================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to ____
Commission File Number 1-9250
Conseco, Inc.
Indiana No. 35-1468632
---------------------- -------------------------------
State of Incorporation IRS Employer Identification No.
11825 N. Pennsylvania Street
Carmel, Indiana 46032 (317) 817-6100
- -------------------------------------- --------------
Address of principal executive offices Telephone
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days: Yes [ X ] No [ ]
Shares of common stock outstanding as of May 10, 2000: 325,264,121
================================================================================
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
ASSETS
March 31, December 31,
2000 1999
---- ----
(unaudited)
<S> <C> <C>
Investments:
Actively managed fixed maturities at fair value (amortized cost: 2000 - $23,829.5;
1999 - $23,690.4)........................................................................ $22,214.4 $22,203.8
Interest-only securities at fair value (amortized cost: 2000 - $929.0; 1999 - $916.2)...... 889.7 905.0
Equity securities at fair value (cost: 2000 - $355.1; 1999 - $323.7)....................... 360.8 312.7
Mortgage loans............................................................................. 1,294.7 1,274.5
Policy loans............................................................................... 660.2 664.1
Venture capital investments at fair value (cost: 2000 - $149.4; 1999 - $142.5)............. 656.0 527.5
Other invested assets ..................................................................... 657.5 544.0
--------- ---------
Total investments...................................................................... 26,733.3 26,431.6
Cash and cash equivalents..................................................................... 1,064.4 1,686.9
Accrued investment income..................................................................... 484.7 436.0
Finance receivables........................................................................... 6,184.7 5,104.1
Finance receivables - securitized............................................................. 6,505.7 4,730.5
Cost of policies purchased.................................................................... 2,144.5 2,258.5
Cost of policies produced..................................................................... 2,212.2 2,087.4
Reinsurance receivables....................................................................... 729.1 728.6
Income tax assets............................................................................. 215.8 209.8
Goodwill...................................................................................... 3,900.4 3,927.8
Assets held in separate accounts and investment trust ........................................ 2,686.3 2,231.4
Cash held in segregated accounts for investors................................................ 789.9 853.0
Other assets.................................................................................. 1,817.8 1,500.3
--------- ---------
Total assets........................................................................... $55,468.8 $52,185.9
========= =========
</TABLE>
(continued on next page)
The accompanying notes are an integral part of the
consolidated financial statements.
2
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET, continued
(Dollars in millions)
LIABILITIES AND SHAREHOLDERS' EQUITY
March 31, December 31,
2000 1999
---- ----
(unaudited)
<S> <C> <C>
Liabilities:
Liabilities for insurance and asset accumulation products:
Interest-sensitive products.............................................................. $17,108.9 $17,322.4
Traditional products..................................................................... 7,719.2 7,537.3
Claims payable and other policyholder funds.............................................. 1,034.2 1,042.3
Liabilities related to separate accounts and investment trust............................ 2,686.3 2,231.4
Liabilities related to certificates of deposit........................................... 1,355.3 870.5
Investor payables.......................................................................... 789.9 853.0
Other liabilities.......................................................................... 1,592.4 1,498.7
Investment borrowings...................................................................... 298.6 828.9
Notes payable and commercial paper:
Corporate................................................................................ 2,746.1 2,481.8
Finance.................................................................................. 5,562.5 4,682.5
Related to securitized finance receivables structured as collateralized borrowings....... 6,520.7 4,641.8
--------- ---------
Total liabilities.................................................................... 47,414.1 43,990.6
--------- ---------
Minority interest:
Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts..................................................................... 2,641.8 2,639.1
Shareholders' equity:
Preferred stock............................................................................ 481.3 478.4
Common stock and additional paid-in capital (no par value, 1,000,000,000 shares
authorized, shares issued and outstanding: 2000 - 325,264,121;
1999 - 327,678,638)...................................................................... 2,889.5 2,987.1
Accumulated other comprehensive loss....................................................... (876.4) (771.6)
Retained earnings.......................................................................... 2,918.5 2,862.3
--------- ---------
Total shareholders' equity........................................................... 5,412.9 5,556.2
--------- ---------
Total liabilities and shareholders' equity........................................... $55,468.8 $52,185.9
========= =========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
3
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(Dollars in millions except per share amounts)
(unaudited)
Three months ended
March 31,
-------------------
2000 1999
---- ----
<S> <C> <C>
Revenues:
Insurance policy income....................................................................... $1,048.7 $1,007.4
Net investment income......................................................................... 1,060.9 667.7
Gain on sale of finance receivables........................................................... - 199.2
Net gains (losses) from sale of investments................................................... (35.3) 1.0
Fee revenue and other income.................................................................. 131.6 111.3
-------- --------
Total revenues............................................................................ 2,205.9 1,986.6
-------- --------
Benefits and expenses:
Insurance policy benefits..................................................................... 1,067.5 889.7
Provision for losses.......................................................................... 82.0 21.3
Interest expense.............................................................................. 257.7 110.6
Amortization.................................................................................. 198.3 151.4
Other operating costs and expenses............................................................ 406.1 308.6
Impairment charge............................................................................. 2.5 12.2
-------- --------
Total benefits and expenses............................................................... 2,014.1 1,493.8
-------- --------
Income before income taxes and minority interest.......................................... 191.8 492.8
Income tax expense............................................................................... 75.4 174.8
-------- --------
Income before minority interest........................................................... 116.4 318.0
Minority interest:
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, net of income taxes.............................. 39.0 30.2
-------- --------
Net income................................................................................ 77.4 287.8
Preferred stock dividends........................................................................ 4.2 .6
-------- --------
Net income applicable to common stock..................................................... $ 73.2 $ 287.2
======== ========
Earnings per common share:
Basic:
Weighted average shares outstanding.........................................................327,302,800 320,645,000
=========== ===========
Net income.................................................................................. $.22 $.90
==== ====
Diluted:
Weighted average shares outstanding.........................................................356,700,700 331,108,600
=========== ===========
Net income.................................................................................. $.22 $.87
==== ====
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
4
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
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, January 1, 2000............................. $5,556.2 $ 478.4 $2,987.1 $(771.6) $2,862.3
Comprehensive income (loss), net of tax:
Net income...................................... 77.4 - - - 77.4
Change in unrealized depreciation of
investments (net of applicable income tax
benefit of $37.1)............................. (104.8) - - (104.8) -
--------
Total comprehensive loss.................... (27.4)
Issuance of common shares......................... 5.0 - 5.0 - -
Issuance of convertible preferred shares.......... 2.9 2.9 - - -
Cost of shares acquired........................... (102.6) - (102.6) - -
Dividends on common stock......................... (17.0) - - - (17.0)
Dividends on preferred stock...................... (4.2) - - - (4.2)
-------- ------- -------- ------- --------
Balance, March 31, 2000.............................. $5,412.9 $ 481.3 $2,889.5 $(876.4) $2,918.5
======== ======= ======== ======= ========
Balance, January 1, 1999............................. $5,273.6 $ 105.5 $2,736.5 $ (28.4) $2,460.0
Comprehensive income, net of tax:
Net income...................................... 287.8 - - - 287.8
Change in unrealized depreciation of
investments (net of applicable income tax
benefit of $107.8)............................ (199.7) - - (199.7) -
--------
Total comprehensive income.................. 88.1
Conversion of preferred stock into
common shares .................................. - (105.5) 105.5 - -
Issuance of shares for stock options and for
employee benefit plans.......................... 69.9 - 69.9 - -
Tax benefit related to issuance of shares under
stock option plans.............................. 24.2 - 24.2 - -
Cost of shares acquired........................... (89.2) - (89.2) - -
Dividends on common stock......................... (45.2) - - - (45.2)
Dividends on preferred stock...................... (.6) - - - (.6)
-------- ------- -------- ------- --------
Balance, March 31, 1999.............................. $5,320.8 $ - $2,846.9 $(228.1) $2,702.0
======== ======= ======== ======= ========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
5
<PAGE>
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in millions)
(unaudited)
Three months ended
March 31,
----------------------
2000 1999
---- ----
<S> <C> <C>
Cash flows from operating activities:
Insurance policy income................................................................... $ 1,038.2 $ 994.4
Net investment income..................................................................... 921.2 701.5
Points and origination fees............................................................... - 110.5
Fee revenue and other income.............................................................. 133.4 113.7
Insurance policy benefits................................................................. (893.7) (842.6)
Interest expense.......................................................................... (212.0) (101.1)
Policy acquisition costs.................................................................. (227.0) (182.9)
Other operating costs..................................................................... (444.3) (351.7)
Taxes..................................................................................... (.1) (28.8)
--------- -------
Net cash provided by operating activities............................................... 315.7 413.0
-------- -------
Cash flows from investing activities:
Sales of investments...................................................................... 2,109.4 5,165.5
Maturities and redemptions of investments................................................. 187.2 333.3
Purchases of investments.................................................................. (2,883.9) (6,607.0)
Cash received from the sale of finance receivables, net of expenses....................... - 2,771.2
Principal payments received on finance receivables........................................ 2,160.0 1,644.5
Finance receivables originated............................................................ (5,054.0) (5,117.4)
Other..................................................................................... (249.1) (79.2)
-------- ---------
Net cash used by investing activities .................................................. (3,730.4) (1,889.1)
--------- ---------
Cash flows from financing activities:
Issuance of common and convertible preferred shares....................................... .4 9.4
Issuance of notes payable and commercial paper............................................ 6,185.1 4,447.7
Payments on notes payable and commercial paper............................................ (3,211.5) (3,807.5)
Payments for settlement of forward contract and to repurchase equity securities........... (102.6) (29.5)
Investment borrowings..................................................................... (530.3) 256.1
Amounts received for deposit products..................................................... 1,503.8 749.2
Withdrawals from deposit products......................................................... (959.1) (583.9)
Dividends and distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts......................................................... (93.6) (72.0)
--------- ---------
Net cash provided by financing activities............................................. 2,792.2 969.5
--------- ---------
Net decrease in cash and cash equivalents............................................. (622.5) (506.6)
Cash and cash equivalents, beginning of period............................................... 1,686.9 1,704.7
--------- ---------
Cash and cash equivalents, end of period..................................................... $ 1,064.4 $ 1,198.1
========= =========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
6
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
The following notes should be read together with the notes to the
consolidated financial statements included in the 1999 Form 10-K of Conseco,
Inc. ("we", "Conseco" or the "Company").
Conseco is a financial services holding company with subsidiaries operating
throughout the United States. Our insurance subsidiaries develop, market and
administer supplemental health insurance, annuity, individual life insurance,
individual and group major medical insurance and other insurance products. Our
finance subsidiaries originate, purchase, sell and service consumer and
commercial finance loans. On March 31, 2000, we announced that we plan to
explore the sale of Conseco Finance Corp. ("Conseco Finance"), a wholly owned
subsidiary of Conseco. If the planned sale is completed, the Company will no
longer have finance operations. No assurance can be provided as to the timing,
price, or other terms related to the possible sale of Conseco Finance. 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, to seek to achieve superior investment returns through active asset
management and to control expenses.
BASIS OF PRESENTATION
Our unaudited consolidated financial statements reflect all adjustments,
consisting only of normal recurring items, that 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. As permitted
by rules and regulations of the Securities and Exchange Commission applicable to
quarterly reports on Form 10-Q, we have condensed or omitted certain information
and disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles ("GAAP"). We have also
reclassified certain amounts from the prior periods to conform to the 2000
presentation. Results for interim periods are not necessarily indicative of the
results that may be expected for a full year.
When we prepare financial statements in conformity with GAAP, we are
required to make estimates and assumptions that significantly affect various
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements and revenues and
expenses during the reporting periods. For example, we use significant estimates
and assumptions in calculating values for cost of policies produced, the cost of
policies purchased, interest-only securities, servicing rights, goodwill,
liabilities for insurance and deposit products, liabilities related to
litigation, guaranty fund assessment accruals, gain on sale of finance
receivables, provision for losses and deferred income taxes. If our future
experience differs from these estimates and assumptions, our financial
statements could be materially affected.
Net income and diluted earnings per share, as previously reported in our
Form 10-Q, as amended, for the three months ended March 31, 1999, have been
restated to reflect adjustments, principally related to: (i) impairment charges
relating to interest-only securities and servicing rights; (ii) delaying the
recognition of revenue from sales of loans to certain commercial paper conduit
trusts until the loans were subsequently placed in their final securitization
structures; and (iii) adjusting loan origination cost deferrals. These changes
decreased previously reported net income by $9.3 million, or $.03 per diluted
share, in the first quarter of 1999.
Our consolidated financial statements exclude the results of material
transactions between us and our consolidated affiliates, or among our
consolidated affiliates.
ACCOUNTING FOR INVESTMENTS
We classify our fixed maturity securities into three categories: (i)
"actively managed" (which we carry at estimated fair value); (ii) "trading"
(which we carry at estimated fair value); and (iii) "held to maturity" (which we
carry at amortized cost). We held $52.0 million of trading securities at March
31, 2000, which we included in other invested assets. We had no fixed maturity
securities in the held to maturity category at March 31, 2000.
7
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Accumulated other comprehensive loss is primarily comprised of unrealized
losses on actively managed fixed maturity investments. Such amounts, included in
shareholders' equity as of March 31, 2000 and December 31, 1999, were as
follows:
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Unrealized losses on investments...................................................... $(1,647.9) $(1,504.3)
Adjustments to cost of policies purchased and cost of policies produced............... 292.5 291.2
Deferred income tax benefit........................................................... 480.5 443.4
Other................................................................................. (1.3) (1.7)
--------- ---------
Net unrealized losses on investments............................................. (876.2) (771.4)
Minimum pension liability adjustment, net of income tax benefit...................... (.2) (.2)
--------- ---------
Accumulated other comprehensive loss............................................. $ (876.4) $ (771.6)
========= =========
</TABLE>
VENTURE CAPITAL INVESTMENTS
Venture capital investments include equity and equity-type investments made
by our subsidiary which engages in venture capital investment activity. At the
time we enter into these investments, we believe they have high growth or
appreciation potential. These investments are carried at estimated fair value,
with changes in fair value recognized as investment income. When these venture
capital investments are publicly traded, the fair value is generally based upon
market prices. When liquidity is limited because of thinly traded securities,
limited partnership structures, large-block holdings, restricted shares or other
special situations, we adjust quoted market prices to produce an estimate of the
attainable fair values. We estimate the fair values of securities that are not
publicly traded based upon transactions which directly affect the value of such
securities and consideration of the investee's financial results, conditions and
prospects.
During 1999, we invested $53.2 million in a company in the wireless
communication business. The market values of many companies in this sector
increased significantly in 1999 and early 2000. In the fourth quarter of 1999,
our investee sold shares of common stock to the public in an initial public
offering. As a result, an ascertainable market value was established for our
investment, which we adjusted to recognize liquidity restrictions. We recognized
venture capital income of $105.1 million in the first quarter of 2000 related to
this investment, bringing the total carrying value of our investment to $545.1
million.
FINANCE RECEIVABLES AND INTEREST-ONLY SECURITIES
On September 8, 1999, we announced that we would no longer structure our
securitizations in a manner that results in recording a sale of the loans.
Instead, we are using the portfolio method to account for securitization
transactions structured after that date. Our new securitizations are structured
to include provisions that entitle the Company to repurchase assets transferred
to the special purpose entity when the aggregate unpaid principal balance
reaches a specified level. Until these assets are repurchased, however, the
assets are the property of the special purpose entity and are not available to
satisfy claims of creditors of the Company. Pursuant to SFAS 125, such
securitization transactions are accounted for under the portfolio method,
whereby the loans and securitization debt remain on our balance sheet, rather
than as sales.
We classify the finance receivables transferred to the securitization
trusts and held as collateral for the notes issued to investors as finance
receivables-securitized. We are generally able to repurchase these receivables
from the trust when the aggregate unpaid principal balance reaches 20 percent of
the initial principal balance of the finance receivables. The average interest
rate earned on these receivables at March 31, 2000, was approximately 11.7
percent. We classify the notes issued to investors in the securitization trusts
as "notes payable related to securitized finance receivables structured as
collateralized borrowings".
8
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Following our March 31, 2000, announcement regarding the plan to explore
the sale of Conseco Finance and the other events described in the note entitled
"Subsequent Events" which follows and elsewhere herein, the uncertainty
surrounding the ultimate outcome of Conseco's plan has made it more difficult to
complete new public securitization transactions. We are currently funding loans
through our warehouse and bank credit facilities and expect to commence offering
securities in public or private securitization transactions in the near future.
