UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___ to ___
Commission File Number 1-9250
Conseco, Inc.
Indiana No. 35-1468632
-------------------- -----------------------------
State of Incorporation IRS Employer Identification No.
11825 N. Pennsylvania Street
Carmel, Indiana 46032 (317) 817-6100
------------------------------- --------------
Address of principal executive offices Telephone
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days: Yes [ X ] No [ ]
Shares of common stock outstanding as of August 1, 1997: 187,880,480
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
ASSETS
June 30, December 31,
1997 1996
---- ----
(unaudited)
<S> <C> <C>
Investments:
Actively managed fixed maturities at fair value (amortized cost:
1997 - $18,977.1; 1996 - $17,203.3)...................................................... $19,060.2 $17,307.1
Equity securities at fair value (cost: 1997 - $181.8; 1996 - $97.6)........................ 186.7 99.7
Mortgage loans............................................................................. 324.5 356.0
Credit-tenant loans........................................................................ 545.2 447.1
Policy loans............................................................................... 619.4 542.4
Other invested assets ..................................................................... 367.6 259.6
Short-term investments..................................................................... 364.3 281.6
Assets held in separate accounts........................................................... 393.5 337.6
--------- ---------
Total investments...................................................................... 21,861.4 19,631.1
Accrued investment income..................................................................... 339.6 296.9
Cost of policies purchased.................................................................... 2,505.3 2,015.0
Cost of policies produced..................................................................... 728.0 544.3
Reinsurance receivables....................................................................... 792.7 504.2
Income tax assets............................................................................. 289.8 8.8
Goodwill (net of accumulated amortization: 1997 - $122.0; 1996 - $83.2)....................... 3,133.6 2,200.8
Property and equipment (net of accumulated depreciation: 1997 - $78.8; 1996 - $69.7) ......... 148.7 110.5
Securities segregated for future redemption of redeemable preferred stock of a subsidiary.... 33.3 45.6
Other assets.................................................................................. 355.4 255.5
--------- ---------
Total assets........................................................................... $30,187.8 $25,612.7
========= =========
(continued on next page)
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
2
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<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET, continued
(Dollars in millions)
LIABILITIES AND SHAREHOLDERS' EQUITY
June 30, December 31,
1997 1996
---- ----
(unaudited)
<S> <C> <C>
Liabilities:
Insurance liabilities:
Interest sensitive products.............................................................. $15,589.1 $14,795.5
Traditional products..................................................................... 4,699.2 3,180.1
Claims payable and other policyholder funds.............................................. 1,370.2 1,056.3
Unearned premiums........................................................................ 439.2 272.4
Investment borrowings...................................................................... 433.0 383.4
Other liabilities.......................................................................... 988.8 709.5
Liabilities related to separate accounts .................................................. 393.5 337.6
Commercial paper........................................................................... 487.2 -
Notes payable.............................................................................. 1,286.5 1,094.9
--------- ---------
Total liabilities.................................................................. 25,686.7 21,829.7
--------- ---------
Minority interest:
Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts..................................................................... 900.0 600.0
Mandatorily redeemable preferred stock of subsidiary....................................... 67.7 97.0
Common stock of subsidiary................................................................. .7 .7
Shareholders' equity:
Preferred stock............................................................................ 122.0 267.1
Common stock and additional paid-in capital (no par value, 500,000,000 shares
authorized, shares issued and outstanding: 1997 - 187,210,297;
1996 - 167,128,228)...................................................................... 2,448.9 2,029.6
Unrealized appreciation (depreciation) of securities:
Fixed maturity securities (net of applicable deferred income taxes:
1997 - $13.8; 1996 - $21.5)........................................................... 25.6 39.8
Other investments (net of applicable deferred income taxes:
1997 - $(.2); 1996 - $(.5))........................................................... (.4) (.9)
Retained earnings.......................................................................... 936.6 749.7
--------- ---------
Total shareholders' equity......................................................... 3,532.7 3,085.3
--------- ---------
Total liabilities and shareholders' equity......................................... $30,187.8 $25,612.7
========= =========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
3
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<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(Dollars in millions)
(unaudited)
Three months ended Six months ended
June 30, June 30,
------------------- ------------------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Insurance policy income:
Traditional products..................................................... $ 776.5 $339.6 $1,342.6 $ 682.4
Interest sensitive products.............................................. 108.5 32.0 212.5 59.0
Net investment income...................................................... 444.9 288.2 854.1 561.9
Net investment gains (losses).............................................. 15.8 (3.0) 20.9 2.9
Fee revenue and other income............................................... 14.8 15.7 29.4 27.7
Restructuring income....................................................... - - - 30.4
-------- ------ -------- ---------
Total revenues......................................................... 1,360.5 672.5 2,459.5 1,364.3
-------- ------ -------- ---------
Benefits and expenses:
Insurance policy benefits.................................................. 573.2 269.8 986.9 544.5
Change in future policy benefits........................................... 40.0 2.8 81.6 12.0
Amounts added to annuity and financial product policyholder
account balances......................................................... 189.9 150.6 379.8 289.7
Interest expense on notes payable.......................................... 25.5 25.8 51.3 54.2
Interest expense on short-term investment borrowings....................... 5.5 4.9 8.3 8.6
Amortization related to operations......................................... 114.9 54.9 218.5 99.5
Amortization related to investment gains (losses).......................... 14.8 3.2 26.6 12.3
Nonrecurring expense related to death of an executive officer.............. 9.3 - 9.3 -
Other operating costs and expenses......................................... 156.2 59.2 270.6 122.0
-------- ------ -------- ---------
Total benefits and expenses............................................ 1,129.3 571.2 2,032.9 1,142.8
-------- ------ -------- ---------
Income before income taxes, minority interest and extraordinary charge. 231.2 101.3 426.6 221.5
Income tax expense............................................................ 84.3 39.4 154.9 84.3
-------- ------ -------- ---------
Income before minority interest and extraordinary charge .............. 146.9 61.9 271.7 137.2
Minority interest:
Distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts.......................................... 12.9 - 21.6 -
Dividends on preferred stock of subsidiaries............................... 1.2 2.5 2.5 5.1
Equity in earnings of subsidiaries......................................... - 9.3 - 18.3
-------- ------ -------- ---------
Income before extraordinary charge .................................... 132.8 50.1 247.6 113.8
Extraordinary charge on extinguishment of debt, net of taxes and
minority interest.......................................................... 2.2 - 5.5 17.4
-------- ------ -------- ---------
Net income............................................................. 130.6 50.1 242.1 96.4
Less amounts applicable to preferred stock:
Charge related to induced conversions...................................... .9 - 13.2 -
Preferred stock dividends.................................................. 2.2 9.1 4.5 17.2
-------- ------ --------- ---------
Net income applicable to common stock.................................. $ 127.5 $ 41.0 $ 224.4 $ 79.2
======== ======= ========= =========
(continued on next page)
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
4
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<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS, continued
(Dollars in millions, except per share data)
(unaudited)
Three months ended Six months ended
June 30, June 30,
-------------------- -----------------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Earnings per common share and common equivalent share:
Primary:
Weighted average shares outstanding............................ 214,917,600 105,133,300 209,436,300 102,250,200
Income before extraordinary charge............................. $.62 $.43 $1.12 $1.02
Extraordinary charge........................................... .01 - .02 .17
---- ---- ----- ------
Net income.................................................... $.61 $.43 $1.10 $ .85
==== ==== ===== ======
Fully diluted:
Weighted average shares outstanding............................. 214,917,600 123,011,300 209,436,300 121,286,400
Income before extraordinary charge.............................. $.62 $.41 $1.12 $.94
Extraordinary charge............................................ .01 - .02 .15
---- ---- ----- -----
Net income.................................................... $.61 $.41 $1.10 $.79
==== ==== ===== ====
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
5
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<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(Dollars in millions)
(unaudited)
Six months ended
June 30,
------------------
1997 1996
---- ----
<S> <C> <C>
Preferred stock:
Balance, beginning of period.............................................................. $ 267.1 $ 283.5
Issuance of convertible preferred stock................................................. - 267.1
Conversion of preferred stock into common shares........................................ (145.1) (14.1)
-------- --------
Balance, end of period.................................................................... $ 122.0 $ 536.5
======== ========
Common stock and additional paid-in capital:
Balance, beginning of period.............................................................. $2,029.6 $ 157.2
Amounts related to stock options and employee benefit plans............................. 162.2 8.9
Tax benefit related to issuance of shares under stock option plans...................... 82.5 15.5
Conversion of convertible debentures into common shares................................. 152.1 -
Conversion of preferred stock into common shares........................................ 145.1 14.1
Issuance of shares in merger with Capitol American Financial Corporation................ 115.7 -
Issuance of shares in merger with Pioneer Financial Services, Inc....................... 342.5 -
Cost of issuance of preferred stock..................................................... (3.3) (9.2)
Cost of shares acquired charged to common stock and additional paid-in capital.......... (574.9) (3.1)
Other................................................................................... (2.6) -
-------- --------
Balance, end of period.................................................................... $2,448.9 $ 183.4
======== ========
Unrealized appreciation (depreciation) of securities:
Fixed maturity securities:
Balance, beginning of period............................................................ $ 39.8 $ 112.6
Change in unrealized appreciation (depreciation)...................................... (14.2) (168.6)
-------- --------
Balance, end of period.................................................................. $ 25.6 $ (56.0)
======== ========
Other investments:
Balance, beginning of period............................................................ $ (.9) $ .1
Change in unrealized appreciation (depreciation)...................................... .5 .2
-------- --------
Balance, end of period.................................................................. $ ( .4) $ .3
======== ========
Retained earnings:
Balance, beginning of period.............................................................. $ 749.7 $ 558.3
Net income ............................................................................. 242.1 96.4
Cost of shares acquired charged to retained earnings.................................... (25.4) (22.9)
Amounts applicable to preferred stock:
Charge related to induced conversion of convertible preferred stock................... (12.3) -
Dividends on preferred stock.......................................................... (5.4) (17.2)
Dividends on common stock............................................................... (12.1) (1.9)
-------- --------
Balance, end of period.................................................................... $ 936.6 $ 612.7
======== ========
Total shareholders' equity............................................................ $3,532.7 $1,276.9
======== ========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
6
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<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in millions)
(unaudited)
Six months ended
June 30,
------------------
1997 1996
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income................................................................................ $ 242.1 $ 96.4
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization and depreciation........................................................... 254.3 115.8
Income taxes............................................................................ (11.4) (3.3)
Insurance liabilities................................................................... (27.2) 41.3
Amounts added to annuity and financial product policyholder account balances............ 379.8 289.7
Fees charged to insurance liabilities................................................... (211.1) (58.4)
Accrual and amortization of investment income........................................... (27.4) (31.4)
Deferral of cost of policies produced................................................... (261.6) (139.2)
Restructuring income.................................................................... - (30.4)
Minority interest....................................................................... - 17.6
Extraordinary charge on extinguishment of debt.......................................... 8.4 26.7
Net investment gains.................................................................... (20.9) (2.9)
Other................................................................................... 10.0 (38.9)
--------- ---------
Net cash provided by operating activities............................................. 335.0 283.0
--------- ---------
Cash flows from investing activities:
Sales of investments...................................................................... 6,259.8 3,037.1
Maturities and redemptions................................................................ 249.4 302.2
Purchases of investments.................................................................. (6,552.4) (3,622.8)
Purchase of property and casualty insurance brokerage businesses.......................... - (12.0)
Purchase of mandatorily redeemable preferred stock of subsidiary.......................... (30.5) -
Repurchase of equity securities by Bankers Life Holding Corporation....................... - (27.7)
Acquisition of Capitol American Financial Corporation, net of cash held at date of merger. (522.1) -
Cash held by Pioneer Financial Services, Inc. at date of merger........................... 44.2 -
Other..................................................................................... (59.4) (26.1)
--------- ---------
Net cash used by investing activities ................................................ (611.0) (349.3)
--------- ---------
Cash flows from financing activities:
Issuance of Company-obligated mandatorily redeemable preferred stock of subsidiary trusts. 296.7 -
Issuance of shares related to stock options and employee benefit plans.................... 27.1 1.5
Issuance of convertible preferred stock................................................... - 257.9
Issuance of commercial paper, net......................................................... 487.2 -
Issuance of notes payable................................................................. 1,317.4 404.1
Payments on notes payable................................................................. (1,180.7) (645.4)
Payments to repurchase equity securities of Conseco....................................... (480.6) (21.5)
Investment borrowings..................................................................... 49.6 146.9
Deposits to insurance liabilities......................................................... 956.4 770.5
Withdrawals from insurance liabilities.................................................... (1,083.6) (875.3)
Charge related to induced conversion of convertible preferred stock....................... (13.2) -
Dividends paid ........................................................................... (17.6) (15.6)
--------- ---------
Net cash provided by financing activities............................................. 358.7 23.1
--------- ---------
Net increase (decrease) in short-term investments..................................... 82.7 (43.2)
Short-term investments, beginning of period.................................................. 281.6 189.9
--------- ---------
Short-term investments, end of period........................................................ $ 364.3 $ 146.7
========= =========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
7
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following notes should be read in conjunction with the notes to
consolidated financial statements included in the 1996 Form 10-K of Conseco,
Inc. ("We", "Conseco" or the "Company").
