UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
[x] Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the fiscal year ended December 31, 1996 or
[ ] 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: 0-20174
American Life Holding Company
Delaware No. 42-1362294
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State of Incorporation IRS Employer Identification No.
11825 N. Pennsylvania Street
Carmel, Indiana 46032 (317) 817-6100
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Address of principal executive offices Telephone
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Series Preferred Stock
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [x]
Aggregate market value of common stock held by nonaffiliates (Computed as
of March 28, 1997): $ -0-
Shares of common stock outstanding as of March 28, 1997: 1,500,100
DOCUMENTS INCORPORATED BY REFERENCE: None
<PAGE>
PART I
ITEM 1. BUSINESS OF AMERICAN LIFE HOLDING COMPANY
Background
American Life Holding Company (the "Company" or "American Life Holding")
is an insurance holding company specializing in the development, marketing,
issuance and administration of individual fixed annuity products and, to a
lesser extent, individual life insurance products through its insurance
subsidiaries, American Life and Casualty Insurance Company ("American Life and
Casualty") and Vulcan Life Insurance Company ("Vulcan Life"). The Company owns
100 percent of American Life and Casualty, which owns 98 percent of Vulcan Life.
The Company is a wholly owned subsidiary of American Life Holdings, Inc.
("ALH"). ALH is a wholly owned subsidiary of Conseco, Inc., a publicly-held
company that owns and operates life insurance companies. In 1996, ALH changed
its name from American Life Group, Inc. (formerly known as The Statesman Group,
Inc. prior to its name change in 1995).
American Life and Casualty and Vulcan Life are licensed to sell annuities
and life insurance in 48 states and the District of Columbia. The Company
collected $706.2 million of annuity deposits and insurance premiums (net of
reinsurance) in 1996, of which approximately 96 percent (99 percent of first
year premiums) was from the sale of annuities. At December 31, 1996, the Company
had approximately 272,000 individual policies in force.
The Company was incorporated under the laws of the State of Delaware on
August 9, 1990. Its executive offices are located at 11825 N. Pennsylvania
Street, Carmel, Indiana, 46032, and its telephone number is (317) 817-6100.
On September 29, 1994, Conseco Capital Partners II, L.P. ("Partnership
II"), a Delaware limited partnership, completed the acquisition of ALH (the
"Acquisition") pursuant to an Agreement and Plan of Merger, providing for the
merger of ALH with a subsidiary of Partnership II. ALH's former shareholders
received $15.25 in cash per common equivalent share plus a contingent payment
right to receive up to another $2.00 in cash per common equivalent share based
on the outcome of ALH's and the Company's pending litigation against the U.S.
Government concerning ALH's and the Company's former savings bank subsidiary
(for further discussion see "Item 3 - Legal Proceedings" and note 8 to the
consolidated financial statements). The sole general partner of Partnership II
was a wholly owned subsidiary of Conseco. On September 30, 1996, Conseco and its
subsidiaries purchased all of the outstanding common stock of ALH not already
owned by Conseco from Partnership II and others who had a direct ownership
interest in ALH (the "ALH Stock Purchase").
Products
The Company's products include single premium deferred annuities
("SPDAs"), flexible premium deferred annuities ("FPDAs"), single premium
immediate annuities, interest-sensitive life insurance products (primarily
universal life insurance), traditional life insurance products and accident and
health insurance products. Of the $706.2 million of annuity deposits and
insurance premiums collected (net of reinsurance) in 1996, approximately 92
percent were from sales of deferred annuities, 4 percent were from life
insurance products, 3 percent were from single premium immediate annuities and
less than 1 percent were from accident and health insurance products.
Annuities accounted for $675.0 million of the Company's annuity deposits
and insurance premiums collected in 1996 (net of reinsurance). In general, a
SPDA is a savings vehicle in which the policyholder, or annuitant, makes a
single premium payment to an insurance company which guarantees the principal
and accrues a stated rate of interest. After a number of years, as specified in
the annuity contract, the annuitant may elect to take the proceeds of the
annuity in a single payment, a specified income for life or for a fixed number
of years or a combination of certain and life contingent payments. FPDAs are
similar to SPDAs in many respects, except that FPDAs allow additional premium
payments in varying amounts.
The Company's SPDAs and FPDAs typically have an interest rate (the
"crediting rate") that is guaranteed by the Company for the first policy year,
after which the Company has the discretionary ability to change the crediting
rate to any rate not below a guaranteed minimum rate generally ranging from 3.0
percent to 5.5 percent. The initial crediting rate is largely a function of the
interest rate the Company can earn on invested assets acquired with the new
annuity fund deposits and the rates offered on similar products by the Company's
competitors. For subsequent adjustments to crediting rates, the Company takes
into account the yield on its investment portfolio, annuity surrender
assumptions, competitive industry pricing and the crediting rate history for
particular groups of annuity policies with similar characteristics. Since 1992,
more than 80 percent of the Company's new annuity sales have been "bonus"
products. The initial crediting rate on these products specifies a bonus
crediting rate ranging from 1 percent to 8 percent of the annuity deposit for
the first policy year only, after which the bonus interest portion of the
initial crediting rate is automatically discontinued and the renewal crediting
rate is established. Commissions to agents are generally reduced by 3 or more
percentage points on products with bonus crediting rates of 3 percent or more to
partially compensate the Company for the higher initial crediting
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rate on these products. As of December 31, 1996, the average crediting rate on
the Company's outstanding SPDAs and FPDAs, including interest bonuses guaranteed
for the first year of the annuity contract only, was 5.4 percent (the average
rate exclusive of the bonuses was 5.1 percent).
The policyholder is typically permitted to withdraw all or a part of the
premium paid plus the accumulated interest credited to his account (the
"accumulation value"), subject in many cases to the assessment of a surrender
charge for withdrawals in excess of specified limits. Most of the Company's
SPDAs and FPDAs provide for penalty-free withdrawals of up to 10 percent of the
accumulation value each year, subject to limitations. Withdrawals in excess of
allowable penalty-free amounts are assessed a surrender charge during a penalty
period which generally ranges from five to 12 years after the date a policy was
issued. The surrender charge is initially 6 percent to 12 percent of the
accumulation value and generally decreases by approximately 1 to 2 percentage
points per year during the penalty period. Surrender charges are set at levels
to protect the Company from loss on early terminations and to reduce the
likelihood of policyholders terminating their policies during periods of
increasing interest rates, thereby lengthening the effective duration of policy
liabilities and better enabling the Company to maintain profitability on such
policies. In addition, beginning in September 1995, the Company offered a
deferred annuity product with a "market value adjustment" feature that is
designed to provide the Company with additional protection from early
terminations during a period of rising interest rates by reducing the surrender
value payable upon a full or partial surrender of the policy in excess of the
allowable penalty-free withdrawal amount. Conversely, during a period of
declining interest rates, the market value adjustment feature would increase the
surrender value payable to the policyholder. In 1996, the Company collected
premiums of $205.0 million from sales of FPDAs with this feature.
In response to consumers' desire for alternative investment products with
returns linked to those of common stocks, the Company introduced an
equity-linked SPDA in June 1996. This product accounted for $87.1 million of
SPDA premiums collected during 1996. The annuity's accumulation value is
credited with interest at an annual minimum guaranteed rate of 3 percent, but
the annuity provides for higher returns based on a percentage (the
"participation rate") of the change in the S&P 500 Index during each year of its
term. The Company has the discretionary ability to change the participation rate
(which is currently 100 percent), subject to a minimum of 50 percent. The
annuity provides for penalty-free withdrawals of up to 10 percent of the
accumulation value in each year after the first year of the annuity's term. Most
other withdrawals during the first eight years of the annuity's term are subject
to a 9 percent surrender charge. The Company purchases S&P 500 Index Options,
the values of which change as benefits accrue to these annuities as a result of
the equity-linked return feature.
Life insurance products accounted for $28.6 million of the Company's
annuity deposits and insurance premiums collected (net of reinsurance) in 1996.
The Company offers a portfolio of interest-sensitive life insurance products,
including single and flexible premium universal life insurance products and
single premium whole life products and traditional life insurance, including
term insurance. The principal differences among these types of products offered
by the Company relate to policy provisions affecting the amount and timing of
premium payments. Prior to December 31, 1995, the Company derived approximately
one-third of its life insurance premiums from several group term life insurance
programs, including a program established in 1963 for members of state National
Guard Associations. On December 31, 1995, the Company entered into a coinsurance
agreement that ceded the National Guard group insurance to another life
insurance company.
The Company's interest-sensitive life insurance products offer
policyholders life insurance protection and the opportunity to accumulate assets
at competitive interest rates. Interest-sensitive life insurance products have
similar characteristics to annuities with respect to the crediting of a current
rate of interest above a guaranteed minimum rate and the use of surrender
charges to discourage premature withdrawal of cash values. The surrender charges
are typically larger and decline over a longer period. Interest-sensitive life
insurance policies also generally provide for charges against the policyholder's
account balance for the cost of insurance and administrative expenses.
Accident and health insurance is no longer being actively marketed by the
Company. Premiums are being generated principally from renewals of guaranteed
renewable and non-cancelable individual plans.
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Premium collections by product type for the periods presented are as
follows:
<TABLE>
<CAPTION>
Years ended December 31,
------------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C> <C>
First year premiums collected:
Traditional individual life....................... $ 1.4 $ 1.1 $ 1.7 $ 1.7 $ 1.4
Universal life.................................... 2.8 4.2 3.8 4.1 5.0
------ ------ -------- -------- ------
Total life...................................... 4.2 5.3 5.5 5.8 6.4
Individual annuities ............................. 649.4 754.0 1,055.5 989.9 434.7
------ ------ -------- -------- ------
Total first year premiums....................... 653.6 759.3 1,061.0 995.7 441.1
------ ------ -------- -------- ------
Renewal premiums collected:
Traditional individual life....................... 12.2 13.5 13.4 12.9 13.6
Universal life.................................... 15.9 15.7 15.5 14.9 14.5
Group life and other.............................. 3.6 14.2 15.1 15.0 16.1
------ ------ -------- -------- ------
Total life...................................... 31.7 43.4 44.0 42.8 44.2
Individual annuities ............................. 26.2 23.2 24.8 26.1 24.1
Accident and health............................... 3.7 4.1 4.4 4.7 4.7
------ ------ -------- -------- ------
Total renewal premiums.......................... 61.6 70.7 73.2 73.6 73.0
------ ------ -------- -------- ------
Total gross premiums............................ 715.2 830.0 1,134.2 1,069.3 514.1
Reinsurance ceded.................................... (9.0) (4.4) (5.1) (4.4) (4.4)
------ ------ -------- -------- ------
Net premiums collected.......................... $706.2 $825.6 $1,129.1 $1,064.9 $509.7
====== ====== ======== ======== ======
</TABLE>
4
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Insurance liabilities and life insurance in force as of the dates presented
are as follows:
<TABLE>
<CAPTION>
December 31,
----------------------
1996 1995
---- ----
(Dollars in millions)
<S> <C> <C>
Insurance liabilities:
Deferred annuities................................................... $ 4,881.3 $ 4,716.4
Universal life-type contracts........................................ 235.5 234.2
Traditional life insurance contracts................................. 72.7 87.0
Limited-payment contracts............................................ 36.4 8.1
Individual accident and health....................................... 6.7 7.2
Group life and health................................................ 3.2 3.3
Other policyholders' funds and claims payable........................ 106.5 92.5
--------- ---------
Total insurance liabilities................................. $ 5,342.3 $ 5,148.7
========= =========
Life insurance in force:
Individual life:
Universal life.................................................. $ 1,590.2 $ 1,598.4
Single premium life............................................. 174.6 180.4
Traditional whole life.......................................... 597.6 595.3
Individual term................................................. 1,313.2 1,364.7
--------- ---------
Gross individual life insurance............................. 3,675.6 3,738.8
Reinsurance ceded.................................................... (1,033.5) (949.9)
--------- ---------
Net individual life insurance............................... 2,642.1 2,788.9
--------- ---------
Group life and other................................................. 2,777.0 3,727.1
Reinsurance ceded on group life and other (a)........................ (2,771.7) (3,700.3)
--------- ---------
Net group life insurance and other.......................... 5.3 26.8
--------- ---------
Net life insurance in force................................. $ 2,647.4 $ 2,815.7
========= =========
<FN>
(a) In 1995, the Company entered into a reinsurance contract to cede
substantially all of its group life insurance.
</FN>
</TABLE>
Marketing and Distribution
The Company maintains a diverse distribution network and provides high
quality service to its agents and policyholders. The Company markets its
products primarily through a general agency and insurance brokerage distribution
system comprised of approximately 29,000 independent licensed agents located in
the 49 states in which the Company is licensed to transact business.
The insurance brokerage distribution system is comprised of insurance
brokers and marketing organizations. In the past several years, the Company has
pursued a strategy to increase the size of its brokerage distribution network by
developing relationships with national and regional marketing organizations.
These organizations typically recruit agents for the Company by advertising the
Company's products and its commission structure, through direct mail
advertising, or through seminars for insurance agents and brokers. These
organizations bear most of the costs incurred in marketing the Company's
products. The Company compensates the marketing organizations by paying them a
percentage of the commissions earned on new annuity and life insurance policy
sales generated by the agents recruited by such organizations. The Company
generally does not enter into exclusive arrangements with these marketing
organizations.
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The Company's distribution costs, which principally consist of
commissions to agents based upon premiums actually received, are largely
variable. Management believes that its distribution methods and relatively low
average premium per annuity ($29,900 in 1996) result in a lower policy
termination rate and more stable earnings than a strategy emphasizing larger
individual sales or relying on substantial sales through stock brokerage firms.
The Company does not believe that the loss of any agent, broker or
organization would have a material adverse effect on its operating results. No
single agent, insurance broker or marketing organization accounted for more than
10 percent of annuity deposits and insurance premium collections in any of the
past five years. The six states with the largest shares of premiums collected in
1996 were California (11 percent), Florida (9.7 percent), Michigan (7.4
percent), New Jersey (7.0 percent), Illinois (6.2 percent) and Texas (5.5
percent). No other state accounted for more than 4 percent of total collected
premiums in 1996.
Competition and Ratings
The insurance industry is highly competitive and consists of a large
number of insurance companies, many of which are substantially larger and have
greater financial resources, higher ratings, broader and more diversified
product lines, larger sales forces and/or more widespread agency and brokerage
relationships than the Company. Competition also is encountered from the
expanding number of banks, securities brokerage firms and other financial
intermediaries that market insurance products and offer competing products, such
as mutual fund products, traditional bank investments and/or other investment
and retirement funding alternatives. Insurers compete with other insurance
companies, financial intermediaries and other institutions based on a number of
factors, including pricing and other product terms and service provided to
distributors and policyholders. The Company must also compete with other
insurers to attract and retain the allegiance of agents.
Crediting rates, commissions, the perceived quality of the insurer,
product features and service are generally the principal factors influencing an
agent's willingness and ability to sell particular annuity products. The Company
does not have exclusive agency agreements with its agents and believes most of
these agents sell products, similar to those sold by American Life and Casualty,
for other insurance companies. This can result in reduced sales if for any
reason American Life and Casualty is relatively less competitive or there are
concerns about asset quality or a rating downgrade.
In addition, over the past two years the Company has experienced
increased competition from issuers of variable annuity and life insurance
products. Variable annuities differ from the annuities that the Company offers
in that the annuitant's rate of return is dependent upon the investment
performance of the particular equity, fixed income, money market, asset
allocation or other mutual fund selected by the annuitant. The Company does not
currently have any variable annuity products available.
An important competitive factor for life insurance companies is the
ratings they receive from nationally recognized rating organizations. Agents,
brokers, marketing companies and financial institutions who market the Company's
products and prospective purchasers of the Company's products use the ratings of
an insurer as one factor in determining which insurer's annuity to market or
purchase. American Life and Casualty and Vulcan Life are rated "A- (Excellent)"
by A.M. Best Company ("A.M. Best"). Publications of A.M. Best indicate the "A-"
rating is assigned to those companies that, in A.M. Best's opinion, have
achieved excellent overall performance when compared to the standards
established by A.M. Best and have demonstrated a strong ability to meet their
obligations to policyholders over a long period of time. American Life and
Casualty has also been assigned a claims-paying rating of "A- (Good)" by
Standard & Poor's Corporation ("Standard & Poor's"). Standard & Poor's
claims-paying ability ratings range from "AAA (Superior)" to "R (Regulatory
Action)." An "A" is assigned by Standard & Poor's to those companies which, in
its opinion, have a secure claims-paying ability and whose financial capacity to
meet policyholder obligations is viewed on balance as sound, but their capacity
to meet such policyholder obligations is somewhat more susceptible to adverse
changes in economic or underwriting conditions than more highly rated insurers.
According to Standard & Poor's, a minus (-) sign attached to a Standard & Poor's
claims-paying rating shows relative standing within a ratings category. A.M.
Best's rating and Standard & Poor's claims-paying rating are principally based
upon factors of concern to policyholders, agents and intermediaries and are not
directed toward the protection of investors. Given the competitive nature of the
Company's business and the increasing focus placed on the aforementioned
ratings, the Company manages its business with the objective of preserving
existing ratings and, where possible, achieving more favorable ratings. There
can be no assurance that any particular rating will continue for any given
period of time or that it will not be changed or withdrawn entirely if, in the
judgment of the rating agency, circumstances so warrant. If the Company's
ratings were downgraded from their current levels, sales of its products and the
persistency of its in force business could be materially and adversely affected.
Reinsurance
Consistent with the general practice of the life insurance industry, the
Company reinsures portions of the coverage provided by their insurance products
with other insurance companies under agreements of both facultative- and
treaty-indemnity reinsurance. Reinsurance assumed from other insurers is not
significant. Indemnity reinsurance agreements are intended to limit a life
insurer's maximum loss on a large or unusually hazardous risk or to obtain a
greater diversification of risk. Indemnity reinsurance does not
6
<PAGE>
discharge the original insurer's primary liability to the insured. The Company's
reinsured business is ceded to several reinsurers. The Company believes the
assuming companies are able to honor all contractual commitments, based on the
Company's periodic reviews of their financial statements, insurance industry
reports and reports filed with state insurance departments.
As of December 31, 1996, the Company's policy risk retention limit on the
life of any one individual is $.1 million. Reinsurance ceded by the Company
represented 37 percent of gross combined life insurance in force. Reinsurance
assumed was not material. At December 31, 1996, the total ceded business inforce
of $3.8 billion included $2.9 billion ceded to American Equity Investment Life
Insurance Company, which is not rated by A.M. Best because, (according to A.M.
Best) it did not have sufficient operating history to evaluate its performance.
Underwriting
Substantially all the life insurance policies issued by the Company are
underwritten individually, although standardized underwriting procedures have
been adopted for certain coverages. After initial processing, each file is
reviewed and the information needed to make an underwriting decision (such as
medical examinations, doctors' statements and special medical tests) is
obtained. After the information is collected and reviewed, the Company either
issues the policy as applied for, issues the policy with an extra premium charge
because of unfavorable factors, or rejects the application. Group insurance
policies are underwritten based on the characteristics of the group and its past
claim experience. Underwriting with respect to SPDAs and FPDAs is minimal.
Investments
Conseco Capital Management, Inc. ("CCM"), a registered investment adviser
wholly owned by Conseco, manages the investment portfolios of the Company. CCM
had approximately $31.1 billion of assets (at fair value) under management at
December 31, 1996, of which $5.4 billion were assets of the Company. CCM's
investment philosophy is to maintain a largely investment-grade fixed-income
portfolio, provide adequate liquidity for expected liability durations and other
requirements and maximize total return through active investment management.
Investment activities are an integral part of the Company's business;
investment income is a significant component of the Company's total revenues.
Profitability of many of the Company's products is significantly affected by
spreads between interest yields on investments and rates credited on insurance
liabilities. Although substantially all credited rates on SPDAs and FPDAs may be
changed annually, changes in crediting rates may not be sufficient to maintain
targeted investment spreads in all economic and market environments. In
addition, competition and other factors, including the impact of the level of
surrenders and withdrawals, may limit the Company's ability to adjust or to
maintain crediting rates at levels necessary to avoid narrowing of spreads under
certain market conditions. As of December 31, 1996, the average yield, computed
on the cost basis of the Company's investment portfolio, was 8.0 percent and the
average interest rate credited on the Company's interest sensitive products,
excluding interest bonuses guaranteed for the first year of the annuity contract
only, was 5.1 percent.
The Company seeks to balance the duration of its invested assets with the
expected duration of benefit payments arising from its insurance liabilities. At
December 31, 1996, the adjusted modified duration of fixed maturities and
short-term investments and the duration of the Company's insurance liabilities
were both approximately six years.
For information regarding the composition and diversification of the
Company's investment portfolio, see "Management's Discussion and Analysis of
Consolidated Financial Condition and Results of Operations - Investments" and
note 2 to the consolidated financial statements.
Regulation
Insurance companies are subject to regulation and supervision by the
states in which they transact business. The laws of these jurisdictions
generally establish agencies with broad regulatory authority, including powers
to: (i) grant and revoke licenses to transact business; (ii) regulate and
supervise trade practices and market conduct; (iii) establish guaranty
associations; (iv) license agents; (v) approve policy forms; (vi) approve
premium rates for some lines of business; (vii) establish reserve requirements;
(viii) prescribe the form and content of required financial statements and
reports; (ix) determine the reasonableness and adequacy of statutory capital and
surplus; and (x) regulate the type and amount of permitted investments.
Most states also have enacted legislation which regulates insurance
holding company systems, including acquisitions, extraordinary dividends, the
terms of surplus notes, the terms of affiliate transactions and other related
matters. Currently, the Company and its insurance subsidiaries have registered
as holding company systems pursuant to such legislation in Iowa and Alabama and
routinely report to other jurisdictions.
7
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The federal government does not directly regulate the insurance business.
However, federal legislation and administrative policies in several areas,
including pension regulation, age and sex discrimination, financial services
regulation and federal taxation, do affect the insurance business. Recently,
increased scrutiny has been placed upon the insurance regulatory framework, and
a number of state legislatures have considered or enacted legislative proposals
that alter, and in many cases increase, the authority of state agencies to
regulate insurance companies and holding company systems. In addition,
legislation has been introduced from time to time in recent years which, if ever
enacted, could result in the federal government assuming a more direct role in
the regulation of the insurance industry.
State insurance regulators and the National Association of Insurance
Commissioners (an association of state regulators and their staffs, the "NAIC")
are continually re-examining existing laws and regulations and their application
to insurance companies. In recent years, the NAIC has approved and recommended
to the states for adoption and implementation several regulatory initiatives
designed to decrease the risk of insolvency of insurance companies in general.
These initiatives include risk based capital ("RBC") requirements for
determining the levels of statutory capital and surplus an insurer must maintain
in relation to its investment and insurance risks. The NAIC regulatory
initiatives also impose restrictions on an insurance company's ability to pay
dividends to its stockholders. These initiatives may be adopted by the various
states in which the Company's insurance subsidiaries are licensed, but the
ultimate content and timing of any statutes and regulations adopted by the
states cannot be determined at this time. It is not possible to predict the
future impact of changing state and federal regulations on the Company's
operations, and there can be no assurance that existing insurance related laws
and regulations will not become more restrictive in the future or that laws and
regulations enacted in the future will not be more restrictive.
The NAIC's RBC requirements, which became effective December 31, 1993,
are intended to be used by insurance regulators as an early warning tool to
identify deteriorating or weakly capitalized companies for the purpose of
initiating regulatory action. Such requirements are not designed as a ranking
mechanism for adequately capitalized companies. In addition, the formula defines
a new minimum capital standard which supplements the low, fixed minimum capital
and surplus requirements previously implemented on a state-by-state basis.
The NAIC's RBC requirements provide for four levels of regulatory
attention, depending on the ratio of the company's total adjusted capital
(defined as the total of its statutory capital, surplus, asset valuation reserve
and certain other adjustments) to its RBC. If a company's total adjusted capital
is less than 100 percent but greater than or equal to 75 percent of its RBC, or
if a negative trend has occurred (as defined by the regulations) and total
adjusted capital is less than 125 percent of its RBC (the "Company Action
Level"), the company must submit a comprehensive plan to the regulatory
authority which discusses proposed corrective actions to improve its capital
position. If a company's total adjusted capital is less than 75 percent but
greater than or equal to 50 percent of its RBC (the "Regulatory Action Level"),
the regulatory authority will perform a special examination of the company and
issue an order specifying corrective actions that must be followed. If a
company's total adjusted capital is less than 50 percent but greater than or
equal to 35 percent of its RBC (the "Authorized Control Level"), the regulatory
authority may take any action it deems necessary, including placing the company
under regulatory control. If a company's total adjusted capital is less than 35
percent of its RBC (the "Mandatory Control Level"), the regulatory authority is
mandated to place the company under its control. The total adjusted capital of
American Life and Casualty at December 31, 1996, was approximately two times the
Company Action Level.
In the event of default on the Company's debt or the bankruptcy,
liquidation or other reorganization of the Company, the creditors and
shareholders of the Company would have no right to proceed against the assets of
the Company's insurance subsidiaries. If American Life and Casualty or Vulcan
Life were to be liquidated, such liquidation would be conducted by the Iowa
Insurance Commissioner or the Alabama Insurance Commissioner, as the case may
be, as the receiver with respect to such insurance company's property and
business. Under the Iowa and Alabama insurance laws, all creditors of the
Company's insurance subsidiaries, including, without limitation, holders of its
reinsurance agreements and the various state guaranty associations, would be
entitled to payment in full from such assets before the Company as a shareholder
would be entitled to receive any distribution.
Approximately once every three to five years as part of their routine
regulatory oversight process, insurance departments conduct detailed
examinations of the books, records and accounts of insurance companies domiciled
in their states. Such examinations are generally conducted in cooperation with
the departments of two or three other states, under guidelines promulgated by
the NAIC. An examination of American Life and Casualty was completed in 1995 for
the years 1991, 1992 and 1993. The conclusions reached in the examination report
did not have a material adverse effect on either the Company's or American Life
and Casualty's business or operations. Vulcan Life was last examined as of
December 31, 1991, and the conclusions reached did not have a material adverse
effect on either the Company's or Vulcan Life's business or operations.
On the basis of statutory statements filed with state regulators
annually, the NAIC calculates twelve financial ratios to assist state regulators
in monitoring the financial condition of insurance companies. A "usual range" of
results for each ratio is used as a benchmark. In the past, variances in certain
ratios of the Company's insurance subsidiaries have resulted in inquiries from
insurance departments to which the Company has responded. Such inquiries did not
lead to any restrictions affecting the Company's operations.
