================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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 July 31, 2000: 325,292,186
================================================================================
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
<TABLE>
<CAPTION>
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
ASSETS
June 30, December 31,
2000 1999
---- ----
(unaudited)
<S> <C> <C>
Investments:
Actively managed fixed maturities at fair value (amortized cost: 2000 - $23,429.9;
1999 - $23,690.4)........................................................................ $21,574.1 $22,203.8
Interest-only securities at fair value (amortized cost: 2000 - $897.4; 1999 - $916.2)...... 852.8 905.0
Equity securities at fair value (cost: 2000 - $316.0; 1999 - $323.7)....................... 305.4 312.7
Mortgage loans............................................................................. 1,470.4 1,274.5
Policy loans............................................................................... 660.5 664.1
Venture capital investments at fair value (cost: 2000 - $140.8; 1999 - $142.5)............. 561.7 527.5
Other invested assets ..................................................................... 607.4 544.0
--------- ---------
Total investments...................................................................... 26,032.3 26,431.6
Cash and cash equivalents..................................................................... 1,515.8 1,686.9
Accrued investment income..................................................................... 480.4 436.0
Finance receivables........................................................................... 5,680.6 5,104.1
Finance receivables - securitized............................................................. 8,942.1 4,730.5
Cost of policies purchased.................................................................... 2,103.5 2,258.5
Cost of policies produced..................................................................... 2,423.7 2,087.4
Reinsurance receivables....................................................................... 707.4 728.6
Income tax assets............................................................................. 389.9 209.8
Goodwill...................................................................................... 3,874.4 3,927.8
Assets held in separate accounts and investment trust ........................................ 2,750.6 2,231.4
Cash held in segregated accounts for investors in securitizations............................. 731.6 853.0
Cash held in segregated accounts related to servicing agreements and securitization
transactions............................................................................... 982.8 274.0
Other assets.................................................................................. 1,436.3 1,226.3
--------- ---------
Total assets........................................................................... $58,051.4 $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
June 30, December 31,
2000 1999
---- ----
(unaudited)
<S> <C> <C>
Liabilities:
Liabilities for insurance and asset accumulation products:
Interest-sensitive products.............................................................. $16,738.4 $17,322.4
Traditional products..................................................................... 7,818.3 7,537.3
Claims payable and other policyholder funds.............................................. 1,058.2 1,042.3
Liabilities related to separate accounts and investment trust............................ 2,750.6 2,231.4
Liabilities related to certificates of deposit........................................... 1,398.9 870.5
Investor payables.......................................................................... 731.6 853.0
Other liabilities.......................................................................... 1,569.2 1,498.7
Investment borrowings...................................................................... 230.7 828.9
Notes payable and commercial paper:
Corporate................................................................................ 3,628.4 2,481.8
Finance.................................................................................. 5,679.1 4,682.5
Related to securitized finance receivables structured as collateralized borrowings....... 9,136.4 4,641.8
--------- ---------
Total liabilities.................................................................... 50,739.8 43,990.6
--------- ---------
Minority interest:
Company-obligated mandatorily redeemable preferred securities of subsidiary trusts......... 2,399.2 2,639.1
Shareholders' equity:
Preferred stock............................................................................ 482.5 478.4
Common stock and additional paid-in capital (no par value, 1,000,000,000 shares
authorized, shares issued and outstanding: 2000 - 325,288,857;
1999 - 327,678,638)...................................................................... 2,905.6 2,987.1
Accumulated other comprehensive loss....................................................... (970.7) (771.6)
Retained earnings.......................................................................... 2,495.0 2,862.3
--------- ---------
Total shareholders' equity........................................................... 4,912.4 5,556.2
--------- ---------
Total liabilities and shareholders' equity........................................... $58,051.4 $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 Six months ended
June 30, June 30,
-------------------- -------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Insurance policy income........................................... $1,072.4 $1,020.0 $2,121.1 $2,027.4
Net investment income............................................. 882.4 735.9 1,943.3 1,403.6
Gain on sale:
Securitization transactions..................................... - 169.4 - 368.6
Other loan sales................................................ 2.6 - 2.6 -
Net investment losses ............................................ (118.2) (22.9) (153.5) (21.9)
Fee revenue and other income...................................... 126.0 121.3 257.6 232.6
-------- -------- -------- --------
Total revenues................................................ 1,965.2 2,023.7 4,171.1 4,010.3
-------- -------- -------- --------
Benefits and expenses:
Insurance policy benefits......................................... 1,019.2 920.5 2,086.7 1,810.2
Provision for losses.............................................. 152.7 27.2 234.7 48.5
Interest expense.................................................. 338.6 125.5 596.3 236.1
Amortization...................................................... 185.2 153.2 383.5 304.6
Other operating costs and expenses................................ 409.9 352.2 816.0 660.8
Special charges................................................... 327.2 - 327.2 -
Impairment charges................................................ 9.6 71.6 12.1 83.8
--------- -------- -------- --------
Total benefits and expenses................................... 2,442.4 1,650.2 4,456.5 3,144.0
-------- -------- -------- --------
Income (loss) before income taxes, minority interest and
extraordinary charge........................................ (477.2) 373.5 (285.4) 866.3
Income tax expense (benefit)......................................... (108.3) 129.9 (32.9) 304.7
-------- -------- -------- --------
Income (loss) before minority interest and
extraordinary charge ....................................... (368.9) 243.6 (252.5) 561.6
Minority interest:
Distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts, net of income taxes.. 35.7 30.3 74.7 60.5
-------- -------- -------- --------
Income (loss) before extraordinary charge..................... (404.6) 213.3 (327.2) 501.1
Extraordinary charge on extinguishment of debt, net of taxes...... .1 - .1 -
--------- -------- -------- --------
Net income (loss)............................................. (404.7) 213.3 (327.3) 501.1
Preferred stock dividends............................................ 2.5 - 6.7 .6
--------- -------- -------- --------
Net income (loss) applicable to common stock.................. $ (407.2) $ 213.3 $ (334.0) $ 500.5
======== ======== ======== ========
Earnings (loss) per common share:
Basic:
Weighted average shares outstanding.............................325,259,000 323,576,000 326,602,000 322,111,000
=========== =========== =========== ===========
Net income (loss)............................................... $(1.25) $.66 $(1.02) $1.55
====== ==== ====== =====
Diluted:
Weighted average shares outstanding.............................325,259,000 331,201,000 326,602,000 331,155,000
=========== =========== =========== ===========
Net income (loss)............................................... $(1.25) $.64 $(1.02) $1.51
====== ==== ====== =====
</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........................................ (327.3) - - - (327.3)
Change in unrealized depreciation of
investments (net of applicable income tax
benefit of $87.0)............................. (199.1) - - (199.1) -
--------
Total comprehensive loss.................... (526.4)
Issuance of shares for stock options and for
employee benefit plans.......................... .1 - .1 -
Issuance of convertible preferred shares.......... 4.1 4.1 - - -
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...................... (6.7) - - - (6.7)
--------- -------- -------- ------- --------
Balance, June 30, 2000............................... $4,912.4 $ 482.5 $2,905.6 $(970.7) $2,495.0
======== ======= ======== ======= ========
Balance, January 1, 1999............................. $5,273.6 $ 105.5 $2,736.5 $ (28.4) $2,460.0
Comprehensive income, net of tax:
Net income...................................... 501.1 - - - 501.1
Change in unrealized depreciation of
investments (net of applicable income tax
benefit of $250.1)............................ (466.1) - - (466.1) -
--------
Total comprehensive income.................. 35.0
Conversion of preferred stock into
common shares .................................. - (105.5) 105.5 - -
Issuance of shares for stock options and for
employee benefit plans.......................... 163.5 - 163.5 - -
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......................... (90.6) - - - (90.6)
Dividends on preferred stock...................... (.6) - - - (.6)
--------- ------- -------- ------- --------
Balance, June 30, 1999............................... $5,315.9 $ - $2,940.5 $(494.5) $2,869.9
======== ======= ======== ======= ========
</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)
Six months ended
June 30,
------------------
2000 1999
---- ----
<S> <C> <C>
Cash flows from operating activities:
Insurance policy income....................................................................... $ 1,949.6 $ 1,809.1
Net investment income......................................................................... 1,936.5 1,449.5
Points and origination fees................................................................... - 243.2
Fee revenue and other income.................................................................. 265.5 237.6
Insurance policy benefits..................................................................... (1,568.2) (1,442.6)
Interest expense.............................................................................. (550.6) (257.8)
Policy acquisition costs...................................................................... (442.8) (386.8)
Special charges............................................................................... (188.4) -
Other operating costs......................................................................... (860.8) (704.8)
Taxes......................................................................................... (21.9) (235.2)
--------- ---------
Net cash provided by operating activities................................................... 518.9 712.2
--------- ---------
Cash flows from investing activities:
Sales of investments.......................................................................... 2,969.1 8,620.5
Maturities and redemptions of investments..................................................... 422.9 598.6
Purchases of investments...................................................................... (4,148.2) (10,687.2)
Cash received from the sale of finance receivables, net of expenses........................... 1,774.6 5,737.4
Principal payments received on finance receivables............................................ 4,485.1 3,960.3
Finance receivables originated................................................................ (11,198.2) (11,793.4)
Other......................................................................................... (117.6) (76.5)
--------- ---------
Net cash used by investing activities ...................................................... (5,812.3) (3,640.3)
--------- ---------
Cash flows from financing activities:
Repurchase of Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts........................................................................ (250.0) -
Issuance of common and convertible preferred shares........................................... .5 101.5
Issuance of notes payable and commercial paper................................................ 16,077.4 10,182.7
Payments on notes payable and commercial paper................................................ (9,488.3) (8,438.0)
Change in cash held in restricted accounts for settlement of collateralized
borrowings.................................................................................. (749.8) -
Payments for settlement of forward contract and to repurchase equity securities............... (102.6) (29.5)
Investment borrowings......................................................................... (598.2) 393.1
Amounts received for deposit products......................................................... 2,595.8 1,746.4
Withdrawals from deposit products............................................................. (2,181.8) (1,425.7)
Dividends and distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts............................................................. (180.7) (170.6)
--------- ---------
Net cash provided by financing activities................................................. 5,122.3 2,359.9
--------- ---------
Net decrease in cash and cash equivalents................................................. (171.1) (568.2)
Cash and cash equivalents, beginning of period................................................... 1,686.9 1,704.7
--------- ---------
Cash and cash equivalents, end of period......................................................... $ 1,515.8 $ 1,136.5
========= =========
</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,
individual and group major medical insurance and other insurance products. Our
finance subsidiaries originate, purchase, sell and service consumer and
commercial finance 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.
The Company has debt and guarantees at the parent company level of
approximately $1.4 billion which are expected to become due on or before
September 30, 2000. Because of the time required to complete the sale of assets
and other contemplated activities described in the paragraph which follows,
extension of the Company's bank credit facilities will be required if the
Company is to meet its September debt maturities. The Company is currently in
discussions with its bank lenders and management is optimistic appropriate
extensions can be negotiated. However, there can be no assurance that these
negotiations will be successful, or as to the amount, maturity, cost or terms
associated with any such extension. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations Liquidity of Conseco (parent
company)."
On July 27, 2000, we announced several courses of action with respect to
Conseco Finance Corp. ("Conseco Finance"), a wholly owned subsidiary of Conseco,
as well as an asset disposition program with respect to certain non-strategic
assets held at the parent company level, which are designed to allow us to
reduce parent company debt over time. These 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 are designed to provide a business model which will result in
positive cash flow at Conseco Finance. In addition, we plan to sell certain
non-strategic assets, such as 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 sale of non-strategic assets and the actions contemplated at
Conseco Finance will generate cash proceeds of approximately $2.0 billion over
the next 12 to 15 months. We are already well underway with these actions, and
have completed the sale of the bankcard business and our subprime auto loan
portfolio, generating cash proceeds of over $300 million. 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. Furthermore, the Company's ability to use cash
generated from the actions being undertaken at Conseco Finance is substantially
limited by restrictions in agreements with Lehman Brothers Holdings, Inc. and
its affiliates (collectively, with its direct and indirect subsidiaries,
referred to as "Lehman"). In connection with the negotiations with our banks
relating to the extension of the maturity dates of our debt, we are also engaged
in discussions with Lehman concerning a modification of these restrictions and
are optimistic an acceptable modification can be obtained. However, there can be
no assurance that these negotiations will be successful, or as to the terms of
any such modification. See the note entitled "Changes in Corporate Notes Payable
and Commercial Paper."
BASIS OF PRESENTATION
Our unaudited consolidated financial statements reflect all adjustments,
consisting only of normal recurring items, that are necessary to present fairly
Conseco's financial position and results of operations on a basis consistent
with that of our prior audited consolidated financial statements. As permitted
by rules and regulations of the Securities and Exchange Commission applicable to
quarterly reports on Form 10-Q, we have condensed or omitted certain information
and disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles ("GAAP"). We have also
reclassified certain amounts from the prior periods to conform to the 2000
presentation. Results for interim periods are not necessarily indicative of the
results that may be expected for a full year.
When we prepare financial statements in conformity with GAAP, we are
required to make estimates and assumptions that significantly affect various
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements and revenues and
expenses during the reporting periods. For example, we use significant estimates
and assumptions in calculating values for 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.
7
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Net income and diluted earnings per share, as previously reported in our
Form 10-Q, as amended, for the three and six months ended June 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 loan origination cost deferrals.
These changes reduced previously reported net income by $84.2 million, or $.26
per diluted share, and by $93.5 million, or $.29 per diluted share, in the three
and six months ended June 30, 1999, respectively.
Our consolidated financial statements exclude the results of material
transactions between us and our consolidated affiliates, or among our
consolidated affiliates.
ACCOUNTING FOR INVESTMENTS
We classify our fixed maturity securities into three categories: (i)
"actively managed" (which we carry at estimated fair value); (ii) "trading"
(which we carry at estimated fair value); and (iii) "held to maturity" (which we
carry at amortized cost). We held $78.1 million of trading securities at June
30, 2000, which we included in "other invested assets." We had no fixed maturity
securities in the "held to maturity" category at June 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 June 30, 2000 and December 31, 1999, were as follows:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Unrealized losses on investments...................................................... $(1,907.4) $(1,504.3)
Adjustments to cost of policies purchased and cost of policies produced............... 406.5 291.2
Deferred income tax benefit........................................................... 530.4 443.4
Other................................................................................. - (1.7)
--------- ---------
Net unrealized losses on investments............................................. (970.5) (771.4)
Minimum pension liability adjustment, net of income tax benefit....................... (.2) (.2)
----------- ---------
Accumulated other comprehensive loss............................................. $ (970.7) $ (771.6)
========= =========
</TABLE>
VENTURE CAPITAL INVESTMENTS
Venture capital investments include equity and equity-type investments made
by our subsidiary which engages in venture capital investment activity. At the
time we enter into these investments, we believe they have high growth or
appreciation potential. These investments are carried at estimated fair value,
with changes in fair value recognized as investment income. When these venture
capital investments are publicly traded, the fair value is generally based upon
market prices. When liquidity is limited because of thinly traded securities,
limited partnership structures, large-block holdings, restricted shares or other
special situations, we adjust quoted market prices to produce an estimate of the
attainable fair values. We estimate the fair values of securities that are not
publicly traded based upon transactions which directly affect the value of such
securities and consideration of the investee's financial results, conditions and
prospects.
