================================================================================
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 September 30, 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 October 31, 2000: 325,305,657
================================================================================
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
ASSETS
September 30, December 31,
2000 1999
---- ----
(unaudited)
<S> <C> <C>
Investments:
Actively managed fixed maturities at fair value (amortized cost: 2000 - $23,164.7;
1999 - $23,690.4)........................................................................ $21,552.3 $22,203.8
Interest-only securities at fair value (amortized cost: 2000 - $637.2; 1999 - $916.2)...... 640.1 905.0
Equity securities at fair value (cost: 2000 - $310.3; 1999 - $323.7)....................... 298.5 312.7
Mortgage loans............................................................................. 1,460.0 1,274.5
Policy loans............................................................................... 648.8 664.1
Venture capital investment in Tritel, Inc. (cost: 2000 - $53.2; 1999 - $53.2).............. 223.4 430.1
Other invested assets ..................................................................... 477.3 641.4
--------- ---------
Total investments...................................................................... 25,300.4 26,431.6
Cash and cash equivalents:
Held by the parent company................................................................. 332.3 1.9
Held by subsidiaries....................................................................... 932.5 1,685.0
Accrued investment income..................................................................... 486.5 436.0
Finance receivables........................................................................... 5,119.9 5,104.1
Finance receivables - securitized............................................................. 11,604.6 4,730.5
Cost of policies purchased.................................................................... 1,988.4 2,258.5
Cost of policies produced..................................................................... 2,523.6 2,087.4
Reinsurance receivables....................................................................... 680.8 728.6
Income tax assets............................................................................. 554.4 209.8
Goodwill...................................................................................... 3,847.1 3,927.8
Assets held in separate accounts and investment trust ........................................ 2,878.9 2,231.4
Cash held in segregated accounts for investors in securitizations............................. 637.8 853.0
Cash held in segregated accounts related to servicing agreements and securitization
transactions............................................................................... 547.0 274.0
Cash held in segregated accounts for the payment of debt...................................... 86.8 -
Other assets.................................................................................. 1,372.9 1,226.3
--------- ---------
Total assets........................................................................... $58,893.9 $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
September 30, December 31,
2000 1999
---- ----
(unaudited)
<S> <C> <C>
Liabilities:
Liabilities for insurance and asset accumulation products:
Interest-sensitive products.............................................................. $16,329.3 $17,322.4
Traditional products..................................................................... 7,801.9 7,537.3
Claims payable and other policyholder funds.............................................. 1,040.0 1,042.3
Liabilities related to separate accounts and investment trusts........................... 2,878.9 2,231.4
Liabilities related to certificates of deposit........................................... 1,574.4 870.5
Investor payables.......................................................................... 637.8 853.0
Other liabilities.......................................................................... 1,530.4 1,498.7
Investment borrowings...................................................................... 354.5 828.9
Notes payable and commercial paper:
Direct corporate obligations............................................................. 5,189.7 4,624.2
Direct finance obligations:
Master repurchase agreements........................................................... 2,642.8 1,620.9
Credit facility collateralized by retained interests in securitizations................ 600.0 499.0
Other borrowings....................................................................... 418.1 420.2
Related to securitized finance receivables structured as collateralized borrowings....... 10,944.6 4,641.8
--------- ---------
Total liabilities.................................................................... 51,942.4 43,990.6
--------- ---------
Minority interest:
Company-obligated mandatorily redeemable preferred securities of subsidiary trusts......... 2,401.5 2,639.1
Shareholders' equity:
Preferred stock............................................................................ 484.7 478.4
Common stock and additional paid-in capital (no par value, 1,000,000,000 shares
authorized, shares issued and outstanding: 2000 - 325,305,857;
1999 - 327,678,638)...................................................................... 2,908.8 2,987.1
Accumulated other comprehensive loss....................................................... (849.0) (771.6)
Retained earnings.......................................................................... 2,005.5 2,862.3
--------- ---------
Total shareholders' equity........................................................... 4,550.0 5,556.2
--------- ---------
Total liabilities and shareholders' equity........................................... $58,893.9 $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 Nine months ended
September 30, September 30,
------------------- -------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Insurance policy income........................................... $1,074.1 $1,017.5 $3,195.2 $3,044.9
Net investment income............................................. 830.6 667.9 2,773.9 2,071.5
Gain on sale:
Securitization transactions..................................... - 156.7 - 525.3
Other loan sales................................................ 1.9 - 4.5 -
Net investment losses ............................................ (74.4) (74.0) (227.9) (95.9)
Fee revenue and other income...................................... 123.1 121.6 380.7 354.2
-------- --------- --------- ---------
Total revenues................................................ 1,955.3 1,889.7 6,126.4 5,900.0
-------- --------- --------- ---------
Benefits and expenses:
Insurance policy benefits......................................... 1,000.0 814.7 3,086.7 2,624.9
Provision for losses.............................................. 110.8 28.3 345.5 76.8
Interest expense.................................................. 410.2 135.2 1,006.5 371.3
Amortization...................................................... 128.7 168.1 512.2 472.7
Other operating costs and expenses................................ 418.9 332.2 1,234.9 993.0
Special charges................................................... 253.3 - 580.5 -
Impairment charges................................................ 205.0 100.1 217.1 183.9
-------- --------- --------- ---------
Total benefits and expenses................................... 2,526.9 1,578.6 6,983.4 4,722.6
-------- --------- --------- ---------
Income (loss) before income taxes, minority interest,
extraordinary charge and cumulative effect of
accounting change........................................... (571.6) 311.1 (857.0) 1,177.4
Income tax expense (benefit)......................................... (179.8) 122.1 (212.7) 426.8
-------- --------- -------- ---------
Income (loss) before minority interest, extraordinary charge
and cumulative effect of accounting change.................. (391.8) 189.0 (644.3) 750.6
Minority interest:
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, net of income taxes.. 35.3 33.4 110.0 93.9
-------- --------- -------- ---------
Income (loss) before extraordinary charge and cumulative
effect of accounting change................................. (427.1) 155.6 (754.3) 656.7
Extraordinary charge on extinguishment of debt, net of taxes......... 4.9 - 5.0 -
Cumulative effect of accounting change, net of taxes................. 55.3 - 55.3 -
-------- --------- -------- ---------
Net income (loss)............................................. (487.3) 155.6 (814.6) 656.7
Preferred stock dividends............................................ 2.2 - 8.9 .6
-------- --------- -------- ---------
Net income (loss) applicable to common stock.................. $ (489.5) $ 155.6 $ (823.5) $ 656.1
======== ========= ======== =========
Earnings (loss) per common share:
Basic:
Weighted average shares outstanding............................. 325,300,000 327,000,000 326,168,000 323,741,000
Income (loss) before extraordinary charge and
cumulative effect of accounting change........................ $(1.32) $.48 $(2.34) $2.03
Extraordinary charge on extinguishment of debt.................. (.01) - (.01) -
Cumulative effect of accounting change.......................... (.17) - (.17) -
------ ------ ------- -----
Net income (loss)........................................... $(1.50) $ .48 $(2.52) $2.03
====== ===== ====== =====
Diluted:
Weighted average shares outstanding............................. 325,300,000 332,849,000 326,168,000 331,720,000
Net income (loss) before extraordinary charge and
cumulative effect of accounting change........................ $(1.32) $.47 $(2.34) $1.98
Extraordinary charge on extinguishment of debt.................. (.01) - (.01) -
Cumulative effect of accounting change.......................... (.17) - (.17) -
------ ---- ------ -----
Net income (loss)........................................... $(1.50) $.47 $(2.52) $1.98
====== ==== ====== =====
</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 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 loss, net of tax:
Net loss........................................ (814.6) - - - (814.6)
Change in unrealized depreciation of
investments (net of applicable income tax
benefit of $42.1)............................. (77.4) - - (77.4) -
--------
Total comprehensive loss.................... (892.0)
Issuance of shares for stock options and for
employee benefit plans.......................... 3.3 - 3.3 - -
Issuance of convertible preferred shares.......... 6.3 6.3 - - -
Issuance of warrants.............................. 21.0 - 21.0 - -
Cost of shares acquired........................... (102.6) - (102.6) - -
Dividends on common stock......................... (33.3) - - - (33.3)
Dividends on preferred stock...................... (8.9) - - - (8.9)
-------- ------ -------- ------- --------
Balance, September 30, 2000.......................... $4,550.0 $484.7 $2,908.8 $(849.0) $2,005.5
======== ====== ======== ======= ========
Balance, January 1, 1999............................. $5,273.6 $105.5 $2,736.5 $ (28.4) $2,460.0
Comprehensive income, net of tax:
Net income...................................... 656.7 - - - 656.7
Change in unrealized depreciation of
investments (net of applicable income tax
benefit of $344.0)............................ (638.0) - - (638.0) -
--------
Total comprehensive income.................. 18.7
Conversion of preferred stock into
common shares .................................. - (105.5) 105.5 - -
Issuance of shares for stock options and for
employee benefit plans.......................... 205.7 - 205.7 - -
Tax benefit related to issuance of shares under
stock option plans.............................. 24.4 - 24.4 - -
Cost of shares acquired........................... (89.4) - (89.4) - -
Dividends on common stock......................... (141.1) - - - (141.1)
Dividends on preferred stock...................... (.6) - - - (.6)
--------- ------- -------- ------- --------
Balance, September 30, 1999.......................... $5,291.3 $ - $2,982.7 $(666.4) $2,975.0
======== ======= ======== ======= ========
</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)
Nine months ended
September 30,
------------------
2000 1999
---- ----
<S> <C> <C>
Cash flows from operating activities:
Insurance policy income....................................................................... $ 2,945.9 $ 2,756.0
Net investment income......................................................................... 3,007.6 2,137.6
Points and origination fees................................................................... - 359.0
Fee revenue and other income.................................................................. 392.0 367.5
Insurance policy benefits..................................................................... (2,461.9) (2,113.9)
Interest expense.............................................................................. (899.8) (350.1)
Policy acquisition costs...................................................................... (643.6) (625.7)
Special charges............................................................................... (202.7) -
Other operating costs......................................................................... (1,276.4) (1,094.7)
Taxes......................................................................................... (37.7) (280.4)
---------- ----------
Net cash provided by operating activities................................................... 823.4 1,155.3
---------- ----------
Cash flows from investing activities:
Sales of investments.......................................................................... 4,705.4 12,839.3
Maturities and redemptions of investments..................................................... 597.6 821.5
Purchases of investments...................................................................... (5,718.6) (15,320.0)
Cash received from the sale of finance receivables, net of expenses........................... 1,964.0 8,567.2
Principal payments received on finance receivables............................................ 6,225.4 6,718.5
Finance receivables originated................................................................ (15,602.6) (18,784.9)
Other......................................................................................... (133.0) (18.2)
---------- ----------
Net cash used by investing activities ...................................................... (7,961.8) (5,176.6)
---------- ----------
Cash flows from financing activities:
Issuance of Company-obligated mandatorily redeemable preferred securities of
subsidiary trusts........................................................................... - 534.3
Repurchase of Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts........................................................................ (250.0) -
Issuance of common and convertible preferred shares........................................... 0.6 109.6
Issuance of notes payable and commercial paper................................................ 21,030.6 15,318.5
Payments on notes payable and commercial paper................................................ (13,058.1) (13,317.7)
Change in cash held in restricted accounts for settlement of borrowings....................... (441.1) -
Payments for settlement of forward contract and to repurchase equity securities............... (102.6) (29.5)
Investment borrowings......................................................................... (474.4) 140.9
Amounts received for deposit products......................................................... 3,720.1 2,935.2
Withdrawals from deposit products............................................................. (3,472.5) (2,186.9)
Dividends and distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts............................................................. (236.3) (253.3)
---------- ----------
Net cash provided by financing activities................................................. 6,716.3 3,251.1
---------- ----------
Net decrease in cash and cash equivalents................................................. (422.1) (770.2)
Cash and cash equivalents, beginning of period................................................... 1,686.9 1,704.7
---------- ----------
Cash and cash equivalents, end of period......................................................... $ 1,264.8 $ 934.5
========== ==========
</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 and
other insurance products. Our finance subsidiaries originate, securitize and
service manufactured housing, home equity, retail credit and floorplan loans.
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.
During the third quarter of 2000, we announced several courses of action
with respect to Conseco Finance Corp. ("Conseco Finance"), a wholly owned
subsidiary of Conseco, as well as our intent to sell our individual and group
major medical insurance lines and certain non-strategic assets held at the
parent company level, which are designed to reduce parent company debt over
time. These planned actions and the reduction of parent company debt are an
integral part of the restructuring of the bank debt which occurred during the
third quarter of 2000 (see "Changes in Direct Corporate Obligations"). The
actions with respect to Conseco Finance, include: (i) the sale, closing or
runoff of five units (i.e., asset-based lending, vendor finance, bankcards,
transportation and park construction); (ii) efforts to better utilize existing
assets so as to increase cash; and (iii) cost savings and restructuring of
ongoing businesses such as the streamlining of the field force in the
manufactured housing and home equity lending divisions. The Company believes
these contemplated actions offer better opportunities than the previously
announced plan to explore the sale of Conseco Finance and the actions are
designed to provide a business model which will result in positive cash flow at
Conseco Finance. The actions with respect to the sale of certain non-strategic
assets include the sales of our investment in the wireless communication
company, Tritel, Inc. ("Tritel"), our interest in the riverboat casino in
Lawrenceberg, Indiana, and our subprime auto loan portfolio. The Company
believes the announced courses of action will generate cash proceeds of
approximately $2.0 billion over the next 12 to 15 months; approximately $876
million of cash had been generated through September 30, 2000. However, no
assurance can be provided as to the timing, proceeds, or other terms related to
the possible disposition of assets, the timing or extent of the cost savings to
be achieved, or the amount of the restructuring or other charges to be incurred
with respect to these actions.
Several elements of the plans we previously announced have already been
completed:
(i) We completed the restructuring of the operations of our finance
division (see the note entitled "Special Charges and Recent Events");
(ii) We completed the restructuring of our bank debt (see the note
entitled "Changes in Direct Corporate Obligations");
(iii) We have made significant progress in achieving our asset liquidation
and monetization transaction goals. Through November 14, 2000, we
have completed transactions which generated cash proceeds in excess
of $1.0 billion (approximately $170 million of which represent
refinancing or additional indebtedness); and
(iv) On November 7, 2000, A.M. Best upgraded the financial strength
ratings of our principal life insurance subsidiaries to A-
(Excellent) from B++ (Very Good). The return of these ratings to A-
(Excellent) satisfies a covenant in the recently amended bank credit
facilities, well before the required date of March 31, 2001.
BASIS OF PRESENTATION
Our unaudited consolidated financial statements reflect normal recurring
adjustments 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
7
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
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 certain fixed maturity securities,
interest-only securities, certain venture capital investments, the cost of
policies produced, the cost of policies purchased, 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 and nine months ended September 30, 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 deferred loan
origination costs. These changes reduced previously reported net income by $37.8
million, or $.11 per diluted share, and by $131.3 million, or $.40 per diluted
share, in the three and nine months ended September 30, 1999, respectively.
Our consolidated financial statements exclude the results of material
transactions between us and our consolidated affiliates, or among our
consolidated affiliates.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE
During the third quarter of 2000, the Emerging Issues Task Force of the
Financial Accounting Standards Board reached a consensus on a new accounting
requirement for the recognition of impairments on interest-only securities and
other retained beneficial interests in securitized finance assets. The new
guidance is summarized in EITF Issue No. 99-20, "Recognition of Interest Income
and Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets" ("EITF 99-20").
Under the prior accounting rule, declines in the value of our interest-only
securities and other retained beneficial interests in securitized financial
assets were recognized in the statement of operations when the present value of
estimated cash flows discounted at a risk-free rate using current assumptions
was less than the carrying value of the interest-only security.
Under the new accounting rule, declines in value are recognized when: (i)
the fair value of the security is less than its carrying value; and (ii) the
timing and/or amount of cash expected to be received from the security has
changed adversely from the previous valuation which determined the carrying
value of the security. When both occur, the security is written down to fair
value.