8
<PAGE>
Under the solvency or guaranty laws of most states in which they do
business, the Company's insurance subsidiaries may be required to pay
assessments (up to certain prescribed limits) to guaranty funds, which are
established by various states to fund policyholder losses or liabilities of
insolvent or rehabilitated insurance companies. These assessments may be
deferred or forgiven under most guaranty laws if they would threaten an
insurer's financial strength. In certain instances, the assessments may be
offset against future premium taxes. Prior to 1991, these assessments were not
material. However, the amount of such assessments has increased in recent years.
The Company's insurance subsidiaries statutory financial statements for the year
ended December 31, 1996, include $6.0 million of expenses as a result of such
assessments.
Employees
The Company has no full-time employees. The Company's day-to-day
operations are administered by Conseco pursuant to agreements between the
Company and Conseco.
Federal Income Taxation
The annuity and life insurance products marketed and issued by the
Company generally provide the policyholder with an income tax advantage, as
compared to other savings investments such as certificates of deposit and bonds,
in that income taxation on the increase in value of the product is deferred
until receipt by the policyholder. With other savings investments, the increase
in value is taxed as earned. Annuity benefits and life insurance benefits which
accrue prior to the death of the policyholder are generally not taxable until
paid. Life insurance death benefits are generally exempt from income tax. Also,
benefits received on immediate annuities (other than structured settlements) are
recognized as taxable income ratably as opposed to the economic accrual methods,
which tend to accelerate taxable income into earlier years and which are
required for other investments. The tax advantage for annuities and life
insurance is provided in the Internal Revenue Code (the "Code"), and is
generally followed in all states and other United States taxing jurisdictions.
Accordingly, it is subject to change by Congress and the legislatures of the
respective taxing jurisdictions.
The Company's insurance subsidiaries are taxed under the life insurance
company provisions of the Code. Provisions in the Code require a portion of the
expenses incurred in selling insurance products to be deducted over a period of
years, as opposed to immediate deduction in the year incurred. This provision
increases the tax for statutory accounting purposes which reduces statutory
surplus and, accordingly, decreases the amount of cash dividends that may be
paid by the life insurance subsidiaries. For 1996 the increase in the Company's
current tax due to this provision was $15.1 million.
The Company had regular tax loss carryforwards ("NOLs") at December 31,
1996 of approximately $29.6 million, portions of which begin expiring in 1999.
The utilization of the NOLs is limited by Section 382 of the Code to
approximately $12 million per year, subject to certain exceptions for gains
existing at the Acquisition date.
ITEM 2. PROPERTIES
None.
ITEM 3. LEGAL PROCEEDINGS
ALH and American Life and Casualty (the "plaintiffs") have filed suit in
the United States Court of Federal Claims (the "Court of Federal Claims")
against the United States of America for breach of certain contractual
agreements which were made by certain former government regulatory agencies to
induce the plaintiffs to capitalize their former savings bank subsidiary (the
"Savings Bank") in connection with the acquisition of four failed thrift
institutions in March 1988 and the subsequent seizure of the Savings Bank by the
Office of Thrift Supervision in July 1990 (the "Savings Bank Litigation"). In
the Savings Bank Litigation, the plaintiffs claim that the defendant breached
its contractual agreements with respect to regulatory capital and contends that
this breach, which resulted in the disallowance of $21 million of capital which
the defendant contractually promised would be perpetual for regulatory
accounting purposes, and such subsequent seizure, constitutes a taking of the
plaintiffs' property without just compensation and due process, in violation of
the Fifth Amendment of the United States Constitution.
The Savings Bank Litigation seeks monetary damages from the government,
including recovery of: (i) the plaintiffs' investment in the Savings Bank of
143,640 shares of ALH's 1988 Series Preferred Stock and $8.4 million of cash and
(ii) compensation for costs incurred and the value of benefits conferred on the
defendant through the plaintiffs' purchase, operation and management of the
Savings Bank. Total restitution sought by the plaintiffs exceed $30 million.
On July 24, 1992, the Court of Federal Claims granted the plaintiffs'
motion for summary judgment as to the defendant's liability for breach of
contract in the Savings Bank Litigation. The court also consolidated this case
with two others and certified these cases for interlocutory appeal to the United
States Court of Appeals for the Federal Circuit (the "Court of Appeals").
Subsequently, the
9
<PAGE>
Court of Appeals entered a judgment reversing the order of the Court of Federal
Claims by a decision of two to one, and the plaintiffs filed a Petition for
Rehearing with Suggestion for Rehearing in Banc (the "Rehearing Petition") with
the Court of Appeals. On August 18, 1993, the Court of Appeals accepted the
Rehearing Petition, vacated the judgment which was entered in favor of the
defendant and withdrew its opinion accompanying such judgment. On August 30,
1995, the Court of Appeals, in banc, affirmed the summary judgment of the Court
of Federal Claims in the plaintiffs' favor by a decision of nine to two. On July
1, 1996, the Supreme Court affirmed the summary judgment of the Court of Federal
Claims in the plaintiffs' favor by a decision of seven to two. A trial has been
scheduled in May 1997, in the Court of Federal Claims to determine damages
related to the breach of contract by the United States of America.
In conjunction with the Acquisition, each common or equivalent share of
ALH outstanding immediately prior to the Acquisition received a Contingent
Payment Right, designed to provide holders with certain financial benefits that
ALH may receive if ALH prevails in the Savings Bank Litigation. If the rights of
the holder of the 1988 Series Preferred Stock were not an issue in the Savings
Bank Litigation, the 1988 Series Preferred Stock would be convertible, at the
option of the holder thereof, into approximately $30.1 million in connection
with the Acquisition.
If the Savings Bank Litigation results in the return of the 1988 Series
Preferred Stock to ALH, the $30.1 million amount referred to above will be
payable to the holders of the Contingent Payment Rights, together with any money
damages recovered by ALH, subject to certain adjustments and limitations. If,
however, the plaintiffs are unsuccessful in the Savings Bank Litigation, the
$30.1 million will instead become payable to the holder of the 1988 Series
Preferred Stock upon the conversion thereof or as otherwise directed by the
court. Since the timing of a final determination of the Savings Bank Litigation
is uncertain, the plaintiffs are unable to predict when such $30.1 million will
become payable.
ALH, Vulcan Life and certain of its independent agents have been named as
defendants in litigation in the state of Alabama concerning life insurance
products sold to school teachers in the late 1980's. The cases are: (i) Sentell,
et al. v. Vulcan Life Insurance Company et al., filed in the Circuit Court for
Pickens County, Alabama, on August 22, 1994; (ii) Rembert, et al. v. Vulcan Life
Insurance Company et al., filed on June 29, 1995, and pending in the Circuit
Court of Marengo County, Alabama; (iii) Baldwin et al. v. Vulcan Life Insurance
Company et al., filed on July 6, 1995, and pending in the Circuit Court of
Marengo County, Alabama; (iv) Thomas, et al., v. Charley, et al., filed in the
Circuit Court of Wilcox County, Alabama on or about December 20, 1994; (v)
Wheeler v. Vulcan Life Insurance Company, et al., filed in the Circuit Court in
Lamar County, Alabama on May 18, 1995; and (vi) Pitts, et al. v. Vulcan Life
Insurance Company et al., filed in June 1996 in the Circuit Court in Lamar
County, Alabama (all cases are referred to herein as the "Vulcan Life
Litigation"). The plaintiffs in the Vulcan Life Litigation allege, among other
things, that the agent defendants misrepresented that the life insurance
products were part of an employee benefit plan and that such plan would pay the
premiums for their policies although, under the Code, life insurance products
may not be purchased through such a plan. The plaintiffs allege that they
purchased the life insurance products because of such alleged
misrepresentations. The plaintiffs have requested an award of compensatory and
punitive damages of unspecified amounts. The defendants have denied any
liability and have raised numerous defenses including the statute of
limitations.
In addition to the foregoing, the Company's subsidiaries are involved in
various pending or threatened legal proceedings arising from the conduct of
their businesses. These proceedings in some instances include claims for
punitive damages and similar types of relief in unspecified or substantial
amounts, in addition to amounts for alleged contractual liability or claims for
equitable relief. In management's opinion, after consultation with counsel and a
review of available facts, these proceedings will be ultimately resolved without
materially affecting the financial condition or results of operations of the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
10
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
All of the Company's outstanding common stock is owned by ALH and
accordingly, is not traded on an established public trading market.
The Company did not pay any dividends on its common stock during 1996
or 1995. Restrictions and limitations on the Company's ability to pay cash
dividends and on the ability of the Company's subsidiaries to transfer funds to
the Company and to ALH in the form of cash dividends, surplus note payments,
loans or advances are discussed in "Item 7 - Management's Discussion and
Analysis of Consolidated Financial Condition and Results of Operations -
Liquidity and Capital Resources" and notes 6 and 13 to the consolidated
financial statements.
11
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents certain consolidated financial data for the
periods indicated and should be read in conjunction with the consolidated
financial statements and notes thereto and Management's Discussion and Analysis
of Financial Condition and Results of Operations appearing elsewhere in this
Form 10-K. The comparison of consolidated financial data set forth below is
significantly affected by: (i) the Acquisition on September 29, 1994; and (ii)
the ALH Stock Purchase effective September 30, 1996. The Acquisition was
accounted for using the purchase method of accounting. Under purchase
accounting, the total purchase cost was allocated to the assets and liabilities
acquired based on their fair values, with the excess of the total purchase cost
over the fair value of the net assets acquired recorded as goodwill (the "prior
basis"). The consolidated balance sheet at December 31, 1994 and 1995, and the
consolidated statements of operations, shareholder's equity and cash flows for
the three months ended December 31, 1994, the year ended December 31, 1995, and
the nine months ended September 30, 1996, are reported based on such purchase
values. As a result of the ALH Stock Purchase, a new basis of accounting under
the "push down" method was adopted effective September 30, 1996. Under this
method, the assets and liabilities of the Company were revalued to reflect
Conseco's cost basis, which is based on the fair values of such assets and
liabilities on the dates Conseco's ownership interests were acquired. The new
accounting basis was reflected in the consolidated balance sheet at September
30, 1996, and is reflected in the statements of operations, shareholder's equity
and cash flows for periods subsequent to September 30, 1996. As a result, the
assets and liabilities of the Company included in the December 31, 1996,
consolidated balance sheet reflect the following combination of values: (i) the
portion of the Company's net assets acquired by Conseco in the Acquisition of
the Company made by Partnership II is valued as of September 29, 1994; and (ii)
the portion of the Company's net assets acquired in the ALH Stock Purchase is
valued as of September 30, 1996. For periods prior to the Acquisition, financial
data presented are the historical financial data of the Company ("predecessor
basis").
<TABLE>
<CAPTION>
Prior Basis Predecessor Basis
------------------------------------------ ----------------------------
Three months Nine months Three months Nine months Year ended
ended ended Year ended ended ended December 31,
December 31, September 30, December 31, December 31, September 30, --------------
1996 (2) 1996 (1)(2) 1995 (1) 1994 (1) 1994 1993 1992
-------- ----------- -------- -------- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C> <C> <C> <C>
Income Statement Data
Insurance policy income............... $ 11.2 $ 33.0 $ 58.1 $ 13.6 $ 40.2 $ 50.0 $ 51.7
Net investment income................. 102.6 306.4 415.5 92.7 248.4 303.5 274.1
Net investment gains (losses)......... 10.4 9.9 149.3 .4 (16.2) 20.3 11.2
Total revenues........................ 124.9 352.6 627.6 107.9 276.2 378.4 340.0
Interest expense on notes payable..... 3.9 20.8 32.6 8.2 5.9 4.3 5.8
Total benefits and expenses........... 105.0 287.8 488.2 95.5 246.9 302.9 293.6
Income before income taxes, minority
interest and extraordinary items... 19.9 64.8 139.4 12.4 29.3 75.5 46.6
Income before extraordinary items..... 11.5 39.9 87.4 7.3 19.8 49.0 30.4
Net income (3)........................ 11.5 39.1 83.4 7.3 19.8 49.0 35.3
Net income applicable to common
stock (3).......................... 9.8 32.5 74.7 5.1 12.6 39.7 32.6
Balance Sheet Data (at period end)
Total assets.......................... $6,440.3 $6,203.7 $5,425.9 $4,493.8 $3,468.4
Notes payable to non-affiliates....... 103.4 267.5 305.8 47.7 54.5
Notes payable to affiliates........... 54.7 - - 45.0 -
Total liabilities..................... 5,815.0 5,684.9 5,237.2 4,213.5 3,257.0
Redeemable preferred stock:
Held by non-affiliates............. 97.0 99.0 99.0 95.3 65.2
Held by Conseco.................... 6.5 - - - -
Shareholder's equity ................. 521.1 419.2 89.1 173.5 133.6
<FN>
(1) Income statement data, balance sheet data and other financial data at
and for the three months ended December 31, 1994, at and for the year
ended December 31, 1995, and for the nine months ended September 30,
1996, reflect purchase accounting adjustments to record the Company's
assets and liabilities at their estimated fair value as of the
Acquisition date. As a result of such adjustments, the financial data
with respect to the Company prior to the Acquisition may not be
comparable to that of the Company following the Acquisition.
12
<PAGE>
(2) As a result of the ALH Stock Purchase, a new accounting basis was
reflected in the balance sheet data at September 30, 1996, and December
31, 1996, and was reflected in the statement of operations data and
other financial data for the three months ended December 31, 1996. As a
result of such adjustments, the financial data with respect to the
Company prior to the ALH Stock Purchase may not be comparable to that
of the Company after the ALH Stock Purchase.
(3) In the nine months ended September 30, 1996, and the year ended
December 31, 1995, the Company recognized an extraordinary charge (net
of income taxes) of $.8 million and $4.0 million, respectively, on the
extinguishment of debt. Net income in 1992 includes an extraordinary
credit of $4.9 million (net of income taxes) attributable to the
reduction of federal income tax expense arising from the carryforward
of prior years' realized losses on investments.
</FN>
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
The following discussion addresses the principal factors affecting
earnings and financial condition including liquidity and capital resources and
should be read in conjunction with the consolidated financial statements and
notes thereto appearing elsewhere in this Form 10-K.
Results of Operations
1996 Periods Combined (Three Months Ended December 31, 1996 and Nine
Months Ended September 30, 1996) Compared to Year Ended December 31, 1995
Operating data for 1996 are presented in two periods: the three months
ended December 31, 1996, and the nine months ended September 30, 1996 (the
period preceding the ALH Stock Purchase). As explained above under Item 6 -
Selected Consolidated Financial Data, the purchase accounting adjustments
resulting from the ALH Stock Purchase materially affect the comparability of
operating data for the periods before and after the ALH Stock Purchase.
Insurance policy income, which consists of premiums received on
traditional life insurance products and policy fund and surrender charges
assessed against investment type products, decreased 24 percent to $44.2 million
in the 1996 periods from $58.1 million in 1995. This decrease was primarily the
result of a reduction in life insurance premiums related to group life insurance
business coinsured to an unaffiliated company, partially offset by an increase
in surrender charges earned on annuity policy withdrawals. Surrender charges
assessed against universal life-type and investment-type contracts for the 1996
periods were $18.3 million compared to $15.4 million for 1995 while withdrawals
from such contracts were $756.4 million and $766.2 million for the same periods,
respectively. The Company has experienced increases in withdrawals during 1996
due to: (i) the increased size of the Company's annuity portfolio; and (ii)
competition from other investment products, which caused some policyholders to
surrender policies and incur a surrender charge to invest funds in alternative
investments.
Net investment income decreased 1.6 percent to $409.0 million in the 1996
periods from $415.5 million in 1995. The average invested assets (amortized cost
basis) increased to $5.1 billion in the 1996 periods compared to $4.7 billion in
1995 while the yield earned on average invested assets decreased to 8.1 percent
in the 1996 periods from 8.8 percent in 1995. Cash flows received during 1995
and 1996 (including cash flows from the sales of investments) were invested in
lower-yielding securities due to a general decline in interest rates.
Net investment gains (losses) were $20.3 million in the 1996 periods and
$149.3 million in 1995 and often fluctuate from period to period. The Company
sold approximately $2.5 billion of investments (principally fixed maturities) in
the 1996 periods compared to $2.8 billion in 1995.
Selling securities at a gain and reinvesting the proceeds at lower yields
may, absent other management action, tend to decrease future investment yields.
The Company believes, however, that certain factors would mitigate the adverse
effect of such decreases as follows: (i) additional amortization of the cost of
policies purchased and the cost of policies produced is recognized in the same
period as the gain in order to reflect reduced future yields thereby reducing
such amortization in future periods (see amortization related to investment
gains below); (ii) interest rates credited to some products can be reduced
thereby diminishing the effect of the yield decrease on the investment spread;
and (iii) the investment portfolio grows as a result of reinvesting the
investment gains.
Insurance policy benefits and change in future policy benefits decreased
27 percent to $24.1 million in the 1996 periods from $33.1 million in 1995
primarily as a result of the reinsuring of the group life insurance business.
13
<PAGE>
Interest expense on annuities and financial products decreased 4.9
percent to $246.2 million in the 1996 periods from $258.8 million in 1995
primarily due to: (i) lower crediting rates; and (ii) the expensing of the first
year interest rate bonuses of approximately $5.9 million in 1995 on policies
issued prior to the Acquisition date as a result of the application of purchase
accounting on the Acquisition date. Such amounts were considered in determining
the cost of policies purchased and its amortization. Prior to the Acquisition
date, such first year interest rate bonuses (related to policies issued prior to
the Acquisition date) were capitalized as a cost of policies produced. At
December 31, 1996 and 1995, the weighted average crediting rate for the
Company's annuity liabilities excluding interest bonuses guaranteed for the
first year of the annuity contract was 5.1 percent and 5.3 percent,
respectively.
Interest expense on notes payable decreased to $24.7 million in the 1996
periods from $32.6 million in 1995 due to reductions in outstanding indebtedness
and from lower interest rates on the borrowings.
Amortization related to operations increased 6.9 percent to $45.2 million
in the 1996 periods from $42.3 million in 1995. Such increase is affected by:
(i) the adoption of a new basis of accounting as discussed above; and (ii) the
increased amount of business in force on which acquisition costs are
capitalized.
Cost of policies produced represents the cost of producing new business
(primarily commissions, bonus interest and certain costs of policy issuance and
underwriting) which varies with and is primarily related to the production of
new business. Costs deferred may represent amounts paid in the period the new
business is written (such as underwriting costs and first year commissions) or
in periods after the business is written (such as commissions paid in subsequent
years in excess of ultimate commissions paid and bonus interest credited through
the first policy anniversary date).
Cost of policies purchased represents the portion of the cost to acquire
the Company that is attributable to the right to receive cash flows from
insurance contracts in force at the acquisition dates. Some costs incurred
subsequent to the acquisition dates on policies issued prior to such dates,
which otherwise would have been deferred had it not been for the Acquisition or
change in accounting basis (because they vary with and are primarily related to
the production of the acquired policies), are expensed. Examples include
commissions paid in excess of ultimate commissions and bonus interest. However,
such amounts were considered in determining the cost of policies purchased and
its amortization.
Amortization of goodwill increased to $9.3 million in the 1996 periods
from $9.1 million in 1995 due to the adoption of the new basis of accounting.
Amortization related to investment gains decreased to $16.8 million in
the 1996 periods from $83.3 million in 1995 as a result of the decrease in
investment gains.
Income tax expense decreased to $33.3 million in the 1996 periods from
$51.9 million in 1995. This decrease is primarily due to the decrease in pretax
income to $84.7 million in the 1996 periods from $139.4 million in 1995. The
effective tax rate of 39 percent in 1996 and 37 percent in 1995 exceeded the
statutory corporate federal income tax rate (35 percent) primarily because
goodwill amortization is not deductible for federal income tax purposes.
Extraordinary charge incurred in 1996 relates to debt issuance costs that
were written off when the $125.0 million principal balance outstanding under the
senior credit facility was repaid using the proceeds from the capital
contribution from ALH. The extraordinary charge incurred in 1995 relates to debt
issuance costs that were written off when the former senior term loan was paid
off with the proceeds of the new senior credit facility.
Year Ended December 31, 1995 Compared to 1994 Periods Combined (Three
Months Ended December 31, 1994 and Nine Months Ended September 30, 1994)
Operating data for 1994 are presented in two periods: the three months
ended December 31, 1994, and the nine months ended September 30, 1994 (the
period preceding the Acquisition). As explained above, under Item 6 - Selected
Consolidated Financial Data, the purchase accounting adjustments resulting from
the Acquisition materially affect the comparability of operating data for the
periods before and after the Acquisition.
Insurance policy income, which consists of premiums received on
traditional life insurance products and policy fund and surrender charges
assessed against investment type products, increased 8 percent to $58.1 million
in 1995 from $53.8 million in the 1994 periods, primarily because increased
annuity policy withdrawals resulted in higher surrender charges. Surrender
charges assessed against universal life-type and investment-type contracts for
1995 were $15.4 million compared to $10.2 million for the 1994 periods while
withdrawals from such contracts were $766.2 million and $539.2 million for the
same periods, respectively. The Company has experienced increases in withdrawals
during 1995 due to: (i) the increased size of the Company's annuity portfolio;
and
14
<PAGE>
(ii) competition from other investment products, which caused some policyholders
to surrender policies and incur a surrender charge to invest funds in
alternative investments.
Net investment income increased 22 percent to $415.5 million in 1995 from
$341.1 million in the 1994 periods on a 7 percent increase in average invested
assets (amortized cost basis) to $4.7 billion in 1995 compared to $4.4 billion
in the 1994 periods. The percentage increase in net investment income was
greater than the percentage increase in average invested assets because the
yield earned on average invested assets increased to 8.8 percent in 1995 from
7.9 percent in the 1994 periods. The increase in yield primarily resulted from
the application of purchase accounting as a result of the Acquisition.
Net investment gains (losses) were $149.3 million in 1995 and $(15.8)
million in the 1994 periods and often fluctuate from period to period. The
Company sold approximately $2.8 billion of investments (principally fixed
maturities) in 1995 compared to $1.1 billion in the 1994 periods. Net investment
gains from sales of investments in the 1994 periods were offset by a loss on
certain interest rate swap contracts that no longer effectively hedged interest
rate risks in the second quarter of 1994 and were therefore recorded at fair
value, resulting in a net realized loss of $21.3 million. Substantially all of
the Company's interest rate swap contracts were terminated subsequent to the
Acquisition with no additional loss. The increased level of investment activity
in 1995 is the result of planned changes in the fixed maturity investment
portfolio to reduce the portfolio's duration and exposure to more volatile CMO
investments.
Selling securities at a gain and reinvesting the proceeds at lower yields
may, absent other management action, tend to decrease future investment yields.
The Company believes, however, that certain factors would mitigate the adverse
effect of such decreases as follows: (i) additional amortization of the cost of
policies purchased and the cost of policies produced is recognized in the same
period as the gain in order to reflect reduced future yields thereby reducing
such amortization in future periods (see amortization related to investment
gains below); (ii) interest rates credited to some products can be reduced
thereby diminishing the effect of the yield decrease on the investment spread;
and (iii) the investment portfolio grows as a result of reinvesting the
investment gains.
Interest expense on annuities and financial products increased 18 percent
to $258.8 million in 1995 from $220.1 million in the 1994 periods primarily due
to: (i) a larger block of annuity business in force in 1995; and (ii) the
expensing of the first year interest rate bonuses of approximately $5.9 million
in 1995 on policies issued prior to the Acquisition date as a result of the
application of purchase accounting on the Acquisition date. At December 31, 1995
and 1994, the weighted average crediting rate for the Company's annuity
liabilities excluding interest bonuses guaranteed for the first year of the
annuity contract was 5.3 percent.
Interest expense on notes payable increased to $32.6 million in 1995 from
$14.1 million in the 1994 periods as a result of additional interest on debt
incurred to finance the Acquisition, partially offset by a reduction in interest
expense resulting from the repayment of subsidiary bank debt that had been
outstanding prior to the Acquisition.
Amortization related to operations increased 9.6 percent to $42.3 million
in 1995 from $38.6 million in the 1994 periods. Amortization related to
operations during the first nine months of 1994 is comprised solely of
amortization of cost of policies produced. Amortization related to operations
during 1995 and the last three months of 1994 is comprised of amortization of:
(i) the cost of policies purchased for business in force at the Acquisition
date; and (ii) the cost of policies produced for business written subsequent to
the Acquisition date.
Cost of policies produced represents the cost of producing new business
(primarily commissions, bonus interest and certain costs of policy issuance and
underwriting) which varies with and is primarily related to the production of
new business. Costs deferred may represent amounts paid in the period the new
business is written (such as underwriting costs and first year commissions) or
in periods after the business is written (such as commissions paid in subsequent
years in excess of ultimate commissions paid and bonus interest credited through
the first policy anniversary date).
Cost of policies purchased represents the portion of the cost to acquire
the Company that is attributable to the right to receive cash flows from
insurance contracts written at the Acquisition date. Some costs incurred
subsequent to the Acquisition date on policies issued prior to such date, which
otherwise would have been deferred had it not been for the Acquisition (because
they vary with and are primarily related to the production of the acquired
policies), are expensed. Examples include commissions paid in excess of ultimate
commissions and bonus interest. However, such amounts were considered in
determining the cost of policies purchased and its amortization. The amount of
amortization related to operations in the 1995 period is less than the 1994
period primarily due to costs related to purchased policies that would have been
deferred as the cost of policies produced but instead are expensed as either:
(i) other operating costs; or (ii) interest on annuities and financial products.
Amortization of goodwill increased to $9.1 million in 1995 from $2.2
million in the 1994 periods. The 1995 amount includes an entire year of
amortization and 1994 includes amortization for three months. Goodwill prior to
the Acquisition was insignificant.
15
<PAGE>
Amortization related to investment gains increased to $83.3 million in
1995 from $2.8 million in the 1994 periods as a result of the increase in
investment gains.
Income tax expense increased to $51.9 million in 1995 from $14.7 million
in the 1994 periods. This increase is primarily due to the increase in pretax
income to $139.4 million in 1995 from $41.7 million in the 1994 periods. The
effective tax rate of 37 percent in 1995 exceeded the statutory corporate
federal income tax rate (35 percent) because goodwill amortization is not
deductible for federal income tax purposes. The effective tax rate approximated
the statutory rate of 35 percent in 1994.
