UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 8-K/A
CURRENT REPORT
Pursuant to Section 13 or 15 (d) of
the Securities Exchange Act of 1934
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Date of Report (Date of earliest event reported): June 30, 1998
CONSECO, INC.
(Exact name of registrant as specified in its charter)
Indiana 1-9250 35-1468632
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(State or other (Commission (I.R.S. Employer
jurisdiction of File Number) Identification No.)
organization)
11825 North Pennsylvania Street
Carmel, Indiana 46032
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(Address of principal executive offices) (Zip Code)
(317) 817-6100
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(Registrant's telephone number, including area code)
Not Applicable
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(Former name or former address,
if changed since last report.)
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CONSECO, INC. AND SUBSIDIARIES
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INDEX
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Page
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Item 2 - Acquisition or Disposition of Assets 3
Item 5 - Other Events 3
Item 7 - Financial Statements, Pro Forma Financial Information and Exhibits
(a) Financial Statements of Business Acquired.
The historical audited consolidated financial statements of Green
Tree Financial Corporation as of December 31, 1997 and 1996 and
for each of the three years ended December 31, 1997 are
incorporated by reference to Exhibit 99.3 filed herewith. 17
The unaudited consolidated financial statements of Green Tree
Financial Corporation as of March 31, 1998, and for the three
month periods ended March 31, 1998 and 1997 are incorporated by
reference to Exhibit 99.4 filed herein. 17
(b) Pro Forma Financial Information.
Pro Forma Combined Financial Statements of Conseco, Inc. and
Subsidiaries were filed with the Commission as Exhibit 99.1 to
the Registrant's Form 8-K dated June 3, 1998, and are
incorporated herein by this reference and are being filed
pursuant to General Instruction F to Form 8-K. 18
(c) Exhibits. 32
Exhibit 2.1 Agreement and Plan of Merger dated as of April 6,
1998, as amended, among Conseco, Inc., Marble
Acquisition Corp., a Delaware corporation and a
wholly owned subsidiary of Conseco, Inc. and Green
Tree Financial Corporation (composite conformed
copy included as Annex A to the Joint Proxy
Statement - Prospectus of Conseco, Inc. contained
within the Registration of Conseco, Inc. on Form
S-4 (File No. 333-51123) which Agreement and
Plan of Merger is incorporated herein by
reference).
Exhibit 12.1 Computation of Earnings to Fixed Charges
Exhibit 23.1 Consent of PricewaterhouseCoopers LLP
Exhibit 23.2 Consent of KPMG Peat Marwick LLP
Exhibit 23.3 Consent of PricewaterhouseCoopers LLP
Exhibit 27 Restated Financial Data Schedule
Exhibit 27.1 Restated Financial Data Schedule
Exhibit 27.2 Restated Financial Data Schedule
Exhibit 99.1 Supplemental Consolidated Financial Statements of
Conseco, Inc. as of December 31, 1997 and 1996, and
for each of the three years ended December 31,
1997.
Exhibit 99.2 Unaudited Supplemental Consolidated Financial
Statements of Conseco, Inc. as of March 31, 1998,
and for the three months ended March 31, 1998 and
1997.
Exhibit 99.3 Consolidated Financial Statements of Green Tree
Financial Corporation as of December 31, 1997 and
1996 and for each of the three years ended December
31, 1997.
Exhibit 99.4 Unaudited Consolidated Financial Statements of
Green Tree Financial Corporation as of March
31,1998, and for the three months ended March 31,
1998 and 1997.
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2
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ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS.
On June 30, 1998, Conseco, Inc. ("Conseco") completed the acquisition
(the "Merger") of Green Tree Financial Corporation ("Green Tree") pursuant to an
Agreement and Plan of Merger (the "Merger Agreement") dated as of April 6, 1998,
as amended, among Conseco, Marble Acquisition Corp., a Delaware corporation and
a wholly owned subsidiary of Conseco, and Green Tree. In the Merger, each share
of Green Tree's common stock, par value $.01 per share was converted into 0.9165
of a share of Conseco's common stock, no par value. Conseco issued approximately
124 million shares of Conseco common stock in exchange for all of Green Tree's
common shares and equivalents. After the Merger, Conseco's total common shares
outstanding increased to approximately 312 million. As a result of the Merger,
Green Tree became a wholly owned subsidiary of Conseco. The Merger will be
accounted for as a pooling of interests.
Green Tree is a diversified financial services company that provides
financing for manufactured homes, home equity, home improvements, consumer
products and equipment and provides consumer and commercial revolving credit.
Green Tree's insurance agencies market physical damage and term mortgage life
insurance and other credit protection relating to the customers' contracts Green
Tree services. Green Tree is the largest servicer of manufactured housing
contracts in the United States. Through its principal offices in Saint Paul,
Minnesota and service centers throughout the United States, Green Tree serves
all 50 states.
Green Tree pools and securitizes substantially all of the contracts it
originates, retaining the servicing on the contracts. Such pools are structured
into asset-backed securities which are sold in the public securities markets. In
servicing the contracts, Green Tree collects payments from the borrower and
remits principal and interest payments to the holder of the contract or investor
certificate backed by the contracts.
Green Tree was originally incorporated under the laws of the State of
Minnesota in 1975. In 1995, Green Tree reincorporated under the laws of the
State of Delaware. Green Tree's principal executive offices are located at 1100
Landmark Towers, 345 Saint Peter Street, Saint Paul, Minnesota 55102-1639, and
its telephone number is (612) 293-3400.
ITEM 5. OTHER EVENTS.
A. SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
As reported above under Item 2, on June 30, 1998, Conseco completed
its merger with Green Tree. The Merger was accounted for as a "pooling of
interests" under generally accepted accounting principles.
The following supplemental consolidated financial statements of
Conseco restating Conseco's historical consolidated financial statements as of
and for the three years ended December 31, 1997, to reflect the Merger are
incorporated herein by reference to Exhibit 99.1 filed herewith:
1. Management's Discussion and Analysis.
2. Consolidated Balance Sheet at December 31, 1997 and 1996.
3. Consolidated Statement of Operations for the years ended
December 31, 1997, 1996 and 1995.
4. Consolidated Statement of Shareholder's Equity for the years ended
December 31, 1997, 1996 and 1995.
5. Consolidated Statement of Cash Flows for the years ended December
31, 1997, 1996 and 1995.
6. Notes to Consolidated Financial Statements.
The report of PricewaterhouseCoopers LLP, independent accountants, on
the supplemental consolidated financial statements of Conseco as of December 31,
1997 and 1996, and for each of the three years ended December 31, 1997 is filed
herein as part of Exhibit 99.1 and the related consent is filed herein as
Exhibit 23.1. Both the opinion and consent are incorporated herein by reference.
The following unaudited supplemental interim consolidated financial
statements of Conseco restating Conseco's historical unaudited consolidated
financial statements as of March 31, 1998, and for the three months ended March
31, 1998 and 1997, to reflect the Merger are incorporated herein by reference to
Exhibit 99.2 filed herein.
1. Consolidated Balance Sheet at March 31, 1998 (unaudited) and
December 31, 1997.
2. Consolidated Statement of Operations for the three months ended
March 31, 1998 and 1997 (unaudited).
3. Consolidated Statement of Shareholder's Equity for the three
months ended March 31, 1998 and 1997 (unaudited).
4. Consolidated Statement of Cash Flows for the three months ended
March 31, 1998 and 1997 (unaudited).
5. Notes to the Consolidated Financial Statements (unaudited).
3
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B. BUSINESS OF GREEN TREE
Green Tree Financial Corporation ("Green Tree" or the "Company" as used in
Item 5.B herein) is a diversified financial services company with operations
serving customers in the consumer finance, commercial finance and insurance
markets. Through its principal offices in Saint Paul, Minnesota and service
centers throughout the United States, Green Tree serves all 50 states.
The Company originates a variety of fixed term financing transactions on either
a "direct" or "indirect" basis. Under an "indirect" financing transaction, a
dealer sells a product to a customer and enters into a sales contract with the
customer evidencing a monetary obligation and providing security for that
obligation. The Company purchases such sales contracts from dealers and
contractors in the ordinary course of its business. Under a "direct"
origination, the Company and borrower are direct parties to the loan
documentation which evidences the borrower's obligation to the Company.
References herein to the terms "contracts," "sales contracts" or "loans" may be
used to refer to either "direct" or "indirect" financing transactions as the
context requires. Reference herein to the term "finance volume" refers to the
dollar amount of loans originated by the Company in a given period. All direct
or indirect originations are written on forms provided or approved by the
Company and are originated or purchased on an individually approved basis in
accordance with Company underwriting guidelines.
The Company provides commercial revolving credit to dealers, manufacturers and
distributors of various consumer and commercial products and provides consumer
revolving credit through selected merchants and dealers. Pursuant to the terms
of such revolving credit agreements, the Company funds product inventory or
customer purchases. Typically inventory products secure the commercial
revolving credit transactions. Reference herein to the term "revolving credit"
may be used in reference to commercial finance, floorplan receivables, asset-
based receivables or retail credit.
Green Tree pools and securitizes substantially all of the contracts it
originates, retaining the servicing on the contracts. Such pools are structured
into asset-backed securities which are primarily sold in the public securities
markets. In the servicing contracts, the Company collects payments from the
borrower and remits principal and interest payments to the holder of the
contract or investor certificate backed by the contracts. References herein to
the term "managed finance receivables" refers to the total dollar amount of
loans serviced as of a certain point in time without regard to whether or not
the loans have been securitized.
The Company was originally incorporated under the laws of the State of Minnesota
in 1975. In 1995, the Company reincorporated under the laws of the State of
Delaware. Green Tree Financial Corporation's principal executive offices are
located at 1100 Landmark Towers, 345 Saint Peter Street, Saint Paul, Minnesota
55102-1639, and its telephone number is (612) 293-3400. Unless the context
otherwise requires, "Green Tree" or the "Company" means Green Tree Financial
Corporation and its subsidiaries.
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Consumer Financing Activities
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Manufactured Housing
"Manufactured housing" (MH) or a "manufactured home" is a structure,
transportable in one or more sections, which is designed to be a dwelling with
or without a permanent foundation. Since most manufactured homes are never
moved once the home has reached the homesite, the wheels and axles are removable
and have not been designed for continuous use. Manufactured housing does not
include either modular housing (which typically involves more sections, greater
assembly and a separate means of transporting the sections) or recreational
vehicles ("RV's") (which are either self-propelled vehicles or units towed by
passenger vehicles).
The majority of the Company's sales contracts for manufactured home purchases
are financed on a conventional basis, with a small number of units insured by
the FHA or partially guaranteed by the VA. With respect to manufactured
housing, the relative volume of conventional, FHA or VA contracts originated by
the Company depends on customer and dealer preferences as well as prevailing
market conditions. The Company has developed more cost effective conventional
manufactured housing lending programs and as a result, FHA and VA contracts
represented less than 1% of the Company's manufactured housing originations
during 1997. FHA and VA contracts constituted 5% of the Company's servicing
portfolio at December 31, 1997. Manufactured housing contracts are generally
subject to minimum down payments of at least 5% of the amount financed. The
Company offers manufactured housing contract terms of up to 30 years.
Through its regional service centers, the Company arranges to purchase MH
contracts from MH dealers located throughout the United States. The Company's
regional service center personnel contact dealers located in their region and
explain the Company's available financing plans, terms, prevailing rates, and
credit and financing policies. If the dealer wishes to utilize the Company's
available customer financing, the dealer must make an application for dealer
approval. Upon satisfactory results of the Company's investigation of the
dealer's creditworthiness and general business reputation, the Company and the
dealer execute a dealer agreement. The Company also originates manufactured
housing installment loan agreements directly with customers. For the year ended
December 31, 1997, the Company's manufactured housing contract originations
consisted of 79% purchased from dealers, and 21% directly originated by the
Company.
The dealer or the customer submits the customer's credit application and, with
respect to new manufactured homes, the purchase order to a central or regional
service center where Company personnel make an analysis of the creditworthiness
of such customer. If the application meets the Company's guidelines and credit
is approved, the Company generally purchases the contract after the manufactured
home is delivered and set up and the customer has moved in.
For manufactured housing contracts, the Company uses a proprietary automated
credit scoring system. The scoring system is statistically based, quantifying
information using variables obtained from customer credit applications and
credit reports. As of December 31, 1997, this credit scoring system has been
used in making credit determinations on over three million applications.
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Home Equity
The Company originates home equity loans through a system of retail satellite
offices and regional centers, and through a network of correspondent lenders.
As of December 31, 1997, the Company marketed home equity loan products directly
to consumers from 75 retail satellite offices and six regional centers located
throughout the United States. The satellite offices are responsible for
originating, processing, underwriting and funding the loan transaction.
Subsequently, loans are re-underwritten in the regional service center and on a
test basis by a third party to ensure compliance with policy. Upon completion
of the loan closing, the loan package is forwarded to the Company's loan
servicing center located in Tempe, Arizona. The servicing center is responsible
for handling customer service and loan functions, as well as performing document
handling, custodial and quality control functions.
During 1997, approximately 50% of the Company's home equity finance volume
resulted from the Company's marketing personnel working directly with consumers.
The remaining finance volume was the result of transactions between the Company
and correspondents, with a much smaller percentage of transactions occurring
between the Company and brokers. (The purchases from correspondents typically
occur on a monthly basis either on a flow or bulk basis from a network of
approximately 75 correspondents.) The Company re-underwrites each of the loan
documents forwarded from correspondents to ensure compliance with the Company's
underwriting, grading and pricing policies.
Typically, home equity loans are secured by first or second liens on site-built
homes. Homes used for collateral in securing home equity loans may be either
residential or investor owned one-to-four-family properties having a minimum
appraised value of $25,000. During 1997 and 1996, approximately 75% of the
loans originated were secured by first liens. The average loan to value for the
same period for the loans originated was approximately 85%. The majority of the
Company's home equity loans are fixed rate closed end loans. The Company
periodically purchases adjustable rate loans from its correspondent network.
Adjustable rate loans accounted for 15% of the Company's home equity finance
volume during 1997.
Home Improvement
The Company originates the majority of its home improvement loan contracts
indirectly through a network of home improvement contractors located throughout
the United States. The Company has a contractor approval process pursuant to
which the financial condition, business experience and qualifications of the
contractor are reviewed prior to his or her approval to sell contracts to the
Company.
The Company finances both conventional home improvement (HI) contracts and HI
contracts insured through the FHA Title I program. Such contracts are generally
secured by first, second or, to a lesser extent, third liens on the improved
real estate. The Company has also implemented an unsecured conventional HI
lending program for certain customers which generally allows for loan amounts
ranging from $2,500 to $15,000. Unsecured loans account for less than 10% of
the home improvement servicing portfolio.
Typically, the approved contractor submits the customer's credit application and
construction contract to the Company's centralized service center, where an
analysis of the creditworthiness of the customer is made using a proprietary
credit scoring system that was implemented by the
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Company in 1993. If it is determined that the application meets the Company's
underwriting guidelines and applicable FHA regulations (for FHA-insured
contracts) and the credit is approved, the Company purchases the contract from
the contractor generally when the customer verifies satisfactory completion of
the work.
During 1997, the Company launched a direct-to-consumer origination channel for
home improvement loans. Through a direct mail solicitation campaign, the
customer calls the Company's telemarketing center and the Company's sales
representative explains to the customer the available financing plans, terms and
rates depending on the customers needs. The majority of the loans are secured
by a second or third lien on the real estate of the customer. This direct
channel resulted in approximately 5% of the home improvement finance volume
during 1997.
The types of home improvements financed by the Company include exterior
renovations, such as windows, siding and roofing; pools and spas; kitchen and
bath remodeling; and room additions and garages. The Company may also, under
certain limited conditions, extend additional credit beyond the purchase price
of the home improvement for the purpose of debt consolidation.
Consumer Products
Green Tree provides consumer financing for the purchase of marine products
(including boats, boat trailers and outboard motors); motorcycles; recreational
vehicles; sport vehicles (including snowmobiles, personal watercraft and all-
terrain vehicles); pianos and organs; and horse and utility trailers.
The Company arranges to purchase certain contracts originated by dealers
throughout the United States. The Company's personnel contact dealers and
explain Green Tree's available financing plans, terms, prevailing rates and
credit and financing policies. If the dealer wishes to utilize the Company's
available customer financing, the dealer must complete an application for
approval.
The approved dealer submits the customer's credit application and purchase order
to the Company's central service center where an analysis of the
creditworthiness of the proposed buyer is made. If the application meets the
Company's guidelines and credit is approved, the Company purchases the contract
when the customer completes the purchase transaction with the dealer.
Revolving Credit Card
The Company began offering a private label retail credit program in 1996 and has
entered into program agreements with selected retailers to provide competitive
credit card services to the customers of such retailers. Green Tree chartered a
limited purpose credit card bank to conduct its credit card business. The bank,
Green Tree Retail Services Bank, is a state chartered bank located in Rapid
City, South Dakota. The Company has a retailer approval process pursuant to
which the financial condition, business experience and customer service
reputation are reviewed. The Company also underwrites the credit of individual
customers for approval utilizing a credit scoring system.
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On November 2, 1997, the Company chartered a Utah industrial loan company, Green
Tree Capital Bank, Inc. ("Capital Bank"). This entity has the authority to
engage generally in the banking business, including the acceptance of all types
of deposits, other than demand deposits. Consumer retail credit card business
was first conducted in the Capital Bank in January 1998.
Commercial Financing Activities
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Commercial
Through its three regional lending centers, the Company extends credit generally
under revolving credit agreements with dealers, manufacturers and distributors
("Dealer") of various consumer and commercial products. "Floorplan Receivables"
represent the financing of product inventory for retail dealers of a variety of
consumer products. The products securing the Floorplan Receivables currently
include manufactured housing, recreational vehicles and marine products.
"Asset-Based Receivables" generally represent the financing of production and
inventory by manufacturers, such revolving credit arrangements being secured by
finished goods inventory, accounts receivable rising from the sale of such
inventory, certain work-in-process, raw materials and component parts, as well
as other assets of the borrower, and may include real estate.
The Company will provide floorplan financing for products for a particular
dealer or distributor, in most instances, only if the Company has also entered
into a floorplanning agreement with the manufacturer, distributor or other
vendor of such product. A Dealer requesting the establishment of a credit line
with Green Tree is required to submit an application and financial information.
Advances made for the purchase of inventory are most commonly arranged in the
following manner: the Dealer will contact the manufacturer and place a purchase
order for a shipment of inventory. If the manufacturer has been advised that
Green Tree is the Dealer's inventory financing source, the manufacturer will
contact Green Tree to obtain an approval number with respect to such purchase
order. Upon such request, the Company will determine whether (i) the
manufacturer is in compliance with its floorplan agreement, (ii) the Dealer is
in compliance with its program with Green Tree and (iii) such purchase order is
within the Dealer's credit limit. If all of such requirements are met, the
Company will issue an approval number to the manufacturer. The manufacturer
will then ship the inventory and directly submit its invoice for such purchase
order to Green Tree for payment. Interest or finance charges normally begin to
accrue on the Dealer's accounts as of the invoice date. The proceeds of the
loan being made by the Company to the Dealer are paid directly to the
manufacturer in satisfaction of the invoice price and are often funded a number
of days subsequent to the invoice date depending upon the Company's arrangements
with the manufacturer. Inventory inspections are frequently performed to
physically verify the collateral used to secure a Dealer's loan, check the
condition of the inventory, account for any missing inventory and collect any
funds due. Approximately two-thirds of Green Tree's MH dealers are participants
in this program.
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Asset-Based Receivables are credit facilities provided to certain manufacturers
and distributors which typically involve a revolving line of credit, for a
contractually committed period of time, pursuant to which the borrower may draw
the lesser of the maximum amount of such line of credit or a specifically
negotiated loan availability amount, subject to the availability of adequate
collateral. The loan availability amount is determined by multiplying an agreed
upon advance rate against the value of certain types of assets. In these
facilities, Green Tree will most typically lend against finished inventory and
eligible accounts receivable arising from the sale of such inventory which are
free and clear of other liens and otherwise in compliance with specified
standards. Certain Asset-Based Receivables may also be secured by real estate.
Equipment
The Company's equipment finance operations provide financing programs for
commercial borrowers, including truck and trailer financing for over the road
new and used class eight trucks/tractors and new and used trailers. In
addition, financing is provided on various types of new and used aircraft, from
small single engine pistons to multi-jet engine aircraft. Financing or lease
agreements for office automation equipment (e.g., telecommunication systems,
facsimile machines, copiers) and other equipment types, and fixed rate financing
for the land, building or equipment of franchise operations are also available.
Company sales personnel contact equipment dealers or vendors and provide an
explanation of the available financing plans offered, including terms,
prevailing interest rates, credit guidelines, residual purchase options, and
financing policies. The dealer or vendor submits an application for approval if
the dealer or vendor wishes to utilize Green Tree available financing for their
commercial customer.
Upon receipt of a customer's credit application and purchase order from the
dealer or vendor, the Company analyzes the creditworthiness of the applicant.
If the application meets the Company's guidelines and credit is approved, the
Company purchases the sales contract or lease equipment at the time the customer
accepts delivery of the product. Customer service, collection and other
administrative and support functions for the Company's equipment operations are
handled from the Company's offices in Saint Paul and Bloomington, Minnesota and
in Paramus, New Jersey.
Other Activities
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Insurance
Through certain subsidiaries, the Company markets physical damage insurance on
manufactured homes, certain consumer and equipment products and dealer inventory
which collateralize contracts and receivables serviced by the Company. The
Company also markets term mortgage and credit life insurance to its manufactured
housing, home improvement, home equity and equipment finance customers and
provides retail credit insurance to consumer cardholders. In addition, the
Company owns a reinsurance subsidiary which functions as a reinsurer for
policies written by selected other insurers covering individuals whose contracts
are serviced by the Company.
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The following table provides certain information with respect to new written
premiums (gross premiums on new or renewal policies issued less cancellations of
previous policies) on policies written by the Company. The Company acts as an
agent with respect to the sale of such policies and, in some cases, the Company
also acts as reinsurer of such policies.
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Year ended December 31
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1997 1996 1995 1994 1993
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<S> <C> <C> <C> <C> <C>
(dollars in thousands)
Net written premiums:
Physical damage $109,623 $ 91,883 $82,438 $63,979 $48,172
Credit/Mortgage Insurance 13,534 12,125 10,154 7,240 5,683
-------------- -------------- -------------- -------------- --------------
Total $123,157 $104,008 $92,592 $71,219 $53,855
============== ============== ============== ============== ==============
</TABLE>
Managed Finance Receivables
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The Company services all of the fixed term and revolving credit receivables that
it originates or purchases from other originators, collecting loan payments,
taxes and insurance payments, where applicable, and other payments from
borrowers and remitting principal and interest payments to the holders of its
asset-backed securities.
The following table reflects the composition of the Company's managed finance
receivables at December 31, for the years indicated.
<TABLE>
<CAPTION>
December 31
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1997 1996 1995 1994 1993
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<S> <C> <C> <C> <C> <C>
(dollars in millions)
Fixed term $ 26,036 $ 18,965 $ 13,314 $ 9,653 $ 7,194
Revolving credit 1,921 1,108 574 168 --
---------------- -------------- -------------- -------------- --------------
Total $ 27,957 $ 20,073 $ 13,888 $ 9,821 $ 7,194
================ ============== ============== ============== ==============
Number of fixed term
contracts serviced 1,076,000 827,000 657,000 512,000 406,000
Number of revolving credit
accounts serviced 700,000 180,000 23,000 8,000 --
</TABLE>
Credit Quality
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The Company considers revolving credit receivables with any due and unpaid
balance and fixed term receivables with any due and unpaid balance of $25 or
more to be delinquent. Beginning in 1996, certain receivables for which the
obligor was in bankruptcy but was current under their court-approved bankruptcy
payment plan were generally not considered delinquent. Delinquent receivables
are subject to acceleration and repossession or foreclosure of the underlying
collateral.
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The following table provides certain information with respect to the 60-days-
and-over contractual dollar delinquency, loss experience and repossessed
collateral for the Company's managed finance receivables as of December 31, for
the years indicated.
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<CAPTION>
1997 1996 1995
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<S> <C> <C> <C>
Delinquency (a)
Manufactured Housing 1.22% 1.19% .96%
Home Equity/Improvement .88% .85% .56%
Other Consumer 1.24% .94% .84%
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Total Consumer Lending 1.15% 1.13% .92%
Commercial Lending .55% .61% 1.81%
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Total 1.08% 1.08% .93%
============= ============= =============
Net Credit Losses (b)
Manufactured Housing 1.15% .76% .56%
Home Equity/Improvement .69% 1.12% .59%
Other Consumer 1.20% .52% .46%
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Total Consumer Lending 1.07% .77% .56%
Commercial Lending .75% .44% .04%
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Total 1.04% .74% .56%
============= ============= =============
Repossessed Collateral (c)
Manufactured Housing 1.04% .93% .65%
Home Equity/Improvement .71% .23% .09%
Other Consumer .69% .51% .35%
------------- ------------- -------------
Total Consumer Lending .95% .84% .60%
Commercial Lending 1.00% 1.26% .27%
------------- ------------- -------------
Total .95% .85% .58%
============= ============= =============
</TABLE>
(a) As a percentage of managed finance receivables at period end, excluding
receivables already in repossession or foreclosure.
(b) As a percentage of average managed finance receivables during the period,
net of recoveries.
(c) Includes receivables in the process of foreclosure and repossessed
collateral in process of liquidation as a percentage of managed receivables
at period end.
Prior to 1997, the Company reported delinquency information separately for fixed
term contracts and commercial and consumer revolving credit. Fixed term
contracts were based on the number of contracts delinquent and commercial and
consumer revolving credit was based on the dollar amount delinquent. In 1997,
the Company began reporting delinquencies based on dollars by product line. The
1996 and 1995 delinquency information has been restated for comparative
purposes. As of December 31, 1994 and 1993, the number of fixed term contracts
delinquent as a percentage of average fixed term contracts outstanding was .70%
and .77%, respectively. The commercial and consumer revolving credit
receivables were not significant in 1994 and 1993.
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Prior to 1997, the Company reported loss experience and repossessed collateral
information for its fixed term contracts. In 1997, the Company began reporting
this information on the basis of product line. Information for 1996 and 1995
has been restated for comparative purposes. Credit losses for fixed term
contracts in 1994 and 1993 were .63% and .85%, respectively. Losses related to
revolving credit during 1994 and 1993 were not significant. The number of
repossessed collateral units as a percentage of the total number of fixed term
contracts serviced as of December 31, 1994 and 1993 was .43% and .51%,
respectively. Repossessed collateral relating to revolving credit assets as of
these dates were not significant.
Finance Volume
- - --------------
Consumer and commercial finance volume originated by the Company during each of
the past five years is indicated below:
<TABLE>
<CAPTION>
Year ended December 31
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1997 1996 1995 1994 1993
----------------- ----------------- --------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C>
(dollars in thousands)
Manufactured
Housing $ 5,479,290 $ 4,882,018 $4,159,836 $3,201,491 $2,449,121
Home Equity/Home
Improvement 3,476,229 1,493,720 626,986 465,523 169,443
Consumer/
Retail Credit 1,510,918 835,578 361,449 96,131 47,306
----------------- ----------------- --------------- ---------------- ----------------
Total Consumer $10,466,437 $ 7,211,316 $5,148,271 $3,763,145 $2,665,870
Commercial/
Equipment 5,181,362 3,343,000 1,742,704 302,419 136
----------------- ----------------- --------------- ---------------- ----------------
Total $15,647,799 $10,554,316 $6,890,975 $4,065,564 $2,666,006
================= ================= =============== ================ ================
</TABLE>
The Company believes that, in addition to an individual analysis of each
contract, it is important to achieve a geographic dispersion of contracts in
order to reduce the impact of regional economic conditions on the overall
performance of the Company's portfolio. Accordingly, the Company seeks to
maintain a portfolio of contracts dispersed throughout the United States. At
December 31, 1997, no state accounted for more than 10% of all contracts
serviced by the Company. In addition, no single contractor, dealer, or vendor
accounted for more than 5% of the total dollar volume of contracts originated by
the Company.
Securitized Asset Sales
- - -----------------------
The Company regularly pools contracts for sale to investors. It is the
Company's policy to sell substantially all of the contracts it originates or
purchases through asset-backed securities.
Manufactured housing, home equity, home improvement, consumer and equipment
finance contracts and leases are pooled and sold by the Company through
securitized asset sales which have been either single class or
senior/subordinate pass-through structures. Under its securitized sale
structures, the Company has provided a variety of forms of credit enhancements.
While such credit enhancements generally take the form of corporate guarantees,
they have also
12
<PAGE>
included bank letters of credit, surety bonds, cash deposits or other equivalent
collateral. The Company analyzes the cash flows unique to each transaction, as
well as the marketability, earnings potential and risk transference of such
transactions when choosing the appropriate structure for each securitized loan
sale. The structure of each securitized sale depends, to a great extent, on
conditions of the fixed income markets at the time of sale as well as cost
considerations and availability and effectiveness of the various enhancement
methods. Customer principal and interest payments are deposited in separate bank
accounts as received by the Company and are held for monthly distribution to the
certificateholders.
In previous years Green Tree sold a substantial portion of its interest only
securities, representing net cash flows retained from the securitization of its
manufactured housing contracts, in the form of securitized Net Interest Margin
Certificates ("NIM Certificates") through public offerings. A subordinated
interest in those certificates was retained by the Company. As a result of
these transactions, certain net cash flows that formerly were retained by Green
Tree are now passed through to investors. Payments on the subordinated interests
retained do not commence until the senior certificateholders have been paid all
principal and interest due them under the terms of the transaction.
The Company securitizes a majority of its commercial finance and credit card
receivables through revolving trust structures which generally include the
issuance of senior/subordinate bonds with contractual terms to maturity. As
such, the principal balance of the bonds does not receive any paydowns until
such time as either the contractual revolving period has ended and the bonds
have entered an amortization period or an early amortization event has occurred.
Early amortization events as detailed in the various trusts include, among
others, asset quality tests, asset turn rate tests, requirements as to the
minimum required amount of receivables and/or cash maintained within the trust,
and the occurrence of an event of default with respect to the Company.
Information on the Company's securitized asset sales is as follows:
<TABLE>
<CAPTION>
Year ended December 31
---------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
(dollars in millions)
Contracts sold:
Manufactured Housing $ 5,370 $5,033 $4,020 $3,226 $2,303
Home Equity/Home
Improvement 3,020 1,324 579 544 43
Consumer/Equipment 1,627 1,556 -- -- --
------------- ------------ ------------ ------------ ------------
10,017 7,913 4,599 3,770 2,346
NIM Certificates -- -- 308 600 --
Floorplan/Asset-Based 74 500 428 -- --
Lease 508 -- -- -- --
Revolving Credit Card 150 -- -- -- --
------------- ------------ ------------ ------------ ------------
Total $10,749 $8,413 $5,335 $4,370 $2,346
============= ============ ============ ============ ============
</TABLE>
13
<PAGE>
Regulation
- - ----------
The Company's operations are subject to supervision by various state authorities
(typically state mortgage lending, financial institutions, consumer credit and
insurance authorities) that generally require that the Company be licensed to
conduct its business. In many states, issuance of licenses is dependent upon a
finding of public convenience, and of financial responsibility, character and
fitness of the applicant. The Company is generally subject to state
regulations, examinations and reporting requirements, and licenses are revocable
for cause.
Contracts insured under the FHA Title I manufactured home and home improvement
lending programs are subject to compliance with detailed federal regulations
governing originations, servicing, and loss claim payments by the FHA to cover a
portion of losses due to default and repossessions or foreclosures. Other
governmental programs such as VA also contain similar detailed regulations
governing loan origination and servicing responsibilities.
The Federal Consumer Credit Protection Act ("FCCPA") requires, among other
things, a written disclosure showing the cost of credit to debtors when consumer
credit contracts are executed. The Federal Equal Credit Opportunity Act
requires certain disclosures to applicants for credit concerning information
that is used as a basis for denial of credit and prohibits discrimination
against applicants with respect to any aspect of a credit transaction on the
basis of sex, race, color, religion, national origin, age, marital status,
derivation of income from a public assistance program, or the good faith
exercise of a right under the FCCPA, of which it is a part. By virtue of a
Federal Trade Commission rule, consumer credit contracts must contain a
provision that the holder of the contract is subject to all claims and defenses
which the debtor could assert against the seller, but the debtor's recovery
under such provisions cannot exceed the amount paid under the contract.
The Company is also required to comply with other federal disclosure laws for
certain of its lending programs. The home equity lending program, the
combination land-and-home program, the land-in-lieu program and the home
improvement lending program are subject to the Federal Real Estate Settlement
and Procedures Act. In addition, the Company is subject to the reporting
requirements of the Home Mortgage Disclosure Act for its manufactured home,
purchase money mortgage and home improvement lending products.
The construction of manufactured housing is subject to compliance with
governmental regulation. Changes in such regulations may occur from time to
time and such changes may affect the cost of manufactured housing. The Company
cannot predict whether any regulatory changes will occur or what impact such
future changes would have on the manufactured housing industry.
The Company is subject to state usury laws. Generally, state law has been
preempted by federal law with respect to certain manufactured home, mortgage
lending and home improvement products, although certain states have enacted
legislation superseding federal law. To be eligible for the federal preemption,
the Company's contract form must comply with certain consumer protection
provisions. The Company offers its products within the limitations set by the
state usury laws and federal preemption of these laws.
14
<PAGE>
The Company has chartered both a limited purpose credit card bank, Green Tree
Retail Services Bank ("Retail Bank"), and a Utah industrial loan company, Green
Tree Capital Bank, Inc. ("Capital Bank"). Both Retail Bank and Capital Bank are
regulated by the Federal Deposit Insurance Corporation. Retail Bank is regulated
by the South Dakota Department of Banking and Capital Bank is regulated by the
Utah Department of Financial Institutions. The ownership of these entities does
not subject the Company to regulation by the Federal Reserve Board as a bank
holding company. Retail Bank is authorized only to engage in the credit card
business and may issue certificates of deposit in denominations of $100,000 or
greater. Capital Bank has the authority to engage generally in the banking
business and may accept all types of deposits, other than demand deposits if the
assets of the industrial loan company exceed $100 million. Generally state laws
relating to permissible interest rates and fees have been preempted by federal
law applicable to both Retail Bank and Capital Bank, although certain states
have enacted or may in the future enact legislation superseding federal law.
The regulatory procedures discussed above are subject to changes by the
regulatory authorities. There are no assurances that future regulatory changes
will not occur. These regulatory changes could place additional burdens on the
Company's programs.
Competition and Other Factors
- - -----------------------------
The Company is affected by consumer demand for manufactured housing, home equity
financing, home improvements, consumer and equipment products, and consumer and
commercial revolving credit as well as its insurance products. Consumer and
commercial demand, in turn, are partially influenced by regional trends,
economic conditions and personal preferences. The Company competes primarily
with banks, finance companies, savings and loan associations, and credit unions.
The Company competes by offering superior service, prompt credit review and
integrated financing programs.
Prevailing interest rates are typically affected by economic conditions.
Changes in rates, however, generally do not inhibit the Company's ability to
compete for loan originations, although from time to time in particular
geographic areas, local competition may choose to offer more favorable rates.
In addition, in a falling interest rate environment the Company's servicing
portfolio is more susceptible to the refinancing initiatives of competitors,
although the Company has initiated programs to mitigate such activity.
The Company's business is generally subject to seasonal trends, reflecting the
general pattern of sales of manufactured housing and site-built homes. Sales
typically peak during the spring and summer seasons and decline to lower levels
from mid-November through January.
15
<PAGE>
C. LEGAL PROCEEDINGS OF GREEN TREE
-------------------------------
Green Tree Financial Corporation (the"Company", as used in Item 5.c.)
has been served with various related lawsuits which were filed against
the Company in United States District Court for the District of Minnesota.
These lawsuits were filed by certain stockholders of the Company as
purported class actions on behalf of persons or entities who purchased
common stock of the Company during the alleged class periods that
generally run from February 1995 to January 1988. One such action did
not include class action claims. In addition to the Company, certain
current and former officers and directors of the Company are named as
defendants in one or more of the lawsuits. The Company and other defendants
intend to seek consolidation in the United States District Court for the
District of Minnesota of each of the lawsuits seeking class action status.
Plaintiffs in the lawsuits assert claims under Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934. In each case, plaintiffs allege that the
Company and the other defendants violated federal securities laws by, among
other things, making false and misleading statements about the current state
and future prospects of the Company (particularly with respect to prepayment
assumptions and performance of certain of the Company's loan portfolios) which
allegedly rendered the Company's financial statements false and misleading The
Company believes that the lawsuits are without merit and intends to defend such
lawsuits vigorously.
In addition, the nature of the Company's business is such that it is routinely a
party or subject to items of pending or threatened litigation. Although the
ultimate outcome of certain of these matters cannot be predicted, management
believes, based upon information currently available, that the resolution
of these routine legal matters will not result in any material adverse
effect on its consolidated financial condition.
16
<PAGE>
Item 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS
(a) Financial Statements of Business Acquired.
The historical audited consolidated financial statements of Green
Tree Financial Corporation as of December 31, 1997 and 1996 and
for each of the three years ended December 31, 1997 are
incorporated by reference to Exhibit 99.3 filed herewith.
The unaudited consolidated financial statements of Green Tree
Financial Corporation as of March 31, 1998, and for the three
month periods ended March 31, 1998 and 1997 are incorporated by
reference to Exhibit 99.4 filed herein.
17
<PAGE>
(b) Pro Forma Financial Information.
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS OF CONSECO, INC.
On April 6, 1998, Conseco, Inc. ("Conseco") and Green Tree Financial
Corporation ("Green Tree") entered into an Agreement and Plan of Merger pursuant
to which Green Tree would become a wholly owned subsidiary of Conseco (the
"Merger"). The following unaudited pro forma combined balance sheet as of March
31, 1998, combines the historical combined balance sheets of Conseco and Green
Tree as if the Merger had been effective on March 31, 1998, after giving effect
to certain adjustments described in the accompanying notes to the unaudited pro
forma combined financial information.
The unaudited pro forma combined statements of operations for the three
months ended March 31, 1998 and 1997, and for each of the three years ended
December 31, 1997, present the combined results of operations of Conseco and
Green Tree as if the Merger had been effective at the earliest period presented.
The unaudited pro forma combined financial information and accompanying
notes reflect the application of the pooling of interests method of accounting
for the Merger. Under this method of accounting, the recorded assets,
liabilities, shareholders' equity, income and expense of Conseco and Green Tree
are combined and reflected at their historical amounts.
The unaudited pro forma combined financial statements are based on the
historical financial statements of Conseco and Green Tree and are qualified in
their entirety by, and should be read in conjunction with, these financial
statements and the notes thereto. The unaudited pro forma combined financial
statements are not necessarily indicative of the results of operations or the
combined financial position that would have resulted had the Merger been
consummated at the beginning of the period indicated, nor are they necessarily
indicative of future results of operations or financial position.
18
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
March 31, 1998
(Dollars in millions)
ASSETS
PRO FORMA
CONSECO GREEN TREE ADJUSTMENTS COMBINED
------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Investments:
Actively managed fixed maturities at fair value.................. $22,968.9 $ - $ - $22,968.9
Equity securities at fair value.................................. 263.4 - - 263.4
Interest only securities......................................... - 1,412.3 - 1,412.3
Finance receivables.............................................. - 2,154.6 - 2,154.6
Mortgage loans................................................... 474.2 - - 474.2
Credit-tenant loans.............................................. 596.6 - - 596.6
Policy loans..................................................... 691.7 - - 691.7
Other invested assets ........................................... 534.8 19.1 - 553.9
Short-term investments........................................... 837.7 888.7 - 1,726.4
Assets held in separate accounts................................. 675.2 - - 675.2
--------- -------- ------ ---------
Total investments.......................................... 27,042.5 4,474.7 - 31,517.2
Accrued investment income............................................ 399.9 - - 399.9
Other receivables.................................................... - 228.5 - 228.5
Servicing rights..................................................... - 111.8 - 111.8
Cost of policies purchased........................................... 2,442.6 - - 2,442.6
Cost of policies produced............................................ 1,022.5 - - 1,022.5
Reinsurance receivables.............................................. 761.8 - - 761.8
Income tax assets.................................................... 42.4 - (42.4) (2) -
Goodwill............................................................. 3,604.9 55.4 - 3,660.3
Property and equipment............................................... 176.0 121.2 - 297.2
Cash deposits, restricted............................................ - 234.2 - 234.2
Other assets......................................................... 431.3 29.4 - 460.7
--------- -------- ------ ---------
Total assets............................................... $35,923.9 $5,255.2 $(42.4) $41,136.7
========= ======== ====== =========
(continued on next page)
The accompanying notes are an integral
part of the unaudited pro forma combined financial
statements.
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED BALANCE SHEET (Continued)
March 31, 1998
(Dollars in millions)
LIABILITIES AND SHAREHOLDERS' EQUITY
PRO FORMA
CONSECO GREEN TREE ADJUSTMENTS COMBINED
------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
Liabilities:
Insurance liabilities:
Interest sensitive products................................... $17,320.6 $ - $ - $17,320.6
Traditional products.......................................... 5,758.0 - - 5,758.0
Claims payable and other policyholder funds................... 1,617.3 - - 1,617.3
Unearned premiums............................................. 409.1 - - 409.1
Liabilities related to separate accounts...................... 675.2 - - 675.2
Investment borrowings............................................ 1,196.1 - - 1,196.1
Investor payables................................................ - 653.3 - 653.3
Other liabilities................................................ 1,223.4 556.2 240.0 (3) 2,019.6
Income tax liabilities........................................... - 637.4 (42.4) (2) 595.0
Notes payable and commercial paper:
Corporate...................................................... 2,435.1 - - 2,435.1
Related to finance receivables................................. - 2,059.1 - 2,059.1
--------- -------- ------- ---------
Total liabilities.......................................... 30,634.8 3,906.0 197.6 34,738.4
--------- -------- ------- ---------
Minority interest:
Company-obligated mandatorily redeemable
preferred securities of subsidiary trust...................... 1,388.1 - - 1,388.1
Common stock of subsidiary....................................... .7 - - .7
Shareholders' equity:
Preferred stock.................................................. 115.8 - - 115.8
Common stock and additional paid-in capital...................... 2,397.0 446.6 (222.6) (4) 2,621.0
Accumulated other comprehensive income:
Unrealized appreciation of fixed maturity investments......... 159.0 - - 159.0
Unrealized appreciation of other investments.................. 10.9 .9 - 11.8
Minimum pension liability adjustment.......................... - (3.1) - (3.1)
Less treasury shares at cost..................................... - (222.6) 222.6 (4) -
Retained earnings................................................ 1,217.6 1,127.4 (240.0) (3) 2,105.0
--------- -------- ------- ---------
Total shareholders' equity................................. 3,900.3 1,349.2 (240.0) 5,009.5
--------- -------- ------- ---------
Total liabilities and shareholders' equity................. $35,923.9 $5,255.2 $ (42.4) $41,136.7
========= ======== ======= =========
The accompanying notes are an integral
part of the unaudited pro forma combined financial
statements.
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
for the three months ended March 31, 1998
(Dollars in millions, except per share data)
PRO FORMA
CONSECO GREEN TREE ADJUSTMENTS COMBINED
------- ---------- ----------- --------
<S> <C> <C> <C> <C>
Revenues:
Insurance policy income:
Traditional products............................................. $ 859.4 $ - $ 859.4
Interest sensitive products...................................... 130.7 - 130.7
Net investment income............................................... 583.3 101.0 684.3
Gain on sale of receivables......................................... - 129.1 129.1
Net investment gains................................................ 104.8 - 104.8
Fee revenue and other income........................................ 20.8 55.7 76.5
-------- ------ --------
Total revenues.............................................. 1,699.0 285.8 1,984.8
-------- ------ --------
Benefits and expenses:
Insurance policy benefits........................................... 680.4 - 680.4
Amounts added to annuity and financial product
policyholder account balances:
Interest...................................................... 188.4 - 188.4
Other amounts added to variable and equity-indexed
annuity products........................................... 85.6 - 85.6
Interest expense on notes payable................................... 39.0 48.5 87.5
Interest expense on short-term investment borrowings................ 18.9 - 18.9
Amortization related to operations.................................. 117.1 - 117.1
Amortization related to investment gains............................ 86.4 - 86.4
Other operating costs and expenses.................................. 165.0 134.9 299.9
-------- ------ --------
Total benefits and expenses................................... 1,380.8 183.4 1,564.2
-------- ------ --------
Income before income taxes, minority interest
and extraordinary charge ................................. 318.2 102.4 420.6
Income tax expense...................................................... 131.3 38.9 170.2
-------- ------ --------
Income before minority interest and
extraordinary charge ..................................... 186.9 63.5 250.4
Minority interest - distributions on Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts, net of
income taxes........................................................ 19.4 - 19.4
-------- ------ --------
Income before extraordinary charge ......................... 167.5 63.5 231.0
Extraordinary charge on extinguishment of
debt, net of taxes and minority interest............................ 16.4 - 16.4
-------- ------ --------
Net income.................................................. 151.1 63.5 214.6
Less preferred stock dividends.......................................... 2.0 - 2.0
-------- ------ --------
Net income applicable to common stock....................... $ 149.1 $ 63.5 $ 212.6
======== ====== ========
(continued on next page)
The accompanying notes are an integral
part of the unaudited pro forma combined financial
statements.
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS (Continued)
for the three months ended March 31, 1998
(Dollars in millions, except per share data)
PRO FORMA
CONSECO GREEN TREE ADJUSTMENTS COMBINED
------- ---------- ----------- --------
<S> <C> <C> <C> <C>
Earnings per common share:
Basic:
Weighted average shares outstanding............................ 185,941,000 134,237,000 (11,209,000) (4) 308,969,000
Net income before extraordinary charge ........................ $.89 $.47 $.74
Extraordinary charge .......................................... .09 - .05
---- ---- ----
Net income................................................ $.80 $.47 $.69
==== ==== ====
Diluted:
Weighted average shares outstanding........................... 207,930,000 135,820,000 (11,341,000) (4) 332,409,000
Net income before extraordinary charge ........................ $.81 $.47 $.70
Extraordinary charge........................................... .08 - .05
---- ---- ----
Net income................................................ $.73 $.47 $.65
==== ==== ====
The accompanying notes are an integral
part of the unaudited pro forma combined financial
statements.
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
for the three months ended March 31, 1997
(Dollars in millions, except per share data)
PRO FORMA
CONSECO GREEN TREE ADJUSTMENTS COMBINED
------- ---------- ----------- --------
<S> <C> <C> <C> <C>
Revenues:
Insurance policy income:
Traditional products............................................. $ 566.2 $ - $ 566.2
Interest sensitive products...................................... 103.9 - 103.9
Net investment income............................................... 409.2 75.4 484.6
Gain on sale of receivables......................................... - 153.4 153.4
Net investment gains................................................ 5.1 - 5.1
Fee revenue and other income........................................ 14.6 38.4 53.0
-------- ------ --------
Total revenues.............................................. 1,099.0 267.2 1,366.2
-------- ------ --------
Benefits and expenses:
Insurance policy benefits........................................... 455.3 - 455.3
Amounts added to annuity and financial product
policyholder account balances:
Interest...................................................... 173.7 - 173.7
Other amounts added to variable and equity-indexed
annuity products........................................... 16.2 - 16.2
Interest expense on notes payable................................... 25.8 29.8 55.6
Interest expense on short-term investment borrowings................ 2.8 - 2.8
Amortization related to operations.................................. 103.6 - 103.6
Amortization related to investment gains............................ 11.8 - 11.8
Other operating costs and expenses.................................. 114.4 89.3 203.7
-------- ------ --------
Total benefits and expenses................................... 903.6 119.1 1,022.7
-------- ------ --------
Income before income taxes, minority interest
and extraordinary charge ................................. 195.4 148.1 343.5
Income tax expense...................................................... 70.6 56.3 126.9
-------- ------ --------
Income before minority interest and
extraordinary charge ..................................... 124.8 91.8 216.6
Minority interest:
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, net of income taxes.... 8.7 - 8.7
Dividends on preferred stock of subsidiaries........................ 1.3 - 1.3
-------- ------ --------
Income before extraordinary charge ........................... 114.8 91.8 206.6
Extraordinary charge on extinguishment of
debt, net of taxes and minority interest............................ 3.3 - 3.3
-------- ------ --------
Net income.................................................... 111.5 91.8 203.3
Less amounts applicable to preferred stock:
Charge related to induced conversions............................... 12.3 - 12.3
Preferred stock dividends........................................... 2.3 - 2.3
-------- ------ --------
Net income applicable to common stock....................... $ 96.9 $ 91.8 $ 188.7
======== ====== ========
(continued on next page)
The accompanying notes are an integral
part of the unaudited pro forma combined financial
statements.
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS (Continued)
for the three months ended March 31, 1997
(Dollars in millions, except per share data)
PRO FORMA
CONSECO GREEN TREE ADJUSTMENTS COMBINED
------- ---------- ----------- --------
<S> <C> <C> <C> <C>
Earnings per common share:
Basic:
Weighted average shares outstanding............................ 177,670,000 138,511,000 (11,566,000) (4) 304,615,000
Net income before extraordinary charge ........................ $.57 $.66 $.63
Extraordinary charge .......................................... .02 - .01
---- ---- ----
Net income................................................ $.55 $.66 $.62
==== ==== ====
Diluted:
Weighted average shares outstanding........................... 203,620,000 142,220,000 (11,875,000) (4) 333,965,000
Net income before extraordinary charge ........................ $.51 $.65 $.58
Extraordinary charge........................................... .02 - .01
---- ---- ----
Net income................................................ $.49 $.65 $.57
==== ==== ====
The accompanying notes are an integral
part of the unaudited pro forma combined financial
statements.
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
for the year ended December 31, 1997
(Dollars in millions, except per share data)
PRO FORMA
CONSECO GREEN TREE ADJUSTMENTS COMBINED
------- ---------- ----------- --------
<S> <C> <C> <C> <C>
Revenues:
Insurance policy income:
Traditional products............................................. $2,954.1 $ - $2,954.1
Interest sensitive products...................................... 456.7 - 456.7
Net investment income............................................... 1,825.3 370.6 2,195.9
Gain on sale of receivables......................................... - 546.8 546.8
Net investment gains................................................ 266.5 - 266.5
Fee revenue and other income........................................ 65.8 174.1 239.9
-------- -------- --------
Total revenues.............................................. 5,568.4 1,091.5 6,659.9
-------- -------- --------
Benefits and expenses:
Insurance policy benefits........................................... 2,368.3 - 2,368.3
Amounts added to annuity and financial product
policyholder account balances:
Interest...................................................... 697.1 - 697.1
Other amounts added to variable and equity-indexed
annuity products........................................... 109.6 109.6
Interest expense on notes payable................................... 109.4 160.9 270.3
Interest expense on short-term investment borrowings................ 42.0 - 42.0
Amortization related to operations.................................. 408.8 - 408.8
Amortization related to investment gains............................ 181.2 - 181.2
Nonrecurring charges................................................ 71.7 - 71.7
Other operating costs and expenses.................................. 577.2 444.5 1,021.7
-------- -------- --------
Total benefits and expenses................................... 4,565.3 605.4 5,170.7
-------- -------- --------
Income before income taxes, minority interest
and extraordinary charge ................................. 1,003.1 486.1 1,489.2
Income tax expense...................................................... 376.6 184.7 561.3
-------- -------- --------
Income before minority interest and
extraordinary charge ..................................... 626.5 301.4 927.9
Minority interest:
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, net of income taxes... 49.0 - 49.0
Dividends on preferred stock of subsidiaries........................ 3.3 - 3.3
-------- -------- --------
Income before extraordinary charge ......................... 574.2 301.4 875.6
Extraordinary charge on extinguishment of
debt, net of taxes and minority interest............................ 6.9 - 6.9
-------- -------- --------
Net income.................................................. 567.3 301.4 868.7
Less amounts applicable to preferred stock:
Charge related to induced conversions............................... 13.2 - 13.2
Preferred stock dividends........................................... 8.7 - 8.7
-------- -------- --------
Net income applicable to common stock....................... $ 545.4 $ 301.4 $ 846.8
======== ======== ========
(continued on next page)
The accompanying notes are an integral
part of the unaudited pro forma combined financial
statements.
</TABLE>
25
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS (Continued)
for the year ended December 31, 1997
(Dollars in millions, except per share data)
PRO FORMA
CONSECO GREEN TREE ADJUSTMENTS COMBINED
------- ---------- ----------- --------
<S> <C> <C> <C> <C>
Earnings per common share:
Basic:
Weighted average shares outstanding............................ 185,751,000 136,715,000 (11,416,000)(4) 311,050,000
Net income before extraordinary charge ........................ $2.98 $2.20 $2.74
Extraordinary charge .......................................... .04 - .02
----- ----- -----
Net income................................................ $2.94 $2.20 $2.72
===== ===== =====
Diluted:
Weighted average shares outstanding............................ 210,179,000 140,254,000 (11,711,000)(4) 338,722,000
Net income before extraordinary charge ........................ $2.67 $2.15 $2.55
Extraordinary charge........................................... .03 - .02
----- ----- -----
Net income................................................ $2.64 $2.15 $2.53
===== ===== =====
The accompanying notes are an integral
part of the unaudited pro forma combined financial
statements.
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
PRO FORMA COMBINED STATEMENT OF OPERATIONS
for the year ended December 31, 1996
(Dollars in millions, except per share data)
PRO FORMA
CONSECO GREEN TREE ADJUSTMENTS COMBINED
------- ---------- ----------- --------
<S> <C> <C> <C> <C>
Revenues:
Insurance policy income:
Traditional products............................................. $1,384.3 $ - $1,384.3
Interest sensitive products...................................... 269.9 - 269.9
Net investment income............................................... 1,302.5 215.3 1,517.8
Gain on sale of receivables......................................... - 389.7 389.7
Net investment gains................................................ 60.8 - 60.8
Fee revenue and other income........................................ 49.8 119.1 168.9
-------- -------- --------
Total revenues.............................................. 3,067.3 724.1 3,791.4
-------- -------- --------
Benefits and expenses:
Insurance policy benefits........................................... 1,195.0 - 1,195.0
Amounts added to annuity and financial product
policyholder account balances:
Interest...................................................... 620.2 - 620.2
Other amounts added to variable and equity-indexed
annuity products........................................... 48.4 - 48.4
Interest expense on notes payable................................... 108.1 70.1 178.2
Interest expense on short-term investment borrowings................ 22.0 - 22.0
Amortization related to operations.................................. 240.0 - 240.0
Amortization related to investment gains............................ 36.0 - 36.0
Other operating costs and expenses.................................. 304.0 330.2 634.2
-------- -------- --------
Total benefits and expenses................................... 2,573.7 400.3 2,974.0
-------- -------- --------
Income before income taxes, minority interest
and extraordinary charge ................................. 493.6 323.8 817.4
Income tax expense...................................................... 179.8 123.0 302.8
-------- -------- --------
Income before minority interest and
extraordinary charge ..................................... 313.8 200.8 514.6
Minority interest:
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, net of income taxes... 3.6 - 3.6
Dividends on preferred stock of subsidiaries........................ 8.9 - 8.9
Equity in earnings of subsidiaries.................................. 22.4 - 22.4
-------- -------- --------
Income before extraordinary charge ......................... 278.9 200.8 479.7
Extraordinary charge on extinguishment of
debt, net of taxes and minority interest............................ 26.5 - 26.5
-------- -------- --------
Net income.................................................. 252.4 200.8 453.2
Less preferred stock dividends.......................................... 27.4 - 27.4
-------- -------- --------
Net income applicable to common stock....................... $ 225.0 $ 200.8 $ 425.8
======== ======== ========
(continued on next page)
The accompanying notes are an integral
part of the pro forma combined financial
statements.
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
PRO FORMA COMBINED STATEMENT OF OPERATIONS (Continued)
for the year ended December 31, 1996
(Dollars in millions, except per share data)
PRO FORMA
CONSECO GREEN TREE ADJUSTMENTS COMBINED
------- ---------- ----------- --------
<S> <C> <C> <C> <C>
Earnings per common share:
Basic:
Weighted average shares outstanding............................ 104,584,000 136,996,000 (11,439,000)(4) 230,141,000
Net income before extraordinary charge ........................ $2.40 $1.47 $1.96
Extraordinary charge .......................................... .25 - .11
----- ----- -----
Net income................................................ $2.15 $1.47 $1.85
===== ===== =====
Diluted:
Weighted average shares outstanding............................ 138,860,000 140,562,000 (11,737,000)(4) 267,685,000
Net income before extraordinary charge ........................ $2.01 $1.43 $1.79
Extraordinary charge........................................... .19 - .10
----- ----- -----
Net income................................................ $1.82 $1.43 $1.69
===== ===== =====
The accompanying notes are an integral
part of the pro forma combined financial
statements.
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
PRO FORMA COMBINED STATEMENT OF OPERATIONS
for the year ended December 31, 1995
(Dollars in millions, except per share data)
PRO FORMA
CONSECO GREEN TREE ADJUSTMENTS COMBINED
------- ---------- ----------- --------
<S> <C> <C> <C> <C>
Revenues:
Insurance policy income:
Traditional products............................................. $1,355.6 $ - $1,355.6
Interest sensitive products...................................... 109.4 - 109.4
Net investment income............................................... 1,142.6 176.0 1,318.6
Gain on sale of receivables......................................... - 448.7 448.7
Net investment gains................................................ 204.1 - 204.1
Fee revenue and other income........................................ 43.6 86.6 130.2
-------- -------- --------
Total revenues.............................................. 2,855.3 711.3 3,566.6
-------- -------- --------
Benefits and expenses:
Insurance policy benefits........................................... 1,107.5 - 1,107.5
Amounts added to annuity and financial product
policyholder account balances:
Interest...................................................... 556.6 - 556.6
Other amounts added to variable and equity-indexed
annuity products........................................... 28.8 - 28.8
Interest expense on notes payable................................... 119.4 57.3 176.7
Interest expense on short-term investment borrowings................ 22.2 - 22.2
Amortization related to operations.................................. 203.6 - 203.6
Amortization related to investment gains............................ 126.6 - 126.6
Other operating costs and expenses.................................. 272.1 244.4 516.5
-------- -------- --------
Total benefits and expenses................................... 2,436.8 301.7 2,738.5
-------- -------- --------
Income before income taxes, minority interest
and extraordinary charge ................................. 418.5 409.6 828.1
Income tax expense...................................................... 87.0 155.6 242.6
-------- -------- --------
Income before minority interest and
extraordinary charge ..................................... 331.5 254.0 585.5
Minority interest:
Dividends on preferred stock of subsidiaries........................ 11.9 - 11.9
Equity in earnings of subsidiaries.................................. 97.1 - 97.1
-------- -------- --------
Income before extraordinary charge ......................... 222.5 254.0 476.5
Extraordinary charge on extinguishment of
debt, net of taxes and minority interest............................ 2.1 - 2.1
-------- -------- --------
Net income.................................................. 220.4 254.0 474.4
Less preferred stock dividends.......................................... 18.4 - 18.4
-------- -------- --------
Net income applicable to common stock....................... $ 202.0 $ 254.0 $ 456.0
======== ======== ========
(continued on next page)
The accompanying notes are an integral
part of the pro forma combined financial
statements.
