Washington National Insurance Company
1997 Audited GAAP Consolidated Financial Statements
Report of Independent Accountants 1
Consolidated Balance Sheet 2
Consolidated Statement of Operations 4
Consolidated Statement of Shareholder's Equity 5
Consolidated Statement of Cash Flows 6
Notes to the Consolidated Financial Statements 7
<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, 1997, and the related consolidated statements of
operations, shareholder's equity and cash flows for 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 balance sheet of the Company for the year ended
December 31, 1996, and the related statements of operations,
shareholder's equity and cash flows of the Company for the years ended
December 31, 1996 and December 31, 1995, were audited by other
auditors, whose report, dated March 7, 1997 expressed an unqualified
opinion on those financial statements.
We conducted our audit 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 audit provides 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, 1997 and the results of their operations and their cash flows for
the month ended December 31, 1997 and the eleven months ended November
30, 1997 in conformity with generally accepted accounting principles.
/c/ Coopers & Lybrand L.L.P.
Indianapolis, Indiana
April 27, 1998
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
December 31, 1997 and 1996
(Dollars in millions)
ASSETS
<TABLE>
1997 1996
---- ----
(prior
basis)
<S> <C> <C>
Investments:
Actively managed fixed maturities at fair value (amortized cost:
1997 - $1,874.7; 1996 - $1,899.1) $1,887.4 $1,931.1
Mortgage loans 174.2 219.9
Credit-tenant loans 36.6 37.7
Policy loans 58.3 55.9
Other invested assets 17.7 31.6
Short-term investments 42.4 102.7
Cash 1.2 3.0
Assets held in Separate Accounts 47.2 39.6
-------- --------
Total investments 2,265.0 2,421.5
Accrued investment income 29.4 31.7
Cost of policies purchased 218.5 31.4
Cost of policies produced 2.7 211.1
Reinsurance recoverables and prepaid premiums 101.2 109.6
Goodwill (net of accumulated amortization: 1997 - $0.1; 1996 - $7.5) 36.8 17.7
Other assets 35.9 43.6
-------- --------
Total assets $2,689.5 $2,866.6
-------- --------
-------- --------
<FN>
(Continued on next page)
The accompanying notes are an integral part
of the consolidated financial statements.
</TABLE>
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (Continued)
December 31, 1997 and 1996
(Dollars in millions, except share amounts)
LIABILITIES AND SHAREHOLDER'S EQUITY
<TABLE>
1997 1996
---- ----
(prior
basis)
<S> <C> <C>
Liabilities:
Insurance liabilities $2,170.6 $2,282.5
Income tax liabilities 4.5 13.0
Other liabilities 128.9 125.4
Liabilities related to Separate Accounts 47.2 39.6
-------- --------
Total liabilities 2,351.2 2,460.5
Minority interest 56.2 58.5
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) (See Note 1) 273.2 68.3
Unrealized appreciation of securities:
Fixed maturity securities (net of applicable federal income taxes:
1997 - $0, 1996 - $7.2) 6.1 13.5
Other investments (net of applicable federal income taxes:
1997 - $0, 1996 - $0.5) 0.5 0.9
Retained earnings 2.3 264.9
-------- --------
Total shareholder's equity 282.1 347.6
-------- --------
Total liabilities and shareholder's equity $2,689.5 $2,866.6
-------- --------
<FN> -------- --------
The accompanying notes are an integral part
of the consolidated financial statements.
</TABLE>
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(Dollars in millions)
<TABLE>
Prior Basis
-------------------------------------------
One month Eleven months
ended ended Year ended Year ended
December 31, November 30, December 31, December 31,
1997 1997 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Insurance policy income $ 14.2 $149.1 $157.6 $145.4
Net investment income 12.0 146.1 165.7 168.7
Net investment gains (losses) (0.1) 4.3 0.6 (1.1)
Other - 8.0 4.4 4.3
------ ------ ------ ------
Total revenues 26.1 307.5 328.3 317.3
------ ------ ------ ------
Benefits and expenses:
Insurance policy benefits 17.3 193.8 214.3 214.2
Amortization of cost of policies produced and purchased 1.2 24.2 22.7 23.1
Other operating costs and expenses 3.1 44.3 42.4 41.2
------ ------ ------ ------
Total benefits and expenses 21.6 262.3 279.4 278.5
------ ------ ------ ------
Income before income taxes, minority
interest and discontinued operations 4.5 45.2 48.9 38.8
Income tax expense on continuing
operations 1.6 16.6 16.8 12.0
------ ------ ------ ------
Income before minority interest and
discontinued operations 2.9 28.6 32.1 26.8
Minority interest 0.6 4.6 4.5 3.6
------ ------ ------ ------
Income from continuing operations 2.3 24.0 27.6 23.2
Income (loss) from discontinued operations - 1.8 (26.0) 7.2
------ ------ ------ ------
Net income $ 2.3 $ 25.8 $ 1.6 $ 30.4
------ ------ ------ ------
------ ------ ------ ------
<FN>
The accompanying notes are an integral part
of the consolidated financial statements.
</TABLE>
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY
(Dollars in millions)
<TABLE>
Prior Basis
-------------------------------------------
One month Eleven months
ended ended Year ended Year ended
December 31, November 30, December 31, December 31,
1997 1997 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Common stock and additional paid-in capital:
Balance, beginning of period $ 68.3 $ 68.3 $ 68.3 $ 68.3
Adjustment of balance pursuant to
purchase accounting (See Note 1) 204.9 - - -
------ ------ ------ ------
Balance, end of period $273.2 $ 68.3 $ 68.3 $ 68.3
------ ------ ------ ------
------ ------ ------ ------
Unrealized appreciation (depreciation) of securities:
Fixed maturity securities:
Balance, beginning of period $ 23.6 $ 13.5 $ 44.6 $(56.8)
Elimination of prior balance pursuant to acquisition (23.6) - - -
Change in unrealized appreciation (depreciation) 10.0 25.7 (63.2) 192.2
Cost of policies purchased and produced (3.9) (14.5) 21.1 (50.4)
Deferred tax (expense) benefit - (1.1) 11.0 (40.4)
------ ------ ------ ------
Balance, end of period $ 6.1 $ 23.6 $ 13.5 $ 44.6
------ ------ ------ ------
------ ------ ------ ------
Other investments:
Balance, beginning of period $ 1.0 $ 0.9 $ 0.6 $ (0.1)
Elimination of prior balance pursuant to acquisition (1.0) - - -
Change in unrealized appreciation 0.5 0.1 0.5 1.1
Deferred tax expense - - (0.2) (0.4)
------ ------ ------ ------
Balance, end of period $ 0.5 $ 1.0 $ 0.9 $ 0.6
------ ------ ------ ------
------ ------ ------ ------
Retained earnings:
Balance, beginning of period $262.7 $264.9 $267.9 $247.6
Common stock dividends (73.7) (28.0) (8.1) (9.1)
Adjustment of balance pursuant to
purchase accounting (See Note 1) (189.0) - - -
Net income 2.3 25.8 1.6 30.4
Other - - 3.5 (1.0)
------ ------ ------ ------
Balance, end of period $ 2.3 $262.7 $264.9 $267.9
------ ------ ------ ------
------ ------ ------ ------
Total shareholder's equity $282.1 $355.6 $347.6 $381.4
------ ------ ----- ------
------ ------ ----- ------
<FN>
The accompanying notes are an integral part
of the consolidated financial statements.
</TABLE>
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in millions)
<TABLE>
Prior Basis
-------------------------------------------
One month Eleven months
ended ended Year ended Year ended
December 31, November 30, December 31, December 31,
1997 1997 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income $ 2.3 $ 25.8 $ 1.6 $ 30.4
Adjustments to reconcile net income to net
cash (used) provided by operating activities:
Change in policy liabilities (9.2) (13.6) 63.2 52.0
Change in reinsurance receivable 8.8 (0.4) (45.9) 4.0
Loss (income) from discontinued operations, net of tax - (1.8) 25.1 -
Cost of policies purchased and produced (1.5) (7.3) (12.6) (10.7)
Other, net (17.5) 9.4 (14.6) 13.3
------ ------ ------ ------
Net cash (used) provided by operating activities (17.1) 12.1 16.8 89.0
------ ------ ------ ------
Cash flows from investing activities:
Sales of investments 26.8 64.0 240.3 315.4
Maturities and redemptions 2.0 205.5 142.4 162.5
Purchases of investments - (139.1) (238.9) (513.6)
Change in policy loans (0.4) (2.1) 0.5 (1.9)
Net payments on sale of discontinued operations - (24.0) (11.7) -
Purchases of property and equipment - (0.1) (0.6) (0.8)
Net change in short-term investments 68.3 (8.0) (54.8) 3.7
------ ------ ------ ------
Net cash provided (used) by investing activities 96.7 96.2 77.2 (34.7)
------ ------ ------ ------
Cash flows from financing activities:
Policyholder account deposits 12.7 134.6 149.9 150.5
Policyholder account withdrawals (18.8) (215.8) (234.0) (194.0)
Dividends paid (73.7) (28.0) (11.2) (9.0)
Repayment of mortgage payable - (0.7) (0.6) (0.6)
------ ------ ------ ------
Net cash used by financing activities (79.8) (109.9) (95.9) (53.1)
------ ------ ------ ------
Net (decrease) increase in cash (0.2) (1.6) (1.9) 1.2
Cash, beginning of period 1.4 3.0 4.9 3.7
------ ------ ------ ------
Cash, end of period $ 1.2 $ 1.4 $ 3.0 $ 4.9
------ ------ ------ ------
------ ------ ------ ------
<FN>
The accompanying notes are an integral part
of the consolidated financial statements.