Extraordinary charge incurred in 1995 relates to debt issuance costs that
were written off when the former senior term loan was paid off with the proceeds
of the new bank financing.
Dividends on preferred stock decreased to $8.7 million in 1995 from $9.4
million in the 1994 periods primarily due to the elimination of the dividends on
the issues of preferred stock held by ALH which were redeemed at the Acquisition
date.
Investment Portfolio
The Company's investment strategy is to: (i) maintain a diversified
predominantly investment grade fixed income portfolio; (ii) provide adequate
liquidity to meet the cash flow requirements of policyholder and other
obligations; and (iii) maximize current income and total investment return
through active investment management. Consistent with this strategy, investments
in fixed maturity securities, mortgage loans, policy loans and short-term debt
investments collectively comprised 98 percent of the Company's investment
portfolio at December 31, 1996. The remainder of the invested assets was in
equity securities and other investments.
The Company's insurance subsidiaries are regulated by insurance statutes
and regulations as to the type of investments that they are permitted to make
and the amount of funds that may be used for any one type of investment. In
light of these statutes and regulations and the Company's business and
investment strategy, the Company generally seeks to invest in United States
government and government agency securities and corporate securities rated
investment grade by established nationally-recognized rating organizations or,
if not rated, in securities of comparable investment quality.
The Company's investment portfolio has been managed by CCM since the
Acquisition. Prior to the Acquisition, the Company maintained a predominantly
investment grade fixed maturity investment portfolio with the primary goal of
avoiding credit risk. As a result, fixed maturity investments on the Acquisition
date included approximately $2.0 billion of mortgage-backed securities which
comprised 50 percent of the Company's fixed maturity investments. While these
securities had minimal credit risk they were subject to greater interest rate
risk (as discussed hereafter) than traditional fixed income securities. Since
the Acquisition, the Company has reduced its overall exposure to interest rate
risk by, in part, selling mortgage-backed security investments with high
interest rate risk and investing proceeds and new cash flows in intermediate
term investment grade corporate securities.
The amortized cost and estimated fair value of fixed maturities (all of
which were actively managed) at December 31, 1996 were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
(Dollars in millions)
<S> <C> <C> <C> <C>
United States Treasury securities.......................... $ 49.7 $ 1.9 $ - $ 51.6
Obligations of states and political subdivisions
and foreign government obligations...................... 54.5 1.5 .5 55.5
Public utility securities.................................. 739.5 29.3 .5 768.3
Other corporate securities................................. 2,759.0 63.8 12.3 2,810.5
Mortgage-backed securities................................. 1,496.9 35.6 2.9 1,529.6
-------- ------ ----- --------
Total fixed maturities.............................. $5,099.6 $132.1 $16.2 $5,215.5
======== ====== ===== ========
</TABLE>
16
<PAGE>
The following table sets forth fixed maturity investments at December 31,
1996, classified by rating categories (designated categories include securities
with "+" or "-" ratings modifiers). The category assigned is the highest rating
by Standard & Poor's or Moody's Investors Service or, as to $41.1 million fair
value of fixed maturities not rated by such firms, the rating assigned by the
NAIC. For the purposes of this table, NAIC Class 1 is included in the "A"
rating; Class 2, "BBB"; and Class 3, "BB"; and Classes 4-6, "B+ and below".
<TABLE>
<CAPTION>
Percent of
------------------------------
Fixed Total
Investment rating maturities investments
----------------- ---------- -----------
<S> <C> <C>
AAA.............................................. 32% 31%
AA............................................... 11 10
A................................................ 28 27
BBB.............................................. 25 24
--- --
Investment grade........................ 96 92
--- --
BB............................................... 3 3
B+ and below..................................... 1 1
--- --
Below investment grade.................. 4 4
--- --
Total fixed maturities.................. 100% 96%
=== ==
</TABLE>
Below investment grade securities generally have greater risks than other
corporate debt investments, including risk of loss upon default by the borrower,
and are often unsecured and subordinated to other creditors. Below investment
grade issuers usually have high levels of indebtedness and are more sensitive to
adverse economic conditions, such as recession or increasing interest rates,
than are investment grade issuers. The Company is aware of these risks and
monitors its below investment grade securities closely. At December 31, 1996,
the Company's below investment grade corporate fixed maturities had an amortized
cost of $187.8 million and an estimated fair value of $191.7 million.
The Company, in conjunction with CCM, periodically evaluates the
creditworthiness of each issuer whose securities are held in the portfolio.
Special attention is paid to those securities whose market values have declined
materially for reasons other than changes in interest rates or other general
market conditions. The Company considers available information to evaluate the
realizable value of the investment, the specific condition of the issuer, and
the issuer's ability to comply with the material terms of the security.
Information reviewed may include the recent operational results and financial
position of the issuer, information about its industry, recent press releases
and other information. If evidence does not exist to support a realizable value
equal to or greater than the carrying value of the investment and such decline
in market value is determined to be other than temporary, the Company reduces
the carrying amount to its net realizable value, which becomes the new cost
basis, and the amount of the reduction is reported as a realized loss. The
Company recognizes any recovery of such reductions in the cost basis of an
investment as a realized gain only upon the sale, repayment or other disposition
of the investment. During 1996 and 1995, the Company recorded realized losses
for investment writedowns of $1.5 million and $7.1 million, respectively, as a
result of changes in the financial condition of an issuer and changes in the
value of the underlying collateral, which caused the Company to conclude that
the decline in fair value of such investments was other than temporary. The
Company's investment portfolio is subject to the risk of further declines in
realizable value, however, the Company attempts to mitigate this risk through
the diversification and active management of its portfolio.
The Company had no fixed maturity investments in technical or substantive
default as of December 31, 1996. There were no fixed maturity investments about
which the Company had serious doubts as to the ability of the issuers to comply
with the contractual terms of their obligations on a timely basis.
The Company's policy is to discontinue the accrual of interest and
eliminate all previous interest accruals for defaulted securities, if based on
the Company's assessment such amounts will not be ultimately realized in full.
Investment income forgone due to defaulted securities was $.2 million, $.7
million and $.5 million for the three months ended December 31, 1996, the nine
months ended September 30, 1996, and the year ended December 31, 1995,
respectively. There was no forgone investment income in the 1994 periods.
Proceeds from the sales of investments (principally fixed maturities)
were $1.5 billion and $1.1 billion for the three months ended December 31, 1996,
and the nine months ended September 30, 1996, respectively, and such sales
resulted in net investment gains of $11.9 million and $9.9 million for the same
respective periods. Proceeds from the sales of investments (principally fixed
maturities) were $2.8 billion for the year ended December 31, 1995. Such sales
resulted in net investment gains of $156.4 million. Proceeds from the sales of
investments (principally fixed maturities) were $.5 billion for the three months
ended December 31, 1994.
17
<PAGE>
Such sales resulted in net investment gains of $.9 million. Proceeds from sales
of fixed maturity securities during the first nine months of 1994 were $604
million, of which $596 million were from sales of securities classified as
actively managed and $8 million were from the sale of securities classified as
held-to-maturity as of January 1, 1994. These sales resulted in net investment
gains of $5.8 million. The securities classified as held-to-maturity were sold
subsequent to a debtor being placed on credit watch by a major independent
rating agency. A loss of $1.6 million was recognized on such sale. The issuer's
credit ratings were subsequently downgraded.
At December 31, 1996, fixed maturity investments included $1.5 billion
(29 percent of the fixed maturity investment portfolio) of mortgage-backed
securities. The yield characteristics of mortgage-backed securities differ from
those of traditional fixed income securities. Interest and principal payments
occur more frequently, often monthly, and mortgage-backed securities are subject
to risks associated with variable prepayments. Prepayment rates are influenced
by a number of factors which cannot be predicted with certainty, including the
relative sensitivity of the underlying mortgages backing the assets to changes
in interest rates; a variety of economic, geographic and other factors; and the
repayment priority of the securities in the overall securitization structures.
In general, prepayments on the underlying mortgage loans, and the
securities backed by these loans, increase when the level of prevailing interest
rates declines significantly below the interest rates on such loans.
Mortgage-backed securities purchased at a discount to par will experience an
increase in yield when the underlying mortgages prepay faster than expected.
Those securities purchased at a premium that prepay faster than expected will
incur a reduction in yield. When declines in interest rates occur, the proceeds
from the prepayment of mortgage-backed securities are likely to be reinvested at
lower rates than the Company was earning on the prepaid securities. As the level
of prevailing interest rates increases, prepayments on mortgage-backed
securities decrease as fewer underlying mortgages are refinanced. When this
occurs, the average maturity and duration of the mortgage-backed securities
increase, which decreases the yield on mortgage-backed securities purchased at a
discount because the discount is realized as income at a slower rate and
increases the yield on those purchased at a premium as a result of a decrease in
annual amortization of the premium.
The following table sets forth the par value, amortized cost and
estimated fair value of mortgage-backed securities including CMOs at December
31, 1996, summarized by interest rates on the underlying collateral at December
31, 1996:
<TABLE>
<CAPTION>
Par Amortized Estimated
value cost fair value
----- ---- ----------
(Dollars in millions)
<S> <C> <C> <C>
Below 7 percent..................................................... $ 411.8 $ 386.4 $ 392.4
7 percent - 8 percent............................................... 955.8 898.9 919.3
8 percent - 9 percent............................................... 175.0 166.1 172.3
9 percent and above................................................. 51.2 45.5 45.6
-------- -------- --------
Total mortgage-backed securities............................... $1,593.8 $1,496.9 $1,529.6
======== ======== ========
</TABLE>
The amortized cost and estimated fair value of mortgage-backed securities
including CMOs at December 31, 1996, summarized by type of security, were as
follows:
<TABLE>
<CAPTION>
Estimated fair value
-----------------------
% of
Amortized fixed
Type cost Amount maturities
- ---- ---- ------ ----------
(Dollars in millions)
<S> <C> <C> <C>
Pass-throughs and sequential and targeted amortization classes............. $1,075.6 $1,095.4 21%
Support classes............................................................ 105.7 110.2 2
Accrual (Z tranche) bonds.................................................. 22.7 23.8 1
Planned amortization classes and accretion directed bonds.................. 171.9 175.9 3
Subordinated classes....................................................... 121.0 124.3 2
-------- -------- --
$1,496.9 $1,529.6 29%
======== ======== ==
</TABLE>
Pass-throughs and sequential and targeted amortization classes have similar
prepayment variability. Pass-throughs have historically provided the best
liquidity in the mortgage-backed securities market and provide the best
price/performance ratio in a highly volatile interest rate environment. This
type of security is also frequently used as collateral in the dollar roll
market. Sequential
18
<PAGE>
classes pay in a strict sequence with all principal payments received by the CMO
paid to the sequential tranches in order of priority. Targeted amortization
classes provide a modest amount of prepayment protection when prepayments on the
underlying collateral increase from those assumed at pricing and thus offer
slightly better call protection than sequential classes and pass-throughs.
Planned amortization classes and accretion directed bonds are some of the
most stable and liquid instruments in the mortgage-backed securities market.
Planned amortization class bonds adhere to a fixed schedule of principal
payments provided that the underlying mortgage collateral experiences
prepayments within a certain range. Changes in prepayment rates are first
absorbed by support classes which insulate the planned amortization classes from
the consequences of both faster prepayments (average life shortening) and slower
prepayments (average life extension).
Support classes absorb the prepayment risk from which planned
amortization and targeted amortization classes are protected. As such, they are
usually extremely sensitive to prepayments. Most of the Company's support
classes are higher average life instruments that generally will not lengthen if
interest rates rise from year end levels and will have a tendency to shorten if
interest rates decline. However, since these bonds have costs below par values,
higher prepayments will have the effect of increasing yields.
Accrual bonds are CMOs structured such that the payment of coupon
interest is deferred until principal payments begin on these bonds. On each
accrual date, the principal balance is increased by the amount of the interest
(based upon the stated coupon rate) that otherwise would have been payable. As
such, these securities act much the same as zero coupon bonds until cash
payments begin. Cash payments typically do not commence until earlier classes in
the CMO structure have been retired, which can be significantly influenced by
the prepayment experience of the underlying mortgage loan collateral in the CMO
structure. Because of the zero coupon element of these securities and the
potential uncertainty as to the timing of cash payments, their market values and
yields are more sensitive to changing interest rates than other CMOs,
pass-through securities and coupon bonds.
Subordinated CMO classes have both prepayment and credit risk. The
subordinated classes are used to lend credit enhancement to the senior
securities and as such, rating agencies require that this support not
deteriorate due to the prepayment of the subordinated securities. The credit
risk of subordinated classes is derived from the negative leverage of owning a
small percentage of the underlying mortgage loan collateral while bearing a
majority of the risk of loss due to homeowner defaults.
At December 31, 1996, the mortgage loan portfolio of the Company was
diversified across 58 properties with an average loan size of approximately $1.0
million. Approximately 99 percent of the mortgage loan balance relates to
commercial properties including retail, multifamily residential, office,
industrial, nursing home, restaurant and other properties. Less than 1 percent
of the mortgage loan balance was noncurrent at December 31, 1996. The Company
had $.2 million in realized losses on mortgage loans during 1996. At December
31, 1996, the Company had a loan loss reserve of $.3 million.
At December 31, 1996, the Company held no trading account securities.
Trading account securities are investments that are purchased with the intent to
be traded prior to their maturity, or are believed likely to be disposed of in
the foreseeable future as a result of market or issuer developments. Trading
account securities are carried at estimated fair value, with the changes in fair
value reflected in the statement of operations.
Other invested assets include certain non-traditional investments,
including investments in venture capital funds, limited partnerships and
promissory notes.
Short-term investments totaled $15.4 million, or .3 percent of invested
assets at December 31, 1996, and consisted primarily of commercial paper and
repurchase agreements relating to government securities.
As part of its investment strategy, the Company enters into reverse
repurchase agreements and dollar roll transactions to increase its return on
investments and improve its liquidity. Reverse repurchase agreements involve a
sale of securities and an agreement to repurchase the same securities at a later
date at an agreed upon price. Dollar rolls are similar to reverse repurchase
agreements except that the repurchase involves securities that are only
substantially the same as the securities sold. The Company enhances its
investment yield by investing the proceeds from the sales in short-term
securities pending the contractual repurchase of the securities at discounted
prices in the forward market. The Company is able to engage in such transactions
due to the market demand for mortgage-backed securities to form CMOs. Such
investment borrowings averaged $81.4 million during 1996 and were collateralized
by investment securities with fair values approximately equal to the loan value.
The weighted average interest rate on short-term collateralized borrowings was
5.6 percent in 1996. The primary risk associated with short-term collateralized
borrowings is that the counterparty will be unable to perform under the terms of
the contract. The Company's exposure is limited to the excess of the net
replacement cost of the securities over the value of the short-term investments
(which was not material at December 31, 1996). The Company believes that the
counterparties to its reverse repurchase and dollar roll agreements are
financially responsible and that the counterparty risk is minimal.
19
<PAGE>
Liquidity and Capital Resources
Insurance Operations
The Company's annuity and life insurance business generally provides the
Company's insurance subsidiaries with positive cash flows from premium
collections and investment income. Cash flows from insurance subsidiary
financing activities principally result from the excess of premium collections
from annuities and interest-sensitive insurance contracts over related benefit
payments, including withdrawal and surrender payments. Changes in the account
balances for insurance liabilities accounted for as universal life-type and
investment-type contracts (primarily deferred annuities) (see note 1 in the
consolidated financial statements) for the three years ended December 31, 1996
are summarized as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------
1996 1995 1994
---- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Account balances, beginning of period........................... $4,950.6 $4,677.9 $3,904.8
Annuity deposits................................................ 675.0 777.2 1,080.3
Life insurance deposits......................................... 19.8 19.9 19.3
Interest credited, including first year bonus interest.......... 263.2 271.4 232.4
Policy fund and surrender charges assessed...................... (32.8) (29.6) (24.3)
Withdrawals and surrender payments.............................. (756.4) (766.2) (539.2)
Other reserve adjustments....................................... (2.6) - 4.6
-------- -------- --------
Account balances, end of period................................. $5,116.8 $4,950.6 $4,677.9
======== ======== ========
Net cash flows (total deposits less withdrawal
and surrender payments)................................ $ (61.6) $ 30.9 $ 560.4
========= ======== ========
</TABLE>
Growth in annuity deposits began to slow in 1994 and declined in 1995 and
1996 as a result of several factors. The demand for individual fixed annuity
products offered by all insurance companies decreased during 1995 and 1996. Such
decrease is believed to be attributable to increased competition from products
such as mutual funds, traditional bank investments, variable annuities and other
investment and retirement funding alternatives as a result of a flattened yield
curve and rising equity markets.
Withdrawals and surrenders have increased in recent years due to: (i) the
aging of the Company's annuity business in force resulting in an increased
amount of deferred annuity liabilities that could be surrendered without penalty
or with a nominal penalty; (ii) growth in the Company's annuity business
resulting from the substantial volume of premium collections in 1993 through
1995; (iii) increased policyholder utilization of the systematic withdrawal
features which first became available on annuity policies in 1992; and (iv)
increased competition from alternative investments such as certificates of
deposit, mutual funds and variable annuity products as a result of a flattened
yield curve and declining interest rates.
The trend of significant increases in withdrawals and surrenders subsided
in 1996 as policy withdrawal and surrender payments decreased moderately to
$756.4 million compared to $766.2 million in 1995. Withdrawal and surrender
payments accelerated in recent years primarily due to a certain policy form
principally issued during 1988 through 1990 whose surrender charge declined from
4 percent at the fifth policy anniversary date to 0 percent at the sixth policy
anniversary date. Surrenders have occurred after these policies have reached
their sixth anniversary. The Company expects the trend of accelerated
withdrawals and surrenders of this product to subside since sales of this
product peaked in the second quarter of 1989 and were effectively discontinued
after June 30, 1990. At December 31, 1996, the aggregate account balances still
in force for this product were $469.2 million.
Substantially all of the Company's annuity products have a surrender
charge feature designed to reduce early withdrawal or surrender of the policies
and to partially compensate the Company for its costs if policies are withdrawn
early. Surrender charge periods on annuity policies currently being issued
generally range from five years to 12 years. Most of the Company's annuities
that were issued during 1995 and 1996 have a surrender charge period of eight
years or more. The initial surrender charge on annuity policies ranges from 6
percent to 12 percent of the accumulation value and generally decreases by
approximately 1 to 2 percentage points per year during the surrender charge
period.
20
<PAGE>
The following table summarizes the Company's deferred annuity liabilities
at December 31, 1996 and 1995, and sales for the years then ended, respectively,
by surrender charge category.
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
-------------------------------------- ------------------------------------
Annuity Annuity
Surrender Charge % Deposits % Liabilities % Deposits % Liabilities %
- ------------------ -------- ---- ----------- ---- -------- --- ----------- --
(Dollars in millions)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
No surrender charge................. $ .6 * $ 891.2 18% $ .2 * $ 986.1 21%
1 to 3.9 percent.................... - - 442.0 9 - - 317.2 7
4 to 6.9 percent.................... 2.4 * 776.2 16 6.4 1 555.7 12
7 to 9.9 percent.................... 96.9 16 1,481.7 30 64.4 9 605.4 13
10 to 11.9 percent.................. 180.7 29 867.8 18 371.3 51 1,059.6 22
12 percent and greater.............. 345.4 55 422.4 9 285.9 39 1,192.4 25
------ --- -------- --- ------- --- ------- ---
$626.0 100% $4,881.3 100% $ 728.2 100% $4,716.4 100%
====== === ======== === ======= === ======== ===
<FN>
* less than 1 percent
</FN>
</TABLE>
Deferred annuity liabilities that could be surrendered without penalty
increased from $508.8 million, or 14 percent of deferred annuity liabilities, at
December 31, 1993 to $891.2 million, or 18 percent of deferred annuity
liabilities, at December 31, 1996. The following table summarizes the Company's
deferred annuity liabilities in which the surrender charge expires within the
first subsequent year and the second subsequent year at December 31, 1994, 1995
and 1996.
<TABLE>
<CAPTION>
Within
-----------------------
first second Total
subsequent subsequent within next
year year 2 years
---- ---- -------
(Dollars in millions)
<S> <C> <C> <C>
December 31, 1994.................................... $456.0 $168.1 $624.1
December 31, 1995.................................... 158.9 71.3 230.2
December 31, 1996.................................... 64.9 202.1 267.0
</TABLE>
Most of the Company's assets are invested in bonds and other securities,
substantially all of which are readily marketable. Although there is no present
need or intent to dispose of such investments, the Company could liquidate
portions of its investments or use them to facilitate borrowings under reverse
repurchase agreements if such a need arose. At December 31, 1996, the Company's
portfolio of bonds, notes and redeemable preferred stocks had an aggregate net
unrealized gain of $115.9 million.
Liquidity of the Company
The Company needs liquidity primarily to service its debt, pay dividends
on its capital stock and pay operating expenses. The primary sources of funds
for these payments are dividends on capital stock from subsidiaries, interest
payments on surplus notes and net tax sharing payments received from American
Life and Casualty.
Effective September 30, 1996, Conseco purchased 5,434,783 newly issued
shares of ALH's common stock for $125.0 million. The proceeds from the issuance
of the shares were used by ALH to make a $125.0 million capital contribution to
the Company. The Company used the proceeds from the capital contribution to
repay all amounts borrowed under its senior credit facility.
At December 31, 1996, the Company had $150 million of senior subordinated
notes outstanding. The Company and its subsidiaries may incur additional
indebtedness in the future, subject to the limitations contained in the
indenture for the senior subordinated notes. In addition, the indenture contains
limitations on the ability of the Company to pay dividends on its capital stock
other than the two series of its redeemable preferred stock discussed in the
following paragraph. Under the most restrictive covenants of the indenture, the
Company is limited to paying dividends of $28.3 million per year to ALH.
21
<PAGE>
The Company has two series of redeemable preferred stock outstanding.
Principal and interest payments on the Company's senior subordinated notes have
priority over dividend payments on these issues of preferred stock, however the
rights of the holders of such preferred stock with respect to the securities
segregated in escrow accounts for the future redemption of that stock are
unaffected by the incurrence of the new indebtedness.
The payment of dividends and other distributions, including surplus note
payments, by American Life and Casualty are subject to regulation by the Iowa
Insurance Division. Currently, American Life and Casualty may pay dividends or
make other distributions without the prior approval of the Iowa Insurance
Division, unless such payments, together with all other such payments within the
preceding 12 months, exceed the greater of (1) American Life and Casualty's net
gain from operations (excluding net investment gains or losses) for the
preceding calendar year or (2) 10 percent of its statutory surplus at the
preceding December 31. For 1997, up to $28.3 million can be distributed as
dividends or surplus note payments without prior approval of the Iowa Insurance
Division. In addition, dividends and surplus note payments may be made only out
of earned surplus, and all surplus note payments are subject to prior approval
by regulatory authorities. Vulcan Life, which is subject to similar regulatory
limitations on its ability to pay dividends, has not paid a dividend during the
entire period of time it has been a subsidiary of the Company and no future
dividend payments by Vulcan Life are currently contemplated.
The maximum distribution permitted by law is not necessarily indicative
of an insurer's actual ability to pay such distribution, which may be
constrained by business and regulatory considerations, such as the impact of
such distributions on surplus, which could affect an insurer's ratings or
competitive position, the amount of premiums that can be written and the ability
to pay future dividends or make other distributions. Further, the Iowa insurance
laws and regulations require that the statutory surplus of American Life and
Casualty following any dividend or distribution be reasonable in relation to its
outstanding liabilities and adequate for its financial needs. The Iowa Insurance
Division may bring an action to enjoin or rescind the payment of a dividend or
distribution by American Life and Casualty that would, in its judgment, cause
American Life and Casualty's statutory surplus to be unreasonable or inadequate
under this standard.
Statutory accounting practices prescribed or permitted for the Company's
insurance subsidiaries differ in many respects from those governing the
preparation of financial statements under GAAP. Accordingly, statutory operating
results and statutory capital and surplus may differ substantially from amounts
reported in the GAAP basis financial statements for comparable items. The
Company's insurance subsidiaries follow certain permitted statutory accounting
practices which are not specifically prescribed in state laws, regulations,
general administrative rules or various NAIC publications. Such permitted
practices do not enhance statutory surplus. Further, the Company's insurance
subsidiaries do not have any reinsurance agreements generally known as "surplus
relief reinsurance" which have the effect of increasing statutory surplus at
inception and reducing statutory surplus in subsequent years as amounts are
recaptured by reinsurers. Information as to statutory capital and surplus and
statutory net income for the Company's insurance subsidiaries as of and for the
years ended December 31, 1996 and 1995, is included in note 13 in the
accompanying consolidated financial statements.
The Company's cash flow also includes dividends and tax sharing payments
derived from American Life and Casualty Marketing Division Co.'s ("ALMD")
income, if any. ALMD functions as a general agent for American Life and
Casualty, and its primary purpose is to pay commissions to American Life and
Casualty's agents on annuity and life insurance policies issued by American Life
and Casualty pursuant to a general agency commission and servicing agreement
between ALMD and American Life and Casualty. This agreement initially benefits
the statutory surplus of American Life and Casualty by extending the payment of
first year commissions by American Life and Casualty to ALMD on certain deferred
annuity policies over a longer period of time. In subsequent periods, American
Life and Casualty's statutory surplus is reduced through the payment of renewal
commissions to ALMD equal to a specified percentage of the accumulated
policyholder account values of certain deferred annuity policies in force issued
by American Life and Casualty since July 1990 remaining in force. These renewal
commissions and capital contributions and/or advances from the Company are the
sources of funds for ALMD's payment of the first year commissions to agents on
the deferred annuity policies issued by American Life and Casualty.
ALH has no direct ownership interest in the Company's insurance
subsidiaries and must rely on dividends from the Company and payments under the
tax sharing agreement with its subsidiaries to fund its operating expenses and
any dividends or interest expense it may seek or be obligated to pay. ALH
remains obligated to pay interest on the remaining $13.0 million principal
balance of its convertible Subordinated Debentures ("Convertible Debentures") as
long as such amounts remain outstanding.