Although adoption is not required until January 1, 2001, we adopted the new
accounting rule on July 1, 2000, as permitted. The cumulative effect of the
accounting change for periods prior to July 1, 2000 was a decrease to net income
of $55.3 million (net of an income tax benefit of $29.9 million), or $.17 per
diluted share. The cumulative effect of the accounting change includes: (i)
$45.5 million (net of an income tax benefit of $24.7 million) related to
interest-only securities; and (ii) $9.8 million (net of an income tax benefit of
$5.2 million) related to other retained beneficial interests in securitized
financial assets held by our insurance segment.
8
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
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 $46.1 million of trading securities at
September 30, 2000, which we included in "other invested assets." We had no
fixed maturity securities in the "held to maturity" category at September 30,
2000.
Accumulated other comprehensive loss is primarily comprised of unrealized
losses on actively managed fixed maturity investments. Such amounts, included in
shareholders' equity as of September 30, 2000 and December 31, 1999, were as
follows:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Unrealized losses on investments...................................................... $(1,662.2) $(1,504.3)
Adjustments to cost of policies purchased and cost of policies produced............... 327.9 291.2
Deferred income tax benefit........................................................... 485.5 443.4
Other................................................................................. - (1.7)
--------- ---------
Net unrealized losses on investments............................................. (848.8) (771.4)
Minimum pension liability adjustment, net of income tax benefit....................... (.2) (.2)
--------- ---------
Accumulated other comprehensive loss............................................. $ (849.0) $ (771.6)
========= =========
</TABLE>
VENTURE CAPITAL INVESTMENT IN TRITEL, INC.
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, 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.
At September 30, 2000, our principal venture capital investment was 22.6
million common shares of Tritel, a company in the wireless communication
business. During 1999, we invested $53.2 million in Tritel. The market values of
many companies in this sector have been subject to market valuation volatility
in recent periods. We recognized a venture capital gain in net investment income
of $354.8 million in the fourth quarter of 1999 and a loss of $216.7 million in
the first nine months of 2000, of which $219.9 million was recognized in the
third quarter of 2000.
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 Financial Accounting
Standards Board Statement No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities" ("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.
9
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
The Financial Accounting Standards Board recently issued Financial
Accounting Standards Board Statement No. 140 ("SFAS 140"), which is a
replacement of SFAS 125, and a preliminary draft of an implementation guide for
SFAS 140 (the "preliminary draft"). The preliminary draft proposes a change that
could require the Company to structure securitization transactions in a
different manner to avoid recording a sale under the new proposed guidance. The
Company is studying the effects of the proposed change, which could be effective
for securitization transactions completed after March 31, 2001.
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 September 30, 2000, was approximately 11.9
percent. We classify the notes issued to investors in the securitization trusts
as "notes payable related to securitized finance receivables structured as
collateralized borrowings."
During the third quarter of 2000, we completed three securitization
transactions, securitizing $2.2 billion of finance receivables. During the first
nine months of 2000, we have securitized or sold over $6.9 billion of finance
receivables. We continue to be able to finance loans through: (i) our warehouse
and bank credit facilities; (ii) the sale of securities through securitization
transactions; and (iii) whole-loan sales.
The following table summarizes our finance receivables - securitized by
business line and categorized as either: (i) a part of our continuing lines; or
(ii) a part of the business units we have decided to sell, close or runoff (the
"discontinued lines"):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Continuing lines:
Manufactured housing............................................................... $ 4,575.2 $ 953.0
Mortgage services.................................................................. 4,498.0 2,077.3
Retail credit...................................................................... 738.9 -
Floorplan.......................................................................... 637.0 637.0
--------- --------
10,449.1 3,667.3
Less allowance for credit losses................................................... 110.7 4.4
--------- --------
Net finance receivables - securitized for continuing lines....................... 10,338.4 3,662.9
--------- --------
Discontinued lines:
Consumer finance................................................................... 262.5 278.9
Transportation..................................................................... 447.4 581.9
Vendor finance..................................................................... 579.4 216.1
---------- --------
1,289.3 1,076.9
Less allowance for credit losses................................................... 23.1 9.3
--------- --------
Net finance receivables - securitized for discontinued lines..................... 1,266.2 1,067.6
--------- --------
Total finance receivables - securitized.......................................... $11,604.6 $4,730.5
========= ========
</TABLE>
10
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
The following table summarizes our other finance receivables by business
line and categorized as either: (i) a part of our continuing lines; or (ii) a
part of our discontinued lines:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Continuing lines:
Manufactured housing............................................................... $ 770.5 $ 795.8
Mortgage services.................................................................. 1,813.2 1,277.0
Retail credit...................................................................... 977.2 867.8
Floorplan.......................................................................... 261.3 602.7
-------- --------
3,822.2 3,543.3
Less allowance for credit losses................................................... 63.7 38.8
-------- --------
Net other finance receivables for continuing lines............................... 3,758.5 3,504.5
-------- --------
Discontinued lines:
Consumer finance................................................................... 580.5 142.2
Transportation..................................................................... 333.3 337.8
Vendor finance..................................................................... 203.6 423.3
Park construction.................................................................. 229.3 188.7
Other ............................................................................ 55.8 543.5
-------- --------
1,402.5 1,635.5
Less allowance for credit losses................................................... 41.1 35.9
-------- --------
Net other finance receivables for discontinued lines............................. 1,361.4 1,599.6
-------- --------
Total other finance receivables.................................................. $5,119.9 $5,104.1
======== ========
</TABLE>
The changes in the allowance for credit losses included in finance
receivables were as follows:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------ ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Allowance for credit losses, beginning of period..................... $153.2 $ 55.2 $ 88.4 $ 43.0
Additions to the allowance........................................... 156.0 (a) 28.3 298.7 76.8
Credit losses........................................................ (70.6) (21.9) (148.5) (58.2)
------ ------ ------- ------
Allowance for credit losses, end of period........................... $238.6 $ 61.6 $ 238.6 $ 61.6
====== ====== ======= ======
<FN>
--------------------
(a) Additions to the allowance for the three months ended September 30, 2000
includes: (i) $91.3 million related to continuing lines and classified as
"provision for losses"; (ii) $45.9 million related to discontinued lines
and classified as a component of "special charges" (see the note entitled
"Special Charges and Recent Events"); and (iii) $18.8 million related to a
block of finance receivables purchased during the third quarter of 2000.
</FN>
</TABLE>
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
11
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
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, $475.6 million and $715.7 million, respectively, at September
30, 2000, and were classified as "actively managed fixed maturity securities."
During the first nine months of 1999, the Company sold $9.2 billion of
finance receivables in various securitized transactions and recognized gains of
$525.3 million. We recognized no gain on sale related to securitized
transactions during the first nine 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 September 30, 2000 and
December 31, 1999. We include the difference between estimated fair value and
the amortized cost of the interest-only securities (after adjustments for
impairments required to be recognized in earnings) in "accumulated other
comprehensive loss, net of taxes."
<TABLE>
<CAPTION>
Manufactured Home equity/ Consumer/
September 30, 2000 housing home improvement equipment Total
------------------ ------- ---------------- --------- -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Interest-only securities at fair value............. $ 399.6 $ 222.7 $ 17.8 $ 640.1
Cumulative principal balance of sold finance
receivables at September 30, 2000............... 20,846.9 7,022.4 2,132.8 30,002.1
Weighted average stated customer interest rate
on sold finance receivables..................... 10.0% 11.6% 10.8%
Assumptions to determine estimated fair value
of interest-only securities at September 30, 2000:
Expected weighted average annual constant
prepayment rate as a percentage of principal
balance of related finance receivables (a).. 9.7% 20.6% 22.4%
Expected nondiscounted credit losses as a
percentage of principal balance of
related finance receivables (a)............. 8.9% 6.0% 6.4%
Weighted average discount rate ............... 15.0% 15.0% 15.0%
Manufactured Home equity/ Consumer/
December 31, 1999 housing home improvement equipment Total
----------------- ------- ---------------- --------- -----
(Dollars in millions)
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%
12
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
<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>
As described above under the note entitled "Cumulative Effect of Accounting
Change", the Company adopted the requirements of EITF 99-20 effective July 1,
2000. During the third quarter of 2000, management analyzed the assumptions used
to determine the estimated fair value of the interest-only securities and made
changes to the credit loss assumptions and the discount rate used to determine
the value of several securities. These changes were made considering recent
adverse default and loss trends and other economic factors. As a result of these
changes, the cash flows from interest-only securities changed adversely from
previous estimates. Pursuant to the requirements of EITF 99-20, the effect of
these changes are reflected immediately in earnings as an impairment charge. The
effect of the impairment charge and adjustments to the value of our servicing
rights totaled $205.0 million ($133.3 million after income tax benefit) for the
third quarter of 2000 (in addition to the cumulative effect of adopting EITF
99-20 of $70.2 million ($45.5 million after the income tax benefit )).
Activity in the interest-only securities account was as follows:
<TABLE>
<CAPTION>
Nine months ended
September 30,
------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Balance, beginning of period................................................................... $ 905.0 $1,305.4
Additions resulting from securitizations during the period.................................. - 378.6
Additions resulting from clean-up calls (a)................................................. 74.0 -
Investment income........................................................................... 85.0 137.9
Cash received............................................................................... (164.6) (343.0)
Impairment charge to reduce carrying value.................................................. (203.2) (180.1)
Cumulative effect of change in accounting principle......................................... (70.2) -
Change in unrealized appreciation (depreciation) charged to shareholders' equity............ 14.1 (5.8)
------- --------
Balance, end of period......................................................................... $ 640.1 $1,293.0
======= ========
<FN>
---------------
(a) During the first nine months of 2000, clean-up calls were exercised for
seven 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 seven securitizations triggered a requirement for the
Company to repurchase a portion of the interest-only securities.
</FN>
</TABLE>
13
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Credit quality of managed finance receivables was as follows:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
<S> <C> <C>
60-days-and-over delinquencies as a percentage of managed finance
receivables at period end:
Manufactured housing.................................................... 2.12% 1.57%
Mortgage services....................................................... .85 1.00
Retail credit........................................................... 2.87 3.02
Floorplan............................................................... .23 .07
Total continuing lines................................................ 1.67 1.36
Total discontinued lines................................................ 2.07 1.72
Total................................................................. 1.71% 1.42%
Net credit losses incurred during the last twelve months as a percentage of
average managed finance receivables during the period:
Manufactured housing.................................................... 1.47% 1.25%
Mortgage services....................................................... 1.09 .99
Retail credit........................................................... 5.17 4.33
Floorplan............................................................... .25 .17
Total continuing lines................................................ 1.41 1.20
Total discontinued lines................................................ 3.28 1.97
Total................................................................. 1.62% 1.31%
Repossessed collateral inventory as a percentage of managed finance receivables
at period end:
Manufactured housing.................................................... 1.23% 1.09%
Mortgage services....................................................... 2.71 2.29
Floorplan............................................................... .37 .07
Total continuing lines................................................ 1.61 1.36
Total discontinued lines................................................ 2.35 1.18
Total................................................................. 1.68% 1.34%
</TABLE>
CASH HELD IN SEGREGATED ACCOUNTS FOR THE PAYMENT OF DEBT
Pursuant to the amendment to our bank credit facilities, we have agreed to
transfer defined amounts of cash received from asset sales and refinancing
transactions to a segregated account for the payment of public debt maturing in
2000 and 2001 (see the note entitled "Changes in Direct Corporate Obligations").
At September 30, 2000, $86.8 million has been transferred to this account. At
November 14, 2000, the segregated cash balance exceeds the amount needed to
repay the $131.5 million of public debt due in December 2000.
14
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
EARNINGS PER SHARE
A reconciliation of income (loss) and shares used to calculate basic and
diluted earnings per share is as follows:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
----------------- ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions
and shares in thousands)
<S> <C> <C> <C> <C>
Income (loss):
Net income (loss).................................................. $(487.3) $155.6 $(814.6) $656.7
Preferred stock dividends.......................................... 2.2 - 8.9 .6
------- ------ -------- -------
Income (loss) applicable to common ownership for basic
earnings per share............................................. (489.5) 155.6 (823.5) 656.1
Effect of dilutive securities:
Preferred stock dividends.......................................... - - - .6
------- ------ -------- -------
Income (loss) applicable to common ownership and assumed
conversions for diluted earnings per share..................... $(489.5) $155.6 $(823.5) $656.7
======= ====== ======= ======
Shares:
Weighted average shares outstanding for basic earnings per share... 325,300 327,000 326,168 323,741
Effect of dilutive securities on weighted average shares:
Stock options.................................................... - 1,739 - 2,646
Employee benefit plans........................................... - 2,073 - 2,036
PRIDES........................................................... - - - 590
Convertible securities........................................... - 1,752 - 2,612
Forward purchase agreements...................................... - 285 - 95
------- ------- -------- -------
Dilutive potential common shares............................... - 5,849 - 7,979
------- ------- ------- -------
Weighted average shares outstanding for diluted earnings
per share.................................................. 325,300 332,849 326,168 331,720
======= ======= ======= =======
</TABLE>
There were no dilutive common stock equivalents during the 2000 periods
because of the net loss realized by the Company during those periods.
BUSINESS SEGMENTS
We manage our business operations through two segments, based on the
products offered, in addition to the corporate segment.
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, home equity loans, private label credit card
programs, and floorplan financing. These products are primarily marketed through
intermediary channels such as dealers, vendors, contractors and retailers.
Insurance and fee-based segment. Our insurance and fee-based segment
provides supplemental health, annuity and life insurance 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. Fee-based
activities include services performed for other companies, including: (i)
investment management; and (ii) insurance product marketing.
Corporate and other segment. Our corporate segment includes certain
investment activities, such as our venture capital investment in the wireless
communication company, Tritel, and our ownership interest in the riverboat
casino in
15
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Lawrenceberg, Indiana. In addition, the corporate segment includes interest
expense related to the Company's corporate debt, special corporate charges,
income from the major medical lines of business which we intend to sell and
other income and expenses. Corporate expenses are net of charges to our
subsidiaries for services provided by the corporate operations.