BASIS OF PRESENTATION
Our unaudited consolidated financial statements as of and for the periods
ended June 30, 1997 and 1996, reflect all adjustments, consisting only of normal
recurring items, which are necessary to present fairly Conseco's financial
position and results of operations on a basis consistent with that of our prior
audited consolidated financial statements. We have reclassified certain amounts
from the prior period to conform to the 1997 presentation. We have restated all
share and per share amounts for the February 11, 1997, and April 1, 1996
two-for-one stock splits.
In preparing financial statements in conformity with generally accepted
accounting principles ("GAAP"), we are required to make estimates and
assumptions that significantly affect various reported amounts. For example, we
use significant estimates and assumptions in calculating the cost of policies
produced, the cost of policies purchased, goodwill, insurance liabilities,
liabilities related to litigation, guaranty fund assessment accruals and
deferred income taxes. If our future experience differs materially from these
estimates and assumptions, our financial statements could be affected.
Consolidation issues. Conseco's ownership of Bankers Life Holding
Corporation ("BLH") was 88 percent at December 31, 1995, and increased to 90.5
percent at March 31, 1996, as a result of share repurchases by BLH. On December
31, 1996, we completed the purchase of BLH common shares we did not previously
own in a transaction pursuant to which BLH merged with a wholly owned subsidiary
of Conseco (the "BLH Merger"). The accounts of BLH are consolidated with
Conseco's accounts for all periods in the accompanying consolidated financial
statements.
The assets and liabilities of BLH included in Conseco's consolidated
balance sheet represent the following combination of values: (i) the portion of
BLH's net assets acquired by Conseco in the November 1992 acquisition made by
Conseco Capital Partners, L.P. is valued as of that acquisition date; (ii) the
portion of BLH's net assets acquired in 1993, 1995 and the first quarter of 1996
is valued as of the dates of their purchase; and (iii) the portion of BLH's net
assets acquired in the BLH Merger is valued as of December 31, 1996.
Conseco Capital Partners II, L.P. ("Partnership II"), Conseco's second
investment partnership, acquired American Life Holdings, Inc. ("ALH") on
September 29, 1994. Because Conseco was the sole general partner of Partnership
II, Conseco controlled Partnership II and ALH even though our ownership interest
was less than 50 percent. Because of this control, Conseco's consolidated
financial statements were required to include the accounts of ALH. Immediately
after the acquisition of ALH, Conseco, through its direct investment and through
its equity interests in the investments made by BLH and other affiliates, had
approximately a 27 percent ownership interest in ALH. Conseco's ownership
interest in ALH increased to 36 percent in 1995.
On September 30, 1996, we purchased all of the common shares of ALH we did
not previously own from Partnership II for $165.0 million in cash (the "ALH
Stock Purchase") and Partnership II was terminated. We were required to use
step-basis accounting when we acquired the shares of ALH common stock in the ALH
Stock Purchase and for our previous acquisitions. As a result, the assets and
liabilities of ALH included in Conseco's consolidated balance sheet represent
the following combination of values: (i) the portion of ALH's net assets
acquired by Conseco in the initial acquisition of ALH made by Partnership II is
valued as of September 29, 1994; (ii) the portion of ALH's net assets acquired
on November 30, 1995 is valued as of that date; and (iii) the portion of ALH's
net assets acquired in the ALH Stock Purchase is valued as of September 30,
1996.
On August 2, 1996, we completed the acquisition (the "LPG Merger") of Life
Partners Group, Inc. ("LPG") and LPG became a wholly owned subsidiary of
Conseco. On December 17, 1996, we completed the acquisition (the "ATC Merger")
of American Travellers Corporation ("ATC") and ATC was merged with and into
Conseco, with Conseco being the surviving corporation. On December 23, 1996, we
completed the acquisition (the "THI Merger") of Transport Holdings Inc. ("THI")
and THI was merged with and into Conseco with Conseco being the surviving
corporation. On March 4, 1997, we completed the acquisition (the "CAF Merger")
of Capitol American Financial Corporation ("CAF") and CAF became a wholly owned
subsidiary of Conseco. On May 30, 1997, we completed the acquisition (the "PFS
Merger") of Pioneer Financial Services, Inc. ("PFS") and PFS became a wholly
owned subsidiary of Conseco. The accounts of LPG are consolidated with Conseco
effective July 1, 1996; the accounts of ATC and THI are
8
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
consolidated effective December 31, 1996; the accounts of CAF are consolidated
effective January 1, 1997; and the accounts of PFS are consolidated effective
April 1, 1997.
ADJUSTMENT TO ACTIVELY MANAGED FIXED MATURITY SECURITIES
We classify fixed maturity securities into three categories: "actively
managed" (which are carried at estimated fair value), "trading account" (which
are carried at estimated fair value) and "held to maturity" (which are carried
at amortized cost). We did not classify any fixed maturity securities in the
held to maturity or trading categories at June 30, 1997.
Adjustments to carry actively managed fixed maturity securities at fair
value have no effect on our earnings. We record them, net of tax and other
adjustments, as an adjustment to shareholders' equity. The components of the
balance sheet caption "unrealized appreciation (depreciation) of fixed maturity
securities, net" in shareholders' equity at June 30, 1997, and December 31,
1996, are as follows:
<TABLE>
<CAPTION>
June 30, 1997 December 31, 1996
------------------------------------- ----------------------------------
Effect of Effect of
fair value Carrying fair value Carrying
Cost basis adjustments value Cost basis adjustments value
---------- ----------- ----- ---------- ----------- -----
(Dollars in millions)
<S> <C> <C> <C> <C> <C> <C>
Actively managed fixed maturity
securities............................... $18,977.1 $ 83.1 $19,060.2 $17,203.3 $103.8 $17,307.1
Other balance sheet items:
Cost of policies purchased............... 2,552.0 (46.7) 2,505.3 2,059.2 (44.2) 2,015.0
Cost of policies produced................ 723.0 5.0 728.0 542.6 1.7 544.3
Amounts related to assets held in trust
under reinsurance agreements
(included in other liabilities)....... - (2.0) (2.0) - - -
Income tax assets........................ 303.6 (13.8) 289.8 30.3 (21.5) 8.8
------- -------
Unrealized appreciation (depreciation)
of fixed maturity securities, net..... $ 25.6 $ 39.8
======= =======
</TABLE>
DERIVATIVE FINANCIAL INSTRUMENTS
Conseco has entered into interest rate swap agreements which expire in
2002. Such agreements effectively convert the fixed cost the Company incurs on
$200.0 million of Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts to a variable rate during the next five years. Under the
agreements, Conseco receives a weighted average fixed rate of 6.82 percent and
pays a floating rate based on LIBOR, determined quarterly. At June 30, 1997, the
weighted average floating rate was approximately 5.79 percent. Unrealized gains
or losses related to the interest rate swap agreements (which were not material
at June 30, 1997) are not reflected in the consolidated financial statements.
In 1996, we introduced equity-indexed annuity products, which provide a
guaranteed base rate of return with a higher potential return linked to the
performance of a broad-based equity index. We also implemented a hedging program
under which we purchase Standard & Poor's 500 Index Call Options ("S&P
Options"). We buy S&P Options to offset potential increases in policyholder
account balances for equity-indexed annuity policies resulting from increases in
the index to which the products are linked. We include the cost of the S&P
Options in the pricing of the equity-indexed annuity products. We reflect
changes in the values of the S&P Options, which fluctuate in relation to changes
in policyholder account balances for these annuities, in net investment income.
During the six months ended June 30, 1997, net investment income increased
by $16.9 million as a result of changes in the value of the S&P Options. Such
investment income was offset by amounts added to policyholder account balances
for annuities and financial products. The value of the S&P Options was $29.2
million at June 30, 1997. Such instruments are classified as other invested
assets.
9
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Conseco is exposed to the risk of loss in the event of non-performance by
the counterparties of the aforementioned derivative financial instruments.
Conseco limits its exposure to such a loss by diversifying among counterparties
and limiting its exposure to parties believed to be creditworthy. At June 30,
1997, all of the counterparties were rated A or higher by Standard & Poor's
Corporation.
ACQUISITIONS
Capitol American Financial Corporation
On March 4, 1997, we completed the CAF Merger. Each outstanding share of
CAF common stock was exchanged for the right to receive $30.75 in cash plus
0.1647 of a share of Conseco common stock. We paid $549.3 million (including
acquisition expenses of $10.7 million) in cash and issued 3.0 million shares of
Conseco common stock (including .1 million common equivalent shares issued in
exchange for CAF's outstanding options) having a value of approximately $115.7
million. We also assumed a $31.0 million note payable of CAF, which was repaid
at the date of the CAF Merger.
CAF, through its insurance subsidiaries, underwrites, markets and
distributes individual and group supplemental health and accident insurance.
CAF's principal insurance subsidiary is Capitol American Life Insurance Company
("CALI"), an Arizona- domiciled insurance company. CALI is licensed to sell its
products in 47 states, the District of Columbia, Puerto Rico and the U.S. Virgin
Islands, and markets its products through a sales force consisting of
independent agents, agent organizations and brokers.
Pioneer Financial Services, Inc.
On May 30, 1997, we completed the PFS Merger. Each outstanding share of PFS
common stock was exchanged for .7077 of a share of Conseco common stock. We
issued 8.6 million shares of Conseco common stock (including .2 million common
equivalent shares issued in exchange for PFS's outstanding options) having a
value of approximately $342.5 million. We assumed PFS's convertible subordinated
notes, which are convertible into 3.1 million shares of Conseco common stock
having a value of $140.9 million (of which $86.1 million, representing the
principal amount outstanding, is included in notes payable and $54.8 million,
representing the additional value attributable to the conversion feature, is
included in other liabilities). We also assumed a $21.3 million note payable of
PFS, which was repaid at the date of the PFS Merger.
PFS, through its insurance subsidiaries, underwrites life insurance,
annuities and health insurance in selected niche markets throughout the United
States.
Effect of Merger Transactions on Consolidated Financial Statements
We used purchase accounting to account for the CAF Merger effective January
1, 1997, and the PFS Merger effective April 1, 1997. We allocated the cost to
acquire CAF and PFS to the assets and liabilities acquired based on their fair
values as of their effective dates, and recorded the excess of the total
purchase cost over the fair value of the liabilities we assumed as goodwill.
We allocated the total purchase cost to the assets and liabilities acquired
based on a preliminary determination of their fair values. We may adjust this
allocation when we make a final determination of such values. We do not expect
any adjustment to be material, however.
10
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following summarizes the effects of the acquisitions described above on
the consolidated balance sheet and consolidated statement of cash flows as of
the effective date of the respective transactions (dollars in millions):
<TABLE>
<CAPTION>
CAF PFS
Merger Merger
------ ------
<S> <C> <C>
Fixed maturities................................................................... $ 808.4 $ 1,007.4
Equity securities.................................................................. 9.4 30.9
Policy loans....................................................................... - 83.9
Accrued investment income.......................................................... 8.6 16.4
Cost of policies purchased......................................................... 400.1 260.2
Reinsurance receivables............................................................ - 207.6
Goodwill........................................................................... 370.6 318.3
Income tax assets (liabilities).................................................... (35.9) 34.8
Insurance liabilities.............................................................. (874.5) (1,463.0)
Notes payable...................................................................... (31.0) (107.4)
Common stock and additional paid-in capital........................................ (115.7) (342.5)
Other.............................................................................. (17.9) (90.8)
------- ---------
Cash (provided) used........................................................... $ 522.1 $ (44.2)
======= =========
</TABLE>
The Company intends to reduce significantly the operating expenses of the
companies acquired during 1996 and 1997 by centralizing most of their operations
with those of its other companies. Accordingly, most employees of the acquired
companies will either be terminated or relocated. The following estimated
liabilities related to these terminations and relocations were included in the
costs to acquire these companies: $8.2 million, with respect to LPG; $3.3
million, with respect to ALH; $5.2 million, with respect to ATC; $7.8 million,
with respect to THI; $11.2 million, with respect to CAF; and $30.3 million, with
respect to PFS. Through June 30, 1997, the plans with respect to LPG, ALH, THI
and CAF have been completed and the amounts established as a liability for such
plans, consisting primarily of employee severance benefits, have been paid.
There have been no significant adjustments to the estimated liabilities
established for termination and relocation costs. If the ultimate costs to
complete these plans are less than the estimated liability, the excess liability
will be reflected as an adjustment to the liabilities assumed (with a
corresponding adjustment to goodwill). If the ultimate costs to complete these
plans are more than the estimated liability, an adjustment to the liability will
be made (with a corresponding adjustment to goodwill), if such adjustment is
determined within one year of the date of each of the mergers. Thereafter, any
additional amounts will be included in the determination of the Company's net
income.
REINSURANCE
Prior to its acquisition by Conseco, a subsidiary of PFS entered into
certain reinsurance arrangements under which the subsidiary retained the assets
and related insurance liabilities, but not the risks associated with the
business. Such assets and liabilities each totaled approximately $220 million at
June 30, 1997. The PFS subsidiary does not participate in the realized gains and
losses on the assets held in trust under these arrangements. Accordingly, we
have established an amount due to the reinsurer (classified as other
liabilities) of $2.0 million at June 30, 1997, representing the unrealized gain
related to actively managed fixed maturities held in trust under these
agreements (with a corresponding reduction to unrealized appreciation).
