UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q/A
Amendment No. 1
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 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 October 31, 1997: 188,414,549
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
EXPLANATORY NOTE
This Form 10-Q/A amends the Form 10-Q filed by Conseco, Inc. on November
14, 1997 to correct the typographical errors included in the table summarizing
mortgage-backed securities by type of security. The descriptions of such
securities in the table were not properly matched with their corresponding
balances. Such balances are presented in the table on page 38 included in the
section entitled "Investments" in Item 2. Item 2 is included herein in its
entirety.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following discussion highlights material factors affecting our results
of operations and significant changes in our balance sheet. Many of the changes
in 1997 and 1996 affecting our results of operations were caused 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. These
transactions, as well as the Colonial Penn Purchase (completed on September 30,
1997), also caused significant changes in our balance sheet during these
periods. This discussion should be read in conjunction with the consolidated
financial statements and notes included herein and in our 1996 Form 10-K.
RESULTS OF OPERATIONS
We conduct and manage our business through five segments, reflecting our
major lines of insurance business and target markets: (i) supplemental health
insurance; (ii) annuities; (iii) life insurance; (iv) individual and group major
medical insurance; and (v) other.
Consolidated Results and Analysis
The following table and narrative summarize the consolidated results of our
operations:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------ -----------------
1997 1996 1997 1996
---- ---- ---- ----
(Dollars in millions, except per share data)
<S> <C> <C> <C> <C>
Operating earnings..................................................... $152.2 $79.6 $407.9 $181.8
Net investment gains (losses), net of related costs, amortization
and taxes........................................................... 42.8 (.3) 39.0 (6.4)
Nonrecurring items..................................................... (40.5) - (44.8) 17.7
------ ----- ------ ------
Income before extraordinary charge.............................. 154.5 79.3 402.1 193.1
Extraordinary charge................................................... .7 1.2 6.2 18.6
------ ----- ------ ------
Net income...................................................... 153.8 78.1 395.9 174.5
Less amounts applicable to preferred stock:
Charge related to induced conversions............................... - - 13.2 -
Preferred stock dividends........................................... 2.2 5.5 6.7 22.7
------ ----- ------ ------
Net income applicable to common stock........................... $151.6 $72.6 $376.0 $151.8
====== ===== ====== ======
Per fully diluted common share:
Weighted average shares outstanding (in millions)................... 212.1 158.1 210.2 134.7
====== ===== ===== =====
Operating earnings.................................................. $.72 $.50 $1.94 $1.35
Net investment gains (losses), net of related costs, amortization
and taxes......................................................... .20 - .18 (.05)
Nonrecurring items.................................................. (.19) - (.21) .13
Charge related to induced conversion of preferred stock............. - - (.06) -
------ ----- ----- -----
Income before extraordinary charge.............................. .73 .50 1.85 1.43
Extraordinary charge................................................ - .01 .03 .14
------ ----- ----- -----
Net income...................................................... $.73 $.49 $1.82 $1.29
==== ==== ===== =====
</TABLE>
18
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Our third quarter 1997 operating earnings were $152.2 million, or 72 cents
per fully diluted share, up 91 percent and 44 percent, respectively, over the
third quarter of 1996. Operating earnings during the first nine months of 1997
were $407.9 million, or $1.94 per fully diluted share, up 124 percent and 44
percent, respectively, over the first nine 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 34 percent increase in
common shares or equivalents outstanding during the third quarter of 1997 and
the 56 percent increase during the first nine months of 1997. These increases
resulted from shares issued as part of 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 $153.8 million in the third quarter of 1997, or 73 cents per
fully diluted share, included: (i) net investment gains (net of related costs,
amortization and taxes) of $42.8 million, or 20 cents per share; (ii)
nonrecurring charges totaling $40.5 million, or 19 cents per share, related to
the Company's Medicare supplement business in Massachusetts; and (iii) an
extraordinary charge of $.7 million, or nil per share, related to the early
retirement of debt. The Massachusetts insurance department has been unwilling to
approve reasonable rate increases to Medicare supplement providers. Conseco is
discontinuing the sale of new Medicare supplement policies in Massachusetts and
in the third quarter wrote down the cost of policies purchased and produced and
accrued additional claim reserves related to its inforce Massachusetts Medicare
supplement business. Conseco is appealing the department's rating actions to the
Supreme Court of Massachusetts. Net income of $78.1 million for the third
quarter of 1996, or 49 cents per fully diluted share, included: (i) net
investment losses (net of related costs, amortization and taxes) of $.3 million,
or nil per share; and (ii) an extraordinary charge of $1.2 million, or 1 cent
per share, related to early retirement of debt.
Net income of $395.9 million in the first nine months of 1997, or $1.82 per
fully diluted share, included: (i) net investment gains (net of related costs,
amortization and taxes) of $39.0 million, or 18 cents per fully diluted share;
(ii) an extraordinary charge of $6.2 million, or 3 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) nonrecurring items totaling $44.8 million, or 21 cents per share,
related to the previously discussed third quarter actions on the Company's
Massachusetts Medicare supplement business and to the death of an executive
officer in the second quarter of 1997. Net income of $174.5 million in the first
nine months of 1996, or $1.29 per fully diluted share, included: (i) net
investment losses (net of related costs, amortization and taxes) of $6.4
million, or 5 cents per share; (ii) nonrecurring income totaling $17.7 million,
or 13 cents per share, primarily arising from the sale of our investment in
Noble Broadcast Group, Inc.; and (iii) an extraordinary charge of $18.6 million,
or 14 cents per share, related to the early retirement of debt.