</TABLE>
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
1. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Washington National Insurance Company ("WNIC" 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
engaged primarily in the development, marketing and administration of
annuity, supplemental health and individual life products.
The Company and its indirectly owned insurance subsidiary, United
Presidential Life Insurance Company ("UPI") are engaged primarily in
marketing and underwriting life insurance and annuity products for
individuals and specialty health insurance for educators. The markets for
the life insurance and annuity products include individuals and small
businesses seeking universal life insurance and other interest-sensitive
life insurance and annuity products. The market for the specialty health
insurance products for educators consists primarily of school district
employees.
The accompanying consolidated financial statements have been prepared
in accordance with generally accepted accounting principles ("GAAP") and
include the accounts and operations of the Company. Significant
intercompany transactions have been eliminated. Certain amounts applicable
to prior years' financial statements have been reclassified to conform to
the 1997 presentation. Revenue and expense amounts related to the
Company's health business sold in 1996 have been reclassified to
discontinued operations (See Note 12). The preparation of financial
statements in conformity with GAAP requires management to make estimates
and assumptions that affect the amounts reported. Actual results could
differ from these estimates.
The Company owns a 71.3% interest in United Presidential Corporation
("UPC"), the parent company of 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 represented by a 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, 1997, and the
consolidated statement of operations, shareholder's equity and cash flows
for the one month ended December 31, 1997, are reported under the push-down
purchase method of accounting. The consolidated balance sheet as of
December 31, 1996, and the consolidated statements of operations,
shareholder's equity and cash flows for the eleven months ended November
30, 1997, the year ended December 31, 1996 and the year ended December 31,
1995, are the historical financial data of the Company ("prior basis").
Investments
Fixed maturity investments are securities that mature more than one
year after they are issued and include bonds, mortgage-backed securities
and preferred stocks with mandatory redemption features and are classified
as follows:
Actively managed - fixed maturity securities that may be sold prior to
maturity due to changes that might occur in market rates, issuer
credit quality or the Company's liquidity requirements. Actively
managed fixed maturity securities are carried at fair value and the
unrealized appreciation or depreciation is recorded net of tax and
related adjustments described below as a component of shareholder's
equity.
Trading account - fixed maturity securities are bought and held
principally for the purpose of selling them in the near term. Trading
account securities are carried at estimated fair value. Unrealized
appreciation and depreciation are included in net investment gains and
losses. The Company did not hold any trading account securities at
December 31, 1997 or 1996.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
Held to maturity - (all other fixed maturity securities) are those
securities which the Company has the ability and positive intent to
hold to maturity, and are carried at amortized cost. The Company may
dispose of these securities if the credit quality of the issuer
deteriorates, if regulatory requirements change or under other
unforeseen circumstances. The Company did not hold any securities in
this classification at December 31, 1997 or 1996. In 1995, the
Company transferred its $84.1 million of "held to maturity" fixed
maturities to "actively managed" fixed maturities resulting in a $5.3
million increase to unrealized appreciation of investments.
Anticipated returns, including investment gains and losses, from the
investment of policyholder balances are considered in determining the
amortization of the cost of policies purchased and the cost of policies
produced. When actively managed fixed maturity securities are stated at
fair value, an adjustment to the cost of policies purchased and the cost of
policies produced may be necessary if a change in amortization would have
been recorded if such securities had been sold at their fair value and the
proceeds reinvested at current yields. Furthermore, if future yields
expected to be earned on such securities decline, it may be necessary to
increase certain insurance liabilities. Adjustments to such liabilities
are required when their balances, in addition to future net cash flows
(including investment income), are insufficient to cover future benefits
and expenses.
Unrealized appreciation and depreciation on investments and the
related adjustments described above have no effect on earnings. The
Company records them, net of tax, as a component of shareholder's equity.
The following table summarizes the effect of these adjustments on the
related balance sheet accounts as of December 31, 1997:
<TABLE>
Effect of fair value
adjustment to
Balance actively managed Reported
before adjustment fixed maturities amount
----------------- ---------------- ------
(Dollars in millions)
<S> <C> <C> <C>
Actively managed fixed maturities securities $1,874.7 $ 12.7 $1,887.4
Cost of policies purchased 224.0 (5.5) 218.5
Cost of policies produced 2.7 - 2.7
Income tax liability 4.5 - 4.5
Minority interest 57.3 (1.1) 56.2
Unrealized appreciation of actively
managed fixed maturity securities - 6.1 6.1
</TABLE>
Mortgage loans are carried at the unpaid principal balance, net of
allowance for losses. The allowance is based on estimated uncollectible
amounts considering past credit loss experience and current economic
conditions and is subject to fluctuation based on actual experience. Loans
for which the Company determines that it is probable that all amounts due
under the contractual terms will not be collected, are deemed to be
impaired and are reported at the lower of amortized cost or fair value of
the underlying collateral, less estimated costs to sell.
Credit-tenant loans are loans for commercial properties. When these
loans are made: (i) the lease of the principal tenant is assigned to the
Company; (ii) the lease must produce adequate cash flow to fund
substantially all the requirements of the loan; and (iii) the principal
tenant or the guarantor of such tenant's obligations must have an
investment-grade credit rating when the loan is made. The loans also must
be secured by the value of the related property. Underwriting guidelines
take into account such factors as: (i) the lease term of the property; (ii)
the borrower's management ability, including business experience, property
management capabilities and financial soundness; and (iii) such economic,
demographic or other factors that may affect the income generated by the
property, or its value. Credit-tenant loans are carried at amortized cost.
Policy loans to policyholders are carried at the unpaid principal
balance.
Short-term investments include commercial paper, variable demand
notes, and money market funds with maturities less than one year and are
carried at amortized cost.
Other invested assets principally consist of real estate investments,
investments in equity securities, joint ventures, and venture capital
investments. Real estate investments are considered actively managed and
carried at the lower of amortized cost or fair value less estimated costs
to sell. Investments in equity securities are reported at fair value.
Joint ventures and venture capital investments are accounted for under the
equity method.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
Net investment income consists primarily of interest and dividends
less expenses. Interest on actively managed fixed maturities and
performing mortgage loans, adjusted for any amortization of discount or
premium, is recorded as income when earned and includes adjustments
resulting from prepayments or expected changes in prepayments on mortgage-
backed securities. Income on impaired loans and real estate is
recorded principally on a cash basis. Income on investments
accounted for under the equity method is recognized as it becomes earned.
Investment expenses are accrued as incurred.
The specific identification method is used to account for the
disposition of investments. The differences between sale proceeds and
amortized cost are reported as investment gains and losses, or as
adjustments to investment income if the proceeds are prepayments by issuers
prior to maturity.
The Company manages its investments to limit credit risk by
diversifying its portfolio among various security types and industry
sectors. The Company regularly evaluates investment securities, credit-
tenant loans and mortgage loans based on current economic conditions, past
credit experience and other circumstances of the investee. A decline in a
security's net realizable value that is other than temporary is treated as
an investment loss and the cost basis of the security is reduced to its
estimated fair value. Impaired loans are revalued at the present value of
expected cash flows discounted at the loan's effective interest rate when
it is probable that the Company will be unable to collect all amounts due
according to the contractual terms of the agreement.
Cost of Policies Purchased
The cost of policies purchased represents the portion of the cost to
acquire the Company that is attributable to the right to receive future
cash flows from insurance contracts existing at the date of the
acquisition. The value of cost of policies purchased is the actuarially
determined present value of the projected future cash flows from the
insurance contracts existing at the acquisition date.
The method used by the Company to value the cost of policies purchased
is consistent with the valuation methods used most commonly to value blocks
of insurance business, which is also consistent with the basic methodology
generally used to value assets. The method used by the Company is
summarized as follows:
- Identify the expected future cash flows from the blocks of business.
- Identify the risks inherent in realizing those cash flows (i.e., the
probability that the cash flows will be realized).
- Identify the rate of return that the Company believes it must earn in
order to accept the risks inherent in realizing the cash flows, based on
consideration of the factors summarized below.
- Determine the value of the policies purchased by discounting the
expected future cash flows by the discount rate the Company requires.
Expected future cash flows used in determining such value are based on
actuarially determined projections of future premium collections,
mortality, surrenders, operating expenses, changes in insurance
liabilities, investment yields on the assets held to back the policy
liabilities and other factors. The projections take into account all
factors known or expected at the valuation date based on the collective
judgment of the management of the Company. Actual experience on purchased
business may vary from projections due to differences in renewal premiums
collected, investment spread, investment gains or losses, mortality and
morbidity costs and other factors.
The discount rates used to determine the value of the cost of policies
purchased is the rate of return to invest in the business being acquired.
The following factors have been considered in determining this rate:
- The magnitude of the risks associated with each of the actuarial
assumptions used in determining expected future cash flows as
described in the preceding paragraphs.
- The cost of capital to fund the acquisition.
- The perceived likelihood of changes in projected future cash flows
that might occur if there are changes in insurance regulations and tax
laws.