During 1999, we invested $53.2 million in 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,
our investee sold shares of common stock to the public in an initial public
offering. As a result, an ascertainable market value was established for our
investment, which we adjusted to recognize liquidity restrictions. We recognized
venture capital income of $3.2 million in the first six months of 2000 related
to this investment (consisting of $105.1 million of income recognized in the
first quarter of 2000 and a loss of $101.9 million in the second quarter of
2000), bringing the total carrying value of our investment to $443.3 million.
8
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
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.
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 June 30, 2000, was approximately 11.8
percent. We classify the notes issued to investors in the securitization trusts
as "notes payable related to securitized finance receivables structured as
collateralized borrowings."
After the March 31, 2000 announcement that we planned to explore the sale
of Conseco Finance and the other events described elsewhere herein, it was
difficult to complete new securitization transactions for a period of time.
However, these markets eventually became available to the Company. During the
second quarter of 2000, we completed five transactions, securitizing over $2.5
billion of finance receivables. In May 2000, we sold $1.3 billion of finance
receivables to Lehman. The proceeds from such sale were used to repay various
warehouse credit lines, creating increased warehousing capacity for Conseco
Finance. Lehman also amended its repurchase and other financing facilities with
Conseco Finance to expand the types of assets financed. 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.
Finance receivables-securitized, summarized by type, were as follows at
June 30, 2000 and December 31, 1999:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Manufactured housing.................................................................. $3,216.9 $ 953.0
Mortgage services..................................................................... 4,190.6 2,077.3
Consumer/credit card.................................................................. 256.5 1,076.9
Commercial............................................................................ 1,330.5 637.0
-------- --------
8,994.5 4,744.2
Less allowance for credit losses...................................................... 52.4 13.7
-------- --------
Net finance receivables-securitized........................................... $8,942.1 $4,730.5
======== ========
</TABLE>
9
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
The other finance receivables, summarized by type, were as follows:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Manufactured housing.................................................................. $ 834.4 $ 795.8
Mortgage services..................................................................... 1,404.4 1,277.0
Consumer/credit card.................................................................. 1,668.2 824.7
Commercial............................................................................ 1,874.4 2,281.3
-------- -------
5,781.4 5,178.8
Less allowance for credit losses...................................................... 100.8 74.7
-------- --------
Net other finance receivables................................................. $5,680.6 $5,104.1
======== ========
</TABLE>
The changes in the allowance for credit losses included in finance
receivables were as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
------------------ ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Allowance for credit losses, beginning of period..................... $119.1 $ 53.1 $ 88.4 $ 43.0
Provision for losses................................................. 84.1 27.2 142.7 48.5
Credit losses........................................................ (50.0) (25.1) (77.9) (36.3)
------ ------ ------ ------
Allowance for credit losses, end of period........................... $153.2 $ 55.2 $153.2 $ 55.2
====== ====== ====== ======
</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 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, $468.9 million and $714.7 million,
respectively, at June 30, 2000, and were classified as "actively managed fixed
maturity securities."
During the first six months of 1999, the Company sold $6.5 billion of
finance receivables in various securitized transactions and recognized gains of
$368.6 million. We recognized no gain on sale related to securitized
transactions during the first six 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 June 30, 2000 and December
31, 1999. We include the difference between estimated fair value and the
amortized cost of the interest-only securities in "accumulated other
comprehensive loss, net of taxes."
10
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
<TABLE>
<CAPTION>
Manufactured Home equity/ Consumer/
June 30, 2000 housing home improvement equipment Total
------------- ------- ---------------- --------- -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Interest-only securities at fair value............. $ 522.2 $ 280.7 $ 49.9 $ 852.8
Cumulative principal balance of sold finance
receivables at June 30, 2000.................... 21,451.5 7,590.6 2,386.1 31,428.2
Weighted average stated customer interest rate
on sold finance receivables..................... 10.0% 11.5% 10.9%
Assumptions to determine estimated fair value
of interest-only securities at June 30, 2000:
Expected weighted average annual constant
prepayment rate as a percentage of principal
balance of related finance receivables (a).. 9.6% 21.0% 22.2%
Expected nondiscounted credit losses as a
percentage of principal balance of
related finance receivables (a)............. 8.7% 5.9% 5.1%
Weighted average discount rate ............... 14.0% 14.0% 14.0%
Manufactured Home equity/ Consumer/
December 31, 1999 housing home improvement equipment Total
----------------- ------- ---------------- --------- -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Interest-only securities at fair value............. $ 528.3 $ 318.0 $ 58.7 $ 905.0
Cumulative principal balance of sold finance
receivables at December 31, 1999................ 22,854.6 8,804.8 3,049.4 34,708.8
Weighted average stated customer interest rate on
sold finance receivables........................ 10.0% 11.5% 11.0%
Assumptions to determine estimated fair value of
interest-only securities at December 31, 1999:
Expected weighted average annual constant
prepayment rate as a percentage of principal
balance of related finance receivables (a).. 9.4% 21.7% 22.4%
Expected nondiscounted credit losses as a
percentage of principal balance of related
finance receivables (a)..................... 9.0% 5.8% 5.1%
Weighted average discount rate................ 14.0% 14.0% 14.0%
<FN>
----------
(a) The valuation of interest-only securities is affected not only by the
projected level of prepayments of principal and net credit losses, but also
by the projected timing of such prepayments and net credit losses. Should
such timing differ materially from our projections, it could have a
material effect on the valuation of our interest-only securities.
Additionally, such valuation is determined by discounting cash flows over
the entire expected life of the receivables sold.
</FN>
</TABLE>
11
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Activity in the interest-only securities account was as follows:
<TABLE>
<CAPTION>
Six months ended
June 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.................................. - 266.4
Additions resulting from clean-up calls (a)................................................. 64.9 -
Investment income........................................................................... 56.1 91.5
Cash received............................................................................... (126.5) (234.1)
Impairment charge to reduce carrying value.................................................. (13.3) (83.2)
Change in unrealized depreciation charged to shareholders' equity........................... (33.4) 3.5
------- --------
Balance, end of period......................................................................... $ 852.8 $1,349.5
======= ========
<FN>
----------
(a) During the first six months of 2000, clean-up calls were exercised for five
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 five
securitizations triggered a requirement for the Company to repurchase a
portion of the interest-only securities.
</FN>
</TABLE>
Credit quality of managed finance receivables was as follows:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
--- ----
<S> <C> <C>
60-days-and-over delinquencies as a percentage of managed finance
receivables at period end................................................. 1.47% 1.42%
==== ====
Net credit losses incurred during the last twelve months as a percentage
of average managed finance receivables during the period.................. 1.49% 1.31%
==== ====
Repossessed collateral inventory as a percentage of managed finance
receivables at period end................................................. 1.41% 1.34%
==== ====
</TABLE>
12
<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 Six months ended
June 30, June 30,
------------------ ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions
and shares in thousands)
<S> <C> <C> <C> <C>
Income (loss):
Net income (loss).................................................. $(404.7) $213.3 $(327.3) $501.1
Preferred stock dividends.......................................... 2.5 - 6.7 .6
------- ------ ------- ------
Income (loss) applicable to common ownership for basic
earnings per share............................................. (407.2) 213.3 (334.0) 500.5
Effect of dilutive securities:
Preferred stock dividends.......................................... - - - .6
------- ------ ------- ------
Income (loss) applicable to common ownership and assumed
conversions for diluted earnings per share..................... $(407.2) $213.3 $(334.0) $501.1
======= ====== ======= ======
Shares:
Weighted average shares outstanding for basic earnings per share... 325,259 323,576 326,602 322,111
Effect of dilutive securities on weighted average shares:
Stock options.................................................... - 2,552 - 3,100
Employee benefit plans........................................... - 2,031 - 2,018
Convertible securities........................................... - 3,042 - 3,926
------- ------- ----------- -------
Dilutive potential common shares............................... - 7,625 - 9,044
------- ------- ----------- -------
Weighted average shares outstanding for diluted earnings
per share.................................................. 325,259 331,201 326,602 331,155
======= ======= ======= =======
</TABLE>
There were no dilutive common stock equivalents during the 2000 periods
because of the net loss realized by the Company during such 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 commercial loans such as floorplan and equipment 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, life, and individual and group major
medical products to a broad spectrum of customers through multiple distribution
channels, each focused on a specific market segment. These products are
primarily marketed through career agents, professional independent producers and
direct marketing. Fee-based activities include services performed for other
companies, including: (i) investment management; and (ii) insurance product
marketing.
13
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Corporate 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
Lawrenceberg, Indiana. In addition, the corporate segment includes interest
expense related to the Company's corporate debt, special corporate charges and
other income and expenses. Corporate expenses are net of charges to our
subsidiaries for services provided by the corporate operations.
Segment operating information was as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
------------------ ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Revenues:
Insurance and fee-based segment:
Insurance policy income:
Annuities..................................................... $ 34.2 $ 30.5 $ 67.2 $ 54.1
Supplemental health........................................... 533.5 513.8 1,060.6 1,029.7
Life.......................................................... 236.3 223.5 459.6 443.1
Individual and group major medical............................ 229.7 217.5 458.8 427.2
Other......................................................... 38.7 34.7 74.9 73.3
Net investment income (a)....................................... 500.1 550.5 1,043.4 1,064.5
Fee revenue and other income (a)................................ 35.1 32.2 65.9 59.4
Net losses from sale of investments (a)......................... (118.2) (22.9) (153.5) (21.9)
-------- -------- --------- --------
Total insurance and fee-based segment revenues.............. 1,489.4 1,579.8 3,076.9 3,129.4
-------- -------- --------- --------
Finance segment:
Net investment income:
Interest-only securities (a).................................. 28.6 47.4 56.1 91.1
Manufactured housing.......................................... 109.3 22.4 191.4 41.4
Mortgage services............................................. 154.8 25.5 284.4 46.5
Consumer/credit card.......................................... 108.0 44.5 204.4 77.8
Commercial.................................................... 62.4 29.0 115.3 49.0
Other (a)..................................................... 16.6 11.9 37.7 25.5
Gain on sale:
Securitization transactions:
Manufactured housing........................................ - 93.5 - 210.2
Mortgage services........................................... - 63.9 - 138.0
Consumer/credit card........................................ - 4.6 - 4.6
Commercial.................................................. - 10.2 - 18.6
Other....................................................... - (2.8) - (2.8)
Other loan sales - mortgage services.......................... 2.6 - 2.6 -
Fee revenue and other income.................................... 94.9 87.6 194.1 170.2
-------- -------- --------- --------
Total finance segment revenues.............................. 577.2 437.7 1,086.0 870.1
-------- -------- --------- --------
Corporate:
Net investment income........................................... 14.5 11.1 23.7 20.6
Venture capital income (loss) related to investment in Tritel... (101.9) - 3.2 -
Other........................................................... (2.6) (.1) (2.6) (.1)
-------- -------- --------- --------
Total corporate segment revenues (losses)................... (90.0) 11.0 24.3 20.5
-------- -------- --------- ---------
Eliminations...................................................... (11.4) (4.8) (16.1) (9.7)
-------- -------- -------- ---------
Total revenues.............................................. 1,965.2 2,023.7 4,171.1 4,010.3
-------- -------- -------- ---------
Expenses:
Insurance and fee-based segment:
Insurance policy benefits....................................... 1,019.2 920.5 2,086.7 1,810.2
Amortization.................................................... 213.6 152.4 382.1 303.0
Interest expense................................................ 5.0 16.6 10.0 28.4
Other operating costs and expenses.............................. 210.3 191.5 433.0 373.6
-------- -------- -------- ---------
Total insurance and fee-based segment expenses................ 1,448.1 1,281.0 2,911.8 2,515.2
-------- -------- -------- ---------
</TABLE>
(continued)
14
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
(continued from previous page)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
------------------ ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Finance segment:
Provision for losses............................................ 84.1 27.2 142.7 48.5
Interest expense................................................ 266.9 69.6 471.4 124.2
Special charges................................................. 63.4 - 63.4 -
Impairment charges.............................................. 9.6 71.6 12.1 83.8
Other operating costs and expenses.............................. 198.1 156.9 408.0 317.6
-------- -------- -------- --------
Total finance segment expenses................................ 622.1 325.3 1,097.6 574.1
-------- -------- -------- --------
Corporate:
Interest expense on corporate debt.............................. 75.8 44.1 127.8 93.2
Provision for losses............................................ 68.6 - 92.0 -
Special charges................................................. 263.8 - 263.8 -
General corporate expenses, less charges to subsidiaries
for services provided......................................... (24.6) 4.6 (20.4) (28.8)
-------- -------- -------- --------
Total corporate segment expenses.............................. 383.6 48.7 463.2 64.4
-------- -------- -------- --------
Eliminations...................................................... (11.4) (4.8) (16.1) (9.7)
-------- -------- -------- --------
Total expenses................................................ 2,442.4 1,650.2 4,456.5 3,144.0
-------- -------- -------- --------
Income (loss) before income taxes and minority interest:
Insurance operations............................................ 41.3 298.8 165.1 614.2
Finance operations.............................................. (44.9) 112.4 (11.6) 296.0
Corporate interest and other expenses........................... (473.6) (37.7) (438.9) (43.9)
-------- -------- -------- --------
Income (loss) before income taxes, minority interest
and extraordinary charge.................................. $ (477.2) $ 373.5 $ (285.4) $ 866.3
======== ======== ======== ========
<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 six months of 2000 and 1999, net investment
income included $6.6 million and $84.4 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 $103.2
million at June 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 $59.9 million
and $43.4 million during the first six months of 2000 and 1999, respectively.
The unamortized premium of the S&P 500 Call Options was $66.7 million at June
30, 2000.
15
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
We periodically use interest-rate swaps to hedge the interest rate risk
associated with our borrowed capital. At June 30, 2000, we held instruments
having an aggregate notional principal amount of $1.5 billion that effectively
converted a portion of our fixed-rate borrowed capital into floating-rate
instruments for specified periods of time. The agreements mature in various
years through 2005 and have an average remaining life of 2.9 years (the average
call date is 2.1 years). We record the difference between the rates as an
adjustment to interest expense. During the first six months of 2000, interest
expense was increased by $6.0 million as a result of these interest-rate swap
agreements. At June 30, 2000, such agreements had a fair value of $(25.8)
million, which is not recognized in the consolidated balance sheet because such
agreements effectively hedge the interest rate risk associated with portions of
the Company's fixed rate debt.