We are also exploring other possible transactions such as whole loan sales. In
May 2000, we sold $1.3 billion of finance receivables to Lehman Brothers and its
affiliates (see "Subsequent Events").
Finance receivables-securitized, summarized by type, were as follows at
March 31, 2000 and December 31, 1999:
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Manufactured housing.................................................................. $1,646.9 $ 953.0
Mortgage services..................................................................... 3,245.9 2,077.3
Consumer/credit card.................................................................. 1,000.5 1,076.9
Commercial............................................................................ 637.0 637.0
-------- --------
6,530.3 4,744.2
Less allowance for credit losses...................................................... 24.6 13.7
-------- --------
Net finance receivables-securitized........................................... $6,505.7 $4,730.5
======== ========
</TABLE>
The other finance receivables, summarized by type, were as follows:
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Manufactured housing.................................................................. $1,318.1 $ 795.8
Mortgage services..................................................................... 1,521.9 1,277.0
Consumer/credit card.................................................................. 2,473.8 824.7
Commercial............................................................................ 965.4 2,281.3
-------- --------
6,279.2 5,178.8
Less allowance for credit losses...................................................... 94.5 74.7
-------- --------
Net finance receivables....................................................... $6,184.7 $5,104.1
======== ========
</TABLE>
The changes in the allowance for credit losses included in finance
receivables were as follows:
<TABLE>
<CAPTION>
Three months ended
March 31,
-------------------
2000 1999
---- -----
(Dollars in millions)
<S> <C> <C>
Allowance for credit losses, beginning of period................................................. $ 88.4 $ 43.0
Provision for losses............................................................................. 58.6 21.3
Credit losses.................................................................................... (27.9) (11.2)
------ ------
Allowance for credit losses, end of period....................................................... $119.1 $ 53.1
====== ======
</TABLE>
9
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
The securitizations structured prior to our September 8, 1999, announcement
met the applicable criteria to be accounted for as sales. At the time the loans
were securitized and sold, we recognized a gain and recorded our retained
interest represented by the interest-only security. The interest-only security
represents the right to receive, over the life of the pool of receivables, the
excess of the principal and interest received on the receivables transferred to
the special purpose entity over the sum of: (i) principal and interest paid to
the holders of other interests in the securitization; and (ii) contractual
servicing fees. In some of those securitizations, we also retained certain
lower-rated securities that are senior in payment priority to the interest-only
securities. Such retained securities had a par value, fair market value and
amortized cost of $769.8 million, $472.0 million and $713.7 million,
respectively, at March 31, 2000, and were classified as actively managed fixed
maturity securities. In addition, our insurance subsidiaries purchased
securities backed by the loans originated by Conseco Finance.
During the first three months of 1999, the Company sold $2.7 billion, of
finance receivables in various securitized transactions and recognized gains of
$199.2 million. There were no such sales during the first three months of 2000.
The interest-only securities on our consolidated balance sheet represent an
allocated portion of the cost basis of the finance receivables in the
securitization transactions accounted for as sales related to transactions
structured prior to September 8, 1999. We used the following assumptions to
adjust the amortized cost to estimated fair value at March 31, 2000 and December
31, 1999. The difference between estimated fair value and the amortized cost of
the interest-only securities is included in accumulated other comprehensive
loss, net of taxes.
<TABLE>
<CAPTION>
Manufactured Home equity/ Consumer/
March 31, 2000 housing home improvement equipment Total
- -------------- ------- ---------------- --------- -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Interest-only securities at fair value...............$ 538.1 $ 295.6 $ 56.0 $ 889.7
Cumulative principal balance of sold finance
receivables at March 31, 2000..................... 22,105.4 8,200.5 2,666.1 32,972.0
Weighted average stated customer interest rate
on sold finance receivables....................... 10.0% 11.5% 10.9%
Assumptions to determine estimated fair value
of interest-only securities at March 31, 2000:
Expected weighted average annual constant
prepayment rate as a percentage of principal
balance of related finance receivables (a).... 9.4% 21.4% 22.4%
Expected nondiscounted credit losses as a
percentage of principal balance of
related finance receivables (a)............... 8.8% 5.9% 5.1%
Weighted average discount rate ................. 14.0% 14.0% 14.0%
</TABLE>
10
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
<TABLE>
<CAPTION>
Manufactured Home equity/ Consumer/
December 31, 1999 housing home improvement equipment Total
- ----------------- ------- ---------------- --------- -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Interest-only securities at fair value............... $ 528.3 $ 318.0 $ 58.7 $ 905.0
Cumulative principal balance of sold finance
receivables at December 31, 1999.................. 22,854.6 8,804.8 3,049.4 34,708.8
Weighted average stated customer interest rate on
sold finance receivables.......................... 10.0% 11.5% 11.0%
Assumptions to determine estimated fair value of
interest-only securities at December 31, 1999:
Expected weighted average annual constant
prepayment rate as a percentage of principal
balance of related finance receivables (a).... 9.4% 21.7% 22.4%
Expected nondiscounted credit losses as a
percentage of principal balance of related
finance receivables (a)....................... 9.0% 5.8% 5.1%
Weighted average discount rate.................. 14.0% 14.0% 14.0%
<FN>
- --------------------
(a) The valuation of interest-only securities is affected not only by the
projected level of prepayments of principal and net credit losses, but also
by the projected timing of such prepayments and net credit losses. Should
such timing differ materially from our projections, it could have a
material effect on the valuation of our interest-only securities.
Additionally, such valuation is determined by discounting cash flows over
the entire expected life of the receivables sold.
</FN>
</TABLE>
Activity in the interest-only securities account was as follows:
<TABLE>
<CAPTION>
Three months ended
March 31,
--------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Balance, beginning of period................................................ $905.0 $1,305.4
Additions resulting from securitizations during the period............... - 137.5
Additions resulting from clean-up call (a)............................... 60.7 -
Investment income........................................................ 27.5 43.7
Cash received............................................................ (70.6) (123.5)
Impairment charge to reduce carrying value............................... (4.8) (11.3)
Change in unrealized depreciation charged to shareholders' equity........ (28.1) (14.8)
------ --------
Balance, end of period...................................................... $889.7 $1,337.0
====== ========
<FN>
- --------------------
(a) During the first quarter of 2000, clean-up calls were exercised for four
securitizations that were previously recognized as sales. The interest-only
securities related to these securitizations had previously been separately
securitized with other interest-only securities in transactions recognized
as sales. The repurchase of the collateral underlying the four
securitizations triggered a requirement for the Company to repurchase a
portion of the interest-only securities.
</FN>
</TABLE>
11
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Credit quality of managed finance receivables was as follows:
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
---- ----
<S> <C> <C>
60-days-and-over delinquencies as a percentage
of managed finance receivables at period end............................ 1.32% 1.42%
==== ====
Net credit losses incurred during the last twelve months as a percentage
of average managed finance receivables during the period................ 1.39% 1.31%
==== ====
Repossessed collateral inventory as a percentage of managed finance
receivables at period end............................................... 1.36% 1.34%
==== ====
</TABLE>
EARNINGS PER SHARE
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,
-------------------
2000 1999
---- ----
(Dollars in millions
and shares in thousands)
<S> <C> <C>
Income:
Net income........................................................................... $77.4 $287.8
Preferred stock dividends............................................................ 4.2 .6
----- ------
Income applicable to common ownership for basic earnings per share................. 73.2 287.2
Effect of dilutive securities:
Preferred stock dividends............................................................ 4.2 .6
----- ------
Income applicable to common ownership and assumed conversions for
diluted earnings per share....................................................... $77.4 $287.8
===== ======
Shares:
Weighted average shares outstanding for basic earnings per share..................... 327,303 320,645
Effect of dilutive securities on weighted average shares:
Stock options...................................................................... 343 3,649
Employee benefit plans............................................................. 1,071 2,004
Preferred stock.................................................................... 26,079 1,769
Convertible securities............................................................. - 3,042
Forward purchase agreement......................................................... 1,905 -
------- -------
Dilutive potential common shares................................................. 29,398 10,464
------- -------
Weighted average shares outstanding for diluted earnings
per share.................................................................... 356,701 331,109
======= =======
</TABLE>
BUSINESS SEGMENTS
We manage our business operations through two segments, based on the
products offered.
Finance segment. Our finance segment provides a variety of finance products
including: loans for the purchase of manufactured housing, home improvements and
various consumer products; private label credit card programs; and commercial
loans such as floorplan and equipment financing. These products are primarily
marketed through intermediary
12
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
channels such as dealers, vendors, contractors and retailers. On March 31, 2000,
we announced that we plan to explore the sale of Conseco Finance. If the planned
sale is completed, the Company will no longer have finance operations.
Insurance and fee-based segment. Our insurance and fee-based segment
provides supplemental health, annuity, life, and individual and group major
medical products to a broad spectrum of customers through multiple distribution
channels, each focused on a specific market segment. These products are
primarily marketed through career agents, professional independent producers and
direct marketing. This segment also includes our venture capital investment
activity.
13
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Segment operating information was as follows:
<TABLE>
<CAPTION>
Three months ended
March 31,
--------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Revenues:
Insurance and fee-based segment:
Insurance policy income:
Annuities...................................................................... $ 33.0 $ 23.6
Supplemental health............................................................ 527.1 515.9
Life........................................................................... 223.3 219.6
Individual and group major medical............................................. 229.1 209.7
Other.......................................................................... 36.2 38.6
Net investment income (a)........................................................ 656.0 522.0
Fee revenue and other income (a)................................................. 32.4 28.7
Net gains (losses) from sale of investments (a).................................. (35.3) 1.0
-------- --------
Total insurance and fee-based segment revenues............................... 1,701.8 1,559.1
-------- --------
Finance segment:
Net investment income:
Interest-only securities (a)................................................... 27.5 43.7
Manufactured housing........................................................... 82.1 19.0
Mortgage services.............................................................. 129.6 21.0
Consumer/credit card........................................................... 96.4 33.3
Commercial..................................................................... 52.9 20.0
Other (a)...................................................................... 21.1 13.6
Gain on sale of finance receivables:
Manufactured housing........................................................... - 116.7
Mortgage services.............................................................. - 74.1
Commercial..................................................................... - 8.4
Fee revenue and other income..................................................... 99.2 82.6
-------- --------
Total finance segment revenues............................................... 508.8 432.4
-------- --------
Eliminations....................................................................... (4.7) (4.9)
-------- --------
Total revenues............................................................... 2,205.9 1,986.6
-------- --------
Expenses:
Insurance and fee-based segment:
Insurance policy benefits........................................................ 1,067.5 889.7
Amortization..................................................................... 197.5 150.6
Interest expense................................................................. 5.0 11.8
Other operating costs and expenses............................................... 194.1 145.0
-------- --------
Total insurance and fee-based segment expenses................................. 1,464.1 1,197.1
-------- --------
Finance segment:
Provision for losses............................................................. 58.6 21.3
Interest expense................................................................. 204.5 54.6
Impairment charge................................................................ 2.5 12.2
Other operating costs and expenses............................................... 209.9 160.7
-------- --------
Total finance segment expenses................................................. 475.5 248.8
-------- --------
</TABLE>
14
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
<TABLE>
<CAPTION>
Three months ended
March 31,
---------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
(continued from previous page)
Not allocated to segments:
Interest expense on corporate debt............................................... $ 53.0 $ 49.1
Provision for losses............................................................. 23.4 -
Other operating costs and expenses............................................... 2.8 3.7
-------- --------
Total expenses not allocated to segments..................................... 79.2 52.8
-------- --------
Eliminations....................................................................... (4.7) (4.9)
-------- --------
Total expenses............................................................... 2,014.1 1,493.8
-------- --------
Income (loss) before income taxes and minority interest:
Insurance operations............................................................. 237.7 362.0
Finance operations............................................................... 33.3 183.6
Corporate interest and other expenses............................................ (79.2) (52.8)
-------- --------
Income before income taxes and minority interest............................. $ 191.8 $ 492.8
======== ========
<FN>
- --------------------
(a) It is not practicable to provide additional components of revenue by
product or services.
</FN>
</TABLE>
STANDARD & POOR'S 500 INDEX CALL OPTIONS AND INTEREST RATE SWAP AGREEMENTS
Our equity-indexed annuity products provide a guaranteed base rate of
return and a higher potential return linked to the performance of the Standard &
Poor's 500 Index ("S&P 500 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 these products. Policyholder
account balances for these annuities fluctuate in relation to changes in the
values of these options. We reflect changes in the value of these options in net
investment income. During the first three months of 2000 and 1999, net
investment income included $22.7 million and $33.6 million, respectively,
related to these changes. Such investment income was substantially offset by
increases to policyholder account balances. The value of the S&P 500 Call
Options was $133.0 million at March 31, 2000. We classify such instruments as
other invested assets. We defer the premiums paid to purchase the S&P 500 Call
Options and amortize them to investment income over their terms. Such
amortization was $28.8 million and $20.1 million during the first three months
of 2000 and 1999, respectively. The unamortized premium of the S&P 500 Call
Options was $62.0 million at March 31, 2000.
We periodically use interest-rate swaps to hedge the interest rate risk
associated with our borrowed capital. At March 31, 2000, we held instruments
having an aggregate notional principal amount of $3.1 billion that effectively
convert a portion of our fixed-rate borrowed capital into floating-rate
instruments for specified periods of time. The agreements mature in various
years through 2008 and have an average remaining life of 3.4 years (the average
call date is 2.1 years). We record the difference between the rates as an
adjustment to interest expense. During the first three months of 2000, interest
expense was increased by $2.5 million as a result of these interest-rate swap
agreements. At March 31, 2000, such agreements had a fair value of $(48.9)
million.
Following our March 31, 2000, announcement regarding the plan to explore
the sale of Conseco Finance and other events described in the note entitled
"Subsequent Events" and elsewhere herein, ratings agencies lowered their ratings
on Conseco's debt (see "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity of Conseco"). These actions
triggered requirements for Conseco to terminate several swap agreements, or
provide cash
15
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
collateral equal to the current fair value of certain swap agreements. Conseco
paid approximately $40 million to terminate certain swap agreements, which will
be recognized as a loss in the quarter ended June 30, 2000. In addition, Conseco
provided $16 million of cash collateral related to certain other swap
agreements.
If the counterparties of these financial instruments fail to 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, 2000, all of the counterparties were rated
"A" or higher by Standard & Poor's Corporation.
GUARANTEES
In conjunction with certain sales of finance receivables, we provided
guarantees aggregating approximately $1.6 billion at March 31, 2000. We believe
the likelihood of a significant loss from such guarantees is remote.
We have guaranteed bank loans totaling $575.8 million to approximately 170
directors, officers and key employees. The funds were used by the participants
to purchase approximately 19.0 million Conseco shares in open market or
negotiated transactions with independent parties. Such shares are held by the
bank as collateral for the loans. The bank loans we have guaranteed are
scheduled to mature as follows: $150.0 million on May 31, 2000 and $425.8
million on August 30, 2001. The Company is currently negotiating with the bank
to extend the maturity date of the loan which becomes due on May 31, 2000. At
March 31, 2000, the guaranteed bank loans exceeded the value of the common stock
collateralizing the loans by $358.5 million. All participants have agreed to
indemnify Conseco for any loss incurred on their loans. In addition, Conseco has
provided loans to participants for interest on the bank loans totaling $54.9
million. We regularly evaluate these guarantees and loans in light of the
collateral and the creditworthiness of the participants. In the first quarter of
2000, we established a noncash provision of $23.4 million ($14.7 million after
tax) in connection with these guarantees and loans, which was included as a
component of the provision for losses. At March 31, 2000, the total reserve for
losses on the loan guarantees was $42.3 million.
The value of Conseco common stock has declined further since March 31,
2000. Based on the May 8, 2000, value of the Conseco common stock which serves
as collateral for the loans (based on $5.31 per share, the market price on such
date) and the most current information regarding the creditworthiness of the
participants (which was the same information used to determine the reserve for
losses on the loan guarantees at March 31, 2000), an additional estimated
noncash provision in the area of $100 million ($65 million after tax) would need
to be established. The provision established for the quarter ended June 30,
2000, will be based on the value of Conseco common stock and information
regarding the creditworthiness of the participants on that date.
