-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FIyLQTdmHJoHUe2XfycECnQapqKjkg1LI+DwxA+d/cxo9XvdBM1axfpi4/K5fW0n mfra7fe7rz5EsqLFnVb7Yw== 0001224608-03-000014.txt : 20031119 0001224608-03-000014.hdr.sgml : 20031119 20031119125839 ACCESSION NUMBER: 0001224608-03-000014 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20030930 FILED AS OF DATE: 20031119 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CONSECO INC CENTRAL INDEX KEY: 0001224608 STANDARD INDUSTRIAL CLASSIFICATION: ACCIDENT & HEALTH INSURANCE [6321] IRS NUMBER: 753108137 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-31792 FILM NUMBER: 031012286 BUSINESS ADDRESS: STREET 1: 11825 N PENNSYLVANIA ST CITY: CARMEL STATE: IN ZIP: 46032 BUSINESS PHONE: 3178176100 MAIL ADDRESS: STREET 1: 11825 NORTH PENNSYLVANIA STREET CITY: CARMEL STATE: IN ZIP: 46032 10-Q 1 conseco.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the period ended September 30, 2003 [ ] 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 001-31792 Conseco, Inc. Delaware 75-3108137 ---------------------- ------------------------------- State of Incorporation IRS Employer Identification No. 11825 N. Pennsylvania Street Carmel, Indiana 46032 (317) 817-6100 -------------------------------------- -------------- Address of principal executive offices Telephone Conseco, Inc. (an Indiana corporation) -------------------------------------- Former Name 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act): Yes [x] No [ ] Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court: Yes [x] No [ ] Shares of common stock outstanding as of November 10, 2003: 100,098,119 ================================================================================ PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (Dollars in millions) ASSETS
Successor Predecessor ----------------------------- --------------- September 30, August 31, December 31, 2003 2003 2002 ---- ---- ---- (unaudited) Investments: Actively managed fixed maturities at fair value (amortized cost: September 30, 2003 - $18,885.5; August 31, 2003 - $18,701.0; December 31, 2002 - $18,989.8)..................................... $19,352.7 $18,701.0 $19,417.4 Equity securities at fair value (cost: September 30, 2003 - $104.6; August 31, 2003 - $101.4; December 31, 2002 - $161.4).............. 107.5 101.4 156.0 Mortgage loans....................................................... 1,154.1 1,159.7 1,308.3 Policy loans......................................................... 514.2 515.8 536.2 General Motors building.............................................. - 1,336.3 - Trading securities................................................... 944.9 952.1 - Venture capital investment in AT&T Wireless Services, Inc. at fair value (cost: September 30, 2003 - $36.4; August 31, 2003 - $36.4; December 31, 2002 - $14.2)......................................... 33.7 36.4 25.0 Other invested assets ............................................... 308.7 321.5 340.8 --------- --------- --------- Total investments................................................ 22,415.8 23,124.2 21,783.7 Cash and cash equivalents: Unrestricted......................................................... 1,724.3 1,215.9 1,268.9 Restricted........................................................... 22.1 - - Accrued investment income............................................... 316.0 304.6 389.8 Value of policies in force at the Effective Date........................ 2,770.4 2,836.9 - Cost of policies purchased.............................................. - - 1,170.0 Cost of policies produced............................................... 23.2 - 2,014.4 Reinsurance receivables................................................. 933.6 932.3 934.2 Income tax assets....................................................... 86.7 88.0 101.5 Goodwill................................................................ 935.4 1,102.8 100.0 Other intangible assets................................................. 173.8 174.8 - Assets held in separate accounts and investment trust .................. 37.5 87.7 447.0 Assets of discontinued operations....................................... - - 17,624.3 Other assets............................................................ 421.1 545.7 675.2 --------- --------- --------- Total assets..................................................... $29,859.9 $30,412.9 $46,509.0 ========= ========= =========
(continued on next page) The accompanying notes are an integral part of the consolidated financial statements. 2 CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET, continued (Dollars in millions) LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Successor Predecessor ---------------------------- -------------- September 30, August 31, December 31, 2003 2003 2002 ---- ---- ---- (unaudited) Liabilities: Liabilities for insurance and asset accumulation products: Interest-sensitive products........................................... $12,851.5 $12,837.9 $13,469.5 Traditional products.................................................. 10,727.5 10,701.0 7,971.4 Claims payable and other policyholder funds........................... 873.1 886.7 909.2 Liabilities related to separate accounts and investment trust......... 37.5 87.7 447.0 Other liabilities....................................................... 748.5 875.2 673.5 Liabilities of discontinued operations.................................. - - 17,624.3 Investment borrowings................................................... 524.4 1,224.4 669.7 Notes payable - direct corporate obligations............................ 1,300.0 1,300.0 - --------- --------- --------- Total liabilities not subject to compromise....................... 27,062.5 27,912.9 41,764.6 --------- --------- --------- Liabilities subject to compromise....................................... - - 4,873.3 --------- --------- --------- Total liabilities................................................. 27,062.5 27,912.9 46,637.9 --------- --------- --------- Minority interest: Company-obligated mandatorily redeemable preferred securities of subsidiary trusts.................................................... - - 1,921.5 Shareholders' equity (deficit): Preferred stock......................................................... 865.0 859.7 501.7 Common stock and additional paid-in capital ($0.01 par value, 8,000,000,000 shares authorized, shares issued and outstanding: September 30, 2003 - 100,098,119; August 31, 2003 - 100,098,119; no par value, 1,000,000,000 shares authorized, shares issued and outstanding at December 31, 2002 - 346,007,133)....................... 1,640.3 1,640.3 3,497.0 Accumulated other comprehensive income.................................. 273.2 - 580.6 Retained earnings (deficit)............................................. 18.9 - (6,629.7) --------- --------- --------- Total shareholders' equity (deficit).............................. 2,797.4 2,500.0 (2,050.4) --------- --------- --------- Total liabilities and shareholders' equity (deficit).............. $29,859.9 $30,412.9 $46,509.0 ========= ========= =========
The accompanying notes are an integral part of the consolidated financial statements. 3 CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS (Dollars in millions, except per share data) (unaudited)
Successor Predecessor ------------- -------------------------------- One month Two months Three months ended ended ended September 30, August 31, September 30, 2003 2003 2002 ---- ---- ---- Revenues: Insurance policy income........................................... $256.2 $ 516.8 $ 902.6 Net investment income: General account assets.......................................... 106.0 237.3 373.0 Policyholder and reinsurer accounts............................. (2.1) 6.8 (32.6) Venture capital income (loss) related to investment in AT&T Wireless Services, Inc................................... (2.7) 2.0 (6.6) Net realized investment gains (losses) ......................... 6.7 (35.8) (261.1) Fee revenue and other income...................................... 2.2 7.8 15.5 ------ --------- --------- Total revenues................................................ 366.3 734.9 990.8 ------ --------- --------- Benefits and expenses: Insurance policy benefits......................................... 243.3 407.4 883.4 Provision for losses.............................................. - 24.5 59.9 Interest expense (contractual interest of $73.7 for the two months ended August 31, 2003).......................................... 7.0 55.4 84.5 Amortization...................................................... 26.9 44.8 200.2 Other operating costs and expenses................................ 51.3 106.8 180.8 Goodwill impairment............................................... - - 500.0 Special charges................................................... - - 34.9 Reorganization items.............................................. - (2,163.0) - ------ --------- --------- Total benefits and expenses................................... 328.5 (1,524.1) 1,943.7 ------ --------- --------- Income (loss) before income taxes, minority interest, and discontinued operations................................ 37.8 2,259.0 (952.9) Income tax expense (benefit): Tax expense (benefit) on period income (losses)................... 13.6 17.7 (154.8) Valuation allowance for deferred tax assets....................... - - 311.4 ------ --------- --------- Income (loss) before minority interest and discontinued operations................................................. 24.2 2,241.3 (1,109.5) Minority interest: Distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts, net of income taxes. - - 29.2 ------ --------- --------- Income (loss) before discontinued operations.................. 24.2 2,241.3 (1,138.7) Discontinued operations, net of income taxes......................... - - (630.3) ------ --------- --------- Net income (loss)............................................. 24.2 2,241.3 (1,769.0) Preferred stock dividends............................................ 5.3 - .2 ------ --------- --------- Net income (loss) applicable to common stock.................. $ 18.9 $ 2,241.3 $(1,769.2) ====== ========= =========
(continued) The accompanying notes are an integral part of the consolidated financial statements. 4 CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS, continued (Dollars in millions, except per share data) (unaudited)
Successor ------------- One month ended September 30, 2003 ---- Earnings per common share: Basic: Weighted average shares outstanding........................ 100,098,000 =========== Net income................................................. $.19 ==== Diluted: Weighted average shares outstanding........................ 144,671,000 =========== Net income................................................. $.17 ====
The accompanying notes are an integral part of the consolidated financial statements. 5 CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS (Dollars in millions, except per share data) (unaudited)
Successor Predecessor ------------- -------------------------------- One month Eight months Nine months ended ended ended September 30, August 31, September 30, 2003 2003 2002 ---- ---- ---- Revenues: Insurance policy income........................................... $256.2 $ 2,204.3 $ 2,726.2 Net investment income: General account assets.......................................... 106.0 933.3 1,164.2 Policyholder and reinsurer accounts............................. (2.1) 25.2 (106.3) Venture capital income (loss) related to investment in AT&T Wireless Services, Inc................................... (2.7) 10.5 (106.6) Net realized investment gains (losses) ......................... 6.7 (5.4) (493.9) Fee revenue and other income...................................... 2.2 34.3 56.1 ------ --------- --------- Total revenues................................................ 366.3 3,202.2 3,239.7 ------ --------- --------- Benefits and expenses: Insurance policy benefits......................................... 243.3 2,138.7 2,469.9 Provision for losses.............................................. - 55.6 199.9 Interest expense (contractual interest of $268.5 for the eight months ended August 31, 2003)................................... 7.0 202.5 248.8 Amortization...................................................... 26.9 341.4 635.2 Other operating costs and expenses................................ 51.3 422.3 510.1 Goodwill impairment............................................... - - 500.0 Special charges................................................... - - 103.1 Extraordinary gain on extinguishment of debt...................... - - (1.8) Reorganization items.............................................. - (2,130.5) - ------ --------- --------- Total benefits and expenses................................... 328.5 1,030.0 4,665.2 ------ --------- --------- Income (loss) before income taxes, minority interest, discontinued operations and cumulative effect of accounting change.......................................... 37.8 2,172.2 (1,425.5) Income tax expense (benefit): Tax expense (benefit) on period income (losses)................... 13.6 (13.5) (316.1) Valuation allowance for deferred tax assets....................... - - 1,314.4 ------ --------- --------- Income (loss) before minority interest, discontinued operations and cumulative effect of accounting change...... 24.2 2,185.7 (2,423.8) Minority interest: Distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts, net of income taxes. - - 87.6 ------ --------- --------- Income (loss) before discontinued operations and cumulative effect of accounting change................................. 24.2 2,185.7 (2,511.4) Discontinued operations, net of income taxes......................... - 16.0 (686.6) Cumulative effect of accounting change for goodwill impairment, net of income taxes............................................... - - (2,949.2) ------ --------- --------- Net income (loss)............................................. 24.2 2,201.7 (6,147.2) Preferred stock dividends............................................ 5.3 - 2.1 ------ --------- --------- Net income (loss) applicable to common stock.................. $ 18.9 $ 2,201.7 $(6,149.3) ====== ========= =========
(continued) The accompanying notes are an integral part of the consolidated financial statements. 6 CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS, continued (Dollars in millions, except per share data) (unaudited)
Successor ----------- One month ended September 30, 2003 ---- Earnings per common share: Basic: Weighted average shares outstanding........................ 100,098,000 =========== Net income................................................. $.19 ==== Diluted: Weighted average shares outstanding........................ 144,671,000 =========== Net income................................................. $.17 ====
The accompanying notes are an integral part of the consolidated financial statements. 7 CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT) (Dollars in millions) (unaudited)
Common stock Accumulated other Retained Preferred and additional comprehensive earnings Total stock paid-in capital income (loss) (deficit) ----- ----- --------------- ------------- ------- Predecessor balance, January 1, 2003................. $(2,050.4) $ 501.7 $ 3,497.0 $ 580.6 $(6,629.7) Comprehensive income, net of tax: Net income...................................... 2,201.7 - - - 2,201.7 Change in unrealized appreciation of investments (net of applicable income tax benefit of nil)............................... (151.6) - - (151.6) - --------- Total comprehensive income.................. 2,050.1 Change in shares for employee benefit plans....... .3 - .3 - - --------- ------- --------- ------- --------- Predecessor balance, August 31, 2003................. - 501.7 3,497.3 429.0 (4,428.0) Elimination of Predecessor's equity securities................................. (3,999.0) (501.7) (3,497.3) - - Issuance of Successor's equity securities................................. 2,500.0 859.7 1,640.3 - - Fresh start adjustments.............................. 3,999.0 - - (429.0) 4,428.0 --------- ------- --------- ------- --------- Successor balance, August 31, 2003................... 2,500.0 859.7 1,640.3 - - Comprehensive income, net of tax: Net income...................................... 24.2 - - - 24.2 Change in unrealized appreciation of investments (net of applicable income tax expense of $154.4)............................ 273.2 - - 273.2 - --------- Total comprehensive income.................. 297.4 Payment-in-kind dividends on convertible exchangeable preferred stock.................. 5.3 5.3 - - - Dividends on preferred stock.................... (5.3) - - - (5.3) --------- ------- --------- ------- --------- Successor balance, September 30, 2003................ $ 2,797.4 $ 865.0 $ 1,640.3 $ 273.2 $ 18.9 ========= ======= ========= ======= ========= Predecessor balance, January 1, 2002................. $4,753.0 $ 499.6 $ 3,484.3 $(439.0) $ 1,208.1 Comprehensive loss, net of tax: Net loss........................................ (6,147.2) - - - (6,147.2) Change in unrealized depreciation of investments (net of applicable income tax expense of $324.0)............................ 569.4 - - 569.4 - ---------- Total comprehensive loss.................... (5,577.8) Issuance of shares for stock options and for employee benefit plans.......................... 13.0 - 13.0 - - Payment-in-kind dividends on convertible preferred stock................................. 2.1 2.1 - - - Dividends on preferred stock...................... (2.1) - - - (2.1) ----------- ------- --------- ------- --------- Predecessor balance, September 30, 2002.............. $ (811.8) $ 501.7 $ 3,497.3 $ 130.4 $(4,941.2) ======== ======= ========= ======= =========
The accompanying notes are an integral part of the consolidated financial statements. 8 CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (Dollars in millions) (unaudited)
Successor Predecessor -------------- --------------------------------- One month Eight months Nine months ended ended ended September 30, August 31, September 30, 2003 2003 2002 ---- ---- ---- Cash flows from operating activities: Insurance policy income....................................... $ 223.7 $ 1,876.2 $ 2,313.1 Net investment income......................................... 103.6 933.5 2,723.6 Fee revenue and other income.................................. 2.2 34.3 236.6 Insurance policy benefits..................................... (178.1) (1,466.1) (1,810.4) Interest expense.............................................. - - (1,013.1) Policy acquisition costs...................................... (25.6) (287.5) (391.4) Special charges............................................... - - (46.7) Reorganization items.......................................... - (26.5) - Other operating costs......................................... (73.6) (360.8) (1,143.9) Taxes......................................................... .3 44.2 (130.4) --------- --------- ---------- Net cash provided by operating activities................... 52.5 747.3 737.4 --------- --------- ---------- Cash flows from investing activities: Sales of investments.......................................... 2,121.9 5,378.9 15,592.4 Maturities and redemptions of investments..................... 288.7 1,854.7 1,143.9 Purchases of investments...................................... (1,225.6) (7,385.9) (15,771.7) Cash received from the sale of finance receivables, net of expenses............................................. - - 1,450.6 Finance receivables originated................................ - - (6,401.8) Consolidation of partnership which holds General Motors building..................................... 28.4 - - Principal payments received on finance receivables............ - - 6,196.6 Change in restricted cash..................................... (22.1) - - Other......................................................... 4.3 (19.6) (139.2) --------- --------- ---------- Net cash provided (used) by investing activities ........... 1,195.6 (171.9) 2,070.8 --------- --------- ---------- Cash flows from financing activities: Amounts received for deposit products......................... 121.8 1,272.7 3,465.0 Withdrawals from deposit products............................. (133.1) (1,784.2) (4,228.6) Issuance of notes payable..................................... - - 6,034.3 Payments on notes payable..................................... - - (7,918.0) Ceding commission received on reinsurance transactions........ - - 83.0 Change in cash held in restricted accounts for settlement of borrowings............................................... - - (210.7) Investment borrowings......................................... (700.0) (145.3) (1,399.6) Dividends on preferred shares and distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts............................. - - (86.2) --------- --------- ---------- Net cash used by financing activities..................... (711.3) (656.8) (4,260.8) --------- --------- ---------- Net increase (decrease) in cash and cash equivalents...... 536.8 (81.4) (1,452.6) Cash and cash equivalents, beginning of period................... 1,187.5 1,268.9 3,060.8 --------- --------- ---------- Cash and cash equivalents, end of period......................... $ 1,724.3 $ 1,187.5 $ 1,608.2 ========= ========= ==========
The accompanying notes are an integral part of the consolidated financial statements. 9 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- The following notes should be read together with the notes to the consolidated financial statements included in the 2002 Form 10-K of our predecessor, Conseco, Inc., an Indiana corporation ("Old Conseco"). Conseco, Inc., a Delaware corporation ("CNO"), is the top tier holding company for our insurance subsidiaries that develop, market and administer supplemental health insurance, annuity, individual life insurance and other products. CNO became the successor to Old Conseco in connection with our bankruptcy reorganization. The terms "Conseco," the "Company," "we," "us," and "our" as used in this report refer to CNO and its subsidiaries and, unless the context requires otherwise, Old Conseco and its subsidiaries. PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE On December 17, 2002 (the "Petition Date"), Old Conseco and three of its non-insurance company subsidiaries (collectively, the "Filing Entities") filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the Northern District of Illinois, Eastern Division (the "Bankruptcy Court"). During the pendency of the Chapter 11 cases, the Filing Entities continued to operate their businesses as debtors-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. We emerged from bankruptcy protection under the Sixth Amended Joint Plan of Reorganization (the "Plan"), which was confirmed pursuant to an order of the Bankruptcy Court on September 9, 2003 (the "Confirmation Date"), and became effective on September 10, 2003 (the "Effective Date"). In accordance with Statement of Position 90-7, "Financial Reporting by Entities in Reorganization under the Bankruptcy Code," ("SOP 90-7"), we adopted fresh start accounting on the Effective Date. However, in light of the proximity of such date to the August month end, for accounting convenience purposes, the effects of fresh start accounting have generally been reported "as if" they occurred on August 31, 2003. See the note entitled "Fresh Start Reporting" for more information relating to fresh start accounting. The Plan generally provided for the full payment or reinstatement of allowed administrative claims, priority claims, fully secured claims and certain intercompany claims, and the distribution of new equity securities (including warrants) of CNO to partially secured and unsecured creditors of the Filing Entities. Holders of claims arising under Old Conseco's $1.5 billion senior bank credit facility also received a pro rata interest in a new $1.3 billion senior bank credit facility. Holders of Old Conseco's common stock and preferred stock did not receive any distribution under the Plan, and these securities, together with all other prepetition securities and the $1.5 billion senior bank credit facility of Old Conseco, were cancelled on the Effective Date. On the Effective Date, under the terms of the Plan, we emerged from the bankruptcy proceedings with a capital structure consisting of: (i) a new $1.3 billion senior bank credit facility; (ii) approximately 34.4 million shares of Class A Senior Cumulative Convertible Exchangeable Preferred Stock of CNO (the "Preferred Stock") with an initial aggregate liquidation preference of $859.7 million; (iii) 100 million shares of common stock of CNO, excluding shares issued to our new non-executive chairman upon his appointment and shares issued or to be issued to directors, officers, or employees under a new equity incentive plan; and (iv) warrants to purchase 6.0 million shares of CNO common stock. Under the terms of the Plan, we distributed CNO equity securities to the creditors of Old Conseco in the amounts outlined below: o lenders under Old Conseco's senior bank credit facility and director and officer loan program received approximately 34.4 million shares of our Preferred Stock with an initial aggregate liquidation preference of $859.7 million; o holders of Old Conseco's senior notes received approximately 32.3 million shares of our common stock; o holders of Old Conseco's guaranteed senior notes received approximately 60.6 million shares of our common stock; o holders of Old Conseco's general unsecured claims received approximately 2.9 million shares of our common stock; and 10 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- o holders of trust preferred securities issued by Old Conseco's subsidiary trusts received approximately 1.5 million shares of our common stock and warrants to purchase 6.0 million shares of our common stock at an exercise price of $27.60 per share. The distribution of our common stock summarized above represents approximately 97 percent of all of the shares of common stock to be distributed under the Plan. Approximately 2.7 million shares of common stock have been reserved for distribution under the Plan in respect of disputed claims, the resolution of which is still pending. If reserved shares remain after resolution of these disputed claims, then the reserved shares will be reallocated to other general unsecured creditors of Old Conseco as provided for under the Plan. For a complete discussion of the distributions provided for under the Plan, investors should refer to the complete text of the Plan confirmed by the Bankruptcy Court on September 9, 2003, and filed with the Securities and Exchange Commission on September 15, 2003 with our Current Report on Form 8-K. Our common stock is listed on the New York Stock Exchange ("NYSE") under the symbol "CNO," and our warrants are listed on the NYSE under the symbol "CNO WS." Our Preferred Stock currently trades on the Over-the-Counter Bulletin Board under the symbol "CNSJP." DISCONTINUED FINANCE BUSINESS -- SALE OF CFC As part of our Chapter 11 reorganization, we sold substantially all of the assets of our finance business and exited from this line of business. Our finance business was conducted through our indirect wholly-owned subsidiary, Conseco Finance Corp. ("CFC"). We accounted for our finance business as a discontinued operation in 2002 once we formalized plans to sell it. On April 1, 2003, CFC and 22 of its direct and indirect subsidiaries, which collectively comprised substantially all of our finance business, filed liquidating plans of reorganization with the Bankruptcy Court in order to facilitate the sale of this business. The sale of the finance business was completed in the second quarter of 2003. We did not receive any proceeds from this sale in respect of our interest in CFC, nor did any creditors of Old Conseco. As of March 31, 2003, we ceased to include the assets and liabilities of CFC on our consolidated balance sheet. BASIS OF PRESENTATION References in these consolidated financial statements to "Predecessor" refer to Old Conseco prior to August 31, 2003. References to "Successor" refer to the Company on and after August 31, 2003, after giving effect to the implementation of fresh start reporting. The accompanying consolidated financial statements have been prepared in accordance with SOP 90-7. Accordingly, all prepetition liabilities subject to compromise have been segregated in the Predecessor's consolidated balance sheet and classified as "liabilities subject to compromise" at the estimated amount of allowable claims. Pursuant to SOP 90-7, professional fees associated with the Chapter 11 cases are expensed as incurred and reported as reorganization items. Interest expense is reported only to the extent that it was paid during the Chapter 11 cases. During the period January 1, 2003 through August 31, 2003, the Company recognized a charge of $70.9 million associated with the Chapter 11 cases for fees payable to professionals to assist with the Chapter 11 cases. Upon our emergence from bankruptcy, we implemented fresh start reporting in accordance with SOP 90-7. These rules required the Company to revalue its assets and liabilities to current estimated fair value, re-establish shareholders' equity at the reorganization value determined in connection with the Plan, and record any portion of the reorganization value which cannot be attributed to specific tangible or identified intangible assets as goodwill. As a result, the Company's financial statements for periods following August 31, 2003, will not be comparable with those of Old Conseco prepared before that date. Our unaudited consolidated financial statements reflect normal recurring adjustments that are necessary to present fairly our financial position and results of operations on a basis consistent with that of our prior audited consolidated financial statements. As permitted by rules and regulations of the Securities and Exchange Commission applicable to quarterly reports on Form 10-Q, we have condensed or omitted certain information and disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles ("GAAP"). We have also reclassified certain amounts from the prior periods to conform to the 2003 presentation. These reclassifications have no effect on net income or 11 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- shareholders' equity. Results for interim periods are not necessarily indicative of the results that may be expected for a full year. During the third quarter of 2002, Old Conseco entered into an agreement to sell Conseco Variable Insurance Company ("CVIC"), its wholly owned subsidiary and the primary writer of its variable annuity products. The sale was completed in October 2002. The operating results of CVIC have been reported as discontinued operations in all periods presented in the accompanying consolidated statement of operations. See the note to the consolidated financial statements entitled "Discontinued Operations." During 2001, we stopped renewing a large portion of our major medical lines of business. These lines of business are referred to herein as the "major medical business in run-off". When we prepare financial statements in conformity with GAAP, we are required to make estimates and assumptions that significantly affect various reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting periods. For example, we use significant estimates and assumptions in calculating values for the cost of policies produced, the cost of policies purchased, the value of policies in force at the Effective Date, certain investments, assets and liabilities related to income taxes, goodwill, liabilities for insurance and asset accumulation products, liabilities related to litigation, guaranty fund assessment accruals and liabilities related to guarantees of bank loans and the related interest loans to certain former directors and to certain current and former officers and key employees. If our future experience differs from these estimates and assumptions, our financial statements would be materially affected. Our consolidated financial statements exclude the results of material transactions between us and our consolidated affiliates, or among our consolidated affiliates. FRESH START REPORTING Upon the confirmation of the Plan on September 9, 2003, we implemented fresh start reporting in accordance with SOP 90-7. However, in light of the proximity of this date to the August month end, for accounting convenience purposes, we have reported the effects of fresh start accounting as if they occurred on August 31, 2003. We engaged an independent financial advisor to assist in the determination of our reorganization value as defined in SOP 90-7. We determined a reorganization value, together with our financial advisor, using various valuation methods, including: (i) selected comparable companies analysis; and (ii) actuarial valuation analysis. These analyses are necessarily based on a variety of estimates and assumptions which, though considered reasonable by management, may not be realized, and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. Changes in these estimates and assumptions may have had a significant effect on the determination of our reorganization value. The estimated reorganization value of the Company was calculated to be approximately $3.7 billion to $3.9 billion. We selected the midpoint of the range, $3.8 billion, as the reorganization value. Such value was confirmed by the Bankruptcy Court on the Confirmation Date. 12 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- Under fresh start reporting, a new reporting entity is considered to be created and the Company is required to revalue its assets and liabilities to current estimated fair value, re-establish shareholders' equity at the reorganization value determined in connection with the Plan, and record any portion of the reorganization value which can not be attributed to specific tangible or identified intangible assets as goodwill. In addition, all accounting standards that are required to be adopted in the financial statements within twelve months following the adoption of fresh start accounting were adopted as of August 31, 2003. Adjustments to the Predecessor's consolidated balance sheet as of August 31, 2003, to reflect the discharge of debt, change in capital structure and the fair value of our assets and liabilities are presented in the following table (dollars in millions):
Debt Fresh Predecessor discharge and start Successor balance sheet(a) reorganization (b) adjustments balance sheet ---------------- ------------------ ----------- ------------- Assets: Investments .............................................. $22,018.3 $ - $ 1,043.5 (c) $23,124.2 62.4 (d) Cash and cash equivalents................................. 1,187.5 - 28.4 (c) 1,215.9 Accrued investment income................................. 304.6 - - 304.6 Value of policies in force at the Effective Date.......... - - 2,836.9 (e) 2,836.9 Cost of policies purchased................................ 1,099.2 - (1,099.2) (e) - Cost of policies produced................................. 2,019.5 - (2,019.5) (e) - Reinsurance receivables................................... 878.3 - 54.0 (f) 932.3 Goodwill.................................................. 99.4 - 1,003.4 (f) 1,102.8 Other intangible assets................................... - - 174.8 (f) 174.8 Income tax assets......................................... 88.0 - - 88.0 Assets held in separate accounts and investment trust..... 87.7 - - 87.7 Other assets.............................................. 535.6 - 10.1 (f) 545.7 --------- --------- --------- --------- Total assets......................................... $28,318.1 $ - $ 2,094.8 $30,412.9 ========= ========= ========= ========= Liabilities: Liabilities for insurance and asset accumulation products. $22,175.6 $ - $ 2,337.7 (g) $24,513.3 Other liabilities......................................... 868.1 - (23.7) (f) 875.2 30.8 (c) Investment borrowings..................................... 524.4 - 700.0 (c) 1,224.4 Notes payable - direct corporate obligations.............. - 1,300.0 - 1,300.0 --------- --------- --------- --------- Total liabilities not subject to compromise.......... 23,568.1 1,300.0 3,044.8 27,912.9 Liabilities subject to compromise......................... 6,951.4 (6,951.4) - - --------- --------- --------- --------- Total liabilities ................................... 30,519.5 (5,651.4) 3,044.8 27,912.9 --------- --------- --------- --------- Shareholders' equity (deficit): Convertible preferred stock............................... 501.7 - (501.7) - Convertible exchangeable preferred stock.................. - 859.7 - 859.7 Common stock and additional paid-in capital............... 3,497.3 1,640.3 (3,497.3) 1,640.3 Retained earnings (accumulated deficit)................... (6,629.4) 3,151.4 3,478.0 - Accumulated other comprehensive income.................... 429.0 - (429.0) - --------- --------- --------- --------- Total shareholders' equity (deficit)................. (2,201.4) 5,651.4 (950.0) 2,500.0 --------- --------- --------- --------- Total liabilities and shareholders' equity (deficit).......... $28,318.1 $ - $ 2,094.8 $30,412.9 ========= ========= ========= =========
13 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- - ----------------- (a) Predecessor balance sheet as of August 31, 2003, prior to the recording of the discharge of prepetition liabilities and the effects of the fresh start adjustments. (b) The fresh start balance sheet reflects the reorganization value for Conseco of $3,800.0 million. After deducting from Conseco's reorganization value the long-term indebtedness of Conseco at the Effective Date, consisting of $1,300 million of indebtedness under the new senior secured bank credit facility, the total equity of Conseco is $2,500 million. After deducting from Conseco's total equity the value of the new Preferred Stock of $859.7 million, the value of the new common stock is $1,640.3 million. These adjustments also reflect the gain on the discharge of prepetition liabilities. (c) In accordance with a new accounting pronouncement, the Company was required to consolidate the assets and liabilities of the partnership which owned the General Motors building into its balance sheet. As a result of the consolidation and the adoption of fresh start accounting we increased our investment in the General Motors building by $1,043.5 million and recognized the following other assets and liabilities held by the partnership which owns the General Motors building: (i) cash of $28.4 million; (ii) other liabilities of $30.8 million; and (iii) a note payable of $700 million. We sold the General Motors building in September 2003 at a value that was approximately equal to the fresh start value. The note payable of the partnership was paid in full and the net proceeds from the sale were distributed to the partners. (d) The values of our mortgage loans, policy loans and other invested assets were adjusted to market value at the Effective Date. In addition, the cost basis of our actively managed fixed maturities was increased by $436.6 million to recognize all of the unrealized appreciation based on the Predecessor cost basis at the Effective Date. (e) The Company's historical cost of policies purchased and cost of policies produced are eliminated and replaced with the value of policies in force at the Effective Date. The value of policies in force reflects the estimated fair value of the Company's business in force and represents the portion of the estimated reorganization value allocated to the value of the right to receive future cash flows from the policies in force on the Effective Date. A discount rate of 12 percent was used to determine the value of policies in force and is the rate of return which management of the Company (with assistance from an independent actuarial firm) believes would be required by a purchaser of the business based on conditions existing as of the Effective Date. In determining such rate of return, the following factors, among others, are considered. o The magnitude of the risks associated with each of the actuarial assumptions used in determining the expected cash flows. o Market rates of interest that would be applicable to an acquisition of the business. o The perceived likelihood of changes in insurance regulations and tax laws. o The complexity of the business. o Prices paid for similar blocks of business. (f) Assets and liabilities are adjusted to reflect their estimated fair market value. The portion of the reorganization value that could not be attributed to specific tangible or identified intangible assets has been recorded as goodwill. (g) The Company establishes reserves for insurance policy benefits based on assumptions as to investment yields, mortality, morbidity, withdrawals and lapses. These reserves include amounts for estimated future payment of claims based on actuarial assumptions. Many factors can affect these reserves, such as economic conditions, inflation, hospital and pharmaceutical costs, changes in doctrines of legal liability and extra contractual damage 14 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- awards. The balance is based on the Company's best estimate (with assistance from an independent actuarial firm) of the future performance of this business, given recent and expected future changes in experience. REORGANIZATION ITEMS Reorganization items represent amounts the Predecessor incurred as a result of its Chapter 11 reorganization, and are presented separately in the consolidated statement of operations. These items consist of the following (dollars in millions):
Two months Eight months ended ended August 31, 2003 August 31, 2003 --------------- --------------- Gain on discharge of prepetition liabilities......... $3,151.4 $ 3,151.4 Fresh start adjustments.............................. (950.0) (950.0) Professional fees.................................... (38.4) (70.9) -------- --------- Total reorganization items....................... $2,163.0 $ 2,130.5 ======== =========
LIABILITIES SUBJECT TO COMPROMISE Under the Bankruptcy Code, actions by creditors to collect indebtedness owed prior to the Petition Date were stayed and certain other prepetition contractual obligations could not be enforced against the Filing Entities. The Filing Entities received approval from the Bankruptcy Court to pay certain prepetition liabilities including employee salaries and wages, benefits and other employee obligations. All other prepetition liabilities were classified as "liabilities subject to compromise" in the accompanying consolidated balance sheet. The following table summarizes the components of the liabilities included in the line "liabilities subject to compromise" in our consolidated balance sheet at December 31, 2002 (dollars in millions): Other liabilities: Liability for guarantee of bank loans to former directors and current and former officers and key employees of Old Conseco to purchase common stock of Old Conseco................................ $ 480.8 Interest payable....................................................... 171.6 Accrual for distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts of Old Conseco. 90.1 Liability for retirement benefits pursuant to executive employment agreements............................................... 22.6 Liability for deferred compensation.................................... 2.3 Other liabilities...................................................... 48.8 -------- Total other liabilities subject to compromise....................... 816.2 Notes payable - direct corporate obligations............................... 4,057.1 -------- Total liabilities subject to compromise............................. $4,873.3 ========
GOODWILL Upon our emergence from bankruptcy, we revalued our assets and liabilities to current estimated fair value and established our capital accounts at the reorganization value determined in connection with the Plan. We recorded the $1,102.8 million of the reorganization value which could not be attributed to specific tangible or identified intangible assets as goodwill. Under current accounting rules (which became effective January 1, 2002) goodwill is not amortized but is subject to an annual impairment test (or more frequent under certain circumstances). We obtained an independent appraisal of our business in connection with the preparation of the Plan and our implementation of fresh start accounting. 15 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- Although the goodwill balance will not be subject to amortization, it will be reduced by future use of the Company's net deferred income tax assets (including the tax operating loss carryforwards) existing at August 31, 2003 (such balance was reduced by $l67.4 million in the one month ended September 30, 2003). A valuation allowance has been provided for the remaining balance of such net deferred income tax assets due to the uncertainties regarding their realization. See the note entitled "Income Taxes" for further discussion. 16 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- Changes in the carrying amount of goodwill are as follows (dollars in millions):
Successor -------------- One month ended September 30, 2003 ---- Goodwill balance, beginning of period................................ $1,102.8 Recognition of tax valuation reserve established at the Effective Date.................................................. (167.4) -------- Goodwill balance, end of period...................................... $ 935.4 ========
OTHER INTANGIBLE ASSETS In conjunction with our adoption of fresh start accounting, we identified certain intangible assets other than goodwill. We determined the value of these assets with assistance from an independent valuation firm. In accordance with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), other intangible assets with indefinite lives are not amortized, but are subject to impairment tests on an annual basis (or more frequent under certain circumstances). SFAS 142 requires intangible assets with finite useful lives to be amortized over their estimated useful lives and to be reviewed for impairment in accordance with Statement of Financial Accounting Standards No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). The following summarizes other identifiable intangible assets as of September 30, 2003 (dollars in millions): Indefinite lived other intangible assets: Trademarks and tradenames...................................... $ 25.1 State licenses and charters.................................... 34.0 ------ Total indefinite lived other intangible assets............. 59.1 ------ Finite lived other intangible assets: Career agency force............................................ 64.7 Independent agency force....................................... 49.8 Other.......................................................... 1.2 Less accumulated amortization.................................. (1.0) ------ Total finite lived other intangible assets................. 114.7 ------ Total other intangible assets..................................... $173.8 ======