During the second quarter of 2000, ratings agencies lowered their ratings
on Conseco's debt (see "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity of Conseco (parent company)").
These actions triggered requirements for Conseco to terminate several swap
agreements, or provide cash collateral equal to the current fair value of
certain swap agreements. We realized a $38.7 million net investment loss related
to the termination of the swap agreements in the second quarter of 2000. In
addition, Conseco provided $12.7 million of cash collateral related to certain
other swap agreements.
If the counterparties of these financial instruments fail to meet their
obligations, Conseco may have to recognize a loss. Conseco limits its exposure
to such a loss by diversifying among several counterparties believed to be
strong and creditworthy. At June 30, 2000, all of the counterparties were rated
"A" or higher by Standard & Poor's Corporation.
GUARANTEES
In conjunction with certain sales of finance receivables, we provided
guarantees aggregating approximately $1.6 billion at June 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 $570.2 million to approximately 170
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. During the second quarter of 2000,
Conseco and certain participants in the stock purchase plan refinanced $144.4
million principal amount of the guaranteed bank loans. Conseco granted a
security interest in most of its assets to secure the financing of such loans
and for a new working capital facility (see "Changes in Corporate Notes
Payable"). The bank loans we have guaranteed are scheduled to mature as follows:
$144.4 million on September 1, 2000 and $425.8 million on August 30, 2001. The
Company is currently negotiating with various financial institutions to
refinance or extend the maturity dates of these loans. At June 30, 2000, the
guaranteed bank loans exceeded the value of the common stock collateralizing the
loans by $385.3 million. All participants have agreed to indemnify Conseco for
any loss incurred on their loans. In addition, Conseco has provided loans to
participants for interest on the bank loans totaling $64.8 million. We regularly
evaluate these guarantees and loans in light of the collateral and the
creditworthiness of the participants. In the second quarter of 2000, we
established an additional noncash provision of $68.6 million in connection with
these guarantees and loans, which was included as a component of the provision
for losses. At June 30, 2000, the total reserve for losses on the loan
guarantees was $110.9 million (which was established as follows: $68.6 million
($44.6 million after income taxes) in the second quarter of 2000; $23.4 million
($14.7 million after income taxes) in the first quarter of 2000; and $18.9
million ($11.9 million after income taxes) in the fourth quarter of 1999).
REINSURANCE
The cost of reinsurance ceded totaled $141.2 million and $232.7 million in
the first six 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 $141.7 million and $229.1 million in the first
six months of 2000 and 1999, respectively.
16
<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>
Six months ended
June 30,
-------------------
2000 1999
---- ----
<S> <C> <C>
U.S. statutory corporate rate.................................................................. (35.0)% 35.0%
Nondeductible goodwill amortization............................................................ 6.8 2.1
Other nondeductible expenses................................................................... 5.8 -
State taxes.................................................................................... 1.4 2.2
Settlement of tax issues....................................................................... - (3.3)
Provision for tax issues and other............................................................. 9.5 (.8)
----- ----
Effective tax rate...................................................................... (11.5)% 35.2%
====== ====
</TABLE>
CHANGES IN CORPORATE NOTES PAYABLE AND COMMERCIAL PAPER (EXCLUDING NOTES
PAYABLE RELATED TO SECURITIZED FINANCE RECEIVABLES STRUCTURED AS
COLLATERALIZED BORROWINGS)
Notes payable and commercial paper (excluding notes payable related to
securitized finance receivables structured as collateralized borrowings) were as
follows (interest rates as of June 30, 2000):
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
$2.266 billion bank credit facilities (6.91%)................................ $2,256.0 $1,032.0
$155 million collateralized bank credit facility (9.16%)..................... 125.0 -
Commercial paper (6.52%)..................................................... 51.7 898.4
Master repurchase agreements due on various dates in 2000 and
2001 (7.89%).............................................................. 2,525.3 1,620.9
Credit facility collateralized by retained interests in securitizations due
2001 (8.62%).............................................................. 525.0 499.0
Medium term notes due September 2002 and April 2003 (6.52%).................. 223.7 226.7
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
10.25% senior subordinated notes due 2002.................................... 193.6 193.6
Notes payable due 2003 (7.18%)............................................... 250.0 250.0
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........................................................................ 94.2 146.6
-------- --------
Total principal amount.................................................. 9,332.9 7,186.1
Unamortized net discount..................................................... 25.4 21.8
-------- --------
Total notes payable and commercial paper................................ $9,307.5 $7,164.3
======== ========
Total allocated to:
Corporate............................................................. $3,628.4 $2,481.8
Finance segment....................................................... 5,679.1 4,682.5
-------- --------
Total notes payable and commercial paper............................ $9,307.5 $7,164.3
======== ========
</TABLE>
17
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Our current bank credit facilities allow us to borrow up to $2.3 billion,
of which $1.5 billion may be borrowed until 2003 and $.8 billion may be borrowed
until September 22, 2000. Borrowings under these facilities averaged $1,332.0
million during the first six months of 2000, at a weighted average interest rate
of 6.58 percent. At June 30, 2000, the available borrowings under our bank
credit facilities were $40 million and we held approximately $450 million of
cash at the parent company level. The credit facility requires us to maintain
various financial ratios, as defined in the agreement, including: (i) a
debt-to-total capitalization ratio less than .45:1 (such ratio was .43:1 at June
30, 2000); and (ii) an interest coverage ratio greater than 2.25:1 for the
period October 1, 1999 through September 30, 2001 and greater than 2.50:1
thereafter (such ratio was 2.86:1 for the period ended June 30, 2000). Our
current plans to restructure our finance operations could adversely affect such
financial ratios.
The interest rates on our bank credit facilities are based on a LIBOR rate
plus a margin based on the credit rating of Conseco's senior unsecured notes.
During the second quarter of 2000, rating agencies lowered their ratings on
Conseco's senior unsecured debt (see "Management's Discussion and Analysis of
Financial Condition and Results of Operations Liquidity of Conseco (parent
company)"). Accordingly, the weighted average interest rates under these bank
credit facilities increased .15 percent.
During the second quarter of 2000, we entered into a collateralized bank
credit facility which allows us to borrow up to $155 million until September 1,
2000. The interest rate on the new facility is based on LIBOR plus 2.5 percent.
The proceeds from the credit facility were used to repay a similar credit
facility entered into in April 2000. Conseco granted a collateral interest in
most of its assets to secure the new credit facility and a portion of the loans
to directors, officers and key employees, guaranteed by Conseco, related to the
purchase of shares of Conseco common stock (see "Guarantees").
The covenants of the collateralized bank credit facility and the guarantee
related to the directors, officers and key employee loans limit additional
collateralized debt of the Company to $50 million, excluding certain
collateralized indebtedness (such as the collateralized finance segment
indebtedness). This debt is due and is expected to be repaid or refinanced in
September 2000.
The parent company has debt and guarantees of approximately $1.4 billion
which are expected to become due on or before September 30, 2000. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations Liquidity of Conseco (parent company)" for additional information on
the alternatives the Company is exploring to meet these obligations and related
risks.
The covenants of certain of the Company's unsecured debt agreements
generally limit the amount of collateralized debt the Company can incur, issue,
assume or guarantee, without providing that existing indebtedness is similarly
collateralized in terms of ranking, as long as the other indebtedness is
collateralized. Such limit does not apply to certain excluded collateralized
indebtedness (such as the collateralized finance segment indebtedness) and is
equal to 10 percent of consolidated capitalization, as defined. At June 30,
2000, the most restrictive covenant related to collateralized indebtedness
(excluding: (i) the aforementioned covenant related to the collateralized bank
credit facility and Conseco guarantee; and (ii) $88 million of debt which
provides that it will be collateralized equally with any collateralized debt)
would have permitted additional collateralized indebtedness of approximately
$400 million (excluding the $325 million of collateralized debt and guarantees
outstanding at June 30, 2000).
The credit facility collateralized by retained interests in securitizations
requires the Company's finance subsidiary to maintain various financial ratios,
as defined in the agreement, including: (i) an adjusted tangible net worth of at
least $1.8 billion (such amount was $2.0 billion at June 30, 2000); (ii) a fixed
charge coverage ratio of not less than 1.10:1.0 (such ratio was 1.11:1 at June
30, 2000); (iii) a debt to equity ratio of not more than 12.0:1.0 (such ratio
was 9.0:1.0 at June 30, 2000); and (iv) a net worth equal to averaged managed
receivables ratio of not less than .0375:1 (such ratio was .0393:1 at June 30,
2000). Our current plans to restructure our finance operations could adversely
affect such financial ratios.
In connection with the modification of certain master repurchase agreements
and other transactions with Lehman described in the note entitled "Special
Charges and Recent Events", Conseco Finance agreed that it will not pay
dividends until 2001 and then pay such dividends only to the extent certain
financial covenants are met. In addition, Conseco Finance agreed that without
Lehman's consent, it will limit additional prepayments on the intercompany note
payable to
18
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
Conseco (with a balance of $2,210.8 million at June 30, 2000) to $50 million,
as long as certain financing arrangements with Lehman remain outstanding.
Borrowings under our commercial paper program averaged $678.2 million
during the first six 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
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity of Conseco"), have affected our ability to issue
commercial paper. Accordingly, we have curtailed its issuance in favor of
borrowing under our bank credit facilities.
On February 7, 2000, the Company completed the public offering of $800.0
million of 8.75 percent notes due February 9, 2004. The notes are unsecured and
rank equally with all other unsecured senior indebtedness of Conseco. Proceeds
from the offering of approximately $794.3 million (after underwriting discounts
and estimated offering expenses) were used to repay outstanding indebtedness.
Notes payable due 2003 bear interest at LIBOR plus .5 percent. Such notes
are putable by the holder prior to the maturity date at a 1-to-3 percent
discount to par. The notes and accrued interest thereon are secured by standby
letters of credit, which expire on September 30, 2000.
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.
At June 30, 2000, we had $5.7 billion in master repurchase agreements,
commercial paper conduit facilities and other facilities with various banking
and investment banking firms for the purpose of financing our consumer and
commercial finance loan production. These facilities typically provide financing
of a certain percentage of the underlying collateral and are subject to the
availability of eligible collateral and, in many cases, the willingness of the
banking firms to continue to provide financing. These agreements generally
provide for annual terms, some of which are extended either quarterly or
semi-annually by mutual agreement of the parties for an additional annual term
based upon receipt of updated quarterly financial information. At June 30, 2000,
we had borrowed $3.3 billion of the $5.7 billion available under such
agreements.
NOTES PAYABLE RELATED TO SECURITIZED FINANCE RECEIVABLES STRUCTURED AS
COLLATERALIZED BORROWINGS
Notes payable related to securitized finance receivables structured as
collateralized borrowings were $9,136.4 million at June 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 June 30, 2000 was 8.0 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 dividend will be
payable in
19
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
cash, and the remainder may be paid in additional Series F shares valued at
$19.25 per share. 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>
Six months ended
June 30,
-------------------
2000 1999
---- ----
(Shares in thousands)
<S> <C> <C>
Balance, beginning of period................................................................... 327,679 315,844
Stock options exercised..................................................................... 65 4,718
Issuance of shares.......................................................................... - 3,115
Common shares converted from PRIDES......................................................... - 5,904
Settlement of forward contract and common stock acquired.................................... (4,246) (2,900)
Shares issued under employee benefit compensation plans..................................... 1,791 50
------- -------
Balance, end of period......................................................................... 325,289 326,731
======= =======
</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. We are currently evaluating the impact of SFAS 133, which is
required to be implemented in 2001. Because of ongoing changes to implementation
guidance, we do not plan on adopting the new standard until the first quarter of
2001.
LITIGATION
Conseco Finance was served with various related lawsuits filed in the
United States District Court for the District of Minnesota. These lawsuits were
generally filed as purported class actions on behalf of persons or entities who
purchased common stock or options to purchase common stock of Conseco Finance
during alleged class periods that generally run from February 1995 to January
1998. One action (Florida State Board of Admin. v. Green Tree Financial Corp.,
Case No. 98-1162) did not include class action claims. In addition to Conseco
Finance, certain current and former officers and directors of Conseco Finance
are named as defendants in one or more of the lawsuits. Conseco Finance and
other defendants obtained an order consolidating the lawsuits seeking class
action status into two actions, one of which pertains to a purported class of
common stockholders (In re Green Tree Financial Corp. Stock Litig., Case No.
97-2666) and the other which pertains to a purported class action of stock
option traders (In re Green Tree Financial Corp. Options Litig., Case No.
97-2679). Plaintiffs in the lawsuits assert claims under Sections 10(b) and
20(a) of the Securities Exchange Act
20
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
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 have been filed against the Company in the
United States District Court for the Southern District of Indiana. Nineteen of
these cases are putative class actions on behalf of persons or entities that
purchased the Company's common stock during alleged class periods that generally
run from April 1999 through April 2000. Luisi v. Conseco, Inc., et al., Case No.
IP00-C-0593-Y/S; Sechrist v. Conseco, Inc., et al., Case No. IP00-C-0585-Y/S;
Klein v. Conseco, Inc., et al., Case No. IP00-C-0602-Y/S; Brody v. Conseco,
Inc., et al., Case No. IP00-C-0609-Y/S; Dana v. Conseco, Inc., et al., Case No.
IP00-C-0623-Y/S; Krim v. Conseco, Inc., et al., Case No. IP00-C-0631-Y/S; Nadaf
v. Conseco, Inc., et al., Case No. IP00-C-0628-Y/S; Greiner v. Conseco, Inc., et
al., Case No. IP00-C-0639-Y/S (naming as a defendant only one officer/director);
Sedgwick v. Conseco, Inc., et al., Case No. IP00-C-0657-Y/S; Irle v. Conseco,
Inc., et al., Case No. IP00-C-0746-Y/S; Schwartz v. Conseco, Inc., et al., Case
No. IP00-C-0770-Y/S; Leopold v. Conseco, Inc., et al., Case No. IP00-C-0843-Y/S;
Slovacek v. Conseco, Inc., et al., Case No. IP00-C-0858-Y/S (naming as a
defendant only one officer/director); Swei v. Conseco, Inc., et al., Case No.
IP00-C-0839-Y/S (naming as a defendant only one officer/director); Nicholson v.
Conseco, Inc., et al., Case No. IP00-C-0826-Y/S; Browne v. Conseco, Inc., et
al., Case No. IP00-C-0897-Y/S; Chacharone v. Conseco, Inc., et al., Case No.