COMMERCIAL PAPER PROGRAM
We instituted a commercial paper program in April 1997 to lower our
borrowing costs and improve our liquidity. Borrowings under our commercial paper
program for the period April 24, 1997 through June 30, 1997, averaged
approximately $328 million. The weighted average rate on such borrowings was 6.1
percent at June 30, 1997. Maximum permitted borrowings under our revolving
credit facility are reduced by the aggregate outstanding commercial paper of
Conseco. At June 30, 1997, we could borrow up to an additional $181.2 million
under our revolving credit facility or commercial paper program.
11
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CHANGES IN NOTES PAYABLE
Notes payable of the Company were as follows:
<TABLE>
<CAPTION>
June 30, December 31,
Interest rate 1997 1996
------------- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Borrowings under revolving credit agreements......................... 6.03% (1) $ 730.0 $ 465.0
Senior notes due 2003................................................ 8.125% 170.0 170.0
Senior notes due 2004................................................ 10.5% 191.6 200.0
Subordinated notes due 2004.......................................... 11.25% 22.0 98.1
Convertible subordinated debentures due 2005......................... 6.5% 33.7 102.8
Convertible subordinated notes due 2003.............................. 6.5% 86.1 -
Other................................................................ Various 44.8 45.2
-------- --------
Total principal amount.......................................... 1,278.2 1,081.1
Unamortized net premium.............................................. 8.3 13.8
-------- --------
Total........................................................... $1,286.5 $1,094.9
======== ========
<FN>
(1) Current weighted average rate at June 30, 1997.
</FN>
</TABLE>
1997 changes in notes payable
In the first six months of 1997, we repurchased $76.1 million par value of
the 11.25 percent subordinated notes due 2004 for $87.7 million. We recognized
an extraordinary charge of $4.9 million (net of a $2.6 million tax benefit) as a
result of such repurchases.
During the first six months of 1997, we repurchased $8.4 million par value
of the 10.5 percent senior notes due 2004 for $9.8 million. We recognized an
extraordinary charge of $.6 million (net of $.3 million tax benefit) as a result
of such repurchases.
During the first six months of 1997, $65.1 million par value of convertible
subordinated debentures due 2005 were converted into 5.0 million shares of
Conseco common stock. Such convertible debentures were acquired in conjunction
with the ATC Merger. We paid $4.4 million to induce the holders to convert such
convertible subordinated debentures. In addition, we repurchased $4.0 million
par value of the convertible debentures for $12.2 million. The extraordinary
charge recognized as a result of the inducement payment and repurchases was not
significant since such amount approximated amounts reflected in the fair value
of the debentures which was recorded as a liability at the ATC Merger date. At
June 30, 1997, the value of the remaining convertible debentures in excess of
the principal balance (the value attributable to the conversion feature) of
$46.7 million is included in other liabilities.
1996 changes in notes payable
In January 1996, we repaid $245.0 million principal amount of borrowings
under a credit agreement using the proceeds of the sale of convertible preferred
stock. As a result of the prepayment and amendments to the credit agreement
(including substantive modifications of the maturity date and interest rate
terms), we recognized an extraordinary charge of $9.3 million (net of a $5.0
million tax benefit) representing the unamortized debt issuance costs related to
the prior agreement.
In March 1996, BLH completed a tender offer pursuant to which it
repurchased $148.3 million principal balance of its 13 percent senior
subordinated notes for $173.2 million. The repurchased notes had a carrying
value of $157.8 million. In the first quarter of 1996, we recognized an
extraordinary charge of $8.1 million (net of a $4.3 million tax benefit)
representing the unamortized debt issuance costs related to the prior agreement.
During the second quarter of 1996, BLH repurchased $.1 million par value of its
13 percent senior subordinated notes with no material loss realized.
12
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CHANGES IN PREFERRED STOCK
During the first six months of 1997, 2,374,300 shares of Preferred
Redeemable Increased Dividend Equity Securities Convertible Preferred Stock
("PRIDES") were converted by holders of such shares into 8.1 million shares of
common stock. We paid $13.2 million to induce the holders to convert the PRIDES.
Such payment is reflected in the consolidated financial statements as a dividend
paid to such holders.
CHANGES IN COMMON STOCK
Changes in the number of shares of common stock outstanding for the first
six months of 1997 were as follows:
<TABLE>
<CAPTION>
<S> <C>
Balance, December 31, 1996................................................................ 167,128,228
Stock options exercised................................................................ 10,998,478
Shares issued in conjunction with the CAF Merger....................................... 2,881,597
Shares issued in conjunction with the PFS Merger....................................... 8,382,617
Common shares converted from convertible subordinated debentures....................... 4,976,429
Common shares converted from PRIDES.................................................... 8,120,106
Common stock acquired under option exercise and repurchase programs.................... (15,397,463)
Shares issued under employee benefit and compensation plans............................ 120,305
------------
Balance, June 30, 1997.................................................................... 187,210,297
============
</TABLE>
In the second quarter of 1997, Conseco implemented an option exercise
program under which its chief executive officer and four of its executive vice
presidents exercised outstanding options to purchase approximately 9.1 million
shares of Conseco common stock. The options exercised would otherwise have
remained exercisable until various dates through 2006. As a result of the
exercise, the Company realized a tax benefit of $80.0 million (net of payroll
taxes incurred of $3.5 million), equal to the aggregate tax incurred by the
executives as a result of the exercise. The tax benefit is reflected as an
increase to additional paid-in capital. The executives paid for the exercised
options by tendering 3.0 million previously owned shares. The Company withheld
2.8 million exercised shares to cover federal and state taxes owed by the
executives as a result of the exercise transaction. No cash was exchanged and
the Company issued approximately 3.3 million shares of common stock to the
executives, net of withheld shares. The Company also granted to the executive
officers new options to purchase a total of 5.8 million shares at a weighted
average price of $39.48 per share (the market price per share on the grant
dates) to replace the shares surrendered for taxes and the exercise price.
In April 1997, we commenced a new program to repurchase up to 5 million
Conseco common shares in open market or negotiated transactions. In June 1997,
the program was expanded to 10 million shares. The timing and terms of the
purchases are to be determined based on market conditions and other
considerations. We repurchased 9.6 million shares under the program in the
second quarter of 1997 for $371.7 million.
The $600.3 million cost of the shares repurchased by Conseco in connection
with the option exercise program and share repurchase program was allocated to
shareholders' equity accounts as follows: (i) $574.9 million to common stock and
additional paid-in capital (such allocation was based on the value received by
Conseco for shares issued in our recent acquisitions); and (ii) $25.4 million to
retained earnings.
CHANGES IN MINORITY INTEREST
Minority interest represents the interests of investors other than Conseco
in its subsidiaries. Minority interest at June 30, 1997, included: (i) $900.0
million par value of Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts; (ii) $67.7 million interest in the mandatorily
redeemable preferred stock of a subsidiary; and (iii) $.7 million interest in
the common stock of a subsidiary.
13
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Effective March 31, 1997, Conseco Financing Trust III, a subsidiary of
Conseco, issued 300,000 Capital Securities at $1,000 per security. Each Capital
Security will pay cumulative cash distributions at the annual rate of 8.796
percent of the stated $1,000 liquidation amount per security payable
semi-annually commencing October 1, 1997. The Capital Securities are fully and
unconditionally guaranteed by Conseco as to distributions and other payments.
Conseco Financing Trust III used the proceeds of the offering to acquire an
equivalent amount of 8.796% Subordinated Deferrable Interest Debentures due
April 1, 2027 (the "Debentures") issued by Conseco. Conseco, in turn, used the
net proceeds from the issuance of the Debentures of approximately $296.7 million
(after underwriting and associated costs) to repay bank debt. The sole asset of
Conseco Financing Trust III is the Debentures. We can cause the Capital
Securities to be redeemed at our option at a price equal to the greater of: (i)
the principal amount; or (ii) the sum of the present values of the principal
amount and scheduled interest payments from the redemption date to the maturity
date. The Debentures are subordinated to all of our senior indebtedness and
mature on April 1, 2027.
Changes in minority interest during the first six months of 1997 and 1996
are summarized below:
<TABLE>
<CAPTION>
1997 1996
---- ----
(Dollars in millions)
<S> <C> <C>
Minority interest, beginning of period......................................................... $697.7 $ 403.3
Changes in investments made by minority shareholders:
Issuance of Company-obligated mandatorily redeemable preferred securities of
subsidiary trusts....................................................................... 300.0 -
Repurchase of mandatorily redeemable preferred stock of a subsidiary...................... (26.0) -
Mandatorily redeemable preferred stock of a subsidiary held by
PFS prior to the PFS Merger............................................................. (2.7) -
Repurchase by BLH of its common stock..................................................... - (18.7)
Minority interests' equity in the change in financial position of the
Company's subsidiaries:
Net income................................................................................ 24.1 23.4
Unrealized depreciation of securities .................................................... - (109.9)
Dividends................................................................................. (24.1) (5.8)
Amortization of value in excess of par of mandatorily redeemable preferred stock
of a subsidiary......................................................................... (.6) -
------ -------
Minority interest, end of period .............................................................. $968.4 $ 292.3
====== =======
</TABLE>
During the first six months of 1997, we completed the purchase of all of
the $2.32 Redeemable Cumulative Preferred Stock of a subsidiary formerly held by
minority interests. As a result, securities having an amortized cost of $13.8
million were removed from a segregated account.
DIRECTOR, EXECUTIVE AND SENIOR OFFICER STOCK PURCHASE PLAN
The Director, Executive and Senior Officer Stock Purchase Plan is designed
to encourage direct, long-term ownership of Conseco common stock by Board
members, executive officers and certain senior officers. Under the program, up
to 8.0 million shares of Conseco common stock may be purchased in open market or
negotiated transactions with independent parties. At June 30, 1997, 4.0 million
shares had been purchased under the plan. Purchases are financed by personal
loans to the participants from a bank. Such loans are collateralized by the
Conseco common stock purchased. Conseco guaranteed the loans, but has recourse
to the participants if it incurs a loss under the guarantee. In addition, we
provide loans to the participants for interest payments under the bank loans. At
June 30, 1997, the bank loans guaranteed by Conseco totaled $83.4 million, the
loans provided by Conseco for interest totaled $4.8 million and the common stock
that collateralizes the loans had a fair value of $148.0 million.
14
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENT OF CASH FLOWS
The following non-cash items were not reflected in the consolidated
statement of cash flows in 1997: (i) the issuance of Conseco common stock valued
at $342.5 million in the PFS Merger; (ii) the issuance of Conseco common stock
valued at $115.7 million in the CAF Merger; (iii) the acquisition of Conseco
common stock of $119.7 million pursuant to the tender of shares under the option
exercise program; (iv) the issuance of Conseco common stock under stock option
and employee benefit plans of $135.1 million; (v) the tax benefit of $82.5
million related to the issuance of Conseco common stock under employee benefit
plans; (vi) the conversion of $145.1 million of PRIDES into 8.1 million shares
of Conseco common stock; and (vii) the conversion of $65.1 million par value of
convertible debentures into 5.0 million shares of Conseco common stock with a
recorded value of $152.1 million. The following non-cash items were not
reflected in the consolidated statement of cash flows in 1996: (i) the issuance
of $7.4 million of Conseco common stock to employee benefit plans; and (ii) the
tax benefit of $15.5 million related to the issuance of Conseco common stock
under employee benefit plans.
PENDING MERGER
Colonial Penn Life Insurance Company
On April 30, 1997, Conseco and Leucadia National Corporation ("Leucadia")
entered into an agreement under which we will acquire Leucadia's Colonial Penn
Life Insurance Company unit, a direct marketer of whole life insurance to senior
citizens, for $460 million in cash and notes. The transaction, which is subject
to customary terms and conditions, including regulatory approvals, is expected
to be completed in the third quarter of 1997. The Colonial Penn Life Insurance
Company unit had total assets of approximately $1.0 billion at June 30, 1997.
RECENTLY ISSUED ACCOUNTING STANDARD
In February 1997, the Financial Accounting Standards Board released
Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS
128"). SFAS 128 changes the computational guidelines for earnings per share
information. We will adopt the provisions of SFAS 128 in our December 31, 1997,
consolidated financial statements. SFAS 128 will eliminate the presentation of
primary earnings per share and replace it with basic earnings per share. Basic
earnings per share differs from primary earnings per share because common stock
equivalents are not considered in computing basic earnings per share. Fully
diluted earnings per share will be replaced with diluted earnings per share.
Diluted earnings per share is similar to fully diluted earnings per share,
except in determining the number of dilutive shares outstanding for options and
warrants, the proceeds that would be received upon the conversion of all
dilutive options and warrants are assumed to be used to repurchase the Company's
common shares at the average market price of such stock during the period. For
fully diluted earnings per share, the higher of the average market price or
ending market price is used. If SFAS 128 had been in effect, we would have
reported the following earnings per share amounts for the three and six months
ended June 30, 1997 and 1996:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
------------------ -----------------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Basic earnings per share................................................. $.67 $.49 $1.22 $.96
Diluted earnings per share............................................... .61 .41 1.10 .81
</TABLE>
15
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following discussion highlights material factors affecting the results
of operations and the significant changes in the balance sheet items. Changes in
1997 and 1996 balances in the consolidated financial statements are largely
affected by the LPG Merger, the ALH Stock Purchase, the ATC Merger, the THI
Merger, the BLH Merger, the CAF Merger, the PFS Merger and various financings
described in the notes to the consolidated financial statements included herein
and the notes to the consolidated financial statements included in our 1996 Form
10-K. This discussion should be read in conjunction with both sets of
consolidated financial statements and notes.