CUMULATIVE EFFECT OF ACCOUNTING CHANGE AND GOODWILL IMPAIRMENT RELATED TO PREDECESSOR The Financial Accounting Standards Board ("FASB") issued SFAS 142, in June 2001. Under the new rule, intangible assets with an indefinite life are no longer amortized in periods subsequent to December 31, 2001, but are subject to annual impairment tests (or more frequent under certain circumstances), effective January 1, 2002. The Company determined that all of its goodwill had an indefinite life and was therefore subject to the new rules. The Company adopted SFAS 142 on January 1, 2002. Pursuant to the transitional rules of SFAS 142, we completed the two-step impairment test during 2002 and, as a result of that test, we recorded the cumulative effect of the accounting change for the goodwill impairment charge of $2,949.2 million. The impairment charge is reflected as the cumulative effect of an accounting change in the accompanying 17 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- consolidated statement of operations for the nine months ended September 30, 2002. Subsequent impairment tests will be performed on an annual basis, or more frequently if circumstances indicate a possible impairment. Subsequent impairment charges are classified as an operating expense. As described below, the Company performed an impairment test in the quarter ended September 30, 2002, as a result of circumstances which indicated a possible impairment. The significant factors used to determine the amount of the initial impairment included analyses of industry market valuations, historical and projected performance of our insurance segment, discounted cash flow analyses and the market value of our capital. The valuation utilized the best available information, including assumptions and projections we considered reasonable and supportable. The assumptions we used to determine the discounted cash flows involve significant judgments regarding the best estimate of future premiums, expected mortality and morbidity, interest earned and credited rates, persistency and expenses. The discount rate used was based on an analysis of the weighted average cost of capital for several insurance companies and considered the specific risk factors related to Conseco. Pursuant to the guidance in SFAS 142, quoted market prices in active markets are the best evidence of fair value and shall be used as the basis for measurement, if available. On August 14, 2002, our insurance subsidiaries' financial strength ratings were downgraded by A.M. Best to "B (fair)" and on September 8, 2002, the Company defaulted on its public debt. These developments caused sales of our insurance products to fall and policyholder redemptions and lapses to increase. The adverse impact on our insurance subsidiaries resulting from the ratings downgrade and parent company default required that an additional impairment test be performed as of September 30, 2002, in accordance with SFAS 142. In connection with the preparation of the Plan, we retained an outside actuarial consulting firm to assist in valuing our insurance subsidiaries. That valuation work and our internal evaluation were used in performing the additional impairment tests that resulted in an impairment charge to goodwill in the third quarter of 2002 of $500.0 million. The charge is reflected in the line item entitled "Goodwill impairment" in our consolidated statement of operations for the three and nine months ended September 30, 2002. The most significant changes made to the January 1, 2002 valuation that resulted in the additional impairment charge were: (i) reduced estimates of projected future sales of insurance products; (ii) increased estimates of future policyholder redemptions and lapses; and (iii) a higher discount rate to reflect the current rates used by the market to value life insurance companies. Management believes that the assumptions and estimates used were reasonable given all available facts and circumstances at the time made. Prior to the adoption of SFAS 142, we determined whether goodwill was recoverable from projected undiscounted net cash flows for the earnings of our subsidiaries over the remaining amortization period. If we determined that undiscounted projected cash flows were not sufficient to recover the goodwill balance, we would reduce its carrying value with a corresponding charge to expense or shorten the amortization period. Cash flows considered in such an analysis were those of the business acquired, if separately identifiable, or the product line that acquired the business, if such earnings were not separately identifiable. Changes in the carrying amount of Predecessor's goodwill are as follows (dollars in millions):
Predecessor ---------------------------------- Eight months Nine months ended ended August 31, September 30, 2003 2002 ---- ---- Goodwill balance, beginning of period............................. $100.0 $ 3,695.4 Cumulative effect of accounting change............................ - (2,949.2) Impairment charge................................................. - (500.0) Reduction of tax valuation contingencies established at acquisition date for acquired companies...................... (.6) (146.2) ------ --------- Goodwill balance, end of period................................... $ 99.4 $ 100.0 ====== =========
18 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- ACCOUNTING FOR INVESTMENTS We classify our fixed maturity securities into three categories: (i) "actively managed" (which we carry at estimated fair value with any unrealized gain or loss, net of tax and related adjustments, recorded as a component of shareholders' equity (deficit)); (ii) "trading" (which we carry at estimated fair value with changes in such value recognized as trading income); and (iii) "held to maturity" (which we carry at amortized cost). We had no fixed maturity securities classified as held to maturity during the periods presented in these financial statements. At August 31, 2003, we established trading security accounts which are designed to act as a hedge for embedded derivatives related to: (i) our equity-indexed annuity products; and (ii) certain modified coinsurance agreements. See the note entitled "Accounting for Derivatives" for further discussion regarding the embedded derivatives and the trading accounts. In addition, the trading account includes the investments backing the market strategies of our multibucket annuity products. The change in market value of these securities is substantially offset by the change in insurance policy benefits for these products. All of our trading securities totaled $944.9 million at September 30, 2003. The change in the market value of these securities is recognized currently in investment income (classified as income from policyholder and reinsurer accounts). Accumulated other comprehensive income is primarily comprised of unrealized gains on actively managed fixed maturity investments. These amounts, included in shareholders' equity (deficit) as of September 30, 2003, and December 31, 2002, were as follows (dollars in millions):
Successor Predecessor ------------ ------------ September 30, December 31, 2003 2002 ---- ---- Unrealized gains on investments....................................................... $ 470.6 $448.1 Adjustments to value of policies inforce at the Effective Date........................ (43.0) - Adjustments to cost of policies purchased and cost of policies produced............... - (95.3) Deferred income tax asset (liability)................................................. (154.4) 249.6 Other................................................................................. - (21.8) ------- ------ Accumulated other comprehensive income........................................... $ 273.2 $580.6 ======= ======
VENTURE CAPITAL INVESTMENT IN AT&T WIRELESS SERVICES, INC. At September 30, 2003, our venture capital investments consisted of 4.1 million shares of AT&T Wireless Services, Inc. ("AWE") with a value of $33.7 million. Our investment in AWE is carried at fair value, with changes in fair value recognized as investment income (loss). We recognized venture capital investment income (losses) of $(2.7) million in the one month ended September 30, 2003; $2.0 million in the two months ended August 31, 2003; and $10.5 million in the eight months ended August 31, 2003, related to this investment. Our venture capital investment losses related to this investment were $6.6 million and $106.6 million in the three and nine months ended September 30, 2002, respectively. COST OF POLICIES PRODUCED In conjunction with the implementation of fresh start accounting, we eliminated the historical balance of Old Conseco's cost of policies produced as of August 31, 2003 and replaced it with the value of policies in force at the Effective Date. The costs that vary with, and are primarily related to, producing new insurance business in the period after August 31, 2003 are referred to as cost of policies produced. We amortize these costs (using the interest rate credited to the underlying policy for universal life or investment-type products and the projected investment earnings rate for other products): (i) in relation to the estimated gross profits for universal life-type and investment-type products; or (ii) in relation to future anticipated premium revenue for other products. 19 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- When we realize a gain or loss on investments backing our universal life or investment-type products, we adjust the amortization to reflect the change in estimated gross profits from the products due to the gain or loss realized and the effect of the event on future investment yields. We also adjust the cost of policies produced for the change in amortization that would have been recorded if actively managed fixed maturity securities had been sold at their stated aggregate fair value and the proceeds reinvested at current yields. We include the impact of this adjustment in accumulated other comprehensive income (loss) within shareholders' equity (deficit). When we replace an existing insurance contract with another insurance contract with substantially different terms, all unamortized cost of policies produced related to the replaced contract is immediately written off. When we replace an existing insurance contract with another insurance contract with substantially similar terms, we continue to defer the cost of policies produced associated with the replaced contract. We regularly evaluate the recoverability of the unamortized balance of the cost of policies produced. We consider estimated future gross profits or future premiums, expected mortality or morbidity, interest earned and credited rates, persistency and expenses in determining whether the balance is recoverable. If we determine a portion of the unamortized balance is not recoverable, it is charged to amortization expense. VALUE OF POLICIES INFORCE AT THE EFFECTIVE DATE In conjunction with the implementation of fresh start accounting, we eliminated the historical balances of Old Conseco's cost of policies purchased and cost of policies produced as of the Effective Date and replaced them with the value of policies inforce as of the Effective Date. The cost assigned to the right to receive future cash flows from contracts existing at August 31, 2003 is referred to as the value of policies inforce as of the Effective Date. We also defer renewal commissions paid in excess of ultimate commission levels related to the existing policies in this account. The balance of this account is amortized, evaluated for recovery, and adjusted for the impact of unrealized gains (losses) in the same manner as the cost of policies produced described above. The discount rate we used to determine the value of policies inforce as of the Effective Date is the rate of return we need to earn in order to invest in the business. In determining this required rate of return, we consider many factors including: (i) the magnitude of the risks associated with each of the actuarial assumptions used in determining expected future cash flows; (ii) the cost of our capital; (iii) the likelihood of changes in projected future cash flows that might occur if there are changes in insurance regulations and tax laws; (iv) the compatibility of the business with our future business plans that may favorably affect future cash flows; (v) the complexity of the business; and (vi) recent prices (i.e., discount rates used in determining valuations) paid by others to acquire similar blocks of business. The weighted average discount rate we used to determine the value of business inforce as of the Effective Date was 12 percent. The Company expects to amortize approximately 2 percent of the August 31, 2003 balance of cost of policies purchased during the remainder of 2003, 8 percent in 2004, 9 percent in 2005, 9 percent in 2006 and 8 percent in 2007. 20 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- EARNINGS PER SHARE A reconciliation of net income and shares used to calculate basic and diluted earnings per share is as follows:
One month ended September 30, 2003 ------------------ (Dollars in millions and shares in thousands) Net income.................................................................... $24.2 Preferred stock dividends..................................................... (5.3) ----- Income applicable to common stock for basic earnings per share........................................... 18.9 Effect of dilutive securities: Preferred stock dividends.................................................. 5.3 ----- Income applicable to common stock and assumed conversions for diluted earnings per share................................................. $24.2 ===== Shares: Weighted average shares outstanding for basic earnings per share............................................. 100,098 ------- Effect of dilutive securities on weighted average shares: Preferred Stock (a)...................................................... 44,566 Stock options and employee benefit plans................................. 7 ------- Dilutive potential common shares....................................... 44,573 ------- Weighted average shares outstanding for diluted earnings per share......... 144,671 ======= - --------------- (a) The dilutive effect is determined under the treasury stock method using the average market price during the period.
On the Effective Date, the Successor adopted a new long-term incentive plan, which permits the grant of CNO incentive or non-qualified stock options and restricted stock awards to certain directors, officers and employees of CNO and certain other individuals who perform services for the Company. A maximum of 10 million shares may be issued under the plan. Restricted share grants are limited to 3.3 million shares. During September 2003, the Company granted options to purchase 500,000 shares of CNO common stock at $16.40 per share and 500,000 restricted shares of CNO common stock to the Chief Executive Officer in accordance with his employment agreement. These options and restricted stock vest over the next four years. In addition, the Company granted options to purchase 500,000 shares of CNO common stock at $19.61 per share and 500,000 restricted shares of CNO common stock to the non-executive Chairman of the Board of Directors in accordance with his agreement. These options and restricted shares vest over the next three years. Basic earnings per common share ("EPS") is computed by dividing income applicable to common stock by the weighted average number of common shares outstanding for the period. Restricted shares are not included in basic EPS until vested. Diluted EPS reflects the potential dilution that could occur if the Preferred Stock were converted into common stock, the options were exercised and the restricted stock was vested. The dilution from options and restricted shares are calculated using the treasury stock method. 21 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- STOCK-BASED COMPENSATION In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure", an Amendment of FASB Statement No. 123 ("SFAS 148"), which provides three alternative methods of transition to the fair value method of accounting for stock options. SFAS 148 also amends the disclosure requirements of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). We apply Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for our stock option plans. Since the amount an employee must pay to acquire the stock is equal to the market price of the stock on the grant date, no compensation cost has been recognized for our stock option plans. Had compensation cost been determined based on the fair value at the grant dates consistent with the method of SFAS 123, the Company's pro forma net income (loss) and pro forma earnings (loss) per share would have been as follows (dollars in millions, except per share amounts):
Successor Predecessor --------------- ---------------------------------------------------------- One month Two months Three months Eight months Nine months ended ended ended ended ended September 30, August 31, September 30, August 31, September 30, 2003 2003 2002 2003 2002 ---- ---- ---- ---- ---- Net income (loss), as reported .................. $24.2 $2,241.3 $(1,769.0) $2,201.7 $(6,147.2) Less stock-based employee compensation expense determined under the fair value based method for all awards, net of income taxes....................................... - (2.0) 2.5 7.2 10.5 ----- -------- --------- -------- --------- Pro forma net income (loss)...................... $24.2 $2,243.3 $(1,771.5) $2,194.5 $(6,157.7) ===== ======== ========= ======== ========= Earnings per share: Basic, as reported.......................... $.19 ==== Basic, pro forma............................ $.19 ==== Diluted, as reported........................ $.17 ==== Diluted, pro forma.......................... $.17 ====
All outstanding stock options of the Predecessor were cancelled pursuant to the Plan. Pro forma compensation expense in the two and eight months ended August 31, 2003, has been reduced by $5.0 million due to the reversal of expense for options that were not vested upon cancellation of the outstanding stock options of the Predecessor. BUSINESS SEGMENTS We have historically managed our business operations through two segments, based on the products offered, in addition to the corporate segment. We are reorganizing our business and plan to manage them through three segments in the future: (i) products marketed through career agents and direct marketing; (ii) products marketed through professional independent producers; and (iii) the long-term care products which were sold through professional independent producers but are no longer being marketed. The Company is currently modifying its accounting and reporting systems to provide information consistent with this structure. Insurance and fee-based segment. Our insurance and fee-based segment provides supplemental health, annuity and life insurance products to a broad spectrum of customers through multiple distribution channels, each focused on a specific market segment. These products are primarily marketed through career agents, professional independent producers and direct 22 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- marketing. Fee-based activities include services performed for other companies, including investment management and insurance product marketing. Finance segment. CFC historically provided a variety of finance products including: (i) loans for the purchase of manufactured housing, home improvements and various consumer products; (ii) home equity loans; and (iii) private label credit card programs. As a result of the formalization of the plan to sell the finance business and the filing of petitions under the Bankruptcy Code by CFC and several of its subsidiaries, we accounted for the finance business as a discontinued business in our consolidated financial statements in 2002. As of March 31, 2003, we no longer included the assets and liabilities of CFC in our consolidated financial statements. Corporate and other segment. Our corporate segment includes certain investment activities, such as our venture capital investment in AWE. In addition, the corporate segment includes interest expense related to the Company's corporate debt, special corporate charges, income (loss) from the major medical business in run-off and other income and expenses. Corporate expenses are net of charges to our subsidiaries for services provided by the corporate operations. 23 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- Operating information regarding the insurance and corporate segments was as follows (dollars in millions):
Successor Predecessor --------------- -------------------------------------------------------- One month Two months Three months Eight months Nine months ended ended ended ended ended September 30, August 31, September 30, August 31, September 30, 2003 2003 2002 2003 2002 ---- ---- ---- ---- ---- Revenues: Insurance and fee-based segment: Insurance policy income: Annuities................................ $ 7.3 $ 16.0 $ 48.1 $ 84.5 $ 111.3 Supplemental health...................... 192.2 380.3 568.6 1,529.2 1,705.9 Life..................................... 43.6 94.9 155.0 395.4 469.8 Other.................................... 5.8 8.5 28.8 46.2 88.1 Net investment income (a).................. 103.2 239.5 332.5 938.6 1,034.7 Fee revenue and other income (a)........... 1.9 8.2 19.9 34.4 69.9 Net realized investment gains (losses) (a)............................ 6.7 (35.8) (261.1) (5.4) (493.9) ------- ------- -------- -------- -------- Total insurance and fee-based segment revenues.................... 360.7 711.6 891.8 3,022.9 2,985.8 ------- ------- -------- -------- -------- Corporate and other: Net investment income...................... .1 3.2 3.5 12.4 8.8 Venture capital gain (loss) related to investment in AWE..................... (2.7) 2.0 (6.6) 10.5 (106.6) Revenue from the major medical business in run-off...................... 8.2 18.1 107.0 156.4 366.8 ------- ------- -------- -------- -------- Total corporate segment revenues...... 5.6 23.3 103.9 179.3 269.0 Eliminations................................ - - (4.9) - (15.1) -------- ------- -------- -------- -------- Total revenues........................ 366.3 734.9 990.8 3,202.2 3,239.7 -------- ------- -------- -------- -------- Expenses: Insurance and fee-based segment: Insurance policy benefits.................. 236.8 380.1 (b) 841.1 1,999.5 2,256.9 Amortization............................... 27.0 58.4 (b) 160.1 337.6 555.1 Interest expense on investment borrowings............................... .6 1.9 2.1 8.3 12.4 Other operating costs and expenses......... 47.0 100.7 133.6 380.6 378.7 Goodwill impairment........................ - - 500.0 - 500.0 Special charges............................ - - 2.3 - 42.0 ------- ------- -------- -------- -------- Total insurance and fee-based segment expenses..................... 311.4 541.1 1,639.2 2,726.0 3,745.1 ------- ------- -------- -------- --------
(continued on the following page) 24 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements -------------------
Successor Predecessor --------------- ---------------------------------------------------------- One month Two months Three months Eight months Nine months ended ended ended ended ended September 30, August 31, September 30, August 31, September 30, 2003 2003 2002 2003 2002 ---- ---- ---- ---- ---- Corporate and other: Interest expense on corporate debt.......... 6.4 53.5 82.5 194.1 236.5 Provision for losses and interest expense related to stock purchase plan................................... - 24.5 59.9 55.6 199.9 Expenses from the major medical business in run-off.................... 8.2 18.1 107.0 156.4 366.8 Other corporate expenses, less charges to subsidiaries for services provided............................... 2.5 1.7 27.4 28.4 72.7 Extraordinary gain on extinguishment of debt................................ - - - - (1.8) Reorganization items........................ - (2,163.0) - (2,130.5) - Special charges............................. - - 32.6 - 61.1 ------ -------- -------- --------- --------- Total corporate segment expenses.......... 17.1 (2,065.2) 309.4 (1,696.0) 935.2 Eliminations.................................. - - (4.9) - (15.1) ------ -------- -------- --------- --------- Total expenses............................ 328.5 (1,524.1) 1,943.7 1,030.0 4,665.2 ------ -------- -------- --------- --------- Income (loss) before income taxes, minority interest, discontinued operations and cumulative effect of accounting change: Insurance and fee-based operations.......... 49.3 170.5 (747.4) 296.9 (759.3) Corporate operations........................ (11.5) 2,088.5 (205.5) 1,875.3 (666.2) ------ -------- -------- --------- ---------- Income (loss) before income taxes, minority interest, discontinued operations and cumulative effect of accounting change.................. $ 37.8 $2,259.0 $ (952.9) $ 2,172.2 $(1,425.5) ====== ======== ======== ========= ========= - -------------------- (a) It is not practicable to provide additional components of revenue by product or service. (b) In August 2003, the Company decided to change a non-guaranteed element of certain policies. This element was not required by the policy and the change will eliminate the former practice of reducing the cost of insurance charges to amounts below the level permitted under the provisions of the policies. As a result of this decision, our estimates of future expected gross profits on these products used as a basis for amortization of cost of policies purchased and cost of policies produced and the establishment of insurance liabilities has changed. We adjusted the total amortization and reserve charge we had recorded since the acquisition of these policies as a result of the change to our earlier estimates in accordance with Statement of Financial Accounting Standards No. 97, "Accounting and Reporting by Insurance Enterprises of Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments." The effect of the change in estimate was a $220.2 million reduction to insurance policy benefits and a $39.8 million reduction in amortization recorded in the two months ended August 31, 2003.
25 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- ACCOUNTING FOR DERIVATIVES Our equity-indexed annuity products provide a guaranteed base rate of return and a higher potential return linked to the performance of the S&P 500 Index based on a percentage (the participation rate) over an annual period. At the beginning of each policy year, a new index period begins. We are able to change the participation rate at the beginning of each index period, subject to contractual minimums. We buy S&P 500 Call Options in an effort to hedge potential increases to policyholder benefits resulting from increases in the S&P 500 Index to which the product's return is linked. We include the cost of the S&P 500 Call Options in the pricing of these products. Policyholder account balances for these annuities fluctuate in relation to changes in the values of these options. We reflect changes in the estimated market value of these options in net investment income. Option costs that are attributable to benefits provided were $5.2 million in the one month ended September 30, 2003; $53.5 million in the eight months ended August 31, 2003; and $72.9 million in the first nine months of 2002. These costs are reflected in the change in market value of the S&P 500 Call Options included in investment income. Net investment income (loss) related to equity-indexed products before this expense was $(3.1) million in the one month ended September 30, 2003; $78.7 million in the eight months ended August 31, 2003; and $(24.9) million in the first nine months of 2002. These amounts were substantially offset by the corresponding charge to insurance policy benefits. The estimated fair value of the S&P 500 Call Options was $83.7 million and $32.8 million at September 30, 2003 and December 31, 2002, respectively. We classify these instruments as other invested assets. The Company accounts for the options attributed to the policyholder for the estimated life of the annuity contract as embedded derivatives as defined by Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended by Statement of Financial Accounting Standards No. 137, "Deferral of the Effective Date of FASB Statement No. 133" and Statement of Financial Accounting Standards No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities". We record the change in the fair values of the embedded derivatives in current earnings as a component of policyholder benefits. The fair value of these derivatives, which are classified as "liabilities for interest-sensitive products", was $243.7 million and $301.9 million at September 30, 2003 and December 31, 2002, respectively. We have transferred a specified block of investments which are equal to the balance of these liabilities to our trading securities account, which we carry at estimated fair value with changes in such value recognized as investment income (classified as investment income from policyholder accounts). The change in value of these trading securities should largely offset the portion of the change in the value of the embedded derivative which is caused by interest rate fluctuations. If the counterparties for the derivatives we hold fail to meet their obligations, we may have to recognize a loss. We limit our exposure to such a loss by diversifying among several counterparties believed to be strong and creditworthy. At September 30, 2003, all of the counterparties were rated "A" or higher by Standard & Poor's Corporation. The FASB's Derivative Implementation Group issued SFAS No. 133 Implementation Issue No. B36, "Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments that Incorporate Credit Risk Exposures that are Unrelated or Only Partially Related to the Creditworthiness of the Obligor of Those Instruments" ("DIG B36") in April 2003. DIG B36 addresses specific circumstances under which bifurcation of an instrument into a host contract and an embedded derivative is required. DIG B36 requires the bifurcation of a derivative from the receivable or payable related to a modified coinsurance agreement, where the yield on the receivable and payable is based on a return of a specified block of assets rather than the creditworthiness of the ceding company. We implemented this guidance on August 31, 2003, in conjunction with our adoption of fresh start accounting. We have determined that certain of our reinsurance payable balances contain embedded derivatives. Such derivatives had an estimated fair value of $20.9 million and $29.5 million at August 31, 2003 and September 30, 2003, respectively. We record the change in the fair value of these derivatives as a component of investment income (classified as investment income from policyholder and reinsurer accounts). We have transferred the specific block of investments related to these agreements to our trading securities account, which we carry at estimated fair value with changes in such value recognized as investment income (also classified as investment income from reinsurer accounts). The change in value of these trading securities should largely offset the change in value of the embedded derivatives. GUARANTEES In conjunction with the Plan, $481.3 million principal amount of bank loans made to certain former directors and certain current and former officers and key employees to enable them to purchase common stock of Old Conseco were transferred to the Company. These loans had been guaranteed by Old Conseco. We received all rights to collect the balances due pursuant to the original terms of these loans. In addition, we hold loans to participants for interest on the bank loans which total approximately $200 million. The former bank loans and the interest loans are collectively referred to as the 26 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- "D&O loans." We regularly evaluate the collectibility of these loans in light of the collateral we hold and the credit worthiness of the participants. At August 31, 2003 and September 30, 2003, we have estimated that approximately $52.3 million of the D&O balance (which is included in other assets) is collectible (net of the cost of collection). An allowance has been established to reduce the recorded balance of the D&O loans to this balance. Pursuant to the settlement that was reached with the Official Committee of the Trust Originated Preferred Securities ("TOPrS") Holders and the Official Committee of Unsecured Creditors in the Plan, the former holders of TOPrS (issued by Old Conseco's subsidiary trusts and eliminated in our reorganization) who did not opt out of the bankruptcy settlement, will be entitled to receive 45 percent of any proceeds from the collection of certain D&O loans in an aggregate amount not to exceed $30 million. We have established a liability of $23.5 million (which is included in other liabilities), representing our estimate of the amount which will be paid to the former holders of TOPrS pursuant to the settlement. In accordance with the terms of the Company's former Chief Executive Officer's employment agreement, Bankers Life and Casualty Company, a wholly-owned subsidiary of the Company, is the guarantor of the former executive's nonqualified supplemental retirement benefit. The liability for such benefit at September 30, 2003 was $15.4 million and is included in the caption "Other liabilities" in the liability section of the consolidated balance sheet. REINSURANCE The cost of reinsurance ceded totaled $25.0 million in the one month ended September 30, 2003; $199.1 million in the eight months ended August 31, 2003; and $258.9 million in the first nine months of 2002. We deducted this cost from insurance policy income. In each case, the ceding Conseco subsidiary is contingently liable for claims reinsured if the assuming company is unable to pay. Reinsurance recoveries netted against insurance policy benefits totaled $24.9 million in the one month ended September 30, 2003; $183.4 million in the eight months ended August 31, 2003; and $232.8 million in the first nine months of 2002. Reinsurance premiums assumed totaled $10.6 million in the one month ended September 30, 2003; $57.3 million in the eight months ended August 31, 2003; and $56.3 million in the first nine months of 2002. See the note entitled "Accounting for Derivatives" for a discussion of the derivative embedded in the payable related to certain modified coinsurance agreements. INCOME TAXES The components of income tax expense (benefit) are as follows (dollars in millions):
Successor Predecessor ------------------ ----------------------------------- One month Eight months Nine months ended ended ended September 30, 2003 August 31, 2003 September 30, 2002 ------------------ --------------- ------------------ Current tax provision..................................... $ .6 $ (13.5) $ 127.7 Deferred tax provision (benefit).......................... 13.0 - (443.8) ----- -------- -------- Income tax expense (benefit) on period income.... 13.6 (13.5) (316.1) Valuation allowance....................................... - - 1,314.4 ----- -------- -------- Total income tax expense (benefit)............... $13.6 $ (13.5) $ 998.3 ===== ======= ========
27 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- A reconciliation of the U.S. statutory corporate tax rate to the effective rate reflected in the consolidated statement of operations is as follows:
Successor Predecessor ------------------ ----------------------------------- One month Eight months Nine months ended ended ended September 30, 2003 August 31, 2003 September 30, 2002 ------------------ --------------- ------------------ U.S. statutory corporate rate............................. 35.0% 35.0% (35.0)% Valuation allowance....................................... - 25.8 92.2 Gain on debt restructuring................................ - (39.7) - Subsidiary stock basis adjustment......................... - (21.8) - Nondeductible goodwill amortization and impairment........ - - 12.2 Other nondeductible expenses.............................. .1 (.1) - State taxes............................................... .9 .2 (.1) Provision for tax issues and other........................ - - .7 --- ------ ----- Effective tax rate............................... 36.0% (.6)% 70.0% ==== ====== =====
Conseco and its affiliates are currently under examination by the Internal Revenue Service (the "IRS") for tax years ending December 31, 1999 through December 31, 2001. The outcome of the examination is not expected to result in material adverse deficiencies, but may result in utilization or adjustment to the income tax loss carryforwards reported below. The components of the Company's income tax assets and liabilities were as follows (dollars in millions):
Successor Predecessor ------------- ------------- September 30, December 31, 2003 2002 ---- ---- Deferred tax assets: Net operating loss carryforwards: Portion attributable to CFC worthless investment............................... $ 1,133.9 $ - Other.......................................................................... 135.2 615.0 Deductible temporary differences: Actively managed fixed maturities.............................................. - 196.0 Capital loss carryforwards..................................................... 406.8 112.8 Interest-only securities....................................................... - 536.3 Insurance liabilities.......................................................... 1,258.5 750.4 Allowance for loan losses...................................................... - 252.2 Reserve for loss on loan guarantees............................................ 221.5 229.2 Venture capital income......................................................... 26.6 - Unrealized depreciation........................................................ - - Debt obligations............................................................... - 39.4 Other.......................................................................... 75.4 14.0 --------- --------- Gross deferred tax assets.................................................... 3,257.9 2,745.3 --------- --------- Deferred tax liabilities: Actively managed fixed maturities.............................................. (9.3) - Cost of policies purchased and cost of policies produced....................... (613.6) (773.8) Unrealized appreciation........................................................ (154.4) (126.2) Other.......................................................................... (60.8) (125.7) --------- --------- Gross deferred tax liabilities............................................... (838.1) (1,025.7) --------- --------- Valuation allowance............................................................ (2,419.8) (1,719.6) --------- --------- Net deferred tax assets...................................................... - - --------- --------- Current income taxes prepaid.......................................................... 86.7 66.9 Income tax liabilities classified as liabilities of discontinued operations........... - 34.6 --------- --------- Net income tax assets........................................................ $ 86.7 $ 101.5 ========= =========
28 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- Our income tax expense includes deferred income taxes arising from temporary differences between the financial reporting bases of assets and liabilities, capital loss carryforwards and net operating loss carryforwards. In assessing the realization of deferred income tax assets, we consider whether it is more likely than not that the deferred income tax assets will be realized. The ultimate realization of our deferred income tax assets depends upon generating future taxable income during the periods in which our temporary differences become deductible and before our net operating loss carryforwards expire. In addition, the use of the Company's net ordinary loss carryforwards is dependent, in part, on whether the IRS ultimately agrees with the tax position we plan to take in our current and future tax returns. We evaluate the realizability of our deferred income tax assets by assessing the need for a valuation allowance on a quarterly basis. A valuation allowance has been provided for the entire balance of net deferred income tax assets at September 30, 2003, as we believe the realization of such assets in future periods is uncertain. We reached this conclusion after considering the availability of taxable income in prior carryback years, tax planning strategies, our recent history of significant losses and the likelihood of future taxable income exclusive of reversing temporary differences and carryforwards. As of September 30, 2003, we had about $3.6 billion of net operating loss carryforwards (after taking into account the reduction in tax attributes described in the paragraph which follows and the loss resulting from the worthlessness of CFC discussed below), which expire as follows: $2.3 million in 2003; $11.2 million in 2004; $4.5 million in 2005; $0.2 million in 2006; $5.7 million in 2007; $6.6 million in 2008; $10.5 million in 2009; $4.2 million in 2010; $2.5 million in 2011; $16.0 million in 2012; $43.4 million in 2013; $6.9 million in 2014; $60.5 million in 2016; $116.7 million in 2017; $3,322.5 million in 2018; $.2 million in 2019; $12.1 million in 2020. The timing and manner in which we will utilize the net operating loss carryforwards in any year or in total may be limited by various provisions of the Internal Revenue Code (the "Code") (and interpretation thereof) and our ability to generate sufficient future taxable income in the relevant carryforward period. The Code provides that any income realized as a result of the cancellation of indebtedness (cancellation of debt income or "CODI") in bankruptcy, will reduce certain tax attributes including net operating loss carryforwards. We realized an estimated $2.5 billion of CODI when we emerged from bankruptcy. Accordingly, our net operating loss carryforwards were reduced by $2.5 billion. The following paragraphs summarize some of the various limitations and contingencies which exist with respect to the future utilization of the net operating loss carryforwards. The Company realized an estimated $5.4 billion tax loss in 2003 as a result of its investment in CFC. In consultation with our tax advisors and based on relevant provisions of the Code, the Company intends to treat this loss as an ordinary loss, thereby increasing the Company's net operating loss carryforward. The Company has requested a pre-filing examination by the IRS to confirm that this loss should be treated as an ordinary loss. If the IRS were to disagree with our conclusion and such determination ultimately prevailed, the loss would be treated as a capital loss, which would only be available to reduce future capital gains for the next 5 years. The procedures related to the pre-filing examination are in process, but are not expected to be completed before August 2004. The Code limits the extent to which losses realized by a non-life entity (or entities) may offset income from a life insurance company (or companies) to the lesser of: (i) 35 percent of the income of the life insurance company; or (ii) 35 percent of the total loss. There is no limitation with respect to the ability to utilize net operating losses generated by a life insurance company. Subsequent to our emergence from bankruptcy, we reorganized certain of our subsidiaries to improve their capital position. As a result of the reorganization, the loss related to CFC was realized by a life insurance company. Accordingly, we believe the loss should be treated as a life insurance loss and would not be subject to the limitations described above. The timing and manner in which the Company will be able to utilize its net operating loss carryforward will be limited by Section 382 of the Code. Section 382 imposes on a corporation's ability to use its net operating losses if the company undergoes an ownership change. Because the Company underwent an ownership change pursuant to its reorganization, we have determined that this limitation applies to the Company. In order to determine the amount of this limitation we must determine how much of our net operating loss carryforward relates to the period prior to our emergence from bankruptcy (such amount will be subject to the 382 limitation) and how much relates to the period after emergence (such amount will not be subject to the 382 limitation). Pursuant to the Code, we may: (i) allocate the current year tax loss on a pro rata basis to determine earnings (loss) post- and pre-emergence; or (ii) specifically identify transactions in each period and record it in the 29 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- period it actually occurred. We intend to elect the latter, which we believe will result in a substantial portion of the loss related to CFC being treated as post emergence and therefore not subject to the Section 382 limitation. Any losses that are subject to the Section 382 limitation will only be utilized by the Company up to approximately $140 million per year with any unused amounts carried forward to the following year. The use of the Company's net deferred income tax assets (including the net operating loss carryforwards) existing as of August 31, 2003, will be accounted for as a reduction of goodwill when utilized pursuant to SOP 90-7. If goodwill is eliminated, any additional use of net deferred income tax assets existing at August 31, 2003 will be accounted for as a reduction of other intangible assets until exhausted and thereafter as an addition to paid-in-capital. Goodwill was reduced by $167.4 million during the one month ended September 30, 2003, due to a reduction in the valuation allowance for net deferred income tax assets established at the Effective Date. CHANGES IN DIRECT CORPORATE OBLIGATIONS This note contains information regarding the following notes payable that were direct corporate obligations of the Company as of September 30, 2003 and December 31, 2002 (dollars in millions):
Successor Predecessor ------------- ------------ September 30, December 31, 2003 2002 ---- ---- $1.3 billion credit agreement........................................................... $1,300.0 $ - $1.5 billion senior credit facility..................................................... - 1,531.4 8.5% senior notes due 2002.............................................................. - 224.9 8.5% guaranteed senior notes due 2003................................................... - 1.0 8.125% senior notes due 2003............................................................ - 63.5 6.4% senior notes due 2003.............................................................. - 234.1 6.4% guaranteed senior notes due 2004................................................... - 14.9 10.5% senior notes due 2004............................................................. - 24.5 8.75% senior notes due 2004............................................................. - 423.7 8.75% guaranteed senior notes due 2006.................................................. - 364.3 6.8% senior notes due 2005.............................................................. - 99.2 6.8% guaranteed senior notes due 2007................................................... - 150.8 9.0% senior notes due 2006.............................................................. - 150.8 9.0% guaranteed senior notes due 2008................................................... - 399.2 10.75% senior notes due 2008............................................................ - 37.6 10.75% guaranteed senior notes due 2009................................................. - 362.4 -------- --------- Total principal amount............................................................. 1,300.0 4,082.3 Unamortized net discount related to issuance of notes payable .......................... - (34.0) Unamortized fair market value of terminated interest rate swap agreements.................................................................... - 8.8 -------- --------- Less amounts subject to compromise...................................................... - (4,057.1) -------- --------- Direct corporate obligations....................................................... $1,300.0 $ - ======== =========
30 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- Pursuant to the Plan, we entered into a senior secured bank credit facility with a principal balance of $1.3 billion (the "New Credit Facility"). The New Credit Facility consists of two tranches: Tranche A - $1.0 billion; and Tranche B - $.3 billion. Principal repayments are due as follows (dollars in millions):
Tranche A Tranche B --------- --------- June 30, 2004......................................................... $ 50.0 $ 3.0 June 30, 2005......................................................... 50.0 3.0 June 30, 2006......................................................... 50.0 1.5 December 31, 2006..................................................... 50.0 1.5 June 30, 2007......................................................... 75.0 1.5 December 31, 2007..................................................... 75.0 1.5 June 30, 2008......................................................... 75.0 1.5 December 31, 2008..................................................... 75.0 1.5 June 30, 2009......................................................... - 1.5 September 10, 2009.................................................... 500.0 - December 31, 2009..................................................... - 1.5 September 10, 2010.................................................... - 282.0 -------- ------ $1,000.0 $300.0 ======== ======