- The compatibility with other company activities that may favorably
affect future cash flows.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
- The complexity of the acquired business.
- Recent purchase prices (i.e., discount rates used in determining
valuations) on similar blocks of business.
After the cost of purchased policies is determined using the methods
described above, the amount is amortized based on the incidence of the
expected cash flows and the interest rate credited to the underlying
products.
To the extent that past or future experience on purchased business
varies from projections due to differences in renewal premiums collected,
investment spread, investment gains or losses, mortality and morbidity
costs and other factors, it may be necessary to adjust the amortization of
the cost of policies purchased. For example, sales of fixed maturity
investments that result in a gain (or loss), but also reduce (or increase)
the future investment spread because the sale proceeds are reinvested at a
lower (or higher) earnings rate, may cause amortization to increase (or
decrease) reflecting the change in the incidence of cash flows. For
universal life-type contracts and investment-type contracts, the
accumulated amortization is adjusted whenever there is a material change in
the estimated gross profits expected over the life of a block of business
in order to maintain a constant relationship between cumulative
amortization and the present value (discounted at the rate of interest that
accrues to the policies) of expected gross profits. For most other
contracts, the unamortized asset balance is reduced by a charge to income
only when the present value of future cash flows, net of the policy
liabilities, is not sufficient to cover such asset balance.
Recoverability of the cost of policies purchased is evaluated
regularly by comparing the current estimate of expected future cash flows
(discounted at the rate of interest earned on invested assets) to the
unamortized asset balance by line of insurance business. If such current
estimate indicates that the existing insurance liabilities, together with
the present value of future net cash flows from the blocks of business
purchased, will not be sufficient to recover the cost of policies
purchased, the difference would be charged to expense.
Cost of Policies Produced
Costs of producing new business (primarily commissions, bonus interest
and certain costs of policy issuance and underwriting, net of fees charged
to the policy in excess of ultimate fees charged), which vary with and are
primarily related to the production of new business, are deferred to the
extent recoverable from future profits. Such costs are amortized with
interest as follows:
- For universal life-type contracts and investment-type contracts, in
relation to the present value of expected gross profits from these
contracts, discounted using the interest rate credited to the policy.
- For immediate annuities with mortality risks, in relation to the
present value of benefits to be paid.
- For traditional life insurance products, in relation to future
anticipated premium revenue using the same assumptions that are used in
calculating the insurance liabilities.
Recoverability of the unamortized balance of the cost of policies
produced is evaluated regularly. Cumulative and future amortization of the
cost of policies produced is adjusted, when there is a material change in
estimated gross profits expected over the life of a block of business,
consistent with the methods described above for the cost of policies
purchased.
Goodwill
The excess of the cost of acquiring the Company's net assets over
their estimated fair value is recorded as goodwill and is being amortized
on the straight-line basis over a forty year period. The Company
periodically assesses the recoverability of goodwill through projections of
future earnings of the related subsidiaries. Such assessment is made based
on whether goodwill is fully recoverable from projected undiscounted net
cash flows from earnings over the remaining amortization period. If future
evaluations of goodwill indicate a material change in the factors
supporting recoverability over the remaining amortization period, all or a
portion of goodwill may need to be written off or the amortization period
shortened.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
Depreciation
Depreciation for real estate investments and property and equipment is
based on the estimated useful life of the asset primarily using the
straight-line method. Information on depreciation related to continuing
operations is as follows:
<TABLE>
December 31,
---------------------
1997 1996
---- ----
(Dollars in millions)
<S> <C> <C>
Accumulated depreciation:
Real estate investments $ - $13.2
Property and equipment 0.1 4.4
</TABLE>
<TABLE>
One month Eleven months
ended ended Year ended Year ended
December 31, November 30, December 31, December 31,
1997 1997 1996 1995
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Depreciation expense:
Real estate investments $ - $ 0.5 $ 0.9 $ 1.3
Property and equipment 0.1 0.7 0.8 1.1
</TABLE>
Insurance Liabilities, Recognition of Insurance Policy Income and
Related Benefits and Expenses
Reserves for universal life-type and investment-type contracts
(principally deferred annuities) are based on the contract account balance
if future benefit payments in excess of the account balance are not
guaranteed, or on the present value of future benefit payments when such
payments are guaranteed. Additions to insurance liabilities are made if
future cash flows including investment income are insufficient to cover
future benefits and expenses.
For investment contracts without mortality risk (such as deferred
annuities and immediate annuities with benefits paid for a period certain)
and for contracts that permit the Company or the insured to make changes in
the contract terms (such as universal life), premium deposits and benefit
payments are recorded as increases or decreases in a liability account
rather than as revenue and expense. Amounts charged against the liability
account for the cost of insurance, policy administration fees, surrender
penalties and amortization of policy initiation fees are recorded as
revenues. Interest credited to the liability account and benefit payments
made in excess of the contract liability account balance are charged to
expense.
Reserves for traditional life insurance policy benefits are generally
calculated using the net level premium method and assumptions made at the
time the contract is issued (or in the case of policies acquired by
purchase, at purchase date) as to investment yields, mortality, withdrawals
and other assumptions based on projections of past experience modified as
necessary to reflect anticipated trends and include provisions for possible
unfavorable deviation. Policy benefit claims are charged to expense in the
period that claims are incurred.
For traditional insurance contracts, premiums are recognized as income
when due or, for short duration contracts, over the period to which the
premiums relate. Benefits and expenses are recognized as a level
percentage of earned premiums. Such recognition is accomplished through
the provision for future policy benefits and the amortization of the cost
of policies produced. Participating business is immaterial and dividends
related to such business are included as part of the policy reserves.
For investment contracts with mortality risk, but with premiums paid
for only a limited period (such as single-premium immediate annuities with
benefits paid for the life of the annuitant), the accounting treatment is
similar to traditional contracts. However, the excess of the gross premium
over the net premium is deferred and recognized in relation to the present
value of expected future benefit payments (when accounting for annuity
contracts) or in relation to insurance in force (when accounting for life
insurance contracts).
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
Liabilities for incurred claims are determined using historical
experience and published tables for disabled lives and represent an
estimate of the present value of the remaining ultimate net cost of all
reported and unreported claims. Management believes these estimates are
adequate. Such estimates are reviewed continually and any adjustments are
reflected in current operations.
Accident and health insurance reserves are comprised of unearned
premium reserves computed on a pro rata basis, return of premium reserves
and the present value of amounts not yet due on long-term disability
policies computed on the same basis as life insurance.
Reinsurance
In the normal course of business, the Company minimizes its exposure
to loss by reinsuring a portion of its life insurance, annuity, and health
insurance risks with other insurance companies. The Company's policy on
claim exposure for life insurance and annuity products is to retain a
maximum of $300,000 of life insurance exposure on any one individual. The
Company retains 100% of all long-term disability and a maximum of 50% of
all long-term care claims.
For continuing operations, the Company cedes reinsurance to entities
with A.M. Best ratings of "A-" or better or to entities required to
maintain assets in an independent trust fund whose fair value is sufficient
to discharge the obligations of the reinsurer. Reinsurance contracts do
not discharge the Company from its obligations to the policyholders.
For the Company's discontinued operations, paid-claim exposure for
group insurance products is limited to $750,000 per claim for major medical
coverage and $250,000 per claim for individual stop-loss in any one
calendar year. WNIC's reinsurance for individual health insurance claims
was designed to protect the Company from an excessive amount of claims over
$250,000 on an individual basis.
Separate Account
Separate Account assets and liabilities are principally carried at
fair value and represent funds that are separately administered for annuity
contracts for which the contract holders bear the investment risk. The
assets are legally segregated from the Company's assets and are not subject
to any claims that arise from any other business of the Company.
Investment income and investment gains and losses accrue directly to the
contract holders and are excluded from the accompanying consolidated
statement of operations.
Income Taxes
Income tax expense includes deferred income taxes arising from
temporary differences between the financial statement and income tax
reporting basis of assets and liabilities. Deferred income tax expense or
benefit is based on the changes in the deferred income tax asset or
liability from period to period. Additionally, the effect of a tax rate
change on accumulated deferred income taxes is reflected in income in the
period in which the change is enacted.
In assessing the realization of deferred income tax assets, management
considers whether it is more likely than not that the deferred income tax
assets will be realized. The ultimate realization of deferred income tax
assets is dependent upon the generation of future taxable income during the
periods in which temporary differences become deductible. If future
taxable income does not occur as expected, deferred income tax assets may
need to be written off.
Minority Interest
A charge is made against consolidated income representing WNC's share
of earnings of UPC attributable to its minority interest. Shareholder's
equity attributable to the minority interest is shown separately on the
consolidated balance sheet.
Business Segments
The Company has three business segments: life insurance, annuity
products, and other. The markets for the life insurance and annuity
products include individuals and small businesses seeking universal life
insurance and other interest-sensitive life insurance and annuity products.
The other segment includes the specialty health insurance products for
educators as well as operations that do not specifically support the life
insurance or annuity product segments. The market for the specialty health
insurance products for educators consists primarily of school district
employees.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
Fair Value of Financial Instruments
Due to the merger with Conseco, the 1997 estimated fair values of
financial instruments approximate the carrying values. Prior to the
merger, the following methods and assumptions were used by the Company in
determining the estimated fair values of financial instruments:
Actively managed fixed maturities: - Fair values are based on
publicly quoted market prices at the close of trading on the last
business day of the year. In cases where publicly quoted market
prices are not available, fair values are based on estimates using
values obtained from independent pricing services or, in the case of
private placements, by discounting expected future cash flows using a
current market rate applicable to the yield, credit quality, and
maturity of the investments.