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
PRO FORMA COMBINED STATEMENT OF OPERATIONS (Continued)
for the year ended December 31, 1995
(Dollars in millions, except per share data)
PRO FORMA
CONSECO GREEN TREE ADJUSTMENTS COMBINED
------- ---------- ----------- --------
<S> <C> <C> <C> <C>
Earnings per common share:
Basic:
Weighted average shares outstanding............................ 81,405,000 136,644,000 (11,410,000)(4) 206,639,000
Net income before extraordinary charge ........................ $2.51 $1.86 $2.22
Extraordinary charge .......................................... .03 - .01
----- ----- -----
Net income................................................ $2.48 $1.86 $2.21
===== ===== =====
Diluted:
Weighted average shares outstanding............................ 103,881,000 140,090,000 (11,698,000)(4) 232,273,000
Net income before extraordinary charge ........................ $2.14 $1.81 $2.05
Extraordinary charge........................................... .02 - .01
----- ----- -----
Net income................................................ $2.12 $1.81 $2.04
===== ===== =====
The accompanying notes are an integral
part of the pro forma combined financial
statements.
</TABLE>
30
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The unaudited pro forma combined financial statements have been prepared
to give effect to the Merger under the pooling of interests method and
are based on the historical consolidated financial statements of Conseco
and Green Tree. Certain amounts in the historical financial statements of
Green Tree have been reclassified to conform with Conseco's historical
financial statement presentation.
Green Tree pools and securitizes substantially all of the loan contracts
it originates, retaining: (i) investments in interest-only securities
that are subordinated to the rights of other investors; and (ii) the
servicing on the contracts. The valuation of interest-only securities and
servicing rights is determined by discounting the projected cash flows
over the expected life of the finance receivables sold using prepayment,
default, loss, servicing cost and discount rate assumptions. Impairment
in the value of interest-only securities considered other than temporary
is recognized as a reduction to earnings, while impairment that is
temporary is recognized as a reduction to shareholders' equity.
Impairment in the value of servicing rights is recognized as a reduction
in earnings. The assumptions used in calculating the value of
interest-only securities and servicing rights are subject to volatility.
Prepayments resulting from competition, obligor mobility, general and
regional economic conditions, and prevailing interest rates, as well as
actual losses incurred, may vary from the performance projected in future
periods. Assumptions with respect to future prepayments, defaults,
losses, servicing costs and discount rates are reviewed periodically. As
disclosed in its Quarterly Report on Form 10-Q for the quarter ended
March 31, 1998, Green Tree realized a material writedown of its interest-
only securities due to higher than expected prepayments. Prepayments have
continued to exceed expectations in April 1998. If prepayments continue
above expectations, or upon review certain other assumptions are revised,
it is likely that there will be a further material writedown in the value
of the interest-only securities and servicing rights and this reduction
in value could materially affect operating results. Any adjustments to be
made in future periods will depend on circumstances existing at that
time.
The unaudited pro forma consolidated financial information should be read
in conjunction with the historical consolidated financial statements of
Conseco and Green Tree and the notes thereto.
2. INCOME TAX LIABILITIES
The income tax assets of Conseco are netted against the income tax
liabilities of Green Tree.
3. MERGER AND INTEGRATION COSTS
In connection with the Merger, Conseco expects to incur Merger-related
costs of approximately $240 million, net of income taxes. Such costs
include investment banking, accounting, legal and regulatory fees,
severance and retention costs and other costs associated with the Merger.
These expenses (including the related tax effect) have been reflected in
the unaudited pro forma combined balance sheet financial information, but
are not reflected in the unaudited pro forma statement of operations
financial information since such expenses are not expected to have a
continuing impact on the combined company.
4. SHAREHOLDERS' EQUITY AND WEIGHTED AVERAGE SHARES OUTSTANDING
Weighted average shares outstanding have been adjusted to reflect the
issuance of .9165 shares of Conseco common stock for each share of Green
Tree common stock or equivalent. The following shares of Green Tree
common stock or equivalents were outstanding at April 6, 1998: (i)
134,012,054 shares of Green Tree common stock; (ii) 10,297,132 options
outstanding to purchase Green Tree common stock at an average price of
$23.12 per share (such options are equivalent to 6,174,713 shares of
Conseco common stock, based on the last reported sale price of a share of
Conseco common stock on April 6, 1998); and (iii) warrants to purchase
2,735,688 shares of Green Tree common stock at $22.75 per share (such
warrants are equivalent to 710,568 shares of Conseco common stock, based
on the last reported sale price of a share of Conseco common stock on
April 6, 1998 based on Green Tree's right to call the warrant by issuing
stock equivalents at $15 per warrant). The treasury stock held by Green
Tree prior to the Merger has been reclassified to common stock and
additional paid-in capital to conform to Conseco's presentation.
5. OPERATING COST SAVINGS
No adjustment has been included in the unaudited pro forma consolidated
financial information for the anticipated operating cost savings. The
combined company expects to achieve operating cost savings through the
reduction of certain borrowing costs as well as potentially through the
elimination of redundant staff functions, data processing, marketing
synergies and certain back office operations and the reduction of
corporate overhead. There can be no assurance that anticipated operating
cost savings will be achieved.
31
<PAGE>
(c) Exhibits.
Exhibit 2.1 Agreement and Plan of Merger dated as of April 6,
1998, as amended, among Conseco, Inc., Marble
Acquisition Corp., a Delaware corporation and a
wholly owned subsidiary of Conseco, Inc. and Green
Tree Financial Corporation (composite conformed
copy included as Annex A to the Joint Proxy
Statement - Prospectus of Conseco, Inc. contained
within the Registration of Conseco, Inc. on Form
S-4 (File No. 333-51123) which Agreement and Plan
of Merger is incorporated herein by reference).
Exhibit 12.1 Computation of Ratio of Earnings to Fixed Charges
Exhibit 23.1 Consent of PricewaterhouseCoopers LLP
Exhibit 23.2 Consent of KPMG Peat Marwick LLP
Exhibit 23.3 Consent of PricewaterhouseCoopers LLP
Exhibit 27 Restated Financial Data Schedule
Exhibit 27.1 Restated Financial Data Schedule
Exhibit 27.2 Restated Financial Data Schedule
Exhibit 99.1 Supplemental Consolidated Financial Statements of
Conseco, Inc. as of December 31, 1997 and 1996, and
for each of the three years ended December 31,
1997.
Exhibit 99.2 Unaudited Supplemental Consolidated Financial
Statements of Conseco, Inc. as of March 31, 1998,
and for the three months ended March 31, 1998 and
1997.
Exhibit 99.3 Consolidated Financial Statements of Green Tree
Financial Corporation as of December 31, 1997 and
1996 and for each of the three years ended December
31, 1997.
Exhibit 99.4 Unaudited Consolidated Financial Statements of
Green Tree Financial Corporation as of March 31,
1998, and for the three months ended March 31, 1998
and 1997.
32
<PAGE>
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 hereunto duly authorized.
CONSECO, INC.
DATE: August 6, 1998 By: /s/ ROLLIN M. DICK
----------------------------------
Name: Rollin M. Dick
Title: Executive Vice President
and Chief Financial Officer
33
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
Exhibit 12.1
Computation of Ratio of Earnings to Fixed Charges,
Preferred Dividends and Distributions on Company-Obligated Mandatorily
Redeemable Preferred Securities of Subsidiary Trusts
(Dollars in millions)
Three Months Ended
Year Ended December 31, March 31,
---------------------------------------------------- ---------------------
1993 1994 1995 1996 1997 1997 1998
-------- -------- -------- -------- -------- -------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Pretax income from operations:
Net income.................................... $ 413.1 $330.5 $ 470.9 $ 452.2 $ 866.4 $202.7 $214.6
Add income tax expense........................ 307.1 231.2 240.7 302.2 560.1 126.5 170.2
Add extraordinary charge on
extinguishment of debt...................... 11.9 4.0 2.1 26.5 6.9 3.3 16.4
Add minority interest......................... 78.2 59.0 109.0 34.9 52.3 10.0 19.4
Less equity in undistributed
earnings of CCP Insurance, Inc.............. (36.6) (23.8) - - - - -
Less equity in undistributed
earnings of Western National Corp........... - (37.2) - - - - -
-------- ------ -------- -------- -------- ------ ------
Pretax income........................... 773.7 563.7 822.7 815.8 1,485.7 342.5 420.6
-------- ------ -------- -------- -------- ------ ------
Add fixed charges:
Interest expense on annuities and financial
products................................... 408.5 134.7 585.4 668.6 697.1 173.7 188.4
Interest expense:
Corporate................................... 58.0 59.3 119.4 108.1 109.4 25.8 39.0
Finance and investment borrowings........... 61.8 49.3 79.5 92.1 202.9 32.6 67.4
Other ....................................... .6 .9 1.0 .9 .7 .2 .1
Portion of rental(1).......................... 5.4 7.9 8.9 10.9 13.7 2.9 3.7
-------- ------ -------- -------- -------- ------ ------
Fixed charges............................. 534.3 252.1 794.2 880.6 1,023.8 235.2 298.6
-------- ------ -------- -------- -------- ------ ------
Adjusted earnings......................... $1,308.0 $815.8 $1,616.9 $1,696.4 $2,509.5 $577.7 $719.2
======== ====== ======== ======== ======== ====== ======
Ratio of earnings to fixed charges........ 2.45X 3.24X 2.04X 1.93X 2.45X 2.46X 2.41X
===== ===== ===== ===== ===== ===== =====
Ratio of earnings to fixed charges,
excluding interest on annuities and
financial products .................... 7.15X 5.80X 4.94X 4.85X 5.55X 6.57X 4.82X
===== ===== ===== ===== ===== ===== =====
Fixed charges................................. $534.3 $252.1 $ 794.2 $ 880.6 $1,023.8 $235.2 $298.6
Add dividends on preferred stock (multiplied
by the rate of pretax income to income
before minority interest and extraordinary
charge)..................................... 35.3 34.8 40.3 57.6 40.4 25.2 3.4
-------- ------ -------- -------- -------- ------ ------
Adjusted fixed charges.................... $ 569.6 $286.9 $ 834.5 $ 938.2 $1,064.2 $260.4 $302.0
======== ====== ======== ======== ======== ====== ======
Adjusted earnings......................... $1,308.0 $815.8 $1,616.9 $1,696.4 $2,509.5 $577.7 $719.2
======== ====== ======== ======== ======== ====== ======
Ratio of earnings to fixed
charges and preferred dividends........ 2.30X 2.84X 1.94X 1.81X 2.36X 2.22X 2.38X
===== ===== ===== ===== ===== ===== =====
Ratio of earnings to fixed charges
and preferred dividends, excluding
interest on annuities and financial
products............................... 5.58X 4.48X 4.14X 3.81X 4.94X 4.66X 4.67X
===== ===== ===== ===== ===== ===== =====
(continued on following page)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
Computation of Ratio of Earnings to Fixed Charges,
Preferred Dividends and Distributions on Company-Obligated Mandatorily
Redeemable Preferred Securities of Subsidiary Trusts, continued
(Dollars in millions)
Three Months Ended
Year Ended December 31, March 31,
---------------------------------------------------- ---------------------
1993 1994 1995 1996 1997 1997 1998
-------- -------- -------- -------- -------- -------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Adjusted fixed charges........................ $ 569.6 $286.9 $ 834.5 $ 938.2 $1,064.2 $260.4 $302.0
Add distributions on Company-obligated
mandatorily redeemable preferred securities
of subsidiary trusts........................ - - - 5.5 75.4 13.4 29.5
-------- ------ -------- -------- -------- ------ ------
Fixed charges............................. $ 569.6 $286.9 $ 834.5 $ 943.7 $1,139.6 $273.8 $331.5
======== ====== ======== ======== ======== ====== ======
Adjusted earnings......................... $1,308.0 $815.8 $1,616.9 $1,696.4 $2,509.5 $577.7 $719.2
======== ====== ======== ======== ======== ====== ======
Ratio of earnings to fixed charges,
preferred dividends and distributions
on Company-obligated mandatorily
redeemable preferred securities
of subsidiary trusts................... 2.30X 2.84X 1.94X 1.80X 2.20X 2.11X 2.17X
===== ===== ===== ===== ===== ===== =====
Ratio of earnings to fixed charges,
preferred dividends and distributions
on Company-obligated mandatorily
redeemable preferred securities of
subsidiary trusts, excluding interest
on annuities and financial products.... 5.58X 4.48X 4.14X 3.74X 4.10X 4.04X 3.71X
===== ===== ===== ===== ===== ===== =====
<FN>
(1) Interest portion of rental is assumed to be 33 percent.
</FN>
</TABLE>
Exhibit 23.1
CONSENT OF INDEPEDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statement of
Conseco, Inc. on Form S-3 (File No. 333-56611) of: (i) our reports dated March
23, 1998 on our audits of the consolidated financial statements and financial
statement schedules of Conseco, Inc. and subsidiaries as of December 31, 1997
and 1996, and for the years ended December 31, 1997, 1996 and 1995, included in
the Annual Report on Form 10-K; and (ii) our report dated July 7, 1998 on our
audits of the supplemental consolidated financial statements of Conseco, Inc.
and subsidiaries as of December 31, 1997 and 1996, and for the years ended
December 31, 1997, 1996 and 1995, included as Exhibit 99.1 to the Current Report
on Form 8-K of Conseco, Inc. dated June 30, 1998, as amended. We also consent to
the reference to our firm under the caption "Experts."
/S/ PRICEWATERHOUSECOOPERS LLP
------------------------------
/S/ PRICEWATERHOUSECOOPERS LLP
Indianapolis, Indiana
August 6, 1998
Exhibit 23.2
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
Green Tree Financial Corporation:
We consent to the incorporation by reference in the Registration Statement (No.
333-56611) on Form S-3 of Conseco, Inc. of our report dated January 27, 1998,
except as to Note O which is as of February 13, 1998, with respect to the
consolidated balance sheets of Green Tree Financial Corporation and subsidiaries
as of December 31, 1997 and 1996, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the years in the
three-year period ended December 31, 1997, which report appears in the Current
Report on Form 8-K of Conseco, Inc. dated June 30, 1998, as amended, and to the
reference to our firm under the heading "EXPERTS" in the Registration Statement.
Our report refers to the Company's adoption of the Financial Accounting
Standards Board's Statement No. 125 "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," in 1997.
/S/ KPMG PEAT MARWICK LLP
-------------------------
/S/ KPMG PEAT MARWICK LLP
Minneapolis, Minnesota
August 6, 1998
Exhibit 23.3
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements of
Conseco, Inc. (File Nos. 33-57079, 33-56901, 33-57931, 33-40556, 33-58710,
33-58712, 333-10297, 333-18037, 333- 18581, 333-19783, 333-23251, 333-27803,
333-28305, 333-32615, 333-32617 and 333-32621) of our reports dated July 7, 1998
on our audits of the supplemental consolidated financial statements of Conseco,
Inc. and subsidiaries as of December 31, 1997 and 1996, and for the years ended
December 31, 1997, 1996 and 1995, included as Exhibit 99.1 to the Current Report
on Form 8-K of Conseco, Inc. dated June 30, 1998, as amended.
/S/ PRICEWATERHOUSECOOPERS LLP
------------------------------
/S/ PRICEWATERHOUSECOOPERS LLP
Indianapolis, Indiana
August 6, 1998
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND> THE SCHEDULE CONTAINS SUMMARY FINANCIAL
INFORMATION EXTRACTED FROM THE COMPANY'S CONSOLIDATED
FINANCIAL STATEMENTS AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<DEBT-HELD-FOR-SALE> 22,968,900
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 263,400
<MORTGAGE> 1,070,800 <F1>
<REAL-ESTATE> 0
<TOTAL-INVEST> 28,696,600
<CASH> 0
<RECOVER-REINSURE> 761,800
<DEFERRED-ACQUISITION> 3,465,100 <F2>
<TOTAL-ASSETS> 41,124,000
<POLICY-LOSSES> 23,078,600
<UNEARNED-PREMIUMS> 409,100
<POLICY-OTHER> 1,280,700
<POLICY-HOLDER-FUNDS> 336,600
<NOTES-PAYABLE> 4,494,200 <F3>
1,388,100
115,800
<COMMON> 2,621,000
<OTHER-SE> 2,504,400 <F4>
<TOTAL-LIABILITY-AND-EQUITY> 41,124,000
990,100
<INVESTMENT-INCOME> 676,200
<INVESTMENT-GAINS> 104,800
<OTHER-INCOME> 213,700 <F5>
<BENEFITS> 954,400 <F6>
<UNDERWRITING-AMORTIZATION> 170,600 <F7>
<UNDERWRITING-OTHER> 295,000
<INCOME-PRETAX> 420,600
<INCOME-TAX> 170,200
<INCOME-CONTINUING> 250,400
<DISCONTINUED> 0
<EXTRAORDINARY> (16,400)
<CHANGES> 0
<NET-INCOME> 214,600
<EPS-PRIMARY> .69
<EPS-DILUTED> .65
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1> Includes $596,600 of credit-tenant loans.
<F2> Includes $2,442,600 of cost of policies purchased.
<F3> Includes $2,059,100 related to consumer and commercial finance debt.
<F4> Includes retained earnings of $2,336,700, and accumulated other
comprehensive income of $167,700.
<F5> Includes gain on loan securitizations of $137,200 and fee revenue and
other income of $76,500.
<F6> Includes insurance policy benefits of $680,400 and amounts added to
annuity and financial product policyholder account balances of $274,000.
<F7> Includes amortization of cost of policies purchased of $51,000,
amortization of cost of policies produced of $33,200 and amortization
related to investment gains of $86,400.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND> THE SCHEDULE CONTAINS SUMMARY FINANCIAL
INFORMATION EXTRACTED FROM THE COMPANY'S CONSOLIDATED
FINANCIAL STATEMENTS AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1996 DEC-31-1995
<PERIOD-END> DEC-31-1997 DEC-31-1996 DEC-31-1995
<DEBT-HELD-FOR-SALE> 22,773,700 17,307,100 12,963,300
<DEBT-CARRYING-VALUE> 0 0 0
<DEBT-MARKET-VALUE> 0 0 0
<EQUITIES> 228,900 99,700 36,600
<MORTGAGE> 1,074,800 <F1> 803,100 <F2> 559,000 <F3>
<REAL-ESTATE> 0 0 0
<TOTAL-INVEST> 28,525,600 20,743,900 15,098,000
<CASH> 0 0 0
<RECOVER-REINSURE> 795,800 504,200 84,800
<DEFERRED-ACQUISITION> 3,381,600 <F4> 2,559,300 <F5> 1,421,700 <F6>
<TOTAL-ASSETS> 40,629,900 28,692,700 19,510,100
<POLICY-LOSSES> 23,142,400 17,975,600 12,673,100
<UNEARNED-PREMIUMS> 406,100 272,400 187,900
<POLICY-OTHER> 1,250,600 815,900 244,700
<POLICY-HOLDER-FUNDS> 364,900 240,400 272,700
<NOTES-PAYABLE> 4,221,200 <F7> 1,857,400 <F8> 1,839,700 <F9>
1,383,900 600,000 0
115,800 267,100 283,500
<COMMON> 2,619,800 2,350,700 428,200
<OTHER-SE> 2,478,300 <F10> 1,599,000 <F11> 1,320,000 <F12>
<TOTAL-LIABILITY-AND-EQUITY> 40,629,900 28,692,700 19,510,100
3,410,800 1,654,200 1,465,000
<INVESTMENT-INCOME> 2,170,100 1,517,800 1,318,600
<INVESTMENT-GAINS> 266,500 60,800 204,100
<OTHER-INCOME> 809,000 <F13> 557,000 <F14> 573,500 <F15>
<BENEFITS> 3,175,000 <F16> 1,863,600 <F17> 1,692,900 <F18>
<UNDERWRITING-AMORTIZATION> 548,000 <F19> 266,400 <F20> 307,500 <F21>
<UNDERWRITING-OTHER> 1,006,300 634,200 516,500
<INCOME-PRETAX> 1,485,700 815,800 822,700
<INCOME-TAX> 560,100 302,200 240,700
<INCOME-CONTINUING> 925,600 513,600 582,000
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> (6,900) (26,500) (2,100)
<CHANGES> 0 0 0
<NET-INCOME> 866,400 452,200 470,900
<EPS-PRIMARY> 2.72 1.85 2.19
<EPS-DILUTED> 2.52 1.69 2.03
<RESERVE-OPEN> 0 0 0
<PROVISION-CURRENT> 0 0 0
<PROVISION-PRIOR> 0 0 0
<PAYMENTS-CURRENT> 0 0 0
<PAYMENTS-PRIOR> 0 0 0
<RESERVE-CLOSE> 0 0 0
<CUMULATIVE-DEFICIENCY> 0 0 0
<FN>
<F1> Includes $558,600 of credit-tenant loans.
<F2> Includes $447,100 of credit-tenant loans.
<F3> Includes $259,100 of credit-tenant loans.
<F4> Includes $2,466,400 of cost of policies purchased.
<F5> Includes $2,015,000 of cost of policies purchased.
<F6> Includes $1,030,700 of cost of policies purchased.
<F7> Includes $1,866,300 related to consumer and commercial finance debt.
<F8> Includes $762,500 related to consumer and commercial finance debt.
<F9> Includes $383,600 related to consumer and commercial finance debt and
notes payable of subsidiaries of $584,700 which were not direct
obligations of Conseco.
<F10> Includes retained earnings of $2,277,700 and accumulated other
comprehensive income of $200,600.
<F11> Includes retained earnings of $1,562,400 and accumulated other
comprehensive income of $36,600.
<F12> Includes retained earnings of $1,207,300 and accumulated other
comprehensive income of $112,700.
<F13> Includes gain on loan securitizations of $569,100 and fee revenue and
other income of $239,900.
<F14> Includes gain on loan securitizations of $388,100 and fee revenue and
other income of $168,900.
<F15> Includes gain on loan securitizations of $443,300 and fee revenue and
other income of $130,200.
<F16> Includes insurance policy benefits of $2,368,300 and amounts added to
annuity and financial product policyholder account balances of $806,700.
<F17> Includes insurance policy benefits of $1,195,000 and amounts added to
annuity and financial product policyholder account balances of $668,600.
<F18> Includes insurance policy benefits of $1,107,500 and amounts added to
annuity and financial product policyholder account balances of $585,400.
<F19> Includes amortization of cost of policies purchased of $261,800,
amortization of cost of policies produced of $105,000 and amortization
related to investment gains of $181,200.
<F20> Includes amortization of cost of policies purchased of $157,500,
amortization of cost of policies produced of $72,900 and amortization
related to investment gains of $36,000.
<F21> Includes amortization of cost of policies purchased of $118,800,
amortization of cost of policies produced of $62,100 and amortization
related to investment gains of $126,600.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND> THE SCHEDULE CONTAINS SUMMARY FINANCIAL
INFORMATION EXTRACTED FROM THE COMPANY'S CONSOLIDATED
FINANCIAL STATEMENTS AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997 DEC-31-1997
<PERIOD-END> MAR-31-1997 JUN-30-1997 SEP-30-1997
<DEBT-HELD-FOR-SALE> 17,623,500 19,060,200 21,065,300
<DEBT-CARRYING-VALUE> 0 0 0
<DEBT-MARKET-VALUE> 0 0 0
<EQUITIES> 147,800 186,700 238,500
<MORTGAGE> 825,600 <F1> 869,700 <F2> 878,900 <F3>
<REAL-ESTATE> 0 0 0
<TOTAL-INVEST> 21,209,100 23,234,900 26,135,600
<CASH> 0 0 0
<RECOVER-REINSURE> 537,700 792,700 787,900
<DEFERRED-ACQUISITION> 3,127,700 <F4> 3,233,300 <F5> 3,423,600 <F6>
<TOTAL-ASSETS> 30,879,100 34,142,400 37,773,000
<POLICY-LOSSES> 19,185,500 20,288,300 21,007,500
<UNEARNED-PREMIUMS> 347,800 439,200 442,600
<POLICY-OTHER> 787,000 1,019,500 957,600
<POLICY-HOLDER-FUNDS> 321,500 350,700 307,800
<NOTES-PAYABLE> 2,292,500 <F7> 3,248,600 <F8> 4,215,100 <F9>
900,000 900,000 900,000
133,100 122,000 122,000
<COMMON> 2,764,000 2,717,000 2,726,300
<OTHER-SE> 1,577,500 <F10> 1,917,700 <F11> 2,200,300 <F12>
<TOTAL-LIABILITY-AND-EQUITY> 30,879,100 34,142,400 37,773,000
670,100 1,555,100 2,440,900
<INVESTMENT-INCOME> 478,900 1,007,000 1,561,700
<INVESTMENT-GAINS> 5,100 20,900 137,300
<OTHER-INCOME> 211,100 <F13> 459,000 <F14> 732,200 <F15>
<BENEFITS> 645,200 <F16> 1,448,300 <F17> 2,275,500 <F18>
<UNDERWRITING-AMORTIZATION> 97,600 <F19> 206,300 <F20> 325,400 <F21>
<UNDERWRITING-OTHER> 201,100 460,900 716,500
<INCOME-PRETAX> 342,500 747,200 1,212,400
<INCOME-TAX> 126,500 276,800 456,000
<INCOME-CONTINUING> 216,000 470,400 756,400
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> (3,300) (5,500) (6,200)
<CHANGES> 0 0 0
<NET-INCOME> 202,700 440,800 712,300
<EPS-PRIMARY> .62 1.37 2.23
<EPS-DILUTED> .57 1.27 2.06
<RESERVE-OPEN> 0 0 0
<PROVISION-CURRENT> 0 0 0
<PROVISION-PRIOR> 0 0 0
<PAYMENTS-CURRENT> 0 0 0
<PAYMENTS-PRIOR> 0 0 0
<RESERVE-CLOSE> 0 0 0
<CUMULATIVE-DEFICIENCY> 0 0 0
<FN>
<F1> Includes $491,200 of credit-tenant loans.
<F2> Includes $545,200 of credit-tenant loans.
<F3> Includes $570,100 of credit-tenant loans.
<F4> Includes $2,470,100 of cost of policies purchased.
<F5> Includes $2,505,300 of cost of policies purchased.
<F6> Includes $2,581,800 of cost of policies purchased.
<F7> Includes $1,024,400 related to consumer and commercial finance debt.
<F8> Includes $1,474,900 related to consumer and commercial finance debt.
<F9> Includes $1,845,400 related to consumer and commercial finance debt.
<F10> Includes retained earnings of $1,734,300 and accumulated other
comprehensive income of $(156,800).
<F11> Includes retained earnings of $1,927,400 and accumulated other
comprehensive income of $(9,700).
<F12> Includes retained earnings of $2,158,900 and accumulated other
comprehensive income of $41,400.
<F13> Includes gain on loan securitizations of $158,100 and fee revenue and
other income of $53,000.
<F14> Includes gain on loan securitizations of $348,600 and fee revenue and
other income of $110,400.
<F15> Includes gain on loan securitizations of $554,900 and fee revenue and
other income of $177,300.
<F16> Includes insurance policy benefits of $455,300 and amounts added to
annuity and financial product policyholder account balances of $189,900.
<F17> Includes insurance policy benefits of $1,068,500 and amounts added to
annuity and financial product policyholder account balances of $379,800.
<F18> Includes insurance policy benefits of $1,686,900 and amounts added to
annuity and financial product policyholder account balances of $588,600.
<F19> Includes amortization of cost of policies purchased of $60,000,
amortization of cost of policies produced of $24,900 and amortization
related to investment gains of $11,800.
<F20> Includes amortization of cost of policies purchased of $129,400,
amortization of cost of policies produced of $50,300 and amortization
related to investment gains of $26,600.
<F21> Includes amortization of cost of policies purchased of $175,900,
amortization of cost of policies produced of $79,100 and amortization
related to investment gains of $70,400.
</FN>
</TABLE>
Exhibit 99.1
INTRODUCTION
On June 30, 1998, Conseco, Inc. ("Conseco" or the "Company") completed its
merger (the "Green Tree Merger") with Green Tree Financial Corporation ("Green
Tree"). The Green Tree Merger has been accounted for as a pooling of interests
and, accordingly, the amounts for all periods reported in this supplemental
filing are reported on a combined basis including both Conseco and Green Tree.
1
<PAGE>
SELECTED SUPPLEMENTAL CONSOLIDATED FINANCIAL DATA (a).
<TABLE>
<CAPTION>
Years ended December 31,
---------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Amounts in millions, except per share data)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Insurance policy income..................................... $3,410.8 $1,654.2 $1,465.0 $1,285.6 $1,293.8
Gain on sale of finance receivables......................... 569.1 388.1 443.3 318.6 201.5
Net investment income:
Assets held by insurance subsidiaries..................... 1,825.3 1,302.5 1,142.6 385.7 896.2
Finance receivables....................................... 214.5 138.1 124.7 78.1 57.7
Interest-only securities.................................. 130.3 77.2 51.3 33.3 54.8
Net investment gains (losses) .............................. 266.5 60.8 204.1 (30.5) 242.6
Total revenues.............................................. 6,656.4 3,789.8 3,561.2 2,357.6 3,002.3
Interest expense:
Corporate................................................. 109.4 108.1 119.4 59.3 58.0
Finance and investment borrowings......................... 202.9 92.1 79.5 49.3 61.8
Total benefits and expenses................................. 5,170.7 2,974.0 2,738.5 1,732.9 2,192.0
Income before income taxes, minority interest and
extraordinary charge...................................... 1,485.7 815.8 822.7 624.7 810.3
Extraordinary charge on extinguishment of debt, net of tax.. 6.9 26.5 2.1 4.0 11.9
Net income.................................................. 866.4 452.2 470.9 330.5 413.1
Preferred stock dividends and charge related to induced
conversions of convertible preferred stock................ 21.9 27.4 18.4 18.6 20.6
Net income applicable to common stock....................... 844.5 424.8 452.5 311.9 392.5
PER SHARE DATA (b)
Net income, basic........................................... $2.72 $1.85 $ 2.19 $ 1.39 $ 1.82
Net income, diluted......................................... 2.52 1.69 2.03 1.32 1.63
Dividends declared per common share......................... .313 .083 .046 .125 .075
Book value per common share outstanding..................... 16.45 13.47 8.52 5.58 6.27
Shares outstanding at year-end.............................. 310.0 293.4 205.2 212.7 224.1
Weighted average shares outstanding for diluted earnings.... 338.7 267.7 232.3 250.5 251.8
BALANCE SHEET DATA - PERIOD END
Total assets................................................ $40,629.9 $28,692.7 $19,510.1 $12,302.3 $15,266.3
Notes payable and commercial paper:
Corporate................................................. 2,354.9 1,094.9 871.4 191.8 413.0
Consumer and commercial finance........................... 1,866.3 762.5 383.6 309.3 515.0
Notes payable of affiliates, not direct
obligations of Conseco................................. - - 584.7 611.1 290.3
Total liabilities........................................... 34,031.4 23,778.2 17,075.1 10,509.2 13,350.8
Minority interests in consolidated subsidiaries:
Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts.............. 1,383.9 600.0 - - -
Preferred stock........................................... - 97.0 110.7 130.1 -
Common stock.............................................. .7 .7 292.6 191.6 223.8
Shareholders' equity ....................................... 5,213.9 4,216.8 2,031.7 1,471.4 1,691.7
OTHER FINANCIAL DATA (b) (c)
Premiums collected (d)...................................... $5,055.7 $3,280.2 $3,106.5 $1,879.1 $2,140.1
Operating earnings (e)...................................... 874.0 467.5 381.8 331.8 278.1
Operating earnings per diluted common share (e)............. 2.58 1.75 1.64 1.33 1.10
Assets under management and managed receivables
(at fair value) (g)....................................... 60,036.0 51,182.0 38,613.0 32,934.0 25,454.0
Shareholders' equity excluding unrealized appreciation
(depreciation) of fixed maturity securities (f)........... 5,036.7 4,177.0 1,919.1 1,609.1 1,604.3
Book value per common share outstanding, excluding
unrealized appreciation (depreciation) of fixed
maturity securities (f)................................... 15.88 13.33 7.97 6.23 5.88
2
<PAGE>
- --------------------
<FN>
(a) Comparison of selected supplemental consolidated financial data in the
table above is significantly affected by: (i) the acquisitions
consummated by Conseco Capital Partners, L.P. and Conseco Capital
Partners II, L.P. ("Partnership II"); (ii) the sale of Western National
Corporation ("Western National"); (iii) the transactions affecting
Conseco's ownership interest in Bankers Life Holding Corporation ("BLH")
and CCP Insurance, Inc. ("CCP"); (iv) the acquisition of Life Partners
Group, Inc. ("LPG"); (v) the acquisition of American Travellers
Corporation (the "ATC Merger"); (vi) the acquisition of Transport
Holdings Inc. (the "THI Merger"); (vii) the acquisition of Capitol
American Financial Corporation (the "CAF Merger"); (viii) the acquisition
of Pioneer Financial Services, Inc., (the "PFS Merger"); (ix) the
acquisition of (the "Colonial Penn Purchase") of Colonial Penn Life
Insurance Company and Providential Life Insurance Company and certain
other assets (collectively referred to as "Colonial Penn"); and (x) the
acquisition of Washington National Corporation (the "WNIC Merger").
Conseco did not have unilateral control to direct all of CCP's activities
during 1993 and 1994 and, therefore, did not consolidate the financial
statements of CCP with the financial statements of Conseco. As a result
of the purchase by Conseco of all the shares of common stock of CCP it
did not already own on August 31, 1995, the financial statements of CCP's
subsidiaries are consolidated with the financial statements of Conseco,
effective January 1, 1995. Conseco has included BLH in its financial
statements since November 1, 1992. Through December 31, 1993, the
financial statements of Western National were consolidated with the
financial statements of Conseco. Following the completion of the initial
public offering of Western National (and subsequent disposition of
Conseco's remaining equity interest in Western National), the financial
statements of Western National were no longer consolidated with the
financial statements of Conseco. As of September 29, 1994, Conseco began
to include in its financial statements the newly acquired Partnership II
subsidiary, American Life Holdings, Inc. As of July 1, 1996, Conseco
began to include in its financial statements its newly acquired
subsidiary, LPG. Effective December 31, 1996, Conseco began to include in
its financial statements its subsidiaries acquired in the ATC Merger and
the THI Merger. As of January 1, 1997, Conseco began to include in its
financial statements its subsidiaries acquired in the CAF Merger. As of
April 1, 1997, Conseco began to include in its financial statements its
subsidiaries acquired in the PFS Merger. Effective September 30, 1997,
Conseco began to include in its financial statements its subsidiaries
acquired in the Colonial Penn Purchase. Effective December 1, 1997,
Conseco began to include in its financial statements its subsidiaries
acquired in the WNIC Merger. Such business combinations are described in
the notes to Conseco's supplemental consolidated financial statements
included in this supplemental filing.
(b) All share and per-share amounts have been restated to reflect the
two-for-one stock splits paid on February 11, 1997 and April 1, 1996.
Prior period earnings per share amounts have been restated to comply with
the new reporting standards as described in note 1 to the consolidated
financial statements.
(c) Amounts under this heading are included to assist the reader in analyzing
the Company's financial position and results of operations. Such amounts
are not intended to, and do not, represent insurance policy income, net
income, net income per share, shareholders' equity or book value per
share prepared in accordance with generally accepted accounting
principles ("GAAP").
(d) Includes premiums received from universal life products and products
without mortality or morbidity risk. Such premiums are not reported as
revenues under GAAP and were $2,099.4 million in 1997; $1,881.3 million
in 1996; $1,757.5 million in 1995; $634.6 million in 1994; and $891.9
million in 1993.
(e) Represents income before extraordinary charge, excluding net investment
gains (losses) of our life insurance and corporate segments (less that
portion of change in future policy benefits, amortization of cost of
policies purchased and cost of policies produced and income taxes
relating to such gains (losses)) and nonrecurring charges (net of income
taxes).
(f) Excludes the effects of reporting fixed maturities at fair value and
recording the unrealized gain or loss on such securities as a component
of shareholders' equity, net of tax and other adjustments. Such
adjustments are in accordance with Statement of Financial Accounting
Standards No. 115 "Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS 115"), as described in note 1 to the consolidated
financial statements.
(g) Represents: (i) the total market value of the investment portfolios
managed by Conseco Capital Management, Inc. ("CCM") including assets of
Conseco's subsidiaries of $27.0 billion, $18.5 billion, $13.7 billion,
$11.5 billion and $7.4 billion at December 31, 1997, 1996, 1995, 1994 and
1993, respectively, and assets of unaffiliated parties of $5.1 billion,
$12.6 billion, $11.0 billion, $11.6 billion and $10.9 billion at December
31, 1997, 1996, 1995, 1994 and 1993, respectively; and (ii) the total
fixed and revolving credit receivables that Green Tree manages, including
receivables on its balance sheet and receivables applicable to the
holders of asset-backed securities sold by Green Tree.
</FN>
</TABLE>
3
<PAGE>
SUPPLEMENTAL MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The supplemental management's discussion and analysis reviews the
consolidated financial condition of Conseco and Green Tree on a combined basis
at December 31, 1997 and 1996, the supplemental consolidated results of
operations for the three years ended December 31, 1997, and where appropriate,
factors that may affect future financial performance. This discussion should be
read in conjunction with the accompanying supplemental consolidated financial
statements, notes thereto and selected supplemental consolidated financial data.
All statements, trend analyses and other information contained in this
report and elsewhere (such as in other filings by Conseco or Green Tree with the
Securities and Exchange Commission, press releases, presentations by Conseco or
Green Tree or its management or oral statements) relative to markets for
Conseco's or Green Tree's products and trends in Conseco's or Green Tree's
operations or financial results, as well as other statements including words
such as "anticipate," "believe," "plan," "estimate," "expect," "intend," and
other similar expressions, constitute forward-looking statements under the
Private Securities Litigation Reform Act of 1995. These forward-looking
statements are subject to known and unknown risks, uncertainties and other
factors that may cause actual results to be materially different from those
contemplated by the forward-looking statements. Such factors include, among
other things: (i) general economic conditions and other factors, including
prevailing interest rate levels, short-term interest rate fluctuations, stock
market performance and health care inflation, which may affect the ability of
Conseco to sell its products, the ability of Green Tree to make loans and access
capital are sources, the market value of Conseco's and Green Tree's investments,
the lapse rate and profitability of Conseco's policies; and the level of
defaults and prepayments of loans made by Green Tree; (ii) Conseco'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 that may
affect the profitability of Conseco's insurance products; (v) changes in the
federal income tax laws and regulations that may affect the relative tax
advantages of some of Conseco's products; (vi) increasing competition in the
sale of insurance and annuities and in the consumer finance business; (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 Conseco's supplemental
health insurance products; (viii) the availability and terms of future
acquisitions; and (ix) the risk factors or uncertainties listed in Conseco's or
Green Tree's other filings with the Securities and Exchange Commission. In
addition to the above, these statements are subject to uncertainties related to
the synergies, charges and expenses associated with the Green Tree Merger.
Consolidated results and analysis
Our 1997 operating earnings were $874.0 million, or $2.58 per diluted
share, up 87 percent and 47 percent, respectively, over 1996. Operating earnings
increased as a result of our recent acquisitions: the LPG Merger (completed
effective July 1, 1996), the ALH Stock Purchase (September 30, 1996), the ATC
Merger (December 31, 1996), the THI Merger (December 31, 1996), the BLH Merger
(December 31, 1996), the CAF Merger (January 1, 1997), the PFS Merger (April 1,
1997), the Colonial Penn Purchase (September 30, 1997) and the WNIC Merger
(December 1, 1997). In addition, operating earnings increased as a result of the
increased business in force of the recently acquired companies and companies
previously owned and increased finance receivable originations and sales by
Green Tree. The percentage increase in operating earnings was greater than the
percentage increase in operating earnings per diluted share primarily because of
the 27 percent increase in weighted average diluted common shares or equivalents
outstanding during 1997. The increase in weighted average diluted shares
resulted from shares issued in certain 1997 and 1996 acquisitions (the LPG
Merger, the ATC Merger, the THI Merger, the BLH Merger, the CAF Merger and the
PFS Merger), partially offset by repurchases of common stock.
Our 1996 operating earnings were $467.5 million, or $1.75 per diluted
share, up 22 percent and 7 percent, respectively, over 1995. Operating earnings
increased as a result of the LPG Merger, the ALH Stock Purchase, the effect of
increased ownership of BLH as a result of purchases of BLH common stock during
1995 and 1996, and profit improvements in each of our segments. Such increases
were partially offset by decreased earnings of Green Tree resulting primarily
from a writedown of interest-only securities. Operating earnings for 1996 were
not affected by the ATC Merger, the THI Merger or the BLH Merger, all of which
were recorded as of December 31, 1996. The percentage increase in operating
earnings was greater than the increase in operating earnings per diluted share
primarily because of the additional common shares or equivalents outstanding in
1996 resulting from: (i) the LPG Merger; and (ii) the Company's January 1996
offering of Preferred Redeemable Increased Dividend Equity Securities, 7% PRIDES
Convertible Preferred Stock ("PRIDES"), which are mandatorily convertible into
shares of Conseco common stock.
Net income of $866.4 million in 1997, or $2.52 per diluted share,
included: (i) net investment gains of our life insurance and corporate segments
(net of related costs, amortization and taxes) of $44.1 million, or 13 cents per
diluted share; (ii) an extraordinary charge of $6.9 million, or 2 cents per
share, related to early retirement of debt; (iii) a charge of 4 cents per share
related to the induced conversion of preferred stock (treated as a preferred
stock dividend); and (iv) nonrecurring charges totaling $44.8 million, or 13
cents
4
<PAGE>
per share. Nonrecurring charges include: (i) $40.5 million related to our
Medicare supplement business in Massachusetts; and (ii) $4.3 million related to
the death of an executive officer. Regulators in Massachusetts have not allowed
premium increases for Medicare supplement products necessary to avoid losses on
the business. We are currently seeking rate increases. We are no longer writing
new Medicare supplement business in Massachusetts. We have written off the cost
of policies purchased and produced and accrued additional claim reserves related
to our in-force Massachusetts Medicare supplement business due to the estimated
premium deficiencies.
Net income of $452.2 million in 1996, or $1.69 per diluted share,
included: (i) net investment gains of our life insurance and corporate segments
(net of related costs, amortization and taxes) of $11.2 million, or 4 cents per
diluted share; and (ii) an extraordinary charge of $26.5 million, or 10 cents
per share, related to early retirement of debt. Net income of $470.9 million in
1995, or $2.03 per diluted share, included: (i) net investment gains (net of
related costs, amortization and taxes) of $16.3 million, or 7 cents per share;
(ii) restructuring income of $74.9 million, or 32 cents per share, arising from
the release of deferred income taxes previously accrued on income related to CCP
and BLH (such deferred tax was no longer required when Conseco's ownership of
these companies exceeded 80 percent); and (iii) an extraordinary charge of $2.1
million, or nil per share, related to early retirement of debt.
Total revenues include net investment gains of our life insurance and
corporate segments of $266.5 million in 1997, $60.8 million in 1996 and $204.1
million in 1995. Excluding net investment gains, total revenues were $6.4
billion in 1997, up 71 percent from $3.7 billion in 1996. Total revenues in 1997
include a full year of activity for acquisitions completed in 1996 and the
revenues of CAF, PFS, Colonial Penn and WNIC in the periods subsequent to their
acquisitions. Total revenues in 1996 include LPG revenues after July 1, 1996.
Total revenues, excluding net investment gains of our life insurance and
corporate segments, were up 11.0 percent in 1996 from $3.4 billion in 1995.
5
<PAGE>
Results of operations by segment for the three years ended December 31,
1997:
The following tables and narratives summarize the results of our
operations by business segment. All amounts reported in these summaries relate
solely to periods after the companies were included in our consolidated
financial statements.
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Income before income taxes, minority interest and extraordinary charge:
Consumer and commercial finance:
Operating income...........................................................$ 482.6 $ 322.2 $ 404.2
-------- ------- -------
Supplemental health:
Operating income........................................................... 408.0 136.6 96.0
Net investment gains, net of related costs................................. 26.3 .1 1.1
Nonrecurring charges....................................................... (62.4) - -
-------- ------- -------
Income before income taxes, minority interest and extraordinary charge. 371.9 136.7 97.1
-------- ------- -------
Annuities:
Operating income .......................................................... 305.1 255.0 244.1
Net investment gains (losses), net of related costs and amortization ...... 53.2 (.7) 72.0
-------- ------- -----
Income before income taxes, minority interest and extraordinary charge. 358.3 254.3 316.1
-------- ------- -------
Life insurance:
Operating income........................................................... 304.7 126.8 74.8
Net investment gains (losses), net of related costs and amortization....... 2.4 (2.0) (4.6)
-------- ------- -------
Income before income taxes, minority interest and extraordinary charge. 307.1 124.8 70.2
-------- ------- -------
Individual and group major medical:
Operating income........................................................... 40.2 32.1 35.1
Net investment gains, net of related costs................................. .1 - .1
-------- ------- -------
Income before income taxes, minority interest and extraordinary charge. 40.3 32.1 35.2
-------- ------- -------
Other:
Operating income........................................................... 58.3 30.7 31.5
Net investment gains (losses), net of related costs........................ 3.3 27.4 (6.3)
-------- ------- -------
Income before income taxes, minority interest and extraordinary charge. 61.6 58.1 25.2
-------- ------- -------
Corporate:
Interest and other corporate expenses...................................... (126.8) (112.4) (140.5)
Nonrecurring charges....................................................... (9.3) - -
Net investment gains, net of related costs................................. - - 15.2
-------- ------- -------
Net corporate expenses................................................. (136.1) (112.4) (125.3)
-------- ------- -------
Consolidated:
Operating income........................................................... 1,472.1 791.0 745.2
Net investment gains, net of related costs and amortization ............... 85.3 24.8 77.5
Nonrecurring charges....................................................... (71.7) - -
-------- ------- -------
Income before income taxes, minority interest and extraordinary charge. 1,485.7 815.8 822.7
Income tax expense.............................................................. 560.1 302.2 240.7
-------- ------- -------
Income before minority interest and extraordinary charge............... 925.6 513.6 582.0
Minority interest in consolidated subsidiaries:
Distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts............................................ 49.0 3.6 -
Dividends on preferred stock of subsidiaries................................. 3.3 8.9 11.9
Equity in earnings of subsidiaries........................................... - 22.4 97.1
-------- ------- -----
Income before extraordinary charge..................................... 873.3 478.7 473.0
Extraordinary charge on extinguishment of debt, net of taxes and
minority interest............................................................ 6.9 26.5 2.1
-------- ------- -------
Net income.............................................................$ 866.4 $ 452.2 $ 470.9
======== ======= =======
</TABLE>
6
<PAGE>
Consumer and Commercial Financing:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Contract originations:
Manufactured housing.............................................. $ 5,479.3 $ 4,882.0 $ 4,159.8
Home equity/home improvement...................................... 3,476.2 1,493.7 627.0
Consumer/retail credit............................................ 1,510.9 835.6 361.4
Commercial/equipment.............................................. 5,181.4 3,343.0 1,742.7
--------- --------- ---------
Total........................................................... $15,647.8 $10,554.3 $ 6,890.9
========= ========= =========
Sales of receivables:
Manufactured housing.............................................. $ 5,370.0 $ 5,033.0 $ 4,020.0
Home equity/home improvement...................................... 3,020.0 1,324.0 579.0
Consumer/equipment................................................ 1,627.0 1,556.0 -
Commercial and revolving credit................................... 224.0 500.0 428.0
Lease and other................................................... 508.0 - 308.0
--------- --------- ---------
Total........................................................... $10,749.0 $ 8,413.0 $ 5,335.0
========= ========== =========
Managed receivables (at period end):
Fixed contracts................................................... $26,036.0 $18,965.0 $13,314.0
Revolving credit.................................................. 1,921.0 1,108.0 574.0
--------- --------- ---------
Total........................................................... $27,957.0 $20,073.0 $13,888.0
========= ========= =========
Gain on sale of receivables.......................................... $ 569.1 $ 388.1 $ 443.3
Net investment income:
Finance receivables............................................... 214.5 138.1 124.7
Interest-only securities.......................................... 130.3 77.2 51.3
Fee revenue and other income......................................... 174.1 119.1 86.6
--------- --------- ---------
Total revenues.................................................. 1,088.0 722.5 705.9
--------- --------- ---------
Consumer and commercial finance interest expense..................... 160.9 70.1 57.3
Amortization of servicing rights and goodwill........................ 15.4 - -
Other operating costs and expenses................................... 429.1 330.2 244.4
--------- --------- ---------
Total expenses.................................................. 605.4 400.3 301.7
--------- --------- ---------
Income before income taxes, minority interest
and extraordinary charge...................................... $ 482.6 $ 322.2 $ 404.2
========= ========= =========
</TABLE>
General: This segment provides financing for manufactured housing, home
equity, home improvements, consumer products and equipment and provides consumer
and commercial revolving credit. The segment's financing products include both
fixed term and revolving loans and leases. The segment also markets physical
damage and term mortgage life insurance and other credit protection relating to
the customers contracts it services.
Contract originations in 1997 were $15,647.8 million, up 48 percent over
1996. Contract originations in 1996 were $10,554.3 million, up 53 percent over
1995.
Manufactured housing contract originations increased $597.3 million, or 12
percent, during 1997 over 1996. The number of contracts originated during the
1997 period increased as well as the average contract size reflecting an
increase in land-and-home contracts and slight price increases by the
manufactured housing manufacturers.
Home equity/home improvement contract originations increased $1,982.5
million, or 133 percent, during 1997 over 1996, and increased $866.7 million, or
138 percent, during 1996 over 1995. The increase is primarily the result of the
segment's continued expansion of the home equity retail origination network.
7
<PAGE>
Consumer and retail credit originations increased $675.3 million, or 81
percent, during 1997 over 1996, and increased $474.2 million, or 131 percent,
during 1996 over 1995. The increase reflects several credit card portfolio
purchases and overall growth in the consumer products sector.
Commercial and equipment originations increased $1,838.4 million, or 55
percent, during 1997 over 1996, and increased $1,600.3 million, or 92 percent,
during 1996 over 1995. The increase reflects higher production in all areas of
commercial financing.
Sales of receivables occur when the segment sells finance receivables it
originates in secondary markets through securitizations. The total receivables
sold in a particular period is dependent on many factors including: (i) the
volume of recent originations; (ii) market conditions; and (iii) the
availability and cost of alternative financing. Total finance receivables sold
in 1997 were up 28 percent over 1996. Total finance receivables sold in 1996
were up 58 percent over 1995.
Managed finance receivables include finance receivables sold through
securitizations upon which we continue to receive servicing fees as well as
finance receivables. The total portfolio serviced by the segment increased to
$28.0 billion at December 31, 1997, a 39 percent increase over 1996. The total
portfolio increased to $20.1 billion at December 31, 1996, a 45 percent increase
over 1995.
Gain on sale of finance receivables represents the difference between the
proceeds from the sale, net of related transaction costs, and the allocated
carrying amount of the receivables sold. The allocated carrying amount is
determined by allocating the original amount of the receivables between the
portion sold and any retained interests (interest-only securities and servicing
rights), based on their relative fair values at the time of sale. Assumptions
used in calculating the estimated fair value of interest-only securities and
servicing rights are subject to volatility that could materially affect
operating results. Prepayments from competition, obligor mobility, general and
regional economic conditions and prevailing interest rates, as well as actual
losses incurred, may vary from the performance projected, which may result in an
increase or decrease to the value of the interest-only securities and servicing
rights we retain.
Gain on sale of receivables increased 47 percent, to $569.1 million, in
1997 and decreased 12 percent, to $388.1 million, in 1996. Such gain fluctuates
when changes occur in: (i) the amount of loans sold; (ii) market conditions;
(iii) the amount and type of interest retained in the receivables sold; and (iv)
changes in assumptions used to calculate the gain. Recent experience has
indicated that prepayment rates have exceeded expectations for loans sold in
prior periods. As a result, writedowns of interest-only securities of $190.0
million and $200.0 million were recognized as a reduction to the gain during
1997 and 1996. The 1997 writedown of interest-only securities was generally the
result of adverse prepayment experience. The 1996 writedown was the result of
adjustments necessary to consider the effects of partial prepayments on
projected future interest collections.
Prior to giving effect to the writedowns, the gain on sale of finance
receivables increased 29 percent and 33 percent in 1997 and 1996, respectively.
These increases resulted primarily from the increased finance receivables
originated during these years. The increase in sales during 1996 was partially
offset by a higher concentration of shorter term consumer loans originated and
sold compared to the longer term manufactured housing and home equity and home
improvement loans.
Net investment income on finance receivables consists of interest earned on
the segment's unsold finance receivables and interest income on short-term and
other investments. Such income increased 55 percent, to $214.5 million in 1997,
and increased 11 percent, to $138.1 million in 1996. The increases are
consistent with the increases in the average finance receivables during these
years.
Net investment income on interest-only securities represents the accretion
recognized on the interest-only securities retained when finance receivables are
sold. Such income increased 69 percent, to $130.3 million in 1997, and increased
50 percent to $77.2 million in 1996. The increases are consistent with the
increase in the average interest-only securities held during these years.
Fee revenue and other income includes servicing income, commissions earned
on new insurance policies written and renewals on existing policies, as well as
other income from late fees. Such income increased 46 percent, to $174.1
million, in 1997 and increased 38 percent, to $119.1 million, in 1996. The
increase reflects: (i) the growth in the segment's managed receivable portfolio
on which servicing income is earned; and (ii) the increase in net written
insurance premiums consistent with the growth of the segment's managed
receivables.
Consumer and commercial finance interest expense increased 130 percent, to
$160.9 million, in 1997 and increased 22 percent, to $70.1 million, in 1996. The
increase primarily reflects increased borrowings to fund loan originations,
commercial revolving credit and lease portfolio financings.
Other operating costs and expenses include the costs associated with
servicing the segment's managed receivables and costs of originating new loans.
Such expense increased 30 percent, to $429.1 million, in 1997 and increased 35
percent, to $330.2 million, in 1996. The increase reflects: (i) the growth in
the segment's servicing portfolio; and (ii) the increased volume of contracts
originated.
8
<PAGE>
Supplemental health:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Premiums collected:
Medicare supplement (first-year)............................. $ 101.9 $ 72.5 $ 81.1
Medicare supplement (renewal)................................ 694.5 545.4 515.6
--------- ------- -------
Subtotal - Medicare supplement........................... 796.4 617.9 596.7
--------- ------- -------
Long-term care (first-year).................................. 143.4 51.6 44.4
Long-term care (renewal)..................................... 520.5 141.3 97.7
--------- ------- -------
Subtotal - long-term care................................ 663.9 192.9 142.1
--------- ------- -------
Specified-disease (first-year)............................... 44.7 - -
Specified-disease (renewal).................................. 338.7 - -
--------- ------- --------
Subtotal - specified-disease............................. 383.4 - -
--------- ------- -------
Total supplemental health premiums collected............. $1,843.7 $ 810.8 $738.8
======== ======= ======
Insurance policy income......................................... $1,858.1 $ 805.9 $756.9
Net investment income........................................... 273.8 66.6 66.9
-------- ------- -------
Total revenues (a)......................................... 2,131.9 872.5 823.8
--------- ------- -------
Insurance policy benefits and change in future policy benefits.. 1,217.5 531.8 525.6
Amortization related to operations.............................. 232.1 87.8 81.6
Interest expense on investment borrowings....................... 6.3 1.1 1.4
Other operating costs and expenses.............................. 268.0 115.2 119.2
--------- ------- -------
Total benefits and expenses................................ 1,723.9 735.9 727.8
--------- ------- -------
Operating income before income taxes,
minority interest and extraordinary
charge................................................... 408.0 136.6 96.0
Net investment gains, net of related costs...................... 26.3 .1 1.1
Nonrecurring charges............................................ (62.4) - -
--------- ------- -------
Income before income taxes, minority
interest and extraordinary charge...................... $ 371.9 $136.7 $97.1
========= ====== =====
Loss ratios:
Medicare supplement products................................. 69.1% 68.2% 71.7%
Long-term care products...................................... 63.6 58.7 60.5
Specified-disease products................................... 61.6 - -
<FN>
(a) Revenues exclude net investment gains.
</FN>
</TABLE>
General: This segment includes Medicare supplement and long-term care
insurance products, primarily sold to senior citizens, and effective January 1,
1997 (as a result of the acquisitions of CAF and THI), specified-disease
products. Through December 31, 1996, the supplemental health operations consist
solely of Bankers Life's Medicare supplement and long-term care products,
distributed through a career agency force. The segment's 1997 results of
operations are significantly affected by recent acquisitions (ATC, THI and CAF,
effective January 1, 1997; PFS, effective April 1, 1997; and Colonial Penn,
effective September 30, 1997). The supplemental health products of THI, CAF,
ATC, PFS and Colonial Penn are all distributed through professional independent
producers. The profitability of this segment largely depends on the overall
level of sales, persistency of in-force business, claim experience and expense
management.
9
<PAGE>
Premiums collected by this segment in 1997 were $1,843.7 million, up 127
percent from 1996. Premiums collected in 1996 increased to $810.8 million, up
9.7 percent.
Medicare supplement policies accounted for 43 percent of this segment's
collected premiums in 1997, compared with more than 75 percent of this segment's
collected premiums in 1996 and 1995. The change in the mix of premiums collected
reflects the more diverse supplemental health lines sold by Conseco as a result
of the recent acquisitions. Collected premiums on Medicare supplement policies
increased 29 percent in 1997, to $796.4 million, and increased 3.6 percent in
1996, to $617.9 million. Such increases primarily reflect the recent
acquisitions and a larger base of premiums due to rate increases. The sales of
Medicare supplement policies have been affected by: (i) steps taken to improve
profitability by increasing premium rates and changing both the commission
structure and the underwriting criteria for these policies; and (ii) increased
competition from alternative providers, including HMOs.
Premiums collected on long-term care policies increased 244 percent in
1997, to $663.9 million, and 36 percent in 1996, to $192.9 million. First-year
collected premiums in 1997, 1996 and 1995 were $143.4 million, $51.6 million and
$44.4 million, respectively. The increase in long-term care premiums collected
primarily reflects the acquisition of recently acquired companies.
Premiums collected on specified-disease policies were $383.4 million in
1997, substantially all of which were collected by recently acquired companies.
Insurance policy income comprises premiums earned on the segment's
policies and has increased over the last three years consistent with the
explanations provided above for premiums collected.
Net investment income increased 311 percent in 1997, to $273.8 million,
and did not change materially in 1996 compared with 1995. 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 1997, the segment's average invested assets increased approximately 278
percent, to $3.4 billion, and the net yield on invested assets increased to 8.0
percent from 7.6 percent. During 1996, the segment's average invested assets
increased approximately 5.0 percent, to $.9 billion, and the net yield on
invested assets decreased from 8.0 percent to 7.6 percent. Invested assets grew
as a result of the growth in insurance liabilities related to the segment's
business.
Insurance policy benefits and change in future policy benefits increased
in 1997, reflecting recent acquisitions, the larger amount of business in force
on which benefits are incurred, and a higher incidence of claims. This account
increased in 1996 as a result of the larger amount of business in force on which
benefits are incurred, net of the lower incidence of claims. In 1997, the ratio
of policy benefits to insurance policy income for the Medicare supplement
policies increased to 69.1 percent from 68.2 percent, reflecting the different
characteristics of such policies in recently acquired companies as well as
fluctuations in claim experience. In 1996, the ratio of policy benefits to
insurance policy income for Medicare supplement policies fell 3.5 percentage
points to 68.2 percent, reflecting the premium rate increases implemented in
1996 and 1995.
Changes in the ratio of policy benefits to insurance policy income for
long-term care policies reflect different characteristics of such policies in
recently acquired companies as well as fluctuations in claim experience and
reserve development. In 1997, the long-term care loss ratio increased by 4.9
percentage points, to 63.6 percent. In 1996, the long-term care loss ratio fell
by 1.8 percentage points, to 58.7 percent.
The ratio of policy benefits to insurance policy income for
specified-disease policies was 61.6 percent in 1997. Such products were not sold
by Conseco prior to the acquisitions of THI and CAF.
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 increased
primarily because of the increase in balances subject to amortization as a
result of recent acquisitions.
Interest expense on investment borrowings was affected by changes in
investment borrowing activities during the last three years and the changes in
interest rates paid on such borrowings.