Tranche A and Tranche B borrowings bear interest, payable monthly, based on either an offshore rate or a base rate. Offshore rates are equal to LIBOR plus an applicable margin based on the rating of the Company's senior secured long-term debt securities by Moody's Investors Service, Inc. ("Moody's") or Standard & Poor's Ratings Group ("S&P"). Base rates are equal to: (i) the greater of: (a) the Federal funds rate plus .50 percent; or (b) Bank of America's prime rate; plus (ii) an applicable margin based on the rating of the Company's senior secured long-term debt securities by Moody's or S&P. With respect to Tranche A, the LIBOR rate may not be less than 2.0 percent through September 30, 2004, or less than 2.50 percent thereafter. With respect to Tranche B, the LIBOR rate may not be less than 2.25 percent through September 30, 2004, or less than 2.75 percent thereafter. The range of applicable margins are summarized in the following table:
Offshore Base rate rate margin margin ----------- --------- Tranche A...................................................... 3.75% - 5.25% 1.75% - 3.25% Tranche B...................................................... 5.75% - 7.25% 3.75% - 5.25%
On September 30, 2003, the interest rates on our Tranche A and Tranche B borrowings were 7.25 percent and 9.50 percent, respectively. Pursuant to the New Credit Facility, the Company is required to make mandatory prepayments with all or a portion of the proceeds from the following transactions or events including: (i) the issuance of certain indebtedness; (ii) equity issuances; (iii) certain asset sales or casualty events; (iv) a certain percentage of amounts received or recovered with respect to the D&O loans; and (v) excess cash flow as defined in the credit agreement. Proceeds not used to prepay indebtedness must generally be: (i) used to redeem a portion of our Preferred Stock; or (ii) contributed to the capital of our insurance subsidiaries. The New Credit Facility requires the Company to maintain various financial ratios and balances, as defined in the agreement including: (i) a debt-to-total capitalization ratio of less than .358:1.0 or less at September 30, 2003, and decreasing over time to .200:1.0 at June 30, 2008 (such ratio was .341:1.0 at September 30, 2003); (ii) an interest coverage ratio greater than or equal to 1.00:1.0 for the quarter ending December 31, 2003, and increasing over time to 4.50:1.0 for the year ending December 31, 2009; (iii) EBITDA, as defined in the credit agreement, greater than or equal to $490.0 million for the two quarters ended March 31, 2004, and increasing over time to $1,296.0 million for the four quarters ending March 31, 2010; (iv) an aggregate risk-based capital ratio, as defined in the credit agreement, greater than or equal to 158 percent at September 30, 2003, and increasing over time to 225 percent at March 31, 2006 (such ratio was 257 percent at September 30, 2003); (v) 31 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- minimum individual risk-based capital ratios for certain insurance companies as of the end of each fiscal year; (vi) minimum levels of statutory capital and surplus, as defined in the credit agreement (statutory capital and surplus at September 30, 2003 exceeded such requirements); and (vii) minimum investment portfolio requirements (such minimum investment portfolio requirements were met at September 30, 2003). In addition, if we experience a ratings downgrade, or if we fail to achieve an A.M. Best "A-" rating by August 15, 2005 (or December 31, 2005 if we meet certain financial ratios), we will suffer an event of default under the New Credit Facility. If we experience a ratings downgrade below "B (Fair)" or a downgrade by two or more levels in any six-month period, a "trigger event" will also occur and holders of our Preferred Stock will have the right to vote with holders of our common stock on all matters on an as-converted basis. The New Credit Facility prohibits or restricts, among other things: (i) the payment of cash dividends on the Company's common or preferred stock; (ii) the repurchase of our common stock; (iii) the issuance of additional debt or capital stock; (iv) liens; (v) asset dispositions; (vi) affiliate transactions; (vii) certain investment activities; (viii) change in business; and (ix) prepayment of indebtedness (other than the New Credit Facility). The obligations under our New Credit Facility are guaranteed by Conseco's current and future domestic subsidiaries, other than: (i) its insurance companies; (ii) subsidiaries of the insurance companies; or (iii) certain immaterial subsidiaries as defined in the credit agreement. This guarantee was secured by granting liens on substantially all the assets of the guarantors including the capital stock of our top tier insurance company, Conseco Life Insurance Company of Texas. Pursuant to the New Credit Facility, the Company is required to pay a fee of $6.5 million on June 30, 2004, unless all borrowings under the credit agreement have been repaid. The outstanding notes payable that were direct corporate obligations of Old Conseco prior to our emergence from bankruptcy and the $1.5 billion senior credit facility were discharged in accordance with the Plan. PREFERRED STOCK Pursuant to the Plan, CNO issued 34.4 million shares of Preferred Stock with an aggregate liquidation preference of approximately $859.7 million. The Preferred Stock has a par value of $.01 per share and a liquidation preference of $25 per share. Dividends are payable at a rate equal to 10.5 percent of the liquidation preference per share, payable semi-annually on March 1 and September 1. This rate will increase to 11 percent beginning September 11, 2005. These dividends are payable in additional shares of Preferred Stock until the later of: (i) September 10, 2005; or (ii) the beginning of the first fiscal quarter after which our primary insurance companies have received a financial strength rating of at least "A-" by A.M. Best Company ("A.M. Best"). Thereafter, dividends are payable, at our option, in cash or additional shares of Preferred Stock. The Preferred Stock may be redeemed by CNO, in whole or in part, at any time in cash equal to the liquidation preference plus cumulative unpaid dividends thereon. The Preferred Stock is convertible, at the option of the holder, into common stock of CNO at any time on or after September 30, 2005. The conversion rate is equal to the total liquidation preference plus cumulative unpaid dividends thereon divided by the greater of: (i) the average price of CNO's common stock, as defined, for each of the trading days in the 60 calendar day period immediately preceding January 8, 2004; or (ii) $.15 per share of common stock. The Preferred Stock is exchangeable, at the option of the holder, into common stock of CNO at any time on or after September 10, 2013. The exchange rate is equal to the total liquidation preference plus cumulative unpaid dividends thereon divided by the average market price of CNO's common stock, as defined, for the ten trading days ending on the date of exchange. The maximum number of common shares that can be issued shall not exceed the greater of: (i) 7.84 billion shares of common stock; or (ii) the number of authorized but unissued shares of CNO's common stock. In addition, CNO, at its option, may pay cash in an amount equal to the liquidation preference in lieu of delivering the exchanged common stock. The holders of the Preferred Stock will be entitled to voting rights beginning September 30, 2005 or earlier if there is: (i) a reduction in the financial strength rating assigned to any of our active material insurance subsidiaries (as defined) by A.M. Best; (ii) an event of default under our credit agreement; (iii) the occurrence of a material adverse regulatory event, as defined, with respect to any of our material insurance subsidiaries (as defined); or (iv) a failure to maintain various financial ratios and balances (none of which are more restrictive than the covenants contained in our credit agreement). 32 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- WARRANTS Pursuant to the Plan, we issued 6.0 million Series A Warrants (the "Warrants") entitling the holders to purchase shares of CNO common stock at a price of $27.60 per share. The Warrants expire on September 10, 2008. The exercise price and number of common shares issuable are subject to adjustment based on the occurrence of certain events, including: (i) stock dividends; (ii) stock splits; and (iii) the issuance of instruments or securities which are exercisable for or convertible into shares of common stock entitling the holders to purchase shares of common stock at a price per share that is less than the market price on the date of issuance. SALE OF THE GENERAL MOTORS BUILDING During the summer of 2003, we successfully enforced our contractual right to buy out our 50 percent equity partner in the General Motors building ("GM building"), a landmark 50-story office tower in New York City. After obtaining an award in arbitration, and confirming that award in the New York court system, we finally settled our differences with our equity partner, thus permitting us to put the building up for sale. On September 26, 2003, we sold our investment in the GM building. We received cash of $636.8 million, which was approximately equal to the value established upon the adoption of fresh start accounting. Our investment in the GM building was made through a partnership which acquired the building in 1998 for $878 million. The initial capital structure of the partnership consisted of: (i) a $700 million senior mortgage; (ii) $200 million of subordinated debt with a stated fixed return of 12.7 percent payable-in-kind, and the opportunity to earn an additional residual return; and (iii) $30 million of partnership equity, owned 50 percent by Conseco and 50 percent by an affiliate of Donald Trump. A Trump affiliate also served as general manager of the acquired building. We owned 100 percent of the subordinated debt. The $30 million of partnership equity represented less than 10 percent of the total capital of the partnership. In addition, the subordinated debt was intended to absorb virtually all expected losses and receive a significant portion of expected residual returns. Based on our 100 percent ownership of the subordinated debt, we were the primary beneficiary of the GM building. The partnership was consolidated in our financial statements effective August 31, 2003 in accordance with the requirements of FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"), which was implemented in conjunction with fresh start accounting. The August 31, 2003 fresh start balance sheet reflected the following balances of the partnership: the GM building at $1,336.3 million; cash of $28.4 million; and a non-recourse loan of $700 million (classified as an investment borrowing). Our income statement for the one month ended September 30, 2003, reflected investment income of $2.9 million related to this investment (representing our equity interest in the income from the building for the 26 days prior to the sale). RECENTLY ISSUED ACCOUNTING STANDARDS Pursuant to SOP 90-7, we have implemented the provisions of accounting principles required to be adopted within twelve months of the adoption of fresh start accounting. The following summarizes the new accounting pronouncements we have recently adopted: The FASB's Derivative Implementation Group issued DIG B36 in April 2003. DIG B36 addresses specific circumstances under which bifurcation of an instrument into a host contract and an embedded derivative is required. DIG B36 requires the bifurcation of a derivative from the receivable or payable related to a modified coinsurance agreement, where the yield on the receivable and payable is based on a return of a specified block of assets rather than the creditworthiness of the ceding company. We implemented this guidance on August 31, 2003, in conjunction with our adoption of fresh start accounting. See the note entitled "Accounting for Derivatives" for a discussion of the impact of implementing this guidance. The FASB issued Financial Accounting Standards No. 149 "Amendment of SFAS No. 133 on Derivative Instruments and Hedging Activities" ("SFAS 149") in April 2003. SFAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." Except for certain 33 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- implementation guidance included in SFAS 149 which is already effective, the new guidance is effective for: (i) contracts entered into or modified after June 30, 2003; and (ii) hedging relationships designated after June 30, 2003. The adoption of SFAS 149 did not have a material impact on the Company's consolidated financial statements. The FASB issued Financial Accounting Standards No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity" ("SFAS 150") in May 2003. SFAS 150 establishes standards for classifying and measuring certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. For example, mandatorily redeemable preferred stock is required to be classified as a liability pursuant to SFAS 150. SFAS 150 is effective immediately for financial instruments entered into or modified after May 31, 2003, and for all other financial instruments beginning with the third quarter of 2003. Effective July 1, 2003, Old Conseco's Company-obligated mandatorily redeemable preferred securities of subsidiary trusts, or TOPrS, with an aggregate carrying value of $1,921.5 million, were reclassified to liabilities pursuant to the provisions of SFAS 150. The adoption of SFAS 150 does not impact the financial statements of Conseco subsequent to the Effective Date since the Company-obligated mandatorily redeemable preferred securities of subsidiary trusts are no longer outstanding. The Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 03-1 "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts" ("SOP 03-01") in July 2003. SOP 03-01 provides guidance on several insurance company disclosure and accounting matters including the appropriate accounting for: (i) separate accounts; (ii) additional interest (for example, persistency bonus) accruing to the investment contract holder; (iii) the liability for contracts where the amounts assessed against the contract holder each period are assessed in a manner that is expected to result in profits in earlier years and losses in subsequent years; (iv) potential benefits to annuity holders in addition to their account balance; (v) sales inducements to contract holders; and (vi) other provisions. The Company recently sold most of its separate account business. Accordingly, the new guidance related to separate accounts will have no impact on the Company's consolidated financial position, results of operations or cash flows. As a result of our adoption of fresh start accounting, we were required to revalue our insurance product liabilities and record them at their estimated fair market value. In calculating the value of the liabilities for insurance and asset accumulation products, we followed the guidance of SOP 03-01. We have changed the way we classify the costs related to sales inducements in accordance with the new guidance. However, such change was not material. Our reserve for sales inducement persistency bonus benefits was $280.0 million at September 30, 2003, and $278.6 million at August 31, 2003. In January 2003, the FASB issued FIN 46, which requires expanded disclosures for and, in some cases, consolidation of significant investments in variable interest entities ("VIE"). A VIE is an entity in which the equity investors do not have the characteristics of a controlling financial interest, or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Under FIN 46, a company is required to consolidate a VIE if it is the primary beneficiary of the VIE. FIN 46 defines primary beneficiary as the party which will absorb a majority of the VIE's expected losses or receive a majority of the VIE's expected residual returns, or both. The Company has investments in various types of VIEs, some of which require additional disclosure under FIN 46, and several of which will require consolidation under FIN 46. As further discussed in the note to the consolidated financial statements entitled "Investments in Variable Interest Entities", we have consolidated all of our investments in VIEs. The adoption of the consolidation requirements of FIN 46 did not have a material impact on our financial condition or results of operations. The note entitled "Investments in Variable Interest Entities" includes the expanded disclosures required by FIN 46. The FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45") in November 2002. FIN 45 requires certain guarantees to be recognized as liabilities at fair value. In addition, it requires a guarantor to make new disclosures regarding its obligations. We implemented the new disclosure requirements as of December 31, 2002. FIN 45's liability recognition requirement is effective on a prospective basis for guarantees issued or modified after December 31, 2002. The adoption of FIN 45 did not impact the Company's results of operations or financial condition. The FASB issued Statement of Financial Accounting Standards No. 146, "Accounting for Exit or Disposal Activities" ("SFAS 146") in June 2002. SFAS 146 addresses financial accounting and reporting for costs that are associated with exit and disposal activities and supersedes Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" 34 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- ("EITF 94-3"). SFAS 146 is required to be used to account for exit or disposal activities that are initiated after December 31, 2002. The provisions of EITF 94-3 shall continue to apply for an exit activity initiated prior to the adoption of SFAS 146. SFAS 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of commitment to an exit or disposal plan. The Company adopted the provisions of SFAS 146 on January 1, 2003. The initial adoption of SFAS 146 did not have an impact on the Company's consolidated financial statements. The FASB issued Statement of Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections" ("SFAS 145") in April 2002. Under previous guidance all gains and losses resulting from the extinguishment of debt were required to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. SFAS 145 rescinds that guidance and requires that gains and losses from extinguishments of debt be classified as extraordinary items only if they are both unusual and infrequent in occurrence. SFAS 145 also amends previous guidance to require certain lease modifications that have economic effects similar to sale-leaseback transactions to be accounted for in the same manner as sale-leaseback transactions. The Company adopted SFAS 145 on January 1, 2003. Prior period amounts related to extraordinary gains on the extinguishment of debt have been reclassified in accordance with the new guidance. The FASB issued SFAS 144 in August 2001. This standard addresses the measurement and reporting for impairment of all long-lived assets. It also broadens the definition of what may be presented as a discontinued operation in the consolidated statement of operations to include components of a company's business segments. SFAS 144 requires that long-lived assets currently in use be written down to fair value when considered impaired. Long-lived assets to be disposed of are written down to the lower of cost or fair value less the estimated cost to sell. The Company adopted this standard on January 1, 2002. We followed this standard in determining when it was appropriate to recognize impairments on assets we decided to sell as part of our efforts to raise cash. We also followed this standard in determining that our variable annuity business line and CFC should be presented as discontinued operations in our consolidated financial statements (see the note to the consolidated financial statements entitled "Discontinued Operations"). 35 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- DISCONTINUED OPERATIONS As previously described in the notes to the consolidated financial statements entitled "Discontinued Finance Business - Sale of CFC" and "Basis of Presentation", the operations of CFC and CVIC were classified as discontinued operations in the 2002 consolidated statement of operations. The following summarizes selected financial information of CFC and CVIC:
Three months ended Nine months ended September 30, 2002 September 30, 2002 ------------------------- ------------------------- (dollars in millions) CFC CVIC Total CFC CVIC Total --- ---- ----- --- ---- ----- Insurance policy income.......................... $ - $ 12.4 $ 12.4 $ - $ 30.5 $ 30.5 Net investment income (loss)..................... 533.3 (120.6) 412.7 1,647.2 (217.3) 1,429.9 Impairment charge................................ (701.3) - (701.3) (701.3) - (701.3) Fee revenue and other income..................... 70.1 - 70.1 201.3 .2 201.5 Total revenues................................... (129.2) (128.3) (257.5) 1,133.3 (244.4) 888.9 Provision for losses............................. 234.2 - 234.2 550.9 - 550.9 Insurance policy benefits........................ - (125.9) (125.9) - (234.7) (234.7) Interest expense................................. 282.2 .1 282.3 852.4 1.0 853.4 Amortization..................................... - 132.8 132.8 - 224.6 224.6 Other operating costs and expenses............... 174.0 4.6 178.6 472.1 15.5 487.6 Special charges.................................. 53.4 - 53.4 109.9 - 109.9 Extraordinary gain on extinguishment of debt...................................... - - - (6.2) - (6.2) Total expenses................................... 743.8 11.6 755.4 1,979.1 6.4 1,985.5 Pre-tax loss..................................... (873.0) (139.9) (1,012.9) (845.8) (250.8) (1,096.6) Income tax benefit............................... (331.6) (51.0) (382.6) (321.3) (88.7) (410.0) ------- ------- -------- -------- ------- -------- Amount classified as discontinued operations..... $(541.4) $ (88.9) $ (630.3) $ (524.5) $(162.1) $ (686.6) ======= ======= ======== ======== ======= ========
In addition, in the nine months ended September 30, 2002, CVIC recognized a $43.8 million cumulative effect of accounting change for goodwill impairment pursuant to the adoption of SFAS 142. During 2002, we recognized estimated losses related to the ultimate sale and disposition of the aforementioned discontinued businesses, including estimated costs to sell and costs related to the resolution of contingencies. During the eight months ended August 31, 2003, we reduced the accrual for such estimated costs by $16.0 million (after income taxes of $.7 million) to reflect our current estimate. We recorded the reduction of such accrual as income from discontinued operations. LITIGATION AND OTHER LEGAL PROCEEDINGS We are involved on an ongoing basis in lawsuits (including purported class actions) relating to our operations, including with respect to sales practices, and we and current and former officers and former directors are defendants in pending class action lawsuits asserting claims under the securities laws and derivative lawsuits. The ultimate outcome of these lawsuits cannot be predicted with certainty and we have estimated the potential exposure for each of the matters and have recorded a liability if a loss is deemed probable. Securities Litigation Since we announced our intention to restructure our capital on August 9, 2002, a total of eight purported securities fraud class action lawsuits have been filed in the United States District Court for the Southern District of Indiana. The 36 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- complaints name us as a defendant, along with certain current and former officers of Old Conseco. These lawsuits were filed on behalf of persons or entities who purchased Old Conseco's common stock on various dates between October 24, 2001 and August 9, 2002. In each case Plaintiffs allege claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and allege material omissions and dissemination of materially misleading statements regarding, among other things, the liquidity of Conseco and alleged problems in CFC's manufactured housing division, allegedly resulting in the artificial inflation of Old Conseco's stock price. On March 13, 2003, all of these cases were consolidated into one case in the United States District Court for the Southern District of Indiana, captioned Franz Schleicher, et al. v. Conseco, Inc., et al., File No. 02-CV-1332 DFH-TAB. The lawsuits were stayed as to all defendants by order of the United States Bankruptcy Court for the Northern District of Illinois. The stay was lifted on October 15, 2003. It is expected that plaintiffs will file a consolidated class action complaint with respect to the individual defendants in November 2003. Our liability with respect to these lawsuits was discharged in the Plan and our obligation to indemnify certain individual defendants is limited by the Plan. We believe these lawsuits are without merit and intend to defend them vigorously. The ultimate outcome of these lawsuits cannot be predicted with certainty. Derivative Litigation Nine shareholder derivative suits were filed in 2000 in the United States District Court for the Southern District of Indiana. The complaints named as defendants the then current directors, certain former directors, certain non-director officers of Old Conseco (in one case), and, alleging aiding and abetting liability, certain banks that made loans in relation to Old Conseco's "Stock Purchase Plan" (in three cases). Old Conseco is also named as a nominal defendant in each complaint. Plaintiffs allege that the defendants breached their fiduciary duties by, among other things, intentionally disseminating false and misleading statements concerning the acquisition, performance and proposed sale of CFC, and engaged in corporate waste by causing Old Conseco to guarantee loans that certain officers, directors and key employees of Old Conseco used to purchase stock under the Stock Purchase Plan. These cases have now been consolidated into one case in the United States District Court for the Southern District of Indiana, captioned: In Re Conseco, Inc. Derivative Litigation, Case Number IP00655-C-Y/S. An amended complaint was filed on April 12, 2001, making generally the same allegations and allegations of violation of the Federal Reserve Board's margin rules. Three similar cases have been filed in the Hamilton County Superior Court in Indiana. Schweitzer v. Hilbert, et al., Case No. 29D01-0004CP251; Evans v. Hilbert, et al., Case No. 29D01-0005CP308 (both Schweitzer and Evans name as defendants certain non-director officers); Gintel v. Hilbert, et al., Case No. 29003-0006CP393 (naming as defendants, and alleging aiding and abetting liability as to, banks that allegedly made loans in relation to the Stock Purchase Plan). We believe that these lawsuits are without merit and intend to defend them vigorously. The cases filed in Hamilton County have been stayed pending resolution of the derivative suits filed in the United States District Court. We have asserted that these lawsuits are assets of the estate pursuant to section 541(a) of the Bankruptcy Code and do not intend to pursue them following emergence from bankruptcy because they are meritless. In October and November 2003, CNO filed motions to dismiss all the pending derivative matters. The ultimate outcome of these lawsuits cannot be predicted with certainty. Other Litigation Collection efforts by the Company and Conseco Services, LLC related to the 1996-1999 director and officer loan programs have been commenced against various past board members and executives/officers with outstanding loan balances. In addition, certain former officers and directors have sued the companies for declaratory relief concerning their liability for the loans. Currently, we are involved in litigation with Stephen C. Hilbert, James D. Massey, Dennis E. Murray, Sr., Rollin Dick and Bruce Crittenden. The specific lawsuits include: Hilbert v. Conseco, Case No. 03A 04283 (Bankr. N.D. Ill.); Conseco Services v. Hilbert, Case No.29C01-0310 MF 1296 (Cir. Ct. Hamilton Cty, Ind.); Murray and Massey v. Conseco, Case No.1:03-CV-1482 LJM-WTL (S.D. Ind.); Dick v. Conseco Services, Case No. 29 D01-0207-PL-549 (Sup. Ct. Hamilton Cty, Ind.); and Crittenden v. Conseco, Case No.IP02-1823-C B/S (S.D. Ind.). The Company and Conseco Services, LLC believe that all amounts due under the director and officer loan programs, including all applicable interest, are valid obligations owed to the companies. We intend to prosecute these claims to obtain the maximum recovery possible. Further, with regard to the various claims brought against the Company and Conseco Services, LLC by certain former directors and officers, we believe that these claims are without merit and intend to defend them vigorously. The ultimate outcome of the lawsuit cannot be predicted with certainty. In October 2002, Roderick Russell, on behalf of himself and a class of persons similarly situated, and on behalf of the ConsecoSave Plan filed an action in the United States District Court for the Southern District of Indiana against Old Conseco, 37 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- Conseco Services, LLC and certain current and former officers of Old Conseco (Roderick Russell, et al. v Conseco, Inc., et al., Case No. 1:02-CV-1639 LJM). The purported class action consists of all individuals whose 401(k) accounts held common stock of Old Conseco at any time since April 28, 1999. The complaint alleges, among other things, breaches of fiduciary duties under ERISA by continuing to permit employees to invest in Old Conseco's common stock without full disclosure of the Company's true financial condition. Old Conseco filed a motion to dismiss the complaint in December 2002. This lawsuit was stayed as to all defendants by order of the Bankruptcy Court. The stay was lifted on October 15, 2003. It is expected that there will be a ruling on the motion to dismiss before further proceedings occur in this matter. We believe the lawsuit is without merit and intend to defend it vigorously. The ultimate outcome of the lawsuit cannot be predicted with certainty. On June 24, 2002, the heirs of a former officer, Lawrence Inlow, commenced an action against Old Conseco, Conseco Services, LLC, and two former officers in the Boone Circuit Court (Inlow et al. v. Conseco, Inc., et al., Cause No. 06C01-0206-CT-244). The heirs assert that unvested options to purchase 756,248 shares of Old Conseco common stock should have been vested at Mr. Inlow's death. The heirs further claim that if such options had been vested, they would have been exercised, and that the resulting shares of common stock would have been sold for a gain of approximately $30 million based upon a stock price of $58.125 per share, the highest stock price during the alleged exercise period of the options. We believe the heirs' claims are without merit and will defend the action vigorously. The maximum exposure to the Company for this lawsuit is estimated to be $33 million. The heirs did not file a proof of claim with the Bankruptcy Court. Subject to dispositive motions which are yet to be filed, the matter will continue to trial against Conseco Services, LLC and the other co-defendants on September 13, 2004. The ultimate outcome cannot be predicted with certainty. On June 27, 2001, two suits against the Company's subsidiary, Philadelphia Life Insurance Company (now known as Conseco Life Insurance Company), both purported nationwide class actions seeking unspecified damages, were consolidated in the U.S. District Court, Middle District of Florida (In Re PLI Sales Litigation, Cause No. 01-MDL-1404), alleging among other things, fraudulent sales and a "vanishing premium" scheme. Philadelphia Life filed a motion for summary judgment against both named plaintiffs, which motion was granted in June 2002. Plaintiffs appealed to the 11th Circuit. The 11th Circuit, in July 2003, affirmed in part and reversed in part, allowing two fraud counts with respect to one plaintiff to survive. The plaintiffs' request for a rehearing with respect to this decision has been denied. Philadelphia Life has filed a summary judgment motion with respect to the remaining claims. Philadelphia Life believes this lawsuit is without merit and intends to defend it vigorously. The ultimate outcome of the lawsuit cannot be predicted with certainty. On December 1, 2000, the Company's former subsidiary, Manhattan National Life Insurance Company, was named in a purported nationwide class action seeking unspecified damages in the First Judicial District Court of Santa Fe, New Mexico (Robert Atencio and Theresa Atencio, for themselves and all other similarly situated v. Manhattan National Life Insurance Company, an Ohio corporation, Cause No. D-0101-CV-2000-2817), alleging among other things fraud by non-disclosure of additional charges for those policyholders wishing to pay premium modes other than annual. We retained liability for this litigation in connection with the sale of Manhattan National Life in June 2002. We believe this lawsuit is without merit and intend to defend it vigorously. The ultimate outcome of the lawsuit cannot be predicted with certainty. On December 19, 2001, four of the Company's subsidiaries were named in a purported nationwide class action seeking unspecified damages in the District Court of Adams County, Colorado (Jose Medina and others similarly situated v. Conseco Annuity Assurance Company, Conseco Life Insurance Company, Bankers National Life Insurance Company and Bankers Life and Casualty Company, Cause No. 01-CV-2465), alleging among other things breach of contract regarding alleged non-disclosure of additional charges for those policy holders wishing to pay premium modes other than annual. On July 14 and 15, 2003 the plaintiff's motion for class certification was heard and the Court took the matter under advisement. On November 10, 2003, the Court denied the motion for class certification. The defendants believe this lawsuit is without merit and intend to defend it vigorously. The ultimate outcome of the lawsuit cannot be predicted with certainty. On July 31, 2001, the Company's subsidiary, Conseco Senior Health Insurance Company, was named in an action filed by the State of Texas in the District Court of Travis County, Texas (State of Texas v. Conseco Senior Health Insurance Company, Cause No. GV102103), alleging among other things a violation of the Deceptive Trade Practices Act related to allegations of failure to adequately notify policyholders that premium rates could increase. Conseco Senior has reached a tentative settlement with the State of Texas, however in the event a settlement is not consummated, Conseco Senior intends to defend this matter vigorously as it believes the lawsuit is without merit. The ultimate outcome of this lawsuit cannot be predicted with certainty. 38 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- On December 30, 2002 and December 31, 2002, five suits were filed in various Mississippi counties against the Company's subsidiary, Conseco Life Insurance Company (Kathie Allen, et al. v. Conseco Life Insurance Company, et al., Circuit Court of Jones County, Mississippi, Cause No. 2002-448-CV12; Malcolm Bailey, et al. v. Conseco Life Insurance Company, et al., Circuit Court of Claiborne County, Mississippi, Cause No. CV-2002-371; Anthony Cascio, et al. v. Conseco Life Insurance Company, et al, Circuit Court of LeFlore County, Mississippi, Cause No. CV-2002-0242-CICI; William Garrard, et al. v. Conseco Life insurance Company, et al., Circuit Court of Sunflower County, Mississippi, Cause No. CV-2002-0753-CRL; and William Weaver, et al. v. Conseco Life Insurance Company, et al., Circuit Court of LeFlore County, Mississippi, Cause No. CV-2002-0238-CICI), alleging among other things, a "vanishing premium" scheme. Conseco Life removed all of the cases to the U.S. District Courts in Mississippi. In September 2003, plaintiffs' Motion to Remand was denied in the Garrard and Weaver matters, but granted in the Cascio matter. Conseco Life awaits the court's ruling on Plaintiff's Motion to Remand in the Allen matter. In Bailey the parties have agreed to stay in Federal court. Conseco Life believes the lawsuits are without merit and intends to defend them vigorously. The ultimate outcome of the lawsuits cannot be predicted with certainty. In addition, the Company and its subsidiaries are involved on an ongoing basis in other lawsuits and arbitrations (including purported class actions) related to their operations. The ultimate outcome of all of these other legal matters pending against the Company or its subsidiaries cannot be predicted, and, although such lawsuits are not expected individually to have a material adverse effect on the Company, such lawsuits could have, in the aggregate, a material adverse effect on the Company's consolidated financial condition, cash flows or results of operations. Other Proceedings The Company has been notified that the staff of the SEC has obtained a formal order of investigation in connection with an inquiry that relates to events in and before the spring of 2000, including CFC's accounting for its interest-only securities and servicing rights. These issues were among those addressed in the Company's write-down and restatement in the spring of 2000, and were the subject of shareholder class action litigation, which was settled in the second quarter of 2003. The Company is cooperating fully with the SEC staff in this matter. The deadline to file administrative claims in the bankruptcy proceeding was October 9, 2003. The Plan provides that all such claims must be paid in full, in cash. We are reviewing all timely filed administrative claims and may resolve disputes regarding allowance of such claims in the Bankruptcy Court. If significant administrative claims are allowed, our cash flow would be negatively affected. 39 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- CONSOLIDATED STATEMENT OF CASH FLOWS The following disclosures supplement our consolidated statement of cash flows (dollars in millions):
Successor Predecessor -------------- --------------------------------- One month Eight months Nine months ended ended ended September 30, August 31, September 30, 2003 2003 2002 ---- ---- ---- Cash flows from operating activities: Net income (loss).............................................. $ 24.2 $ 2,201.7 $(6,147.2) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Interest-only securities investment income................. - - (15.8) Cash received from interest-only securities, net........... - - (54.2) Servicing income........................................... - - (54.5) Cash received from servicing activities.................... - - 33.7 Provision for losses....................................... - 55.6 735.2 Gain on sale of finance receivables........................ - - 13.9 Amortization and depreciation.............................. 30.3 369.8 800.3 Income taxes............................................... 13.9 31.4 410.7 Insurance liabilities...................................... 35.8 265.8 279.9 Accrual and amortization of investment income.............. (.7) 43.2 162.8 Deferral of cost of policies produced and purchased........ (25.6) (287.5) (391.4) Impairment charges......................................... - - 701.3 Goodwill impairment........................................ - - 500.0 Special charges............................................ - - 166.3 Reorganization items....................................... - (2,157.0) - Cumulative effect of accounting change..................... - - 2,949.2 Minority interest.......................................... - - 134.8 Net realized investment (gains) losses..................... (6.7) 5.4 551.7 Discontinued operations.................................... - (16.7) 109.3 Extraordinary gain on extinguishment of debt............... - - (8.1) Other...................................................... (18.7) 235.6 (140.5) ------ --------- --------- Net cash provided by operating activities................ $ 52.5 $ 747.3 $ 737.4 ====== ========= ========= Non-cash items not reflected in the investing and financing activities sections of the consolidated statement of cash flows: Issuance of common stock under stock option and employee benefit plans............................................. $ - $.3 $13.0 Issuance of convertible preferred shares.................... 5.3 - 2.1
At September 30, 2003, we held restricted cash of $22.1 million in trust for the payment of bankruptcy-related professional fees. 40 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- INVESTMENTS IN VARIABLE INTEREST ENTITIES The Company has investments in various types of special purpose entities and other entities, some of which are VIEs under FIN 46. The following are descriptions of our significant investments in VIEs: Brickyard Trust We liquidated and distributed all the assets of the Brickyard Loan Trust ("Brickyard") during the third quarter of 2003. We recognized a loss of $11.1 million during the second quarter of 2003 to record our investment at its estimated fair value as we intended to liquidate it. No additional gain or loss was recognized upon the ultimate disposition of Brickyard. Brickyard was a collateralized debt obligation trust which participated in an underlying pool of commercial loans. The initial capital structure of Brickyard consisted of $575 million of senior financing provided by unrelated third party investors and $127 million of notes and subordinated certificates owned by the Company and others. As a result of our 85 percent ownership interest in the subordinated certificates, we were the primary beneficiary of Brickyard. In accordance with ARB 51 "Consolidated Financial Statements", Brickyard was consolidated in our financial statements because: (i) our investment management subsidiary, 40|86 Advisors, Inc. was the investment manager; and (ii) we owned a significant interest in the subordinated certificates. Included in "Assets held in separate accounts and investment trust" at December 31, 2002 were $410.2 million of assets which served as collateral for Brickyard's obligations. These amounts were offset by a corresponding liability account, the value of which fluctuated in relation to changes in the values of the investments. The senior note obligations had no recourse to the general credit of the Company. Other Investment Trusts In December 1998, Old Conseco formed three investment trusts which were special purpose entities formed to hold various fixed maturity, limited partnership and other types of investments. The initial capital structure of each of the trusts consisted of: (i) approximately 96 percent principal-protected senior notes; (ii) approximately 3 percent subordinated junior notes; and (iii) 1 percent equity. The senior principal-protected notes are collateralized by zero coupon treasury notes with par values and maturities matching the par values and maturities of the principal-protected senior notes. Conseco's life insurance subsidiaries own 100 percent of the senior principal-protected notes. Certain of Conseco's non-life insurance subsidiaries own all of the subordinated junior notes, which have a preferred return equal to the total return on the trusts' assets in excess of principal and interest on the senior notes. The equity of the trusts is owned by unrelated third parties. The three investment trusts are VIEs under FIN 46 because the trusts' equity represents significantly less than 10 percent of total capital and the subordinated junior notes were intended to absorb expected losses and receive virtually all expected residual returns. Based on our 100 percent ownership of the subordinated junior notes, we are the primary beneficiary of the investment trusts. All three trusts are consolidated in our financial statements. The carrying value of the total invested assets in the three trusts was approximately $397 million and $382 million at September 30, 2003 and December 31, 2002, respectively, which also represents Conseco's maximum exposure to loss as a result of our ownership interests in the trusts. The trusts have no obligations or debt to outside parties. Investment in General Motors Building See the note entitled "Sale of the General Motors Building" for a discussion of this investment. 41 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------- SPECIAL CHARGES 2002 The following table summarizes the special charges incurred by the Company during the three and nine months ended September 30, 2002, which are further described in the paragraphs which follow (dollars in millions):
Three months ended Nine months ended September 30, 2002 September 30, 2002 ------------------ ------------------ Loss related to reinsurance transaction and businesses sold to raise cash......................................................... $20.0 $ 47.0 Costs related to debt modification and refinancing transactions....... .3 17.7 Restructuring costs................................................... 12.1 12.1 Expenses related to the termination of the former chief financial officer.................................................. - 6.5 Other items........................................................... 2.5 19.8 ----- ----- Special charges before income tax benefit......................... $34.9 $103.1 ===== ======