16
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Segment operating information was as follows:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------ ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Revenues:
Insurance and fee-based segment:
Insurance policy income:
Annuities..................................................... $ 41.7 $ 51.0 $ 109.3 $ 111.3
Supplemental health........................................... 537.0 508.3 1,597.6 1,537.9
Life.......................................................... 224.2 207.6 683.4 650.2
Other......................................................... 36.4 27.2 111.3 100.5
Net investment income (a)....................................... 474.7 453.9 1,499.5 1,501.3
Fee revenue and other income (a)................................ 34.9 25.3 94.8 79.1
Net losses from sale of investments (a)......................... (74.4) (74.0) (227.9) (95.9)
-------- -------- -------- --------
Total insurance and fee-based segment revenues.............. 1,274.5 1,199.3 3,868.0 3,884.4
-------- -------- -------- --------
Finance segment:
Net investment income:
Interest-only securities (a).................................. 28.9 46.8 85.0 137.9
Manufactured housing.......................................... 163.4 26.9 354.8 68.3
Mortgage services............................................. 184.4 36.1 468.8 82.6
Consumer/credit card.......................................... 101.7 56.3 306.1 134.1
Commercial.................................................... 50.3 29.5 165.6 78.5
Other (a)..................................................... 28.7 9.7 66.4 35.2
Gain on sale:
Securitization transactions:
Manufactured housing........................................ - 67.7 - 277.9
Mortgage services........................................... - 48.8 - 186.8
Consumer/credit card........................................ - 22.4 - 27.0
Commercial.................................................. - 10.1 - 28.7
Other....................................................... - 7.7 - 4.9
Other loan sales.............................................. 1.9 - 4.5 -
Fee revenue and other income.................................... 86.5 95.9 280.6 266.0
-------- -------- -------- --------
Total finance segment revenues.............................. 645.8 457.9 1,731.8 1,327.9
-------- -------- -------- --------
Corporate and other:
Net investment income........................................... 17.5 9.2 41.2 29.8
Venture capital loss related to investment in Tritel............ (219.9) - (216.7) -
Revenue from major medical lines, which the Company
intends to sell............................................... 245.1 231.7 722.9 676.0
-------- -------- -------- --------
Total corporate segment revenues............................ 42.7 240.9 547.4 705.8
-------- -------- -------- --------
Eliminations...................................................... (7.7) (8.4) (20.8) (18.1)
-------- -------- -------- --------
Total revenues.............................................. 1,955.3 1,889.7 6,126.4 5,900.0
-------- -------- -------- --------
Expenses:
Insurance and fee-based segment:
Insurance policy benefits....................................... 798.8 667.7 2,493.6 2,177.4
Amortization.................................................... 171.4 134.2 524.7 417.8
Interest expense................................................ 3.7 14.4 13.8 42.8
Other operating costs and expenses.............................. 174.1 121.1 519.4 421.0
-------- -------- -------- --------
Total insurance and fee-based segment expenses................ 1,148.0 937.4 3,551.5 3,059.0
-------- -------- -------- --------
</TABLE>
(continued)
17
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
(continued from previous page)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------ ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Finance segment:
Provision for losses............................................ $ 91.3 $ 28.3 $ 234.0 $ 76.8
Interest expense................................................ 335.2 86.0 806.6 210.2
Special charges................................................. 226.6 - 290.0 -
Impairment charges.............................................. 205.0 100.1 217.1 183.9
Other operating costs and expenses.............................. 179.3 170.6 587.4 488.0
-------- -------- -------- --------
Total finance segment expenses................................ 1,037.4 385.0 2,135.1 958.9
-------- -------- -------- --------
Corporate and other:
Interest expense on corporate debt.............................. 79.3 41.9 207.0 135.1
Provision for losses............................................ 19.5 - 111.5 -
Expenses from major medical lines, which the Company
intends to sell............................................... 258.2 206.5 766.8 600.2
Special charges................................................. 26.7 - 290.5 -
General corporate expenses, less charges to subsidiaries
for services provided......................................... (34.5) 16.2 (58.2) (12.5)
-------- -------- -------- --------
Total corporate segment expenses.............................. 349.2 264.6 1,317.6 722.8
-------- -------- -------- --------
Eliminations...................................................... (7.7) (8.4) (20.8) (18.1)
-------- -------- -------- --------
Total expenses................................................ 2,526.9 1,578.6 6,983.4 4,722.6
-------- -------- -------- --------
Income (loss) before income taxes and minority interest:
Insurance and fee-based operations.............................. 126.5 261.9 316.5 825.4
Finance operations.............................................. (391.6) 72.9 (403.3) 369.0
Corporate interest and other expenses........................... (306.5) (23.7) (770.2) (17.0)
-------- -------- -------- --------
Income (loss) before income taxes, minority interest
and extraordinary charge.................................. $ (571.6) $ 311.1 $ (857.0) $1,177.4
======== ======== ======== ========
<FN>
--------------------
(a) It is not practicable to provide additional components of revenue by
product or service.
</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 nine months of 2000 and 1999, net investment
income included $8.4 million and $57.8 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 $75.9
million at September 30, 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 $92.5
million and $69.8 million
18
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
during the first nine months of 2000 and 1999, respectively. The unamortized
premium of the S&P 500 Call Options was $63.2 million at September 30, 2000.
In the past, we have used interest-rate swaps to hedge the interest rate
risk associated with our borrowed capital. These agreements were terminated
during the first nine months of 2000. We realized a net investment loss of $38.6
million (net of income tax benefit of $20.6 million) related to such
terminations during the first nine months of 2000.
GUARANTEES
In conjunction with certain sales of finance receivables, we provided
guarantees aggregating approximately $1.6 billion at September 30, 2000. We
consider any potential payments related to these guarantees in the projected net
cash flows used to determine the value of our interest-only securities. We
believe the likelihood of a significant loss from such guarantees is remote.
We have guaranteed bank loans totaling $557.6 million to approximately 170
current and former directors, officers and key employees. The funds were used by
the participants to purchase approximately 19.0 million shares of Conseco common
stock in open market or negotiated transactions with independent parties. Such
shares are held by the bank as collateral for the loans. In addition, Conseco
has provided loans to participants for interest on the bank loans totaling $79.2
million. During the third quarter of 2000, the Company negotiated a new
guarantee with the banks which expires on December 31, 2003, and is available to
participants who qualify and choose to participate in a new lending program. A
key goal of the program is to reduce the balance of each participant's bank and
interest loans to $25 per share of stock purchased through the program. Such
reductions are to occur through cash payments and pay for performance programs.
Participants in the new program are required to put to the Company, 75 percent
of the value in excess of $25 per share of the shares purchased through this
program, as determined on December 31, 2003. A subsidiary of Conseco has pledged
$50 million of cash collateral in conjunction with the guarantee of a portion of
the bank loans. Conseco also granted a security interest in most of its assets
in conjunction with the guarantee of a portion of the bank loans. At September
30, 2000, the guaranteed bank loans exceeded the value of the common stock
collateralizing the loans by $405.0 million. All participants have agreed to
indemnify Conseco for any loss incurred on their loans. We regularly evaluate
these guarantees and loans in light of the collateral and the creditworthiness
of the participants. We established an additional noncash provision of $19.5
million ($12.7 million after the income tax benefit) during the third quarter of
2000 and $111.5 million ($72.0 million after the income tax benefit) during the
first nine months of 2000 in connection with these guarantees and loans. Such
provision is included as a component of the provision for losses. At September
30, 2000, the total reserve for losses on the loan guarantees was $130.4
million.
REINSURANCE
The cost of reinsurance ceded totaled $216.5 million and $325.2 million in
the first nine 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 $216.0 million and $342.7 million in the first
nine months of 2000 and 1999, respectively.
19
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
INCOME TAXES
A reconciliation of the U.S. statutory corporate income tax rate to the
effective rate reflected in the consolidated statement of operations is as
follows:
<TABLE>
<CAPTION>
Nine months ended
September 30,
-------------------
2000 1999
---- ----
<S> <C> <C>
U.S. statutory corporate rate.................................................................. (35.0)% 35.0%
Nondeductible goodwill amortization............................................................ 3.4 2.4
Other nondeductible expenses................................................................... 1.9 .1
State taxes.................................................................................... .4 1.4
Settlement of tax issues....................................................................... - (2.7)
Provision for tax issues and other............................................................. 4.5 -
----- -----
Effective tax rate...................................................................... (24.8)% 36.2%
===== ====
</TABLE>
CHANGES IN DIRECT CORPORATE OBLIGATIONS
Notes payable and commercial paper, representing direct corporate
obligations, were as follows (interest rates as of September 30, 2000):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
$1.5 billion bank credit facility (9.12%).................................... $1,500.0 $1,032.0
Other bank credit facilities (9.12%)......................................... 563.7 -
Commercial paper............................................................. - 898.4
7.875% notes due December 2000............................................... 131.5 150.0
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
Notes payable due 2003....................................................... - 250.0
8.75% notes due 2004......................................................... 788.0 -
6.8% senior notes due 2005................................................... 250.0 250.0
9.0% notes due 2006.......................................................... 550.0 550.0
Other........................................................................ 92.1 143.5
-------- --------
Total principal amount.................................................. 5,244.2 4,642.8
Unamortized net discount..................................................... 54.5 18.6
-------- --------
Direct corporate obligations............................................ $5,189.7 $4,624.2
======== ========
</TABLE>
During the third quarter of 2000, the Company repaid $664.6 million of
direct corporate obligations including: (i) $250 million notes payable due 2003;
and (ii) $414.6 million of bank credit facilities. The Company also restructured
its bank credit facilities. The amended facilities include: (i) a $1.5 billion
five year facility (the "$1.5 billion facility"); and (ii) other bank credit
facilities due December 31, 2001 (the "near-term facilities").
The $1.5 billion facility is due December 31, 2003, however, subject to the
absence of any default, the Company may further extend its maturity to March 31,
2005, provided that: (i) Conseco pays an extension fee of 3.5 percent of the
amount extended; and (ii) cumulative principal payments of at least $150 million
have been paid by September 30, 2002 and at least $300 million by September 30,
2003.
In amending our bank credit facilities, we agreed to the manner in which
the proceeds from asset sales and refinancing transactions would be used.
Through September 30, 2000, the $876.0 million of proceeds from such
transactions were used as follows: (i) $257.1 million was used to repay the
notes payable due 2003; (ii) $407.3 million was used to reduce
20
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
the total borrowings under our near-term facilities; and (iii) $86.8 million was
transferred to a segregated cash account for the payment of public debt maturing
in December 2000; (iv) $74.8 million was added to the general cash balance of
the Company; and (v) $50.0 million was transferred to a segregated cash account
to provide collateral for Conseco's guarantee related to the directors, officers
and key employee stock purchase program. Additional amounts have been added to
the segregated cash account for the payment of public debt through November 14,
2000; its balance is now $128.5 million.
Pursuant to the amendment of our bank credit facilities, we have agreed
that any amounts received from asset sales or refinancing transactions occurring
after September 30, 2000 (with certain exceptions), would be used as follows:
(i) the first $56 million received may be retained by Conseco until we have cash
on hand of $330 million; (ii) of the next $599 million received, $86 million
would be used to reduce our near-term facilities and $513 million would be added
to the segregated cash account for the payment of public debt maturing in 2001;
(iii) the next $200 million received would be added to the segregated cash
account for the payment of debt maturing in 2001; (iv) the next available
proceeds would be applied 80 percent to reduce our near-term facilities, with
the remaining 20 percent retained by Conseco until we have cash on hand of $330
million, and then 100 percent to our near-term facilities until such facilities
have been paid in full; and (v) any subsequent proceeds would be applied: (a) 50
percent to repay the $1.5 billion facility and to fund a segregated cash account
to provide collateral for Conseco's guarantee related to the directors, officers
and key employee stock purchase program (based on the relative balance due under
each facility); and (b) the remaining 50 percent would be retained by Conseco.
No assurance can be provided as to the timing, proceeds, or other terms related
to any potential asset sale or financing transaction.
The amended bank credit facilities require the Company to maintain various
financial ratios and balances, as defined in the agreement including: (i) a
debt-to-total capitalization ratio to be less than .450:1.0 at December 31, 2000
and decreasing over time, as defined in the agreement, to 0.300:1.0 at March 31,
2004 and thereafter (such ratio was .43:1 at September 30, 2000); (ii) an
interest coverage ratio greater than 1.00:1.0 for the quarter ending December
31, 2000 and increasing over time, as defined in the agreement, to 2.00:1.0 for
the four quarters ending December 31, 2003 and thereafter (such ratio was
1.38:1.0 at September 30, 2000); (iii) adjusted earnings, as defined in the
agreement, of at least $650 million for the six months ending March 31, 2001 and
increasing over time, as defined in the agreement, to $2,175.0 million for the
year ending December 31, 2004 (the adjusted earnings for the third quarter of
2000 exceeds one-half of the requirement for the six months ended March 31,
2001); (iv) Conseco Finance tangible net worth, as defined in the agreement, of
at least $950.0 million at December 31, 2000; $1.2 billion at December 31, 2001;
$1.4 billion at December 31, 2002; $1.65 billion at December 31, 2003; and $2.0
billion at December 31, 2004 (such tangible net worth was in excess of $1.2
billion at September 30, 2000); and (v) an aggregate risk-based capital ratio
with respect to our insurance subsidiaries of at least 200 percent (such ratio
was greater than 250 percent at September 30, 2000).
The amended bank credit facilities require the Company's principal
insurance subsidiaries to achieve a financial strength rating of A- (Excellent)
from A.M. Best by March 31, 2001. On November 7, 2000, A.M. Best upgraded the
financial strength rating of our principal life insurance subsidiaries to A-
(Excellent) from B++ (Very Good), satisfying the covenant requirement. The
amended bank credit facilities also prohibit the payment of cash dividends on
our common stock until the Company has received investment grade ratings on its
outstanding public debt and all amounts due under the near-term facilities have
been paid. The amended bank credit agreements also limit the issuance of
additional debt, contingent obligations, liens, asset dispositions, other
restrictive agreements, affiliate transactions, change in business and
modification of terms of debt or preferred stock, all as defined in the
agreements. The obligations under the amended bank credit facilities are
guaranteed by CIHC, Incorporated, a wholly owned subsidiary of Conseco, and the
ultimate holding company for Conseco's principal operating subsidiaries. In
addition, $155 million of our near-term facilities are collateralized by most of
Conseco's assets.
The interest rate on our amended bank credit facilities is based on an IBOR
rate plus a margin of 2.5 percent. Borrowings under the former and amended bank
credit facilities averaged $1,634.2 million during the first nine months of
2000, at a weighted average interest rate of 7.2 percent.
Borrowings under our commercial paper program averaged $450.5 million
during the first nine months of 2000, at a weighted average interest rate of 6.1
percent. The actions by rating agencies which occurred after March 31, 2000 (see
21
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity of Conseco"), have affected our ability to issue
commercial paper.
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.
During the third quarter of 2000, the Company repurchased $250 million of
notes payable due 2003. We recognized an extraordinary loss of $4.9 million (net
of income taxes of $2.6 million) related to this repurchase.
During the second quarter of 2000, we repurchased: (i) $18.5 million par
value of the 7.875 percent notes due 2000 for $16.7 million; and (ii) $12
million par value of the 8.75 percent notes due 2004 for $8.7 million. We
recognized an extraordinary gain of $3.2 million (net of income taxes of $1.7
million) related to these repurchases.
CHANGES IN DIRECT FINANCE OBLIGATIONS (EXCLUDING NOTES PAYABLE RELATED TO
SECURITIZED FINANCE RECEIVABLES STRUCTURED AS COLLATERALIZED BORROWINGS)
Notes payable (excluding notes payable related to securitized finance
receivables structured as collateralized borrowings) of the finance segment were
as follows (interest rates as of September 30, 2000):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Master repurchase agreements due on various dates in
2000 and 2001 (7.82%)..................................................... $2,642.8 $1,620.9
Credit facility collateralized by retained interests in securitizations
due 2001 (8.62%).......................................................... 600.0 499.0
Medium term notes due September 2002 and April 2003 (6.52%).................. 223.7 226.7
10.25% senior subordinated notes due 2002.................................... 193.6 193.6
Other........................................................................ 3.2 3.1
-------- --------
Total principal amount.................................................. 3,663.3 2,543.3
Unamortized net discount..................................................... 2.4 3.2
-------- --------
Direct finance obligations.............................................. $3,660.9 $2,540.1
======== ========
</TABLE>
Amounts borrowed under master repurchase agreements have increased as the
balance of finance receivables eligible as collateral for these agreements has
increased. At September 30, 2000, we had $4.3 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. Some of these
agreements provide for annual terms 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 September 30,
2000, we had borrowed $2.6 billion of the $4.3 billion available under such
agreements.
During the third quarter of 2000, the Company amended an agreement with
Lehman related to certain master repurchase agreements and the collateralized
credit facility. Such amendment significantly reduced the restrictions on
intercompany payments from Conseco Finance to Conseco as required by the
previous agreement. In conjunction with the amendment, Conseco agreed to convert
$750 million principal balance of its intercompany note due from Conseco Finance
to $750 million stated value of Conseco Finance 9 percent redeemable cumulative
preferred stock (the "intercompany preferred stock"). After such conversion and
prepayments made during the third quarter of 2000, the intercompany note had a
balance of $916.2 million.
Pursuant to the amended agreement, Conseco Finance may make the following
payments to Conseco: (i) interest on the intercompany note; (ii) payments for
products and services provided by Conseco; and (iii) intercompany tax sharing
payments. Conseco Finance may also make the following payments to Conseco
provided the minimum liquidity requirements defined in the amended agreement are
met and the cash payments are applied in the order summarized: (i) unpaid
interest on the intercompany note; (ii) prepayments of principal on the
intercompany note or repayments of any increase to the intercompany receivable
balance; (iii) dividends on the intercompany preferred stock; (iv) redemption of
the
22
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
intercompany preferred stock; and (v) common stock dividends. The liquidity test
of the amended agreement requires Conseco Finance to have minimum levels of cash
liquidity immediately after making payments to Conseco. Cash liquidity, as
defined, includes unrestricted cash and may include up to $150 million of
liquidity available at Conseco Finance's bank subsidiaries and the aggregate
amount available to be drawn under Conseco Finance's master repurchase
facilities (based on eligible excess collateral pledged to the lender multiplied
by the appropriate advance rate). The minimum cash liquidity must equal or
exceed $250 million, plus: (i) 50 percent of cash up to $100 million generated
by Conseco Finance subsequent to September 21, 2000; and (ii) 25 percent of cash
generated by Conseco Finance in excess of $100 million, provided the total
minimum cash liquidity shall not exceed $350 million and the cash generated by
Conseco Finance (used in the calculation to increase the minimum) will exclude
operating cash flows and the net proceeds received from certain asset sales and
other events listed in the amended agreement (which are consistent with the
courses of actions we have previously announced).