Other operating costs and expenses increased in 1997 from the increased
business of recently acquired companies. Such expenses did not change materially
in 1996 compared with 1995.
10
<PAGE>
Net investment gains, net of related costs, often fluctuate from period
to period.
Nonrecurring charges for 1997 represent 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 seeking rate increases. We are no longer writing new
Medicare supplement business in Massachusetts.
11
<PAGE>
<TABLE>
<CAPTION>
Annuities:
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Annuity premiums collected:
Traditional fixed (first-year)................................ $ 857.8 $1,148.6 $1,536.4
Traditional fixed (renewal)................................... 79.4 92.7 62.8
--------- -------- --------
Subtotal - traditional fixed.............................. 937.2 1,241.3 1,599.2
--------- -------- --------
Market value - adjusted (first-year).......................... 165.7 237.2 27.7
Market value - adjusted (renewal)............................. 13.8 20.5 3.1
--------- -------- --------
Subtotal - market value - adjusted........................ 179.5 257.7 30.8
--------- -------- --------
Equity-indexed (all first-year)............................... 387.7 80.4 -
--------- -------- --------
Variable annuities (first-year)............................... 127.4 37.9 17.2
Variable annuities (renewal).................................. 57.8 53.0 46.7
--------- -------- --------
Subtotal - variable annuities............................. 185.2 90.9 63.9
--------- -------- --------
Total annuity premiums collected.......................... $1,689.6 $1,670.3 $1,693.9
======== ======== ========
Insurance policy income.......................................... $ 96.8 $ 77.6 $ 68.4
Net investment income:
General account invested assets............................... 960.9 891.2 851.5
Change in fair value of S&P 500 Call Options.................. 39.4 - -
Separate account assets....................................... 70.3 48.4 28.8
--------- -------- --------
Total revenues (a)...................................... 1,167.4 1,017.2 948.7
--------- -------- --------
Insurance policy benefits and change in future policy benefits... 74.1 67.3 61.8
Amounts added to policyholder account balances:
Annuity products other than those listed below................ 542.2 523.2 505.0
Equity-indexed products based on S&P 500 Index................ 39.3 - -
Variable annuity products..................................... 70.3 48.4 28.8
Amortization related to operations............................... 84.8 76.9 64.9
Interest expense on investment borrowings........................ 23.2 14.3 16.9
Other operating costs and expenses............................... 28.4 32.1 27.2
--------- -------- --------
Total benefits and expenses (a)......................... 862.3 762.2 704.6
--------- -------- --------
Operating income before income taxes, minority
interest and extraordinary charge..................... 305.1 255.0 244.1
Net investment gains (losses), net of related costs and
amortization.................................................. 53.2 (.7) 72.0
--------- -------- --------
Income before income taxes, minority interest
and extraordinary charge.............................. $ 358.3 $ 254.3 $ 316.1
========= ========= ========
Weighted average gross interest spread on annuity products (b)... 2.8% 2.9% 3.1%
=== === ===
Total traditional fixed and market value-adjusted annuity
product insurance liabilities at end of period................ $13,007.4 $11,998.6 $10,169.1
========= ========= =========
Total annuity product insurance liabilities at end of period..... $14,150.8 $12,421.8 $10,396.1
========= ========= =========
<FN>
(a) Revenues exclude net investment gains (losses); benefits and expenses
exclude amortization related to net investment gains (losses).
(b) Excludes variable annuity products where the credited amount is based on
investment income from segregated investments.
</FN>
</TABLE>
General: This segment includes traditional fixed rate annuity products
(SPDAs, FPDAs and SPIAs), market value-adjusted annuity products, equity-indexed
annuity products 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
12
<PAGE>
over interest credited on annuity deposits), the persistency of in-force
business, and expense management. In addition, comparability between periods is
affected by: (i) the LPG Merger, effective July 1, 1996; and (ii) the ALH Stock
Purchase, effective September 30, 1996.
Premiums collected by this segment in 1997 were $1,689.6 million, up 1.2
percent over 1996. Premiums collected in 1996 were $1,670.3 million, down 1.4
percent from 1995. Increased competition from products such as mutual funds,
traditional bank investments, variable annuities and other investment and
retirement funding alternatives was a significant factor in the modest increase
in annuity premiums collected, despite the full-year impact of the former LPG
subsidiaries.
Traditional fixed rate annuity products include SPDAs, FPDAs and SPIAs,
which are credited with a guaranteed rate. SPDA and FPDA policies (which make up
78 percent, 84 percent and 90 percent of traditional fixed rate annuity premiums
collected in 1997, 1996 and 1995, respectively) typically have an interest rate
that is guaranteed for the first policy year, after which we have the
discretionary ability to change the crediting rate to any rate not below a
guaranteed minimum rate. The interest rate credited on SPIAs is based on market
conditions existing when a policy is issued and remains unchanged over the life
of the SPIA. The demand for traditional fixed rate annuity contracts has
decreased in recent years, as relatively low interest rates have made other
investment products more attractive. Annuity premiums on these products
decreased 24 percent in 1997, to $937.2 million, and decreased 22 percent in
1996, to $1,241.3 million.
We offer deferred annuity products with a "market value adjustment"
feature designed to provide 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 11 percent
and 16 percent of total annuity premiums collected during 1997 and 1996,
respectively.
In response to consumers' desire for alternative investment products with
returns linked to equities, we introduced an equity- indexed annuity product in
June 1996. The accumulation value of these annuities is credited with interest
at an annual minimum guaranteed rate of 3 percent, but the annuities provide for
higher returns based on a percentage of the change in the S&P 500 Index during
each year of their term. We purchase S&P 500 Call Options in an effort to hedge
potential increases to policyholder benefits resulting from increases in the S&P
500 Index to which the product's return is linked. Total collected premiums for
this product were $387.7 million in 1997 compared with $80.4 million in 1996.
Variable annuities offer contract holders a rate of return based on 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 we 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. Variable annuity collected premiums increased
104 percent in 1997, to $185.2 million, and increased 42 percent in 1996, to
$90.9 million.
Insurance policy income includes: (i) premiums received on SPIA policies
that incorporate significant mortality features; (ii) 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 in 1997 and 1996 primarily because of increased surrender charges
collected (changes in premiums received on policies with mortality features and
cost of insurance and expenses charged to annuity policies were not
significant). Surrender charges were $64.0 million in 1997, $41.2 million in
1996 and $28.6 million in 1995. Annuity policy withdrawals were $1.8 billion in
1997, compared with $1.7 billion in 1996 and $1.5 billion in 1995. 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 were 15 percent, 16
percent and 16 percent of insurance liabilities related to surrenderable
policies in 1997, 1996 and 1995, respectively.
Net investment income on general account invested assets (excluding
income on separate account assets related to variable annuities and the change
in the fair value of S&P 500 Call Options related to equity-indexed products)
increased 7.8 percent in 1997, to $960.9 million, and increased 4.7 percent in
1996, to $891.2 million. 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 11 percent to
$12.8 billion in 1997, compared with 1996, and the annualized yield earned on
average invested assets decreased from 7.9 percent to 7.5 percent in 1997. The
segment's average invested assets increased 10 percent to $11.2 billion in 1996,
and the annualized yield earned on average invested assets decreased from 8.4
percent to 7.9 percent in 1996. Cash flows received during 1997 and 1996
(including cash flows from the sales of investments) were invested in lower
yielding securities due to a general decline in interest rates.
13
<PAGE>
Net investment income from the change in fair value of S&P 500 Call
Options is substantially offset by a corresponding charge to amounts added to
policyholder account balances for equity-indexed products. Such income and
related charge fluctuate based on the performance of the S&P 500 Index to which
the returns on such products are linked.
Net investment income on separate account assets is offset by a
corresponding charge to amounts added to policyholder account balances for
variable annuity products. Such income and related charge fluctuate 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 the increase in the in-force block of such policies.
Amounts added to policyholder account balances for interest expense on
annuity products increased 3.6 percent in 1997 and 3.6 percent in 1996,
primarily due to a larger block of annuity business in force in 1997, partially
offset by a reduction in crediting rates. The weighted average crediting rates
for these annuity liabilities were 4.8 percent in 1997, 5.0 percent in 1996 and
5.3 percent in 1995.
Amortization related to operations increased 10 percent in 1997 and 18
percent 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
increased primarily because of the increase in balances subject to amortization
as a result of recent acquisitions.
Interest expense on investment borrowings is affected by changes in
investment borrowing activities during the last three years and the changes in
interest rates paid on such borrowings.
Other operating costs and expenses decreased 12 percent in 1997 and
increased 18 percent in 1996. Other operating costs and expenses were favorably
affected in 1997 by the consolidation of all annuity operations in Conseco's
Carmel, Indiana facilities. The increase in 1996 corresponds to the increases in
the total business in force primarily related to acquisition transactions
described above under "General."
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. We believe, 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 realized gains. As a result of the sales of fixed maturity
investments, the amortization of the cost of policies produced and the cost of
policies purchased increased $132.0 million in 1997, $31.6 million in 1996 and
$117.3 million in 1995.
14
<PAGE>
Life insurance:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Premiums collected:
Universal life (first-year).......................................$ 96.6 $ 62.2 $ 15.7
Universal life (renewal).......................................... 354.3 208.9 97.4
---------- ------- ---------
Subtotal - universal life..................................... 450.9 271.1 113.1
---------- ------- ---------
Traditional life (first-year)..................................... 49.0 17.0 16.1
Traditional life (renewal)........................................ 209.1 115.5 124.4
---------- ------- ---------
Subtotal - traditional life................................... 258.1 132.5 140.5
---------- ------- ---------
Total life premiums collected.............................$ 709.0 $ 403.6 $ 253.6
========== ======= =========
Insurance policy income:
Premiums earned on traditional life products......................$ 258.6 $ 141.1 $ 143.5
Mortality charges and administrative fees......................... 357.8 211.2 73.8
Surrender charges................................................. 14.1 8.2 5.1
---------- ------- ---------
Total insurance policy income................................... 630.5 360.5 222.4
Net investment income................................................ 448.2 279.7 176.9
---------- ------- ---------
Total revenues (a)........................................ 1,078.7 640.2 399.3
---------- ------- ---------
Insurance policy benefits and change in future policy benefits....... 456.9 270.5 182.5
Interest added to financial product policyholder account balances.... 154.9 97.0 51.6
Amortization related to operations................................... 61.3 48.1 33.4
Interest expense on investment borrowings............................ 11.6 6.3 3.5
Other operating costs and expenses................................... 89.3 91.5 53.5
---------- ------- ---------
Total benefits and expenses (a)........................... 774.0 513.4 324.5
---------- ------- ---------
Operating income before income taxes,
minority interest and extraordinary
charge................................................. 304.7 126.8 74.8
Net investment gains (losses), net of related costs
and amortization.................................................. 2.4 (2.0) (4.6)
---------- ------- ---------
Income before income taxes, minority
interest and extraordinary charge......................$ 307.1 $ 124.8 $ 70.2
========== ======= =========
Total life product insurance liabilities.............................$ 7,075.0 $4,992.7 $ 2,102.2
========== ======== =========
Life insurance in force..............................................$104,144.5 $80,149.5 $33,783.2
========== ========= =========
<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 career agents, professional independent producers and
direct response distribution channels. This segment's operations were
significantly affected by recent acquisitions (LPG effective July 1, 1996; PFS
effective April 1, 1997; Colonial Penn effective September 30, 1997; and WNIC
effective December 1, 1997). The profitability of this segment largely depends
on the investment spread earned (for universal life), the persistency of
in-force business, claim experience and expense management.
15
<PAGE>
Premiums collected by this segment were up 76 percent in 1997, to $709.0
million. Premiums collected in 1996 were up 59 percent in 1996, to $403.6
million. Such increases relate primarily to premiums collected by recently
acquired companies in periods after their acquisition.
Universal life product collected premiums increased 66 percent in 1997,
to $450.9 million, and increased 140 percent in 1996, to $271.1 million.
Traditional life product collected premiums increased 95 percent in 1997,
to $258.1 million, and decreased 5.7 percent in 1996, to $132.5 million.
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. 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
policyholders' account balances.
All three components of insurance policy income have increased over the
last three years primarily as a result of the acquisition transactions described
above under "General."
Net investment income increased 60 percent in 1997, to $448.2 million,
and 58 percent in 1996, to $279.7 million. Investment income fluctuates with
changes in: (i) the amount of average invested assets supporting insurance
liabilities; and (ii) the yield earned on invested assets. During 1997, the
segment's average invested assets increased 71 percent, to $6.0 billion, and the
net yield on invested assets decreased from 7.9 percent to 7.5 percent. During
1996, the segment's average invested assets increased 66 percent, to $3.5
billion, and the net yield on invested assets decreased from 8.4 percent to 7.9
percent. Invested assets grew primarily as a result of the growth in insurance
liabilities from the acquisition transactions described above under "General."
Insurance policy benefits and change in future policy benefits increased
in 1997 and 1996, reflecting the larger amount of business in force on which
benefits are incurred as a result of the acquisition transactions described
above under "General." There were no unusual fluctuations in claim experience
during the periods.
Interest added to financial product policyholder account balances
increased 60 percent in 1997, to $154.9 million, and 88 percent in 1996, to
$97.0 million. 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. During 1997, such average liabilities increased 66
percent, to $3.3 billion, and the rate credited decreased from 5.0 percent to
4.8 percent. During 1996, such average liabilities increased 98 percent, to $2.0
billion, and the rate credited decreased from 5.2 percent to 5.0 percent.
Universal life product liabilities increased primarily as a result of the
acquisition transactions described above under "General."
Amortization related to operations increased 27 percent in 1997, to $61.3
million, and 44 percent in 1996, to $48.1 million. 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 increases 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 and 1996 (see "Net investment gains (losses)" below).
Interest expense on investment borrowings is affected by changes in
investment borrowing activities during the last three years and the changes in
interest rates paid on such borrowings.
Other operating costs and expenses decreased 2.4 percent in 1997, to
$89.3 million, and increased 71 percent in 1996, to $91.5 million. The
fluctuations correspond to the increases in this segment's business as a result
of recent acquisitions, offset in 1997 by 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 costs of policies purchased and the cost of
policies produced. As a result of net investment gains (losses) from the sales
of fixed maturity investments, amortization of cost of policies purchased and
cost of policies produced increased $49.2 million in 1997, $4.4 million in 1996
and $9.3 million in 1995.
16
<PAGE>
Individual and group major medical:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Premiums collected:
Individual (first-year)...............................................$ 70.3 $ 6.0 $ 8.4
Individual (renewal).................................................. 147.4 44.9 56.1
------- -------- --------
Subtotal - individual............................................. 217.7 50.9 64.5
------- -------- --------
Group (first-year).................................................... 63.6 - -
Group (renewal)....................................................... 462.9 290.1 289.1
------- -------- --------
Subtotal - group.................................................. 526.5 290.1 289.1
------- -------- --------
Total individual and group major medical premiums collected.......$ 744.2 $ 341.0 $ 353.6
======= ======== ========
Insurance policy income..................................................$ 758.1 $ 357.0 $ 352.0
Net investment income.................................................... 17.3 8.8 9.5
------- -------- --------
Total revenues (a)................................................ 775.4 365.8 361.5
------- -------- --------
Insurance policy benefits and changes in future policy benefits.......... 579.5 300.3 300.8
Amortization related to operations....................................... 21.2 16.0 13.6
Interest expense on investment borrowings................................ .6 .1 .2
Other operating costs and expenses....................................... 133.9 17.3 11.8
------- -------- --------
Total benefits and expenses....................................... 735.2 333.7 326.4
------- -------- --------
Operating income before income taxes, minority interest and
extraordinary charge............................................ 40.2 32.1 35.1
Net investment gains, net of related costs............................... .1 - .1
------- -------- --------
Income before income taxes, minority interest and extraordinary
charge..........................................................$ 40.3 $ 32.1 $ 35.2
======= ======== ========
Benefit ratio ........................................................... 78.0% 85.7% 85.4%
<FN>
(a) Revenues exclude net investment gains.
</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, effective April 1, 1997, and to a lesser extent, by the LPG Merger,
effective July 1, 1996. The profitability of this business depends largely on
the overall persistency of the business in force, as well as claim experience
and expense management.
Premiums collected by this segment increased 118 percent in 1997, to
$744.2 million, and decreased 3.6 percent in 1996, to $341.0 million. Individual
health premiums increased 328 percent in 1997, to $217.7 million, and decreased
21 percent in 1996, to $50.9 million. Group premiums increased 81 percent in
1997, to $526.5 million, and did not change materially between 1995 and 1996.
The recently acquired companies accounted for all of the 1997 increases.
Insurance policy income comprises premiums earned on the segment's
policies and fee income earned for group medical risk management services.
Fluctuations in premiums earned have been consistent with the fluctuations in
premiums collected described above. Fee income (which is earned by a subsidiary
acquired in the LPG Merger) was $15.0 million in 1997 and $7.0 million in 1996.
Net investment income increased 97 percent in 1997, to $17.3 million, and
decreased 7.4 percent in 1996, to $8.8 million. 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
1997, the segment's average invested assets increased approximately 111 percent,
to $244.0 million, and the net yield on invested assets decreased from 7.6
percent to 7.1 percent. During 1996, the segment's average
17
<PAGE>
invested assets did not change significantly and the net yield on invested
assets decreased from 7.9 percent to 7.6 percent. Average invested assets
increased in 1997 as a result of the PFS Merger.
Insurance policy benefits and change in future policy benefits increased
in 1997, primarily as a result of the larger amount of segment business in
force. In 1997, the ratio of policy benefits to insurance policy income
decreased 7.7 percentage points, to 78.0 percent. In 1996, the ratio of policy
benefits to insurance policy income increased from 85.4 percent to 85.7 percent.
The lower benefit ratio in 1997 reflects: (i) the lower incidence of claims
experienced on business written by the acquired companies compared with the
business of other Conseco subsidiaries; and (ii) favorable claim developments.
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 expense increased 33 percent in
1997, to $21.2 million, and 18 percent in 1996, to $16.0 million. 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 during the last three years and the changes in
interest rates paid on such borrowings.
Other operating costs and expenses increased 674 percent in 1997, to
$133.9 million, and 47 percent in 1996, to $17.3 million. Such increases
correspond to the increases in the total business in force related primarily to
the recently acquired companies.
Net investment gains, net of related costs, realized by this segment were
not material in 1997, 1996 or 1995.
18
<PAGE>
Other:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Premiums collected:
Other (first-year)................................................ $ 3.9 $ 2.2 $ 2.6
Other (renewal)................................................... 65.3 52.3 64.0
-------- -------- ---------
Total other premiums collected................................ $ 69.2 $ 54.5 $ 66.6
======== ======== =========
Insurance policy income.............................................. $ 67.3 $ 53.2 $ 65.3
Net investment income................................................ 15.4 7.8 9.0
Fee revenue and other income......................................... 65.8 49.8 43.6
-------- -------- ---------
Total revenues (a)............................................ 148.5 110.8 117.9
-------- -------- ---------
Insurance policy benefits and changes in future policy benefits...... 40.3 25.1 36.8
Amortization related to operations................................... 9.4 11.2 10.1
Interest expense on investment borrowings............................ .3 .2 .2
Other operating costs and expenses................................... 40.2 43.6 39.3
-------- -------- ---------
Total benefits and expenses .................................. 90.2 80.1 86.4
-------- -------- ---------
Operating income before income taxes,
minority interest and extraordinary
charge...................................................... 58.3 30.7 31.5
Net investment gains (losses), net of related costs.................. 3.3 27.4 (6.3)
-------- -------- --------
Income before income taxes, minority
interest and extraordinary charge........................... $ 61.6 $ 58.1 $ 25.2
======== ======== =========
<FN>
(a) Revenues exclude net investment gains (losses).
</FN>
</TABLE>
General: This segment includes: (i) various other health insurance
products that are not currently being actively marketed; and (ii) beginning
December 1, 1997, the specialty health insurance products of WNIC marketed to
educators through career agents. The segment's operations were significantly
affected by recent acquisitions (THI, effective January 1, 1997, and WNIC,
effective December 1, 1997). The profitability of this business depends largely
on the overall persistency of the business in force, claim experience and
expense management.
This 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 and commissions we charge to our
consolidated subsidiaries. The profitability of the fee-based business depends
on the total fees generated and on expense management.
Premiums collected by this segment increased 27 percent in 1997, to $69.2
million, and decreased 18 percent in 1996, to $54.5 million. The increase in
premiums collected in 1997 primarily relates to recent acquisitions.
We do not emphasize the sale of many of the products in this segment,
andcollected premiums are expected to decrease in future years. However, the
in-force business continues to be profitable.
Insurance policy income comprises premiums earned on the segment's
policies, and has fluctuated over the last three years consistent with the
explanations provided above for premiums collected.
Net investment income increased 97 percent in 1997, to $15.4 million, and
decreased 13 percent in 1996, to $7.8 million. Such investment income fluctuated
primarily in relationship to the amount of average invested assets supporting
this segment's insurance liabilities. During 1997, the segment's average
invested assets increased 96 percent, to $199.5 million, and the net yield on
invested assets did not change materially. During 1996, the segment's average
invested assets decreased approximately 8.6 percent, to $101.6 million, and the
net yield on invested assets decreased from 8.1 percent to 7.7 percent.
19
<PAGE>
Fee revenue and other income includes: (i) fees for investment management
and for mortgage origination and servicing; and (ii) commissions earned for
insurance and investment product marketing and distribution. Such amounts
exclude the fees and commissions we charge our consolidated subsidiaries. Fee
revenue and other income increased 32 percent in 1997, to $65.8 million,
primarily due to increased investment management fees. Fee revenue and other
income increased 14 percent in 1996, to $49.8 million, primarily as a result of
the acquisition of certain property and casualty insurance brokerage businesses.
Insurance policy benefits and change in future policy benefits fluctuate
in relationship to the amount of segment business in force and the incidence of
claims.
Amortization related to operations decreased 16 percent in 1997, to $9.4
million, and increased 11 percent in 1996, to $11.2 million. 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 in 1997 is consistent with
the declining balance of cost of policies purchased and cost of policies
produced associated with the business included in this segment. The increase in
1996 was primarily due to the increases in such balances as a result of our
purchase of additional shares of BLH common stock in 1995 and 1996. The
acquisitions of THI and WNIC did not materially increase the balance of goodwill
and cost of policies purchased of this segment (valuations of the acquired
blocks indicated that such amounts were insignificant).
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, nonrecurring charges and net investment gains not
attributable to the operating segments.
Interest and other corporate expenses were $126.8 million in 1997, $112.4
million in 1996, and $140.5 million in 1995. Interest expense included therein
was $109.4 million in 1997, $108.1 million in 1996, and $119.4 million in 1995.
Such expense fluctuates in relationship to the average debt outstanding during
each period and the interest rate thereon.
Nonrecurring charges of $9.3 million in 1997 represent expenses incurred
related to the death of an executive officer.
Net investment gains, net of related costs, of $15.2 million in 1995
primarily arose from the gain realized on the sale of Conseco's investment in
Eagle Credit (a finance subsidiary of Harley-Davidson).
LIFE INSURANCE SEGMENT 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 assessed to the policy.
20
<PAGE>
Total premiums collected by our business segments during the last three
years were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Supplemental health:
First-year....................................................................... $ 290.0 $ 124.1 $ 125.5
Renewal.......................................................................... 1,553.7 686.7 613.3
--------- --------- ---------
Total supplemental health.................................................... 1,843.7 810.8 738.8
--------- --------- ---------
Annuities:
First-year ...................................................................... 1,538.6 1,504.1 1,581.3
Renewal.......................................................................... 151.0 166.2 112.6
--------- --------- ---------
Total annuities.............................................................. 1,689.6 1,670.3 1,693.9
--------- --------- ---------
Life insurance:
First-year....................................................................... 145.6 79.2 31.8
Renewal.......................................................................... 563.4 324.4 221.8
--------- --------- ---------
Total life insurance......................................................... 709.0 403.6 253.6
--------- --------- ---------
Individual and group major medical:
First-year....................................................................... 133.9 6.0 8.4
Renewal.......................................................................... 610.3 335.0 345.2
--------- --------- ---------
Total individual and group major medical..................................... 744.2 341.0 353.6
--------- --------- ---------
Other:
First-year....................................................................... 3.9 2.2 2.6
Renewal.......................................................................... 65.3 52.3 64.0
--------- --------- ---------
Total other.................................................................. 69.2 54.5 66.6
--------- --------- ---------
Total:
First-year....................................................................... 2,112.0 1,715.6 1,749.6
Renewal.......................................................................... 2,943.7 1,564.6 1,356.9
--------- --------- ---------
Total collected premiums...................................................... $ 5,055.7 $ 3,280.2 $ 3,106.5
========= ========= =========
</TABLE>
21
<PAGE>
Fluctuations in premiums collected are discussed above under "Results of
operations by segment for the three years ended December 31, 1997." Our recent
acquisitions will have a significant effect on future premiums collected. Total
premiums collected for all currently consolidated companies (except subsidiaries
of WNIC, which were acquired on December 1, 1997) for all periods (including
periods prior to ownership by Conseco) are provided below:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Supplemental health:
First-year....................................................................... $ 303.7 $ 306.0 $ 296.6
Renewal.......................................................................... 1,631.7 1,521.1 1,417.3
--------- --------- ---------
Total supplemental health.................................................... 1,935.4 1,827.1 1,713.9
--------- --------- ---------
Annuities:
First-year....................................................................... 1,540.9 1,549.1 1,613.1
Renewal.......................................................................... 138.8 182.9 177.3
--------- --------- ---------
Total annuities.............................................................. 1,679.7 1,732.0 1,790.4
--------- --------- ---------
Life insurance:
First-year....................................................................... 165.1 185.9 136.0
Renewal.......................................................................... 647.3 620.9 681.5
--------- --------- ---------
Total life insurance......................................................... 812.4 806.8 817.5
--------- --------- ---------
Individual and group major medical:
First-year....................................................................... 172.4 145.6 137.0
Renewal.......................................................................... 691.4 630.8 652.3
--------- --------- ---------
Total individual and group major medical..................................... 863.8 776.4 789.3
--------- --------- ---------
Other:
First-year....................................................................... 1.7 2.3 2.6
Renewal.......................................................................... 89.9 112.5 144.1
--------- --------- ---------
Total other.................................................................. 91.6 114.8 146.7
--------- --------- ---------
Total:
First-year....................................................................... 2,183.8 2,188.9 2,185.3
Renewal.......................................................................... 3,199.1 3,068.2 3,072.5
--------- --------- ---------
Total collected premiums..................................................... $ 5,382.9 $ 5,257.1 $ 5,257.8
========= ========= =========
</TABLE>
INVESTMENTS HELD BY OUR LIFE INSURANCE SUBSIDIARIES
Our investment strategy is to: (i) maintain a predominately
investment-grade fixed income portfolio; (ii) provide adequate liquidity to meet
the cash flow requirements of policyholders and other obligations; and (iii)
maximize current income and total investment return through active investment
management. Consistent with this strategy, investments in fixed maturity
securities, mortgage loans, credit-tenant loans, policy loans, separate accounts
and short-term investments made up 97 percent of our $27.0 billion investment
portfolio at December 31, 1997. The remainder of the invested assets were equity
securities and other invested assets.
Our insurance subsidiaries are regulated by insurance statutes and
regulations as to the type of investments that they are permitted to make and
the amount of funds that may be used for any one type of investment. In light of
these statutes and regulations and our business and investment strategy, Conseco
generally seeks to invest in United States government and government-agency
securities and corporate securities rated investment grade by established
nationally recognized rating organizations or, if not rated, in securities of
comparable investment quality.
22
<PAGE>
The following table summarizes investment yields earned over the past
three years, excluding the investments and investment income of the consumer and
commercial finance segment.
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Weighted average invested assets:
As reported ................................................................. $23,288.8 $16,356.3 $13,769.3
Excluding unrealized appreciation (depreciation) (a)......................... 23,177.7 16,278.8 13,690.6
Net investment income............................................................... 1,825.3 1,302.5 1,142.6
Yields earned:
As reported.................................................................. 7.8% 8.0% 8.3%
Excluding unrealized appreciation (depreciation) (a) ........................ 7.9% 8.0% 8.3%
<FN>
(a) Excludes the effect of reporting fixed maturities at fair value as
described in note 1 to the consolidated financial statements.
</FN>
</TABLE>
Although investment income is a significant component of total revenues,
the profitability of a portion of our insurance products is determined primarily
by spreads between interest rates earned and rates credited or accruing to our
insurance liabilities. At December 31, 1997, the average yield, computed on the
cost basis of our investment portfolio, was 7.5 percent, and the average
interest rate credited or accruing to our total insurance liabilities was 5.2
percent, excluding interest bonuses guaranteed only for the first year of the
contract.
Actively managed fixed maturities
Our actively managed fixed maturity portfolio at December 31, 1997,
included primarily debt securities of the United States government, public
utilities and other corporations, and mortgage-backed securities.
Mortgage-backed securities included collateralized mortgage obligations ("CMOs")
and mortgage-backed pass-through securities.
At December 31, 1997, our fixed maturity portfolio had net unrealized
gains of $484.4 million (equal to approximately 2.1 percent of the portfolio's
carrying value), consisting of $611.5 million of unrealized gains and $127.1
million of unrealized losses. Estimated fair values for fixed maturity
investments were determined based on: (i) estimates from nationally recognized
pricing services (82 percent of the portfolio); (ii) broker-dealer market makers
(8 percent of the portfolio); and (iii) internally developed methods (10 percent
of the portfolio).
As discussed in the notes to the consolidated financial statements, when
we adjust carrying values of actively managed fixed maturity securities for
changes in fair value, we also adjust the cost of policies purchased, cost of
policies produced and liabilities. These adjustments are made in order to
reflect the change in amortization and liability accruals that would be needed
if those fixed maturity investments had actually been sold at their fair values
and the proceeds reinvested at current interest rates.
At December 31, 1997, approximately 5.5 percent of our invested assets
and 6.6 percent of fixed maturity investments were rated below-investment grade
by nationally recognized statistical rating organizations (or, if not rated by
such firms, with ratings below Class 2 assigned by the NAIC). We plan to
maintain approximately the present level of below-investment-grade fixed
maturities. These securities generally have greater risks than other corporate
debt investments, including risk of loss upon default by the borrower, and are
often unsecured and subordinated to other creditors. Below-investment-grade
issuers usually have high levels of indebtedness and are more sensitive to
adverse economic conditions, such as recession or increasing interest rates,
than are investment grade issuers. We are aware of these risks and monitor our
below-investment-grade securities closely. At December 31, 1997, our below-
investment-grade fixed maturity investments had an amortized cost of $1,525.1
million and an estimated fair value of $1,496.2 million.
We periodically evaluate the creditworthiness of each issuer whose
securities the Company holds. Special attention is paid to those securities
whose market values have declined materially for reasons other than changes in
interest rates or other general market conditions. We consider available
information to evaluate the realizable value of the investment, the specific
condition of the issuer and the issuer's ability to comply with the material
terms of the security. Information reviewed may include the recent operational
results and financial position of the issuer, information about its industry,
recent press releases and other information. Conseco employs a staff of
experienced securities analysts in a variety of specialty areas. Among its other
responsibilities, this staff is charged with compiling and reviewing such
information. If evidence does not exist to support a realizable value equal to
or greater than the carrying value of the investment, and such decline in market
value is determined to be other than temporary, we reduce the carrying amount to
its net realizable value, which becomes the new cost basis; the amount of the
reduction is reported as a realized loss. We recognize any recovery of such
reductions in the cost basis of an investment only upon the sale, repayment or
other disposition of the investment. We recorded writedowns of fixed maturity
investments and other invested assets totaling $1.2 million
23
<PAGE>
in 1997, primarily as a result of: (i) changes in the financial condition of a
private company in which we had an indirect equity investment; and (ii) changes
in the value of the underlying collateral associated with certain notes. These
changes caused us to conclude that the decline in fair value of such investments
was other than temporary. Our investment portfolio is subject to the risks of
further declines in realizable value. However, we attempt to mitigate this risk
through the diversification and active management of our portfolio.
As of December 31, 1997, fixed maturity investments in substantive
default (i.e., in default due to nonpayment of interest or principal) had an
amortized cost and carrying value of $2.1 million and $1.2 million,
respectively. Fixed maturity investments in technical (but not substantive)
default (i.e., in default, but not as to the payment of interest or principal)
had an amortized cost and carrying value of $.3 million. There were no other
fixed maturity investments about which we had serious doubts as to the ability
of the issuer to comply on a timely basis with the material terms of the
instruments.
Our policy is to discontinue the accrual of interest and eliminate all
previous interest accruals for defaulted securities, if it is determined that
such amounts will not be ultimately realized in full. Investment income forgone
due to defaulted securities was $.2 million in 1997, $3.8 million in 1996 and
$1.6 million in 1995.
At December 31, 1997, fixed maturity investments included $6.9 billion of
mortgage-backed securities (or 30 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 that 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, because 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 annual amortization of the premium.
CMOs are securities backed by pools of pass-through securities and/or
mortgages that are segregated into sections or "tranches" that provide for
sequential retirement of principal, rather than the pro rata share of principal
return that occurs through regular monthly principal payments on pass-through
securities.
All mortgage-backed securities are subject to risks associated with
variable prepayments. As a result, these securities may have a different actual
maturity than planned at the time of purchase. When securities having a cost
greater than par are backed by mortgages that prepay faster than expected, we
record a charge to investment income. When securities having a cost less than
par prepay faster than expected, we record investment income.
The degree to which a mortgage-backed security is susceptible to income
fluctuations is influenced by: (i) the difference between its cost and par; (ii)
the relative sensitivity of the underlying mortgages backing the security to
prepayment in a changing interest rate environment; and (iii) the repayment
priority of the security in the overall securitization structure. The Company
seeks to limit the extent of these risks by: (i) purchasing securities that are
backed by collateral with lower prepayment sensitivity (such as mortgages priced
at a discount to par value and mortgages that are extremely seasoned); (ii)
avoiding securities whose values are heavily influenced by changes in
prepayments (such as interest-only and principal-only securities); (iii)
investing in securities structured to reduce prepayment risk (such as planned
amortization class ("PAC") and targeted amortization class ("TAC") CMOs); and
(iv) actively managing the entire portfolio of mortgage-backed securities to
dispose of those which are deemed more likely to be prepaid. PAC and TAC
instruments represented approximately 24 percent of our mortgage-backed
securities at December 31, 1997. The call-adjusted modified duration of our
mortgage-backed securities at December 31, 1997, was 5.2 years.
24
<PAGE>
The following table sets forth the par value, amortized cost and
estimated fair value of mortgage-backed securities at December 31, 1997,
summarized by interest rates on the underlying collateral:
<TABLE>
<CAPTION>
Par Amortized Estimated
value cost fair value
----- ---- ----------
(Dollars in millions)
<S> <C> <C> <C>
Below 7 percent............................................................ $2,025.5 $1,980.4 $2,014.7
7 percent - 8 percent...................................................... 3,568.0 3,546.5 3,638.2
8 percent - 9 percent...................................................... 712.9 716.1 730.5
9 percent and above........................................................ 445.1 455.5 467.0
-------- -------- --------
Total mortgage-backed securities............................... $6,751.5 $6,698.5 $6,850.4
======== ======== ========
</TABLE>
The amortized cost and estimated fair value of mortgage-backed securities
at December 31, 1997, summarized by type of security, were as follows:
<TABLE>
<CAPTION>
Estimated fair value
--------------------
% of
Amortized fixed
Type cost Amount maturities
- ---- ---- ------ ----------
(Dollars in millions)
<S> <C> <C> <C>
Pass-throughs and sequential and targeted amortization classes............ $4,599.7 $4,697.5 21%
Planned amortization classes and accretion-directed bonds.................. 1,515.9 1,547.6 7
Support classes............................................................ 36.0 36.9 -
Accrual (Z tranche) bonds.................................................. 27.9 28.8 -
Subordinated classes....................................................... 519.0 539.6 2
-------- -------- --
$6,698.5 $6,850.4 30%
======== ======== ==
</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 CMO 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 and 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 a certain range. Changes in prepayment rates are first absorbed by
support classes. This insulates the planned amortization classes from the
consequences of both 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 on the
stated coupon rate) that otherwise would have been payable. As such, these
securities act much the same as 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.
25
<PAGE>
If we determine that an investment held in the actively managed fixed
maturity category will be sold, we will either sell the security or transfer it
to the trading account at its fair value and recognize the gain or loss
immediately. There were no material transfers in 1997. During 1997, we sold
actively managed fixed maturity securities with a $17.8 billion book value,
resulting in $342.6 million of investment gains and $41.4 million of investment
losses (both before related expenses, amortization and taxes). Such securities
were sold in response to changes in the investment environment, which created
opportunities to enhance the total return of the investment portfolio without
adversely affecting the quality of the portfolio or the matching of expected
maturities of assets and liabilities. The realization of gains and losses
affects the timing of the amortization of the cost of policies produced and the
cost of policies purchased, as explained in note 10 to the consolidated
financial statements.
Other investments of our life insurance subsidiaries
Credit-tenant loans are loans on commercial properties where the lease of
the principal tenant is assigned to the lender. The principal tenant, or any
guarantor of such tenant's obligations, must have a credit rating at the time of
origination of the loan of at least BBB- or its equivalent. The underwriting
guidelines consider such factors as: (i) the lease term of the property; (ii)
the mortgagee's management ability, including business experience, property
management capabilities and financial soundness; and (iii) economic, demographic
or other factors that may affect the income generated by the property or its
value. The underwriting guidelines also generally require a loan-to-value ratio
of 75 percent or less. Credit-tenant loans are carried at amortized cost and
totaled $558.6 million at December 31, 1997, or 2.1 percent of total invested
assets. The total estimated fair value of credit-tenant loans was $587.2 million
at December 31, 1997.
At December 31, 1997, we held mortgage loan investments with a carrying
value of $516.2 million (or 1.9 percent of total invested assets) and a fair
value of $551.0 million. The balance of mortgage loans included 96 percent
commercial loans, 2 percent residential loans and 2 percent residual interests
in CMOs. The residual interests in CMOs entitle the Company to the excess cash
flows arising from the difference between: (i) the cash flows required to make
principal and interest payments on the related senior interests in the CMOs; and
(ii) the actual cash flows received on the mortgage loan assets included in the
CMO portfolios. If prepayments vary from projections on the mortgage loan assets
included in such CMO portfolios, the total cash flows to the Company from such
junior and residual interests could change from projected cash flows, resulting
in a gain or loss.
Noncurrent mortgage loans were insignificant at December 31, 1997. We
recognized realized losses of $.8 million on mortgage loans for the year ended
December 31, 1997. At December 31, 1997, we had a loan loss reserve of $9.0
million. Approximately 20 percent of the mortgage loans were on properties
located in California, 11 percent in Texas and 9 percent in Florida. No other
state accounted for more than 7 percent of the mortgage loan balance.
At December 31, 1997, we held $64.8 million of trading securities that
are included in other invested assets. Trading securities are investments that
are held with the intent to be traded prior to their maturity, or are believed
likely to be disposed of in the foreseeable future as a result of market or
issuer developments. Trading securities are carried at estimated fair value,
with the changes in fair value reflected in the statement of operations.
Other invested assets include: (i) trading securities; (ii) S&P 500 Call
Options; and (iii) certain nontraditional investments, including investments in
venture capital funds, limited partnerships, mineral rights and promissory
notes.
Short-term investments totaled $990.5 million, or 3.7 percent of invested
assets at December 31, 1997, and consisted primarily of commercial paper and
repurchase agreements relating to government securities.
As part of our investment strategy, we enter into reverse repurchase
agreements and dollar-roll transactions to increase our return on investments
and improve our liquidity. Reverse repurchase agreements involve a sale of
securities and an agreement to repurchase the same securities at a later date at
an agreed-upon price. Dollar rolls are similar to reverse repurchase agreements
except that the repurchase involves securities that are only substantially the
same as the securities sold. We enhance our investment yield by investing the
proceeds from the sales in short-term securities pending the contractual
repurchase of the securities at discounted prices in the forward market. We are
able to engage in such transactions due to the market demand for mortgage-backed
securities to form CMOs. Such investment borrowings averaged $719.3 million
during 1997 and were collateralized by investment securities with fair values
approximately equal to the loan value. The weighted average interest rate on
short-term collateralized borrowings was 5.8 percent in 1997. The primary risk
associated with short-term collateralized borrowings is that the counterparty
will be unable to perform under the terms of the contract. Our exposure is
limited to the excess of the net replacement cost of the securities over the
value of the short-term investments (which was not material at December 31,
1997). We believe that the counterparties to our reverse repurchase and
dollar-roll agreements are financially responsible and that the counterparty
risk is minimal.
26
<PAGE>
INVESTMENTS, FINANCE RECEIVABLES AND SERVICING RIGHTS OF FINANCE
SUBSIDIARIES
We pool and securitize substantially all of the finance receivables we
originate, retaining: (i) investments in interest-only securities that are
subordinated to the rights of other investors; (ii) servicing on the contracts;
and (iii) investment in senior securities made by our insurance subsidiaries
(classified as fixed maturity securities). In a typical securitization, we sell
finance receivables to a special purpose entity, established for the limited
purpose of purchasing the finance receivables and selling securities
representing interests in the receivables. The special purpose entity issues
interest-bearing securities that are collateralized by the underlying pool of
finance receivables. We receive the proceeds from the sale of the securities in
exchange for the finance receivables. The securities are typically sold at the
same amount as the principal balance of the receivables sold. We retain a
residual interest representing the right to receive, over the life of the pool
of finance receivables, the excess of the cash flows received on the receivables
transferred to the trust over the return paid to the holders of other interests
in the securitization and servicing fees.
We recognize a gain on the sale of finance receivables equal to the
difference between the proceeds from the sale, net of related transaction costs,
and the allocated carrying amount of the receivables sold. We allocate the
carrying amount of finance receivables between the assets sold and retained
based on their relative fair values at the date of sale. The estimated fair
value of interest-only securities and servicing rights is determined by
discounting the projected cash flows over the expected life of the finance
receivables sold using prepayment, default, loss, servicing cost and discount
rate assumptions.
On a quarterly basis, we determine the estimated fair value of our
interest-only securities based on discounted projected future cash flows using
current assumptions. Differences between the estimated fair value and carrying
value of interest-only securities considered temporary declines are recognized
as reductions to shareholders' equity, while differences that are considered
other than temporary declines in value are recognized as a reduction to
earnings. Other than temporary declines in value are deemed to occur when the
present value of estimated future cash flows discounted at a risk free rate
using appropriate assumptions is less than the carrying value of the
interest-only securities. If other than temporary impairment occurs, the
carrying value is reduced to estimated fair value and a loss is recognized in
the statement of operations.
27
<PAGE>
A summary of the principal balance of finance receivables sold, the gain on
sale recognized and writedowns of interest-only securities is as follows:
<TABLE>
<CAPTION>
For the year ended
December 31,
-------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C> <C>
Manufactured housing............................. $ 5,370 $5,033 $4,020 $3,226 $2,303
Home improvement/home equity..................... 3,020 1,324 579 544 43
Consumer/equipment............................... 1,627 1,556 - - -
Commercial and revolving credit.................. 224 500 428 - -
Lease and other.................................. 508 - 308 600 -
-------- ------ ------ ------ ------
Total....................................... $10,749 $8,413 $5,335 $4,370 $2,346
======= ====== ====== ====== ======
Gain on sale of finance receivables
before writedowns............................. $ 759.1 $588.1 $443.3 $318.6 $201.5
Writedowns of interest-only securities........... (190.0) (200.0) - - -
------- ------ ------ ------ ------
Net gain on sale............................ $ 569.1 $388.1 $443.3 $318.6 $201.5
======= ====== ====== ====== ======
</TABLE>
We service all of the finance receivables we originate or purchase from
other originators, (i) collecting loan payments, taxes and insurance payments,
where applicable, and other payments from borrowers; and (ii) remitting
principal and interest payments to holders of securities backed by the finance
receivables we have sold.
The following summarizes the composition of our managed finance
receivables:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C> <C>
Fixed term....................................... $26,036 $18,965 $13,314 $9,653 $7,194
Revolving credit................................. 1,921 1,108 574 168 -
--------- ------- ------- -------- ------
Total....................................... $27,957 $20,073 $13,888 $9,821 $7,194
======= ======= ======= ====== ======
Number of fixed term contracts serviced.......... 1,076,000 827,000 657,000 512,000 406,000
========= ======= ======= ======= =======
Number of revolving credit accounts serviced..... 700,000 180,000 23,000 8,000 -
======== ======== ======= ===== =======
</TABLE>
The following summarizes information with respect to the 60-days-and-over
contractual dollar delinquencies, loss experience and repossessed collateral
experience of our managed finance receivables:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
60-days-and-over delinquencies as a percentage
of managed finance receivables at period end........... 1.08% 1.08% .93%
==== ==== ===
Net credit losses as a percentage of average managed
receivables during the year............................ 1.04% .74% .56%
==== === ===
Repossessed collateral during the year as a percentage of
managed receivables at year end........................ .95% .85% .58%
=== === ===
</TABLE>
28
<PAGE>
The following summarizes the finance receivables we originated:
<TABLE>
<CAPTION>
Year ended
December 31,
------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C> <C>
Manufactured housing............................. $ 5,479.3 $ 4,882.0 $4,159.8 $3,201.5 $2,449.1
Home improvement/home equity..................... 3,476.2 1,493.7 627.0 465.5 169.5
Consumer/retail credit........................... 1,510.9 835.6 361.4 96.1 47.3
Commercial....................................... 5,181.4 3,343.0 1,742.7 302.4 .1
--------- --------- -------- -------- --------
Total....................................... $15,647.8 $10,554.3 $6,890.9 $4,065.5 $2,666.0
========= ========= ======== ======== ========
</TABLE>
At December 31, 1997, no single state accounted for more than 10 percent of
the contracts we serviced. In addition, no single contractor, dealer or vendor
accounted for more than 5 percent of the total contracts we originated.
Activity in the interest-only securities account during 1997 is as follows
(dollars in millions):
<TABLE>
<S> <C>
Balance at January 1, 1997............................................... $1,014.3
Transfer to servicing rights in conjunction with implementation
of SFAS 125......................................................... (30.8)
Additions resulting from securitizations during the period............ 674.7
Investment income..................................................... 130.3
Principal and interest received....................................... (270.5)
Realized loss......................................................... (190.0)
Change in unrealized appreciation..................................... 35.2
--------
Balance at December 31, 1997............................................. $1,363.2
========
</TABLE>
In 1995 and previous years, we sold a substantial portion of our
interest-only securities related to manufactured housing securitization
transactions between 1978 and 1995 in the form of securitized net interest
margin certificates. We retained a subordinated interest in the cash flow of the
interest-only securities sold. These interests are included in interest-only
securities and total $77.0 million at December 31, 1997.
Generally, interest-only securities relate to the sale of closed end
manufactured housing, home equity, home improvement, consumer and equipment
finance receivables. Interest-only securities are subject to a substantial
amount of credit loss and prepayment risk related to the receivables sold. In
connection with the valuation of interest-only securities, the Company has
provided for approximately $900.0 million of credit losses as of December 31,
1997. On a nondiscounted basis, the amount of credit losses provided for in
connection with the valuation of the interest-only securities is approximately
$1.3 billion. These estimated losses, if realized, would reduce the amount of
cash flows available to the interest-only securities and are considered in the
determination of the estimated fair value of such securities.
The following summarizes assumptions used to determine the estimated fair
value of interest-only securities as of December 31, 1997.
<TABLE>
<CAPTION>
Manufactured Home equity/ Consumer/
housing home improvement equipment Total
------- ---------------- --------- -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Interest-only securities............................ $857.4 $335.1 $170.7 $1,363.2
Principal balance of sold managed finance
receivables...................................... 17,558.2 4,251.6 2,467.5 24,277.3
Weighted average customer interest rate on sold
managed finance receivables...................... 10.49% 11.82% 11.33%
Expected weighted average constant prepayment
rate as a percentage of principal balance of
sold managed finance receivables (1)............. 9.5% 24.0% 22.0%
Expected nondiscounted credit losses as a
percentage of principal balance of sold managed
finance receivables (1).......................... 6.2% 4.3% 2.1%
29
<PAGE>
- -------------------
<FN>
(1) The valuation of interest-only securities is affected not only by the
projected level of prepayments of principal and net credit losses, as shown
above, but also by the projected timing of such prepayments and net credit
losses. Should the timing of projected prepayments of principal or net
credit losses differ materially from the timing projected by the Company,
such timing could have a material effect on the valuation of the
interest-only securities.
</FN>
</TABLE>
The weighted average interest rate we use to discount expected future
cash flows of the interest-only securities is 11.47 percent at December 31,
1997.
CONSOLIDATED FINANCIAL CONDITION
Changes in the consolidated balance sheet of 1997 compared with 1996
Our consolidated balance sheet at December 31, 1997, compared with 1996,
reflects 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 $800 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
$130.1 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) the
WNIC Merger; (x) common stock repurchases; and (xi) the issuance of commercial
paper and notes payable.
Our total capital (excluding the notes payable of the consumer and
corporate finance segment used to fund finance receivables) at December 31, 1997
and 1996, was as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
(Dollars in millions)
<S> <C> <C>
Notes payable...................................................... $1,906.7 $1,094.9
Commercial paper................................................... 448.2 -
Minority interest:
Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts............................. 1,383.9 600.0
Mandatorily redeemable preferred stock of subsidiary........... - 97.0
Common stock of subsidiary..................................... .7 .7
Shareholders' equity:
Preferred stock................................................ 115.8 267.1
Common stock and additional paid-in capital.................... 2,619.8 2,350.7
Accumulated other comprehensive income......................... 200.6 36.6
Retained earnings.............................................. 2,277.7 1,562.4
--------- ----------
Total shareholders' equity.................................. 5,213.9 4,216.8
--------- ---------
Total capital of Conseco.................................... $8,953.4 $6,009.4
======== ========
</TABLE>
Notes payable increased during 1997 primarily as a result of: (i) debt
issued or assumed in connection with the acquisitions of CAF, PFS, Colonial Penn
and WNIC; (ii) debt used to finance common stock repurchases; and (iii) the
redemption of mandatorily redeemable preferred stock of a subsidiary of ALH. The
increase in notes payable was partially offset by the repayment of debt using
the proceeds from the issuance of Company-obligated mandatorily redeemable
preferred securities.
We instituted a commercial paper program in April 1997 to lower our
borrowing costs and improve our liquidity. Borrowings under our commercial paper
program averaged approximately $525.9 million during the period of April 24,
1997 through December 31, 1997. The weighted average interest rate on such
borrowings was 5.8 percent during 1997.
Company-obligated mandatorily redeemable preferred securities of
subsidiary trusts are classified as minority interest in accordance with GAAP.
During 1997, we issued $300 million of Capital Securities and $500 million of
FELINE PRIDES. See note 8 to the consolidated financial statements for a
description of these securities.
30
<PAGE>
Minority interest, excluding the Company-obligated mandatorily redeemable
preferred securities, at December 31, 1997, included a $.7 million interest in
common stock of a subsidiary of ALH. At December 31, 1996, minority interest
included: (i) $97.0 million of mandatorily redeemable preferred stock of a
subsidiary of ALH; and (ii) $.7 million interest in the common stock of a
subsidiary of ALH.
During 1997, we repurchased all of the mandatorily redeemable preferred
stock of a subsidiary of ALH formerly held by minority interests. As a result,
gains of $3.7 million were realized from the sale of securities having an
amortized cost of $47.7 million; such securities had been held in a segregated
account to ensure the redemption of such preferred stock.
Shareholders' equity increased by $997.1 million in 1997, to $5.2
billion. Significant components of the increase included: (i) Conseco common
stock issued in the CAF Merger with a value of $117.4 million; (ii) Conseco
common stock issued in the PFS Merger with a value of $354.1 million; (iii) net
income of $866.4 million; (iv) the conversion of convertible debentures into
Conseco common stock with a value of $150.0 million; (v) the issuance of common
stock related to stock options and employee benefit plans (including the tax
benefit thereon) of $338.1 million; and (vi) the increase in net unrealized
appreciation of $164.9 million. These increases were partially offset by: (i)
repurchases of common stock for $857.0 million; and (ii) common and preferred
stock dividends totaling $125.0 million.
Book value per common share outstanding increased to $16.45 at December
31, 1997, from $13.47 at December 31, 1996. Such increase was primarily
attributable to the factors discussed in the previous paragraph. Excluding
unrealized appreciation of fixed maturity securities in accordance with SFAS
115, book value per common share outstanding was $15.88 at December 31, 1997,
compared with $13.33 at December 31, 1996.
Total assets increased by $11.9 billion in 1997, to $40.6 billion,
primarily due to the assets acquired in the CAF Merger, the PFS Merger, the
Colonial Penn Purchase and the WNIC Merger.
In accordance with SFAS 115, Conseco records its actively managed fixed
maturity investments at estimated fair value. At December 31, 1997 and 1996,
such investments were increased by $484.4 million and $103.8 million,
respectively, as a result of the SFAS 115 adjustment.
Financial ratios
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Ratio of earnings to fixed charges:
As reported........................................................ 2.45X 1.93X 2.04X 3.24X 2.45X
Excluding interest on annuities and financial products(a).......... 5.55X 4.85X 4.94X 5.80X 7.15X
Ratio of earnings to fixed charges and preferred dividends:
As reported........................................................ 2.36X 1.81X 1.94X 2.84X 2.30X
Excluding interest on annuities and financial products(a).......... 4.94X 3.81X 4.14X 4.48X 5.58X
Ratio of earnings to fixed charges, preferred dividends and
distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts:
As reported..................................................... 2.20X 1.80X 1.94X 2.84X 2.30X
Excluding interest on annuities and financial products(a)....... 4.10X 3.74X 4.14X 4.48X 5.58X
Ratio of corporate debt to total capital: (b)
As reported........................................................ .26X .18X .30X .12X .20X
Excluding unrealized appreciation (depreciation)(c)................ .27X .18X .31X .11X .20X
Ratio of corporate debt and Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts to total capital:(b) (d)
As reported..................................................... .42X .28X .30X .12X .20X
Excluding unrealized appreciation (depreciation) (c)............ .43X .28X .31X .11X .20X
Rating agency ratios: (c) (e) (f) (g)
Debt to total capital.............................................. .22X .12X .25X .00X .14X
Debt and preferred stock to total capital (h)...................... .38X .23X .25X .00X .14X
31
<PAGE>
- --------------------
<FN>
(a) These ratios are included to assist the reader in analyzing the impact
of interest on annuities and financial products (which is not generally
required to be paid in cash in the period in which 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
charges; the ratio of earnings to fixed charges and preferred dividends;
and the ratio of earnings to fixed charges, preferred dividends and
distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts.
(b) For periods prior to 1996, debt includes obligations for which Conseco
was not directly liable. Excludes debt of consumer and corporate finance
segment used to fund finance receivables.
(c) Excludes the effect of reporting fixed maturities at fair value.
(d) Represents the ratio of debt and the Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts to the sum of
shareholders' equity, debt, minority interest and the Company-obligated
mandatorily redeemable preferred securities of subsidiary trusts.
(e) Consistent with our discussions with rating agencies, the Company has
targeted: (i) the ratio of corporate debt to total capital to be at or
below 35 percent; and (ii) the ratio of corporate debt and preferred
stock to total capital to be at or below 49 percent. These ratios are
calculated in a manner discussed with rating agencies.
(f) Corporate debt is reduced by cash and investments held by non-life
companies and excludes, for periods prior to 1996, obligations for which
Conseco was not directly liable.
(g) Assumes conversion of all convertible debentures.
(h) Assumes purchase of common shares under purchase contracts.
Liquidity for insurance operations
</FN>
</TABLE>
Our insurance operating companies generally receive adequate cash flow
from premium collections and investment income to meet their obligations. Life
insurance and annuity liabilities are generally long-term in nature.
Policyholders may, however, withdraw funds or surrender their policies, subject
to surrender and withdrawal penalty provisions. We seek to balance the duration
of our invested assets with the estimated duration of benefit payments arising
from contract liabilities.
Of our total insurance liabilities at December 31, 1997, approximately 17
percent could be surrendered by the policyholder without a penalty.
Approximately 59 percent could be surrendered by the policyholder subject to
penalty or the release of an insurance liability in excess of surrender benefits
paid. The remaining 24 percent are not subject to surrender. Payment
characteristics of the insurance liabilities at December 31, 1997, were as
follows (dollars in millions):
<TABLE>
<S> <C>
Payments under contracts containing fixed payment dates:
Due in one year or less.............................................. $ 339.6
Due after one year through five years................................ 819.0
Due after five years through ten years............................... 415.9
Due after ten years.................................................. 852.4
---------
Total gross payments whose payment dates are fixed by contract.. 2,426.9
Less amounts representing future interest on such contracts.......... 879.0
---------
Insurance liabilities whose payment dates are fixed by contract. 1,547.9
Insurance liabilities whose payment dates are not fixed by contract........ 24,352.2
---------
Total insurance liabilities..................................... $25,900.1
=========
</TABLE>
Of the above insurance liabilities under contracts containing fixed
payment dates, approximately 59 percent relate to payments that will be made for
the lifetime of the contract holder. We consider expected mortality in
determining the amount of this liability. The remaining insurance liabilities
having fixed payment dates are payable regardless of the contract holder's
survival.
Approximately 30 percent of insurance liabilities were contracts subject
to a fixed interest rate for the life of the contract. The remaining liabilities
generally were subject to interest rates that could be reset annually.
32
<PAGE>
The following summarizes insurance liabilities for investment contracts
by credited rate (excluding interest rate bonuses for the first policy year
only) at December 31, 1997 (dollars in millions):
<TABLE>
<S> <C>
Below 4.75 percent......................................................... $ 2,627.0
4.75 percent - 5.00 percent................................................ 2,533.0
5.00 percent - 5.25 percent................................................ 3,588.0
5.25 percent - 5.50 percent................................................ 1,703.0
5.50 percent - 5.75 percent................................................ 676.0
5.75 percent and above..................................................... 1,597.0
---------
Total insurance liabilities on investment contracts.................. $12,724.0
=========
</TABLE>
We believe that the diversity of the investment portfolio of our life
insurance subsidiaries and the concentration of investments in high quality
liquid securities provide sufficient liquidity to meet foreseeable cash
requirements. The investment portfolio of our life insurance subsidiaries at
December 31, 1997, included $1.0 billion of short-term investments and $19.2
billion of publicly traded investment grade bonds, including $.6 billion of
United States government and agency securities. Although there is no present
need or intent to dispose of such investments, our life insurance subsidiaries
could readily liquidate portions of their investments, if such a need arose. In
addition, investments could be used to facilitate borrowings under reverse
repurchase agreements or dollar-roll transactions. Such borrowings have been
used by the life companies from time to time to increase their return on
investments and to improve liquidity. At December 31, 1997, our portfolio of
bonds and redeemable preferred stocks had an aggregate unrealized gain of $484.4
million.
Liquidity for finance operations
Our consumer and commercial finance segment requires continued access to
the capital markets for the warehousing and sale of finance receivables. To
satisfy these needs, a variety of capital resources are utilized.
Historically, the most important liquidity source for our finance segment
has been our ability to sell finance receivables in the secondary markets
through loan securitizations. Under certain securitized sales structures, we
have provided a variety of credit enhancements, which generally take the form of
corporate guarantees, but have also included bank letters of credit, surety
bonds, cash deposits or other equivalent collateral. We analyze the cash flows
unique to each transaction, as well as the marketability and projected economic
value of such transactions when choosing the appropriate structure for a
securitized loan sale. The structure of each securitized sale depends, to a
great extent, on conditions of the fixed income markets at the time of sale as
well as cost considerations and availability and effectiveness of the various
enhancement methods. During 1997, we used a senior/subordinated structure for
the eight manufactured home loan sales and enhanced a portion of the
subordinated certificates sold with a corporate guarantee. During 1997, our home
equity and home improvement loan sales included two separate but
cross-collateralized loan pools, both of which employed a senior/subordinated
structure with a limited guarantee on a portion of the subordinate certificates.