Total revenues include net investment gains of $116.4 million and $6.9
million in the third quarters of 1997 and 1996, respectively. Excluding net
investment gains, total revenues were $1,367.1 million in the third quarter of
1997, up 65 percent from $827.4 million in the third quarter of 1996. Total
revenues include net investment gains of $137.3 million and $9.8 million during
the first nine months of 1997 and 1996, respectively. Excluding net investment
gains, total revenues were $3,805.7 million in the first nine months of 1997, up
74 percent from $2,188.8 million in the first nine months of 1996. Total
revenues in the 1997 periods include revenues of ATC, THI, CAF and PFS in the
periods subsequent to their acquisitions. Total revenues in the nine-month
period of 1996 include: (i) revenues of LPG for the third quarter of 1996; and
(ii) nonrecurring income of $30.4 million primarily arising from the sale of our
investment in Noble Broadcast Group, Inc.
19
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
First Nine Months of 1997 Compared to the First Nine Months of 1996 and the
Third Quarter of 1997 Compared to the Third Quarter of 1996:
The following tables and narratives summarize the results of our operations
by business segment.
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 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 ................................................. $120.2 $ 28.7 $307.4 $ 94.7
Net investment gains (losses), net of related costs and
amortization.................................................... 11.3 .4 6.5 (.2)
Nonrecurring items................................................ (62.4) - (62.4) -
------ ------- ------ ------
Income before income taxes, minority interest and
extraordinary charge.......................................... 69.1 29.1 251.5 94.5
------ ------- ------ ------
Annuities:
Operating income ................................................. 78.1 59.8 223.9 186.7
Net investment gains, net of related costs and amortization ...... 48.6 4.8 49.8 1.1
------ ------- ------ ------
Income before income taxes, minority interest and
extraordinary charge.......................................... 126.7 64.6 273.7 187.8
------ ------- ------ ------
Life insurance:
Operating income.................................................. 65.1 53.1 183.4 89.0
Net investment gains (losses), net of related costs and
amortization................................................... 8.5 (1.6) 6.8 (3.0)
------ ------- ------ ------
Income before income taxes, minority interest and
extraordinary charge.......................................... 73.6 51.5 190.2 86.0
------ ------- ------ ------
Individual and group major medical:
Operating income.................................................. 12.2 11.1 33.1 20.3
Net investment gains, net of related costs and amortization....... .1 - .1 -
------ ------- ------ ------
Income before income taxes, minority interest and
extraordinary charge.......................................... 12.3 11.1 33.2 20.3
------ ------- ------ ------
Other:
Operating income.................................................. 18.8 5.7 47.3 24.7
Net investment gains (losses), net of related costs and
amortization................................................... 4.1 - 3.7 (3.7)
Nonrecurring items................................................ - - (9.3) 30.4
------ ------- ------ ------
Income before income taxes, minority interest and
extraordinary charge.......................................... 22.9 5.7 41.7 51.4
------ ------- ------ ------
Interest and other corporate expenses............................... (29.4) (30.5) (88.5) (87.0)
------ ------- ------ ------
Consolidated earnings:
Operating income.................................................. 265.0 127.9 706.6 328.4
Net investment gains (losses), net of related costs and
amortization................................................... 72.6 3.6 66.9 (5.8)
Nonrecurring items................................................ (62.4) - (71.7) 30.4
------ ------- ------ ------
Income before income taxes, minority interest and
extraordinary charge.......................................... 275.2 131.5 701.8 353.0
Income tax expense..................................................... 106.9 49.8 261.8 134.1
------ ------- ------ ------
Income before minority interest and extraordinary charge........ 168.3 81.7 440.0 218.9
Minority interest in consolidated subsidiaries:
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts........................ 13.0 - 34.6 -
Dividends on preferred stock of subsidiaries........................ .8 2.3 3.3 7.4
Equity in earnings of subsidiaries.................................. - .1 - 18.4
------ ------- ------ ------
Income before extraordinary charge.............................. 154.5 79.3 402.1 193.1
Extraordinary charge on extinguishment of debt, net of taxes and
minority interest................................................... .7 1.2 6.2 18.6
------ ------- ------ ------
Net income...................................................... $153.8 $ 78.1 $395.9 $174.5
====== ======= ====== ======
</TABLE>
20
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
Supplemental health:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
1997 1996 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Premiums collected:
Medicare supplement (first year)........................................... $ 31.7 $ 17.1 $ 75.4 $ 53.9
Medicare supplement (renewal).............................................. 177.7 133.3 511.3 409.6
------ ------ -------- ------
Subtotal - Medicare supplement......................................... 209.4 150.4 586.7 463.5
------ ------ -------- ------
Long-term care (first year)................................................ 35.1 12.7 108.7 38.0
Long-term care (renewal)................................................... 129.1 36.6 375.0 104.1
------ ------ -------- ------
Subtotal - long-term care.............................................. 164.2 49.3 483.7 142.1
------ ------ -------- ------
Specified disease (first year)............................................. 11.3 - 34.2 -
Specified disease (renewal)................................................ 86.2 - 255.1 -
------ ------ -------- ------
Subtotal - specified disease........................................... 97.5 - 289.3 -
------ ------ -------- ------
Total supplemental health premiums collected........................... $471.1 $199.7 $1,359.7 $605.6
====== ====== ======== ======
Insurance policy income....................................................... $472.9 $202.9 $1,363.0 $604.4
Net investment income......................................................... 64.8 16.4 184.9 49.8
------ ------ -------- ------
Total revenues (a)..................................................... 537.7 219.3 1,547.9 654.2
------ ------ -------- ------
Insurance policy benefits and change in future policy benefits................ 301.2 133.9 875.1 408.6
Amortization related to operations............................................ 43.0 24.4 148.7 63.5
Interest expense on investment borrowings..................................... 1.5 .3 2.8 .8
Other operating costs and expenses............................................ 71.8 32.0 213.9 86.6
------ ------ -------- ------
Total benefits and expenses (a)........................................ 417.5 190.6 1,240.5 559.5
------ ------ -------- ------
Operating income before income taxes, minority interest and
extraordinary charge................................................. 120.2 28.7 307.4 94.7
Net investment gains (losses), net of related costs and amortization.......... 11.3 .4 6.5 (.2)
Nonrecurring expense.......................................................... (62.4) - (62.4) -
------ ------ -------- ------
Income before income taxes, minority interest and extraordinary charge $ 69.1 $ 29.1 $ 251.5 $ 94.5
====== ====== ======== ======
Benefit ratios:
Medicare supplement products............................................... 68.6% 68.0% 70.3% 69.2%
Long-term care products.................................................... 56.3 59.5 59.2 61.9
Specified disease products................................................. 66.3 - 60.6 -
<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
management.