REINSURANCE
The cost of reinsurance ceded totaled $78.0 million and $115.0 million in
the first three months of 2000 and 1999, respectively. We deducted this cost
from insurance policy income. Conseco is contingently liable for claims
reinsured if the assuming company is unable to pay. Reinsurance recoveries
netted against insurance policy benefits totaled $73.8 million and $118.2
million in the first three months of 2000 and 1999, respectively.
16
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
CHANGES IN CORPORATE NOTES PAYABLE AND COMMERCIAL PAPER (EXCLUDING NOTES
PAYABLE RELATED TO SECURITIZED FINANCE RECEIVABLES STRUCTURED AS
COLLATERALIZED BORROWINGS)
Notes payable and commercial paper (excluding notes payable related to
securitized finance receivables structured as collateralized borrowings) were as
follows (interest rates as of March 31, 2000):
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Bank credit facilities (6.19%)............................................... $ 700.0 $1,032.0
Commercial paper (6.34%)..................................................... 1,256.8 898.4
Master repurchase agreements due on various dates in 2000 (6.95%)............ 2,443.1 1,620.9
Credit facility collateralized by retained interests in securitizations due
2000 .................................................................... - 499.0
Medium term notes due April 2000 to April 2003 (6.53%)....................... 226.7 226.7
7.875% notes due 2000........................................................ 150.0 150.0
7.6% senior notes due 2001................................................... 118.9 118.9
6.4% notes due 2001 to 2003.................................................. 800.0 800.0
8.5% notes due 2002.......................................................... 450.0 450.0
10.25% senior subordinated notes due 2002.................................... 193.6 193.6
Notes payable due 2003 (6.63%)............................................... 250.0 250.0
8.75% notes due 2004......................................................... 800.0 -
6.8% senior notes due 2005................................................... 250.0 250.0
9.0% notes due 2006.......................................................... 550.0 550.0
Other........................................................................ 145.4 146.6
-------- --------
Total principal amount.................................................. 8,334.5 7,186.1
Unamortized net discount..................................................... 25.9 21.8
-------- --------
Total notes payable and commercial paper................................ $8,308.6 $7,164.3
======== ========
Total allocated to:
Corporate............................................................. $2,746.1 $2,481.8
Finance segment....................................................... 5,562.5 4,682.5
-------- --------
Total notes payable and commercial paper............................ $8,308.6 $7,164.3
======== ========
</TABLE>
Our current bank credit facilities allow us to borrow up to $2.3 billion,
of which $1.5 billion may be borrowed until 2003 and $.8 billion may be borrowed
until September 2000. Borrowings under these facilities averaged $836.4 million
during the first quarter of 2000, at a weighted average interest rate of 6.11
percent. The credit facility requires us to maintain various financial ratios,
as defined in the agreement, including: (i) a debt-to-total capitalization ratio
less than .45:1 (such ratio was .40:1 at March 31, 2000); and (ii) an interest
coverage ratio greater than 2.25:1 for the period October 1, 1999 through
September 30, 2001 and greater than 2.50:1 thereafter (such ratio was 4.08:1 for
the period ended March 31, 2000). We use unsecured bank credit facilities to
support our commercial paper program. The ultimate price we may receive from the
sale of Conseco Finance could affect such financial ratios.
The interest rates on our bank credit facilities are based on a LIBOR rate
plus a margin based on the credit rating of Conseco's senior unsecured notes.
Following our March 31, 2000, announcement regarding the plan to explore the
sale of Conseco Finance and other events described in the note entitled
"Subsequent Events" and elsewhere herein, rating agencies lowered their ratings
on Conseco's senior unsecured debt (see "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity of Conseco").
Accordingly, the weighted average interest rates under these bank credit
facilities increased .15 percent.
17
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Borrowings under our commercial paper program averaged $1,013.3 million
during the first quarter of 2000, at a weighted average interest rate of 6.1
percent. The actions by rating agencies which occurred after March 31, 2000 (see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity of Conseco"), have affected our ability to issue
commercial paper. Accordingly, we have curtailed its issuance in favor of
borrowing under our bank credit facilities.
On February 7, 2000, the Company completed the public offering of $800.0
million of 8.75 percent notes due February 9, 2004. The notes are unsecured and
rank equally with all other unsecured senior indebtedness of Conseco. Proceeds
from the offering of approximately $794.3 million (after underwriting discounts
and estimated offering expenses) were used to repay outstanding indebtedness.
At March 31, 2000, we had $6.7 billion in master repurchase agreements,
commercial paper conduit facilities and other facilities with various banking
and investment banking firms for the purpose of financing our consumer and
commercial finance loan production. These facilities typically provide financing
of a certain percentage of the underlying collateral and are subject to the
availability of eligible collateral and, in many cases, the willingness of the
banking firms to continue to provide financing. These agreements generally
provide for annual terms, some of which are extended either quarterly or
semi-annually by mutual agreement of the parties for an additional annual term
based upon receipt of updated quarterly financial information. At March 31,
2000, we had borrowed $3.7 billion of the $6.7 billion available under such
agreements.
NOTES PAYABLE RELATED TO SECURITIZED FINANCE RECEIVABLES STRUCTURED AS
COLLATERALIZED BORROWINGS
Notes payable related to securitized finance receivables structured as
collateralized borrowings were $6,520.7 million at March 31, 2000. The principal
and interest on these notes are paid using the cash flows from the underlying
finance receivables which serve as collateral for the notes. Accordingly, the
timing of the principal payments on these notes is dependent on the payments
received on the underlying finance receivables which back the notes. The average
interest rate on these notes at March 31, 2000 was 7.0 percent.
CHANGES IN PREFERRED STOCK
On December 15, 1999, we issued $500.0 million (2.6 million shares) of
Series F Common-Linked Convertible Preferred Stock (the "Series F Preferred
Stock") to Thomas H. Lee Company and affiliated investors. The Series F
Preferred Stock is convertible into Conseco common stock at a common equivalent
rate of $19.25 per share. The Series F Preferred Stock pays a 4 percent
dividend, of which an amount at least equal to the common dividend will be
payable in cash, and the remainder may be paid in additional Series F shares
valued at $19.25 per share. The Series F Preferred Stock rank senior to the
common stock outstanding and have a liquidation preference of $192.50 per share
plus all declared and unpaid dividends.
In February 1999, we redeemed all $105.5 million (carrying value) of
outstanding shares of Preferred Redeemable Increased Dividend Equity Securities,
7% PRIDES Convertible Preferred Stock ("PRIDES") in exchange for 5.9 million
shares of Conseco common stock.
18
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
CHANGES IN COMMON STOCK
Changes in the number of shares of common stock outstanding were as
follows:
<TABLE>
<CAPTION>
Three months ended
March 31,
-------------------
2000 1999
---- ----
(Shares in thousands)
<S> <C> <C>
Balance, beginning of period................................................................... 327,679 315,844
Stock options exercised..................................................................... 34 4,561
Common shares converted from PRIDES......................................................... - 5,904
Settlement of forward contract and common stock acquired.................................... (4,240) (2,896)
Shares issued under employee benefit compensation plans..................................... 1,791 49
------- -------
Balance, end of period......................................................................... 325,264 323,462
======= =======
</TABLE>
On June 30, 1999, we sold 3.1 million shares of our common stock to an
unaffiliated party (the "Buyer") at the then-current market value of $29.0625
per share. Simultaneous with the issuance of the common stock, we entered into a
forward transaction with the Buyer to be settled at $29.0625 per share in a
method of our choosing (i.e., we may select cash settlement, transfer of net
shares to or from the Buyer, or transfer of net cash to or from the Buyer). We
make payments to the Buyer equivalent to a total fixed return of LIBOR plus 65
basis points for the length of time the forward transaction is outstanding. We
settled the contract in March 2000 by repurchasing the shares held by the Buyer.
RECENTLY ISSUED ACCOUNTING STANDARDS
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"), as amended by
Statement of Financial Accounting Standards No. 137, "Deferral of the Effective
Date of FASB Statement No. 133" requires all derivative instruments to be
recorded on the balance sheet at estimated fair value. Changes in the fair value
of derivative instruments are to be recorded each period either in current
earnings or other comprehensive income, depending on whether a derivative is
designated as part of a hedge transaction and, if it is, on the type of hedge
transaction. We are currently evaluating the impact of SFAS 133, which is
required to be implemented in 2001. Because of ongoing changes to implementation
guidance, we do not plan on adopting the new standard until the first quarter of
2001.
LITIGATION
Conseco Finance was served with various related lawsuits filed in the
United States District Court for the District of Minnesota. These lawsuits were
generally filed as purported class actions on behalf of persons or entities who
purchased common stock or options to purchase common stock of Conseco Finance
during alleged class periods that generally run from February 1995 to January
1998. One action (Florida State Board of Admin. v. Green Tree Financial Corp.,
Case No. 98-1162) did not include class action claims. In addition to Conseco
Finance, certain current and former officers and directors of Conseco Finance
are named as defendants in one or more of the lawsuits. Conseco Finance and
other defendants obtained an order consolidating the lawsuits seeking class
action status into two actions, one of which pertains to a purported class of
common stockholders (In re Green Tree Financial Corp. Stock Litig., Case No.
97-2666) and the other which pertains to a purported class action of stock
option traders (In re Green Tree Financial Corp. Options Litig., Case No.
97-2679). 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 Conseco Finance 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 Conseco Finance (particularly with respect to
prepayment assumptions and performance of certain loan portfolios of Conseco
Finance) which allegedly rendered Conseco Finance's financial statements false
and misleading. On August 24, 1999, the United States District Court for the
District of Minnesota issued an order to dismiss with prejudice all claims
alleged in the lawsuits. The plaintiffs subsequently appealed the decision to
the U.S. Court of Appeals for the 8th Circuit, and the appeal is currently
pending. The Company believes that the lawsuits are without merit and intends to
continue to defend them vigorously. The ultimate outcome of these lawsuits
cannot be predicted with certainty.
19
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
A total of twenty-one suits have been filed against the Company in the
United States District Court for the Southern District of Indiana. Eleven of
these cases are putative class actions on behalf of persons or entities that
purchased the Company's common stock during alleged class periods that generally
run from April 1999 through April 2000. Luisi v. Conseco, Inc., et al., Case No.
IP00-C-0593-B/S; Sechrist v. Conseco, Inc., et al., Case No. IP00-C-0585-T/G;
Klein v. Conseco, Inc., et al., Case No. IP00-C-0602-M/S; Brody v. Conseco,
Inc., et al., Case No. IP00-C-0609-M/S; Dana v. Conseco, Inc., et al., Case No.
IP00-C-0623-T/G; Krim v. Conseco, Inc., et al., Case No. IP00-C-0631-B/S; Nadaf
v. Conseco, Inc., et al., Case No. IP00-C-0628-Y/G; Greiner v. Conseco, Inc., et
al., Case No. IP00-C-0639-Y/F (naming as a defendant only one officer/director);
Sedgwick v. Conseco, Inc., et al., Case No. IP00-C-0657-B/S; Irle v. Conseco,
Inc., et al., Case No. IP00-C-0746-H/G; Schwartz v. Conseco, Inc., et al., Case
No. IP00-C-0770-M/S. With the one exception noted, two former officers/directors
of the Company are named as defendants in each of the lawsuits. In each case,
the plaintiffs assert claims under Section 10(b) and 20(a) of the Securities
Exchange Act of 1934. In each case, plaintiffs allege that the Company and the
individual defendants violated the federal securities laws by, among other
things, making false and misleading statements about the current state and
future prospects of Conseco Finance (particularly with respect to performance of
certain loan portfolios of Conseco Finance) which allegedly rendered the
Company's financial statements false and misleading. The Company also intends to
defend these lawsuits vigorously. The ultimate outcome of these lawsuits cannot
be predicted with certainty.
Six of the cases in the United States District Court were filed as
purported class actions on behalf of persons or entities that purchased
preferred securities issued by various Conseco Financing Trusts, including
Conseco Financing Trust V, Griffin v. Conseco, Inc., et al., Case No.
IP00-C-0663-M/S; Stifnagle v. Conseco, Inc., et al., Case No. IP00-C-0754-Y/G
(Stifnagle also asserts claims regarding Conseco Financing Trust VII) (making
allegations with respect to an August 24, 1998 offering), Conseco Financing
Trust VI, Costello v. Conseco, Inc., et al., Case No. IP00-C-0705-Y/G (October
8, 1998 offering), and Conseco Financing Trust VII, Zinno v. Conseco, Inc., et
al., Case No. IP00-C-0622-M/S; Shapiro v. Conseco, Inc., et al., Case No.
IP00-C-0650-B/S; Kosseff v. Conseco, Inc., et al., Case No. IP00-C-0753-Y/S
(August 26, 1999 offering). Each of these complaints names as defendants the
Company, the relevant trust (except Shapiro and Kosseff), two former
officers/directors of the Company, and the underwriters for the particular
issuance (except Shapiro). The Kosseff complaint also names an officer and all
of the Company's directors at the time of issuance of the preferred stock by
Conseco Financing Trust VII. In each case, plaintiffs assert claims under
Section 11 and Section 15 of the Securities Act of 1933, and the Zinno, Shapiro,
and Stifnagle complaints also assert claims under Section 12(a)(2) of that Act.
In each case, plaintiffs allege that the defendants violated the federal
securities laws by, among other things, making false and misleading statements,
in Prospectuses and/or Registration Statements related to the issuance of
preferred securities by the Trust involved, regarding the current state and
future prospects of Conseco Finance (particularly with respect to performance of
certain loan portfolios of Conseco Finance) which allegedly rendered the
disclosure documents false and misleading. The Company also intends to defend
these lawsuits vigorously. The ultimate outcome of these lawsuits cannot be
predicted with certainty.
Four shareholder derivative suits have been filed in United States District
Court. Rogney v. Decatur, et al., Case No. IP00-C-0655-Y/F; Fletcher v. Hilbert,
et al., Case No. IP00-C-0693-H/G; Gold v. Decatur, et al., Case No. IP00-C-0747-
T/G; Batcheldor v. Hilbert, Case No. IP00-C-0743-H/G. The complaints name as
defendants the current directors, certain former directors, and, in Fletcher,
certain non-director officers of the Company (the Company is named as a nominal
defendant in each). Plaintiffs allege that the defendants breached their
fiduciary duties by, among other things, intentionally disseminating false and
misleading statements concerning the acquisition, performance and proposed sale
of Conseco Finance, and engaged in corporate waste by causing the Company to
guarantee loans that certain officers, directors and key employees of the
Company used to purchase stock under the Company's "Stock Purchase Plan." A
similar case has been filed in the Hamilton County Superior Court in Indiana.
Schweitzer v. Hilbert, et al., Cause No. 29001-0004CP251. The Company believes
that these lawsuits are without merit and intends to defend them vigorously. The
ultimate outcome of these lawsuits cannot be predicted with certainty.
Conseco, Inc. and its subsidiaries, Conseco Life Insurance Company and
Wabash Life Insurance Company, are currently named defendants in a certified
nationwide class action lawsuit in the Superior Court for Santa Clara County
(California, cause number CV768991) and captioned "John P. Dupell and the John
P. Dupell 1992 Insurance Trust vs. Massachusetts General Life Insurance Company;
Life Partners Group, Inc., Wabash Life Insurance Company, Conseco, Inc., Donovan
R. Bolton, et al." The class, approximately 345,000 in number, consists of all
persons who purchased universal life insurance policies from Conseco Life
Insurance Company, formerly named Massachusetts General Life Insurance Company,
between January 1, 1984 and July 23, 1999 (excluding policies where death
benefits were paid). The claims involve the changing interest rate climate
between the 1980s and the comparatively lower rates in the 1990s, and
20
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
the resulting lower rates credited to universal life products. The plaintiffs
asserted claims of fraud, breach of the covenant of good faith and fair dealing,
negligence, negligent misrepresentation, unjust enrichment and related matters.
Conseco believes this lawsuit is without merit and is defending it vigorously.
The ultimate outcome of this lawsuit cannot be predicted with certainty.
In addition, the Company and its subsidiaries are involved on an ongoing
basis in lawsuits related to their operations. Although the ultimate outcome of
certain of such matters cannot be predicted, such lawsuits currently pending
against the Company or its subsidiaries are not expected, individually or in the
aggregate, to have a material adverse effect on the Company's consolidated
financial condition, cash flows or results of operations.
