borrowings. Due to the short-term nature of these borrowings
(terms generally less than 30 days), estimated fair
10
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY
Notes to Financial Statements
------------------------------
values are assumed to approximate the carrying amount reported in the balance
sheet.
Here are the estimated fair values of our financial instruments:
<TABLE>
<CAPTION>
1998 1997
--------------------------- -------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
(Dollars in millions)
<S> <C> <C> <C> <C>
Financial assets:
Actively managed fixed maturities............................ $1,793.6 $1,793.6 $1,887.4 $1,887.4
Mortgage loans............................................... 126.4 139.6 210.8 210.8
Policy loans................................................. 56.7 56.7 58.3 58.3
Other invested assets........................................ 93.7 93.7 17.7 17.7
Short-term investments....................................... 65.8 65.8 43.6 43.6
Financial liabilities:
Insurance liabilities for investment contracts (1)........... 900.6 900.6 1,003.9 1,003.9
Investment borrowings........................................ 48.1 48.1 - -
<FN>
(1) The estimated fair value of the liabilities for investment contracts
was approximately equal to its carrying value at December 31, 1998 and
1997. This was because interest rates credited on the vast majority of
account balances approximate current rates paid on similar investments
contracts and because these rates are not generally guaranteed beyond
one year. We are not required to disclose fair values for insurance
liabilities, other than those for investment contracts. However, we
take into consideration the estimated fair values of all insurance
liabilities in our overall management of interest rate risk. We attempt
to minimize exposure to changing interest rates by matching investment
maturities with amounts due under insurance contracts.
</FN>
</TABLE>
Recently Issued Accounting Standards
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133") was issued in June
1998. SFAS 133 requires all derivative instruments to be recorded on the balance
sheet at estimated fair value. Changes in the fair value of derivative
instruments are to be recorded each period either in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction and, if it is, on the type of hedge transaction. SFAS 133 is
effective for year 2000. We are currently evaluating the impact of SFAS 133; at
present, we do not believe it will have a material effect on our financial
position or results of operations.
2. INVESTMENTS:
At December 31, 1998, the amortized cost and estimated fair value of
actively managed fixed maturity securities were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Investment grade:
Corporate securities................................................ $1,086.8 $17.5 $15.2 $1,089.1
United States Treasury securities and obligations of
United States government corporations and agencies................ 41.4 .7 .1 42.0
States and political subdivisions................................... 13.0 .3 - 13.3
Debt securities issued by foreign governments....................... 10.7 .5 - 11.2
Mortgage-backed securities ......................................... 547.8 5.6 2.0 551.4
Below-investment grade (primarily corporate securities)................ 90.1 .1 3.6 86.6
--------- ----- ----- --------
Total actively managed fixed maturities........................... $1,789.8 $24.7 $20.9 $1,793.6
======== ===== ===== ========
</TABLE>
11
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY
Notes to Financial Statements
------------------------------
At December 31, 1997, the amortized cost and estimated fair value of
actively managed fixed maturity securities were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Investment grade:
Corporate securities................................................ $1,082.0 $9.9 $.3 $1,091.6
United States Treasury securities and obligations of
United States government corporations and agencies................ 47.8 .2 - 48.0
States and political subdivisions................................... 83.3 .3 .1 83.5
Debt securities issued by foreign governments....................... 24.8 .4 - 25.2
Mortgage-backed securities ......................................... 597.6 2.5 .2 599.9
Below-investment grade (primarily corporate securities)................ 39.2 .1 .1 39.2
--------- ----- --- --------
Total actively managed fixed maturities........................... $1,874.7 $13.4 $.7 $1,887.4
======== ===== === ========
</TABLE>
Net unrealized gains (losses) on actively managed fixed maturity
investments included in shareholder's equity as of December 31, 1998 and 1997,
were as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
(Dollars in millions)
<S> <C> <C>
Net unrealized gains on actively managed fixed maturity investments.................................. $ 3.8 $12.7
Adjustments to cost of policies purchased............................................................ (2.2) (5.5)
Minority interest.................................................................................... (.2) (1.1)
Deferred income tax liability........................................................................ (.6) -
----- -----
Net unrealized gains on actively managed fixed maturity investments........................... $ .8 $ 6.1
===== =====
</TABLE>
The following table sets forth the amortized cost and estimated fair value
of actively managed fixed maturities at December 31, 1998, by contractual
maturity. Actual maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties. Most of the mortgage-backed securities shown below
provide for periodic payments throughout their lives.