21
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Premiums collected by this segment in the third quarter of 1997 were $471.1
million, up 136 percent over 1996. Premiums collected in the first nine months
of 1997 were $1,359.7 million, up 125 percent over 1996. The increases are
primarily due to the recent acquisitions.
Medicare supplement policies accounted for 43 percent of this segment's
collected premiums in the first nine months of 1997 compared to 77 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 39 percent in the third
quarter of 1997, to $209.4 million, and increased 27 percent in the first nine
months of 1997, to $586.7 million. Annualized new business premiums were $51.7
million and $32.8 million, respectively. Medicare supplement premiums collected
by the recently acquired companies were $132.0 million in the first nine 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 233 percent, to
$164.2 million, in the third quarter of 1997 and increased 240 percent, to
$483.7 million, in the first nine months of 1997. Annualized new business
premiums in the first nine months of 1997 and 1996 were $107.1 million and $32.1
million, respectively. Long-term care premiums collected by the recently
acquired companies were $318.1 million in the first nine months of 1997. The
increase in long-term care premiums collected in 1997 reflects the acquisition
of recently acquired companies, 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 third quarter of
1997 and in the first nine months of 1997 were $97.5 million and $289.3 million,
respectively. Such premiums were collected by the recently acquired companies.
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 295 percent, to $64.8 million, in the third
quarter of 1997 and increased 271 percent, to $184.9 million, in the first nine
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 nine months of 1997, the
segment's average invested assets increased to $3.2 billion from approximately
$.9 billion in 1996, primarily as a result of the recent acquisitions. The
annualized net yield on invested assets was 7.6 percent in the first nine months
of 1997 and 1996.
Insurance policy benefits and change in future policy benefits increased in
the third quarter of 1997 and the first nine months of 1997 as a result of the
business in force acquired in the recent acquisitions. In the third quarter of
1997, the Medicare supplement loss ratio (the ratio of policy benefits to
insurance policy income for Medicare supplement policies) increased by .6
percentage points, to 68.6 percent. In the first nine months of 1997, the loss
ratio increased by 1.1 percentage points, to 70.3 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 third quarter of 1997, the long-term care loss ratio (the ratio of
policy benefits to insurance policy income for long-term care policies) fell by
3.2 percentage points, to 56.3 percent. In the first nine months of 1997, the
loss ratio fell by 2.7 percentage points, to 59.2 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 increased in the third quarter of 1997. Our continued review of
the adequacy of claim liabilities indicated the need to increase the liability
for losses incurred in prior periods. 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. Amortization increased primarily because of
increased balances subject to amortization resulting from 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).
22
<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 with the
increased business of the recently acquired companies.
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 totaled $.6 million and $.1 million in the third
quarters of 1997 and 1996, respectively. Such amortization totaled $1.5 million
and $.4 million in the first nine months of 1997 and 1996, respectively.
Nonrecurring expense for the three months ended September 30, 1997 includes
an increase to claim reserves of $41.5 million and the write-off of cost of
policies produced and cost of policies purchased of $20.9 million related to
Medicare supplement business in the State of Massachusetts. Regulators in that
state have not allowed premium increases for Medicare supplement products
necessary to avoid losses on the business. We are currently appealing those rate
actions to the Supreme Court of the State of Massachusetts, but in the
meanwhile, we are ceasing to write new Medicare supplement business in
Massachusetts and are taking all steps possible to control the losses being
incurred on the existing Medicare supplement business inforce. The adjustments
recorded in the third quarter reflect a write-off of all costs of business
purchased and produced related to the Massachusetts Medicare supplement policies
and an accrual of loss reserves to reflect the losses we expect to incur before
rates are permitted to return to levels that will avoid losses on the business.
23
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
Annuities:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
1997 1996 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Premiums collected:
Equity-indexed flexible premium deferred annuities (first year)............ $ 49.0 $ - $ 80.3 $ -
Market value adjusted flexible premium deferred annuities (first year)..... 26.6 46.8 102.8 146.8
Market value adjusted flexible premium deferred annuities (renewal)........ 3.0 5.2 11.5 16.3
Traditional flexible premium deferred annuities (first year)............... 71.4 90.2 219.3 241.1
Traditional flexible premium deferred annuities (renewal).................. 16.9 38.1 60.5 68.9
------ ------ -------- --------
Subtotal - flexible premium deferred annuities........................... 166.9 180.3 474.4 473.1
------ ------ -------- --------
Variable annuities (first year)............................................ 34.5 9.7 76.4 25.2
Variable annuities (renewal)............................................... 10.9 9.5 32.9 31.6
------ ------ -------- --------
Subtotal - variable annuities............................................ 45.4 19.2 109.3 56.8
------ ------ -------- --------
Equity-indexed single premium deferred annuities (first year).............. 69.6 31.3 179.3 33.0
Market value adjusted single premium deferred annuities (first year)....... 9.3 26.8 31.3 26.8
Traditional single premium deferred annuities (first year)................. 79.0 139.5 287.7 507.2
------ ------ -------- --------
Subtotal - single premium deferred annuities............................. 157.9 197.6 498.3 567.0
------ ------ -------- --------
Single premium immediate annuities (first year)............................ 55.6 42.8 155.7 147.7
------ ------- -------- --------
Total annuity premiums collected......................................... $425.8 $439.9 $1,237.7 $1,244.6
====== ====== ======== ========
Insurance policy income....................................................... $ 27.3 $ 19.2 $ 71.0 $ 58.6
Net investment income:
General account invested assets............................................ 239.2 236.4 710.9 655.0
S&P Options................................................................ 13.4 - 33.6 -
Separate account assets.................................................... 19.5 11.1 37.5 28.5
------ ------ -------- --------
Total revenues (a)....................................................... 299.4 266.7 853.0 742.1
------ ------ -------- --------
Insurance policy benefits and change in future policy benefits................ 16.4 17.9 51.1 50.0
Amounts added to policyholder account balances:
Annuity products other than those listed below............................. 136.9 138.3 403.7 384.7
Equity-indexed products.................................................... 12.9 - 33.1 -
Variable annuity products.................................................. 19.5 11.1 37.5 28.5
Amortization related to operations............................................ 24.4 24.9 72.5 55.6
Interest expense on investment borrowings..................................... 5.4 4.3 10.1 10.9
Other operating costs and expenses............................................ 5.8 10.4 21.1 25.7
------ ------- -------- -------
Total benefits and expenses (a).......................................... 221.3 206.9 629.1 555.4
------ ------- -------- -------
Operating income before income taxes, minority interest and
extraordinary charge................................................... 78.1 59.8 223.9 186.7
Net investment gains, net of related costs and amortization................... 48.6 4.8 49.8 1.1
------ ------- -------- -------
Income before income taxes, minority interest and
extraordinary charge................................................... $126.7 $ 64.6 $ 273.7 $ 187.8
====== ======= ======== =======
Weighted average gross interest spread on annuity products (b)................ 2.9% 2.9% 3.0% 3.0%
=== === === ===
24
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
<FN>
- --------------------
(a) Revenues exclude net investment gains; benefits and expenses exclude
amortization related to net investment gains.