Our sale of consumer products and equipment finance loans during the
first quarter of 1997 employed a multi-class credit tranched owner trust
structure with floating rate senior notes and limited corporate guarantee on the
subordinate fixed rate certificates. In the second and third quarters of 1997,
our sale of consumer product, equipment finance, certain home equity and non
lien home improvement loans utilized a multi-class credit tranched grantor trust
structure issuing fixed rate certificates with a limited corporate guarantee on
the most subordinate class. Also during the third quarter, we sold approximately
$150.0 million of private-label credit card receivables and $74.4 million of
floorplan receivables through two separate revolving trusts. In addition, in the
fourth quarter of 1997, we completed a sale of consumer product, equipment
finance, certain home equity and non lien home improvement loans which employed
a multi-class credit tranched owner trust structure with fixed and floating rate
senior certificates and a limited corporate guarantee on the most subordinate
fixed rate certificates. We also sold approximately $551 million of fixed rate
notes backed by lease receivables in the fourth quarter of 1997.
Another liquidity source for our finance segment has been sales of a
portion of our interest-only securities in the form of securitized NIM
Certificates. During 1995, we sold $308.0 million of NIM Certificates. These
certificates represent approximately 75 percent of the estimated interest-only
cash flows from our sale of certain manufactured housing contracts in 1995 and
1994. Net proceeds from these sales were used to reduce short-term borrowings
supporting ongoing loan originations.
Interest on finance receivables increased during 1997 and 1996 primarily
as a result of the increase in the average finance receivables that had not yet
been securitized. Servicing fees and interest income on our interest-only
securities have also increased during 1997 and 1996 primarily as a result of the
increase in our total managed finance receivables and interest-only securities.
33
<PAGE>
As of December 31, 1997, the finance segment had a $1.5 billion unsecured
bank credit agreement. This credit facility included a $750.0 million three-year
committed revolving line of credit which was scheduled to expire on April 28,
2000 and a $750.0 million 364-day committed revolving line of credit which was
scheduled to expire on April 28, 1998. In addition, the finance segment had $2.8
billion in master repurchase agreements, subject to the availability of eligible
collateral, with various investment banking firms for the purpose of financing
contract and commercial finance loan production. At December 31, 1997, the
finance segment had $35.0 million of borrowings outstanding under the unsecured
bank credit agreement and no borrowings outstanding under the repurchase
agreements. The master repurchase agreements generally provide for annual terms
that are extended each quarter by mutual agreement of the parties for an
additional annual term based upon receipt of updated quarterly financial
information.
At December 31, 1997, the finance segment had a commercial paper program
through which we were authorized to issue up to $2 billion in notes of varying
terms (not to exceed 270 days) to meet our liquidity needs. This program was
backed by the bank credit agreement and master repurchase agreements referred to
above. As of December 31, 1997, we had issued and outstanding, net of interest
discount, $1.3 billion in notes under this program.
During the fourth quarter of 1997 and the first quarter of 1998, our
finance subsidiary's senior unsecured debt ratings and short-term debt ratings
were lowered by each of the credit rating agencies which provide ratings on our
subsidiary's debt. As a result of these ratings actions, we curtailed our
issuance of commercial paper in favor of master repurchase agreements.
In addition, effective February 10, 1998, we substantially restructured
our unsecured bank credit agreements reducing the aggregate commitment to $750.0
million and renegotiating significant terms and covenants in lieu of a waiver of
certain representations required of our subsidiary for purposes of utilizing the
credit line.
Certain of our master repurchase agreements have been amended in 1998
primarily to include financing for a broader range of receivables originated.
Additionally, aggregate master repurchase lines have been increased to $3.8
billion.
In addition, on February 13, 1998, we closed on a $500 million line of
credit secured by our interest-only securities. This line of credit matures on
February 12, 2000, with an option to extend for an additional one year term.
Subsequent to the completion of the Green Tree Merger in the third and
fourth quarters of 1998, we contributed over $1.0 billion of additional capital
to the consumer and commercial segment which was used to reduce outstanding debt
and to fund new finance receivables.
Liquidity of Conseco (parent company)
The parent company is a legal entity, separate and distinct from its
subsidiaries, and has no business operations. The parent company needs cash for:
(i) principal and interest on debt; (ii) dividends on preferred and common
stock; (iii) distributions on the Company-obligated mandatorily redeemable
preferred stock of subsidiary trusts; (iv) holding company administrative
expenses; (v) income taxes; and (vi) investments in subsidiaries. The primary
sources of cash to meet these obligations include statutorily permitted payments
from our life insurance subsidiaries, including: (i) dividend payments; (ii)
surplus debenture interest and principal payments; (iii) tax sharing payments;
and (iv) fees for services provided. The parent company may also obtain cash by:
(i) issuing debt or equity securities; (ii) borrowing additional amounts under
its revolving credit agreement, as described in note 7 to the consolidated
financial statements; or (iii) selling all or a portion of its subsidiaries.
These sources have historically provided adequate cash flow to fund: (i) the
needs of the parent company's normal operations; (ii) internal expansion,
acquisitions and investment opportunities; and (iii) the retirement of debt and
equity. In 1997, we also issued new shares of Conseco common stock for a portion
of the cost to acquire CAF and the entire cost to acquire PFS.
34
<PAGE>
The following table shows the cash flow activity of the parent company
and its wholly owned non-life and non-finance subsidiaries:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Items relating to operations:
Dividends and surplus debenture interest payments from life subsidiaries...... $ 166.1 $ 109.9 $ 80.6
Tax sharing payments from life subsidiaries................................... 9.3 4.6 2.7
Fees from life subsidiaries................................................... 89.1 74.8 34.7
Fees from unaffiliated companies.............................................. 35.2 39.3 39.0
Parent and non-life subsidiary costs.......................................... (74.1) (39.8) (64.5)
Interest on debt of Conseco, including direct and indirect obligations........ (117.4) (71.3) (41.6)
Interest on amounts due to life subsidiaries.................................. (26.5) (7.3) (8.8)
Income taxes.................................................................. (2.3) 2.2 (7.7)
Payments from finance subsidiaries (a)........................................ 184.6 29.9 79.4
Other........................................................................ 8.9 (4.7) -
--------- ---------- -------
Total items relating to operations......................................... 272.9 137.6 113.8
--------- ----------- -------
Items relating to investing:
Purchase of investments....................................................... (140.7) (71.1) (70.8)
Sales and maturities of investments........................................... 70.2 45.3 125.6
Cash held by non-life subsidiaries prior to acquisition....................... 4.1 40.9 17.0
Investment in consolidated subsidiaries....................................... (939.7) (226.1) (552.3)
Surplus debenture principal payments.......................................... 73.9 36.5 -
Expense incurred in terminated merger......................................... - - (5.5)
--------- --------- --------
Total items relating to investing.......................................... (932.2) (174.5) (486.0)
--------- --------- --------
Items relating to financing:
Proceeds from issuance of Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, net of issuance costs........... 780.4 587.7 -
Proceeds from the issuance of equity securities............................... 57.4 26.7 4.1
Proceeds from the issuance of debt, net of issuance costs..................... 2,578.8 856.0 827.2
Commercial paper, net......................................................... 448.2 - -
Common and preferred dividends................................................ (121.2) (70.3) (52.4)
Dividends on stock held by subsidiaries....................................... (53.8) (38.1) (38.7)
Distributions on Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts....................................................... (65.7) (2.9) -
Payments on debt, including prepayments and acquired debt..................... (2,218.8) (1,467.2) (330.0)
Payments to retire redeemable preferred stock of a non-life subsidiary........ (72.4) (.3) -
Repurchases of common stock .................................................. (738.6) (21.5) (146.3)
Proceeds from the issuance of convertible preferred stock, net of issuance
cost....................................................................... - 257.7 -
--------- --------- ------
Total items relating to financing.......................................... 594.3 127.8 263.9
--------- --------- ------
Change in short-term investments of parent
and its non-life subsidiaries......................................... (65.0) 90.9 (108.3)
Short-term investments, beginning of year.................................. 115.1 24.2 132.5
--------- --------- -------
Short-term investments, end of year........................................ $ 50.1 $ 115.1 $ 24.2
========= ========= ======
<FN>
(a) Represents amounts transferred from the consumer and commercial
subsidiaries in periods prior to the consummation of the Green Tree Merger
for the payment of Green Tree dividends and for the purchase of Green Tree
treasury stock, net of proceeds from the issuance of Green Tree common
stock.
</FN>
</TABLE>
At December 31, 1997, the parent company and its non-life subsidiaries
had short-term investments of $50.1 million, of which $28.7 million was expended
in January 1998 for accrued interest and dividends. The parent company and its
non-life subsidiaries had additional investments in fixed maturities, equity
securities and other invested assets of $155.0 million at December 31, 1997,
which, if needed, could be liquidated or contributed to the insurance
subsidiaries.
35
<PAGE>
The ability of our insurance subsidiaries to pay dividends is subject to
state insurance department regulations. These regulations generally permit
dividends to be paid for any 12 month period in amounts equal to the greater of
(or in a few states, the lesser of): (i) net gain from operations for the prior
year; or (ii) 10 percent of surplus as of the end of the preceding year. Any
dividends in excess of these levels require the approval of the director or
commissioner of the applicable state insurance department. The amount of
dividends that our insurance subsidiaries could pay to non-life parent companies
in 1998 without prior approval is approximately $165.1 million.
Statutory operating results and statutory surplus are determined
according to accounting practices prescribed or permitted by each state in which
the subsidiaries do business. Statutory surplus bears no direct relationship to
equity as determined under GAAP. With respect to new business, statutory
accounting practices require acquisition costs and reserves for future
guaranteed benefit payments and interest in excess of statutory rates to be
expensed as the new business is written. These items cause a statutory loss
("surplus strain") on many insurance policies in the year in which they are
issued. We manage the effect of such statutory surplus strain by designing our
products to minimize such first-year losses, and by controlling the amount of
new premiums written.
Note 13 to the consolidated financial statements shows the difference
between pretax income reported using statutory accounting practices and GAAP.
Insurance departments in the states where our life insurance subsidiaries
are domiciled or do business require insurance companies to make annual and
quarterly filings. The interest maintenance reserve ("IMR") and the asset
valuation reserve ("AVR") are required to be appropriated and reported as
liabilities. The IMR captures all investment gains and losses resulting from
changes in interest rates and provides for such amounts to be amortized into
statutory net income on a basis reflecting the remaining lives of the assets
sold. The AVR captures investment gains and losses related to changes in
creditworthiness; it is also adjusted each year based on a formula related to
the quality and loss experience of the Company's investment portfolio. These
reserves affect the ability of our insurance subsidiaries to reflect investment
gains and losses in statutory earnings and surplus.
Our debt agreements require the Company to maintain minimum working
capital and RBC ratios and limit the Company's ability to incur additional
indebtedness. They also restrict the amount of retained earnings that is
available for dividends and require Conseco to maintain certain minimum ratings
at its insurance subsidiaries.
INFLATION
Inflation does not have a significant effect on Conseco's balance sheet;
we have minimal investments in property, equipment or inventories.
Medical cost inflation has had a significant impact on our supplemental
health operations. Generally, these costs have increased more rapidly than the
Consumer Price Index. Medical costs will likely continue to rise. The impact of
medical cost inflation on our operations depends on our ability to increase
premium rates. Such increases are subject to approval by state insurance
departments. Before Medicare supplement plans were standardized, approximately
two-thirds of the states permitted rate plans with automatic escalation clauses.
This permitted Conseco, in periods following initial approval, to adjust premium
rates for changes in Medicare deductibles and increases in medical cost
inflation without refiling with the regulators. Currently, rate changes for all
Medicare supplement plans must be individually approved by each state. We seek
to price our new standardized supplement plans to reflect the impact of these
filings and the lengthening of the period required to implement rate increases.
YEAR 2000 CONVERSION COSTS
We have initiated a corporate-wide program designed to ensure that our
computer systems will function properly in the year 2000. For some of our
operations, the most effective solution will be to ensure timely completion of
the previously planned conversions of their older systems to more modern, year
2000 - compliant systems used in other areas of the Company. In some cases, our
most effective solution will be to purchase new, more modern systems; these
costs will be capitalized as assets and amortized over their expected useful
lives. In other cases, we will modify existing systems, thereby incurring costs
that will be charged to operating expense. To date, we have incurred $12.6
million in costs related to year 2000 projects. We expect to spend approximately
an additional $45 million on these projects over the next two years. We began to
incur expenses related to this program several years ago. We expect our year
2000 program to be completed on a timely basis.
36
<PAGE>
MARKET-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT
Insurance subsidiaries
We seek to invest our available funds in a manner that will maximize
shareholder value and fund future obligations to policyholders and debtors,
subject to appropriate risk considerations. We seek to meet this objective
through investments that: (i) have similar characteristics to the liabilities
they support; (ii) are diversified among industries, issuers and geographic
locations; and (iii) make up a predominantly investment-grade fixed maturity
securities portfolio. Many of our insurance products incorporate surrender
charges, market interest rate adjustments or other features to encourage
persistency. Approximately 59 percent of our total insurance liabilities at
December 31, 1997, had surrender penalties or other restrictions and
approximately 24 percent are not subject to surrender.
We seek to maximize the total return on our investments through active
investment management. Accordingly, we have determined that our entire portfolio
of fixed maturity securities is available to be sold in response to: (i) changes
in market interest rates; (ii) changes in relative values of individual
securities and asset sectors; (iii) changes in prepayment risks; (iv) changes in
credit quality outlook for certain securities; (v) liquidity needs; and (vi)
other factors. From time to time, we invest in securities for trading purposes,
although such investments account for a relatively small portion of our total
portfolio.
Profitability of many of our insurance products is significantly affected
by the spreads between interest yields on investments and rates credited on
insurance liabilities. Although substantially all credited rates on our annuity
products may be changed annually (subject to minimum guaranteed rates), changes
in competition and other factors, including the impact of the level of
surrenders and withdrawals, may limit our ability to adjust or to maintain
crediting rates at levels necessary to avoid narrowing of spreads under certain
market conditions. As of December 31, 1997, the average yield, computed on the
cost basis of our investment portfolio, was 7.5 percent, and the average
interest rate credited or accruing to our total insurance liabilities was 5.2
percent, excluding interest bonuses guaranteed for the first year of the annuity
contract only.
We use computer models to perform simulations of the cash flows generated
from our existing insurance business under various interest rate scenarios.
These simulations enable us to measure the potential gain or loss in fair value
of our interest rate-sensitive financial instruments. With such estimates, we
seek to closely match the duration of our assets to the duration of our
liabilities. When the estimated durations of assets and liabilities are similar,
exposure to interest rate risk is minimized because a change in the value of
assets should be largely offset by a change in the value of liabilities. At
December 31, 1997, the adjusted modified duration of the fixed maturity
securities and short-term investments held by our insurance subsidiaries was
approximately 5.8 years and the duration of our insurance liabilities was
approximately 6.7 years.
If interest rates were to increase by 10 percent from their December 31,
1997 levels, the fixed maturity securities and short-term investments held by
our insurance subsidiaries (net of corresponding changes in the value of cost of
policies purchased, cost of policies produced and insurance liabilities) would
decline in fair value by approximately $545 million. The calculations involved
in our computer simulations incorporate numerous assumptions, require
significant estimates and assume an immediate change in interest rates without
any management of the investment portfolio in reaction to such change.
Consequently, potential changes in value of our financial instruments indicated
by the simulations will likely be different from the actual changes experienced
under given interest rate scenarios, and the differences may be material.
Because we actively manage our investments and liabilities, actual losses could
be less than those estimated above.
Finance subsidiary
Our finance receivables are funded primarily with floating-rate debt.
Interest rate risk is substantially eliminated through the sale of such
receivables through securitizations. The finance receivables sold and the
asset-backed securities purchased by investors generally both have fixed rates.
Principal payments on the assets are passed through to investors in the
securities as received, thereby eliminating interest rate exposure that might
otherwise arise from maturities of debt instruments not matching maturities of
assets.
We retain interests in the finance receivables sold through investments in
interest-only securities that are subordinated to the rights of other investors.
Interest-only securities do not have a stated maturity or amortization period.
The expected amount of the cash flow as well as the timing is dependent on the
performance of the underlying collateral supporting each securitization. The
actual cash flow of these instruments could vary substantially if performance is
different from our assumptions. We develop assumptions to value these
investments by analyzing past portfolio performance, current loan
characteristics, current market conditions and the expected effect of our
actions to mitigate adverse performance. Assumptions used as of December 31,
1997, are summarized in note 4 to the supplemental consolidated financial
statements.
37
<PAGE>
The expected cash flows from interest-only securities as of December 31,
1997 were as follows (dollars in millions):
<TABLE>
<S> <C>
1998....................................... $ 456.9
1999....................................... 321.3
2000....................................... 235.3
2001....................................... 188.1
2002....................................... 156.3
Thereafter................................. 1,266.0
--------
Total expected cash flow.............. $2,623.9
========
Estimated fair value.................. $1,363.2
========
</TABLE>
We use computer models to perform simulations of the cash flows generated
from our interest-only securities under various interest rate scenarios. These
simulations enable us to measure the potential gain or loss in fair value of
these financial instruments. If interest rates were to decrease by 10 percent
from their December 31, 1997 levels, our interest-only securities would decline
in fair value by approximately $46 million. The calculations involved in our
computer simulations incorporate numerous assumptions, require significant
estimates and assume an immediate change in interest rates without any
management of the interest-only securities in reaction to such change.
Consequently, potential changes in value of our interest-only securities
indicated by the simulations will likely be different from the actual changes
experienced under given interest rate scenarios, and the differences may be
material.
Corporate
We manage the composition of our borrowed capital by considering factors
such as the ratio of borrowed capital to total capital, the portion of our
outstanding capital subject to fixed and variable rates, the current interest
rate environment and other market conditions. Our borrowed capital at December
31, 1997, includes commercial paper, notes payable and Company-obligated
mandatorily redeemable preferred securities of subsidiary trusts totaling $3.7
billion ($1.8 billion of which is at floating rates and $1.9 billion of which is
at fixed rates). Based on the interest rate exposure and prevalent rates at
December 31, 1997, a relative 10 percent decrease in interest rates would
increase the fair value of our fixed-rate borrowed capital by approximately $75
million. Our interest expense on floating-rate debt will fluctuate as prevailing
interest rates change.
We periodically use options and interest rate swaps to hedge interest rate
risk associated with our investments and borrowed capital. Although we had no
such agreements outstanding at December 31, 1997, we entered into four interest
rate swap agreements in March 1998. The Company entered into such agreements to
create a hedge that effectively converts a portion of its fixed-rate borrowed
capital into floating-rate instruments for the period during which the
agreements are outstanding. Such interest rate swap agreements have an aggregate
notional principal amount of $1.0 billion, mature in various years through 2008,
and have an average remaining life of seven years. If the counterparties of
these interest rate swaps do not meet their obligations, Conseco could have a
loss. Conseco limits its exposure to such a loss by diversifying among several
counterparties believed to be financially sound and creditworthy. At March 13,
1998, all of the counterparties were rated "A" or higher by Standard & Poor's
Corporation. These swap agreements, if in existence when the assumed 10 percent
decrease in interest rates occurred (see preceding paragraph), would cause the
increase in the fair value of our borrowed capital to be $55.0 million, or $20.0
million less than indicated in the preceding paragraph.
38
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Shareholders
Conseco, Inc.
We have audited the accompanying supplemental consolidated balance sheet
of Conseco, Inc. and Subsidiaries as of December 31, 1997 and 1996, and the
related supplemental consolidated statements of operations, shareholders'
equity, and cash flows for each of the three years in the period ended December
31, 1997. The supplemental consolidated financial statements give retroactive
effect to the merger of Conseco, Inc. and Green Tree Financial Corporation on
June 30, 1998, which has been accounted for as a pooling of interests as
described in note 1 to the supplemental consolidated financial statements. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We did not audit the consolidated financial statements of Green Tree
Financial Corporation and subsidiaries which statements reflect total assets of
12 percent and 11 percent as of December 31, 1997 and 1996, respectively, and
total revenues of 16 percent, 13 percent and 20 percent for the years ended
December 31, 1997, 1996 and 1995, respectively, of the related consolidated
financial statement totals. Those statements were audited by other auditors
whose report has been furnished to us, and our opinion, insofar as it relates to
data included for Green Tree Financial Corporation, is based solely on the
report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
Generally accepted accounting principles prohibit giving effect to a
consummated business combination accounted for by the pooling of interests
methods in financial statements that do not include the date of consummation.
These financial statements do not extend through the date of consummation;
however, they will become the historical consolidated financial statements of
Conseco, Inc. and Subsidiaries after financial statements covering the date of
consummation of the business combination are issued.
In our opinion, based on our audits and the report of other auditors, the
supplemental consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Conseco, Inc.
and Subsidiaries as of December 31, 1997 and 1996, and the consolidated results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1997, after giving retroactive effect to the merger of
Conseco, Inc. and Green Tree Financial Corporation described in note 1 to the
supplemental financial statements, all in conformity with generally accepted
accounting principles applicable after financial statements are issued for a
period which includes the date of consummation of the business combination.
/S/ PRICEWATERHOUSECOOPERS LLP
------------------------------
PRICEWATERHOUSECOOPERS LLP
Indianapolis, Indiana
July 7, 1998
39
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED BALANCE SHEET
December 31, 1997 and 1996
(Dollars in millions)
ASSETS
1997 1996
---- ----
<S> <C> <C>
Investments:
Actively managed fixed maturities at fair value (amortized cost:
1997 - $22,289.3; 1996 - $17,203.3)............................................. $22,773.7 $17,307.1
Interest-only securities........................................................... 1,363.2 1,014.3
Equity securities at fair value (cost: 1997 - $227.6; 1996 - $97.6)................ 228.9 99.7
Mortgage loans..................................................................... 516.2 356.0
Credit-tenant loans................................................................ 558.6 447.1
Policy loans....................................................................... 692.4 542.4
Other invested assets ............................................................. 530.7 262.3
Short-term investments............................................................. 1,179.1 377.4
Assets held in separate accounts................................................... 682.8 337.6
--------- ----------
Total investments............................................................ 28,525.6 20,743.9
Accrued investment income.............................................................. 379.3 296.9
Finance receivables.................................................................... 1,971.0 1,220.0
Servicing rights....................................................................... 96.3 -
Cost of policies purchased............................................................. 2,466.4 2,015.0
Cost of policies produced.............................................................. 915.2 544.3
Reinsurance receivables................................................................ 795.8 504.2
Goodwill (net of accumulated amortization: 1997 - $170.9; 1996 - $83.4)............... 3,693.4 2,259.8
Property and equipment (net of accumulated depreciation: 1997 - $153.9; 1996 -
$113.7).............................................................................. 284.0 188.3
Cash held in segregated accounts for investors......................................... 552.8 346.3
Cash deposits, restricted under pooling and servicing agreements....................... 247.2 171.5
Other assets........................................................................... 702.9 402.5
--------- ----------
Total assets................................................................. $40,629.9 $28,692.7
========= =========
(continued on next page)
The accompanying notes are an integral
part of the consolidated financial
statements.
</TABLE>
40
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED BALANCE SHEET (Continued)
December 31, 1997 and 1996
(Dollars in millions)
LIABILITIES AND SHAREHOLDERS' EQUITY
1997 1996
---- ----
<S> <C> <C>
Liabilities:
Insurance liabilities:
Interest sensitive products..................................................... $17,357.6 $14,795.5
Traditional products............................................................ 5,784.8 3,251.5
Claims payable and other policyholder funds..................................... 1,615.5 984.9
Unearned premiums............................................................... 406.1 272.4
Liabilities related to separate accounts ....................................... 682.8 337.6
Investor payables.................................................................. 552.8 346.3
Other liabilities.................................................................. 1,488.3 1,088.0
Income tax liabilities............................................................. 532.8 461.2
Investment borrowings.............................................................. 1,389.5 383.4
Notes payable and commercial paper:
Corporate....................................................................... 2,354.9 1,094.9
Consumer and commercial finance................................................. 1,866.3 762.5
--------- ---------
Total liabilities.......................................................... 34,031.4 23,778.2
--------- ---------
Minority interest:
Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts............................................................ 1,383.9 600.0
Mandatorily redeemable preferred stock of subsidiary............................... - 97.0
Common stock of subsidiary......................................................... .7 .7
Shareholders' equity:
Preferred stock.................................................................... 115.8 267.1
Common stock and additional paid-in capital (no par value, 1,000,000,000 shares
authorized, shares issued and outstanding: 1997 - 310,011,669;
1996 - 293,359,337)............................................................. 2,619.8 2,350.7
Accumulated other comprehensive income:
Unrealized appreciation of fixed maturity securities (net of applicable
deferred income taxes: 1997 - $95.5; 1996 - $21.5).......................... 177.2 39.8
Unrealized appreciation (depreciation) of interest-only securities and
other investments (net of applicable deferred income taxes:
1997 - $16.0; 1996 - $(.5)).................................................. 26.6 (.9)
Minimum pension liability adjustment............................................ (3.2) (2.3)
Retained earnings.................................................................. 2,277.7 1,562.4
--------- ---------
Total shareholders' equity................................................. 5,213.9 4,216.8
--------- ---------
Total liabilities and shareholders' equity................................. $40,629.9 $28,692.7
========= =========
The accompanying notes are an integral
part of the consolidated financial
statements.
</TABLE>
41
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED STATEMENT OF OPERATIONS
for the years ended December 31, 1997, 1996 and 1995
(Dollars in millions, except per share data)
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Revenues:
Insurance policy income:
Traditional products............................................... $2,954.1 $1,384.3 $1,355.6
Interest sensitive products........................................ 456.7 269.9 109.4
Net investment income:
Assets held by insurance subsidiaries.............................. 1,825.3 1,302.5 1,142.6
Finance receivables................................................ 214.5 138.1 124.7
Interest-only securities........................................... 130.3 77.2 51.3
Gain on loan securitizations......................................... 569.1 388.1 443.3
Net investment gains................................................. 266.5 60.8 204.1
Fee revenue and other income......................................... 239.9 168.9 130.2
-------- -------- --------
Total revenues................................................... 6,656.4 3,789.8 3,561.2
-------- -------- --------
Benefits and expenses:
Insurance policy benefits............................................ 2,368.3 1,195.0 1,107.5
Amounts added to annuity and financial product policyholder
account balances:
Interest......................................................... 697.1 620.2 556.6
Other amounts added to variable and equity-indexed
annuity products............................................... 109.6 48.4 28.8
Interest expense:
Corporate.......................................................... 109.4 108.1 119.4
Finance and investment borrowings.................................. 202.9 92.1 79.5
Amortization......................................................... 605.4 276.0 330.2
Nonrecurring charges................................................. 71.7 - -
Other operating costs and expenses................................... 1,006.3 634.2 516.5
-------- -------- --------
Total benefits and expenses...................................... 5,170.7 2,974.0 2,738.5
-------- -------- --------
Income before income taxes, minority interest
and extraordinary charge ...................................... 1,485.7 815.8 822.7
Income tax expense...................................................... 560.1 302.2 240.7
-------- -------- --------
Income before minority interest and extraordinary charge ........ 925.6 513.6 582.0
Minority interest:
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, net of income taxes..... 49.0 3.6 -
Dividends on preferred stock of subsidiaries......................... 3.3 8.9 11.9
Equity in earnings of subsidiaries................................... - 22.4 97.1
-------- -------- --------
Income before extraordinary charge .............................. 873.3 478.7 473.0
Extraordinary charge on extinguishment of
debt, net of taxes and minority interest............................. 6.9 26.5 2.1
-------- -------- --------
Net income....................................................... 866.4 452.2 470.9
Less amounts applicable to preferred stock:
Charge related to induced conversions................................ 13.2 - -
Preferred stock dividends............................................ 8.7 27.4 18.4
-------- -------- --------
Net income applicable to common stock............................ $ 844.5 $ 424.8 $ 452.5
======== ======== ========
(continued on next page)
The accompanying notes are an integral
part of the consolidated financial
statements.
</TABLE>
42
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED STATEMENT OF OPERATIONS (continued)
for the years ended December 31, 1997, 1996 and 1995
(Dollars in millions, except per share data)
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Earnings per common share:
Basic:
Weighted average shares outstanding............................ 311,050,000 230,141,000 206,639,000
Net income before extraordinary charge ........................ $2.74 $1.97 $2.20
Extraordinary charge .......................................... .02 .12 .01
------- ------- -------
Net income................................................ $2.72 $1.85 $2.19
===== ===== =====
Diluted:
Weighted average shares outstanding............................ 338,722,000 267,685,000 232,273,000
Net income before extraordinary charge ........................ $2.54 $1.79 $2.04
Extraordinary charge........................................... .02 .10 .01
------- -------- -------
Net income................................................ $2.52 $1.69 $2.03
===== ===== =====
The accompanying notes are an integral
part of the consolidated financial
statements.
</TABLE>
43
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
for the years ended December 31, 1997, 1996 and 1995
(Dollars in millions)
Common stock Accumulated other
Preferred and additional comprehensive Retained
Total stock paid-in capital income earnings
----- ----- --------------- ------ --------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1995.................................. $ 1,471.4 $ 283.5 $ 463.9 $(139.7) $ 863.7
Comprehensive income, net of tax:
Net income........................................... 470.9 - - - 470.9
Change in unrealized appreciation (depreciation) of
securities (net of applicable income taxes of
$132.8 million).................................... 252.4 - - 252.4 -
---------
Total comprehensive income....................... 723.3
Issuance of shares for stock options and employee
benefit plans........................................ 32.8 - 32.8 - -
Tax benefit related to issuance of shares under stock
option plans......................................... .4 - .4 - -
Cost of shares acquired................................ (146.3) - (68.9) - (77.4)
Dividends on preferred stock........................... (18.4) - - - (18.4)
Dividends on common stock.............................. (31.5) - - - (31.5)
--------- --------- ---------- --------- ---------
Balance, December 31, 1995................................ 2,031.7 283.5 428.2 112.7 1,207.3
Comprehensive income, net of tax:
Net income........................................... 452.2 - - - 452.2
Change in minimum pension liability adjustment....... (2.3) - - (2.3) -
Change in unrealized appreciation (depreciation) of
securities (net of applicable income tax benefit of
$45.9 million)..................................... (73.8) - - (73.8) -
---------
Total comprehensive income....................... 376.1
Issuance of convertible preferred stock................ 267.1 267.1 - - -
Conversion of preferred stock into common shares....... - (283.2) 283.2 - -
Redemption of preferred stock for cash................. (.3) (.3) - - -
Issuance of shares in merger transactions.............. 1,568.6 - 1,568.6 - -
Issuance of shares for stock options and employee
benefit plans........................................ 79.6 - 79.6 - -
Tax benefit related to issuance of shares under stock
option plans......................................... 15.9 - 15.9 - -
Cost of issuance of preferred stock.................... (21.7) - (21.7) - -
Cost of shares acquired................................ (26.0) - (3.1) - (22.9)
Dividends on preferred stock........................... (27.4) - - - (27.4)
Dividends on common stock.............................. (46.8) - - - (46.8)
--------- ------- --------- ------- ---------
Balance, December 31, 1996................................ 4,216.8 267.1 2,350.7 36.6 1,562.4
(continued on following page)
The accompanying notes are an integral
part of the consolidated financial
statements.
</TABLE>
44
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (continued)
for the years ended December 31, 1997, 1996 and 1995
(Dollars in millions)
Common stock Accumulated other
Preferred and additional comprehensive Retained
Total stock paid-in capital income earnings
----- ----- --------------- ------ --------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1996 (carried forward from
prior page)............................................$4,216.8 $ 267.1 $2,350.7 $ 36.6 $1,562.4
Comprehensive income, net of tax:
Net income........................................... 866.4 - - - 866.4
Change in minimum pension liability adjustment....... (.9) - - (.9) -
Change in unrealized appreciation (depreciation) of
securities (net of applicable income taxes of
$90.5 million)..................................... 164.9 - - 164.9 -
--------
Total comprehensive income....................... 1,030.4
Conversion of preferred stock into common shares....... - (151.3) 151.3 - -
Issuance of shares in merger transactions.............. 471.5 - 471.5 - -
Issuance of shares for stock options and agent and
employee benefit plans............................... 252.9 - 252.9 - -
Tax benefit related to issuance of shares under stock
option plans......................................... 85.2 - 85.2 - -
Conversion of convertible debentures into common
shares............................................... 150.0 - 150.0 - -
Cost of shares acquired................................ (857.0) - (830.9) - (26.1)
Value of stock purchase contracts, a component of the
FELINE PRIDES........................................ (3.4) - (3.4) - -
Other.................................................. (7.5) - (7.5) - -
Amounts applicable to preferred stock:
Charge related to induced conversion of convertible
preferred stock.................................... (13.2) - - - (13.2)
Dividends on preferred stock......................... (8.7) - - - (8.7)
Dividends on common stock.............................. (103.1) - - - (103.1)
-------- --------- -------- ------- --------
Balance, December 31, 1997................................$5,213.9 $ 115.8 $2,619.8 $ 200.6 $2,277.7
======== ========= ======== ======= ========
The accompanying notes are an integral
part of the consolidated financial
statements.
</TABLE>
45
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED STATEMENT OF CASH FLOWS
for the years ended December 31, 1997, 1996 and 1995
(Dollars in millions)
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net income....................................................... $ 866.4 $ 452.2 $ 470.9
Adjustments to reconcile net income to net
cash provided by operating activities:
Gain on sale of finance receivables........................ (759.1) (588.1) (443.3)
Valuation adjustments of interest-only securities.......... 190.0 200.0 -
Net increase in cash deposits.............................. (75.8) (19.7) (13.3)
Amortization and depreciation.............................. 651.6 328.1 338.2
Income taxes............................................... 333.9 92.5 83.5
Insurance liabilities...................................... (344.4) (123.8) (3.0)
Amounts added to annuity and financial product policyholder
account balances......................................... 806.7 668.6 585.4
Fees charged to insurance liabilities...................... (456.7) (269.9) (109.4)
Accrual and amortization of investment income.............. 69.8 25.9 (40.9)
Deferral of cost of policies produced...................... (602.6) (308.4) (282.1)
Nonrecurring charges....................................... 71.7 - -
Minority interest.......................................... 75.4 26.8 91.9
Extraordinary charge on extinguishment of debt............. 10.6 36.9 3.7
Net investment gains....................................... (266.5) (60.8) (204.1)
Other...................................................... 19.2 20.5 66.1
----------- ----------- -----------
Net cash provided by operating activities................ 590.2 480.8 543.6
----------- ----------- -----------
Cash flows from investing activities:
Sales of investments............................................. 18,446.0 8,402.1 7,901.9
Maturities and redemptions....................................... 750.7 614.3 417.1
Purchases of investments......................................... (20,043.8) (9,409.7) (9,112.3)
Cash received from sales of finance receivables,
net of expenses................................................ 10,541.0 8,312.2 5,252.2
Principal payments received on finance receivables............... 4,373.3 2,434.6 1,308.4
Finance receivables originated................................... (15,695.6) (10,433.2) (6,790.2)
Acquisition of subsidiaries, net of cash held at the date of the
mergers....................................................... (759.7) (642.3) (586.3)
Short-term investments held by CCP Insurance, Inc. before
consolidation at January 1, 1995.............................. - - 123.0
Repurchase of equity securities by CCP Insurance, Inc............ - - (44.5)
Cash paid in reinsurance transactions............................ - - (71.1)
Other............................................................ (61.4) (31.9) (34.7)
----------- ----------- -----------
Net cash used by investing activities..................... (2,449.5) (753.9) (1,636.5)
----------- ---------- ----------
(continued on next page)
The accompanying notes are an integral
part of the consolidated financial
statements.
</TABLE>
46
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
for the years ended December 31, 1997, 1996 and 1995
(Dollars in millions)
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Cash flows from financing activities:
Issuance of notes payable and commercial paper:
Corporate...................................................... $ 3,027.0 $ 1,315.4 $ 1,028.6
Consumer and commercial finance................................ 10,577.8 7,514.4 4,633.2
Issuance of Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts...................... 780.4 587.7 -
Investment borrowings............................................ 962.5 30.6 298.1
Payments on notes payable and commercial paper:
Corporate...................................................... (2,273.3) (2,134.3) (599.0)
Consumer and commercial finance................................ (9,474.0) (7,128.4) (4,559.8)
Purchase of preferred stock of a subsidiary...................... (98.4) (12.6) -
Deposits to insurance liabilities................................ 2,099.4 1,881.3 1,757.5
Withdrawals from insurance liabilities........................... (2,072.3) (1,842.5) (1,622.6)
Issuance of shares for employee benefit plans.................... 57.4 26.7 4.1
Issuance of convertible preferred stock.......................... - 257.7 -
Issuance of equity interests in subsidiaries, net................ - 2.2 16.8
Payments to repurchase equity securities......................... (738.6) (21.5) (146.3)
Payments related to the induced conversion of convertible
preferred stock................................................ (13.2) - -
Redemption of preferred stock.................................... - (.3) -
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts...................... (65.7) (2.9) -
Dividends paid................................................... (108.0) (70.3) (52.4)
---------- --------- -----------
Net cash provided by financing activities................ 2,661.0 403.2 758.2
---------- --------- -----------
Net increase (decrease) in short-term investments........ 801.7 130.1 (334.7)
Short-term investments, beginning of year............................ 377.4 247.3 582.0
---------- --------- -----------
Short-term investments, end of year.................................. $ 1,179.1 $ 377.4 $ 247.3
========== ========= ===========
The accompanying notes are an integral
part of the consolidated financial
statements.
</TABLE>
47
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Basis of Presentation
The following summary explains the accounting policies we use to arrive
at the more significant numbers in our financial statements. We have restated
all share and per-share amounts for the two-for-one stock splits distributed
February 11, 1997 and April 1, 1996. We prepare our financial statements in
accordance with generally accepted accounting principles ("GAAP"). We follow the
accounting standards established by the Financial Accounting Standards Board,
the American Institute of Certified Public Accountants and the Securities and
Exchange Commission.
Conseco, Inc. (We, "Conseco" or the "Company" ) is a financial services
holding company. The Company's life insurance subsidiaries develop, market and
administer supplemental health insurance, annuity, individual life insurance,
individual and group major medical insurance and other insurance products. The
Company's finance subsidiaries originate, purchase, sell and service consumer
and commercial finance loans throughout the United States. Conseco's operating
strategy is to grow its businesses by focusing its resources on the development
and expansion of profitable products and strong distribution channels. Conseco
has supplemented such growth by acquiring companies that have profitable niche
products and strong distribution systems. Once a company is acquired, our
operating strategy has been to consolidate and streamline management and
administrative functions where appropriate, to realize superior investment
returns through active asset management, to eliminate unprofitable products and
distribution channels and to expand and develop the profitable distribution
channels and products.
Consolidation issues. The supplemental consolidated financial statements
have been prepared to give retroactive effect to the merger (the "Green Tree
Merger") with Green Tree Financial Corporation ("Green Tree") accounted for as a
pooling of interests (see note 2, "Acquisitions/Dispositions"). GAAP prohibits
giving effect to a consummated business combination accounted for by the pooling
of interests method in financial statements that do not include the date of
consummation. These financial statements do not extend through the date of
consummation; however, they will become the historical consolidated financial
statements of Conseco after financial statements covering the date of
consummation of the Merger are issued. The pooling of interests method of
accounting requires the restatement of all periods presented as if Conseco and
Green Tree had always been combined. The consolidated statement of shareholders'
equity reflects the accounts of the Company as if additional shares of Conseco
common stock had been issued during all periods presented. Intercompany
transactions prior to the merger have been eliminated, and certain
reclassifications were made to Green Tree's financial statements to conform to
Conseco's presentations. No material adjustments were recorded to conform Green
Tree's accounting policies. See note 2 for additional discussion of the Green
Tree Merger.
Conseco Capital Partners, L.P. ("Partnership I"), an investment
partnership formed by Conseco with other investors, was the Company's vehicle
for acquiring four insurance companies: Great American Reserve Insurance Company
("Great American Reserve") in June 1990, Jefferson National Life Insurance
Company in November 1990 (it was merged with Great American Reserve in 1994),
Beneficial Standard Life Insurance Company ("Beneficial Standard") in March 1991
and Bankers Life and Casualty Company ("Bankers Life") in November 1992. CCP
Insurance, Inc. ("CCP"), a newly organized holding company for Partnership I's
first three acquisitions, completed an initial public offering ("IPO") in July
1992. In August 1995, we completed the purchase of all the shares of CCP common
stock we did not previously own in a transaction pursuant to which CCP was
merged with Conseco, with Conseco being the surviving corporation (the merger
and related transactions are referred to herein as the "CCP Merger"). As a
result, CCP's subsidiaries (Great American Reserve and Beneficial Standard)
became wholly owned subsidiaries of the Company. The accounts of CCP are
consolidated with Conseco's for all periods in the accompanying financial
statements.
We were required to use step-basis accounting when we acquired the shares
of CCP common stock in various transactions. As a result, the assets and
liabilities of CCP included in our consolidated balance sheet represent the
following combination of values: (i) the portion of CCP's net assets acquired by
Conseco in the initial acquisitions of CCP's subsidiaries made by Partnership I
is valued as of those respective acquisition dates; and (ii) the portion of
CCP's net assets acquired in the CCP Merger is valued as of August 31, 1995.
Bankers Life Holding Corporation ("BLH"), a company formed by Partnership
I to acquire Bankers Life, completed an IPO in March 1993. As a result of the
IPO and the acquisition of additional BLH common shares in September 1993, we
owned 56 percent of BLH at January 1, 1995. In June 1995, we purchased
additional common shares of BLH, increasing the Company's ownership of BLH to 85
percent. Conseco's ownership of BLH increased to 88 percent at December 31,
1995, and 90.5 percent at March 5, 1996, as a result of share repurchases by
BLH. On December 31, 1996, we completed the purchase of all of the shares of
48
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
BLH common stock we did not already 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.
We were required to use step-basis accounting when we acquired the BLH
common shares at the various acquisition dates. The assets and liabilities of
BLH included in our 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 Partnership I 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" and the
parent of American Life and Casualty Insurance Company) 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.
On January 1, 1995, Conseco had a 27 percent ownership interest in ALH.
On November 30, 1995, ALH issued 2,142,857 shares of its common stock for $30.0
million (including $13.2 million paid by Conseco and its subsidiaries) in a
private placement transaction. Conseco's ownership interest in ALH increased to
36 percent at December 31, 1995, as a result of this transaction and changes in
our ownership of affiliated companies with ownership interests in ALH.
On September 30, 1996, we purchased all of the common shares of ALH we
did not previously own from Partnership II for $166.0 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 the December 31, 1996, 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. On September 30, 1997, we completed the acquisition
(the "Colonial Penn Purchase") of Colonial Penn Life Insurance Company and
Providential Life Insurance Company and certain other assets (collectively
referred to as "Colonial Penn"). Colonial Penn became a wholly owned subsidiary
of Conseco. On December 1, 1996, we completed the purchase (the "FINOVA
Purchase") of the net assets of FINOVA Acquisition, Inc. ("FINOVA"). On December
5, 1997, we completed the acquisition (the "WNIC Merger") of Washington National
Corporation ("WNIC") and WNIC 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 consolidated effective December 31, 1996; the
accounts of CAF are consolidated effective January 1, 1997; the accounts of PFS
are consolidated effective April 1, 1997; the accounts of Colonial Penn are
consolidated effective September 30, 1997; and the accounts of WNIC are
consolidated effective December 1, 1997.
Neither "consolidation" nor "non-consolidation" methods of accounting for
partially owned subsidiaries affect our reported net income or shareholders'
equity. Our consolidated financial statements do not include the results of
material transactions between us and our consolidated affiliates, or among our
consolidated affiliates. We reclassified some amounts in our 1996 and 1995
consolidated financial statements and notes to conform with the 1997
presentation.
49
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
Investments
Fixed maturities are securities primarily held by our life insurance
subsidiaries that mature more than one year after issuance. They include bonds,
notes receivable and preferred stocks with mandatory redemption features and are
classified as follows:
Actively managed - fixed maturity securities that we may sell prior
to maturity in response to changes in interest rates, issuer credit
quality or our liquidity requirements. We carry actively managed
securities at estimated fair value. We record any unrealized gain
or loss, net of tax and the related adjustments described below, as
a component of shareholders' equity.
Trading - fixed maturity securities that we buy principally for the
purpose of selling in the near term. We carry trading securities at
estimated fair value. We include any unrealized gain or loss in net
investment gains (losses). We held $64.8 million of trading
securities at December 31, 1997, which are included in other
invested assets. We did not hold any trading securities at December
31, 1996 or 1995.
Held to maturity - fixed maturity securities that we have the
ability and positive intent to hold to maturity. When we own such
securities, we carry them at amortized cost. We may dispose of
these securities if the credit quality of the issuer deteriorates,
if regulatory requirements change or under other unforeseen
circumstances. We have not held any held to maturity securities
since implementing SFAS 115 in 1993.
We consider the anticipated returns from investing policyholder balances,
including investment gains and losses, in determining the amortization of the
cost of policies purchased and the cost of policies produced. When we state
actively managed fixed maturities at fair value, we also adjust the cost of
policies purchased and the cost of policies produced to reflect the change in
cumulative amortization that we would have recorded if we had sold these
securities at their fair value and reinvested the proceeds at current yields. If
future yields on such securities decline, it may be necessary to increase
certain of our insurance liabilities. We are required to adjust such liabilities
when their balances and future net cash flows (including investment income) are
insufficient to cover future benefits and expenses.
The unrealized gains and losses and the related adjustments described
above have no effect on our earnings. We record them, net of tax and other
adjustments, to shareholders' equity. The following table summarizes the effect
of these adjustments on the related balance sheet accounts as of December 31,
1997:
<TABLE>
<CAPTION>
Effect of fair value
adjustment to
actively managed
Cost fixed maturity Reported
basis securities amount
----- ---------- ------
(Dollars in millions)
<S> <C> <C> <C>
Actively managed fixed maturity securities.................... $22,289.3 $ 484.4 $22,773.7
Other balance sheet items:
Cost of policies purchased................................. 2,639.0 (172.6) 2,466.4
Cost of policies produced.................................. 949.9 (34.7) 915.2
Other .................................................... - (4.4) (4.4)
Income tax liabilities..................................... (437.3) (95.5) (532.8)
-------
Unrealized appreciation of fixed maturity securities,
net................................................. $ 177.2
=======
</TABLE>
When there are changes in conditions that cause us to transfer a fixed
maturity investment to a different category (i.e., actively managed, trading or
held to maturity), we transfer it at its fair value on that date. We account for
the security's unrealized gain or loss (such amounts were immaterial in 1997) as
follows:
For a transfer to the trading category - we recognize the unrealized
gain or loss immediately in earnings.
For a transfer from the trading category - we do not reverse the
unrealized gain or loss already recognized in earnings.
50
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CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
For a transfer to actively managed from held to maturity - we
recognize the unrealized gain or loss immediately in shareholders'
equity.
For a transfer to held to maturity from actively managed - we continue
to report the unrealized gain or loss at the date of transfer in
shareholders' equity, but we amortize the gain or loss over the
remaining life of the security as an adjustment of yield.
Interest-only securities represent the right to receive certain cash
flows which exceed the amount of cash flows sold in our securitized receivable
sales. Such cash flows generally are equal to the value of the interest to be
collected on the underlying financial contracts of each securitization in excess
of the sum of the interest to be paid on the securities sold, contractual
servicing fees and credit losses. We carry interest-only securities at estimated
fair value. We determine fair value by discounting the projected cash flows over
the expected life of the receivables sold using current prepayment, default,
loss and interest rate assumptions. We record any unrealized gain or loss
determined to be temporary, net of tax, as a component of shareholders' equity.
See note 4 for additional discussion of gain on sale of receivables and
interest-only securities.
Equity securities include investments in common stocks and non-redeemable
preferred stock. We treat them like actively managed fixed maturities (as
described above).
Credit-tenant loans ("CTLs") are loans for commercial properties. When we
make these loans: (i) the lease of the principal tenant must be assigned to
Conseco; (ii) the lease must produce adequate cash flow to fund substantially
all the requirements of the loan; and (iii) the principal tenant or the
guarantor of such tenant's obligations must have an investment-grade credit
rating when the loan is made. These loans also must be collateralized by the
value of the related property. Our underwriting guidelines take into account
such factors as: (i) the lease term of the property; (ii) the borrower's
management ability, including business experience, property management
capabilities and financial soundness; and (iii) such economic, demographic or
other factors that may affect the income generated by the property, or its
value. The underwriting guidelines generally require a loan-to-value ratio of 75
percent or less. We carry both CTLs and traditional mortgage loans at amortized
cost.
As part of our investment strategy, we may enter into reverse repurchase
agreements and dollar-roll transactions to increase our investment return or to
improve our liquidity. We account for these transactions as collateral
borrowings, where the amount borrowed is equal to the sales price of the
underlying securities.
Policy loans are stated at their current unpaid principal balances.
Other invested assets include: (i) trading securities; (ii) Standard &
Poor's 500 Call Options ("S&P 500 Call Options"); and (iii) certain
non-traditional investments. Trading securities are carried at estimated fair
value as described above. The S&P 500 Call Options are also carried at estimated
fair value and are further described below under "Financial Instruments."
Non-traditional investments include investments in venture capital funds,
limited partnerships, mineral rights and promissory notes and are accounted for
using either the cost method, or for investments in partnerships over whose
operations the Company exercises significant influence, the equity method.
Short-term investments include commercial paper, invested cash and other
investments purchased with maturities of less than three months. We carry them
at amortized cost, which approximates their estimated fair value. We consider
all short-term investments to be cash equivalents.
We defer any fees received or costs incurred when we originate
investments--principally CTLs and mortgages. We amortize fees, costs, discounts
and premiums as yield adjustments over the contractual lives of the investments.
We consider anticipated prepayments on mortgage-backed securities in determining
estimated future yields on such securities.
When we sell a security (other than a trading security), we report the
difference between our sale proceeds and its amortized cost as an investment
gain or loss.
We regularly evaluate all of our investments based on current economic
conditions, credit loss experience and other investee- specific developments. If
there is a decline in a security's net realizable value that is other than
temporary, we treat it as a realized
51
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
loss and we reduce our cost basis of the security to its estimated fair value.
See note 4 for a discussion of other than temporary declines in realizable value
of interest-only securities.
Separate Accounts
Separate accounts are funds on which investment income and gains or
losses accrue directly to certain policyholders. The assets of these accounts
are legally segregated. They are not subject to the claims that may arise out of
any other business of Conseco. We report separate account assets at market
value; the underlying investment risks are assumed by the contract holders. We
record the related liabilities at amounts equal to the underlying assets; the
fair value of these liabilities equals their carrying amount.
Finance Receivables
Finance receivables consist of lease, commercial finance and revolving
credit receivables and loans held for securitization (which include recently
originated manufactured housing, home equity, home improvement, consumer and
equipment loans which will be sold in the near future). We carry finance
receivables held for securitization at the lower of cost or market. We carry our
lease receivables (which are direct financing leases as defined in Statement of
Financial Accounting Standards No. 13 "Accounting for Leases") at the present
value of the future minimum lease payments and related residual values. We carry
commercial finance receivables (which include dealer floor plan, asset-based
financing arrangements with dealers, manufacturers and other commercial entities
and commercial real estate loans) and revolving credit receivables (which
include retail credit card arrangements with merchants and dealers and their
customers) at amortized cost. Finance receivables are net of allowance for
expected losses.
We defer fees received or costs incurred when we originate finance
receivables. We amortize fees, costs, discounts and premiums over the
contractual lives of the receivables, with consideration to anticipated
prepayments. Such deferred fees or costs are included in the cost of finance
receivables sold when receivables are sold. See note 4 for a discussion of the
sale of finance receivables.
Servicing Rights
We generally retain the right to service loans we originate or purchase
and subsequently sell through securitizations. Fees for servicing loans are
based on a stipulated percentage of the unpaid principal balance of the loans.
We recognize a servicing asset when we sell our loans, equal to the present
value of the expected future net servicing revenue using prepayment, default,
loss and interest rate assumptions. We amortize servicing rights in proportion
to total projected net servicing income. We periodically assess our servicing
rights for impairment based on the fair value of such rights. If an impairment
exists, it is recognized in the statement of operations during the period in
which the impairment occurs as an adjustment to the corresponding valuation
allowance. See note 4 for a discussion of the sale of receivables.
Cost of Policies Purchased
When we acquire an insurance company, we assign a portion of its cost to
the right to receive future cash flows from insurance contracts existing at the
date of the acquisition. This cost of policies purchased represents the
actuarially determined present value of the projected future cash flows from the
acquired policies. To determine this value, we use a method that is consistent
with methods commonly used to value blocks of insurance business and with the
basic methodology generally used to value assets. It can be summarized as
follows:
- Identify the expected future cash flows from the blocks of business.
- Identify the risks to realizing those cash flows (i.e., assess the
probability that the cash flows will be realized).
- Identify the rate of return that we must earn in order to accept these
risks, based on consideration of the factors summarized below.
- Determine the value of the policies purchased by discounting the
expected future cash flows by the discount rate we need to earn.
52
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
The expected future cash flows we use in determining such value are based
on actuarially determined projections of future premium collections, mortality,
surrenders, operating expenses, changes in insurance liabilities, investment
yields on the assets held to back the policy liabilities and other factors.
These projections take into account all factors known or expected at the
valuation date, based on the collective judgment of Conseco's management. Our
actual experience on purchased business may vary from projections due to
differences in renewal premiums collected, investment spread, investment gains
or losses, mortality and morbidity costs and other factors.
The discount rate we use to determine the value of the cost of policies
purchased is the rate of return we need to earn in order to invest in the
business being acquired. In determining this required rate of return, we
consider the following factors:
- The magnitude of the risks associated with each of the actuarial
assumptions used in determining expected future cash flows (as
described above).
- The cost of our capital required to fund the acquisition.
- The likelihood of changes in projected future cash flows that might
occur if there are changes in insurance regulations and tax laws.
- The acquired company's compatibility with other Conseco activities that
may favorably affect future cash flows.
- The complexity of the acquired company.
- Recent prices (i.e., discount rates used in determining valuations)
paid by others to acquire similar blocks of business.
After we determine the cost of policies purchased, we amortize that
amount and evaluate recoverability in the same manner as cost of policies
produced as described below.
The cost of policies purchased related to acquisitions completed prior to
November 19, 1992 (representing 8 percent of the balance of cost of policies
purchased at December 31, 1997) is amortized under a slightly different method
than that described above. However, the effect of the different method on 1997
net income was insignificant.
Cost of Policies Produced
The costs that vary with and are primarily related to producing new
business are referred to as cost of policies produced. They consist primarily of
commissions, first-year bonus interest and certain costs of policy issuance and
underwriting, net of fees charged to the policy in excess of ultimate fees
charged. To the extent that they are recoverable from future profits, we defer
these costs and amortize them, using the interest rate credited to the
underlying policies, as follows:
- For universal life-type contracts and investment-type contracts, in
relation to the present value of expected gross profits from the
contracts.
- For immediate annuities with mortality risks, in relation to the
present value of benefits to be paid.
- For traditional life and accident and health products, in relation to
future anticipated premium revenue, using the same assumptions that
are used in calculating the insurance liabilities.
Each year, we evaluate the recoverability of the unamortized balance of
the cost of policies produced. For universal life-type contracts and
investment-type contracts, we increase or decrease the accumulated amortization
whenever there is a material change in the estimated gross profits expected over
the life of a block of business. We do this in order to maintain a constant
relationship between the cumulative amortization and the present value
(discounted at the rate of interest that accrues to the policies) of expected
gross profits. For most other contracts, we reduce the unamortized asset balance
(by a charge to income) only when the present value of future cash flows, net of
the policy liabilities, is insufficient to recover the asset balance.
53
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
Goodwill
Goodwill is the excess of the amount we paid to acquire a company over
the fair value of its net assets. We amortize goodwill on the straight-line
basis generally over a 40-year period. We continually monitor the value of our
goodwill based on our estimates of future earnings. We determine whether
goodwill is fully recoverable from projected undiscounted net cash flows from
earnings of the subsidiaries over the remaining amortization period. If we were
to determine that changes in such projected cash flows no longer supported the
recoverability of goodwill over the remaining amortization period, we would
reduce its carrying value with a corresponding charge to expense or shorten the
amortization period (no such changes have occurred). Cash flows considered in
such an analysis are those of the business acquired, if separately identifiable,
or the business segment that acquired the business if such earnings are not
separately identifiable.
Property and Equipment
We carry property and equipment at depreciated cost. We depreciate
property and equipment on a straight-line basis over the estimated useful lives
of the assets, which average approximately 11 years. Our depreciation expense
was $46.1 million in 1997, $29.8 million in 1996 and $20.3 million in 1995.
Insurance Liabilities, Recognition of Insurance Policy Income and Related
Benefits and Expenses
Our reserves for universal life-type and investment-type contracts are
based either on the contract account balance (if future benefit payments in
excess of the account balance are not guaranteed) or on the present value of
future benefit payments (if such payments are guaranteed). We make additions to
insurance liabilities if we determine that future cash flows (including
investment income) are insufficient to cover future benefits and expenses.
For investment contracts without mortality risk (such as deferred
annuities and immediate annuities with benefits paid for a period certain) and
for contracts that permit either Conseco or the insured to make changes in the
contract terms (such as single- premium whole life and universal life), we are
required to record premium deposits and benefit payments as increases or
decreases in a liability account, rather than as revenue and expense. We record
as revenue any amounts charged against the liability account for the cost of
insurance, policy administration and surrender penalties. We record as expense
any interest credited to the liability account and any benefit payments that
exceed the contract liability account balance.
We calculate our reserves for traditional and limited-payment life
contracts generally using the net-level-premium method, based on assumptions as
to investment yields, mortality, withdrawals and dividends. We make these
assumptions at the time we issue the contract or, in the case of contracts
acquired by purchase, at the purchase date. We base these assumptions on
projections from past experience, modified as necessary to reflect anticipated
trends and making allowance for possible unfavorable deviation.
For traditional life insurance contracts, we recognize premiums as income
when due or, for short-duration contracts, over the period to which the premiums
relate. We recognize benefits and expenses as a level percentage of earned
premiums. We accomplish this by providing for future policy benefits and by
amortizing deferred policy acquisition costs.
For contracts with mortality risk, but with premiums paid for only a
limited period (such as single-premium immediate annuities with benefits paid
for the life of the annuitant), we use an accounting treatment similar to that
used for traditional contracts. An exception is that we defer the excess of the
gross premium over the net premium and recognize it in relation to the present
value of expected future benefit payments (when accounting for annuity
contracts) or in relation to insurance in force (when accounting for life
insurance contracts).
We establish reserves for the estimated present value of the remaining
net cost of all reported and unreported claims. We base our estimates on past
experience and on published tables for disabled lives. We believe that the
reserves we have established are adequate. Final claim payments, however, may
differ from the established reserves, particularly when those payments may not
occur for several years. Any adjustments we make to reserves are reflected in
the results for the year during which the adjustments are made.
The liability for future policy benefits for accident and health policies
consists of active life reserves and the estimated present value of the
remaining ultimate net cost of incurred claims. Active life reserves include
unearned premiums and additional reserves. The additional reserves are computed
on the net level premium method using assumptions for future investment yield,
mortality and
54
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
morbidity experience. Our assumptions are based on projections of past
experience and include provisions for possible adverse deviation.
For participating policies, we determine annually the amount of dividends
to be paid. We include as an insurance liability the portion of the earnings
allocated to participating policyholders.
Reinsurance
In the normal course of business, Conseco seeks to limit its exposure to
loss on any single insured and to recover a portion of the benefits paid over
such limits. We do this by ceding reinsurance to other insurance enterprises or
reinsurers under excess coverage and coinsurance contracts. We limit how much
risk per policy we will retain. We currently retain no more than $.8 million of
risk on any one policy.