21
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
The following disclosures supplement our consolidated statement of cash
flows:
<TABLE>
<CAPTION>
Three months ended
March 31,
--------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Cash flows from operating activities:
Net income................................................................................ $ 77.4 $287.8
Adjustments to reconcile net income to net cash provided
by operating activities:
Gain on sale of finance receivables................................................... - (199.2)
Points and origination fees received.................................................. - 110.5
Interest-only securities investment income............................................ (27.5) (43.7)
Cash received from interest-only securities........................................... 70.6 123.5
Servicing income...................................................................... (31.1) (39.3)
Cash received from servicing activities............................................... 33.7 41.7
Provision for losses.................................................................. 82.0 21.3
Amortization and depreciation......................................................... 215.1 165.2
Income taxes.......................................................................... 54.4 129.7
Insurance liabilities................................................................. 163.3 34.1
Accrual and amortization of investment income......................................... (183.6) (46.0)
Deferral of cost of policies produced and purchased................................... (227.0) (182.9)
Impairment charges.................................................................... 2.5 12.2
Minority interest..................................................................... 59.9 46.5
Net investment (gains) losses......................................................... 35.3 (1.0)
Other ............................................................................... (9.3) (47.4)
-------- -------
Net cash provided by operating activities........................................... $ 315.7 $ 413.0
======= =======
</TABLE>
<TABLE>
<CAPTION>
Three months ended
March 31,
--------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Non-cash items not reflected in the consolidated statement of cash flows:
Issuance of common stock under stock option and employee benefit plans.................... $4.6 $ .8
Issuance of convertible preferred shares.................................................. 2.9 -
Tax benefit related to the issuance of common stock under employee benefit plans.......... - 24.2
Conversion of preferred stock into common stock........................................... - 105.5
</TABLE>
SUBSEQUENT EVENTS
On April 28, 2000, Chairman and Chief Executive Officer, Stephen C.
Hilbert, and Chief Financial Officer, Rollin M. Dick, terminated their positions
with Conseco. David V. Harkins, a Conseco Director and the President of Thomas
H. Lee Partners was elected interim Chairman and Chief Executive Officer of the
Company. In addition, Thomas M. Hagerty, a managing director of Thomas H. Lee
Partners, was elected to Conseco's board of directors. The executive committee
of the board, comprised of David Harkins, James Massey and John Mutz, is working
with the board of directors in searching for a new Chief Executive Officer and
Chief Financial Officer for Conseco.
22
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
On April 28, 2000, Conseco and Mr. Hilbert entered into an agreement
pursuant to which Mr. Hilbert's employment was terminated. As contemplated by
the terms of his employment agreement, Mr. Hilbert received: (i) $72.5 million
(prior to required withholding for taxes), an amount equal to five times his
salary and the non-discretionary bonus amount (as defined in his employment
agreement) for this year; less (ii) the amount due under a secured loan of $23
million, plus accrued interest, made to Mr. Hilbert on April 6, 2000. Mr.
Hilbert also received the bonus of $3,375,000 payable under his employment
agreement for the first quarter of 2000. Conseco agreed to continue to treat Mr.
Hilbert as though he were an employee/participant for purposes of the guaranteed
bank loans and the loans for interest on such loans pursuant to the stock
purchase program. Conseco also entered into a consulting agreement with Mr.
Hilbert pursuant to which Mr. Hilbert has agreed to provide consulting services
up to an average of 25 hours per month for a period of three years. Mr. Hilbert
also agreed not to compete with Conseco during the term of the consulting
agreement. On April 27, 2000, Mr. Hilbert was granted options to purchase an
aggregate of 2,000,000 shares of Conseco common stock at a price of $5.75 per
share (the average of the high and low sales prices on the New York Stock
Exchange on such date). The options expire on April 26, 2003.
On April 28, 2000, Conseco and Mr. Dick entered into an agreement pursuant
to which Mr. Dick's employment was terminated. As contemplated by the terms of
his employment agreement, Conseco agreed to pay Mr. Dick his salary of $250,000
per year through December 31, 2001, and he also received the bonus of $187,500
payable under his employment agreement for the first quarter of 2000. Conseco
also agreed to continue to treat Mr. Dick as though he were an
employee/participant for purposes of the guaranteed bank loans and the loans for
interest on such loans pursuant to the stock purchase program. Conseco also
entered into a consulting agreement with Mr. Dick pursuant to which Mr. Dick has
agreed to provide consulting services up to an average of 25 hours per month for
a period of three years. Mr. Dick also agreed not to compete with Conseco during
the term of the consulting agreement. On April 27, 2000, Mr. Dick was granted
options to purchase an aggregate of 600,000 shares of Conseco common stock at a
price of $5.75 per share. The options expire on April 26, 2003.
In April 2000, the Company and the holder of the Redeemable Hybrid Income
Overnight Shares ("RHINOS") agreed to the repurchase by the Company of the
RHINOS at their $250 million par value. The Company will recognize a loss of
$3.6 million (net of taxes of $2.0 million) in the second quarter of 2000
related to the redemption. In connection with the RHINOS repurchase, the Company
entered into a $125 million term loan agreement with interest at a defined base
rate plus 2.5 percent (8.69 percent at May 10, 2000). The term loan is due as
follows: $25 million on July 15, 2000; $25 million on August 15, 2000; and $75
million on September 15, 2000.
Following the March 31, 2000, announcement that we plan to explore the sale
of Conseco Finance and other events described elsewhere herein, rating agencies
lowered their ratings and placed certain ratings on review as the agencies
analyze the impact of the developing events (see "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Premium and Asset
Accumulation Product Collections" and "Liquidity of Conseco").
In May 2000, we sold approximately $1.3 billion of finance receivables to
Lehman Brothers and its affiliates for cash and a right to share in future
profits from a subsequent sale or securitization of the assets sold. The sale of
finance receivables is not expected to result in a material gain or loss.
Lehman Brothers has also amended its repurchase and other financing
facilities with our finance operations to expand the types of assets financed.
As partial consideration for the financing transaction, Lehman Brothers received
a warrant, with a nominal exercise price, for five percent of the common stock
of Conseco Finance. The warrant has a five-year term. After three years, the
holder of the warrant or Conseco Finance may cause the warrant and any stock
issued upon its exercise to be purchased for cash at an appraised value. Since
the terms of the warrant permits cash settlement at fair value at the option of
the holder of the warrant, the warrant is required to be classified as a
liability measured at fair value, with changes in its value reported in
earnings. The warrant would be cancelled in certain circumstances in the event
the holder thereof or an affiliate participates in a group that purchases
Conseco Finance. The initial value of the warrant will be amortized over the
expected life of the financing facilities of approximately one year.
23
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
In connection with the transaction with Lehman Brothers, the intercompany
demand note from Conseco Finance to Conseco (which had a balance of $2,675.1
million at March 31, 2000) was replaced with a one-year term note and Conseco
Finance is repaying approximately $500 million of this note. Conseco Finance has
agreed with Lehman Brothers that it will not make further prepayments on this
note while certain financing arrangements with Lehman Brothers remain
outstanding. In addition, Conseco Finance has agreed that it will not pay
dividends until 2001 and then pay such dividends only to the extent certain
financial covenants are met.
In 1999, the parent company contributed certain assets then having a book
value of approximately $300 million to a subsidiary of Conseco Finance in
exchange for additional shares of Conseco Finance common stock. The stock of
this subsidiary was distributed to Conseco in 2000 concurrently with the Lehman
Brothers transaction.
24
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
In this section, we review Conseco's consolidated results of operations for
the three months ended March 31, 2000 and 1999, and significant changes in our
consolidated financial condition. Please read this discussion in conjunction
with the accompanying consolidated financial statements and notes. On March 31,
2000, we announced that we plan to explore the sale of Conseco Finance, a wholly
owned subsidiary of Conseco. If the planned sale is completed, the Company will
no longer have finance operations. No assurance can be provided as to the
timing, price, or other terms related to the possible sale of Conseco Finance.
Consolidated results and analysis
Net income of $77.4 million in the first quarter of 2000, or 22 cents per
diluted share, included: (i) net investment losses (including related costs,
amortization and taxes) of $13.3 million, or 4 cents per share; (ii) an
impairment charge of $1.6 million, or nil cents per share, to reduce the value
of interest-only securities and servicing rights; and (iii) a non-cash charge of
$14.7 million, or 4 cents per share, to increase the Company's provision in
connection with its guarantee of bank loans to approximately 170 directors,
officers and key employees. Net income of $287.8 million in the first quarter of
1999, or 87 cents per diluted share, included: (i) net investment losses of $5.9
million, or 2 cents per share; and (ii) an impairment charge of $7.7 million, or
2 cents per share, to reduce the value of interest-only securities and servicing
rights.
Total revenues in the first quarters of 2000 and 1999 included net
investment losses of $35.3 million and net investment gains of $1.0 million,
respectively. Excluding net investment gains (losses), total revenues were
$2,241.2 million in the first quarter of 2000, up 13 percent from $1,985.6
million in the first quarter of 1999.
We evaluate performance and base management's incentives on operating
earnings which is defined as income before extraordinary charge, net investment
gains (losses) of our life insurance and corporate segments (less that portion
of amortization of cost of policies purchased and cost of policies produced and
income taxes relating to such gains (losses)), and unusual or infrequent items
(net of income taxes). Operating earnings are determined by adjusting GAAP net
income for the above mentioned items. While these items may be significant
components in understanding and assessing our consolidated financial
performance, we believe that the presentation of operating earnings enhances the
understanding of our results of operations by highlighting net income
attributable to the normal, recurring operations of the business and by
excluding events that materially distort trends in net income. However,
operating earnings are not a substitute for net income determined in accordance
with GAAP.
25
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Results of operations by segment for the three months ended March 31, 2000
and 1999
The following tables and narratives summarize our results by segment.
<TABLE>
<CAPTION>
Three months ended
March 31,
-------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Operating earnings:
Operating income of segments before income taxes and minority interest:
Insurance and fee-based operations............................................... $258.7 $371.0
Finance operations............................................................... 35.8 195.8
Corporate interest and other expenses............................................ (55.8) (52.8)
------ ------
Operating income before income taxes and minority interest .................... 238.7 514.0
Income taxes related to operating income............................................. 92.7 182.4
------ ------
Operating income before minority interest...................................... 146.0 331.6
Minority interest in consolidated subsidiaries....................................... 39.0 30.2
------ ------
Operating earnings............................................................. 107.0 301.4
Nonoperating items:
Net investment losses, net of tax and other items.................................... (13.3) (5.9)
Impairment charge, net of taxes...................................................... (1.6) (7.7)
Provision for loss on loan guarantees, net of taxes.................................. (14.7) -
------ ------
Net income..................................................................... $ 77.4 $287.8
====== ======
</TABLE>
26
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Insurance and fee-based operations
<TABLE>
<CAPTION>
Three months ended
March 31,
-------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Premiums and asset accumulation product collections:
Annuities........................................................................... $ 645.6 $ 511.0
Supplemental health.................................................................. 586.2 555.7
Life................................................................................. 242.2 241.6
Individual and group major medical................................................... 233.5 209.1
Mutual funds......................................................................... 289.6 82.2
--------- ---------
Total premiums and asset accumulation product collections........................ $ 1,997.1 $ 1,599.6
========= =========
Average liabilities for insurance and asset accumulation products:
Annuities:
Mortality based.................................................................... $ 455.9 $ 687.1
Equity-linked...................................................................... 2,404.8 1,390.5
Deposit based...................................................................... 10,233.5 11,041.9
Separate accounts and investment trust liabilities................................... 2,458.9 1,471.2
Health............................................................................... 5,082.2 4,701.9
Life:
Interest sensitive................................................................. 4,245.3 4,131.5
Non-interest sensitive............................................................. 2,729.9 2,838.3
--------- ---------
Total average liabilities for insurance and asset
accumulation products, net of reinsurance ceded................................ $27,610.5 $26,262.4
========= =========
Revenues:
Insurance policy income.............................................................. $ 1,048.7 $ 1,007.4
Net investment income:
General account invested assets.................................................... 503.6 493.8
Venture capital investments........................................................ 114.0 2.0
Equity-indexed products based on S&P 500 Index..................................... 22.7 33.6
Amortization of cost of S&P 500 Call Options....................................... (28.8) (20.1)
Separate account assets............................................................ 44.5 12.7
Fee revenue and other income......................................................... 32.4 28.7
--------- ---------
Total revenues (a)............................................................... 1,737.1 1,558.1
--------- ---------
Expenses:
Insurance policy benefits............................................................ 831.7 669.6
Amounts added to policyholder account balances:
Annuity products other than those listed below..................................... 167.9 174.1
Equity-indexed products based on S&P 500 Index..................................... 23.4 33.3
Separate account liabilities....................................................... 44.5 12.7
Amortization related to operations................................................... 211.8 140.6
Interest expense on investment borrowings............................................ 5.0 11.8
Other operating costs and expenses................................................... 194.1 145.0
--------- ---------
Total benefits and expenses (a).................................................. 1,478.4 1,187.1
--------- ---------
Operating income before income taxes and minority interest....................... 258.7 371.0
Net investment losses, including related costs and
amortization......................................................................... (21.0) (9.0)
--------- ---------
Income before income taxes and minority interest................................. $ 237.7 $ 362.0
========= =========
</TABLE>
(continued)
27
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
<TABLE>
<CAPTION>
Three months ended
March 31,
--------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Ratios:
Investment income, net of interest credited on annuities and universal life
products and interest expense on investment borrowings, as a percentage of
average liabilities for insurance and asset accumulation products excluding
liabilities related to separate accounts and investment trust and
reinsurance ceded.................................................................. 4.81% 4.47%
Operating costs and expenses (excluding amortization of cost of policies produced
and cost of policies purchased) as a percentage of average liabilities for
insurance and asset accumulation products.......................................... 3.20% 2.60%
Health loss ratios:
All health lines:
Insurance policy benefits.......................................................... $634.6 $503.1
Loss ratio......................................................................... 80.01% 65.68%
Medicare Supplement:
Insurance policy benefits.......................................................... $180.6 $159.2
Loss ratio......................................................................... 76.99% 68.60%
Long-Term Care:
Insurance policy benefits.......................................................... $151.8 $115.5
Loss ratio......................................................................... 76.01% 61.49%
Specified Disease:
Insurance policy benefits.......................................................... $ 77.5 $ 56.0
Loss ratio......................................................................... 83.46% 58.32%
Major Medical:
Insurance policy benefits.......................................................... $197.5 $147.9
Loss ratio......................................................................... 87.35% 71.63%
Other:
Insurance policy benefits.......................................................... $ 27.2 $ 24.5
Loss ratio......................................................................... 75.18% 63.52%
<FN>
- --------------------
(a) Revenues exclude net investment gains (losses); benefits and expenses
exclude amortization related to realized gains.
</FN>
</TABLE>
Premiums and asset accumulation products were $2.0 billion in the first
quarter of 2000, up 25 percent over 1999. See "Premium and Asset Accumulation
Product Collections" for further analysis.
Average liabilities for insurance and asset accumulation products, net of
reinsurance receivables, were $27.6 billion in the first quarter of 2000, up 5.1
percent over 1999.
Insurance policy income is comprised of: (i) premiums earned on policies
which provide mortality or morbidity coverage; and (ii) fees and other charges
made against other policies. See "Premium and Asset Accumulation Product
Collections" for further analysis.
Net investment income on general account invested assets (which excludes
income on separate account assets related to variable annuities; the income,
cost and change in the fair value of S&P 500 Call Options related to
equity-indexed products; and the income related to venture capital investments)
increased by 2.0 percent to $503.6 million in the first
28
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
quarter of 2000, compared to the same period in 1999. The average balance of
general account invested assets increased by 2.0 percent in the first quarter of
2000 to $26.6 billion compared to the same period in 1999. The yield on these
assets was 7.6 percent in the first quarters of both 2000 and 1999.
Venture capital investment income includes the income earned on the
investments made by our venture capital subsidiary. This income will fluctuate
from period-to-period based on changes in estimated market values of our venture
capital investments. When these investments are publicly traded, fair value is
generally based upon market prices. When liquidity is limited because of thinly
traded securities, limited partnership structures, large block holdings,
restricted shares or other special circumstances, we adjust quoted market prices
to determine an estimate of the attainable fair values. During 1999, we invested
$53.2 million in a company in the wireless communication business. The market
values of many companies in this sector increased significantly in 1999 and
early 2000. In the fourth quarter of 1999, our investee sold shares of common
stock to the public in an initial public offering. As a result, an ascertainable
market value was established for our investment, which we adjusted to recognize
liquidity restrictions. In the first quarter of 2000, we recognized venture
capital income of $105.1 million related to this investment.