(b) Excludes: (i) variable annuity products where the credited amount is based
on investment income from segregated investments; and (ii) equity-indexed
products where the credited amount is dependent upon the investment income
from S&P Options.
</FN>
</TABLE>
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 management. In addition, comparability between periods is
affected by: (i) the LPG Merger, effective July 1, 1996; and (ii) to a lesser
extent, the PFS Merger.
Premiums collected by this segment in the third quarter of 1997 were $425.8
million, down 3.2 percent over 1996. Premiums collected by this segment in the
first nine months of 1997 were $1,237.7 million, down .6 percent over 1996.
Annuity premiums collected by recently acquired companies were $31.7 million in
the third quarter of 1997 and $96.2 million in the first nine months of 1997.
SPDA collected premiums decreased 20 percent, to $157.9 million, in the
third quarter of 1997 and decreased 12 percent, to $498.3 million, in the first
nine 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-indexed 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-indexed return feature.
Total collected premiums for this product were $69.6 million in the third
quarter of 1997 and $179.3 million the first nine months of 1997.
FPDA collected premiums decreased 7.4 percent, to $166.9 million, in the
third quarter of 1997 and increased .3 percent, to $474.4 million, in the first
nine months of 1997. In January 1997, we introduced an equity-indexed FPDA
similar to the SPDA product described above. Collected premiums for this product
were $49.0 million in the third quarter of 1997 and $80.3 million in the first
nine months of 1997. FPDAs are similar to SPDAs in many respects, except FPDAs
allow more than one premium payment.
We offer deferred annuity products with a "market value adjustment" feature
designed to provide us with additional protection from early terminations during
a period of rising interest rates by reducing the surrender value payable upon a
full surrender of the policy in excess of the allowable penalty-free withdrawal
amount. Conversely, during a period of declining interest rates, the market
value adjustment feature would increase the surrender value payable to the
policyholder. Annuity premiums collected with this feature represent 12 percent
and 15 percent of total annuity premiums collected during the nine month periods
ended September 30, 1997 and 1996, respectively.
SPIA collected premiums increased 30 percent, to $55.6 million in the third
quarter of 1997 and increased 5.4 percent, to $155.7 million, in the first nine
months of 1997. The increases are primarily the result of increases in SPIAs
purchased with the proceeds of redeemed annuity contracts.
Variable annuity collected premiums increased 136 percent, to $45.4
million, in the third quarter of 1997 and increased 92 percent, to $109.3
million, in the first nine 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 variable annuity marketing efforts. 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 some of the SPIA
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;
instead, they are reported as deposits to insurance liabilities. Insurance
policy income rose primarily because of increased surrender charges collected
(changes in cost of insurance and expenses charged to annuity policies were not
significant). Surrender charges
25
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
were $17.7 million in the third quarter of 1997 and $11.9 million in the third
quarter of 1996. Such charges were $47.5 million in the first nine months of
1997 compared to $29.7 million in the first nine months of 1996. Annuity policy
withdrawals were $1,255.0 million in the first nine months of 1997 and $1,061.4
million in the first nine 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 nine month periods were
approximately 11.0 percent of insurance liabilities related to surrenderable
policies in 1997 and 10.4 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-indexed products) increased 1.2 percent,
to $239.2 million, in the third quarter of 1997 and increased 8.5 percent, to
$710.9 million, in the first nine months of 1997. These increases primarily
reflect the increase in general account invested assets acquired in conjunction
with the recent acquisitions. The segment's average invested assets increased
1.3 percent in the third quarter of 1997 compared to 1996 and the annualized
yield earned on average invested assets was approximately 7.9 percent during
both quarterly periods. The segment's average invested assets increased 11
percent in the first nine months of 1997 and the annualized yield earned on
average invested assets decreased .2 percentage points to 7.8 percent in the
first nine months of 1997.
Net investment income from S&P Options is substantially offset by a
corresponding charge to amounts added to policyholder account balances for
equity-indexed 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
changes are not significant.
Amounts added to policyholder account balances for interest on annuity
products decreased 1.0 percent, to $136.9 million, in the third quarter of 1997
and increased 4.9 percent, to $403.7 million, in the first nine months of 1997.