We report assets and liabilities related to insurance contracts before
the effects of reinsurance. We report reinsurance receivables and prepaid
reinsurance premiums (including amounts related to insurance liabilities) as
assets. We recognize estimated reinsurance receivables in a manner consistent
with the liabilities related to the underlying reinsured contracts.
Income Taxes
Our income tax expense includes deferred income taxes arising from
temporary differences between the tax and financial reporting bases of assets
and liabilities. This liability method of accounting for income taxes also
requires us to reflect in income the effect of a tax-rate change on accumulated
deferred income taxes in the period in which the change is enacted.
In assessing the realization of deferred income tax assets, we consider
whether it is more likely than not that the deferred income tax assets will be
realized. The ultimate realization of deferred income tax assets depends upon
generating future taxable income during the periods in which temporary
differences become deductible. If future income is not generated as expected,
deferred income tax assets may need to be written off.
Minority Interest
Our consolidated financial statements for 1995 and 1996 include all of
the assets, liabilities, revenues and expenses of BLH and ALH, even though we
did not own all of the common stock of these subsidiaries until December 1996.
We make a charge against consolidated income for: (i) the share of earnings
allocable to minority interests; (ii) dividends on preferred stock of
subsidiaries; and (iii) distributions on the Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts. We show the shareholders'
equity of such entities allocable to the minority interests separately on our
consolidated balance sheet.
We report Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts at their book value under minority interest. We charge the
distributions on these securities against consolidated income.
Earnings Per Share
As of December 31, 1997, we adopted Statement of Financial Accounting
Standards No. 128, "Earnings Per Share"("SFAS 128"). SFAS 128 provides new
accounting and reporting standards for earnings per share. It replaces primary
and fully diluted earnings per share with basic and diluted earnings per share.
Basic earnings per share excludes dilution and is computed by dividing income
available to common shareholders by the weighted average number of common shares
outstanding for the period. Diluted earnings per share represents the potential
dilution that could occur if all convertible securities, warrants and stock
options were exercised and converted into common stock if their effect is
dilutive. The diluted earnings per share calculation assumes that the proceeds
received upon the conversion of all dilutive options and warrants are used to
repurchase the Company's common shares at the average market price of such
shares during the period. Prior period earnings per share amounts have been
restated. We have also restated all share and per-share amounts for the
two-for-one stock splits distributed February 11, 1997 and April 1, 1996.
55
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
Comprehensive Income
As of December 31, 1997, we adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130
establishes standards for reporting and presentation of comprehensive income and
its components in a full set of financial statements. Comprehensive income
includes all changes in shareholders' equity (except those arising from
transactions with shareholders) and includes net income, net unrealized gains
(losses) on securities and minimum pension liability adjustments. The new
standard requires only additional disclosures in the consolidated financial
statements; it does not affect our financial position or results of operations.
Comprehensive income excludes net investment gains (losses) included in
net income of: (i) $42.1 million (after income taxes of $22.6 million) in 1997;
(ii) $(2.0) million (after income tax benefit of $1.0 million) in 1996; and
(iii) $48.1 million (net of income taxes of $25.9 million) in 1995.
Use of Estimates
Our financial statements have been prepared in accordance with GAAP. As
such, they include amounts based on our informed estimates and judgment, with
consideration given to materiality. We use many estimates and assumptions
calculating amortized value and recoverability of securities, cost of policies
produced, cost of policies purchased, interest-only securities, servicing
rights, goodwill, insurance liabilities, guaranty fund assessment accruals,
liabilities for litigation, and deferred income taxes. Actual results could
differ from reported results using those estimates.
Financial Instruments
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 buy S&P 500 Call Options in an
effort to hedge potential increases to policyholder benefits resulting from
increases in the S&P 500 Index to which the product's return is linked. We
include the cost of the S&P 500 Call Options in the pricing of the
equity-indexed annuity products. We reflect changes in the values of the S&P 500
Call Options, which fluctuate in relation to changes in policyholder account
balances for these annuities, in net investment income. Premiums paid to
purchase these instruments are deferred and amortized over their term.
During the year ended December 31, 1997, net investment income increased
by $39.4 million as a result of changes in the value of the S&P 500 Call
Options. Such investment income was substantially offset by amounts added to
policyholder account balances for annuities and financial products. The value of
the S&P 500 Call Options was $41.4 million at December 31, 1997. We classify
such instruments as other invested assets.
If the counterparties of the aforementioned financial instruments do not
meet their obligations, Conseco may have to recognize a loss. Conseco limits its
exposure to such a loss by diversifying among several counterparties believed to
be strong and creditworthy. At December 31, 1997, all of the counterparties were
rated "A"or higher by Standard & Poor's Corporation.
In conjunction with its investment in a consumer financing company,
Conseco has guaranteed up to $10.0 million of the financing company's
indebtedness to its primary lender through 1998. In conjunction with certain
finance receivable sales, Conseco has provided guarantees of $1.7 billion and
$1.5 billion as of December 31, 1997 and 1996, respectively. Conseco believes
the likelihood of a significant loss from the guarantee is remote.
Revenue Recognition for Sales of Finance Receivables
Effective January 1, 1997, we account for the sale of finance receivables
in accordance with the new standard, Statement of Financial Accounting Standards
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities "("SFAS 125"). In applying SFAS 125 to our
securitized finance receivables sales, we are required to recognize a gain,
representing the difference between the proceeds from the sale (net of related
sale costs) and the carrying value of the component of the finance receivable
sold. Such carrying amount is determined by allocating the carrying value of the
finance receivables between the portion we sell and the interests in the finance
receivables we retain (generally interest-only securities and servicing rights),
based on each portion's relative fair value on the date of the sale. See note 4
for additional discussion of finance receivable sales.
56
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
Fair Values of Financial Instruments
We use the following methods and assumptions to determine the estimated
fair values of financial instruments:
Investment securities. For fixed maturity securities (including
redeemable preferred stocks) and for equity and trading securities, we
use quotes from independent pricing services, where available. For
investment securities for which such quotes are not available, we use
values obtained from broker-dealer market makers or by discounting
expected future cash flows using a current market rate appropriate for
the yield, credit quality, and for fixed maturity securities, the
maturity of the investment being priced.
Interest-only securities. We determine estimated fair value by
discounting future expected cash flows over the expected life of the
receivables sold using current prepayment, default, loss and interest
rate assumptions.
Short-term investments. We use quoted market prices. The carrying amount
reported on our consolidated balance sheet for these instruments
approximates their estimated fair value.
Mortgage loans, credit-tenant loans and policy loans. We discount future
expected cash flows based on interest rates currently being offered for
similar loans to borrowers with similar credit ratings. We aggregate
loans with similar characteristics in our calculations.
Other invested assets. We use quoted market prices, where available. For
other invested assets, which are not material, we have assumed a market
value equal to carrying value.
Other assets. The portion of other assets in 1996 representing the value
attributable to the U.S. Treasury securities held in escrow for the
future redemption of mandatorily redeemable preferred stock of a
subsidiary of ALH are based on quoted market prices. In 1997, the
redeemable preferred stock was redeemed and the securities held in escrow
were released.
Finance receivables. We estimate the fair value of these loans to be
approximately equal to their carrying value, including adjustments for
deferred fees and costs.
Servicing rights. We determine estimated fair value by discounting future
expected net servicing revenue using prepayment, default, loss and
interest rate assumptions.
Insurance liabilities for investment contracts. We use discounted cash
flow calculations based on interest rates currently being offered for
similar contracts having maturities consistent with the contracts being
valued.
Investment borrowings and notes payable. We use either: (i) discounted
cash flow analyses based on our current incremental borrowing rates for
similar types of borrowing arrangements; or (ii) current market values
for publicly traded debt.
Other liabilities. The portion of other liabilities representing the
value attributable to the conversion features of subordinated convertible
debentures acquired in conjunction with the ATC Merger and the PFS Merger
are valued at estimated fair value.
Company-obligated mandatorily redeemable preferred securities of
subsidiary trusts. We use quoted market prices.
Mandatorily redeemable preferred stock of a subsidiary of ALH (a
component of minority interest). The estimated fair value of redeemable
preferred stock which is publicly-traded is based on quoted market
prices. The estimated fair value of the privately placed redeemable
preferred stock is determined by discounting expected future cash flows
using assumed incremental dividend rates for similar duration securities.
These securities were redeemed in 1997.
57
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
Here are the estimated fair values of our financial instruments:
<TABLE>
<CAPTION>
1997 1996
----------------------- ----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Financial assets held for purposes other than trading:
Actively managed fixed maturities........................ $22,773.7 $22,773.7 $17,307.1 $17,307.1
Interest-only securities................................. 1,363.2 1,363.2 1,014.3 1,006.5
Equity securities ....................................... 228.9 228.9 99.7 99.7
Mortgage loans........................................... 516.2 551.0 356.0 356.1
Credit-tenant loans...................................... 558.6 587.2 447.1 446.3
Policy loans............................................. 692.4 692.4 542.4 542.4
Other invested assets.................................... 530.7 530.7 262.3 262.3
Short-term investments................................... 1,179.1 1,179.1 377.4 377.4
Finance receivables...................................... 1,971.0 1,971.0 1,220.0 1,220.0
Servicing rights......................................... 96.3 96.3 - -
Other assets............................................. - - 45.6 49.1
Financial liabilities held for purposes other than trading:
Insurance liabilities for investment contracts (1)....... 12,724.0 12,724.0 11,491.6 11,491.6
Investment borrowings.................................... 1,389.5 1,389.5 383.4 383.4
Other liabilities........................................ 72.6 95.1 145.5 145.5
Notes payable and commercial paper:
Corporate.............................................. 2,354.9 2,398.8 1,094.9 1,140.8
Consumer and commercial finance........................ 1,866.3 1,876.0 762.5 803.8
Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts.............. 1,383.9 1,491.6 600.0 604.3
Mandatorily redeemable preferred stock of a subsidiary
(a component of minority interest).................... - - 97.0 97.0
<FN>
1) The estimated fair value of the liabilities for investment contracts
was approximately equal to its carrying value at December 31, 1997 and
1996. This was because interest rates credited on the vast majority of
account balances approximate current rates paid on similar investments
and because these rates are not generally guaranteed beyond one year. We
are not required to disclose fair values for insurance liabilities, other
than those for investment contracts. However, we take into consideration
the estimated fair values of all insurance liabilities in our overall
management of interest rate risk. We attempt to minimize exposure to
changing interest rates by matching investment maturities with amounts
due under insurance contracts.
</FN>
</TABLE>
Recently Issued Accounting Standards
Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS 131") establishes new
standards for reporting about operating segments and products and services,
geographic areas and major customers. Under SFAS 131, segments are to be defined
consistent with the basis management uses internally to assess performance and
allocate resources. Implementing SFAS 131 will have no impact on the
consolidated amounts we report, and we do not expect any significant changes to
our segment disclosures. SFAS 131 is effective for our December 31, 1998
financial statements.
58
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
Statement of Financial Accounting Standards No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits" ("SFAS 132") was
issued in February 1998 and revises current disclosure requirements for
employers' pensions and other retiree benefits. SFAS 132 will have no effect on
our financial position or results of operations. SFAS 132 is effective for our
December 31, 1998 financial statements.
Statement of Position 97-3, "Accounting by Insurance and Other
Enterprises for Insurance-Related Assessments" ("SOP 97-3") was issued by the
American Institute of Certified Public Accountants in December 1997 and provides
guidance for determining when an insurance company or other enterprise should
recognize a liability for guaranty-fund assessments and guidance for measuring
the liability. The statement is effective for 1999 financial statements with
early adoption permitted. The adoption of this statement is not expected to have
a material effect on our financial position or results of operations.
2. ACQUISITIONS/DISPOSITIONS:
Green Tree
On June 30, 1998, we completed the Green Tree Merger. Each outstanding
share of Green Tree common stock was exchanged for .9165 of a share of Conseco
common stock. We issued 128.7 million shares of Conseco common stock (including
5.0 million common equivalent shares issued in exchange for Green Tree's
outstanding options). The Green Tree Merger constituted a tax-free exchange and
is accounted for under the pooling of interests method. All prior period
consolidated financial statements presented have been restated to include Green
Tree as though it had always been a subsidiary of Conseco. As a result of the
Green Tree Merger, a restructuring charge of $148 was recorded in the second
quarter of 1998. The restructuring charge includes investment banking,
accounting, legal and regulatory fees, severance costs and other costs
associated with the Green Tree Merger.
The results of operations for Conseco and Green Tree, separately and
combined, were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Revenues:
Conseco............................................................... $5,568.4 $3,067.3 $2,855.3
Green Tree............................................................ 1,091.5 724.1 711.3
Less elimination of intercompany revenues............................. (3.5) (1.6) (5.4)
-------- -------- --------
Combined............................................................ $6,656.4 $3,789.8 $3,561.2
======== ======== ========
Net income:
Conseco............................................................... $567.3 $252.4 $220.4
Green Tree............................................................ 301.4 200.8 254.0
Less elimination of intercompany net income........................... (2.3) (1.0) (3.5)
------ ------ ------
Combined............................................................ $866.4 $452.2 $470.9
====== ====== ======
</TABLE>
Washington National Corporation
On December 5, 1997, we completed the WNIC Merger. In the merger, each
share of WNIC common stock was converted into the right to receive $33.25 in
cash. We paid $400.6 million in cash, of which $73.7 million was funded through
a dividend to Conseco from WNIC. The remaining purchase price was funded with
amounts borrowed under our bank credit facilities.
We accounted for the WNIC Merger under the purchase method of accounting
effective December 1, 1997. Under this method, we allocated the cost to acquire
WNIC to the assets and liabilities acquired based on fair values as of the date
of the WNIC Merger, and reported the excess of the total purchase cost over the
fair value of the assets acquired less the fair value of the liabilities assumed
as goodwill.
59
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
Colonial Penn
On September 30, 1997, we completed the Colonial Penn Purchase from
Leucadia National Corporation ("Leucadia") for $460.0 million in cash and notes
payable. The Colonial Penn Purchase was funded with: (i) $60.0 million in cash
which was borrowed under our bank credit facility; and (ii) notes payable to
Leucadia (the "Leucadia Notes") totaling $400.0 million.
The Colonial Penn Purchase was accounted for under the purchase method of
accounting effective September 30, 1997. Under this method, we allocated the
cost to acquire Colonial Penn to the assets and liabilities acquired based on
fair values as of the date of the Colonial Penn Purchase, and reported the
excess of the total purchase cost over the fair value of the assets acquired
less the fair value of the liabilities assumed as goodwill.
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 9.0 million shares of common stock (including .6 million common
equivalent shares issued in exchange for PFS's outstanding options) with a value
of $354.1 million. We also assumed PFS's convertible subordinated notes, which
are convertible into 3.1 million shares of Conseco common stock, with a value of
$130.6 million (of which $86.3 million, representing the principal amount
outstanding, was classified as notes payable and $44.3 million, representing the
additional value attributable to the conversion feature, was classified as other
liabilities). In addition, we assumed a $21.3 million note payable of PFS, which
we repaid on the merger date.
The PFS Merger was accounted for under the purchase method of accounting
effective April 1, 1997. Under this method, we allocated the cost to acquire PFS
to the assets and liabilities acquired based on fair values as of the date of
the PFS Merger, and reported the excess of the total purchase cost over the fair
value of the assets acquired less the fair value of the liabilities assumed as
goodwill. The PFS Merger did not qualify to be accounted for under the pooling
of interests method in accordance with APB No. 16 because an affiliate of PFS
sold a portion of his holdings of PFS common stock after the PFS Merger was
announced.
Capitol American Financial Corporation
On March 4, 1997, we completed the CAF Merger. Each outstanding share of
CAF common stock was exchanged for $30.75 in cash plus 0.1647 of a share of
Conseco common stock. We paid $552.8 million (including acquisition expenses of
$14.2 million) in cash and issued 3.0 million shares of common stock (including
.1 million common equivalent shares issued in exchange for CAF's outstanding
options) with a value of $117.4 million. In addition, we assumed a $31.0 million
note payable of CAF, which we repaid on the merger date.
The CAF Merger was accounted for under the purchase method of accounting
effective January 1, 1997. Under this method, we allocated the cost to acquire
CAF to the assets and liabilities acquired based on fair values as of the date
of the CAF Merger, and reported the excess of the total purchase cost over the
fair value of the assets acquired less the fair value of the liabilities assumed
as goodwill.
Transport Holdings Inc.
On December 23, 1996, we completed the THI Merger. Each outstanding share
of THI common stock was exchanged for 2.8 shares of Conseco common stock. We
issued 4.9 million shares of common stock (including .4 million common
equivalent shares issued in exchange for THI's outstanding options and warrants)
with a value of $121.7 million. In addition, pursuant to an exchange offer, all
of THI's convertible notes were exchanged for 4.2 million shares of Conseco
common stock with a value of $106.2 million plus a cash premium of $11.9
million.
The THI Merger was accounted for under the purchase method of accounting
effective December 31, 1996. Under this method, we allocated the cost to acquire
THI to the assets and liabilities acquired based on fair values as of the date
of the THI Merger. There was no goodwill acquired with the THI Merger. The THI
Merger did not qualify to be accounted for under the pooling of interests method
in accordance with APB No. 16 because THI was a subsidiary of another
corporation within two years of the transaction.
60
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
American Travellers Corporation
On December 17, 1996, we completed the ATC Merger. Each outstanding share
of ATC common stock was exchanged for 1.1672 shares of Conseco common stock. We
issued 21.0 million shares of common stock (including .9 million common
equivalent shares issued in exchange for ATC's outstanding options) with a value
of $630.9 million. We also assumed ATC's convertible subordinated debentures,
which are convertible into 7.9 million shares of Conseco common stock with a
value of $248.3 million (of which $102.8 million, representing the principal
amount outstanding, was classified as notes payable and $145.5 million,
representing the additional value attributable to the conversion feature, was
classified as other liabilities).
The ATC Merger was accounted for under the purchase method of accounting
effective December 31, 1996. Under this method, we allocated the cost to acquire
ATC to the assets and liabilities acquired based on fair values as of the date
of the ATC Merger, and reported the excess of the total purchase cost over the
fair value of the assets acquired less the fair value of the liabilities assumed
as goodwill. The ATC Merger did not qualify to be accounted for under the
pooling of interests method in accordance with APB No. 16 because an affiliate
of ATC sold a portion of the Conseco common stock received in the ATC Merger
shortly after the consummation of the ATC Merger.
FINOVA Acquisition I, Inc.
On December 1, 1996, we completed the purchase of the net assets of
FINOVA, consisting primarily of leases and loans to manufacturers and dealers
and their customers. We paid $620.6 million in cash for such assets.
We accounted for the FINOVA Purchase under the purchase method of
accounting effective December 1, 1996. Under this method, we allocated the cost
to acquire the net assets based on fair values as of the date of the FINOVA
Purchase and reported the excess of the total purchase cost over the fair value
of the net assets acquired as goodwill.
Life Partners Group, Inc.
Effective July 1, 1996, we completed the LPG Merger. Each of the issued
and outstanding shares of LPG common stock was converted into 1.1666 shares of
Conseco common stock. We issued 32.6 million shares of common stock (including
.4 million common equivalent shares issued in exchange for LPG's outstanding
options) with a value of $586.8 million. In connection with the LPG Merger, we
also assumed notes payable of $253.1 million.
The LPG Merger was accounted for under the purchase method of accounting.
Under this method, we allocated the cost to acquire LPG to the assets and
liabilities acquired based on their fair values as of July 1, 1996, and recorded
the excess of the total purchase cost over the fair value of the liabilities we
assumed as goodwill. The LPG Merger did not qualify to be accounted for under
the pooling of interest method in accordance with Accounting Principles Board
Opinion No. 16, Business Combinations ("APB No. 16"), because of Conseco's
significant common stock repurchases.
American Life Holdings, Inc.
At January 1, 1995, we owned 27 percent of ALH through our direct
investment and through our investment in Partnership II. On November 30, 1995,
ALH issued 2,142,857 shares of its common stock for $30.0 million (including
$13.2 million paid by Conseco and its subsidiaries) in a private placement
transaction. Eighty percent of the shares were purchased by Partnership II and
the remainder were purchased by the other holders of ALH common stock. The
proceeds from the sale were used to reduce the amount of ALH's outstanding debt.
In accordance with the Partnership II agreement, Conseco earned fees of $.2
million (net of taxes of $.1 million) for services in connection with such
transaction. On September 30, 1996, we repurchased all of the common shares of
ALH we did not already own for $166.0 million in cash in the ALH Stock Purchase.
The Partnership II agreement provided that an additional ownership interest
in ALH would be allocated to Conseco if returns to the limited partners were in
excess of prescribed targets. Upon termination of Partnership II, such targets
were exceeded and the additional ownership interest allocated to Conseco was
recognized as follows: (i) $10.2 million, which represents Conseco's increased
ownership interest in the previously reported net income of Partnership II, was
recorded as a reduction of amounts that would otherwise be charged to the
minority interest; and (ii) $16.6 million was recorded as net investment gains.
Such income of Conseco was offset by $16.2 million of expenses incurred in
connection with the realization of the investment gains.
61
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
Bankers Life Holding Corporation
At January 1, 1995, we owned 58 percent of the common stock of BLH, which
was acquired in various transactions beginning in 1992. During 1995, we acquired
12.8 million shares of BLH common stock for $262.4 million in open market and
negotiated transactions, increasing our ownership of BLH to 85 percent. Income
tax expense was reduced by $66.5 million in the second quarter of 1995 as a
result of the release of deferred income taxes previously accrued on income
related to BLH. Such deferred tax was no longer required since we were permitted
to file a consolidated tax return with BLH. In addition, BLH repurchased 2.2
million shares of its common stock during 1995 at a cost of $42.1 million,
increasing our ownership interest in BLH to 88 percent as of December 31, 1995.
During the first three months of 1996, BLH repurchased 1.3 million shares of its
common stock at a cost of $27.7 million. As a result of such repurchases,
Conseco's ownership interest in BLH increased to 90.5 percent.
On December 31, 1996, we completed the BLH Merger. Each outstanding share
of BLH common stock not already owned by Conseco was exchanged for 0.7966 of a
share of Conseco common stock. We issued 3.9 million shares of common stock
(including .1 million common equivalent shares in exchange for BLH's outstanding
options) with a value of $123.0 million.
CCP Insurance, Inc.
At January 1, 1995, we owned 45 percent of the common stock of CCP, which
was acquired through several separate transactions beginning in 1990. In early
1995, CCP repurchased an additional 2.2 million shares under this program
increasing our ownership interest to 49 percent.
In August 1995, we completed the purchase of all of the shares of common
stock of CCP that we did not previously own. A total of 11.8 million shares were
purchased for $281.8 million (including transaction costs and the cost to settle
outstanding stock options of CCP) in a transaction pursuant to which CCP was
merged with Conseco, with Conseco being the surviving corporation. Income tax
expense was reduced by $8.4 million in the third quarter of 1995 as a result of
the release of deferred income taxes previously accrued on income related to
CCP. Such deferred tax is no longer required because the CCP Merger was
completed without incurring additional tax. We funded the CCP Merger with
available cash and borrowings from our credit facility.
Effect of Merger Transactions on Consolidated Financial Statements
We used purchase accounting to account for all our acquisitions during
1997, 1996 and 1995 and the pooling of interest method to account for the Green
Tree Merger. We allocated the total purchase cost of acquisitions completed in
1997 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 (within one year of the acquisition date). We
don't expect any adjustment to be material, however.
The following unaudited pro forma results of operations of the Company are
presented as if the following had occurred as of January 1, 1995: (i) the LPG
Merger; (ii) the call for redemption of Conseco's Series D Convertible Preferred
Stock (the "Series D Call") completed on September 26, 1996; (iii) the ALH Stock
Purchase; (iv) the issuance of $600.0 million of Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts (see note 8); (v) the ATC
Merger; (vi) the THI Merger; (vii) the BLH Merger; (viii) the CCP Merger; (ix)
the increase of Conseco's ownership in BLH to 90.4 percent, as a result of
purchases of BLH common shares in 1995 and 1996; (x) the issuance of 4.37
million shares of Preferred Redeemable Increased Dividend Equity Securities, 7%
PRIDES Convertible Preferred Stock ("PRIDES") in January 1996; (xi) the BLH
tender offer for and repurchase of its 13 percent senior subordinated notes due
2002 and related financing transactions completed in March 1996; and (xii) the
debt
62
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
restructuring of ALH in the fourth quarter of 1995. The pro forma data are not
necessarily indicative of the results of Conseco's operations had these
transactions occurred on January 1, 1995, nor the results of future operations.
We have not presented pro forma data for the 1997 acquisitions because, in
accordance with the disclosure requirements of the Securities and Exchange
Commission, such acquisitions are not significant individually or in the
aggregate.
<TABLE>
<CAPTION>
1996 1995(1)
---- ----
(Dollars in millions,
except per share data)
<S> <C> <C>
Revenues...................................................................................... $4,690.3 $4,737.5
Income before extraordinary charge............................................................ 552.5 564.6
Income before extraordinary charge per common share:
Basic.................................................................................... $1.88 $1.88
Diluted.................................................................................. 1.69 1.76
<FN>
(1) We have excluded $74.9 million from pro forma income before extraordinary
charge and $.23 from income before extraordinary charge per diluted
common share. These amounts related to the release of deferred income
taxes that are no longer required to be accrued as a result of the CCP
Merger and the purchase of additional BLH common shares in 1995.
</FN>
</TABLE>
3. INVESTMENTS:
At December 31, 1997, the amortized cost and estimated fair value of
actively managed fixed maturities 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............. $ 541.4 $ 20.9 $ .1 $ 562.2
Obligations of states and political subdivisions................... 277.1 8.3 .8 284.6
Debt securities issued by foreign governments...................... 204.3 4.4 9.6 199.1
Public utility securities.......................................... 2,267.5 69.0 26.0 2,310.5
Other corporate securities......................................... 12,300.5 352.9 86.5 12,566.9
Mortgage-backed securities ........................................ 6,698.5 156.0 4.1 6,850.4
--------- ------- ------ ---------
Total actively managed fixed maturities..................... $22,289.3 $611.5 $127.1 $22,773.7
========= ====== ====== =========
</TABLE>
At December 31, 1996, the amortized cost and estimated fair value of
actively managed fixed maturities 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............. $ 509.9 $ 5.1 $ 1.2 $ 513.8
Obligations of states and political subdivisions................... 103.5 2.8 .2 106.1
Debt securities issued by foreign governments...................... 144.4 1.4 2.2 143.6
Public utility securities.......................................... 2,148.8 42.8 35.4 2,156.2
Other corporate securities......................................... 8,808.3 145.1 81.2 8,872.2
Mortgage-backed securities ........................................ 5,488.4 64.5 37.7 5,515.2
--------- ------ ------ ---------
Total actively managed fixed maturities..................... $17,203.3 $261.7 $157.9 $17,307.1
========= ====== ====== =========
</TABLE>
63
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
At December 31, 1997, the amortized cost and estimated fair value of
actively managed fixed maturities based upon the pricing source used to
determine estimated fair value were as follows:
<TABLE>
<CAPTION>
Estimated
Amortized fair
cost value
---- -----
(Dollars in millions)
<S> <C> <C>
Nationally recognized pricing services............................................................ $18,272.9 $18,703.7
Broker-dealer market makers....................................................................... 1,808.9 1,831.8
Internally developed methods (calculated based on a weighted-average
current market yield of 7.0 percent)........................................................... 2,207.5 2,238.2
---------- ----------
Total actively managed fixed maturities.................................................... $22,289.3 $22,773.7
========= =========
</TABLE>
The following table sets forth fixed maturity investments at December 31,
1997, classified by rating categories. The category assigned is the highest
rating by a nationally recognized statistical rating organization or, as to
$651.2 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 is included in the "A" rating; Class 2,
"BBB-"; Class 3, "BB-"; and Classes 4-6, "B+ and below."
<TABLE>
<CAPTION>
Percent of Percent of
Investment rating fixed maturities total investments
----------------- ---------------- -----------------
<S> <C> <C>
AAA.................................. 35% 29%
AA................................... 8 7
A.................................... 24 20
BBB+................................. 8 7
BBB.................................. 11 9
BBB- ................................ 7 6
--- ---
Investment grade................. 93 78
--- ---
BB+.................................. 2 2
BB................................... 1 1
BB-.................................. 1 1
B+ and below......................... 3 2
--- ---
Below-investment grade........... 7 6
--- ---
Total fixed maturities........ 100% 84%
=== ==
</TABLE>
The following table sets forth below-investment-grade fixed maturity
investments as of December 31, 1997, summarized by the amount their amortized
cost exceeds fair value:
<TABLE>
<CAPTION>
Estimated
Amortized fair
cost value
---- -----
(Dollars in millions)
<S> <C> <C>
Amortized cost exceeds fair value by 30% or more................................................. $ 9.5 $ 4.7
Amortized cost exceeds fair value by 15%, but less than 30%...................................... 141.3 110.0
Amortized cost exceeds fair value by 5%, but less than 15%....................................... 158.7 142.3
All others....................................................................................... 1,215.6 1,239.2
-------- --------
Total below-investment-grade fixed maturity investments................................ $1,525.1 $1,496.2
======== ========
</TABLE>
64
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
The following table sets forth the amortized cost and estimated fair
value of actively managed fixed maturities at December 31, 1997, by contractual
maturity. Actual maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties and because most mortgage-backed securities provide for
periodic payments throughout their lives.
<TABLE>
<CAPTION>
Estimated
Amortized fair
cost value
---- -----
(Dollars in millions)
<S> <C> <C>
Due in one year or less......................................................................... $ 238.9 $ 239.8
Due after one year through five years........................................................... 2,243.1 2,264.7
Due after five years through ten years.......................................................... 5,481.4 5,539.5
Due after ten years............................................................................. 7,627.4 7,879.3
--------- ---------
Subtotal................................................................................... 15,590.8 15,923.3
Mortgage-backed securities...................................................................... 6,698.5 6,850.4
--------- ---------
Total actively managed fixed maturities ................................................ $22,289.3 $22,773.7
========= =========
</TABLE>
Equity securities consisted of the following:
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
----------------- -----------------
Estimated Estimated
fair fair
Cost value Cost value
---- ----- ---- -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Preferred stock, non-redeemable.......................................... $149.3 $152.5 $64.7 $66.3
Common stock............................................................. 78.3 76.4 32.9 33.4
------ ------ ----- -----
Total equity securities........................................... $227.6 $228.9 $97.6 $99.7
====== ====== ===== =====
</TABLE>
Net investment income consisted of the following:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Assets held by insurance subsidiaries:
Fixed maturities................................................................. $1,467.5 $1,109.5 $ 988.6
Equity securities................................................................ 23.6 6.5 2.8
Mortgage loans................................................................... 39.5 42.6 43.3
Credit-tenant loans.............................................................. 44.5 28.8 19.7
Policy loans..................................................................... 38.6 25.9 19.4
Equity-indexed products.......................................................... 39.4 - -
Other invested assets............................................................ 74.8 27.8 17.5
Short-term investments........................................................... 39.6 15.6 26.4
Separate accounts................................................................ 70.3 48.4 28.8
--------- -------- --------
Gross investment income....................................................... 1,837.8 1,305.1 1,146.5
Investment expenses.................................................................. 12.5 2.6 3.9
--------- -------- --------
Net investment income on assets held by insurance subsidiaries................ 1,825.3 1,302.5 1,142.6
Finance receivables.................................................................. 214.5 138.1 124.7
Interest-only securities............................................................. 130.3 77.2 51.3
-------- -------- --------
Net investment income...................................................... $2,170.1 $1,517.8 $1,318.6
======== ======== ========
</TABLE>
65
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
The carrying value of fixed maturity investments and mortgage loans not
accruing investment income totaled $3.1 million, $2.1 million and $1.5 million
at December 31, 1997, 1996 and 1995, respectively.
The proceeds from sales of fixed maturity investments were $18.1 billion
in 1997, $8.2 billion in 1996, and $7.9 billion in 1995.
Investment gains (losses), net of investment gain expenses, were included
in revenue as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Fixed maturities:
Gross gains......................................................................... $342.6 $126.8 $270.8
Gross losses........................................................................ (41.4) (52.5) (17.5)
Other than temporary decline in fair value.......................................... (1.2) (.6) (21.9)
------ ------ ------
Net investment gains from fixed maturities before expenses..................... 300.0 73.7 231.4
Equity securities....................................................................... 13.2 2.6 .4
Mortgages............................................................................... (.8) (.4) (2.1)
Other than temporary decline in fair value of other invested assets..................... - (8.3) (3.0)
Other................................................................................... (1.2) 29.9 13.9
------ ------ ------
Net investment gains before expenses........................................... 311.2 97.5 240.6
Investment gain expenses................................................................ 44.7 36.7 36.5
------ ------ ------
Net investment gains........................................................... $266.5 $ 60.8 $204.1
====== ====== ======
</TABLE>
Changes in unrealized appreciation (depreciation) on investments were as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Investments carried at fair value:
Actively managed fixed maturities .................................................. $380.6 $(504.4) $981.6
Interest-only securities............................................................ 35.2 - -
Equity securities................................................................... (.8) .1 5.4
Other investments................................................................... 9.6 (2.2) (2.7)
------ ------- ------
424.6 (506.5) 984.3
Equity in unrealized appreciation of CCP's investments.................................. - - 46.2
Adjustment for effect on other balance sheet accounts:
Cost of policies purchased ......................................................... (128.4) 141.6 (269.6)
Cost of policies produced........................................................... (36.4) 45.4 (56.7)
Other............................................................................... (4.4) - -
Income taxes........................................................................ (90.5) 116.4 (246.5)
Minority interest................................................................... - 129.3 (205.3)
------ ------- ------
Change in unrealized appreciation (depreciation) of investments ............... $164.9 $ (73.8) $252.4
====== ======== ======
</TABLE>
At December 31, 1997, net appreciation of equity securities (before
income tax) was $1.3 million, consisting of $7.3 million of appreciation and
$6.0 million of depreciation.
At December 31, 1997, the amortized cost and fair value of fixed maturity
investments in default as to the payment of principal and interest totaled $2.4
million and $1.5 million, respectively. Conseco recorded writedowns of fixed
maturity investments and other invested assets of $1.2 million in 1997, $8.9
million in 1996 and $24.9 million in 1995. These writedowns were the result of
changes
66
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
in conditions that caused the Company to conclude that the decline in fair value
of the investment was other than temporary. Investment income forgone due to
defaulted securities was $.2 million in 1997, $3.8 million in 1996 and $1.6
million in 1995.
Investments in mortgage-backed securities at December 31, 1997, included
collateralized mortgage obligations ("CMOs") of $3,210.2 million and
mortgage-backed pass-through securities of $3,640.2 million. CMOs are securities
backed by pools of pass-through securities and/or mortgages that are segregated
into sections or "tranches." These securities provide for sequential retirement
of principal, rather than the pro rata share of principal return that occurs
through regular monthly principal payments on pass-through securities.
The following table sets forth the par value, amortized cost and
estimated fair value of investments in mortgage-backed securities including CMOs
at December 31, 1997, summarized by interest rates on the underlying collateral:
<TABLE>
<CAPTION>
Par Amortized Estimated
value cost fair value
----- ---- ----------
(Dollars in millions)
<S> <C> <C> <C>
Below 7 percent .................................................................... $2,025.5 $1,980.4 $2,014.7
7 percent - 8 percent............................................................... 3,568.0 3,546.5 3,638.2
8 percent - 9 percent............................................................... 712.9 716.1 730.5
9 percent and above................................................................. 445.1 455.5 467.0
-------- -------- --------
Total mortgage-backed securities................................... $6,751.5 $6,698.5 $6,850.4
======== ======== ========
</TABLE>
The amortized cost and estimated fair value of mortgage-backed securities
including CMOs at December 31, 1997, summarized by type of security were as
follows:
<TABLE>
<CAPTION>
Estimated fair value
--------------------
Percent
Amortized of fixed
Type cost Amount maturities
- ---- ---- ------ ----------
(Dollars in millions)
<S> <C> <C> <C>
Pass-throughs and sequential and targeted amortization classes................ $4,599.7 $4,697.5 21%
Planned amortization classes and accretion directed bonds..................... 1,515.9 1,547.6 7
Support classes............................................................... 36.0 36.9 -
Accrual (Z tranche) bonds..................................................... 27.9 28.8 -
Subordinated classes ......................................................... 519.0 539.6 2
-------- -------- ---
Total mortgage-backed securities............................. $6,698.5 $6,850.4 30%
======== ======== ==
</TABLE>
At December 31, 1997, approximately 73 percent of the estimated fair
value of Conseco's mortgage-backed securities was determined by nationally
recognized pricing services, 8 percent was determined by broker-dealer market
makers, and 19 percent was determined by internally developed methods. The
call-adjusted modified duration of our mortgage-backed securities was 5.2 years
at December 31, 1997.
See note 4 for a discussion on interest-only securities.
At December 31, 1997, the mortgage loan balance was primarily comprised
of commercial loans, including multifamily residential loans. Approximately 20
percent, 11 percent and 9 percent of the mortgage loan balance were on
properties located in California, Texas and Florida, respectively. No other
state comprised greater than 7 percent of the mortgage loan balance. Less than 2
percent of the mortgage loan balance was noncurrent at December 31, 1997. At
December 31, 1997, the Company had an allowance for loss on mortgage loans of
$9.0 million.
At December 31, 1997, we held $558.6 million of CTLs. CTLs are mortgage
loans for commercial properties that we make based on the underwriting
guidelines described in note 1. We classify CTLs as a separate class of
securities because they are
67
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
principally underwritten based on the creditworthiness of the tenant rather than
the value of the underlying property. As with commercial mortgages, CTLs are
additionally collateralized by liens on the underlying property.
As part of its investment strategy, the Company enters into reverse
repurchase agreements and dollar-roll transactions to increase its return on
investments and improve its liquidity. Reverse repurchase agreements involve a
sale of securities and an agreement to repurchase the same securities at a later
date at an agreed upon price. Dollar rolls are similar to reverse repurchase
agreements except that, with dollar rolls, the repurchase involves securities
that are only substantially the same as the securities sold. These transactions
are accounted for as short-term collateralized borrowings. Such borrowings
averaged approximately $719.3 million during 1997 (compared with an average of
$424.7 million during 1996) and were collateralized by investment securities
with fair values approximately equal to the loan value. The weighted average
interest rate on short-term collateralized borrowings was 5.8 percent in 1997
and 5.2 percent in 1996. The primary risk associated with short-term
collateralized borrowings is that the counterparty will be unable to perform
under the terms of the contract. The Company's exposure is limited to the excess
of the net replacement cost of the securities over the value of the short-term
investments (which was not material at December 31, 1997). The Company believes
that the counterparties to its reverse repurchase and dollar-roll agreements are
financially responsible and that the counterparty risk is minimal.
Other invested assets include: (i) trading securities of $64.8 million;
(ii) S&P 500 Call Options issued in conjunction with equity-indexed annuities
described in note 1 of $41.4 million; and (iii) certain non-traditional
investments, including investments in venture capital funds, limited
partnerships, mineral rights and promissory notes of $424.5 million. During
1996, Conseco sold its non-traditional investment in Noble Broadcast Group, Inc.
and realized a gain of $30.0 million. During 1995, Conseco sold its
non-traditional investment in Eagle Credit (a finance subsidiary of
Harley-Davidson) and realized a gain of $20.6 million.
Life insurance companies are required to maintain certain investments on
deposit with state regulatory authorities. Such assets had an aggregate carrying
value of $202.5 million at December 31, 1997.
Conseco had no investments in any single entity in excess of 10 percent
of shareholders' equity at December 31, 1997, other than investments issued or
guaranteed by the United States government or a United States government agency.
4. INVESTMENTS, FINANCE RECEIVABLES AND SERVICING RIGHTS OF FINANCE
SUBSIDIARIES
We pool and securitize substantially all of the finance receivables we
originate, retaining: (i) investments in interest-only securities that are
subordinated to the rights of other investors; (ii) servicing on the contracts;
and (iii) investment in senior securities made by our insurance subsidiaries
(classified as fixed maturity securities). In a typical securitization, we sell
finance receivables to a special purpose entity, established for the limited
purpose of purchasing the finance receivables and selling securities
representing interests in the receivables. The special purpose entity issues
interest-bearing securities that are collateralized by the underlying pool of
finance receivables. We receive the proceeds from the sale of the securities in
exchange for the finance receivables. The securities are typically sold at the
same amount as the principal balance of the receivables sold. We retain a
residual interest representing the right to receive, over the life of the pool
of finance receivables, the excess of the cash flows received on the receivables
transferred to the trust over the return paid to the holders of other interests
in the securitization and servicing fees.
We recognize a gain on the sale of finance receivables equal to the
difference between the proceeds from the sale, net of related transaction costs,
and the allocated carrying amount of the receivables sold. We allocate the
carrying amount of finance receivables between the assets sold and retained
based on their relative fair values at the date of sale. The estimated fair
value of interest-only securities and servicing rights is determined by
discounting the projected cash flows over the expected life of the finance
receivables sold using prepayment, default, loss, servicing cost and discount
rate assumptions.
On a quarterly basis, we determine the estimated fair value of our
interest-only securities based on discounted projected future cash flows using
current assumptions. Differences between the estimated fair value and carrying
value of interest-only securities considered to be temporary declines are
recognized as reductions to shareholders' equity, while differences that are
considered to be other than temporary declines in value are recognized as a
reduction to earnings. Declines in value considered to be temporary are deemed
to occur when the present value of estimated future cash flows discounted at a
risk free rate using appropriate assumptions is less than the carrying value of
the interest-only securities. When declines in value considered to be other than
temporary occur, the carrying value is reduced to estimated fair value and a
loss is recognized in the statement of operations.
68
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
We recorded losses of $190 million and $200 million during 1997 and 1996
due to other than temporary declines in the fair value of interest-only
securities resulting from adverse prepayment experience. The reported value of
interest-only securities at December 31, 1997 reflects an unrealized gain.
Activity in the interest-only securities account during 1997 is as
follows (dollars in millions):
<TABLE>
<S> <C>
Balance at January 1..................................................... $1,014.3
Transfer to servicing rights in conjunction with implementation
of SFAS 125......................................................... (30.8)
Additions resulting from securitizations during the period............ 674.7
Investment income..................................................... 130.3
Principal and interest received....................................... (270.5)
Realized loss......................................................... (190.0)
Change in unrealized appreciation..................................... 35.2
--------
Balance at December 31................................................... $1,363.2
========
</TABLE>
In 1995 and previous years, we sold a substantial portion of our
interest-only securities related to manufactured housing securitization
transactions between 1978 and 1995 in the form of securitized net interest
margin certificates. We retained a subordinated interest in the cash flow of the
interest-only securities sold. These interests are included in interest-only
securities and total $77.0 million at December 31, 1997.
Generally, interest-only securities relate to the sale of closed end
manufactured housing, home equity, home improvement, consumer and equipment
finance receivables. Interest-only securities are subject to a substantial
amount of credit loss and prepayment risk related to the receivables sold. In
connection with the valuation of interest-only securities, the Company has
provided for approximately $900.0 million of credit losses at December 31, 1997.
On a nondiscounted basis, the amount of credit losses provided for in connection
with the valuation of the interest-only securities is approximately $1.3
billion. These estimated losses, if realized, would reduce the amount of cash
flows available to the interest-only securities and are considered in the
determination of the estimated fair value of such securities.
The following summarizes assumptions used to determine the estimated fair
value of interest-only securities as of December 31, 1997.
<TABLE>
<CAPTION>
Manufactured Home equity/ Consumer/
housing home improvement equipment Total
------- ---------------- --------- -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Interest-only securities............................ $857.3 $335.1 $170.8 $1,363.2
Principal balance of sold managed finance
receivables...................................... 17,558.2 4,251.6 2,467.5 24,277.3
Weighted average customer interest rate on sold
managed finance receivables...................... 10.49% 11.82% 11.33%
Expected weighted average constant prepayment
rate as a percentage of principal balance of
sold managed finance receivables (1)............. 9.5% 24.0% 22.0%
Expected nondiscounted credit losses as a
percentage of principal balance of sold managed
finance receivables (1).......................... 6.2% 4.3% 2.1%
- -------------------
<FN>
(1) The valuation of interest-only securities is affected not only by the
projected level of prepayments of principal and net credit losses, as shown
above, but also by the projected timing of such prepayments and net credit
losses. Should the timing of projected prepayments of principal or net
credit losses differ materially from the timing projected by the Company,
such timing could have a material effect on the valuation of the
interest-only securities.
</FN>
</TABLE>
69
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
The weighted average interest rate we use to discount expected future
cash flows of the interest-only securities is 11.47 percent at December 31,
1997.
During the years ended December 31, 1997, 1996 and 1995, we sold $10.5
billion, $7.9 billion and $4.6 billion, respectively, of closed end receivables
in various securitized transactions and recognized gains of $569.1 million,
$388.1 million and $443.3 million, respectively.
Finance receivables, summarized by type, were as follows at December 31,
1997 (dollars in millions):
<TABLE>
<S> <C>
Lease........................................................................ $ 209.3
Commercial finance........................................................... 684.6
Revolving credit card........................................................ 166.3
Loans held for sale.......................................................... 930.6
--------
1,990.8
Less allowance for doubtful accounts......................................... (19.8)
--------
Net finance receivables................................................. $1,971.0
========
</TABLE>
At January 1, 1997, we began to recognize servicing rights, as required by
SFAS 125. Servicing rights, retained subsequent to the sale of finance
receivables, are amortized in proportion to and over the estimated period of net
servicing income.
The activity in the servicing rights account during 1997 is as follows
(dollars in millions):
<TABLE>
<S> <C>
Balance at January 1, 1997................................................... $ -
Transfer from interest-only securities in conjunction with the
implementation of SFAS 125.............................................. 30.8
Additions resulting from securitizations
during the period....................................................... 80.9
Amortization.............................................................. (15.4)
-------
Balance at December 31, 1997................................................. $ 96.3
=======
</TABLE>
Servicing rights are evaluated for impairment on an ongoing basis,
stratified by product type and origination period. To the extent the recorded
amount exceeds the fair value, a valuation allowance is established through a
charge to earnings. Upon subsequent measurement of the fair value of these
servicing rights in future periods, if the fair value equals or exceeds the
carrying amount, any previously recorded valuation allowance would be deemed
unnecessary and, therefore, represent current period earnings only to the extent
of such previously recorded allowance.
Prior to the implementation of SFAS 125 on January 1, 1997, we recorded
the value of our retained interests in securitizations as "excess servicing
rights" and "allowance for losses on loans sold" on our balance sheet. Excess
servicing rights receivable represented the discounted net excess cash flows
expected to be collected over the life of the loans securitized. When we
determined the value of excess servicing rights at the time of securitization,
we established an allowance for expected losses to be realized over the life of
the loans. At December 31, 1996, the excess servicing rights receivable net of
allowance for losses (currently classified as interest-only securities)
consisted of (dollars in millions):
70
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
<TABLE>
<S> <C>
Projected residual cash flows to be received on loans sold............... $ 4,379.3
Less:
Expected prepayments.................................................. (2,221.0)
Expected servicing income............................................. (281.3)
Effect of discounting to current value................................ (505.3)
Other................................................................. (8.8)
Subordinated interests in net interest margin certifications............. 145.3
---------
1,508.2
Less allowance for losses................................................ 493.9
---------
Total net excess servicing rights................................... $ 1,014.3
=========
</TABLE>
5. INSURANCE LIABILITIES:
Insurance liabilities consisted of the following:
<TABLE>
<CAPTION>
Interest
Withdrawal Mortality rate
assumption assumption assumption 1997 1996
---------- ---------- ---------- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C> <C>
Future policy benefits:
Interest-sensitive products:
Investment contracts............................ N/A N/A (c) $12,724.0 $11,491.6
Universal life-type contracts................... N/A N/A 5% 4,633.6 3,303.9
--------- -----------
Total interest-sensitive products............. 17,357.6 14,795.5
--------- ----------
Traditional products:
Traditional life insurance contracts............ Company (a) 4% 1,925.0 1,234.7
experience
Limited-payment contracts....................... None (b) 6% 968.4 761.5
Individual accident and health ................. Company Company 6% 2,820.4 1,184.0
experience experience
Group life and health........................... N/A N/A N/A 71.0 71.3
--------- ---------
Total traditional products.................... 5,784.8 3,251.5
----------- ---------
Claims payable and other policyholder funds ........ N/A N/A N/A 1,615.5 984.9
Unearned premiums................................... N/A N/A N/A 406.1 272.4
Liabilities related to separate accounts............ N/A N/A N/A 682.8 337.6
---------- ---------
Total insurance liabilities..................... $25,846.8 $19,641.9
========= =========
- -------------
<FN>
(a) Principally modifications of the 1965 - 70 and 1975 - 80 Basic, Select
and Ultimate Tables.
(b) Principally the 1984 United States Population Table and the NAIC 1983
Individual Annuitant Mortality Table.
(c) In both 1997 and 1996: (i) approximately 95 percent of this liability
represented account balances where future benefits are not guaranteed;
and (ii) 5 percent represented the present value of guaranteed future
benefits determined using an average interest rate of approximately 5
percent.
</FN>
</TABLE>
Participating policies represented approximately 2 percent, 2 percent and
12 percent of total life insurance in force at December 31, 1997, 1996 and 1995,
respectively. Participating policies represented approximately 2 percent, 1
percent and 1 percent of premium income for the years ended December 31, 1997,
1996 and 1995, respectively. Dividends on participating policies amounted to
$13.0 million, $13.4 million and $12.3 million in 1997, 1996 and 1995,
respectively.
71
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
6. REINSURANCE:
Cost of reinsurance ceded where the reinsured policy contains mortality
risks totaled $499.0 million, $313.8 million and $72.6 million in 1997, 1996 and
1995, respectively. This cost was deducted from insurance premium revenue.
Conseco is contingently liable for claims reinsured if the assuming company is
unable to pay. Reinsurance recoveries netted against insurance policy benefits
totaled $587.5 million, $281.4 million, and $59.8 million in 1997, 1996 and
1995, respectively.
The Company has ceded certain policy liabilities under assumption
reinsurance agreements. Since all of Conseco's obligations under these insurance
contracts have been ceded to another company, insurance liabilities related to
such policies were not reported in the balance sheet. We believe the assuming
companies are able to honor all contractual commitments under the assumption
reinsurance agreements, based on our periodic reviews of financial statements,
insurance industry reports and reports filed with state insurance departments.
The Company's reinsurance receivable at December 31, 1997, relates to
approximately 181 reinsurers. Two major United States insurance companies rated
"A (Excellent)" or better by A.M. Best Company, a recognized insurance rating
agency, account for approximately 19 percent of such balance. Each of our other
reinsurers (the majority of which are rated "A- (Excellent)" or better) accounts
individually for less than 4 percent of reinsurance receivables.
7. INCOME TAXES:
Income tax liabilities were comprised of the following:
<TABLE>
<CAPTION>
1997 1996
---- ----
(Dollars in millions)
<S> <C> <C>
Deferred income tax liabilities:
Actively managed fixed maturities.............................................................$ 95.9 $ (52.2)
Interest-only securities...................................................................... 737.2 451.1
Cost of policies purchased and cost of policies produced...................................... 750.5 573.7
Insurance liabilities......................................................................... (898.9) (474.0)
Unrealized appreciation....................................................................... 98.1 21.0
Net operating loss carryforward............................................................... (393.2) (174.7)
Other......................................................................................... 157.3 130.1
-------- ----------
Deferred income tax liabilities......................................................... 546.9 475.0
Current income tax assets ........................................................................ (14.1) (13.8)
-------- ---------
Income tax liabilities.................................................................. $ 532.8 $ 461.2
======= ========
</TABLE>
Income tax expense was as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Current tax provision.........................................................................$207.9 $165.4 $165.0
Deferred tax provision........................................................................ 352.2 136.8 75.7
------ ------ ------
Income tax expense.............................................................$560.1 $302.2 $240.7
====== ====== ======
</TABLE>
Income tax expense differed from that computed at the applicable federal
statutory rate (35 percent) for the following reasons:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Tax on income before income taxes at statutory rate........................................... $520.0 $285.5 $287.9
Goodwill...................................................................................... 29.6 12.3 7.9
State taxes................................................................................... 27.0 17.0 12.6
Other......................................................................................... (16.5) (12.6) 7.2
Reversal of deferred tax liabilities as a result of increased ownership in certain
subsidiaries............................................................................... - - (74.9)
------ ------ ------
Income tax expense................................................................... $560.1 $302.2 $240.7
====== ====== ======
</TABLE>
72
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
At December 31, 1997, Conseco had federal income tax loss carryforwards
of $1,123.1 million available (subject to various statutory restrictions) for
use on future tax returns. Portions of these carryforwards begin expiring in
1999. Of the loss carryforwards: (i) $25.3 million may be used only to offset
income from the non-life insurance companies and, under certain circumstances, a
portion of the income of life insurance companies; and (ii) $463.5 million are
attributable to acquired companies and may be used only to offset the income
from those companies. None of the carryforwards are available to reduce the tax
provision for financial reporting purposes. With respect to determining that the
Company's net operating loss carryforwards will be fully utilized, the Company
is relying upon its past history of earnings.
The IRS has completed its examination of Conseco's consolidated tax
returns for years through 1994 and is currently conducting an examination for
years 1995 through 1996. Certain companies acquired in the LPG Merger have been
audited by the IRS through 1994. Colonial Penn Life Insurance Company is
currently being examined for the tax years 1992 and 1993. Conseco believes the
adjustment, if any, related to these audits will not be significant.
8. NOTES PAYABLE AND COMMERCIAL PAPER:
Notes payable and commercial paper related to corporate activities at
December 31, 1997 and 1996, were as follows:
<TABLE>
<CAPTION>
Interest rate 1997 1996
------------- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Bank debt............................................................ 6.23% (1) $1,000.0 (2) $ 465.0
Leucadia Notes....................................................... 6.44% (1) 400.0 -
Senior notes due 2003................................................ 8.125% 168.5 170.0
Senior notes due 2004................................................ 10.5% 184.9 200.0
Subordinated notes due 2004.......................................... 11.25% 10.9 98.1
Convertible subordinated notes due 2003.............................. 6.5% 86.1 -
Convertible subordinated debentures due 2005......................... 6.5% 29.1 102.8
Commercial paper..................................................... 5.8% (3) 448.2 -
Other................................................................Various 21.3 45.2
-------- --------
Total principal amount.......................................... 2,349.0 1,081.1
Unamortized net premium.............................................. 5.9 13.8
-------- --------
Total........................................................... $2,354.9 $1,094.9
======== ========
- --------------------
<FN>
(1) Current rate at December 31, 1997.
(2) See note 15 for description of $248.0 million repayment in 1998 using proceeds from the offering of 6.4 percent notes due
February 10, 2003.
(3) Weighted average rate during 1997.
</FN>
</TABLE>
Maturities of notes payable and commercial paper at December 31, 1997,
were as follows:
<TABLE>
<CAPTION>
Maturity date Amount
------------- ------
(Dollars in millions)
<S> <C>
1998....................................................................... $1,049.3 (1)
1999....................................................................... 1.1
2000....................................................................... 1.1
2001....................................................................... 401.1
2002....................................................................... 2.0
Thereafter................................................................. 894.4
--------
Total par value at December 31, 1997.................................. $2,349.0
========
<FN>
(1) See note 15 for description of $248.0 million repayment in 1998 using proceeds from the offering of 6.4 percent notes due
February 10, 2003.
</FN>
</TABLE>
73
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
Bank debt. Bank debt is comprised of our revolving bank credit facility
and various bank loans described below.
The Company's current revolving credit agreement (the "Credit Facility"),
executed in November 1996, permits borrowings up to $1.4 billion. Maximum
permitted borrowings under the Credit Facility are reduced by any aggregate
outstanding commercial paper of Conseco. At December 31, 1997, outstanding
borrowings under the Credit Facility totaled $400.0 million. Borrowings bear
interest at the bank's base rate, a Eurodollar rate or a rate determined based
on a solicitation of bids from lenders. Eurodollar rates are equal to the
reserve-adjusted LIBOR rate plus a margin of .225 percent to .75 percent, based
on the credit rating of Conseco's senior notes. The current margin of .35
percent will increase by .125 percent after December 31, 1997, if Conseco's debt
to total capitalization ratio exceeds 35 percent. Borrowings at December 31,
1997, bore interest at a weighted average rate of 6.21 percent. The Credit
Facility also permits revolving Swingline loans up to $50.0 million. Such loans
are due within 7 days and bear interest at the bank's base rate or a reserve
adjusted three-month CD rate plus the Eurodollar rate margin and an assessment
rate.
Borrowings are due in November 2001. Mandatory prepayments, which reduce
the maximum permitted borrowings, are required under the Credit Facility upon
the sale or disposition of any significant assets other than in the ordinary
course of business. The Credit Facility contains various restrictive covenants
that primarily pertain to levels of indebtedness, limitations on payment of
dividends, limitations on the quality and types of investments, and capital
expenditures. Additionally, the Company must comply with several financial
covenant restrictions, including maintaining: (i) shareholders' equity and
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts in excess of $2.4 billion in 1997 and 1998 and $3.5 billion thereafter;
(ii) the interest coverage ratio in excess of 2.5:1 through December 1997
(escalating to 2.75:1 during the period January 1, 1998 through December 31,
1999; and 3.0:1 thereafter); and (iii) the debt to total capital ratio less than
.45:1. As of December 31, 1997 the Company was in compliance with all covenants
under its debt agreements.
On the last day of each quarter, we pay a commitment fee that ranges from
.08 percent to .25 percent per annum (depending on the credit rating of
Conseco's senior debt) on the average daily unused commitments during the
quarter. This fee was .125 percent per annum during 1997.
During 1997, Conseco entered into various unsecured bank loans totaling
$600 million. The proceeds from such bank loans were used: (i) to finance the
WNIC Merger; (ii) to finance a portion of the Colonial Penn Purchase; (iii) to
redeem all of the $2.16 Redeemable Cumulative Preferred Stock of a subsidiary
formerly held by minority interest; and (iv) for general corporate purposes. The
interest rates on these bank loans are based on LIBOR and averaged 6.25 percent
at December 31, 1997. These bank loans mature at various dates through September
1998.
We recognized an extraordinary loss of $12.9 million during 1996 (net of
a $7.0 million tax benefit) as a result of prepaying our prior bank credit
agreements and the bank credit agreements of BLH and ALH.
Leucadia Notes. Conseco entered into these notes in conjunction with the
Colonial Penn Purchase. The notes bear interest at the one month LIBOR rate plus
a margin of .50 percent payable semi-annually on March 31 and September 30. Such
rate was 6.44 percent at December 31, 1997. The notes mature on January 2, 2003
and may be put back to Conseco by the holder at any time after December 31,
1997, in the event that: (i) all or substantially all of Leucadia's assets are
sold; or (ii) there is an acquisition of beneficial ownership of 20 percent or
more of Leucadia's voting securities. In addition, the notes are putable (in
whole or in increments of $10 million of par value) at any time on or after
September 30, 1999, at a discount to par. The discount rate is equal to (i) 3
percent of the then outstanding principal balance during the period September
30, 1999, through September 29, 2000; (ii) 2 percent of the then outstanding
principal balance during the period September 30, 2000, through September 29,
2001; and (iii) 1 percent of the then outstanding principal balance thereafter
prior to maturity. The notes and accrued interest thereon are secured by standby
letters of credit totaling $420.0 million which Conseco may use to fund
redemption of the notes. Such letters of credit expire on September 30, 1998,
but may be extended in one-year increments through 2003. The Company pays a fee
on the letters of credit based upon the credit rating of Conseco's senior debt.
At December 31, 1997, such fee was .20 percent per annum on the $420.0 million
of outstanding letters of credit.