The amended agreement requires Conseco Finance to maintain various
financial ratios, commencing December 31, 2000, as defined in the agreement.
These ratios include: (i) an adjusted tangible net worth of at least $1.95
billion (such balance was in excess of $2.1 billion at September 30, 2000); (ii)
a fixed charge coverage ratio of not less than 1.0:1.0 for the three-month
period ending December 31, 2000, and defined periods thereafter (such ratio was
in excess of 1.0:1.0 for the quarter ended September 30, 2000); (iii) a ratio of
net worth to total managed receivables of not less than 4:100 (such ratio
exceeded 4.80:100 at September 30, 2000); and (iv) a ratio of total
non-warehouse debt (excluding master repurchase agreements and the
collateralized credit facility) to net worth of less than 1.0:2.0 (such ratio
was less than .5:2.0 at September 30, 2000).
NOTES PAYABLE RELATED TO SECURITIZED FINANCE RECEIVABLES STRUCTURED AS
COLLATERALIZED BORROWINGS
Notes payable related to securitized finance receivables structured as
collateralized borrowings were $10,944.6 million at September 30, 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 September 30, 2000 was 7.6
percent.
CHANGES IN MINORITY INTEREST
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 recognized an extraordinary
loss of $3.3 million (net of income taxes of $1.8 million) in the second quarter
of 2000 related to the redemption.
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 stock dividend will be
payable in cash, and the remainder may be paid in additional Series F shares
valued at $19.25 per share. In September
23
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
2000, we suspended the payment of common stock dividends, so the entire third
quarter dividend on the Series F shares was paid in additional Series F shares.
The Series F Preferred Stock ranks senior to the common stock outstanding and
has 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.
CHANGES IN COMMON STOCK
Changes in the number of shares of common stock outstanding were as
follows:
<TABLE>
<CAPTION>
Nine months ended
September 30,
-------------------
2000 1999
---- ----
(Shares in thousands)
<S> <C> <C>
Balance, beginning of period................................................................... 327,679 315,844
Stock options exercised..................................................................... 82 5,066
Issuance of shares.......................................................................... - 3,115
Common shares converted from PRIDES......................................................... - 5,904
Settlement of forward contract and common stock acquired.................................... (4,247) (2,900)
Shares issued under employee benefit compensation plans..................................... 1,792 89
------- -------
Balance, end of period......................................................................... 325,306 327,118
======= =======
</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. cash settlement, transfer of net shares to or from
the Buyer, or transfer of net cash to or from the Buyer). 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. Currently, we are continuing our implementation efforts, including
reviewing investments and other financial instruments for potential embedded
derivatives, and finalizing the actual impact of adopting SFAS 133 as of its
required implementation date of January 1, 2001.
Effective July 1, 2000, the Company adopted the new accounting principles
required by EITF 99-20 (see note entitled "Cumulative Effect of Accounting
Change").
The Financial Accounting Standards Board recently issued SFAS 140 and a
preliminary draft of an implementation guide which could affect future loan
securitization transactions (see note entitled "Finance Receivables and
Interest-Only Securities.")
24
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
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.
A total of forty-five suits were filed against the Company in the United
States District Court for the Southern District of Indiana. Nineteen of these
cases were 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. Two cases were putative class actions on
behalf of persons or entities that purchased the Company's bonds during the same
alleged class periods. Three cases were putative class actions on behalf of
persons or entities that purchased or sold option contracts, not issued by the
Company, on the Company's common stock during the same alleged class periods.
One case was a putative class action on behalf of persons or entities that
purchased the Company's "Feline Pride" convertible preferred stock instruments
during the same alleged class periods. With four exceptions, in each of these
twenty-five cases two former officers/directors of the Company are named as
defendants. In each case, the plaintiffs assert claims under Sections 10(b) and
20(a) of the Securities Exchange Act of 1934. In each case, plaintiffs allege
that the Company and the 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 these lawsuits are without merit and intends to defend them
vigorously. The ultimate outcome of these lawsuits cannot be predicted with
certainty.
Eleven 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, Conseco Financing Trust VI, and Conseco Financing
Trust VII. Each of these complaints named as defendants the Company, the
relevant trust (with two exceptions), two former officers/directors of the
Company, and underwriters for the particular issuance (with one exception). One
complaint also named 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 eight complaints also asserted claims under Section 12(a)(2) of
that Act. Two complaints also asserted claims under Sections 10(b) and 20(a) of
the Securities Exchange Act of 1934, and one complaint also asserted a claim
under Section 10(b) of that Act. In each case, plaintiffs alleged 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.
25
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
All of the securities cases have now been consolidated into one case in the
United States District Court for the Southern District of Indiana, captioned:
"In Re Conseco, Inc. Securities Litigation", cause number IP00-585-C- Y/S. An
amended complaint is expected to be filed on or about December 13, 2000. The
Company intends to defend this lawsuit vigorously. The ultimate outcome cannot
be predicted with certainty.
Nine shareholder derivative suits were filed in United States District
Court. The complaints named as defendants the current directors, certain former
directors, certain non-director officers of the Company (in one case), and,
alleging aiding and abetting liability, certain banks which allegedly made loans
in relation to the Company's "Stock Purchase Plan" (in these cases). The Company
is also named as a nominal defendant in each complaint. 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
Stock Purchase Plan. These cases have now been consolidated into one case in the
United States District Court for the Southern District of Indiana, captioned:
"In Re Conseco, Inc. Derivative Litigation", cause number IP00655-C-Y/S. An
amended complaint is expected to be filed on or about December 13, 2000. Three
similar cases have been filed in the Hamilton County Superior Court in Indiana.
Schweitzer v. Hilbert, et al., Cause No. 29001-0004CP251; Evans v. Hilbert, et
al., Cause No. 29001-0005CP308 (both Schweitzer and Evans name as defendants
certain non-director officers); Gintel v. Hilbert, et al., Cause No.
29003-0006CP393 (naming as defendants, and alleging aiding and abetting
liability as to, banks which allegedly made loans in relation to the Stock
Purchase Plan). 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 Services, LLC, Washington
National Insurance Company and United Presidential Life Insurance Company are
currently named defendants in a lawsuit filed in the Circuit Court of Claiborne
County, Mississippi, Cause No. CV-99-0106, and captioned "Carla Beaugez, Lois
Dearing, Lee Eaton and all other persons identified in the lawsuit v. Conseco,
Inc., Conseco Services, Inc., Washington National Company, United Presidential
Life Insurance Company and Larry Ratcliff." The claims of the eighty-seven
plaintiffs arise out of allegedly wrongful increases of the cost of insurance
and decrease in the credited interest rates on universal life policies issued to
the plaintiffs by United Presidential Life. The plaintiffs asserted claims
including negligent and intentional misrepresentation, fraudulent concealment,
fraudulent inducement, common law fraud, and deceptive sales practices. Conseco
believes this lawsuit is without merit and is defending it vigorously. The
ultimate outcome of this lawsuit 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 v. 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 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. We intend to continue defending
this action vigorously unless the current settlement discussions and procedures
produce a satisfactory outcome. The ultimate outcome of this lawsuit cannot be
predicted with certainty.
Conseco Finance is a defendant in two arbitration proceedings in South
Carolina (Lackey v. Green Tree Financial Corporation, n/k/a Conseco Finance
Corp. and Bazzle v. Green Tree Financial Corporation, n/k/a Conseco Finance
Corp.) where the arbitrator, over Conseco Finance's objection, allowed the
plaintiffs to pursue purported class action claims in arbitration. The two
purported arbitration classes consist of South Carolina residents who obtained
real estate secured credit from Conseco Finance's Manufactured Housing Division
(Lackey) and Home Improvement Division (Bazzle) in the early and mid 1990s, and
did not receive a South Carolina specific
26
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
disclosure form relating to selection of attorneys in connection with the credit
transactions. The arbitrator, in separate awards issued on July 24, 2000,
awarded a total of $26.8 million in penalties and attorneys' fees. Plaintiffs
have filed motions in South Carolina courts to have the awards confirmed as
judgments. The Bazzle award was confirmed as a judgment and the matter is
currently on appeal. The Lackey award has not been confirmed as a judgment.
Conseco Finance intends to vigorously challenge the awards and believes that the
arbitrator erred by, among other things, conducting class action arbitrations
without the authority to do so and misapplying South Carolina law when awarding
the penalties. The ultimate outcome of these proceedings cannot be predicted
with certainty.
In addition, the Company and its subsidiaries are involved on an ongoing
basis in other 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.
27
<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>
Nine months ended
September 30,
------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)........................................................................... $(814.6) $ 656.7
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Gain on sale of finance receivables..................................................... (4.5) (525.3)
Points and origination fees received.................................................... - 359.0
Interest-only securities investment income.............................................. (85.0) (137.9)
Cash received from interest-only securities............................................. 164.6 343.0
Servicing income........................................................................ (85.8) (123.7)
Cash received from servicing activities................................................. 97.1 137.0
Provision for losses.................................................................... 345.5 76.8
Amortization and depreciation........................................................... 548.3 495.4
Income taxes............................................................................ (342.0) 180.9
Insurance liabilities................................................................... 375.5 222.1
Accrual and amortization of investment income........................................... 154.1 (136.1)
Deferral of cost of policies produced and purchased..................................... (643.6) (625.7)
Impairment charges...................................................................... 217.1 183.9
Special charges......................................................................... 377.8 -
Cumulative effect of change in accounting............................................... 85.2 -
Minority interest....................................................................... 169.2 144.5
Net investment losses................................................................... 227.9 95.9
Other................................................................................... 36.6 (106.1)
Payment of taxes in settlement of prior years........................................... - (85.1)
------- --------
Net cash provided by operating activities............................................. $ 823.4 $1,155.3
======= ========
</TABLE>
<TABLE>
<CAPTION>
Nine months ended
September 30,
------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Non-cash items not reflected in the investing and financing activities sections
of the consolidated statement of cash flows:
Issuance of common stock under stock option and employee benefit plans....................... $ 2.7 $ 3.7
Issuance of convertible preferred shares..................................................... 6.3 -
Issuance of warrants to Lehman............................................................... 48.1 -
Issuance of warrants to General Electric Corporation......................................... 21.0 -
Tax benefit related to the issuance of common stock under employee benefit plans............. - 24.4
Conversion of preferred stock into common stock.............................................. - 138.0
</TABLE>
28
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
SPECIAL CHARGES AND RECENT EVENTS
The following table summarizes the special charges incurred by the Company
during the third quarter of 2000 and for the nine months ended September 30,
2000, which are further described in the paragraphs which follow:
<TABLE>
<CAPTION>
Three months Nine months
ended ended
September 30, September 30,
2000 2000
---- ----
(Dollars in millions)
<S> <C> <C>
Advisory and professional fees related to debt restructuring................ $ 7.2 $ 7.2
Restructuring of finance business:
Lower of cost or market adjustment for finance receivables
identified for sale.................................................. 103.3 103.3
Loss on sale of asset-based loans...................................... 68.2 68.2
Loss on sale of subprime automobile and bankcard business, net......... 3.4 61.9
Costs related to closing offices and streamlining businesses........... 29.5 29.5
Abandonment of computer processing systems............................. 35.8 35.8
Advisory fees and warrant paid and/or issued to Lehman
and other investment banks........................................... - 117.1
Executive contracts:
Executive termination payment ......................................... - 72.5
Chief Executive Officer signing payment................................ - 45.0
Warrants granted to General Electric Corporation....................... - 21.0
Other items................................................................. 5.9 19.0
------ ------
Special charges before income tax benefit.......................... 253.3 580.5
Income tax benefit related to special charges............................... 78.7 152.3
------ ------
Special charges, net of income tax benefit......................... $174.6 $428.2
====== ======
</TABLE>
Advisory and professional fees related to debt restructuring
During the third quarter of 2000, we incurred $7.2 million of
non-deferrable advisory and professional fees related to the restructuring of
our bank credit facilities.
Lower of cost or market adjustment for finance receivables identified for
sale
On July 27, 2000, we announced several courses of action to restructure our
finance business, including the sale or runoff of the finance receivables of
several business lines. The carrying value of the loans held for sale has been
reduced to the lower of cost or market, consistent with our accounting policy
for such loans. The reduction in value of these loans of $103.3 million
(including a $45.9 million increase to the allowance for credit losses)
primarily relates to transportation finance receivables (primarily loans for the
purchase of trucks and buses). These loans have experienced a significant
decrease in value as a result of the adverse economic effect that the recent
increases in oil prices and competition have had on borrowers in the
transportation business.
29
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Loss on sale of asset-based loans
During the third quarter of 2000, we sold asset-based loans with a carrying
value of $216.1 million in whole loan sale transactions. We recognized a loss of
$68.2 million on these sales.
Loss on sale of subprime automobile and bankcard business
During the second quarter of 2000, we sold all of the finance receivables
of our subprime automobile financing and servicing companies and terminated
their operations. In addition, the Company sold substantially all of its
bankcard (Visa and Mastercard) portfolio. We recognized a net loss on these
sales of $61.9 million.
Costs related to closing offices and streamlining businesses
Our restructuring activities included the closing of several branch offices
and streamlining our businesses. These activities included a reduction in the
work force of approximately 1,700 employees. The Company incurred a charge of
$6.9 million related to severance costs paid to terminated employees in the
third quarter of 2000. The Company also incurred lease termination and direct
closing costs of $12.3 million associated with the branch offices closed in
conjunction with the restructuring activities. In addition, fixed assets and
leasehold improvements of $10.3 million were abandoned when the branch offices
were closed.
Abandonment of computer processing systems
During the third quarter of 2000, we recorded a $35.8 million charge to
write off the carrying value of capitalized computer software costs for projects
that have been abandoned in conjunction with our restructuring. These costs are
primarily associated with: (i) computer processing systems under development
that would require significant additional expenditures to complete and that are
inconsistent with our current business plan; and (ii) computer systems related
to the lines of business discontinued by the Company and therefore are no longer
required.
Advisory fees and warrant paid and/or issued to Lehman and other
investment banks
In May 2000, we sold approximately $1.3 billion of finance receivables to
Lehman and its affiliates for cash and a right to share in future profits from a
subsequent sale or securitization of the assets sold. We paid a $25.0 million
transaction fee to Lehman in conjunction with the sale, which was included in
special charges. Such loans were sold to Lehman at a value which approximated
net book value, less the fee paid to Lehman.
During the second and third quarters of 2000, we repurchased a significant
portion of the finance receivables sold to Lehman. These finance receivables
were subsequently included in securitization transactions structured as
financings. The cost of the finance receivables purchased from Lehman did not
differ materially from the book value of the loans prior to their sale to
Lehman.
Lehman has also amended its master repurchase financing facilities with our
finance operations to expand the types of assets financed. As partial
consideration for the financing transaction, Lehman 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 warrant permits cash
settlement at fair value at the option of the holder of the warrant, it has been
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 $48.1 million estimated value of the
warrant was recognized as an expense during the second quarter of 2000. The
estimated fair value of the warrant did not change materially during the third
quarter of 2000.
30
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
We also paid Lehman $20.0 million in fees for its efforts to form an
investor group to purchase Conseco Finance. In addition, the Company paid other
investment banks and financial institutions $24.0 million in advisory fees
related to the potential sale of Conseco Finance and consultation regarding
various other transactions.
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 back to Conseco in 2000, concurrently with the
Lehman transaction, at book value.