Such decrease in the third quarter is due to a .1 percentage point decrease in
average crediting rates to 4.9 percent partially offset by a .9 percent increase
in the amount of annuity business inforce. The increase in the nine month period
is primarily due to a larger amount of annuity business inforce as a result of
recent acquisitions offset by a decrease in crediting rates. The weighted
average crediting rates for these annuity liabilities decreased .2 percentage
points to 4.8 percent in the first nine months of 1997.
Amounts added to policyholder account balances related to the change in
value of the S&P index related to equity-indexed products fluctuate as the
benefits accrue on these products as a result of the equity-indexed return
feature. Such amounts are substantially offset by the net investment income from
the S&P Options.
Amounts added to policyholder account balances for variable annuity
products are 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 decreased
primarily because of the changes in the balances of the cost of policies
purchased and cost of policies produced as a result of net investment gains
recognized during 1997, partially offset 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 of this segment have been favorably
affected by the consolidation of all annuity operations in Conseco's Carmel,
Indiana, facilities.
Net investment gains, 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
26
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Company believes, however, that the following factors mitigate the adverse
effect of such decreases on net income: (i) we recognize 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 totaled $36.0
million and $3.0 million in the third quarters of 1997 and 1996, respectively.
Such amortization totaled $56.7 million and $13.8 million in the first nine
months of 1997 and 1996, respectively.
27
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
Life insurance:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
1997 1996 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Premiums collected:
Universal life (first year)............................................... $ 23.5 $ 31.7 $ 73.1 $ 38.4
Universal life (renewal).................................................. 83.2 79.5 251.2 122.1
------ ------ ------ ------
Subtotal - universal life............................................. 106.7 111.2 324.3 160.5
------ ------ ------ ------
Traditional life (first year)............................................. 14.9 4.3 32.0 9.5
Traditional life (renewal)................................................ 49.5 29.6 131.9 86.3
------ ------ ------ ------
Subtotal - traditional life........................................... 64.4 33.9 163.9 95.8
------ ------ ------ ------
Total life premiums collected......................................... $171.1 $145.1 $488.2 $256.3
====== ====== ====== ======
Insurance policy income:
Premiums earned on traditional life products.............................. $ 67.3 $ 36.8 $167.6 $ 98.4
Mortality charges and administrative fees................................. 88.8 85.2 262.4 123.5
Surrender charges......................................................... 2.6 3.2 10.2 5.5
------ ------ ------ ------
Total insurance policy income......................................... 158.7 125.2 440.2 227.4
Net investment income........................................................ 115.4 96.8 326.0 180.8
------ ------ ------ ------
Total revenues (a).................................................... 274.1 222.0 766.2 408.2
------ ------ ------ ------
Insurance policy benefits and change in future policy benefits............... 128.0 88.8 330.9 172.3
Interest added to financial product policyholder account balances............ 39.6 35.3 114.4 61.2
Amortization related to operations........................................... 17.7 17.2 69.2 20.7
Interest expense on investment borrowings.................................... 2.4 1.8 4.5 3.1
Other operating costs and expenses........................................... 21.3 25.8 63.8 61.9
------ ------ ------ ------
Total benefits and expenses (a)....................................... 209.0 168.9 582.8 319.2
------ ------ ------ ------
Operating income before income taxes, minority interest and
extraordinary charge................................................ 65.1 53.1 183.4 89.0
Net investment gains (losses), net of related costs and amortization......... 8.5 (1.6) 6.8 (3.0)
------ ------ ------ ------
Income before income taxes, minority interest and
extraordinary charge................................................ $ 73.6 $ 51.5 $190.2 $ 86.0
====== ====== ====== ======
<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 management.
28
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Premiums collected by this segment in the third quarter of 1997 were $171.1
million, up 18 percent over 1996. Premiums collected by this segment in the
first nine months of 1997 were $488.2 million, up 90 percent over 1996. Such
fluctuations reflect the recent acquisitions.
Universal life product collected premiums decreased 4.0 percent, to $106.7
million, in the third quarter of 1997 and increased 102 percent, to $324.3
million, in the first nine months of 1997. Universal life product premiums
collected by the recently acquired companies were: (i) $85.0 million and $86.0
million in the third quarters of 1997 and 1996, respectively; and (ii) $258.0
million and $86.0 million (representing premiums collected by LPG only during
the period after its acquisition on July 1, 1996) in the first nine months of
1997 and 1996, respectively.
Traditional life product collected premiums increased 90 percent, to $64.4
million, in the third quarter of 1997, and increased 71 percent, to $163.9
million, in the first nine months of 1997. The recently acquired companies
collected $74.0 million of traditional life product premiums in the first nine
months of 1997. Such premiums collected in the third quarter of 1996 include
$5.1 million collected by LPG after the LPG Merger.
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 earned on terminated universal life
insurance policies. All three categories 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 19 percent, to $115.4 million, in the third
quarter of 1997 and 80 percent, to $326.0 million, in the first nine 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 79
percent, to approximately $5.3 billion, in the first nine months of 1997; the
net yield on invested assets increased by .1 percentage points, to 8.1 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. The recent acquisitions produced 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
12 percent, to $39.6 million, in the third quarter of 1997 and increased 87
percent, to $114.4 million, in the first nine 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 91 percent, to $3.2 billion, in the first
nine months of 1997. The interest rate credited decreased by .2 percentage
points, to 4.8 percent, in the first nine months of 1997. The recent
acquisitions caused an increase in insurance liabilities for universal life
products.
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, net of the effect of reductions in the balances of the cost
of policies purchased and cost of policies produced resulting from net
investment gains recognized during 1997.
Interest expense on investment borrowings is affected by changes in
investment borrowing activities.
Other operating costs and expenses have increased 3 percent, to $63.8
million, in the first nine months of 1997 as a result of the increased block of
business related to this segment. Third quarter expenses reflect expense
reductions realized as a result of the consolidation of certain operations.
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 totaled $7.2 million and $.1 million in the third
quarters of 1997 and 1996, respectively. Such amortization totaled $12.0 million
and $1.3 million in the first nine months of 1997 and 1996, respectively.