Mortgage loans and credit-tenant loans: - Fair values are estimated
using discounted cash flow analyses based on interest rates currently
being offered for similar loans to borrowers with similar credit
ratings. A pricing cap is put on mortgage loans that carry
significant above-market interest rate yields to reflect the
prepayment risk.
Policy loans: - Fair values are estimated using discounted cash flow
calculations based on interest rates currently being offered for
similar contracts with similar maturities.
Cash and short-term investments: - The carrying amount reported in the
consolidated balance sheet for these instruments approximates their
estimated fair value.
Accrued investment income: - The fair value of these assets
approximates carrying value.
Investment-type insurance contracts: - Fair values are estimated using
discounted cash flow calculations based on interest rates currently
being offered for similar contracts with similar maturities.
Mortgage payable: - Fair values are estimated using discounted cash
flow analyses based on interest rates currently being offered for
similar loans to borrowers with similar credit ratings. A pricing cap
is put on mortgage loans that carry significant above-market interest
rate yields to reflect the prepayment risk.
The estimated fair values of the Company's financial instruments are as
follows:
<TABLE>
1997 1996
----------------- ----------------
Carrying Fair Carrying Fair
amount value amount value
------ ----- ------ -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Financial assets:
Actively managed fixed maturities $1,887.4 $1,887.4 $1,931.1 $1,931.1
Mortgage loans 174.2 174.2 219.9 234.0
Credit-tenant loans 36.6 36.6 37.7 38.0
Policy loans 58.3 58.3 55.9 54.3
Cash and short-term investments 43.6 43.6 105.7 105.7
Accrued investment income 29.4 29.4 31.7 31.7
Financial liabilities:
Investment-type insurance contracts $1,003.9 $1,003.9 $1,070.6 $1,043.7
Mortgage payable - - 0.7 0.8
</TABLE>
Recently issued accounting standards
Statement of Financial Accounting Standards No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities" ("SFAS 125"), was issued in June 1996 and provides accounting
and reporting standards for transfers of financial assets and
extinguishments of liabilities. SFAS 125 is effective for 1997 financial
statements; however, certain provisions relating to accounting for
repurchase agreements and securities lending are not effective until
January 1, 1998. Provisions effective in 1997 did not have any effect on
the Company's financial position or results of operations. The adoption of
provisions effective in 1998 are not expected to have a material effect on
the Company's financial position or results of operations.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130"), was issued in June 1997 and establishes
standards for reporting and display of comprehensive income. SFAS 130 will
have no effect on the Company's financial position or results of
operations. SFAS 130 is effective for the December 31, 1998 financial
statements.
Statement of Financial Accounting Standards No. 131, "Disclosures
about Segments of an Enterprise and Related Information" ("SFAS 131"),
establishes new standards for reporting about operating segments and
products and services, geographic areas and major customers. Under SFAS
131, segments are to be defined consistent with the basis that management
uses internally to assess performance and allocate resources. Implementing
SFAS 131 will have no impact on the consolidated amounts reported and the
Company does not expect any significant changes to our segment disclosures.
SFAS 131 is effective for the December 31, 1998 financial statements.
Statement of Financial Accounting Standards No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits" ("SFAS 132"),
was issued in February 1998 and revises current disclosure requirements for
employers' pensions and other retiree benefits. SFAS 132 will have no
effect on the Company's financial position or results of operations. SFAS
132 is effective for the December 31, 1998 financial statements.
Statement of Position 97-3, "Accounting by Insurance and Other
Enterprises for Insurance-Related Assessments" ("SOP 97-3"), was issued by
the American Institute of Certified Public Accountants in December 1997.
It provides guidance for determining when an insurance company or other
enterprise should recognize a liability for guaranty-fund assessments as
well as guidance for measuring the liability. SOP 97-3 is effective for
1999 financial statements, with early adoption permitted. The adoption of
this statement is not expected to have a material effect on the Company's
financial position or results of operations.
2. INVESTMENTS
At December 31, 1997, the amortized cost and estimated fair value of
actively managed fixed maturity investments were as follows:
<TABLE>
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
(Dollars in millions)
<S> <C> <C> <C> <C>
United States Treasury securities $ 47.8 $ 0.2 $ - $ 48.0
Obligations of states and political subdivisions 89.9 0.3 0.1 90.1
Public utility securities 165.6 1.8 0.2 167.2
Industrial and miscellaneous securities 949.0 8.2 0.2 957.0
Mortgage-backed securities 597.6 2.5 0.2 599.9
Other securities 24.8 0.4 - 25.2
-------- -------- ------ --------
$1,874.7 $ 13.4 $ 0.7 $1,887.4
-------- -------- ------ --------
-------- -------- ------ --------
</TABLE>
At December 31, 1996, the amortized cost and estimated fair value of
actively managed fixed maturity investments were as follows:
<TABLE>
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
(Dollars in millions)
<S> <C> <C> <C> <C>
United States Treasury securities $ 70.1 $ 1.6 $ 0.5 $ 71.2
Obligations of states and political subdivisions 79.0 2.4 0.3 81.1
Public utility securities 150.0 2.5 2.4 150.1
Industrial and miscellaneous securities 1,000.2 34.0 9.1 1,025.1
Mortgage-backed securities 575.9 9.4 6.9 578.4
Other securities 23.9 1.4 0.1 25.2
-------- -------- ------ ---------
$1,899.1 $ 51.3 $ 19.3 $1,931.1
-------- -------- ------ ---------
-------- -------- ------ ---------
</TABLE>
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
The following table sets forth the amortized cost and estimated fair
value of actively managed fixed maturities at December 31, 1997, based upon
the pricing source used to determine the estimated fair value:
<TABLE>
Estimated
Amortized fair
cost value
---- -----
(Dollars in millions)
<S> <C> <C>
Nationally recognized pricing services $1,733.1 $1,745.4
Broker-dealer market makers 33.4 33.8
Internally developed methods (calculated based on a weighted
current market yield of 7 percent) 108.2 108.2
-------- --------
Total actively managed fixed maturities $1,874.7 $1,887.4
-------- --------
-------- --------
</TABLE>
The following table sets forth actively managed fixed maturity
investments at December 31, 1997, classified by rating categories. The
category assigned is the highest rating by a nationally recognized
statistical rating organization or, as to $58.3 million fair value of fixed
maturities not rated by such firms, the rating assigned by the National
Association of Insurance Commissioners ("NAIC"). For the purposes of this
table, NAIC Class 1 is included in the "A" rating; Class 2, "BBB-"; and
Class 3, "BB-"; and Classes 4-6, "B+ and below".
<TABLE>
Percent of
actively managed Percent of
Investment rating fixed maturities total investments
----------------- ---------------- -----------------
<S> <C> <C>
AAA 40.4% 33.6%
AA 10.9 9.0
A 31.9 26.6
BBB+ 4.8 4.0
BBB 6.1 5.1
BBB- 3.8 3.2
------ ------
Investment grade 97.9 81.5
------ ------
BB+ 0.8 0.6
BB - -
BB- 0.9 0.7
B+ and below 0.4 0.3
------ ------
Below investment grade 2.1 1.6
------ ------
Total actively managed fixed maturities 100.0% 83.1%
------ ------
------ ------
</TABLE>
At December 31, 1997, the Company's below investment grade industrial
and miscellaneous actively managed fixed maturities had an amortized cost
and an estimated fair value of $39.2 million. Investment income forgone
due to defaulted securities was $0, $0.1 million, $0.6 million, and $0.6
million for the one month ended December 31,1997, the eleven months ended
November 30, 1997, the year ended December 31, 1996, and the year ended
December 31, 1995, respectively.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
The following table sets forth the amortized cost and estimated fair
value of actively managed fixed maturity securities at December 31, 1997,
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 and because most
mortgage-backed securities provide for periodic payments throughout their
lives.