<TABLE>
<CAPTION>
Estimated
Amortized fair
cost value
---- -----
(Dollars in millions)
<S> <C> <C>
Due in one year or less........................................................................ $ 45.6 $ 45.8
Due after one year through five years.......................................................... 261.5 264.2
Due after five years through ten years......................................................... 308.7 307.6
Due after ten years............................................................................ 626.2 624.6
-------- --------
Subtotal.................................................................................. 1,242.0 1,242.2
Mortgage-backed securities..................................................................... 547.8 551.4
-------- --------
Total actively managed fixed maturities ............................................... $1,789.8 $1,793.6
======== ========
</TABLE>
12
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY
Notes to Financial Statements
------------------------------
Net investment income consisted of the following:
<TABLE>
<CAPTION>
One month Eleven months
Year ended ended ended Year ended
December 31, December 31, November 30, December 31,
1998 1997 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Actively managed fixed maturity securities....... $121.6 $10.7 $124.4 $139.0
Mortgage loans................................... 16.7 1.5 19.4 25.7
Policy loans..................................... 3.8 .4 3.4 3.8
Other invested assets............................ 7.2 (.1) 2.4 5.1
Short-term investments........................... 2.9 .1 4.5 2.7
------ ----- ------ ------
Gross investment income....................... 152.2 12.6 154.1 176.3
Investment expenses.............................. 3.7 .6 8.0 10.6
------ ----- ------ ------
Net investment income....................... $148.5 $12.0 $146.1 $165.7
====== ===== ====== ======
</TABLE>
The Company had no significant fixed maturity investments and mortgage
loans that were not accruing investment income during the year ended December
31, 1998, the one month ended December 31, 1997, the eleven months ended
November 30, 1997, and the year ended December 31, 1996.
Investment gains (losses), net of investment expenses, were included in
revenue as follows:
<TABLE>
<CAPTION>
One month Eleven months
Year ended ended ended Year ended
December 31, December 31, November 30, December 31,
1998 1997 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Fixed maturities:
Gross gains................................... $17.1 $ - $ 5.9 $ 4.0
Gross losses.................................. (3.7) - (1.0) (3.5)
----- ----- ----- -----
Net investment gains from fixed maturities
before expenses......................... 13.4 - 4.9 .5
Other............................................ - (.1) (.6) .1
----- ----- ----- -----
Net investment gains (losses) before
expenses................................ 13.4 (.1) 4.3 .6
Investment expenses.............................. 3.5 - - -
----- ----- ----- ------
Net investment gains (losses)............. $ 9.9 $ (.1) $ 4.3 $ .6
===== ===== ===== =====
</TABLE>
At December 31, 1998, the mortgage loan balance was primarily comprised of
commercial loans. Approximately 17 percent, 12 percent, 11 percent, 10 percent
and 9 percent of the mortgage loan balance were on properties located in
California, Illinois, Indiana, Florida and Texas, respectively. No other state
comprised greater than 5 percent of the mortgage loan balance. Noncurrent
mortgage loans were insignificant at December 31, 1998. At December 31, 1998,
our allowance for loss on mortgage loans was $7.0 million.
13
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY
Notes to Financial Statements
------------------------------
Life insurance companies are required to maintain certain investments on
deposit with state regulatory authorities. Such assets had an aggregate carrying
value of $12.1 million at December 31, 1998.