8.125% senior notes due 2003 were issued to the public in 1993, are
unsecured and rank pari passu with all other unsecured and unsubordinated
indebtedness of the Company. The notes are not redeemable prior to maturity. We
recognized an extraordinary charge of $.1 million during 1997 as a result of
repurchasing $1.5 million par value of these notes.
74
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
10.5% senior notes due 2004 were issued to the public by CCP in 1994, are
unsecured and rank pari passu with all other unsecured and unsubordinated
indebtedness of Conseco. The notes are not redeemable prior to maturity. We
recognized an extraordinary charge of $1.2 million (net of a $.6 million tax
benefit) during 1997 as a result of repurchasing $15.1 million par value of
these notes.
11.25% senior subordinated notes due 2004 were issued to the public by
ALH in conjunction with its acquisition by Partnership II. Such notes are
unsecured and will be subordinated in the right of payment to the prior payment
in full of all senior indebtedness. The notes are redeemable at the Company's
option, in whole or in part, at any time on or after September 15, 1999,
initially at 105.625 percent of their principal amount, plus accrued interest,
declining to 100 percent of their principal amount, plus accrued interest, on
and after September 15, 2001. We recognized an extraordinary charge of $5.6
million (net of a $3.0 million tax benefit) during 1997 as a result of
repurchasing $87.2 million par value of these notes. We recognized an
extraordinary charge of $4.2 million (net of a $2.3 million tax benefit) during
1996 as a result of repurchasing $51.9 million par value of these notes.
6.5% convertible subordinated notes due 2003 were acquired in conjunction
with the PFS Merger and bear interest at 6.5 percent payable semi-annually on
April 1 and October 1. The notes are redeemable by Conseco, under certain
conditions, at 103.3 percent of par value after April 1999 under certain
conditions. The notes are convertible into Conseco common stock any time prior
to maturity at a conversion rate of 35.38 Conseco common shares per $1,000
principal amount of notes. During 1997, $.2 million par value of the notes were
converted into 6,613 shares of Conseco common stock. At December 31, 1997, the
value of the remaining debentures in excess of the principal balance (the value
attributable to the conversion feature) of $34.4 million is included in other
liabilities.
6.5% convertible subordinated debentures due 2005 were acquired in
conjunction with the ATC Merger and are convertible into Conseco common stock at
any time prior to maturity, at a conversion ratio of 76.96 shares of Conseco
common stock for each $1,000 principal amount of debentures. The convertible
debentures may be redeemed at Conseco's option at a price equal to 103.25
percent after October 1998, declining to 100 percent after October 2001. During
1997, we induced the conversion of $64.8 million par value of the debentures
into 5.0 million shares of Conseco common stock. Conseco paid $4.4 million to
induce the holders to convert. In addition, during 1997, Conseco repurchased
$7.5 million par value of the debentures for $24.8 million. An additional $1.4
million par value of the debentures was converted into .1 million shares of
Conseco common stock at the option of the holders during 1997. At December 31,
1997, the value of the remaining debentures in excess of the principal balance
(the value attributable to the conversion feature) of $38.2 million is included
in other liabilities.
Other debt. During the third quarter of 1997, we repurchased or called
for redemption the remaining $23.2 million par value of 12.75 percent senior
subordinated notes due 2002. Such notes had been assumed in connection with the
LPG Merger.
In March 1996, BLH completed a tender offer in which it repurchased
$148.3 million principal balance of its senior subordinated notes. In addition,
Conseco repurchased $28.5 million of such notes during 1996. Conseco recognized
an extraordinary charge of $9.0 million (net of a $4.9 million tax benefit)
related to such repurchases.
In conjunction with the LPG Merger and the THI Merger, Conseco repaid
acquired debt in 1996 of $214.5 million and $78.5 million, respectively. Conseco
also repurchased other debt of $65.8 million during 1996. Conseco recognized an
extraordinary charge of $.4 million (net of $.2 million tax benefit) related to
such repurchases.
Conseco recognized extraordinary charges of $2.1 million (net of a $1.5
million tax benefit) in 1995 related to the repayment of notes payable.
Commercial paper. We instituted a commercial paper program in April 1997
to lower our borrowing costs and improve our liquidity. Borrowings under our
commercial paper program averaged approximately $525.9 million during the period
April 24, 1997 through December 31, 1997. The weighted average interest rate on
such borrowings was 5.8 percent during 1997. Conseco's commercial paper has
maturities ranging from 2 to 37 days. However, the Company has the ability to
refinance such obligations through its bank credit facility.
75
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
Notes payable related to consumer and commercial financing activities of
our subsidiary, Green Tree, were as follows:
<TABLE>
<CAPTION>
December 31,
------------------
Interest rate 1997 1996
------------- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Commercial paper..................................................... 6.08% $1,319.1 $431.2
Medium term notes.................................................... 6.62 246.6 26.7
Senior subordinated notes............................................ 10.80 263.7 263.7
Unsecured lines of credit............................................ 5.80 35.0 39.0
Other................................................................ 2.00 1.9 1.9
-------- ------
Total............................................................. $1,866.3 $762.5
======== ======
</TABLE>
Commercial paper. At December 31, 1997, Green Tree had a commercial paper
program through which it was authorized to issue up to $2.0 billion in notes of
varying terms to meet its warehousing liquidity needs. This program was backed
by a combination of Green Tree's bank credit agreements and master repurchase
agreements. During the fourth quarter of 1997 and the first quarter of 1998,
Green Tree's senior unsecured debt ratings were lowered by each of the credit
rating agencies which provide ratings on its debt. As a result of these ratings
actions, Green Tree curtailed its issuance of commercial paper in favor of its
master repurchase agreements and bank credit lines.
Medium term notes. The medium term notes are senior notes with either
fixed or floating rates of interest and with maturities in excess of nine
months. Interest on these notes is payable semi-annually.
Senior subordinated notes. The senior subordinated notes are due June 1,
2002. Interest on the notes is payable semi-annually.
Unsecured lines of credit. At December 31, 1997, Green Tree had two lines
of credit totaling $1.5 billion, one of which expired April 28, 1998, and
another which expires April 28, 2000. Green Tree had total borrowings of $35.0
million outstanding under the lines at December 31, 1997. The lines contained
various restrictive covenants such as maintenance of a minimum net worth by
Green Tree of $750 million and a debt to net worth ratio of less than 5 to 1.
The lines were substantially restructured in early 1998 and were subsequently
paid off.
Green Tree also had various master repurchase agreements in place with
several investment banking firms which could provide up to $2.8 billion in
borrowings subject to the availability of eligible collateral. There were no
outstanding balances due under these facilities at December 31, 1997 and 1996.
Subsequent to year end, Green Tree amended several of its master
repurchase agreements to provide for financing a broader range of receivables,
which increased the total potential lines to $3.8 billion. In addition, Green
Tree entered into a $500 million line of credit secured by interest-only
securities. Such line matures on February 12, 2000, with an option to extend for
an additional one year term.
76
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
9. OTHER DISCLOSURES:
Leases
The Company rents office space, equipment and computer software under
noncancellable operating leases. Rental expense was $48.2 million in 1997, $30.0
million in 1996 and $26.9 million in 1995. Future required minimum rental
payments as of December 31, 1997, were as follows (dollars in millions):
<TABLE>
<S> <C>
1998....................................... $ 34.7
1999....................................... 30.6
2000....................................... 26.3
2001....................................... 22.1
2002....................................... 17.9
Thereafter................................. 55.5
------
Total.................... $187.1
======
</TABLE>
Employment Arrangements
Some officers of the Company are employed under long-term employment
agreements. One of these agreements provides for a base salary plus an annual
bonus equal to 3 percent of the Company's consolidated defined pretax profits.
This contract was modified to permit a reduction in such bonus amount for 1997.
This agreement renews annually for a five-year period unless either party
notifies the other, in which case the agreement expires five years from the last
renewal date. In addition, a $1.9 million interest-free loan has been granted to
the officer. Repayment is due two years after termination of the officer's
employment contract.
The agreements described above also include provisions under which the
employees may elect to receive, in the event of a termination of the agreement
following a change in control of the Company (as defined), a severance allowance
equal to 60 months' salary, bonus and other benefits. The employee also may
elect to have the Company purchase all Conseco stock and all options to purchase
Conseco stock, without deduction of the applicable exercise prices, held by such
person at a price per share equal to the highest market price in the preceding
six months.
Green Tree had a key executive stock bonus plan pursuant to which shares
were issued based on Green Tree's earnings and the market price of a share of
Green Tree common stock at the date of the employment agreement (such price
being equivalent to $2.72 per share of Conseco common stock). Total equivalent
shares of Conseco common stock issued under the plan during 1997, 1996 and 1995
were 2.2 million, 1.8 million and 1.2 million, respectively. In January 1998,
the executive returned .7 million equivalent shares of Conseco common stock in
connection with Green Tree's recomputation of the bonus amount for 1996.
The Company has qualified defined contribution plans in which
substantially all employees are eligible to participate. Company contributions,
which match certain voluntary employee contributions to the plan, totaled $3.8
million in 1997, $2.0 million in 1996, and $2.2 million in 1995. These
contributions may be made either in cash or in Conseco common stock.
The Company also has a stock bonus and deferred compensation program for
certain officers and directors. Company contributions vary based on the
profitability of the Company. Each year's contribution, which is fully funded in
the form of Conseco common stock, vests five years later or upon certain other
events. The cost of the program is charged to expense over the vesting period
and amounted to $14.4 million in 1997 ($10.3 million of which is a nonrecurring
charge due to the death of an executive officer), $3.9 million in 1996 and $3.7
million in 1995. The market value of Conseco common stock held under the program
(included in other assets and other liabilities) was $158.0 million and $101.7
million at December 31, 1997 and 1996, respectively.
The Company has a noncontributory, unfunded deferred compensation plan
for qualifying members of Bankers Life's career agency force. Benefits are based
on years of service and career earnings. The liability recognized in the
consolidated balance sheet for the agents' deferred compensation plan was $37.3
million and $34.5 million at December 31, 1997 and 1996, respectively.
Substantially all of this liability represents vested benefits. Costs incurred
on this plan, primarily representing interest on unfunded benefit costs, were
$3.4 million, $3.2 million and $2.8 million during 1997, 1996 and 1995,
respectively.
77
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
The Company also provides certain health care and life insurance benefits
for eligible retired employees of certain subsidiaries under partially funded
and unfunded plans in existence at the date on which such subsidiaries were
acquired. Benefits under the plans are provided on a contributory basis. Some of
the benefits provided are subject to cost-sharing features determined at the
discretion of management. Amounts related to these postretirement benefit plans
(which increased in 1997 as a result of acquisitions) are as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
(Dollars in millions)
<S> <C> <C>
Accumulated postretirement benefit obligations:
Retirees, dependents and disabled participants.................... $23.1 $1.9
Fully eligible active plan participants........................... 2.1 4.6
Other active participants......................................... .5 .6
----- ----
Total accumulated postretirement benefit obligations............ 25.7 7.1
Unrecognized net reduction in prior service cost.................... 1.6 2.8
Fair value of assets held for partially funded plan................. (5.9) -
----- ----
Accrued liability included in other liabilities................. $21.4 $9.9
===== ====
</TABLE>
The weighted average rate used in determining the accumulated
postretirement benefit obligations under the plans was 7.25 percent. The
weighted average after-tax expected rate of return on plan assets was 4.60
percent. The health care cost trend rate in 1997 was 11.1 percent for pre-age 65
and 9.3 percent for post-age 65 participants, graded evenly to 5.0 percent in 13
years. Increasing the trend rate by 1 percent would increase the accumulated
postretirement benefit obligation by $1.5 million at December 31, 1997 (for
plans without employer's maximum cost sharing provisions).
Green Tree has a qualified noncontributory defined benefit pension plan
covering substantially all of its employees over 21 years of age. The plan's
benefits are based on years of service and the employee's compensation. The plan
is funded annually based on the maximum amount that can be deducted for federal
income tax purposes. The assets of the plan are primarily invested in common
stock, corporate bonds and cash equivalents. In addition, Green Tree maintains a
nonqualified pension plan for certain key employees. Amounts related to the
Green Tree plans are as follows:
<TABLE>
<CAPTION>
1997 1996
---------------------------- ---------------------------
Qualified Supplemental Qualified Supplemental
Plan Plan Plan Plan
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Vested benefit obligation.......................... $ 7.8 $17.1 $ 6.9 $13.0
===== ===== ===== =====
Accumulated benefit obligation..................... $11.1 $17.1 $ 8.3 $13.2
===== ===== ===== =====
Projected benefit obligation....................... $21.8 $51.1 $17.0 $22.8
Fair value of assets held for partially funded plan (9.1) - (7.1) -
----- ----- ----- -----
Excess of projected benefit obligation
over plan assets............................ 12.7 51.1 9.9 22.8
Unrecognized net loss.............................. (7.7) (35.4) (7.1) (13.4)
Prior service cost................................. .3 - .4 -
Unrecognized net obligation (asset)................ - (.2) .1 (.3)
----- ----- ----- -----
Accrued liability included in other liabilities $ 5.3 $15.5 $ 3.3 $ 9.1
===== ===== ===== =====
</TABLE>
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Net periodic pension cost:
Service cost............................................. $ 4.9 $3.1 $1.1
Interest cost on projected benefit obligation............ 3.9 1.9 .6
Actual return on plan assets............................. (1.3) (.8) (.8)
Net amortization and deferral............................ 2.5 1.1 .4
----- ---- ----
Net periodic pension cost.............................. $10.0 $5.3 $1.3
===== ==== ====
</TABLE>
The preretirement discount rate, postretirement discount rate and rate of
increase in future compensation levels used for determining obligations as of
December 31, 1997 were 6.75 percent, 6.5 percent and 5.5 percent, respectively,
and for determining expense at December 31, 1996 were 7.25 percent, 6.5 percent
and 5.5 percent, respectively. Preretirement mortality table and
78
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
postretirement mortality tables were used for determining expense and
obligations at December 31, 1997. The wage base under Social Security was
assumed to increase at 4.5 percent per year starting in 1997. The maximum
benefit and compensation contained in Sections 415(b) and 401(a)(17) of the IRS
Code are assumed to increase by 4.0 percent per year in the future. Total
pension expense for the Green Tree plans in 1997, 1996 and 1995 was $14.1
million, $5.3 million and $3.1 million, respectively.
Green Tree also has a 401(k) Retirement Savings Plan available to all
eligible employees. To be eligible for the plan, the employee must be at least
21 years of age and have completed six months of employment at Green Tree during
which the employee worked at least 1,000 hours. Eligible employees may
contribute to the plan up to 15 percent of their earnings with a maximum of
$9,500 for 1997 based on the Internal Revenue Service annual contribution limit.
The Company will match 50 percent of the employee contributions for an amount up
to 6 percent of each employee's earnings. Contributions are invested at the
direction of the employee to one or more funds. Company contributions vest after
three years. Company contributions to the Green Tree plan were $2.5 million,
$1.3 million and $.9 million in 1997, 1996 and 1995, respectively.
Litigation
Green Tree has been served with various related lawsuits which were filed
against Green Tree in United States District Court for the District of
Minnesota. These lawsuits were filed by certain former stockholders of Green
Tree as purported class actions on behalf of persons or entities who purchased
common stock of Green Tree during the alleged class periods that generally run
from February 1995 to January 1998. One such action did not include class action
claims. In addition to Green Tree, certain current and former officers and
directors of Green Tree are named as defendants in one or more of the lawsuits.
Green Tree and other defendants intend to seek consolidation in the United
States District Court for the District of Minnesota of each of the lawsuits
seeking class action status. Plaintiffs in the lawsuits assert claims under
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. In each case,
plaintiffs allege that Green Tree and the other defendants violated federal
securities laws by, among other things, making false and misleading statements
about the current state and future prospects of Green Tree (particularly with
respect to prepayment assumptions and performance of certain of Green Tree's
loan portfolios) which allegedly rendered Green Tree's financial statements
false and misleading. The Company believes that the lawsuits are without merit
and intends to defend such lawsuits vigorously.
The Company and its subsidiaries are involved in lawsuits related to
their operations. In most cases, such lawsuits involve claims under insurance
policies or other contracts of the Company.
None of the lawsuits currently pending, either individually or in the
aggregate, is expected to have a material effect on the Company's consolidated
financial condition, cash flows or results of operations.
Guaranty Fund Assessments
From time to time, mandatory assessments are levied on the Company's
insurance subsidiaries by life and health guaranty associations of most states
in which these subsidiaries are licensed. These assessments are to cover losses
to policyholders of insolvent or rehabilitated insurance companies. The
associations levy assessments (up to prescribed limits) on all insurers in a
particular state in order to pay claims on the basis of the proportionate share
of premiums written by insurers in the lines of business in which the insolvent
or rehabilitated insurer is engaged. These assessments may be deferred or
forgiven in certain states if they would threaten an insurer's financial
strength and, in some states, these assessments can be partially recovered
through a reduction in future premium taxes. The balance sheet at December 31,
1997, includes accruals of $16.9 million, which approximate the Company's
estimate of: (i) all known assessments that will be levied against the Company's
insurance subsidiaries by various state guaranty associations based on premiums
that have been written through December 31, 1997; less (ii) amounts that would
be recoverable through a reduction in
79
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
future premium taxes as a result of such assessments. Such estimate is subject
to change as the associations determine more precisely the losses that have
occurred and how such losses will be allocated to insurance companies. The
Company's cost for such assessments incurred by its insurance company
subsidiaries was $3.7 million in 1997, $4.0 million in 1996 and $3.2 million in
1995.
Minority Interest
Minority interest represents the interest of investors other than Conseco
in its subsidiaries. Minority interest at December 31, 1997, includes: (i)
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts with a carrying value of $1,383.9 million; and (ii) $.7 million interest
in the common stock of a subsidiary of ALH. Minority interest at December 31,
1996, included: (i) $600.0 million par value of Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts; (ii) $97.0 million
interest in the redeemable preferred stock of a subsidiary of ALH; and (iii) $.7
million interest in the common stock of a subsidiary of ALH.
Company-Obligated Mandatorily Redeemable Preferred Securities of
Subsidiary Trusts
Company-obligated mandatorily redeemable preferred securities of
subsidiary trusts at December 31, 1997, were as follows:
<TABLE>
<CAPTION>
Estimated
Amount Carrying fair
outstanding value value
----------- ----- -----
(Dollars in millions)
<S> <C> <C> <C>
9.16% Trust Originated Preferred Securities ("TOPrS")................. $ 275.0 $ 275.0 $ 284.6
8.70% Capital Trust Pass-through Securities ("TruPS")................. 325.0 325.0 359.2
8.796% Capital Securities............................................. 300.0 300.0 335.3
FELINE PRIDES......................................................... 500.0 483.9 512.5
--------- -------- --------
$1,400.0 $1,383.9 $1,491.6
======== ======== ========
</TABLE>
On November 19, 1996, Conseco Financing Trust I ("Trust I"), a wholly
owned subsidiary of Conseco, issued 11 million of the TOPrS at $25 per security.
Each TOPrS security pays cumulative cash distributions at the annual rate of
9.16 percent of the stated $25 liquidation amount per security, payable
quarterly. The TOPrS are fully and unconditionally guaranteed by Conseco.
Proceeds from the offering of $266.1 million (after underwriting and associated
costs) were used by the trust to purchase a subordinated debenture from Conseco.
Conseco then used the net proceeds to repay bank debt. Conseco has the right to
redeem the securities at any time, in whole or in part, on or after November 19,
2001, at the principal amount plus accrued and unpaid interest. The securities
are subordinated to all senior indebtedness of Conseco and mature on November
30, 2026. Conseco may extend the maturity date by one or more periods, but in no
event later than November 30, 2045. The terms of the TOPrS parallel the terms of
Conseco's debentures held by Trust I, which debentures account for substantially
all of the assets of Trust I.
On November 27, 1996, Conseco Financing Trust II ("Trust II"), a wholly
owned subsidiary of Conseco, issued 325,000 of the TruPS at $1,000 per security.
Each TruPS security pays cumulative cash distributions at the annual rate of
8.70 percent of the stated $1,000 liquidation amount per security, payable
semi-annually. The TruPS are fully and unconditionally guaranteed by Conseco.
Proceeds from the offering of $321.6 million (after underwriting and associated
costs) were used by the trust to purchase a subordinated debenture from Conseco.
Conseco then used the net proceeds to repay bank debt. Conseco has the right to
redeem the securities at the principal amount plus a premium equal to the
excess, if any, of the sum of the discounted present values of the remaining
scheduled payments of principal and interest over the principal amount of
securities to be redeemed. The securities are subordinated to all senior
indebtedness of Conseco and mature on November 15, 2026. The terms of the TruPS
parallel the terms of Conseco's debentures held by Trust II, which debentures
account for substantially all of the assets of Trust II.
On March 31, 1997, Conseco Financing Trust III ("Trust III"), a wholly
owned subsidiary of Conseco, issued 300,000 Capital Securities at $1,000 per
security. Each Capital Security pays cumulative cash distributions at the annual
rate of 8.796 percent of the stated $1,000 liquidation amount per security,
payable semi-annually. The Capital Securities are fully and unconditionally
guaranteed by Conseco. Proceeds from the offering of $296.7 million (after
underwriting and associated costs) were used by the trust to purchase
80
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
a subordinated debenture from Conseco. Conseco then used the net proceeds to
repay bank debt. Conseco has the right to redeem the securities at the principal
amount plus a premium equal to the excess, if any, of the sum of the discounted
present values of the remaining scheduled payments of principal and interest
over the principal amount of securities to be redeemed. The securities are
subordinated to all senior indebtedness of Conseco and mature on April 1, 2027.
The terms of the Capital Securities parallel the terms of Conseco's debentures
held by Trust III, which debentures account for substantially all of the assets
of Trust III.
On December 12, 1997, Conseco Financing Trust IV ("Trust IV"), a wholly
owned subsidiary of Conseco, issued 10,000,000 FELINE PRIDES at $50 per
security. Each FELINE PRIDES includes: (a) a stock purchase contract under which
(i) the holder will purchase a number of shares of Conseco common stock on
February 16, 2001 (ranging from .9363 and 1.1268 shares per FELINE PRIDES) under
the terms specified in the stock purchase contract; and (ii) will receive a
contract adjustment payment equal to .25 percent of the value of the security;
and (b) a beneficial ownership of a 6.75 percent trust originated preferred
security. Each holder will receive aggregate cumulative cash distributions at
the annual rate of 7 percent of the $50 stated amount per security, payable
quarterly. The applicable distribution rate on the trust originated preferred
securities that remain outstanding during the period February 16, 2001 through
February 16, 2003, will be reset so that the market value of the trust
originated preferred securities will be equal to 100.5 percent of the par value.
Conseco may limit the market rate reset to be no higher than the rate on the
2-year benchmark Treasury plus 200 basis points. The trust originated preferred
securities are fully and unconditionally guaranteed by Conseco. Proceeds from
the offering of approximately $483.7 million (after underwriting and associated
costs) were used by the trust to purchase a subordinated debenture from Conseco.
Conseco then used the net proceeds to repay bank debt and for other corporate
purposes. The trust originated preferred securities are subordinated to all
senior indebtedness of Conseco and mature on February 16, 2001. The terms of the
trust originated preferred security parallel the terms of Conseco's debentures
held by Trust IV, which debentures account for substantially all of the assets
of Trust IV.
Common Stock
At December 31, 1997 and 1996, minority interest in common stock of
Conseco's subsidiaries includes only the $.7 million interest in the common
stock of a subsidiary.
Changes in minority interest in common and preferred stock of
consolidated subsidiaries during 1997 and 1996 are summarized below:
<TABLE>
<CAPTION>
1997 1996
---- ----
(Dollars in millions)
<S> <C> <C>
Minority interest, beginning of year........................................................... $ 97.7 $403.3
Changes in investments held by minority interest:
Repurchase of mandatorily redeemable preferred stock of a subsidiary.................... (93.4) -
Mandatorily redeemable preferred stock of a subsidiary held by PFS prior to the
PFS Merger........................................................................... (2.7) -
Transactions resulting from ALH Stock Purchase, BLH Merger and related events........... - (224.9)
Equity of minority interest in the change in financial position of the
Company's subsidiaries:
Dividends............................................................................. (3.3) (10.0)
Amortization of value in excess of par of mandatorily redeemable preferred stock...... (.9) -
Net income before extraordinary charge................................................ 3.3 31.3
Extraordinary charge.................................................................. - (1.7)
Unrealized depreciation of securities ................................................ - (100.3)
------ ------
Minority interest, end of year ................................................................ $ .7 $ 97.7
====== ======
</TABLE>
During 1997, we completed the purchase of all of the mandatorily
redeemable preferred stock of a subsidiary formerly held by minority interests.
81
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
10. SHAREHOLDERS' EQUITY:
Authorized preferred stock is 20 million shares. On January 23, 1996,
Conseco completed the offering of 4.37 million shares of PRIDES. Proceeds from
the offering of $257.7 million (after underwriting and other associated costs)
were used to repay notes payable of Conseco. Each share of PRIDES pays quarterly
dividends at the annual rate of 7 percent of the $61.125 liquidation preference
per share (equivalent to an annual amount of $4.279 per share). On February 1,
2000, unless either previously redeemed by Conseco or converted at the option of
the holder, each share of PRIDES will mandatorily convert into four shares of
Conseco common stock, subject to adjustment in certain events. Shares of PRIDES
are not redeemable prior to February 1, 1999. From February 1, 1999 through
February 1, 2000, the Company may redeem any or all of the outstanding shares of
PRIDES. Upon such redemption, each holder will receive, in exchange for each
share of PRIDES, the number of shares of Conseco common stock equal to (i) the
sum of (a) $62.195, declining to $61.125; and (b) accrued and unpaid dividends
divided by (ii) the market price of Conseco common stock at such date. In no
event will a holder receive less than 3.42 shares of Conseco common stock.
During 1996, 400 shares of PRIDES were converted by holders of such shares into
1,368 shares of Conseco common stock. In 1997, the holders of 2,374,300 shares
of PRIDES converted such shares into 8.1 million shares of common stock. We paid
$13.2 million to induce these conversions. We recorded this payment in the
consolidated financial statements as a dividend paid to such holders. In
addition, during 1997, 100,050 shares of PRIDES were converted by holders of
such shares into 342,171 shares of Conseco common stock.
Conseco issued 5.75 million shares of Series D Cumulative Convertible
Preferred Stock ("Series D preferred stock") with annual dividends of $3.25 per
share and with a total stated value of $287.5 million ($50 per share) in January
1993 in a public offering. Prior to January 1, 1995, Conseco had repurchased or
the holders had converted 80,275 Series D preferred shares. In 1996, the Company
exercised its right to redeem all outstanding Series D preferred stock. A total
of 6,358 Series D shares were redeemed at $52.916 per share including $.641 per
share of accrued and unpaid dividends. Holders of the remaining 5,666,559 Series
D shares elected to convert their shares into 17,766,864 shares of Conseco
common stock.
Changes in the number of shares of common stock outstanding during the
years ended December 31, 1997, 1996 and 1995 were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Shares in thousands)
<S> <C> <C> <C>
Balance, beginning of year...................................................... 293,359 205,202 212,737
Stock options exercised..................................................... 12,825 5,990 2,010
Shares issued in conjunction with acquired companies........................ 11,264 60,560 -
Common shares converted from convertible subordinated debentures............ 5,138 4,250 -
Common shares converted from Series D preferred shares...................... - 17,767 -
Common shares converted from PRIDES......................................... 8,463 1 -
Shares issued under employee and agent benefit compensation plans........... 1,498 1,246 425
Treasury stock purchased.................................................... (22,535) (1,657) (9,970)
------- ------- -------
Balance, end of year............................................................ 310,012 293,359 205,202
======= ======= =======
</TABLE>
Dividends declared on common stock for 1997, 1996 and 1995, were $.313,
$.083 and $.046 per common share, respectively. A liability was accrued for
dividends declared but unpaid at December 31, 1997, totaling $23.5 million. Such
dividends were paid in January 1998.
The Company was authorized under its 1983 employee stock option plan to
grant options to purchase up to 48 million shares of Conseco common stock at a
price not less than its market value on the date the option was granted. The
1983 stock option plan continues to govern options granted thereunder, but
expired in all other respects in December 1993. The 1994 Stock and Incentive
Plan authorizes the granting of options to employees and directors of the
Company to purchase up to 24 million shares of Conseco common stock at a price
not less than its market value on the date the option is granted. The options
may become exercisable immediately or over a period of time. The plan also
permits granting of stock appreciation rights and certain other awards. In 1997,
the Company adopted the 1997 Non-qualified Stock Option Plan which authorizes
the granting of non-qualified options to employees of the Company to purchase
shares of Conseco common stock. The aggregate number of shares of common stock
for which options may be granted under the 1997 plan, when added to all
outstanding, unexpired options under the Company's other employee benefit
82
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
plans, shall not exceed 20 percent of the total of shares of common stock
outstanding plus the number of shares issuable upon conversion of any
outstanding convertible security on the date of grant (calculated in the manner
set forth in the 1997 plan).
Conseco implemented two option exercise programs under which its chief
executive officer and four of its executive vice presidents exercised
outstanding options to purchase 9.1 million shares of Conseco common stock under
the 1997 program (the "1997 Program") and 3.1 million shares under the 1996
program (the "1996 Program"). The options exercised would otherwise have
remained exercisable until various dates through 2006 with respect to the 1997
Program and until the years 2000 through 2002 with respect to the 1996 Program.
We implemented these programs in order to accelerate the recording of tax
benefits we derived from the exercise of the options and to better manage our
capital structure. With respect to both programs, no cash was exchanged as the
executives paid for the exercise price of the options by tendering previously
owned shares. The Company withheld shares or the executives tendered previously
held shares to cover federal and state taxes owed by the executives as a result
of the exercise transactions. The 1997 Program resulted in the following changes
to common stock and additional paid-in capital: (i) an increase for a tax
benefit of $81.9 million (net of payroll taxes incurred of $3.5 million); (ii)
an increase for the exercise price of $120.0 million; and (iii) a decrease of
$229.9 million related to shares withheld or tendered by the executives for the
exercise price and for federal and state taxes. The 1996 Program resulted in the
following changes to common stock and additional paid-in capital: (i) an
increase for a tax benefit of $15.1 million (net of payroll taxes incurred of
$.7 million); (ii) an increase for the exercise proceeds of $5.2 million; and
(iii) a decrease of $20.8 million related to shares withheld or tendered by the
executives for federal and state taxes. Net of shares withheld or tendered, the
Company issued approximately 3.3 million and 1.6 million shares of common stock
to the executives under the 1997 Program and the 1996 Program, respectively. As
an inducement to encourage the exercise of options prior to their expiration
date, we granted to the executive officers new options to purchase a total of
5.8 million shares at an average price of $39.52 per share and 1.6 million
shares at $16.22 per share (in each case equal to the market price per share on
the grant date) to replace the shares surrendered for taxes and the exercise
price in connection with the 1997 and 1996 Programs, respectively.
In 1997, 1996 and 1995, we repurchased approximately 22.5 million, 1.7
million and 10.0 million shares of our common stock for $857.0 million, $26.0
million and $146.3 million, respectively, in connection with our stock
repurchase programs and shares withheld or tendered for the exercise price of
options and for federal and state taxes. The cost of the common stock we
repurchased in connection with these programs was allocated to the shareholders'
equity accounts in 1997, 1996 and 1995 as follows: (i) $830.9 million, $3.1
million and $68.9 million, respectively, to common stock and additional paid-in
capital (such allocation was based on the average common stock and paid-in
capital balance per share) and (ii) $26.1 million, $22.9 million and $77.4
million, respectively, to retained earnings (representing the purchase price in
excess of such average).
Conseco's Director, Executive and Senior Officer Stock Purchase Plan was
implemented to encourage direct, long-term ownership of Conseco stock by Board
members, executive officers and certain senior officers. Under the program, 8
million shares of Conseco common stock have been purchased in open market or
negotiated transactions with independent parties. Purchases are financed by
personal loans to the participants from a bank. Such loans are collateralized by
the Conseco stock purchased. Conseco has guaranteed the loans, but has recourse
to the participants if we incur a loss under the guarantee. In addition, we
provide loans to the participants for interest payments under the bank loans. A
total of 39 directors and officers of Conseco participated in the plan. At
December 31, 1997, the bank loans guaranteed by us totaled $247.4 million, and
the loans provided by us for interest totaled $9.3 million. The common stock
that collateralizes the loans had a fair value of $343.5 million on December 31,
1997.
In December 1996, we granted options to selected key managers to purchase
1.1 million shares at a price of $30.41 per share (the "Key Manager Program").
These options contain lengthy vesting and non-compete requirements designed to
encourage continuity of employment with these individuals. The options will
become fully vested normally only upon both: (i) eleven years of continuous
employment; and (ii) the earlier of: (a) two years following termination of
employment during which time the individual is not in competition with the
Company; (b) the grantee reaching age 65; or (c) death or disability of the
grantee. In certain cases, the options remain exercisable throughout the
lifetime of the grantee.
83
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
We apply Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" and related interpretations in accounting for our
stock option plans. Accordingly, no compensation cost has been recognized for
such plans. Had compensation cost been determined based on the fair value at the
grant dates for awards granted after January 1, 1995, consistent with the method
of Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), the Company's pro forma net income and
pro forma earnings per share for the years ended December 31, 1997, 1996 and
1995 would have been as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------------------- ------------------------- -------------------------
As reported Pro forma As reported Pro forma As reported Pro forma
----------- --------- ----------- --------- ----------- ---------
(Dollars in millions, except per share amounts)
<S> <C> <C> <C> <C> <C> <C>
Net income........................ $866.4 $800.6 $452.2 $434.7 $470.9 $459.3
Basic earnings per share.......... 2.72 2.50 1.85 1.77 2.19 2.13
Diluted earnings per share........ 2.52 2.32 1.69 1.62 2.03 1.98
</TABLE>
The fair value of each option grant used to determine the pro forma
amounts summarized above is estimated on the date of grant using the
Black-Scholes option valuation model with the following weighted average
assumptions for 1997, 1996 and 1995:
<TABLE>
<CAPTION>
1997 Grants 1996 Grants 1995 Grants
-------------------------- ------------------------------------ ---------------
Option Option Key
Traditional exercise Traditional exercise Manager Traditional
grants program grants program Program grants
------ ------- ------ ------ ------- -----
<S> <C> <C> <C> <C> <C> <C>
Weighted average risk-free interest rates.. 6.0% 6.5% 6.1% 6.0% 6.8% 6.2%
Weighted average dividend yields........... .9% .9% .1% .1% .1% .2%
Volatility factors......................... .28 .28 .28 .28 .28 .43
Weighted average expected life............. 6 years 4 years 5 years 5 years 25 years 5 years
Weighted average fair value per share...... $13.13 $11.95 $10.17 $5.54 $24.50 $5.53
</TABLE>
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferrable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because our employee stock options have characteristics
significantly different from those of traded options, and because changes in
subjective assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not provide a reliable single
measure of the fair value of our employee stock options. Because SFAS 123 is
effective only for awards granted after January 1, 1995, the pro forma
disclosures provided above may not be representative of the effects on reported
net income for future years.
In conjunction with the CAF Merger and the PFS Merger in 1997 and the LPG
Merger, the ATC Merger, the THI Merger and the BLH Merger in 1996, outstanding
options to purchase common stock of the acquired companies were converted into
options to purchase Conseco stock. These options, which were immediately
exercisable, were for the number of shares and the price per share equal to what
holders would have been entitled to receive at the dates of the mergers had the
former options been exercised at that time and exchanged for Conseco shares in
the mergers. The fair value of these options is included in the cost to acquire
the companies (see note 2). A summary of options issued in connection with the
mergers and, together with related information, is presented below:
84
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
<TABLE>
<CAPTION>
Weighted
Total value average
at merger exercise price
Shares date per share
------ ---- ---------
(Shares in (Dollars in millions, except
thousands) per share amounts)
<S> <C> <C> <C>
Options issued in 1997 in connection with the:
CAF Merger................................................... 226 $ 3.5 $23.96
PFS Merger................................................... 1,132 22.4 19.78
----- -----
1,358 $25.9 20.48
===== =====
Options issued in 1996 in connection with the:
LPG Merger................................................... 1,133 $ 7.7 11.18
ATC Merger................................................... 2,049 26.9 16.87
THI Merger................................................... 644 6.5 14.90
BLH Merger................................................... 609 2.6 27.18
----- -----
4,435 $43.7 16.54
===== =====
</TABLE>
A summary of the Company's stock option activity and related information
for the years ended December 31, 1997, 1996 and 1995, is presented below (shares
in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
---------------------- ---------------------- ----------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Shares price Shares price Shares price
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Outstanding at the beginning of year.. 37,951 $17.98 31,221 $12.33 26,745 $10.27
Granted or assumed in connection with:
Traditional grants................. 2,394 40.37 6,368 33.73 6,880 18.06
Option exercise program............ 5,818 39.52 1,605 16.22 - -
Key Manager Program................ - - 1,100 30.41 - -
Mergers............................ 1,358 20.48 4,435 16.54 - -
------- ------ -------
Total granted................ 9,570 37.03 13,508 25.73 6,880 18.06
------- ------ ------
Exercised............................. (12,825) 13.59 (5,990) 4.82 (2,010) 4.48
Forfeited............................. (1,185) 26.94 (788) 24.10 (394) 14.12
------- ------ ------
Outstanding at the end of the year.... 33,511 24.79 37,951 18.04 31,221 12.31
======= ====== ======
Options exercisable at year-end....... 13,079 11,686 9,859
======= ====== ======
Available for future grant............ 17,206 2,933 8,399
======= ====== ======
</TABLE>
85
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
The following table summarizes information about fixed stock options
outstanding at December 31, 1997 (shares in thousands):
<TABLE>
<CAPTION>
Options outstanding Options exercisable
---------------------------------------- --------------------------
Weighted Weighted Weighted
average average average
Range of Number remaining exercise Number exercise
exercise prices outstanding life (in years) price exercisable price
- --------------- ----------- -------------- ----- ----------- -----
<S> <C> <C> <C> <C> <C>
$ 1.36 - 1.56...................... 50 .6 $ 1.51 50 $ 1.51
2.61 - 3.24...................... 797 3.2 3.21 797 3.21
4.57 - 6.72...................... 886 4.1 5.63 844 5.59
6.91 - 10.28...................... 113 2.1 8.24 113 8.24
10.47 - 15.55...................... 13,286 5.3 14.27 1,713 13.28
15.73 - 23.49...................... 958 6.5 19.15 914 19.13
23.67 - 30.41...................... 3,888 6.6 27.58 1,806 27.26
30.41 (Key Manager Program).......... 1,100 24.0 30.41 - -
30.73 - 45.84...................... 12,399 8.0 37.98 6,842 38.69
48.38 - 51.28...................... 34 9.9 48.99 - -
------ ------
33,511 13,079
====== ======
</TABLE>
In connection with the THI Merger, the outstanding warrants to purchase
shares of THI common stock were converted into warrants to purchase the same
number of shares of Conseco common stock at the same total cost that the holders
would have been entitled to receive if such warrants were exercised immediately
prior to the THI Merger. Such warrants may be exercised to buy 700,000 shares of
Conseco common stock for $13.8 million at anytime through September 29, 2005.
Accordingly, 700,000 shares of common stock are reserved for issuance under the
warrants. The value of the warrants on the THI Merger date of $3.8 million is
included in the total cost to acquire THI (see note 2).
A total of 69.0 million shares of common stock are reserved for issuance
under the previously described convertible subordinated debentures, PRIDES,
FELINE PRIDES, stock options granted and available for future grant, warrants,
and stock bonus and deferred compensation plans.
86
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
A reconciliation of income and shares used to calculate basic and diluted
earnings per share is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions and shares in thousands)
<S> <C> <C> <C>
Income:
Net income before extraordinary charge.................................. $873.3 $478.7 $473.0
Preferred stock dividends............................................... 21.9 27.4 18.4
------ ------ ------
Income before extraordinary charge applicable to common ownership
for basic earnings per share........................................ 851.4 451.3 454.6
Effect of dilutive securities:
Preferred stock dividends............................................. 8.7 27.4 18.4
------ ------ ------
Income before extraordinary charge applicable to common ownership
and assumed conversions for diluted earnings per share.............. $860.1 $478.7 $473.0
====== ====== ======
Shares:
Weighted average shares outstanding for basic earnings per share........ 311,050 230,141 206,639
Effect of dilutive securities on weighted average shares:
Stock options......................................................... 13,011 9,281 6,079
Employee stock plans.................................................. 2,268 2,172 1,768
PRIDES................................................................ 6,936 14,042 -
Convertible preferred stock........................................... - 12,049 17,787
Convertible debentures................................................ 5,457 - -
------ ------ -------
Dilutive potential common shares.................................. 27,672 37,544 25,634
------ ------ -------
Weighted average shares outstanding for diluted earnings
per share.................................................... 338,722 267,685 232,273
======= ======= =======
</TABLE>
11. OTHER OPERATING STATEMENT DATA:
Insurance policy income consisted of the following:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Traditional products:
Direct premiums collected......................................................... $5,264.4 $3,528.2 $3,173.0
Reinsurance assumed............................................................... 290.3 65.8 6.1
Reinsurance ceded................................................................. (499.0) (313.8) (72.6)
-------- -------- --------
Premiums collected, net of reinsurance...................................... 5,055.7 3,280.2 3,106.5
Change in unearned premiums....................................................... (2.2) (14.6) 6.6
Less premiums on universal life and products
without mortality and morbidity risk which are
recorded as additions to insurance liabilities ................................ 2,099.4 1,881.3 1,757.5
-------- -------- --------
Premiums on traditional products with mortality or morbidity risk,
recorded as insurance policy income...................................... 2,954.1 1,384.3 1,355.6
Fees and surrender charges on interest sensitive products............................. 456.7 269.9 109.4
-------- ------- --------
Insurance policy income..................................................... $3,410.8 $1,654.2 $1,465.0
======== ======== ========
</TABLE>
87
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
The five states with the largest shares of premiums collected in 1997
were Florida (9.4 percent), Illinois (9.0 percent), California (8.4 percent),
Texas (8.1 percent) and Michigan (5.0 percent). No other state accounted for
more than 5 percent of total collected premiums.
Other operating costs and expenses were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Commission expense.................................................................... $ 201.2 $ 72.5 $ 47.7
Other................................................................................. 805.1 561.7 468.8
-------- ------ -----
Other operating costs and expenses........................................... $1,006.3 $634.2 $516.5
======== ====== ======
</TABLE>
Conseco considers anticipated returns from the investment of policyholder
balances in determining the amortization of the cost of policies purchased and
cost of policies produced for universal life-type and investment-type contracts.
Sales of fixed maturity investments change the incidence of profits on such
policies because gains (losses) are recognized currently and, if the sale
proceeds are reinvested at the current market yields, the expected future yields
on the investment of policyholder balances are reduced (increased). Accordingly,
amortization of the cost of policies purchased was increased by $151.4 million,
$31.1 million and $106.4 million in the years ended December 31, 1997, 1996 and
1995, respectively. Amortization of the cost of policies produced was increased
by $29.8 million, $4.9 million and $20.2 million in the years ended December 31,
1997, 1996 and 1995, respectively.
The changes in the cost of policies purchased were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Balance, beginning of year............................................................ $2,015.0 $1,030.7 $1,021.6
Additional acquisition expense on acquired policies............................... 93.9 - -
Amortization related to operations:
Cash flow realized............................................................. (436.5) (285.1) (252.0)
Interest added................................................................. 174.7 127.6 133.2
Amortization related to sales of investments...................................... (151.4) (31.1) (106.4)
Amounts related to fair value adjustment
of actively managed fixed maturities........................................... (128.4) 141.6 (395.6)
Transferred to cost of policies produced related to
exchanged health policies...................................................... (16.1) (13.4) (13.5)
Amounts acquired in mergers and acquisitions...................................... 914.2 1,042.0 643.4
Nonrecurring charge............................................................... (8.8) - -
Reinsurance and other ............................................................ 9.8 2.7 -
---------- ---------- --------
Balance, end of year.................................................................. $2,466.4 $2,015.0 $1,030.7
======== ======== ========
</TABLE>
Based on current conditions and assumptions as to future events on all
policies in force, the Company expects to amortize approximately 9 percent of
the December 31, 1997, balance of cost of policies purchased in 1998, 9 percent
in 1999, 8 percent in 2000, 7 percent in 2001, and 7 percent in 2002. The
discount rates used to determine the cost of policies purchased ranged from 18
percent to 20 percent during the three-year period ended December 31, 1997. The
discount rates used to determine the amortization of the cost of policies
purchased averaged 7 percent in 1997, 10 percent in 1996, and 12 percent in
1995.
88
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
The changes in the cost of policies produced were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Balance, beginning of year............................................................ $544.3 $391.0 $300.7
Additions......................................................................... 550.7 331.5 302.9
Amortization related to operations................................................ (110.4) (72.9) (62.0)
Amortization of deferred revenue.................................................. 5.4 1.4 1.3
Amortization related to sales of investments...................................... (29.8) (4.9) (20.2)
Amounts related to fair value adjustment of
actively managed fixed maturities.............................................. (36.4) 45.4 (74.9)
Transferred from cost of policies purchased related to
exchanged health policies, net of related reserves............................. 3.5 4.0 1.6
Amounts related to BLH Merger and share repurchases............................... - (54.7) (107.5)
Amounts related to ALH Stock Purchase............................................. - (96.5) -
Amounts related to CCP Merger..................................................... - - (62.8)
Consolidation of CCP, effective January 1, 1995................................... - - 111.9
Nonrecurring charge............................................................... (12.1) - -
------ ------ ------
Balance, end of year.................................................................. $915.2 $544.3 $391.0
====== ====== ======
</TABLE>
Nonrecurring charges in 1997 include 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 premium deficiencies on our
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 seeking rate
increases. We are no longer writing new Medicare supplement business in
Massachusetts.
Nonrecurring charges in 1997 also include expenses of $9.3 million (net
of proceeds from a life insurance policy) related to the death of an executive
officer.
89
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
12. CONSOLIDATED STATEMENT OF CASH FLOWS:
The following disclosures are provided to support and/or supplement our
consolidated statement of cash flows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Impact of acquisition transactions (described in note 2) on the consolidated statement
of cash flows:
Total investments................................................................ $ 4,716.6 $ 5,643.4 $ 4,528.4
Finance receivables.............................................................. - 590.1 -
Cost of policies purchased....................................................... 914.2 1,046.4 493.7
Goodwill......................................................................... 1,133.9 1,806.4 241.6
Income taxes..................................................................... 6.4 134.9 (114.9)
Insurance liabilities............................................................ (5,193.8) (5,943.6) (4,405.8)
Notes payable.................................................................... (540.6) (448.2) (213.7)
Minority interest................................................................ - 210.4 225.4
Common stock and additional paid-in capital...................................... (471.5) (1,568.6) -
Other............................................................................ 194.5 (208.3) (168.4)
---------- --------- ---------
Net cash used.................................................................. $ 759.7 $ 1,262.9 $ 586.3
========= ========= =========
Additional non-cash items not reflected in the consolidated statement of cash
flows:
Issuance of common stock under stock option and employee benefit plans............. $ 20.2 $ 12.2 $ 4.2
Tax benefit related to the issuance of common stock under employee benefit plans... 85.2 15.9 .4
Conversion of preferred stock into common stock.................................... 151.3 283.2 -
Conversion of convertible debentures into common stock............................. 150.0 - -
Redemption of convertible subordinated debentures of a subsidiary using
segregated cash.................................................................. - - 9.2
Cash paid for:
Interest expense on debt and commercial paper...................................... 273.9 177.7 167.2
Income taxes....................................................................... 231.8 166.7 127.8
</TABLE>
At December 31, 1997 and 1996, cash of approximately $552.8 million and
$346.3 million, respectively, was held in trust for subsequent payment to
investors. In addition, cash of $247.2 million and $171.5 million, respectively,
was restricted by the pooling and servicing agreements.
13. STATUTORY INFORMATION:
Statutory accounting practices prescribed or permitted for the Company's
insurance subsidiaries by regulatory authorities differ from GAAP. The Company's
life insurance subsidiaries reported the following amounts to regulatory
agencies, after appropriate eliminations of intercompany accounts among such
subsidiaries:
<TABLE>
<CAPTION>
1997 1996
---- ----
(Dollars in millions)
<S> <C> <C>
Statutory capital and surplus.................................................................... $1,662.4 $1,170.8
Asset valuation reserve.......................................................................... 329.2 232.9
Interest maintenance reserve..................................................................... 414.9 272.6
Portion of surplus debenture carried as a liability ............................................. 99.2 98.8
-------- --------
Total...................................................................................... $2,505.7 $1,775.1
======== ========
</TABLE>
90
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
Combined statutory net income of the Company's life insurance
subsidiaries for the periods during which such subsidiaries were included in our
consolidated financial statements was $243.4 million, $215.0 million and $183.8
million in 1997, 1996 and 1995, respectively, after appropriate eliminations of
intercompany amounts among such subsidiaries, but before elimination of
intercompany amounts between such subsidiaries and non-life insurance
subsidiaries and the parent company.
The statutory capital and surplus of the insurance subsidiaries include
surplus debentures issued to the parent holding companies totaling $793.4
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.
Statutory accounting practices require the asset valuation reserve
("AVR") and the interest maintenance reserve ("IMR") be reported as liabilities.
The purpose of these reserves is to stabilize statutory surplus against
fluctuations in the market value of investments. The IMR captures all realized
investment gains and losses, net of income taxes, on debt instruments resulting
from changes in interest rates, and provides for subsequent amortization of such
amounts into statutory net income on a basis reflecting the remaining lives of
the assets sold. The AVR captures all realized and unrealized investment gains
(losses), net of income taxes, related to equity investments and to changes in
creditworthiness of debt instruments. AVR is also adjusted each year based on a
formula related to the quality and loss experience of the Company's investment
portfolio.
Included in statutory capital and surplus shown above are the following
investments in non-life insurance affiliates, all of which are eliminated in the
consolidated financial statements prepared in accordance with GAAP:
<TABLE>
<CAPTION>
1997 1996
-------------------- ---------------------
Admitted Admitted
asset asset
Cost value Cost value
---- ----- ---- -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Common stock of Conseco purchased in open market transactions
(1997 includes 39,823,149 shares and 1996
includes 39,021,822 shares)......................................... $ 99.8 $152.4 $ 89.6 $ 80.9
Notes payable of Conseco and its non-life subsidiaries................. 275.0 275.7 261.3 245.2
Common stock of ALH (463,649 shares in 1997 and 614,057
shares in 1996) .................................................... 2.4 6.3 5.8 9.8
Preferred stock of a non-life subsidiary............................... 900.0 - 900.0 -
Investment in ALH 1994 Series PIK Preferred Stock...................... 72.2 72.2 62.8 62.8
Preferred stock of American Life Holding Company....................... 6.5 6.5 6.5 6.5
</TABLE>
91
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
The following table compares the consolidated pretax income determined on a
statutory accounting basis with such income reported in accordance with GAAP:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Life insurance subsidiaries:
Pretax income as reported on a statutory accounting
basis before transfers to and from and amortization of the IMR...................... $ 606.3 $332.2 $370.4
GAAP adjustments:
Change in difference in carrying values of investments.............................. 111.7 51.9 185.9
Changes in cost of policies purchased and produced and insurance liabilities........ 256.2 70.1 (52.0)
Other adjustments, net.............................................................. (7.9) (.1) (7.7)
-------- ------ ------
GAAP pretax income of life insurance subsidiaries........................... 966.3 454.1 496.6
Non-life companies:
Interest expense:
Corporate........................................................................... (109.4) (108.1) (119.4)
Consumer and commercial finance..................................................... (160.9) (70.1) (57.3)
All other income and expense, net:
Consumer and commercial finance..................................................... 643.5 392.3 461.5
Other non-life companies............................................................ 146.2 147.6 41.3
-------- ------- ------
GAAP consolidated pretax income............................................. $1,485.7 $815.8 $822.7
======== ====== ======
</TABLE>
State insurance laws generally restrict the ability of insurance
companies to pay dividends or make other distributions. Net assets of the
Company's wholly owned life insurance subsidiaries, determined in accordance
with GAAP, aggregated approximately $7.8 billion at December 31, 1997, of which
approximately $165.1 million is available for distribution to Conseco in 1998
without the permission of state regulatory authorities.
Most states have adopted risk-based capital ("RBC") rules to evaluate the
adequacy of statutory capital and surplus in relation to investment and
insurance risks. The RBC formula is designed as an early warning tool to help
state regulators identify possible weakly capitalized companies for the purpose
of initiating regulatory action. At December 31, 1997, the average ratio of
total adjusted capital to RBC (as defined by the rules) for our principal
insurance subsidiaries was greater than twice the level at which regulatory
attention is triggered.
92
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
14. BUSINESS SEGMENT AND DISTRIBUTION CHANNELS:
Conseco conducts and manages its business through six segments,
reflecting the Company's major lines of business and target markets: (i)
consumer and commercial finance; (ii) supplemental health; (iii) annuities; (iv)
life insurance; (v) individual and group major medical insurance; and (vi)
other. Summarized data for the Company's business segments follows:
<TABLE>
<CAPTION>
Income before
Amortization income taxes,
of cost of minority
policies produced interest and
Premiums Total and cost of policies extraordinary Total
collected revenues purchased (a) charge assets
--------- -------- ------------- ------ ------
(Dollars in millions)
<S> <C> <C> <C> <C> <C>
1997
Consumer and commercial finance..........$ - $1,088.0 $ - $ 482.6 $ 4,768.4
Supplemental health...................... 1,843.7 2,160.2 194.9 371.9 7,522.5
Annuities................................ 1,689.6 1,350.5 198.9 358.3 16,535.6
Life insurance........................... 709.0 1,130.3 87.8 307.1 9,717.8
Individual and group major medical....... 744.2 775.5 16.8 40.3 896.8
Other ................................... 69.2 151.9 7.3 61.6 577.4
Corporate................................ - - - (136.1) 611.4
-------- -------- ------ -------- ---------
Total.................................. $5,055.7 $6,656.4 $505.7 $1,485.7 $40,629.9
======== ======== ====== ======== =========
1996
Consumer and commercial finance.......... $ - $ 722.5 $ - $ 322.2 $ 3,080.0
Supplemental health...................... 810.8 873.2 81.2 136.7 3,841.1
Annuities................................ 1,670.3 1,047.4 95.1 254.3 14,186.5
Life insurance........................... 403.6 642.6 41.5 124.8 6,512.4
Individual and group major medical....... 341.0 365.8 15.1 32.1 418.2
Other ................................... 54.5 138.3 7.9 58.1 170.0
Corporate ............................... - - - (112.4) 484.5
-------- -------- ------ ---------- ---------
Total.................................. $3,280.2 $3,789.8 $240.8 $ 815.8 $28,692.7
======== ======== ====== ========= =========
1995
Consumer and commercial finance.......... $ - $ 705.9 $ - $ 404.2 $ 2,212.6
Supplemental health...................... 738.8 827.2 78.3 97.1 1,759.6
Annuities................................ 1,693.9 1,135.5 169.9 316.1 12,152.8
Life insurance........................... 253.6 404.0 38.6 70.2 2,667.6
Individual and group major medical....... 353.6 361.7 13.1 35.2 269.4
Other ................................... 66.6 111.7 7.6 25.2 193.8
Corporate................................ - 15.2 - (125.3) 254.3
-------- -------- ------ --------- ---------
Total.................................. $3,106.5 $3,561.2 $307.5 $ 822.7 $19,510.1
======== ======== ====== ========= =========
<FN>
(a) Includes additional amortization related to gains on sales of investments.
</FN>
</TABLE>
93
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
15. QUARTERLY FINANCIAL DATA (UNAUDITED):
We compute earnings per common share for each quarter independently of
earnings per share for the year. The sum of the quarterly earnings per share may
not equal the earnings per share for the year because of: (i) transactions
affecting the weighted average number of shares outstanding in each quarter; and
(ii) the uneven distribution of earnings during the year.
<TABLE>
<CAPTION>
1997
----------------------------------------------
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
-------- -------- -------- --------
(Dollars in millions, except per share data)
<S> <C> <C> <C> <C>
Insurance policy income................................................... $ 670.1 $ 885.0 $ 885.8 $ 969.9
Revenues.................................................................. 1,365.2 1,676.8 1,830.1 1,784.3
Income before income taxes, minority interest
and extraordinary charge .............................................. 342.5 404.7 465.2 273.3
Net income................................................................ 202.7 238.1 271.5 154.1
Net income per common share:
Basic:
Income before extraordinary charge .................................. $.63 $.76 $.86 $.49
Extraordinary charge................................................. .01 .01 - -
---- ---- ---- ----
Net income......................................................... $.62 $.75 $.86 $.49
==== ==== ==== ====
Diluted:
Income before extraordinary charge .................................. $.58 $.70 $.80 $.45
Extraordinary charge................................................. .01 .01 - -
---- ---- ---- ----
Net income......................................................... $.57 $.69 $.80 $.45
==== ==== ==== ====
</TABLE>
<TABLE>
<CAPTION>
1996
----------------------------------------------
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
-------- -------- -------- --------
(Dollars in millions, except per share data)
<S> <C> <C> <C> <C>
Insurance policy income..................................................... $369.8 $371.6 $451.8 $461.0
Revenues.................................................................... 859.9 868.6 1,054.0 1,007.3
Income before income taxes, minority interest
and extraordinary charge ................................................ 227.2 222.9 269.4 96.3
Net income.................................................................. 112.7 125.5 163.6 50.4
Net income per common share:
Basic:
Income before extraordinary charge .................................... $.59 $.56 $.64 $.21
Extraordinary charge................................................... .08 - - .03
---- ---- ---- ----
Net income........................................................... $.51 $.56 $.64 $.18
==== ==== ==== ====
Diluted:
Income before extraordinary charge .................................... $.53 $.50 $.57 $.21
Extraordinary charge................................................... .07 - - .03
---- ---- ---- ----
Net income........................................................... $.46 $.50 $.57 $.18
==== ==== ==== ====
</TABLE>
Our quarterly results of operations are based on numerous estimates,
principally related to policy reserves, amortization of cost of policies
purchased, amortization of cost of policies produced and income taxes. We revise
all such estimates each quarter and we ultimately adjust them to year-end
amounts. When we determine revisions are necessary, we report them as part of
operations of the current quarter.
94
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
------------------------------------
16. SUBSEQUENT EVENTS (UNAUDITED):
On February 9, 1998, we completed the offering of $250.0 million of 6.4
percent Notes (the "Notes") due February 10, 2003. Proceeds from the offering of
approximately $248.0 million (after original issue discount and other associated
costs) were used to retire bank debt. Interest is paid semi-annually on February
10 and August 10 of each year. The Notes are redeemable in whole or in part at
the option of Conseco at any time, at a redemption price equal to the sum of (a)
the greater of: (i) 100 percent of the principal amount; and (ii) the sum of the
present values of the remaining scheduled payments of principal and interest
thereon from the redemption date to the maturity date, computed by discounting
such payments, in each case, to the redemption date on a semi-annual basis at
the Treasury rate (as defined in the Notes) plus 25 basis points, plus (b)
accrued and unpaid interest on the principal amount thereof to the date of
redemption. The Notes are unsecured and rank pari passu with all other unsecured
and unsubordinated obligations of Conseco.
We periodically use options and interest rate swaps to hedge interest
rate risk associated with our investments and borrowed capital. Although we had
no such agreements outstanding at December 31, 1997, we entered into four
interest rate swap agreements in March 1998. The Company entered into such
agreements to create a hedge that effectively converts a portion of its
fixed-rate borrowed capital into floating-rate instruments for the period during
which the agreements are outstanding. Such interest rate swap agreements have an
aggregate notional principal amount of $1.0 billion, mature in various years
through 2008 and have an average remaining life of 7 years. If the
counterparties of these interest rate swaps do not meet their obligations,
Conseco could have a loss. Conseco limits its exposure to such a loss by
diversifying among several counterparties believed to be financially sound and
creditworthy. At March 13, 1998, all of the counterparties were rated A or
higher by Standard & Poor's Corporation.