Executive Terminations
On April 28, 2000, Conseco and Stephen C. Hilbert, the Company's former
Chairman and Chief Executive Officer, 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 withholdings 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 Rollin M. Dick, the Company's former Chief
Financial Officer, 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.
Executive Hiring
On June 28, 2000, the Company hired Gary C. Wendt as its Chief Executive
Officer. Pursuant to the terms of his employment agreement, Mr. Wendt received a
payment of $45 million (prior to required withholdings for taxes) and was
granted options to purchase an aggregate of 10,000,000 shares of Conseco common
stock at a price of $5.875 per share (the average of the high and low sales
price on the New York Stock Exchange on the date on which the substantial terms
of Mr. Wendt's employment were agreed to). The options vest over the next five
years and expire on June 28, 2010. The Company also issued 3,200,000 shares of
restricted stock to Mr. Wendt. The restrictions on the stock lapse if Mr. Wendt
remains employed by Conseco through June 30, 2002, or upon a "change in control"
of the Company. The value of the restricted shares ($18.8 million) will be
recognized as an expense to the Company over the two year period ending June 30,
2002. Mr. Wendt is also being provided certain supplemental retirement,
insurance and other benefits under the terms of his employment agreement.
In conjunction with Mr. Wendt's hiring and his release from noncompete
provisions of a prior agreement, the Company issued a warrant to a subsidiary of
General Electric Company to purchase 10,500,000 shares of Conseco common stock
at a purchase price of $5.75 per share. The estimated value of the warrant
($21.0 million) was recognized as a special charge in the second quarter of
2000.
31
<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 and nine months ended September 30, 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.
Consolidated results and analysis
The net loss applicable to common stock of $489.5 million in the third
quarter of 2000, or $1.50 per diluted share, included: (i) net investment losses
(including related costs, amortization and taxes) of $42.8 million, or 13 cents
per share; (ii) a loss of $107.6 million, or 33 cents per share, related to our
venture capital investment in Tritel; (iii) special items of $380.9 million, or
$1.17 per share (including the special charges of $174.6 million (net of an
income tax benefit of $78.7 million) as summarized in the note to the
consolidated financial statements entitled "Special Charges and Recent Events";
the provision for loss of $12.7 million (net of an income tax benefit of $6.8
million) related to the Company's guarantee of bank loans made to directors,
officers and key employees to purchase shares of Conseco common stock; an
impairment charge of $133.3 million (net of an income tax benefit of $71.7
million) related to the Company's interest-only securities and servicing rights;
the cumulative effect of an accounting change of $55.3 million (net of an income
tax benefit of $29.9 million) related to new requirements for the valuation of
interest-only securities; and the extraordinary charge of $4.9 million (net of
an income tax benefit of $2.6 million) related to the early retirement of debt);
and (iv) the net loss of $8.6 million, or 2 cents per share, related to the
major medical lines of business which we intend to sell. Net income applicable
to common stock of $155.6 million in the third quarter of 1999, or 47 cents per
diluted share, included: (i) net investment losses of $48.1 million, or 14 cents
per share; (ii) an impairment charge of $63.1 million, or 19 cents per share, to
reduce the value of interest-only securities and servicing rights; and (iii) the
net income of $16.3 million, or 5 cents per share, related to the major medical
lines of business we intend to sell. The aforementioned special and impairment
charges are explained in more detail in the notes to the accompanying
consolidated financial statements.
The net loss applicable to common stock of $823.5 million in the first nine
months of 2000, or $2.52 per diluted share, included: (i) net investment losses
(including related costs, amortization and taxes) of $127.4 million, or 39 cents
per share; (ii) a loss of $107.2 million, or 33 cents per share, related to our
venture capital investment in Tritel; (iii) special items of $701.8 million, or
$2.15 per share (including the special charges of $428.2 million (net of an
income tax benefit of $152.3 million) as summarized in the note to the
consolidated financial statements entitled "Special Charges and Recent Events";
the provision for loss of $72.0 million (net of an income tax benefit of $39.5
million) related to the Company's guarantee of bank loans made to directors,
officers and key employees to purchase shares of Conseco common stock; an
impairment charge of $141.3 million (net of an income tax benefit of $75.8
million) related to the Company's interest-only securities and servicing rights;
the cumulative effect of an accounting change of $55.3 million (net of an income
tax benefit of $29.9 million) related to new requirements for the valuation of
interest-only securities; and the extraordinary charge of $5.0 million (net of
an income tax benefit of $2.6 million) related to the early retirement of debt);
and (iv) the net loss of $28.7 million, or 9 cents per share, related to the
major medical lines of business which we intend to sell. Net income applicable
to common stock of $656.1 million in the first nine months of 1999, or $1.98 per
diluted share, included: (i) net investment losses of $72.8 million, or 22 cents
per share; (ii) an impairment charge of $115.9 million, or 35 cents per share,
to reduce the value of interest-only securities and servicing rights; and (iii)
the net income of $49.3 million, or 5 cents per share, related to the major
medical lines of business we intend to sell. The aforementioned special and
impairment charges are explained in more detail in the notes to the accompanying
consolidated financial statements.
Total revenues in the third quarters of 2000 and 1999 included net
investment losses of $74.4 million and $74.0 million, respectively. Excluding
net investment losses, total revenues were $2,029.7 million in the third quarter
of 2000, up 3.4 percent from $1,963.7 million in the third quarter of 1999.
Total revenues in the first nine months of 2000 and 1999 included net investment
losses of $227.9 million and $95.9 million, respectively. Excluding net
investment losses, total revenues were $6,354.3 million in the first nine months
of 2000, up 6.0 percent from $5,995.9 million in the first nine months of 1999.
We evaluate the performance and determine future earnings goals based on
operating earnings which are defined as income before: (i) net investment gains
(losses)(less that portion of amortization of cost of policies purchased and
cost of
32
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
policies produced and income taxes relating to such gains (losses)); (ii) the
venture capital income (loss) related to our investment in Tritel; (iii) special
items not related to the continuing operations of our businesses; and (iv) the
net income (loss) related to the major medical lines of business we intend to
sell. 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.
Results of operations by segment for the three and nine months ended
September 30, 2000 and 1999
The following tables and narratives summarize our results by segment.
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------ ------------------
2000 1999 2000 1999
---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Operating earnings before taxes:
Insurance and fee based segment operating earnings................ $ 192.3 $ 335.8 $ 512.5 $ 937.3
Finance segment operating earnings................................ 40.0 173.0 103.8 552.9
------- ------- ------- --------
Subtotal........................................................ 232.3 508.8 616.3 1,490.2
------- ------- ------- --------
Holding company activities:
Interest expense.................................................. (79.3) (41.9) (207.0) (135.1)
Other, net........................................................ (2.2) (6.9) 47.7 42.3
------- ------- ------- --------
Operating earnings from continuing operations before taxes and
preferred stock dividends..................................... 150.8 460.0 457.0 1,397.4
Taxes .............................................................. (62.9) (176.1) (196.4) (507.4)
Preferred stock dividends (including dividends on preferred
securities of subsidiary trusts, net of tax)...................... (37.5) (33.4) (118.9) (94.5)
------- ------- ------- --------
Operating earnings from continuing operations................... 50.4 250.5 141.7 795.5
------- ------- ------- --------
Net realized gains (losses)....................................... (42.8) (48.1) (127.4) (72.8)
Venture capital loss from investment in Tritel.................... (107.6) - (107.2) -
Special charges................................................... (380.9) (63.1) (701.9) (115.9)
Major medical lines, which the Company intends to sell............ (8.6) 16.3 (28.7) 49.3
------- ------- ------- --------
Net income (loss) applicable to common stock......................... $(489.5) $ 155.6 $(823.5) $ 656.1
======= ======= ======= ========
</TABLE>
33
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Insurance and fee-based operations
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------ ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Premiums and asset accumulation product collections:
Annuities........................................................... $ 480.2 $ 592.5 $ 1,759.4 $ 1,875.8
Supplemental health................................................. 531.7 538.0 1,692.4 1,646.9
Life................................................................ 240.4 270.1 727.6 736.2
Individual and group major medical.................................. 223.5 220.2 697.2 636.2
---------- --------- --------- ---------
Total collections on insurance products......................... 1,475.8 1,620.8 4,876.6 4,895.1
Mutual funds........................................................ 224.0 78.3 656.7 243.3
--------- --------- --------- ---------
Total premiums and asset accumulation product collections....... $ 1,699.8 $ 1,699.1 $ 5,533.3 $ 5,138.4
========= ========= ========= =========
Average liabilities for insurance and asset accumulation products:
Annuities:
Mortality based................................................... $ 459.3 $ 567.0 $ 455.5 $ 648.5
Equity-linked..................................................... 2,609.4 1,785.7 2,525.5 1,585.8
Deposit based..................................................... 9,366.5 10,865.9 9,804.1 10,921.4
Separate accounts and investment trust liabilities.................. 2,814.8 1,758.5 2,664.0 1,617.4
Health.............................................................. 4,808.4 4,327.0 4,708.7 4,287.8
Life:
Interest sensitive................................................ 4,280.6 4,084.2 4,265.3 4,097.3
Non-interest sensitive............................................ 2,664.6 2,775.6 2,699.4 2,823.1
--------- --------- --------- ---------
Total average liabilities for insurance and asset
accumulation products, net of reinsurance ceded............... $27,003.6 $26,163.9 $27,122.5 $25,981.3
========= ========= ========= =========
Revenues:
Insurance policy income............................................. $ 839.3 $ 794.1 $ 2,501.6 $ 2,399.9
Net investment income:
General account invested assets................................... 455.7 495.6 1,431.4 1,472.4
Equity-indexed products based on S&P 500 Index.................... 1.9 (26.6) 8.4 57.8
Amortization of cost of S&P 500 Call Options...................... (32.6) (26.4) (92.5) (69.8)
Separate account assets........................................... 49.7 11.3 152.2 40.9
Fee revenue and other income........................................ 34.9 25.3 94.8 79.1
---------- --------- --------- --------
Total revenues (a).............................................. 1,348.9 1,273.3 4,095.9 3,980.3
--------- --------- --------- --------
Expenses:
Insurance policy benefits........................................... 601.5 519.4 1,873.8 1,569.5
Amounts added to policyholder account balances:
Annuity products and interest-sensitive life products other than
those listed below.............................................. 150.9 163.3 470.0 510.8
Equity-indexed products based on S&P 500 Index.................... (3.3) (26.3) (2.4) 56.2
Separate account liabilities...................................... 49.7 11.3 152.2 40.9
Amortization related to operations.................................. 180.0 134.3 556.6 401.8
Interest expense on investment borrowings........................... 3.7 14.4 13.8 42.8
Other operating costs and expenses.................................. 174.1 121.1 519.4 421.0
--------- --------- --------- --------
Total benefits and expenses (a)................................. 1,156.6 937.5 3,583.4 3,043.0
--------- --------- --------- --------
Operating income before income taxes and minority interest...... 192.3 335.8 512.5 937.3
Net investment losses, including related costs and
amortization........................................................ (65.8) (73.9) (196.0) (111.9)
--------- --------- --------- --------
Income before income taxes and minority interest................ $ 126.5 $ 261.9 $ 316.5 $ 825.4
========= ========= ========= ========
</TABLE>
34
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
(continued from previous page)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
----------------- ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <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 (b)................... 4.48% 4.77% 4.63% 4.60%
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........................................... 2.72% 2.12% 2.66% 2.35%
Health loss ratios:
All health lines:
Insurance policy benefits....................................... $426.0 $362.2 $1,322.4 $1,079.7
Loss ratio...................................................... 74.30% 67.64% 77.39% 65.90%
Medicare Supplement:
Insurance policy benefits....................................... $163.1 $156.0 $514.2 $477.6
Loss ratio...................................................... 68.98% 68.83% 72.71% 68.73%
Long-Term Care:
Insurance policy benefits....................................... $178.2 $125.3 $521.7 $360.4
Loss ratio...................................................... 85.90% 65.66% 85.42% 64.12%
Specified Disease:
Insurance policy benefits....................................... $53.6 $64.7 $195.5 $175.6
Loss ratio...................................................... 57.55% 71.29% 69.91% 62.49%
Other:
Insurance policy benefits....................................... $31.1 $16.2 $91.0 $66.1
Loss ratio...................................................... 85.54% 59.37% 81.78% 65.72%
<FN>
--------------------
(a) Revenues exclude net investment gains (losses); benefits and expenses
exclude amortization related to realized gains.
(b) Investment income includes income from general account assets only. Average
insurance liabilities exclude liabilities related to separate accounts,
investment trust and reinsurance ceded.
</FN>
</TABLE>
Premiums and asset accumulation product collections were $1.7 billion in
the third quarter of 2000, approximately equal to 1999. Premiums and asset
accumulation product collections were $5.5 billion in the first nine months of
2000, up 7.7 percent over 1999. Recent rating actions adversely affected the
marketing of our insurance products during the current quarter. On November 7,
2000, A.M. Best upgraded the financial strength ratings of our principal life
insurance subsidiaries to A- (Excellent) from B++ (Very Good). See "Premium and
Asset Accumulation Product Collections" for further analysis.
Average liabilities for insurance and asset accumulation products, net of
reinsurance receivables, were $27.0 billion in the third quarter of 2000, up 3.2
percent over 1999. Average liabilities for insurance and asset accumulation
products, net of reinsurance receivables, were $27.1 billion in the first nine
months of 2000, up 4.4 percent over 1999.
35
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
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; and the income
(loss), cost and change in the fair value of S&P 500 Call Options related to
equity- indexed products) was $455.7 million in the third quarter of 2000, down
8.1 percent from the same period in 1999 and was $1,431.4 million in the first
nine months of 2000, down 2.8 percent from the same period in 1999. The average
balance of general account invested assets in the third quarter of 2000 was
comparable to the same period in 1999. The yield on these assets was 7.2 percent
in 2000 and 7.7 percent in 1999. The average balance of general account invested
assets increased by .9 percent in the first nine months of 2000 to $25.9 billion
compared to the same period in 1999. The yield on these assets decreased by .2
percentage points to 7.4 percent during the first nine months of 2000.
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 third quarter of 2000, we recorded income
from the S&P 500 Options of $1.9 million and deducted amounts from
policyholders' account balances of the equity- indexed products of $3.3 million.
During the first nine months of 2000, we recorded income from the S&P 500
Options of $8.4 million and deducted amounts to policyholders' account balances
of the equity-indexed products of $2.4 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 nine months of 2000 as a
result of the factors summarized in the explanations for loss ratio fluctuations
related to specific products which follows.
The loss ratio for Medicare supplement products in the third quarter of
2000 was stable and on plan. These ratios increased in the nine month period
ended September 30, 2000, for the following reasons: (i) our year end reserves
developed adversely; (ii) 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); and (iii)
Medicare supplement business has recently experienced higher persistency among
older blocks of business. While the Company benefits from the additional profits
earned on the larger blocks of business, the loss ratio will generally increase
since the older policies have higher claim costs. 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 2000, reflecting:
(i) unfavorable claims experience; (ii) refinements made to the reserve
estimation process; and (iii) 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 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
36
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
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. As a result of recent unfavorable claim
experience in our long-term care insurance lines, we closely reviewed our
reserving methodologies. Certain changes in estimates were made that adversely
affected the loss ratio in the 2000 periods.
The loss ratio for our specified disease policies reflects the favorable
development of prior quarter loss reserves. The loss ratio for the nine months
ended September 30, 2000, reflects refinements we made to the reserve estimation
process during the first quarter of 2000 and changes in estimates of period end
claim liabilities. Our general expectation is for this loss ratio to be
approximately 65 percent.
The loss ratios on other products fluctuated due to the smaller size of
these blocks of business. While the increase in 2000 reflects worse than
expected experience, the loss ratios on this business over longer periods of
time have generally been within our expectations.
Amounts added to policyholder account balances for annuity products
decreased by 7.6 percent in the third quarter of 2000 to $150.9 million and by
8.0 percent in the first nine months of 2000 to $470.0 million, primarily due to
a smaller block of this type of annuity business in force, on the average, in
the first nine months of 2000. The weighted average crediting rate for these
annuity liabilities was 4.5 percent in both the first nine months of 2000 and
1999.