29
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
Individual major medical and group:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
1997 1996 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Premiums collected:
Individual (first year).................................................... $ 23.5 $ 1.8 $ 42.9 $ 4.7
Individual (renewal)....................................................... 39.3 10.8 88.8 34.6
------ ------ ------ ------
Subtotal - individual.................................................. 62.8 12.6 131.7 39.3
------ ------ ------ ------
Group (first year)......................................................... 22.2 - 44.9 -
Group (renewal)............................................................ 127.6 72.1 334.4 215.5
------ ------ ------ ------
Subtotal - group....................................................... 149.8 72.1 379.3 215.5
------ ------ ------ ------
Total individual major medical and group premiums collected............ $212.6 $ 84.7 $511.0 $254.8
====== ====== ====== ======
Insurance policy income....................................................... $213.0 $ 91.5 $522.5 $262.0
Net investment income......................................................... 5.0 2.3 11.1 6.6
------ ------ ------ ------
Total revenues (a)..................................................... 218.0 93.8 533.6 268.6
------ ------ ------ ------
Insurance policy benefits and changes in future policy benefits............... 161.9 73.0 401.2 225.1
Amortization related to operations............................................ 5.4 4.4 14.2 11.8
Interest expense on investment borrowings..................................... .1 - .2 -
Other operating costs and expenses............................................ 38.4 5.3 84.9 11.4
------ ------ ------ ------
Total benefits and expenses (a)........................................ 205.8 82.7 500.5 248.3
------ ------ ------ ------
Operating income before income taxes, minority interest and
extraordinary charge................................................. 12.2 11.1 33.1 20.3
Net investment gains, net of related costs and amortization................... .1 - .1 -
------ ------ ------ ------
Income before income taxes, minority interest and extraordinary
charge.............................................................. $ 12.3 $ 11.1 $ 33.2 $ 20.3
====== ====== ====== ======
Benefit ratio................................................................. 76% 80% 77% 86%
== == == ==
<FN>
- --------------------
(a) Revenues exclude net investment gains; benefits and expenses exclude
amortization related to net investment losses.
</FN>
</TABLE>
General: This segment includes individual and group major medical health
insurance products. The segment's operations were significantly affected by the
PFS Merger. The profitability of this business depends largely on the overall
persistency of the business inforce, claim experience and expense control.
Premiums collected by this segment in the third quarter of 1997 were $212.6
million, up 151 percent over the third quarter of 1996. Premiums collected by
this segment in the first nine months of 1997 were $511.0 million, up 101
percent from the first nine months of 1996. Premiums collected by the recently
acquired companies were $125.5 million in the third quarter of 1997 and $255.2
million in the first nine 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) for the nine month
period have increased slightly. Over the last several years, a number of steps
were taken to improve the profitability of such business, including changes in
product, price, underwriting and agent compensation.
30
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Group premiums increased 108 percent, to $149.8 million, in the third
quarter of 1997 and 76 percent, to $379.3 million, in the first nine months of
1997. The recently acquired companies collected $153.5 million of group premiums
in the first nine 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 398 percent, to $62.8 million, in the
third quarter of 1997 and 235 percent, to $131.7 million, in the first nine
months of 1997. The recently acquired companies collected $101.7 million of
individual health premiums in the first nine months of 1997. Excluding such
premiums, the decrease reflects policy lapses in response to rate increases.
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 117 percent, to $5.0 million, in the third
quarter of 1997 and increased 68 percent, to $11.1 million, in the first nine
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.
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 76 percent
in the third quarter of 1997 and 77 percent for the first nine months of 1997.
Such ratio was approximately 80 percent in the third quarter of 1996 and 86
percent for the first nine months of 1996. The decrease reflects the premium
rate increases effected 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 recent acquisitions increased the
balances subject to amortization.
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 gains, net of related costs and amortization, often
fluctuate from period to period.
31
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
Other:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
1997 1996 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Premiums collected:
Other (first year)......................................................... $ .4 $ .6 $ 1.3 $ 1.8
Other (renewal)............................................................ 17.7 19.4 59.6 64.9
----- ----- ------ -----
Total other premiums collected......................................... $18.1 $20.0 $ 60.9 $66.7
===== ===== ====== =====
Insurance policy income....................................................... $13.8 $12.8 $ 44.3 $40.5
Net investment income......................................................... 3.3 1.9 10.8 6.0
Fee revenue and other income.................................................. 20.7 10.8 50.1 38.5
----- ----- ------ -----
Total revenues (a)..................................................... 37.8 25.5 105.2 85.0
----- ----- ------ -----
Insurance policy benefits and changes in future policy benefits............... 10.7 4.2 28.4 18.4
Amortization related to operations............................................ 1.8 3.7 6.2 9.2
Interest expense on investment borrowings..................................... - - .1 -
Other operating costs and expenses............................................ 6.5 11.9 23.2 32.7
----- ----- ------ -----
Total benefits and expenses (a)........................................ 19.0 19.8 57.9 60.3
----- ----- ------ -----
Operating income before income taxes, minority interest and
extraordinary charge................................................. 18.8 5.7 47.3 24.7
Net investment gains (losses), net of related costs and amortization.......... 4.1 - 3.7 (3.7)
Nonrecurring items............................................................ - - (9.3) 30.4
----- ----- ------ -----
Income before income taxes, minority interest and extraordinary
charge.............................................................. $22.9 $ 5.7 $ 41.7 $51.4
===== ===== ====== =====
<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 various other health insurance products. The
profitability of this business depends largely on the overall persistency of the
business inforce, claim experience and expense management.
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 we provide to our
consolidated subsidiaries. The profitability of the fee-based business depends
on the total fees generated and expense management.