RESULTS OF OPERATIONS
We conduct and manage our business through four segments, reflecting our
major lines of insurance business and target markets: (i) supplemental health
insurance; (ii) annuities; (iii) life insurance; and (iv) other.
Consolidated Results and Analysis
The following table and narrative summarize the consolidated results of our
operations:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
1997 1996 1997 1996
---- ---- ---- ----
(Dollars in millions, except per share data)
<S> <C> <C> <C> <C>
Operating earnings..................................................... $136.6 $53.8 $255.7 $102.2
Net investment gains (losses), net of related costs, amortization
and taxes........................................................... .5 (3.7) (3.8) (6.1)
Nonrecurring items..................................................... (4.3) - (4.3) 17.7
------ ----- ------ ------
Income before extraordinary charge.............................. 132.8 50.1 247.6 113.8
Extraordinary charge................................................... 2.2 - 5.5 17.4
------ ----- ------ ------
Net income...................................................... 130.6 50.1 242.1 96.4
Less amounts applicable to preferred stock:
Charge related to induced conversions............................... .9 - 13.2 -
Preferred stock dividends........................................... 2.2 9.1 4.5 17.2
------ ----- ------ ------
Net income applicable to common stock........................... $127.5 $41.0 $224.4 $ 79.2
====== ===== ====== ======
Per fully diluted common share:
Weighted average shares outstanding (in millions)................... 214.9 123.0 209.4 121.3
===== ===== ===== =====
Operating earnings.................................................. $ .64 $.44 $1.22 $.84
Net investment losses, net of related costs, amortization and taxes. - (.03) (.02) (.05)
Nonrecurring items.................................................. (.02) - (.02) .15
Charge related to induced conversion of preferred stock............. - - (.06) -
----- ----- ------ ----
Income before extraordinary charge.............................. .62 .41 1.12 .94
Extraordinary charge................................................ .01 - .02 .15
----- ----- ------ ----
Net income...................................................... $ .61 $.41 $1.10 $.79
===== ==== ===== ====
</TABLE>
16
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Our second quarter 1997 operating earnings were $136.6 million, or 64 cents
per fully diluted share, up 154 percent and 45 percent, respectively, over the
second quarter of 1996. Operating earnings during the first six months of 1997
were $255.7 million, or $1.22 per fully diluted share, up 150 percent and 45
percent, respectively, over the first six months of 1996. Operating earnings
increased primarily as a result of the LPG Merger (completed effective July
1996), the ALH Stock Purchase (September 1996), the ATC Merger (December 1996),
the THI Merger (December 1996), the BLH Merger (December 1996), the CAF Merger
(January 1997), and the PFS Merger (April 1997). The percentage increase in
operating earnings was greater than the percentage increase in operating
earnings per fully diluted share primarily because of the 73 percent increase in
common shares or equivalents outstanding during the second quarter of 1997 and
the 75 percent increase during the first six months of 1997, resulting from the
LPG Merger, the ATC Merger, the THI Merger, the CAF Merger and the PFS Merger
partially offset by the repurchases of Conseco common stock.
Net income of $130.6 million in the second quarter of 1997, or 61 cents per
fully diluted share, included: (i) net investment gains (net of related costs,
amortization and taxes) of $.5 million, or nil per share; (ii) an extraordinary
charge of $2.2 million, or 1 cent per share, related to the early retirement of
debt; and (iii) a special nonrecurring charge (net of related taxes) of $4.3
million, or 2 cents per share, related to the death of an executive officer. Net
income of $50.1 million for the second quarter of 1996, or 41 cents per fully
diluted share, included net investment losses (net of related costs,
amortization and taxes) of $3.7 million, or 3 cents per share. Net income of
$242.1 million in the first six months of 1997, or $1.10 per fully diluted
share, included: (i) net investment losses (net of related costs, amortization
and taxes) of $3.8 million, or 2 cents per fully diluted share; (ii) an
extraordinary charge of $5.5 million, or 2 cents per share, related to early
retirement of debt; (iii) a charge of 6 cents per share related to the induced
conversion of preferred stock (treated as a preferred stock dividend); and (iv)
2 cents per share related to the previously discussed special nonrecurring
charge. Net income of $96.4 million in the first six months of 1996, or 79 cents
per fully diluted share, included: (i) net investment losses (net of related
costs, amortization and taxes) of $6.1 million, or 5 cents per share; (ii)
restructuring income of $17.7 million, or 15 cents per share, primarily arising
from the sale of our investment in Noble Broadcast Group, Inc.; and (iii) an
extraordinary charge of $17.4 million, or 15 cents per share, related to the
early retirement of debt.
Total revenues include net investment gains of $15.8 million in the second
quarter of 1997 and net investment losses of $3.0 million in the second quarter
of 1996. Excluding net investment gains (losses), total revenues were $1,344.7
million in the second quarter of 1997, up 99 percent from $675.5 million in the
second quarter of 1996. Total revenues include net investment gains of $20.9
million and $2.9 million during the first six months of 1997 and 1996,
respectively. Excluding net investment gains, total revenues were $2,438.6
million in the first six months of 1997, up 79 percent from $1,361.4 million in
the first six months of 1996. Total revenues in the 1997 periods include
revenues of LPG, ATC, THI, CAF and PFS (such companies were acquired in periods
subsequent to the second quarter of 1996). Total revenues in the six-month
period of 1996 include restructuring income of $30.4 million primarily arising
from the sale of our investment in Noble Broadcast Group, Inc.
17
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
First Six Months of 1997 Compared to the First Six Months of 1996 and the
Second Quarter of 1997 Compared to the Second Quarter of 1996:
The following tables and narratives summarize the results of our operations
by business segment.
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
--------------------- -----------------
1997 1996 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Income before income taxes, minority interest and extraordinary charge:
Supplemental health:
Operating income ................................................. $102.9 $ 36.0 $187.2 $ 66.1
Net investment losses, net of related costs and amortization ..... (2.5) (.2) (4.8) (.5)
------ ------- ------ -------
Income before income taxes, minority interest and
extraordinary charge.......................................... 100.4 35.8 182.4 65.6
------ ------- ------ -------
Annuities:
Operating income ................................................. 80.4 66.0 145.8 126.9
Net investment gains (losses), net of related costs and amortization 1.8 (3.4) 1.1 (3.9)
------ ------- ------ -------
Income before income taxes, minority interest and
extraordinary charge.......................................... 82.2 62.6 146.9 123.0
------ ------- ------ -------
Life insurance:
Operating income.................................................. 61.3 20.2 119.3 38.7
Net investment gains (losses), net of related costs and amortization 1.7 (1.0) (1.7) (1.4)
------ ------- ------ -------
Income before income taxes, minority interest and
extraordinary charge.......................................... 63.0 19.2 117.6 37.3
------ ------- ------ -------
Other:
Operating income.................................................. 24.2 11.9 48.4 25.3
Net investment losses, net of related costs and amortization...... - (1.6) (.3) (3.6)
------ ------- ------ -------
Income before income taxes, minority interest and
extraordinary charge.......................................... 24.2 10.3 48.1 21.7
------ ------- ------ -------
Interest and other corporate expenses............................... (29.3) (26.6) (59.1) (56.5)
------ ------- ------ -------
Nonrecurring items.................................................. (9.3) - (9.3) 30.4
------ ------- ------ -------
Consolidated earnings:
Operating income.................................................. 239.5 107.5 441.6 200.5
Net investment gains (losses), net of related costs and amortization 1.0 (6.2) (5.7) (9.4)
Nonrecurring items................................................ (9.3) - (9.3) 30.4
------ ------- ------ -------
Income before income taxes, minority interest and
extraordinary charge.......................................... 231.2 101.3 426.6 221.5
Income tax expense..................................................... 84.3 39.4 154.9 84.3
------ ------- ------ -------
Income before minority interest and extraordinary charge........ 146.9 61.9 271.7 137.2
Minority interest in consolidated subsidiaries:
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts........................ 12.9 - 21.6 -
Dividends on preferred stock of subsidiaries........................ 1.2 2.5 2.5 5.1
Equity in earnings of subsidiaries.................................. - 9.3 - 18.3
------ ------- ------ -------
Income before extraordinary charge.............................. 132.8 50.1 247.6 113.8
Extraordinary charge on extinguishment of debt, net of taxes and
minority interest................................................... 2.2 - 5.5 17.4
------ ------- ------ -------
Net income...................................................... $130.6 $ 50.1 $242.1 $ 96.4
====== ======= ====== =======
</TABLE>
18
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Supplemental health:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
--------------------- -----------------
1997 1996 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Premiums collected:
Medicare supplement (first year).................................... $ 23.5 $ 17.4 $ 43.7 $ 36.8
Medicare supplement (renewal)....................................... 186.3 132.4 333.6 276.3
------- ------- -------- -------
Subtotal - Medicare supplement.................................. 209.8 149.8 377.3 313.1
------- ------- -------- -------
Long-term care (first year)......................................... 38.6 12.9 73.6 25.3
Long-term care (renewal)............................................ 126.8 34.2 245.9 67.5
------- ------- -------- -------
Subtotal - long-term care....................................... 165.4 47.1 319.5 92.8
------- ------- -------- -------
Specified disease (first year)...................................... 11.3 - 22.9 -
Specified disease (renewal)......................................... 81.6 - 168.9 -
------- ------- -------- -------
Subtotal - specified disease.................................... 92.9 - 191.8 -
------- ------- -------- -------
Total supplemental health premiums collected.................... $468.1 $196.9 $ 888.6 $ 405.9
====== ====== ======== =======
Insurance policy income................................................ $478.7 $202.8 $ 890.1 $ 401.5
Net investment income.................................................. 63.3 17.2 120.2 33.4
------ ------ -------- -------
Total revenues (a).............................................. 542.0 220.0 1,010.3 434.9
------ ------ -------- -------
Insurance policy benefits and change in future policy benefits......... 308.0 135.2 573.9 274.5
Amortization related to operations..................................... 57.2 21.6 105.6 39.1
Interest expense on investment borrowings.............................. .9 .3 1.3 .5
Other operating costs and expenses..................................... 73.0 26.9 142.3 54.7
------ ------ -------- -------
Total benefits and expenses (a)................................. 439.1 184.0 823.1 368.8
------ ------ -------- -------
Operating income before income taxes, minority interest and
extraordinary charge.......................................... 102.9 36.0 187.2 66.1
Net investment losses, net of related costs and amortization........... (2.5) (.2) (4.8) (.5)
------ ------ -------- -------
Income before income taxes, minority interest and
extraordinary charge.......................................... $100.4 $ 35.8 $ 182.4 $ 65.6
====== ====== ======== =======
Benefit ratios:
Medicare supplement products........................................ 72.4% 68.0% 71.3% 69.8%
Long-term care products............................................. 58.0 62.2 60.7 63.3
Specified disease products.......................................... 57.0 - 57.7 -
<FN>
(a) Revenues exclude net investment gains; benefits and expenses exclude
amortization related to net investment gains.
</FN>
</TABLE>
General: This segment includes Medicare supplement and long-term care
insurance products primarily sold to senior citizens. Through December 31, 1996,
the supplemental health operations consist solely of BLH's Medicare supplement
and long-term care products, distributed through a career agency force.
Beginning January 1, 1997, this segment includes the specified disease products
of THI and CAF and the long-term care products of ATC; these products are
distributed through professional independent producers. Beginning April 1, 1997,
this segment includes the Medicare supplement and long-term care products of
PFS; these products are also distributed through professional independent
producers. The profitability of this segment largely depends on the overall
level of sales, persistency of inforce business, claim experience and expense
control.
19
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Premiums collected by this segment in the second quarter of 1997 were
$468.1 million, up 138 percent over 1996. Premiums collected in the first six
months of 1997 were $888.6 million up 119 percent over 1996. The increases are
primarily due to the recent acquisitions.
Medicare supplement policies accounted for 42 percent of this segment's
collected premiums in the first six months of 1997 compared to more than 75
percent in 1996. The change in mix of premiums collected reflects the long-term
care and specified disease premiums collected by THI, ATC, CAF and PFS.
Collected premiums on Medicare supplement policies increased 40 percent in the
second quarter of 1997 to $209.8 million and increased 21 percent in the first
six months of 1997 to $377.3 million. The number of new Medicare supplement
policies sold in the first six months of 1997 and 1996 totaled 33,704 and
24,339, respectively, and annualized new business premiums were $32.4 million
and $23.5 million, respectively. Medicare supplement premiums collected by the
recently acquired companies were $68.9 million in the first six months of 1997.
The sales of Medicare supplement premiums have been affected by steps taken to
improve profitability by increasing premium rates and changing the commission
structure and underwriting criteria for these policies and by increased
competition from alternative providers, including HMOs.
Premiums collected on long-term care policies increased 251 percent in the
second quarter of 1997 to $165.4 million and increased 244 percent to $319.5
million in the first six months of 1997. Annualized new business premiums in the
first six months of 1997 and 1996 were $72.3 million and $21.7 million,
respectively. Long-term care premiums collected by the recently acquired
companies were $210.2 million in the first six months of 1997. In addition, the
increase in long-term care premiums collected in 1997 reflect new product
introductions, the competitiveness of our products, the success of agent
cross-selling activities, increased consumer awareness and demand, and improved
persistency on a larger base of renewal premiums.