IP00-C-0885-Y/S; Muhlenfeld v. Conseco, Inc., et al., Case No. IP00-C-0933-Y/S;
Young v. Conseco, Inc., et al. (case number pending; originally filed in the
United States District Court for the Eastern District Michigan, Case No.
00-72939, and now in the process of transferred by stipulation). Two cases are
putative class actions on behalf of persons or entities that purchased the
Company's bonds during the same alleged class periods. Waring v. Conseco, Inc.,
et al., Case No. IP00-C-0793-Y/S; Lutt v. Conseco, Inc., et al., Case No.
IP00-C-0905-Y/S. Three cases are 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. Syndicated
Fin. Servs., Inc. v. Conseco, Inc., et al., Case No. IP00-C-0795-Y/S (naming as
a defendant only one officer/director); Joel Mandel v. Conseco, Inc., et al.,
Case No. IP00-C-0815-Y/S; Avi Mandel v. Conseco, Inc., et al., Case No.
IP00-C-0884- Y/S. One case is 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. Kelly v. Conseco, Inc., et
al., Case No. IP00- C-0789-Y/S. With the four exceptions noted, 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 Section 10(b) and
20(a) of the Securities Exchange Act of 1934. In each case, plaintiffs allege
that the Company and the individual defendants violated the federal securities
laws by, among other things, making false and misleading statements about the
current state and future prospects of Conseco Finance (particularly with respect
to performance of certain loan portfolios of Conseco Finance) which allegedly
rendered the Company's financial statements false and misleading. The Company
believes that 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, Griffin v. Conseco, Inc., et al., Case No.
IP00-C-0663-Y/S; Stifnagle v. Conseco, Inc., et al., Case No. IP00-C-0754- Y/S
(Stifnagle also asserts claims regarding Conseco Financing Trust VII);
Gastfriend v. Conseco, Inc., et al., Case No. IP00-C-0883-Y/S; Powers v. Conseco
Financing Trust V, et al., Case No. IP00-C-0953-Y/S (also naming Conseco
Financing Trusts VI and VII) (each of the preceding make allegations with
respect to an August 24, 1998 offering for Conseco Financing Trust V); Gabora v.
Conseco, Inc., et al., Case No. IP00-C-0852-Y/S (also naming Conseco Financing
Trust VII, but containing allegations relating only to notes issued by the
Company on October 18, 1999, unrelated to the Conseco Financing Trusts named);
Schmidt v. Conseco, Inc., et al., Case No. IP00-C-0823-Y/S (also naming Conseco
Financing Trust VII, but containing allegations relating only to Conseco
Financing Trusts VI and VII), Conseco Financing Trust VI, Costello v. Conseco,
Inc., et al., Case No. IP00-C-0705-Y/S (October 8, 1998 offering), and Conseco
Financing Trust VII, Zinno v. Conseco, Inc., et al., Case No. IP00-C-0622-Y/S;
Shapiro v. Conseco, Inc., et al., Case No. IP00-C-
21
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
0650-Y/S; Kosseff v. Conseco, Inc., et al., Case No. IP00-C-0753-Y/S; Harris v.
Conseco, Inc., et al., Case No. IP00-C- 0797-Y/S (August 26, 1999 offering).
Each of these complaints names as defendants the Company, the relevant trust
(except Shapiro and Kosseff), two former officers/directors of the Company, and
underwriters for the particular issuance (except Shapiro). The Kosseff complaint
also names an officer and all of the Company's directors at the time of issuance
of the preferred stock by Conseco Financing Trust VII. In each case, plaintiffs
assert claims under Section 11 and Section 15 of the Securities Act of 1933, and
the Zinno, Shapiro, Stifnagle, Harris, Gabora, Gastfriend, Powers and Schmidt
complaints also assert claims under Section 12(a)(2) of that Act. Gabora and
Gastfriend also assert claims under Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934, and Powers also asserts a claim under Section 10(b) of
that Act. In each case, plaintiffs allege that the defendants violated the
federal securities laws by, among other things, making false and misleading
statements, in Prospectuses and/or Registration Statements related to the
issuance of preferred securities by the Trust involved, regarding the current
state and future prospects of Conseco Finance (particularly with respect to
performance of certain loan portfolios of Conseco Finance) which allegedly
rendered the disclosure documents false and misleading. The Company also intends
to defend these lawsuits vigorously. The ultimate outcome of these lawsuits
cannot be predicted with certainty.
Nine shareholder derivative suits have been filed in United States District
Court. Rogney v. Decatur, et al., Case No. IP00-C-0655-Y/S; Fletcher v. Hilbert,
et al., Case No. IP00-C-0693-Y/S; Gold v. Decatur, et al., Case No. IP00-C-0747-
Y/S; Batcheldor v. Hilbert, Case No. IP00-C-0743-Y/S; Youssef v. Decatur, et
al., Case No. IP00-C-0809-Y/S; Gintel v. Hilbert, Case No. IP00-C-0987-Y/S;
Frankel v. Coss, et al. (case number pending; originally filed in the Evansville
Division of United States District Court for the Southern District of Indiana,
Case No. EV00-134-C-Y/H, and now in the process of transfer); Evans v. Hilbert,
Case No. IP00-C-1019-Y/S; Marks v. Hilbert, Case No. IP00-C-0877-Y/S. The
complaints name as defendants the current directors, certain former directors,
certain non-director officers of the Company (in Fletcher), and, alleging aiding
and abetting liability, certain banks which allegedly made loans in relation to
the Company's "Stock Purchase Plan" (in Batcheldor, Gintel and Evans). 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. 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 vs. Massachusetts General Life Insurance Company;
Life Partners Group, Inc., Wabash Life Insurance Company, Conseco, Inc., Donovan
R. Bolton, et al." The class, approximately 345,000 in number, consists of all
persons who purchased universal life insurance policies from Conseco Life
Insurance Company, formerly named Massachusetts General Life Insurance Company,
between January 1, 1984 and July 23, 1999 (excluding policies where death
benefits were paid). The claims involve the changing interest rate climate
between the 1980s and the comparatively lower rates in the 1990s, and
22
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
the resulting lower rates credited to universal life products. The plaintiffs
asserted claims of fraud, breach of the covenant of good faith and fair dealing,
negligence, negligent misrepresentation, unjust enrichment and related matters.
Conseco believes this lawsuit is without merit. 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 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. 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.
CONSOLIDATED STATEMENT OF CASH FLOWS
The following disclosures supplement our consolidated statement of cash
flows:
<TABLE>
<CAPTION>
Six months ended
June 30,
------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)........................................................................... $(327.3) $ 501.1
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Gain on sale of finance receivables..................................................... (2.6) (368.6)
Points and origination fees received.................................................... - 243.2
Interest-only securities investment income.............................................. (56.1) (91.5)
Cash received from interest-only securities............................................. 126.5 234.1
Servicing income........................................................................ (55.3) (81.1)
Cash received from servicing activities................................................. 63.2 86.1
Provision for losses.................................................................... 234.7 48.5
Amortization and depreciation........................................................... 445.2 344.2
Income taxes............................................................................ (95.0) 122.1
Insurance liabilities................................................................... 347.0 149.3
Accrual and amortization of investment income........................................... (77.2) (96.7)
Deferral of cost of policies produced and purchased..................................... (442.8) (386.8)
Impairment charges...................................................................... 12.1 83.8
Special charges......................................................................... 138.8 -
Minority interest....................................................................... 115.0 93.0
Net investment losses................................................................... 153.5 21.9
Other................................................................................... (60.8) (105.3)
Payment of taxes in settlement of prior years........................................... - (85.1)
------- -------
Net cash provided by operating activities............................................... $ 518.9 $ 712.2
======= =======
</TABLE>
23
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
<TABLE>
<CAPTION>
Six months ended
June 30,
------------------
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Non-cash items not reflected in the consolidated statement of cash flows:
Issuance of common stock under stock option and employee benefit plans....................... $ - $ 2.1
Issuance of convertible preferred shares..................................................... 4.1 -
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.............................................. - 105.5
</TABLE>
SPECIAL CHARGES AND RECENT EVENTS
During the second quarter of 2000, the Company incurred the following
charges which are further described in the paragraphs which follow (dollars in
millions):
<TABLE>
<S> <C>
Advisory fees and warrant paid and/or issued to Lehman and other investment banks................ $117.1
Exit from subprime automobile and bankcard business.............................................. 58.5
Executive termination payment.................................................................... 72.5
Chief Executive Officer signing payment.......................................................... 45.0
Warrants granted to General Electric Company..................................................... 21.0
Other .......................................................................................... 13.1
------
Special charges before income tax benefit................................................. 327.2
Income tax benefit related to special charges.................................................... (98.6)
------
Special charges, net of income tax benefit................................................ $228.6
======
</TABLE>
Lehman transactions
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 quarter of 2000, we repurchased approximately $.7 billion
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.
24
<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 connection with the transaction with Lehman, the intercompany demand
note from Conseco Finance to Conseco was replaced with a one-year term note and
Conseco Finance repaid $450.0 million of this note. At June 30, 2000, the
one-year term note had a balance of $2,210.8 million. Conseco Finance agreed
that without Lehman's consent, it will limit additional prepayments on this note
to $50 million, as long as certain financing arrangements with Lehman remain
outstanding. In addition, Conseco Finance has agreed that it will not pay
dividends until 2001 and then pay such dividends only to the extent certain
financial covenants are met.
In 1999, the parent company contributed certain assets then having a book
value of approximately $300 million to a subsidiary of Conseco Finance in
exchange for additional shares of Conseco Finance common stock. The stock of
this subsidiary was distributed back to Conseco in 2000 concurrently with the
Lehman transaction at book value.
Exit from subprime automobile and bankcard business
Late in the second quarter of 2000, we decided to terminate the operations
of our subprime automobile financing and servicing companies. A binding sale
agreement for the operation's finance receivables was entered into on June 28,
2000. In addition, the Company sold substantially all of its bankcard (Visa and
Mastercard) portfolio. We recognized a net loss on these sales of $58.5 million.
Executive Termination
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
25
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------
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.
26
<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 six months ended June 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.
The parent company has debt and guarantees of approximately $1.4 billion
which are expected to become due on or before September 30, 2000. Because of the
time required to complete the sale of assets and other contemplated activities
described in the paragraph which follows, extension of the Company's bank credit
facilities will be required if the Company is to meet its September debt
maturities. The Company is currently in discussions with its bank lenders and
management is optimistic appropriate extensions can be negotiated. However,
there can be no assurance that these negotiations will be successful, or as to
the amount, maturity, cost or terms associated with any such extension. See
"Liquidity of Conseco (parent company)."
On July 27, 2000, we announced several courses of action with respect to
Conseco Finance, as well as an asset disposition program with respect to certain
non-strategic assets held at the parent company level, which are designed to
allow us to reduce parent company debt over time. These 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 are designed to provide a business model which will result in
positive cash flow at Conseco Finance. In addition, we plan to sell certain
non-strategic assets, such as our investment in the wireless communication
company, Tritel, our interest in the riverboat casino in Lawrenceberg, Indiana,
and our subprime auto loan portfolio. The Company believes the sale of
non-strategic assets and the actions contemplated at Conseco Finance will
generate cash proceeds of approximately $2.0 billion over the next 12 to 15
months. We are already well underway with these actions, and we have completed
the sale of the bankcard business and our subprime auto loan portfolio,
generating cash proceeds of over $300 million. 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. Furthermore, the Company's ability to use cash generated from
the actions being undertaken at Conseco Finance is substantially limited by
restrictions in agreements with Lehman. In connection with the negotiations with
our banks relating to the extension of the maturity dates of our debt, we are
also engaged in discussions with Lehman concerning a modification of these
restrictions and are optimistic an acceptable modification can be obtained.
However, there can be no assurance that these negotiations will be successful,
or as to the terms of any such modification. See the note entitled "Changes in
Corporate Notes Payable and Commercial Paper."
Consolidated results and analysis
The net loss of $404.7 million in the second quarter of 2000, or $1.25 per
diluted share, included: (i) net investment losses (including related costs,
amortization and taxes) of $71.3 million, or 22 cents per share; (ii) special
and impairment charges of $304.7 million, or 94 cents per share; and (iii) an
extraordinary charge (net of taxes) of $.1 million, or nil cents per share,
related to the early retirement of debt. Net income of $213.3 million in the
second quarter of 1999, or 64 cents per diluted share, included: (i) net
investment losses of $18.8 million, or 6 cents per share; and (ii) an impairment
charge of $45.1 million, or 14 cents per share, to reduce the value of
interest-only securities and servicing rights. The aforementioned special and
impairment charges are explained in more detail in the notes to the accompanying
consolidated financial statements.
The net loss of $327.3 million in the first six months of 2000, or $1.02
per diluted share, included: (i) net investment losses (including related costs,
amortization and taxes) of $84.6 million, or 26 cents per share; (ii) special
and impairment charges of $321.0 million, or 98 cents per share; and (iii) an
extraordinary charge (net of taxes) of $.1 million, or nil cents per share,
related to the early retirement of debt. Net income of $501.1 million in the
first six months of 1999, or $1.51 per diluted share, included: (i) net
investment losses of $24.7 million, or 8 cents per share; and (ii) an impairment
charge of $52.8 million, or 16 cents per share, to reduce the value of
interest-only securities and servicing rights. The aforementioned special and
impairment charges are explained in more detail in the notes to the accompanying
consolidated financial statements.
Total revenues in the second quarters of 2000 and 1999 included net
investment losses of $118.2 million and $22.9 million, respectively. Excluding
net investment losses, total revenues were $2,083.4 million in the second
quarter of 2000, up 1.8 percent from $2,046.6 million in the second quarter of
1999. Total revenues in the first six months of 2000 and
27
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
1999 included net investment losses of $153.5 million and $21.9 million,
respectively. Excluding net investment losses, total revenues were $4,324.6
million in the first six months of 2000, up 7.3 percent from $4,032.2 million in
the first six months of 1999.
We evaluate performance and base management's incentives on operating
earnings which is defined as income before extraordinary charge, net investment
gains (losses) of our life insurance and corporate segments (less that portion
of amortization of cost of policies purchased and cost of policies produced and
income taxes relating to such gains (losses)), and unusual or infrequent items
(net of income taxes). Operating earnings are determined by adjusting GAAP net
income for the above mentioned items. While these items may be significant
components in understanding and assessing our consolidated financial
performance, we believe that the presentation of operating earnings enhances the
understanding of our results of operations by highlighting net income
attributable to the normal, recurring operations of the business and by
excluding events that materially distort trends in net income. However,
operating earnings are not a substitute for net income determined in accordance
with GAAP.
Results of operations by segment for the three and six months ended June
30, 2000 and 1999
The following tables and narratives summarize our results by segment.