Amortization related to operations includes amortization of: (i) the cost
of policies produced; (ii) the cost of policies purchased; and (iii) goodwill.
Amortization has increased in relationship to the total account balances subject
to amortization. In addition, amortization increased in the 2000 periods as a
result of adjustments to the surrender and lapse assumptions to reflect our
current estimate of future experience related to certain blocks of business.
Interest expense on investment borrowings decreased along with our
investment borrowing activities. Investment borrowings averaged approximately
$345.8 million during the first nine months of 2000 compared to $1,121.1 million
during the same period of 1999. Borrowing rates increased 20 basis points to 5.3
percent during the first nine 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
(2.66 percent for the nine months ended September 30, 2000, compared to 2.35
percent for the same period in 1999).
Net investment gains (losses), including related costs and amortization,
fluctuate from period to period. During the first nine months of 2000, we
recorded $88.9 million of writedowns of fixed maturity securities and other
invested assets as a result of conditions which caused us to conclude a decline
in fair value of the investment was other than temporary. In addition, as
described in the note to the consolidated financial statements entitled
"Standard & Poor's 500 Index Call Options and Interest Rate Swap Agreements" we
realized a $59.2 million loss related to the termination of certain swap
agreements during the first nine months of 2000.
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 $8.6 million and $31.9 million in the third quarter of 2000 and the first
nine months of 2000, respectively. Such sales resulted in a reduction in the
amortization of the cost of policies purchased and the cost of policies produced
of $.1 million in the third quarter of 1999 and resulted in additional
amortization of $16.0 million in the first nine months of 1999.
37
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Finance operations
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------ ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Contract originations:
Manufactured housing............................................... $ 1,107.5 $ 1,794.5 $ 3,769.9 $ 5,189.2
Mortgage services.................................................. 933.6 1,726.5 3,948.9 5,095.8
Consumer/credit card............................................... 821.7 1,123.7 2,662.6 2,404.9
Commercial......................................................... 1,055.6 2,367.2 3,966.4 6,506.1
--------- --------- --------- ---------
Total............................................................ $ 3,918.4 $ 7,011.9 $14,347.8 $19,196.0
========= ========= ========= =========
Securitization of finance receivables accounted for as sales:
Manufactured housing............................................... $ - $ 1,854.5 $ - $ 5,335.6
Home equity/home improvement....................................... - 999.6 - 3,648.4
Consumer/equipment................................................. - - - 600.0
Commercial and retail revolving credit............................. - 25.2 - 117.7
Retained bonds..................................................... - (143.8) - (515.2)
--------- --------- --------- ---------
Total............................................................ $ - $ 2,735.5 $ - $ 9,186.5
========= ========= ========= =========
Managed receivables (average):
Manufactured housing............................................... $26,153.4 $23,469.1 $25,509.3 $22,426.4
Mortgage services.................................................. 13,720.3 10,810.8 13,197.2 9,740.5
Consumer/credit card............................................... 3,868.2 3,444.9 3,913.6 3,178.1
Commercial......................................................... 4,533.5 5,492.1 4,884.6 5,388.3
--------- --------- --------- ---------
Total............................................................ $48,275.4 $43,216.9 $47,504.7 $40,733.3
========= ========= ========= =========
Revenues:
Net investment income:
Finance receivables and other.................................... $ 528.5 $ 158.5 $ 1,361.7 $ 398.7
Interest-only securities......................................... 28.9 46.8 85.0 137.9
Gain on sale:
Securitization transactions...................................... - 156.7 - 525.3
Whole-loan sales................................................. 1.9 - 4.5 -
Fee revenue and other income....................................... 86.5 95.9 280.6 266.0
--------- --------- --------- ---------
Total revenues................................................... 645.8 457.9 1,731.8 1,327.9
--------- --------- --------- ---------
Expenses:
Provision for losses............................................... 91.3 28.3 234.0 76.8
Finance interest expense........................................... 335.2 86.0 806.6 210.2
Other operating costs and expenses................................. 179.3 170.6 587.4 488.0
--------- --------- --------- ---------
Total expenses................................................... 605.8 284.9 1,628.0 775.0
--------- --------- --------- ---------
Operating income before special charges, impairment charges
and income taxes............................................... 40.0 173.0 103.8 552.9
Special charges....................................................... 226.6 - 290.0 -
Impairment charges.................................................... 205.0 100.1 217.1 183.9
--------- --------- --------- ---------
Income (loss) before income taxes................................ $ (391.6) $ 72.9 $ (403.3) $ 369.0
========= ========= ========= =========
</TABLE>
38
<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 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 SFAS 125, 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.
During the third quarter of 2000, we completed three securitization
transactions, securitizing $2.2 billion of finance receivables. During the first
nine months of 2000, we have securitized or sold over $6.9 billion of finance
receivables.
During the third quarter of 2000, we announced several courses of action
with respect to Conseco Finance, including: (i) the sale, closing or runoff of
five units (i.e., asset-based lending, vendor finance, bankcards, transportation
and park construction); (ii) efforts to better utilize existing assets so as to
increase cash; and (iii) cost savings and restructuring of ongoing businesses
such as streamlining of the field force in the manufactured housing and home
equity divisions.
Loan originations in the third quarter of 2000 were $3.9 billion, down 44
percent from 1999. Loan originations in the first nine months of 2000 were $14.3
billion, down 25 percent over 1999. The primary reason for the decrease was our
decision to no longer originate certain lines and to manage our growth
consistent with our revised business plan. The significant decrease in new loan
originations allowed the finance segment to enhance net interest margins, to
reduce the amount of available cash required for new loan originations, and to
transfer cash to the parent company. The following table summarizes our loan
originations in the third quarters of 2000 and 1999 summarized by product and
whether part of our continuing or discontinued lines:
<TABLE>
<CAPTION>
Three months ended
September 30,
-------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Continuing lines:
Manufacturing housing............................................. $1,107.5 $1,794.5
Mortgage services................................................. 933.6 1,726.5
Retail credit..................................................... 652.3 796.6
Floorplan......................................................... 933.1 1,573.3
-------- --------
Total continuing lines........................................ 3,626.5 5,890.9
-------- --------
Discontinued lines:
Consumer finance.................................................. 166.6 194.8
Bankcard.......................................................... 2.8 132.3
Vendor finance.................................................... 95.6 125.4
Transportation.................................................... 2.3 262.0
Park construction and asset-based loans........................... 24.6 406.5
-------- --------
Total discontinued lines...................................... 291.9 1,121.0
-------- --------
Total......................................................... $3,918.4 $7,011.9
======== ========
</TABLE>
39
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Sales of finance receivables decreased as a result of the change in the
structure of our securitizations.
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 $48.3 billion in the third quarter of 2000, up 12 percent over
1999, and to $47.5 billion in the first nine months of 2000, up 17 percent over
the same period in 1999.
The following table summarizes our average managed receivables at September
30, 2000 and 1999 summarized by product and whether part of our continuing or
discontinued lines:
<TABLE>
<CAPTION>
September 30,
-------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Continuing lines:
Manufactured housing.............................................. $26,153.4 $23,469.1
Mortgage services................................................. 13,720.3 10,810.8
Retail credit..................................................... 1,670.2 1,032.5
Floorplan......................................................... 2,018.0 2,210.1
--------- ---------
Total continuing lines.......................................... 43,561.9 37,522.5
--------- ---------
Discontinued lines:
Consumer finance.................................................. 2,161.2 2,139.5
Bankcard.......................................................... 36.8 272.9
Vendor finance.................................................... 970.5 948.1
Transportation.................................................... 1,170.6 1,570.3
Park construction and asset-based loans........................... 374.4 763.6
--------- ---------
Total discontinued lines........................................ 4,713.5 5,694.4
--------- ---------
Total........................................................... $48,275.4 $43,216.9
========= =========
</TABLE>
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 233 percent, to $528.5 million,
in the third quarter of 2000 and by 242 percent, to $1,361.7 million, in the
first nine months 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 13.0 percent and 10.1 percent during the
third quarters of 2000 and 1999, respectively, and such weighted average yields
were 13.0 percent and 10.8 percent during the first nine months 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. The weighted
average yield on our securitized on- balance sheet receivables increased 28
basis points to 11.71 percent from the second to third quarter of 2000. The
weighted average margin on these loans increased 7 basis points to 3.94 percent.
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 38 percent, to $28.9 million, in the third
quarter of 2000 and by 38 percent, to $85.0 million, in the first nine months 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 13.1 percent and 13.8 percent during the first nine months of
2000 and 1999, respectively. As a result of the change in the structure of our
securitizations, we will account for future securitizations as secured
borrowings and we will not recognize gain-on-sale revenue or additions to
interest-only securities from such transactions. 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 only $180.1 million was incurred in the first nine
months of 1999) and by $273.4 million during 2000 (including $70.2 million due
to the accounting change described in the note to the accompanying consolidated
financing statements entitled
40
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
"Cumulative Effect of Accounting Change") due to impairment charges 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
whether an impairment has occurred. Under current accounting principles, we are
required to recognize declines in value of our interest-only securities in
earnings when: (i) the fair value of the security is less than its carrying
value; and (ii) the timing and/or amount of cash expected to be received from
the security has changed adversely from the previous valuation which determined
the carrying value of the security.
Gain on sale related to securitization transactions was nil in the 2000
periods, 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
structures. 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 held 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 September 30,
2000, we held $475.6 million of such securities which are classified as actively
managed fixed maturities.
Gain on whole-loan sales totaled $1.9 million during the third quarter of
2000 and $4.5 million during the first nine months of 2000. During the second
quarter of 2000, we sold approximately $1.3 billion of finance receivables to
Lehman for cash and a right to share in future profits from a subsequent sale or
securitization of the assets sold. We paid a $25.0 million transaction fee to
Lehman in conjunction with the sale which was included in special charges. Such
loans were sold to Lehman at a value which approximated net book value, less the
fee paid to Lehman. Gain on whole-loan sales excludes the gain realized on the
sale of our bankcard portfolio which is included in special charges.
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 decreased by 9.8 percent, to $86.5
million, in the third quarter of 2000, and increased by 5.4 percent, to $280.6
million, in the first nine months of 2000. 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 223
percent, to $91.3 million, in the third quarter of 2000, and by 205 percent, to
$234.0 million, in the first nine months of 2000. The increase is principally
due to the increase in loans held on our balance sheet. Under the portfolio
method (which is used for securitizations structured as collateralized
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.
Finance interest expense increased by 290 percent, to $335.2 million, in
the third quarter of 2000, and by 284 percent, to $806.6 million, in the first
nine months of 2000. Our borrowings grew in order to fund the increase in
finance receivables. In addition, our average borrowing rate increased to 7.9
percent in the third quarter of 2000 from 5.6 percent in the third quarter of
1999. Our average borrowing rate during the first nine months of 2000 was 7.6
percent compared to 5.6 percent during the first nine months 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.
41
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
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 5.1 percent, to $179.3 million,
in the third quarter of 2000, and by 20 percent, to $587.4 million, in the first
nine months of 2000. Such costs increased consistent with the prior business
plans for the segment. Other operating costs and expenses decreased $18.8
million to $179.4 million from the second to third quarters of 2000, as we began
to realize the cost savings from the previously announced restructuring of
Conseco Finance.
Special charges in the finance segment include: (i) the $103.3 million
adjustment to the value of finance receivables identified for sale; (ii) the
$53.0 million loss on the sale of asset-based loans; (iii) $29.5 million of
costs related to closing offices and streamlining businesses; (iv) $35.8 million
related to the abandonment of computer processing systems; (v) $25.0 million
transaction fee paid to Lehman in conjunction with the previously described sale
of $1.3 billion of finance receivables; (vi) the issuance of a warrant valued at
$48.1 million related to the modification of the Lehman master repurchase
financing facilities; and (vii) $4.7 million of net gains related to the sale of
certain lines of business, net of other items. These charges are described in
greater detail in the note to the accompanying financial statements entitled
"Special Charges and Recent Events".
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. 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. We record any unrealized gain or loss determined to be
temporary, net of tax, as a component of shareholders' equity. We adopted a new
accounting rule during the third quarter of 2000, which affects when impairments
are considered to be other than temporary and, therefore, are recognized in
earnings (see the note to the accompanying consolidated financial statements
entitled "Cumulative Effect of Accounting Change").
The Company continually evaluates 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 third
quarters of 2000 and 1999, we recognized an impairment charge of $205.0 million
and $100.1 million, respectively, to reduce the book value of the interest-only
securities and servicing rights. The change in accounting principle described in
the note to the accompanying consolidated financial statements entitled
"Cumulative Effect of Accounting Change" affected the impairment charge
recognized in the third quarter of 2000. Such impairment charge for the first
nine months of 2000 and 1999 was $217.1 million and $183.9 million,
respectively.
42
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Corporate operations
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
-------------------- ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Corporate operations:
Venture capital loss related to investment in
Tritel, net of related expenses................................... $(165.5) $ - $(164.9) $ -
Interest expense on corporate debt.................................. (79.3) (41.9) (207.0) (135.1)
Investment income................................................... 17.5 9.2 41.2 29.8
Other items......................................................... (19.9) (16.2) 6.4 12.5
-------- ------ ------- -------
Operating loss before provision for loss on loan
guarantees, special charges, income taxes and
minority interest............................................. (247.2) (48.9) (324.3) (92.8)
Provision for loss on loan guarantees............................... (19.5) - (111.5) -
Major medical lines, which the Company intends to sell.............. (13.1) 25.2 (43.9) 75.8
Special charges..................................................... (26.7) - (290.5) -
------- ------ ------- -------
Loss before income taxes and minority interest.................. $(306.5) $(23.7) $(770.2) $ (17.0)
======= ====== ======= =======
</TABLE>
Venture capital loss relates to our investment in Tritel, 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, Tritel 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 third
quarter of 2000, we recognized a venture capital loss of $165.5 million related
to this investment (net of a related reduction to expenses of $54.4 million). In
the first nine months of 2000, we recognized a venture capital loss of $164.9
million related to this investment (net of a related reduction to expenses of
$41.8 million).
Interest expense on corporate debt fluctuated due to the increase in the
average balance and interest rate on outstanding debt. The average debt
outstanding (net of the intercompany note due from the finance segment) was $3.3
billion and $2.8 billion in the first nine months of 2000 and 1999,
respectively. The average interest rate on such debt was 8.33 percent and 6.38
percent in the first nine months of 2000 and 1999, respectively. General levels
of interest rates have increased over the last twelve months. In addition, as a
result of recent rating agency actions, the interest rates on our bank credit
facilities have increased (see the note to the consolidated financial statements
entitled "Changes in Direct Corporate Obligations"). Such interest expense
includes affiliated interest expense (which is eliminated in consolidation) of:
(i) $7.4 million and $3.2 million for the three months ended September 30, 2000
and 1999, respectively; and (ii) $19.1 million and $9.1 million for the nine
months ended September 30, 2000 and 1999, respectively.
Investment income includes the income from our investment in a riverboat
casino and miscellaneous other income.
Other items include general corporate expenses, net of amounts charged to
subsidiaries for services provided by the corporate operations.
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 $111.5 million (of which $19.5 million was
established in the third quarter of 2000) in connection with these guarantees
and loans. At September 30, 2000, the total reserve for losses on the loan
guarantees was $130.4 million.
Major medical lines represent the results of our individual and group major
medical health insurance products, which we intend to sell. These lines have
experienced adverse loss ratios during 2000.
Special charges in corporate operations for the first nine months of 2000
include: (i) advisory and professional fees related to debt restructuring of
$7.2 million; (ii) a portion of the loss on the sale of asset-backed loans
(excluding loss related to loans
43
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
held by the finance segment) of $15.2 million; (iii) advisory fees paid to
investment banks of $44.0 million; (iv) the loss related to our exit from the
subprime automobile business of $71.6 million; (v) the amount paid to terminated
executive pursuant to his employment agreement of $72.5 million; (vi) the amount
paid to newly hired Chief Executive Officer of $45.0 million; (vii) the value of
warrants issued to release newly hired Chief Executive Officer from a noncompete
provision of a prior agreement of $21.0 million; and (viii) other charges of
$14.0 million. These charges are described in greater detail in the note to the
accompanying consolidated financial statements entitled "Special Charges and
Recent Events".