Premiums collected on specified disease policies in the second quarter of
1997 and in the first six months of 1997 were $92.9 million and $191.8 million,
respectively. Such premiums were a result of the recent acquisitions.
Insurance policy income is comprised of premiums earned on the segment's
policies, and has increased consistent with the explanations provided above for
premiums collected.
Net investment income increased 268 percent to $63.3 million in the second
quarter of 1997 and increased 260 percent to $120.2 million in the first six
months of 1997. Such investment income fluctuates when changes occur in: (i) the
amount of average invested assets supporting insurance liabilities; and (ii) the
yield earned on invested assets. During the first six months of 1997, the
segment's average invested assets increased to $3.1 billion from approximately
$.9 billion in 1996, primarily as a result of the recent acquisitions. The
annualized net yield on invested assets decreased .1 percentage point to 7.6
percent in the first six months of 1997.
Insurance policy benefits and change in future policy benefits increased in
the second quarter of 1997 and the first six months of 1997, as a result of the
business in force acquired in the recent acquisitions. In the second quarter of
1997, the ratio of policy benefits to insurance policy income for the Medicare
supplement policies increased by 4.4 percentage points, to 72.4 percent. In the
first six months of 1997; such ratio increased by 1.5 percentage points to 71.3
percent. These increases reflect a higher incidence of claims incurred during
the 1997 periods. The loss ratios consistently incurred by the recently acquired
companies have exceeded those of other Conseco companies.
In the second quarter of 1997, the ratio of policy benefits to insurance
policy income for long-term care policies fell by 4.2 percentage points to 58.0
percent. In the first six months of 1997, such ratio fell by 2.6 percentage
points to 60.7 percent. These decreases reflect a lower incidence of claims
incurred during the 1997 periods.
The ratio of policy benefits to insurance policy income for specified
disease policies did not fluctuate materially in the first two quarters of
1997. Such products were not sold by Conseco in 1996.
Amortization related to operations includes amortization of: (i) the cost
of policies produced; (ii) the cost of policies purchased; and (iii) goodwill
related to this segment's business. The amount of amortization was primarily
affected by the increase in balances subject to amortization as a result of the
recent acquisitions.
The cost of policies produced represents the cost of producing new
business. This cost varies with, and is primarily related to, the production of
new business. Costs deferred may represent amounts paid in the period new
business is written (such as underwriting costs and first year commissions) or
in periods after the business is written (such as commissions paid in subsequent
years in excess of ultimate commissions paid).
20
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Interest expense on investment borrowings is primarily affected by changes
in investment borrowing activities.
Other operating costs and expenses increased in the 1997 periods as a
result of the costs incurred related to the increased business of the recently
acquired companies.
Net investment losses, net of related costs and amortization often
fluctuate from period to period. Net investment losses affect the timing of the
amortization of cost of policies purchased and the cost of policies produced. As
a result of net investment losses from the sales of fixed maturity investments,
related amortization of cost of policies purchased and cost of policies produced
increased $.9 million and $.3 million in the second quarters of 1997 and 1996,
respectively. Such amortization increased $1.0 million and $.3 million in the
first six months of 1997 and 1996, respectively.
21
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Annuities:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
------------------- ----------------
1997 1996 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Premiums collected:
Single-premium immediate annuities.................................. $ 57.0 $ 56.8 $100.1 $104.8
Single-premium deferred annuities................................... 169.0 179.3 340.2 369.4
------ ------ ------ ------
Subtotal - single-premium annuities............................. 226.0 236.1 440.3 474.2
------ ------ ------ ------
Flexible-premium deferred annuities (first year).................... 149.2 134.6 255.4 250.9
Flexible-premium deferred annuities (renewal)....................... 26.8 19.6 52.1 41.9
------ ------ ------ ------
Subtotal - flexible-premium deferred annuities.................. 176.0 154.2 307.5 292.8
------ ------ ------ ------
Variable annuities (first year)..................................... 25.4 8.8 41.9 15.5
Variable annuities (renewal)........................................ 11.2 10.8 22.0 22.1
------ ------ ------ ------
Subtotal - variable annuities................................... 36.6 19.6 63.9 37.6
------ ------ ------ ------
Total annuity premiums collected................................ $438.6 $409.9 $811.7 $804.6
====== ====== ====== ======
Insurance policy income................................................ $ 24.8 $ 18.4 $ 43.6 $ 39.4
Net investment income:
General account invested assets..................................... 242.0 211.4 475.0 418.6
S&P Options......................................................... 14.8 - 16.9 -
Separate account assets............................................. 3.8 13.5 17.9 17.4
------ ------ ------ ------
Total revenues (a).............................................. 285.4 243.3 553.4 475.4
------ ------ ------ ------
Insurance policy benefits and change in future policy benefits......... 20.9 11.9 34.7 32.0
Amounts added to policyholder account balances:
Interest on annuity products........................................ 133.5 123.9 270.2 246.4
Change in S&P index related to equity-linked products............... 14.8 - 16.9 -
Change in asset values related to variable annuity products......... 3.8 13.5 17.9 17.4
Amortization related to operations..................................... 21.3 17.9 48.1 30.7
Interest expense on investment borrowings.............................. 3.2 3.8 4.9 6.6
Other operating costs and expenses..................................... 7.5 6.3 14.9 15.4
------ ------ ------ ------
Total benefits and expenses (a)................................. 205.0 177.3 407.6 348.5
------ ------ ------ ------
Operating income before income taxes, minority interest and
extraordinary charge.......................................... 80.4 66.0 145.8 126.9
Net investment gains (losses), net of related costs and amortization... 1.8 (3.4) 1.1 (3.9)
------ ------ ------ ------
Income before income taxes, minority interest and
extraordinary charge.......................................... $ 82.2 $ 62.6 $146.9 $123.0
====== ====== ====== ======
Weighted average gross interest spread on annuity products (b)......... 3.1% 3.0% 3.0% 3.0%
=== === === ===
<FN>
(a) Revenues exclude net investment gains (losses); benefits and expenses
exclude amortization related to net investment gains (losses).
(b) Excludes: (i) variable annuity products where the credited amount is based
on investment income from segregated investments; and (ii) equity-linked
products where the credited amount is dependent upon the investment income
from S&P Options.
</FN>
</TABLE>
22
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
General: This segment includes single-premium deferred annuities ("SPDAs"),
flexible-premium deferred annuities ("FPDAs"), single-premium immediate
annuities ("SPIAs") and variable annuities sold through both career agents and
professional independent producers. The profitability of this segment largely
depends on the investment spread earned (i.e., the excess of investment earnings
over interest credited on annuity deposits), the persistency of inforce
business, and expense control. In addition, comparability between periods is
affected by: (i) the LPG Merger, effective July 1, 1996; (ii) the ALH Stock
Purchase, effective September 30, 1996; and (iii) to a lesser extent, the BLH
Merger and the PFS Merger.
Premiums collected by this segment in the second quarter of 1997 were
$438.6 million, up 7.0 percent over 1996. Premiums collected by this segment in
the first six months of 1997 were $811.7 million, up .9 percent over 1996.
Annuity premiums collected by recently acquired companies were $32.0 million in
the second quarter of 1997 and $64.5 million in the first six months of 1997.
SPDA collected premiums decreased 5.7 percent to $169.0 million in the
second quarter of 1997 and decreased 7.9 percent to $340.2 million in the first
six months of 1997. The demand for SPDA products offered by all insurance
companies decreased during 1997, when relatively low interest rates made other
investment products more attractive. We introduced an equity-linked SPDA in July
1996 to appeal to consumers' desire for alternative investment products with
returns linked to equities. The accumulation value of these annuities is
guaranteed to increase on a cumulative basis at a rate of approximately 3
percent, but the increase may be higher based on a percentage of the change in
the S&P 500 Index during each year of their term. To provide for the higher
increase, we purchase S&P Options, the values of which change as the benefits
accrue to these annuities as a result of the equity-linked return feature. Total
collected premiums for this product were $53.4 in the second quarter of 1997 and
$105.7 million the first six months of 1997.
FPDA collected premiums increased 14 percent to $176.0 million in the
second quarter of 1997 and increased 5.0 percent to $307.5 million in the first
six months of 1997. In January 1997, we introduced an equity-linked FPDA similar
to the SPDA product described above. Collected premiums for this product were
$28.7 million in the second quarter of 1997 and $35.3 million in the first six
months of 1997. FPDAs are similar to SPDAs in many respects, except FPDAs allow
more than one premium payment.
SPIA collected premiums did not change materially in the second quarter of
1997 and decreased 4.5 percent to $100.1 million in the first six months of
1997. The decrease for the six month period was primarily the result of
decreases in SPIAs purchased from the proceeds of redeemed annuity contracts.
Variable annuity collected premiums increased 87 percent to $36.6 million
in the second quarter of 1997 and increased 70 percent to $63.9 million in the
first six months of 1997. Variable annuities offer contract holders a rate of
return based upon the specific investment portfolios into which premiums may be
directed. The popularity of such annuities has increased recently as a result of
the desire of investors to invest in common stocks. In addition, in 1996 we
began to offer more investment options for variable annuity deposits and
expanded our marketing efforts, which resulted in increased collected premiums.
Profits on variable annuities are derived from the fees charged to contract
holders, rather than from the investment spread.
Insurance policy income includes: (i) premiums received on annuity policies
that incorporate significant mortality features; (ii) the cost of insurance and
expenses charged to annuity policies; and (iii) surrender charges earned on
annuity policy withdrawals. In accordance with GAAP, premiums on annuity
contracts without mortality features are not reported as revenues, but rather
are reported as deposits to insurance liabilities. Insurance policy income
increased primarily because of increased surrender charges (changes in cost of
insurance and expenses charged to annuity policies were not significant).
Surrender charges were $16.8 million in the second quarter of 1997 and $10.0
million in the second quarter of 1996. Such charges were $29.8 million in the
first six months of 1997 compared to $17.8 million in the first six months of
1996. Annuity policy withdrawals were $863.1 million in the first six months of
1997 and $683.0 million in the first six months of 1996. The increase in policy
withdrawals and surrender charges generally corresponds to the aging and the
growth of our annuity business in force. In addition, policyholders are using
the systematic withdrawal features available in several of our annuity policies,
and more policyholders are surrendering in order to invest in alternative
investments. Total withdrawals and surrenders during the six month periods were
approximately 7.4 percent of insurance liabilities related to surrenderable
policies in 1997 and 7.0 percent in 1996.
Net investment income on general account invested assets (excluding income
on separate account assets related to variable annuities and the change in the
value of S&P Options related to equity-linked products) increased 14 percent in
the second quarter of 1997 to $242.0 million and increased 13 percent to $475.0
million in the first six months of 1997. These increases primarily reflect the
increase in general account invested assets acquired in conjunction with the
recent acquisitions. The annualized yield earned on average invested assets
decreased .2 percentage points to 7.8 percent in the first six months of 1997.
Cash flows received during 1997
23
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
and 1996 (including cash flows from the sales of investments) were invested in
lower yielding securities due to a general decline in interest rates.
Net investment income from S&P Options is offset by a corresponding charge
to amounts added to policyholder account balances for equity-linked products.
Such income fluctuates based on the performance of the Standard & Poor's 500
index to which such products are linked.
Net investment income from separate account assets is offset by a
corresponding charge to amounts added to policyholder account balances for
variable annuity products. Such income fluctuates in relationship to total
separate account assets and the return earned on such assets.
Insurance policy benefits and change in future policy benefits relate
solely to annuity policies that incorporate significant mortality features. The
increase corresponds to changes in the in-force block of such policies as a
result of recent acquisitions.
Amounts added to policyholder account balances for interest on annuity
products increased 7.7 percent to $133.5 million in the second quarter of 1997
and 9.7 percent to $270.2 million in the first six months of 1997. Such
increases are primarily due to a larger block of annuity business inforce as a
result of recent acquisitions. The weighted average crediting rates for these
annuity liabilities decreased .2 percentage points to 4.8 percent in the first
six months of 1997.
Amounts added to policyholder account balances related to the change in
value of the S&P index related to equity-linked products approximates the net
investment income related to the S&P Options.
Amounts added to policyholder account balances for variable annuity
products is equal to the net investment income on separate account assets.
Amortization related to operations includes amortization of: (i) the cost
of policies produced; (ii) the cost of policies purchased; and (iii) goodwill
related to this segment's business. The amount of amortization was primarily
affected by the increase in balances subject to amortization as a result of
recent acquisitions.
Interest expense on investment borrowings is primarily affected by changes
in investment borrowing activities.
Other operating costs and expenses have not fluctuated materially even
though the annuity block of business has grown. Such expenses of this segment
have been favorably affected by the consolidation of all annuity operations in
Conseco's Carmel, Indiana, facilities.
Net investment gains (losses), net of related costs and amortization often
fluctuate from period to period. Selling securities at a gain and reinvesting
the proceeds at lower yields may, absent other management action, tend to
decrease future investment yields. The Company believes, however, that the
following factors mitigate the adverse effect of such decreases on net income:
(i) we recognized additional amortization of cost of policies purchased and cost
of policies produced in order to reflect reduced future yields (thereby reducing
such amortization in future periods); (ii) we can reduce interest rates credited
to some products, thereby diminishing the effect of the yield decrease on the
investment spread; and (iii) the investment portfolio grows as a result of
reinvesting the investment gains. As a result of the sales of fixed maturity
investments, related amortization of the cost of policies purchased and the cost
of policies produced increased by $13.5 million and $2.6 million in the second
quarters of 1997 and 1996, respectively. Such amortization increased $20.8
million and $10.8 million in the first six months of 1997 and 1996,
respectively.