On March 3, 1998, we commenced a new program to repurchase up to 5
million Conseco common shares in open market or negotiated transactions. The
timing and terms of the purchases are to be determined based on market
conditions and other considerations. As of March 17, 1998, we had repurchased .5
million shares under the program for $26.4 million.
In March 1998, we repurchased $139 million par value of our 10.5 percent
senior notes due 2004 for $171 million. We will recognize an extraordinary
charge of approximately $15.6 million (net of an $8.3 million tax benefit)
related to the repurchases in the quarter ended March 31, 1998.
On July 7, 1998, we announced that we would be taking a charge of $498.0
million (net of income taxes of $190.0 million) in the quarter ended June 30,
1998, related to the Green Tree Merger. The charge is comprised of 148.0 million
of merger-related costs and non-cash charges of $350.0 million to recognize an
other-than-temporary impairment of our interest-only securities.
95
<TABLE>
<CAPTION>
Exhibit 99.2
CONSECO, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED BALANCE SHEET
(Dollars in millions)
ASSETS
March 31, December 31,
1998 1997
---- ----
(unaudited)
<S> <C> <C>
Investments:
Actively managed fixed maturities at fair value (amortized cost:
1998 - $22,616.3; 1997 - $22,289.3)...................................................... $22,968.9 $22,773.7
Interest-only securities................................................................... 1,412.3 1,363.2
Equity securities at fair value (cost: 1998 - $254.6; 1997 - $227.6)....................... 263.4 228.9
Mortgage loans............................................................................. 474.2 516.2
Credit-tenant loans........................................................................ 596.6 558.6
Policy loans............................................................................... 691.7 692.4
Other invested assets ..................................................................... 541.2 530.7
Short-term investments..................................................................... 1,073.1 1,179.1
Assets held in separate accounts........................................................... 675.2 682.8
---------- ---------
Total investments...................................................................... 28,696.6 28,525.6
Accrued investment income..................................................................... 399.9 379.3
Finance receivables........................................................................... 2,154.6 1,971.0
Servicing rights.............................................................................. 111.8 96.3
Cost of policies purchased.................................................................... 2,442.6 2,466.4
Cost of policies produced..................................................................... 1,022.5 915.2
Reinsurance receivables....................................................................... 761.8 795.8
Goodwill (net of accumulated amortization: 1998 - $196.2; 1997 - $170.9)...................... 3,660.3 3,693.4
Property and equipment (net of accumulated depreciation: 1998 - $161.8; 1997 - $153.9) ....... 297.2 284.0
Cash held in segregated accounts for investors................................................ 653.3 552.8
Cash deposits, restricted under pooling and servicing agreements.............................. 234.2 247.2
Other assets.................................................................................. 689.2 702.9
---------- ---------
Total assets........................................................................... $41,124.0 $40,629.9
========= =========
(continued on next page)
The accompanying notes are an integral part of the
consolidated financial statements.
</TABLE>
1
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED BALANCE SHEET, continued
(Dollars in millions)
LIABILITIES AND SHAREHOLDERS' EQUITY
March 31, December 31,
1998 1997
--- ----
(unaudited)
<S> <C> <C>
Liabilities:
Insurance liabilities:
Interest sensitive products.............................................................. $17,320.6 $17,357.6
Traditional products..................................................................... 5,758.0 5,784.8
Claims payable and other policyholder funds.............................................. 1,617.3 1,615.5
Unearned premiums........................................................................ 409.1 406.1
Liabilities related to separate accounts................................................. 675.2 682.8
Investor payables.......................................................................... 653.3 552.8
Other liabilities.......................................................................... 1,779.6 1,488.3
Income tax liabilities..................................................................... 590.6 532.8
Investment borrowings...................................................................... 1,196.1 1,389.5
Notes payable and commercial paper:
Corporate................................................................................ 2,435.1 2,354.9
Consumer and commercial finance.......................................................... 2,059.1 1,866.3
--------- ---------
Total liabilities.................................................................... 34,494.0 34,031.4
--------- ---------
Minority interest:
Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts..................................................................... 1,388.1 1,383.9
Common stock of subsidiary................................................................. .7 .7
Shareholders' equity:
Preferred stock............................................................................ 115.8 115.8
Common stock and additional paid-in capital (no par value, 1,000,000,000 shares
authorized, shares issued and outstanding: 1998 - 309,717,887;
1997 - 310,011,669)...................................................................... 2,621.0 2,619.8
Accumulated other comprehensive income:
Unrealized appreciation of fixed maturity securities (net of applicable deferred
income taxes: 1998 - $85.7; 1997 - $95.5)............................................. 159.0 177.2
Unrealized appreciation of interest-only securities and other investments (net of
applicable deferred income taxes: 1998 - $6.4; 1997 - $16.0).......................... 11.8 26.6
Minimum pension liability adjustment..................................................... (3.1) (3.2)
Retained earnings.......................................................................... 2,336.7 2,277.7
--------- ---------
Total shareholders' equity........................................................... 5,241.2 5,213.9
--------- ---------
Total liabilities and shareholders' equity........................................... $41,124.0 $40,629.9
========= =========
The accompanying notes are an integral part of the
consolidated financial statements.
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED STATEMENT OF OPERATIONS
(Dollars in millions)
(unaudited)
Three months ended
March 31,
-------------------
1998 1997
---- ----
<S> <C> <C>
Revenues:
Insurance policy income:
Traditional products...................................................................... $ 859.4 $ 566.2
Interest sensitive products............................................................... 130.7 103.9
Net investment income:
Assets held by insurance subsidiaries..................................................... 583.3 409.2
Finance receivables....................................................................... 56.6 42.9
Interest-only securities.................................................................. 36.3 26.8
Gain on loan securitizations................................................................ 137.2 158.1
Net investment gains........................................................................ 104.8 5.1
Fee revenue and other income................................................................ 76.5 53.0
-------- --------
Total revenues.......................................................................... 1,984.8 1,365.2
-------- --------
Benefits and expenses:
Insurance policy benefits................................................................... 680.4 455.3
Amounts added to annuity and financial product policyholder
account balances:
Interest................................................................................ 188.4 173.7
Other amounts added to variable and equity-indexed annuity products..................... 85.6 16.2
Interest expense:
Corporate................................................................................. 39.0 25.8
Finance and investment borrowings......................................................... 67.4 32.6
Amortization................................................................................ 208.4 118.0
Other operating costs and expenses.......................................................... 295.0 201.1
-------- --------
Total benefits and expenses............................................................. 1,564.2 1,022.7
-------- --------
Income before income taxes, minority interest and extraordinary charge ................. 420.6 342.5
Income tax expense............................................................................. 170.2 126.5
-------- --------
Income before minority interest and extraordinary charge ............................... 250.4 216.0
Minority interest:
Distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts........................................................... 19.4 8.7
Dividends on preferred stock of subsidiaries................................................ - 1.3
---------- --------
Income before extraordinary charge ..................................................... 231.0 206.0
Extraordinary charge on extinguishment of debt, net of taxes and minority interest............. 16.4 3.3
-------- --------
Net income.............................................................................. 214.6 202.7
Less amounts applicable to preferred stock:
Charge related to induced conversions....................................................... - 12.3
Preferred stock dividends................................................................... 2.0 2.3
-------- --------
Net income applicable to common stock................................................... $ 212.6 $ 188.1
======== ========
(continued on next page)
The accompanying notes are an integral part of the
consolidated financial statements.
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED STATEMENT OF OPERATIONS, continued
(Dollars in millions, except per share data)
(unaudited)
Three months ended
March 31,
----------------------
1998 1997
---- ----
<S> <C> <C>
Earnings per common share:
Basic:
Weighted average shares outstanding..................................................... 308,969,000 304,615,000
Net income before extraordinary charge.................................................. $.74 $.63
Extraordinary charge.................................................................... .05 .01
---- ----
Net income............................................................................ $.69 $.62
==== ====
Diluted:
Weighted average shares outstanding..................................................... 332,409,000 333,965,000
Net income before extraordinary charge.................................................. $.70 $.58
Extraordinary charge.................................................................... .05 .01
---- ----
Net income............................................................................ $.65 $.57
==== ====
The accompanying notes are an integral part of the
consolidated financial statements.
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(Dollars in millions)
(unaudited)
Common stock Accumulated other
Preferred and additional comprehensive Retained
Total stock paid-in capital income (loss) earnings
----- ----- --------------- ------------- --------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1997........................... $5,213.9 $115.8 $2,619.8 $200.6 $2,277.7
Comprehensive income, net of tax:
Net income...................................... 214.6 - - - 214.6
Change in minimum pension liability adjustment.. .1 - - .1 -
Change in unrealized appreciation of securities
(net of applicable income tax benefit
of $19.4).................................. (33.0) - - (33.0) -
--------
Total comprehensive income.................. 181.7
Issuance of shares for stock options and for agent
and employee benefit plans...................... 103.1 - 103.1 - -
Tax benefit related to issuance of shares under
stock options plans............................. 36.8 - 36.8 - -
Cost of shares acquired........................... (257.2) - (138.7) - (118.5)
Dividends on preferred stock...................... (2.0) - - - (2.0)
Dividends on common stock......................... (35.1) - - - (35.1)
-------- ------ -------- ------ ---------
Balance, March 31, 1998.............................. $5,241.2 $115.8 $2,621.0 $167.7 $2,336.7
======== ====== ======== ====== ========
Balance, December 31, 1996........................... $4,216.8 $267.1 $2,350.7 $ 36.6 $1,562.4
Comprehensive income, net of tax:
Net income...................................... 202.7 - - - 202.7
Change in unrealized appreciation of securities
(net of applicable income tax benefit
of $104.2).................................. (193.4) - - (193.4) -
--------
Total comprehensive income.................. 9.3
Conversion of preferred stock into common shares.. - (134.0) 134.0 - -
Issuance of shares in merger transactions......... 115.7 - 115.7 - -
Issuance of shares for stock options and for agent
and employee benefit plans...................... 62.9 - 62.9 - -
Tax benefit related to issuance of shares under
stock option plans.............................. .5 - .5 - -
Conversion of convertible debentures into
common shares................................... 142.1 - 142.1 - -
Cost of shares acquired........................... (36.7) - (36.7) - -
Other ............................................ (5.2) - (5.2) - -
Amounts applicable to preferred stock:
Charge related to induced conversion of
convertible preferred stock................... (12.3) - - - (12.3)
Dividends on preferred stock.................... (2.3) - - - (2.3)
Dividends on common stock......................... (16.2) - - - (16.2)
-------- ------ -------- ------ --------
Balance, March 31, 1997.............................. $4,474.6 $133.1 $2,764.0 $(156.8) $1,734.3
======== ====== ======== ======= ========
The accompanying notes are an integral part of the
consolidated financial statements.
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in millions)
(unaudited)
Three months ended
March 31,
------------------------
1998 1997
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income............................................................................... $ 214.6 $ 202.7
Adjustments to reconcile net income to net cash provided by operating activities:
Gain on sale of finance receivables.................................................... (184.2) (158.1)
Valuation adjustments of interest-only securities...................................... 47.0 -
Net increase in cash deposits.......................................................... 13.0 (4.2)
Amortization and depreciation.......................................................... 223.8 128.8
Income taxes........................................................................... 129.3 107.2
Insurance liabilities.................................................................. (128.2) (7.4)
Amounts added to annuity and financial product policyholder account balances........... 274.0 189.9
Fees charged to insurance liabilities.................................................. (116.3) (103.7)
Accrual and amortization of investment income.......................................... 36.8 28.1
Deferral of cost of policies produced.................................................. (169.6) (109.6)
Minority interest...................................................................... 29.5 13.4
Extraordinary charge on extinguishment of debt......................................... 25.2 5.1
Net investment gains................................................................... (104.8) (5.1)
Other.................................................................................. 36.1 (75.5)
--------- ---------
Net cash provided by operating activities............................................ 326.2 211.6
--------- ---------
Cash flows from investing activities:
Sales of investments..................................................................... 8,246.3 3,483.9
Maturities and redemptions............................................................... 321.3 127.8
Purchases of investments................................................................. (8,543.6) (3,592.0)
Cash received from sales of finance receivables, net of expenses......................... 2,894.1 1,798.2
Principal payments received on finance receivables....................................... 1,364.3 936.4
Finance receivables originated........................................................... (4,459.1) (2,926.4)
Purchase of mandatorily redeemable preferred stock of subsidiary......................... - (27.6)
Acquisition of Capitol American Financial Corporation, net of cash held at date of merger - (522.1)
Other.................................................................................... (35.1) (37.7)
--------- ---------
Net cash used by investing activities ............................................... (211.8) (759.5)
--------- ---------
Cash flows from financing activities:
Issuance of Company-obligated mandatorily redeemable preferred stock of subsidiary
trusts................................................................................. 3.6 296.7
Issuance of shares related to stock options and employee benefit plans ................. 57.7 10.3
Issuance of notes payable and commercial paper:
Corporate.............................................................................. 1,090.8 745.8
Consumer and commercial finance........................................................ 2,553.7 1,921.4
Payments of notes payable and commercial paper:
Corporate.............................................................................. (1,035.9) (548.7)
Consumer and commercial finance........................................................ (2,354.0) (1,659.8)
Payments to repurchase equity securities................................................. (199.6) (36.7)
Investment borrowings.................................................................... (193.4) (65.1)
Deposits to insurance liabilities........................................................ 533.1 456.8
Withdrawals from insurance liabilities................................................... (626.4) (504.9)
Charge related to induced conversion of convertible preferred stock...................... - (12.3)
Distributions on Company-obligated mandatorily redeemable preferred stock of
subsidiary trusts...................................................................... (12.8) (6.3)
Dividends paid .......................................................................... (37.2) (19.1)
---------- ---------
Net cash provided (used) by financing activities..................................... (220.4) 578.1
--------- ---------
Net increase (decrease) in short-term investments.................................... (106.0) 30.2
Short-term investments, beginning of period................................................. 1,179.1 377.4
--------- ---------
Short-term investments, end of period....................................................... $ 1,073.1 $ 407.6
========= =========
The accompanying notes are an integral part of the
consolidated financial statements.
</TABLE>
6
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
The following notes should be read in conjunction with the notes to
supplemental consolidated financial statements of Conseco, Inc. ("We", "Conseco"
or the "Company") as of December 31, 1997 and 1996 and for each of the three
years ended December 31, 1997 included as Exhibit 99.1 to Conseco's Form 8-K
dated June 30, 1998, as amended.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The unaudited consolidated financial statements 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. Results for
interim periods are not necessarily indicative of the results that may be
expected for a full year. We have reclassified certain amounts from the prior
periods to conform to the 1998 presentation.
The following summary explains the accounting policies we use to arrive at
the more significant numbers in our financial statements. We have restated all
share and per-share amounts for the two-for-one stock splits distributed
February 11, 1997. We prepare our financial statements in accordance with
generally accepted accounting principles ("GAAP"). We follow the accounting
standards established by the Financial Accounting Standards Board, the American
Institute of Certified Public Accountants and the Securities and Exchange
Commission.
Conseco, Inc. ("We," "Conseco" or the "Company" ) is a financial services
holding company. The Company's life insurance subsidiaries develop, market and
administer supplemental health insurance, annuity, individual life insurance,
individual and group major medical insurance and other insurance products. The
Company's finance subsidiaries originate, purchase, sell and service consumer
and commercial finance loans throughout the United States. Conseco's operating
strategy is to grow its business by focusing its resources on the development
and expansion of profitable products and strong distribution channels. Conseco
has supplemented such growth by acquiring companies that have profitable niche
products and strong distribution systems. Once a company is acquired, our
operating strategy has been to consolidate and streamline management and
administrative functions where appropriate, to realize superior investment
returns through active asset management, to eliminate unprofitable products and
distribution channels and to expand and develop the profitable distribution
channels and products.
In preparing financial statements in conformity with GAAP, we are required
to make estimates and assumptions that significantly affect various reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and revenues and expenses
during the reporting periods. For example, we use significant estimates and
assumptions in calculating the cost of policies produced, the cost of policies
purchased, interest-only securities, servicing rights, 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. The supplemental consolidated financial statements
have been prepared to give retroactive effect to the merger (the "Green Tree
Merger") with Green Tree Financial Corporation ("Green Tree") in a transaction
accounted for as a pooling of interests (see "Green Tree Merger"). GAAP
prohibits giving effect to a consummated business combination accounted for by
the pooling of interests method in financial statements that do not include the
date of consummation. These financial statements do not extend through the date
of consummation; however, they will become the historical consolidated financial
statements of Conseco after financial statements covering the date of
consummation of the Merger are issued. The pooling of interests method of
accounting requires the restatement of all periods presented as if Conseco and
Green Tree had always been combined. The consolidated statement of stockholders'
equity reflects the accounts of the Company as if additional shares of Conseco
common stock had been issued during all periods presented. Intercompany
transactions prior to the merger have been eliminated, and certain
reclassifications were made to Green Tree's financial statements to conform to
Conseco's presentations. No material adjustments were recorded to conform Green
Tree's accounting policies.
Our financial statements do not include the results of material
transactions between us and our consolidated affiliates, or among our
consolidated affiliates.
7
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
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" (which are
carried at estimated fair value) and "held to maturity" (which are carried at
amortized cost). We held $38.7 million of trading securities at March 31, 1998,
which are included in other invested assets. We did not classify any fixed
maturity securities in the held to maturity category at March 31, 1998.
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, to shareholders' equity. The following table summarizes the effect
of these adjustments on the related balance sheet accounts at March 31, 1998 and
December 31, 1997:
<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
------------------------------------ ----------------------------------
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............................... $22,616.3 $352.6 $22,968.9 $22,289.3 $484.4 $22,773.7
Other balance sheet items:
Cost of policies purchased............... 2,508.7 (66.1) 2,442.6 2,639.0 (172.6) 2,466.4
Cost of policies produced................ 1,062.4 (39.9) 1,022.5 949.9 (34.7) 915.2
Other.................................... - (1.9) (1.9) - (4.4) (4.4)
Income tax liabilities................... (504.9) (85.7) (590.6) (437.3) (95.5) (532.8)
------ ------
Unrealized appreciation of fixed maturity
securities, net.......................... $159.0 $177.2
====== ======
</TABLE>
GREEN TREE MERGER
On June 30, 1998, we completed the Green Tree Merger. Each outstanding
share of Green Tree common stock was exchanged for .9165 of a share of Conseco
common stock. We issued 128.7 million shares of Conseco common stock (including
5.0 million common equivalent shares issued in exchange for Green Tree's
outstanding options). The Green Tree Merger constituted a tax-free exchange and
is accounted for under the pooling of interests method. As a result of the Green
Tree Merger, a restructuring charge of $148 million (net of taxes) was recorded
in the second quarter of 1998. The restructuring charge includes investment
banking, accounting, legal and regulatory fees, severance costs and other costs
associated with the Green Tree Merger.
The results of operations for Conseco and Green Tree, separately and
combined, for periods prior to the merger were as follows:
<TABLE>
<CAPTION>
Three months ended
March 31,
------------------
1998 1997
----- ----
(Dollars in millions)
<S> <C> <C>
Revenues:
Conseco............................................................... $1,699.0 $1,099.0
Green Tree............................................................ 285.8 267.2
Less elimination of intercompany revenues............................. - (1.0)
-------- --------
Combined............................................................ $1,984.8 $1,365.2
======== ========
Net income:
Conseco............................................................... $ 151.1 $ 111.5
Green Tree............................................................ 63.5 91.8
Less elimination of intercompany net income........................... - (.6)
-------- --------
Combined............................................................ $ 214.6 $ 202.7
======== ========
</TABLE>
8
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
INVESTMENTS, FINANCE RECEIVABLES AND SERVICING RIGHTS OF FINANCE
SUBSIDIARIES
We pool and securitize substantially all of the finance receivables we
originate, retaining: (i) investments in interest-only securities that are
subordinated to the rights of other investors; (ii) servicing on the contracts;
and (iii) investment in senior securities made by our insurance subsidiaries
(classified as fixed maturity securities). In a typical securitization, we sell
finance receivables to a special purpose entity, established for the limited
purpose of purchasing the finance receivables and selling securities
representing interests in the receivables. The special purpose entity issues
interest-bearing securities that are collateralized by the underlying pool of
finance receivables. We receive the proceeds from the sale of the securities in
exchange for the finance receivables. The securities are typically sold at the
same amount as the principal balance of the receivables sold. We retain a
residual interest representing the right to receive, over the life of the pool
of finance receivables, the excess of the cash flows received on the receivables
transferred to the trust over the return paid to the holders of other interests
in the securitization and servicing fees.
We recognize a gain on the sale of finance receivables equal to the
difference between the proceeds from the sale, net of related transaction costs,
and the allocated carrying amount of the receivables sold. We allocate the
carrying amount of finance receivables between the assets sold and retained
based on their relative fair values at the date of sale. The estimated fair
value of interest-only securities and servicing rights is determined by
discounting the projected cash flows over the expected life of the finance
receivables sold using prepayment, default, loss, servicing cost and discount
rate assumptions.
On a quarterly basis, we determine the estimated fair value of our
interest-only securities based on discounted projected future cash flows using
current assumptions. Differences between the estimated fair value and carrying
value of interest-only securities considered temporary declines are recognized
as reductions to shareholders' equity, while differences that are considered
other than temporary declines in value are recognized as a reduction to
earnings. Other than temporary declines in value are deemed to occur when the
present value of estimated future cash flows discounted at a risk free rate
using appropriate assumptions is less than the carrying value of the
interest-only securities. If other than temporary impairment occurs, the
carrying value is reduced to estimated fair value and a loss is recognized in
the statement of operations.
We recorded losses of $47 million during the first quarter of 1998 due to
other than temporary declines in the fair value of interest-only securities
resulting from adverse prepayment experience. The reported values of
interest-only securities at March 31, 1998 and December 31, 1997 have been
adjusted to reflect unrealized gains (before income taxes) of $1.5 million and
$35.2 million, respectively.
Activity in the interest-only securities account during the first quarter
of 1998 is as follows (dollars in millions):
<TABLE>
<S> <C>
Balance at January 1, 1998............................................... $1,363.2
Additions resulting from securitizations during the period............ 164.3
Investment income..................................................... 33.4
Principal and interest received....................................... (67.9)
Realized loss......................................................... (47.0)
Change in unrealized appreciation..................................... (33.7)
--------
Balance at March 31, 1998................................................ $1,412.3
========
</TABLE>
In 1995 and previous years, we sold a substantial portion of our
interest-only securities related to manufactured housing securitization
transactions between 1978 and 1995 in the form of securitized net interest
margin certificates. We retained a subordinated interest in the cash flow of the
interest-only securities sold. These interests are included in interest-only
securities and total $79.4 million at March 31, 1998.
Generally, interest-only securities relate to the sale of closed end
manufactured housing, home equity, home improvement, consumer and equipment
finance receivables. Interest-only securities are subject to a substantial
amount of credit loss and prepayment risk related to the receivables sold. In
connection with the valuation of interest-only securities, the Company has
provided for approximately $946.1 million of credit losses as of March 31, 1998.
On a nondiscounted basis, the amount of credit losses provided for in connection
with the valuation of the interest-only securities is approximately $1.4
billion. These estimated losses, if realized, would reduce the amount of cash
flows available to the interest-only securities and are considered in the
determination of the estimated fair value of such securities.
9
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
The following summarizes assumptions used to determine the estimated fair
value of interest-only securities as of March 31, 1998.
<TABLE>
<CAPTION>
Manufactured Home equity/ Consumer/
housing home improvement equipment Total
------- ---------------- --------- -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Interest-only securities............................ $872.6 $396.5 $143.2 $1,412.3
Principal balance of sold managed finance
receivables...................................... 18,186.7 5,005.0 2,655.3 25,847.0
Weighted average customer interest rate on
sold managed finance receivables (1)............. 10.46% 11.85% 11.12%
Expected weighted average constant prepayment
rate as a percentage of principal balance of
sold managed finance receivables (1)............. 9.75% 25.0% 22.0%
Expected nondiscounted credit losses as a
percentage of principal balance of sold managed
financed receivables (1)......................... 6.2% 4.4% 2.0%
- -------------------
<FN>
(1) The valuation of interest-only securities is affected not only by the
projected level of prepayments of principal and net credit losses, as shown
above, but also by the projected timing of such prepayments and net credit
losses. Should the timing of projected prepayments of principal or net
credit losses differ materially from the timing projected by the Company,
such timing could have a material effect on the valuation of the
interest-only securities.
</FN>
</TABLE>
The weighted average interest rate we use to discount expected future cash
flows of the interest-only securities is 11.60 percent at March 31, 1998.
During the quarters ended March 31, 1998 and 1997, we sold $3.0 billion and
$1.8 billion, respectively, of closed end receivables in various securitized
transactions and recognized gains of $137.2 million and $158.1 million,
respectively.
Finance receivables, summarized by type, were as follows at March 31, 1998
and December 31, 1997 (dollars in millions):
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
---- ----
<S> <C> <C>
Lease........................................................................ $ 282.0 $ 209.3
Commercial finance........................................................... 634.4 684.6
Revolving credit card........................................................ 334.3 166.3
Loans held for sale.......................................................... 929.7 930.6
-------- --------
2,180.4 1,990.8
Less allowance for doubtful accounts......................................... (25.8) (19.8)
-------- --------
Net finance receivables................................................. $2,154.6 $1,971.0
======== ========
</TABLE>
Servicing rights, retained subsequent to the sale of finance receivables,
are amortized in proportion to and over the estimated period of net servicing
income.
10
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
The activity in the servicing rights account during the first quarter of
1998 is as follows (dollars in millions):
<TABLE>
<S> <C>
Balance at January 1, 1998................................................. $ 96.3
Additions resulting from securitizations
during the period..................................................... 20.5
Amortization............................................................ (5.0)
------
Balance at March 31, 1998.................................................. $111.8
======
</TABLE>
Servicing rights are evaluated for impairment on an ongoing basis,
stratified by product type and origination period. To the extent the recorded
amount exceeds the fair value, a valuation allowance is established through a
charge to earnings. Upon subsequent measurement of the fair value of these
servicing rights in future periods, if the fair value equals or exceeds the
carrying amount, any previously recorded valuation allowance would be deemed
unnecessary and, therefore, represent current period earnings only the extent of
such previously recorded allowance.
EARNINGS PER SHARE
As of December 31, 1997, we adopted Statement of Financial Accounting
Standards No. 128, "Earnings Per Share"("SFAS 128"). SFAS 128 provides new
accounting and reporting standards for earnings per share. It replaces primary
and fully diluted earnings per share with basic and diluted earnings per share.
Basic earnings per share excludes dilution and is computed by dividing income
available to common shareholders by the weighted average number of common shares
outstanding for the period. Diluted earnings per share represents the potential
dilution that could occur if all dilutive convertible securities, warrants and
stock options were exercised and converted into common stock. The diluted
earnings per share calculation assumes that the proceeds received upon the
conversion of all dilutive options and warrants are used to repurchase the
Company's common shares at the average market price of such shares during the
period. Prior period earnings per share amounts have been restated. We have also
restated all share and per-share amounts for the two-for-one stock split
distributed February 11, 1997.
11
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
A reconciliation of income and shares used to calculate basic and diluted
earnings per share is as follows:
<TABLE>
<CAPTION>
Three months ended
March 31,
------------------
1998 1997
---- ----
(Dollars in millions and
shares in thousands)
<S> <C> <C>
Income:
Net income before extraordinary charge........................................... $231.0 $206.0
Preferred stock dividends........................................................ 2.0 14.6
------ ------
Income before extraordinary charge applicable to common ownership
for basic earnings per share................................................. 229.0 191.4
Effect of dilutive securities:
Preferred stock dividends...................................................... 2.0 2.3
------ -------
Income before extraordinary charge applicable to common ownership
and assumed conversions for diluted earnings per share....................... $231.0 $193.7
====== ======
Shares:
Weighted average shares outstanding for basic earnings per share................. 308,969 304,615
Effect of dilutive securities on weighted average shares:
Stock options.................................................................. 9,591 14,863
Warrants....................................................................... 110 -
Employee stock plans........................................................... 1,970 2,079
PRIDES......................................................................... 6,482 7,447
Convertible debentures......................................................... 5,287 4,961
------- -------
Dilutive potential common shares........................................... 23,440 29,350
------- -------
Weighted average shares outstanding for diluted earnings
per share............................................................. 332,409 333,965
======= =======
</TABLE>
COMPREHENSIVE INCOME
As of December 31, 1997, we adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130
establishes standards for reporting and presentation of comprehensive income and
its components in a full set of financial statements. Comprehensive income
includes all changes in shareholders' equity (except those arising from
transactions with shareholders) and includes net income and net unrealized gains
(losses) on securities. The new standard requires only additional disclosures in
the consolidated financial statements; it does not affect our financial position
or results of operations.
The change in unrealized gains included in comprehensive income in the
first quarter of 1997 was net of $4.3 million (after an income tax benefit of
$2.2 million) of net investment losses included in net income.
BUSINESS SEGMENTS
As of January 1, 1998, we adopted Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS 131"). Under SFAS 131, companies are required to provide
disclosures about operating segments on the same basis used internally by a
company for evaluating the performance of its operations and the allocation of
its resources. The segment disclosure under SFAS 131 is not significantly
different from our prior disclosures because our prior disclosures reflected the
same operating data and results used by management in evaluating the performance
of our business.
12
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
The following table summarizes financial data by segment:
<TABLE>
<CAPTION>
Three months ended
March 31,
------------------
1998 1997
---- ----
(Dollars in millions)
<S> <C> <C>
Total revenues:
Consumer and commercial finance.................................................. $ 285.8 $ 266.2
Supplemental health.............................................................. 585.4 466.1
Annuities........................................................................ 437.5 274.5
Life insurance................................................................... 370.5 226.5
Individual and group major medical............................................... 238.3 98.7
Other............................................................................ 67.3 33.2
--------- --------
$1,984.8 $1,365.2
======== ========
Income before income taxes, minority interest and extraordinary charge:
Consumer and commercial finance.................................................. $ 102.4 $ 147.1
Supplemental health.............................................................. 138.7 82.1
Annuities........................................................................ 82.0 64.6
Life insurance................................................................... 101.0 54.3
Individual and group major medical............................................... 19.3 10.2
Other............................................................................ 20.0 14.0
Corporate........................................................................ (42.8) (29.8)
-------- --------
$ 420.6 $ 342.5
======== ========
</TABLE>
FINANCIAL INSTRUMENTS
We periodically use options and interest rate swaps to hedge interest rate
risk associated with our investments and borrowed capital. At March 31, 1998, we
held agreements to create a hedge that effectively converts a portion of our
fixed-rate borrowed capital into floating-rate instruments for the period during
which the agreements are outstanding. The difference between the interest rates
is accrued as interest rates change and recorded as an adjustment to interest
expense. During the first quarter of 1998, interest expense was reduced by $.7
million as a result of our interest rate swap agreements. Such interest rate
swap agreements have an aggregate notional principal amount of $1.0 billion,
mature in various years through 2008 and have an average remaining life of 7
years.
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 buy Standard & Poor's 500 Index
Call Options (the "S&P 500 Call Options") in an effort to hedge potential
increases to policyholder benefits resulting from increases in the S&P 500 Index
to which the product's return is linked. We include the cost of the S&P 500 Call
Options in the pricing of the equity-indexed annuity products. We reflect
changes in the values of the S&P 500 Call Options, which fluctuate in relation
to changes in policyholder account balances for these annuities, in net
investment income. Premiums paid to purchase these instruments are deferred and
amortized over their term.
During the three months ended March 31, 1998, net investment income
included $59.7 million related to changes in the value of the S&P 500 Call
Options. Such investment income was substantially offset by amounts added to
policyholder account balances for annuities and financial products. The value of
the S&P 500 Call Options was $71.8 million at March 31, 1998. We classify such
instruments as other invested assets.
If the counterparties of the aforementioned financial instruments do not
meet their obligations, Conseco may have to recognize a loss. Conseco limits its
exposure to such a loss by diversifying among several counterparties believed to
be strong and creditworthy. At March 31, 1998, all of the counterparties were
rated "A" or higher by Standard & Poor's Corporation.
13
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
REINSURANCE
Cost of reinsurance ceded where the reinsured policy contains mortality
risks totaled $133.9 million and $92.3 million in the first quarters of 1998 and
1997, respectively. This cost was deducted from insurance premium revenue.
Conseco is contingently liable for claims reinsured if the assuming company is
unable to pay. Reinsurance recoveries netted against insurance policy benefits
totaled $135.5 million and $70.8 million in the first quarters of 1998 and 1997,
respectively.
The Company has ceded certain policy liabilities under assumption
reinsurance agreements. Since all of Conseco's obligations under these insurance
contracts have been ceded to another company, insurance liabilities related to
such policies were not reported in the balance sheet. We believe the assuming
companies are able to honor all contractual commitments under the assumption
reinsurance agreements, based on our periodic reviews of financial statements,
insurance industry reports and reports filed with state insurance departments.
CHANGES IN NOTES PAYABLE AND COMMERCIAL PAPER
Notes payable and commercial paper related to the corporate activities of
the Company were as follows:
<TABLE>
<CAPTION>
March 31, December 31,
Interest rate 1998 1997
------------- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Bank debt............................................................ 5.99% (1) $ 695.0 $1,000.0
Leucadia Notes....................................................... 6.19% (1) 400.0 400.0
Notes due 2003....................................................... 6.4% 250.0 -
Senior notes due 2003................................................ 8.125% 168.5 168.5
Senior notes due 2004................................................ 10.5% 41.1 184.9
Subordinated notes due 2004.......................................... 11.25% 8.1 10.9
Convertible subordinated debentures due 2005......................... 6.5% 29.1 29.1
Convertible subordinated notes due 2003.............................. 6.5% 86.0 86.1
Commercial paper..................................................... 5.95% 741.0 448.2
Other................................................................Various 20.2 21.3
-------- --------
Total principal amount.......................................... 2,439.0 2,349.0
Unamortized net (discount) premium................................... (3.9) 5.9
------- --------
Total........................................................... $2,435.1 $2,354.9
======== ========
<FN>
(1) Current rate at March 31, 1998.
</FN>
</TABLE>
First quarter 1998 changes in notes payable
On February 9, 1998, we completed the offering of $250.0 million of 6.4
percent Notes (the "Notes") due February 10, 2003. Proceeds from the offering of
approximately $248.0 million (after original issue discount and other associated
costs) were used to retire bank debt. Interest is paid semi-annually on February
10 and August 10 of each year. The Notes are redeemable in whole or in part at
the option of Conseco at any time, at a redemption price equal to the sum of (a)
the greater of: (i) 100 percent of the principal amount; and (ii) the sum of the
present values of the remaining scheduled payments of principal and interest
thereon from the redemption date to the maturity date, computed by discounting
such payments, in each case, to the redemption date on a semi-annual basis at
the Treasury rate (as defined in the Notes) plus 25 basis points, plus (b)
accrued and unpaid interest on the principal amount thereof to the date of
redemption. The Notes are unsecured and rank pari passu with all other unsecured
and unsubordinated obligations of Conseco.
During the first quarter of 1998, we repurchased $2.8 million par value of
the 11.25 percent subordinated notes due 2004 for $3.2 million. We recognized an
extraordinary charge of $.2 million (net of a $.1 million tax benefit) as a
result of such repurchases. In addition, assets with a carrying value at March
31, 1998, of $9.6 million were segregated for the purpose of defeasing the
remaining $8.1 million par value of our 11.25 percent subordinated notes due
2004.
14
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
During the first quarter of 1998, we repurchased $143.8 million par value of
our 10.5 percent senior notes due 2004 for $176.7 million. We recognized an
extraordinary charge of $16.2 million (net of an $8.7 million tax benefit) as a
result of such repurchases.
First quarter 1997 changes in notes payable
In the first quarter of 1997, we repurchased $76.1 million par value of the
11.25 percent senior subordinated notes due 2004 for $87.7 million. We
recognized an extraordinary charge of $3.3 million (net of a $1.8 million tax
benefit) as a result of such repurchases.
During the first quarter of 1997, $61.0 million par value of convertible
subordinated debentures due 2005 were converted into 4.7 million shares of
Conseco common stock. Such convertible debentures were acquired in conjunction
with the acquisition (the "ATC Merger") of American Travellers Corporation
("ATC") in December 1996. We paid $4.2 million to induce the holders to convert
such convertible subordinated debentures. The charge recognized as a result of
the inducement payment was not significant since such amount approximated
amounts reflected in the fair value of the debentures at the ATC Merger date.
NOTES PAYABLE RELATED TO CONSUMER AND COMMERCIAL FINANCING ACTIVITIES
Notes payable related to consumer and commercial financing activities of
our subsidiary, Green Tree, were as follows:
<TABLE>
<CAPTION>
Interest March 31, December 31,
rate 1998 1997
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Bank debt................................................. 6.53% $ 690.0 $ 35.0
Credit facility secured by interest-only securities....... 7.69 492.8 -
Master repurchase agreements.............................. 6.45 315.1 -
Medium term notes......................................... 6.62 246.6 246.6
Senior subordinated notes................................. 10.80 263.8 263.7
Commercial paper.......................................... 5.84 48.9 1,319.1
Other ................................................... 2.00 1.9 1.9
-------- --------
Total................................................ $2,059.1 $1,866.3
======== ========
</TABLE>
Green Tree had unsecured lines of credit with various financial
institutions of $1.5 billion at December 31, 1997, which were substantially
restructured in the first quarter of 1998 and the balance outstanding was
reduced and a portion of the commitment was terminated in the second quarter
using contributions to Green Tree's capital from Conseco. Subsequent to the
restructuring and payments, the unsecured lines provide potential financings up
to $225.0 million and expire in April 1999.
Green Tree entered into a new credit facility in February 1998, which
provides for a $500 million line of credit secured by the Company's
interest-only securities. The line of credit matures on February 12, 2000, with
an optional one year extension. In addition, Green Tree issued warrants to
purchase 2.5 million equivalent shares of Conseco common stock at $24.8227 per
share to the provider of the facility subject to a maximum appreciation of
$16.37 per equivalent share. The warrants were exercised at the date of the
Green Tree Merger.
At March 31, 1998, Green Tree had $3.8 billion of master repurchase
agreements, subject to the availability of eligible collateral, with various
investment banking firms. The master repurchase agreements generally provide for
annual terms which are extended each quarter by mutual agreement of the parties
for an additional annual term based upon the review of updated quarterly
financial information from Green Tree.
During the fourth quarter of 1997 and the first quarter of 1998, Green
Tree's senior unsecured debt ratings were lowered by each of the credit rating
agencies which provide ratings on its debt. As a result of these actions, Green
Tree curtailed its issuance of commercial paper in favor of its master
repurchase agreements and bank credit line.
15
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
CHANGES IN PREFERRED STOCK
During the first quarter of 1997, 2,192,000 shares of Preferred Redeemable
Increased Dividend Equity Securities Convertible Preferred Stock ("PRIDES") were
converted by holders of such shares into 7.5 million shares of common stock. We
paid $12.3 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
three months of 1998 and 1997 were as follows (shares in thousands):
<TABLE>
<CAPTION>
Three months ended
March 31,
------------------
1998 1997
---- ----
<S> <C> <C>
Balance, beginning of period.............................................................. 310,012 293,359
Stock options exercised................................................................ 4,861 938
Shares issued in conjunction with merger............................................... - 2,882
Common shares converted from convertible subordinated debentures....................... - 4,728
Common shares converted from PRIDES.................................................... - 7,497
Common stock acquired under option exercise and repurchase programs.................... (5,812) (932)
Shares issued under employee benefit and compensation plans............................ 657 1,297
------- -------
Balance, end of period.................................................................... 309,718 309,769
======= =======
</TABLE>
In the first quarter of 1998, Conseco's chief executive officer and three
of its executive vice presidents exercised outstanding options to purchase
approximately 2.4 million shares of Conseco common stock under Conseco's option
exercise program. The options exercised would otherwise have remained
exercisable until 2004. The option exercise program was created in 1994 in order
to accelerate the recording of tax benefits we derive from the exercise of the
options and to better manage our capital structure. No cash was exchanged as the
executives paid for the exercise price of the options and a portion of the
federal and state taxes thereon by tendering previously owned shares. The
Company withheld shares to cover a portion of the federal and state taxes owed
by the executives as a result of the exercise transactions. The program resulted
in the following changes to common stock and additional paid-in capital: (i) an
increase for a tax benefit of $26.6 million (net of payroll taxes incurred of
$1.1 million); (ii) an increase for the exercise price of $35.2 million; and
(iii) a decrease of $72.4 million related to shares withheld or tendered by the
executives for the exercise price and for federal and state taxes. Net of shares
withheld or tendered, we issued approximately .9 million shares of common stock
to the executives under the program. As an inducement to encourage the exercise
of options prior to their expiration date, we granted to the executive officers
new options to purchase a total of 1.5 million shares at a price of $48.1875 per
share (equal to the market price per share on the grant date) to replace the
shares surrendered for taxes and the exercise price.
During the first quarter of 1998, we repurchased 3.6 million Conseco common
shares under our share repurchase programs for $161.2 million. In conjunction
with our announcement of the agreement to merge with Green Tree Financial
Corporation ("Green Tree"), we announced the termination of our current share
repurchase program to repurchase 5 million Conseco common shares (719,400 shares
of Conseco common stock were repurchased under such program prior to its
termination). In the first quarter of 1998, .7 million shares were returned to
the Company due to the recomputation of the bonus for fiscal year 1996, and the
remaining 1.5 million shares were repurchased in connection with the stock
option exercise program.
We allocated the $257.2 million cost of the 5.8 million shares we repurchased
in connection with the stock option exercise program and share repurchase
program to shareholders' equity accounts as follows: (i) $138.7 million to
common stock and additional paid-in capital (such allocation was based on the
value we received for shares issued in our recent acquisitions); and (ii) $118.5
million to retained earnings.
STOCK OPTION PLANS
As a result of the Green Tree Merger, all options previously issued by Green
Tree became immediately exercisable on June 30, 1998. In addition, on March 1,
1998, Green Tree offered to reprice certain employee stock options to the
current market price on March 1, 1998.
16
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
A summary of stock option activity and related information of the Company
(including the combined stock options of Conseco and Green Tree) for the first
three months of 1998 is presented below (shares in thousands):
<TABLE>
<CAPTION>
Number of Weighted average
shares exercise price
------- --------------
<S> <C> <C>
Outstanding at January 1, 1998............................................. 33,511 $24.78
Granted in connection with:
Traditional grants.................................................... 773 25.18
Option exercise program............................................... 1,502 48.19
Repricing program..................................................... 2,594 25.10
------
Total granted....................................................... 4,869 32.23
------
Exercised............................................................... (4,861) 19.83
Forfeited............................................................... (314) 25.79
Terminated in repricing program......................................... (2,594) 37.13
------
Outstanding at March 31, 1998.............................................. 30,611 25.69
======
</TABLE>
The following summarizes information about fixed stock options outstanding
at March 31, 1998 (shares in thousands):
<TABLE>
<CAPTION>
Options outstanding Options exercisable
----------------------------------------- ---------------------------
Weighted Weighted Weighted
average average average
Range of Number remaining exercise Number exercise
exercise prices outstanding life (in years) price exercisable price
- --------------- ----------- --------------- ----- ----------- -----
<S> <C> <C> <C> <C> <C>
$ 1.56 .................... 22 .3 $1.56 22 $1.56
3.24 - 4.86.................... 830 3.2 3.37 830 3.37
5.00 - 6.91.................... 589 3.7 5.60 547 5.53
7.77 - 11.57.................... 572 3.7 10.31 302 10.09
11.79 - 16.96.................... 9,604 4.7 14.37 1,154 13.97
17.88 - 26.19.................... 5,960 8.4 24.61 1,551 22.83
27.19 - 30.41.................... 1,623 5.9 29.45 641 28.95
30.41 (Key Manager Program)........ 1,100 24.0 30.41 - -
30.73 - 45.84.................... 8,775 7.8 38.05 5,552 38.75
48.19 - 51.28.................... 1,536 8.4 48.20 1,509 48.21
------ ------
30,611 12,108
====== ======
</TABLE>
CHANGES IN MINORITY INTEREST
Minority interest represents the interest of investors other than Conseco
in its subsidiaries. Minority interest at March 31, 1998, included: (i)
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts with a carrying value of $1,388.1 million; and (ii) $.7 million interest
in the common stock of a subsidiary.
17
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts at March 31, 1998, were as follows :
<TABLE>
<CAPTION>
Estimated
Amount Carrying fair
outstanding value value
----------- ----- -----
(Dollars in millions)
<S> <C> <C> <C>
9.16% Trust Originated Preferred Securities ("TOPrS")................. $ 275.0 $ 275.0 $ 286.7
8.70% Capital Trust Pass-through Securities ("TruPS")................. 325.0 325.0 363.1
8.796% Capital Securities............................................. 300.0 300.0 338.7
FELINE PRIDES......................................................... 503.7 488.1 607.6
-------- -------- --------
$1,403.7 $1,388.1 $1,596.1
======== ======== ========
</TABLE>
In January 1998, an additional 74,900 FELINE PRIDES were issued for a total
of $3.6 million to cover the over-allotments associated with our original
offering of such securities in December 1997.
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, 8
million shares of Conseco common stock have been purchased in 1997 and 1996 in
open market transactions with independent parties. Purchases were financed by
personal loans to the participants from a bank. Such loans are collateralized by
the Conseco common stock purchased. Conseco has guaranteed the loans, but has
recourse to the participants if we incur a loss under the guarantee. In
addition, we provide loans to the participants for interest payments under the
bank loans. A total of 39 directors and officers of Conseco participated in the
plan. At March 31, 1998, the bank loans guaranteed by us totaled $247.4 million,
and the loans provided by us for interest totaled $11.5 million. The common
stock that collateralizes the loans had a fair value of $428.1 million.
CONSOLIDATED STATEMENT OF CASH FLOWS
The following non-cash items were not reflected in the consolidated
statement of cash flows in 1998: (i) the acquisition of common stock of $57.6
million pursuant to the tender of shares for the exercise of stock options; (ii)
the issuance of common stock under stock option and employee benefit plans of
$45.4 million; and (iii) the tax benefit of $36.8 million related to the
issuance of common stock under employee benefit plans. The following non-cash
items were not reflected in the consolidated statement of cash flows in 1997:
(i) the issuance of common stock valued at $115.7 million in the CAF Merger;
(ii) the issuance of $52.6 million of common stock to employee benefit plans;
(iii) the tax benefit of $.5 million related to the issuance of common stock
under employee benefit plans; (iv) the conversion of $134.0 million of PRIDES
into 2.2 million shares of common stock; and (v) the conversion of $61.0 million
par value of convertible debentures into 4.7 million shares of common stock.
RECENTLY ISSUED ACCOUNTING STANDARDS
Statement of Financial Accounting Standards No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits" ("SFAS 132") was
issued in February 1998 and revises current disclosure requirements for
employers' pensions and other retiree benefits. SFAS 132 will have no effect on
our financial position or results of operations. SFAS 132 is effective for our
December 31, 1998 financial statements.
Statement of Position 97-3, "Accounting by Insurance and Other Enterprises
for Insurance-Related Assessments" ("SOP 97-3") was issued by the American
Institute of Certified Public Accountants in December 1997 and provides guidance
for determining when an insurance company or other enterprise should recognize a
liability for guaranty-fund assessments and guidance for measuring the
liability. The statement is effective for 1999 financial statements with early
adoption permitted. The adoption of this statement is not expected to have a
material effect on our financial position or results of operations.
18
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
Notes to Supplemental Consolidated Financial Statements
YEAR 2000 CONVERSION COSTS
We have initiated a corporate-wide program designed to ensure that all of
our computer systems will function properly in the year 2000. For some of our
operations, the most effective solution will be to ensure timely completion of
the previously planned conversions of their older systems to more modern, year
2000 - compliant systems used in other areas of the Company. In some cases, our
most effective solution will be to purchase new, more modern systems; these
costs will be capitalized as assets and amortized over their expected useful
lives. In other cases, we will modify existing systems, thereby incurring costs
that will be charged to operating expense. In the first quarter of 1998, we
incurred $5.8 million in costs related to year 2000 projects. We expect to spend
approximately an additional $39 million on these projects over the next two
years. We began to incur expenses related to this program several years ago. We
expect our year 2000 program to be completed on a timely basis.
SUBSEQUENT EVENTS
On April 1, 1998, we announced a fixed spread tender offer for our 8.125%
Senior Notes due 2003 (the "8.125% Senior Notes"). The purchase price paid for
each 8.125% Senior Note tendered was the price per $1,000 principal amount equal
to a spread of 42 basis points over the yield to maturity of the 5.5 percent
U.S. Treasury Note due February 28, 2003, at the time the holder tendered its
8.125% Senior Note plus accrued and unpaid interest, up to but excluding the
settlement date. The tender offer expired on April 21, 1998. As a result of the
tender offer, we repurchased $104.7 million principal of the 8.125% Senior Notes
for $113.8 million. Such repurchases were funded with available cash, bank
credit facilities and the issuance of commercial paper. We will recognize an
extraordinary charge of $6.8 million (net of income taxes of $3.7 million)
related to such repurchases in the second quarter of 1998.
In July 1998, we announced that we would be taking a charge of $498.0
million (net of income taxes of $190.0 million) in the quarter ended June 30,
1998 related to the Green Tree Merger. The charge is comprised of $148.0 million
of merger-related costs and non-cash charges of $350.0 million to recognize an
other-than-temporary impairment of our interest-only securities.
19
<PAGE>
EXHIBIT 99.3 - Consolidated financial statements of Green Tree
Financial Corporation as of December 31, 1997 and 1996, and
for each of the three years ended December 31, 1997
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Green Tree Financial Corporation
Saint Paul, Minnesota:
We have audited the accompanying consolidated balance sheets of Green Tree
Financial Corporation and subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the years in the three-year period ended December 31, 1997.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Green Tree Financial
Corporation and subsidiaries as of December 31, 1997 and 1996, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1997 in conformity with generally accepted accounting
principles.
As discussed in Note A to the consolidated financial statements, the Company
adopted the provisions of the Financial Accounting Standards Board's Statement
of Financial Accounting Standards No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities," in 1997.
/s/ KPMG PEAT MARWICK LLP
Minneapolis, Minnesota
January 27, 1998, except as to Note O which is as of February 13, 1998
1
<PAGE>
GREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES
-------------------------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
<TABLE>
<CAPTION>
December 31
---------------------------------------------
1997 1996
------------------- -------------------
<S> <C> <C>
ASSETS:
Cash and cash equivalents $ 741,398,000 $ 442,071,000
Cash deposits, restricted 247,237,000 171,484,000
Other investments 25,294,000 11,925,000
Interest only securities 1,363,200,000 1,014,340,000
Finance receivables 1,971,024,000 1,219,983,000
Other receivables 235,705,000 85,503,000
Servicing rights 96,311,000 --
Property, furniture and fixtures 112,404,000 77,859,000
Goodwill 56,095,000 58,950,000
Other assets 18,124,000 15,929,000
------------------- -------------------
Total assets $4,866,792,000 $3,098,044,000
=================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY:
Notes payable $1,355,995,000 $ 472,181,000
Senior/Senior subordinated notes 510,316,000 290,348,000
Accounts payable and accrued liabilities 492,789,000 378,559,000
Investors payable 552,781,000 346,272,000
Deferred income taxes 622,771,000 473,192,000
------------------- -------------------
Total liabilities 3,534,652,000 1,960,552,000
Commitments and contingencies
Stockholders' equity
Common stock, $.01 par; authorized 400,000,000
shares; issued 141,595,984
and 139,782,706 shares, respectively 1,416,000 1,398,000
Additional paid-in capital 435,570,000 373,573,000
Retained earnings 1,075,670,000 818,733,000
Minimum pension liability adjustments (3,142,000) (2,299,000)
Unrealized gain on securities
available for sale, net 21,824,000 --
------------------- -------------------
1,531,338,000 1,191,405,000
Less treasury stock, 7,012,156 and 2,051,000
shares at cost (199,198,000) (53,913,000)
------------------- -------------------
Total stockholders' equity 1,332,140,000 1,137,492,000
------------------- -------------------
Total liabilities and stockholders' equity $4,866,792,000 $3,098,044,000
=================== ===================
</TABLE>
See notes to consolidated financial statements.
2
<PAGE>
GREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES
-------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
<TABLE>
<CAPTION>
Year ended December 31
--------------------------------------------------------------------
1997 1996 1995
-------------------- ------------------ ------------------
<S> <C> <C> <C>
REVENUES:
Gain on sale of receivables $ 546,828,000 $389,743,000 $448,702,000
Interest 370,569,000 215,315,000 175,990,000
Service 109,253,000 73,263,000 53,572,000
Commissions and other 64,810,000 45,790,000 33,056,000
-------------------- ------------------ ------------------
1,091,460,000 724,111,000 711,320,000
EXPENSES:
Interest 160,882,000 70,050,000 57,313,000
Cost of servicing 88,740,000 53,022,000 39,168,000
General and administrative 355,715,000 277,210,000 205,211,000
-------------------- ------------------ ------------------
605,337,000 400,282,000 301,692,000
-------------------- ------------------ ------------------
EARNINGS BEFORE INCOME
TAXES 486,123,000 323,829,000 409,628,000
INCOME TAXES 184,727,000 123,055,000 155,659,000
-------------------- ------------------ ------------------
NET EARNINGS $ 301,396,000 $200,774,000 $253,969,000
==================== ================== ==================
EARNINGS PER COMMON SHARE:
BASIC $2.20 $1.47 $1.86
DILUTED $2.15 $1.43 $1.81
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
GREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES
-------------------------------------------------
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
-----------------------------------------------
<TABLE>
<CAPTION>
Additional Unrealized
Common paid-in Treasury gain on
stock capital stock securities, net
-------------- --------------- -------------- ---------------
(dollars in thousands)
<S> <C> <C> <C> <C>
BALANCES, December 31, 1994 $1,352 $296,732 $ -- $ --
Common stock issuance of 2,300,000 23 26,832 -- --
shares
Cost of 2,051,000 shares of treasury -- -- (53,913) --
stock acquired
Dividends on common stock -- -- -- --
Net earnings -- -- -- --
-------------- --------------- -------------- ----------------
BALANCES, December 31, 1995 1,375 323,564 (53,913) --
Common stock issuance of 2,300,000 23 50,009 -- --
shares
Minimum pension liability adjustments -- -- -- --
Dividends on common stock -- -- -- --
Net earnings -- -- -- --
-------------- --------------- -------------- ----------------
BALANCES, December 31, 1996 1,398 373,573 (53,913) --
Common stock issuance of 1,800,000 18 61,997 -- --
shares
Cost of 4,961,156 shares of treasury -- -- (145,285) --
stock acquired
Minimum pension liability adjustments -- -- -- --
Unrealized gain on securities, net -- -- -- 21,824
Dividends on common stock -- -- -- --
Net earnings -- -- -- --
-------------- --------------- -------------- ----------------
BALANCES, December 31, 1997 $1,416 $435,570 $(199,198) $21,824
============== =============== ============== ================
<CAPTION>
Minimum Total
pension Retained stockholders'
liability earnings equity
-------------- --------------- --------------
(dollars in thousands)
<S> <C> <C> <C>
BALANCES, December 31, 1994 $ -- $ 427,807 $ 725,891
Common stock issuance of 2,300,000
shares -- -- 26,855
Cost of 2,051,000 shares of treasury
stock acquired -- -- (53,913)
Dividends on common stock -- (27,780) (27,780)
Net earnings -- 253,969 253,969
-------------- --------------- --------------
BALANCES, December 31, 1995 -- 653,996 925,022
Common stock issuance of 2,300,000
shares -- -- 50,032
Minimum pension liability
adjustments (2,299) -- (2,299)
Dividends on common stock -- (36,037) (36,037)
Net earnings -- 200,774 200,774
-------------- --------------- --------------
BALANCES, December 31, 1996 (2,299) 818,733 1,137,492
Common stock issuance of 1,800,000
shares -- -- 62,015
Cost of 4,961,156 shares of treasury
stock acquired -- -- (145,285)
Minimum pension liability
adjustments (843) -- (843)
Unrealized gain on securities, net -- -- 21,824
Dividends on common stock -- (44,459) (44,459)
Net earnings -- 301,396 301,396
-------------- --------------- --------------
BALANCES, December 31, 1997 $(3,142) $1,075,670 $1,332,140
============== =============== ==============
</TABLE>
See notes to consolidated financial statements.
4
<PAGE>
GREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES
-------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
<TABLE>
<CAPTION>
Year ended December 31
-------------------------------------------------------------------------
1997 1996 1995
--------------------- -------------------- --------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Servicing fees and net interest
payments
collected on sold loans $ 419,537,000 $ 217,922,000 $ 159,535,000
Net proceeds from sale of net interest
margin certificates -- -- 302,312,000
Net principal payments collected on 152,302,000 77,810,000 40,571,000
sold loans
Interest on unsold loans 196,103,000 99,046,000 102,785,000
Interest on cash and investments 37,314,000 27,496,000 22,712,000
Commissions 32,461,000 26,340,000 18,616,000
Other (916,000) 3,784,000 484,000
--------------------- -------------------- --------------------
836,801,000 452,398,000 647,015,000
--------------------- -------------------- --------------------
Cash paid to employees and suppliers (398,022,000) (252,625,000) (171,935,000)
Interest paid on debt (156,487,000) (66,381,000) (55,214,000)
Income taxes paid (31,822,000) (44,182,000) (37,496,000)
--------------------- -------------------- --------------------
(586,331,000) (363,188,000) (264,645,000)
--------------------- -------------------- --------------------
NET CASH PROVIDED BY
OPERATIONS 250,470,000 89,210,000 382,370,000
Purchase of loans and leases (10,916,782,000) (7,564,745,000) (5,210,560,000)
Proceeds from sale of loans
and leases 10,378,121,000 7,864,008,000 4,562,468,000
Principal collections on unsold loans
and leases 390,397,000 144,716,000 120,989,000
Commercial and revolving credit loans (4,778,837,000) (2,868,508,000) (1,579,568,000)
disbursed
Principal collections on commercial
and revolving credit loans 3,982,865,000 2,289,916,000 1,187,431,000
Proceeds from sale of commercial
and revolving credit loans 224,400,000 499,115,000 426,304,000
Net cash deposits provided as credit
enhancements (75,753,000) (19,673,000) (13,254,000)
--------------------- -------------------- --------------------
NET CASH (USED FOR) PROVIDED
BY OPERATING ACTIVITIES (545,119,000) 434,039,000 (123,820,000)
--------------------- -------------------- --------------------
</TABLE>
(continued)
5
<PAGE>
GREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES
-------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
<TABLE>
<CAPTION>
Year ended December 31
-----------------------------------------------------------------------
1997 1996 1995
------------------- ------------------- --------------------
<S> <C> <C> <C>
NET CASH FLOWS FROM INVESTING
ACTIVITIES:
Purchase of subsidiary -- (620,566,000) --
Purchase of property, furniture and
fixtures (61,381,000) (31,231,000) (31,478,000)
Net (purchases) sales of investment
securities (13,369,000) 7,955,000 1,040,000
------------------- ------------------- --------------------
NET CASH USED FOR INVESTING
ACTIVITIES (74,750,000) (643,842,000) (30,438,000)
------------------- ------------------- --------------------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Borrowings on credit facilities 10,357,770,000 7,514,398,000 4,633,237,000
Repayments on credit facilities (9,473,955,000) (7,128,379,000) (4,539,575,000)
Issuance of long-term debt 220,000,000 -- --
Common stock issued 5,125,000 6,125,000 2,346,000
Common stock repurchased (145,285,000) -- (53,913,000)
Dividends paid (44,459,000) (36,037,000) (27,780,000)
Payments of debt -- -- (20,246,000)
------------------- ------------------- --------------------
NET CASH PROVIDED BY (USED
FOR) FINANCING ACTIVITIES 919,196,000 356,107,000 (5,931,000)
------------------- ------------------- --------------------
NET INCREASE (DECREASE) IN
CASH AND CASH EQUIVALENTS 299,327,000 146,304,000 (160,189,000)
CASH AND CASH EQUIVALENTS
AT BEGINNING OF YEAR 442,071,000 295,767,000 455,956,000
------------------- ------------------- --------------------
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 741,398,000 $ 442,071,000 $ 295,767,000
=================== =================== ====================
</TABLE>
(continued)
6
<PAGE>
GREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES
-------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
<TABLE>
<CAPTION>
Year ended December 31
--------------------------------------------------------------------
1997 1996 1995
------------------- ------------------ -------------------
<S> <C> <C> <C>
RECONCILIATION OF NET EARNINGS TO
NET CASH (USED FOR) PROVIDED BY
OPERATING ACTIVITIES:
Net earnings $ 301,396,000 $ 200,774,000 $ 253,969,000
Deferred income taxes 149,579,000 67,460,000 109,686,000
Valuation adjustment of interest only 190,000,000 200,000,000 --
securities
Depreciation and amortization 32,125,000 22,427,000 13,518,000
Net proceeds from sale of net interest
margin certificates -- -- 302,312,000
Net loan payments collected, less
interest only securities and servicing
rights recorded (309,026,000) (394,021,000) (331,882,000)
Amortization of servicing rights 15,372,000 -- --
Amortization of deferred service income -- (30,594,000) (14,689,000)
Accretion of yield on interest only
securities (125,831,000) (77,223,000) (51,267,000)
Net increase in cash deposits (75,753,000) (19,673,000) (13,254,000)
Purchase of loans and leases, net of sales (134,597,000) 443,978,000 (527,103,000)
and principal collections
Commercial and revolving loans
disbursed, net of sales and
principal collections (571,572,000) (79,477,000) 34,167,000
Net selling expenses on sale of loans 61,513,000 50,900,000 38,852,000
Increase in current income tax accruals 3,326,000 11,413,000 8,477,000
Increase in amounts payable to employees 16,183,000 9,041,000 54,951,000
and suppliers
Increase in other receivables (77,508,000) (178,000) --
Other (20,326,000) 29,212,000 (1,557,000)
------------------- ------------------ -------------------
NET CASH (USED FOR) PROVIDED
BY OPERATING ACTIVITIES $(545,119,000) $ 434,039,000 $(123,820,000)
=================== ================== ===================
</TABLE>
See notes to consolidated financial statements.