22
<PAGE>
Inflation
Disclosures related to the financial effect of inflation generally focus
on the items most often affected by inflation - inventories and property, plant
and equipment. For a life insurance organization these items are insignificant
or nonexistent. Most of the Company's assets are investments, repayable in the
future in dollars that, assuming that inflation continues, will have less
purchasing power than the dollars originally invested. Similarly, most of the
Company's reserves and liabilities would be payable in the future with dollars
with less purchasing power. An effect of inflation is a decline in purchasing
power when monetary assets exceed monetary liabilities.
23
<PAGE>
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
<TABLE>
<CAPTION>
Index to Consolidated Financial Statements
Page
<S> <C>
Report of Management............................................................................................... 25
Report of Independent Accountants.................................................................................. 26
Consolidated Balance Sheet......................................................................................... 27
Consolidated Statement of Operations............................................................................... 29
Consolidated Statement of Shareholder's Equity..................................................................... 30
Consolidated Statement of Cash Flows............................................................................... 31
Notes to Consolidated Financial Statements......................................................................... 33
</TABLE>
24
<PAGE>
REPORT OF MANAGEMENT
To Our Shareholders
Management of American Life Holding Company is responsible for the
reliability of the financial information in this annual report. The financial
statements are prepared in accordance with generally accepted accounting
principles and the other financial information in this annual report is
consistent with that of the financial statements (except for such information
described as being in accordance with regulatory or statutory accounting
requirements).
The integrity of the financial information relies in large part on
maintaining a system of internal control that is established by management to
provide reasonable assurance that assets are safeguarded and transactions are
properly authorized, recorded and reported. Reasonable assurance is based upon
the premise that the cost of controls should not exceed the benefits derived
from them. The Company's internal auditors continually evaluate the adequacy and
effectiveness of this system of internal control and actions are taken to
correct deficiencies as they are identified.
Certain financial information presented depends upon management's estimates
and judgments regarding the ultimate outcome of transactions which are not yet
complete. Management believes these estimates and judgments are fair and
reasonable in view of present conditions and available information.
The Company engages independent accountants to audit its financial
statements and express their opinion thereon. They have full access to each
member of management in conducting their audits. Such audits are conducted in
accordance with generally accepted auditing standards and include a review of
internal controls, tests of the accounting records, and such other auditing
procedures as they consider necessary to express an opinion on the Company's
financial statements.
Stephen C. Hilbert Rollin M. Dick
Chief Executive Officer Executive Vice President and
Chief Financial Officer
25
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
Shareholders and Board of Directors
American Life Holding Company
We have audited the accompanying consolidated balance sheet of American
Life Holding Company and subsidiaries as of December 31, 1996, and the related
consolidated statements of operations, shareholder's equity, and cash flows for
the three months ended December 31, 1996. We have also audited the accompanying
consolidated balance sheet of American Life Holding Company as of December 31,
1995, and the related consolidated statements of operations, shareholder's
equity, and cash flows for the nine months ended September 30, 1996, the year
ended December 31, 1995, and the three months ended December 31, 1994 based on
the prior basis of accounting prior to Conseco, Inc.'s purchase of all of the
common stock of the Holding Company's parent. (See note 1 to the notes to
consolidated financial statements regarding the September 30, 1996 stock
purchase). We have also audited the accompanying consolidated statements of
operations, shareholder's equity and cash flows of American Life Holding Company
and subsidiaries for the nine months ended September 30, 1994 based on the
historical predecessor basis applicable to periods prior to the acquisition of
the Company (see note 1 of the notes to consolidated financial statements
regarding the September 29, 1994 acquisition). These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
American Life Holding Company and subsidiaries as of December 31, 1996 and 1995,
and the consolidated results of their operations and their cash flows for the
three months ended December 31, 1996, the nine months ended September 30, 1996,
the year ended December 31, 1995, and the three months ended December 31, 1994
and the consolidated results of operations and cash flows for the nine months
ended September 30, 1994 of American Life Holding Company in conformity with
generally accepted accounting principles.
/S/ COOPERS & LYBRAND L.L.P.
-----------------------------
COOPERS & LYBRAND L.L.P.
Indianapolis, Indiana
March 14, 1997
26
<PAGE>
<TABLE>
<CAPTION>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
December 31, 1996 and 1995
(Dollars in millions)
ASSETS
1996 1995
---- ----
(prior
basis)
<S> <C> <C>
Investments:
Actively managed fixed maturities at fair value (amortized cost:
1996 - $5,099.6; 1995 - $4,667.3).................................................... $5,215.5 $5,083.1
Equity securities at fair value (cost: 1996 - $5.8; 1995 - $16.5)...................... 6.5 18.8
Mortgage loans......................................................................... 58.5 64.6
Credit-tenant loans.................................................................... 37.1 13.6
Policy loans........................................................................... 63.9 62.9
Short-term investments................................................................. 15.4 107.8
Other invested assets.................................................................. 59.3 18.2
-------- --------
Total investments.................................................................. 5,456.2 5,369.0
Accrued investment income................................................................. 87.1 80.8
Cost of policies purchased................................................................ 331.9 250.1
Cost of policies produced................................................................. 68.9 77.6
Income tax assets......................................................................... 2.2 -
Securities segregated for the future redemption of redeemable preferred stock............. 45.6 39.2
Goodwill (net of accumulated amortization: 1996 - $20.6; 1995 - $11.3).................... 404.7 348.9
Other assets ............................................................................ 43.7 38.1
-------- --------
Total assets....................................................................... $6,440.3 $6,203.7
======== ========
</TABLE>
(Continued on next page)
The accompanying notes are an integral
part of the consolidated financial
statements.
27
<PAGE>
<TABLE>
<CAPTION>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (Continued)
December 31, 1996 and 1995
(Dollars in millions, except per share amounts)
LIABILITIES AND SHAREHOLDER'S EQUITY
1996 1995
---- ----
(prior
basis)
<S> <C> <C>
Liabilities:
Insurance liabilities.................................................................. $5,342.3 $5,148.7
Income tax liabilities................................................................. - 40.6
Investment borrowings.................................................................. 186.5 130.7
Payable to ALH upon determination of the Savings Bank Litigation (see note 8).......... 30.1 30.1
Other liabilities...................................................................... 88.1 66.4
Accounts payable to affiliates......................................................... 9.9 .9
Notes payable:
To affiliates........................................................................ 54.7 -
To non-affiliates.................................................................... 103.4 267.5
-------- --------
Total liabilities.................................................................. 5,815.0 5,684.9
Minority interest......................................................................... .7 .6
Redeemable preferred stock:
Held by non-affiliates................................................................. 97.0 99.0
Held by affiliates..................................................................... 6.5 -
Shareholder's equity:
Common stock, $.01 par value, and additional paid-in capital
1,600,000 shares authorized; 1,500,100 shares issued and outstanding................. 429.0 143.0
Unrealized appreciation (depreciation) of securities:
Fixed maturity securities (net of applicable deferred income taxes:
1996 - $21.6; 1995 - $105.0)....................................................... 40.1 194.9
Other investments (net of applicable deferred income taxes:
1996 - $(.4); 1995 - $.8).......................................................... (.8) 1.5
Retained earnings...................................................................... 52.8 79.8
-------- --------
Total shareholder's equity......................................................... 521.1 419.2
-------- --------
Total liabilities and shareholder's equity......................................... $6,440.3 $6,203.7
======== ========
</TABLE>
The accompanying notes are an integral
part of the consolidated financial
statements.
28
<PAGE>
<TABLE>
<CAPTION>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(Dollars in millions)
Predecessor
Prior Basis Basis
---------------------------------------- -----------
Three months Nine months Three months Nine months
ended ended Year ended ended ended
December 31, September 30, December 31, December 31, September 30,
1996 1996 1995 1994 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Revenues:
Insurance policy income............................ $ 11.2 $ 33.0 $ 58.1 $ 13.6 $ 40.2
Net investment income.............................. 102.6 306.4 415.5 92.7 248.4
Net investment gains (losses)...................... 10.4 9.9 149.3 .4 (16.2)
Other ........................................... .7 3.3 4.7 1.2 3.8
------- ------- ------ ------ -------
Total revenues................................ 124.9 352.6 627.6 107.9 276.2
------- ------- ------ ------ -------
Benefits and expenses:
Insurance policy benefits.......................... 7.6 18.1 28.7 6.0 16.7
Change in future policy benefits................... (1.4) (.2) 4.4 3.4 9.4
Interest expense on annuities and financial products 62.0 184.2 258.8 61.3 158.8
Interest expense on notes payable.................. 3.9 20.8 32.6 8.2 5.9
Interest expense on investment borrowings.......... 1.7 2.9 7.7 - -
Amortization related to operations................. 9.0 36.2 42.3 8.9 29.7
Amortization related to investment gains .......... 12.0 4.8 83.3 - 2.8
Other operating costs and expenses................. 10.2 21.0 30.4 7.7 23.6
------- ------- ------ ------ -------
Total benefits and expenses................... 105.0 287.8 488.2 95.5 246.9
------- ------- ------ ------ -------
Income before income taxes,
minority interest and extraordinary charge. 19.9 64.8 139.4 12.4 29.3
Income tax expense................................... 8.4 24.9 51.9 5.1 9.6
------- ------- ------ ------ -------
Income before minority interest and
extraordinary charge....................... 11.5 39.9 87.5 7.3 19.7
Minority interest (credit)........................... - - .1 - (.1)
------- ------- ------ ------ -------
Income before extraordinary charge............ 11.5 39.9 87.4 7.3 19.8
Extraordinary charge on extinguishment of debt,
net of income tax benefit.......................... - .8 4.0 - -
------- ------- ------ ------- -------
Net income.................................... 11.5 39.1 83.4 7.3 19.8
Dividend requirements of Series Preferred Stock...... 1.7 6.6 8.7 2.2 7.2
------- ------- ------ ------- ------
Net income applicable to common stock......... $ 9.8 $ 32.5 $ 74.7 $ 5.1 $ 12.6
======= ======= ====== ======= ======
</TABLE>
The accompanying notes are an
integral part of the consolidated
financial statements.
29
<PAGE>
<TABLE>
<CAPTION>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY
(Dollars in millions)
Predecessor
Prior Basis Basis
----------------------------------------- -------------
Three months Nine months Three months Nine months
ended ended Year ended ended ended
December 31, September 30, December 31, December 31, September 30,
1996 1996 1995 1994 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Common stock and additional paid-in capital:
Balance, beginning of period.......................... $429.0 $ 143.0 $113.0 $113.0 $ 13.0
Capital contribution by ALH........................ - 125.0 30.0 - -
Redemption of preferred stock...................... - - - - (5.9)
Adjustment of balance due to adoption of new basis - 161.0 - - -
Deemed contribution pursuant to
Acquisition...................................... - - - - 105.9
------ ------- ------ ------ -------
Balance, end of period................................ $429.0 $ 429.0 $143.0 $ 113.0 $113.0
====== ======= ====== ======= ======
Unrealized appreciation (depreciation) of securities:
Fixed maturity securities:
Balance, beginning of period....................... $ 13.8 $ 194.9 $(28.5) $ - $ -
Adoption of FASB Statement 115................... - - - - 38.2
Change in unrealized appreciation (depreciation) 26.3 (159.0) 223.4 (28.5) (188.9)
Adjustment of balance due to adoption of
new basis..................................... - (22.1) - - -
Elimination of balance pursuant to Acquisition... - - - - 150.7
------- -------- ------- ------- -------
Balance, end of period............................. $ 40.1 $ 13.8 $194.9 $ (28.5) $ -
======= ======== ====== ======= =======
Other investments:
Balance, beginning of period....................... $ .5 $ 1.5 $ (.5) $ - $ (.3)
Change in unrealized appreciation (depreciation) (1.3) (.1) 2.0 (.5) (1.3)
Adjustment of balance due to adoption of new basis - (.9) - - -
Elimination of balance pursuant to Acquisition... - - - - 1.6
------- -------- ------ ------ -------
Balance, end of period............................. $ (.8) $ .5 $ 1.5 $ (.5) $ -
======= ======== ====== ====== =======
Retained earnings:
Balance, beginning of period.......................... $ 43.0 $ 79.8 $ 5.1 $ - $ 160.8
Net income......................................... 11.5 39.1 83.4 7.3 19.8
Dividends:
Preferred stock ................................. (1.7) (6.6) (8.7) (2.2) (7.1)
Common stock .................................... - - - - (153.0)
Other.............................................. - - - - (.4)
Adjustment of balance due to adoption of new basis - (69.3) - - -
Elimination of balance pursuant to Acquisition..... - - - - (20.1)
------- ------- ------ ----- -------
Balance, end of period................................ $ 52.8 $ 43.0 $ 79.8 $ 5.1 $ -
======= ======= ====== ====== =======
Total shareholder's equity............................ $ 521.1 $ 486.3 $419.2 $ 89.1 $ 113.0
======= ======= ====== ======= =======
</TABLE>
The accompanying notes are an
integral part of the consolidated
financial statements.
30
<PAGE>
<TABLE>
<CAPTION>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in millions)
Predecessor
Prior Basis Basis
------------------------------------------ -----------
Three months Nine months Three months Nine months
ended ended Year ended ended ended
December 31, September 30, December 31, December 31, September 30,
1996 1996 1995 1994 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income......................................... $ 11.5 $ 39.1 $ 83.4 $ 7.3 $ 19.8
Adjustments to reconcile net income to net
cash provided by operating activities:
Amortization and depreciation................. 21.1 41.5 126.4 9.8 33.9
Income taxes.................................. 12.5 19.2 54.2 5.7 (3.9)
Insurance liabilities......................... 40.1 26.1 44.8 4.3 13.9
Interest credited to insurance liabilities.... 62.0 184.2 258.8 61.3 158.8
Fees charged to insurance liabilities......... (8.3) (24.5) (29.6) (5.9) (18.4)
Accrual and amortization of investment income (4.7) (16.8) (54.6) (25.1) (39.8)
Deferral of cost of policies produced......... (18.6) (61.6) (87.3) (25.2) (85.2)
Other liabilities............................. 19.2 (3.8) 4.4 (14.5) 23.5
Extraordinary charge on extinguishment of debt - 1.3 6.2 - -
Realized investment (gains) losses............ (10.4) (9.9) (149.3) (.4) 16.2
Other......................................... (28.8) (7.4) (8.1) 1.1 (4.6)
-------- ------- -------- ------- --------
Net cash provided by operating activities..... 95.6 187.4 249.3 18.4 114.2
-------- ------- -------- ------- --------
Cash flows from investing activities:
Purchases of investments........................... (1,725.7) (1,323.4) (3,244.2) (764.8) (1,324.4)
Sales of investments............................... 1,452.6 1,067.0 2,835.9 505.5 609.2
Maturities and redemptions......................... 44.5 123.7 77.7 36.1 242.4
-------- -------- -------- ------- --------
Net cash used by investing activities......... (228.6) (132.7) (330.6) (223.2) (472.8)
-------- -------- -------- -------- --------
</TABLE>
(Continued on next page)
The accompanying notes are an
integral part of the consolidated
financial statements.
31
<PAGE>
<TABLE>
<CAPTION>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
(Dollars in millions)
Predecessor
Prior Basis Basis
----------------------------------------- ------------
Three months Nine months Three months Nine months
ended ended Year ended ended ended
December 31, September 30, December 31, December 31, September 30,
1996 1996 1995 1994 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Cash flows from financing activities:
Issuance of notes payable, including obligations
to ALH, net of issuance costs................... $ - $ - $ 125.0 $ - $336.8
Payments on notes payable, including obligations
to ALH.......................................... - (125.0) (170.0) - (124.3)
Payments on surplus notes.......................... - - - - (1.0)
Purchase of subsidiary's surplus notes and
preferred stock................................. - - - - (10.5)
Capital contribution from ALH...................... - 125.0 30.0 - -
Repayment of advances from ALH..................... - - - - (1.7)
Redemption of preferred stock...................... - - - - (6.1)
Investment borrowings, net......................... 63.4 (7.6) 130.7 - -
Deposits to insurance liabilities.................. 165.4 529.4 797.1 275.5 824.1
Withdrawals from insurance liabilities............. (171.3) (585.1) (766.2) (149.8) (389.4)
Dividends paid..................................... (1.7) (6.6) (8.7) (2.2) (160.1)
-------- ------- -------- ------- -------
Net cash provided (used) by financing
activities................................. 55.8 (69.9) 137.9 123.5 467.8
-------- ------ ------- ------- ------
Net increase (decrease) in
short-term investments..................... (77.2) (15.2) 56.6 (81.3) 109.2
Short-term investments, beginning of period... 92.6 107.8 51.2 132.5 23.3
--------- ------ ------- ------- ------
Short-term investments, end of period......... $ 15.4 $ 92.6 $ 107.8 $ 51.2 $ 132.5
========= ====== ======= ====== =======
</TABLE>
The accompanying notes are an
integral part of the consolidated
financial statements.
32
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
1. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
American Life Holding Company (the "Company") is a wholly owned
subsidiary of American Life Holdings, Inc. ("ALH"). In 1996, ALH changed its
name from American Life Group, Inc. (formerly The Statesman Group, Inc. prior to
its name change in 1995). Effective September 30, 1996, ALH became a wholly
owned subsidiary of Conseco, Inc. ("Conseco"). Conseco is a financial services
holding company engaged primarily in the development, marketing and
administration of annuity, supplemental health and individual life products.
The Company is an insurance holding company engaged primarily in the
development, marketing, issuance and administration of annuity and life
insurance products through its insurance subsidiaries, American Life and
Casualty Insurance Company ("American Life and Casualty") and Vulcan Life
Insurance Company ("Vulcan Life"). The Company markets its annuity and life
insurance products primarily to middle-income individuals, ages 45 and over,
through a general agency and insurance brokerage distribution system. The
Company owns 100 percent of American Life and Casualty, which owns 98 percent of
Vulcan Life.
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles ("GAAP"), which, as to
the subsidiary insurance companies, differ in some respects from statutory
accounting practices followed in the preparation of financial statements
submitted to state insurance departments. The financial statements prepared in
conformity with GAAP include amounts based on informed estimates and judgment of
management, with consideration given to materiality. Significant estimates and
assumptions are utilized in the calculation of cost of policies produced, cost
of policies purchased, goodwill, insurance liabilities, liabilities related to
litigation, guaranty fund assessment accruals and deferred income taxes.
Actual experience may differ from those estimates.
On September 29, 1994, Conseco Capital Partners II, L.P. ("Partnership
II"), a Delaware limited partnership, completed the acquisition (the
"Acquisition") of ALH. ALH's former shareholders received $15.25 in cash per
common equivalent share plus a contingent payment right (the "Contingent Payment
Right") to receive up to another $2.00 in cash per common equivalent share (the
"Contingent Consideration"), based on the outcome of ALH's and American Life and
Casualty's pending litigation against the U.S. Government concerning their
former savings bank subsidiary (the "Savings Bank Litigation") (see note 8). The
sole general partner of Partnership II is a wholly owned subsidiary of Conseco.
As a result of the Acquisition and related financing transactions, Partnership
II owned 80 percent of ALH's outstanding common stock. Conseco, through its
direct investment and interests in certain of its subsidiaries had a 38 percent
ownership interest in ALH and the Company prior to the transactions described in
the following paragraphs. The Acquisition was accounted for using the purchase
method of accounting effective September 29, 1994. Under this method, the total
cost to acquire the Company was allocated to the assets and liabilities acquired
based on their fair values, with the excess of the total purchase cost over the
fair value of the net assets acquired recorded as goodwill.
Effective September 30, 1996, Conseco: (i) purchased all of the
outstanding common stock of ALH not previously owned by Conseco for $165.0
million in cash (the "ALH Stock Purchase"); (ii) purchased 5,434,783 newly
issued shares of ALH common stock for $125.0 million; and (iii) terminated
Partnership II.
ALH contributed the proceeds from the issuance of the shares to the
Company. The Company used the proceeds from the capital contribution to repay
all amounts borrowed under its senior credit facility. As a result of the ALH
Stock Purchase, the Company is an indirect wholly owned subsidiary of Conseco.
Effective September 30, 1996, the Company adopted a new basis of accounting
under the "push down" method effective September 30, 1996. Under this method,
the assets and liabilities of the Company were revalued to reflect Conseco's
cost basis, which is based on the fair values of such assets and liabilities on
the dates Conseco's ownership interests were acquired. As a result, the assets
and liabilities included in the December 31, 1996, consolidated balance sheet
represent the following combination of values: (i) the portion of the Company's
net assets acquired by Partnership II in the Acquisition is valued as of
September 29, 1994; and (ii) the portion of the Company's net assets acquired in
the ALH Stock Purchase is valued as of September 30, 1996.
The consolidated balance sheet as of December 31, 1996, and the
consolidated statement of operations, shareholder's equity and cash flows for
the three months ended December 31, 1996, are reported under the new basis of
accounting described in the previous paragraph. The consolidated balance sheets
as of December 31, 1995 and 1994, and the consolidated statements of
33
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
operations, shareholder's equity and cash flows for the nine months ended
September 30, 1996, the year ended December 31, 1995 and the three months ended
December 31, 1994 are reported based on such purchase values ("prior basis").
Financial data for the nine months ended September 30, 1994, are the historical
financial data of the Company ("predecessor basis").
The effect of the adoption of the new basis of accounting on the
Company's balance sheet accounts was as follows (dollars in millions):
<TABLE>
<CAPTION>
Debit
(Credit)
--------
<S> <C>
Cost of policies purchased................................................... $ 80.2
Cost of policies produced.................................................... (96.5)
Goodwill..................................................................... 101.8
Other........................................................................ 2.0
Minority interest in redeemable preferred stock.............................. (5.0)
Notes payable................................................................ (13.8)
Common stock and additional paid-in capital.................................. (161.0)
Net unrealized appreciation of securities.................................... 23.0
Retained earnings............................................................ 69.3
</TABLE>
The consolidated financial statements include the accounts of the
Company and its subsidiaries after elimination of all significant intercompany
accounts and transactions. Certain amounts from prior periods were reclassified
to conform to the 1996 presentation.
Investments
Fixed maturity investments are securities that mature more than one year
after they are issued and include bonds, notes receivable and preferred stocks
with mandatory redemption features and are classified as follows:
Actively managed - fixed maturity securities that may be sold prior to
maturity due to changes that might occur in market interest rates, issuer
credit quality or the Company's liquidity requirements. Actively managed
fixed maturity securities are carried at fair value and the unrealized
gain or loss is recorded net of tax and related adjustments described
below as a component of shareholder's equity.
Trading account - fixed maturity securities are bought and held
principally for the purpose of selling them in the near term. Trading
account securities are carried at estimated fair value. Unrealized gains
or losses are included in net investment gains (losses). The Company did
not hold any trading account securities at December 31, 1996 or 1995.
Held to maturity - (all other fixed maturity securities) are those
securities which the Company has the ability and positive intent to hold
to maturity, and are carried at amortized cost. The Company may dispose
of these securities if the credit quality of the issuer deteriorates, if
regulatory requirements change or under other unforeseen circumstances.
The Company has not held any securities in this classification since the
Acquisition.
Anticipated returns, including investment gains and losses, from the
investment of policyholder balances are considered in determining the
amortization of the cost of policies purchased and the cost of policies
produced. When actively managed fixed maturity securities are stated at fair
value, an adjustment to the cost of policies purchased and the cost of policies
produced may be necessary if a change in amortization would have been recorded
if such securities had been sold at their fair value and the proceeds reinvested
at current yields. Furthermore, if future yields expected to be earned on such
securities decline, it may be necessary to increase certain insurance
liabilities. Adjustments to such liabilities are required when their balances,
in addition to future net cash flows (including investment income), are
insufficient to cover future benefits and expenses.
34
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
Unrealized gains and losses and the related adjustments described above
have no effect on earnings. The Company records them, net of tax, as a component
of shareholder's equity. The following table summarizes the effect of these
adjustments on the related balance sheet accounts as of December 31, 1996:
<TABLE>
<CAPTION>
Effect of fair value
adjustment to
Balance actively managed Reported
before adjustment fixed maturities amount
----------------- ---------------- ------
(Dollars in millions)
<S> <C> <C> <C>
Actively managed fixed maturities...................... $5,099.6 $115.9 $5,215.5
Cost of policies purchased............................. 378.7 (46.8) 331.9
Cost of policies produced.............................. 76.3 (7.4) 68.9
Income tax asset....................................... 23.8 (21.6) 2.2
Unrealized appreciation of fixed maturity securities.. - 40.1 40.1
</TABLE>
When there are changes in conditions that cause a fixed maturity
investment to be transferred to a different category (e.g., actively managed,
held to maturity or trading), the security is transferred to the new category at
its fair value at the date of the transfer. At the date of transfer, the
security's unrealized gain or loss (which was immaterial in 1996) is accounted
for as follows:
For transfers to the trading category - the unrealized gain or loss is
recognized in earnings;
For transfers from the trading category - the unrealized gain or loss
already recognized in earnings is not reversed;
For transfers to actively managed from held to maturity - the unrealized
gain or loss is recognized in shareholder's equity; and
For transfers to held to maturity from actively managed - the unrealized
gain or loss at the date of transfer continues to be reported in
shareholder's equity, but is amortized over the remaining life of the
security as an adjustment of yield.
As part of its investment strategy, the Company enters into reverse
repurchase agreements and dollar roll transactions to increase its return on
investments and improve liquidity. These transactions are accounted for as
collateral borrowings, where the amount borrowed is equal to the sales price of
the underlying securities.
Credit-tenant loans are loans for commercial properties. When these loans
are made: (i) the lease of the principal tenant is assigned to the Company; (ii)
the lease must produce adequate cash flow to fund substantially all the
requirements of the loan; and (iii) the principal tenant or the guarantor of
such tenant's obligations must have an investment-grade credit rating when the
loan is made. These loans also must be secured by the value of the related
property. Underwriting guidelines take into account such factors as: (i) the
lease term of the property; (ii) the borrower's management ability, including
business experience, property management capabilities and financial soundness;
and (iii) such economic, demographic or other factors that may affect the income
generated by the property, or its value. The underwriting guidelines generally
require a loan-to-value ratio of 75 percent or less. Credit-tenant loans and
traditional mortgage loans are carried at amortized cost.
Policy loans are stated at their current unpaid principal balance.
Short-term investments include commercial paper, invested cash and other
investments purchased with maturities less than three months and are carried at
amortized cost, which approximates estimated fair value. The Company considers
all short-term investments to be cash equivalents.
Other invested assets principally consist of debt instruments, which are
generally recorded at amortized cost, and limited partnership investments, which
are reported under the equity method.