Loss related to debt modification and reinsurance transaction and businesses sold to raise cash We completed various asset sales and reinsurance transactions to raise cash which resulted in net losses of $47.0 million during the first nine months of 2002. These amounts included: (i) a loss of $39.0 million related to the reinsurance of a portion of our life insurance business; (ii) a loss of $20.0 million associated with the sale of our subsidiary in India; partially offset by (iii) asset sales resulting in a net gain of $12.0 million. Costs related to debt modification and refinancing transactions In conjunction with the various modifications to borrowing arrangements (including the debt exchange offer completed in April 2002) entered into in the first nine months of 2002, we incurred costs of $17.7 million which are not permitted to be deferred pursuant to GAAP. Restructuring costs We incurred expenses totaling $12.1 million in the three and nine months ended September 30, 2002, related to professional and advisory fees incurred related to the restructuring of our capital. Expenses related to termination of the former chief financial officer The employment of Old Conseco's chief financial officer was terminated in the first quarter of 2002. As a result, the vesting provisions associated with the restricted stock issued to the chief financial officer pursuant to his employment agreement were accelerated. We recognized a charge of $5.1 million related to the immediate vesting of such restricted stock in the first quarter of 2002. In addition, we recognized severance benefits of $1.4 million associated with the termination. Other items Other items include expenses incurred: (i) in conjunction with the transfer of certain customer service and backroom operations to our India subsidiary; (ii) for severance benefits related to the transfer of such operations; and (iii) for other items which are not individually significant. The Company sold its India subsidiary in the fourth quarter of 2002 and has significantly reduced the customer service and backroom operations conducted there. 42 CONSECO, INC. AND SUBSIDIARIES ------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. In this section, we review the consolidated financial condition of Conseco at September 30, 2003, and the consolidated results of operations for: (i) the one month ended September 30, 2003; (ii) the two months ended August 31, 2003; (iii) the eight months ended August 31, 2003; and (iv) the three and nine months ended September 30, 2002 and, where appropriate, factors that may affect future financial performance. Please read this discussion in conjunction with the accompanying consolidated financial statements and notes. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS All statements, trend analyses and other information contained in this report and elsewhere (such as in filings by Conseco with the Securities and Exchange Commission, press releases, presentations by Conseco or its management or oral statements) relative to markets for Conseco's products and trends in Conseco's operations or financial results, as well as other statements including words such as "anticipate," "believe," "plan," "estimate," "expect," "project," "intend," "may," "will," "would," "contemplate," "possible," "attempts," "seeks," "should," "could," "goal," "target," "on track," "comfortable with," "optimistic" and other similar expressions, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to known and unknown risks, uncertainties and other factors which may cause actual results, performance or achievements to be materially different from the future results, performance or achievements expressed or implied by the forward-looking statements. Assumptions and other important factors that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, among other things: (i) the potential lingering adverse impact of the Chapter 11 petitions on Conseco's business operations, and relationships with our customers, employees, regulators, distributors and agents; (ii) our ability to operate our business under the restrictions imposed by our senior bank credit facility; (iii) our ability to improve the financial strength ratings of our insurance companies and the impact of recent rating downgrades on our business; (iv) general economic conditions and other factors, including prevailing interest rate levels, stock and credit market performance and health care inflation, which may affect (among other things) Conseco's ability to sell its products and access capital on acceptable terms, the market value of Conseco's investments, and the lapse rate and profitability of policies; (v) Conseco's ability to achieve anticipated synergies and levels of operational efficiencies; (vi) customer response to new products, distribution channels and marketing initiatives; (vii) mortality, morbidity, usage of health care services and other factors which may affect the profitability of Conseco's insurance products; (viii) performance of our investments; (ix) changes in the Federal income tax laws and regulations which may affect the relative tax advantages of some of Conseco's products; (x) increasing competition in the sale of insurance and annuities; (xi) regulatory changes or actions, including those relating to regulation of the financial affairs of our insurance companies (including the payment of dividends to our holding company), regulation of financial services affecting (among other things) bank sales and underwriting of insurance products, regulation of the sale, underwriting and pricing of products, and health care regulation affecting health insurance products; (xii) the ultimate outcome of lawsuits filed against Conseco; and (xiii) the risk factors or uncertainties listed from time to time in Conseco's filings with the Securities and Exchange Commission. Other factors and assumptions not identified above are also relevant to the forward-looking statements, and if they prove incorrect, could also cause actual results to differ materially from those projected. All written or oral forward-looking statements attributable to us are expressly qualified in their entirety by the foregoing cautionary statement. Our forward-looking statements speak only as of the date made. We assume no obligation to update or to publicly announce the results of any revisions to any of the forward-looking statements to reflect actual results, future events or developments, changes in assumptions or changes in other factors affecting the forward-looking statements. CHAPTER 11 REORGANIZATION On the Petition Date, the Filing Entities filed voluntary petitions for relief under the Bankruptcy Code in the Bankruptcy Court. During the pendency of the Chapter 11 cases, the Filing Entities continued to operate their businesses as debtors-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. We emerged from bankruptcy protection under the Plan, which was confirmed pursuant to an order of the Bankruptcy Court on September 9, 2003, the Confirmation Date, and became effective on September 10, 2003, the Effective Date. In accordance with SOP 90-7, we adopted fresh start accounting on the Effective Date. However, in light of the proximity of 43 CONSECO, INC. AND SUBSIDIARIES ------------------- this date to the August month end, for accounting convenience purposes, we have reported the effects of fresh start accounting as if they occurred on August 31, 2003. The Plan generally provided for the full payment or reinstatement of allowed administrative claims, priority claims, fully secured claims and certain intercompany claims, and the distribution of shares of new equity securities (including warrants) of CNO to partially secured and unsecured creditors of the Filing Entities. Holders of claims arising under Old Conseco's $1.5 billion senior bank credit facility also received a pro rata interest in the New Credit Facility. Holders of Old Conseco's common stock and preferred stock did not receive any distribution under the Plan, and these securities, together with all other prepetition securities and the $1.5 billion senior bank credit facility of Old Conseco, were cancelled on the Effective Date. On the Effective Date, under the terms of the Plan, we emerged from the bankruptcy proceedings with a capital structure consisting of: (i) $1.3 billion of indebtedness under the New Credit Facility; (ii) approximately 34.4 million shares of Preferred Stock of CNO with an initial aggregate liquidation preference of $859.7 million; (iii) 100 million shares of common stock of CNO, excluding shares issued to our new non-executive chairman upon his appointment and shares issued or to be issued to directors, officers, or employees under a new equity incentive plan; and (iv) warrants to purchase 6.0 million shares of CNO common stock. Under the terms of the Plan, we distributed CNO equity securities to the creditors of Old Conseco in the amounts outlined below: o lenders under Old Conseco's senior bank credit facility and director and officer loan program received approximately 34.4 million shares of our Preferred Stock with an initial aggregate liquidation preference of $859.7 million; o holders of Old Conseco's senior notes received approximately 32.3 million shares of our common stock; o holders of Old Conseco's guaranteed senior notes received approximately 60.6 million shares of our common stock; o holders of Old Conseco's general unsecured claims received approximately 2.9 million shares of our common stock; and o holders of trust preferred securities issued by Old Conseco's subsidiary trusts received approximately 1.5 million shares of our common stock and warrants to purchase 6.0 million shares of our common stock at an exercise price of $27.60 per share. The distribution of our common stock summarized above represents approximately 97 percent of all of the shares of common stock to be distributed under the Plan. Approximately 2.7 million shares of common stock have been reserved for distribution under the Plan in respect of disputed claims, the resolution of which is still pending. If reserved shares remain after resolution of these disputed claims, then the reserved shares will be reallocated to other general unsecured creditors of Old Conseco as provided for under the Plan. For a complete discussion of the distributions provided for under the Plan, investors should refer to the complete text of the Plan confirmed by the Bankruptcy Court on September 9, 2003, and filed with the Securities and Exchange Commission on September 15, 2003 with our Current Report on Form 8-K. CRITICAL ACCOUNTING POLICIES Refer to "Critical Accounting Policies" in Old Conseco's 2002 Annual Report on Form 10-K for information on accounting policies that we consider critical in preparing our consolidated financial statements. Since the Petition Date, our consolidated financial statements have been prepared in accordance with SOP 90-7. Accordingly, all prepetition liabilities subject to compromise were segregated in the consolidated balance sheet and classified as "liabilities subject to compromise" at the estimated amount of allowable claims. Pursuant to SOP 90-7, professional fees associated with the Chapter 11 cases were expensed as incurred and reported as reorganization items. Interest expense was reported only to the extent that it was paid during the Chapter 11 cases or when it was probable that it would be an allowed claim. 44 CONSECO, INC. AND SUBSIDIARIES ------------------- Under fresh start reporting the Company was required to revalue its assets and liabilities to current estimated fair value, re-establish shareholders' equity at the reorganization value determined in connection with the Plan, and record any portion of the reorganization value which can not be attributed to specific tangible or identified intangible assets as goodwill. As a result, the Company's financial statements for periods following August 31, 2003, will not be comparable with those of Old Conseco prepared before that date. Consistent with SOP 90-7 we have implemented accounting standards that were required to be adopted in our consolidated financial statements within twelve months of our Effective Date. RISK FACTORS We are subject to a number of risks. These risks could have a material adverse effect on our business, financial condition or results of operations. Our Recent Bankruptcy May Continue to Disrupt Our Operations and the Operations of Our Subsidiaries. The announcement of our intention to seek a restructuring of our capital in August 2002 and the filing of bankruptcy petitions under the Bankruptcy Code in December 2002 caused significant disruptions in our operations. In August 2002, A.M. Best downgraded the financial strength ratings of our primary insurance subsidiaries to "B (Fair)." Rating downgrades and other adverse publicity concerning our financial condition and bankruptcy filings caused sales of our insurance products to decline and policyholder redemptions and lapses to increase. In some cases, this caused defections among our agent sales force or increases in the commissions or sales incentives we must pay in order to retain them. We emerged from bankruptcy on September 10, 2003. The full extent to which our bankruptcy impacted our business operations and relationship with our customers, employees, regulators, distributors and agents may not be known for some time and there may be lingering adverse effects associated with our bankruptcy filing. Our Degree of Leverage May Limit Our Financing and Operating Activities. We continue to have significant indebtedness after our emergence from bankruptcy. As of September 30, 2003, our debt to total capital ratio was 34 percent and our debt and preferred stock to total capital ratio was 57 percent. Furthermore, our historical capital requirements have been significant and our future capital requirements could vary significantly and may be affected by general economic conditions, industry trends, performance, and many other factors that are not within our control. We cannot assure you that we will be able to obtain financing in the future. We have suffered significant losses in the past and cannot assure you that we will not continue to experience losses in the future. Our profitability and ability to generate cash flow will depend upon our ability to successfully implement our business strategy. However, we cannot assure you that we will be able to do so. We may encounter liquidity problems, which could affect our ability to meet our obligations while attempting to meet competitive pressures or adverse economic conditions. A Failure to Improve and Maintain the Financial Strength Ratings of Our Insurance Subsidiaries Could Negatively Impact Our Operations and Financial Results. An important competitive factor for our insurance subsidiaries is the ratings they receive from nationally recognized rating organizations. In July 2002, A.M. Best downgraded the financial strength ratings of our primary insurance subsidiaries to "B++ (Very Good)" and placed the ratings "under review with negative implications." On August 14, 2002, A.M. Best further lowered the financial strength ratings of our primary insurance subsidiaries from "B++ (Very Good)" to "B (Fair)". The A.M. Best downgrades caused sales of our insurance products to decline and policyholder redemptions and lapses to increase. In some cases, the downgrades also caused defections among our agent sales force or increases in the commissions or sales incentives we must pay in order to retain them. These events have had a material adverse effect on our operations, financial results and liquidity. On September 11, 2003, A.M. Best affirmed its financial strength ratings of our primary insurance companies ("B (Fair)") and removed the ratings from under review, indicating that the ratings outlook is positive. On October 3, 2003, A.M. Best assigned a positive outlook to all of our ratings. Our plan of reorganization contemplated that our insurance subsidiaries would achieve an A.M. Best "A" rating approximately by the end of 2004, but we cannot assure you that we will be able to either achieve or maintain this rating. If we fail to achieve and maintain an A.M. Best "A" rating, sales of our insurance products could fall and additional existing policyholders may redeem or allow their policies to lapse, adversely affecting our future operations, financial results and liquidity. In addition, if we experience a ratings downgrade, or if we fail to achieve 45 CONSECO, INC. AND SUBSIDIARIES ------------------- an A.M. Best "A-" rating by August 15, 2005 (or December 31, 2005 if we meet certain financial ratios), we will suffer an event of default under the New Credit Facility. If we experience a ratings downgrade below "B (Fair)" or a downgrade by two or more levels in any six-month period, a "trigger event" will also occur and holders of our Preferred Stock will have the right to vote with holders of our common stock on all matters on an as-converted basis. The Covenants in the New Credit Facility Restrict Our Activities and Require Us to Meet or Maintain Various Financial Ratios and Minimum Insurance Ratings. We entered into a senior secured bank credit facility with our lenders in connection with our reorganization. The New Credit Facility contains a number of covenants and other provisions that restrict our ability to engage in various financing transactions and pursue certain operating activities without the prior consent of the lenders under the New Credit Facility. We also must meet or maintain various financial ratios and minimum financial strength ratings for our insurance subsidiaries. For instance, if we experience a ratings downgrade by A.M. Best, or if we fail to achieve an A.M. Best "A-" rating by August 15, 2005 (or December 31, 2005 if we meet certain financial ratios), we will suffer an event of default under the New Credit Facility. Our ability to meet these financial and ratings covenants may be affected by events beyond our control. These requirements represent significant restrictions on the manner in which we may operate our business. If we default under any of these requirements, the lenders could declare all outstanding borrowings, accrued interest and fees to be due and payable. If that were to occur, we cannot assure you that we would have sufficient liquidity to repay or refinance this indebtedness or any of our other debts. Refer to the note to the consolidated financial statements entitled "Changes in Direct Corporate Obligations" for additional discussion of the New Credit Facility and related covenants. Conseco, Inc. and CDOC, Inc. are Holding Companies and Depend on their Subsidiaries for Cash. Conseco, Inc. and CDOC, Inc., our wholly owned subsidiary and a guarantor under the New Credit Facility, are holding companies with no business operations of their own; they depend on their operating subsidiaries for cash to make principal and interest payments on debt, and to pay administrative expenses and income taxes. The cash they receive from insurance subsidiaries consists of dividends and distributions, principal and interest payments on surplus debentures, fees for services, tax-sharing payments, and from our non-insurance subsidiaries, loans and advances. A deterioration in the financial condition, earnings or cash flow of the significant subsidiaries of Conseco or CDOC for any reason could limit their ability to pay cash dividends or other disbursements to Conseco and CDOC, which, in turn, would limit the ability of Conseco and CDOC to meet debt service requirements and satisfy other financial obligations. The ability of our insurance subsidiaries to pay dividends is subject to state insurance department regulations. These regulations generally permit dividends to be paid from earned surplus of the insurance company for any 12-month period in amounts equal to the greater of (or in a few states, the lesser of): (i) net gain from operations or net income for the prior year; or (ii) 10 percent of capital and surplus as of the end of the preceding year. Any dividends in excess of these levels require the approval of the director or commissioner of the applicable state insurance department. We recently were subject to consent orders with the Commissioner of Insurance for the State of Texas that, among other things, limited the ability of our insurance subsidiaries to pay dividends. We have been informed by the Texas Department of Insurance that it intends to formally release the consent orders in the near future. We have agreed with the Commissioner of Insurance for the State of Texas to provide prior notice of certain transactions, including up to 30 days prior notice for the payment of ordinary dividends to any non-insurance company parent, and periodic reporting of information concerning our financial performance and operations. If our financial condition were to deteriorate, we may be required to enter into consent orders in the future. In addition, actions that we may need to take to improve the authorized control level risk based capital ("ACLRBC") ratios of our insurance subsidiaries could affect the ability of our insurance subsidiaries to pay dividends. The Obligations of Conseco, Inc. and CDOC, Inc. are Structurally Subordinated to the Obligations of Their Subsidiaries. Because our operations are conducted through subsidiaries, claims of the creditors of those subsidiaries (including policyholders) will rank senior to claims to distributions from the subsidiaries, upon which we depend to make payments on our obligations. CDOC's subsidiaries had indebtedness for borrowed money (excluding indebtedness to affiliates), policy reserves and other liabilities of approximately $25.6 billion at September 30, 2003. The obligations of Conseco and CDOC, as parent holding companies, will rank effectively junior to these liabilities. 46 CONSECO, INC. AND SUBSIDIARIES ------------------- If an insurance company subsidiary were to be liquidated, that liquidation would be conducted under the insurance laws of its state of domicile by such state's insurance regulator as the receiver with respect to such insurer's property and business. In the event of a default on our debt or our insolvency, liquidation or other reorganization, our creditors and stockholders will not have the right to proceed against the assets of our insurance subsidiaries or to cause their liquidation under federal and state bankruptcy laws. Our Insurance Business Performance May Decline if Our Premium Rates Are Not Adequate. We set the premium rates on our health insurance policies based on facts and circumstances known at the time we issue the policies and on assumptions about numerous variables, including the actuarial probability of a policyholder incurring a claim, the probable size of the claim, and the interest rate earned on our investment of premiums. In setting premium rates, we consider historical claims information, industry statistics, the rates of our competitors and other factors. If our actual claims experience proves to be less favorable than we assumed and we are unable to raise our premium rates, our financial results may be adversely affected. Our estimates of insurance liabilities assume we will be able to raise rates if future experience results in blocks of our health insurance business becoming unprofitable. We generally cannot raise our health insurance premiums in any state unless we first obtain the approval of the insurance regulator in that state. We review the adequacy of our premium rates regularly and file rate increases on our products when we believe existing premium rates are too low. It is possible that we will not be able to obtain approval for premium rate increases from currently pending requests or requests filed in the future. If we are unable to raise our premium rates because we fail to obtain approval for a rate increase in one or more states, our net income may decrease. If we are successful in obtaining regulatory approval to raise premium rates due to unfavorable actual claims experience, the increased premium rates may reduce the volume of our new sales and cause existing policyholders to allow their policies to lapse. This could result in anti-selection if healthier policyholders allow their policies to lapse. This would reduce our premium income and profitability in future periods. Increased lapse rates also could require us to expense all or a portion of the deferred policy costs relating to lapsed policies in the period in which those policies lapse, adversely affecting our financial results in that period. The loss ratios for our long-term care products have increased in recent periods and exceeded 96 percent during the one month period ended September 30, 2003. We will have to raise rates or take other actions with respect to certain of these policies or this business will continue to be unprofitable and our financial results will be adversely affected. We May Not Achieve the Goals of Certain Initiatives We Have Undertaken With Respect to the Restructuring of Our Principal Insurance Business. Several of our principal insurance businesses have experienced substantial recent losses in their investment portfolios, declining sales and expense levels that exceed product pricing. We have adopted several initiatives designed to improve these operations, including focusing sales efforts on higher margin products; reducing operating expenses by eliminating or reducing the costs of marketing certain products; personnel reductions and streamlined administrative procedures; stabilizing the profitability of inforce business, particularly long-term care policies; and combining certain legal insurance entities to reduce burdens associated with statutory capital requirements and certain other redundancies. We are subject to the risk that our investments will decline in value. This has occurred in the past and may occur again. We are working to improve the performance of investments by reducing exposure to credit events and certain types of higher risk assets. We have only recently adopted some of these initiatives and we cannot assure you that they will be successfully implemented. Our Reserves for Future Insurance Policy Benefits and Claims May Prove To Be Inadequate, Requiring Us to Increase Liabilities and Resulting in Reduced Net Income and Shareholders' Equity. We calculate and maintain reserves for the estimated future payment of claims to our policyholders based on assumptions made by our actuaries. For our health insurance business, we establish an active life reserve plus a liability for due and unpaid claims, claims in the course of settlement, and incurred but not reported claims, as well as a reserve for the present value of amounts not yet due on claims. Many factors can affect these reserves and liabilities, such as economic and social conditions, inflation, hospital and pharmaceutical costs, regulatory actions (including those related to the pricing of our policies), changes in doctrines of legal liability, and extra-contractual damage awards. Therefore, the reserves and liabilities we establish are necessarily based on extensive estimates, assumptions and prior years' statistics. Establishing reserves is an uncertain process, and it is possible that actual claims will materially exceed our reserves and have a material adverse effect on our results of operations and financial condition. Our financial performance depends significantly upon the extent to which our actual claims experience is consistent with the assumptions we used in setting our reserves and pricing our policies. If our assumptions with respect to future claims are incorrect, and our reserves are insufficient to cover our actual losses and 47 CONSECO, INC. AND SUBSIDIARIES ------------------- expenses, we would be required to increase our liabilities resulting in an adverse effect to our financial results and financial position. Our Insurance Subsidiaries May be Required to Pay Assessments to Fund Policyholder Losses or Liabilities; This May Have a Material Adverse Effect on Our Results of Operations. The solvency or guaranty laws of most states in which an insurance company does business may require that company to pay assessments (up to certain prescribed limits) to fund policyholder losses or liabilities of insurance companies that become insolvent. Insolvencies of insurance companies increase the possibility that these assessments may be required. These assessments may be deferred or forgiven under most guaranty laws if they would threaten an insurer's financial strength and, in certain instances, may be offset against future premium taxes. We cannot estimate the likelihood and amount of future assessments. Any future assessments may have a material adverse effect on our financial results and financial position. We are Subject to Further Risk of Loss Notwithstanding Our Reinsurance Arrangements. We transfer exposure to certain risks to others through reinsurance arrangements. Under these arrangements, other insurers assume a portion of our losses and expenses associated with reported and unreported claims in exchange for a portion of policy premiums. The availability, amount and cost of reinsurance depend on general market conditions and may vary significantly. Furthermore, we face credit risk with respect to reinsurance. When we obtain reinsurance, we are still liable for those transferred risks if the reinsurer cannot meet its obligations. Therefore, the inability of our reinsurers to meet their financial obligations could materially affect our operations and financial condition. We Are Subject to Extensive Regulation. Our insurance business is subject to extensive regulation and supervision in the jurisdictions in which we operate, which is primarily for the benefit and protection of our customers, and not for the benefit of our investors or creditors. Our insurance subsidiaries are subject to state insurance laws that establish supervisory agencies with broad administrative powers relative to granting and revoking licenses to transact business, regulating sales and other practices, licensing agents, approving policy forms, setting reserve and solvency requirements, determining the form and content of required statutory financial statements, limiting dividends and prescribing the type and amount of investments. We have been operating under heightened scrutiny from state insurance regulators. Our insurance subsidiaries domiciled in Texas, Bankers National Life Insurance Company and Conseco Life Insurance Company of Texas (on behalf of itself and its subsidiaries), entered into consent orders with the Commissioner of Insurance for the State of Texas on October 30, 2002 which we expect to be released in the near future. In Certain Circumstances, Regulatory Authorities May Place Our Insurance Subsidiaries Under Regulatory Control. Our insurance subsidiaries are subject to risk-based capital requirements. These requirements were designed to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks associated with: asset quality; mortality and morbidity; asset and liability matching; and other business factors. The requirements are used by states as an early warning tool to discover potential weakly-capitalized companies for the purpose of initiating regulatory action. Generally, if an insurer's ACLRBC falls below specified levels, the insurer would be subject to different degrees of regulatory action depending upon the magnitude of the deficiency. Possible regulatory actions range from requiring the insurer to propose actions to correct the ACLRBC deficiency to placing the insurer under regulatory control. The 2002 statutory annual statements filed with the state insurance regulators of each of our insurance subsidiaries reflected total adjusted capital in excess of levels subjecting the subsidiary to any regulatory action. The 2002 audited financial statements of our insurance subsidiaries were completed in June 2003. Two of our subsidiaries' ACLRBC ratios, based on the capital balances reflecting audit adjustments, were less than 250 percent. As a result of an additional adjustment in the amended 2002 Annual Statement relating to one such subsidiary's investment in the General Motors building its ACLRBC ratio exceeded 250 percent. As a result of the sale of the General Motors building, the ACLRBC ratio for the other subsidiary has increased to a level above 250 percent. However, as a result of losses on the long-term care business within Conseco Insurance Group during the third quarter of 2003, including claim reserve strengthening of $87 million, we will need to contribute additional capital to one subsidiary to enable its ACLRBC to equal or exceed 250 at December 31, 2003. See the information described under the 48 CONSECO, INC. AND SUBSIDIARIES ------------------- caption "Statutory Information" within "Management's Discussion and Analysis of Financial Condition and Results of Operations." Recently Enacted and Pending or Future Legislation Could Also Affect the Financial Performance of Our Insurance Operations. During recent years, the health insurance industry has experienced substantial changes, including those caused by healthcare legislation. Recent federal and state legislation and legislative proposals relating to healthcare reform contain features that could severely limit or eliminate our ability to vary our pricing terms or apply medical underwriting standards with respect to individuals which could have the effect of increasing our loss ratios and have an adverse effect on our financial results. In particular, Medicare reform and legislation concerning prescription drugs could affect our ability to price or sell our products. Proposals currently pending in Congress and some state legislatures may also affect our financial results. These proposals include the implementation of minimum consumer protection standards for inclusion in all long-term care policies, including: guaranteed premium rates; protection against inflation; limitations on waiting periods for pre-existing conditions; setting standards for sales practices for long-term care insurance; and guaranteed consumer access to information about insurers (including lapse and replacement rates for policies and the percentage of claims denied). Enactment of any of these proposals could adversely affect our financial results. In addition, the federal government may seek to regulate the insurance industry, and recent government regulation may increase competition in the insurance industry and may affect our insurance subsidiaries' current sales methods. Although the federal government generally does not directly regulate the insurance industry, federal initiatives often have a direct impact on the insurance business. Current and proposed measures that may significantly affect the insurance business generally include limitations on antitrust immunity and minimum solvency requirements. Changing Interest Rates May Adversely Affect Our Results of Operations. Our profitability may be directly affected by the level of and fluctuations in interest rates. While we monitor the interest rate environment and have previously employed hedging strategies designed to mitigate the impact of changes in interest rates, our financial results could be adversely affected by changes in interest rates. Our spread-based insurance and annuity business is subject to several inherent risks arising from movements in interest rates, especially if we fail to anticipate or respond to such movements. First, interest rate changes can cause compression of our net spread between interest earned on investments and interest credited on customer deposits, thereby adversely affecting our results. Second, if interest rate changes produce an unanticipated increase in surrenders of our spread-based products, we may be forced to sell invested assets at a loss in order to fund such surrenders. The profits from many non-spread-based insurance products, such as long-term care policies will be adversely affected if interest rates decline. Finally, changes in interest rates can have significant effects on the performance of our mortgage-backed securities portfolio, including collateralized mortgage obligations, as a result of changes in the prepayment rate of the loans underlying such securities. We follow asset/liability strategies that are designed to mitigate the effect of interest rate changes on our profitability. However, we cannot assure that we will be successful in implementing these strategies and achieving adequate investment spreads. Litigation and Regulatory Investigations May Harm Our Financial Strength and Reduce Our Profitability. Insurance companies historically have been subject to substantial litigation resulting from claims disputes and other matters. In addition to the traditional policy claims associated with their businesses, insurance companies are increasingly facing policyholder suits, class action suits and disputes with reinsurers. The class action and policyholder suits are often in connection with insurance sales practices, policy and claims administration practices and other market conduct issues. State insurance departments are increasingly focusing on sales practices and product issues in their market conduct examinations. Negotiated settlements of class action and other lawsuits have had a material adverse effect on the business, financial condition and results of operations of insurance companies. As a result of these trends, we are, in the ordinary course of our business, a plaintiff or defendant in actions arising out of our insurance business and investment operations, including class actions and reinsurance disputes, and, from time to time, are also involved in various governmental and administrative proceedings. Such litigation and proceedings may harm our financial strength and reduce our profitability. We cannot assure you that such litigation will not adversely affect our future business, financial condition or results of operations. 49 CONSECO, INC. AND SUBSIDIARIES ------------------- The Markets in Which We Compete Are Highly Competitive. Each of the markets in which we operate is highly competitive. Competitors include other life and accident and health insurers, commercial banks, thrifts, mutual funds and broker-dealers. Many of our competitors in different segments and regions are larger companies that have greater capital, technological and marketing resources, and have access to capital at a lower cost. Because the actual cost of products is unknown when they are sold, we are subject to competitors who may sell a product at a price that does not cover its actual cost. Agents placing insurance business with our insurance subsidiaries generally are compensated on a commission basis. There are many life and health insurance companies in the U.S., most of which currently enjoy higher financial strength ratings than we do. Some of these companies may pay higher commissions and charge lower premium rates, and many companies have more substantial resources than we do. Publicity about our recent financial difficulties, including our bankruptcy, caused agents to place business with other insurers, and we may not be able to recapture lost business following our emergence from bankruptcy. We must attract and retain sales representatives to sell our insurance and annuity products. Strong competition exists among financial services companies for efficient sales representatives. We compete with other financial services companies for sales representatives primarily on the basis of our financial position, financial strength ratings, support services and compensation and product features. Our competitiveness for such agents also depends upon the relationships we develop with these agents. If we are unable to attract and retain sufficient numbers of sales representatives to sell our products, our ability to compete and our revenues would suffer. Tax Law Changes Could Adversely Affect Our Insurance Product Sales and Profitability. We sell deferred annuities and some forms of life insurance products which are attractive to purchasers, in part, because policyholders generally are not subject to United States federal income tax on increases in policy values until some form of distribution is made. Recently, Congress enacted legislation to lower marginal tax rates, reduce the federal estate tax gradually over a ten-year period, with total elimination of the federal estate tax in 2010, and increase contributions which may be made to individual retirement accounts and 401(k) accounts. While these tax law changes will sunset at the beginning of 2011 absent future congressional action, they could in the interim diminish the appeal of our annuity and life insurance products. Additionally, Congress has considered, from time to time, other possible changes to the U.S. tax laws, including elimination of the tax deferral on the accretion of value within certain annuities and life insurance products. There can be no assurance that further tax legislation will not be enacted which would contain provisions with possible adverse effects on our annuity and life insurance products. A Broad Range of Uncertainties Arising Out of World Events May Adversely Affect the Insurance Industry and Financial Markets. Terrorist attacks in New York City and Washington, D.C. on September 11, 2001 adversely affected commerce throughout the United States and resulted in significant disruption to the insurance industry and significant declines and volatility in financial markets. The continued threat of terrorism within the United States and abroad, the military action and heightened security measures in response to that threat and the risk of global outbreaks of illnesses such as SARS may cause additional disruptions to the insurance industry, reduced economic activity and continued volatility in markets throughout the world, which may adversely impact our financial results. 50 CONSECO, INC. AND SUBSIDIARIES ------------------- RESULTS OF OPERATIONS As previously discussed, due to the application of fresh start accounting, the reported historical financial statements of the Predecessor for periods prior to August 31, 2003, generally are not comparable to financial statements prepared after that date. Therefore, the results of operations of the Successor have not been combined with those of the Predecessor. Please read this discussion in conjunction with the accompanying consolidated financial statements and notes. The following tables and narratives summarize our operating results for the periods presented (dollars in millions):
Successor Predecessor ------------ -------------------------------------------------------- One month Two months Three months Eight months Nine months ended ended ended ended ended September 30, August 31, September 30, August 31, September 30, 2003 2003 2002 2003 2002 ---- ---- ---- ---- ---- Earnings (losses) before taxes: Insurance and fee-based segment earnings (losses)................................... $49.3 $ 170.5 $(747.4) $ 296.9 $ (759.3) Corporate operations: Corporate expenses, less charges to subsidiaries for services provided....... (2.5) (1.7) (27.4) (28.4) (72.7) Interest expense on corporate debt, net of corporate investment income........... (6.3) (50.3) (79.0) (181.7) (227.7) Venture capital income (loss).............. (2.7) 2.0 (6.6) 10.5 (106.6) Provision for losses....................... - (24.5) (59.9) (55.6) (199.9) Special charges............................ - - (32.6) - (61.1) Extraordinary gain on extinguishment of debt.................................. - - - - 1.8 Reorganization items....................... - 2,163.0 - 2,130.5 - ----- -------- ------- -------- --------- Income (loss) before income taxes, minority interest, discontinued operations and cumulative effect of accounting change... $37.8 $2,259.0 $(952.9) $2,172.2 $(1,425.5) ===== ======== ======= ======== =========
51 CONSECO, INC. AND SUBSIDIARIES ------------------- Insurance and fee-based operations (dollars in millions)
Successor Predecessor ------------ ---------------------------- One month Two months Three months ended ended ended September 30, August 31, September 30, 2003 2003 2002 ---- ---- ---- Premiums and asset accumulation product collections: Annuities.................................................................. $ 68.7 $ 162.2 $ 270.4 Supplemental health........................................................ 191.7 386.6 588.1 Life....................................................................... 46.5 100.7 159.0 Group major medical........................................................ 17.4 28.9 83.8 --------- --------- --------- Collections on insurance products from continuing lines of business......................................................... 324.3 678.4 1,101.3 Individual major medical in run-off........................................ .5 1.6 16.6 Discontinued operations.................................................... - - 72.2 --------- --------- --------- Total collections on insurance products................................ 324.8 680.0 1,190.1 Deposit type contracts..................................................... 30.8 57.5 78.3 Deposit type contracts - discontinued operations........................... - - 1.3 Mutual funds............................................................... 6.2 24.6 18.1 --------- --------- --------- Total premiums and asset accumulation product collections.............. $ 361.8 $ 762.1 $ 1,287.8 ========= ========= ========= Average liabilities for insurance and asset accumulation products (excluding discontinued operations and our major medical business in run-off): Annuities: Mortality based........................................................ $ 338.8 $ 258.2 $ 251.3 Equity-linked.......................................................... 1,569.5 1,648.3 2,086.6 Deposit based.......................................................... 7,447.2 7,386.0 7,841.5 Separate accounts and investment trust liabilities..................... 87.7 271.9 627.1 Health................................................................... 8,112.9 6,055.1 5,518.1 Life: Interest sensitive..................................................... 3,680.6 3,650.3 4,122.9 Non-interest sensitive................................................. 2,249.4 2,145.0 1,889.7 --------- --------- --------- Total average liabilities for insurance and asset accumulation products, net of reinsurance ceded.................... $23,486.1 $21,414.8 $22,337.2 ========= ========= ========= Revenues: Insurance policy income.................................................... $ 248.9 $ 499.7 $ 800.5 Net investment income: General account invested assets.......................................... 105.3 232.7 365.1 Equity-indexed products based on the change in value of the S&P 500 Call Options................................................... (8.3) 6.8 (27.3) Separate account assets.................................................. - - (5.3) Trading account income related to policyholder and reinsurer accounts.... 14.8 - - Change in value of embedded derivatives related to modified coinsurance agreements................................................. (8.6) - - Fee revenue and other income............................................... 1.9 8.2 19.9 --------- --------- --------- Total revenues (a)..................................................... 354.0 747.4 1,152.9 --------- --------- --------- Expenses: Insurance policy benefits.................................................. 203.9 288.1 729.3 Amounts added to policyholder account balances: Annuity products and interest-sensitive life products other than those listed below.......................................... 38.1 77.7 120.8 Equity-indexed products based on S&P 500 Index........................... (5.2) 14.3 (3.7) Separate account liabilities............................................. - - (5.3) Amortization related to operations......................................... 27.0 59.0 182.5 Interest expense on investment borrowings.................................. .6 1.9 2.1 Other operating costs and expenses......................................... 47.0 100.7 133.6 --------- --------- --------- Total benefits and expenses (a)........................................ 311.4 541.7 1,159.3 --------- --------- --------- Income (loss) before goodwill impairment, net investment gains (losses), special charges, income taxes, minority interest, discontinued operations and cumulative effect of accounting change................ 42.6 205.7 (6.4) Goodwill impairment........................................................... - - (500.0) Net investment gains (losses), including related costs and amortization............................................................... 6.7 (35.2) (238.7) Special charges............................................................... - - (2.3) --------- --------- --------- Income (loss) before income taxes, minority interest, discontinued operations and cumulative effect of accounting change..................... $ 49.3 $ 170.5 $ (747.4) ========= ========= ========= (continued)
52 CONSECO, INC. AND SUBSIDIARIES ------------------- (continued from previous page)
Successor Predecessor ------------- ------------------------------ One month Two months Three months ended ended ended September 30, August 31, September 30, 2003 2003 2002 ---- ---- ---- Ratios (annualized): Investment income, net of interest credited on annuities and universal life products and interest expense on investment borrowings, as a percentage of average liabilities for insurance and asset accumulation products (b).............................. 2.90% 3.99% 3.93% Operating costs and expenses (excluding amortization of cost of policies produced and cost of policies purchased) as a percentage of average liabilities for insurance and asset accumulation products (c).................................................. 2.41% 2.85% 2.46% Health loss ratios: All health lines: Insurance policy benefits.................................................. $154.0 $418.1 $575.0 Loss ratio................................................................. 77.78% 107.54% 96.25% Medicare Supplement: Insurance policy benefits.................................................. $57.3 $102.3 $161.8 Loss ratio................................................................. 67.15% 60.54% 64.07% Long-Term Care: Insurance policy benefits.................................................. $73.7 $252.4 $323.9 Loss ratio................................................................. 96.07% 167.18% 144.82% Interest-adjusted loss ratio............................................... 66.35% 141.26% 122.44% Specified Disease: Insurance policy benefits.................................................. $18.3 $49.7 $66.0 Loss ratio................................................................. 60.68% 82.48% 71.50% Interest-adjusted loss ratio............................................... 30.90% 52.32% 43.53% Other: Insurance policy benefits.................................................. $4.7 $13.7 $23.3 Loss ratio................................................................. 81.16% 160.82% 80.78% - -------------------- (a) Revenues exclude net investment gains (losses); benefits and expenses exclude amortization related to realized gains. (b) Investment income includes income from general account assets only. Average insurance liabilities exclude liabilities related to separate accounts, investment trust and reinsurance ceded. (c) Average insurance liabilities exclude liabilities related to separate accounts, investment trust and reinsurance ceded.