7
<PAGE>
GREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES
-------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
--------------------------------------------
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
- - ---------------------
(a) Consolidation
-------------
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All material intercompany profits,
transactions and balances have been eliminated. In certain cases, prior
year amounts have been reclassified to conform to the current year's
presentation.
(b) Use of Estimates
----------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates. Material estimates that are particularly susceptible to
significant change relate to the valuation of the interest only securities.
(c) Restatement of 1996 Financial Statements
----------------------------------------
During the fourth quarter of 1997, the Company determined that its
processes for assessing the valuation of its excess servicing rights had
not fully considered the effects of partial prepayments on projected future
interest collections and the impact of changes in projected future interest
due to investors on a weighted average basis on bonds outstanding. In
consideration of these items, the Company has restated its previously
reported financial statements for 1996 as follows:
<TABLE>
<S> <C>
Decrease net gains on contract sales and excess servicing rights $200,000,000
Decrease in general and administrative expense and accrued liabilities $ 25,868,000
Decrease in earnings before income taxes $174,132,000
Decrease in provision for income taxes and deferred tax liability $ 66,170,000
Decrease in net earnings for 1996 and decrease in retained earnings
as of December 31, 1996 $107,962,000
Decrease in net earnings per common share $ 0.77
</TABLE>
8
<PAGE>
ADOPTION OF NEW ACCOUNTING STANDARDS
- - ------------------------------------
(a) Accounting for Stock Based Compensation
---------------------------------------
On January 1, 1996, the Company adopted the pro forma disclosure provisions
of Statement of Financial Accounting Standards No. 123 (SFAS No. 123),
"Accounting for Stock-Based Compensation". The Company continues to apply
the accounting provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees", and related interpretations.
(b) Accounting for Transfers and Servicing of Financial Assets and
--------------------------------------------------------------
Extinguishments of Liabilities
------------------------------
On January 1, 1997, the Company adopted Statement of Financial Accounting
Standards No. 125 (SFAS No. 125), "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities". SFAS No. 125
requires prospective implementation only; however, certain
reclassifications have been made to prior year's financial statements to
conform to the current year's presentation.
Among other provisions, SFAS No. 125 uses a "financial components" approach
relative to the recognition of financial assets and liabilities resulting
from the transfer of financial assets. SFAS No. 125 also provides guidance
relative to the classification and ongoing measurement of the financial
components retained in connection with financial asset sales. Such
components are recorded at allocated cost. The Company retains interest
only securities and servicing rights upon the sale of its financial assets
or receivables.
(c) Earnings Per Share
------------------
On December 31, 1997 the Company adopted Statement of Financial Accounting
Standards No. 128 (SFAS No. 128), "Earnings Per Share", which establishes
new standards for calculating and disclosing earnings per share. All prior
period earnings per share data has been restated to conform with the
provisions of SFAS No. 128, as shown in Note G, "Earnings Per Share".
(d) Disclosure of Information about Capital Structure
-------------------------------------------------
On December 31, 1997 the Company adopted Statement of Financial Accounting
Standards No. 129 (SFAS No. 129), "Disclosure of Information about Capital
Structure", which establishes standards for disclosing information about an
entity's capital structure. The statement has no effect on the Company's
current capital structure disclosures.
9
<PAGE>
REVENUE RECOGNITION
- - -------------------
(a) Gain on Sale of Receivables
---------------------------
Effective January 1, 1997 the Company accounts for the sale of receivables
in accordance with SFAS No. 125. Gain on sale of receivables represents the
difference between the proceeds from the sale, net of related transaction
costs, and the allocated carrying amount of the receivables sold. The
allocated carrying amount is determined by allocating the original amount
of the receivables between the portion sold and any retained interests
(interest only securities and servicing rights), based on their relative
fair values at the date of sale. The initial unrealized gain on the
valuation of interest only securities which represents the difference
between the allocated carrying amount of the receivables and their fair
market value at time of sale is recorded in stockholders' equity. In
addition, gain on sale of receivables includes pointsreceived and premiums
paid.
The fair value of interest only securities and servicing rights as of the
sale date are determined by discounting the cash flows over the expected
life of the financial contracts using prepayment, default, loss and
interest rate assumptions that the Company believes market participants
would use for similar financial instruments.
(b) Interest
--------
Interest revenue generally represents interest earned on unsold finance
receivables, custodial trust cash and other investments. In addition, the
Company recognizes interest yield on its interest only securities.
(c) Service
-------
Service income represents the contractual servicing fees received less the
amortization of servicing rights. Servicing rights are amortized in
proportion to and over the period of estimated net future servicing fee
income.
(d) Commission and Other
--------------------
Commission and other income generally represents insurance commissions and
late fees.
CASH AND CASH EQUIVALENTS
- - -------------------------
For purposes of the statements of cash flows, the Company considers all highly
liquid temporary investments purchased with a maturity of three months or less
to be cash equivalents. At December 31, 1997 and 1996, cash of approximately
$528,644,000 and $341,936,000, respectively, was held in trust for subsequent
payment to investors. In addition, cash of $247,237,000 and $171,484,000 is
restricted by the pooling and servicing agreements and approximately $3,261,000
and $3,101,000 is restricted and held by the Company's subsidiaries pursuant to
various government requirements at December 31, 1997 and 1996, respectively.
OTHER INVESTMENTS
- - -----------------
Other investments consist of liquid investments with original maturities of no
more than three months. Investments are held in trust for FDIC requirements and
policy and claim reserves and a master repurchase agreement for the Company's
bank and insurance subsidiaries.
10
<PAGE>
INTEREST ONLY SECURITIES
- - ------------------------
Effective January 1, 1997, the Company accounts for interest only securities in
accordance with SFAS No. 125 and SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities". Interest only securities represent
the right to receive certain cash flows which exceed the amount of cash flows
sold in the Company's securitized receivable sales. Interest only securities
generally represent the value of interest to be collected on the underlying
financial contracts of each securitization over the sum of the interest to be
paid to security classes sold, contractual servicing fees and credit losses.
The Company classifies its interest only securities as available for sale and
carries these securities at fair market value. Accordingly, unrealized gains
and losses are reported net of deferred income taxes, as a separate component of
stockholders' equity.
The Company monitors its interest only securities for other than temporary
impairment. Generally, other than temporary impairment is deemed to occur when
the present value of estimated future cash flows discounted at a risk free rate
using appropriate prepayment and default assumptions is less than the carrying
value of the interest only securities. If other than temporary impairment
occurs, the carrying value is reduced to fair value and a loss is recognized in
the statements of operations.
FINANCE RECEIVABLES
- - -------------------
Finance receivables consist of lease, commercial finance and revolving credit
receivables and loans held for sale. Generally all lease receivables are direct
financing leases as defined in SFAS No. 13 "Accounting for Leases". The
carrying value of lease receivables represents the present value of both the
future minimum lease payments and related residual values. The Company's
commercial finance receivables generally represent dealer floorplan, asset-based
financing arrangements with dealers, manufacturers and other commercial entities
and commercial real estate loans. Revolving credit receivables consist of retail
credit card arrangements with merchants and dealers and their customers. Loans
held for sale generally consist of recent originations of manufactured housing,
home equity, home improvement and consumer and equipment contracts which will be
sold during the following quarter. Finance receivables are net of allowance for
expected losses.
OTHER RECEIVABLES
- - -----------------
Other receivables consist of the Company's miscellaneous accounts receivable,
insurance related, interest and other production and servicing related
receivables.
SERVICING RIGHTS
- - ----------------
Servicing rights are carried at allocated cost and amortized in proportion to
and over the estimated period of net servicing income.
GOODWILL
- - --------
Goodwill, which represents the excess of purchase price over fair value of net
assets acquired, is amortized on a straight-line basis over the expected periods
to be benefited, generally 20 years.
11
<PAGE>
DEPRECIATION
- - ------------
Property, furniture and fixtures are carried at cost and are depreciated over
their estimated useful lives on a straight-line basis.
B. INTEREST ONLY SECURITIES
Effective January 1, 1997 the Company began accounting for its sales of
receivables, interest only securities and servicing rights in accordance with
SFAS No. 125 and SFAS No. 115.
The activity in interest only securities for 1997 is summarized as follows:
<TABLE>
<S> <C>
Balance at beginning of year $1,014,340,000
Transfer to servicing rights (30,755,000)
Additions 674,660,000
Yield on interest only securities 125,831,000
Net cash collected (266,077,000)
Realized loss on valuation of interest
only securities (190,000,000)
Unrealized gain on valuation of interest
only securities 35,201,000
--------------
Balance at end of year $1,363,200,000
==============
</TABLE>
In 1995 and previous years, the Company sold a substantial portion of its
interest only securities related to manufactured housing securitization
transactions between 1978 and 1995 in the form of securitized Net Interest
Margin Certificates. The Company retained a subordinated interest in the cash
flow of the interest only securities sold. These interests are included in
interest only securities and total $77,030,000 at December 31, 1997.
Generally interest only securities relate to the sale of closed end manufactured
housing, home equity, home improvement, consumer and equipment finance
receivables. The Company's interest only securities are subject to a
substantial amount of credit loss and prepayment risk related to the receivables
sold. In connection with the valuation of interest only securities the Company
has provided for approximately $899,981,000 of credit losses as of December 31,
1997. On a nondiscounted basis the amount of credit losses provided for in
connection with the valuation of the interest only securities is approximately
$1,321,260,000. These estimated losses if realized, would reduce the amount of
cash flows available to the interest only securities and are considered in the
company's valuation processes.
12
<PAGE>
The table below details information pertinent to the valuation of the interest
only securities as of December 31, 1997.
<TABLE>
<CAPTION>
Manufactured Home Equity / Consumer /
Housing Home Improvement Equipment Total
---------------- ----------------- -------------- ---------------
<S> <C> <C> <C> <C>
Interest only securities carrying amount $ 857,352,000 335,089,000 170,759,000 $ 1,363,200,000
Unpaid principal balance of sold receivables $17,558,224,000 4,251,590,000 2,467,478,000 $24,277,292,000
Weighted average customer interest rate on
sold receivables 10.49% 11.82% 11.33%
Approximate expected weighted average
constant prepayment rate as a percentage
of unpaid principal balance of sold
receivables (1) 9.5% 24.0% 22.0%
Approximate remaining expected non
discounted credit losses as a percentage
of unpaid principal balance of sold
receivables (1) 6.2% 4.3% 2.1%
</TABLE>
(1) Valuation of the Company's interest only securities is impacted not only by
the projected level of prepayments of principal and net credit losses, as
shown above, but also by the projected timing of such prepayments and net
credit losses. Should the timing of projected pre-payments of principal or
net credit losses differ materially from the timing projected by the
Company, such timing could have a material effect on the valuation of the
interest only securities.
13
<PAGE>
The weighted average interest rate used to discount expected future cash flows
of the interest only securities is 11.47% as of December 31, 1997.
Prior to the implementation of SFAS 125, the Company recorded "excess servicing
rights receivable" and "allowance for losses on loans sold" on its balance
sheet. Excess servicing rights receivable consisted of net excess cash
expected to be collected over the life of the loans sold. In initially valuing
its excess servicing rights receivable at the time of securitization, the
Company established an allowance for expected losses on loans sold. This
allowance represents the Company's best estimate of future credit losses likely
to be incurred over the entire life of the loans. As of December 31, 1996,
excess servicing rights receivable consisted of:
<TABLE>
<S> <C>
Gross cash flows receivable on loans sold $ 4,379,336,000
Less:
Prepayment reserve (2,221,016,000)
Deferred service income (281,301,000)
Discount to present value (505,297,000)
FHA insurance and other fees (8,813,000)
Subordinated interest in NIM certificates 145,307,000
---------------
1,508,216,000
Allowance for losses (493,876,000)
---------------
Net excess servicing rights receivable $ 1,014,340,000
===============
</TABLE>
During the years ended December 31, 1997, 1996 and 1995, the Company sold
$10,524,758,000, $7,913,357,000 and $4,599,087,000, respectively, of closed end
receivables in various securitized transactions.
The Company recorded a writedown of interest only securities carrying value of
$190 million in 1997 due to adverse prepayment experience. Additionally, the
Company recorded a $35 million unrealized gain at December 31, 1997. As further
discussed in Note A the Company recorded a $200 million writedown in 1996.
Writedowns are recorded as a reduction of "gain on sale of receivables" in the
consolidated statements of operations. Unrealized gains are recorded as a
component of stockholders' equity.
C. FINANCE RECEIVABLES
Finance receivables consisted of the following at December 31:
<TABLE>
<CAPTION>
1997 1996
---------------------- ----------------------
<S> <C> <C>
Lease $ 191,572,000 $ 570,407,000
Commercial Finance 683,691,000 212,920,000
Revolving Credit Card 165,151,000 40,803,000
Loans Held For Sale 930,610,000 395,853,000
---------------------- ----------------------
Total $1,971,024,000 $1,219,983,000
====================== ======================
</TABLE>
14
<PAGE>
The allowance for doubtful accounts included in finance receivables at December
31 is as follows:
<TABLE>
<CAPTION>
1997 1996
---------------------- ----------------------
<S> <C> <C>
Lease $17,776,000 $13,334,000
Commercial Finance 875,000 687,000
Revolving Credit Card 1,149,000 239,000
---------------------- ----------------------
Total $19,800,000 $14,260,000
====================== ======================
</TABLE>
D. SERVICING RIGHTS
The activity in servicing rights for 1997 is summarized as follows:
<TABLE>
<CAPTION>
<S> <C>
Balance at beginning of year $ --
Transfer from interest only securities 30,755,000
Additions 80,928,000
Amortization (15,372,000)
-------------------------
Balance at end of year $ 96,311,000
=========================
</TABLE>
Servicing rights are evaluated for impairment on an ongoing basis, stratified by
product type and origination period. To the extent the recorded amount exceeds
the fair value of those servicing rights, a valuation allowance is established
through a charge to earnings. Upon subsequent measurement of the fair value of
these servicing rights in future periods, if the fair value equals or exceeds
the carrying amount, any previously recorded valuation allowance would be deemed
unnecessary and, therefore, represent current period earnings only to the extent
of such previously recorded allowance. Fair value of servicing rights
approximated the carrying amount and no valuation allowance with respect to the
servicing rights was necessary at December 31, 1997.
E. PROPERTY, FURNITURE AND FIXTURES
Property, furniture and fixtures consist of:
<TABLE>
<CAPTION>
December 31
Estimated -----------------------------------------
useful life 1997 1996
---------------- ------------------ -----------------
<S> <C> <C> <C>
Cost:
Building 35 years $ 20,024,000 $ 20,648,000
Furniture and equipment 3-7 years 137,451,000 87,686,000
Leasehold improvements 3-10 years 17,829,000 11,779,000
Land and improvements 7,159,000 1,724,000
------------------ -----------------
182,463,000 121,837,000
Less accumulated depreciation (70,059,000) (43,978,000)
------------------ -----------------
$112,404,000 $ 77,859,000
================== =================
</TABLE>
Depreciation expense for 1997, 1996 and 1995 was $26,851,000, $17,932,000 and
$10,956,000, respectively.
15
<PAGE>
F. DEBT
In 1997 the Company had a $2,000,000,000 commercial paper program which was used
primarily for purposes of financing its loan production inventory prior to sale
of those receivables in the form of securitization. This program was backed by
both committed bank facilities and master repurchase agreements with various
investment banking firms. During the first quarter of 1998, the Company
substantially curtailed its issuance of commercial paper, as discussed in Note
O, "Subsequent Events".
As of December 31, 1997, the Company had both a one-year and three-year
unsecured revolving line of credit totaling $1,500,000,000 which were scheduled
to expire April 28, 1998 and April 28, 2000, respectively. The credit agreement
contained certain restrictive covenants which included maintenance of a minimum
net worth of $750 million and a debt to net worth ratio not to exceed 5 to 1. In
addition, the Company utilized master repurchase agreements that were in place
with a variety of investment banking firms totaling $2,800,000,000 at December
31, 1997 which were subject to the availability of eligible collateral. There
were no outstanding balances under these facilities as of December 31, 1997 and
1996. See Note O, "Subsequent Events", for new revolving line of credit
agreement information.
The Company has a $2,000,000 promissory note which contains a balloon payment
due on April 9, 2001, bearing interest at an annual rate of 2%.
The Company also has a $250,000,000 medium term note program under which it may
issue senior notes bearing either fixed or floating rates of interest with
maturities in excess of nine months. As of December 31, 1997, $246,650,000 of
notes were outstanding under this program. Interest on these notes is payable
semi-annually.
The Senior Subordinated Notes due June 1, 2002 were issued in connection with a
debt exchange completed in April 1992. The effective interest rate on these
notes is 10.8%. There is unamortized original issue discount of $3,588,000 and
$3,556,000 at December 31, 1997 and 1996, respectively. The Company must
maintain net worth of $80,000,000 or will be required, through the use of a
sinking fund, to redeem $25,000,000 on such contingent sinking fund payment
date. Interest on these notes is payable semi-annually.
Debt outstanding and its weighted average interest rates are as follows:
<TABLE>
<CAPTION>
December 31
--------------------------------------------------------------
1997 1996
------------------------------ ----------------------------
Amount Rate Amount Rate
-------------------------------- ------------------------------
<S> <C> <C> <C> <C>
Commercial paper $1,319,140,000 6.08% $431,242,000 5.68%
Revolving line of credit 35,000,000 5.80 39,000,000 5.63
Promissory note 1,855,000 2.00 1,939,000 2.00
------------------- -------------------
Notes payable 1,355,995,000 472,181,000
------------------- -------------------
Medium term notes 246,650,000 6.62 26,650,000 7.27
Senior subordinated notes 263,666,000 10.80 263,698,000 10.80
------------------- -------------------
Senior/Senior subordinated notes 510,316,000 290,348,000
------------------- -------------------
Total $1,866,311,000 $762,529,000
=================== ===================
</TABLE>
16
<PAGE>
At December 31, 1997, aggregate maturities of debt, excluding commercial paper
and the revolving line of credit, for the following five years are $512,109,000,
payable as follows: $3,085,000 in 1998, $5,087,000 in 1999, $12,088,000 in
2000, $4,595,000 in 2001, and $487,254,000 in 2002.
G. EARNINGS PER SHARE
Basic earnings per share is computed by dividing net earnings by the weighted
average number of shares of Common Stock outstanding during each year. Diluted
earnings per share is computed by dividing net earnings by the weighted average
number of shares of Common Stock and potential Common Stock outstanding during
each year. All share and per-share amounts have been restated to reflect the
two-for-one stock split the Company effected in October 1995. The following
table presents the earnings per share data as required by SFAS No. 128. Options
to purchase 628,548, 33,063 and 1,124,776 shares are excluded from the
computation of diluted earnings per common share because of their anti-dilutive
effect, as the exercise price of the option exceeds the average market price of
the Common Stock for the years ended December 31, 1997, 1996 and 1995,
respectively.
<TABLE>
<CAPTION>
Year ended December 31
-------------------------------------------------------------------
1997 1996 1995
----------------- ------------------- -------------------
<S> <C> <C> <C>
Net Earnings $301,396,000 $200,774,000 $253,969,000
================= =================== ===================
Weighted average Common Stock
outstanding 136,714,884 136,995,701 136,644,397
Effect of dilutive securities:
Options 3,539,558 3,566,129 3,445,259
----------------- ------------------- -------------------
Diluted Common Stock 140,254,442 140,561,830 140,089,656
================= =================== ===================
Earnings per common share:
Basic $ 2.20 $ 1.47 $ 1.86
Diluted $ 2.15 $ 1.43 $ 1.81
</TABLE>
H. STOCKHOLDERS' EQUITY
COMMON STOCK
- - ------------
In May 1996, the Board of Directors and shareholders approved the authorization
of 250,000,000 additional shares of Common Stock for general corporate purposes,
including stock dividends, raising additional capital and issuances pursuant to
employee stock option plans and possible future acquisitions.
In September 1995, the Board of Directors declared a two-for-one stock split, in
the form of stock dividends, payable on October 15, 1995 to stockholders of
record as of September 30, 1995. All references in the consolidated financial
statements and notes with regard to number of shares, stock options and related
prices and per-share amounts have been restated to give retroactive effect to
the stock split.
In February 1995, the Company's Board of Directors approved and authorized the
repurchase of up to 7,000,000 shares of the Company's Common Stock. As of
December 31, 1997, the Company had repurchased the entire 7,000,000 shares.
17
<PAGE>
STOCK BONUS PLAN
- - ----------------
The Company had a key executive compensation stock bonus plan. Shares issued
under this plan are pursuant to an employment agreement and the stock is valued
at $2.96875 per share which represents the closing market price of the stock on
the date of the employment agreement. Total shares issued under this plan
during 1997, 1996 and 1995 were 2,400,000, 1,998,745 and 1,349,216,
respectively. On January 27, 1998, 761,210 shares issued in 1997 were returned
to the Company in connection with the Company's recomputation of the bonus
amount for fiscal year 1996.
STOCK OPTION PLANS
- - ------------------
The Company has two stock option plans: an employee stock option plan and an
outside director plan. In 1992, the Board of Directors approved a supplemental
stock option plan for its outside directors and in 1995, the Company's
stockholders approved an Employee Stock Incentive Plan.
In 1996, the Company's stockholders approved a chief executive plan. Two
million options were granted under this plan at an exercise price equal to the
fair market value of the Company's stock on February 9, 1996, of $30.875. The
term of the option, which commences in 1997, is for ten years, with a five-year
vesting schedule providing vesting of 20% per year for each full year of
service.
Options for 742,120 shares were available for future grant under these plans.
The Company's Board of Directors has reserved 13,833,752 shares for future
issuance under all plans as of December 31, 1997.
A summary of the stock option plan activity is as follows:
<TABLE>
<CAPTION>
Number of Weighted Average
Shares Exercise Price
--------------- ------------------------
<S> <C> <C>
Outstanding at December 31, 1994 5,146,468 $ 4.45
Granted 3,015,000 24.00
Exercised (1,794,936) 4.39
Expired (110,000) 24.00
---------------
Outstanding at December 31, 1995 6,256,532 13.60
Granted 5,632,500 32.02
Exercised (1,196,500) 4.69
Expired (620,500) 26.49
---------------
Outstanding at December 31, 1996 10,072,032 23.91
Granted 1,289,500 37.32
Exercised (528,500) 9.69
Expired (922,567) 28.13
---------------
Outstanding at December 31, 1997 9,910,465 25.98
===============
</TABLE>
18
<PAGE>
Of the 9,910,465 options outstanding at December 31, 1997, 9,778,465 options
relate to the employee and chief executive stock option plans and 132,000
options relate to the outside director plan. The exercise price per share
represents the market value of the Company's stock on the date of grant except
for certain options granted in 1996 and 1995. The option price per share on
850,000 options granted in 1996 represents approximately 77% of the market value
of the Company's stock on the date of grant and 370,000 options granted in 1995
represents approximately 79% of the market value of the Company's stock on the
date of grant.
A summary of stock options outstanding and exercisable at December 31, 1997 is
as follows:
Options Outstanding:
<TABLE>
<CAPTION>
Range of Number Remaining Weighted Average
Exercise Prices Outstanding Contractual Life Exercise Price
- - ---------------- ------------------ --------------------- -----------------------
<S> <C> <C> <C>
$ 2.97-24.00 3,621,665 5.97 $14.77
25.00-30.62 1,602,300 8.58 29.23
30.87-30.87 2,020,000 8.11 30.87
31.25-38.37 2,558,500 8.89 35.40
38.62-47.00 108,000 9.12 39.49
- - ---------------- ------------------ --------------------- -----------------------
$ 2.97-47.00 9,910,465 7.62 $25.98
Options Exercisable:
<CAPTION>
Range of Number Weighted Average
Exercise Prices Exercisable Exercise Price
- - ---------------- ------------------ -----------------------
<S> <C> <C>
$ 2.97-24.00 2,496,398 $11.03
25.00-30.62 351,100 28.82
30.87-30.87 404,000 30.87
31.25-38.37 348,000 34.07
38.62-47.00 16,000 38.94
- - ---------------- ------------------ -----------------------
$ 2.97-47.00 3,615,498 $17.32
</TABLE>
19
<PAGE>
The Company applies Accounting Principles Board Opinion No. 25, and related
interpretations in accounting for its stock incentive plans. Proceeds from
stock options exercised are credited to common stock and paid-in capital. There
are no charges or credits to expense with respect to the granting or exercise of
options that were issued at fair market value on their respective dates of
grant. Had compensation costs for the Company's stock-based compensation plans
been determined consistent with Statement of Financial Accounting Standards No.
123, the Company's net earnings and earnings per share would have been reduced
to the pro forma amounts indicated below.
<TABLE>
<CAPTION>
1997 1996 1995
------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
Net Earnings As Reported $301,396,000 $200,774,000 $253,969,000
Pro Forma 281,645,000 190,185,000 250,805,000
Diluted Earnings
Per Share As Reported $2.15 $1.43 $1.81
Pro Forma 2.01 1.35 1.79
</TABLE>
The fair value for each option granted in 1997, 1996 and 1995 utilized in the
foregoing pro forma amounts is estimated on the date of grant using an option
pricing model. The model incorporates the following assumptions in 1997, 1996
and 1995: .8% dividend yield; 41.9%, 38.5% and 39.7% expected volatility,
respectively; risk-free interest rates ranging from 5.2% to 7.7%; and expected
option term beyond vesting of 2 years.
DIVIDENDS
- - ---------
During 1997, 1996 and 1995 the Company declared and paid dividends of $.33, $.26
and $.20 per share, respectively, on its Common Stock. Under a letter of credit
agreement, the Company is subject to restrictions limiting the payment of
dividends and common stock repurchases. At December 31, 1997, such payments
were limited to $106,239,000 which represents 50% of consolidated net earnings
for the most recently concluded four fiscal quarter periods less dividends paid.
I. FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS
Fair value estimates as of December 31, 1997 and 1996 are based on pertinent
information available to management as of the respective dates. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been revalued for purposes
of these financial statements subsequent to December 31, 1997 and 1996.
Therefore, current estimates of fair value may differ significantly from the
amounts presented herein. Fair value estimates, methods and assumptions are set
forth below for the Company's financial instruments.
CASH AND CASH EQUIVALENTS, CASH DEPOSITS AND OTHER INVESTMENTS
- - --------------------------------------------------------------
The carrying amount of cash and cash equivalents, cash deposits and other
investments approximates fair value because they generally mature in 90 days or
less and do not present unanticipated credit concerns.
20
<PAGE>
INTEREST ONLY SECURITIES
- - ------------------------
Fair value on interest only securities is calculated using prepayment, default
and interest rate assumptions on expected future cash flows that the Company
believes market participants would use for similar instruments, as shown in Note
B, "Interest Only Securities".
FINANCE RECEIVABLES
- - -------------------
(a) Lease
-----
Lease receivables generally consist of a large number of individually small
finance leases with average remaining terms of less than 36 months. Fair
value approximates carrying value.
(b) Commercial Finance
-------------------
Commercial finance receivables consist primarily of loans which reprice
monthly, typically in accordance with the prime lending rate offered by
banks. Given this repricing structure, the Company estimates the fair value
of these receivables to approximate their carrying value.
(c) Revolving Credit Card
---------------------
Revolving credit card receivables consist of retail credit and the
applicable interest from credit card agreements applied to revolving credit.
The Company estimates the fair value of these receivables to approximate
their carrying value.
(d) Loans Held for Sale
--------------------
Loans held for sale are generally recent originations which will be sold
during the following quarter. Generally, the loans have origination rates in
excess of rates on the securities into which they will be pooled. Since
these loans have not been converted into securitized pools, the Company
estimates the fair value to be the carrying amount plus the cost of
origination.
NOTES PAYABLE
- - -------------
Notes payable consist of short-term amounts payable under the Company's
commercial paper program, line of credit or repurchase agreements and are at a
rate which approximates market. As such, fair value approximates the carrying
amount.
SENIOR NOTES AND SENIOR SUBORDINATED NOTES
- - ------------------------------------------
The fair value of the Company's senior notes is estimated based on their quoted
market price or on the current rates offered to the Company for debt of a
similar maturity. The Company's senior subordinated notes are valued at quoted
market prices.
21
<PAGE>
The carrying amounts and estimated fair values of the Company's financial assets
and liabilities are as follows:
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
-------------------------------------- -----------------------------------
Carrying Estimated Carrying Estimated
amount fair value amount fair value
----------------- ----------------- ---------------- ---------------
<S> <C> <C> <C> <C>
(dollars in thousands)
Financial assets:
Cash and cash equivalents, cash
deposits and other investments $1,013,929 $1,013,929 $ 625,480 $ 625,480
Interest only securities 1,363,200 1,363,200 1,014,340 1,006,480
Finance receivables:
Lease 191,572 191,572 570,407 570,407
Commercial finance 683,691 683,691 212,920 212,920
Revolving credit 165,151 165,151 40,803 40,803
Loans held for sale 930,610 945,965 395,853 404,738
Financial liabilities:
Notes payable 1,355,995 1,355,995 472,181 472,181
Senior notes/senior subordinated
notes 510,316 520,018 290,348 331,580
</TABLE>
Fair value estimates are made at a specific point in time, based on relevant
market information and information about the financial instrument. The
estimates do not reflect any premium or discount that could result from offering
for sale at one time, the Company's entire holdings of a particular financial
instrument. Fair value estimates are based on judgments regarding future loss
and prepayment experience, current economic conditions, specific risk
characteristics and other factors. Changes in market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts.
J. COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENTS
- - -----------------
At December 31, 1997, aggregate minimum rental commitments under noncancelable
leases having terms of more than one year were $32,984,000, payable $10,425,000
(1998), $9,485,000 (1999), $7,116,000 (2000), $4,400,000 (2001) and $1,558,000
(2002). Total rental expense for the years ended December 31, 1997, 1996 and
1995 was $13,055,000, $8,664,000 and $6,101,000, respectively. These leases are
for office facilities and equipment and many contain either clauses for cost of
living increases and/or options to renew or terminate the lease.
CONTINGENT LIABILITY
- - --------------------
The Company services all receivables securitized. In connection with certain
securitization transactions, the Company has provided guarantees in the amount
of $1.7 billion and $1.5 billion as of December 31, 1997 and 1996, respectively.
The Company believes it has adequately considered this guarantee in connection
with its presentation of its financial condition and no liability is necessary
to provide for exposure related to this guarantee.
22
<PAGE>
LITIGATION
- - ----------
The Company has been served with various lawsuits in United States District
Court. These lawsuits were filed by certain stockholders of the Company as
purported class actions on behalf of persons or entities who purchased common
stock of the Company during the alleged class periods. In addition to the
Company, certain current and former officers and directors of the Company are
named as defendants in one or more of the lawsuits. The Company and the other
defendants intend to seek consolidation of each of the lawsuits in the United
States District Court for the District of Minnesota. Plaintiffs in the lawsuits
assert claims under Sections 10(b) and 20(a) of the Securities Exchange Act of
1934. In each case, plaintiffs allege that the Company and the other defendants
violated federal securities laws by, among other things, making false and
misleading statements about the current state and future prospects of the
Company (particularly with respect to prepayment assumptions and performance of
certain of the Company's loan portfolios) which allegedly rendered the Company's
financial statements false and misleading. The Company believes that the
lawsuits are without merit and intends to defend such lawsuits vigorously.
In addition, the nature of the Company's business is such that it is routinely a
party or subject to items of pending or threatened litigation. Although the
ultimate outcome of certain of these matters cannot be predicted, management
believes, based upon information currently available that the resolution of
these legal matters will not result in any material adverse effect on its
consolidated financial condition.
K. BENEFIT PLANS
The Company has a qualified noncontributory defined benefit pension plan
covering substantially all of its employees over 21 years of age. The plan's
benefits are based on years of service and the employee's compensation. The
plan is funded annually based on the maximum amount that can be deducted for
federal income tax purposes. The assets of the plan are primarily invested in
common stock, corporate bonds and cash equivalents. In addition, the Company
maintains a nonqualified pension plan for certain key employees as designated by
the Board of Directors. The following table sets forth the plans' funded status
and amounts recognized in the Company's statement of financial position at
December 31.
<TABLE>
<CAPTION>
1997 1996
--------------------------------------- ---------------------------------------
Actuarial Present Value of Qualified Supplemental Qualified Supplemental
Benefit Obligations Plan Plan Plan Plan
- - --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Vested benefit obligation $ (7,800,861) $(17,066,920) $ (6,851,740) $(13,029,105)
----------------- ----------------- ----------------- -----------------
Accumulated benefit obligation (11,112,689) (17,066,920) (8,340,969) (13,167,331)
----------------- ----------------- ----------------- -----------------
Projected benefit obligation (21,780,333) (51,101,268) (17,033,929) (22,840,557)
Plan assets at fair value 9,071,280 -- 7,074,888 --
----------------- ----------------- ----------------- -----------------
Excess of projected benefit
obligation over plan assets (12,709,053) (51,101,268) (9,959,041) (22,840,557)
Unrecognized net loss 7,753,539 35,395,087 7,089,685 13,381,065
Prior service cost (339,491) -- (375,599) --
Unrecognized net (asset)
obligation (44,600) 212,600 (59,140) 359,000
----------------- ----------------- ----------------- -----------------
Net pension liability recognized
in the consolidated balance sheet $ (5,339,605) $(15,493,581) $ (3,304,095) $ (9,100,492)
================= ================= ================= =================
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
- - --------------------------------- -------------------- ------------------- -------------------
Net Periodic Pension Cost -
Qualified and Supplemental 1997 1996 1995
- - --------------------------------- -------------------- ------------------- -------------------
<S> <C> <C> <C>
Service cost $ 4,854,946 $3,074,664 $1,105,952
Interest cost on projected
benefit obligation 3,949,924 1,944,237 622,688
Actual return on plan assets (1,304,116) (776,764) (816,479)
Net amortization and deferral 2,493,995 1,104,904 391,726
-------------------- ------------------- -------------------
Net periodic pension cost $ 9,994,749 $5,347,041 $1,303,887
==================== =================== ===================
</TABLE>
The preretirement discount rate, postretirement discount rate and rate of
increase in future compensation levels used for determining obligations as of
December 31, 1997 were 6.75%, 6.5% and 5.5% respectively, and for determining
expense at December 31, 1996 were 7.25%, 6.5% and 5.5% respectively.
Preretirement mortality table and postretirement mortality tables were used for
determining expense and obligations at December 31, 1997. The wage base under
Social Security was assumed to increase at 4.5% per year starting in 1997. The
maximum benefit and compensation contained in Sections 415(b) and 401(a)(17) of
the IRS Code are assumed to increase by 4.0% per year in the future. Total
pension expense for the plans in 1997, 1996 and 1995 was $14,064,000, $5,347,000
and $3,091,000, respectively.
The Company also has a 401(k) Retirement Savings Plan available to all eligible
employees. To be eligible for the plan, the employee must be at least 21 years
of age and have completed six months of employment at Green Tree during which
the employee worked at least 1,000 hours. Eligible employees may contribute to
the plan up to 15% of their earnings with a maximum of $9,500 for 1997 based on
the Internal Revenue Service annual contribution limit. The Company will match
50% of the employee contributions for an amount up to 6% of each employee's
earnings. Contributions are invested at the direction of the employee to one or
more funds. Company contributions vest after three years. Company
contributions to the plan were $2,498,000, $1,316,000 and $859,000 in 1997, 1996
and 1995, respectively.
24
<PAGE>
L. INCOME TAXES
Income taxes consist of the following:
<TABLE>
<CAPTION>
Year ended December 31
---------------------------------------------------------------------
1997 1996 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Current:
Federal $ 32,574,000 $ 51,908,000 $ 43,883,000
State 2,574,000 3,687,000 2,090,000
------------------- ------------------- -------------------
35,148,000 55,595,000 45,973,000
Deferred:
Federal 129,717,000 56,201,000 92,870,000
State 19,862,000 11,259,000 16,816,000
------------------- ------------------- -------------------
149,579,000 67,460,000 109,686,000
------------------- ------------------- -------------------
$184,727,000 $123,055,000 $155,659,000
=================== =================== ===================
Deferred income taxes are provided for temporary differences between financial
statement carrying amounts and their respective tax basis. The tax effects of
temporary differences that give rise to significant portions of the deferred tax
assets and deferred tax liabilities at December 31, 1997 and 1996 are
presented below.
<CAPTION>
December 31
--------------------------------------------
1997 1996
------------------- -------------------
<S> <C> <C>
Deferred tax liabilities:
Interest only securities $737,238,000 $451,051,000
Other 45,282,000 50,602,000
------------------- -------------------
Gross deferred tax liabilities 782,520,000 501,653,000
------------------- -------------------
Deferred tax assets:
Net operating loss carryforward 135,180,000 20,347,000
Other 24,569,000 8,114,000
------------------- -------------------
Gross deferred tax assets 159,749,000 28,461,000
------------------- -------------------
Net deferred tax liability $622,771,000 $473,192,000
=================== ===================
</TABLE>
At December 31, 1997, the Company has net operating loss carryforwards for
federal income tax purposes of approximately $386,000,000 which are available to
offset future federal taxable income and expire no earlier than 2003. No
valuation allowance was required as of December 31, 1997 or 1996 since it is
likely that the deferred tax asset will be realized against future income and
the reversal of deferred tax liabilities.
The effective tax rate for December 31, 1997, 1996 and 1995 is 38.0%. It is
comprised of the statutory federal income tax rate of 35.0% and a state tax
rate, net of federal benefit of 3.0%.
25
<PAGE>
M. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement No. 130,
"Reporting Comprehensive Income", which the Company is required to adopt
effective January 1, 1998. This adoption requires information to be reported in
interim periods in the initial year and will have no financial impact to the
Company, but will require new disclosure information.
In June, 1997, the Financial Accounting Standards Board issued Statement No.
131, "Disclosures about Segments of an Enterprise and Related Information",
which the Company is required to adopt for the 1998 fiscal period. This
adoption does not require that segment information be reported in interim
periods in the initial year, but that segment information is disclosed in the
following year for comparability purposes. The segmentation disclosure
requirements are under review by the Company's management.
N. BUSINESS ACQUISITION
On December 1, 1996, the Company purchased the net assets of FINOVA Acquisition
I, Inc. for approximately $620,000,000. The business acquired under a stock
purchase agreement provides equipment leases, loans and related services to
manufacturers and dealers and their customers. Goodwill totaling $59,201,000,
was recorded as part of this acquisition. The December 1996 financial
operations of this leasing/loan business is included in the Company's December
31, 1996 financial statements.
O. SUBSEQUENT EVENTS
During the fourth quarter of 1997 and in early 1998 the Company's senior
unsecured debt ratings and short-term debt ratings were lowered by each of the
credit rating agencies which provide ratings on the Company's debt. As a result
of these ratings actions the Company has, in 1998, substantially curtailed its
issuance of commercial paper in favor of its master repurchase agreements.
In addition, effective February 10, 1998, the Company has substantially
restructured its unsecured bank credit agreements reducing the aggregate
commitment to $750,000,000 and renegotiating significant terms and covenants in
lieu of a waiver of certain representations required of the Company for purposes
of utilizing the credit line. This waiver/amendment expires on April 28, 1998.
Certain of the Company's master repurchase agreements have been amended in 1998
primarily to include financing for a broader range of receivables originated by
the Company. Additionally, aggregate master repurchase lines have been increased
to $3.8 billion.
In addition, on February 13, 1998 the Company closed on a $500 million line of
credit secured by its interest only securities. This line of credit matures on
February 12, 2000, with an option to extend for an additional one year term.
26
<PAGE>
QUARTERLY RESULTS OF OPERATIONS (unaudited)
-------------------------------------------
<TABLE>
<CAPTION>
First Second Third Fourth
quarter quarter quarter quarter
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
(dollars in thousands except per-share amounts)
1997:
Income $267,155 $317,145 $348,260 $158,900
Net earnings (loss) 91,803 108,093 118,822 (17,322)
Diluted earnings (loss)
per share .65 .78 .85 (.12)
1996:
Income $168,118 $196,102 $219,665 $140,226
Net earnings (loss) 66,362 75,422 85,518 (26,528)
Diluted earnings (loss)
per share .48 .54 .61 (.19)
1995:
Income $128,199 $153,274 $174,374 $255,473
Net earnings 50,729 61,712 72,037 69,491
Diluted earnings per
share .36 .44 .51 .50
</TABLE>
27
<TABLE>
<CAPTION>
EXHIBIT 99.4
GREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
1998 1997
--------------- ---------------
(unaudited)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 888,743,000 $ 741,398,000
Cash deposits, restricted 234,194,000 247,237,000
Other investments 19,096,000 25,294,000
Interest only securities 1,412,280,000 1,363,200,000
Finance receivables 2,154,646,000 1,971,024,000
Other receivables 228,525,000 235,705,000
Servicing rights 111,823,000 96,311,000
Property, furniture and fixtures 121,164,000 112,404,000
Goodwill 55,399,000 56,095,000
Other assets 29,372,000 18,124,000
--------------- ---------------
Total assets $ 5,255,242,000 $ 4,866,792,000
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Notes payable $ 1,548,618,000 $ 1,355,995,000
Senior/Senior subordinated notes 510,484,000 510,316,000
Accounts payable and accrued liabilities 556,194,000 492,789,000
Investors payable 653,297,000 552,781,000
Deferred income taxes 637,430,000 622,771,000
--------------- ---------------
Total liabilities 3,906,023,000 3,534,652,000
Common stock, $.01 par; authorized 400,000,000
shares; issued 141,899,317 and
and 141,595,984 shares, respectively 1,419,000 1,416,000
Additional paid-in capital 445,190,000 435,570,000
Retained earnings 1,127,417,000 1,075,670,000
Accumulated other comprehensive income (loss):
Minimum pension liability adjustments (3,142,000) (3,142,000)
Unrealized gain on securities
available for sale, net 902,000 21,824,000
--------------- ---------------
1,571,786,000 1,531,338,000
Less treasury stock, 7,773,366 and 7,012,156
shares at cost (222,567,000) (199,198,000)
--------------- ---------------
Total stockholders' equity 1,349,219,000 1,332,140,000
--------------- ---------------
Total liabilities and stockholders' equity $ 5,255,242,000 $ 4,866,792,000
=============== ===============
See notes to unaudited financial statements.
</TABLE>
1
<PAGE>
GREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three months ended March 31,
---------------------------
1998 1997
------------ ------------
REVENUES:
Gain on sale of receivables $129,116,000 $153,367,000
Interest 100,991,000 75,429,000
Service 30,216,000 24,681,000
Commissions and other 25,431,000 13,678,000
------------ ------------
285,754,000 267,155,000
------------ ------------
EXPENSES:
Interest 48,492,000 29,818,000
Cost of servicing 26,974,000 19,379,000
General and administrative 107,912,000 69,889,000
------------ ------------
183,378,000 119,086,000
------------ ------------
EARNINGS BEFORE INCOME TAXES 102,376,000 148,069,000
INCOME TAXES 38,903,000 56,266,000
------------ ------------
NET EARNINGS $ 63,473,000 $ 91,803,000
============ ============
EARNINGS PER COMMON SHARE:
BASIC $ .47 $ .66
DILUTED $ .47 $ .65
See notes to unaudited financial statements.
2
<PAGE>
GREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(unaudited, dollars in thousands)
<TABLE>
<CAPTION>
Accumulated
Additional other Total
Common paid-in Treasury comprehensive Retained stockholders'
stock capital stock income (loss) earnings equity
----------- ----------- ----------- -------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCES, December 31, 1996 $ 1,398 $ 373,573 $ (53,913) $ (2,299) $ 818,733 $ 1,137,492
Comprehensive income, net of tax:
Net earnings -- -- -- -- 91,803 91,803
Unrealized loss on securities,
net of applicable
income taxes ($17,080) -- -- -- (27,867) -- (27,867)
-----------
Total comprehensive income 63,936
Common stock issuance of
1,300,000 shares 13 51,761 -- -- -- 51,774
Cost of 1,017,000 shares of
treasury stock acquired -- -- (36,688) -- -- (36,688)
Dividends on common stock -- -- -- -- (10,430) (10,430)
----------- ----------- ----------- ----------- ----------- -----------
BALANCES, March 31, 1997 $ 1,411 $ 425,334 $ (90,601) $ (30,166) $ 900,106 $ 1,206,084
=========== =========== =========== =========== =========== ===========
BALANCES, December 31, 1997 $ 1,416 $ 435,570 $ (199,198) $ 18,682 $ 1,075,670 $ 1,332,140
Comprehensive income, net of tax:
Net earnings -- -- -- -- 63,473 63,473
Unrealized loss on securities,
net of applicable
income taxes ($12,823) -- -- -- (20,922) -- (20,922)
-----------
Total comprehensive income 42,551
Stock warrants issuance -- 7,687 -- -- -- 7,687
Common stock issuance of
303,000 shares 3 1,933 -- -- -- 1,936
Cost of 761,210 shares of
treasury stock acquired -- -- (23,369) -- -- (23,369)
Dividends on common stock -- -- -- -- (11,726) (11,726)
----------- ----------- ----------- ----------- ----------- -----------
BALANCES, March 31, 1998 $ 1,419 $ 445,190 $ (222,567) $ (2,240) $ 1,127,417 $ 1,349,219
=========== =========== =========== =========== =========== ===========
See notes to unaudited financial statements.
</TABLE>
3
<PAGE>
GREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Three months ended March 31,
----------------------------------
1998 1997
------------- ----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Servicing fees and net interest
payments collected on sold loans $ 84,070,000 $ 78,009,000
Net principal payments collected on sold loans 128,678,000 64,067,000
Interest on unsold loans 50,972,000 46,166,000
Interest on cash and investments 14,540,000 8,539,000
Commissions 19,160,000 11,501,000
Other 13,322,000 (2,523,000)
--------------- ---------------
310,742,000 205,759,000
--------------- ---------------
Cash paid to employees and suppliers (132,988,000) (126,443,000)
Interest paid on debt (40,571,000) (20,251,000)
Income taxes paid (10,114,000) (7,430,000)
--------------- ---------------
(183,673,000) (154,124,000)
--------------- ---------------
NET CASH PROVIDED BY OPERATIONS 127,069,000 51,635,000
Purchase of loans and leases (2,766,690,000) (2,087,204,000)
Proceeds from sale of loans and leases 2,607,081,000 1,809,087,000
Principal collections on unsold loans and leases 102,141,000 178,880,000
Commercial and revolving credit loans disbursed (1,692,443,000) (839,249,000)
Principal collections on commercial and revolving credit loans 1,262,226,000 757,492,000
Proceeds from sale of commercial and revolving credit loans 317,840,000 --
Net cash deposits provided as credit enhancements 13,043,000 (4,249,000)
--------------- ---------------
NET CASH USED FOR
OPERATING ACTIVITIES (29,733,000) (133,608,000)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, furniture and fixtures (17,846,000) (10,084,000)
Net sales (purchases) of investment securities 6,198,000 (3,839,000)
--------------- ---------------
NET CASH USED FOR INVESTING
ACTIVITIES (11,648,000) (13,923,000)
--------------- ---------------
</TABLE>
4
<PAGE>
GREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued, unaudited)
<TABLE>
<CAPTION>
Three months ended March 31,
------------------------------------
1998 1997
--------------- -----------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings on credit facilities 2,553,788,000 1,921,498,000
Repayments on credit facilities (2,353,963,000) (1,659,804,000)
Common stock issued 627,000 475,000
Common stock repurchased -- (36,688,000)
Dividends paid (11,726,000) (10,430,000)
--------------- ---------------
NET CASH PROVIDED BY
FINANCING ACTIVITIES 188,726,000 215,051,000
--------------- ---------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 147,345,000 67,520,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 741,398,000 442,071,000
--------------- ---------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 888,743,000 $ 509,591,000
=============== ===============
RECONCILIATION OF NET EARNINGS TO NET CASH
USED FOR OPERATING ACTIVITIES:
Net earnings $ 63,473,000 $ 91,803,000
Deferred income taxes 38,903,000 56,266,000
Valuation adjustments of interest only securities 47,000,000 --
Depreciation and amortization 10,669,000 7,556,000
Net loan payments collected, less interest only securities
and servicing rights recorded (11,746,000) (50,189,000)
Amortization of servicing rights 4,947,000 2,569,000
Accretion of yield on interest only securities (33,384,000) (25,257,000)
Net decrease (increase) in cash deposits 13,043,000 (4,249,000)
Purchase of loans and leases,
net of sales and principal collections (72,367,000) (99,237,000)
Commercial and revolving loans disbursed, net of
sales and principal collections (109,816,000) (81,757,000)
Net selling expenses on sale of loans 30,786,000 10,897,000
Interest payable increase 7,128,000 8,434,000
Income taxes paid (10,114,000) (7,430,000)
Decrease in amounts payable to employees and suppliers (7,977,000) (43,598,000)
Decrease (increase) in other receivables 2,570,000 (5,033,000)
Other (2,848,000) 5,617,000
--------------- ---------------
NET CASH USED FOR
OPERATING ACTIVITIES ($ 29,733,000) ($ 133,608,000)
=============== ===============
See notes to unaudited financial statements.
</TABLE>
5
<PAGE>
GREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED FINANCIAL STATEMENTS
A. BASIS OF PRESENTATION
The interim financial statements have been prepared by Green Tree Financial
Corporation (the "Company"), without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission applicable to quarterly
reports on Form 10-Q. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. In the opinion of management, all adjustments which are of a normal
recurring nature and are necessary for a fair presentation have been included.
However, results for interim periods are not necessarily indicative of the
results that may be expected for a full year. It is suggested that these
financial statements be read in conjunction with the consolidated financial
statements and related notes and schedules included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997.
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130
establishes standards for reporting and presentation of comprehensive income and
its components in a full set of financial statements. Comprehensive income
includes all changes in stockholders' equity except those arising from
transactions with shareholders. The new standard requires only additional
disclosures in the consolidated financial statements; it does not affect the
Company's financial position or results of operations.
6
<PAGE>
B. INTEREST ONLY SECURITIES
The activity in interest only securities for the three months ended March 31,
1998 is summarized as follows:
Balance at beginning of period $1,363,200,000
Additions 164,349,000
Yield on interest only securities 33,384,000
Net cash collected (67,908,000)
Realized writedown of interest only
securities (47,000,000)
Unrealized writedown of interest
only securities (33,745,000)
----------------
Balance at end of period $1,412,280,000
================
In 1995 and previous years, the Company sold a substantial portion of its
interest only securities related to manufactured housing securitization
transactions between 1978 and 1995 in the form of securitized Net Interest
Margin Certificates. The Company retained a subordinated interest in the cash
flow of the interest only securities sold. These interests are included in
interest only securities and total $79,357,000 at March 31, 1998.
Generally, interest only securities relate to the sale of closed end
manufactured housing, home equity, home improvement, consumer and equipment
finance receivables. The Company's interest only securities are subject to a
substantial amount of credit loss and prepayment risk related to the receivables
sold. In connection with the valuation of interest only securities, the Company
has provided for approximately $946,060,000 of credit losses as of March 31,
1998. On a nondiscounted basis the amount of credit losses provided for in
connection with the valuation of the interest only securities is approximately
$1,399,149,000. These estimated losses if realized, would reduce the amount of
cash flows available to the interest only securities and are considered in the
Company's valuation processes.
The weighted average interest rate used to discount expected future cash flows
of the interest only securities is 11.60% as of March 31, 1998.
7
<PAGE>
The table below details information pertinent to the valuation of the interest
only securities as of March 31, 1998.
<TABLE>
<CAPTION>
Manufactured Home Equity/ Consumer/
Housing Home Improvement Equipment Total
--------------- ---------------- ------------- ----------------
<S> <C> <C> <C> <C>
Interest only securities carrying amount $ 872,578,000 396,498,000 143,204,000 $ 1,412,280,000
Unpaid principal balance of sold receivables $18,186,731,000 5,004,964,000 2,655,252,000 $25,846,947,000
Weighted average customer interest rate on
sold receivables 10.46% 11.85% 11.12%
Approximate expected weighted average constant
prepayment rate as a percentage
of unpaid principal balance of sold
receivables (1) 9.75% 25.0% 22.0%
Approximate remaining expected non
discounted credit losses as a percentage
of unpaid principal balance of sold
receivables (1) 6.2% 4.4% 2.0%
</TABLE>
(1) Valuation of the Company's interest only securities is impacted not only
by the projected level of prepayments of principal and net credit losses,
as shown above, but also by the projected timing of such prepayments and
net credit losses. Should the timing of projected prepayments of principal
or net credit losses differ materially from the timing projected by the
Company, such timing could have a material effect on the valuation of the
interest only securities.
8
<PAGE>
C. FINANCE RECEIVABLES
Finance receivables consisted of the following:
March 31, 1998 December 31,1997
-------------- ----------------
Lease $ 267,987,000 $ 191,572,000
Commercial Finance 632,172,000 683,691,000
Revolving Credit Card 324,795,000 165,151,000
Loans Held For Sale 929,692,000 930,610,000
-------------- --------------
Total $2,154,646,000 $1,971,024,000
============== ==============
D. SERVICING RIGHTS
The activity in servicing rights for the period ended March 31, 1998 is
summarized as follows:
Balance at beginning of period $ 96,311,000
Additions 20,459,000
Amortization ( 4,947,000)
--------------
Balance at end of period $ 111,823,000
==============
E. EARNINGS PER SHARE
Basic earnings per share is computed by dividing net earnings by the weighted
average number of shares of Common Stock outstanding during each period. Diluted
earnings per share is computed by dividing net earnings by the weighted average
number of shares of Common Stock and potential Common Stock outstanding during
each period. The following table presents the earnings per share data. Options
to purchase 5,529,469 and 298,544 shares are excluded from the computation of
diluted earnings per common share because of their anti-dilutive effect, as the
exercise price of the option exceeds the average market price of the Common
Stock for the three months ended March 31, 1998 and 1997, respectively.
Three months ended March 31,
---------------------------
1998 1997
------------ ------------
Net Earnings $ 63,473,000 $ 91,803,000
============ ============
Weighted average Common Stock
outstanding 134,236,605 138,511,310
Effect of dilutive securities:
Options 1,463,317 3,708,253
Warrants 119,981 --
------------ ------------
Diluted Common Stock 135,819,903 142,219,563
============ ============
Earnings per common share:
Basic $ .47 $ .66
Diluted $ .47 $ .65
9
<PAGE>
F. STOCKHOLDERS' EQUITY
STOCK OPTION PLANS
The Company has three stock option plans: two employee stock option plans and an
outside director plan. In 1992, the Board of Directors approved a supplemental
stock option plan for its outside directors. In 1995, the Company's stockholders
approved an Employee Stock Incentive Plan. In 1998 the Board of Directors
approved a Company Stock Option Plan for issuances of stock options to non-
officer employees.
Options for 864,520 shares were available for future grant under these plans.
The Company's Board of Directors has reserved 11,149,252 shares for future
issuance under all plans as of March 31, 1998.
A summary of the stock option plan activity is as follows:
Number of Weighted Average
Shares Exercise Price
---------- -----------------
Outstanding at December 31, 1997 9,910,465 $25.98
Granted 835,500 23.00
Exercised (303,333) 12.87
Expired (156,900) 30.92
----------
Outstanding at March 31, 1998 10,285,732 $23.04
==========
Of the 10,285,732 options outstanding at March 31, 1998, 10,145,732 options
relate to the employee and chief executive stock option plans and 140,000
options relate to the outside director plan.
On March 1, 1998, the Company offered to reprice certain employee stock options
to the current market price on March 1, 1998. The offer was not extended to the
six most senior executive officers. Employees accepting this offer agreed to a
revised vesting schedule and an exercise price of $23.00, representing the
market price at March 1, 1998. Approximately 2.8 million options were repriced.
10
<PAGE>
A summary of stock options outstanding and exercisable at March 31, 1998 is as
follows:
Options Outstanding:
Range of Number Remaining Weighted Average
Exercise Prices Outstanding Contractual Life Exercise Price
- - ----------------- ------------- ---------------- -------------------
$ 2.97-22.50 1,714,332 4.17 $ 6.46
23.00-23.00 3,639,500 9.92 23.00
23.38-30.50 2,350,300 7.68 25.52
30.88-33.38 2,323,000 7.90 31.21
33.50-47.00 258,600 9.17 37.61
----------- --------- ---- -------
$ 2.97-47.00 10,285,732 7.97 $ 23.04
Options Exercisable:
Range of Number Weighted Average
Exercise Prices Exercisable Exercise Price
- - ------------------- ----------- -----------------
$ 2.97-22.50 1,563,665 $ 5.45
23.00-23.00 0 0.00
23.38-30.50 824,300 25.01
30.88-33.38 493,000 31.31
33.50-47.00 57,600 38.10
-------------- ---------- -------
$ 2.97-47.00 2,938,565 $ 15.92
WARRANTS
On February 13, 1998, the Company issued warrants to purchase 2.7 million common
shares at $22.75 per share to the provider of a credit facility secured by the
Company's interest only securities. The warrant expires on the later of February
13, 2000 or 90 days after the credit facility has been paid in full. The Company
has the option to call and repurchase the warrant for $15.00 per warrant share
regardless of the closing price of the common shares at the call date.
11