Net investment income related to equity-indexed products based on the S&P
500 Index is substantially offset by a corresponding charge to amounts added to
policyholder account balances for equity-indexed products. Such income and
related charge fluctuated based on the policyholder account balances subject to
this provision and the performance of the S&P 500 Index to which the returns on
such products are linked. During the first quarter of 2000, we recorded income
from the S&P 500 Options of $22.7 million and added amounts to policyholders'
account balances of the equity-indexed products of $23.4 million.
Amortization of cost of S&P 500 Call Options represents the premiums paid
to purchase S&P 500 Call Options related to our equity-linked products. We
amortize these amounts over the terms of the options. Such amortization has
increased because of the increase in our equity-linked product business, changes
in the participation rate of such business in the S&P 500 Index, and the cost of
the options. Our equity-indexed products are designed in an effort to have the
investment income spread earned on the related insurance liabilities be adequate
to cover the cost of the S&P 500 Call Options and other costs related to these
policies.
Net investment income from separate account assets is offset by a
corresponding charge to amounts added to policyholder account balances for
variable annuity products. Such income and related charge fluctuated in
relationship to total separate account assets and the return earned on such
assets.
Fee revenue and other income includes: (i) revenues we receive for managing
investments for other companies; and (ii) fees received for marketing insurance
products of other companies. This amount has increased as a result of growth in
both of these businesses.
Insurance policy benefits increased in the first quarter of 2000 as a
result of the factors summarized in the explanations for loss ratio fluctuations
related to specific products which follows.
Loss ratios for Medicare supplement products increased in the first quarter
of 2000 primarily due to adverse development of the year end reserve. In
addition, the mix of our Medicare supplement business in 2000 includes a higher
percent of less profitable standard Medicare supplement policies than the prior
year (and a lower percent of more profitable nonstandard policies that we are no
longer able to offer to new policyholders). Governmental regulations generally
require us to attain and maintain a loss ratio, after three years, of not less
than 65 percent.
The loss ratios for long-term care products increased in the first quarter
of 2000, reflecting unfavorable claims experience and the effects of the asset
accumulation phase of these products. The net cash flows from our long-term care
products generally result in the accumulation of amounts in the early policy
years of a policy (accounted for as reserve increases) which will be paid out as
benefits in later policy years (accounted for as reserve decreases).
Accordingly, during the asset accumulation phase of these policies, the loss
ratio will increase, but the increase in the change in reserve will be partially
offset by investment income earned on the assets which have accumulated. In
order to improve the profitability of the long-term care product line, we are
currently selling products with higher margins and we have continued to apply
for appropriate rate increases on older blocks of business.
29
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
The 2000 loss ratio for our specified disease policies reflect refinements
we made to the reserve estimation process and unfavorable development of the
year end claim liabilities.
The 2000 loss ratio for major medical policies reflects unfavorable claims
experience. We plan to increase our sales focus on the individual major medical
product lines while decreasing our group blocks of business. Since individual
products are more profitable than group products, this mix change should support
our efforts to improve profitability. In addition, we are also raising rates on
certain products and exiting certain product lines and states.
The loss ratios on other products will fluctuate more than other lines due
to the smaller size of these blocks of business. Such ratios have generally been
within our expectations.
Amounts added to policyholder account balances for annuity products
decreased by 3.6 percent in the first quarter of 2000 to $167.9 million,
primarily due to a smaller block of this type of annuity business in force, on
the average, in the first three months of 2000, partially offset by the increase
in average crediting rates. The weighted average crediting rate for these
annuity liabilities was 4.7 percent and 4.6 percent in the first three months of
2000 and 1999, respectively.
Amortization related to operations includes amortization of: (i) the cost
of policies produced; (ii) the cost of policies purchased; and (iii) goodwill.
We are required to amortize the cost of policies purchased and produced in
relationship to the profits earned on universal life, annuity and investment
products. The venture capital income recognized in 2000 resulted from
investments backing these products. Accordingly, additional amortization expense
was recognized because of the income recognized. Balances subject to
amortization increased as a result of new policies sold.
Interest expense on investment borrowings decreased along with our
investment borrowing activities. Investment borrowings averaged approximately
$389.8 million during the first three months of 2000 compared to $997.4 million
during the same period of 1999. Borrowing rates increased 40 basis points to 5.1
percent during the first three months of 2000.
Other operating costs and expenses increased in 2000 primarily as a result
of our increased business and marketing initiatives. Such increased expenses are
consistent with the increase in the ratio of operating expenses (excluding
amortization of cost of policies produced and cost of policies purchased) as a
percentage of average liabilities for insurance and asset accumulation products
(3.20 percent for the three months ended March 31, 2000, compared to 2.60
percent for the same period in 1999).
Net investment gains (losses), including related costs and amortization,
fluctuate from period to period. When we sell securities at a gain (loss) and
reinvest the proceeds at a different yield, we increase (reduce) the
amortization of cost of policies purchased and cost of policies produced in
order to reflect the change in future yields. Sales of fixed maturity
investments resulted in a reduction in the amortization of the cost of policies
purchased and the cost of policies produced of $14.2 million in the first
quarter of 2000 and resulted in additional amortization of $10.0 million in the
first quarter of 1999.
30
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Finance operations
<TABLE>
<CAPTION>
Three months ended
March 31,
-------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Contract originations:
Manufactured housing.............................................................. $ 1,183.7 $ 1,411.1
Mortgage services................................................................. 1,544.2 1,437.6
Consumer/credit card.............................................................. 774.5 538.6
Commercial........................................................................ 1,506.7 1,986.9
--------- ---------
Total.......................................................................... $ 5,009.1 $ 5,374.2
========= =========
Securitizations of receivables recorded as sales:
Manufactured housing.............................................................. $ - $ 1,800.0
Home equity/home improvement...................................................... - 961.1
Consumer/equipment................................................................ - -
Leases............................................................................ - -
Commercial and retail revolving credit............................................ - -
Retained bonds.................................................................... - (23.2)
--------- ---------
Total.......................................................................... $ - $ 2,737.9
========= =========
Managed receivables (average):
Manufactured housing.............................................................. $24,936.7 $21,447.3
Mortgage services................................................................. 12,734.1 8,685.6
Consumer/credit card.............................................................. 3,885.7 2,988.5
Commercial........................................................................ 5,144.4 5,121.3
--------- ---------
Total.......................................................................... $46,700.9 $38,242.7
========= =========
Revenues:
Net investment income:
Finance receivables and other.................................................. $ 382.1 $ 106.9
Interest-only securities....................................................... 27.5 43.7
Gain on sale of finance receivables............................................... - 199.2
Fee revenue and other income...................................................... 99.2 82.6
--------- -----------
Total revenues................................................................. 508.8 432.4
--------- -----------
Expenses:
Provision for losses.............................................................. 58.6 21.3
Finance interest expense.......................................................... 204.5 54.6
Other operating costs and expenses................................................ 209.9 160.7
--------- -----------
Total expenses................................................................. 473.0 236.6
--------- -----------
Operating income before impairment charges and income taxes.................... 35.8 195.8
Impairment charges.................................................................... 2.5 12.2
---------- -----------
Income before income taxes..................................................... $ 33.3 $ 183.6
========= ==========
</TABLE>
31
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
General: Conseco's finance subsidiaries provide financing for manufactured
housing, home equity, home improvements, consumer products and equipment, and
provide consumer and commercial revolving credit. Finance products include both
fixed-term and revolving loans and leases. Conseco also markets physical damage
and term mortgage life insurance and other credit protection relating to the
loans it services.
On March 31, 2000, we announced that we plan to explore the sale of Conseco
Finance. If the planned sale is completed, the Company will no longer have
finance operations.
On September 8, 1999, we announced that we would no longer structure our
securitizations in a manner that results in recording a sale of the loans.
Instead, new securitization transactions after that date are being structured to
include provisions that entitle the Company to repurchase assets transferred to
the special purpose entity when the aggregate unpaid principal balance reaches a
specified level. Until these assets are repurchased, however, the assets are the
property of the special purpose entity and are not available to satisfy the
claims of creditors of the Company. Pursuant to Financial Accounting Standards
Board Statement No. 125, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishment of Liabilities", such securitization transactions are
accounted for as secured borrowings whereby the loans and securitization debt
remain on the consolidated balance sheet, rather than as sales.
The change to the structure of our new securitizations will have no effect
on the total profit we recognize over the life of each new loan, but it will
change the timing of profit recognition. Under the portfolio method (the
accounting method required for our securitizations which are structured as
secured borrowings), we will recognize: (i) earnings over the life of new loans
as interest revenues are generated; (ii) interest expense on the securities
which are sold to investors in the loan securitization trusts; and (iii)
provisions for losses. As a result, our reported earnings from new loans
securitized in transactions accounted for under the portfolio method will be
lower in the period in which the loans are securitized (compared to our
historical method) and higher in later periods, as interest spread is earned on
the loans.
Following our March 31, 2000, announcement regarding the plan to explore
the sale of Conseco Finance and the other events described in the note to the
consolidated financial statements entitled "Subsequent Events" and elsewhere
herein, the uncertainty surrounding the ultimate outcome of Conseco's plan has
made it more difficult to complete new public securitization transactions. We
are currently funding loans through our warehouse and bank credit facilities and
expect to commence offering securities in public or private securitization
transactions in the near future. We are also exploring other possible
transactions such as whole loan sales. In May 2000, we sold $1.3 billion of
finance receivables to Lehman Brothers and its affiliates (see the note to the
consolidated financial statements entitled "Subsequent Events").
Loan originations in the first quarter of 2000 were $5.0 billion, down 6.8
percent from 1999.
Manufactured housing loan originations decreased by $227.4 million, or 16
percent, in the first quarter of 2000. The 2000 decrease was primarily due to a
decrease in the number of contracts written (the change in the average size of
contracts originated was not significant).
Mortgage services loan originations increased by $106.6 million, or 7.4
percent, in the first quarter of 2000. The increase reflects growth in both home
equity and home improvement business. We have continued to expand these
origination networks.
Consumer/credit card loan originations increased by $235.9 million, or 44
percent, in the first quarter of 2000. The increase is primarily the result of
our successful marketing efforts, including a number of new private label credit
card relationships with large retailers.
Commercial loan originations decreased by $480.2 million, or 24 percent, in
the first quarter of 2000. The decrease primarily reflects lower production in
floorplan financing.
Securitizations of receivables recorded as sales relate to the
securitizations structured prior to our September 8, 1999, announcement. The
decrease in finance receivables sold in 2000 reflects the change in
securitization structure described above.
32
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Managed receivables include finance receivables transferred to special
purpose entities in securitization transactions (whether accounted for as sales
or on the portfolio method) and finance receivables recorded on our consolidated
balance sheet that have not been securitized. Average managed receivables
increased to $46.7 billion in 2000, up 22 percent over 1999.
Net investment income on finance receivables and other consists of: (i)
interest earned on finance receivables; and (ii) interest income on short-term
and other investments. Such income increased by 257 percent, to $382.1 million,
in the first quarter of 2000, consistent with the increase in average on-balance
sheet finance receivables. The weighted average yields earned on finance
receivables and other investments were 13.3 percent and 11.8 percent during the
first quarters of 2000 and 1999, respectively. As a result of the change in the
structure of our securitizations, future interest earned on finance receivables
should increase as our average on-balance sheet finance receivables increase.
Net investment income on interest-only securities is the accretion
recognized on the interest-only securities we retain after we sell finance
receivables. Such income decreased by 37 percent, to $27.5 million, in the first
quarter of 2000. The decrease is consistent with the change in the average
balance of interest-only securities. The weighted average yields earned on
interest-only securities were 12.2 percent and 13.2 percent during the first
three months of 2000 and 1999, respectively. As a result of the change in the
structure of our securitizations, we will account for future transactions as
secured borrowings and we will not recognize gain-on-sale revenue or additions
to interest-only securities. Accordingly, future investment income accreted on
the interest-only security will decrease, as cash remittances from the prior
gain-on- sale securitizations reduce the interest-only security balances. The
balance of the interest-only securities was reduced by $533.8 million during
1999 (of which $11.3 million was incurred in the first quarter of 1999) which
will cause a reduction in interest income accreted to this security in future
years. We regularly analyze future expected cash flows from this security to
determine the appropriate interest accretion rate. If we determine that this
rate should be lower, investment income accreted on the interest-only security
will decrease in future periods.
Gain on sale of finance receivables decreased in the first quarter of 2000
reflecting our decision to no longer structure our securitizations as sales. Our
new securitizations are being structured as secured borrowings and no gain on
sale is recognized. The gain recognized for our previous securitizations
fluctuated when changes occurred in: (i) the amount of loans sold; (ii) market
conditions (such as the market interest rates available on securities sold in
these securitizations); (iii) the amount and type of interest we retained in the
receivables sold; and (iv) assumptions used to calculate the gain.
Conditions in the credit markets have frequently resulted in
less-attractive pricing of certain lower-rated securities in our securitization
structure. As a result, we have chosen to hold rather than sell some of the
securities in the securitization trusts, particularly securities having
corporate guarantee provisions. Prior to our September 8, 1999, announcement,
the securities that we hold were treated as retained interests in the
securitization trusts. We recognized no gain on the portion of the assets
related to such securities, but we expect to recognize greater interest income,
net of related interest expense, over the term we hold them. At March 31, 2000,
we held $472.0 million of such securities which are classified as actively
managed fixed maturities.
Fee revenue and other income includes servicing income, commissions earned
on insurance policies written in conjunction with financing transactions, and
other income from late fees. Such income increased by 20 percent, to $99.2
million, in the first quarter of 2000. Our net written insurance premiums and
other income both grew with managed receivables. As a result of the change in
the structure of our future securitizations announced on September 8, 1999, we
no longer record an asset for servicing rights at the time of our
securitizations, nor do we record servicing fee revenue; instead, the entire
amount of interest income is recorded as investment income. Accordingly, the
amount of servicing income has declined in the current period, and will decline
further in future periods.
Provision for losses related to finance operations increased by 175
percent, to $58.6 million, in the first quarter of 2000. The increase is
principally due to the increase of loans held on our balance sheet. Under the
portfolio method (which is used for securitizations structured as secured
borrowings), we recognize the credit losses on the loans on our balance sheet as
the losses are incurred. For loans previously recorded as sales, the anticipated
discounted credit losses are reflected through a reduction in the gain-on-sale
revenue recorded at the time of securitization.
33
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Finance interest expense increased by 275 percent, to $204.5 million, in
the first quarter of 2000. Our borrowings grew in order to fund the increase in
finance receivables. In addition, our average borrowing rate increased to 7.1
percent in the first quarter of 2000 from 6.0 percent in the first quarter of
1999.
Under the portfolio method, we recognize interest expense on the securities
issued to investors in the securitization trusts. These securities typically
have higher interest rates than our other debt, which increases our average
borrowing rate as compared to prior periods.
Other operating costs and expenses include the costs associated with
servicing our managed receivables, and non- deferrable costs related to
originating new loans. Such expense increased by 31 percent, to $209.9 million,
in the first quarter of 2000 reflecting: (i) the growth in our servicing
portfolio; and (ii) the growth in our loan origination offices and
infrastructure.
Impairment charges represent reductions in the value of interest-only
securities and servicing rights recognized as a loss in the statement of
operations. We carry interest-only securities at estimated fair value, which is
determined by discounting the projected cash flows over the expected life of the
receivables sold using current prepayment, default, loss and interest rate
assumptions. Estimates for prepayments, defaults and losses for manufactured
housing loans are determined based on a macroeconomic model developed by the
Company with the assistance of outside experts. We record any unrealized gain or
loss determined to be temporary, net of tax, as a component of shareholders'
equity. Declines in value are considered to be other than temporary when the
present value of estimated future cash flows discounted at a risk free rate
using current assumptions is less than the amortized cost of the interest-only
securities. When declines in value considered to be other than temporary occur,
we reduce the amortized cost to estimated fair value and recognize a loss in the
statement of operations. The assumptions used to determine new values are based
on our internal evaluations and consultation with external advisors having
significant experience in valuing these securities.