The Company had no investments in any single entity in excess of 10 percent
of shareholder's equity at December 31, 1998, other than investments issued or
guaranteed by the United States government or a United States government agency.
3. INSURANCE LIABILITIES:
These liabilities consisted of the following:
<TABLE>
<CAPTION>
Interest
Withdrawal Mortality rate
assumption assumption assumption 1998 1997
---------- ---------- ---------- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C> <C>
Future policy benefits:
Interest-sensitive products:
Investment contracts............................ N/A N/A (b) $ 900.6 $1,003.9
Universal life-type contracts................... N/A N/A (b) 750.4 735.7
-------- --------
Total interest-sensitive products............. 1,651.0 1,739.6
-------- --------
Traditional products:
Limited-payment contracts....................... None (a) 4.7% 110.9 109.4
Other traditional products...................... N/A N/A N/A 65.9 89.6
-------- --------
Total traditional products.................... 176.8 199.0
-------- --------
Claims payable and other policyholder funds ........ N/A N/A N/A 201.6 232.0
-------- --------
Total......................................... $2,029.4 $2,170.6
======== ========
<FN>
- -------------
(a) Principally modifications of the 1965 - 70 Basic Tables.
(b) This balance represents account balances because future benefits are not
guaranteed.
</FN>
</TABLE>
14
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY
Notes to Financial Statements
------------------------------
4. INCOME TAXES:
Income tax liabilities were comprised of the following:
<TABLE>
<CAPTION>
1998 1997
---- ----
(Dollars in millions)
<S> <C> <C>
Deferred income tax liabilities (assets):
Investments (primarily actively managed fixed maturities).................................. $ 14.6 $ .4
Cost of policies purchased and cost of policies produced................................... 74.1 70.3
Insurance liabilities...................................................................... (69.1) (57.1)
Unrealized appreciation (depreciation)..................................................... (.4) 24.2
Net operating loss carryforward............................................................ (1.7) -
Other...................................................................................... (4.5) (25.0)
------ ------
Deferred income tax liabilities....................................................... 13.0 12.8
Current income tax liabilities (assets)........................................................ (4.0) (8.3)
------ ------
Income tax liabilities................................................................ $ 9.0 $ 4.5
====== ======
</TABLE>
Income tax expense was as follows:
<TABLE>
<CAPTION>
One month Eleven months
Year ended ended ended Year ended
December 31, December 31, November 30, December 31,
1998 1997 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Current tax provision (benefit)................... $17.2 $(2.9) $ 6.2 $15.0
Deferred tax provision............................ 6.0 4.5 10.4 1.8
----- ----- ----- -----
Income tax expense from continuing
operations............................... 23.2 1.6 16.6 16.8
Income tax benefit from discontinued operations... - - (1.8) (13.1)
----- ----- ----- -----
Total income tax expense................... $23.2 $ 1.6 $14.8 $ 3.7
===== ===== ===== =====
</TABLE>
A reconciliation of the income tax provisions based on the U.S. statutory
corporate tax rate to the provisions reflected in the statement of operations is
as follows:
<TABLE>
<CAPTION>
One month Eleven months
Year ended ended ended Year ended
December 31, December 31, November 30, December 31,
1998 1997 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Tax on income before income taxes at statutory
rate........................................... 35.0% 35.0% 35.0% 35.0%
Other............................................. 1.8% .6% 1.7% (.6)%
---- ---- ---- ---
Income tax expense from continuing
operations............................. 36.8% 35.6% 36.7% 34.4%
==== ==== ==== ====
</TABLE>
At December 31, 1998, the Company had a net operating loss carryforward of
$4.8 million for tax return purposes, which will expire in 2017.
15
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY
Notes to Financial Statements
------------------------------
The Company is currently being examined by the Internal Revenue Service for
the 1995 and 1996 tax years. The Company believes that the outcome of this
examination will not have a material impact on its financial position or results
of operations.