35
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
Fees received and costs incurred in connection with origination of
investments, principally mortgage loans, are deferred. Fees, costs, discounts
and premiums are amortized as yield adjustments over the contractual life of the
investments. Anticipated prepayments on mortgage-backed securities are taken
into consideration in determining estimated future yields on such securities.
The specific identification method is used to account for the disposition
of investments. The differences between sale proceeds and carrying values are
reported as gains and losses on investments, or as adjustments to investment
income if the proceeds are prepayments by issuers prior to maturity.
The Company manages its investments to limit credit risk by diversifying
its portfolio among various security types and industry sectors. The Company
regularly evaluates investment securities, credit-tenant loans and mortgage
loans based on current economic conditions, past credit loss experience and
other circumstances of the investee. A decline in a security's net realizable
value that is other than temporary is treated as a realized loss and the cost
basis of the security is reduced to its estimated fair value. Impaired loans are
revalued at the present value of expected cash flows discounted at the loan's
effective interest rate when it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the agreement. The
Company accrues interest on the net carrying amount of impaired loans.
Cost of Policies Purchased
The cost of policies purchased represents the portion of the cost to
acquire the Company that is attributable to the right to receive future cash
flows from insurance contracts existing at the date of the Acquisition. The
value of cost of policies purchased is the actuarially determined present value
of the projected future cash flows from the insurance contracts existing at the
Acquisition date.
The method used by the Company to value the cost of policies purchased is
consistent with the valuation methods used most commonly to value blocks of
insurance business, which is also consistent with the basic methodology
generally used to value assets. The method used by the Company is summarized as
follows:
o Identify the expected future cash flows from the blocks of business.
o Identify the risks inherent in realizing those cash flows (i.e.,
the probability that the cash flows will be realized).
o Identify the rate of return that the Company believes it must earn
in order to accept the risks inherent in realizing the cash flows,
based on consideration of the factors summarized below.
o Determine the value of the policies purchased by discounting the
expected future cash flows by the discount rate the Company
requires.
Expected future cash flows used in determining such value are based on
actuarially determined projections of future premium collections, mortality,
surrenders, operating expenses, changes in insurance liabilities, investment
yields on the assets held to back the policy liabilities and other factors.
These projections take into account all factors known or expected at the
valuation date based on the collective judgment of the management of the
Company. Actual experience on purchased business may vary from projections due
to differences in renewal premiums collected, investment spread, investment
gains or losses, mortality and morbidity costs and other factors.
The discount rates used to determine the value of the cost of policies
purchased is the rate of return required by Partnership II and Conseco to invest
in the business being acquired. The following factors have been considered in
determining this rate:
o The magnitude of the risks associated with each of the actuarial
assumptions used in determining expected future cash flows as
described in the preceding paragraphs.
o The cost of capital to fund the Acquisition.
o The perceived likelihood of changes in projected future cash flows
that might occur if there are changes in insurance regulations and
tax laws.
o The compatibility with other company activities that may favorably
affect future cash flows.
36
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
o The complexity of the acquired business.
o Recent purchase prices (i.e., discount rates used in determining
valuations) on similar blocks of business.
After the cost of purchased policies is determined using the methods
described above, the amount is amortized based on the incidence of the expected
cash flows and the interest rate credited to the underlying products.
To the extent that past or future experience on purchased business varies
from projections due to differences in renewal premiums collected, investment
spread, investment gains or losses, mortality and morbidity costs and other
factors, it may be necessary to adjust the amortization of the cost of policies
purchased. For example, sales of fixed maturity investments that result in a
gain (or loss), but also reduce (or increase) the future investment spread
because the sale proceeds are reinvested at a lower (or higher) earnings rate,
may cause amortization to increase (or decrease) reflecting the change in the
incidence of cash flows. For universal life- type contracts and investment-type
contracts, the accumulated amortization is adjusted (whether an increase or a
decrease) whenever there is a material change in the estimated gross profits
expected over the life of a block of business in order to maintain a constant
relationship between cumulative amortization and the present value (discounted
at the rate of interest that accrues to the policies) of expected gross profits.
For most other contracts, the unamortized asset balance is reduced by a charge
to income only when the present value of future cash flows, net of the policy
liabilities, is not sufficient to cover such asset balance.
Recoverability of the cost of policies purchased is evaluated regularly
by comparing the current estimate of expected future cash flows (discounted at
the rate of interest earned on invested assets) to the unamortized asset balance
by line of insurance business. If such current estimate indicates that the
existing insurance liabilities, together with the present value of future net
cash flows from the blocks of business purchased, will not be sufficient to
recover the cost of policies purchased, the difference would be charged to
expense.
Cost of Policies Produced
Costs of producing new business (primarily commissions, bonus interest
and certain costs of policy issuance and underwriting, net of fees charged to
the policy in excess of ultimate fees charged), which vary with and are
primarily related to the production of new business, are deferred to the extent
recoverable from future profits. Such costs are amortized with interest as
follows:
o For universal life-type contracts and investment-type contracts, in
relation to the present value of expected gross profits from these
contracts, discounted using the interest rate credited to the policy.
o For immediate annuities with mortality risks, in relation to the
present value of benefits to be paid.
o For traditional life insurance products, in relation to future
anticipated premium revenue using the same assumptions that are used
in calculating the insurance liabilities.
Recoverability of the unamortized balance of the cost of policies
produced is evaluated regularly. Cumulative and future amortization of the cost
of policies produced is adjusted, when there is a material change in estimated
gross profits expected over the life of a block of business, consistent with the
methods described above for the cost of policies purchased.
Goodwill
The excess of the cost of acquiring the Company's net assets over their
estimated fair values is recorded as goodwill and is being amortized on the
straight-line basis over a 40 year period. The Company periodically assesses the
recoverability of goodwill through projections of future earnings of the related
subsidiaries. Such assessment is made based on whether goodwill is fully
recoverable from projected undiscounted net cash flows from earnings of the
subsidiaries over the remaining amortization period. If future evaluations of
goodwill indicate a material change in the factors supporting recoverability
over the remaining amortization period, all or a portion of goodwill may need to
be written off or the amortization period shortened (no such changes have
occurred).
37
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
Property and Equipment
Property and equipment are reported at cost, less accumulated
depreciation and amortization. Provisions for depreciation and amortization are
computed using the straight-line method over the estimated useful lives of the
assets.
Insurance Liabilities, Recognition of Insurance Policy Income and Related
Benefits and Expenses
Reserves for universal life-type and investment-type contracts
(principally deferred annuities) are based on the contract account balance, if
future benefit payments in excess of the account balance are not guaranteed, or
on the present value of future benefit payments when such payments are
guaranteed. Additions to insurance liabilities are made if future cash flows
including investment income are insufficient to cover future benefits and
expenses.
For investment contracts without mortality risk (such as deferred
annuities and immediate annuities with benefits paid for a period certain) and
for contracts that permit the Company or the insured to make changes in the
contract terms (such as universal life), premium deposits and benefit payments
are recorded as increases or decreases in a liability account rather than as
revenue and expense. Amounts charged against the liability account for the cost
of insurance, policy administration fees, surrender penalties and amortization
of policy initiation fees are recorded as revenues. Interest credited to the
liability account and benefit payments made in excess of the contract liability
account balance are charged to expense.
Reserves for traditional life insurance policy benefits are generally
calculated using the net level premium method and assumptions made at the time
the contract is issued (or in the case of policies acquired by purchase, at
purchase date) as to investment yields, mortality, withdrawals and other
assumptions based on projections of past experience modified as necessary to
reflect anticipated trends and include provisions for possible unfavorable
deviation. Policy benefit claims are charged to expense in the period that
claims are incurred.
For traditional insurance contracts, premiums are recognized as income
when due or, for short duration contracts, over the period to which the premiums
relate. Benefits and expenses are recognized as a level percentage of earned
premiums. Such recognition is accomplished through the provision for future
policy benefits and the amortization of the cost of policies produced.
Participating business is immaterial and dividends related to such business are
included as part of the policy reserves.
For investment contracts with mortality risk, but with premiums paid for
only a limited period (such as single-premium immediate annuities with benefits
paid for the life of the annuitant), the accounting treatment is similar to
traditional contracts. However, the excess of the gross premium over the net
premium is deferred and recognized in relation to the present value of expected
future benefit payments (when accounting for annuity contracts) or in relation
to insurance in force (when accounting for life insurance contracts).
Liabilities for incurred claims are determined using historical
experience and published tables for disabled lives and represent an estimate of
the present value of the remaining ultimate net cost of all reported and
unreported claims. Management believes these estimates are adequate. Such
estimates are reviewed continually and any adjustments are reflected in current
operations.
Accident and health insurance reserves are comprised of unearned premium
reserves computed on a pro rata basis, return of premium reserves and the
present value of amounts not yet due on long-term disability policies computed
on the same basis as life insurance.
Reinsurance
In the normal course of business, the Company seeks to limit its exposure
to loss on any single insured and to recover a portion of the benefits paid by
ceding reinsurance to other insurance enterprises or reinsurers under agreements
of indemnity reinsurance. The Company has set its retention limit on life
insurance policies at $.1 million.
Assets and liabilities related to insurance contracts are reported before
the effects of reinsurance. Reinsurance receivables and prepaid reinsurance
premiums (including amounts related to insurance liabilities) are reported as
assets. Estimated reinsurance receivables are recognized in a manner consistent
with the liabilities related to the underlying reinsured contracts.
38
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
Income Taxes
Income tax expense includes deferred income taxes arising from temporary
differences between the financial statement and income tax reporting basis of
assets and liabilities. Deferred income tax expense or benefit is based on the
changes in the deferred income tax asset or liability from period to period.
Additionally, the effect of a tax rate change on accumulated deferred income
taxes is reflected in income in the period in which the change is enacted.
In assessing the realization of deferred income tax assets, management
considers whether it is more likely than not that the deferred income tax assets
will be realized. The ultimate realization of deferred income tax assets is
dependent upon the generation of future taxable income during the periods in
which temporary differences become deductible. If future taxable income does not
occur as expected, deferred income tax assets may need to be written off.
Minority Interest
A charge is made against consolidated income representing the share of
earnings of Vulcan Life attributable to its minority interest. Shareholder's
equity attributable to the minority interest is shown separately on the
consolidated balance sheet.
Securities Segregated for the Future Redemption of Redeemable Preferred
Stock
Securities segregated for the future redemption of redeemable preferred
stock are reported at amortized cost. The Company has the positive intent and
ability to hold these securities until maturity. See note 7 for a description of
these securities and the redeemable preferred stock.
Derivative Financial Instruments
The Company's use of derivative financial instruments is primarily
limited to S&P 500 Index Options. The Company buys these options in order to
offset changes in policyholder liabilities resulting from certain policy
benefits tied to the S&P 500 Index. The Company buys these options at the time
it issues the related annuity contracts, with similar maturity dates and benefit
features which fluctuate as the value of the options change. Accordingly,
changes in the value of the options are offset by changes to policyholder
liabilities; such changes are reflected in the consolidated statement of
operations. The credit risk associated with these options is considered low
because such options are purchased from strong creditworthy parties. Both the
carrying value and fair value of these contracts were $7.2 million at December
31, 1996. Such instruments are classified as other invested assets.
Business Segments
The Company operates in the single business segment of providing
individual life insurance and annuity coverage within the United States.
Fair Values of Financial Instruments
The following methods and assumptions are used by the Company in
determining estimated fair values of financial instruments:
Investment securities: The estimated fair values for fixed maturity
securities (including redeemable preferred stocks) and equity securities are
based on quotes from independent pricing services, where available. For
investment securities for which such quotes are not available, the estimated
fair values are determined using values obtained from broker-dealer market
makers or, by discounting expected future cash flows using current market
interest rates applicable to the yield, credit quality and, for fixed
maturity securities, the maturity of the investments.
Credit-tenant loans, mortgage loans and policy loans: The estimated fair
values of these loans are determined by discounting future expected cash
flows using interest rates currently being offered for similar loans to
borrowers with similar credit ratings. Loans with similar characteristics
are aggregated for purposes of the calculations.
39
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
Short-term investments: The estimated fair values for short-term investments
are based on quoted market prices. The carrying amount reported in the
consolidated balance sheet for these instruments approximates their estimated
fair value.
Other invested assets: The estimated fair value of these assets, which are
not material, have been assumed to be equal to carrying value.
Securities segregated for the future redemption of redeemable preferred
stock: Estimated fair values of the U.S. Treasury securities held in escrow
for the future redemption of redeemable preferred stock are based on quoted
market prices.
Insurance liabilities for investment contracts: The estimated fair values of
the Company's liabilities under investment-type insurance contracts are
determined using discounted cash flow calculations using interest rates
currently being offered for similar contracts with maturities consistent with
those remaining for the contracts being valued.
Investment borrowings: Due to the short-term nature of these borrowings
(terms generally less than 30 days), estimated fair values are assumed to
approximate the carrying amount reported in the consolidated balance sheet.
Notes payable: The estimated fair value of variable rate notes payable
approximates their par value. The estimated fair value of fixed rate notes
payable is based on quoted market prices.
Redeemable preferred stock: The estimated fair value of the Company's
publicly-traded redeemable preferred stock is based on quoted market prices.
The estimated fair value of the Company's privately placed redeemable
preferred stock is determined by discounting expected future cash flows using
assumed incremental dividend rates for similar duration securities.
40
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
The estimated fair values of the Company's financial instruments are as
follows:
<TABLE>
<CAPTION>
1996 1995
---------------------- -----------------------
Carrying Fair Carrying Fair
amount value amount value
------ ----- ------ -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Financial assets:
Fixed maturities......................................... $5,215.5 $5,215.5 $5,083.1 $5,083.1
Equity securities........................................ 6.5 6.5 18.8 18.8
Mortgage loans........................................... 58.5 60.8 64.6 74.0
Credit-tenant loans...................................... 37.1 37.7 13.6 14.5
Policy loans............................................. 63.9 63.9 62.9 62.9
Short-term investments................................... 15.4 15.4 107.8 107.8
Other invested assets.................................... 59.3 59.3 18.2 18.2
Securities segregated for the future redemption
of redeemable preferred stock........................ 45.6 49.1 39.2 50.1
Financial liabilities:
Insurance liabilities for investment contracts (1)....... $4,972.2 $4,972.2 $4,716.4 $4,716.4
Investment borrowings.................................... 186.5 186.5 130.7 130.7
Notes payable............................................ 158.1 171.2 267.5 284.8
Redeemable preferred stock............................... 103.5 103.5 99.0 94.0
<FN>
(1) The estimated fair values of the insurance liabilities for
investment contracts were approximately equal to their carrying
value at December 31, 1996 and 1995, because interest rates
credited on the vast majority of account balances approximate
current rates paid on similar contracts and are not generally
guaranteed beyond one year. Fair values for the Company's
insurance liabilities other than those for investment contracts
are not required to be disclosed. However, the estimated fair
values of liabilities for all insurance contracts are taken into
consideration in the Company's overall management of interest rate
risk, which minimizes exposure to changing interest rates through
the matching of investment maturities with amounts due under
insurance contracts.
</FN>
</TABLE>
2. INVESTMENTS
At December 31, 1996, the amortized cost and estimated fair value of
actively managed fixed maturity investments were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
(Dollars in millions)
<S> <C> <C> <C> <C>
United States Treasury securities................................ $ 49.7 $ 1.9 $ - $ 51.6
Obligations of states and political subdivisions................. 32.8 1.4 - 34.2
Foreign government obligations................................... 21.7 .1 .5 21.3
Public utility securities........................................ 739.5 29.3 .5 768.3
Other corporate securities....................................... 2,759.0 63.8 12.3 2,810.5
Mortgage-backed securities....................................... 1,496.9 35.6 2.9 1,529.6
--------- ------ ----- --------
$5,099.6 $132.1 $16.2 $5,215.5
======== ====== ===== ========
</TABLE>
41
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
At December 31, 1995, the amortized cost and estimated fair value of
actively managed fixed maturity investments were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---- ----- ------ -----
(Dollars in millions)
<S> <C> <C> <C> <C>
United States Treasury securities................................ $ 95.0 $ 7.8 $ - $ 102.8
Obligations of states and political subdivisions................. 22.2 1.4 - 23.6
Foreign government obligations................................... 33.1 .7 1.7 32.1
Public utility securities........................................ 821.5 104.1 .2 925.4
Other corporate securities....................................... 2,304.6 189.9 11.9 2,482.6
Mortgage-backed securities....................................... 1,390.9 126.7 1.0 1,516.6
-------- ------ ----- --------
$4,667.3 $430.6 $14.8 $5,083.1
======== ====== ===== ========
</TABLE>
The following table sets forth the amortized cost and estimated fair
value of fixed maturities at December 31, 1996, based upon the pricing source
used to determine the estimated fair value:
<TABLE>
<CAPTION>
Estimated
Amortized fair
cost value
---- -----
(Dollars in millions)
<S> <C> <C>
Nationally recognized pricing services.................................................... $4,302.6 $4,411.7
Broker-dealer market makers............................................................... 715.0 722.3
Internally developed methods (calculated based on a weighted-average
current market yield of 8.8 percent).................................................... 82.0 81.5
-------- --------
Total fixed maturities................................................................ $5,099.6 $5,215.5
======== ========
</TABLE>
42
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
The following table sets forth fixed maturity investments at December 31,
1996, classified by rating categories. The category assigned is the highest
rating by a nationally recognized statistical rating organization or, as to
$41.1 million fair value of fixed maturities not rated by such firms, the rating
assigned by the National Association of Insurance Commissioners ("NAIC"). For
the purposes of this table, NAIC Class 1 is included in the "A" rating; Class 2,
"BBB-"; and Class 3, "BB-"; and Classes 4-6, "B+ and below."
<TABLE>
<CAPTION>
Percent of Percent of
Investment rating fixed maturities total investments
----------------- ---------------- -----------------
<S> <C> <C>
AAA............................. 32% 31%
AA.............................. 11 10
A............................... 28 27
BBB+............................ 11 10
BBB............................. 10 10
BBB-............................ 4 4
--- ---
Investment grade............. 96 92
--- ---
BB+............................. 1 1
BB.............................. 1 1
BB-............................. 1 1
B+ and below.................... 1 1
--- ---
Below investment grade....... 4 4
--- ---
Total fixed maturities....... 100% 96%
=== ==
</TABLE>
At December 31, 1996, the Company's below investment grade corporate
fixed maturities had an amortized cost of $187.8 million and an estimated fair
value of $191.7 million. For substantially all of these securities, the
amortized cost exceeded the fair value by less than 5 percent or the fair value
of the securities exceeded amortized cost. During the three months ended
December 31, 1996, the year ended December 31, 1995 and the nine months ended
September 30, 1994, the Company recorded realized losses for investment
writedowns of $1.5 million, $7.1 million and $1.2 million, respectively, as a
result of changes in the financial condition of an issuer and changes in the
value of underlying collateral, which caused the Company to conclude that a
decline in fair value of such investments was other than temporary. There were
no such realized losses in the nine months ended September 30, 1996, or the
three months ended December 31, 1994. The Company had no fixed maturity
investments in technical or substantive default as of December 31, 1996. As of
December 31, 1996, there were no fixed maturity investments about which the
Company had serious doubts as to the ability of the issuer to comply with the
contractual terms of their obligations on a timely basis. Investment income
forgone due to defaulted securities was $.2 million, $.7 million and $.5 million
for the three months ended December 31, 1996, the nine months ended September
30, 1996, and the year ended December 31, 1995, respectively. There was no
forgone investment income in the 1994 periods.
43
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
The following table sets forth the amortized cost and estimated fair
value of fixed maturity securities at December 31, 1996, by contractual
maturity. Actual maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties and because most mortgage-backed securities provide for
periodic payments throughout their lives.
<TABLE>
<CAPTION>
Estimated
Amortized fair
cost value
---- -----
(Dollars in millions)
<S> <C> <C>
Due in one year or less............................................................... $ 100.5 $ 101.1
Due after one year through five years................................................. 669.0 680.5
Due after five years through ten years................................................ 1,123.1 1,140.3
Due after ten years................................................................... 1,710.1 1,764.0
--------- --------
Subtotal.......................................................................... 3,602.7 3,685.9
Mortgage-backed securities............................................................ 1,496.9 1,529.6
--------- --------
Total actively managed fixed maturities .......................................... $5,099.6 $5,215.5
======== ========
</TABLE>
Net investment income consisted of the following:
<TABLE>
<CAPTION>
Three months Nine months Three months Nine months
ended ended Year ended ended ended
December 31, September 30, December 31, December 31, September 30,
1996 1996 1995 1994 1994
---- ---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C> <C>
Fixed maturities...................... $ 99.9 $294.4 $398.8 $90.7 $237.5
Equity securities..................... .3 1.4 1.7 .3 1.4
Mortgage loans ....................... 1.6 4.8 6.9 1.8 5.1
Policy loans.......................... 1.1 3.1 4.0 1.0 2.9
Short-term investments................ .6 2.7 6.5 1.5 3.0
Other................................. .5 3.5 2.2 .7 1.7
------- ------ ------ ----- ------
Gross investment income............. 104.0 309.9 420.1 96.0 251.6
Less investment expenses.............. 1.4 3.5 4.6 3.3 3.2
------- ------ ------ ----- ------
Net investment income............... $102.6 $306.4 $415.5 $92.7 $248.4
====== ====== ====== ===== ======
</TABLE>
Proceeds from sales of fixed maturity investments were $1,449.2 million,
$1,038.6 million, $2,822.1 million, $502.0 million and $603.8 million for the
three months ended December 31, 1996, the nine months ended September 30, 1996,
the year ended December 31, 1995, the three months ended December 31, 1994, and
the nine months ended September 30, 1994, respectively.
44
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
Net investment gains (losses) included in revenues were as follows:
<TABLE>
<CAPTION>
Three months Nine months Three months Nine months
ended ended Year ended ended ended
December 31, September 30, December 31, December 31, September 30,
1996 1996 1995 1994 1994
---- ---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C> <C>
Fixed maturities:
Gross gains.................................. $13.8 $ 25.5 $165.2 $ 1.8 $ 18.0
Gross losses................................. (.5) (10.7) (1.8) (.9) (11.6)
Other than temporary decline in fair value... - - (7.1) - -
----- ------ ------ ----- ------
Net investment gains from fixed maturities 13.3 14.8 156.3 .9 6.4
Equity securities, net gains (losses).......... - 1.5 1.1 (.1) .3
Other than temporary decline in fair value
of equity securities......................... (1.5) - - - (1.2)
Mortgage loans................................. (.2) - - - (.1)
Interest rate swap contracts................... - - - - (21.3)
Other.......................................... .9 - .3 (.4) (.3)
----- ------ ------ ------ ------
Net investment gains (losses)
before expenses.................. 12.5 16.3 157.7 .4 (16.2)
Less investment gain expenses.................. 2.1 6.4 8.4 - -
------ ------ ------ ------ ------
Net investment gains (losses)............. $10.4 $ 9.9 $149.3 $ .4 $(16.2)
===== ======= ====== ====== ======
</TABLE>
45
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
Changes in unrealized appreciation (depreciation) of investments were as
follows:
<TABLE>
<CAPTION>
Three months Nine months Three months Nine months
ended ended Year ended ended ended
December 31, September 30, December 31, December 31, September 30,
1996 1996 1995 1994 1994
---- ---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C> <C>
Fixed maturities carried at amortized cost. $ - $ - $ - $ - $(315.2)
======= ======= ======= ====== =======
Investments carried at fair value:
Actively managed fixed maturities ....... $ 73.4 $(351.2) $459.7 $(43.9) $(249.7)
Equity securities........................ - (.7) 3.1 (.8) (1.2)
Other invested assets.................... (2.0) - (.1) - -
------ ------- ------ ------ ------
71.4 (351.9) 462.7 (44.7) (250.9)
Adjustment for effect on other balance
sheet accounts:
Cost of policies purchased.......... (30.8) 77.6 (93.6) - -
Cost of policies produced........... (2.1) 17.0 (22.3) - 17.9
Income tax assets (liabilities)..... (13.5) 98.2 (121.4) 15.7 81.0
------ ------- ------ ------- -------
25.0 (159.1) 225.4 (29.0) (152.0)
Adjustment of balance due to adoption
of new basis............................. - (23.0) - - -
Elimination of balance pursuant to
Acquisition.............................. - - - - 152.3
------- ------- ------ -------- -------
Change in unrealized appreciation
(depreciation) of investments
carried at fair value............... $ 25.0 $(182.1) $225.4 $(29.0) $ .3
====== ======= ====== ====== ======
</TABLE>
At December 31, 1996, net unrealized appreciation of equity securities
(before income taxes) was $.7 million, consisting of $.7 million of gross
appreciation and no depreciation.
The following table sets forth the par value, amortized cost and estimated
fair value of mortgage-backed securities including CMOs at December 31, 1996,
summarized by interest rates on the underlying collateral at December 31, 1996:
<TABLE>
<CAPTION>
Par Amortized Estimated
value cost fair value
----- ---- ----------
(Dollars in millions)
<S> <C> <C> <C>
Below 7 percent..................................................... $ 411.8 $ 386.4 $ 392.4
7 percent - 8 percent............................................... 955.8 898.9 919.3
8 percent - 9 percent............................................... 175.0 166.1 172.3
9 percent and above................................................. 51.2 45.5 45.6
-------- -------- --------
Total mortgage-backed securities............................... $1,593.8 $1,496.9 $1,529.6
======== ======== ========
</TABLE>
46
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
The amortized cost and estimated fair value of mortgage-backed securities
including CMOs at December 31, 1996, summarized by type of security were as
follows:
<TABLE>
<CAPTION>
Estimated fair value
------------------------
% of
Amortized fixed
Type cost Amount maturities
- ---- ---- ------ ----------
(Dollars in millions)
<S> <C> <C> <C>
Pass-throughs and sequential and targeted amortization classes............. $1,075.6 $1,095.4 21%
Support classes............................................................ 105.7 110.2 2
Accrual (Z tranche) bonds.................................................. 22.7 23.8 1
Planned amortization classes and accretion directed bonds.................. 171.9` 175.9 3
Subordinated classes....................................................... 121.0 124.3 2
-------- -------- --
$1,496.9 $1,529.6 29%
======== ======== ==
</TABLE>
At December 31, 1996, approximately 83 percent of the estimated fair
value of the Company's mortgage-backed securities was determined by nationally
recognized pricing services, 14 percent was determined by broker-dealer market
makers and 3 percent was determined by internally developed methods.