53 CONSECO, INC. AND SUBSIDIARIES ------------------- Insurance and fee-based operations (dollars in millions)
Successor Predecessor ------------- ----------------------------- One month Eight months Nine months ended ended ended September 30, August 31, September 30, 2003 2003 2002 ---- ---- ---- Premiums and asset accumulation product collections: Annuities.................................................................... $ 68.7 $ 772.4 $ 804.1 Supplemental health.......................................................... 191.7 1,552.9 1,794.4 Life......................................................................... 46.5 383.4 483.8 Group major medical.......................................................... 17.4 152.4 248.2 --------- --------- -------- Collections on insurance products from continuing lines of business........................................................... 324.3 2,861.1 3,330.5 Individual major medical in run-off.......................................... .5 4.0 89.2 Discontinued operations...................................................... - - 260.8 --------- --------- -------- Total collections on insurance products.................................. 324.8 2,865.1 3,680.5 Deposit type contracts....................................................... 30.8 260.1 237.6 Deposit type contracts - discontinued operations............................. - - 5.8 Mutual funds................................................................. 6.2 159.7 144.6 --------- --------- --------- Total premiums and asset accumulation product collections................ $ 361.8 $ 3,284.9 $ 4,068.5 ========= ========= ========= Average liabilities for insurance and asset accumulation products (excluding discontinued operations and our major medical business in run-off): Annuities: Mortality based.......................................................... $ 338.8 $ 255.9 $ 250.5 Equity-linked............................................................ 1,569.5 1,697.9 2,258.1 Deposit based............................................................ 7,447.2 7,376.3 7,998.1 Separate accounts and investment trust liabilities....................... 87.7 401.3 695.9 Health..................................................................... 8,112.9 5,941.0 5,376.3 Life: Interest sensitive....................................................... 3,680.6 3,732.2 4,052.7 Non-interest sensitive................................................... 2,249.4 2,146.3 2,089.7 --------- --------- --------- Total average liabilities for insurance and asset accumulation products, net of reinsurance ceded...................... $23,486.1 $21,550.9 $22,721.3 ========= ========= ========= Revenues: Insurance policy income...................................................... $ 248.9 $ 2,055.3 $ 2,375.1 Net investment income: General account invested assets............................................ 105.3 913.4 1,141.0 Equity-indexed products based on the change in value of the S&P 500 Call Options..................................................... (8.3) 25.2 (97.8) Separate account assets.................................................... - - (8.5) Trading income related to policyholder and reinsurer accounts.............. 14.8 - - Change in value of embedded derivatives related to modified coinsurance agreements................................................... (8.6) - - Fee revenue and other income................................................. 1.9 34.4 69.9 --------- --------- --------- Total revenues (a)....................................................... 354.0 3,028.3 3,479.7 --------- --------- --------- Expenses: Insurance policy benefits.................................................... 203.9 1,621.3 1,907.0 Amounts added to policyholder account balances: Annuity products and interest-sensitive life products other than those listed below............................................ 38.1 311.6 377.3 Equity-indexed products based on S&P 500 Index............................. (5.2) 66.6 (18.9) Separate account liabilities............................................... - - (8.5) Amortization related to operations........................................... 27.0 338.0 579.6 Interest expense on investment borrowings.................................... .6 8.3 12.4 Other operating costs and expenses........................................... 47.0 380.6 378.7 --------- --------- --------- Total benefits and expenses (a).......................................... 311.4 2,726.4 3,227.6 --------- --------- --------- Income before goodwill impairment, net investment gains (losses), special charges, income taxes, minority interest, discontinued operations and cumulative effect of accounting change.................. 42.6 301.9 252.1 Goodwill impairment............................................................. - - (500.0) Net investment gains (losses), including related costs and amortization................................................................. 6.7 (5.0) (469.4) Special charges................................................................. - - (42.0) --------- --------- --------- Income (loss) before income taxes, minority interest, discontinued operations and cumulative effect of accounting change...................... .$ 49.3 $ 296.9 $ (759.3) ========= ========= ========= (continued)
54 CONSECO, INC. AND SUBSIDIARIES ------------------- (continued from previous page)
Successor Predecessor ------------- ---------------------------- One month Eight months Nine months ended ended ended September 30, August 31, September 30, 2003 2003 2002 ---- ---- ---- Ratios (annualized): Investment income, net of interest credited on annuities and universal life products and interest expense on investment borrowings, as a percentage of average liabilities for insurance and asset accumulation products (b)........................... 2.90% 3.86% 4.27% Operating costs and expenses (excluding amortization of cost of policies produced and cost of policies purchased) as a percentage of average liabilities for insurance and asset accumulation products (c)............................................... 2.41% 3.03% 2.29% Health loss ratios: All health lines: Insurance policy benefits............................................... $154.0 $1,417.8 $1,492.1 Loss ratio.............................................................. 77.78% 89.99% 83.17% Medicare Supplement: Insurance policy benefits............................................... $57.3 $450.5 $491.6 Loss ratio.............................................................. 67.15% 66.06% 65.33% Long-Term Care: Insurance policy benefits............................................... $73.7 $745.2 $741.0 Loss ratio.............................................................. 96.07% 123.49% 110.08% Interest-adjusted loss ratio............................................ 66.35% 98.47% 88.52% Specified Disease: Insurance policy benefits............................................... $18.3 $184.7 $192.6 Loss ratio.............................................................. 60.68% 75.77% 68.72% Interest-adjusted loss ratio............................................ 30.90% 46.33% 41.48% Other: Insurance policy benefits............................................... $4.7 $37.4 $66.9 Loss ratio.............................................................. 81.16% 80.81% 75.87% - -------------------- (a) Revenues exclude net investment gains (losses); benefits and expenses exclude amortization related to realized gains. (b) Investment income includes income from general account assets only. Average insurance liabilities exclude liabilities related to separate accounts, investment trust and reinsurance ceded. (c) Average insurance liabilities exclude liabilities related to separate accounts, investment trust and reinsurance ceded.
General: As more fully described in "Premium and Asset Accumulation Product Collections," within "Management's Discussion and Analysis of Financial Condition and Results of Operations", our insurance subsidiaries' financial strength ratings were downgraded by A.M. Best on August 14, 2002 to "B (Fair)" and the ratings remain "under review with developing implications". The downgrade has caused sales of our insurance products to fall and policyholder redemptions and lapses to increase. This has had a material adverse impact on our financial results. On September 11, 2003, A.M. Best affirmed its financial strength ratings of our primary insurance companies ("B (Fair)") and removed the ratings from under review, indicating that the ratings outlook is positive. On October 3, 2003, A.M. Best assigned a positive outlook to all of our ratings. Conseco's insurance subsidiaries develop, market and administer annuity, supplemental health, individual life insurance and other insurance products. We distribute these products through a career agency force, professional independent producers and direct response marketing. This segment excludes our discontinued operations and the major medical business in run-off. 55 CONSECO, INC. AND SUBSIDIARIES ------------------- Liabilities for insurance products are calculated using management's best judgments of mortality, morbidity, lapse rates, investment experience and expense levels that are based on the Company's past experience and standard actuarial tables. Collections on insurance products from continuing operations were $.3 billion in the one month ended September 30, 2003; $.7 billion in the two months ended August 31, 2003; $2.9 billion in the eight months ended August 31, 2003; $1.1 billion in the three months ended September 30, 2002; and $3.3 billion in the nine months ended September 30, 2002. Annuity premium collections were positively impacted by sales inducements provided to purchasers of our annuities, sales incentives to our career agents and by the attractive minimum guaranteed rates on certain of these products. Our premium collections have been negatively impacted by the A.M. Best ratings downgrade to "B (Fair)." See "Premium and Asset Accumulation Product Collections" for further analysis. Average liabilities for insurance and asset accumulation products, net of reinsurance receivables, were $23.5 billion in the one month ended September 30, 2003; $21.4 billion in the two months ended August 31, 2003; $21.6 billion in the eight months ended August 31, 2003; $22.3 billion in the three months ended September 30, 2002; and $22.7 billion in the nine months ended September 30, 2002. The decrease in such liabilities through August 31, 2003, is primarily due to the increase in policyholder redemptions and lapses following the downgrade of our A.M. Best financial strength rating to "B (Fair)". See "Liquidity for insurance and fee-based operations" within "Management's Discussion and Analysis of Financial Condition and Results of Operations" for additional discussion of the A.M. Best ratings downgrade. The increase in such liabilities for the one month ended September 30, 2003, is due to the adoption of fresh start accounting. Insurance policy income is comprised of: (i) premiums earned on policies which provide mortality or morbidity coverage; and (ii) fees and other charges made against other policies. See "Premium and Asset Accumulation Product Collections" for further analysis. Net investment income on general account invested assets (which excludes income on policyholder and reinsurer accounts) was $105.3 million in the one month ended September 30, 2003; $232.7 million in the two months ended August 31, 2003; $913.4 million in the eight months ended August 31, 2003; $365.1 million in the three months ended September 30, 2002; and $1,141.0 million in the nine months ended September 30, 2002. The average balance of general account invested assets was $23.0 million in the one month ended September 30, 2003; $22.3 million in the two months ended August 31, 2003; $22.2 million in the eight months ended August 31, 2003; $22.6 million in the three months ended September 30, 2002; and $23.6 million in the nine months ended September 30, 2002. The yield on these assets was 5.5 percent in the one month ended September 30, 2003; 6.3 percent in the two months ended August 31, 2003; 6.2 percent in the eight months ended August 31, 2003; 6.5 percent in the three months ended September 30, 2002; and 6.4 percent in the nine months ended September 30, 2002. The decrease in yield for the month ended September 30, 2003 reflects the adoption of fresh start accounting. Net investment income related to equity-indexed products based on the change in value of the S&P 500 Call Options represents the change in the estimated fair value of our S&P 500 Index Call Options which are purchased in an effort to cover certain benefits accruing to the policyholders of our equity-indexed products. Our equity-indexed products are designed so that the investment income spread earned on the related insurance liabilities should be more than adequate to cover the cost of the S&P 500 Call Options and other costs related to these policies. Option costs that are attributable to benefits provided were $5.2 million in the one month ended September 30, 2003; $14.0 million in the two months ended August 31, 2003; $53.5 million in the eight months ended August 31, 2003; $20.7 million in the three months ended September 30, 2002; and $72.9 million in the nine months ended September 30, 2002. These costs are reflected in the change in market value of the S&P 500 Call Options included in the investment income amounts. Net investment income (loss) related to equity-indexed products before this expense was $(3.1) million in the one month ended September 30, 2003; $20.9 million in the two months ended August 31, 2003; $78.7 million in the eight months ended August 31, 2003; $(6.6) million in the three months ended September 30, 2002; and $(24.9) million in the nine months ended September 30, 2002. Such amounts were partially offset by the corresponding charge (credit) to amounts added to policyholder account balances for equity-indexed products of $(5.2) million in the one month ended September 30, 2003; $14.3 million in the two months ended August 31, 2003; $66.6 million in the eight months ended August 31, 2003; $(3.7) million in the three months ended September 30, 2002; and $(18.9) million in the nine months ended September 30, 2002. Such income and related charge fluctuate based on the value of options embedded in the Company's equity-indexed annuity policyholder account balances subject to this benefit and to the performance of the S&P 500 Index to which the returns on such products are linked. 56 CONSECO, INC. AND SUBSIDIARIES ------------------- Net investment income (loss) from separate account assets is offset by a corresponding charge (credit) to amounts added to policyholder account balances for separate account liabilities. Such income (loss) and related charge (credit) fluctuated in relationship to total separate account assets and the return earned on such assets. Trading account income related to policyholder and reinsurer accounts represents the income on trading security accounts established on August 31, 2003, which are designed to act as a hedge for embedded derivatives related to: (i) our equity-indexed products; and (ii) certain modified coinsurance agreements. In addition, such income includes the income on investments backing the market strategies of our multibucket annuity products. The income on our trading account securities are designed to substantially offset: (i) the change in value of embedded derivatives related to modified coinsurance agreements described below; and (ii) certain amounts included in insurance policy benefits. Change in value of embedded derivatives related to modified coinsurance agreements are described in the note to our consolidated financial statements entitled "Accounting for Derivatives." We have transferred the specific block of investments related to these agreements to our trading securities account, which we carry at estimated fair value with changes in such value recognized as trading account income. The change in the value of the embedded derivatives should largely be offset by the change in value of the trading securities. Fee revenue and other income includes: (i) revenues we receive for managing investments for other companies; and (ii) fees received for marketing insurance products of other companies. In the three and nine months ended September 30, 2002, this amount included $4.6 million and $14.5 million, respectively, of affiliated fee revenue earned by our subsidiary in India. Such revenue is eliminated in consolidation. Excluding such affiliated income, fee revenue and other income decreased in the 2003 periods primarily as a result of a decrease in the market value of investments managed for others, upon which these fees are based. The Company sold its India subsidiary in the fourth quarter of 2002 and has substantially eliminated the customer service and backroom operations conducted there. Insurance policy benefits fluctuated as a result of the factors summarized in the explanations for loss ratios related to specific products which follow and, in the two month period ended August 31, 2003, as a result of a change in estimates of future losses on certain policies. Loss ratios are calculated by taking the related insurance product's: (i) policy benefits; divided by (ii) policy income. The loss ratios on our Medicare supplement products increased slightly in the 2003 periods, although they have generally been within our range of expectations. Governmental regulations generally require us to attain and maintain a loss ratio, after three years, of not less than 65 percent on these products. Our loss experience on long-term care products issued by independent agents has been worse than we expected. Although we anticipated a higher level of benefits to be paid out on these products as the policies age, the paid claims have exceeded our projections. We are experiencing adverse developments on home health care policies issued in certain areas of Florida and other states (primarily policies issued by certain of our subsidiaries prior to their acquisitions). This adverse experience is reflected in the higher loss ratios in 2003. We are aggressively seeking rate increases and pursuing other actions on certain long-term care policies. We hired an actuarial consulting firm to help evaluate the adequacy of our long-term care reserves given our recent adverse experience and claim reserve deficiencies. Based on the results of their study and our internal evaluations, we modified our claim continuance tables to reflect longer benefit payment periods consistent with our current estimate of future loss experience. Accordingly, claim reserves increased by $95.3 million in the two months ended August 31, 2003, most of which was due to the new continuance tables. The net cash flows from our long-term care products generally result in the accumulation of amounts in the early years of a policy (accounted for as reserve increases) which will be paid out as benefits in later policy years (accounted for as reserve decreases). Accordingly, as the policies age, the loss ratio will typically increase, but the increase in the change in reserve will be partially offset by investment income earned on the assets which have accumulated. The interest-adjusted loss ratio for long-term care products is calculated by taking the insurance product's (i) policy benefits less interest income on the accumulated assets which back the insurance liabilities; divided by (ii) policy income. The loss ratio for our specified disease products reflects higher than expected incurred claims on certain cancer insurance policies during the first eight months of 2003. These policies generally provide fixed or limited benefits. Payments under cancer insurance policies are generally made directly to, or at the direction of, the policyholder following diagnosis of, or treatment for a covered type of cancer. We had favorable claims experience in the one month ended September 30, 2003. 57 CONSECO, INC. AND SUBSIDIARIES ------------------- The loss ratios on our other products fluctuate due to the smaller size of these blocks of business. The loss ratios on this business have generally been within our expectations. In August 2003, the Company decided to change a non-guaranteed element of certain policies. This element was not required by the policy and the change will eliminate the former practice of reducing the cost of insurance charges to amounts below the level permitted under the provisions of the policies. As a result of this decision, our estimates of future expected gross profits on these products used as a basis for amortization of cost of policies purchased and cost of policies produced and the establishment of insurance liabilities has changed. We adjusted the total amortization and reserve charge we had recorded since the acquisition of these policies as a result of the change to our earlier estimates in accordance with Statement of Financial Accounting Standards No. 97, "Accounting and Reporting by Insurance Enterprises of Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments." The effect of the change in estimate was a $220.2 million reduction to insurance policy benefits and a $39.8 million reduction in amortization recorded in the two months ended August 31, 2003. Amounts added to policyholder account balances for annuity products were $38.1 million in the one month ended September 30, 2003; $77.7 million in the two months ended August 31, 2003; $311.6 million in the eight months ended August 31, 2003; $120.8 million in the three months ended September 30, 2002; and $377.3 million in the nine months ended September 30, 2002. This decrease is primarily due to: (i) a smaller block of annuity business inforce; and (ii) a decrease in the weighted average crediting rates. The weighted average crediting rates for these products were 4.2 percent for the one month ended September 30, 2003; 4.3 percent for the eight months ended August 31, 2003; and 4.3 percent for the nine months ended September 30, 2002. Amounts added to equity-indexed products and separate account liabilities correspond to the related investment income accounts described above. Amortization related to operations includes amortization of the cost of policies produced and the cost of policies purchased. Amortization recorded in the two months ended August 31, 2003 was affected by the change in estimates of future losses on certain policies described above under "insurance policy benefits." Policyholder redemptions of annuity and, to a lesser extent, life products have increased in recent periods. We have experienced additional redemptions following the downgrade of our A.M. Best financial strength rating to "B (Fair)" in August of 2002. When redemptions are greater than our previous assumptions, we are required to accelerate the amortization of our cost of policies produced and cost of policies purchased to write off the balance associated with the redeemed policies. Amortization in recent periods has fluctuated as a result of the acceleration of the amortization of our cost of policies produced and cost of policies purchased associated with policy redemptions and changes in future lapse assumptions with respect to the policies in force. In 2002, we changed the lapse assumptions used to determine the amortization of the cost of policies produced and the cost of policies purchased related to certain universal life products and our annuities to reflect our then current estimates of future lapses. For certain universal life products, we changed the ultimate lapse assumption from: (i) a range of 6 percent to 7 percent; to (ii) a tiered assumption based on the level of funding of the policy of a range of 2 percent to 10 percent. We recorded additional amortization related to higher redemptions and changes to our lapse assumptions of $48 million and $122 million in the three and nine months ended September 30, 2002. Policyholder redemptions during the 2003 periods have generally been consistent with our revised lapse assumptions. Interest expense on investment borrowings fluctuates along with our investment borrowing activities and the interest rates thereon. Average investment borrowings (excluding borrowings related to the GM building) were $531.5 million during the one month ended September 30, 2003; $689.1 million during the eight months ended August 31, 2003; and $1,226.4 million in the nine months ended September 30, 2002. The weighted average interest rates on such borrowings (excluding borrowings related to the GM building) were 1.3 percent during the one month ended September 30, 2003; 1.8 percent during the eight months ended August 31, 2003; and 1.3 percent during the nine months ended September 30, 2002. Other operating costs and expenses were $47.0 million in the one month ended September 30, 2003; $100.7 million in the two months ended August 31, 2003; $380.6 million in the eight months ended August 31, 2003; $133.6 million in the three months ended September 30, 2002; and $378.7 million in the nine months ended September 30, 2002. Such increase is primarily related to increased policy acquisition costs which were non-deferrable. The ratio of operating expenses (excluding amortization of cost of policies produced and cost of policies purchased) as a percentage of average liabilities for insurance and asset accumulation products was 2.41 percent in the one month ended September 30, 2003; 2.85 percent in the two 58 CONSECO, INC. AND SUBSIDIARIES ------------------- months ended August 31, 2003; 3.03 percent in the eight months ended August 31, 2003; 2.46 percent in the three months ended September 30, 2002; and 2.29 percent in the nine months ended September 30, 2002. Net investment gains (losses), including related costs and amortization fluctuate from period to period. During the one month ended September 30, 2003, we recognized net investment gains of $6.7 million related to the net gains from the sales of investments (primarily fixed maturities). There were no writedowns of fixed maturity investments in the one month period. During the first eight months of 2003, we recognized net investment losses of $5.4 million. During the first eight months of 2003, the net investment losses included: (i) $40.5 million of net gains from the sales of investments (primarily fixed maturities); net of (ii) $45.9 million of writedowns of fixed maturity investments as a result of conditions which caused us to conclude a decline in fair value of the investment was other than temporary. The net investment losses during the first nine months of 2002 included: (i) $489.8 million of writedowns of fixed maturity investments, equity securities and other invested assets as a result of conditions which caused us to conclude a decline in fair value of the investment was other than temporary; and (ii) $4.1 million of net losses from the sales of investments (primarily fixed maturities). The facts and circumstances resulting in the other-than-temporary losses are described in "Investments with Other-Than-Temporary Losses" included in this "Management's Discussion and Analysis of Financial Condition and Results of Operations." When we sell securities at a gain (loss) and reinvest the proceeds at a different yield, we increase (reduce) the amortization of cost of policies purchased and cost of policies produced in order to reflect the change in future yields. Sales of fixed maturity investments resulted in a decrease in the amortization of the cost of policies purchased and the cost of policies produced of nil in the one month ended September 30, 2003; $.6 million in the two months ended August 31, 2003; $.4 million in the eight months ended August 31, 2003; $22.4 million in the three months ended September 30, 2002; and $24.5 million in the nine months ended September 30, 2002. Special charges in 2002 include: (i) losses of $34.5 million on reinsurance and asset sale transactions entered into as part of our cash raising initiatives (all recognized in the second quarter of 2002); and (ii) other items totaling $7.5 million ($2.3 million of which was recognized in the third quarter of 2002) primarily related to severance benefits and costs incurred with the transfer of certain customer service and backroom operations to our India subsidiary. These charges are described in greater detail in the note to the accompanying consolidated financial statements entitled "Special Charges". 59 CONSECO, INC. AND SUBSIDIARIES ------------------- Corporate operations (dollars in millions)
Successor Predecessor ------------- ----------------------------- One month Two months Three months ended ended ended September 30, August 31, September 30, 2003 2003 2002 ---- ---- ---- Corporate operations: Interest expense on corporate debt, net of investment income............... $ (6.3) $ (50.3) $ (79.0) Provision for losses and interest expense related to stock purchase plan............................................................ - (24.5) (59.9) Venture capital income (loss) related to investment in AWE, net of related expenses............................................. (2.7) 2.0 (6.6) Other items................................................................ (2.5) (1.7) (27.4) Special charges............................................................ - - (32.6) Reorganization items....................................................... - 2,163.0 - ------ -------- ------- Income (loss) before income taxes and minority interest................ $(11.5) $2,088.5 $(205.5) ====== ======== =======
Successor Predecessor ------------- ----------------------------- One month Eight months Nine months ended ended ended September 30, August 31, September 30, 2003 2003 2002 ---- ---- ---- Corporate operations: Interest expense on corporate debt, net of investment income............... $ (6.3) $ (181.7) $(227.7) Provision for losses and interest expense related to stock purchase plan............................................................ - (55.6) (199.9) Venture capital income (loss) related to investment in AWE, net of related expenses............................................. (2.7) 10.5 (106.6) Other items................................................................ (2.5) (28.4) (72.7) Special charges............................................................ - - (61.1) Extraordinary gain on extinguishment of debt............................... - - 1.8 Reorganization items....................................................... - 2,130.5 - ------ -------- ------- Income (loss) before income taxes and minority interest................ $(11.5) $1,875.3 $(666.2) ====== ======== =======
Interest expense on corporate debt, net of investment income in the one month ended September 30, 2003, includes interest expense on the New Credit Facility. Interest expense decreased in the 2003 Predecessor periods primarily as a result of our ceasing to accrue interest on notes payable (excluding Old Conseco's senior credit facility, the guaranteed senior notes and certain secured senior notes). Provision for losses and interest expense related to stock purchase plan represents the non-cash provision we established in connection with our guarantees of bank loans to former directors and current and former officers and key employees and our related loans for interest. The funds from the bank loans were used by the participants to purchase approximately 18.0 million shares of Old Conseco common stock. In the eight months ended August 31, 2003, and the nine months ended September 30, 2002, we increased our reserve by $55.6 million and $199.9 million, respectively, in connection with these guarantees and loans. We determined the reserve based upon the value of the collateral held by the banks (primarily the purchased stock). At August 31, 2003, the reserve for losses on the loan guarantees totaled $715.7 million. The outstanding principal balance on the bank loans was $481.3 million. In addition, Conseco has provided loans to participants for interest on the bank loans totaling $219.0 million. During 2002, Conseco purchased $55.5 million of loans from the banks utilizing cash held in a segregated cash account as collateral for our guarantee of the bank loans (including accrued interest, the balance on these loans was $60.3 million at August 31, 2003). The guarantees of the bank loans are discussed in greater detail in the note to the accompanying consolidated financial statements entitled "Guarantees". Venture capital income (loss) relates to our investment in AWE, a company in the wireless communication business. Our investment in AWE is carried at estimated fair value, with changes in fair value recognized as investment income. 60 CONSECO, INC. AND SUBSIDIARIES ------------------- Other items include general corporate expenses, net of amounts charged to subsidiaries for services provided by the corporate operations. During the first eight months of 2003, disputes with certain of our insurance carriers were resolved and a previously established liability of $40 million was released which was substantially offset by increases to various litigation reserves of $30 million (none of which occurred in the two months ended August 31, 2003). Special charges in corporate operations for 2002 include: (i) an impairment charge of $20.0 million (recognized in the third quarter of 2002) associated with the value of a subsidiary which we had entered into an agreement to sell; (ii) $17.7 million related to refinancing transactions (of which $.3 million was recognized in the third quarter of 2002); (iii) restructuring expenses of $12.1 million (all of which was recognized in the third quarter of 2002); (iv) other items totaling $18.8 million (of which $.2 million was recognized in the third quarter of 2002); partially offset by (v) net gains of $7.5 million related to the sale of certain non-core assets. These charges are described in greater detail in the note to the accompanying consolidated financial statements entitled "Special Charges". Reorganization items in the two months ended August 31, 2003 included: (i) $3,151.4 million related to the gain on the discharge of prepetition liabilities; (ii) $(950.0) million related to fresh start adjustments; and (iii) $(38.4) million related to professional fees associated with our bankruptcy proceedings which are expensed as incurred in accordance with SOP 90-7. The reorganization items in the eight months ended August 31, 2003 included: (i) $3,151.4 million related to the gain on the discharge of prepetition liabilities; (ii) $(950.0) million related to fresh start adjustments; and (iii) $(70.9) million related to professional fees. PREMIUM AND ASSET ACCUMULATION PRODUCT COLLECTIONS In accordance with GAAP, insurance policy income as shown in our consolidated statement of operations consists of premiums earned for policies that have life contingencies or morbidity features. For annuity and universal life contracts without such features, premiums collected are not reported as revenues, but as deposits to insurance liabilities. We recognize revenues for these products over time in the form of investment income and surrender or other charges. Agents, insurance brokers and marketing companies who market our products and prospective purchasers of our products use the ratings of our insurance subsidiaries as an important factor in determining which insurer's products to market or purchase. Ratings have the most impact on our annuity and interest-sensitive life insurance products. In July 2002, A.M. Best downgraded the financial strength ratings of our primary insurance subsidiaries from "A- (Excellent)" to "B++ (Very Good)" and placed the ratings "under review with negative implications." On August 14, 2002, A.M. Best lowered the financial strength ratings of our primary insurance subsidiaries from "B++ (Very Good)" to "B (Fair)". A.M. Best ratings for the industry currently range from "A++ (Superior)" to "F (In Liquidation)" and some companies are not rated. An "A++" rating indicates superior overall performance and a superior ability to meet ongoing obligations to policyholders. The "B" rating is assigned to companies which have, on balance, fair balance sheet strength, operating performance and business profile, when compared to the standards established by A.M. Best, and a fair ability in A.M. Best's opinion to meet their current obligations to policyholders, but are financially vulnerable to adverse changes in underwriting and economic conditions. The rating reflected A.M. Best's view of the uncertainty surrounding our restructuring initiatives and the potential adverse financial impact on our subsidiaries. On September 11, 2003, A.M. Best affirmed its financial strength ratings of our primary insurance companies ("B (Fair)") and removed the ratings from under review, indicating that the ratings outlook is positive. On October 3, 2003, A.M. Best assigned a positive outlook to all of our ratings. The assignment of a positive outlook to Conseco's ratings reflects A.M. Best's favorable view of our bankruptcy reorganization and a number of management initiatives including the sale of the GM building, restructuring of our investment portfolios, expense reductions, merging of certain subsidiaries, stabilization of surrenders and a commitment in the near-to medium-term to focus on selling higher margin products with lower capital requirements. On September 11, 2003, S&P assigned a "B+" counterparty credit and financial strength rating of our primary insurance companies and placed each company on positive CreditWatch, with the exception of Conseco Senior Health Insurance Company, which was placed on CreditWatch developing. Rating categories from "BB" to "CCC" are classified as "vulnerable", and pluses and minuses show the relative standing within a category. In S&P's view, an insurer rated "B" has weak financial security characteristics and adverse business conditions will likely impair its ability to meet financial commitments. On September 12, 2003, Moody's affirmed the B3 rating of our insurance companies and placed each insurance company on review for possible upgrade, with the exception of Conseco Senior Health Insurance Company, which had a developing outlook. Rating categories from "Ba" to "C" are classified as "vulnerable" by Moody's, and may be 61 CONSECO, INC. AND SUBSIDIARIES ------------------- supplemented with numbers "1", "2", or "3" to show relative standing within a category. In Moody's view, an insurer rated "B" offers poor financial security and cannot offer assurance of punctual payment of claims over a long period of time. The ratings downgrades have generally caused sales of our insurance products to decline and policyholder redemptions and lapses to increase. In some cases, the downgrades have also caused defections among our independent agent sales force and increases in the commissions we must pay in order to retain them. These events have had a material adverse effect on our financial results. Further downgrades by A.M. Best or S&P would likely have further material and adverse effects on our financial results and liquidity, and will constitute a default under our New Credit Facility. We set the premium rates on our health insurance policies based on facts and circumstances known at the time we issue the policies and on assumptions about numerous variables, including the actuarial probability of a policyholder incurring a claim, the probable size of the claim, and the interest rate earned on our investment of premiums. In setting premium rates, we consider historical claims information, industry statistics, the rates of our competitors and other factors. If our actual claims experience proves to be less favorable than we assumed and we are unable to raise our premium rates, our financial results may be adversely affected. Our estimates of insurance liabilities assume we will be able to raise rates if future experience results in blocks of our health insurance business becoming unprofitable. We generally cannot raise our health insurance premiums in any state unless we first obtain the approval of the insurance regulator in that state. We review the adequacy of our premium rates regularly and file rate increases on our products when we believe existing premium rates are too low. It is possible that we will not be able to obtain approval for premium rate increases from currently pending requests or requests filed in the future. If we are unable to raise our premium rates because we fail to obtain approval for a rate increase in one or more states, our net income may decrease. If we are successful in obtaining regulatory approval to raise premium rates due to unfavorable actual claims experience, the increased premium rates may reduce the volume of our new sales and cause existing policyholders to allow their policies to lapse. This could result in anti-selection if healthier policyholders allow their policies to lapse. This would reduce our premium income and profitability in future periods. Increased lapse rates also could require us to expense all or a portion of the deferred policy costs relating to lapsed policies in the period in which those policies lapse, adversely affecting our financial results in that period. We sell our insurance products through three primary distribution channels - - career agents, independent producers and direct marketing. Our career agency force sells primarily Medicare supplement and long-term care insurance policies, senior life insurance and annuities. These agents visit the customer's home, which permits one-on-one contact with potential policyholders and promotes strong personal relationships with existing policyholders. Our independent producer distribution channel consists of a general agency and insurance brokerage distribution system comprised of independent licensed agents doing business in all fifty states, the District of Columbia, and certain protectorates of the United States. Independent producers are a diverse network of independent agents, insurance brokers and marketing organizations. Our direct marketing distribution channel is engaged primarily in the sale of "graded benefit life" insurance policies which are sold directly from the Company to the policyholder. 62 CONSECO, INC. AND SUBSIDIARIES ------------------- Total premiums and accumulation product collections were as follows (dollars in millions):