5. OTHER DISCLOSURES:
Leases
The Company rents office space, equipment and computer software under
noncancellable operating leases. As a result of the sale of the Company's health
insurance business in 1996 and the acquisition by Conseco, the Company entered
into an agreement to sublease its home office building to ACCO, a subsidiary of
American Brands. The building was leased from a joint venture partnership in
which WNIC has a one-third interest. ACCO took possession of approximately 80%
of the building at the beginning of August 1997. A portion of the Company's
operations occupied the remaining 20% of the building through February 15, 1998.
The sublease resulted in the Company recording a $9.1 million charge in the
second quarter of 1997 for the difference between the rent expected to be
received and the remaining lease obligation on the original lease. Rental
expense was $1.3 million in 1998, $.2 million in the one month ended December
31, 1997, $10.7 million (including the previously described $9.1 million charge)
in the eleven months ended November 30, 1997, and $2.7 million in 1996. Future
required minimum rental payments as of December 31, 1998, were as follows
(dollars in millions):
<TABLE>
<S> <C>
1999........................................................ $ 3.4
2000........................................................ 3.4
2001........................................................ 3.4
2002........................................................ 3.5
2003........................................................ 3.6
Thereafter.................................................. 37.5
-----
Total.................... $54.8
=====
</TABLE>
Postretirement Plan
The Company provides certain health care and life insurance benefits for
certain eligible retired employees under a partially funded plan. Such
postretirement benefit plan is contributory, with participants' contributions
adjusted annually. Amounts related to the postretirement benefit plan was as
follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
(Dollars in millions)
<S> <C> <C>
Benefit obligation, beginning of year......................................... $19.0 $23.0
Service cost.............................................................. - -
Interest cost............................................................. 1.3 1.6
Plan participants' contributions.......................................... .4 .4
Actuarial loss (gain)..................................................... .5 (4.6)
Acquisitions.............................................................. - -
Benefits paid............................................................. (1.7) (1.4)
----- -----
Benefit obligation, end of year............................................... $19.5 $19.0
===== =====
Fair value of plan assets, beginning of year.................................. $ 5.9 $ -
Actual return on plan assets.............................................. .3 -
Acquisition............................................................... - 6.9
Employer contributions.................................................... - -
Plan participants' contributions.......................................... .4 .4
Benefits paid............................................................. (1.5) (1.4)
----- -----
Fair value of plan assets, end of year........................................ $ 5.1 $ 5.9
===== =====
Funded status................................................................. $(14.4) $(13.1)
Unrecognized net actuarial gain (loss)........................................ (8.5) (8.4)
Unrecognized prior service cost............................................... - -
------- ----
Accrued benefit liability.............................................. $(22.9) $(21.5)
====== ======
</TABLE>
16
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY
Notes to Financial Statements
------------------------------
We used the following weighted average assumptions to calculate benefit
obligations for our 1998 and 1997 valuations: discount rate of approximately 6.5
percent and 7.25 percent, respectively; and an expected return on plan assets of
approximately 4.6 percent and 4.6 percent, respectively. For measurement
purposes, we assumed a 9.5 percent annual rate of increase in the per capita
cost of covered health care benefits for 1999, decreasing gradually to 5.0
percent in 2011 and remaining level thereafter.
Components of the cost we recognized related to the postretirement plan
were as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
(Dollars in millions)
<S> <C> <C>
Interest cost.................................................. $1.3 $1.6
Expected return of plan assets................................. (.2) (.3)
Amortization of prior service cost............................. (.5) (.2)
Recognized net actuarial loss.................................. (.1) (.1)
---- ----
Net periodic benefit cost............................... $ .5 $1.0
==== ====
</TABLE>
A one-percentage-point change in the assumed health care cost trend rates
would have an insignificant effect on the net periodic benefit cost of our
postretirement benefit obligation.