The Company continually reevaluates its interest-only securities and
servicing rights, including the underlying assumptions, in light of loss
experience exceeding previous expectations. The principal change in the revised
assumptions resulting from this process was an increase in expected future
credit losses, relating primarily to reduced assumptions as to future housing
price inflation, recent loss experience and refinements to the methodology of
the model. The effect of this change in 1999 was offset somewhat by a revision
to the estimation methodology to incorporate the value associated with the
cleanup call rights held by the Company in securitizations. In the first
quarters of 2000 and 1999, we recognized an impairment charge of $2.5 million
($1.6 million after tax) and $12.2 million ($7.7 million after tax),
respectively, to reduce the book value of the interest-only securities and
servicing rights.
Other components of income before income taxes and minority interest:
Corporate interest and other expenses were $55.8 million in the first
quarter of 2000 and $52.8 million in the first quarter of 1999. Interest expense
on corporate debt included in that total was $53.0 million and $49.1 million in
the first quarters of 2000 and 1999, respectively, fluctuating in relationship
to the average debt outstanding and the average interest rate thereon. The
average debt outstanding was $2.6 billion and $3.0 billion during the first
quarters of 2000 and 1999, respectively. The average interest rate on such debt
was 7.48 percent and 6.14 percent during the first quarters of 2000 and 1999,
respectively. As a result of the recent rating agency actions, the interest
rates on our bank credit facility has increased (see the note to the
consolidated financial statements entitled "Changes in Corporate Notes Payable
and Commercial Paper").
Provision for loss on loan guarantees represents the noncash provision we
established in connection with our guarantees of bank loans to approximately 170
directors, officers and key employees and our related loans for interest. The
funds from the bank loans were used by the participants to purchase
approximately 19.0 million shares of Conseco common stock. In 2000, we
established a provision of $23.4 million ($14.7 million after tax) in connection
with these guarantees and loans.
34
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
PREMIUM AND ASSET ACCUMULATION PRODUCT COLLECTIONS
In accordance with GAAP, insurance policy income as shown in our
consolidated statement of operations consists of premiums earned 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 as deposits to insurance liabilities. We recognize revenues for
these products over time in the form of investment income and surrender or other
charges.
Marketing companies, agents who market insurance products, school
districts, financial institutions and policyholders use the financial strength
ratings assigned to an insurer by independent rating agencies as one factor in
determining which insurer's products to market or purchase. Following our March
31, 2000, announcement regarding the plan to explore the sale of Conseco Finance
and the other events described in the note to the consolidated financial
statements entitled "Subsequent Events" and elsewhere herein, rating agencies
lowered their financial strength ratings, and many were placed on review as the
agencies analyze the impact of the developing events. Our primary life insurance
companies have received the following ratings as of May 10, 2000: (i) an "A-"
rating, under review, by A.M. Best Company; (ii) an "A" rating, rating
watch-down, from Duff & Phelps' Credit Rating Company; (iii) a "BBB" financial
strength rating from Standard & Poor's; and (iv) a "Baa1" rating, on review for
possible downgrade, from Moody's Investor Services. The recent or future rating
actions could adversely affect the marketing and persistency of our insurance
products and other asset accumulation products.
35
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Total premiums and accumulation product collections were as follows:
<TABLE>
<CAPTION>
Three months ended
March 31,
--------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Premiums collected by our insurance subsidiaries:
Annuities:
Equity-indexed (first-year)............................................................... $ 221.3 $ 187.4
Equity-indexed (renewal).................................................................. 18.4 16.5
--------- --------
Subtotal - equity-indexed annuities..................................................... 239.7 203.9
-------- --------
Other fixed (first-year).................................................................. 146.4 170.7
Other fixed (renewal)..................................................................... 17.1 15.8
--------- --------
Subtotal - other fixed annuities........................................................ 163.5 186.5
-------- --------
Variable (first-year)..................................................................... 218.1 91.4
Variable (renewal)........................................................................ 24.3 29.2
--------- --------
Subtotal - variable annuities........................................................... 242.4 120.6
-------- --------
Total annuities....................................................................... 645.6 511.0
-------- --------
Supplemental health:
Medicare supplement (first-year).......................................................... 27.1 27.6
Medicare supplement (renewal)............................................................. 213.5 205.3
-------- --------
Subtotal - Medicare supplement.......................................................... 240.6 232.9
-------- --------
Long-term care (first-year)............................................................... 31.1 29.4
Long-term care (renewal).................................................................. 184.0 163.3
-------- --------
Subtotal - long-term care............................................................... 215.1 192.7
-------- --------
Specified disease (first-year)............................................................ 9.6 9.4
Specified disease (renewal)............................................................... 86.0 86.7
--------- --------
Subtotal - specified disease............................................................ 95.6 96.1
--------- --------
Other health (first-year)................................................................. 8.1 5.2
Other health (renewal).................................................................... 26.8 28.8
--------- --------
Subtotal - other health................................................................. 34.9 34.0
--------- --------
Total supplemental health............................................................. 586.2 555.7
-------- --------
Life insurance:
First-year................................................................................ 52.6 37.2
Renewal................................................................................... 189.6 204.4
-------- --------
Total life insurance.................................................................. 242.2 241.6
-------- --------
Individual and group major medical:
Individual (first-year)................................................................... 32.7 22.1
Individual (renewal)...................................................................... 60.0 59.4
--------- --------
Subtotal - individual................................................................... 92.7 81.5
--------- --------
Group (first-year)........................................................................ 20.0 9.2
Group (renewal)........................................................................... 120.8 118.4
-------- --------
Subtotal - group........................................................................ 140.8 127.6
-------- --------
Total major medical................................................................... 233.5 209.1
-------- --------
Mutual funds (all first year, excludes variable annuities)..................................... 289.6 82.2
-------- --------
Total first-year premiums................................................................. 1,056.6 671.8
Total renewal premiums.................................................................... 940.5 927.8
-------- --------
Total collections..................................................................... $1,997.1 $1,599.6
======== ========
</TABLE>
36
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Annuities include equity-indexed annuities, other fixed annuities and
variable annuities sold through both career agents and professional independent
producers.
We introduced our first equity-indexed annuity product in 1996. The
accumulation value of these annuities is credited with interest at an annual
guaranteed minimum rate of 3 percent (or, including the effect of applicable
sales loads, a 1.7 percent compound average interest rate over the term of the
contracts). These annuities provide for potentially 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 increases to policyholder
benefits resulting from increases in the S&P 500 Index. Total collected premiums
for this product were $239.7 million in the first quarter of 2000 compared with
$203.9 million in the first quarter of 1999.
Other fixed rate annuity products include single-premium deferred annuities
("SPDAs"), flexible-premium deferred annuities ("FPDAs") and single-premium
immediate annuities ("SPIAs"), which are credited with a declared rate. 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. SPDA and FPDA policies 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 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. Annuity
premiums on these products decreased by 12 percent, to $163.5 million, in the
first quarter of 2000.
Variable annuities offer contract holders the ability to direct premiums
into specific investment portfolios; rates of return are based on the
performance of the portfolio. Such annuities have become increasingly popular
recently as a result of the desire of investors to invest in common stocks. In
1996, we began to offer more investment options for variable annuity deposits,
and we expanded our marketing efforts, resulting in increased collected
premiums. Our profits on variable annuities come from the fees charged to
contract holders. Variable annuity collected premiums increased by 101 percent,
to $242.4 million, in the first quarter of 2000.
Supplemental health products include Medicare supplement, long-term care,
specified disease and other insurance products distributed through a career
agency force and professional independent producers. Our profits on supplemental
health policies depend on the overall level of sales, persistency of in-force
business, investment yields, claim experience and expense management.
Collected premiums on Medicare supplement policies increased by 3.3 percent
to $240.6 million, in the first quarter of 2000. Sales of Medicare supplement
policies in recent periods have been affected by: (i) steps taken to improve
profitability by increasing premium rates and changing our commission structure
and underwriting criteria; and (ii) increased competition from alternative
providers, including HMOs.
Premiums collected on long-term care policies increased by 12 percent, to
$215.1 million, in the first quarter of 2000, due to increases in premium rates
and increased sales volume.
Premiums collected on specified disease policies decreased by .5 percent to
$95.6 million in the first quarter of 2000. During 1999, we curtailed sales of
these products in one state due to adverse regulatory decisions, which accounts
for most of the decrease.
Other health products include: (i) various health insurance products that
are not currently being actively marketed; and (ii) in 1999, the specialty
health insurance products sold to educators. Premiums collected in the first
quarter of 2000 were $34.9 million, up 2.6 percent over the first quarter of
1999. Since we no longer actively market these products, we expect collected
premiums to decrease in future years. The in-force business continues to be
profitable.
Life products are sold through career agents, professional independent
producers and direct response distribution channels. Life premiums collected
increased by .2 percent to $242.2 million in the first quarter of 2000. In the
first quarter of 1999, life renewal premiums included $10.5 million of single
premium life business acquired in a reinsurance transaction.
37
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Individual and group major medical products include major medical health
insurance products sold to individuals and groups. Group premiums increased by
10 percent, to $140.8 million, in the first quarter of 2000. Individual health
premiums collected in the first quarter of 2000 increased 14 percent, to $92.7
million. Our efforts to secure rate increases and write only profitable major
medical business restrict our ability to grow these premiums.
Mutual fund sales have been very strong in 2000, reflecting our expanded
distribution and new marketing programs. We also believe that these sales have
been positively impacted by the recent strong investment performance of our
funds.
LIQUIDITY AND CAPITAL RESOURCES
Changes in our consolidated balance sheet between March 31, 2000 and
December 31, 1999, reflect: (i) our operating results; (ii) our origination of
finance receivables; (iii) the transfer of finance receivables to securitization
trusts and sale of notes to investors in transactions accounted for as secured
borrowings; (iv) changes in the fair value of actively managed fixed maturity
securities and interest-only securities; and (v) various financing transactions.
Financing transactions (described in the notes to the consolidated financial
statements) include: (i) the issuance and repurchase of common stock; and (ii)
the issuance and repayment of notes payable and commercial paper.
In accordance with GAAP, we record our actively managed fixed maturity
investments, interest-only securities, equity securities and certain other
invested assets at estimated fair value with any unrealized gain or loss, net of
tax and related adjustments, recorded as a component of shareholders' equity. At
March 31, 2000, primarily because of the recent increases in interest rates and
related decrease in values of interest-bearing securities, we decreased the
carrying value of such investments by $1,647.9 million as a result of this fair
value adjustment. The fair value adjustment resulted in a $1,504.3 million
decrease in carrying value at year-end 1999, for the same reasons.
Total capital shown below excludes debt of the finance segment used to fund
finance receivables. Total capital, before the fair value adjustment recorded in
accumulated other comprehensive loss, increased $228.5 million, or 2.0 percent,
to $11.7 billion.
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Total capital, excluding accumulated other comprehensive loss:
Corporate notes payable and commercial paper........................... $ 2,746.1 $ 2,481.8
Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts..................................... 2,641.8 2,639.1
Shareholders' equity:
Preferred stock..................................................... 481.3 478.4
Common stock and additional paid-in capital......................... 2,889.5 2,987.1
Retained earnings................................................... 2,918.5 2,862.3
--------- ----------
Total shareholders' equity, excluding accumulated
other comprehensive loss...................................... 6,289.3 6,327.8
--------- ----------
Total capital, excluding accumulated other comprehensive loss.... 11,677.2 11,448.7
Accumulated other comprehensive loss....................................... (876.4) (771.6)
--------- ---------
Total capital.................................................... $10,800.8 $10,677.1
========= =========
</TABLE>
Corporate notes payable and commercial paper increased during the first
three months of 2000 primarily due to the settlement of a forward contract
described in the note to the consolidated financial statements entitled "Changes
in Common Stock" and the settlement of certain intercompany accounts with
Conseco Finance.
38
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Shareholders' equity, excluding accumulated other comprehensive loss,
decreased by $38.5 million in the first three months of 2000, to $6.3 billion.
Significant components of the decrease included: (i) the settlement of the
forward contract and repurchases of common stock of $102.6 million; and (ii)
$21.2 million of common and preferred stock dividends. These decreases were
partially offset by net income of $77.4 million. The accumulated other
comprehensive loss increased by $104.8 million, principally related to the
decreasing fair value of our insurance companies' investment portfolio as
interest rates rose.
Book value per common share outstanding decreased to $15.16 at March 31,
2000, from $15.50 at December 31, 1999, primarily due to the factors discussed
in the previous paragraph. Excluding accumulated other comprehensive loss, book
value per common share outstanding was $17.85 at both March 31, 2000, and
December 31, 1999.
Goodwill (representing the excess of the amounts we paid to acquire
companies over the fair value of net assets acquired in transactions accounted
for as purchases) was $3,900.4 million and $3,927.8 million at March 31, 2000
and December 31, 1999, respectively. Goodwill as a percentage of shareholders'
equity was 72 percent and 71 percent at March 31, 2000 and December 31, 1999,
respectively. Goodwill as a percentage of total capital, excluding other
comprehensive loss, was 33 percent and 34 percent at March 31, 2000 and December
31, 1999, respectively. We believe that the life of our goodwill is
indeterminable and, therefore, have generally amortized its balance over 40
years as permitted by generally accepted accounting principles. Amortization of
goodwill totaled $27.4 million and $27.5 million during the first quarters of
2000 and 1999, respectively. If we had determined the estimated useful life of
our goodwill was less than 40 years, amortization expense would have been
higher.
We continually monitor the value of our goodwill based on our best
estimates of future earnings considering all available evidence. We determine
whether goodwill is fully recoverable from projected undiscounted net cash flows
from earnings of the business acquired over the remaining amortization period.
If we were to determine that changes in such projected cash flows no longer
support the recoverability of goodwill over the remaining amortization period,
we would reduce its carrying value with a corresponding charge to expense or
shorten the amortization period (no such changes have occurred). Cash flows
considered in such an analysis are those of the business acquired, if separately
identifiable, or the product line of the business acquired, if such earnings are
not separately identifiable.
Dividends declared on common stock for the three months ended March 31,
2000, were 5 cents per share. As part of our plan to strengthen our capital
structure, the Board of Directors reduced the cash dividend on our common stock
to a quarterly rate of 5 cents per share, beginning with the dividend paid in
April of 2000.
39
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
The following table summarizes certain financial ratios as of and for the
three months ended March 31, 2000, and as of and for the year ended December 31,
1999:
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
---- ----
<S> <C> <C>
Book value per common share:
As reported............................................................................... $15.16 $15.50
Excluding accumulated other comprehensive income (loss) (a)............................... $17.85 $17.85
Ratio of earnings to fixed charges:
As reported............................................................................... 1.73X 2.98X
Excluding interest expense on debt related to finance
receivables and other investments (b)................................................... 4.50X 7.06X
Ratio of operating earnings to fixed charges (c):
As reported............................................................................... 1.91X 4.26X
Excluding interest expense on debt related to finance
receivables and other investments (b)................................................... 5.36X 10.99X
Ratio of earnings to fixed charges, preferred dividends and distributions on
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts:
As reported............................................................................. 1.38X 2.20X
Excluding interest expense on debt related to finance
receivables and other investments (b)................................................. 2.03X 3.38X
Ratio of operating earnings to fixed charges, preferred dividends and
distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts (c):
As reported............................................................................. 1.52X 3.14X
Excluding interest expense on debt related to finance
receivables and other investments (b)................................................. 2.42X 5.26X
Rating agency ratios (a) (d) (e):
Debt to total capital..................................................................... 24% 22%
Debt and Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts to total capital (f)............................................... 46% 45%
<FN>
- ----------------------
(a) Excludes accumulated other comprehensive income (loss).
(b) We include these ratios to assist you in analyzing the impact of interest
expense on debt related to finance receivables and other investments (which
is generally offset by interest earned on finance receivables and other
investments financed by such debt). Such ratios are not intended to, and do
not, represent the following ratios prepared in accordance with GAAP: the
ratio of earnings and operating earnings to fixed charges; and the ratio of
earnings and operating earnings to fixed charges, preferred dividends and
distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts.
(c) Such ratios exclude the following items from earnings: (i) net investment
gains (losses) (less that portion of amortization of cost of policies
purchased and cost of policies produced relating to such gains (losses));
(ii) impairment charges; and (iii) charges that are considered to be
unusual. 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; and the ratio of earnings to fixed charges, preferred
dividends and distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts.
40
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
(d) Excludes debt of the finance segment used to fund finance receivables and
investment borrowings of the insurance segment.