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
------------------ ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Operating earnings (loss):
Operating income of segments before income taxes and
minority interest:
Insurance and fee-based operations............................ $ 150.5 $327.8 $ 295.3 $ 652.2
Finance operations............................................ 28.1 184.0 63.9 379.8
------- ------ ------- --------
Subtotal for: (i) insurance and fee-based operations; and
(ii) finance operations................................ 178.6 511.8 359.2 1,032.0
------- ------ ------- --------
Corporate operations:
Venture capital income (loss) related to investment in
Tritel, net of amortization and other expenses............ (75.5) - .6 -
Interest expense on corporate debt.......................... (75.8) (44.1) (127.8) (93.2)
Other, net.................................................. 10.1 6.4 44.1 49.3
------- ------ ------- --------
Subtotal for corporate operations......................... (141.2) (37.7) (83.1) (43.9)
------- ------ ------- --------
Operating income before income taxes and
minority interest...................................... 37.4 474.1 276.1 988.1
Income taxes related to operating income.......................... 30.3 166.6 123.0 349.0
------- ------ ------- --------
Operating income before minority interest................. 7.1 307.5 153.1 639.1
Minority interest................................................. 35.7 30.3 74.7 60.5
------- ------ ------- --------
Operating earnings (loss)................................. (28.6) 277.2 78.4 578.6
Nonoperating items:
Net investment losses, net of tax and other items................. (71.3) (18.8) (84.6) (24.7)
Special and impairment charges, net of taxes...................... (304.7) (45.1) (321.0) (52.8)
Extraordinary charge, net of taxes................................ (.1) - (.1) -
------- ------ ------- --------
Net income (loss)......................................... $(404.7) $213.3 $(327.3) $ 501.1
======= ====== ======= ========
</TABLE>
28
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Insurance and fee-based operations
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
------------------- ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Premiums and asset accumulation product collections:
Annuities........................................................... $ 633.6 $ 772.3 $1,279.2 $1,283.3
Supplemental health................................................. 574.5 553.2 1,160.7 1,108.9
Life................................................................ 245.0 224.5 487.2 466.1
Individual and group major medical.................................. 240.2 206.9 473.7 416.0
Mutual funds........................................................ 143.1 82.8 432.7 165.0
-------- -------- -------- --------
Total premiums and asset accumulation product collections....... $1,836.4 $1,839.7 $3,833.5 $3,439.3
======== ======== ======== ========
Average liabilities for insurance and asset accumulation products:
Annuities:
Mortality based................................................... $ 451.1 $ 691.5 $ 453.5 $ 689.3
Equity-linked..................................................... 2,562.2 1,581.1 2,483.5 1,485.8
Deposit based..................................................... 9,812.2 10,856.5 10,022.9 10,949.2
Separate accounts and investment trust liabilities.................. 2,718.5 1,622.5 2,588.7 1,546.8
Health.............................................................. 5,220.4 4,711.4 5,151.3 4,706.7
Life:
Interest sensitive................................................ 4,269.8 4,076.2 4,257.5 4,103.9
Non-interest sensitive............................................ 2,703.7 2,855.3 2,716.8 2,846.8
--------- --------- --------- ----------
Total average liabilities for insurance and asset
accumulation products, net of reinsurance ceded............... $27,737.9 $26,394.5 $27,674.2 $26,328.5
========= ========= ========= =========
Revenues:
Insurance policy income............................................. $ 1,072.4 $ 1,020.0 $ 2,121.1 $ 2,027.4
Net investment income:
General account invested assets................................... 489.3 506.1 994.2 993.9
Equity-indexed products based on S&P 500 Index.................... (16.1) 50.8 6.6 84.4
Amortization of cost of S&P 500 Call Options...................... (31.1) (23.3) (59.9) (43.4)
Separate account assets........................................... 58.0 16.9 102.5 29.6
Fee revenue and other income........................................ 35.1 32.2 65.9 59.4
--------- --------- --------- ---------
Total revenues (a).............................................. 1,607.6 1,602.7 3,230.4 3,151.3
--------- --------- --------- ---------
Expenses:
Insurance policy benefits........................................... 832.5 681.0 1,664.2 1,350.6
Amounts added to policyholder account balances:
Annuity products other than those listed below.................... 151.2 173.4 319.1 347.5
Equity-indexed products based on S&P 500 Index.................... (22.5) 49.2 .9 82.5
Separate account liabilities...................................... 58.0 16.9 102.5 29.6
Amortization related to operations.................................. 222.6 146.3 405.4 286.9
Interest expense on investment borrowings........................... 5.0 16.6 10.0 28.4
Other operating costs and expenses.................................. 210.3 191.5 433.0 373.6
--------- --------- --------- ---------
Total benefits and expenses (a)................................. 1,457.1 1,274.9 2,935.1 2,499.1
--------- --------- ---------- ----------
Operating income before income taxes and minority interest...... 150.5 327.8 295.3 652.2
Net investment losses, including related costs and
amortization........................................................ (109.2) (29.0) (130.2) (38.0)
--------- --------- --------- ---------
Income before income taxes and minority interest................ $ 41.3 $ 298.8 $ 165.1 $ 614.2
========= ========= ========= =========
</TABLE>
29
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
(continued from previous page)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 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)................... 4.72% 4.71% 4.75% 4.57%
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........................................... 2.96% 2.92% 3.06% 2.90%
Health loss ratios:
All health lines:
Insurance policy benefits....................................... $652.6 $514.9 $1,287.2 1,018.0
Loss ratio...................................................... 81.49% 67.07% 80.63% 66.38%
Medicare Supplement:
Insurance policy benefits....................................... $170.5 $162.4 $351.1 $321.6
Loss ratio...................................................... 72.21% 68.76% 74.59% 68.68%
Long-Term Care:
Insurance policy benefits....................................... $191.8 $119.6 $343.6 $235.1
Loss ratio...................................................... 94.15% 65.22% 85.17% 63.33%
Specified Disease:
Insurance policy benefits....................................... $64.4 $55.0 $141.9 $110.9
Loss ratio...................................................... 68.75% 58.28% 76.07% 58.30%
Major Medical:
Insurance policy benefits....................................... $193.2 $152.6 $390.7 $300.5
Loss ratio...................................................... 84.84% 71.30% 86.09% 71.46%
Other:
Insurance policy benefits....................................... $32.7 $25.3 $59.9 $49.9
Loss ratio...................................................... 84.40% 73.16% 79.95% 68.08%
<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 $1.8 billion in
the second quarter of 2000, down .2 percent from 1999. Premiums and asset
accumulation product collections were $3.8 billion in the first six months of
2000, up 11 percent over 1999. Recent rating actions have adversely affected the
marketing of our insurance products. See "Premium and Asset Accumulation Product
Collections" for further analysis.
Average liabilities for insurance and asset accumulation products, net of
reinsurance receivables, were $27.7 billion in the second quarter of 2000, up
5.1 percent over 1999. Average liabilities for insurance and asset accumulation
products, net of reinsurance receivables, were $27.7 billion in the first six
months of 2000, up 5.1 percent over 1999.
30
<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 $489.3 million in the second quarter of 2000, down
3.3 percent from the same period in 1999 and was $994.2 million in the first six
months of 2000, virtually equal with the same period in 1999. The average
balance of general account invested assets in the second quarter of 2000 was
comparable to the same period in 1999. The yield on these assets was 7.4 percent
in 2000 and 7.7 percent in 1999. The average balance of general account invested
assets increased by 1.4 percent in the first six months of 2000 to $26.4 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 six 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 second quarter of 2000, we recorded losses
from the S&P 500 Options of $16.1 million and deducted amounts from
policyholders' account balances of the equity- indexed products of $22.5
million. During the first six months of 2000, we recorded income from the S&P
500 Options of $6.6 million and added amounts to policyholders' account balances
of the equity-indexed products of $.9 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 six months of 2000 as a
result of the factors summarized in the explanations for loss ratio fluctuations
related to specific products which follows.
Loss ratios for Medicare supplement products increased in 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
increase in the change in reserve will be partially offset by investment income
earned on the assets which have
31
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
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
second quarter of 2000.
The 2000 loss ratios for our specified disease policies reflect refinements
we made to the reserve estimation process during the first quarter of 2000 and
changes in estimates of period end claim liabilities.
The 2000 loss ratios for major medical policies reflects unfavorable claims
experience. We plan to increase our sales focus on the individual major medical
product lines while decreasing our group blocks of business. Since individual
products are expected to be more profitable than group products, this change
should support our efforts to improve profitability. In addition, we are also
raising rates on certain products and exiting certain product lines and states.
The loss ratios on other products fluctuate due to the smaller size of
these blocks of business. While the increase in the second quarter of 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 13 percent in the second quarter of 2000 to $151.2 million and
decreased by 8.2 percent in the first six months of 2000 to $319.1 million,
primarily due to a smaller block of this type of annuity business in force, on
the average, in the first six months of 2000. In addition, the average crediting
rate on these annuities decreased slightly. The weighted average crediting rate
for these annuity liabilities was 4.5 percent and 4.6 percent in the first six
months of 2000 and 1999, respectively.
Amortization related to operations includes amortization of: (i) the cost
of policies produced; (ii) the cost of policies purchased; and (iii) goodwill.
Amortization has increased in relationship to the total account balances subject
to amortization. In addition, amortization increased in the second quarter of
2000 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
$369.3 million during the first six months of 2000 compared to $1,111.9 million
during the same period of 1999. Borrowing rates increased 30 basis points to 5.4
percent during the first six months of 2000.
Other operating costs and expenses increased in 2000 primarily as a result
of our increased business and marketing initiatives. Such increased expenses are
consistent with the increase in the ratio of operating expenses (excluding
amortization of cost of policies produced and cost of policies purchased) as a
percentage of average liabilities for insurance and asset accumulation products
(3.06 percent for the six months ended June 30, 2000, compared to 2.90 percent
for the same period in 1999).
Net investment gains (losses), including related costs and amortization,
fluctuate from period to period. During the first six months of 2000, we
recorded $68.2 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 $38.7 million loss related to the termination of certain swap
agreements during the first six 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 $9.0 million and $23.3 million in the second quarter of 2000 and the first
six months of 2000, respectively, and resulted in additional amortization of
$6.1 million and $16.1 million in the second quarter of 1999 and the first six
months of 1999, respectively.
32
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Finance operations
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
------------------ ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Contract originations:
Manufactured housing............................................... $ 1,478.7 $ 1,983.6 $ 2,662.4 $ 3,394.7
Mortgage services.................................................. 1,471.1 1,931.7 3,015.3 3,369.3
Consumer/credit card............................................... 1,066.4 742.6 1,840.9 1,281.2
Commercial......................................................... 1,404.1 2,152.0 2,910.8 4,138.9
--------- --------- --------- ---------
Total............................................................ $ 5,420.3 $ 6,809.9 $10,429.4 $12,184.1
========= ========= ========= =========
Sales of finance receivables:
Manufactured housing............................................... $ 597.8 $ 1,681.1 $ 597.8 $ 3,481.1
Home equity/home improvement....................................... 824.0 1,687.7 824.0 2,648.8
Consumer/equipment................................................. - 600.0 - 600.0
Commercial and retail revolving credit............................. 409.0 92.5 409.0 92.5
Retained bonds..................................................... - (348.2) - (371.4)
--------- --------- --------- ---------
Total............................................................ $ 1,830.8 $ 3,713.1 $ 1,830.8 $ 6,451.0
========= ========= ========= =========
Managed receivables (average):
Manufactured housing............................................... $25,518.4 $22,362.8 $25,198.3 $21,905.1
Mortgage services.................................................. 13,340.2 9,725.0 12,962.4 9,205.3
Consumer/credit card............................................... 3,971.6 3,101.0 3,924.2 3,044.7
Commercial......................................................... 5,043.2 5,551.5 5,082.4 5,336.4
--------- --------- --------- ---------
Total............................................................ $47,873.4 $40,740.3 $47,167.3 $39,491.5
========= ========= ========= =========
Revenues:
Net investment income:
Finance receivables and other.................................... $ 451.1 $ 133.3 $ 833.2 $ 240.2
Interest-only securities......................................... 28.6 47.4 56.1 91.1
Gain on sale:
Securitization transactions...................................... - 169.4 - 368.6
Whole-loan sales................................................. 2.6 - 2.6 -
Fee revenue and other income....................................... 94.9 87.6 194.1 170.2
--------- --------- --------- ---------
Total revenues................................................... 577.2 437.7 1,086.0 870.1
--------- --------- --------- ---------
Expenses:
Provision for losses............................................... 84.1 27.2 142.7 48.5
Finance interest expense........................................... 266.9 69.6 471.4 124.2
Other operating costs and expenses................................. 198.1 156.9 408.0 317.6
--------- --------- --------- ---------
Total expenses................................................... 549.1 253.7 1,022.1 490.3
--------- --------- --------- ---------
Operating income before special charges, impairment charges
and income taxes............................................... 28.1 184.0 63.9 379.8
Special charges....................................................... 63.4 - 63.4 -
Impairment charges.................................................... 9.6 71.6 12.1 83.8
--------- --------- --------- ---------
Income (loss) before income taxes................................ $ (44.9) $ 112.4 $ (11.6) $ 296.0
========= ========= ========= =========
</TABLE>
33
<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.
After the March 31, 2000 announcement that we planned to explore the sale
of Conseco Finance and other events described elsewhere herein, it was difficult
to complete new public securitization transactions for a period of time.
However, these markets eventually became available to the Company. During the
second quarter of 2000, we completed five transactions, securitizing over $2.5
billion of finance receivables. In May 2000, we sold $1.3 billion of finance
receivables to Lehman. The proceeds from such sale were used to repay various
warehouse credit lines, creating increased warehousing capacity for Conseco
Finance. Lehman also amended its repurchase and other financing facilities with
Conseco Finance to expand the types of assets financed. See the note to the
accompanying consolidated financial statements entitled "Special Charges and
Recent Events" for a further description of the transactions with Lehman. 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.
Loan originations in the second quarter of 2000 were $5.4 billion, down 20
percent from 1999. Loan originations in the first six months of 2000 were $10.4
billion, down 14 percent over 1999. We believe there are several factors which
contribute to the decrease in loan originations during the second quarter of
2000. General levels of interest rates have increased, which has resulted in a
decrease in the demand for certain finance products. Sales of manufactured
housing have also decreased recently. The Company has also limited the
origination of certain loans, reflecting the cost and the limitations of our
capital and efforts to control our growth.
Manufactured housing loan originations decreased by $504.9 million, or 25
percent, in the second quarter of 2000 and by $732.3 million, or 22 percent,
during the first six months of 2000. The decrease was primarily due to a
decrease in the number of contracts written, which is consistent with the
decrease in sales of manufactured housing during the second quarter of 2000.