The Company's mortgage loans are primarily commercial loans, including
retail, multifamily residential, office, industrial, nursing home, restaurant
and other properties. Approximately 19 percent, 12 percent, 12 percent, 10
percent and 9 percent of the mortgage loan balance was on properties located in
Minnesota, Florida, Iowa, California and Arizona, respectively. No other state
comprised greater than 8 percent of the mortgage loan balance. Less than 1
percent of the mortgage loan balance was noncurrent at December 31, 1996. The
Company had a loan loss reserve of $.3 million at December 31, 1996.
As part of its investment strategy, the Company enters into reverse
repurchase agreements and dollar roll transactions to increase its return on
investments and improve its liquidity. Reverse repurchase agreements involve a
sale of securities and an agreement to repurchase the same securities at a later
date at an agreed upon price. Dollar rolls are similar to reverse repurchase
agreements except that the repurchase involves securities that are only
substantially the same as the securities sold. These transactions are accounted
for as short-term collateralized borrowings. Such borrowings averaged
approximately $81.4 million during 1996 and were collateralized by investment
securities with fair values approximately equal to the loan value. The weighted
average interest rate on short-term collateralized borrowings was 5.6 percent in
1996. The primary risk associated with short-term collateralized borrowings is
that the counterparty will be unable to perform under the terms of the contract.
The Company's exposure is limited to the excess of the net replacement cost of
the securities over the value of the short-term invesments (which was not
material at December 31, 1996). The Company believes that the counterparties to
its reverse repurchase and dollar roll agreements are financially responsible
and that the counterparty risk is minimal.
Life insurance companies are required to maintain certain amounts of
assets on deposit with state regulatory authorities. Such assets had an
aggregate carrying value of $11.4 million at December 31, 1996.
The Company had no investments in any single entity in excess of 10
percent of shareholder's equity at December 31, 1996, other than investments
issued or guaranteed by the United States government or a United States
government agency.
47
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
3. INSURANCE LIABILITIES
Insurance liabilities consisted of the following:
<TABLE>
<CAPTION>
Interest
Withdrawal Mortality rate December 31,
assumption assumption assumption 1996 1995
---------- ---------- ---------- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C> <C>
Future policy benefits:
Investment contracts......................... N/A N/A (b) $4,881.3 $4,716.4
Limited-payment contracts.................... None (a) 7% 36.4 8.1
Traditional life insurance contracts......... Company (a) 4% 72.7 87.0
experience
Universal life-type contracts................ N/A N/A (b) 235.5 234.2
Individual accident and health............... Company Company 6% 6.7 7.2
experience experience
Group life and health....................... N/A N/A N/A 3.2 3.3
Other policyholders' funds and claims payable ... N/A N/A N/A 106.5 92.5
-------- --------
Total insurance liabilities.............. $5,342.3 $5,148.7
======== ========
<FN>
(a) Principally modifications of the 1965 - 70 Basic, Select and Ultimate Tables.
(b) This balance represents account balances because future benefits are not guaranteed.
</FN>
</TABLE>
4. REINSURANCE
Reinsurance contracts do not relieve the Company from its obligations to
its policyholders. The Company remains contingently liable to its policyholders
for the portion reinsured to the extent that the reinsuring companies do not
meet their obligations assumed under the reinsurance agreements. At December 31,
1996, the total reinsurance receivable of $13.7 million, included $7.7 million
from an insurance company that is not rated by A.M. Best Company, because
(according to A.M. Best) it did not have sufficient operating history to
evaluate its performance. No other balance from a single reinsurer exceeded $1.2
million. Ceded reinsurance premiums deducted from premiums and policy fund
charges were $1.5 million, $7.5 million, $6.0 million, $1.2 million and $3.9
million for the three months ended December 31,1996, the nine months ended
September 30, 1996, the year ended December 31, 1995, the three months ended
December 31, 1994 and the nine months ended September 30, 1994, respectively.
5. INCOME TAXES
Income tax assets (liabilities) were comprised of the following:
<TABLE>
<CAPTION>
December 31,
1996 1995
---- ----
(Dollars in millions)
<S> <C> <C>
Deferred income tax assets (liabilities):
Cost of policies purchased, cost of policies produced and policy initiation fees............... $(125.1) $(100.7)
(Increase) reduction in reported values of investments not currently deductible for tax........ 9.5 (54.1)
Insurance liabilities.......................................................................... 109.3 101.6
Net operating loss carryforwards............................................................... 10.4 9.7
Other.......................................................................................... (1.2) 5.1
------- -------
Deferred income tax assets (liabilities)............................................... 2.9 (38.4)
Current income tax liabilities..................................................................... (.7) (2.2)
------- -------
Income tax assets (liabilities)........................................................ $ 2.2 $ (40.6)
======= =======
</TABLE>
48
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
The $2.9 million deferred income tax asset at December 31, 1996, is net
of $21.6 million which is attributed to the effect of the fair value adjustment
to actively managed fixed maturities pursuant to SFAS 115.
Income tax expense was as follows:
<TABLE>
<CAPTION>
Three months Nine months Three months Nine months
ended ended Year ended ended ended
December 31, September 30, December 31, December 31, September 30,
1996 1996 1995 1994 1994
---- ---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C> <C>
Current income tax provision............... $2.1 $ 5.1 $ 9.0 $(8.5) $ 9.3
Deferred income tax provision.............. 6.3 19.8 42.9 13.6 .3
----- ----- ------ ----- -----
Income tax expense.................... $8.4 $24.9 $51.9 $ 5.1 $ 9.6
==== ===== ===== ===== =====
</TABLE>
Federal income tax expense differed from that computed at the applicable
federal statutory income tax rate (35 percent for all periods) for the following
reasons:
<TABLE>
<CAPTION>
Three months Nine months Three months Nine months
ended ended Year ended ended ended
December 31, September 30, December 31, December 31, September 30,
1996 1996 1995 1994 1994
---- ---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C> <C>
Tax on income before income taxes at
statutory rate........................... $7.0 $22.7 $48.8 $4.3 $10.3
Nondeductible items........................ .4 3.0 3.2 .8 .2
Other...................................... 1.0 (.8) (.1) - (.9)
----- ------ ----- ---- -----
Income tax expense................ $8.4 $24.9 $51.9 $5.1 $ 9.6
==== ===== ===== ==== =====
</TABLE>
The Company files a consolidated federal income tax return with ALH and
all subsidiaries of ALH. The Company reports income tax expense as allocated
under a consolidated tax allocation agreement. Generally this allocation results
in profitable companies recognizing an income tax provision as if the individual
company filed a separate income tax return and loss companies recognizing
benefits to the extent their losses contributed to reduce consolidated income
taxes. At December 31, 1996, the Company has net operating loss carryforwards of
$29.6 million which expire in 1999 through 2010. These loss carryforwards relate
to the operations of the parent company and the Company's marketing subsidiary,
American Life and Casualty Marketing Division Co. ("ALMD"). Utilization of the
operating loss carryforwards to offset taxable income of the life insurance
subsidiaries is limited under existing federal income tax rules and regulations.
49
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
6. NOTES PAYABLE
Notes payable are summarized as follows:
<TABLE>
<CAPTION>
Interest rate 1996 1995
------------- ---- ----
(Dollars in millions)
<S> <C> <C> <C>
Senior subordinated notes.............................. 11.25% $150.0 $150.0
Senior credit facility................................. - - 125.0
------ ------
Total principal amount.......................... 150.0 275.0
Unamortized net premium (discount)..................... 8.1 (7.5)
------ ------
Total........................................... $158.1 $267.5
====== ======
</TABLE>
In connection with the financing of the Acquisition, the Company issued
$150 million of senior subordinated notes in a public offering. The senior
subordinated notes bear interest at 11.25 percent, payable semiannually and will
mature on September 15, 2004. Such notes are unsecured and are subordinated in
right of payment to the prior payment in full of all senior indebtedness (as
defined in the indenture for the subordinated notes). The notes are redeemable
at the Company's option, in whole or in part, at any time on or after September
15, 1999, initially at 105.625 percent of their principal amount, plus accrued
interest, declining to 100 percent of their principal amount, plus accrued
interest, on or after September 15, 2001. At the date of Acquisition, the senior
subordinated notes were recorded net of $6.6 million of debt issuance costs. In
connection with the ALH Stock Purchase, Conseco guaranteed the Company's
obligations under its senior subordinated notes due in 2004. At December 31,
1996, senior subordinated notes with a principal balance and carrying value of
$51.9 million and $54.7 million, respectively, were held by subsidiaries of
Conseco. In the first three months of 1997, subsidiaries of Conseco purchased
$76.1 million par value of the Company's senior subordinated notes for
approximately $87.1 million.
The indenture governing the senior subordinated notes contains a waiver
of any rights, claims or interests in the securities held in escrow for the
benefit of the holders of the Company's redeemable preferred stock and contain
certain covenants, which among other things: (i) require the maintenance of
specified statutory capital and surplus, ratings, and financial and other ratios
by the Company and its subsidiaries; (ii) limit the incurrence of additional
indebtedness, the payment of dividends by the Company and its subsidiaries and
investments in certain types of investments including non-investment grade
securities and certain classes of collateralized mortgage obligations; and (iii)
restrict transfers of funds from American Life and Casualty to the Company. In
addition, the occurrence of a change of control (as defined) would accelerate
the repayment of the Senior Credit Facility and senior subordinated notes at the
holders' option.
Effective September 30, 1996, the Company repaid the $125.0 million
principal balance outstanding under the Senior Credit Facility using the
proceeds from a $125.0 million capital contribution received from ALH. As a
result of the repayment, the Company recognized an extraordinary charge of $.8
million, net of an income tax benefit of $.5 million. In 1995, the Company
recognized an extraordinary charge of $4.0 million (net of a $2.2 million income
tax benefit) when the proceeds from the Senior Credit Facility were used to
repay the existing term loan.
7. SERIES PREFERRED STOCK
The Board of Directors has authorized the Company to issue 4,160,000
shares of Series Preferred Stock, par value $.01, from time to time in one or
more series and to fix the number of shares, designations, voting powers (if
any), and other terms of each series. Each series shall be distinctly designated
and, except as otherwise stated, shall rank equally and be identical in all
respects.
$2.16 Redeemable Cumulative Preferred Stock
In August 1992, the Company issued 2.8 million shares of $2.16 Redeemable
Cumulative Preferred Stock (the "$2.16 preferred shares") at a public offering
price of $25 per share. A portion of the net proceeds were used to purchase
$69.0 million face amount of zero coupon United States Treasury securities
maturing in August 2007. These securities have been placed in an escrow account
to be used for the future redemption of the $2.16 preferred shares on or before
their mandatory redemption date in 2007.
50
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
The $2.16 preferred shares are entitled to annual cumulative cash
dividends of $2.16 per share, payable quarterly. The Company may, at its option,
redeem the $2.16 preferred shares in whole or in part, at any time after five
years from date of issue initially at $26.25 per share and declining to $25.00
per share on or after September 30, 2000, plus cumulative unpaid dividends. The
$2.16 preferred shares are mandatorily redeemable by the Company on September
30, 2007 at a redemption price of $25 per share, plus cumulative unpaid
dividends. In liquidation, the $2.16 preferred stockholders are entitled to $25
per share (aggregate $69.0 million) plus cumulative unpaid dividends before any
distributions shall be made to common shareholders.
The $2.16 preferred shares rank on parity with the other Series Preferred
Stock shares with respect to dividends and distributions except that in the
event of liquidation, they rank senior to all other preferred stock of the
Company now or hereafter existing with respect to the distribution of assets
held in the escrow account for the future redemption of the $2.16 preferred
shares and on parity with the $2.32 preferred shares (as defined herein) and
senior to all other preferred stock of the Company now or hereafter existing
with respect to the distribution of assets held in the separate escrow account
for the future redemption of the $2.32 preferred shares.
The $2.16 preferred shares are non-voting except as required by the
Delaware General Corporation Law and except that whenever cumulative dividends
on the $2.16 preferred shares aggregating an amount equal to eight or more full
quarterly dividends are in arrears, the authorized number of directors will be
increased by two and the holders of the $2.16 preferred shares and the $2.32
preferred shares (if eligible to vote as discussed hereafter), voting as a
single class, will have the right to elect two directors. The $2.16 preferred
shares are not convertible.
$2.32 Redeemable Cumulative Preferred Stock
In February 1993, the Company issued 1.2 million shares of $2.32
Redeemable Cumulative Preferred Stock (the "$2.32 preferred shares") at an issue
price of $25 per share (aggregate $30.0 million) in exchange for all of the
Company's then outstanding 11.5 percent subordinated debentures which were
retired. At that time, the Company purchased $30.0 million face amount of zero
coupon United States Treasury securities maturing in February 2008. These
securities have been placed in an escrow account to be used for the future
redemption of the $2.32 preferred shares on or before their mandatory redemption
date in 2008.
The $2.32 preferred shares are entitled to annual cumulative cash
dividends of $2.32 per share, payable quarterly. The Company may, at its option,
redeem the $2.32 preferred shares in whole or in part, at any time after five
years from date of issue initially at $26.25 per share and declining to $25.00
per share on or after February 1, 2001, plus cumulative unpaid dividends. The
$2.32 preferred shares are mandatorily redeemable by the Company on February 15,
2008 at a redemption price of $25 per share, plus cumulative unpaid dividends.
In liquidation, the $2.32 preferred stockholders are entitled to $25 per share
(aggregate $30.0 million) plus cumulative unpaid dividends before any
distributions shall be made to common shareholders.
The $2.32 preferred shares rank on parity with the other Series Preferred
Stock shares with respect to dividends and distributions except that in the
event of liquidation, they rank junior to the $2.16 preferred shares with
respect to the distribution of assets held in the escrow account for the future
redemption of the $2.16 preferred shares and on parity with the $2.16 preferred
shares and senior to all other preferred stock of the Company now or hereafter
existing with respect to the distribution of assets held in the separate escrow
account for the future redemption of the $2.32 preferred shares.
The $2.32 preferred shares are non-voting except as required by the
Delaware General Corporation Law and except, that, whenever cumulative dividends
on the $2.32 preferred shares aggregating an amount equal to eight or more full
quarterly dividends are in arrears, the authorized number of directors will be
increased by two and the holders of the $2.32 preferred shares and the $2.16
preferred shares (if eligible to vote as discussed above), voting as a single
class, will have the right to elect two directors. The $2.32 preferred shares
are not convertible.
At December 31, 1996, a subsidiary of Conseco held 260,000 of the $2.32
preferred shares with a carrying value of $6.5 million. In March 1997, Conseco
purchased all $2.32 preferred shares it did not previously own for approximately
$25.9 million. Such shares had a carrying value of $25 million at December 31,
1996.
51
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
8. PAYABLE TO ALH UPON DETERMINATION OF SAVINGS BANK LITIGATION
ALH and American Life and Casualty (the "plaintiffs") have filed suit in
the United States Court of Federal Claims (the "Court of Federal Claims")
against the United States of America for breach of certain contractual
agreements which were made by certain former government regulatory agencies to
induce the plaintiffs to capitalize their former savings bank subsidiary (the
"Savings Bank") in connection with the acquisition of four failed thrift
institutions in March 1988 and the subsequent seizure of the Savings Bank by the
Office of Thrift Supervision in July 1990 (the "Savings Bank Litigation"). In
the Savings Bank Litigation, the plaintiffs claim that the defendant breached
its contractual agreements with respect to regulatory capital and contends that
this breach, which resulted in the disallowance of $21 million of capital which
the defendant contractually promised would be perpetual for regulatory
accounting purposes, and such subsequent seizure, constitutes a taking of the
plaintiffs' property without just compensation and due process of law, in
violation of the Fifth Amendment of the United States Constitution.
The Savings Bank Litigation seeks monetary damages from the government
including recovery of: (i) the Company's investment in the Savings Bank of
143,640 shares of ALH's 1988 Series Preferred Stock and $8.4 million of cash;
and (ii) compensation for costs incurred and the value of benefits conferred on
the defendant through the plaintiffs' purchase, operation and management of the
Savings Bank. Total restitution sought by the plaintiffs exceeds $30 million.
On July 24, 1992, the Court of Federal Claims granted the plaintiffs'
motion for summary judgment as to the defendant's liability for breach of
contract in the Savings Bank Litigation. The court also consolidated this case
with two others and certified these cases for interlocutory appeal to the United
States Court of Appeals for the Federal Circuit (the "Court of Appeals").
Subsequently, the Court of Appeals entered a judgment reversing the order of the
Court of Federal Claims by a decision of two to one and the plaintiffs filed a
Petition for Rehearing with Suggestion for Rehearing in Banc (the "Rehearing
Petition") with the Court of Appeals. On August 18, 1993, the Court of Appeals
accepted the Rehearing Petition, vacated the judgment which was entered in favor
of the defendant and withdrew its opinion accompanying the judgment. On August
30, 1995, the Court of Appeals, in banc, affirmed the summary judgment of the
Court of Federal Claims in the plaintiffs' favor by a decision of nine to two.
On July 1, 1996, the Supreme Court affirmed the summary judgment of the Court of
Federal Claims in the plaintiffs' favor by a decision of seven to two. A trial
has been scheduled for May 1997, in the Court of Federal Claims to determine
damages related to the breach of contract by the United States of America.
In conjunction with the Acquisition, each common or equivalent share of
ALH outstanding immediately prior to the Acquisition received a Contingent
Payment Right, designed to provide holders with certain financial benefits that
the plaintiffs may receive from a favorable determination of the Savings Bank
Litigation. If the rights of the holder of the 1988 Series Preferred Stock were
not an issue in the Savings Bank Litigation, the 1988 Series Preferred Stock was
convertible into approximately $30.1 million in conjunction with the
Acquisition.
If the Savings Bank Litigation results in the return of the 1988 Series
Preferred Stock to ALH, the $30.1 million amount referred to above will be
payable to the holders of the Contingent Payment Rights, together with any money
damages recovered by the plaintiffs, subject to certain adjustments and
limitations. If, however, the plaintiffs are unsuccessful in the Savings Bank
Litigation, the $30.1 million amount will instead become payable to the holder
of the 1988 Series Preferred Stock upon the conversion thereof or as otherwise
directed by the court. Since the timing of a final determination of the Savings
Bank Litigation is uncertain, the plaintiffs are unable to predict when such
$30.1 million amount will become payable.
A liability to ALH of $30.1 million was established at the Acquisition
date representing the consideration that would be payable by ALH to either the
holder of the 1988 Series Preferred Stock or to ALH's other former shareholders.
9. COMMON SHAREHOLDER'S EQUITY
The Board of Directors has authorized the Company to issue 1,600,000
shares of common stock, par value $.01. There were 1,500,100 shares issued and
outstanding for all periods presented in the consolidated financial statements.
All of the outstanding common stock is owned by ALH. The Company paid a cash
dividend of $153.0 million on its common stock to ALH in connection with the
Acquisition.
52
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
In the fourth quarter of 1995, the Company received a $30.0 million
capital contribution from ALH. Also, in connection with the ALH Stock Purchase,
the Company received a $125.0 million capital contribution from ALH effective
September 30, 1996. The proceeds were used to repay amounts outstanding under
the Senior Credit Facility as discussed in note 6.
10. OTHER DISCLOSURES
Related Party Transactions
In 1994, the Company paid $4.0 million to a subsidiary of Conseco for
services provided in connection with the financings related to the Acquisition.
Since the Acquisition, the Company and certain of its subsidiaries have
received services from or shared expenses with subsidiaries of Conseco under
written agreements or based on cost allocation principles in accordance with
GAAP, including investment advisory agreements which provide investment
management and related accounting and reporting services. Fees charged under all
such arrangements totaled $7.7 million, $11.2 million, $14.1 million and $2.5
million for the three months ended December 31, 1996, the nine months ended
September 30, 1996, the year ended December 31, 1995, and the three months ended
December 31, 1994, respectively.
Litigation
See note 8 for a description of the Savings Bank Litigation.
ALH, Vulcan Life and certain of its independent agents have been named as
defendants in litigation in the state of Alabama concerning life insurance
products sold to school teachers in the late 1980's. The cases are: (i) Sentell,
et al. v. Vulcan Life Insurance Company et al., filed in the Circuit Court for
Pickens County, Alabama, on August 22, 1994; (ii) Rembert, et al. v. Vulcan Life
Insurance Company et al., filed on June 29, 1995, and pending in the Circuit
Court of Marengo County, Alabama; (iii) Baldwin et al. v. Vulcan Life Insurance
Company et al., filed on July 6, 1995, and pending in the Circuit Court of
Marengo County, Alabama; (iv) Thomas, et al., v. Charley, et al., filed in the
Circuit Court of Wilcox County, Alabama on or about December 20, 1994; (v)
Wheeler v. Vulcan Life Insurance Company, et al., filed in the Circuit Court in
Lamar County, Alabama on May 18, 1995; and (vi) Pitts, et al. v. Vulcan Life
Insurance Company et al., filed in June 1996 in the Circuit Court in Lamar
County, Alabama (all cases are referred to herein as the "Vulcan Life
Litigation"). The plaintiffs in the Vulcan Life Litigation allege, among other
things, that the agent defendants misrepresented that the life products were
part of an employee benefit plan and that such plan would pay the premiums for
their policies although, under the Code, life insurance products may not be
purchased through such a plan. The plaintiffs allege that they purchased the
life insurance products because of such alleged misrepresentations. The
plaintiffs have requested an award of compensatory and punitive damages of
unspecified amounts. The defendants have denied any liability and have raised
numerous defenses including the statute of limitations.
The Company's subsidiaries are involved in various pending or threatened
legal proceedings arising from the conduct of their businesses. These
proceedings in some instances include claims for punitive damages and similar
types of relief in unspecified or substantial amounts, in addition to amounts
for alleged contractual liability or claims for equitable relief. In
management's opinion, after consultation with counsel and review of available
facts, these proceedings will ultimately be resolved without materially
affecting the Company's financial condition or results of operations.
Guaranty Fund Assessments
From time to time, mandatory assessments are levied on the Company's
insurance subsidiaries by life and health guaranty associations of most states
in which these subsidiaries are licensed to cover losses to policyholders of
insolvent or rehabilitated insurance companies. The associations levy
assessments (up to prescribed limits) on all insurers in a particular state in
order to pay claims on the basis of the proportionate share of premiums written
by insurers in the lines of business in which the insolvent or rehabilitated
insurer are engaged. These assessments may be deferred or forgiven in certain
states if they would threaten an insurer's financial strength and, in some
states, these assessments can be partially recovered through a reduction in
future premium taxes. Assessments levied against the Company's insurance
subsidiaries and charged to expense were $.5 million in 1996, $.2 million in
1995 and $2.0 million in 1994. The balance sheet at December 31, 1996, includes
a liability of $4.9 million representing the Company's estimate of all known
assessments that will be levied against the Company's insurance subsidiaries by
various state
53
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
guaranty associations on premiums that have been written through December 31,
1996. Such estimate is subject to change as the associations determine more
precisely the losses due to all failures that have occurred and how such losses
will be allocated to insurance companies.
11. OTHER OPERATING DATA
Insurance policy income consisted of the following:
<TABLE>
<CAPTION>
Three months Nine months Three months Nine months
ended ended Year ended ended ended
December 31, September 30, December 31, December 31, September 30,
1996 1996 1995 1994 1994
---- ---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C> <C>
Direct premiums collected................... $169.8 $545.4 $830.0 $284.4 $849.8
Reinsurance ceded........................... 1.5 7.5 4.4 1.2 3.9
------ ------ ------ ------ ------
Premiums collected, net of reinsurance 168.3 537.9 825.6 283.2 845.9
Less premiums on universal life and
products without mortality and
morbidity risk which are recorded
as additions to insurance liabilities..... 165.4 529.4 797.1 275.5 824.1
------ ------ ------ ------ ------
Premiums on products with mortality risk,
recorded as insurance policy income 2.9 8.5 28.5 7.7 21.8
Fees and surrender charges.................. 8.3 24.5 29.6 5.9 18.4
------ ------ ------ ------ ------
Insurance policy income................ $ 11.2 $ 33.0 $ 58.1 $ 13.6 $ 40.2
====== ====== ====== ====== ======
</TABLE>
The six states with the largest shares of the subsidiaries' premiums
collected in 1996 were California (11 percent), Florida (9.7 percent), Michigan
(7.4 percent), New Jersey (7.0 percent), Illinois (6.2 percent) and Texas (5.5
percent). No other state accounted for more than 4 percent of total collected
premiums.
Other operating costs and expenses were as follows:
<TABLE>
<CAPTION>
Three months Nine months Three months Nine months
ended ended Year ended ended ended
December 31, September 30, December 31, December 31, September 30,
1996 1996 1995 1994 1994
---- ---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C> <C>
Commission expense......................... $ .5 $ 2.5 $ 7.4 $2.2 $ 4.3
Other...................................... 9.7 18.5 23.0 5.5 19.3
----- ----- ----- ---- -----
Other operating costs and expenses....... $10.2 $21.0 $30.4 $7.7 $23.6
===== ===== ===== ==== =====
</TABLE>
Anticipated returns from the investment of policyholder balances are
considered in determining the amortization of the cost of policies purchased and
cost of policies produced. Sales of fixed maturity investments change the
incidence of profits on such policies because investment gains (losses) are
recognized currently and the expected future yields on the investment of
policyholder balances are reduced (increased). Accordingly, amortization of the
cost of policies produced and the cost of policies purchased was increased by
$12.0 million, $4.8 million, $83.3 million and $2.8 million for the three months
ended December 31, 1996, the nine months ended September 30, 1996, the year
ended December 31, 1995, and the nine months ended September 30, 1994,
respectively.
54
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
The changes in the cost of policies purchased were as follows:
<TABLE>
<CAPTION>
Three months Nine months Three months
ended ended Year ended ended
December 31, September 30, December 31, December 31,
1996 1996 1995 1994
---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C>
Balance, beginning of period.............................. $382.7 $250.1 $447.8 $454.3
Amortization related to operations:
Cash flow realized............................... (10.1) (37.8) (53.3) (13.7)
Interest added................................... 5.1 13.0 22.8 7.2
Amortization related to gains on sales of investments (11.2) (4.3) (73.6) -
Amounts related to the ALH Stock Purchase............ (3.9) 84.1 - -
Effect of fair value adjustment to actively managed
fixed maturities................................. (30.7) 77.6 (93.6) -
------ ------ ------ ------
Balance, end of period.................................... $331.9 $382.7 $250.1 $447.8
====== ====== ====== ======
</TABLE>
Based on current conditions and assumptions as to future events on all
policies in force, the Company expects to amortize approximately 9 percent of
the cost of policies purchased balance in 1997, 10 percent in 1998, 10 percent
in 1999, 10 percent in 2000 and 9 percent in 2001. The discount rate used to
determine the amortization of the cost of policies purchased was approximately 6
percent.