(e) These ratios are calculated in a manner discussed with rating agencies.
(f) Total Company-obligated mandatorily redeemable preferred securities of
subsidiary trusts exclude, and total capital includes: (i) amounts related
to FELINE PRIDES which require the holders to purchase a number of shares
of the Company's common stock under the terms specified in the stock
purchase contracts; and (ii) amounts related to RHINOS. In April 2000, the
Company and the holder of the RHINOS agreed to the repurchase by the
Company of the RHINOS. In connection with the RHINOS repurchase, the
Company entered into a bank credit facility of $125.0 million.
</FN>
</TABLE>
We continually review our capital structure, including the need and
desirability of modifying our existing debt and equity.
Liquidity for insurance and fee-based operations
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 any applicable 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.
We believe that the diversity of the investment portfolio and the
concentration of investments in high-quality, liquid securities provide
sufficient liquidity to meet foreseeable cash requirements.
Liquidity for finance operations
Following our March 31, 2000, announcement regarding the plan to explore
the sale of Conseco Finance and the other events described in the note to the
consolidated financial statements entitled "Subsequent Events" and elsewhere
herein, the uncertainty surrounding the ultimate outcome of Conseco's plan has
made it more difficult to complete new public securitization transactions. We
are currently funding loans through our warehouse and bank credit facilities and
expect to commence offering securities in public or private securitization
transactions in the near future. We are also exploring other possible
transactions such as whole loan sales. In May 2000, we sold $1.3 billion of
finance receivables to Lehman Brothers and its affiliates. A portion of the
proceeds from such sale was used to repay various warehouse credit lines,
creating increased warehousing capacity for Conseco Finance. Lehman Brothers
also amended its repurchase and other financing facilities with Conseco Finance
to expand the types of assets financed.
At March 31, 2000, we had $6.7 billion in master repurchase agreements,
commercial paper conduit facilities and other facilities with various banking
and investment banking firms for the purpose of financing our consumer and
commercial finance loan production. These facilities typically provide financing
of a certain percentage of the underlying collateral and are subject to the
availability of eligible collateral and, in many cases, the willingness of the
banking firms to continue to provide financing. These agreements generally
provide for annual terms, some of which are extended either quarterly or
semi-annually by mutual agreement of the parties for an additional annual term
based upon receipt of updated quarterly financial information. At March 31,
2000, we had borrowed $3.7 billion of the $6.7 billion available under such
agreements.
Our finance operations require cash to originate finance receivables. Our
primary sources of cash are the collection of receivable balances; proceeds from
the issuance of debt, certificate of deposits and securitization or sales of
loans; cash provided by operations; and cash provided by the parent company from
its credit sources.
Prior to March 31, 2000, the most significant source of liquidity for our
finance operations has been our ability to finance the receivables we originate
in the secondary markets through loan securitizations. Under certain
securitization 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 and over-collateralization
or other equivalent collateral. When choosing the appropriate structure for a
securitization of loans, we analyze the cash flows unique to each transaction,
as well as its marketability and projected economic value. The structure of each
securitized transaction depends, to a great extent, on conditions in the
fixed-income markets at the time the transaction is completed, as well as on
cost considerations and the availability and effectiveness of the various
enhancement methods.
41
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
The market for securities backed by receivables is a cost-effective source
of funds. Conditions in the credit markets during 1998, 1999 and early 2000
resulted in less-attractive pricing of certain lower-rated securities typically
included in loan securitization transactions. As a result, we chose to hold
rather than sell some of the securities in the securitization trusts,
particularly securities having corporate guarantee provisions.
Market conditions in the credit markets for loan securitizations and loan
sales change from time to time. For example, during certain periods of 1999, the
general levels of interest rates have increased on securities issued in
securitizations, causing us to incur higher interest costs on securitizations
completed during those periods. Changes in market conditions could affect the
interest rate spreads we earn on the loans we originate and the cash provided by
our finance operations. We have increased interest rates on our lending products
as we strive to maintain our targeted spread in the current interest rate
environment.
We continually investigate and pursue alternative and supplementary methods
to finance our lending operations. In late 1998, we began issuing certificates
of deposit through our bank subsidiary. At March 31, 2000, we had $1,355.3
million of such deposits outstanding which are recorded as liabilities related
to certificates of deposit. The average annual rate paid on these deposits was
6.1 percent during the first quarter of 2000.
Our finance segment generated cash flows from operating activities of
$121.2 million during the three months ended March 31, 2000, compared to
approximately $161.9 million in the same period of 1999. Such cash flows include
cash received from the securitization trusts of $104.3 million in the 2000
period and $165.2 million in the 1999 period, representing distributions of
excess interest and servicing fees.
On September 8, 1999, we announced that, although we plan to continue to
finance the receivables we originate through loan securitizations, we will no
longer structure future securitizations in a manner that results in gain-on-sale
revenues. This change is not expected to have any material effect on the amount
or timing of cash flows we receive, but the change required us to classify
certain activities differently on our cash flow statement (e.g., certain cash
flows recorded as "operating cash flows" under the gain-on-sale method must be
recorded as "investing activities" under the portfolio method and vice versa).
Independent rating agencies, financial institutions, analysts and other
interested parties monitor the leverage ratio of our finance segment. Such ratio
(calculated, as discussed with independent rating agencies, as the ratio of debt
to equity of our finance subsidiary calculated on a pro forma basis as if we had
accounted for the securitizations of our finance receivables as financing
transactions throughout the Company's history) was 23-to-1 and 22-to-1 at March
31, 2000, and December 31, 1999, respectively.
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 uses cash for:
(i) principal and interest payments on debt; (ii) dividends on preferred and
common stock; (iii) payments to subsidiary trusts to be used for distributions
on the Company-obligated mandatorily redeemable preferred securities of
subsidiary trusts; (iv) holding company administrative expenses; (v) income
taxes; and (vi) investments in subsidiaries and other investments. The primary
sources of cash to meet these obligations are payments from our subsidiaries,
including the statutorily permitted payments from our life insurance
subsidiaries in the form of: (i) fees for services provided; (ii) tax sharing
payments; (iii) dividend payments; and (iv) surplus debenture interest and
principal payments. 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 the notes to the consolidated financial
statements; or (iii) selling all or a portion of its subsidiaries or its other
investments. These sources have historically provided adequate cash flow to fund
the needs of the parent company's: (i) normal operations; (ii) internal
expansion, acquisitions and investment opportunities; and (iii) the retirement
of debt and equity.
42
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
During the first quarter of 2000, our insurance subsidiaries paid dividends
to Conseco of $93.1 million and our finance subsidiary repurchased shares of its
common stock for $126.0 million. The cash provided by operating activities at
the parent company, including dividends received from our insurance
subsidiaries, plus the amount paid to us to repurchase shares of common stock of
our finance subsidiary totaled $209.5 million during the first quarter of 2000.
In connection with the Lehman Brothers transaction described in the note to the
consolidated financial statements entitled "Subsequent Events", Conseco Finance
has agreed that it will not pay dividends until 2001 and then pay such dividends
only to the extent certain financial covenants are met.
The ability of our insurance subsidiaries to pay dividends is subject to
state insurance department regulations. These regulations generally permit
dividends to be paid from earned surplus of the insurance company 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.
In addition to fees and interest, during the remainder of 2000, our
insurance subsidiaries may pay dividends to Conseco of $111.5 million without
permission from state regulatory authorities.
The ratings assigned to Conseco's senior debt, trust preferred securities
and commercial paper are important factors in determining the Company's ability
to access the public capital markets for additional liquidity. Following our
March 31, 2000, announcement regarding the plan to explore the sale of Conseco
Finance and other events described in the note to the consolidated financial
statements entitled "Subsequent Events" and elsewhere herein, rating agencies
lowered their ratings on Conseco's senior debt, trust preferred securities and
commercial paper. As of May 10, 2000, the rating agencies have assigned the
following ratings: (i) Standard & Poor's has assigned a "BB-" rating to
Conseco's senior debt; a "B-" rating to trust preferred securities and a "B"
rating to commercial paper; (ii) Duff & Phelp's Credit Rating Company has
assigned a "BBB-" rating, rating watch-down, to Conseco's senior debt; a "BB"
rating to trust preferred securities and a "D-2" rating to commercial paper; and
(iii) Moody's Investor Services has assigned a "Ba1" rating, on review for
possible downgrade, to Conseco's senior debt; and a "ba3" rating to trust
preferred securities. The uncertainty surrounding the ultimate outcome of
Conseco's plan regarding Conseco Finance has made it difficult for the Company
to issue additional securities in the public markets.
In conjunction with the Lehman Brothers transaction, the intercompany
demand note due from Conseco Finance to the parent company was replaced with a
one-year term note and Conseco Finance is prepaying approximately $500 million
of this note. After such prepayment, the one-year term note has a balance of
$2,160.7 million. Conseco Finance has agreed with Lehman Brothers that it will
not make further prepayments on this note while certain financing arrangements
with Lehman Brothers remain outstanding.
The parent company has debt securities of approximately $1.5 billion which
are expected to become due during the remainder of 2000. The Company is
exploring numerous alternatives to meet the obligations under these agreements
including using any one or more of the following: (i) the proceeds from the sale
of Conseco Finance; (ii) extension of the maturity dates or refinancing current
facilities; (iii) the proceeds from the sale of other assets, including various
nonstrategic investments; (iv) cash on hand (including the $500 million Conseco
Finance is repaying on the intercompany demand note in conjunction with the
Lehman Brothers transaction); or (v) cash generated from operations.
43
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
INVESTMENTS
At March 31, 2000, the amortized cost and estimated fair value of fixed
maturity securities (all of which were actively managed) were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Investment grade:
Corporate securities................................................ $13,599.6 $ 63.3 $ 871.8 $12,791.1
United States Treasury securities and obligations of
United States government corporations and agencies................ 294.5 3.0 5.8 291.7
States and political subdivisions................................... 147.9 .1 7.2 140.8
Debt securities issued by foreign governments....................... 211.1 1.4 11.7 200.8
Mortgage-backed securities ......................................... 7,615.6 10.3 594.0 7,031.9
Below-investment grade (primarily corporate securities)................ 1,960.8 43.6 246.3 1,758.1
--------- ------ -------- ---------
Total actively managed fixed maturities........................... $23,829.5 $121.7 $1,736.8 $22,214.4
========= ====== ======== =========
</TABLE>
During the first quarter of 2000, we recorded $8.2 million of writedowns of
fixed maturity and equity securities as a result of changes in conditions which
caused us to conclude that a decline in fair value of the investments was other
than temporary. There were no such writedowns in the first quarter of 1999. At
March 31, 2000, fixed maturity securities in default as to the payment of
principal or interest had an aggregate amortized cost of $64.4 million and a
carrying value of $57.8 million.
Sales of invested assets (primarily fixed maturity securities) during the
first three months of 2000 generated proceeds of $2.1 billion, resulting in net
investment losses of $27.1 million.
At March 31, 2000, fixed maturity investments included $7.1 billion of
mortgage-backed securities (or 32 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 for
mortgage-backed securities 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 prevailing interest rates decline
significantly relative to the interest rates on such loans. The yields on
mortgage-backed securities purchased at a discount to par will increase when the
underlying mortgages prepay faster than expected. The yields on mortgage-backed
securities purchased at a premium will decrease when they prepay faster than
expected. When interest rates decline, the proceeds from the prepayment of
mortgage-backed securities are likely to be reinvested at lower rates than we
were earning on the prepaid securities. When interest rates increase,
prepayments on mortgage-backed securities decrease as fewer underlying mortgages
are refinanced. When this occurs, the average maturity and duration of the
mortgage-backed securities increase, which decreases the yield on
mortgage-backed securities purchased at a discount, because the discount is
realized as income at a slower rate, and increases the yield on those purchased
at a premium as a result of a decrease in the annual amortization of the
premium.
44
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
The following table sets forth the par value, amortized cost and estimated
fair value of mortgage-backed securities, summarized by interest rates on the
underlying collateral at March 31, 2000:
<TABLE>
<CAPTION>
Par Amortized Estimated
value cost fair value
----- ---- ----------
(Dollars in millions)
<S> <C> <C> <C>
Below 7 percent..................................................................... $4,618.1 $4,584.0 $4,300.7
7 percent - 8 percent............................................................... 1,925.7 1,910.4 1,856.0
8 percent - 9 percent............................................................... 288.3 288.0 284.6
9 percent and above................................................................. 856.0 860.6 616.9
-------- -------- --------
Total mortgage-backed securities............................................. $7,688.1 $7,643.0 $7,058.2
======== ======== ========
</TABLE>
The amortized cost and estimated fair value of mortgage-backed securities
at March 31, 2000, 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............ $4,030.5 $3,853.8 17%
Planned amortization classes and accretion-directed bonds................. 1,952.2 1,833.9 8
Commercial mortgage-backed securities..................................... 792.6 749.4 4
Subordinated classes and mezzanine tranches............................... 831.0 587.8 3
Other..................................................................... 36.7 33.3 -
-------- -------- ---
Total mortgage-backed securities (a)............................... $7,643.0 $7,058.2 32%
======== ======== ==
<FN>
- --------------------
(a) Includes below-investment grade mortgage-backed securities with an
amortized cost and estimated fair value of $27.4 million and $26.3 million,
respectively.
</FN>
</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. Pass-throughs are also used frequently in
the dollar roll market and can be used as the collateral when creating
collateralized mortgage obligations. Sequential classes are a series of tranches
that return principal to the holders in sequence. Targeted amortization classes
offer slightly better structure in return of principal than sequentials when
prepayment speeds are close to the speed at the time of creation.
Planned amortization classes and accretion-directed bonds are some of the
most stable and liquid instruments in the mortgaged-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 or companion classes. This insulates the planned amortization class from
the consequences of both faster prepayments (average life shortening) and slower
prepayments (average life extension).
Commercial mortgage-backed securities ("CMBS") are bonds secured by
commercial real estate mortgages. Commercial real estate encompasses income
producing properties that are managed for economic profit. Property types
include multi-family dwellings including apartments, retail centers, hotels,
restaurants, hospitals, nursing homes, warehouses, and office buildings. The
CMBS market currently offers high yields, strong credits, and call protection
compared to similar rated corporate bonds. Most CMBS have strong call protection
features where borrowers are locked out from prepaying their mortgages for a
stated period of time. If the borrower does prepay any or all of the loan, they
will be required to pay prepayment penalties.
45
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Subordinated and mezzanine tranches are classes that provide credit
enhancement to the senior tranches. The rating agencies require that this credit
enhancement not deteriorate due to prepayments for a period of time, usually
five years of complete lockout followed by another period of time where
prepayments are shared pro rata with senior tranches. The credit risk of
subordinated and mezzanine tranches is derived from owning a small percentage of
the mortgage collateral, while bearing a majority of the risk of loss due to
property owner defaults. Subordinated bonds can be anything rated "AA" or lower,
while typically we do not buy anything lower than "BB".
At March 31, 2000, the mortgage loan balance was primarily comprised of
commercial loans. Less than 1 percent of the mortgage loan balance was
noncurrent (loans which are two or more scheduled payments past due) at March
31, 2000.
At March 31, 2000, we held $52.0 million of trading securities; we
included them in other invested assets.
Our investment borrowings averaged approximately $389.8 million during the
first three months of 2000, compared with approximately $997.4 million during
the same period of 1999 and were collateralized by investment securities with
fair values approximately equal to the loan value. The weighted average interest
rates on such borrowings were 5.1 percent and 4.7 percent during the first three
months of 2000 and 1999, respectively.
STATUTORY INFORMATION
Statutory accounting practices prescribed or permitted by regulatory
authorities for the Company's insurance subsidiaries differ from GAAP. The
statutory income (loss) before net realized capital gains (losses) of our life
insurance subsidiaries was $(2.6) million and $79.5 million in the first three
months of 2000 and 1999, respectively. The Company's life insurance subsidiaries
reported the following amounts to regulatory agencies at March 31, 2000, after
appropriate eliminations of intercompany accounts among such subsidiaries
(dollars in millions):
<TABLE>
<S> <C>
Statutory capital and surplus .................................. $2,026.4
Asset valuation reserve......................................... 388.3
Interest maintenance reserve.................................... 490.8
--------
Total........................................................ $2,905.5
========
</TABLE>
The statutory capital and surplus shown above included investments in
up-stream affiliates, all of which were eliminated in the consolidated financial
statements prepared in accordance with GAAP, as follows:
<TABLE>
<CAPTION>
March 31,
2000
----
<S> <C>
Securitization debt issued by special purpose entities and guaranteed by our
finance subsidiary, all of which was purchased by our insurance subsidiaries
prior to the Merger (a)......................................................... $ 72.3
Preferred and common stock of intermediate holding company........................ 201.8
Common stock of Conseco (39.8 million shares)..................................... 37.6
Other............................................................................. 2.5
------
Total......................................................................... $314.2
======
<FN>
- --------------------
(a) Total par value, amortized cost and fair value of securities issued by
special purpose entities which hold loans originated by our finance
subsidiary (including the securities that are not guaranteed by Conseco
Finance, and therefore are not considered affiliated investments) were
$259.1 million, $254.7 million and $248.4 million, respectively.