Mortgage services loan originations decreased by $460.6 million, or 24
percent, in the second quarter of 2000 and by $354.0 million, or 11 percent,
during the first six months of 2000. The decrease was primarily due to a
decrease in the number of contracts written, which is generally consistent with
the reduced demand for these products in the rising interest rate environment.
Consumer/credit card loan originations increased by $323.8 million, or 44
percent, in the second quarter of 2000 and by $559.7 million, or 44 percent,
during the first six months of 2000. The increase is primarily the result of our
successful marketing efforts, including a number of new private label credit
card relationships with large retailers. During the second quarter of 2000, we
entered into an agreement to sell our bankcard portfolio, which accounted for
$203 million of our originations during the six months ended June 30, 2000.
34
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Commercial loan originations decreased by $747.9 million, or 35 percent, in
the second quarter of 2000 and by $1,228.1 million, or 30 percent, during the
first six months of 2000. The decrease primarily reflects the sale of certain
commercial lines in September 1999, and our decision in early 2000 to
significantly limit additional transportation and certain other commercial
loans.
Sales of finance receivables decreased as a result of the change in the
structure of our securitizations. The sales in the second quarter of 2000
include the previously described sale of finance receivables to Lehman and the
sale of our bankcard portfolio.
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 $47.9 billion in the second quarter of 2000, up 18 percent over
1999, and to $47.2 billion in the first six months of 2000, up 19 percent over
the same period in 1999.
Net investment income on finance receivables and other consists of: (i)
interest earned on finance receivables; and (ii) interest income on short-term
and other investments. Such income increased by 238 percent, to $451.1 million,
in the second quarter of 2000 and by 247 percent, to $833.2 million, in the
first six 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 11.0 percent during the
second quarters of 2000 and 1999, respectively, and such weighted average yields
were 13.0 percent and 11.3 percent during the first six 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.
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 40 percent, to $28.6 million, in the
second quarter of 2000 and by 38 percent, to $56.1 million, in the first six
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 12.5 percent and 13.7 percent during the first six
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 $83.2 million was incurred in the
first six months of 1999) due to an impairment charge which will cause a
reduction in interest income accreted to this security in future years. We
regularly analyze future expected cash flows from this security to determine the
appropriate interest accretion rate. If we determine that this rate should be
lower, investment income accreted on the interest-only security will decrease in
future periods.
Gain on sale related to securitization transactions were 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 hold were treated as retained interests in the
securitization trusts. We recognized no gain on the portion of the assets
related to such securities, but we expect to recognize greater interest income,
net of related interest expense, over the term we hold them. At June 30, 2000,
we held $468.9 million of such securities which are classified as actively
managed fixed maturities.
Gain on whole-loan sales totaled $2.6 million during the second quarter 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
35
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
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 increased by 8.3 percent, to $94.9
million, in the second quarter of 2000, and by 14 percent, to $194.1 million, in
the first six months of 2000. Our net written insurance premiums and other
income both grew with managed receivables. As a result of the change in the
structure of our future securitizations announced on September 8, 1999, we no
longer record an asset for servicing rights at the time of our securitizations,
nor do we record servicing fee revenue; instead, the entire amount of interest
income is recorded as investment income. Accordingly, the amount of servicing
income has declined in the current period, and will decline further in future
periods.
Provision for losses related to finance operations increased by 209
percent, to $84.1 million, in the second quarter of 2000, and by 194 percent, to
$142.7 million, in the first six 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 283 percent, to $266.9 million, in
the second quarter of 2000, and by 280 percent, to $471.4 million, in the first
six months of 2000. Our borrowings grew in order to fund the increase in finance
receivables. In addition, our average borrowing rate increased to 7.6 percent in
the second quarter of 2000 from 5.4 percent in the second quarter of 1999. Our
average borrowing rate during the first six months of 2000 was 7.3 percent
compared to 5.6 percent during the first six 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.
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 26 percent, to $198.1 million,
in the second quarter of 2000, and by 28 percent, to $408.0 million, in the
first six months of 2000, reflecting: (i) the growth in our servicing portfolio;
and (ii) the growth in our loan origination offices and infrastructure.
Special charges in the finance segment include: (i) the $25.0 million
transaction fee paid to Lehman in conjunction with the previously described sale
of $1.3 billion of finance receivables; (ii) the issuance of a warrant valued at
$48.1 million related to the modification of the Lehman master repurchase
financing facilities; and (iii) the $9.7 million gain realized on the sale of
our bankcard portfolio and other items.
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 manuafactured
housing loans are determined based on a macroeconomic model developed by the
Company with the assisstance of outside experts. We record any unrealized gain
or loss determined to be temporary, net of tax, as a component of shareholders'
equity. Declines in value are considered to be other than temporary when the
present value of estimated future cash flows discounted at a risk- free rate
using current assumptions is less than the amortized cost of the interest-only
securities. When declines in value considered to be other than temporary occur,
we reduce the amortized cost to estimated fair value and recognize a loss in the
statement of operations. The assumptions used to determine new values are based
on our internal evaluations and consultation with external advisors having
significant experience in valuing these securities.
36
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
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 second
quarters of 2000 and 1999, we recognized an impairment charge of $9.6 million
and $71.6 million, respectively, to reduce the book value of the interest-only
securities and servicing rights. Such impairment charge for the first six months
of 2000 and 1999 was $12.1 million and $83.8 million, respectively.
Corporate operations
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
-------------------- ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Corporate operations:
Venture capital income (loss) related to investment in
Tritel, net of related expenses................................... $ (75.5) $ - $ .6 $ -
Interest expense on corporate debt.................................. (75.8) (44.1) (127.8) (93.2)
Investment income................................................... 14.5 11.1 23.7 20.6
Other items......................................................... (4.4) (4.7) 20.4 28.7
-------- ------ ------- ------
Operating loss before provision for loss on loan
guarantees, special charges, income taxes and
minority interest............................................. (141.2) (37.7) (83.1) (43.9)
Provision for loss on loan guarantees............................... (68.6) - (92.0) -
Special charges..................................................... (263.8) - (263.8) -
------- ------ ------- ------
Loss before income taxes and minority interest.................. $(473.6) $(37.7) $(438.9) $(43.9)
======= ====== ======= ======
</TABLE>
Venture capital income (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, our investee sold shares of common stock to the public
in an initial public offering. As a result, an ascertainable market value was
established for our investment, which we adjusted to recognize liquidity
restrictions. In the second quarter of 2000, we recognized a venture capital
loss of $75.5 million related to this investment (net of a related reduction to
expenses of $26.4 million). In the first six months of 2000, we recognized
venture capital income of $.6 million related to this investment (net of related
expenses of $12.6 million).
Interest expense on corporate debt fluctuated due to the increase in the
average interest rate on our outstanding debt. The average debt outstanding was
$3.0 billion in both the first six months of 2000 and 1999. The average interest
rate on such debt was 7.75 percent and 5.87 percent in the first six 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 facility and new borrowings has
increased (see the note to the consolidated financial statements entitled
"Changes in Corporate Notes Payable and Commercial Paper"). Such interest
expense includes affiliated interest expense (which is eliminated in
consolidation) of: (i) $8.7 million and $2.9 million for the three months ended
June 30, 2000 and 1999, respectively; and (ii) $11.8 million and $5.9 million
for the six months ended June 30, 2000 and 1999, respectively.
Investment income includes the income from our investment in a riverboat
casino and miscellaneous other revenues.
Other items include general corporate expenses, net of amounts charged to
subsidiaries for services provided by the corporate operations.
37
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
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 $92.0 million (of which $68.6 million was established
in the second quarter of 2000) in connection with these guarantees and loans. At
June 30, 2000, the total reserve for losses on the loan guarantees was $110.9
million.
Special charges in corporate operations include: (i) the advisory fees paid
to investment banks of $44.0 million; (ii) the loss related to our exit from the
subprime automobile business of $68.5 million; (iii) the amount paid to
terminated executive pursuant to his employment agreement of $72.5 million; (iv)
the amount paid to newly hired Chief Executive Officer of $45.0 million; (v) 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 (vi) other
charges of $12.8 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 or other
charges.
Marketing companies, agents who market insurance products, school
districts, financial institutions and policyholders use the financial strength
ratings assigned to an insurer by independent rating agencies as one factor in
determining which insurer's products to market or purchase. Following 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. Our primary
life insurance companies have received the following ratings as of August 10,
2000: (i) a "B++" rating, under review, by A.M. Best Company; (ii) an "A-"
rating, from Fitch Rating Company; (iii) a "BBB" financial strength rating,
watch negative, from Standard & Poor's; and (iv) a "Baa3" rating, from Moody's
Investor Services. The recent rating actions are adversely affecting the
marketing and persistency of our insurance products and other asset accumulation
products. We are not able to predict the extent to which these or possible
additional ratings actions will further affect the marketing and persistency of
these products.
38
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Total premiums and accumulation product collections were as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
------------------- ------------------
2000 1999 2000 1999
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Premiums collected by our insurance subsidiaries:
Annuities:
Equity-indexed (first-year)..................................... $ 173.2 $ 250.6 $ 394.5 $ 438.0
Equity-indexed (renewal)........................................ 10.5 10.8 28.9 27.3
-------- -------- -------- --------
Subtotal - equity-indexed annuities........................... 183.7 261.4 423.4 465.3
-------- -------- -------- --------
Other fixed (first-year)........................................ 159.2 346.7 305.6 517.4
Other fixed (renewal)........................................... 17.7 18.7 34.8 34.5
-------- -------- -------- --------
Subtotal - other fixed annuities.............................. 176.9 365.4 340.4 551.9
-------- -------- -------- --------
Variable (first-year)........................................... 225.7 128.1 443.8 219.5
Variable (renewal).............................................. 47.3 17.4 71.6 46.6
-------- -------- -------- --------
Subtotal - variable annuities................................. 273.0 145.5 515.4 266.1
-------- -------- -------- --------
Total annuities............................................... 633.6 772.3 1,279.2 1,283.3
-------- -------- -------- --------
Supplemental health:
Medicare supplement (first-year)................................ 25.4 26.7 52.5 54.3
Medicare supplement (renewal)................................... 206.4 198.6 419.9 403.9
-------- -------- -------- --------
Subtotal - Medicare supplement................................ 231.8 225.3 472.4 458.2
-------- -------- -------- --------
Long-term care (first-year)..................................... 31.3 29.8 62.4 59.2
Long-term care (renewal)........................................ 179.6 171.1 363.6 334.4
-------- -------- -------- --------
Subtotal - long-term care..................................... 210.9 200.9 426.0 393.6
-------- -------- -------- --------
Specified disease (first-year).................................. 10.0 10.0 19.6 19.4
Specified disease (renewal)..................................... 86.1 84.4 172.1 171.1
-------- -------- -------- --------
Subtotal - specified disease.................................. 96.1 94.4 191.7 190.5
-------- -------- -------- --------
Other health (first-year)....................................... 10.4 6.4 18.5 11.6
Other health (renewal).......................................... 25.3 26.2 52.1 55.0
-------- -------- -------- --------
Subtotal - other health....................................... 35.7 32.6 70.6 66.6
-------- -------- -------- --------
Total supplemental health..................................... 574.5 553.2 1,160.7 1,108.9
-------- -------- -------- --------
Life insurance:
First-year...................................................... 54.7 42.7 107.3 79.9
Renewal......................................................... 190.3 181.8 379.9 386.2
-------- -------- -------- --------
Total life insurance.......................................... 245.0 224.5 487.2 466.1
-------- -------- -------- --------
Individual and group major medical:
Individual (first-year)......................................... 40.5 23.2 73.2 45.3
Individual (renewal)............................................ 62.0 54.8 122.0 114.2
-------- -------- -------- --------
Subtotal - individual......................................... 102.5 78.0 195.2 159.5
-------- -------- -------- --------
Group (first-year).............................................. 18.7 13.1 38.7 22.3
Group (renewal)................................................. 119.0 115.8 239.8 234.2
-------- -------- -------- --------
Subtotal - group.............................................. 137.7 128.9 278.5 256.5
-------- -------- -------- --------
Total major medical........................................... 240.2 206.9 473.7 416.0
-------- -------- -------- --------
Mutual funds (all first year, excludes variable annuities)........... 143.1 82.8 432.7 165.0
-------- -------- -------- --------
Total first-year premiums....................................... 892.2 960.1 1,948.8 1,631.9
Total renewal premiums.......................................... 944.2 879.6 1,884.7 1,807.4
-------- -------- -------- --------
Total collections............................................. $1,836.4 $1,839.7 $3,833.5 $3,439.3
======== ======== ======== ========
</TABLE>
39
<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 $183.7 million in the second quarter of 2000 compared with
$261.4 million in the second quarter of 1999 and were $423.4 million in the
first six months of 2000 compared with $465.3 million in the first six 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 52 percent, to $176.9 million, in the
second quarter of 2000 and by 38 percent, to $340.4 million, in the first six
months of 2000. Fixed annuity collections in the second quarter of 1999 included
$160.8 million 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 88 percent,
to $273.0 million, in the second quarter of 2000 and by 94 percent, to $515.4
million, in the first six 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 increased by 2.9 percent
to $231.8 million, in the second quarter of 2000 and by 3.1 percent, to $472.4
million, in the first six 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 by 5.0 percent, to
$210.9 million, in the second quarter of 2000 and by 8.2 percent, to $426.0
million, in the first six months of 2000 due to increases in premium rates and
increased sales volume.
Premiums collected on specified disease policies in the 2000 periods were
comparable to the 1999 periods.
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
increased by 9.1 percent to $245.0 million in the second quarter of 2000 and by
4.5 percent, to $487.2 million, in the first six months of 2000. In the first
six months of 1999, life renewal premiums included $12.6 million of single
premium life business acquired in a reinsurance transaction.
40
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
Individual and group major medical products include major medical health
insurance products sold to individuals and groups. Group premiums increased by
6.8 percent, to $137.7 million, in the second quarter of 2000 and by 8.6
percent, to $278.5 million, in the first six months of 2000. Individual health
premiums collected in the second quarter of 2000 increased 31 percent, to $102.5
million and by 22 percent, to $195.2 million, in the first six months of 2000.
Our efforts to secure rate increases and write only profitable major medical
business may restrict our ability to grow these premiums in future periods.
Mutual fund sales have been very strong in 2000, reflecting our expanded
distribution and new marketing programs. We also believe that these sales have
been positively impacted by the recent strong investment performance of our
funds.
LIQUIDITY AND CAPITAL RESOURCES
Changes in our consolidated balance sheet between June 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
June 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 $1,907.4 million as a result of this fair
value adjustment. The fair value adjustment resulted in a $1,504.3 million
decrease in carrying value at year-end 1999, for the same reasons.