Successor Predecessor -------------- ------------------------------- One month Two months Three months ended ended ended September 30, August 31, September 30, 2003 2003 2002 ---- ---- ---- Premiums collected by our insurance subsidiaries: Annuities: Equity-indexed (first-year)..................................... $ 2.0 $ 9.2 $ 43.6 Equity-indexed (renewal)........................................ .9 2.1 4.6 ------ ------ -------- Subtotal - equity-indexed annuities........................... 2.9 11.3 48.2 ------ ------ -------- Other fixed (first-year)........................................ 63.3 147.9 216.2 Other fixed (renewal)........................................... 2.5 3.0 6.0 ------ ------ -------- Subtotal - other fixed annuities.............................. 65.8 150.9 222.2 ------ ------ -------- Total annuities............................................... 68.7 162.2 270.4 ------ ------ -------- Supplemental health: Medicare supplement (first-year)................................ 8.7 17.7 38.6 Medicare supplement (renewal)................................... 74.1 148.2 211.7 ------ ------ -------- Subtotal - Medicare supplement................................ 82.8 165.9 250.3 ------ ------ -------- Long-term care (first-year)..................................... 6.2 12.7 23.4 Long-term care (renewal)........................................ 66.5 139.7 204.1 ------ ------ -------- Subtotal - long-term care..................................... 72.7 152.4 227.5 ------ ------ -------- Specified disease (first-year).................................. 2.4 4.8 8.6 Specified disease (renewal)..................................... 27.1 51.6 81.8 ------ ------ -------- Subtotal - specified disease.................................. 29.5 56.4 90.4 ------ ------ -------- Other health (first-year)....................................... 1.9 3.2 2.2 Other health (renewal).......................................... 4.8 8.7 17.7 ------ ------ -------- Subtotal - other health....................................... 6.7 11.9 19.9 ------ ------ -------- Total supplemental health..................................... 191.7 386.6 588.1 ------ ------ -------- Life insurance: First-year...................................................... 5.6 12.8 27.9 Renewal......................................................... 40.9 87.9 131.1 ------ ------ -------- Total life insurance.......................................... 46.5 100.7 159.0 ------ ------ -------- Group major medical: Renewal......................................................... 17.4 28.9 83.8 ------ ------ -------- Total group major medical..................................... 17.4 28.9 83.8 ------ ------ -------- Collections on insurance products from continuing lines of business: Total first-year premium collections on insurance products...... 90.1 208.3 360.5 Total renewal premium collections on insurance products......... 234.2 470.1 740.8 ------ ------ -------- Total collections on insurance products....................... $324.3 $678.4 $1,101.3 ====== ====== ======== Deposit type contracts............................................... $ 30.8 $ 57.5 $ 78.3 ====== ====== ========
(continued) 63 CONSECO, INC. AND SUBSIDIARIES ------------------- (continued from previous page)
Successor Predecessor -------------- --------------------------------- One month Two months Three months ended ended ended September 30, August 31, September 30, 2003 2003 2002 ---- ---- ---- Premiums collected from discontinued businesses and products in run-off: Major medical............................................... $ .5 $1.6 $16.6 Annuities (primarily variable).............................. - - 72.1 Other ...................................................... - - .1 ---- ---- ----- Total collections on insurance products from discontinued operations and products in run-off...................... $ .5 $1.6 $88.8 ==== ==== ===== Deposit type contracts - discontinued operations............... $ - $ - $ 1.3 ==== ==== =====
(continued) 64 CONSECO, INC. AND SUBSIDIARIES ------------------- (continued from previous page)
Successor Predecessor ---------------- --------------------------------- One month Eight months Nine months ended ended ended September 30, August 31, September 30, 2003 2003 2002 ---- ---- ---- Premiums collected by our insurance subsidiaries: Annuities: Equity-indexed (first-year)..................................... $ 2.0 $ 42.8 $ 167.0 Equity-indexed (renewal)........................................ .9 12.1 22.2 ------ -------- -------- Subtotal - equity-indexed annuities........................... 2.9 54.9 189.2 ------ -------- -------- Other fixed (first-year)........................................ 63.3 699.7 591.6 Other fixed (renewal)........................................... 2.5 17.8 23.3 ------ -------- -------- Subtotal - other fixed annuities.............................. 65.8 717.5 614.9 ------ -------- -------- Total annuities............................................... 68.7 772.4 804.1 ------ -------- -------- Supplemental health: Medicare supplement (first-year)................................ 8.7 74.1 122.6 Medicare supplement (renewal)................................... 74.1 595.4 636.4 ------ -------- -------- Subtotal - Medicare supplement................................ 82.8 669.5 759.0 ------ -------- -------- Long-term care (first-year)..................................... 6.2 51.9 74.1 Long-term care (renewal)........................................ 66.5 547.6 606.3 ------ -------- -------- Subtotal - long-term care..................................... 72.7 599.5 680.4 ------ -------- -------- Specified disease (first-year).................................. 2.4 19.7 28.0 Specified disease (renewal)..................................... 27.1 216.7 248.4 ------ -------- -------- Subtotal - specified disease.................................. 29.5 236.4 276.4 ------ -------- -------- Other health (first-year)....................................... 1.9 10.5 9.3 Other health (renewal).......................................... 4.8 37.0 69.3 ------ -------- -------- Subtotal - other health....................................... 6.7 47.5 78.6 ------ -------- -------- Total supplemental health..................................... 191.7 1,552.9 1,794.4 ------ -------- -------- Life insurance: First-year...................................................... 5.6 45.7 75.9 Renewal......................................................... 40.9 337.7 407.9 ------ -------- -------- Total life insurance.......................................... 46.5 383.4 483.8 ------ -------- -------- Group major medical: First-year...................................................... - - .4 Renewal......................................................... 17.4 152.4 247.8 ------ -------- -------- Total group major medical..................................... 17.4 152.4 248.2 ------ -------- -------- Collections on insurance products from continuing lines of business: Total first-year premium collections on insurance products...... 90.1 944.4 1,068.9 Total renewal premium collections on insurance products......... 234.2 1,916.7 2,261.6 ------ -------- -------- Total collections on insurance products....................... $324.3 $2,861.1 $3,330.5 ====== ======== ======== Deposit type contracts............................................... $ 30.8 $ 260.1 $ 237.6 ====== ======== ========
(continued) 65 CONSECO, INC. AND SUBSIDIARIES ------------------- (continued from previous page)
Successor Predecessor --------------- ---------------------------------- One month Eight months Nine months ended ended ended September 30, August 31, September 30, 2003 2003 2002 ---- ---- ---- Premiums collected from discontinued businesses and products in run-off: Major medical............................................... $ .5 $4.0 $ 89.2 Annuities (primarily variable annuities).................... - - 260.4 Other....................................................... - - .4 ---- ---- ------ Total collections on insurance products from discontinued operations and products in run-off...................... $ .5 $4.0 $350.0 ==== ==== ====== Deposit type contracts - discontinued operations................. $ - $ - $ 5.8 ==== ==== ======
Continuing operations Annuities include equity-indexed annuities and other fixed annuities sold through both career agents and professional independent producers. Pursuant to our initiatives to increase capital and focus on the sale of products that result in less strain on our statutory capital and surplus, we took actions to de-emphasize the sales of annuity products through professional independent producers. Total annuity sales through professional independent producers totaled $5.3 million in the one month ended September 30, 2003; $73.9 million in the eight months ended August 31, 2003; and $307.3 million in the nine months ended September 30, 2002. For annuity sales through career agents, we provided certain sales inducements to purchasers and sales incentives to our agents. These programs ended at various times during the second quarter of 2003. Total annuity collections from career agents totaled $63.4 million in the one month ended September 30, 2003; $698.5 million in the eight months ended August 31, 2003; and $496.8 million in the nine months ended September 30, 2002. We introduced our first equity-indexed annuity product in 1996. The accumulation value of these annuities is credited with interest at an annual guaranteed minimum rate of 3 percent (or, including the effect of applicable sales loads, a 1.7 percent compound average interest rate over the term of the contracts). These annuities provide for potentially higher returns based on a percentage of the change in the S&P 500 Index during each year of their term. We purchase S&P 500 Call Options in an effort to hedge increases to policyholder benefits resulting from increases in the S&P 500 Index. Total collected premiums for this product were $2.9 million in the one month ended September 30, 2003; $11.3 million in the two months ended August 31, 2003; $54.9 million in the eight months ended August 31, 2003; $48.2 million in the three months ended September 30, 2002; and $189.2 million in the nine months ended September 30, 2002. The decreases can be attributed to: (i) the general stock market performance in recent years which has made other investment products more attractive to certain customers; and (ii) the effect of the A.M. Best ratings downgrade to "B (Fair)." Other fixed rate annuity products include single-premium deferred annuities ("SPDAs"), flexible-premium deferred annuities ("FPDAs") and single-premium immediate annuities ("SPIAs"), which are credited with a declared rate. The demand for traditional fixed-rate annuity contracts has increased as such products became more attractive than equity-indexed or variable annuity products to certain customers after the general stock market performance in recent years. SPDA and FPDA policies typically have an interest rate that is guaranteed for the first policy year, after which we have the discretionary ability to change the crediting rate to any rate not below a guaranteed minimum rate. The interest rate credited on SPIAs is based on market conditions existing when a policy is issued and remains unchanged over the life of the SPIA. Annuity premiums on these products were $65.8 million in the one month ended September 30, 2003; $150.9 million in the two months ended August 31, 2003; $717.5 million in the eight months ended August 31, 2003; $222.2 million in the three months ended September 30, 2002; and $614.9 million in the nine months ended September 30, 2002. The annuity premiums collected in 2003 were primarily from sales through our career agency force, which were favorably impacted by the sales inducements and incentives discussed above. In addition, the minimum guaranteed crediting rates on certain of our annuity 66 CONSECO, INC. AND SUBSIDIARIES ------------------- products were very attractive. We recently introduced new annuity products which have lower minimum guaranteed crediting rates. Given the elimination of the sales inducements and incentives and the lower minimum guaranteed crediting rates, sales of fixed rate annuity products have declined. Supplemental health products include Medicare supplement, long-term care, specified disease and other insurance products distributed through a career agency force and professional independent producers. Our profits on supplemental health policies depend on the overall level of sales, the length of time the business remains inforce, investment yields, claim experience and expense management. Collected premiums on Medicare supplement policies were $82.8 million in the one month ended September 30, 2003; $165.9 million in the two months ended August 31, 2003; $669.5 million in the eight months ended August 31, 2003; $250.3 million in the three months ended September 30, 2002; and $759.0 million in the nine months ended September 30, 2002. Collected premiums have been affected by the decrease in new sales. Premiums collected on long-term care policies totaled $72.7 million in the one month ended September 30, 2003; $152.4 million in the two months ended August 31, 2003; $599.5 million in the eight months ended August 31, 2003; $227.5 million in the three months ended September 30, 2002; and $680.4 million in the nine months ended September 30, 2002. Collected premiums have been affected by the decrease in new sales. We ceased selling new long-term care policies through professional independent producers in the second quarter of 2003. Premiums collected on specified disease products totaled $29.5 million in the one month ended September 30, 2003; $56.4 million in the two months ended August 31, 2003; $236.4 million in the eight months ended August 31, 2003; $90.4 million in the three months ended September 30, 2002; and $276.4 million in the nine months ended September 30, 2002. Collected premiums have been affected by the decrease in new sales. Other health products include disability income, dental and various other health insurance products. We have discontinued the sale of most of these products. The disability income and dental products have been marketed to school systems located in nearly all states. Premiums collected totaled $6.7 million in the one month ended September 30, 2003; $11.9 million in the two months ended August 31, 2003; $47.5 million in the eight months ended August 31, 2003; $19.9 million in the three months ended September 30, 2002; and $78.6 million in the nine months ended September 30, 2002. Life products are sold through career agents, professional independent producers and direct response distribution channels. Life premiums collected totaled $46.5 million in the one month ended September 30, 2003; $100.7 million in the two months ended August 31, 2003; $383.4 million in the eight months ended August 31, 2003; $159.0 million in the three months ended September 30, 2002; and $483.8 million in the nine months ended September 30, 2002. The A.M. Best ratings downgrade to "B (Fair)" has negatively affected our sales of life products. We have recently discontinued the sale of certain life products through the professional independent producer channel. Group major medical premiums totaled $17.4 million in the one month ended September 30, 2003; $28.9 million in the two months ended August 31, 2003; $152.4 million in the eight months ended August 31, 2003; $83.8 million in the three months ended September 30, 2002; and $248.2 million in the nine months ended September 30, 2002. We no longer actively market new sales of these products. Deposit type contracts include guaranteed interest contracts, supplemental contracts without life contingencies and short-term deposit funds. Amounts collected from deposit type contracts were $30.8 million in the one month ended September 30, 2003; $57.5 million in the two months ended August 31, 2003; $260.1 million in the eight months ended August 31, 2003; $78.3 million in the three months ended September 30, 2002; and $237.6 million in the nine months ended September 30, 2002. Such amounts often fluctuate from period-to-period. 67 CONSECO, INC. AND SUBSIDIARIES ------------------- Major medical business in run-off and discontinued operations Major medical in run-off includes major medical health insurance products sold to individuals and small groups. In the second half of 2001, we stopped renewing a large portion of our major medical lines of business. In early 2002, we decided to stop renewing all inforce individual and small group business and discontinue new sales. Individual health premiums collected were $.5 million in the one month ended September 30, 2003; $1.6 million in the two months ended August 31, 2003; $4.0 million in the eight months ended August 31, 2003; $16.6 million in the three months ended September 30, 2002; and $89.2 million in the nine months ended September 30, 2002. Variable annuities offer contract holders the ability to direct premiums into specific investment portfolios; rates of return are based on the performance of the portfolio. Profits on variable annuities are earned from the fees charged to contract holders. We sold our variable annuity business in the fourth quarter of 2002. Life product premiums from discontinued operations represent the life business of CVIC, which was sold in the fourth quarter of 2002. LIQUIDITY AND CAPITAL RESOURCES Changes in our consolidated balance sheet between September 30, 2003 and December 31, 2002, reflect: (i) the reorganization of our capital structure pursuant to the Plan; and (ii) the effect of the sale of CFC. In accordance with GAAP, we record our actively managed fixed maturity investments, equity securities and certain other invested assets at estimated fair value with any unrealized gain or loss (excluding impairment losses which are recognized through earnings), net of tax and related adjustments, recorded as a component of shareholders' deficit. At September 30, 2003, we increased the carrying value of such investments by $470.6 million as a result of this fair value adjustment. The Company's capital structure was determined in accordance with the terms of the Plan and consists of: (i) a $1.3 billion secured bank credit agreement; (ii) Preferred Stock with an aggregate liquidation preference of $859.7 million; (iii) warrants to purchase six million shares of common stock; and (iv) 100 million shares of new common stock. The Company's capital structure as of September 30, 2003, is as follows (dollars in millions): Total capital: Corporate notes payable................................................ $1,300.0 Shareholders' equity: Preferred stock..................................................... 865.0 Common stock and additional paid-in capital......................... 1,640.3 Accumulated other comprehensive income.............................. 273.2 Retained earnings................................................... 18.9 -------- Total shareholders' equity....................................... 2,797.4 -------- Total capital.................................................... $4,097.4 ========
68 CONSECO, INC. AND SUBSIDIARIES ------------------- The following table summarizes certain financial ratios as of and for the one month ended September 30, 2003: Book value per common share..................................................................... $19.31 Ratio of earnings to fixed charges.............................................................. 1.82x Ratio of earnings to fixed charges and preferred dividends...................................... 1.54x Debt to total capital ratios (a): Corporate debt to total capital.............................................................. 34% Corporate debt and preferred stock to total capital.......................................... 57% - --------------- (a) Excludes accumulated other comprehensive income.
Liquidity for insurance and fee-based operations Our insurance operating companies generally receive adequate cash flow from premium collections and investment income to meet their obligations. Life insurance and annuity liabilities are generally long-term in nature. Policyholders may, however, withdraw funds or surrender their policies, subject to any applicable surrender and withdrawal penalty provisions. We seek to balance the duration of our invested assets with the estimated duration of benefit payments arising from contract liabilities. On August 14, 2002, A.M. Best lowered the financial strength ratings of our primary insurance subsidiaries from "B++ (Very Good)" to "B (Fair)". A.M. Best ratings for the industry currently range from "A++ (Superior)" to "F (In Liquidation)" and some companies are not rated. An "A++" rating indicates superior overall performance and a superior ability to meet ongoing obligations to policyholders. The "B" rating is assigned to companies which have, on balance, fair balance sheet strength, operating performance and business profile, when compared to the standards established by A.M. Best, and a fair ability in A.M. Best's opinion to meet their current obligations to policyholders, but are financially vulnerable to adverse changes in underwriting and economic conditions. The rating reflected A.M. Best's view of the uncertainty surrounding our restructuring initiatives and the potential adverse financial impact on our subsidiaries. On September 11, 2003, A.M. Best affirmed its financial strength ratings of our primary insurance companies ("B (Fair)") and removed the ratings from under review, indicating that the ratings outlook is positive. On October 3, 2003, A.M. Best assigned a positive outlook to all of our ratings. The assignment of a positive outlook to Conseco's ratings reflects A.M. Best's favorable view of our bankruptcy reorganization and a number of management initiatives including the sale of the GM building, sale of CFC, restructuring of our investment portfolios, expense reductions, merging of certain subsidiaries, stabilization of surrenders and a commitment in the near-to medium-term to focus on selling higher margin products with lower capital requirements. On September 11, 2003, S&P assigned a "B+" counterparty credit and financial strength rating of our primary insurance companies and placed each company on positive CreditWatch, with the exception of Conseco Senior Health Insurance Company, which was placed on CreditWatch developing. Rating categories from "BB" to "CCC" are classified as "vulnerable", and pluses and minuses show the relative standing within a category. In S&P's view, an insurer rated "B" has weak financial security characteristics and adverse business conditions will likely impair its ability to meet financial commitments. On September 12, 2003, Moody's affirmed the B3 rating of our insurance companies and placed each insurance company on review for possible upgrade, with the exception of Conseco Senior Health Insurance Company, which had a developing outlook. Rating categories from "Ba" to "C" are classified as "vulnerable" by Moody's, and may be supplemented with numbers "1", "2", or "3" to show relative standing within a category. In Moody's view, an insurer rated "B" offers poor financial security and cannot offer assurance of punctual payment of claims over a long period of time. The ratings downgrades have generally caused sales of our insurance products to decline and policyholder redemptions and lapses to increase. In some cases, the downgrades have also caused defections among our independent agent sales force and increases in the commissions we must pay. These events have had a material adverse effect on our financial results. Further downgrades by A.M. Best, S & P or Moody's would likely have further material and adverse effects on our financial results and liquidity. Further downgrades by A.M. Best will also constitute a default under our New Credit Facility. 69 CONSECO, INC. AND SUBSIDIARIES ------------------- As more fully described under the caption "Statutory Information" within "Management's Discussion and Analysis of Financial Condition and Results of Operations", our two insurance subsidiaries domiciled in Texas entered into consent orders with the Texas Department of Insurance. We expect the consent orders to be released in the near future. The consent orders applied to all of our insurance subsidiaries and, among other things, restricted the ability of our insurance subsidiaries to pay dividends and other amounts to the parent company without regulatory consent. State laws generally provide state insurance regulatory agencies with broad authority to protect policyholders in their jurisdictions. Accordingly, we cannot assure you that the regulators will not seek to assert greater supervision and control over our insurance subsidiaries' businesses and financial affairs. We have agreed with the Texas Department of Insurance to provide prior notice of certain transactions, including up to 30 days prior notice for the payment of dividends by an insurance subsidiary to any non-insurance company parent, and periodic reporting of information concerning our financial performance and condition. Our insurance subsidiaries experienced increased lapse rates on annuity policies during 2002. Aggregate annuity surrenders have declined in 2003. We believe that the diversity of the investment portfolios of our insurance subsidiaries and the concentration of investments in high-quality, liquid securities provide sufficient liquidity to meet foreseeable cash requirements of our insurance subsidiaries. Our insurance subsidiaries could readily liquidate portions of their investments, if lapses continue at current levels. Liquidity of the Holding Companies Pursuant to the Plan, we entered into the New Credit Facility. The New Credit Facility consists of two tranches: Tranche A - $1.0 billion; and Tranche B - $.3 billion. See the note to the consolidated financial statements for further discussion related to the New Credit Facility. Principal repayments are due as follows (dollars in millions):
Tranche A Tranche B June 30, 2004......................................................... $ 50.0 $ 3.0 June 30, 2005......................................................... 50.0 3.0 June 30, 2006......................................................... 50.0 1.5 December 31, 2006..................................................... 50.0 1.5 June 30, 2007......................................................... 75.0 1.5 December 31, 2007..................................................... 75.0 1.5 June 30, 2008......................................................... 75.0 1.5 December 31, 2008..................................................... 75.0 1.5 June 30, 2009......................................................... - 1.5 September 10, 2009.................................................... 500.0 - December 31, 2009..................................................... - 1.5 September 10, 2010.................................................... - 282.0 -------- ------ $1,000.0 $300.0 ======== ======
At September 30, 2003, CNO and CDOC held unrestricted cash of $12.7 million and additional restricted cash of $22.1 million held in trust for the payment of bankruptcy-related professional fees. In addition, our other non-life insurance companies held unrestricted cash of approximately $69.6 million. CNO and CDOC are holding companies with no business operations of their own; they depend on their operating subsidiaries for cash to make principal and interest payments on debt, and to pay administrative expenses and income taxes. The cash CNO and CDOC receive from insurance subsidiaries consists of dividends and distributions, principal and interest payments on surplus debentures, fees for services, tax-sharing payments, and from our non-insurance subsidiaries, loans and advances. A further deterioration in the financial condition, earnings or cash flow of the material subsidiaries of CNO or CDOC for any reason could further limit such subsidiaries' ability to pay cash dividends or other disbursements to CNO and/or CDOC, which, in turn, would limit CNO's and/or CDOC's ability to meet debt service requirements and satisfy other financial obligations. The ability of our insurance subsidiaries to pay dividends is subject to state insurance department regulations. These regulations generally permit dividends to be paid from earned surplus of the insurance company for any 12-month period in amounts equal to the greater of (or in a few states, the lesser of): (i) net gain from operations or net income for the prior year; 70 CONSECO, INC. AND SUBSIDIARIES ------------------- or (ii) 10 percent of capital and surplus as of the end of the preceding year. Any dividends in excess of these levels require the approval of the director or commissioner of the applicable state insurance department. Also, we have agreed with the Texas Department of Insurance to provide up to 30 days prior notice of the payment of dividends by an insurance subsidiary to any non-insurance company parent. As described under the caption "Statutory Information" within "Management's Discussion and Analysis of Financial Condition and Results of Operations", we recently were subject to consent orders with the Commissioner of Insurance for the State of Texas that, among other things, limited the ability of our insurance subsidiaries to pay dividends. If our financial condition were to deteriorate, we may be required to enter into similar orders in the future. In addition, we may need to contribute additional capital to improve the ACLRBC ratios of our insurance subsidiaries and this could affect the ability of our top tier insurance subsidiary to pay dividends. Our cash flow may be affected by a variety of factors, many of which are outside of our control, including insurance and banking regulatory issues, competition, financial markets and other general business conditions. We cannot assure you that we will possess sufficient income and liquidity to meet all of our liquidity requirements and other obligations. Although we believe that amounts required for us to meet our financial and operating obligations will be available from our subsidiaries and from funds currently held by CNO and CDOC, our results for future periods are subject to numerous uncertainties. We may encounter liquidity problems, which could affect our ability to meet our obligations while attempting to meet competitive pressures or adverse economic conditions. Because our operations are conducted through subsidiaries, claims of the creditors of those subsidiaries (including policyholders) will rank senior to our claims to distributions from the subsidiaries, which we depend on to make payments on our obligations. CDOC's subsidiaries had indebtedness for borrowed money (excluding indebtedness to affiliates), policy reserves and other liabilities of approximately $25.6 billion at September 30, 2003. The obligations of CNO and CDOC, as parent holding companies, will rank effectively junior to these liabilities. If an insurance company subsidiary were to be liquidated, that liquidation would be conducted under the insurance law of its state of domicile by such state's insurance regulator as the receiver with respect to such insurer's property and business. In the event of a default on our debt or our insolvency, liquidation or other reorganization, our creditors and stockholders will not have the right to proceed against the assets of our insurance subsidiaries or to cause their liquidation under federal and state bankruptcy laws. Even following our emergence from bankruptcy, we have substantial indebtedness. At September 30, 2003, we had indebtedness for borrowed money (excluding indebtedness to affiliates), policy reserves and other liabilities of approximately $27.1 billion. Further, our historical capital requirements have been significant and our future capital requirements could vary significantly and may be affected by general economic conditions, industry trends, performance, and many other factors that are not within our control. We cannot assure you that we will be able to obtain financing or that we will not continue to experience losses in the future. Our profitability and ability to generate cash flow will likely depend upon our ability to successfully implement our business strategy. However, we cannot assure you that we will be able to accomplish these results. Under our New Credit Facility, we have agreed to a number of covenants and other provisions that restrict our ability to engage in various financing transactions and pursue certain operating activities without the prior consent of the lenders under the New Credit Facility. We have also agreed to meet or maintain various financial ratios and minimum financial strength ratings for our insurance subsidiaries. For instance, if we experience another A.M. Best ratings downgrade, if we fail to achieve an "A-" rating from A.M. Best by August 15, 2005 (or December 31, 2005 if we meet certain financial ratios) or if we experience a ratings downgrade from A.M. Best after achieving an "A-" rating, we will suffer an event of default under the New Credit Facility. Our ability to meet these financial and ratings covenants may be affected by events beyond our control. These requirements represent significant restrictions on the manner in which we may operate our business. If we default under any of these requirements, the lenders could declare all outstanding borrowings, accrued interest and fees to be due and payable. If that were to occur, we cannot assure you that we would have sufficient liquidity to repay or refinance this indebtedness or any of our other debts. 71 CONSECO, INC. AND SUBSIDIARIES ------------------- INVESTMENTS At September 30, 2003, the amortized cost and estimated fair value of actively managed fixed maturities and equity securities were as follows (dollars in millions):
Gross Gross Estimated Amortized unrealized unrealized fair cost gains losses value ---- ----- ------ ----- Investment grade: Corporate securities................................................ $10,868.2 $345.3 $12.3 $11,201.2 United States Treasury securities and obligations of United States government corporations and agencies................ 812.6 16.4 .1 828.9 States and political subdivisions................................... 564.5 12.0 .2 576.3 Debt securities issued by foreign governments....................... 84.9 2.3 - 87.2 Structured securities .............................................. 5,767.9 99.2 4.0 5,863.1 Below-investment grade (primarily corporate securities)................ 787.4 12.0 3.4 796.0 --------- ------ ----- --------- Total actively managed fixed maturities............................. $18,885.5 $487.2 $20.0 $19,352.7 ========= ====== ===== ========= Equity securities...................................................... $ 104.6 $ 2.9 $ - $ 107.5 ========= ====== ===== =========
Concentration of Corporate Securities At September 30, 2003, our corporate securities (including below-investment grade) were concentrated in the following industries:
Percent of Percent of amortized estimated cost fair value ---------- ---------- Media and communications......................................................... 12.0% 12.1% Bank/savings and loan............................................................ 11.3 11.4 Electric utility................................................................. 9.5 9.4 Energy........................................................................... 8.2 8.2 Insurance ....................................................................... 7.7 7.7 Real estate and real estate investment trusts.................................... 7.3 7.3 Financial institutions........................................................... 6.2 6.2
With respect to our corporate securities, no other industry accounted for more than 5.0 percent of amortized cost or estimated fair value. Below-Investment Grade Securities At September 30, 2003, the amortized cost of the Company's fixed maturity securities in below-investment grade securities was $787.4 million, or 4.2 percent of the Company's fixed maturity portfolio. The estimated fair value of the below-investment grade portfolio was $796.0 million, or 101 percent of the amortized cost. The value of these securities varies based on the economic terms of the securities, structural considerations and the creditworthiness of the issuer of the securities. Recently a number of large, highly leveraged issuers have experienced significant financial difficulties, which resulted in our recognition of significant other-than-temporary impairments. Below-investment grade securities have different characteristics than investment grade corporate debt securities. Risk of loss upon default by the borrower is significantly greater with respect to below-investment grade securities than with other corporate debt securities. Below-investment grade securities are generally unsecured and are often subordinated to other creditors of the issuer. Also, issuers of below-investment grade securities usually have higher levels of debt and are more 72 CONSECO, INC. AND SUBSIDIARIES ------------------- sensitive to adverse economic conditions, such as recession or increasing interest rates, than are investment grade issuers. The Company attempts to reduce the overall risk in the below-investment grade portfolio, as in all investments, through careful credit analysis, strict investment policy guidelines, and diversification by issuer and/or guarantor and by industry. Net Realized Investment Gains (Losses) During the one month ended September 30, 2003, we recognized net realized investment gains of $6.7 million resulting from the sales of investments (primarily fixed maturities) which generated proceeds of $2.1 billion. There were no writedowns of fixed maturity investments as a result of conditions which caused us to conclude a decline in fair value of the investment was other than temporary. During the first eight months of 2003, we recognized net realized investment losses of $5.4 million. The net realized investment losses during the first eight months of 2003 included: (i) $40.5 million of net gains from the sales of investments (primarily fixed maturities) which generated proceeds of $5.4 billion; net of (ii) $45.9 million of writedowns of fixed maturity investments as a result of conditions which caused us to conclude a decline in fair value of the investment was other than temporary. At September 30, 2003, fixed maturity securities in default as to the payment of principal or interest had an aggregate amortized cost of $21.4 million and a carrying value of $21.5 million. Net realized investment losses during the first nine months of 2002 included: (i) $489.8 million of writedowns of fixed maturity investments, equity securities and other invested assets as a result of conditions which caused us to conclude a decline in fair value of the investment was other than temporary; and (ii) $4.1 million of net losses from the sales of investments (primarily fixed maturities). During the one month ended September 30, 2003, we sold $50.9 million of fixed maturity investments which resulted in gross investment losses (before income taxes) of $.8 million. During the first eight months of 2003, we sold $2.7 billion of fixed maturity investments which resulted in gross investment losses (before income taxes) of $59.4 million. Securities sold at a loss are sold for a number of reasons including: (i) changes in the investment environment; (ii) expectation that the market value could deteriorate further; (iii) desire to reduce our exposure to an issuer or an industry; (iv) changes in credit quality; and (v) our analysis indicating there is a high probability that the security is other-than-temporarily impaired. The following summarizes the investments sold at a loss during the first eight months of 2003 which had been continuously in an unrealized loss position exceeding 20 percent of the amortized cost basis prior to the sale for the period indicated (there were no such investments sold at a loss during the one month ended September 30, 2003) (dollars in millions):
At date of sale ----------------- Number Amortized Fair Period of issuers cost value ------ ---------- ---- ----- Less than 6 months prior to sale.................... 16 $32.0 $24.0 Greater than or equal to 6 and less than 12 months prior to sale.................................... 8 40.6 25.7 Greater than 12 months prior to sale................ 20 39.8 23.7