The Company has qualified defined contribution plans for which
substantially all employees are eligible. Company contributions, which match
certain voluntary employee contributions to the plan, totaled $.1 million in
1998, $.2 million in the one month ended December 31, 1997, $2.2 million in the
eleven months ended November 30, 1997, and $1.6 million in 1996. Matching
contributions may be made either in cash or in Conseco common stock.
Litigation
The Company is involved on an ongoing basis in lawsuits related to its
operations. Although the ultimate outcome of certain of such matters cannot be
predicted, none of such lawsuits currently pending against the Company is
expected, individually or in the aggregate, to have a material adverse effect on
the Company's financial condition, cash flows or results of operations.
Guaranty Fund Assessments
The balance sheet at December 31, 1998, includes: (i) accruals of $6.0
million, representing our estimate of all known assessments that will be levied
against the Company by various state guaranty associations based on premiums
written through December 31, 1998; and (ii) receivables of $2.8 million that we
estimate will be recovered through a reduction in future premium taxes as a
result of such assessments. These estimates are subject to change when the
associations determine more precisely the losses that have occurred and how such
losses will be allocated among the insurance companies. We recognized expense
for such assessments of $.3 million in 1998, $.2 million in the one month ended
December 31, 1997, $1.2 million in the eleven months ended November 30, 1997,
and $1.1 million in 1996.
Related Party Transactions
The Company operates without direct employees through management and
service agreements with subsidiaries of Conseco. Fees for such services
(including data processing, executive management and investment management
services) are based on Conseco's direct and directly allocable costs plus a 10
percent margin. Total fees incurred by the Company under such agreements were
$20.7 million in 1998 and $.3 million in the one month ended December 31, 1997.
17
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY
Notes to Financial Statements
------------------------------
During 1998, the Company purchased $22.0 million par value of senior notes
and senior subordinated notes issued by subsidiaries of Conseco. Such notes had
a carrying value of $26.3 million at December 31, 1998 and are classified as
"other invested assets" in the accompanying balance sheet. In addition, during
1998, the Company purchased $40.0 million of preferred stock issued by a
subsidiary of Conseco, which is classified as "other invested assets" in the
accompanying balance sheet.
6. OTHER OPERATING STATEMENT DATA:
Insurance policy income consisted of the following:
<TABLE>
<CAPTION>
One month Eleven months
Year ended ended ended Year ended
December 31, December 31, November 30, December 31,
1998 1997 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Traditional products:
Direct premiums collected....................... $250.1 $28.8 $247.3 $280.1
Reinsurance ceded............................... (41.7) (8.9) (37.7) (49.1)
------ ----- ------ ------
Premiums collected, net of reinsurance...... 208.4 19.9 209.6 231.0
Less premiums on universal life and products
without mortality and morbidity risk which are
recorded as additions to insurance liabilities 119.8 12.7 134.7 149.9
------ ----- ------ ------
Premiums on traditional products with
mortality or morbidity risk,
recorded as insurance policy income....... 88.6 7.2 74.9 81.1
Fees and surrender charges on interest sensitive
products........................................ 72.5 7.0 74.2 76.5
------ ----- ------ ------
Insurance policy income..................... $161.1 $14.2 $149.1 $157.6
====== ===== ====== ======
</TABLE>
The five states with the largest shares of 1998 collected premiums were New
Jersey (10 percent), Texas (9.2 percent), Pennsylvania (5.9 percent), California
(5.3 percent) and Illinois (5.3 percent). No other state accounted for more than
5.0 percent of total collected premiums.