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 and
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 several
recent events described in the note to the consolidated financial statements
entitled "Special Charges and Recent 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. Such rating
actions adversely affected the marketing and persistency of our insurance
products and other asset accumulation products. On November 7, 2000, A.M. Best
upgraded the financial strength ratings of our principal life insurance
subsidiaries to A- (Excellent) from B++ (Very Good).
44
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Total premiums and accumulation product collections were as follows:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------- ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Premiums collected by our insurance subsidiaries:
Annuities:
Equity-indexed (first-year)..................................... $ 108.6 $ 209.8 $ 503.1 $ 647.8
Equity-indexed (renewal)........................................ 5.8 7.0 34.7 34.3
-------- -------- -------- --------
Subtotal - equity-indexed annuities........................... 114.4 216.8 537.8 682.1
-------- -------- -------- --------
Other fixed (first-year)........................................ 163.9 214.1 469.5 731.5
Other fixed (renewal)........................................... 12.4 13.1 47.2 47.6
-------- -------- -------- --------
Subtotal - other fixed annuities.............................. 176.3 227.2 516.7 779.1
-------- -------- -------- --------
Variable (first-year)........................................... 162.1 131.4 605.9 350.9
Variable (renewal).............................................. 27.4 17.1 99.0 63.7
-------- -------- -------- --------
Subtotal - variable annuities................................. 189.5 148.5 704.9 414.6
-------- -------- -------- --------
Total annuities............................................... 480.2 592.5 1,759.4 1,875.8
-------- -------- -------- --------
Supplemental health:
Medicare supplement (first-year)................................ 23.4 26.6 75.9 80.9
Medicare supplement (renewal)................................... 194.1 198.5 614.0 602.4
-------- -------- -------- --------
Subtotal - Medicare supplement................................ 217.5 225.1 689.9 683.3
-------- -------- -------- --------
Long-term care (first-year)..................................... 28.6 32.6 91.0 91.8
Long-term care (renewal)........................................ 174.8 164.9 538.4 499.3
-------- -------- -------- --------
Subtotal - long-term care..................................... 203.4 197.5 629.4 591.1
-------- -------- -------- --------
Specified disease (first-year).................................. 9.2 9.6 28.8 29.0
Specified disease (renewal)..................................... 77.5 83.1 249.6 254.2
-------- -------- --------- --------
Subtotal - specified disease.................................. 86.7 92.7 278.4 283.2
-------- -------- -------- --------
Other health (first-year)....................................... 7.6 5.0 26.1 16.6
Other health (renewal).......................................... 16.5 17.7 68.6 72.7
-------- -------- -------- --------
Subtotal - other health....................................... 24.1 22.7 94.7 89.3
-------- -------- -------- --------
Total supplemental health..................................... 531.7 538.0 1,692.4 1,646.9
-------- -------- -------- --------
Life insurance:
First-year...................................................... 47.9 78.5 155.2 158.4
Renewal......................................................... 192.5 191.6 572.4 577.8
-------- -------- -------- --------
Total life insurance.......................................... 240.4 270.1 727.6 736.2
-------- -------- -------- --------
Individual and group major medical:
Individual (first-year)......................................... 44.3 24.5 117.5 69.8
Individual (renewal)............................................ 62.1 58.4 184.1 172.6
-------- -------- -------- --------
Subtotal - individual......................................... 106.4 82.9 301.6 242.4
-------- -------- -------- --------
Group (first-year).............................................. 14.6 16.0 53.3 38.3
Group (renewal)................................................. 102.5 121.3 342.3 355.5
-------- -------- -------- --------
Subtotal - group.............................................. 117.1 137.3 395.6 393.8
-------- -------- -------- --------
Total major medical........................................... 223.5 220.2 697.2 636.2
-------- -------- -------- --------
Total first-year premium collections on insurance products...... 610.2 748.1 2,126.3 2,215.0
Total renewal premium collections on insurance products......... 865.6 872.7 2,750.3 2,680.1
-------- -------- -------- --------
Total collections on insurance products....................... $1,475.8 $1,620.8 $4,876.6 $4,895.1
======== ======== ======== ========
Mutual funds (all first year, excludes variable annuities)........... $ 224.0 $ 78.3 $ 656.7 $ 243.3
======== ========= ======== ========
</TABLE>
45
<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 $114.4 million in the third quarter of 2000 compared with
$216.8 million in the third quarter of 1999 and were $537.8 million in the first
nine months of 2000 compared with $682.1 million in the first nine months 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 22 percent, to $176.3 million, in the
third quarter of 2000 and by 34 percent, to $516.7 million, in the first nine
months of 2000. Fixed annuity collections in the third quarter of 1999 and the
first nine months of 1999 included $48.0 million and $209.0 million,
respectively, of business reinsured from other insurers.
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 28 percent,
to $189.5 million, in the third quarter of 2000 and by 70 percent, to $704.9
million, in the first nine months 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 decreased by 3.4 percent
to $217.5 million, in the third quarter of 2000 and increased by 1.0 percent, to
$689.9 million, in the first nine months of 2000. Sales of Medicare supplement
policies in recent periods have been affected by steps taken to improve
profitability by increasing premium rates and changing our commission structure
and underwriting criteria.
Premiums collected on long-term care policies increased 3.0 percent, to
$203.4 million, in the third quarter of 2000 and by 6.5 percent, to $629.4
million, in the first nine months of 2000 due to increases in premium rates and
increased sales volume.
Premiums collected on specified disease policies decreased 6.5 percent, to
$86.7 million, in the third quarter of 2000 and by 1.7 percent, to $278.4
million, in the first nine months of 2000 as a result of steps taken to improve
the profitability of these products.
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 2000
periods were slightly higher than the 1999 periods. 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
decreased by 11 percent to $240.4 million in the third quarter of 2000 and by
1.2 percent, to $727.6
46
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
million, in the first nine months of 2000. In the first nine months of 1999,
life premiums included $49.2 million of business reinsured from other insurers.
Individual and group major medical products include major medical health
insurance products sold to individuals and groups. We have previously announced
our intent to sell these lines of business. In recent periods, we have
emphasized the sale of more profitable individual major medical products and are
de-emphasizing the sale of group products. With respect to group major medical
products, we are: (i) seeking rate increases; (ii) converting the members of
groups to individual policies; or (iii) opting not to renew the group policies.
Group premiums decreased by 15 percent, to $117.1 million, in the third quarter
of 2000 and increased by 0.5 percent, to $395.6 million, in the first nine
months of 2000. Individual health premiums collected in the third quarter of
2000 increased 28 percent, to $106.4 million and by 24 percent, to $301.6
million, in the first nine months of 2000.
Mutual fund sales have been very strong in the first three quarters of
2000, reflecting our expanded distribution and new marketing programs. We also
believe that these sales were positively impacted by the recent strong
investment performance of our funds. Mutual fund sales and redemptions may be
adversely impacted in future periods, following the recent resignation of
certain equity portfolio managers. The Company recently engaged Frank Russell
Company to transition its equity portfolio management.
LIQUIDITY AND CAPITAL RESOURCES
Changes in our consolidated balance sheet between September 30, 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) the sale of finance receivables to Lehman; (v) the sale of
assets of our subprime automobile and bankcard businesses; (vi) changes in the
fair value of actively managed fixed maturity securities and interest-only
securities; and (vii) various financing transactions. Financing transactions
(described in the notes to the accompanying 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
September 30, 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 $1,662.2 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.
47
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
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, decreased $600.9 million, or 4.4 percent,
to $13.0 billion.
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Total capital, excluding accumulated other comprehensive loss:
Corporate notes payable and commercial paper......................... $ 5,189.7 $ 4,624.2
Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts................................... 2,401.5 2,639.1
Shareholders' equity:
Preferred stock................................................... 484.7 478.4
Common stock and additional paid-in capital....................... 2,908.8 2,987.1
Retained earnings................................................. 2,005.5 2,862.3
--------- ---------
Total shareholders' equity, excluding accumulated
other comprehensive loss.................................... 5,399.0 6,327.8
--------- ---------
Total capital, excluding accumulated other comprehensive
loss........................................................ 12,990.2 13,591.1
Accumulated other comprehensive loss..................................... (849.0) (771.6)
--------- ---------
Total capital.................................................. $12,141.2 $12,819.5
========= =========
</TABLE>
Corporate notes payable and commercial paper increased during the first
nine months of 2000 primarily due to: (i) the settlement of a forward contract
described in the note to the accompanying consolidated financial statements
entitled "Changes in Common Stock"; (ii) the redemption of $250 million par
value of Company-obligated mandatorily redeemable preferred securities of
subsidiary trusts; (iii) the acquisition of a long-term care insurance marketing
organization for $32.9 million; (iv) cash required for special charges of $202.7
million; and (v) an increase in cash and cash equivalents held at the parent
company of approximately $330 million.
Shareholders' equity, excluding accumulated other comprehensive loss,
decreased by $928.8 million in the first nine months of 2000, to $5.4 billion.
Significant components of the decrease included: (i) our net loss of $814.6
million; (ii) the settlement of the forward contract and repurchases of common
stock of $102.6 million; and (iii) $42.2 million of common and preferred stock
dividends. These decreases were partially offset by the issuance of warrants of
$21.0 million. The accumulated other comprehensive loss increased by $77.4
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 $12.50 at September
30, 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 $15.11 at September 30, 2000,
and $17.85 at 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 $3,847.1 million and $3,927.8 million at September 30,
2000 and December 31, 1999, respectively. Goodwill as a percentage of
shareholders' equity was 85 percent and 71 percent at September 30, 2000 and
December 31, 1999, respectively. Goodwill as a percentage of total capital,
excluding accumulated other comprehensive loss, was 30 percent and 29 percent at
September 30, 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 $84.7 million and $82.7 million during the
first nine months 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.
48
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
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 nine months ended September 30,
2000, were 10 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, which was paid in April and July of
2000. In September 2000, cash dividend payments on our common stock were
suspended. The amended bank credit facilities prohibit the payment of cash
dividends on our common stock until the Company has received investment grade
ratings on its outstanding public debt and the bank credit facilities maturing
in December 2001 are paid in full.
The following table summarizes certain financial ratios as of and for the
nine months ended September 30, 2000, and as of and for the year ended December
31, 1999:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
<S> <C> <C>
Book value per common share:
As reported............................................................................... $12.50 $15.50
Excluding accumulated other comprehensive income (loss) (a)............................... $15.11 $17.85
Ratio of earnings to fixed charges:
As reported............................................................................... (g) 2.98X
Excluding interest expense on direct third party debt of Conseco Finance (b).............. (g) 5.27X
Ratio of operating earnings to fixed charges (c):
As reported............................................................................... 1.24X 4.26X
Excluding interest expense on direct third party debt of Conseco Finance (b).............. 1.72X 8.04X
Ratio of earnings to fixed charges, preferred dividends and distributions on
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts:
As reported............................................................................. (h) 2.20X
Excluding interest expense on direct third party debt of Conseco Finance (b)............ (h) 2.98X
Ratio of operating earnings to fixed charges, preferred dividends and
distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts (c):
As reported............................................................................. 1.05X 3.14X
Excluding interest expense on direct third party debt of Conseco Finance (b)............ 1.12X 4.55X
Rating agency ratios (a) (d) (e):
Corporate debt to total capital........................................................... 40% 34%
Corporate debt and Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts to total capital (f)............................................... 58% 54%
<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:
49
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
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.
(d) Excludes the direct 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) at December 31, 1999, amounts related to
RHINOS. In April 2000, the Company repurchased the RHINOS.
(g) For such ratios, adjusted earnings were $857.0 million less than fixed
charges. Adjusted earnings for the nine months ended September 30, 2000,
included special and impairment charges of $797.6 million as described in
greater detail in the note to the accompanying consolidated financial
statements entitled "Special Charges and Recent Events".
(h) For such ratios, adjusted earnings were $1,040.0 million less than fixed
charges. Adjusted earnings for the nine months ended September 30, 2000,
included special and impairment charges of $797.6 million as described in
greater detail in the note to the accompanying consolidated financial
statements entitled "Special Charges and Recent Events".
</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 should provide
sufficient liquidity to meet foreseeable cash requirements.
Liquidity for finance operations
Our finance operations require cash to originate finance receivables. Our
primary sources of cash are: (i) the collection of receivable balances; (ii)
proceeds from the issuance of debt, certificates of deposit and securitization
or sales of loans; and (iii) cash provided by operations. During the third
quarter of 2000, the finance segment significantly slowed the origination of
finance receivables to enhance net interest margins, to reduce the amount of
available cash required for new loan originations, and to transfer cash to the
parent company.
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 have taken the form of
corporate guarantees (although we have not provided such guarantees during the
second and third quarters of 2000), 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
50
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
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.
During the third quarter of 2000, we completed three transactions,
securitizing over $2.2 billion of finance receivables. During the first nine
months of 2000, we have securitized or sold over $6.9 billion of finance
receivables. We continue to be able to finance loans through: (i) our warehouse
and bank credit facilities; (ii) the sale of securities through securitization
transactions; and (iii) whole-loan sales.
The market for securities backed by receivables is a cost-effective source
of funds. Conditions in the credit markets in certain periods during 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 had 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.
At September 30, 2000, we had $4.3 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. Some of these agreements provide
for annual terms 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 September 30, 2000, we had borrowed
$2.6 billion of the $4.3 billion available under such agreements.
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 September 30, 2000, we had $1,574.4
million of such deposits outstanding which are recorded as liabilities related
to certificates of deposit. The average annual rate paid on these deposits was
6.6 percent during the first nine months of 2000.
Our finance segment generated cash flows from operating activities of
$314.2 million during the first nine months of 2000, compared to approximately
$479.7 million in the same period of 1999. Such cash flows include cash received
from the securitization trusts of $261.6 million in the 2000 period and $480.0
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 has not had 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 21-to-1 and 22-to-1 at
September 30, 2000, and December 31, 1999, respectively.
51
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
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 mandatorily
redeemable preferred stock of subsidiary trusts; (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.
During the third quarter, we successfully renegotiated the terms of our
bank credit facilities. We repaid $650 million of our bank and other debt and
extended the remaining September 2000 maturities to December 2001. In addition,
the renegotiated bank credit facilities permit the Company to extend the
maturity date of $1.2 billion of the $1.5 billion bank credit facility until
March 31, 2005. The maturities of the direct debt of the parent company at
September 30, 2000 (assuming the Company elects to extend the maturity date of
$1.2 billion of bank debt) were as follows (dollars in millions):
<TABLE>
<S> <C>
2000......................................................... $ 131.5
2001......................................................... 1,233.7
2002......................................................... 601.9
2003......................................................... 463.5
2004......................................................... 812.5
2005......................................................... 1,450.0
Thereafter................................................... 551.1
--------
Total par value at September 30, 2000.................. $5,244.2
========
</TABLE>
In amending our bank credit facilities, we agreed to the manner in which
the proceeds from asset sales and refinancing transactions would be used.
Through September 30, 2000, the $876.0 million of proceeds from such
transactions were used as follows: (i) $257.1 was used to repay the notes
payable due 2003; (ii) $407.3 million was used to reduce the total borrowings
under our near-term facilities; and (iii) $86.8 million was transferred to a
segregated cash account for the payment of public debt in December 2000; (iv)
$74.8 million was added to the general cash balance of the Company; and (v)
$50.0 million was transferred to a segregated cash account to provide collateral
for Conseco's guarantee related to the directors, officers and key employee
stock purchase program. Additional amounts have been added to the segregated
cash account for the payment of public debt through November 14, 2000; its
balance is now approximately $128.5 million.