<TABLE>
Estimated
Amortized fair
cost value
---- -----
(Dollars in millions)
<S> <C> <C>
Due in one year or less $ 40.2 $ 40.2
Due after one year through five years 257.4 258.3
Due after five years through ten years 369.3 371.7
Due after ten years 610.2 617.3
-------- --------
Subtotal 1,277.1 1,287.5
Mortgage-backed securities 597.6 599.9
-------- --------
Total actively managed fixed maturities $1,874.7 $1,887.4
-------- --------
-------- --------
</TABLE>
Net investment income consisted of the following:
<TABLE>
One month Eleven months
ended ended Year ended Year ended
December 31, November 30, December 31, December 31,
1997 1997 1996 1995
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Actively managed fixed maturities $ 10.7 $124.4 $139.0 $139.0
Mortgage loans 1.5 19.4 25.7 28.0
Policy loans 0.4 3.4 3.8 3.6
Short-term investments 0.1 4.5 2.7 2.9
Other (0.1) 2.4 5.1 7.1
------ ------ ------ ------
Gross investment income 12.6 154.1 176.3 180.6
Less investment expenses 0.6 8.0 10.6 11.9
------ ------ ------ ------
Net investment income $ 12.0 $146.1 $165.7 $168.7
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
Proceeds from sales of actively managed fixed maturity investments
were $22.1 million, $45.8 million, $209.2 million, $308.7 million for the
one month ended December 31, 1997, the eleven months ended November 30,
1997, the year ended December 31, 1996, and the year ended December 31,
1995, respectively. During 1995, the Company sold one "held to maturity "
fixed maturity with an amortized cost of $2.0 million. The sale was made
as a result of significant deterioration of the bond issuer's
creditworthiness.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
Net investment gains (losses) included in revenues were as follows:
<TABLE>
One month Eleven months
ended ended Year ended Year ended
December 31, November 30, December 31, December 31,
1997 1997 1996 1995
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Actively managed fixed maturities:
Gross gains $ - $ 5.9 $ 4.0 $ 7.2
Gross losses - (1.0) (3.5) (7.7)
------ ----- ------ ------
Net investment gains (losses) from
actively managed fixed maturities - 4.9 0.5 (0.5)
Mortgage loans - (0.1) 0.1 -
Equity securities - 0.4 0.4 (0.2)
Other (0.1) (0.9) (0.4) (0.4)
------ ------ ------ ------
Net investment gains (losses) $ (0.1) $ 4.3 $ 0.6 $ (1.1)
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
The net unrealized appreciation (depreciation) included in
shareholder's equity was as follows:
<TABLE>
One month Eleven months
ended ended Year ended Year ended
December 31, November 30, December 31, December 31,
1997 1997 1996 1995
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Gross unrealized appreciation $ 13.9 $ 70.4 $ 53.7 $112.8
Gross unrealized depreciation (0.7) (3.9) (20.0) (4.3)
------ ------ ------ ------
Net unrealized appreciation 13.2 66.5 33.7 108.5
Cost of policies purchased and produced (5.5) (28.4) (8.1) (37.8)
Deferred income taxes - (10.2) (9.0) (21.0)
Minority interest (1.1) (3.3) (2.2) (4.5)
------ ------ ------ ------
Net unrealized appreciation of investments $ 6.6 $ 24.6 $ 14.4 $ 45.2
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
The change in gross unrealized appreciation (depreciation) for
actively managed fixed maturity investments was $12.7 million, $32.9
million, $(75.4) million, and $226.9 million for the one month ended
December 31, 1997, the eleven months ended November 30, 1997, the year
ended December 31, 1996, and the year ended December 31, 1995,
respectively.
The following table sets forth the par value, amortized cost and
estimated fair value of mortgage-backed securities including CMOs at
December 31, 1997, summarized by interest rates on the underlying
collateral:
<TABLE>
Estimated
Par Amortized fair
value cost value
----- ---- -----
(Dollars in millions)
<S> <C> <C> <C>
Below 7 percent $ 167.0 $ 163.3 $ 164.4
7 percent - 8 percent 208.6 210.5 211.1
8 percent - 9 percent 133.0 136.8 137.1
9 percent and above 82.8 87.0 87.3
-------- -------- --------
Total mortgage-backed securities $ 591.4 $ 597.6 $ 599.9
-------- -------- --------
-------- -------- --------
</TABLE>
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
The amortized cost and estimated fair value of mortgage-backed
securities including CMOs at December 31, 1997, summarized by type of
security was as follows:
<TABLE>
Estimated fair value
------------------------
% of
Amortized fixed
cost Amount maturities
---- ------ ----------
(Dollars in millions)
<S> <C> <C> <C>
Pass-throughs and sequential and targeted amortization classes $ 510.8 $ 512.8 27.3%
Support classes 14.0 14.1 0.7
Accrual (Z tranche) bonds 3.7 3.7 0.2
Planned amortization classes and accretion directed bonds 60.3 60.5 3.2
Subordinated classes 8.8 8.8 0.5
-------- -------- ----
$ 597.6 $ 599.9 31.9%
-------- -------- ----
-------- -------- ----
</TABLE>
At December 31, 1997, approximately 73 percent of the estimated fair
value of the Company's mortgage-backed securities was determined by
nationally recognized pricing services, 8 percent was determined by broker-
dealer market makers and 19 percent was determined by internally developed
methods.
The Company's mortgage loans and credit-tenant loans are primarily
commercial loans, including retail, office, industrial, medical, multi-
family residential and other properties. Approximately 17 percent, 13
percent, 13 percent, 13 percent, 8 percent, and 6 percent of the mortgage
loan balance was on properties located in California, Illinois, Florida,
Indiana, Texas, and Virginia, respectively. No other state comprised
greater than 5 percent of the mortgage loan and credit-tenant loan balance.
Less than 4 percent of the mortgage loan and credit-tenant loan balance was
noncurrent at December 31, 1997. The Company had a loan loss reserve of
$7.0 million at December 31, 1997.
Information on mortgage loan and credit-tenant loan impairment was as
follows:
<TABLE>
Year ended December 31,
---------------------------
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Non-impaired loans (net of allowance: 1997 - $7.0; 1996 - $6.7
1995 - $7.2) $ 203.9 $ 248.2 $ 306.8
Impaired loans 6.9 9.4 10.4
------- ------- -------
Total mortgage loans and credit tenant loans $ 210.8 $ 257.6 $ 317.2
------- ------- -------
------- ------- -------
Average investment in impaired loans $ 7.7 $ 9.6 $ 5.8
Income recognized on impaired loans 0.3 0.6 0.7
Income received on impaired loans 0.3 0.5 0.7
</TABLE>
Life insurance companies are required to maintain certain amounts of
assets on deposit with state regulatory authorities. Such assets had an
aggregate carrying value of $5.7 million at December 31, 1997.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
3. INSURANCE LIABILITIES
Information on insurance liabilities was as follows:
<TABLE>
Interest December 31,
Withdrawal Mortality Rate ----------------------
assumption assumption assumption 1997 1996
---------- ---------- ---------- ---- ----
<S> <C> <C> <C> <C> <C>
Future policy benefits:
Investment contracts N/A N/A (b) $1,003.9 $1,070.6
Limited-payment contracts None (a) 6% 109.4 122.8
Traditional life insurance contracts Company
experience (a) 6% 58.2 66.3
Universal life-type contracts N/A N/A (b) 735.7 707.4
Individual accident and health Company Company
experience experience N/A 22.6 41.2
Group life and health N/A N/A N/A 8.8 9.6
Other N/A N/A N/A 232.0 264.6
-------- --------
Total insurance liabilities $2,170.6 $2,282.5
-------- --------
-------- --------
<FN>
- -------------------
(a)Principally modifications of the 1965-70 Basic Tables.
(b)This balance represents account balances because future benefits
are not guaranteed.
</TABLE>
4. REINSURANCE
Reinsurance contracts do not relieve the Company from its obligations
to its policyholders. The Company remains contingently liable to its
policyholders for the portion reinsured to the extent that the reinsuring
companies do not meet their obligations assumed under the reinsurance
agreements. Ceded reinsurance premiums deducted from premiums and policy
charges were $8.9 million, $37.7 million, $49.1 million, $53.4 million for
the one month ended December 31, 1997, the eleven months ended November 30
1997, the year ended December 31, 1996, and the year ended December 31,
1995, respectively. Reinsurance benefits ceded were $3.6 million, $18.7
million, $19.8 million, $19.6 million for the one month ended December 31,
1997, the eleven months ended November 30, 1997, the year ended December
31, 1996, and the year ended December 31, 1995, respectively.
At December 31, 1997, approximately 58% of WNIC's total reinsurance
recoverables related to the Company's sale of the health business to
Pioneer Life Insurance Company, an indirectly owned subsidiary of Conseco.
In addition, 21% of WNIC's total reinsurance was due from Combined
Insurance Company of America and 8% was due from UNUM Life Insurance
Company..
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 $6.1 million and $8.0 million for the year ended
December 31, 1997 and the year ended December 31, 1996, respectively.