Investments with Other-Than-Temporary Losses During the one month ended September 30, 2003, we did not record any writedowns of fixed maturity investments. During the eight months ended August 31, 2003, we recorded writedowns of fixed maturity investments totaling $45.9 million as further described in the following paragraphs: During the eight months ended August 31, 2003, we recognized a loss of $11.1 million to record certain commercial loans at their estimated fair value as we intended to liquidate them and use the proceeds to repay the senior financing used to acquire the loans. No additional gain or loss was recognized upon the ultimate disposition of the loans. During the eight months ended August 31, 2003, we recorded writedowns of $8.4 million related to our holdings of fixed maturity investments in a major airline that has filed bankruptcy. Although our investments are backed by collateral, 73 CONSECO, INC. AND SUBSIDIARIES ------------------- our analysis of the value of the underlying collateral indicated that the decline in fair value of the investment is other than temporary. During the eight months ended August 31, 2003, we recorded writedowns of $3.7 million related to our holdings of fixed maturity investments in a fertilizer company that has filed for bankruptcy. A significant portion of its production capacity was rendered unprofitable due to high raw material costs and was temporarily idled. Accordingly, we concluded that the decline in fair value was other than temporary. During the eight months ended August 31, 2003, we recorded writedowns of $1.8 million related to holdings in a health care company that has had financial problems due to financial misstatements, substantial regulatory and litigation exposure and its failure to meet debt service requirements. The adverse effect on liquidity and access to capital may force this issuer to file for bankruptcy. Accordingly, we concluded the decline in fair value was other than temporary. During the eight months ended August 31, 2003, we recorded writedowns of $1.5 million related to holdings of a fixed income security of a finance company that has had significant financial and liquidity problems. Accordingly, we concluded the decline in fair value was other than temporary. During the eight months ended August 31, 2003, we recorded writedowns of $9.6 million related to holdings of a fixed income security in a trust which leases airplanes and related equipment. We believe that the collateral supporting these investments has eroded and, therefore, we concluded the decline in fair value was other than temporary. In addition to the specific investments discussed above, we recorded $9.8 million of writedowns related to various other fixed maturity investments. No other writedown of a single issuer exceeded $1.5 million. Recognition of Losses We regularly evaluate all of our investments for possible impairment based on current economic conditions, credit loss experience and other investee-specific developments. If there is a decline in a security's net realizable value that is other than temporary, the decline is recognized as a realized loss and the cost basis of the security is reduced to its estimated fair value. Our evaluation of investments for impairment requires significant judgments to be made including: (i) the identification of potentially impaired securities; (ii) the determination of their estimated fair value; and (iii) assessment of whether any decline in estimated fair value is other than temporary. If new information becomes available or the financial condition of the investee changes, our judgments may change resulting in the recognition of an investment loss at that time. Our periodic assessment of whether unrealized losses are "other than temporary" requires significant judgment. Factors considered include: (i) the extent to which market value is less than the cost basis; (ii) the length of time that the market value has been less than cost; (iii) whether the unrealized loss is event driven, credit-driven or a result of changes in market interest rates; (iv) the near-term prospects for improvement in the issuer and/or its industry; (v) whether the investment is investment-grade and our view of the investment's rating and whether the investment has been downgraded since its purchase; (vi) whether the issuer is current on all payments in accordance with the contractual terms of the investment and is expected to meet all of its obligations under the terms of the investment; (vii) our ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery; and (viii) the underlying current and prospective asset and enterprise values of the issuer and the extent to which our investment may be affected by changes in such values. If a decline in value is determined to be other than temporary and the cost basis of the security is written down to fair value, we review the circumstances which caused us to believe that the decline was other than temporary with respect to other investments in our portfolio. If such circumstances exist with respect to other investments, those investments are also written down to fair value. Future events may occur, or additional or updated information may become available, which may necessitate future realized losses of securities in our portfolio. Significant losses in the carrying value of our investments could have a material adverse effect on our earnings in future periods. The following table sets forth the amortized cost and estimated fair value of those actively managed fixed maturities with unrealized losses at September 30, 2003, 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. Most of the structured securities shown below provide for periodic payments throughout their lives. 74 CONSECO, INC. AND SUBSIDIARIES -------------------
Estimated Amortized fair cost value --------- --------- (Dollars in millions) Due in one year or less................................................................... $ 11.3 $ 11.3 Due after one year through five years..................................................... 119.7 117.6 Due after five years through ten years.................................................... 165.7 163.6 Due after ten years....................................................................... 336.5 324.6 -------- -------- Subtotal............................................................................... 633.2 617.1 Structured securities..................................................................... 753.9 750.0 -------- -------- Total.................................................................................. $1,387.1 $1,367.1 ======== ========
Investments in fixed maturities rated below-investment grade or classified as equity-type securities in an unrealized loss position exceeding 20 percent of the cost basis as of September 30, 2003 had a cost basis of $.2 million. Our investment strategy is to maximize over a sustained period and within acceptable parameters of risk, investment income and total investment return through active investment management. Accordingly, we may sell securities at a gain or a loss to enhance the total return of the portfolio as market opportunities change. While we have both the ability and intent to hold securities with unrealized losses until they mature or recover in value, we may sell securities at a loss in the future because of actual or expected changes in our view of the particular investment, its industry, its type or the general investment environment. Based on management's current assessment of these securities and other investments with unrealized losses at September 30, 2003, the Company believes the issuers of the securities will continue to meet their obligations (or with respect to equity-type securities, the investment value will recover to its cost basis). The Company has no current plans to sell these securities and has the ability to hold them to maturity. The recognition of an other-than-temporary impairment through a charge to earnings may be recognized in future periods if management later concludes that the decline in market value below the cost basis is other than temporary. Investment in General Motors Building During the summer of 2003, we successfully enforced our contractual right to buy out our 50 percent equity partner in the GM building, a landmark 50-story office tower in New York City. After obtaining an award in arbitration, and confirming that award in the New York court system, we finally settled our differences with our equity partner, thus permitting us to put the building up for sale. On September 26, 2003, we sold our investment in the GM building. We received cash of $636.8 million, which was approximately equal to the value established upon the adoption of fresh start accounting. Our investment in the GM building was made through a partnership which acquired the building in 1998 for $878 million. The initial capital structure of the partnership consisted of: (i) a $700 million senior mortgage; (ii) $200 million of subordinated debt with a stated fixed return of 12.7 percent payable-in-kind, and the opportunity to earn an additional residual return; and (iii) $30 million of partnership equity, owned 50 percent by Conseco and 50 percent by an affiliate of Donald Trump. A Trump affiliate also served as general manager of the acquired building. We owned 100 percent of the subordinated debt. The $30 million of partnership equity represented less than 10 percent of the total capital of the partnership. In addition, the subordinated debt was intended to absorb virtually all expected losses and receive a significant portion of expected residual returns. Based on our 100 percent ownership of the subordinated debt, we were the primary beneficiary of the GM building. The partnership was consolidated in our financial statements effective August 31, 2003 in accordance with the requirements of FIN 46, which was implemented in conjunction with fresh start accounting. The August 31, 2003 fresh start balance sheet reflected the following balances of the partnership: the GM building at $1,336.3 million; cash of $28.4 million; and a non-recourse loan of $700 million (classified as an investment borrowing). Our income statement for the 75 CONSECO, INC. AND SUBSIDIARIES ------------------- month of September reflected investment income of $2.9 million related to this investment (representing our equity interest in the income from the building for the 26 days prior to the sale). Structured Securities At September 30, 2003, fixed maturity investments included $5.9 billion of structured securities (or 30 percent of all fixed maturity securities). Structured securities include mortgage-backed securities, collateralized mortgage obligations, asset-backed securities and commercial mortgage-backed securities. The yield characteristics of structured securities differ from those of traditional fixed-income securities. Interest and principal payments for mortgage-backed securities occur more frequently, often monthly. Mortgage-backed securities are subject to risks associated with variable prepayments. Prepayment rates are influenced by a number of factors that cannot be predicted with certainty, including: the relative sensitivity of the underlying mortgages backing the assets to changes in interest rates; a variety of economic, geographic and other factors; and the repayment priority of the securities in the overall securitization structures. In general, prepayments on the underlying mortgage loans and the securities backed by these loans increase when prevailing interest rates decline significantly relative to the interest rates on such loans. The yields on mortgage-backed securities purchased at a discount to par will increase when the underlying mortgages prepay faster than expected. The yields on mortgage-backed securities purchased at a premium will decrease when the underlying mortgages prepay faster than expected. When interest rates decline, the proceeds from the prepayment of mortgage-backed securities may be reinvested at lower rates than we were earning on the prepaid securities. When interest rates increase, prepayments on mortgage-backed securities decrease as fewer underlying mortgages are refinanced. When this occurs, the average maturity and duration of the mortgage-backed securities increase, which decreases the yield on mortgage-backed securities purchased at a discount, because the discount is realized as income at a slower rate, and increases the yield on those purchased at a premium as a result of a decrease in the annual amortization of the premium. Pursuant to fresh start reporting, we were required to mark all of our investments to market value. The current interest rate environment is much lower than when most of our investments were purchased. Accordingly, the fresh start values of our investments generally exceed the par values of such investments. The amount of value exceeding par is referred to as a "purchase premium" which is amortized against future income. If prepayments in any period are higher than expected, premium amortization is increased. In periods of unexpectedly high prepayment activity, the increased amortization will reduce net investment income. The following table sets forth the par value, amortized cost and estimated fair value of structured securities, summarized by interest rates on the underlying collateral at September 30, 2003 (dollars in millions):
Par Amortized Estimated value cost fair value ----- ---- ---------- Below 5 percent..................................................................... $ 798.4 $ 773.7 $ 796.0 5 percent - 6 percent............................................................... 945.3 939.2 964.0 6 percent - 7 percent............................................................... 3,158.5 3,264.9 3,303.2 7 percent - 8 percent............................................................... 658.9 690.9 700.4 8 percent and above................................................................. 97.2 102.8 103.1 -------- -------- -------- Total structured securities (a).............................................. $5,658.3 $5,771.5 $5,866.7 ======== ======== ======== - ----------------------- (a) Includes below-investment grade structured securities with an amortized cost and estimated fair value of $3.4 million.
76 CONSECO, INC. AND SUBSIDIARIES ------------------- The amortized cost and estimated fair value of structured securities at September 30, 2003, summarized by type of security, were as follows (dollars in millions):
Estimated fair value -------------------- Percent Amortized of fixed Type cost Amount maturities - ---- ---- ------ ---------- Pass-throughs and sequential and targeted amortization classes............ $3,816.4 $3,863.0 20% Planned amortization classes and accretion-directed bonds................. 656.5 673.5 4 Commercial mortgage-backed securities..................................... 1,018.7 1,050.5 5 Subordinated classes and mezzanine tranches............................... 276.2 276.0 1 Other..................................................................... 3.7 3.7 - -------- -------- -- Total structured securities (a).................................... $5,771.5 $5,866.7 30% ======== ======== == - ------------------ (a) Includes below-investment grade structured securities with an amortized cost and estimated fair value of $3.4 million.
Pass-throughs and sequential and targeted amortization classes have similar prepayment variability. Pass-throughs historically provide the best liquidity in the mortgage-backed securities market. Pass-throughs are also used frequently in the dollar roll market and can be used as the collateral when creating collateralized mortgage obligations. Sequential classes are a series of tranches that return principal to the holders in sequence. Targeted amortization classes offer slightly better structure in return of principal than sequentials when prepayment speeds are close to the speed at the time of creation. Planned amortization classes and accretion-directed bonds are some of the most stable and liquid instruments in the mortgaged-backed securities market. Planned amortization class bonds adhere to a fixed schedule of principal payments as long as the underlying mortgage collateral experiences prepayments within a certain range. Changes in prepayment rates are first absorbed by support or companion classes. This insulates the planned amortization class from the consequences of both faster prepayments (average life shortening) and slower prepayments (average life extension). Commercial mortgage-backed securities ("CMBS") are bonds secured by commercial real estate mortgages. Commercial real estate encompasses income producing properties that are managed for economic profit. Property types include multi-family dwellings including apartments, retail centers, hotels, restaurants, hospitals, nursing homes, warehouses, and office buildings. The CMBS market currently offers high yields, strong credits, and call protection compared to similar-rated corporate bonds. Most CMBS have strong call protection features where borrowers are locked out from prepaying their mortgages for a stated period of time. If the borrower does prepay any or all of the loan, they will be required to pay prepayment penalties. Subordinated and mezzanine tranches are classes that provide credit enhancement to the senior tranches. The rating agencies require that this credit enhancement not deteriorate due to prepayments for a period of time, usually five years of complete lockout, followed by another period of time where prepayments are shared pro rata with senior tranches. Subordinated and mezzanine tranches bear a majority of the risk of loss due to property owner defaults. Subordinated bonds are generally rated "AA" or lower; we typically do not hold securities rated lower than "BB". Mortgage Loans At September 30, 2003, the mortgage loan balance was primarily comprised of commercial loans. Less than one percent of the mortgage loan balance was noncurrent (loans with two or more scheduled payments past due) at September 30, 2003. 77 CONSECO, INC. AND SUBSIDIARIES ------------------- Investment Borrowings Our investment borrowings (excluding borrowings related to the GM building) averaged approximately $531.5 million during the one month ended September 30, 2003; $689.1 million during the eight months ended August 31, 2003; and $1,226.4 million during the nine months ended September 30, 2002 and were collateralized by investment securities with fair values approximately equal to the loan value. The weighted average interest rates on such borrowings (excluding borrowings related to the GM building) were 1.3 percent during the one month ended September 30, 2003; 1.8 percent during the eight months ended August 31, 2003; and 1.3 percent during the nine months ended September 30, 2002, respectively. STATUTORY INFORMATION Statutory accounting practices prescribed or permitted by regulatory authorities for the Company's insurance subsidiaries differ from GAAP. The statutory net income (loss) of our insurance subsidiaries was $255.6 million and $(273.3) million in the first nine months of 2003 and 2002, respectively (including realized investment gains (losses) of $33.3 million and $(315.4) million, respectively). The Company's insurance subsidiaries reported the following amounts to regulatory agencies at September 30, 2003, after appropriate eliminations of intercompany accounts among such subsidiaries (dollars in millions): Statutory capital and surplus .................................. $1,412.4 Asset valuation reserve......................................... 78.4 Interest maintenance reserve.................................... 358.5 -------- Total........................................................ $1,849.3 ========
The statutory capital and surplus shown above included investments in the preferred stock of CDOC of $159.0 million, all of which were eliminated in the consolidated financial statements prepared in accordance with GAAP. The ability of our insurance subsidiaries to pay dividends is subject to state insurance department regulations. These regulations generally permit dividends to be paid from earned surplus of the insurance company for any 12-month period in amounts equal to the greater of (or in a few states, the lesser of): (i) net gain from operations or net income for the prior year; or (ii) 10 percent of capital and surplus as of the end of the preceding year. Any dividends in excess of these levels require the approval of the director or commissioner of the applicable state insurance department. On October 30, 2002, Bankers National Life Insurance Company and Conseco Life Insurance Company of Texas (on behalf of itself and all other Conseco insurance subsidiaries), our insurance subsidiaries domiciled in Texas, each entered into consent orders with the Commissioner of Insurance for the State of Texas whereby they agreed: (i) not to request any dividends or other distributions before January 1, 2003 and, thereafter, not to pay any dividends or other distributions to parent companies outside of the insurance system without the prior approval of the Texas Insurance Commissioner; (ii) to continue to maintain sufficient capitalization and reserves as required by the Texas Insurance Code; (iii) to request approval from the Texas Insurance Commissioner before making any disbursements not in the ordinary course of business; (iv) to complete any pending transactions previously reported to the proper insurance regulatory officials prior to and during Conseco's restructuring, unless not approved by the Texas Insurance Commissioner; (v) to obtain a commitment from Conseco and CIHC to maintain their infrastructure, employees, systems and physical facilities prior to and during Conseco's restructuring; and (vi) to continue to permit the Texas Insurance Commissioner to examine its books, papers, accounts, records and affairs. The consent orders are expected to be released in the near future. We have agreed with the Texas Insurance Commissioner to provide prior notice of certain transactions, including 30 days prior notice of the payment of dividends by an insurance subsidiary to any non-insurance company parent, and periodic reporting of information concerning the financial performance and condition of Conseco, Inc. and its subsidiaries. The National Association of Insurance Commissioners' Risk-Based Capital for Life and/or Health Insurers Model Act (the "Model Act") provides a tool for insurance regulators to determine the levels of statutory capital and surplus an insurer must maintain in relation to its insurance and investment risks and whether there is a need for possible regulatory attention. The Model Act provides four levels of regulatory attention, varying with the ratio of the insurance company's total adjusted capital (defined as the total of its statutory capital and surplus, asset valuation reserve and certain other adjustments) to its ACLRBC: (i) if a company's total adjusted capital is less than or equal to 200 percent but greater than 150 percent of its 78 CONSECO, INC. AND SUBSIDIARIES ------------------- ACLRBC (the "Company Action Level"), the company must submit a comprehensive plan to the regulatory authority proposing corrective actions aimed at improving its capital position; (ii) if a company's total adjusted capital is less than or equal to 150 percent but greater than 100 percent of its ACLRBC (the "Regulatory Action Level"), the regulatory authority will perform a special examination of the company and issue an order specifying the corrective actions that must be followed; (iii) if a company's total adjusted capital is less than or equal to 100 percent but greater than 70 percent of its ACLRBC (the "Authorized Control Level"), the regulatory authority may take any action it deems necessary, including placing the company under regulatory control; and (iv) if a company's total adjusted capital is less than or equal to 70 percent of its ACLRBC (the "Mandatory Control Level"), the regulatory authority must place the company under its control. In addition, the Model Law provides for an annual trend test if a company's total adjusted capital is between 200 percent and 250 percent of its ACLRBC at the end of the year. The trend test calculates the greater of the decrease in the margin of total adjusted capital over ACLRBC: (i) between the current year and the prior year; and (ii) for the average of the last 3 years. It assumes that such decrease could occur again in the coming year. Any company whose trended total adjusted capital is less than 190 percent of its ACLRBC would trigger a requirement to submit a comprehensive plan as described above for the Company Action Level. The 2002 statutory annual statements filed with the state insurance regulators of each of our insurance subsidiaries reflected total adjusted capital in excess of the levels subjecting the subsidiary to any regulatory action. The 2002 audited financial statements of our insurance subsidiaries were completed in June 2003. Two of our subsidiaries' ACLRBC ratios, based on the capital balances reflecting audit adjustments, were less than 250 percent. As a result of an additional adjustment that we made in the amended 2002 Annual Statement relating to one such subsidiary's investment in the General Motors building, its ACLRBC ratio exceeded 250 percent. As a result of the sale of the General Motors building, the ACLRBC ratio for the other such subsidiary has increased to a level above 250 percent. However, as a result of losses on the long-term care business within Conseco Insurance Group during the third quarter of 2003, including long-term care claim reserve strengthening of $87 million, we will need to contribute additional capital to one subsidiary to enable its ACLRBC ratio to equal or exceed 250 at December 31, 2003. The combined ACLRBC ratio for our insurance subsidiaries was 332 percent at December 31, 2002. At December 31, 2002, the ratios for our insurance subsidiaries that are subject to the four levels of regulatory attention described above ranged from 250 percent to 563 percent. We are taking actions intended to improve the ACLRBC ratios of our insurance subsidiaries. Such actions include: (i) discontinuing or reducing sales of products that create initial reductions in statutory surplus because of the costs of selling the products; (ii) reducing operating expenses; (iii) merging some of our insurance subsidiaries with other insurance subsidiaries; and (iv) restructuring our investment portfolio to better match the risk profile of the portfolio with each insurance subsidiary's earnings and capital requirements. We have discussed these actions with insurance regulators in each of the states in which our insurance subsidiaries are domiciled. NEW ACCOUNTING STANDARDS See "Recently Issued Accounting Standards" in the notes to consolidated financial statements for a discussion of recently issued accounting standards. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Our market risks, and the ways we manage them, are summarized in "Management's Discussion and Analysis of Financial Condition and Results of Operations", included in Old Conseco's Form 10-K for the year ended December 31, 2002. There have been no material changes in the first nine months of 2003 to such risks or our management of such risks. ITEM 4. CONTROLS AND PROCEDURES. Conseco's management, under the supervision and with the participation of the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of Conseco's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2003, Conseco's disclosure controls and procedures were effective to ensure that information required to be disclosed by Conseco in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission's rules and forms. 79 CONSECO, INC. AND SUBSIDIARIES ------------------- There were no significant changes in Conseco's internal controls over financial reporting that occurred during the quarter ended September 30, 2003, that have materially affected, or are reasonably likely to materially affect, Conseco's internal controls over financial reporting. 80 CONSECO, INC. AND SUBSIDIARIES ------------------- PART II - OTHER INFORMATION ITEM 1. LITIGATION AND OTHER LEGAL PROCEEDINGS. LITIGATION AND OTHER LEGAL PROCEEDINGS We are involved on an ongoing basis in lawsuits (including purported class actions) relating to our operations, including with respect to sales practices, and we and current and former officers and former directors are defendants in pending class action lawsuits asserting claims under the securities laws and derivative lawsuits. The ultimate outcome of these lawsuits cannot be predicted with certainty and we have estimated the potential exposure for each of the matters and have recorded a liability if a loss is deemed probable. Securities Litigation Since we announced our intention to restructure our capital on August 9, 2002, a total of eight purported securities fraud class action lawsuits have been filed in the United States District Court for the Southern District of Indiana. The complaints name us as a defendant, along with certain current and former officers of Old Conseco. These lawsuits were filed on behalf of persons or entities who purchased Old Conseco's common stock on various dates between October 24, 2001 and August 9, 2002. In each case Plaintiffs allege claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and allege material omissions and dissemination of materially misleading statements regarding, among other things, the liquidity of Conseco and alleged problems in CFC's manufactured housing division, allegedly resulting in the artificial inflation of Old Conseco's stock price. On March 13, 2003, all of these cases were consolidated into one case in the United States District Court for the Southern District of Indiana, captioned Franz Schleicher, et al. v. Conseco, Inc., et al., File No. 02-CV-1332 DFH-TAB. The lawsuits were stayed as to all defendants by order of the United States Bankruptcy Court for the Northern District of Illinois. The stay was lifted on October 15, 2003. It is expected that plaintiffs will file a consolidated class action complaint with respect to the individual defendants in November 2003. Our liability with respect to these lawsuits was discharged in the Plan and our obligation to indemnify certain individual defendants is limited by the Plan. We believe these lawsuits are without merit and intend to defend them vigorously. The ultimate outcome of these lawsuits cannot be predicted with certainty. Derivative Litigation Nine shareholder derivative suits were filed in 2000 in the United States District Court for the Southern District of Indiana. The complaints named as defendants the then current directors, certain former directors, certain non-director officers of Old Conseco (in one case), and, alleging aiding and abetting liability, certain banks that made loans in relation to Old Conseco's "Stock Purchase Plan" (in three cases). Old Conseco is also named as a nominal defendant in each complaint. Plaintiffs allege that the defendants breached their fiduciary duties by, among other things, intentionally disseminating false and misleading statements concerning the acquisition, performance and proposed sale of CFC, and engaged in corporate waste by causing Old Conseco to guarantee loans that certain officers, directors and key employees of Old Conseco used to purchase stock under the Stock Purchase Plan. These cases have now been consolidated into one case in the United States District Court for the Southern District of Indiana, captioned: In Re Conseco, Inc. Derivative Litigation, Case Number IP00655-C-Y/S. An amended complaint was filed on April 12, 2001, making generally the same allegations and allegations of violation of the Federal Reserve Board's margin rules. Three similar cases have been filed in the Hamilton County Superior Court in Indiana. Schweitzer v. Hilbert, et al., Case No. 29D01-0004CP251; Evans v. Hilbert, et al., Case No. 29D01-0005CP308 (both Schweitzer and Evans name as defendants certain non-director officers); Gintel v. Hilbert, et al., Case No. 29003-0006CP393 (naming as defendants, and alleging aiding and abetting liability as to, banks that allegedly made loans in relation to the Stock Purchase Plan). We believe that these lawsuits are without merit and intend to defend them vigorously. The cases filed in Hamilton County have been stayed pending resolution of the derivative suits filed in the United States District Court. We have asserted that these lawsuits are assets of the estate pursuant to section 541(a) of the Bankruptcy Code and do not intend to pursue them following emergence from bankruptcy because they are meritless. In October and November 2003, CNO filed motions to dismiss all the pending derivative matters. The ultimate outcome of these lawsuits cannot be predicted with certainty. 81 CONSECO, INC. AND SUBSIDIARIES ------------------- Other Litigation Collection efforts by the Company and Conseco Services, LLC related to the 1996-1999 director and officer loan programs have been commenced against various past board members and executives/officers with outstanding loan balances. In addition, certain former officers and directors have sued the companies for declaratory relief concerning their liability for the loans. Currently, we are involved in litigation with Stephen C. Hilbert, James D. Massey, Dennis E. Murray, Sr., Rollin Dick and Bruce Crittenden. The specific lawsuits include: Hilbert v. Conseco, Case No. 03A 04283 (Bankr. N.D. Ill.); Conseco Services v. Hilbert, Case No.29C01-0310 MF 1296 (Cir. Ct. Hamilton Cty, Ind.); Murray and Massey v. Conseco, Case No.1:03-CV-1482 LJM-WTL (S.D. Ind.); Dick v. Conseco Services, Case No. 29 D01-0207-PL-549 (Sup. Ct. Hamilton Cty, Ind.); and Crittenden v. Conseco, Case No.IP02-1823-C B/S (S.D. Ind.). The Company and Conseco Services, LLC believe that all amounts due under the director and officer loan programs, including all applicable interest, are valid obligations owed to the companies. We intend to prosecute these claims to obtain the maximum recovery possible. Further, with regard to the various claims brought against the Company and Conseco Services, LLC by certain former directors and officers, we believe that these claims are without merit and intend to defend them vigorously. The ultimate outcome of the lawsuit cannot be predicted with certainty. In October 2002, Roderick Russell, on behalf of himself and a class of persons similarly situated, and on behalf of the ConsecoSave Plan filed an action in the United States District Court for the Southern District of Indiana against Old Conseco, Conseco Services, LLC and certain current and former officers of Old Conseco (Roderick Russell, et al. v Conseco, Inc., et al., Case No. 1:02-CV-1639 LJM). The purported class action consists of all individuals whose 401(k) accounts held common stock of Old Conseco at any time since April 28, 1999. The complaint alleges, among other things, breaches of fiduciary duties under ERISA by continuing to permit employees to invest in Old Conseco's common stock without full disclosure of the Company's true financial condition. Old Conseco filed a motion to dismiss the complaint in December 2002. This lawsuit was stayed as to all defendants by order of the Bankruptcy Court. The stay was lifted on October 15, 2003. It is expected that there will be a ruling on the motion to dismiss before further proceedings occur in this matter. We believe the lawsuit is without merit and intend to defend it vigorously. The ultimate outcome of the lawsuit cannot be predicted with certainty. On June 24, 2002, the heirs of a former officer, Lawrence Inlow, commenced an action against Old Conseco, Conseco Services, LLC, and two former officers in the Boone Circuit Court (Inlow et al. v. Conseco, Inc., et al., Cause No. 06C01-0206-CT-244). The heirs assert that unvested options to purchase 756,248 shares of Old Conseco common stock should have been vested at Mr. Inlow's death. The heirs further claim that if such options had been vested, they would have been exercised, and that the resulting shares of common stock would have been sold for a gain of approximately $30 million based upon a stock price of $58.125 per share, the highest stock price during the alleged exercise period of the options. We believe the heirs' claims are without merit and will defend the action vigorously. The maximum exposure to the Company for this lawsuit is estimated to be $33 million. The heirs did not file a proof of claim with the Bankruptcy Court. Subject to dispositive motions which are yet to be filed, the matter will continue to trial against Conseco Services, LLC and the other co-defendants on September 13, 2004. The ultimate outcome cannot be predicted with certainty. On June 27, 2001, two suits against the Company's subsidiary, Philadelphia Life Insurance Company (now known as Conseco Life Insurance Company), both purported nationwide class actions seeking unspecified damages, were consolidated in the U.S. District Court, Middle District of Florida (In Re PLI Sales Litigation, Cause No. 01-MDL-1404), alleging among other things, fraudulent sales and a "vanishing premium" scheme. Philadelphia Life filed a motion for summary judgment against both named plaintiffs, which motion was granted in June 2002. Plaintiffs appealed to the 11th Circuit. The 11th Circuit, in July 2003, affirmed in part and reversed in part, allowing two fraud counts with respect to one plaintiff to survive. The plaintiffs' request for a rehearing with respect to this decision has been denied. Philadelphia Life has filed a summary judgment motion with respect to the remaining claims. Philadelphia Life believes this lawsuit is without merit and intends to defend it vigorously. The ultimate outcome of the lawsuit cannot be predicted with certainty. On December 1, 2000, the Company's former subsidiary, Manhattan National Life Insurance Company, was named in a purported nationwide class action seeking unspecified damages in the First Judicial District Court of Santa Fe, New Mexico (Robert Atencio and Theresa Atencio, for themselves and all other similarly situated v. Manhattan National Life Insurance Company, an Ohio corporation, Cause No. D-0101-CV-2000-2817), alleging among other things fraud by non-disclosure of additional charges for those policyholders wishing to pay premium modes other than annual. We retained liability for this litigation in connection with the sale of Manhattan National Life in June 2002. We believe this lawsuit is without merit and intend to defend it vigorously. The ultimate outcome of the lawsuit cannot be predicted with certainty. 82 CONSECO, INC. AND SUBSIDIARIES ------------------- On December 19, 2001, four of the Company's subsidiaries were named in a purported nationwide class action seeking unspecified damages in the District Court of Adams County, Colorado (Jose Medina and others similarly situated v. Conseco Annuity Assurance Company, Conseco Life Insurance Company, Bankers National Life Insurance Company and Bankers Life and Casualty Company, Cause No. 01-CV-2465), alleging among other things breach of contract regarding alleged non-disclosure of additional charges for those policy holders wishing to pay premium modes other than annual. On July 14 and 15, 2003 the plaintiff's motion for class certification was heard and the Court took the matter under advisement. On November 10, 2003, the Court denied the motion for class certification. The defendants believe this lawsuit is without merit and intend to defend it vigorously. The ultimate outcome of the lawsuit cannot be predicted with certainty. On July 31, 2001, the Company's subsidiary, Conseco Senior Health Insurance Company, was named in an action filed by the State of Texas in the District Court of Travis County, Texas (State of Texas v. Conseco Senior Health Insurance Company, Cause No. GV102103), alleging among other things a violation of the Deceptive Trade Practices Act related to allegations of failure to adequately notify policyholders that premium rates could increase. Conseco Senior has reached a tentative settlement with the State of Texas, however in the event a settlement is not consummated, Conseco Senior intends to defend this matter vigorously as it believes the lawsuit is without merit. The ultimate outcome of this lawsuit cannot be predicted with certainty. On December 30, 2002 and December 31, 2002, five suits were filed in various Mississippi counties against the Company's subsidiary, Conseco Life Insurance Company (Kathie Allen, et al. v. Conseco Life Insurance Company, et al., Circuit Court of Jones County, Mississippi, Cause No. 2002-448-CV12; Malcolm Bailey, et al. v. Conseco Life Insurance Company, et al., Circuit Court of Claiborne County, Mississippi, Cause No. CV-2002-371; Anthony Cascio, et al. v. Conseco Life Insurance Company, et al, Circuit Court of LeFlore County, Mississippi, Cause No. CV-2002-0242-CICI; William Garrard, et al. v. Conseco Life insurance Company, et al., Circuit Court of Sunflower County, Mississippi, Cause No. CV-2002-0753-CRL; and William Weaver, et al. v. Conseco Life Insurance Company, et al., Circuit Court of LeFlore County, Mississippi, Cause No. CV-2002-0238-CICI), alleging among other things, a "vanishing premium" scheme. Conseco Life removed all of the cases to the U.S. District Courts in Mississippi. In September 2003, plaintiffs' Motion to Remand was denied in the Garrard and Weaver matters, but granted in the Cascio matter. Conseco Life awaits the court's ruling on Plaintiff's Motion to Remand in the Allen matter. In Bailey the parties have agreed to stay in Federal court. Conseco Life believes the lawsuits are without merit and intends to defend them vigorously. The ultimate outcome of the lawsuits cannot be predicted with certainty. In addition, the Company and its subsidiaries are involved on an ongoing basis in other lawsuits and arbitrations (including purported class actions) related to their operations. The ultimate outcome of all of these other legal matters pending against the Company or its subsidiaries cannot be predicted, and, although such lawsuits are not expected individually to have a material adverse effect on the Company, such lawsuits could have, in the aggregate, a material adverse effect on the Company's consolidated financial condition, cash flows or results of operations. Other Proceedings The Company has been notified that the staff of the SEC has obtained a formal order of investigation in connection with an inquiry that relates to events in and before the spring of 2000, including CFC's accounting for its interest-only securities and servicing rights. These issues were among those addressed in the Company's write-down and restatement in the spring of 2000, and were the subject of shareholder class action litigation, which was settled in the second quarter of 2003. The Company is cooperating fully with the SEC staff in this matter. The deadline to file administrative claims in the bankruptcy proceeding was October 9, 2003. The Plan provides that all such claims must be paid in full, in cash. We are reviewing all timely filed administrative claims and may resolve disputes regarding allowance of such claims in the Bankruptcy Court. If significant administrative claims are allowed, our cash flow would be negatively affected. 83 CONSECO, INC. AND SUBSIDIARIES ------------------- ITEM 5. OTHER INFORMATION Directors and Executive Officers of Conseco Directors. As a result of the reorganization, Conseco made significant changes to its Board of Directors. The Board of Directors now consists of the following seven members: R. Glenn Hilliard, age 60, became the non-executive chairman of Conseco's board of directors in September 2003. From 1999 until his retirement in April 2003, Mr. Hilliard served as chairman and CEO of ING Americas. From 1994 to 1999 he was chairman and CEO of ING North America. Philip Roberts, age 61, joined Conseco's board of directors in September 2003. He is principal of Roberts Ventures L.L.C., consultant for merger and acquisition and product development for investment management firms. From 1990 until 2000, Mr. Roberts served as chief investment officer of trust business for Mellon Financial Corporation and headed its institutional asset management businesses from 1990 to 1996. Neal Schneider, age 59, joined Conseco's board of directors in September 2003. Until June 2000, he was managing partner in the New York office of Smart and Associates, LLP, a business advisory and accounting firm. Mr. Schneider previously spent 34 years with Arthur Andersen & Co., including service as partner in charge of the Worldwide Insurance Industry Practice and the North American Financial Service Practice. Michael Shannon, age 45, joined Conseco's board of directors in September 2003. He is co-founder and current president and chief executive officer of KSL Recreation Corporation (owner and operator of golf courses and destination resorts in the U.S.). William Shea, age 55, has served as a director of Conseco and its predecessor since September 2002. He has served as president and chief executive officer of Conseco since October 2002 and was president and chief operating officer from September 2001 until October 2002. Before joining Conseco Mr. Shea served as CEO of View Tech, Inc. (integrated video-conferencing solutions) from 1999 until 2000. From 1993 to 1998, he was vice chairman and chief financial officer of Bank Boston Corporation. Michael Tokarz, age 53, joined Conseco's board of directors in September 2003. He is managing member of the Tokarz Group, LLC (venture capital investments). Mr. Tokarz was a general partner with Kohlberg Kravis Roberts & Co. until he retired in 2002. John Turner, age 63, joined Conseco's board of directors in September 2003. He is chairman of Hillcrest Capital Partners, a private equity investment firm. Mr. Turner served as chairman and CEO of ReliaStar Financial Corp. from 1991 until it was acquired by ING in 2000. After the acquisition he became vice chairman and a member of the executive committee for ING Americas until his retirement in 2002. 84 CONSECO, INC. AND SUBSIDIARIES ------------------- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. a) Exhibits. 10.4 Guarantee and Security Agreement dated as of September 10, 2003, among Conseco, Inc., the Subsidiary Guarantors Party Thereto and Bank of America, N.A., as Agent. 10.5 Employment Agreement by and between William J. Shea and Conseco, Inc. dated as of May 27, 2003. 10.6 Agreement by and between R. Glenn Hilliard and Conseco, Inc. dated as of June 18, 2003. 12.1 Computation of Ratio of Earnings to Fixed Charges and Preferred Dividends. 31.1 Certification Pursuant to the Securities Exchange Act Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification Pursuant to the Securities Exchange Act Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. b) Reports on Form 8-K. A report on Form 8-K dated July 15, 2003, was filed with the Commission to report under Item 5, the Company's filing with the United States Bankruptcy Court of the Fourth Amended Joint Plan of Reorganization of the Filing Entities. A report on Form 8-K dated August 15, 2003, was filed with the Commission to report under Item 5, the Company's filing with the United States Bankruptcy Court of the Fifth Amended Joint Plan of Reorganization of the Filing Entities. A report on Form 8-K dated September 9, 2003, was filed with the Commission to report under Item 3, the United States Bankruptcy Court's confirmation of the Sixth Amended Joint Plan of Reorganization and to report under Item 5, the registration of the common stock of the Company. A report on Form 8-K dated September 26, 2003, was filed with the Commission to report under Item 5, the Company's completed sale of the General Motors Building in New York City. 85 CONSECO, INC. AND SUBSIDIARIES ------------------- SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CONSECO, INC. Dated: November 19, 2003 By: /s/ William J. Shea ------------------------------------ William J. Shea, President and Chief Executive Officer 86 EX-10 3 exhibit104.txt EXHIBIT 10.4 Exhibit 10.4 GUARANTEE AND SECURITY AGREEMENT dated as of September 10, 2003 among CONSECO, INC. THE SUBSIDIARY GUARANTORS PARTY HERETO and BANK OF AMERICA, N.A. as Agent TABLE OF CONTENTS -----------------