Changes in the cost of policies purchased were as follows:
<TABLE>
<CAPTION>
One month Eleven months
Year ended ended ended Year ended
December 31, December 31, November 30, December 31,
1998 1997 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Balance, beginning of year........................ $218.5 $ 26.1 $31.4 $29.1
Amortization................................... (26.6) (1.2) (1.6) (3.3)
Amounts related to fair value adjustment of
actively managed fixed maturities............ 3.2 (5.5) (3.7) 5.6
Adjustment of balance due to new accounting
basis........................................ - 199.1 - -
Other ......................................... 12.1 - - -
------ ------ ----- ----
Balance, end of year.............................. $207.2 $218.5 $26.1 $31.4
====== ====== ===== =====
</TABLE>
18
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY
Notes to Financial Statements
------------------------------
Based on current conditions and assumptions as to future events on all
policies in force, the Company expects to amortize approximately 8 percent of
the December 31, 1998, balance of cost of policies purchased in 1999, 8 percent
in 2000, 8 percent in 2001, 7 percent in 2002 and 6 percent in 2003. The
discount rates used to determine the amortization of the cost of policies
purchased ranged from 5 percent to 8 percent and averaged 6.5 percent.
Changes in the cost of policies produced were as follows:
<TABLE>
<CAPTION>
One month Eleven months
Year ended ended ended Year ended
December 31, December 31, November 30, December 31,
1998 1997 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Balance, beginning of year........................ $ 2.7 $ 203.4 $211.1 $173.2
Additions...................................... 22.7 2.7 31.3 33.3
Amortization................................... (3.2) - (22.4) (19.4)
Amounts related to fair value adjustment of
actively managed fixed maturities............ - - (16.6) 24.0
Adjustment of balance due to new accounting
basis........................................ - (203.4) - -
----- ------- ------ ------
Balance, end of year.............................. $22.2 $ 2.7 $203.4 $211.1
===== ======= ====== ======
</TABLE>
Changes in the cost of policies produced excludes $2.0 million for the year
ended December 31, 1996, related to the sale of the health business (see note
9).
7. STATEMENT OF CASH FLOWS:
Income taxes paid totaled $16.8 million in 1998, $10.2 million in the
eleven months ended November 30, 1997, and $10.8 million in 1996. No income
taxes were paid in the one month ended December 31, 1997.
Short-term investments having original maturities of three months or less
are considered to be cash equivalents. All cash is invested in short-term
investments.
8. STATUTORY INFORMATION:
Statutory accounting practices prescribed or permitted for insurance
companies by regulatory authorities differ from generally accepted accounting
principles. The Company reported the following amounts to regulatory agencies:
<TABLE>
<CAPTION>
1998 1997
---- ----
(Dollars in millions)
<S> <C> <C>
Statutory capital and surplus.................................................. $143.2 $131.8
Asset valuation reserve........................................................ 17.8 19.9
Interest maintenance reserve................................................... 42.7 19.6
------- ------
Total...................................................................... $203.7 $171.3
====== ======
</TABLE>
The Company's combined statutory net income was $29.6 million, $15.3
million and $19.5 million in 1998, 1997 and 1996, respectively.
State insurance laws generally restrict the ability of insurance companies
to pay dividends or make other distributions. Approximately $29.6 million of the
Company's net assets at December 31, 1998, are available for distribution in
1999 without
19
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY
Notes to Financial Statements
------------------------------
permission of state regulatory authorities.
9. DISCONTINUED OPERATIONS:
In 1996, the Company sold certain health and group insurance business. The
operating results of such business have been reported in the consolidated
statement of operations as discontinued operations. Revenues for the
discontinued operations were $0.3 million, $46.0 million and $268.7 million for
the one month ended December 31, 1997, the eleven months ended November 30, 1997
and the year ended December 31, 1996, respectively. 1997 results consist of a
tax benefit recorded in conjunction with a settlement with the IRS for prior
years' returns. In 1996, the Company recorded a net loss of $25.1 million, net
of a tax credit of $12.5 million related to such sale.
20
<PAGE>
The registrant hereby incorporates by reference the March 1, 1999 Fundamental
Investors Prospectus, file number 811-32, filed with the Commission on March 4,
1999.