These transactions do not materially impact the Company's GAAP financial
statements.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
5. INCOME TAXES
Deferred income tax assets and liabilities were comprised of the
following:
<TABLE>
December 31,
----------------------
1997 1996
---- ----
(Dollars in millions)
<S> <C> <C>
Deferred income tax liabilities:
Cost of policies purchased and produced $ 70.3 $ 76.6
Unrealized appreciation of investments (net of loss carryforward of:
1997 - $2.7, 1996 - $0) 24.2 11.3
Accrued bond discount 1.5 1.8
Joint ventures and venture capital investments 2.3 1.8
Other 1.2 0.8
------ ------
Total deferred income tax liabilities 99.5 92.3
Deferred income tax assets:
Policy liability adjustments 57.1 57.5
Nonrecurring expenses related to acquisition 8.2 -
Liabilities for employee benefits 12.6 12.7
Investment losses 3.4 8.3
Net liabilities related to discontinued business 4.4 4.9
Other 3.9 4.3
------ ------
Total deferred income tax assets 89.6 87.7
Valuation allowance (2.9) (7.8)
------ ------
Deferred income tax assets, net of valuation allowance 86.7 79.9
------ ------
Net deferred income tax liabilities 12.8 12.4
Current income tax liability (recoverable) (8.3) 0.6
------ ------
Income tax liabilities $ 4.5 $ 13.0
------ ------
------ ------
</TABLE>
Other than capital gain or loss items, the nature of WNIC's deferred
income tax assets and liabilities is such that the general reversal pattern
for these temporary differences is expected to result in a full realization
of WNIC's deferred income tax assets.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
Federal income tax expense differed from that computed at the
applicable federal statutory income tax rate (35 percent for all periods)
for the following reasons:
<TABLE>
One month Eleven months
ended ended Year ended Year ended
December 31, November 30, December 31, December 31,
1997 1997 1996 1995
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Income tax at statutory rate applied to income from
continuing operations before income tax $ 1.6 $ 15.8 $ 15.5 $ 12.3
Tax expense not recognized on certain GAAP-basis
capital losses - (2.3) (0.9) (1.5)
Investment income not taxed - (0.3) (0.3) (0.3)
Merger related expenses - 2.3 0.6 -
Amortization of purchase accounting adjustments - 0.2 0.2 0.2
Items related to IRS settlements - (0.9) - -
Other - 1.8 1.7 1.3
------ ------ ------ ------
Income tax expense from continuing operations $ 1.6 $ 16.6 $ 16.8 $ 12.0
------ ------ ------ ------
------ ------ ------ ------
Comprised of:
Current expense (benefit) $ (2.9) $ 6.2 $ 15.0 $ 9.9
Deferred expense 4.5 10.4 1.8 2.1
------ ------ ------ ------
Income tax expense from continuing operations 1.6 16.6 16.8 12.0
Income tax expense (benefit) from
discontinued operations - (1.8) (13.1) 3.6
------ ------ ------ ------
Total income tax expense $ 1.6 $ 14.8 $ 3.7 $ 15.6
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
At December 31, 1997, WNIC had capital loss carryforwards for tax
return purposes of $7.6 million, which will begin to expire in 2000. For
financial reporting purposes, a valuation allowance has been recognized to
offset the deferred tax assets related to those carryforwards, investment
loss reserves, and other capital loss-related deferred tax assets not
expected to be realized. The valuation allowance decreased by $4.9 million
in 1997 and increased by $2.7 million in 1996.
Prior to 1984, the Company was required to accumulate certain untaxed
amounts in a memorandum "policyholders' surplus account." Under the Tax
Reform Act of 1984, the "policyholders' surplus account" balances were
capped at December 31, 1983 and taxed only to the extent distributed to
shareholders or when they exceed certain prescribed limits. The Company
does not intend to make any taxable distributions or to exceed the
prescribed limits in the foreseeable future; therefore, no income tax
provision has been made for those purposes. However, if such taxes were
assessed, the amount of tax payable would be approximately $19.9 million.
At December 31, 1997, the combined "policyholders' surplus account" of the
Company approximates $57.0 million.
Under current and prior law, income of the Company taxed on a current
basis is accumulated in a shareholder's surplus account and can be
distributed without tax to WNC. At December 31, 1997, this shareholder's
surplus was $204.3 million.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
6. DEFINED BENEFIT AND CONTRIBUTION PLANS
Retirement Plans
Prior to the purchase of WNC by Conseco, the Company had three
qualified defined contribution retirement plans: a non-contributory money-
purchase retirement plan, a non-contributory discretionary profit sharing
plan, and a contributory 401(k) plan. The plans cover substantially all
employees who have met the prescribed requirements for participation. The
Company contribution to the money-purchase retirement plan was 3% of each
employee's compensation plus an additional 3% of compensation in excess of
the Social Security wage base. The Company contribution to the profit
sharing plan was 5% for 1997. Employees may contribute the lessor of
$8,500 or 12% of compensation to the 401(k) plan. The Company matched
employee contributions dollar for dollar up to a maximum of 3% of
compensation. The net pension expense for the defined contribution plans
was $0.2 million, $2.2 million, $1.6 million, and $1.2 million for the one
month ended December 31, 1997, the eleven months ended November 30, 1997,
the year ended December 31, 1996, and the year ended December 31, 1995,
respectively. As a result of the Company's decision to dispose of the
health business in 1996, the plans were considered partially terminated
under present income tax law. The effect of the partial termination is an
accelerated vesting schedule which vests at 100% those employees who leave
the Company under certain conditions on or after August 1, 1996. Active
employees who remain with the Company are not 100% vested until they meet
the service requirements of the plans.
As a result of the purchase by Conseco, the plans were modified. The
non-contributory money-purchase retirement plan was frozen on December 31,
1997 and will not be replaced for employees working into 1998. The non-
contributory discretionary profit sharing plan was frozen on December 31,
1997 and there will not be a payout during 1998. The contributory 401(k)
plan will continue, however the eligibility requirements have changed,
along with the employer matching contribution. An employee must be
employed as of the end of the first quarter of 1998 to receive a matching
contribution by Conseco. The new match will be 50 cents on each employee
contributed dollar. The maximum amount eligible for matching is 4% of
salary, however the maximum amount that an employee may contribute
continues at 12% of salary.
The Company had a non-qualified supplemental retirement plan under
which benefits were paid to certain employees equal to the amounts by which
the qualified plan benefits were reduced due to provisions of the Internal
Revenue Code (IRC). As a result of the purchase by Conseco, the plan
assets were distributed to participants in December 1997.
The Company had two defined benefit retirement plans, the Washington
National Retirement Plan ("WNIC Plan") and the United Presidential
Corporation Employees' Retirement Plan ("UPI Plan") both of which covered
certain grandfathered employees and agents. Benefits were based
principally on years of service and compensation. In connection with the
Company's disposal of the health business, the WNIC Plan was terminated on
October 1, 1996. The Company contributed an additional $3.3 million in
1997. As a result of the sale to Conseco, the plan assets were distributed
to participants in September 1997.
The components of net periodic pension income reported in income for
the defined benefit plans are as follows:
<TABLE>
One month Eleven months
ended ended Year ended Year ended
December 31, November 30, December 31, December 31,
1997 1997 1996 1995
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Interest cost on projected benefit obligation $ - $ 0.2 $ 1.8 $ 1.7
Actual return on plan assets - (0.1) (2.9) (3.4)
Net amortization and deferral - (0.1) 0.2 1.1
------ ------ ------ ------
Net periodic pension income $ - $ - $ (0.9) $ (0.6)
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
The funded status and the amounts reported in WNIC's Consolidated
Balance Sheet as part of other liabilities for the defined benefit plans
follows:
<TABLE>
December 31,
------------------------
1997 1996
---- ----
(Dollars in millions)
<S> <C> <C>
Actuarial present value of accumulated benefit obligations:
Vested $ (2.8) $ (24.0)
Non-vested (0.1) (0.1)
-------- ---------
Accumulated benefit obligations $ (2.9) $ (24.1)
Projected benefit obligations $ (2.9) $ (24.1)
Plan assets at fair value 2.3 24.6
-------- ---------
Plan assets in excess of (less than) projected benefit obligation $ (0.6) $ 0.5
-------- ---------
-------- ---------
Comprised of:
Prepaid pension cost $ (0.4) $ 4.4
Unrecognized actuarial net loss (0.2) (6.5)
Unrecognized transition asset - 2.6
-------- ---------
Total $ (0.6) $ 0.5
-------- ---------
-------- ---------
</TABLE>
In addition, WNIC's Consolidated Balance Sheet for December 31, 1996
included an accrual of $3.5 million for the estimated funding for the
termination of the WNIC Plan.
Plan assets are invested in an annuity. On June 2, 1997, WNC called
for the redemption of all the issued and outstanding $2.50 convertible
shares of preferred stock. On July 29, 1997, WNC purchased and retired all
of the common stock from the WNIC Plan for $11.8 million in connection with
the distribution of plan assets to participants. Prior to the
abovementioned redemption and repurchase, the WNIC Plan held 415,564 shares
of WNC common stock and 17,108 shares of preferred stock at year end
December 31, 1996 with a fair value of $12.3 million. No WNC shares were
purchased or sold in 1996. Dividends of $0.4 million and $0.5 million were
received on the WNC common and preferred stock in 1997 and 1996,
respectively.
The actuarial assumptions used to measure the projected benefit
obligations include:
<TABLE>
One month Eleven months
ended ended Year ended Year ended
December 31, November 30, December 31, December 31,
1997 1997 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Discount rate 7.25% 7.25% 7.00% 7.00%
Expected rate of return on plan assets 8.00% 8.00% 7.60% 7.60%
</TABLE>
Postretirement Benefit Plan
In addition to the Company's retirement programs, the Company
provides a contributory group life and medical insurance plan to certain
eligible retirees and certain grandfathered active employees who have met a
combination of age and service requirements (the "Plan"). The Plan pays a
stated percentage of most medical expenses, reduced for deductibles and
payments made by government programs or other group coverage. Active
employees who are not included in the grandfathered group are eligible for
$10,000 of life insurance benefits under the Plan after reaching a
combination of age and service requirements.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
In 1993, the Company established a Voluntary Employees' Beneficiary
Association ("VEBA") trust under section 501(c)(9) of the IRC for the
purpose of paying out postretirement benefits to plan participants. Prior
to 1997, the VEBA was funded annually, based on the difference between the
net periodic postretirement benefit expense as measured by statutory
accounting rules and the retiree medical claims incurred during the
respective periods, subject to certain IRC limitations. In 1997, as a
result of the merger with Conseco, the difference was not funded and
retiree expenses are charged directly to the assets of the fund. Assets of
the VEBA trust were invested in a short-term government money market fund
and corporate demand notes at December 31, 1997. The asset balance of the
VEBA was $5.9 million at December 31, 1997.