Premiums collected by this segment in the third quarter of 1997 were $18.1
million, down 9.5 percent over the third quarter of 1996. Premiums collected by
this segment in the first nine months of 1997 were $60.9 million, down 8.7
percent from the first nine months of 1996. We are not currently emphasizing the
sale of these products, although our 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 74 percent, to $3.3 million, in the third
quarter of 1997 and increased 80 percent, to $10.8 million, in the first nine
months of 1997. Such investment income increased as a result of the income
earned on nontraditional investments held by this segment.
32
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Fee revenue and other income includes: (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 we provide to our consolidated subsidiaries. Fee
revenue and other income increased 30 percent, to $50.1 million, for the first
nine months of 1997. We earned higher fees for investment management and
slightly higher commissions for marketing and distributing insurance and
investment products.
Insurance policy benefits and change in future policy benefits fluctuate in
relationship to the amount of segment business inforce and the incidence of
claims.
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 decrease in amortization is consistent
with the declining balance of cost of policies purchased and cost of policies
produced associated with the business included in this segment
Interest expense on investment borrowings is affected by changes in
investment borrowing activities.
Other operating costs and expenses have been decreasing in recent periods
as a result of our decreased emphasis on growth related to the block of
insurance business included in this segment.
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 totaled $.1 million in the third quarter of 1996.
There was no such amortization in the third quarter of 1997. Such amortization
totaled $.2 million and $.1 million in the first nine months of 1997 and 1996,
respectively.
Nonrecurring items in 1997 represent expenses incurred related to the death
of an executive officer in the second quarter. Nonrecurring items in 1996
represent income from the sale of our investment in Noble Broadcast Group, Inc.
Other components of income before income taxes, minority interest and
extraordinary charge:
In addition to the income of the five operating segments, income before
income taxes, minority interest and extraordinary charge is affected by interest
and other corporate expenses.
Interest and other corporate expenses were $29.4 million in the third
quarter of 1997 and $30.5 million in the third quarter of 1996. Interest and
other corporate expenses were $88.5 million in the first nine months of 1997 and
$87.0 million in the first nine months of 1996. Interest expense is the largest
component of these expenses. Interest expense was $24.7 million in the third
quarter of 1997 and $30.4 million in the third quarter of 1996. Interest expense
was $76.0 million in the first nine months of 1997 and $84.6 million in the
first nine months of 1996. Such interest expense fluctuates in relationship to
the average debt outstanding during each period and the interest rates thereon.
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.
33
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Total premiums collected by our business segments were as follows:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
1997 1996 1997 1996
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Supplemental health......................................................... $ 471.1 $199.7 $1,359.7 $ 605.6
Annuities................................................................... 425.8 439.9 1,237.7 1,244.6
Life insurance.............................................................. 171.1 145.1 488.2 256.3
Individual major medical and group.......................................... 212.6 84.7 511.0 254.8
Other....................................................................... 18.1 20.0 60.9 66.7
-------- ------ -------- --------
Total premiums collected............................................. $1,298.7 $889.4 $3,657.5 $2,428.0
======== ====== ======== ========
</TABLE>
Fluctuations in premiums collected are discussed above under "Results of
Operations - First Nine Months of 1997 Compared to the First Nine Months of 1996
and the Third Quarter of 1997 Compared to the Third 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
September 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 and senior notes with a par
value of $118.8 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) the Colonial Penn Purchase;
(ix) common stock repurchases; and (x) the issuance of commercial paper and
notes payable.
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 September 30, 1997, the carrying value of such investments was
increased by $388.8 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 carrying value of $93.4 million.
The increase in shareholders' equity in the first nine 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 $395.9 million; (iv) the conversion of
convertible debentures into Conseco common stock with a value of $154.4 million;
(v) amounts related to stock options and employee benefit plans (including the
tax benefit thereon) of $263.1 million and (vi) the increase in net unrealized
appreciation of $110.9 million. These increases were partially offset by: (i)
repurchases of common stock for $616.5 million; and (ii) charges related to the
induced conversion of convertible preferred stock and dividends totaling $57.2
million.
Dividends declared on common stock for the nine months ended September 30,
1997, were 18.75 cents per share. In July 1997, Conseco's Board of Directors
increased the quarterly cash dividend on the Company's common stock to 12.5
cents per share from 3.125 cents per share, effective with the dividend payment
on October 1, 1997.
The Company has a definitive agreement to acquire Washington National for
approximately $410 million (see "Pending Merger" in the notes to the
consolidated financial statements included herein). We expect to finance the
acquisition by incurring additional indebtedness.
34
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
The following table summarizes certain financial ratios as of and for the
nine months ended September 30, 1997, and as of and for the year ended December
31, 1996:
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
---- ----
<S> <C> <C>
Book value per common share:
As reported........................................................................ $19.49 $16.86
Excluding unrealized appreciation (depreciation) (a)............................... 18.71 16.62
Ratio of earnings to fixed charges:
As reported........................................................................ 2.13X 1.65X
Excluding interest on annuities and financial product policyholder
account balances (b)............................................................. 7.94X 4.55X
Ratio of earnings to fixed charges, preferred dividends and distributions on
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts:
As reported...................................................................... 1.86X 1.51X
Excluding interest added to annuity and financial product policyholder account
balances (b)................................................................... 4.20X 3.06X
Ratio of adjusted statutory earnings to cash interest (c):
As reported........................................................................ 1.63X 1.54X
Excluding interest added to annuity and financial product policyholder account
balances (b)..................................................................... 5.82X 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)........................................................... 3.45X 4.34X
Ratio of total debt to total capital:
As reported........................................................................ .34X .22X
Excluding unrealized appreciation (a).............................................. .34X .23X
Ratio of debt and Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts to total capital (e):
As reported...................................................................... .46X .35X
Excluding unrealized appreciation (a)............................................ .47X .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: (i) the ratio of
earnings to fixed charges; (ii) the ratio of earnings to fixed charges,
preferred dividends and distributions on Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts; (iii) the ratio of
adjusted statutory earnings to cash interest; or (iv) 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
35
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
(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 September 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...................................... $ 811.6 $ 11.3 $ .3 $ 822.6
Obligations of states and political subdivisions
and foreign government obligations............................. 342.5 10.6 1.4 351.7
Public utility securities......................................... 2,011.2 63.7 27.9 2,047.0
Other corporate securities........................................ 10,571.6 260.7 33.1 10,799.2
Mortgage-backed securities........................................ 6,939.6 117.3 12.1 7,044.8
--------- ------ ----- ---------
Total fixed maturity securities ............................. $20,676.5 $463.6 $74.8 $21,065.3
========= ====== ===== =========
</TABLE>
The following table sets forth the investment ratings of fixed maturity
securities at September 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 $745.2 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................................... 38% 33%
AA.................................... 7 6
A..................................... 24 20
BBB................................... 25 21
--- ---
Investment grade............... 94 80
--- ---
BB.................................... 3 3
B and below........................... 3 2
--- ---
Below investment grade......... 6 5
--- ---
Total fixed maturities......... 100% 85%
=== ==
</TABLE>
36
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
At September 30, 1997, our below investment grade fixed maturity securities
had an amortized cost of $1,163.7 million and an estimated fair value of
$1,187.3 million.