Pursuant to the amendment of our bank credit facilities, we have agreed
that amounts received from asset sales or refinancing transactions occurring
after September 30, 2000, will be used as follows: (i) the first $56 million
received may be retained by Conseco until we have cash on hand of $330 million;
(ii) of the next $599 million received, $86 million will be used to reduce our
near-term facilities and $513 million will be added to the segregated cash
account for the payment of the public debt due in 2001; (iii) the next $200
million will be added to the segregated cash account for payment of debt
maturing in 2001; (iv) the next available proceeds would be applied 80 percent
to reduce our near-term facilities, with the remaining 20 percent retained by
Conseco until we have cash on hand of $330 million, and then 100 percent to the
bank credit facilities due December 2001 until such facilities have been paid in
full; and (v) any subsequent proceeds would be applied 50 percent to repay the
$1.5 billion facility, and to a segregated cash account to provide collateral
for Conseco's guarantee related to the directors, officers and key employee
stock purchase program (based on the relative balance due under each facility)
and the remaining 50 percent retained by Conseco.
During the third quarter of 2000, the Company amended an agreement with
Lehman related to its master repurchase agreements and collateralized credit
facility. Such amendment significantly reduced the restrictions on intercompany
payments from Conseco Finance to Conseco as required by the previous agreement.
In conjunction with the amendment, Conseco agreed to convert $750 million
principal balance of its intercompany note due from Conseco Finance to $750
million stated value of Conseco Finance 9 percent redeemable cumulative
preferred stock (the "intercompany preferred stock"). After such conversion and
prepayments made during the third quarter of 2000, the intercompany note had a
balance of $916.2 million.
52
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Pursuant to the amended agreement, Conseco Finance may make the following
payments to Conseco: (i) interest on the intercompany note; (ii) payments for
products and services provided by Conseco; and (iii) intercompany tax sharing
payments. Conseco Finance may also make the following payments to Conseco
provided the minimum liquidity requirements defined in the amended agreement are
met and the cash payments are applied in the order summarized: (i) unpaid
interest on the intercompany note; (ii) prepayments of principal on the
intercompany note or repayments of any increase to the intercompany receivable
balance; (iii) dividends on the intercompany preferred stock; (iv) redemption of
the intercompany preferred stock; and (v) common stock dividends. The liquidity
test of the amended agreement requires Conseco Finance to have minimum levels of
cash liquidity immediately after making payments to Conseco. Cash liquidity, as
defined, includes unrestricted cash and may include up to $150 million of
liquidity available at Conseco Finance's bank subsidiaries and the aggregate
amount available to be drawn under Conseco Finance's master repurchase
facilities (based on eligible excess collateral pledged to the lender multiplied
by the appropriate advance rate). The minimum cash liquidity must equal or
exceed $250 million, plus: (i) 50 percent of cash up to $100 million generated
by Conseco Finance subsequent to September 21, 2000; and (ii) 25 percent of cash
generated by Conseco Finance in excess of $100 million, provided the total
minimum cash liquidity shall not exceed $350 million and the cash generated by
Conseco Finance (used in the calculation to increase the minimum) will exclude
operating cash flows and the net proceeds actually received from certain asset
sales and other events listed in the amended agreement (which are consistent
with the courses of actions we have previously announced).
Our insurance subsidiaries paid dividends to Conseco of $152.1 million
during the first nine months of 2000. 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 "ordinary" dividends to Conseco of $52.5 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 that we planned to explore the sale of Conseco
Finance and other events described in the note to the accompanying consolidated
financial statements entitled "Special Charges and Recent Events" and elsewhere
herein, rating agencies lowered their ratings on Conseco's senior debt, trust
preferred securities and commercial paper. As of November 7, 2000, the rating
agencies had assigned the following ratings: (i) Standard & Poor's has assigned
a "BB-" rating to Conseco's senior debt and a "B-" rating to trust preferred
securities; (ii) Fitch Rating Company has assigned a "BB-" rating to Conseco's
senior debt and a "B" rating to trust preferred securities; and (iii) Moody's
Investor Services has assigned a "B1" rating to Conseco's senior debt and a
"caa" rating to trust preferred securities. These ratings make it difficult for
the Company to issue additional securities in the public markets, although the
Company does not believe additional issuances will be necessary in the near
future.
53
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
INVESTMENTS
At September 30, 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................................................ $13,364.8 $47.3 $ 872.1 $12,540.0
United States Treasury securities and obligations of
United States government corporations and agencies................ 301.4 4.0 3.1 302.3
States and political subdivisions................................... 142.6 0.4 6.5 136.5
Debt securities issued by foreign governments....................... 180.7 1.0 9.5 172.2
Mortgage-backed securities ......................................... 6,764.5 14.9 240.6 6,538.8
Below-investment grade (primarily corporate securities)................ 2,410.7 26.1 574.3 1,862.5
--------- ----- -------- ---------
Total actively managed fixed maturities........................... $23,164.7 $93.7 $1,706.1 $21,552.3
========= ===== ======== =========
</TABLE>
During the first nine months of 2000 and 1999, we recorded $88.9 million
and $11.0 million, respectively, of writedowns of fixed maturity securities and
other invested assets 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. At September 30, 2000, fixed maturity securities in default as to the
payment of principal or interest had an aggregate amortized cost of $121.9
million and a carrying value of $82.6 million.
Sales of invested assets (primarily fixed maturity securities) during the
first nine months of 2000 generated proceeds of $4.7 billion, resulting in net
investment losses of $79.8 million.
At September 30, 2000, fixed maturity investments included $7.0 billion of
mortgage-backed securities (or 33 percent of all fixed maturity securities). The
yield characteristics of mortgage-backed securities differ from those of
traditional fixed-income securities. Interest and principal payments 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.
54
<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 September 30, 2000:
<TABLE>
<CAPTION>
Par Amortized Estimated
value cost fair value
----- ---- ----------
(Dollars in millions)
<S> <C> <C> <C>
Below 7 percent..................................................................... $4,501.2 $4,463.6 $4,267.2
7 percent - 8 percent............................................................... 1,892.6 1,876.8 1,848.8
8 percent - 9 percent............................................................... 326.4 326.4 325.6
9 percent and above................................................................. 840.5 844.5 602.8
-------- -------- --------
Total mortgage-backed securities (a)......................................... $7,560.7 $7,511.3 $7,044.4
======== ======== ========
<FN>
---------------
(a) Includes below-investment grade mortgage-backed securities with an
amortized cost and estimated fair value of $746.8 million and $505.6
million, respectively.
</FN>
</TABLE>
The amortized cost and estimated fair value of mortgage-backed securities
at September 30, 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............ $3,894.5 $3,788.0 18%
Planned amortization classes and accretion-directed bonds................. 1,980.1 1,891.8 9
Commercial mortgage-backed securities..................................... 772.0 746.4 3
Subordinated classes and mezzanine tranches............................... 832.9 592.3 3
Other..................................................................... 31.8 25.9 -
-------- -------- ---
Total mortgage-backed securities (a)............................... $7,511.3 $7,044.4 33%
======== ======== ==
<FN>
---------------
(a) Includes below-investment grade mortgage-backed securities with an
amortized cost and estimated fair value of $746.8 million and $505.6
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.
55
<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 September 30, 2000, the mortgage loan balance was primarily comprised of
commercial loans. Less than 1 percent of the mortgage loan balance was
noncurrent (loans two or more scheduled payments past due) at September 30,
2000.
At September 30, 2000, we held $46.1 million of trading securities; we
included them in "other invested assets."
Our investment borrowings averaged approximately $345.8 million during the
first nine months of 2000, compared with approximately $1,121.1 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 5.3 percent and 5.1 percent during the first nine
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 before net realized capital gains (losses) of our life
insurance subsidiaries was $82.7 million and $184.8 million in the first nine
months of 2000 and 1999, respectively. The Company's life insurance subsidiaries
reported the following amounts to regulatory agencies at September 30, 2000,
after appropriate eliminations of intercompany accounts among such subsidiaries
(dollars in millions):
<TABLE>
<S> <C>
Statutory capital and surplus .................................. $1,963.1
Asset valuation reserve......................................... 335.2
Interest maintenance reserve.................................... 434.1
--------
Total........................................................ $2,732.4
========
</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>
September 30,
2000
----
(Dollars in
millions)
<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 acquisition of Conseco Finance (a).................................... $ 72.1
Preferred and common stock of intermediate holding company............................ 215.4
Common stock of Conseco (39.8 million shares)......................................... 25.6
Other ................................................................................ 2.5
------
Total........................................................................... $315.6
======
<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
$284.6 million, $279.7 million and $258.8 million, respectively.
</FN>
</TABLE>
State insurance laws generally restrict the ability of insurance companies
to pay dividends or make other distributions. During the remainder of 2000, our
insurance subsidiaries may pay dividends to Conseco of $52.5 million without
permission
56
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
from state regulatory authorities. During the first nine months of 2000, our
insurance subsidiaries paid dividends to Conseco totaling $152.1 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,"
"optimistic" 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 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 Conseco's efforts to sell assets and reduce,
refinance or modify indebtedness and the availability and cost of capital in
connection with this process; (x) actions by rating agencies and the effects of
past or future actions by these agencies on Conseco's business; 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 ways 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 March
31, 2000, announcement that we planned to explore the sale of Conseco Finance
and other events described in the note to the accompanying consolidated
financial statements entitled "Special Charges and Recent Events," 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. See the note
to the accompanying consolidated financial statements entitled "Standard &
Poor's 500 Index Call Options and Interest Rate Swap Agreements" for information
about several interest rate swap agreements that were terminated during the
second quarter of 2000.
57
<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 forty-five suits were filed against the Company in the United
States District Court for the Southern District of Indiana. Nineteen of these
cases were 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. Two cases were putative class actions on
behalf of persons or entities that purchased the Company's bonds during the same
alleged class periods. Three cases were putative class actions on behalf of
persons or entities that purchased or sold option contracts, not issued by the
Company, on the Company's common stock during the same alleged class periods.
One case was a putative class action on behalf of persons or entities that
purchased the Company's "Feline Pride" convertible preferred stock instruments
during the same alleged class periods. With four exceptions, in each of these
twenty-five cases two former officers/directors of the Company are named as
defendants. In each case, the plaintiffs assert claims under Sections 10(b) and
20(a) of the Securities Exchange Act of 1934. In each case, plaintiffs allege
that the Company and the 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 these lawsuits are without merit and intends to defend them
vigorously. The ultimate outcome of these lawsuits cannot be predicted with
certainty.
Eleven 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, Conseco Financing Trust VI, and Conseco Financing
Trust VII. Each of these complaints named as defendants the Company, the
relevant trust (with two exceptions), two former officers/directors of the
Company, and underwriters for the particular issuance (with one exception). One
complaint also named 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 eight complaints also asserted claims under Section 12(a)(2) of
that Act. Two complaints also asserted claims under Sections 10(b) and 20(a) of
the Securities Exchange Act of 1934, and one complaint also asserted a claim
under Section 10(b) of that Act. In each case, plaintiffs alleged 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.
58
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
All of the securities cases have now been consolidated into one case in the
United States District Court for the Southern District of Indiana, captioned:
"In Re Conseco, Inc. Securities Litigation", cause number IP00-585-C- Y/S. An
amended complaint is expected to be filed on or about December 13, 2000. The
Company intends to defend this lawsuit vigorously. The ultimate outcome cannot
be predicted with certainty.
Nine shareholder derivative suits were filed in United States District
Court. The complaints named as defendants the current directors, certain former
directors, certain non-director officers of the Company (in one case), and,
alleging aiding and abetting liability, certain banks which allegedly made loans
in relation to the Company's "Stock Purchase Plan" (in these cases). The Company
is also named as a nominal defendant in each complaint. 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
Stock Purchase Plan. These cases have now been consolidated into one case in the
United States District Court for the Southern District of Indiana, captioned:
"In Re Conseco, Inc. Derivative Litigation", cause number IP00655-C-Y/S. An
amended complaint is expected to be filed on or about December 13, 2000. Three
similar cases have been filed in the Hamilton County Superior Court in Indiana.
Schweitzer v. Hilbert, et al., Cause No. 29001-0004CP251; Evans v. Hilbert, et
al., Cause No. 29001-0005CP308 (both Schweitzer and Evans name as defendants
certain non-director officers); Gintel v. Hilbert, et al., Cause No.
29003-0006CP393 (naming as defendants, and alleging aiding and abetting
liability as to, banks which allegedly made loans in relation to the Stock
Purchase Plan). 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 Services, LLC, Washington
National Insurance Company and United Presidential Life Insurance Company are
currently named defendants in a lawsuit filed in the Circuit Court of Claiborne
County, Mississippi, Cause No. CV-99-0106, and captioned "Carla Beaugez, Lois
Dearing, Lee Eaton and all other persons identified in the lawsuit v. Conseco,
Inc., Conseco Services, Inc., Washington National Company, United Presidential
Life Insurance Company and Larry Ratcliff." The claims of the eighty-seven
plaintiffs arise out of allegedly wrongful increases of the cost of insurance
and decrease in the credited interest rates on universal life policies issued to
the plaintiffs by United Presidential Life. The plaintiffs asserted claims
including negligent and intentional misrepresentation, fraudulent concealment,
fraudulent inducement, common law fraud, and deceptive sales practices. Conseco
believes this lawsuit is without merit and is defending it vigorously. The
ultimate outcome of this lawsuit 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 v. 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 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. We intend to continue defending
this action vigorously unless the current settlement discussions and procedures
produce a satisfactory outcome. The ultimate outcome of this lawsuit cannot be
predicted with certainty.
Conseco Finance is a defendant in two arbitration proceedings in South
Carolina (Lackey v. Green Tree Financial Corporation, n/k/a Conseco Finance
Corp. and Bazzle v. Green Tree Financial Corporation, n/k/a Conseco Finance
Corp.) where the arbitrator, over Conseco Finance's objection, allowed the
plaintiffs to pursue purported class action claims in arbitration. The two
purported arbitration classes consist of South Carolina residents who obtained
real estate secured credit from Conseco Finance's Manufactured Housing Division
(Lackey) and Home Improvement Division (Bazzle) in the early and mid 1990s, and
did not receive a South Carolina specific
59
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
disclosure form relating to selection of attorneys in connection with the credit
transactions. The arbitrator, in separate awards issued on July 24, 2000,
awarded a total of $26.8 million in penalties and attorneys' fees. Plaintiffs
have filed motions in South Carolina courts to have the awards confirmed as
judgments. The Bazzle award was confirmed as a judgment and the matter is
currently on appeal. The Lackey award has not been confirmed as a judgment.
Conseco Finance intends to vigorously challenge the awards and believes that the
arbitrator erred by, among other things, conducting class action arbitrations
without the authority to do so and misapplying South Carolina law when awarding
the penalties. The ultimate outcome of these proceedings cannot be predicted
with certainty.
In addition, the Company and its subsidiaries are involved on an ongoing
basis in other 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.
60
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
ITEM 5. OTHER INFORMATION.
Donald F. Gongaware and Ngaire E. Cuneo have resigned from the Conseco Board
of Directors, reducing the current Board to 10 members.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a) Exhibits.
10.1.11 Employment Agreement by and between David K. Herzog and
Conseco, Inc., dated as of August 11, 2000
10.1.31 Supplemental Retirement Agreement dated as of August 16,
2000, between Conseco, Inc. and Gary C. Wendt
10.1.32 Guaranty dated as of August 16, 2000, between Bankers Life
and Casualty Company as Guarantor, and Gary C. Wendt
10.46 Amended and Restated Agreement dated September 22, 2000,
by and among Conseco Finance Corp., CIHC, Incorporated,
Green Tree Residual Finance Corp. I, Green Tree Finance
Corp. - Five and Lehman Brothers Holdings, Inc.
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 June 28, 2000, was filed with the Commission to
report under Item 5, the hiring of Gary C. Wendt as the Company's Chairman
of the Board and Chief Executive Officer.
A report on Form 8-K/A dated September 22, 2000, was filed with the
Commission to report under Item 5, that the Company and its lender banks
have signed amendments that would restructure the Company's credit
facilities as part of the Company's "Restoration Plan".
A report on Form 8-K dated September 29, 2000, was filed with the
Commission to report under Item 5, the Registrant's letter to certain large
institutional shareholders.
61
<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: November 14, 2000 By: /S/ Thomas M. Hagerty
------------------
Thomas M. Hagerty
Chief Financial Officer
(authorized officer and
principal financial officer)
62