The components of net periodic postretirement benefit expense were as
follows:
<TABLE>
One month Eleven months
ended ended Year ended Year ended
December 31, November 30, December 31, December 31,
1997 1997 1996 1995
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Interest cost $ 0.1 $ 1.5 $ 1.7 $ 1.5
Service cost - - - -
Return on plan assets - (0.3) (0.2) (0.2)
Net amortization and deferral - (0.2) - 0.1
Prior service cost due to curtailment - (0.1) - 0.1
------ ------ ------ ------
Net periodic postretirement benefit expense $ 0.1 $ 0.9 $ 1.5 $ 1.5
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
The funded status of the Plan and amount recognized in WNIC's
Consolidated Balance Sheet as part of other liabilities was as follows:
<TABLE>
December 31,
-------------------------
1997 1996
---- ----
(Dollars in millions)
<S> <C> <C>
Actuarial present value of accumulated benefit obligations:
Retirees, dependents, and disabled participants $ (18.9) $ (22.0)
Fully eligible active plan participants (0.1) (0.7)
Other active plan participants - (0.3)
-------- --------
Total accumulated postretirement benefit obligation (19.0) (23.0)
Fair value of plan assets 5.9 6.6
-------- --------
Accumulated postretirement benefit obligation in excess of plan assets $ (13.1) $ (16.4)
-------- --------
-------- --------
Comprised of:
Accrued postretirement benefit expense $ (21.5) $ (21.7)
Unrecognized actuarial net gain 8.4 5.1
Unrecognized prior service cost - 0.2
-------- --------
Total $ (13.1) $ (16.4)
-------- --------
-------- --------
</TABLE>
The Company's accumulated postretirement benefit obligation is
included on the Consolidated Balance Sheet under the caption "other
liabilities".
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
The actuarial assumptions used to measure the postretirement benefit
obligation include:
<TABLE>
One month Eleven months
ended ended Year ended Year ended
December 31, November 30, December 31, December 31,
1997 1997 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Weighted-average discount rate 7.25% 7.25% 7.25% 7.00%
Weighted-average after-tax expected rate of
return on plan assets 4.60% 4.60% 4.60% 4.60%
Estimated income tax rate 34.00% 34.00% 34.00% 34.00%
</TABLE>
The health care cost trend rate in 1997 was 11.1% for pre-age 65 and
9.3% for post-age 65 participants, graded evenly to 5.0% in 13 years. The
health care cost trend rate assumption has a significant effect on the
amounts reported. Increasing the trend rate by 1% per year would increase
the accumulated postretirement benefit obligation by $1.5 million at
December 31, 1997 and the aggregate of the service and interest cost
components of net periodic postretirement benefit expense by $0.1 million
in 1997.
7. OTHER DISCLOSURES
Leases
WNIC has noncancelable operating leases primarily for office space and
office equipment, the most significant of which is a twenty-year lease of
the Company's home office building with a related party as lessor. Future
minimum lease payments required under operating leases that have initial or
remaining noncancelable lease terms in excess of one year follow:
<TABLE>
December 31,
------------
1997
----
(Dollars in millions)
<S> <C>
1998 $ 4.7
1999 3.8
2000 3.9
2001 3.6
2002 3.6
Thereafter 41.5
--------
Total minimum lease commitments $ 61.1
--------
--------
</TABLE>
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. The remaining Education
business and the administrative support functions 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 expenses were $0.2 million, $10.7 million (including the
abovementioned $9.1 million charge), $2.7 million, and $3.3 million for the
one month ended December 31, 1997, the eleven months ended November 30,
1997, the year ended December 31, 1996, and the year ended December 31,
1995, respectively.
Financial Guarantees
The Company has entered into certain financial guarantees. A
financial guarantee is a conditional commitment to guarantee the payment of
an obligation by an unrelated entity to a third party and has off-balance
sheet risk. The exposure to credit risk is represented by the amount the
Company would be required to pay under certain circumstances.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
At December 31, 1997, the Company had two financial guarantees
totaling $8.3 million with related letters of credit totaling $2.1 million
and a construction completion guarantee. At December 31, 1996, the Company
had three financial guarantees totaling $11.5 million with related letters
of credit totaling $2.1 million and a construction completion guarantee.
The Company feels it has adequate reserves for related potential losses.
Litigation
WNIC and certain affiliated companies have been named in various
pending legal proceedings considered to be ordinary routine litigation
incidental to the business of such companies. A number of other legal
actions have been filed which demand compensatory and punitive damages
aggregating material dollar amounts. The Company believes that such suits
are substantially without merit and that valid defenses exist. The
Company's management and its chief legal officer are of the opinion that
such litigation will not have a material effect on the Company's results of
operations or consolidated financial position.
In June 1996, the estate of a retired employee filed a lawsuit in the
United States District Court for the Northern District of Illinois against
the Company, WNC and the three individual trustees of the Washington
National Insurance Company Home Office Group Insurance Plan (the "Plan"),
and the Plan. The plaintiff, who was subsequently joined by a retired
employee of the Company as an additional named plaintiff, purported to
represent a class consisting of eligible retirees under the Plan who
retired before January 1, 1992.
This complaint, brought under the Employee Retirement Income Security
Act, centers around a January 1992 amendment to the Plan which resulted in
a different coordination of benefits with Medicare. Also, at that time the
retirees were first required to contribute a portion of their premium,
whereas previously the Company paid 100% of retiree medical premiums.
Plaintiff sought certification of the class, permanent no-cost retiree
medical benefits, an accounting and repayment of premium contributions,
attorney fees, costs and expenses, plus other appropriate equitable relief.
Plaintiffs utilize several theories of recovery, namely, promissory
estoppel, equitable estoppel, negligent misrepresentation, breach of
fiduciary duty, and entitlement.
On July 18, 1997, the court denied plaintiffs motion to certify the
proposed class. On July 24, 1997, the Court entered summary judgment for
defendants on the negligent misrepresentation, breach of fiduciary duty and
entitlement counts. In addition, the Court dismissed the three individual
defendants and ruled that plaintiffs were not entitled to a jury trial.
Accordingly, all that remains are the two individual plaintiffs' estoppel
claims against the Company, WNC, and the Plan.
The Company, WNC and the Plan believe that valid defenses exist and
intend to contest vigorously the remaining allegations made in the
complaint.
Guaranty Fund Assessments
From time to time, mandatory assessments are levied on WNIC and UPI by
life and health guaranty associations of most states in which these
subsidiaries are licensed to cover losses to policyholders of insolvent or
rehabilitated insurance companies. The associations levy assessments (up
to prescribed limits) on all insurers in a particular state in order to pay
claims on the basis of the proportionate share of premiums written by
insurers in the lines of business in which the insolvent or rehabilitated
insurer is engaged. These assessments may be deferred or forgiven in
certain states if they would threaten an insurer's financial strength, and
in some states, these assessments can be partially recovered through a
reduction in future premium taxes. Assessments levied against WNIC and UPI
and charged to expense were $0.2 million, $1.2 million, $1.1 million, and
$1.9 million for the one month ended December 31, 1997, the eleven months
ended November 30, 1997, the year ended December 31, 1996, and the year
ended December 31, 1995, respectively. The Company had accrued liabilities
of $4.4 million and $4.5 million for estimated future assessments at
December 31, 1997 and 1996, respectively.
The Company's accounting policy with regard to payments to state
guaranty funds is to treat as assets any such payments in those states
where current law allows an offset against future premium taxes if the
Company expects to utilize the asset. At December 31, 1997 and 1996, other
assets included $2.2 million and $2.8 million, respectively, of deferred
payments to state guaranty funds. Generally, these amounts will be used to
offset future premium tax payments over periods from five to ten years.
Under certain circumstances, including changes in state laws and a change
in the Company's product mix, such amounts might become unrecoverable.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
Mortgage Payable
The Company had a mortgage payable of $0.7 million at December 31,
1996 on investment real estate with an interest rate of 6.5% that matured
and was paid off in July 1997. The property was pledged as collateral with
a carrying value of $6.8 million at December 31, 1996.
Credit Arrangements
WNIC has a $10.0 million short-term line of credit available with one
bank which is also available to WNC and which was unused at December 31,
1997. The line of credit arrangement is renewable annually, but credit can
be withdrawn at the bank's option.
In addition, WNIC has four letters of credit with varying terms and
conditions totaling $2.2 million. As of December 31, 1997, the entire
amount was unused.