Total capital shown below excludes debt of the finance segment used to fund
finance receivables. Total capital, before the fair value adjustment recorded in
accumulated other comprehensive loss, increased $462.0 million, or 4.0 percent,
to $11.9 billion.
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---- ----
(Dollars in millions)
<S> <C> <C>
Total capital, excluding accumulated other comprehensive loss:
Corporate notes payable and commercial paper......................... $ 3,628.4 $ 2,481.8
Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts................................... 2,399.2 2,639.1
Shareholders' equity:
Preferred stock................................................... 482.5 478.4
Common stock and additional paid-in capital....................... 2,905.6 2,987.1
Retained earnings................................................. 2,495.0 2,862.3
--------- ---------
Total shareholders' equity, excluding accumulated
other comprehensive loss.................................... 5,883.1 6,327.8
--------- ---------
Total capital, excluding accumulated other comprehensive
loss........................................................ 11,910.7 11,448.7
Accumulated other comprehensive loss..................................... (970.7) (771.6)
--------- ---------
Total capital.................................................. $10,940.0 $10,677.1
========= =========
</TABLE>
Corporate notes payable and commercial paper increased during the first six
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 settlement of certain intercompany
accounts with Conseco Finance; (iii) the redemption of $250 million par value of
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts; (iv) the acquisition of
41
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
a long-term care insurance marketing organization for $32.9 million; (v) cash
required for special charges of $163.4 million; and (vi) an increase in cash and
cash equivalents held at the parent company of approximately $450 million.
Shareholders' equity, excluding accumulated other comprehensive loss,
decreased by $444.7 million in the first six months of 2000, to $5.9 billion.
Significant components of the decrease included: (i) our net loss of $327.3
million; (ii) the settlement of the forward contract and repurchases of common
stock of $102.6 million; and (iii) $40.0 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 $199.1
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 $13.62 at June 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 $16.60 at June 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 $3,874.4 million and $3,927.8 million at June 30, 2000 and
December 31, 1999, respectively. Goodwill as a percentage of shareholders'
equity was 79 percent and 71 percent at June 30, 2000 and December 31, 1999,
respectively. Goodwill as a percentage of total capital, excluding accumulated
other comprehensive loss, was 33 percent and 34 percent at June 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 $56.6 million and $55.0 million during the first six 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.
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 six months ended June 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, beginning with the dividend paid in
April of 2000.
42
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
The following table summarizes certain financial ratios as of and for the
three months ended June 30, 2000, and as of and for the year ended December 31,
1999:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---- ----
<S> <C> <C>
Book value per common share:
As reported............................................................................... $13.62 $15.50
Excluding accumulated other comprehensive income (loss) (a)............................... $16.60 $17.85
Ratio of earnings to fixed charges:
As reported............................................................................... .53X(g) 2.98X
Excluding interest expense on debt related to finance
receivables and other investments (b)................................................... (g) 7.06X
Ratio of operating earnings to fixed charges (c):
As reported............................................................................... 1.44X 4.26X
Excluding interest expense on debt related to finance
receivables and other investments (b)................................................... 3.25X 10.99X
Ratio of earnings to fixed charges, preferred dividends and distributions on
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts:
As reported............................................................................. .44X(h) 2.20X
Excluding interest expense on debt related to finance
receivables and other investments (b)................................................. (h) 3.38X
Ratio of operating earnings to fixed charges, preferred dividends and
distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts (c):
As reported............................................................................. 1.19X 3.14X
Excluding interest expense on debt related to finance
receivables and other investments (b)................................................. 1.56X 5.26X
Rating agency ratios (a) (d) (e):
Debt to total capital..................................................................... 31% 22%
Debt and Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts to total capital (f)............................................... 51% 45%
<FN>
(a) Excludes accumulated other comprehensive income (loss).
(b) We include these ratios to assist you in analyzing the impact of interest
expense on debt related to finance receivables and other investments (which
is generally offset by interest earned on finance receivables and other
investments financed by such debt). Such ratios are not intended to, and do
not, represent the following ratios prepared in accordance with GAAP: the
ratio of earnings and operating earnings to fixed charges; and the ratio of
earnings and operating earnings to fixed charges, preferred dividends and
distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts.
(c) Such ratios exclude the following items from earnings: (i) net investment
gains (losses) (less that portion of amortization of cost of policies
purchased and cost of policies produced relating to such gains (losses));
(ii) impairment charges; and (iii) charges that are considered to be
unusual. Such ratios are not intended to, and do not, represent the
following ratios prepared in accordance with GAAP: the ratio of earnings to
fixed charges; and the ratio of earnings to fixed charges, preferred
dividends and distributions on Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts.
43
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
(d) Excludes debt of the finance segment used to fund finance receivables and
investment borrowings of the insurance segment.
(e) These ratios are calculated in a manner discussed with rating agencies.
(f) Total Company-obligated mandatorily redeemable preferred securities of
subsidiary trusts exclude, and total capital includes: (i) amounts related
to FELINE PRIDES which require the holders to purchase a number of shares
of the Company's common stock under the terms specified in the stock
purchase contracts; and (ii) at December 31, 1999, amounts related to
RHINOS. In April 2000, the Company repurchased the RHINOS.
(g) For such ratios, adjusted earnings were $285.4 million less than fixed
charges. Adjusted earnings for the six months ended June 30, 2000, included
special charges of $327.2 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 $410.8 million less than fixed
charges. Adjusted earnings for the six months ended June 30, 2000, included
special charges of $327.2 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
After the March 31, 2000 announcement that we planned to explore the sale
of Conseco Finance and other events described elsewhere herein, it was more
difficult to complete new public securitization transactions for a period of
time. However, these markets eventually became available to the Company. During
the second quarter of 2000, we completed five transactions, securitizing over
$2.5 billion of finance receivables. In May 2000, we sold $1.3 billion of
finance receivables to Lehman. The proceeds from such sale were used to repay
various warehouse credit lines, creating increased warehousing capacity for
Conseco Finance. Lehman also amended its repurchase and other financing
facilities with Conseco Finance to expand the types of assets financed. See the
note to the accompanying consolidated financial statements entitled "Special
Charges and Recent Events" for a further description of the transactions with
Lehman. 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.
At June 30, 2000, we had $5.7 billion in master repurchase agreements,
commercial paper conduit facilities and other facilities with various banking
and investment banking firms for the purpose of financing our consumer and
commercial finance loan production. These facilities typically provide financing
of a certain percentage of the underlying collateral and are subject to the
availability of eligible collateral and, in many cases, the willingness of the
banking firms to continue to provide financing. These agreements generally
provide for annual terms, some of which are extended either quarterly or
semi-annually by mutual agreement of the parties for an additional annual term
based upon receipt of updated quarterly financial information. At June 30, 2000,
we had borrowed $3.3 billion of the $5.7 billion available under such
agreements.
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; (iii) cash provided by operations; and (iv) cash provided by
the parent company from its credit sources.
44
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
The most significant source of liquidity for our finance operations has
been our ability to finance the receivables we originate in the secondary
markets through loan securitizations. Under certain securitization structures,
we have provided a variety of credit enhancements, which generally take the form
of corporate guarantees, but have also included bank letters of credit, surety
bonds, cash deposits and over-collateralization or other equivalent collateral.
When choosing the appropriate structure for a securitization of loans, we
analyze the cash flows unique to each transaction, as well as its marketability
and projected economic value. The structure of each securitized transaction
depends, to a great extent, on conditions in the fixed-income markets at the
time the transaction is completed, as well as on cost considerations and the
availability and effectiveness of the various enhancement methods.
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 have increased on securities issued in
securitizations, causing us to incur higher interest costs on securitizations
completed during those periods. Changes in market conditions could affect the
interest rate spreads we earn on the loans we originate and the cash provided by
our finance operations. We have increased interest rates on our lending products
as we strive to maintain our targeted spread in the current interest rate
environment.
We continually investigate and pursue alternative and supplementary methods
to finance our lending operations. In late 1998, we began issuing certificates
of deposit through our bank subsidiary. At June 30, 2000, we had $1,398.9
million of such deposits outstanding which are recorded as liabilities related
to certificates of deposit. The average annual rate paid on these deposits was
6.3 percent during the first six months of 2000.
Our finance segment generated cash flows from operating activities of
$196.0 million during the first six months of 2000, compared to approximately
$266.7 million in the same period of 1999. Such cash flows include cash received
from the securitization trusts of $189.7 million in the 2000 period and $320.2
million in the 1999 period, representing distributions of excess interest and
servicing fees.
On September 8, 1999, we announced that, although we plan to continue to
finance the receivables we originate through loan securitizations, we will no
longer structure future securitizations in a manner that results in gain-on-sale
revenues. This change is not expected to have any material effect on the amount
or timing of cash flows we receive, but the change required us to classify
certain activities differently on our cash flow statement (e.g., certain cash
flows recorded as "operating cash flows" under the gain-on-sale method must be
recorded as "investing activities" under the portfolio method and vice versa).
Independent rating agencies, financial institutions, analysts and other
interested parties monitor the leverage ratio of our finance segment. Such ratio
(calculated, as discussed with independent rating agencies, as the ratio of debt
to equity of our finance subsidiary calculated on a pro forma basis as if we had
accounted for the securitizations of our finance receivables as financing
transactions throughout the Company's history) was 29-to-1 and 22-to-1 at June
30, 2000, and December 31, 1999, respectively.
Liquidity of Conseco (parent company)
The parent company is a legal entity, separate and distinct from its
subsidiaries, and has no business operations. The parent company uses cash for:
(i) principal and interest payments on debt; (ii) dividends on preferred and
common stock; (iii) payments to subsidiary trusts to be used for distributions
on the Company-obligated mandatorily redeemable preferred securities of
subsidiary trusts; (iv) holding company administrative expenses; (v) income
taxes; and (vi) investments in subsidiaries and other investments. The primary
sources of cash to meet these obligations are payments from our subsidiaries,
including the statutorily permitted payments from our life insurance
subsidiaries in the form of: (i) fees for services provided; (ii) tax sharing
payments; (iii) dividend payments; and (iv) surplus debenture interest and
principal payments. The parent company may also obtain cash by: (i) issuing debt
or equity securities; (ii) borrowing additional amounts under its revolving
credit agreement, as described in the notes to the consolidated financial
statements; or (iii) selling all or a portion of its subsidiaries or its other
investments.
45
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
The parent company has significant debt scheduled to become due on or
before September 30, 2000, as follows (dollars in millions):
<TABLE>
<S> <C>
Bank credit facility due September 1, 2000................................................... $ 155.0
Potential payment pursuant to guaranteed debt related to directors, officers and key
employees stock purchase program due September 1, 2000.................................... 144.4
Bank credit facility due September 22, 2000.................................................. 766.0
Commercial paper due September 22, 2000...................................................... 50.0
Notes payable due 2003, but putable by the holder............................................ 250.0(a)
--------
Total................................................................................... $1,365.4
========
<FN>
------------
(a) Such notes payable are putable by the holder prior to the maturity date.
The payment of the note is secured by standby letters of credit which may
be drawn upon by the holder of the note on August 16, 2000 through
September 30, 2000.
</FN>
</TABLE>
Because of the time required to complete the sale of assets and other
contemplated activities described in paragraph which follows, extension of the
Company's bank credit facilities will be required if the Company is to meet its
September debt maturities. The Company is currently in discussions with its bank
lenders and management is optimistic appropriate extensions can be negotiated.
However, there can be no assurance that these negotiations will be successful,
or as to the amount, maturity, cost or terms associated with any such extension.
On July 27, 2000, we announced several courses of action with respect to
Conseco Finance as well as an asset disposition program with respect to certain
non-strategic assets held at the parent company level, which are designed to
allow us to reduce parent company debt over time. These 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 are designed to provide a business model which will result in
positive cash flow at Conseco Finance. In addition, we plan to sell certain
non-strategic assets, such as our investment in the wireless communication
company, Tritel, our interest in the riverboat casino in Lawrenceberg, Indiana,
and our subprime auto loan portfolio. The Company believes the sale of
non-strategic assets and the actions contemplated at Conseco Finance will
generate cash proceeds of approximately $2.0 billion over the next 12 to 15
months. We are already well underway with these actions, and have completed the
sale of the bankcard business and our subprime auto loan portfolio, generating
cash proceeds of over $300 million. 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. Furthermore, the Company's ability to use cash generated from the
actions being undertaken at Conseco Finance is substantially limited by
restrictions in agreements with Lehman. In connection with the negotiations with
our banks relating to the extension of the maturity dates of our debt, we are
also engaged in discussions with Lehman concerning a modification of these
restrictions and are optimistic an acceptable modification can be obtained.
However, there can be no assurance that these negotiations will be successful,
or as to the terms of any such modification. See the note to the accompanying
financial statements entitled "Changes in Corporate Notes Payable and Commercial
Paper."
During the first six months of 2000, our insurance subsidiaries paid
dividends to Conseco of $108.1 million and our finance subsidiary repurchased
shares of its common stock for $126.0 million. The cash provided by operating
activities at the parent company, including dividends received from our
insurance subsidiaries, plus the amount paid to us to repurchase shares of
common stock of our finance subsidiary totaled approximately $110 million during
the first six months of 2000. In connection with the Lehman transaction
described in the note to the accompanying consolidated financial statements
entitled "Special Charges and Recent Events," Conseco Finance has agreed that it
will not pay dividends until 2001 and then pay such dividends only to the extent
certain financial covenants are met. In addition, Conseco Finance agreed that it
will limit additional prepayments on the intercompany note payable to Conseco
(with a balance of $2,210.8 million at June 30, 2000) to $50 million, as long as
certain financing arrangements with Lehman remain outstanding. We are currently
negotiating with Lehman to waive or modify this restriction to permit additional
prepayments on the intercompany note. There can be no assurance as to the
outcome of these negotiations.
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 $96.5 million
without permission from state regulatory authorities.
46
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
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 August 10, 2000, the rating
agencies have assigned the following ratings: (i) Standard & Poor's has assigned
a "BB-" rating to Conseco's senior debt; a "B-" rating to trust preferred
securities and a "B" rating to commercial paper; (ii) Fitch Rating Company has
assigned a "BB-" rating to Conseco's senior debt; a "B" rating to trust
preferred securities and a "B" rating to commercial paper; and (iii) Moody's
Investor Services has assigned a "B1" rating to Conseco's senior debt; and a
"ca" 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.