24
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Life insurance:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
-------------------- -----------------
1997 1996 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Premiums collected:
Universal life (first year)......................................... $ 24.9 $ 3.3 $ 49.6 $ 6.7
Universal life (renewal)............................................ 80.5 21.3 168.0 43.0
------ ------- ------ ------
Subtotal - universal life....................................... 105.4 24.6 217.6 49.7
------ ------- ------ ------
Traditional life (first year)....................................... 13.3 3.0 17.1 5.2
Traditional life (renewal).......................................... 55.3 34.4 99.8 73.0
------ ------- ------ ------
Subtotal - traditional life..................................... 68.6 37.4 116.9 78.2
------ ------- ------ ------
Total life premiums collected................................... $174.0 $ 62.0 $334.5 $127.9
====== ======= ====== ======
Insurance policy income:
Premiums earned on traditional life products........................ $ 70.8 $ 38.9 $117.7 $ 78.4
Mortality charges and administrative fees........................... 87.4 20.2 173.5 38.4
Surrender charges................................................... 3.4 1.6 7.6 2.3
------ ------- ------ ------
Total insurance policy income................................... 161.6 60.7 298.8 119.1
Net investment income.................................................. 113.5 42.1 211.2 84.6
------- ------- ------- ------
Total revenues (a).............................................. 275.1 102.8 510.0 203.7
------- ------- ------- ------
Insurance policy benefits and change in future policy benefits......... 124.6 50.7 219.7 98.4
Interest added to financial product policyholder account balances...... 37.8 13.2 74.8 25.9
Amortization related to operations..................................... 27.9 8.1 51.6 16.8
Interest expense on investment borrowings.............................. 1.4 .7 2.1 1.3
Other operating costs and expenses..................................... 22.1 9.9 42.5 22.6
------- ------- ------- ------
Total benefits and expenses (a)................................. 213.8 82.6 390.7 165.0
------- ------- ------- ------
Operating income before income taxes, minority interest and
extraordinary charge.......................................... 61.3 20.2 119.3 38.7
Net investment gains (losses), net of related costs and amortization... 1.7 (1.0) (1.7) (1.4)
------- ------- ------- ------
Income before income taxes, minority interest and
extraordinary charge.......................................... $ 63.0 $ 19.2 $117.6 $ 37.3
======= ======= ====== ======
<FN>
(a) Revenues exclude net investment gains (losses); benefits and expenses
exclude amortization related to net investment gains (losses).
</FN>
</TABLE>
General: This segment includes traditional life and universal life products
sold through both career agents and professional independent producers. The
segment's operations were significantly affected by the LPG Merger effective
July 1, 1996, and, to a lesser extent, the PFS Merger effective April 1, 1997.
The profitability of this segment largely depends on the investment spread
earned for universal life and other investment products, the persistency of
inforce business, claim experience and expense control.
25
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Premiums collected by this segment in the second quarter of 1997 were
$174.0 million, up 181 percent over 1996. Premiums collected by this segment in
the first six months of 1997 were $334.5 million, up 162 percent over 1996. Such
fluctuations reflect the recent acquisitions.
Universal life product collected premiums increased 328 percent to $105.4
million in the second quarter of 1997 and increased 338 percent to $217.6
million in the first six months of 1997. Universal life product premiums
collected by the recently acquired companies were $173.0 million in the first
six months of 1997.
Traditional life product collected premiums increased 83 percent to $68.6
million in the second quarter of 1997, and increased 49 percent to $116.9
million in the first six months of 1997. Traditional life product premiums
collected by the recently acquired companies were $41.1 million in the first six
months of 1997.
Insurance policy income includes: (i) premiums received on traditional life
products; (ii) the mortality charges and administrative fees earned on universal
life insurance; and (iii) surrender charges on terminated universal life
insurance policies. All categories of insurance policy income have increased
primarily as a result of recent acquisitions. In accordance with GAAP, premiums
on universal life products are accounted for as deposits to insurance
liabilities. Revenues are earned over time in the form of investment income on
policyholder account balances, surrender charges and mortality and other charges
deducted from the policyholders' account balances.
Net investment income increased 170 percent to $113.5 million in the second
quarter of 1997 and 150 percent to $211.2 million in the first six months of
1997. Such investment income fluctuates with changes in: (i) the amount of
average invested assets supporting insurance liabilities; and (ii) the yield
earned on invested assets. The segment's average invested assets increased 152
percent to approximately $5.2 billion in the first six months of 1997, and the
net yield on invested assets decreased by .1 percentage point, to 8.0 percent.
Invested assets increased primarily as a result of the growth in insurance
liabilities from the recent acquisitions.
Insurance policy benefits and change in future policy benefits increased in
1997 primarily as a result of the recent acquisitions which resulted in a larger
amount of business inforce on which benefits are incurred. There were no
material fluctuations in claim experience during the periods.
Interest added to financial product policyholder account balances increased
186 percent to $37.8 million in the second quarter of 1997 and increased 189
percent to $74.8 million in the first six months of 1997. Such expense
fluctuates with changes in: (i) the amount of insurance liabilities for
universal life products; and (ii) the interest rate credited to such products.
Such average liabilities increased 213 percent to $3.1 billion in the first six
months of 1997. The interest rate credited decreased by .3 percentage points to
4.9 percent in the first six months of 1997. Insurance liabilities for universal
life products increased primarily as a result of the recent acquisitions.
Amortization related to operations includes amortization of (i) the cost of
policies produced; (ii) the cost of policies purchased; and (iii) goodwill
related to this segment's business. The amount of amortization was primarily
affected by the increase in balances subject to amortization as a result of the
recent acquisitions.
Interest expense on investment borrowings is affected by changes in
investment borrowing activities.
Other operating costs and expenses increased 123 percent to $22.1 million
in the second quarter of 1997 and 88 percent to $42.5 million in the first six
months of 1997. Such increase is consistent with the increase in the total
insurance liabilities related to this segment's business.
Net investment gains (losses), net of related costs and amortization often
fluctuate from period to period. Net investment gains (losses) affect the timing
of the amortization of cost of policies purchased and the cost of policies
produced. As a result of net investment gains (losses) from the sales of fixed
maturity investments, related amortization of cost of policies purchased and
cost of policies produced increased $4.8 million and $.3 million in the second
quarters of 1997 and 1996, respectively. Such amortization increased $9.2
million and $1.2 million in the first six months of 1997 and 1996, respectively.
26
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Other:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
-------------------- -----------------
1997 1996 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Premiums collected:
Individual (first year)............................................. $ 18.9 $ 1.7 $ 20.3 $ 4.0
Individual (renewal)................................................ 48.4 17.5 66.5 36.1
------ ------- ------ ------
Subtotal - individual........................................... 67.3 19.2 86.8 40.1
------ ------- ------ ------
Group (first year).................................................. 22.7 - 22.7 -
Group (renewal)..................................................... 119.5 64.1 190.3 126.7
------ ------- ------ ------
Subtotal - group................................................ 142.2 64.1 213.0 126.7
------ ------- ------ ------
Accident and health - other (all renewal)........................... 11.3 15.8 24.0 33.2
------ ------- ------ ------
Total other premiums collected.................................. $220.8 $ 99.1 $323.8 $200.0
====== ======= ====== ======
Insurance policy income................................................ $220.0 $ 89.7 $322.7 $181.4
Net investment income.................................................. 7.6 4.0 13.0 7.9
Fee revenue and other income........................................... 14.8 15.7 29.4 27.7
------ ------- ------ ------
Total revenues (a).............................................. 242.4 109.4 365.1 217.0
------ ------- ------ ------
Insurance policy benefits and changes in future policy benefits........ 159.7 74.8 240.2 151.6
Amortization related to operations..................................... 8.5 7.3 13.2 12.9
Interest expense on investment borrowings.............................. .1 .1 .1 .2
Other operating costs and expenses..................................... 49.9 15.3 63.2 27.0
------ ------- ------ -------
Total benefits and expenses (a)................................. 218.2 97.5 316.7 191.7
------ ------- ------ -------
Operating income before income taxes, minority interest and
extraordinary charge.......................................... 24.2 11.9 48.4 25.3
Net investment losses, net of related costs and amortization........... - (1.6) (.3) (3.6)
------ ------- ------ -------
Income before income taxes, minority interest and
extraordinary charge.......................................... $ 24.2 $ 10.3 $ 48.1 $ 21.7
====== ======= ====== =======
<FN>
(a) Revenues exclude net investment losses; benefits and expenses exclude
amortization related to net investment losses.
</FN>
</TABLE>
General: The other segment includes individual and group major medical
health insurance products and various other health insurance products. The
segment's operations were significantly affected by the PFS Merger effective
April 1, 1997. The profitability of this business depends largely on the overall
persistency of the business inforce, claim experience and expense control.
The segment also includes the fee revenue generated by our non-life
subsidiaries, including the investment advisory fees earned by CCM and
commissions earned for insurance and investment product marketing and
distribution. Such amounts exclude the fees for services provided to our
consolidated subsidiaries. The profitability of the fee-based business depends
on the total fees generated and expense control.
27
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Premiums collected by this segment in the second quarter of 1997 were
$220.8 million, up 123 percent over the second quarter of 1996. Premiums
collected by this segment in the first six months of 1997 were $323.8 million,
up 62 percent from the first six months of 1996. Premiums collected by the
recently acquired companies were $128.8 million in the second quarter of 1997
and $136.8 million in the first six months of 1997. Excluding these premiums
collected by the recently acquired companies, this segment's premiums collected
(primarily related to products that we are not currently emphasizing) have
decreased. Over the last several years, a number of steps were taken to improve
the profitability of such business, including product, price, underwriting and
agent compensation revisions. These steps have had the effect of reducing
premiums collected.
Group premiums increased 122 percent to $142.2 million in the second
quarter of 1997 and 68 percent to $213.0 million in the first six months of
1997. Group premiums collected by the recently acquired companies were $81.8
million in the first six months of 1997. Excluding such premiums, the increase
reflects new policies and rate increases, net of premium decreases from policy
lapses.
Individual health premiums increased 251 percent to $67.3 million in the
second quarter of 1997 and 116 percent to $86.8 million in the first six months
of 1997. Individual health premiums collected by the recently acquired companies
were $55.0 million in the first six months of 1997. Excluding such premiums, the
decrease is attributable to policy lapses in response to rate increases.
The other accident and health premiums decreased 28 percent to $11.3
million in the second quarter of 1997 and 28 percent to $24.0 million in the
first six months of 1997. These products are not currently being emphasized,
although the inforce business continues to be profitable.
Insurance policy income is comprised of premiums earned on the segment's
policies, and has fluctuated consistent with the explanations provided above for
premiums collected.
Net investment income increased 90 percent to $7.6 million in the second
quarter of 1997 and increased 65 percent to $13.0 million in the first six
months of 1997. Such investment income fluctuated primarily in relationship to
the amount of average invested assets supporting this segment's insurance
liabilities. Average invested assets increased as a result of the recent
acquisitions.
Fee revenue and other income include: (i) fees for investment management
and mortgage origination and servicing; and (ii) commissions earned for
insurance and investment product marketing and distribution. Such amounts
exclude the fees for services provided to our consolidated subsidiaries. Fee
revenue and other income increased 6.1 percent to $29.4 million for the first
six months of 1996, primarily as a result of an increase in fees for investment
management, partially offset by a decrease in commissions earned for insurance
and investment product marketing and distribution.
Insurance policy benefits and change in future policy benefits fluctuate in
relationship to the amount of segment business inforce and the incidence of
claims. The ratio of policy benefits to insurance policy income was 73 percent
in the second quarter of 1997 and 74 percent for the first six months of 1997.
Such ratio was approximately 83 percent during the 1996 periods. The decrease
reflects the premium rate increases reflected on certain blocks during 1996 and
the more profitable blocks acquired with recent acquisitions.
Amortization related to operations includes amortization of: (i) the cost
of policies produced; (ii) the cost of policies purchased; and (iii) goodwill
related to this segment's business. The amount of amortization was primarily
affected by the increase in balances subject to amortization as a result of the
recent acquisitions.
Interest expense on investment borrowings is affected by changes in
investment borrowing activities.
Other operating costs and expenses fluctuated primarily as a result of
expenses of recently acquired companies.
Net investment losses, net of related costs and amortization, often
fluctuate from period to period.
Other components of income before income taxes, minority interest and
extraordinary charge:
In addition to the income of the four operating segments, income before
income taxes, minority interest and extraordinary charge is affected by: (i)
interest and other corporate expenses; and (ii) nonrecurring items.
28
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Interest and other corporate expenses were $29.3 million in the second
quarter of 1997 and $26.6 million in the second quarter of 1996. Interest and
other corporate expenses were $59.1 million in the first six months of 1997 and
$56.5 million in the first six months of 1996. Interest expense is the largest
component of these expenses. Interest expense was $25.5 million in the second
quarter of 1997 and $25.8 million in the second quarter of 1996. Interest
expense was $51.3 million in the first six months of 1997 and $54.2 million in
the first six months of 1996. Such interest expense fluctuates in relationship
to the average debt outstanding during each period and the interest rates
thereon.