During the first nine 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 nine months
of 1996. At September 30, 1997, fixed maturity securities in default as to the
payment of principal or interest had an aggregate amortized cost of $5.4 million
and a fair value of $4.4 million.
Sales of invested assets (primarily fixed maturity securities) during the
first nine months of 1997 generated proceeds of $11.5 billion, and net
investment gains of $139.2 million. Sales of invested assets during the first
nine months of 1996 generated proceeds of $5.0 billion, and net investment gains
of $11.7 million. Net investment gains in 1997 and 1996 also included $.7
million and $1.9 million, respectively, of writedowns related to mortgage loans.
At September 30, 1997, fixed maturity investments included $7.0 billion of
mortgage-backed securities (or 33 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.
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 September 30, 1997:
<TABLE>
<CAPTION>
Par Amortized Estimated
value cost fair value
----- ---- ----------
(Dollars in millions)
<S> <C> <C> <C>
Below 7 percent..................................................................... $1,717.6 $1,663.0 $1,678.6
7 percent - 8 percent............................................................... 4,177.6 4,123.0 4,195.5
8 percent - 9 percent............................................................... 719.8 690.6 702.7
9 percent and above................................................................. 457.4 463.0 468.0
-------- -------- --------
Total mortgage-backed securities............................................. $7,072.4 $6,939.6 $7,044.8
======== ======== ========
</TABLE>
37
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
The amortized cost and estimated fair value of mortgage-backed securities at
September 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............ $4,907.4 $4,974.9 24%
Planned amortization classes and accretion directed bonds................. 1,409.3 1,428.1 7
Support classes........................................................... 64.4 68.0 -
Accrual (Z tranche) bonds................................................. 43.2 46.4 -
Subordinated classes ..................................................... 515.3 527.4 2
-------- -------- --
$6,939.6 $7,044.8 33%
======== ======== ==
</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.
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 September 30, 1997, the balance of mortgage loans was comprised of 94
percent commercial loans, 3 percent residual interests in collateralized
mortgage obligations and 3 percent residential loans. Less than 1.5 percent of
mortgage loans were noncurrent (loans which are two or more scheduled payments
past due) at September 30, 1997.
Investment borrowings averaged approximately $431.2 million during the
first nine months of 1997, compared to approximately $371.6 million during the
same period of 1996 and were collateralized by investment securities with fair
values approximately equal
38
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
to the loan value. The weighted average interest rate on such borrowings was 5.6
percent and 5.4 percent during the first nine 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 September 30, 1997, after appropriate eliminations of
intercompany accounts among such subsidiaries (dollars in millions):
<TABLE>
<S> <C>
Statutory capital and surplus ............................. $1,583.2
Asset valuation reserve ("AVR")............................ 319.7
Interest maintenance reserve ("IMR")....................... 337.9
Portion of surplus debenture carried as a liability ....... 99.2
--------
Total................................................... $2,340.0
========
</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 11.3 percent at September 30, 1997,
and 9.8 percent at December 31, 1996.
Combined statutory net income of our life insurance subsidiaries included
in the Conseco Consolidated Statutory Statement (after appropriate eliminations
of intercompany amounts among such subsidiaries) was $204.9 million in the first
nine months of 1997 and $147.4 million in the first nine months of 1996.
The statutory capital and surplus of the insurance subsidiaries include
surplus debentures of the parent holding companies totaling $795.5 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 nine 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 nine months of 1997, our life
insurance subsidiaries paid ordinary dividends of $76.3 million to the parent
holding companies. During the remainder of 1997, the life insurance subsidiaries
may pay additional dividends of $98.5 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: (i) general economic conditions and other
factors, including prevailing interest rate levels, stock market performance and
health care inflation, which may affect the ability of the Company to sell its
products, the market value of the Company's investments and the lapse rate and
profitability of the Company's policies; (ii) the Company's ability to achieve
anticipated levels of operational efficiencies at recently acquired companies,
as well as through other cost-saving initiatives; (iii) customer response to new
products, distribution channels and marketing initiatives; (iv) mortality,
morbidity, usage of health care services and other factors which may affect the
profitability of the Company's insurance products; (v) changes in the federal
income tax laws and regulations which may affect the relative tax advantages of
some of the Company's products; (vi) increasing competition in the sale of the
Company's products; (vii) regulatory changes or actions, including those
relating to regulation of financial services affecting (among other things) bank
sales and underwriting of insurance products, regulation of the sale,
underwriting and pricing of insurance products, and health care regulation
affecting the Company's health insurance products; (viii) the availability and
terms of future acquisitions; and (ix) the risk factors or uncertainties listed
from time to time in the Company's other filings with the Securities and
Exchange Commission.
39
<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: December 4, 1997 By: /s/ JAMES S. ADAMS
------------------
James S. Adams
Senior Vice President,
Chief Accounting Officer
and Treasurer
40