The changes in the cost of policies produced were as follows:
<TABLE>
<CAPTION>
Three months Nine months Three months Nine months
ended ended Year ended ended ended
December 31, September 30, December 31, December 31, September 30,
1996 1996 1995 1994 1994
---- ---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C> <C>
Balance, beginning of period............... $54.6 $77.6 $ 25.0 $ - $ 293.9
Additions............................. 18.6 61.6 87.3 25.2 85.2
Amortization related to operations.... (1.5) (4.6) (2.7) (.2) (29.7)
Amortization related to gains on sales
of investments.................... (.8) (.5) (9.7) - (2.8)
Effect of fair value adjustment to
actively managed fixed maturities (2.0) 17.0 (22.3) - -
Amounts related to ALH Stock
Purchase............................ - (96.5) - - -
Amounts eliminated at Acquisition date - - - - (346.6)
----- ----- ------ ------ ------
Balance, end of period..................... $68.9 $ 54.6 $ 77.6 $ 25.0 $ -
===== ====== ====== ====== ======
</TABLE>
55
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
12. CONSOLIDATED STATEMENT OF CASH FLOWS
Supplemental disclosures and non-cash items that are not reflected in the
consolidated statement of cash flows were as follows:
<TABLE>
<CAPTION>
Three months Nine months Three months Nine months
ended ended Year ended ended ended
December 31, September 30, December 31, December 31, September 30,
1996 1996 1995 1994 1994
---- ---- ---- ---- ----
(Dollars in millions)
<S> <C> <C> <C> <C> <C>
Cash paid during the period for:
Interest............................ $.1 $24.6 $28.8 $3.3 $ 1.3
Income taxes........................ - 7.3 3.7 - 14.7
</TABLE>
There were no material non-cash transactions during 1996, 1995 or 1994.
13. STATUTORY INFORMATION
Statutory accounting practices prescribed or permitted for the Company's
insurance subsidiaries by regulatory authorities differ from GAAP. The Company's
life insurance subsidiaries reported the following amounts to regulatory
agencies, after appropriate eliminations of intercompany accounts among such
subsidiaries:
<TABLE>
<CAPTION>
December 31,
-----------------
1996 1995
---- ----
(Dollars in millions)
<S> <C> <C>
Statutory capital and surplus.............................. $217.6 $215.4
Asset valuation reserve.................................... 47.8 37.5
Interest maintenance reserve............................... 23.7 24.9
------ ------
Total.................................................... $289.1 $277.8
====== ======
</TABLE>
Combined statutory net income of the Company's life insurance
subsidiaries was $26.9 million, $27.1 million and $39.7 million in 1996, 1995
and 1994, respectively, after appropriate eliminations of intercompany accounts
between such subsidiaries. The Company's insurance subsidiaries follow certain
permitted accounting practices which are not specifically prescribed in state
laws, regulations, general administrative rules and various NAIC publications.
Such permitted accounting practices do not enhance statutory surplus.
American Life and Casualty's surplus includes a surplus note held by the
Company with a balance of $50.0 million at December 31, 1996. Each payment of
interest or principal on the surplus note requires the prior approval of the
Iowa Insurance Division. The Iowa insurance law provides that payments of
dividends on capital stock and interest and principal on surplus notes may be
made only out of an insurer's earned surplus. At December 31, 1996, American
Life and Casualty had earned surplus of $111.8 million.
The net assets of the insurance subsidiaries available for transfer to
stockholders are limited to the amounts by which the insurance subsidiaries' net
assets, as determined in accordance with statutory accounting practices
prescribed or permitted by state regulatory authorities, exceed minimum
regulatory statutory capital and surplus requirements; however, payment of
dividends or other distributions to stockholders may also be subject to prior
approval by regulatory authorities. The Iowa laws require that the statutory
surplus of American Life and Casualty following any dividend or distribution be
reasonable in relation to its outstanding liabilities and adequate for its
financial needs (as determined under standards contained therein). The Iowa
Insurance Commissioner may bring an action to enjoin or rescind the payment of a
dividend or distribution by an insurer domiciled in its state that would cause
such insurer's statutory surplus to be unreasonable or inadequate under this
standard. At December 31, 1996, $28.3 million was available
56
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
to be transferred to the Company from American Life and Casualty (based on
amounts reported in accordance with statutory accounting practices) in the form
of dividends, surplus note payments, loans or advances.
Statutory accounting practices require that portions of surplus, called
the asset valuation reserve ("AVR") and the interest maintenance reserve
("IMR"), be appropriated and reported as liabilities. The purpose of these
reserves is to stabilize statutory surplus against fluctuations in the market
value of investments. The IMR captures all investment gains and losses on debt
instruments resulting from changes in interest rates and provides for subsequent
amortization of such amounts into statutory net income on a basis reflecting the
remaining life of the assets sold. The AVR captures investment gains and losses
related to changes in creditworthiness and is also adjusted each year based on a
formula related to the quality and loss experience of the Company's investment
portfolio.
ALMD functions as a general agent for American Life and Casualty and its
primary purpose is to pay commissions to American Life and Casualty's agents on
annuity policies issued by American Life and Casualty pursuant to a general
agency commission and servicing agreement between ALMD and American Life and
Casualty. This agreement initially benefits the statutory surplus of American
Life and Casualty by extending the payment of first year commissions to ALMD on
certain deferred annuity policies over a longer period of time. In subsequent
periods, American Life and Casualty's statutory surplus is reduced through the
payment of renewal commissions to ALMD equal to a specified percentage of the
accumulated policyholder account values of certain deferred annuity policies
issued by American Life and Casualty since 1990 remaining in force.
Included in statutory capital and surplus at December 31, 1996, is $6.3
million related to 463,649 shares of ALH's common stock held by Vulcan Life.
Such amount is eliminated in the consolidated financial statements.
Most states have adopted risk-based capital ("RBC") rules, to evaluate
the adequacy of statutory capital and surplus in relation to investment and
insurance risks. The RBC formula is designed as an early warning tool to help
state regulators identify possible weakly capitalized companies for the purpose
of initiating regulatory action. At December 31, 1996, the ratios of total
adjusted capital to RBC, as defined by the rules, for the Company's insurance
subsidiaries were approximately twice the level at which regulatory attention is
triggered.
57
<PAGE>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
14. QUARTERLY FINANCIAL INFORMATION (Unaudited)
Unaudited quarterly results of operations are as follows:
<TABLE>
<CAPTION>
1996
-----------------------------------------------
1st qtr. 2nd qtr. 3rd qtr. 4th qtr.
-------- -------- -------- --------
(Dollars in millions)
<S> <C> <C> <C> <C>
Insurance policy income........................................... $ 11.1 $ 11.0 $ 10.9 $ 11.2
Net investment income............................................. 102.1 101.5 102.8 102.6
Net investment gains (losses) .................................... 3.4 (.6) 6.9 10.4
Total revenues.................................................... 117.6 113.3 121.7 124.9
Income before income taxes, minority interest
and extraordinary charge........................................ 19.4 22.5 22.9 19.9
Income before extraordinary charge................................ 11.6 14.2 14.1 11.5
Net income ....................................................... 11.6 14.2 13.3 11.5
Net income applicable to common stock............................. 9.4 12.0 11.1 9.8
</TABLE>
<TABLE>
<CAPTION>
1995
-----------------------------------------------
1st qtr. 2nd qtr. 3rd qtr. 4th qtr.
-------- -------- -------- --------
(Dollars in millions)
<S> <C> <C> <C> <C>
Insurance policy income........................................... $ 14.6 $ 15.2 $ 13.8 $ 14.5
Net investment income............................................. 102.1 105.4 105.3 102.7
Net investment gains ............................................. 4.4 48.5 11.4 85.0
Total revenues.................................................... 122.4 170.3 131.8 203.1
Income before income taxes, minority interest
and extraordinary charge........................................ 19.6 40.2 24.4 55.2
Income before extraordinary charge................................ 12.0 25.3 15.0 35.1
Net income ....................................................... 12.0 25.3 15.0 31.1
Net income applicable to common stock............................. 9.8 23.1 12.8 29.0
</TABLE>
The results of operations for the fourth quarter of 1996 are based on a
new basis of accounting under the "push down" method adopted on September 30,
1996, as discussed in note 1. The results of operations for 1995 and the first
nine months of 1996 represent results reported based on the purchase method of
accounting as discussed in note 1.
58
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information with respect to the
directors and executive officers of the Company and the positions and offices
held by each person. The current directors and executive officers were elected
on September 29, 1994, concurrent with the acquisition of ALH by Partnership II.
Directors hold their positions until the annual meeting of stockholders, or
until their respective successors are elected and qualify. It is intended that
the current directors will be nominated for re-election as Directors of the
Company at the next annual meeting of stockholders. Officers serve at the
discretion of the Board of Directors and are subject to removal at any time.
There is no family relationship between any of the persons named.
<TABLE>
<CAPTION>
Name (Age) Positions and Offices
---------- ---------------------
<S> <C>
Stephen C. Hilbert (51).................... Director and Chief Executive Officer (since November 1996)
Ngaire E. Cuneo (46)....................... Director
Rollin M. Dick (65)........................ Director, Executive Vice President and Chief Financial Officer
Donald F. Gongaware (61)................... Director, President and Chief Operating Officer
Lawrence W. Inlow (46)..................... Director, Executive Vice President and General Counsel
</TABLE>
Business experience during the past five years of each director and
executive officer is as follows:
Stephen C. Hilbert
Director, Chairman of the Board and Chief Executive Officer since 1979
and President since 1988 of Conseco (the Company's indirect parent).
Also a Director of Vail Resorts Inc.
Ngaire E. Cuneo
Director since 1994 and Executive Vice President since 1992 of Conseco.
Senior Vice President and Corporate Officer of General Electric Capital
Corporation from 1986 to 1992.
Director of Duke Realty Investments, Inc. and NAL Financial Group Inc.
Rollin M. Dick
Director, Executive Vice President and Chief Financial Officer of
Conseco since 1986.
Director of General Acceptance Corporation and Brightpoint, Inc.
Donald F. Gongaware
Director and Executive Vice President of Conseco since 1985, Chief
Operations Officer of Conseco since 1989 and President of Conseco
Marketing, L. L. C. since 1996.
Lawrence W. Inlow
Executive Vice President and General Counsel of Conseco since 1987.
59
<PAGE>
Section 16(a) Beneficial Ownership
Reporting Compliance
The Company's directors and executive officers are required under the
Securities Exchange Act of 1934 to file reports of ownership and changes in
ownership with the Securities and Exchange Commission and to supply copies of
those reports to the Company. Based solely on a review of the copies of the
reports furnished to the Company and written representations that no other
reports were filed, the Company believes that during 1996 all required filings
were made by its directors and executive officers.
ITEM 11. EXECUTIVE COMPENSATION
None of the Company's current executive officers are compensated for
serving in such capacity. The following table sets forth the compensation paid
by the Company to Mr. Newsome (who served as chief executive officer from
November 1995 until August 1996) and Mr. Hilbert (who served as chief executive
officer from September 1994 until November 1995 and since August 1996)
(collectively, the "Named Individuals").
<TABLE>
<CAPTION>
Summary Compensation Table
Annual
Compensation (l)
----------------
All Other
Compen-
Name and Principal Position Year Salary Bonus sation(2)
--------------------------- ---- ------ ----- ---------
<S> <C> <C> <C> <C>
Jon P. Newsome (3)............................ 1996 $400,000 $ -- $313
President and Chief Executive Officer 1995 57,484 -- 40
from November 1995 until
August 1996
Stephen C. Hilbert............................ 1996 -- -- --
Chairman of the Board since September 29, 1995 -- -- --
1994 and Chief Executive Officer from 1994 -- -- --
September 29, 1994 until November 1995
and since August 1996
<FN>
(1) Includes employee tax-deferred contributions to the Company's 401(k) savings plan.
(2) The $313 related to Mr. Newsome in 1996 represented long term disability insurance. The $40 related to Mr. Newsome in 1995
represented life insurance coverage.
(3) Since September 1996, Mr. Newsome has been employed by a subsidiary of Conseco. Compensation paid
to Mr. Newsome by such Conseco subsidiary is not included in this table.
</FN>
</TABLE>
Compensation of Directors
The current Directors of the Company receive no compensation for serving
in such capacity.
Compensation Committee Interlocks and Insider Participation
The current members of the Compensation Committee are Rollin M. Dick,
Donald F. Gongaware and Stephen C. Hilbert, all of whom are executive officers
and directors of Conseco. See "Item 13. Certain Relationships and Related
Transactions." Although they receive no compensation from the Company, Messrs.
Dick, Gongaware and Hilbert are executive officers of the Company.
60
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ALH is the sole shareholder of all of the outstanding shares of the
Company's common stock. ALH is wholly owned by Conseco and its subsidiaries. The
following table sets forth information as of March 1, 1997, regarding the
Conseco subsidiaries which own ALH's common stock.
<TABLE>
<CAPTION>
Shares Owned and
Nature of Ownership
-----------------------
Name and Address Number Percent
---------------- ------ -------
<S> <C> <C>
CIHC, Incorporated (1)
One Commerce Center, Suite 789
1201 Orange Street
Wilmington, Delaware 19801.................................................. 18,726,450 99.2%
Philadelphia Life Insurance Company (1)
11825 N. Pennsylvania Street
Carmel, Indiana 46032....................................................... 150,408 .8%
<FN>
(1) A wholly owned subsidiary of Conseco.
</FN>
</TABLE>
The United States of America, or an agency thereof claims beneficial
ownership of 143,640 shares of ALH's 1988 Series I and II Preferred Stock which
has voting rights under certain limited circumstances and represents 100 percent
of the outstanding 1988 Series I and II Preferred Stock. The 1988 Series I and
II Preferred Stock was used by ALH in 1988 - 1990 to partially capitalize a
savings bank acquired by ALH and American Life and Casualty in 1988 pursuant to
agreements entered into with agencies of the United States of America. ALH and
American Life and Casualty have sued the United States of America, alleging
breach of these agreements. (see "Item 3 - Legal Proceedings" and note 8 to the
consolidated financial statements). The 1988 Series I and II Preferred Stock,
when allowed to vote, has the right to vote less than one percent of the total
voting power of all stock entitled to vote.
Ownership of Common Stock of Conseco
The following table sets forth information as of March 20, 1997,
regarding ownership of common stock of Conseco by the directors, executive
officers and Named Individuals individually and by all directors and executive
officers as a group. Where any footnote indicates that shares included in the
table are owned by, or jointly with, family members or by an affiliate, such
person may be deemed to exercise shared voting and investment power with respect
to those shares, unless otherwise indicated. The Company's directors, executive
officers and Named Individuals do not own any shares of any other class of
equity securities of Conseco.
<TABLE>
<CAPTION>
Shares Owned
------------------------------
Name Number Percent
- ---- ------ -------
<S> <C> <C>
Ngaire E. Cuneo..................................................................... 1,244,088 (1) *
Rollin M. Dick...................................................................... 4,005,198 (2) 2.2%
Donald F. Gongaware................................................................. 3,958,338 (3) 2.1%
Stephen C. Hilbert.................................................................. 8,488,722 (4) 4.5%
Lawrence W. Inlow................................................................... 3,372,042 (5) 1.8%
Jon P. Newsome...................................................................... 18,550 (6) *
All directors and executive officers as a group (five persons)...................... 21,068,388 (7) 10.6%
<FN>
* Less than one percent.
</FN>
</TABLE>
(1) Of these shares, 964,248 are subject to options held by Ms. Cuneo which are
exercisable within 60 days and 10,000 are subject to a currently
exercisable warrant held by her.
(2) Of these shares, 487,520 are owned by Mr. Dick's wife, 527,324 (including
20,000 subject to a currently exercisable warrant) are owned by a
charitable foundation as to which shares he shares voting and investment
power, 800,000 are owned by a limited partnership of which Mr. Dick is the
general partner, 1,355,552 are subject to options held by Mr. Dick which
are exercisable within 60 days, 225,200 are owned by a trust as to which
Mr. Dick's wife has sole voting and investment power, 200,000 are
61
<PAGE>
owned by a trust as to which Mr. Dick shares voting and investment power
and 1,322 are attributable to Mr. Dick's account under the ConsecoSave
Plan, a 401(k) savings plan. Mr. Dick expressly disclaims beneficial
ownership of all shares owned by his wife, the trust as to which she has
sole voting and investment power, and the charitable foundation.
(3) Of these shares, 62,000 are owned by Mr. Gongaware's wife, 75,600
(including 20,000 subject to a currently exercisable warrant) are owned by
a charitable foundation as to which he shares voting and investment power,
280,000 are owned by a charitable trust as to which he shares voting and
investment power, 72,000 are owned by irrevocable trusts as to which Mr.
Gongaware's wife has sole voting and investment power, 126,000 are owned by
a trust as to which Mr. Gongaware shares voting and investment power,
1,315,552 are subject to options held by Mr. Gongaware which are
exercisable within 60 days and 1,062 are attributable to Mr. Gongaware's
account under the ConsecoSave Plan. Mr. Gongaware expressly disclaims
beneficial ownership of all shares owned by his wife, the trusts as to
which she has sole voting and investment power, and the charitable
foundation.
(4) Of these shares, 3,978,992 are subject to options held by Mr. Hilbert which
are exercisable within 60 days, 1,380,000 are owned by trusts as to which
he has voting and investment power and 280,000 (including 20,000 subject to
a currently exercisable warrant) are held by a charitable foundation as to
which he has voting and investment power. Mr. Hilbert expressly disclaims
beneficial ownership of all shares owned by the charitable foundation.
(5) Of these shares, 1,735,552 are subject to options held by Mr. Inlow which
are exercisable within 60 days, 400,000 are owned by trusts as to which he
has voting and investment power, 80,000 (including 20,000 subject to a
currently exercisable warrant) are held by a charitable foundation as to
which he has voting and investment power and 1,158 are attributable to Mr.
Inlow's account under the ConsecoSave Plan. Mr. Inlow expressly disclaims
beneficial ownership of all shares owned by the charitable foundation.
(6) Includes 8,550 shares issuable upon conversion of 2,500 shares of Conseco's
Preferred Redeemable Increased Dividend Equity Securities Convertible
Preferred Stock.
(7) Includes 9,439,896 shares subject to outstanding stock options and warrants
which are exercisable within 60 days.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ALH owns 100 percent of the outstanding shares of common stock of the
Company. Conseco and its subsidiaries own 100 percent of ALH's outstanding
voting shares of common stock. Consequently, Conseco, through such subsidiaries,
is able to control the Company and is able to determine such actions as the
election of directors and the approval of any other matters submitted for
stockholder approval. Also, all five of the Company's directors are persons who
are also executive officers of Conseco.
Since the Acquisition, the Company and its subsidiaries have received
services from or shared expenses with other affiliates or subsidiaries of
Conseco under written agreements or based on cost allocation principles in
accordance with GAAP. The aggregate fees paid or accrued by the Company and the
subsidiaries to Conseco or its subsidiaries or affiliates under all such
arrangements were $18.9 million in 1996. The charges for services rendered by
Conseco and its affiliates were not the result of arms-length negotiations
between independent parties. It has been the intention of the Company and
Conseco that these arrangements as a whole should accommodate the parties'
interests in a manner that is fair and mutually beneficial.
These agreements may be modified in the future and additional agreements
or transactions may be entered into between Conseco and its subsidiaries and the
Company and its subsidiaries. The provisions of the indenture relating to the
senior subordinated notes require that each agreement or transaction between the
Company and Conseco or their respective subsidiaries be on terms at least as
favorable to the Company as could be obtained from unaffiliated parties for
comparable services or arrangements.
Since the Acquisition, each of the Company and its principal subsidiaries
has been party to an agreement with Conseco Capital Management, Inc.("CCM"), a
registered investment advisor wholly owned by Conseco (collectively, the
"Advisory Agreements") pursuant to which, subject to any limitations or
directions of the Board of Directors or officers of the Company and such
subsidiaries, CCM supervises and directs the investment of the invested assets
of the Company and such subsidiaries. For these services, CCM receives a
quarterly fee equal to .0625 percent (.25 percent annually) of the market value
of the investable assets under its supervision. For 1996, the fees under the
Advisory Agreements aggregated $12.4 million. The Advisory Agreements continue
in effect until terminated on their respective annual anniversary by either
party upon 60 days' notice or by the Company or its subsidiary, as the case may
be, upon a default or failure of CCM to perform its obligations thereunder.
The Company files a consolidated federal income tax return with ALH and
all eligible subsidiaries of ALH. Federal income taxes are allocated under a
consolidated tax allocation agreement which generally results in profitable
companies paying income taxes as if the individual company filed a separate
return and loss companies receiving tax benefits to the extent their losses
contribute to reduce consolidated income taxes.
62
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) l. Financial Statements. See Index to Financial Statements on page 24 for
a list of financial statements included in this Report.
2. Financial Statement Schedules. The following consolidated financial
statement schedules are included as part of this Report immediately
following the signature page on pages 65 through 69.
Schedule II--Condensed Financial Information of Registrant (Parent
Company)
Schedule IV--Reinsurance
All other schedules to the consolidated financial statements required
by Article 7 of Regulation S-X are omitted because they are not
applicable or because the information is included elsewhere in the
consolidated financial statements or notes.
3. Exhibits. See Exhibit Index immediately preceding the Exhibits filed
with the Report.
(b) Reports on Form 8-K. None
63
<PAGE>
SIGNATURES
Pursuant to the requirement of Section 13 or 15(d) 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, this 28th day of
March, 1997.
AMERICAN LIFE HOLDING COMPANY
By: /s/ ROLLIN M. DICK
---------------------------
Rollin M. Dick
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title (Capacity) Date
--------- ---------------- ----
<S> <C> <C>
/s/STEPHEN C. HILBERT Chairman of the Board, Chief March 28, 1997
--------------------- Executive Officer and Director
Stephen C. Hilbert (Principal Executive Officer)
/s/ROLLIN M. DICK Executive Vice President, Chief March 28, 1997
------------------ Financial Officer and Director
Rollin M. Dick (Principal Financial Officer and
Principal Accounting Officer)
/s/NGAIRE E. CUNEO Director March 28, 1997
-------------------
Ngaire E. Cuneo
/s/DONALD F. GONGAWARE Director March 28, 1997
----------------------
Donald F. Gongaware
/s/LAWRENCE W. INLOW Director March 28, 1997
----------------------
Lawrence W. Inlow
</TABLE>
64
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULES
To the Shareholders and Board of Directors
American Life Holding Company and Subsidiaries
Our report on the consolidated financial statements of American Life
Holding Company and subsidiaries is included on page 26 of this Form 10-K. In
connection with our audits of such financial statements, we have also audited
the related financial statement schedules listed in the index on page 63 of this
Form 10-K.
In our opinion, the financial statement schedules referred to above, when
considered in relation to the basic financial statements taken as a whole,
present fairly, in all material respects, the information required to be
included therein.
/s/ COOPERS & LYBRAND L.L.P.
-----------------------------
COOPERS & LYBRAND L.L.P.
Indianapolis, Indiana
March 14, 1997
65
<PAGE>
<TABLE>
<CAPTION>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
SCHEDULE II
Condensed Financial Information of Registrant (Parent Company)
Balance Sheet
as of December 31, 1996 and 1995
(Dollars in millions)
ASSETS
1996 1995
---- ----
(Prior
basis)
<S> <C> <C>
Short-term investments............................................................................. $ 4.9 $ .2
Securities segregated for the future redemption of redeemable preferred stock...................... 45.6 39.2
Investment in subsidiaries (eliminated in consolidation)........................................... 712.3 731.8
Receivables from subsidiaries (eliminated in consolidation)........................................ 50.5 50.3
Other assets....................................................................................... 15.4 1.9
------ ------
Total assets................................................................................ $828.7 $823.4
====== ======
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Notes payable.................................................................................. $158.1 $267.5
Payable to ALH upon determination of the Savings Bank Litigation............................... 30.1 30.1
Accounts payable due to affiliates............................................................. 9.9 .5
Other liabilities.............................................................................. 6.0 7.1
------ ------
Total liabilities........................................................................... 204.1 305.2
------ ------
Redeemable preferred stock......................................................................... 103.5 99.0
Shareholder's equity:
Common stock, $.01 par value, and additional paid-in capital, 1,600,000 shares
authorized; 1,500,100 shares issued and outstanding......................................... 429.0 143.0
Unrealized appreciation (depreciation) of securities:
Fixed maturity investments (net of applicable deferred income taxes:
1996 - $21.6; 1995 - $105.0).............................................................. 40.1 194.9
Other investments (net of applicable deferred income taxes:
1996 - $(.4); 1995 - $.8)................................................................. (.8) 1.5
Retained earnings ............................................................................. 52.8 79.8
------ ------
Total shareholder's equity.................................................................. 521.1 419.2
------ ------
Total liabilities and shareholder's equity.................................................. $828.7 $823.4
====== ======
The condensed financial information should be read in
conjunction with the consolidated financial
statements of American Life Holding Company.