Nonrecurring items in 1997 represent expenses incurred related to the death
of an executive officer in the second quarter of 1997. Nonrecurring items in
1996 primarily arose from the sale of our investment in Noble Broadcast Group,
Inc.
SALES
In accordance with GAAP, insurance policy income shown in our consolidated
statement of operations consists of premiums received for policies that have
life contingencies or morbidity features. For annuity and universal life
contracts without such features, premiums collected are not reported as
revenues, but rather are reported as deposits to insurance liabilities. Revenues
for these products are recognized over time in the form of investment income and
surrender or other charges.
Total premiums collected by our business segments were as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
1997 1996 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Supplemental health.................................................... $ 468.1 $196.9 $ 888.6 $ 405.9
Annuities.............................................................. 438.6 409.9 811.7 804.6
Life insurance......................................................... 174.0 62.0 334.5 127.9
Other.................................................................. 220.8 99.1 323.8 200.0
-------- ------ -------- --------
Total premiums collected........................................ $1,301.5 $767.9 $2,358.6 $1,538.4
======== ====== ======== ========
</TABLE>
Fluctuations in premiums collected are discussed above under "Results of
Operations - First Six Months of 1997 Compared to the First Six Months of 1996
and the Second Quarter of 1997 Compared to the Second Quarter of 1996." Our
recent acquisitions have had a significant effect on premiums collected in the
1997 periods.
LIQUIDITY AND CAPITAL RESOURCES
Changes in the consolidated balance sheet between December 31, 1996, and
June 30, 1997, reflect growth through operations, changes in the fair value of
actively managed fixed maturity securities and the following capital and
financing transactions described in the notes to the consolidated financial
statements: (i) the CAF Merger; (ii) the issuance of $300 million of
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts; (iii) the repurchase of senior subordinated notes with a par value of
$84.5 million; (iv) the conversion of convertible debentures acquired in the ATC
Merger into Conseco common stock; (v) the conversion of PRIDES into Conseco
common stock; (vi) the repurchase of mandatorily redeemable preferred stock of a
subsidiary; (vii) the PFS Merger; (viii) common stock repurchases; and (ix) the
issuance of commercial paper.
In accordance with Statement of Financial Accounting Standards No. 115,
Accounting for Certain Investments in Debt and Equity Securities ("SFAS 115"),
we record our actively managed fixed maturity investments at estimated fair
value. At June 30, 1997, the carrying value of such investments was increased by
$83.1 million as a result of the SFAS 115 adjustment, compared to an increase of
$103.8 million at December 31, 1996.
Minority interest increased as a result of the issuance of $300.0 million
of Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts, partially offset by Conseco's purchases of mandatorily redeemable
preferred stock of a subsidiary with a par value of $27.9 million.
29
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
The increase in shareholders' equity in the first six months of 1997
resulted from: (i) Conseco common stock issued in the CAF Merger with a value of
$115.7 million; (ii) Conseco common stock issued in the PFS Merger with a value
of $342.5 million; (iii) net income of $242.1 million; (iv) the conversion of
convertible debentures into Conseco common stock with a value of $152.1 million;
and (v) amounts related to stock options and employee benefit plans (including
the tax benefit thereon) of $244.7 million. These increases were partially
offset by: (i) repurchases of common stock for $600.3 million; (ii) the decrease
in net unrealized appreciation of $13.7 million; and (iii) dividends of $17.5
million.
Dividends declared on common stock for the six months ended June 30, 1997,
were 6.25 cents per share. In July 1997, Conseco's Board of Directors increased
the quarterly cash dividend on the Company's common stock to 12.50 cents per
share from 3.125 cents per share, effective with the next dividend payment on
October 1, 1997.
The following table summarizes certain financial ratios as of and for the
six months ended June 30, 1997, and as of and for the year ended December 31,
1996:
<TABLE>
<CAPTION>
June 30, December 31,
1997 1996
---- ---
<S> <C> <C>
Book value per common share:
As reported........................................................................ $18.22 $16.86
Excluding unrealized appreciation (depreciation) (a)............................... 18.08 16.62
Ratio of earnings to fixed charges:
As reported........................................................................ 2.04X 1.65X
Excluding interest on annuities and financial product policyholder account
balances (b)..................................................................... 7.66X 4.55X
Ratio of earnings to fixed charges, preferred dividends and distributions on
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts:
As reported...................................................................... 1.75X 1.51X
Excluding interest added to annuity and financial product policyholder account
balances (b)................................................................... 3.73X 3.06X
Ratio of adjusted statutory earnings to cash interest (c):
As reported........................................................................ 1.61X 1.54X
Excluding interest added to annuity and financial product policyholder account
balances (b)..................................................................... 5.65X 4.56X
Ratio of adjusted statutory earnings to cash interest and distributions on
Company- obligated mandatorily redeemable preferred securities of subsidiary
trusts (d):
As reported...................................................................... 1.49X 1.53X
Excluding interest on annuities and financial product policyholder account
balances (b)................................................................... 3.46X 4.34X
Ratio of total debt to total capital:
As reported........................................................................ .28X .22X
Excluding unrealized appreciation (depreciation) (a)............................... .28X .23X
Ratio of debt and Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts to total capital (e):
As reported...................................................................... .43X .35X
Excluding unrealized appreciation (depreciation)................................. .43X .35X
<FN>
(a) Excludes the effect of reporting fixed maturity securities at fair value.
(b) These ratios are included to assist the reader in analyzing the impact of
interest added to annuity and financial product policyholder account
balances (which is not generally required to be paid in cash in the period
it is recognized). Such ratios are not intended to, and do not represent
the following ratios prepared in accordance with GAAP: the ratio of
earnings to fixed
30
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
charges; the ratio of earnings to fixed charges, preferred dividends and
distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts; the ratio of adjusted statutory earnings
to cash interest; or the ratio of adjusted statutory earnings to cash
interest and distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts.
(c) Statutory earnings represent: (i) gain from operations of our consolidated
life insurance companies before interest (including, for purposes of the
"as reported" ratio, interest on annuities and financial products) and
income taxes as reported for statutory accounting purposes; plus (ii)
income before interest and income taxes of all non-life companies. Cash
interest includes interest (including, for purposes of the "as reported"
ratio, interest on annuities and financial products) of Conseco and its
consolidated subsidiaries.
(d) Statutory earnings represent: (i) gain from operations of our consolidated
life insurance companies before interest (including, for purposes of the
"as reported" ratio, interest on annuities and financial products) and
income taxes as reported for statutory accounting purposes; plus (ii)
income before interest and income taxes of all non-life companies. Cash
interest includes interest (including, for purposes of the "as reported"
ratio, interest on annuities and financial products) of Conseco and its
consolidated subsidiaries. Distributions on Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts include such
distributions before income taxes of Conseco and its consolidated
subsidiaries.
(e) Represents the ratio of debt and the Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts to the sum of
shareholders' equity, notes payable, minority interest and the
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts.
</FN>
</TABLE>
INVESTMENTS
At June 30, 1997, the amortized cost and estimated fair value of fixed
maturity securities (all of which were actively managed) were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
(Dollars in millions)
<S> <C> <C> <C> <C>
United States Treasury securities and
obligations of United States government
corporations and agencies...................................... $ 452.5 $ 4.4 $ 2.5 $ 454.4
Obligations of states and political subdivisions
and foreign government obligations............................. 356.7 3.8 3.5 357.0
Public utility securities......................................... 2,086.0 32.4 35.7 2,082.7
Other corporate securities........................................ 10,264.7 130.0 86.8 10,307.9
Mortgage-backed securities........................................ 5,817.2 74.8 33.8 5,858.2
--------- ------ ------ ---------
Total fixed maturity securities ............................. $18,977.1 $245.4 $162.3 $19,060.2
========= ====== ====== =========
</TABLE>
31
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
The following table sets forth the investment ratings of fixed maturity
securities at June 30, 1997 (designated categories include securities with "+"
or "-" rating modifiers). The category assigned is the highest rating by a
nationally recognized statistical rating organization, or as to $713.4 million
fair value of fixed maturities not rated by such firms, the rating assigned by
the National Association of Insurance Commissioners ("NAIC"). For purposes of
the table, NAIC Class 1 securities are included in the "A" rating; Class 2,
"BBB"; Class 3, "BB" and Classes 4 to 6, "B and below."
<TABLE>
<CAPTION>
Percent of
Investment ------------------------------------
rating Fixed maturities Total investments
------ ---------------- -----------------
<S> <C> <C>
AAA................................... 35% 30%
AA.................................... 9 8
A..................................... 26 23
BBB................................... 25 22
--- --
Investment grade............... 95 83
--- --
BB.................................... 3 3
B and below........................... 2 1
--- --
Below investment grade......... 5 4
--- --
Total fixed maturities......... 100% 87%
=== ==
</TABLE>
At June 30, 1997, our below investment grade fixed maturity securities had
an amortized cost of $929.4 million and an estimated fair value of $943.8
million.
During the first six months of 1997, we recorded $1.2 million in writedowns
of fixed maturity securities as a result of changes in conditions which caused
us to conclude that a decline in fair value of the investments was other than
temporary. There were no such writedowns during the first six months of 1996. At
June 30, 1997, fixed maturity securities in default as to the payment of
principal or interest had an aggregate amortized cost of $4.7 million and a fair
value of $3.3 million.
Sales of invested assets (primarily fixed maturity securities) during the
first six months of 1997 generated proceeds of $6.3 billion, and net investment
gains of $22.3 million. Sales of invested assets during the first six months of
1996 generated proceeds of $3.0 billion, and net investment gains of $4.2
million. Net investment gains in 1997 and 1996 also included $.2 million and
$1.3 million, respectively, of writedowns related to mortgage loans.
At June 30, 1997, fixed maturity investments included $5.9 billion of
mortgage-backed securities (or 31 percent of all fixed maturity securities). The
yield characteristics of mortgage-backed securities differ from those of
traditional fixed-income securities. Interest and principal payments occur more
frequently, often monthly. Mortgage-backed securities are subject to risks
associated with variable prepayments. Prepayment rates are influenced by a
number of factors which cannot be predicted with certainty, including the
relative sensitivity of the underlying mortgages backing the assets to changes
in interest rates; a variety of economic, geographic and other factors; and the
repayment priority of the securities in the overall securitization structures.
In general, prepayments on the underlying mortgage loans, and the
securities backed by these loans, increase when the level of prevailing interest
rates declines significantly relative to the interest rates on such loans.
Mortgage-backed securities purchased at a discount to par will experience an
increase in yield when the underlying mortgages prepay faster than expected.
These securities purchased at a premium that prepay faster than expected will
incur a reduction in yield. When interest rates decline, the proceeds from the
prepayment of mortgage-backed securities are likely to be reinvested at lower
rates than we were earning on the prepaid securities. When interest rates
increase, prepayments on mortgage-backed securities decrease as fewer underlying
mortgages are refinanced. When this occurs, the average maturity and duration of
the mortgage-backed securities increase, which decreases the yield on
mortgage-backed securities purchased at a discount because the discount is
realized as income at a slower rate and increases the yield on those purchased
at a premium as a result of a decrease in the annual amortization of the
premium.
32
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
The following table sets forth the par value, amortized cost and estimated
fair value of mortgage-backed securities, summarized by interest rates on the
underlying collateral at June 30, 1997:
<TABLE>
<CAPTION>
Par Amortized Estimated
value cost fair value
----- ---- ----------
(Dollars in millions)
<S> <C> <C> <C>
Below 7 percent..................................................................... $1,744.3 $1,672.4 $1,668.9
7 percent - 8 percent............................................................... 3,015.9 2,922.2 2,958.1
8 percent - 9 percent............................................................... 806.4 744.2 751.1
9 percent and above................................................................. 472.1 478.4 480.1
-------- -------- --------
Total mortgage-backed securities............................................. $6,038.7 $5,817.2 $5,858.2
======== ======== ========
</TABLE>
The amortized cost and estimated fair value of mortgage-backed securities at
June 30, 1997, summarized by type of security, were as follows (dollars in
millions):
<TABLE>
<CAPTION>
Estimated fair value
--------------------------
Percent
Amortized of fixed
Type cost Amount maturities
- ---- ---- ------ ----------
<S> <C> <C> <C>
Pass-throughs and sequential and targeted amortization classes............ $3,914.9 $3,941.7 21%
Planned amortization classes and accretion directed bonds................. 1,174.0 1,173.7 6
Support classes........................................................... 162.2 169.1 1
Accrual (Z tranche) bonds................................................. 42.3 44.0 -
Subordinated classes ..................................................... 523.8 529.7 3
-------- -------- --
$5,817.2 $5,858.2 31%
======== ======== ==
</TABLE>
Pass-throughs and sequential and targeted amortization classes have similar
prepayment variability. Pass-throughs historically provide the best liquidity in
the mortgage-backed securities market and provide the best price/performance
ratio in a highly volatile interest rate environment. This type of security is
also frequently used as collateral in the dollar-roll market. Sequential classes
pay in a strict sequence; all principal payments received by the collateralized
mortgage obligations ("CMOs") are paid to the sequential tranches in order of
priority. Targeted amortization classes provide a modest amount of prepayment
protection when prepayments on the underlying collateral increase from those
assumed at pricing. Thus, they offer slightly better call protection than
sequential classes or pass-throughs.