</FN>
</TABLE>
State insurance laws generally restrict the ability of insurance companies
to pay dividends or make other distributions. In addition to fees and interest
described above, during the remainder of 2000, our insurance subsidiaries may
pay dividends to Conseco of $111.5 million without permission from state
regulatory authorities. During the first quarter of 2000, our insurance
subsidiaries paid dividends to Conseco totaling $93.1 million.
In 1998, the National Association of Insurance Commissioners adopted
codified statutory accounting principles, which are expected to constitute the
only source of prescribed statutory accounting practices and are effective in
2001. The changes to statutory accounting practices resulting from the
codification are not expected to have a material effect on the statutory capital
and surplus or statutory operating earnings data shown above.
FORWARD-LOOKING STATEMENTS
All statements, trend analyses and other information contained in this
report and elsewhere (such as in filings by Conseco with the Securities and
Exchange Commission, press releases, presentations by Conseco or its management
or oral statements) relative to markets for Conseco's products and trends in
Conseco's operations or financial results, as well as other statements including
words such as "anticipate," "believe," "plan," "estimate," "expect," "intend,"
"should," "could," "goal," "target," "on track," "comfortable with," and other
similar expressions, constitute forward-looking statements under the Private
Securities Litigation Reform Act of 1995. These forward-looking statements are
subject to known and unknown risks, uncertainties and other factors which may
cause actual results to be materially different from those contemplated by the
forward-looking statements. Such factors include, among other things: (i)
general economic conditions and other factors, including prevailing interest
rate levels, stock and credit market performance and health care inflation,
which may affect (among other things) Conseco's ability to sell its products,
its ability to make loans and access capital resources and the costs associated
therewith, the market value of Conseco's investments, the lapse rate and
profitability of policies, and the level of defaults and prepayments
46
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
of loans made by Conseco; (ii) Conseco's ability to achieve anticipated
synergies and levels of operational efficiencies; (iii) customer response to new
products, distribution channels and marketing initiatives; (iv) mortality,
morbidity, usage of health care services and other factors which may affect the
profitability of Conseco's insurance products; (v) performance of our
investments; (vi) changes in the Federal income tax laws and regulations which
may affect the relative tax advantages of some of Conseco's products; (vii)
increasing competition in the sale of insurance and annuities and in the finance
business; (viii) 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 products, and health care regulation affecting health insurance
products; (ix) the outcome of the contemplated sale process relating to Conseco
Finance Corp. and the terms and availability of capital to Conseco during the
sale process; (x) the effects of actions by rating agencies on financing
transactions, or the sales and persistency of Conseco's insurance and asset
accumulation products; and (xi) the risk factors or uncertainties listed from
time to time in Conseco's filings with the Securities and Exchange Commission.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our market risks, and the way we manage them, are summarized in
management's discussion and analysis of financial condition and results of
operations as of December 31, 1999, included in the Company's Form 10-K for the
year ended December 31, 1999. The fair value of our borrowed capital varies with
credit ratings and other conditions in the capital markets. Following our
announcement of March 31, 2000, concerning our plan to explore the sale of
Conseco Finance, the capital markets reacted by lowering the value of our
publicly traded securities. In addition, the capital markets have also lowered
the value of the securities issued in previous securitization transactions of
Conseco Finance.
47
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Conseco Finance was served with various related lawsuits filed in the
United States District Court for the District of Minnesota. These lawsuits were
generally filed as purported class actions on behalf of persons or entities who
purchased common stock or options to purchase common stock of Conseco Finance
during alleged class periods that generally run from February 1995 to January
1998. One action (Florida State Board of Admin. v. Green Tree Financial Corp.,
Case No. 98-1162) did not include class action claims. In addition to Conseco
Finance, certain current and former officers and directors of Conseco Finance
are named as defendants in one or more of the lawsuits. Conseco Finance and
other defendants obtained an order consolidating the lawsuits seeking class
action status into two actions, one of which pertains to a purported class of
common stockholders (In re Green Tree Financial Corp. Stock Litig., Case No.
97-2666) and the other which pertains to a purported class action of stock
option traders (In re Green Tree Financial Corp. Options Litig., Case No.
97-2679). 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 Conseco Finance 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 Conseco Finance (particularly with respect to
prepayment assumptions and performance of certain loan portfolios of Conseco
Finance) which allegedly rendered Conseco Finance's financial statements false
and misleading. On August 24, 1999, the United States District Court for the
District of Minnesota issued an order to dismiss with prejudice all claims
alleged in the lawsuits. The plaintiffs subsequently appealed the decision to
the U.S. Court of Appeals for the 8th Circuit, and the appeal is currently
pending. The Company believes that the lawsuits are without merit and intends to
continue to defend them vigorously. The ultimate outcome of these lawsuits
cannot be predicted with certainty.
A total of twenty-one suits have been filed against the Company in the
United States District Court for the Southern District of Indiana. Eleven of
these cases are putative class actions on behalf of persons or entities that
purchased the Company's common stock during alleged class periods that generally
run from April 1999 through April 2000. Luisi v. Conseco, Inc., et al., Case No.
IP00-C-0593-B/S; Sechrist v. Conseco, Inc., et al., Case No. IP00-C-0585-T/G;
Klein v. Conseco, Inc., et al., Case No. IP00-C-0602-M/S; Brody v. Conseco,
Inc., et al., Case No. IP00-C-0609-M/S; Dana v. Conseco, Inc., et al., Case No.
IP00-C- 0623-T/G; Krim v. Conseco, Inc., et al., Case No. IP00-C-0631-B/S; Nadaf
v. Conseco, Inc., et al., Case No. IP00-C-0628- Y/G; Greiner v. Conseco, Inc.,
et al., Case No. IP00-C-0639-Y/F (naming as a defendant only one
officer/director); Sedgwick v. Conseco, Inc., et al., Case No. IP00-C-0657-B/S;
Irle v. Conseco, Inc., et al., Case No. IP00-C-0746-H/G; Schwartz v. Conseco,
Inc., et al., Case No. IP00-C-0770-M/S. With the one exception noted, two former
officers/directors of the Company are named as defendants in each of the
lawsuits. In each case, the plaintiffs assert claims under Section 10(b) and
20(a) of the Securities Exchange Act of 1934. In each case, plaintiffs allege
that the Company and the individual defendants violated the federal securities
laws by, among other things, making false and misleading statements about the
current state and future prospects of Conseco Finance (particularly with respect
to performance of certain loan portfolios of Conseco Finance) which allegedly
rendered the Company's financial statements false and misleading. The Company
believes that the lawsuits are without merit and intends to continue to defend
them vigorously. The ultimate outcome of these lawsuits cannot be predicted with
certainty.
Six of the cases in the United States District Court were filed as
purported class actions on behalf of persons or entities that purchased
preferred securities issued by various Conseco Financing Trusts, including
Conseco Financing Trust V, Griffin v. Conseco, Inc., et al., Case No.
IP00-C-0663-M/S; Stifnagle v. Conseco, Inc., et al., Case No. IP00-C-0754-Y/G
(Stifnagle also asserts claims regarding Conseco Financing Trust VII) (making
allegations with respect to an August 24, 1998 offering), Conseco Financing
Trust VI, Costello v. Conseco, Inc., et al., Case No. IP00-C-0705-Y/G (October
8, 1998 offering), and Conseco Financing Trust VII, Zinno v. Conseco, Inc., et
al., Case No. IP00-C-0622-M/S; Shapiro v. Conseco, Inc., et al., Case No.
IP00-C-0650-B/S; Kosseff v. Conseco, Inc., et al., Case No. IP00-C-0753-Y/S
(August 26, 1999 offering). Each of these complaints names as defendants the
Company, the relevant trust (except Shapiro and Kosseff), two former
officers/directors of the Company, and the underwriters for the particular
issuance (except Shapiro). The Kosseff complaint also names an officer and all
of the Company's directors at the time of issuance of the preferred securities
by Conseco Financing Trust VII. In each case, plaintiffs assert claims under
Section 11 and Section 15 of the Securities Act of 1933, and the Zinno, Shapiro,
and Stifnagle complaints also assert claims under Section 12(a)(2) of that Act.
In each case, plaintiffs allege that the defendants violated the federal
securities laws by, among other things, making false and misleading statements,
in Prospectuses and/or Registration Statements related to the issuance of
preferred securities by the Trust involved, regarding the current state and
future prospects of Conseco Finance (particularly with respect to performance of
certain loan portfolios of Conseco Finance) which allegedly rendered the
disclosure documents false and misleading. The Company also intends to defend
these lawsuits vigorously. The ultimate outcome of these lawsuits cannot be
predicted with certainty.
48
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Four shareholder derivative suits have been filed in United States District
Court. Rogney v. Decatur, et al., Case No. IP00- C-0655-Y/F; Fletcher v.
Hilbert, et al., Case No. IP00-C-0693-H/G; Gold v. Decatur, et al., Case No.
IP00-C-0747-T/G; Batcheldor v. Hilbert, Case No. IP00-C-0743-H/G. The complaints
name as defendants the current directors, certain former directors, and, in
Fletcher, certain non-director officers of the Company (the Company is named as
a nominal defendant in each). Plaintiffs allege that the defendants breached
their fiduciary duties by, among other things, intentionally disseminating false
and misleading statements concerning the acquisition, performance and proposed
sale of Conseco Finance, and engaged in corporate waste by causing the Company
to guarantee loans that certain officers, directors and key employees of the
Company used to purchase stock under the Company's "Stock Purchase Plan." A
similar case has been filed in the Hamilton County Superior Court in Indiana.
Schweitzer v. Hilbert, et al., Cause No. 29001-0004CP251. The Company believes
that these lawsuits are without merit and intends to defend them vigorously. The
ultimate outcome of these lawsuits cannot be predicted with certainty.
Conseco, Inc. and its subsidiaries, Conseco Life Insurance Company and
Wabash Life Insurance Company, are currently named as defendants in a certified
nationwide class action lawsuit in the Superior Court for Santa Clara County
(California, cause number CV768991) and captioned "John P. Dupell and the John
P. Dupell 1992 Insurance Trust vs. Massachusetts General Life Insurance Company;
Life Partners Group, Inc., Wabash Life Insurance Company, Conseco, Inc., Donovan
R. Bolton, et al." The class, approximately 345,000 in number, consists of all
persons who purchased universal life insurance policies from Conseco Life
Insurance Company, formerly named Massachusetts General Life Insurance Company,
between January 1, 1984 and July 23, 1999 (excluding policies where death
benefits were paid). The claims involve the changing interest rate climate
between the 1980's and the comparatively lower rates in the 1990's, and the
resulting lower rates credited to universal life products. The plaintiffs
asserted claims of fraud, breach of the covenant of good faith and fair dealing,
negligence, negligent misrepresentation, unjust enrichment and related matters.
Conseco believes this lawsuit is without merit and is defending it vigorously.
The ultimate outcome of this lawsuit cannot be predicted with certainty.
In addition, the Company and its subsidiaries are involved on an ongoing
basis in lawsuits related to its operations. Although the ultimate outcome of
certain of such matters cannot be predicted, such lawsuits currently pending
against the Company or its subsidiaries are not expected, individually or in the
aggregate, to have a material adverse effect on the Company's consolidated
financial condition, cash flows or results of operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a) Exhibits.
12.1 Computation of Ratio of Earnings to Fixed Charges, Preferred
Dividends and Distributions on Company- obligated
Mandatorily Redeemable Preferred Securities of Subsidiary
Trusts
27.0 Financial Data Schedule
b) Reports on Form 8-K.
A report on Form 8-K dated February 7, 2000, was filed with the
Commission to report under Item 5, the completion of the public
offering of $800.0 million of 8.75 percent notes due February 9,
2004.
A report on Form 8-K dated March 31, 2000, was filed with the
Commission to report under Item 5, the Registrant's press release
dated March 31, 2000.
49
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CONSECO, INC.
Dated: May 15, 2000 By: /S/ JAMES S. ADAMS
------------------------
James S. Adams
Senior Vice President,
Chief Accounting Officer and Treasurer
(authorized officer and chief
accounting officer)
50
<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
for the three months ended March 31, 2000 and the year ended December 31, 1999
(Dollars in millions)
Three months
ended Year ended
March 31, December 31,
2000 1999
---- ----
<S> <C> <C>
Pretax income from operations:
Net income........................................................... $ 77.4 $ 595.0
Add income tax expense............................................... 75.4 423.1
Add minority interest................................................ 39.0 132.8
------ --------
Pretax income from operations.............................. 191.8 1,150.9
------ --------
Add fixed charges:
Interest expense on corporate debt, including amortization........... 48.9 169.6
Interest expense on finance debt..................................... 203.8 334.2
Interest expense on investment borrowings............................ 5.0 57.9
Portion of rental(1)................................................. 5.9 20.3
------ --------
Fixed charges................................................... 263.6 582.0
------ --------
Adjusted earnings............................................... $455.4 $1,732.9
====== ========
Ratio of earnings to fixed charges.............................. 1.73X 2.98X
===== ======
Ratio of earnings to fixed charges, excluding interest
expense on debt related to finance receivables and
other investments........................................... 4.50X 7.06X
====== =====
Fixed charges................................................... $263.6 $ 582.0
Add dividends on preferred stock, including dividends on
preferred stock of subsidiaries (divided by the rate of
income before minority interest and extraordinary charge
to pretax income)........................................... 6.5 2.4
Add distributions on Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts........ 59.9 204.3
------ --------
Fixed charges................................................... $330.0 $ 788.7
====== ========
Adjusted earnings............................................... $455.4 $1,732.9
====== ========
Ratio of earnings to fixed charges, preferred dividends and
distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts................... 1.38X 2.20X
====== ========
Ratio of earnings to fixed charges, preferred dividends and
distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, excluding interest
expense on debt related to finance receivables and other
investments................................................... 2.03X 3.38X
===== ======
<FN>
(1) Interest portion of rental is assumed to be 33 percent.
</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>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-END> MAR-31-2000
<DEBT-HELD-FOR-SALE> 22,214,400
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 360,800
<MORTGAGE> 1,294,700
<REAL-ESTATE> 0
<TOTAL-INVEST> 26,733,300
<CASH> 1,064,400
<RECOVER-REINSURE> 729,100
<DEFERRED-ACQUISITION> 4,356,700 <F1>
<TOTAL-ASSETS> 55,468,800
<POLICY-LOSSES> 24,828,100
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 783,700
<POLICY-HOLDER-FUNDS> 250,500
<NOTES-PAYABLE> 14,829,300 <F2>
2,641,800
481,300
<COMMON> 2,889,500
<OTHER-SE> 2,042,100 <F3>
<TOTAL-LIABILITY-AND-EQUITY> 55,468,800
1,048,700
<INVESTMENT-INCOME> 1,060,900
<INVESTMENT-GAINS> (35,300)
<OTHER-INCOME> 131,600
<BENEFITS> 1,067,500
<UNDERWRITING-AMORTIZATION> 173,600 <F4>
<UNDERWRITING-OTHER> 194,100
<INCOME-PRETAX> 191,800
<INCOME-TAX> 75,400
<INCOME-CONTINUING> 116,400
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 77,400
<EPS-BASIC> .22
<EPS-DILUTED> .22
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1> Includes $2,144,500 of cost of policies purchased.
<F2> Includes $5,562,500 related to finance debt and $6,520,700 related to
securitized finance receivables structured as collateralized borrowings.
<F3> Includes retained earnings of $2,918,500 and accumulated other
comprehensive losses of $876,400.
<F4> Includes amortization of cost of policies purchased of $76,800 and
amortization of cost of policies produced of $96,800.
</FN>
</TABLE>