</TABLE>
66
<PAGE>
<TABLE>
<CAPTION>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
SCHEDULE II
Condensed Financial Information of Registrant (Parent Company)
Statement of Operations
(Dollars in millions)
Predecessor
Prior Basis Basis
----------------------------------------- ----------
Three months Nine months Three months Nine months
ended ended Year ended ended ended
December 31, September 30, December 31, December 31, September 30,
1996 1996 1995 1994 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Revenues:
Net investment income............................... $ - $ - $ .2 $ .1 $ -
Dividends from subsidiaries
(eliminated in consolidation).................... 5.2 19.0 34.5 1.7 8.7
Interest income from subsidiaries
(eliminated in consolidation).................... 1.3 3.8 5.3 1.4 1.7
Other income........................................ .6 2.4 2.9 .7 2.0
------ ------ ------- ----- ------
Total revenues................................. 7.1 25.2 42.9 3.9 12.4
------ ------ ------- ----- ------
Expenses:
Interest expense on notes payable................... 3.9 20.8 32.5 8.2 2.4
Operating costs and expenses....................... .2 1.6 1.5 - .1
------ ------ ------- ----- ------
Total expenses................................ 4.1 22.4 34.0 8.2 2.5
------ ------ ------- ------ ------
Income (loss) before income taxes,
equity in undistributed earnings of
subsidiaries and extraordinary charge...... 3.0 2.8 8.9 (4.3) 9.9
Income tax expense (benefit)......................... (.7) (5.7) (9.1) (2.1) (1.1)
------ ------ ------- ------ ------
Income (loss) before equity in undistributed
earnings of subsidiaries and extraordinary
charge..................................... 3.7 8.5 18.0 (2.2) 11.0
Equity in undistributed earnings of subsidiaries
(eliminated in consolidation)...................... 7.8 31.4 69.4 9.5 8.8
------ ------ ------- ------ ------
Income before extraordinary charge............ 11.5 39.9 87.4 7.3 19.8
Extraordinary charge on extinguishment of debt,
net of income tax benefit ......................... - .8 4.0 - -
------ ------ ------- ------ ------
Net income.................................... 11.5 39.1 83.4 7.3 19.8
Dividend requirements of Series Preferred Stock...... 1.7 6.6 8.7 2.2 7.2
------- ------ ------- ------ ------
Net income applicable to common stock......... $ 9.8 $ 32.5 $ 74.7 $5.1 $ 12.6
======= ====== ======= ====== ======
The condensed financial information should be read
in conjunction with the consolidated financial
statements of American Life Holding Company.
</TABLE>
67
<PAGE>
<TABLE>
<CAPTION>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
SCHEDULE II
Condensed Financial Information of Registrant (Parent Company)
Statement of Cash Flows
(Dollars in millions)
Predecessor
Prior Basis Basis
----------------------------------------- --------------
Three months Nine months Three months Nine months
ended ended Year ended ended ended
December 31, September 30, December 31, December 31, September 30,
1996 1996 1995 1994 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income.......................................... $ 11.5 $ 39.1 $ 83.4 $ 7.3 $ 19.8
Adjustments to reconcile net income to net cash
provided by (used for) operating activities:
Equity in undistributed earnings of subsidiaries (7.8) (31.4) (69.4) (9.5) (8.8)
Extraordinary charge........................... - 1.3 6.2 - -
Other.......................................... ( .9) (8.0) (5.0) 2.4 (2.4)
------ ------- ------ ----- -------
Net cash provided by operating activities.. 2.8 1.0 15.2 .2 8.6
------ ------- ------ ----- -------
Cash flows from investing activities:
Purchase of surplus notes........................... - - - - (31.3)
Purchase of subsidiary preferred stock.............. - - - - (3.2)
Investments in subsidiaries........................ - - (.2) - (56.9)
------ ------- ------ ----- -------
Net cash used in investing activities...... - - (.2) - (91.4)
------ ------- ------ ----- -------
Cash flows from financing activities:
Issuance of notes payable, including
obligations to ALH.............................. - - 125.0 - 305.2
Repayments on notes payable, including
obligations to ALH.............................. (125.0) - (170.0) - (45.0)
Capital contribution from ALH...................... 125.0 - 30.0 - -
Preferred stock issuance costs..................... - - - - -
Purchase of securities segregated for the future
redemption of redeemable preferred stock........ - - - - -
Increase (decrease) in intercompany payables....... 3.7 5.7 - (.6) .4
(Increase) decrease in intercompany receivables.... - (.2) 3.5 (1.9) (1.7)
Redemption of preferred stock...................... - - - - (6.1)
Dividends paid..................................... (1.7) (6.6) (8.7) (2.2) (160.1)
------ ------- ------- ----- ------
Net cash provided by (used in)
financing activities................... 2.0 (1.1) (20.2) (4.7) 92.7
------ ------- ------- ----- ------
Net increase (decrease) in short-term investments.... 4.8 (.1) (5.2) (4.5) 9.9
Short-term investments, beginning of period.......... .1 .2 5.4 9.9 -
------ ------- ------- ----- ------
Short-term investments, end of period................ $ 4.9 $ .1 $ .2 $ 5.4 $ 9.9
======= ======= ======= ===== =======
The condensed financial information should be read
in conjunction with the consolidated financial
statements of American Life Holding Company.
</TABLE>
68
<PAGE>
<TABLE>
<CAPTION>
AMERICAN LIFE HOLDING COMPANY AND SUBSIDIARIES
SCHEDULE IV
Reinsurance
(Dollars in millions)
Three months Nine months Three months Nine months
ended ended Year ended ended ended
December 31, September 30, December 31, December 31, September 30,
1996 1996 1995 1994 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Life insurance in force:
Direct .................................. $ 6,452.6 $7,465.7 $7,614.8
Assumed................................... - .2 .2
Ceded..................................... (3,805.2) (4,650.2) (951.9)
--------- -------- --------
Net insurance in force............... $ 2,647.4 $2,815.7 $6,663.1
========= ======== ========
Percentage of assumed to net (a)..... - - -
========= ======== ========
Premiums recorded as revenue for generally
accepted accounting principles:
Direct................................. $4.4 $16.0 $32.9 $ 8.9 $25.7
Assumed................................ - - - - -
Ceded.................................. (1.5) (7.5) (4.4) (1.2) (3.9)
----- ----- ----- ----- -----
Net premiums ........................ $ 2.9 $ 8.5 $28.5 $ 7.7 $21.8
===== ===== ===== ===== =====
Percentage of assumed to net (a) .... - - - - -
===== ===== ===== ===== =====
<FN>
(a) All percentages are less than .01 percent.
</FN>
</TABLE>
69
<PAGE>
<TABLE>
EXHIBIT INDEX
Exhibit
Number Exhibit Description
- ------ -------------------
<S> <C> <C>
(2) (a) Agreement and Plan of Merger, dated as of September 29, 1994,
between American Life Holding Company and ALHC Merger
Corporation incorporated herein by reference to the Form 8-K
dated September 29, 1994
(3) (a) Certificate of Incorporation incorporated herein by reference
to the Form 10-K for the year ended December 31, 1992
(b) Amended and Restated By-Laws incorporated herein by reference
to the Form 10-Q for the quarter ended June 30, 1995
(c) Certificate of Designations, Preferences and Rights of $2.16
Redeemable Cumulative Preferred Stock incorporated herein by
reference to the Form 10-Q for the quarter ended September 30,
1992
(d) Certificate of Designations, Preferences and Rights of $2.32
Redeemable Cumulative Preferred Stock incorporated herein by
reference to the Form 10-K for the year ended December 31,
1992
(4) (a) Escrow Agreement, dated as of August 25, 1992, between
American Life Holding Company and Boatmen's Trust Company
incorporated herein by reference to the Form 10-Q for the
quarter ended September 30, 1992
(b) Escrow Agreement, dated as of February 2, 1993, between
American Life Holding Company and Boatmen's Trust Company
incorporated herein by reference to the Form 10-K for the year
ended December 31, 1992
(c) Indenture, dated as of September 29, 1994, between ALHC Merger
Corporation and LTCB Trust Company and First Supplemental
Indenture, dated as of September 29, 1994, between American
Life Holding Company and LTCB Trust Company for the 11-1/4%
Senior Subordinated Notes due 2004 incorporated herein by
reference to the Form 8-K dated September 29, 1994
The Company agrees to furnish the Commission upon its request
a copy of any instrument defining the rights of holders of
long-term debt of the Company and its consolidated
subsidiaries.
(10) (a) Advisory Agreements between Conseco Capital Management, Inc.
and the following companies are incorporated herein by
reference to the Form 10-K for the year ended December 31,
1994:
(1) American Life Holding Company
(2) American Life and Casualty Insurance Company
(3) Vulcan Life Insurance Company
(b) Federal Income Tax Allocation Agreement, as amended,
incorporated herein by reference to the Form 10-Q for the
quarter ended September 30, 1994
(c) Lease by and among John Trostel, as lessor, and Morris Joseph
and Jacob Joseph, as lessees, dated June 27, 1917;
Supplemental Agreement by and among John Trostel, as lessor,
and Morris Joseph and Jacob Joseph, as lessees, dated July 20,
1927; Amendment to Lease by and between John Trostel, George
W. Trostel, Carl Trostel and Netti Trostel, Fred B. Trostel,
Ruth Trostel Holman and Harry A. Holman, and Helen Trostel
Brobeck and Von H. Brobeck, as lessors and Burton Building
Company as lessee, dated May 31, 1930; and September 1, 1959
Amendment to Lease, Des Moines Building, Des Moines, Iowa are
incorporated herein by reference to the Registrant's annual
report on Form 10-K for the year ended December 31, 1995.
(d) Guarantee Agreement dated September 30, 1996 by and between
the Registrant and Conseco, Inc.
(21) Subsidiaries of the Registrant incorporated herein by
reference to the Form 10-K for the year ended December 31,
1994
</TABLE>
70
GUARANTEE AGREEMENT
GUARANTEE AGREEMENT, dated as of September 30, 1996 ("Guarantee
Agreement"), executed and delivered by Conseco, Inc., an Indiana corporation
(the "Guarantor"), for the benefit of the Holders (as defined below) of the 11
1/4% Senior Subordinated Notes Due 2004 (the "Notes") of American Life Holding
Company, a Delaware corporation (the "Company").
WHEREAS, on September 29, 1994, the Company completed a public offering
of $150 million of Notes, of which $150 million are currently outstanding;
WHEREAS, pursuant to certain stock purchases on September 30, 1996 by
the Guarantor and its affiliates, the Company became a majority owned subsidiary
of the Guarantor;
WHEREAS, the Guarantor believes that certain benefits will result to
the Guarantor and its subsidiaries through its guarantee of the Notes as
provided herein;
NOW, THEREFORE, in consideration of the foregoing and for other good
and valuable consideration the sufficiency of which is hereby acknowledged the
Guarantor executes and delivers this Guarantee Agreement for the benefit of the
Holders.
ARTICLE I
Definitions
As used in this Guarantee Agreement, the terms set forth below shall,
unless the context otherwise requires, have the following meanings.
AFFILIATE: of any specified Person, any Person directly or
indirectly controlling or controlled by, or under direct or indirect
common control with such specified Person. For purposes of this
definition, "control" when used with respect to any specified Person
means the power to direct the management and policies of such Person,
directly or indirectly, whether through the ownership of voting
securities, by contract or otherwise; and the terms "controlling" and
"controlled" have meanings correlative to the foregoing.
BUSINESS DAY: each day that is not a Saturday, Sunday or
a legal holiday in New York, New York.
CAPITALIZED LEASE OBLIGATION: all monetary obligations of
Guarantor under any leasing or similar arrangement which, in
accordance with GAAP, would be classified as a capitalized lease, and,
for purposes of this Agreement, the amount of such
1
<PAGE>
obligations shall be the capitalized amount thereof, determined in
accordance with GAAP, and the stated maturity thereof shall be the date
of the last payment of rent or any other amount due under such lease
prior to the first date upon which such lease may be terminated by the
lessee without payment of a penalty.
CAPITAL STOCK: any and all shares, interests, rights to
purchase, warrants, options, participations or other equivalents of or
interests in (however designated) corporate stock.
CONTINGENT OBLIGATION: any agreement, undertaking or
arrangement by which any Person guarantees, endorses or otherwise
becomes or is contingently liable upon (by direct or indirect
agreement, contingent or otherwise, to provide funds for payment, to
supply funds to, or otherwise to invest in, a debtor, or otherwise to
assure a creditor against loss) the debt, obligation or other liability
of any other Person (other than by endorsements of instruments in the
course of collection), or guarantees the payment of dividends or other
distributions upon the shares of any other Person. The amount of any
Person's liability with respect to any Contingent Obligation shall
(subject to any limitation set forth therein) be deemed to be the
outstanding principal amount (or maximum outstanding principal amount,
if larger) of the debt, obligation or other liability outstanding
thereunder.
DEBT: of any Person means, without duplication,
(i) the principal of and due and payable premium (if any), and
interest in respect of (1) indebtedness of such Person for money
borrowed and (2) indebtedness evidenced by notes, debentures, bonds or
other similar interests for the payment of which such Person is
responsible or liable (but excluding sight drafts that evidence trade
accounts payable arising in the ordinary course of business and
excluding Capital Stock);
(ii) all Capitalized Lease Obligations of such Person;
(iii) all obligations of such person issued or assumed as the
deferred purchase price of property;
(iv) all obligations of such person for the reimbursement of
any obligor on any letter of credit, banker's acceptance or similar
credit transaction (other than obligations with respect to letters of
credit securing obligations (other than obligations described in (i),
(ii) and (iii) above), entered into in the ordinary course of business
of such person to the extent such letters of credit are not drawn upon,
or, if and to the extent drawn upon, such drawing is reimbursed no
later
2
<PAGE>
than the third Business Day following receipt by such person of a
demand for reimbursement following payment on the letter of credit);
(v) all obligations of the type referred to in clauses (i)
through (iv) of other Persons and all dividends of other Persons the
payment of which, in either case, such Person is responsible or liable
as obligor, guarantor or otherwise; and
(vi) all obligations of the type referred to in clauses (i)
through (v) of other Persons secured by any Lien on any property or
asset of such Person (whether or not such obligation is assumed by such
Person), the amount of such obligation being deemed to be the lesser of
the value of such property or assets or the amount of the obligation so
secured; provided that Debt shall not include obligations with respect
to insurance policies, annuities, guaranteed investment contracts, and
similar products underwritten by, or reinsurance agreements entered
into by, any Person that is an insurance corporation.
EVENT OF DEFAULT: as defined in the Subordinated Indenture and
in any supplemental indenture.
GAAP: generally accepted accounting principles.
GUARANTEE PAYMENTS: the following payments, without
duplication, to the extent not paid by the Company: (i) any accrued
and unpaid interest under the Notes and (ii) the principal amounts
outstanding under the Notes when due and payable.
HEDGING OBLIGATIONS: all liabilities of Guarantor under
interest rate swap agreements, interest rate cap agreements and
interest rate collar agreements or agreements designed to protect
against fluctuations in interest rates or currency exchange rates.
HOLDER: any registered owner from time to time of Notes
provided, however, that in determining whether the Holders of the
requisite percentage of the Notes have given any request, notice,
consent or waiver hereunder, "Holder" shall not include the Guarantor
or any Affiliate of the Guarantor, either directly or indirectly.
LIEN: any security interest, mortgage, pledge, hypothecation,
assignment, deposit arrangement, encumbrance, lien (statutory or
other), claim or other priority or preferential arrangement of any
kind or nature whatsoever.
PERSON: any individual, corporation, partnership, joint
venture, limited liability company, association, joint-stock
3
<PAGE>
company, trust, unincorporated organization or government or any agency
or political subdivision thereof.
SENIOR INDEBTEDNESS: at any date, without duplication, whether
outstanding on the date of execution of this Agreement or thereafter
created, assumed or otherwise incurred: (a) all obligations of
Guarantor for borrowed money or in respect of loans or advances; (b)
all obligations of Guarantor evidenced by bonds, debentures, notes or
other similar instruments; (c) all obligations in respect of letters of
credit, whether or not drawn, and bankers' acceptances issued for the
account of Guarantor; (d) all Capitalized Lease Obligations in
accordance with GAAP, and Debt secured by a Lien on property owned or
being purchased by Guarantor (including Debt arising under conditional
sales or other title retention agreements); (e) any Debt of a
partnership in which Guarantor is a general partner; and (f) all
Contingent Obligations of Guarantor in connection with the foregoing;
provided that Senior Indebtedness shall not be deemed to include any
Senior Indebtedness of the type described above under clauses (a)
through (f) which is subordinate or junior in ranking to the Guarantee
Payments.
SENIOR SUBORDINATED DEBT: any Debt of the Guarantor (whether
outstanding on the date hereof or hereafter incurred) that specifically
provides that such Debt ranks pari passu with other Senior Subordinated
Debt of the Guarantor and is not subordinated to any Debt of the
Guarantor which is not Senior Indebtedness.
SUBORDINATED DEBT: any Debt of the Guarantor (whether
outstanding on the date hereof or hereafter incurred) which is
subordinate or junior in right of payment to any Senior Subordinated
Debt.
SUBORDINATED INDENTURE: the Indenture, dated as of September
29, 1994, between the Company and LTCB Trust Company, as Trustee.
ARTICLE II
The Guarantee
2.1. The Guarantor irrevocably and unconditionally agrees to pay in
full to the Holders the Guarantee Payments (except to the extent paid by the
Company), as and when due. The Guarantor's obligation to make a Guarantee
Payment may be satisfied by direct payment of the required amounts by the
Guarantor to the Holders or by causing the Company to pay such amounts to the
Holders.
2.2. The Guarantor hereby waives notice of acceptance of this Guarantee
Agreement and of any liability to which it applies or may
4
<PAGE>
apply, presentment, demand for payment, protest, notice of nonpayment, notice of
dishonor, notice of redemption and all other notices and demands.
2.3. The obligations, covenants, agreements and duties of the Guarantor
under this Guarantee Agreement shall in no way be affected or impaired by reason
of the happening from time to time of any of the following:
(a) the release or waiver, by operation of law or otherwise,
of the performance or observance by the Company of any express or
implied agreement, covenant, term or condition relating to the Notes to
be performed or observed by the Company;
(b) the extension of time for the payment by the Company of
all or any portion of the sums payable under the terms of the Notes or
the extension of time for the performance of any other obligations
under, arising out of, or in connection with, the Notes;
(c) any failure, omission, delay or lack of diligence on the
part of the Holders to enforce, assert or exercise any right,
privilege, power or remedy conferred on the Holders pursuant to the
terms of the Notes or any action on the part of the Company granting
indulgence or extension of any kind;
(d) the voluntary or involuntary liquidation, dissolution,
sale of any collateral, receivership, insolvency, bankruptcy,
assignment for the benefit of creditors, reorganization, arrangement,
composition or readjustment of debt of, or other similar proceedings
affecting, the Company or any of the assets of the Company;
(e) any invalidity or illegality of, or defect or deficiency
in, any of the Notes;
(f) the settlement or compromise of any obligation hereby
guaranteed or incurred;
(g) any reduction, limitation, impairment or termination of
the obligations of the Company under the Notes for any reason,
including any claim of waiver, release, surrender, alteration or
compromise, and shall not be subject to (and Guarantor hereby waives
any right to or claim of) any defense or setoff, counterclaim,
recoupment or termination whatsoever by reason of the invalidity,
illegality, nongenuineness, irregularity, compromise, unenforceability
of, or any other event or occurrence affecting, the obligations of the
Company under the Notes; or
5
<PAGE>
(h) any other condition or event that would otherwise release
the Guarantor from its obligations under this Guarantee Agreement.
There shall be no obligation of the Holders to give notice to, or obtain consent
of, the Guarantor with respect to the happening of any of the foregoing.
2.4. This Guarantee Agreement shall be reinstated in respect of any of
the obligations under the Notes if at any time payment, or any part thereof, of
such obligations is rescinded or must otherwise be restored or returned by a
Holder upon the insolvency, bankruptcy, dissolution, liquidation or
reorganization of the Company or the Guarantor, or upon or as a result of the
appointment of a receiver, intervenor or conservator of, or trustee or similar
officer for, the Company or the Guarantor or any substantial part of its
property, or otherwise, all as though such payments had not been made.
2.5. This is a guarantee of payment and not of collection. A Holder may
enforce this Guarantee Agreement directly against the Guarantor, and the
Guarantor will waive any right or remedy to require that any action be brought
against the Company or any other person or entity before proceeding against the
Guarantor. Subject to Section 2.5, all waivers herein contained shall be without
prejudice to the Holders' right, at the Holders' option, to proceed against the
Company, whether by separate action or by joinder. The Guarantor agrees that
this Guarantee Agreement shall not be discharged except by payment of the
Guarantee Payments in full (to the extent not paid by the Company) and by
complete performance of all obligations of the Guarantor contained in this
Guarantee Agreement.
2.6. The Guarantor shall be subrogated to all rights (if any) of the
Holders against the Company in respect of any amounts paid to the Holders by the
Guarantor under this Guarantee Agreement and shall have the right to waive
payment of any amount in respect of which payment has been made to the Holders
by the Guarantor pursuant to Section 2.1; provided, however, that the Guarantor
shall not (except to the extent required by mandatory provisions of law)
exercise any rights which it may acquire by way of subrogation or any indemnity,
reimbursement or other agreement, in all cases as a result of a payment under
this Guarantee Agreement, if at the time of any such payment, any amounts are
due and unpaid under this Guarantee Agreement. If any amount shall be paid to
the Guarantor in violation of the preceding sentence, the Guarantor agrees to
pay over such amount to the Holders.
2.7. The Guarantor acknowledges that its obligations hereunder are
independent of the obligations of the Company with respect to the Notes and that
the Guarantor shall be liable as principal and sole debtor hereunder to make
Guarantee Payments
6
<PAGE>
pursuant to the terms of this Guarantee Agreement notwithstanding the occurrence
of any event referred to in subsections (a) through (h), inclusive, of Section
2.3.
ARTICLE III
Status of the Guarantee
This Guarantee Agreement constitutes an unsecured obligation of the
Guarantor. Guarantor and the Company covenant and agree that all Guarantee
Payments shall be subordinated and subject to the prior payment in full, in cash
or payment provided for in cash or cash equivalents in a manner satisfactory to
the holders of Senior Indebtedness, of all Senior Indebtedness. The obligations
of the Guarantor hereunder shall in all respects rank pari passu with all
Subordinated Debt, and only indebtedness of the Guarantor which is Senior
Indebtedness or Senior Subordinated Debt shall rank senior to the obligations of
the Guarantor hereunder in accordance with the provisions set forth herein. The
provisions of this Article III are made for the benefit of all present and
future holders of Senior Indebtedness, and any such holder may proceed to
enforce such provisions.
ARTICLE IV
Termination of the Guarantee
4.1. This Guarantee Agreement shall terminate and be of no further
force and effect as to the Notes upon either (i) full payment of the redemption
price (including all accrued and unpaid interest) for all outstanding Notes or
(ii) full payment of the amounts payable to the Holders under the Notes.
ARTICLE V
Miscellaneous Agreements and Provisions
5.1. All guarantees and agreements contained in this Guarantee
Agreement shall bind the successors, assigns, receivers, trustees and
representatives of the Guarantor and shall inure to the benefit of the Holders.
The Guarantor shall not assign its obligations hereunder without the prior
approval of the Holders (excluding the Guarantor and any of its Affiliates) of
not less than 50% of the principal amount of the Notes then outstanding given
either in writing or by vote at a duly constituted meeting of such Holders.
Notwithstanding the foregoing, no assignment hereunder shall be binding against
a Holder who did not vote in favor of such assignment unless such assignment was
by operation of law or the assignee has a credit rating from Standard & Poors
Corporation of the same as or better than the Guarantor.
7
<PAGE>
5.2. Except with respect to amendments that do not adversely affect the
rights of Holders (in which case no vote will be required), this Guarantee
Agreement may only be amended with the prior approval of the Holders (excluding
the Guarantor and any of its Affiliates) of not less than 50% in principal
amount of the Notes then outstanding given either in writing or by vote at a
duly constituted meeting of such Holders who may be present in person or by
proxy.
5.3. Any notice, request or other communication required or permitted
to be given hereunder to the Guarantor shall be given in writing and delivered
personally or by telegram, facsimile transmission or registered or certified
mail (return receipt requested) at the following address and, if so given, shall
be deemed effective when received, to it:
Conseco, Inc.
11825 N. Pennsylvania Street
Carmel, Indiana 46032
Facsimile No.: (317) 817-6327
Attention: Lawrence W. Inlow, Esq.,
Executive Vice President
and General Counsel
Any notice, request or other communication required or permitted to be given
hereunder to the Holders shall be given by the Guarantor in the same manner as
notices sent by the Company to the Holders.
5.4. The masculine and neuter genders used herein shall
include the masculine, feminine and neuter genders.
5.5 This Guarantee Agreement is solely for the benefit of the
Holders and is not separately transferable from the Notes.
5.6. THIS GUARANTEE AGREEMENT SHALL BE GOVERNED BY AND
CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK.
8
<PAGE>
THIS GUARANTEE AGREEMENT is executed as of the day and year first above
written.
CONSECO, INC.
By: /s/ ROLLIN M. DICK
-----------------------------
Rollin M. Dick,
Executive Vice President
Accepted and Agreed:
AMERICAN LIFE HOLDING COMPANY
By: /S/ DONALD F. GONGAWARE
------------------------
Donald F. Gongaware,
Executive Vice President
9
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND> THE SCHEDULE CONTAINS SUMMARY FINANCIAL
INFORMATION EXTRACTED FROM FORM 10-K FOR AMERICAN
LIFE HOLDINGS, INC. DATED DECEMBER 31, 1996 AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<DEBT-HELD-FOR-SALE> 5,215,500
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 6,500
<MORTGAGE> 95,600 <F1>
<REAL-ESTATE> 0
<TOTAL-INVEST> 5,456,200
<CASH> 0 <F2>
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 400,800 <F3>
<TOTAL-ASSETS> 6,440,300
<POLICY-LOSSES> 5,237,800
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 5,700
<POLICY-HOLDER-FUNDS> 98,800
<NOTES-PAYABLE> 103,400
0
429,000
<COMMON> 0
<OTHER-SE> 92,100 <F4>
<TOTAL-LIABILITY-AND-EQUITY> 6,440,300
44,200
<INVESTMENT-INCOME> 409,000
<INVESTMENT-GAINS> 20,300
<OTHER-INCOME> 4,000
<BENEFITS> 280,300 <F5>
<UNDERWRITING-AMORTIZATION> 52,700 <F6>
<UNDERWRITING-OTHER> 31,200
<INCOME-PRETAX> 84,700
<INCOME-TAX> 33,300
<INCOME-CONTINUING> 51,400
<DISCONTINUED> 0
<EXTRAORDINARY> (800)
<CHANGES> 0
<NET-INCOME> 50,600
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
<PAGE>
<FN>
<F1> Includes $37,100 of credit-tenant loans.
<F2> Cash and cash equivalents are classified as short-term investments, which are
included in total investments.
<F3> Includes $331,900 of cost of policies purchased.
<F4> Includes retained earnings of $52,800 and net unrealized appreciation
of securities of $39,300.
<F5> Includes insurance policy benefits of $25,700, change in future policy beneifts
of $(1,600) and interest expense on annuities and financial products of $246,200.
<F6> Includes amortization of cost of policies purchased of $29,800, cost of policies
produced of $6,100 and amortization related to realized gains of $16,800.
</FN>
</TABLE>