Planned amortization classes and accretion directed bonds are some of the
most stable and liquid instruments in the mortgage-backed securities market.
Planned amortization class bonds adhere to a fixed schedule of principal
payments as long as the underlying mortgage collateral experiences prepayments
within an expected range. Changes in prepayment rates are first absorbed by
support classes. This insulates the planned amortization classes from the
consequences of faster prepayments (average life shortening) and slower
prepayments (average life extension).
Support classes absorb the prepayment risk from which planned amortization
and targeted amortization classes are protected. As such, they are usually
extremely sensitive to prepayments. Most of our support classes are higher
average life instruments that generally will not lengthen if interest rates rise
further and will have a tendency to shorten if interest rates decline. However,
since these bonds have costs below their par values, higher prepayments will
have the effect of increasing yields.
Accrual bonds are CMOs structured such that the payment of coupon interest
is deferred until principal payments begin. On each accrual date, the principal
balance is increased by the amount of the interest (based upon the stated coupon
rate) that otherwise would have been payable. As such, these securities act like
zero coupon bonds until cash payments begin. Cash payments typically do not
commence until earlier classes in the CMO structure have been retired, which can
be significantly influenced by the prepayment experience of the underlying
mortgage loan collateral in the CMO structure. Because of the zero coupon
element of these securities and the potential uncertainty as to the timing of
cash payments, their market values and yields are more sensitive to changing
interest rates than are other CMOs, pass-through securities and coupon bonds.
33
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Subordinated CMO classes have both prepayment and credit risk. The
subordinated classes are used to enhance the credit quality of the senior
securities and as such, rating agencies require that this support not
deteriorate due to the prepayment of the subordinated securities. The credit
risk of subordinated classes is derived from the negative leverage of owning a
small percentage of the underlying mortgage loan collateral while bearing a
majority of the risk of loss due to homeowner defaults.
At June 30, 1997, the balance of mortgage loans was comprised of 95 percent
commercial loans, 2 percent residual interests in collateralized mortgage
obligations and 3 percent residential loans. Less than 1 percent of mortgage
loans were noncurrent (loans which are two or more scheduled payments past due)
at June 30, 1997.
Investment borrowings averaged approximately $340.7 million during the
first six months of 1997, compared to approximately $327.7 million during the
same period of 1996 and were collateralized by investment securities with fair
values approximately equal to the loan value. The weighted average interest rate
on such borrowings was 4.9 percent and 5.2 percent during the first six months
of 1997 and 1996, respectively.
STATUTORY INFORMATION
Statutory accounting practices prescribed or permitted for our insurance
subsidiaries by regulatory authorities differ from generally accepted accounting
principles. Our life insurance subsidiaries reported the following amounts to
regulatory agencies at June 30, 1997, after appropriate eliminations of
intercompany accounts among such subsidiaries (dollars in millions):
<TABLE>
<CAPTION>
<S> <C>
Statutory capital and surplus ............................. $1,375.4
Asset valuation reserve ("AVR")............................ 277.0
Interest maintenance reserve ("IMR")....................... 303.5
Portion of surplus debenture carried as a liability ....... 88.2
--------
Total................................................... $2,044.1
========
</TABLE>
The ratio of such consolidated statutory account balances to consolidated
statutory liabilities (excluding AVR, IMR, the portion of surplus debentures
carried as a liability, liabilities from separate account business and
short-term collateralized borrowings) was 10.2 percent at June 30, 1997, and 9.8
percent at December 31, 1996.
Combined statutory net income of our life insurance subsidiaries (after
appropriate eliminations of intercompany amounts among such subsidiaries) was
$127.8 million in the first six months of 1997 and $89.2 million in the first
six months of 1996.
The statutory capital and surplus of the insurance subsidiaries include
surplus debentures of the parent holding companies totaling $806.3 million.
Payments of interest and principal on such debentures are generally subject to
the approval of the insurance department of the subsidiary's state of domicile.
During the first six months of 1997, our life insurance subsidiaries made
scheduled principal payments on surplus debentures of $72.9 million.
State insurance laws generally restrict the ability of insurance companies
to pay dividends or make other distributions. Net assets of our life insurance
subsidiaries, determined in accordance with GAAP, aggregated approximately $8.8
billion at December 31, 1996. During the first six months of 1997, our life
insurance subsidiaries paid ordinary dividends of $61.3 million to the parent
holding companies. During the remainder of 1997, the life insurance subsidiaries
may pay additional dividends of $104.8 million without the permission of state
regulatory authorities.
FORWARD-LOOKING STATEMENTS
All statements, trend analyses and other information contained in this
report and elsewhere (such as in other filings by the Company with the
Securities and Exchange Commission, press releases, presentations by the Company
or its management or oral statements) relative to markets for the Company's
products and trends in the Company's operations or financial results, as well as
other statements including words such as "anticipate," "believe," "plan,"
"estimate," "expect," "intend," and other similar expressions, constitute
forward-looking statements under the Private Securities Litigation Reform Act of
1995. These forward-looking statements are subject to known and unknown risks,
uncertainties and other factors which may cause actual results to be materially
different from those contemplated by the forward-looking statements. Such
factors include, among other things: (1) general economic conditions, including
prevailing interest rate levels and stock market performance, which may affect
the ability of the Company to sell its products,
34
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
the market value of the Company's investments and the lapse rate and
profitability of the Company's policies; (2) the Company's ability to achieve
anticipated levels of operational efficiencies at recently acquired companies,
as well as through other cost-saving initiatives; (3) customer response to new
products, distribution channels and marketing initiatives; (4) changes in the
federal income tax laws and regulations which may affect the relative tax
advantages of some of the Company's products; (5) increasing competition in the
sale of the Company's products; (6) regulatory changes, including modifications
to the regulation of financial services affecting (among other things) bank
sales and underwriting of insurance products and changes to health care
regulation that affect the Company's supplemental health insurance products; (7)
the availability and terms of future acquisitions; and (8) the risk factors or
uncertainties listed from time to time in the Company's other filings with the
Securities and Exchange Commission.
35
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the Company's annual meeting of shareholders on May 13, 1997, the
shareholders approved an amendment to the Company's Articles of Incorporation to
increase the number of shares of authorized common stock from 500,000,000 to
1,000,000,000. Shareholders cast 134,174,749 votes in favor of the amendment and
22,614,025 votes against, with 2,797,909 abstentions. The shareholders also
elected John M. Mutz to serve as a director for a term ending in 1999 and Rollin
M. Dick, James D. Massey and Dennis E. Murray, Sr. to serve as directors for
terms ending in 2000. The results of the voting were as follows (there were no
broker non-votes):
<TABLE>
<CAPTION>
John M. Rollin M. James D. Dennis E.
Mutz Dick Massey Murray, Sr.
---- ---- ------ -----------
<S> <C> <C> <C> <C>
For 158,810,972 159,134,358 158,883,730 158,862,778
Withheld 735,711 722,325 702,953 723,805
</TABLE>
At the annual meeting, the shareholders also approved the adoption of the
Company's 1997 Non-qualified Stock Option Plan (the "Plan"). There were
69,677,936 shares voted for the Plan, 61,871,098 shares voted against the Plan,
1,745,738 abstentions and 25,242,043 broker non-votes.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a) Exhibits.
11.1 Computation of Earnings Per Share - Primary.
11.2 Computation of Earnings Per Share - Fully Diluted.
27.0 Financial Data Schedule.
b) Reports on Form 8-K.
A report on Form 8-K dated April 1, 1997, was filed with the
Commission to report under Item 5, the closing of the offering by
Conseco Financing Trust III of 300,000, 8.796% Capital Securities.
A report on Form 8-K dated April 30, 1997, was filed with the
Commission to report under Item 5, the signing of a stock purchase
agreement with Leucadia National Corporation.
36
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CONSECO, INC.
Dated: August 13, 1997 By: /s/ ROLLIN M. DICK
------------------
Rollin M. Dick
Executive Vice President and
Chief Financial Officer
(authorized officer and principal
financial officer)
37
<TABLE>
<CAPTION>
EXHIBIT 11.1
CONSECO, INC. AND SUBSIDIARIES
COMPUTATION OF EARNINGS PER SHARE - PRIMARY
(unaudited)
Three months ended Six months ended
June 30, June 30,
-------------------- ------------------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Shares outstanding, beginning of period........................ 183,245,130 82,737,604 167,128,228 81,031,828
Weighted average shares issued (acquired) during the period:
Shares issued in conjunction with mergers.................... 9,188,759 - 7,473,571 -
Shares issued under employee benefit and compensation plans - - 101,086 -
Exercise of stock options.................................... 4,651,914 46,378 3,120,112 2,007,752
Shares issued upon conversion of preferred stock............. 89,018 672,196 5,746,993 337,840
Shares issued upon conversion of convertible debentures...... 392,055 - 4,048,362 -
Treasury stock acquired...................................... (8,213,278) (620) (4,106,639) (952,492)
Common equivalent shares related to:
Stock options at average market price ..................... 10,035,158 4,700,162 10,916,957 4,662,020
Employee stock plans ...................................... 2,291,778 2,032,858 2,184,979 2,024,800
PRIDES..................................................... 6,734,908 14,944,768 7,037,497 13,138,498
Convertible debentures..................................... 5,879,059 - 5,420,094 -
------------ ----------- ----------- -----------
Weighted average primary shares outstanding.................... 214,294,501 105,133,346 209,071,240 102,250,246
============ =========== =========== ===========
Net income for primary earnings per share:
Net income as reported....................................... $130,645,000 $50,062,000 $242,134,000 $96,410,000
Less amounts applicable to preferred stock:
Charge related to induced conversions...................... (911,000) - (13,201,000) -
Preferred stock dividends.................................. - (4,412,000) - (9,018,000)
------------ ----------- ------------ -----------
Net income for primary earnings per share...................... $129,734,000 $45,650,000 $228,933,000 $87,392,000
============ =========== ============ ===========
Net income per primary common share............................ $.61 $.43 $1.10 $.85
==== ==== ===== ====
</TABLE>
<TABLE>
<CAPTION>
EXHIBIT 11.2
CONSECO, INC. AND SUBSIDIARIES
COMPUTATION OF EARNINGS PER SHARE - FULLY DILUTED
(unaudited)
Three months ended Six months ended
June 30, June 30,
-------------------- -----------------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Weighted average primary shares outstanding.................... 214,917,625 105,133,346 209,436,284 102,250,246
Incremental common equivalent shares:
Related to options and employee stock plans ............... - 765,280 - 1,586,570
Related to convertible preferred stock..................... - 17,112,680 - 17,449,538
------------ ----------- ------------ -----------
Weighted average fully diluted shares outstanding............. 214,917,625 123,011,306 209,436,284 121,286,354
============ =========== =========== ===========
Net income for fully diluted earnings per share.............. $130,645,000 $50,062,000 $229,844,000 $96,410,000
============ =========== ============ ===========
Net income per fully diluted common share.................... $.61 $.41 $1.10 $.79
==== ==== ===== ====
<FN>
Note: For the three and six months ended June 30, 1997, the closing market
price of a share of Conseco common stock was lower than the average
market price during the periods. Accordingly, there were no
additional incremental common equivalent shares for the purpose of
calculating fully diluted earnings per share.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND> THE SCHEDULE CONTAINS SUMMARY FINANCIAL
INFORMATION EXTRACTED FROM FORM 10-Q FOR CONSECO,
INC. DATED JUNE 30, 1997 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> JUN-30-1997
<DEBT-HELD-FOR-SALE> 19,060,200
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 186,700
<MORTGAGE> 869,700 <F1>
<REAL-ESTATE> 0
<TOTAL-INVEST> 21,861,400
<CASH> 0
<RECOVER-REINSURE> 792,700
<DEFERRED-ACQUISITION> 3,233,300 <F2>
<TOTAL-ASSETS> 30,187,800
<POLICY-LOSSES> 20,288,300
<UNEARNED-PREMIUMS> 439,200
<POLICY-OTHER> 1,019,500
<POLICY-HOLDER-FUNDS> 350,700
<NOTES-PAYABLE> 1,286,500
967,700
122,000
<COMMON> 2,448,900
<OTHER-SE> 961,800 <F3>
<TOTAL-LIABILITY-AND-EQUITY> 30,187,800
1,555,100
<INVESTMENT-INCOME> 854,100
<INVESTMENT-GAINS> 20,900
<OTHER-INCOME> 29,400
<BENEFITS> 1,448,300 <F4>
<UNDERWRITING-AMORTIZATION> 206,300 <F5>
<UNDERWRITING-OTHER> 270,600
<INCOME-PRETAX> 426,600
<INCOME-TAX> 154,900
<INCOME-CONTINUING> 271,700
<DISCONTINUED> 0
<EXTRAORDINARY> (5,500)
<CHANGES> 0
<NET-INCOME> 242,100
<EPS-PRIMARY> 1.10
<EPS-DILUTED> 1.10
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1> Includes $545,200 of credit-tenant loans.
<F2> Includes $2,505,300 of cost of policies purchased.
<F3> Includes retained earnings of $936,600 and net unrealized appreciation
of securities of $25,200.
<F4> Includes insurance policy benefits of $986,900, change in future policy
benefits of $81,600 and amounts added to annuity and financial product
policyholder account balances of $379,800.
<F5> Includes amortization of cost of policies purchased of $129,400 and cost
of policies produced of $50,300 and amortization related to investment
gains of $26,600.
</FN>
</TABLE>