8. OTHER OPERATING DATA
The changes in the cost of policies purchased were as follows:
<TABLE>
One month Eleven months
ended ended Year ended Year ended
December 31, November 30, December 31, December 31,
1997 1997 1996 1995
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Balance, beginning of period $ 26.1 $ 31.4 $ 29.1 $ 45.3
Adjustment of balance pursuant to
purchase accounting (See Note 1) 199.1 - - -
Amortization related to operations:
Cash flow realized (2.3) (3.9) (6.0) (5.7)
Interest added 1.1 2.3 2.7 2.9
Effect of fair value adjustment to actively managed
fixed maturities (5.5) (3.7) 5.6 (13.4)
------ ------ ------ ------
Balance, end of period $218.5 $ 26.1 $ 31.4 $ 29.1
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
Based on current conditions and assumptions as to future events on all
policies in force, the Company expects to amortize approximately 6 percent
of the cost of policies purchased balance in 1998, 7 percent in 1999, 7
percent in 2000, 6 percent in 2001, and 7 percent in 2002. The discount
rate used to determine the amortization of the cost of policies purchased
ranged from 5 percent to 8 percent.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
The changes in the cost of policies produced were as follows:
<TABLE>
One month Eleven months
ended ended Year ended Year ended
December 31, November 30, December 31, December 31,
1997 1997 1996 1995
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Balance, beginning of period $203.4 $211.1 $173.2 $219.3
Adjustment of balance pursuant to
purchase accounting (See Note 1) (203.4) - - -
Additions 2.7 31.3 33.3 31.5
Amortization related to operations - (22.4) (19.4) (20.4)
Effect of fair value adjustment to actively managed
fixed maturities - (16.6) 24.0 (57.2)
------ ------ ------ ------
Balance, end of period $ 2.7 $203.4 $211.1 $173.2
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
Changes in the cost of policies produced excludes $2.0 million and
$2.4 million for year ended December 31, 1996 and December 31, 1995,
respectively, related to the sale of the health business.
9. CONSOLIDATED STATEMENT OF CASH FLOWS
Supplemental disclosures and non-cash items that are not reflected in
the consolidated statement of cash flows were as follows:
<TABLE>
One month Eleven months
ended ended Year ended Year ended
December 31, November 30, December 31, December 31,
1997 1997 1996 1995
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Cash paid during the period for:
Interest $ - $ - $ 0.1 $ 0.1
Income taxes - 10.2 10.8 13.0
</TABLE>
Non-cash investing activities totaled $0.1 million, $5.8 million, $8.5
million, $10.7 million for the one month ended December 31, 1997, the
eleven months ended November 30, 1997, the year ended December 31, 1996,
and the year ended December 31, 1995, respectively. The non-cash
activities consisted of real estate acquired through foreclosure of fixed
maturities, and mortgage loans, purchase money mortgages, and venture
capital distributions of common stock.
10. STATUTORY INFORMATION
WNIC and UPI prepare statutory financial statements in accordance with
accounting principles and practices prescribed or permitted by the
insurance department of the applicable state of domicile. Prescribed
statutory accounting practices currently include state laws, regulations,
and general administrative rules applicable to all insurance enterprises
domiciled in a particular state, as well as practices described in National
Association of Insurance Commissioners' publications. Permitted practices
include practices not prescribed, but allowed, by the domiciliary state
insurance department. The prescribed and permitted statutory accounting
practices differ from GAAP.
Current statutory practice does not address reserves for certain
endowment features of several life insurance products marketed by UPI which
uses a practice permitted by its state of domicile and discounts the future
benefit using mortality and interest rate assumptions.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
WNIC and UPI reported the following amounts to regulatory agencies:
<TABLE>
December 31,
---------------------
1997 1996
---- ----
(Dollars in millions)
<S> <C> <C>
Statutory capital and surplus $ 131.8 $ 240.0
Asset valuation reserve 19.9 19.0
Interest maintenance reserve 19.6 19.2
-------- -------
Total $ 171.3 $ 278.2
-------- -------
-------- -------
</TABLE>
Combined statutory net income of WNIC and UPI was $15.3 million, $19.5
million, and $ 18.3 million in 1997, 1996, and 1995, respectively.
The amount of dividends available for distribution without prior
regulatory approval is limited by regulatory restrictions. This amount is
the greater of: (i) 10% of WNIC's and UPI's statutory capital and surplus
as of the preceding year end; or (ii) WNIC's statutory net income or UPI's
statutory net gain from operations for the preceding year. WNIC is
permitted a maximum of $14.0 million in dividend distributions to WNC in
1998 without prior approval of regulatory authorities. However, due to the
restrictions on dividends within a twelve month period, the maximum
dividend payout may not be made without prior approval until December 6,
1998. UPI is permitted to pay $8.7 million in dividends ($6.2 million to
WNIC and $2.5 million to WNC) without prior regulatory approval. WNIC paid
dividends of $101.7 million to WNC in 1997, of which $95.0 million was an
extraordinary dividend. There were no dividends paid by UPI.
Statutory accounting practices require that portions of surplus,
called the asset valuation reserve ("AVR") and the interest maintenance
reserve ("IMR"), be appropriated and reported as liabilities. The purpose
of these reserves is to stabilize statutory surplus against fluctuations in
the market value of investments. The IMR captures all investment gains and
losses on debt instruments resulting from changes in interest rates and
provides for subsequent amortization of such amounts into statutory net
income on a basis reflecting the remaining life of the assets sold. The
AVR captures investment gains and losses related to changes in
creditworthiness and are also adjusted each year based on a formula related
to the quality and loss experience of the Company's investment portfolio.
Most states have adopted risk-based capital ("RBC") rules to evaluate
the adequacy of statutory capital and surplus in relation to investment and
insurance risks. The RBC formula is designed as an early warning tool to
help state regulators identify possible weakly capitalized companies for
the purpose of initiating regulatory action. At December 31, 1997, the
ratios of total adjusted capital to RBC, as defined by the rules, for WNIC
and UPI were at least three times the level at which regulatory attention
is triggered.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
11. SEGMENT INFORMATION
The Company has three business segments: life insurance, annuity
products and other. In addition, prior to the sale of the Company's health
business, the Company had three business segments (See Note 12). The other
segment includes the Company's specialty health insurance products for
educators, investment gains and losses, and operations that do not
specifically support the life insurance or annuity product segments.
Depreciation expense and capital expenditures are not material. Revenues
and pretax income from continuing operations are as follows:
<TABLE>
One month Eleven months
ended ended Year ended Year ended
December 31, November 30, December 31, December 31,
1997 1997 1996 1995
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Revenues from continuing operations:
Life insurance $ 11.7 $125.3 $133.5 $124.6
Annuity products 6.5 84.9 101.1 109.5
Other 7.9 97.3 93.7 83.2
------ ------ ------ ------
Consolidated total $ 26.1 $307.5 $328.3 $317.3
------ ------ ------ ------
------ ------ ------ ------
Pretax income from continuing operations:
Life insurance $ 2.5 $ 21.3 $ 21.0 $ 20.5
Annuity products 0.4 14.9 19.6 13.5
Other 1.0 4.4 3.8 1.2
------ ------ ------ ------
Consolidated total $ 3.9 $ 40.6 $ 44.4 $ 35.2
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
Assets not individually identifiable by segment are allocated,
generally, based on the amount of segment liabilities. Assets by segment
are as follows:
<TABLE>
December 31,
---------------------
1997 1996
---- ----
(Dollars in millions)
<S> <C> <C>
Assets:
Life insurance $1,081.9 $1,077.0
Annuity products 1,285.4 1,415.5
Other 192.6 153.7
Discontinued operations 129.6 220.4
-------- --------
Consolidated total $2,689.5 $2,866.6
-------- --------
-------- --------
</TABLE>
Actuarial estimates are used in determining certain policy liabilities
and cost of policies purchased which in turn effect the reported
profitability of the segments. Actual results can differ materially from
these actuarial estimates. In addition, changes in these estimates, where
required, may have a significant effect on reported net income, especially
in the year of change.
The profits of the segments are highly dependent on interest rate
spreads, which is the difference between the amount earned on investments
and the amount credited to policyholders. Increases in market interest
rates could result in the need to credit higher rates to policyholders
without a comparable increase in the rate earned on the Company's invested
assets; they could also result in customers surrendering their policies to
obtain higher rates from other insurance companies or alternative products.
Decreases in market interest rates could result in inadequate spreads due
to the inability to lower credited rates below certain minimum guarantees
as to such rates.
<PAGE>
WASHINGTON NATIONAL INSURANCE COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
The profitability of most of the Company's products depends on the
ability to attract and retain customers at a price level sufficient to
cover the various expenses incurred by the Company. The nature of these
products is such that customers can in most cases easily transfer to other
insurance carriers offering more attractive coverage. The profitability of
the products may change over time depending on the degree of competition in
the markets for such products.
12. DISCONTINUED OPERATIONS
In 1996, the Company sold its individual health insurance and its
group life and health insurance business. The operating results of the
Company's sold health insurance business has been reported in the
Consolidated Statement of Operations as discontinued operations. As
permitted, the Consolidated Balance Sheet has not been segregated between
continuing and discontinued operations. At December 31, 1997, the business
had remaining assets of approximately $129.6 million consisting primarily
of invested assets and $76.0 million of reinsurance recoverables, and
liabilities of approximately $129.6 million consisting primarily of policy
liabilities.
Revenues for the discontinued operations were $0.3 million, $46.0
million, $268.7 million, $379.1 million for the one month ended December
31, 1997, the eleven months ended November 30, 1997, the year ended
December 31, 1996, and the year ended December 31, 1995, 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 an estimated net loss of $25.1 million,
net of a tax credit of $12.5 million. The loss consisted principally of
the future operating losses of this business for which the Company remains
responsible after the measurement date, employee severance costs, the cost
to terminate the Company's defined benefit pension plan, related net asset
write-offs, and other related disposal costs net of the anticipated
proceeds. The loss is an estimate due to the nature of the transactions
and may change in future periods.
<PAGE>
The registrant hereby incorporates by reference the March 1, 1998
Fundamental Investors Prospectus, file number 811-32, filed with
the Commission on February 27, 1998.