INVESTMENTS
At June 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................................................ $13,452.0 $ 60.0 $1,029.5 $12,482.5
United States Treasury securities and obligations of
United States government corporations and agencies................ 302.9 2.8 5.4 300.3
States and political subdivisions................................... 143.4 - 9.0 134.4
Debt securities issued by foreign governments....................... 198.4 .8 12.9 186.3
Mortgage-backed securities ......................................... 7,597.8 6.6 589.9 7,014.5
Below-investment grade (primarily corporate securities)................ 1,735.4 30.8 310.1 1,456.1
--------- ------ -------- ---------
Total actively managed fixed maturities........................... $23,429.9 $101.0 $1,956.8 $21,574.1
========= ====== ======== =========
</TABLE>
During the first six months of 2000 and 1999, we recorded $68.2 million and
$1.2 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
June 30, 2000, fixed maturity securities in default as to the payment of
principal or interest had an aggregate amortized cost of $112.9 million and a
carrying value of $73.5 million.
Sales of invested assets (primarily fixed maturity securities) during the
first six months of 2000 generated proceeds of $3.0 billion, resulting in net
investment losses of $46.6 million.
At June 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
47
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
fewer underlying mortgages are refinanced. When this occurs, the average
maturity and duration of the mortgage-backed securities increase, which
decreases the yield on mortgage-backed securities purchased at a discount,
because the discount is realized as income at a slower rate, and increases the
yield on those purchased at a premium as a result of a decrease in the annual
amortization of the premium.
The following table sets forth the par value, amortized cost and estimated
fair value of mortgage-backed securities, summarized by interest rates on the
underlying collateral at June 30, 2000:
<TABLE>
<CAPTION>
Par Amortized Estimated
value cost fair value
----- ---- ----------
(Dollars in millions)
<S> <C> <C> <C>
Below 7 percent..................................................................... $4,586.6 $4,551.5 $4,273.3
7 percent - 8 percent............................................................... 1,949.5 1,933.2 1,877.6
8 percent - 9 percent............................................................... 287.6 287.1 283.9
9 percent and above................................................................. 848.1 853.5 605.5
-------- -------- --------
Total mortgage-backed securities (a)......................................... $7,671.8 $7,625.3 $7,040.3
======== ======== ========
<FN>
(a) Includes below-investment grade mortgage-backed securities with an
amortized cost and estimated fair value of $27.5 million and $25.8 million,
respectively.
</FN>
</TABLE>
The amortized cost and estimated fair value of mortgage-backed securities
at June 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............ $3,993.7 $3,823.5 18%
Planned amortization classes and accretion-directed bonds................. 1,970.7 1,847.7 9
Commercial mortgage-backed securities..................................... 788.7 748.4 3
Subordinated classes and mezzanine tranches............................... 835.5 587.5 3
Other..................................................................... 36.7 33.2 -
-------- -------- --
Total mortgage-backed securities (a)............................... $7,625.3 $7,040.3 33%
======== ======== ==
<FN>
----------
(a) Includes below-investment grade mortgage-backed securities with an
amortized cost and estimated fair value of $27.5 million and $25.8 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).
48
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
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.
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 June 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 June 30, 2000.
At June 30, 2000, we held $78.1 million of trading securities; we included
them in "other invested assets."
Our investment borrowings averaged approximately $369.3 million during the
first six months of 2000, compared with approximately $1,111.9 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 5.4 percent and 5.1 percent during the first six
months of 2000 and 1999, respectively.
STATUTORY INFORMATION
Statutory accounting practices prescribed or permitted by regulatory
authorities for the Company's insurance subsidiaries differ from GAAP. The
statutory income (loss) before net realized capital gains (losses) of our life
insurance subsidiaries was $(2.5) million and $140.1 million in the first six
months of 2000 and 1999, respectively. The Company's life insurance subsidiaries
reported the following amounts to regulatory agencies at June 30, 2000, after
appropriate eliminations of intercompany accounts among such subsidiaries
(dollars in millions):
<TABLE>
<S> <C>
Statutory capital and surplus .................................. $1,970.6
Asset valuation reserve......................................... 393.3
Interest maintenance reserve.................................... 463.0
--------
Total........................................................ $2,826.9
========
</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>
June 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 Merger (a)............................................................ $ 72.2
Preferred and common stock of intermediate holding company............................ 219.0
Common stock of Conseco (39.8 million shares)......................................... 32.4
Other ................................................................................ 2.5
------
Total........................................................................... $326.1
======
49
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CONSECO, INC. AND SUBSIDIARIES
--------------------
<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
$285.1 million, $280.1 million and $256.6 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 $96.5 million without
permission from state regulatory authorities. During the first six months of
2000, our insurance subsidiaries paid dividends to Conseco totaling $108.1
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.
50
<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 have been filed against the Company in the
United States District Court for the Southern District of Indiana. Nineteen of
these cases are putative class actions on behalf of persons or entities that
purchased the Company's common stock during alleged class periods that generally
run from April 1999 through April 2000. Luisi v. Conseco, Inc., et al., Case No.
IP00-C-0593-Y/S; Sechrist v. Conseco, Inc., et al., Case No. IP00-C-0585-Y/S;
Klein v. Conseco, Inc., et al., Case No. IP00-C-0602-Y/S; Brody v. Conseco,
Inc., et al., Case No. IP00-C-0609-Y/S; Dana v. Conseco, Inc., et al., Case No.
IP00-C-0623-Y/S; Krim v. Conseco, Inc., et al., Case No. IP00-C-0631-Y/S; Nadaf
v. Conseco, Inc., et al., Case No. IP00-C- 0628-Y/S; Greiner v. Conseco, Inc.,
et al., Case No. IP00-C-0639-Y/S (naming as a defendant only one
officer/director); Sedgwick v. Conseco, Inc., et al., Case No. IP00-C-0657-Y/S;
Irle v. Conseco, Inc., et al., Case No. IP00-C-0746-Y/S; Schwartz v. Conseco,
Inc., et al., Case No. IP00-C-0770-Y/S; Leopold v. Conseco, Inc., et al., Case
No. IP00-C-0843-Y/S; Slovacek v. Conseco, Inc., et al., Case No. IP00-C-0858-Y/S
(naming as a defendant only one officer/director); Swei v. Conseco, Inc., et
al., Case No. IP00-C-0839-Y/S (naming as a defendant only one officer/director);
Nicholson v. Conseco, Inc., et al., Case No. IP00-C-0826-Y/S; Browne v. Conseco,
Inc., et al., Case No. IP00-C-0897-Y/S; Chacharone v. Conseco, Inc., et al.,
Case No. IP00-C-0885-Y/S; Muhlenfeld v. Conseco, Inc., et al., Case No.
IP00-C-0933-Y/S; Young v. Conseco, Inc., et al. (case number pending; originally
filed in the United States District Court for the Eastern District Michigan,
Case No. 00-72939, and now in the process of transferred by stipulation). Two
cases are putative class actions on behalf of persons or entities that purchased
the Company's bonds during the same alleged class periods. Waring v. Conseco,
Inc., et al., Case No. IP00-C-0793- Y/S; Lutt v. Conseco, Inc., et al., Case No.
IP00-C-0905-Y/S. Three cases are 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. Syndicated
Fin. Servs., Inc. v. Conseco, Inc., et al., Case No. IP00-C-0795-Y/S (naming as
a defendant only one officer/director); Joel Mandel v. Conseco, Inc., et al.,
Case No. IP00-C-0815-Y/S; Avi Mandel v. Conseco, Inc., et al., Case No.
IP00-C-0884-Y/S. One case is 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. Kelly v. Conseco, Inc., et
al., Case No. IP00-C-0789-Y/S. With the four exceptions noted, 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 Section 10(b) and
20(a) of the Securities Exchange Act of 1934. In each case, plaintiffs allege
that the Company and the individual defendants violated the federal securities
laws by, among other things, making false and misleading statements about the
current state and future prospects of Conseco Finance (particularly with respect
to performance of certain loan portfolios of Conseco Finance) which allegedly
rendered the Company's financial statements false and misleading. The Company
believes that these lawsuits are without merit and intends to defend them
vigorously. The ultimate outcome of these lawsuits cannot be predicted with
certainty.
51
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
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, Griffin v. Conseco, Inc., et al., Case No.
IP00-C-0663-Y/S; Stifnagle v. Conseco, Inc., et al., Case No. IP00-C-0754-Y/S
(Stifnagle also asserts claims regarding Conseco Financing Trust VII);
Gastfriend v. Conseco, Inc., et al., Case No. IP00-C-0883-Y/S; Powers v. Conseco
Financing Trust V, et al., Case No. IP00-C-0953-Y/S (also naming Conseco
Financing Trusts VI and VII) (each of the preceding make allegations with
respect to an August 24, 1998 offering for Conseco Financing Trust V); Gabora v.
Conseco, Inc., et al., Case No. IP00-C-0852-Y/S (also naming Conseco Financing
Trust VII, but containing allegations relating only to notes issued by the
Company on October 18, 1999, unrelated to the Conseco Financing Trusts named);
Schmidt v. Conseco, Inc., et al., Case No. IP00-C-0823-Y/S (also naming Conseco
Financing Trust VII, but containing allegations relating only to Conseco
Financing Trusts VI and VII), Conseco Financing Trust VI, Costello v. Conseco,
Inc., et al., Case No. IP00-C-0705-Y/S (October 8, 1998 offering), and Conseco
Financing Trust VII, Zinno v. Conseco, Inc., et al., Case No. IP00- C-0622-Y/S;
Shapiro v. Conseco, Inc., et al., Case No. IP00-C-0650-Y/S; Kosseff v. Conseco,
Inc., et al., Case No. IP00-C- 0753-Y/S; Harris v. Conseco, Inc., et al., Case
No. IP00-C-0797-Y/S (August 26, 1999 offering). Each of these complaints names
as defendants the Company, the relevant trust (except Shapiro and Kosseff), two
former officers/directors of the Company, and underwriters for the particular
issuance (except Shapiro). The Kosseff complaint also names an officer and all
of the Company's directors at the time of issuance of the preferred stock by
Conseco Financing Trust VII. In each case, plaintiffs assert claims under
Section 11 and Section 15 of the Securities Act of 1933, and the Zinno, Shapiro,
Stifnagle, Harris, Gabora, Gastfriend, Powers and Schmidt complaints also assert
claims under Section 12(a)(2) of that Act. Gabora and Gastfriend also assert
claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934,
and Powers also asserts a claim under Section 10(b) of that Act. In each case,
plaintiffs allege that the defendants violated the federal securities laws by,
among other things, making false and misleading statements, in Prospectuses
and/or Registration Statements related to the issuance of preferred securities
by the Trust involved, regarding the current state and future prospects of
Conseco Finance (particularly with respect to performance of certain loan
portfolios of Conseco Finance) which allegedly rendered the disclosure documents
false and misleading. The Company also intends to defend these lawsuits
vigorously. The ultimate outcome of these lawsuits cannot be predicted with
certainty.
Nine shareholder derivative suits have been filed in United States District
Court. Rogney v. Decatur, et al., Case No. IP00- C-0655-Y/S; Fletcher v.
Hilbert, et al., Case No. IP00-C-0693-Y/S; Gold v. Decatur, et al., Case No.
IP00-C-0747-Y/S; Batcheldor v. Hilbert, Case No. IP00-C-0743-Y/S; Youssef v.
Decatur, et al., Case No. IP00-C-0809-Y/S; Gintel v. Hilbert, Case No.
IP00-C-0987-Y/S; Frankel v. Coss, et al. (case number pending; originally filed
in the Evansville Division of United States District Court for the Southern
District of Indiana, Case No. EV00-134-C-Y/H, and now in the process of
transfer); Evans v. Hilbert, Case No. IP00-C-1019-Y/S; Marks v. Hilbert, Case
No. IP00-C-0877-Y/S. The complaints name as defendants the current directors,
certain former directors, certain non-director officers of the Company (in
Fletcher), and, alleging aiding and abetting liability, certain banks which
allegedly made loans in relation to the Company's "Stock Purchase Plan" (in
Batcheldor, Gintel and Evans). 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. 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 vs. 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.
52
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CONSECO, INC. AND SUBSIDIARIES
--------------------
Conseco, Inc. and its subsidiaries, Conseco Life Insurance Company and
Wabash Life Insurance Company, are currently named defendants in a certified
nationwide class action lawsuit in the Superior Court for Santa Clara County
(California, cause number CV768991) and captioned "John P. Dupell and the John
P. Dupell 1992 Insurance Trust vs. Massachusetts General Life Insurance Company;
Life Partners Group, Inc., Wabash Life Insurance Company, Conseco, Inc., Donovan
R. Bolton, et al." The class, approximately 345,000 in number, consists of all
persons who purchased universal life insurance policies from Conseco Life
Insurance Company, formerly named Massachusetts General Life Insurance Company,
between January 1, 1984 and July 23, 1999 (excluding policies where death
benefits were paid). The claims involve the changing interest rate climate
between the 1980s and the comparatively lower rates in the 1990s, and 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 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. 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 its operations. Although the ultimate outcome
of certain of such matters cannot be predicted, such lawsuits currently pending
against the Company or its subsidiaries are not expected, individually or in the
aggregate, to have a material adverse effect on the Company's consolidated
financial condition, cash flows or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the Company's annual meeting on June 23, 2000, the shareholders elected
Lawrence M. Coss, Thomas M. Hagerty, James D. Massey and Dennis E. Murray, Sr.
to serve as directors for terms ending in 2003. Directors whose class was not up
for election and whose term of office continued after the meeting are Ngaire E.
Cuneo, David R. Decatur, Donald F. Gongaware, David V. Harkins, M. Phil
Hathaway, John M. Mutz, and Robert S. Nickoloff. Gary C. Wendt was added to the
Board of Directors on June 28, 2000. The results of the voting were as follows
(there were no broker non-votes):
<TABLE>
<CAPTION>
Lawrence M. Thomas M. James D. Dennis E.
Coss Hagerty Massey Murray, Sr.
---- ------- ------ -----------
<S> <C> <C> <C> <C>
For 286,536,272 285,341,409 289,043,360 288,934,684
Withheld 16,800,538 17,995,401 14,293,450 14,402,126
</TABLE>
At the annual meeting, the shareholders also defeated an advisory proposal
advocating the elimination of the classification of the Board of Directors
(there were 85,716,319 shares voted for the proposal, 130,095,934 shares voted
against the proposal, 3,452,508 abstentions and 58,769,995 broker non-votes).
53
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CONSECO, INC. AND SUBSIDIARIES
--------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a) Exhibits.
10.45 Warrant to Purchase Common Stock of Conseco Finance Corp.,
dated May 11, 2000, by and between Conseco Finance Corp. and
Lehman Brothers Holdings Inc.
10.46 Agreement, dated May 11, 2000, by and among Conseco, Inc.,
CIHC, Incorporated 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 - None.
54
<PAGE>
CONSECO, INC. AND SUBSIDIARIES
--------------------
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CONSECO, INC.
Dated: August 14, 2000 By: /S/ JAMES S. ADAMS
---------------------
James S. Adams
Senior Vice President and
Chief Accounting Officer
(authorized officer and chief
accounting officer)
55