PAGE ---- Section 1. Definitions.......................................................1 Section 2. Guarantees by Subsidiary Guarantors..............................11 Section 3. Grant of Transaction Liens.......................................15 Section 4. General Representations and Warranties...........................17 Section 5. Further Assurances; General Covenants............................19 Section 6. Accounts.........................................................22 Section 7. Chattel Paper and Instruments....................................22 Section 8. Commercial Tort Claims...........................................23 Section 9. Equipment........................................................24 Section 10. Material Government Contracts....................................24 Section 11. Recordable Intellectual Property.................................26 Section 12. Proceeds of Letters of Credit....................................26 Section 13. Investment Property..............................................27 Section 14. Investment Property Collateral Accounts..........................30 Section 15. Controlled Deposit Accounts......................................31 Section 16. Cash Collateral Accounts.........................................31 Section 17. Operation of Collateral Accounts.................................32 Section 18. Transfer of Record Ownership.....................................34 Section 19. Right to Vote Securities.........................................35 Section 20. Certain Cash Distributions.......................................35 Section 21. Remedies upon Event of Default...................................36 Section 22. Application of Proceeds..........................................37 Section 23. Fees and Expenses; Indemnification...............................38 Section 24. Authority to Administer Collateral...............................40 Section 25. Limitation on Duty in Respect of Collateral......................40 Section 26. General Provisions Concerning the Agent..........................41 Section 27. Termination of Transaction Liens; Release of Collateral..........44 Section 28. Additional Subsidiary Guarantors and Lien Grantors...............45 Section 29. Notices..........................................................45 Section 30. No Implied Waivers; Remedies Not Exclusive.......................47 Section 31. Successors and Assigns...........................................47 Section 32. Amendments and Waivers...........................................47 Section 33. Choice of Law....................................................48 Section 34. Waiver of Jury Trial.............................................48 Section 35. Severability.....................................................48
SCHEDULES: - --------- Schedule 1 Equity Interests in Subsidiaries and Affiliates Owned by Original Lien Grantors Schedule 2 Other Investment Property Owned by Original Lien Grantors Schedule 3 Material Commercial Tort Claims Schedule 4 1999 Facility Collateral EXHIBITS: - -------- Exhibit A Security Agreement Supplement Exhibit B Copyright Security Agreement Exhibit C Patent Security Agreement Exhibit D Trademark Security Agreement Exhibit E Perfection Certificate Exhibit F Issuer Control Agreement Exhibit G Securities Account Control Agreement Exhibit H-1 List of Material Government Contracts Exhibit H-2 Assignment of Government Contract Exhibit H-3 Notice of Assignment of Government Contract Exhibit I List of Letters of Credit
ii GUARANTEE AND SECURITY AGREEMENT AGREEMENT dated as of September 10, 2003 among CONSECO, INC., the SUBSIDIARY GUARANTORS party hereto and BANK OF AMERICA, N.A., as Agent. WHEREAS, the Company is entering into the Credit Agreement described in Section 1 hereof in order to provide for the partial satisfaction of certain pre-petition claims against the Company and certain of its Subsidiaries; WHEREAS, the Company is willing to secure its obligations under the Credit Agreement by granting Liens on substantially all of its assets to the Agent as provided in the Security Documents; WHEREAS, the Company is willing to cause each of its current and future Domestic Subsidiaries (other than Insurance Subsidiaries, Subsidiaries of Insurance Subsidiaries and Immaterial Subsidiaries) to guarantee the foregoing obligations of the Company and to secure its guarantee thereof by granting Liens on substantially all of its assets to the Agent as provided in the Security Documents; WHEREAS, the Banks are not willing to enter into the Credit Agreement unless (i) the foregoing obligations of the Company are secured and guaranteed as described above and (ii) each guarantee thereof is secured by Liens on substantially all of the assets of the relevant Subsidiary Guarantor as provided in the Security Documents; and WHEREAS, upon any foreclosure or other enforcement of the Security Documents, the net proceeds of, or other collections on, the relevant Collateral are to be received by or paid over to the Agent and applied as provided in Section 22 hereof; NOW, THEREFORE, in consideration of the foregoing and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: Section 1. Definitions. (a) Terms Defined in Credit Agreement. Terms defined in the Credit Agreement and not otherwise defined in subsection (b) or (c) of this Section have, as used herein, the respective meanings provided for therein. (b) Terms Defined in UCC. As used herein, each of the following terms has the meaning specified in the UCC: Term UCC - ---- --- Account 9-102 Authenticate 9-102 Certificated Security 8-102 Chattel Paper 9-102 Commercial Tort Claim 9-102 Commodity Account 9-102 Commodity Contract 9-102 Commodity Customer 9-102 Commodity Intermediary 9-102 Deposit Account 9-102 Document 9-102 Electronic Chattel Paper 9-102 Entitlement Holder 8-102 Entitlement Order 8-102 Equipment 9-102 Financial Asset 8-102 & 103 General Intangibles 9-102 Instrument 9-102 Inventory 9-102 Investment Property 9-102 Letter-of-Credit Right 9-102 Payment Intangible 9-102 Record 9-102 Securities Account 8-501 Securities Intermediary 8-102 Security 8-102 & 103 Security Entitlement 8-102 Supporting Obligations 9-102 Tangible Chattel Paper 9-102 Uncertificated Security 8-102
(c) Additional Definitions. The following additional terms, as used herein, have the following meanings: "Agent" means Bank of America, N.A., in its capacity as Agent under the Loan Documents, and its successors and assigns in such capacity. "Article 9" means Article 9 of the Uniform Commercial Code as set forth in the 1998 Official Text thereof; provided that, when used with respect to any jurisdiction on or after the date when such Article 9 (with or without local changes therein) first becomes effective in such jurisdiction, "Article 9" refers to Article 9 as in effect in such jurisdiction from time to time. 2 "Assignment of Claims Act" has the meaning specified in Section 10(e). "Cash Collateral Account" has the meaning specified in Section 16. "Cash Distributions" means dividends, interest and other distributions and payments (including proceeds of liquidation, sale or other disposition) made or received in cash upon or with respect to any Collateral. "Collateral" means all property, whether now owned or hereafter acquired, on which a Lien is granted or purports to be granted to the Agent pursuant to the Security Documents. When used with respect to a specific Lien Grantor, the term "Collateral" means all its property on which such a Lien is granted, or purports to be granted, pursuant to the Security Documents. "Collateral Accounts" means the Cash Collateral Accounts, the Controlled Deposit Accounts, the Controlled Securities Accounts and the Investment Property Collateral Accounts. "Commodity Account Control Agreement" means, with respect to any Commodity Account as to which a Lien Grantor is the Commodity Customer, an agreement by such Lien Grantor, the Agent and the relevant Commodity Intermediary that the Commodity Intermediary will apply any value distributed on account of the Commodity Contracts carried in such Commodity Account as directed by the Agent without further consent by such Lien Grantor. Each such agreement must be reasonably satisfactory in form and substance to the Agent. "Company" means Conseco, Inc., a Delaware corporation. "Control" has the following meanings: (a) when used with respect to any Security or Security Entitlement, the meaning specified in UCC Section 8-106; (b) when used with respect to any Deposit Account, the meaning specified in UCC Section 9-104; (c) when used with respect to any Electronic Chattel Paper, the meaning specified in UCC Section 9-105; (d) when used with respect to any Commodity Account or Commodity Contract, the meaning specified in UCC Section 9-106(b); and 3 (e) when used with respect to any right to payment or performance by the issuer or a Nominated Person in respect of a letter of credit, the meaning specified in UCC Section 9-107. "Controlled Commodity Account" means a Commodity Account as to which (i) a Lien Grantor is the Commodity Customer and (ii) a Commodity Account Control Agreement is in effect. "Controlled Deposit Account" means a Deposit Account (i) that is subject to a Deposit Account Control Agreement or (ii) as to which the Agent is the Depositary Bank's "customer" (as defined in UCC Section 4-104). "Controlled Securities Account" means a Securities Account that (i) is maintained in the name of a Lien Grantor at an office of a Securities Intermediary located in the United States and (ii) together with all Financial Assets credited thereto and all related Security Entitlements, is subject to a Securities Account Control Agreement among such Lien Grantor, the Agent and such Securities Intermediary. "Copyright License" means any agreement now or hereafter in existence granting to any Lien Grantor, or pursuant to which any Lien Grantor grants to any other Person, any right to use, copy, reproduce, distribute, prepare derivative works, display or publish any records or other materials on which a Copyright is in existence or may come into existence, including any agreement identified in Schedule 1 to any Copyright Security Agreement. "Copyright Security Agreement" means a Copyright Security Agreement, substantially in the form of Exhibit B, executed and delivered by a Lien Grantor in favor of the Agent for the benefit of the Secured Parties. "Copyrights" means all the following: (i) all copyrights under the laws of the United States (whether or not the underlying works of authorship have been published), all registrations and recordings thereof, all copyrightable works of authorship (whether or not published), and all applications for copyrights under the laws of the United States, including registrations, recordings and applications in the United States Copyright Office or in any similar office or agency of the United States or any State thereof, including those described in Schedule 1 to any Copyright Security Agreement, (ii) all renewals of any of the foregoing, (iii) all claims for, and rights to sue for, past or future infringements of any of the foregoing and (iv) all income, royalties, damages and payments now or hereafter due or payable with respect to any of the foregoing, including damages and payments for past or future infringements thereof. 4 "Credit Agreement" means the Credit Agreement dated as of the date hereof among Conseco, Inc., the Banks party thereto, and Bank of America, N.A., as Agent. "D&O Loan Collateral" means the right, title and interest of the Company in, to and under the D&O Loans and all Proceeds thereof. "Deposit Account Control Agreement" means, with respect to any Deposit Account of any Lien Grantor, an agreement among such Lien Grantor, the Agent and the relevant Depositary Bank, set forth in an Authenticated Record, (i) that such Depositary Bank will comply with instructions originated by the Agent directing disposition of the funds in such Deposit Account without further consent by such Lien Grantor and (ii) subordinating to the relevant Transaction Lien all claims of the Depositary Bank to such Deposit Account (except its right to deduct its customary operating charges and any uncollected funds previously credited thereto). "Depositary Bank" means a bank at which a Controlled Deposit Account is maintained. "Equity Interest" means (i) in the case of a corporation, any shares of its capital stock, (ii) in the case of a limited liability company, any membership interest therein, (iii) in the case of a partnership, any partnership interest (whether general or limited) therein, (iv) in the case of any other business entity, any participation or other interest in the equity or profits thereof, (v) any warrant, option or other right to acquire any Equity Interest described in this definition or (vi) any Security Entitlement in respect of any Equity Interest described in this definition. "Federal Government" means the federal government of the United States or any agency or instrumentality thereof. "Intellectual Property Filing" means (i) with respect to any Patent, Patent License, Trademark or Trademark License, the filing of the applicable Patent Security Agreement or Trademark Security Agreement with the United States Patent and Trademark Office, together with an appropriately completed recordation form and (ii) with respect to any Copyright or Copyright License, the filing of the applicable Copyright Security Agreement with the United States Copyright Office, together with an appropriately completed recordation form, in each case sufficient to record the Transaction Lien granted to the Agent in such Recordable Intellectual Property. "Intellectual Property Security Agreement" means a Copyright Security Agreement, a Patent Security Agreement or a Trademark Security Agreement. 5 "Investment Property Collateral Account" has the meaning specified in Section 14. "Issuer Control Agreement" means an Issuer Control Agreement substantially in the form of Exhibit F (with any changes that the Agent shall have approved). "Lien Grantors" means the Company and the Subsidiary Guarantors. "Liquid Investment" means a Cash Equivalent (other than commercial paper) that matures within 30 days after it is first included in the Collateral. "LLC Interest" means a membership interest or similar interest in a limited liability company. "Material Commercial Tort Claim" means a Commercial Tort Claim involving a claim for more than $500,000. "Material Government Contract" means a contract, between a Lien Grantor and either (i) the Federal Government or (ii) a state or local government or any agency or instrumentality thereof, that provides (or can reasonably be expected to provide) for payments to such Lien Grantor in an aggregate amount exceeding $250,000. "1999 Facility Collateral" has the meaning specified in Schedule 4. "Nominated Person" means a Person whom the issuer of a letter of credit (i) designates or authorizes to pay, accept, negotiate or otherwise give value under such letter of credit and (ii) undertakes by agreement or custom and practice to reimburse. "Opinion of Counsel" means a written opinion of legal counsel (who may be counsel to a Lien Grantor or other counsel, in either case reasonably acceptable to the Agent) addressed and delivered to the Agent. "Original Lien Grantor" means any Lien Grantor that grants a Lien on any of its assets hereunder on the Effective Date. "own" refers to the possession of sufficient rights in property to grant a security interest therein as contemplated by UCC Section 9-203, and "acquire" refers to the acquisition of any such rights. "Partnership Interest" means a partnership interest, whether general or limited. 6 "Patent License" means any agreement now or hereafter in existence granting to any Lien Grantor, or pursuant to which any Lien Grantor grants to any other Person, any right with respect to any Patent or any invention now or hereafter in existence, whether patentable or not, whether a patent or application for patent is in existence on such invention or not, and whether a patent or application for patent on such invention may come into existence or not, including any agreement identified in Schedule 1 to any Patent Security Agreement. "Patent Security Agreement" means a Patent Security Agreement, substantially in the form of Exhibit C, executed and delivered by a Lien Grantor in favor of the Agent for the benefit of the Secured Parties. "Patents" means (i) all letters patent and design letters patent of the United States and all applications for letters patent or design letters patent of the United States, including applications in the United States Patent and Trademark Office or in any similar office or agency of the United States or any State thereof, including those described in Schedule 1 to any Patent Security Agreement, (ii) all reissues, divisions, continuations, continuations in part, revisions and extensions of any of the foregoing, (iii) all claims for, and rights to sue for, past or future infringements of any of the foregoing and (iv) all income, royalties, damages and payments now or hereafter due or payable with respect to any of the foregoing, including damages and payments for past or future infringements thereof. "Perfection Certificate" means, with respect to any Lien Grantor, a certificate substantially in the form of Exhibit E, completed and supplemented with the schedules contemplated thereby to the satisfaction of the Agent, and signed by an officer of such Lien Grantor. "Permitted Liens" means (i) the Transaction Liens and (ii) any other Liens on the Collateral permitted to be created or assumed or to exist pursuant to Section 7.02 of the Credit Agreement. "Pledged", when used in conjunction with any type of asset, means at any time an asset of such type that is included (or that creates rights that are included) in the Collateral at such time. For example, "Pledged Equity Interest" means an Equity Interest that is included in the Collateral at such time and "Pledged letter of credit" means a letter of credit that creates rights to payment or performance that are included in the Collateral at such time. "Post-Petition Interest" means any interest that accrues after the commencement of any case, proceeding or other action relating to the bankruptcy, insolvency or reorganization of the Company (or would accrue but for the operation of applicable bankruptcy or insolvency laws), whether or not such interest is allowed or allowable as a claim in any such proceeding. 7 "Proceeds" means all proceeds of, and all other profits, products, rents or receipts, in whatever form, arising from the collection, sale, lease, exchange, assignment, licensing or other disposition of, or other realization upon, any Collateral, including all claims of the relevant Lien Grantor against third parties for loss of, damage to or destruction of, or for proceeds payable under, or unearned premiums with respect to, policies of insurance in respect of, any Collateral, and any condemnation or requisition payments with respect to any Collateral. "Recordable Intellectual Property" means (i) Patents, (ii) Patent Licenses, (iii) Trademarks, (iv) Trademark Licenses, (v) Copyrights and (vi) Copyright Licenses, and all rights in or under any of the foregoing. "Regulated Subsidiary" means a Subsidiary as to which the consent of a governmental body or official is required for any acquisition of control or change of control thereof. "Release Conditions" means the following conditions for releasing all the Secured Guarantees and terminating all the Transaction Liens: (i) all Commitments under the Credit Agreement shall have expired or been terminated; and (ii) all Secured Obligations (other than contingent indemnification obligations not yet due and payable) shall have been paid in full. "Required D&O Banks" means Banks then holding at least 50.1% of the aggregate unpaid principal amount of the Tranche A-2 Term Loans, the Tranche A-3 Term Loans, the Tranche B-2 Term Loans and the Tranche B-3 Term Loans. "Required 1999 D&O Banks" means Banks then holding at least 50.1% of the aggregate unpaid principal amount of the Tranche A-2 Term Loans and the Tranche B-2 Term Loans. "Secured Agreement", when used with respect to any Secured Obligation, refers collectively to each instrument, agreement or other document that sets forth obligations of the Company, obligations of a Subsidiary Guarantor and/or rights of the holder with respect to such Secured Obligation. "Secured Guarantee" means, with respect to each Subsidiary Guarantor, its guarantee of the Secured Obligations under Section 2 hereof or Section 1 of a Security Agreement Supplement. 8 "Secured Obligations" means all principal of all Loans outstanding from time to time under the Credit Agreement (as the same may be amended, restated, extended, supplemented, refinanced or otherwise modified from time to time), all interest (including Post-Petition Interest) on such Loans and all other amounts now or hereafter payable by the Company pursuant to the Loan Documents (as the same may be amended, restated, extended, supplemented, refinanced or otherwise modified from time to time). "Secured Parties" means the holders from time to time of the Secured Obligations. "Secured Party Requesting Notice" means, at any time, a Secured Party that has, at least five Business Days prior thereto, delivered to the Agent a written notice (i) stating that it holds one or more Secured Obligations and wishes to receive copies of the notices referred to in Section 26(i) and (ii) setting forth its address, facsimile number and electronic mail address to which copies of such notices should be sent. "Securities Account Control Agreement" means, when used with respect to a Securities Account, a Securities Account Control Agreement substantially in the form of Exhibit G (with any changes that the Agent shall have approved) or in any other form reasonably satisfactory to the Agent among the relevant Securities Intermediary, the relevant Lien Grantor and the Agent to the effect that such Securities Intermediary will comply with Entitlement Orders originated by the Agent with respect to such Securities Account without further consent by the relevant Lien Grantor. "Security Agreement Supplement" means a Security Agreement Supplement, substantially in the form of Exhibit A, signed and delivered to the Agent for the purpose of adding a Subsidiary as a party hereto pursuant to Section 28 and/or adding additional property to the Collateral. "Security Documents" means this Agreement, the Security Agreement Supplements, the Commodity Account Control Agreements, the Deposit Account Control Agreements, the Issuer Control Agreements, the Securities Account Control Agreements, the Intellectual Property Security Agreements and all other supplemental or additional security agreements, control agreements, mortgages or similar instruments delivered pursuant to the Loan Documents. "Subsidiary Guarantor" means each Subsidiary listed on the signature pages hereof under the caption "Subsidiary Guarantors" and each Subsidiary that shall, at any time after the date hereof, become a "Subsidiary Guarantor" pursuant to Section 28. 9 "Supporting Letter of Credit" means a letter of credit that supports the payment or performance of one or more items included in the Collateral. "Trademark License" means any agreement now or hereafter in existence granting to any Lien Grantor, or pursuant to which any Lien Grantor grants to any other Person, any right to use any Trademark, including any agreement identified in Schedule 1 to any Trademark Security Agreement. "Trademark Security Agreement" means a Trademark Security Agreement, substantially in the form of Exhibit D, executed and delivered by a Lien Grantor in favor of the Agent for the benefit of the Secured Parties. "Trademarks" means: (i) all trademarks, trade names, corporate names, company names, business names, fictitious business names, trade styles, service marks, logos, brand names, trade dress, prints and labels on which any of the foregoing have appeared or appear, package and other designs, and all other source or business identifiers, and all general intangibles of like nature, and the rights in any of the foregoing which arise under applicable law, (ii) the goodwill of the business symbolized thereby or associated with each of them, (iii) all registrations and applications in connection therewith, including registrations and applications in the United States Patent and Trademark Office or in any similar office or agency of the United States or any State thereof, including those described in Schedule 1 to any Trademark Security Agreement, (iv) all renewals of any of the foregoing, (v) all claims for, and rights to sue for, past or future infringements of any of the foregoing and (vi) all income, royalties, damages and payments now or hereafter due or payable with respect to any of the foregoing, including damages and payments for past or future infringements thereof. "Transaction Liens" means the Liens granted by the Lien Grantors under the Security Documents. "UCC" means the Uniform Commercial Code as in effect from time to time in the State of New York; provided that, if perfection or the effect of perfection or non-perfection or the priority of any Transaction Lien on any Collateral is governed by the Uniform Commercial Code as in effect in a jurisdiction other than New York, "UCC" means the Uniform Commercial Code as in effect from time to time in such other jurisdiction for purposes of the provisions hereof relating to such perfection, effect of perfection or non-perfection or priority. (d) Terms Generally. The definitions of terms herein (including those incorporated by reference to the UCC or to another document) apply equally to the singular and plural forms of the terms defined. Whenever the context may require, any pronoun includes the corresponding masculine, feminine and neuter 10 forms. The words "include", "includes" and "including" shall be deemed to be followed by the phrase "without limitation". The word "will" shall be construed to have the same meaning and effect as the word "shall". Unless the context requires otherwise, (i)any definition of or reference to any agreement, instrument or other document herein shall be construed as referring to such agreement, instrument or other document as from time to time amended, supplemented or otherwise modified (subject to any restrictions on such amendments, supplements or modifications set forth herein), (ii)any reference herein to any Person shall be construed to include such Person's successors and assigns, (iii) the words "herein", "hereof" and "hereunder", and words of similar import, shall be construed to refer to this Agreement in its entirety and not to any particular provision hereof, (iv) all references herein to Sections, Exhibits and Schedules shall be construed to refer to Sections of, and Exhibits and Schedules to, this Agreement and (v) the word "property" shall be construed to refer to any and all tangible and intangible assets and properties, including cash, securities, accounts and contract rights. Section 2. Guarantees by Subsidiary Guarantors. (a) Secured Guarantees. Each Subsidiary Guarantor unconditionally guarantees the full and punctual payment of each Secured Obligation when due (whether at stated maturity, upon acceleration or otherwise). If the Company fails to pay any Secured Obligation punctually when due, each Subsidiary Guarantor agrees that it will forthwith on demand pay the amount not so paid at the place and in the manner specified in the relevant Secured Agreement. (b) Secured Guarantees Unconditional. The obligations of each Subsidiary Guarantor under its Secured Guarantee shall be unconditional and absolute and, without limiting the generality of the foregoing, shall not be released, discharged or otherwise affected by: (i) any extension, renewal, settlement, compromise, waiver or release in respect of any obligation of the Company, any other Subsidiary Guarantor or any other Person under any Secured Agreement, by operation of law or otherwise; (ii) any modification or amendment of or supplement to any Secured Agreement; (iii) any release, impairment, non-perfection or invalidity of any direct or indirect security for any obligation of the Company, any other Subsidiary Guarantor or any other Person under any Secured Agreement; (iv) any change in the corporate existence, structure or ownership of the Company, any other Subsidiary Guarantor or any other 11 Person or any of their respective subsidiaries, or any insolvency, bankruptcy, reorganization or other similar proceeding affecting the Company, any other Subsidiary Guarantor or any other Person or any of their assets or any resulting release or discharge of any obligation of the Company, any other Subsidiary Guarantor or any other Person under any Secured Agreement; (v) the existence of any claim, set-off or other right whatsoever (in any case, whether based on contract, tort or any other theory) that such Subsidiary Guarantor may have at any time against the Company, any other Subsidiary Guarantor, any Secured Party or any other Person, whether in connection with the Loan Documents or any unrelated transactions, provided that nothing herein shall prevent the assertion of any such claim by separate suit or compulsory counterclaim; (vi) any invalidity or unenforceability relating to or against the Company, any other Subsidiary Guarantor or any other Person for any reason of any Secured Agreement, or any provision of applicable law or regulation purporting to prohibit the payment of any Secured Obligation by the Company, any other Subsidiary Guarantor or any other Person; or (vii) other than satisfaction of the Release Conditions, any other act or omission to act or delay of any kind by the Company, any other Subsidiary Guarantor, any other party to any Secured Agreement, any Secured Party or any other Person, or any other circumstance whatsoever that might, but for the provisions of this clause (vii), constitute a legal or equitable discharge of or defense to any obligation of any Subsidiary Guarantor hereunder. (c) Release of Secured Guarantees. (i) All the Secured Guarantees will be released when all the Release Conditions are satisfied. If at any time any payment of a Secured Obligation is rescinded or must be otherwise restored or returned upon the insolvency or receivership of the Company or otherwise, the Secured Guarantees shall be reinstated with respect thereto as though such payment had been due but not made at such time. (ii) If all the capital stock of a Subsidiary Guarantor or all the assets of a Subsidiary Guarantor are sold to a Person other than the Company or one of its Subsidiaries in a transaction permitted by the Credit Agreement (any such sale, a "Sale of Subsidiary Guarantor"), the Secured Guarantee of such Subsidiary Guarantor shall automatically be discharged and released without any further action by the Agent or any other Secured Party effective as of the time of such Sale of Subsidiary Guarantor; provided that, if such sale is an Asset Sale, arrangements 12 reasonably satisfactory to the Agent have been made to apply the Net Proceeds thereof as required by the Credit Agreement. Such release shall not require the consent of any Secured Party, and the Agent shall be fully protected in relying on a certificate of the Company as to whether any particular sale constitutes a Sale of Subsidiary Guarantor. (iii) The Secured Guarantee of CIHC shall automatically be discharged and released without any further action by the Agent or any other Secured Party effective upon the consummation of the Proposed CIHC Transactions; provided that concurrently with the consummation of the Proposed CIHC Transactions, New HoldCo shall have satisfied the Collateral and Guarantee Requirement with respect to all property distributed or otherwise transferred to it in connection with the Proposed CIHC Transactions and shall have become an "Obligor", a "Subsidiary Guarantor" and a "Lien Grantor" for all purposes of the Loan Documents. Such release shall not require the consent of any Secured Party, and the Agent shall be fully protected in relying on a certificate of the Company as to whether the Proposed CIHC Transactions have been consummated. (iv) In addition to any release permitted by subsection (ii) or (iii), the Agent may release any Secured Guarantee with the prior written consent of the Required Banks; provided that any release of all or substantially all the Secured Guarantees shall require the consent of all the Banks. (d) Waiver by Subsidiary Guarantors. Each Subsidiary Guarantor irrevocably waives acceptance hereof, presentment, demand, protest and any notice not provided for herein, as well as any requirement that at any time any action be taken by any Person against the Company, any other Subsidiary Guarantor or any other Person. (e) Subrogation. A Subsidiary Guarantor that makes a payment with respect to a Secured Obligation hereunder shall be subrogated to the rights of the payee against the Company with respect to such payment; provided that no Subsidiary Guarantor shall enforce any payment by way of subrogation against the Company, or by reason of contribution against any other Subsidiary Guarantor of such Secured Obligation, until all the Release Conditions have been satisfied. (f) Stay of Acceleration. If acceleration of the time for payment of any Secured Obligation by the Company is stayed by reason of the insolvency or receivership of the Company or otherwise, all Secured Obligations otherwise subject to acceleration under the terms of any Secured Agreement shall nonetheless be payable by the Subsidiary Guarantors hereunder forthwith on demand by the Agent. 13 (g) Right of Set-Off. In addition to any rights and remedies of the Secured Parties provided by law, if any Secured Obligation is not paid promptly when due, each of the Secured Parties and their respective Affiliates is authorized at any time and from time to time, without prior notice to any Subsidiary Guarantor, any such notice being waived by each Subsidiary Guarantor, to the fullest extent permitted by law, to set off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held by, and other indebtedness at any time owing by, such Secured Party or Affiliate to or for the credit or the account of any Subsidiary Guarantor against the obligations of such Subsidiary Guarantor under its Secured Guarantee, irrespective of whether or not such Secured Party shall have made any demand thereunder and although such obligations may be contingent or unmatured; provided that neither any Secured Party nor any of its Affiliates shall be entitled to exercise any such set off with respect to any account that is certified by a Responsible Officer pursuant to a certificate delivered to such Secured Party (with a copy to the Agent) as being a trust account of the type described in Section 6.15(c)(w) of the Credit Agreement; and provided further that until such time as all outstanding Loans have become due and payable (whether pursuant to Article 8 of the Credit Agreement or otherwise), neither any Secured Party nor any of its Affiliates shall be entitled to exercise any such set off with respect to any account that is certified by a Responsible Officer pursuant to a certificate (which certificate may be included in any account control agreement required by the terms hereof and applicable to such account) delivered to such Secured Party (with a copy to the Agent) as being a payroll account if the aggregate amount of cash and Cash Equivalents in all such accounts does not exceed $15,000,000. Each Secured Party agrees promptly to notify the Company and the Agent after any such set off and application made by such Secured Party; provided, however, that the failure to give such notice shall not affect the validity of such set off and application. (h) Continuing Guarantee. Each Secured Guarantee is a continuing guarantee, shall be binding on the relevant Subsidiary Guarantor and its successors and assigns, and shall be enforceable by the Agent or the Secured Parties. If all or part of any Secured Party's interest in any Secured Obligation is assigned or otherwise transferred, the transferor's rights under each Secured Guarantee, to the extent applicable to the obligation so transferred, shall automatically be transferred with such obligation. (i) Limitation on Obligations of Subsidiary Guarantor. Notwithstanding anything to the contrary herein, it is the intention of the parties hereto that the Secured Guarantee of each Subsidiary Guarantor not constitute a fraudulent conveyance under applicable fraudulent conveyance provisions of the United States Bankruptcy Code or any comparable provision of state law. To effectuate that intention, the parties hereto hereby agree that the obligations of each Subsidiary Guarantor under its Secured Guarantee are limited to the 14 maximum amount that would not render the Subsidiary Guarantor's obligations subject to avoidance under applicable fraudulent conveyance provisions of the United States Bankruptcy Code or any comparable provision of state law. Section 3. Grant of Transaction Liens. (a) The Company, in order to secure the Secured Obligations, and each Subsidiary Guarantor listed on the signature pages hereof, in order to secure its Secured Guarantee, grants to the Agent for the benefit of the Secured Parties a continuing security interest in all right, title and interest of the Company or such Subsidiary Guarantor, as the case may be, in, to and under the following property of the Company or such Subsidiary Guarantor, as the case may be, whether now owned or existing or hereafter acquired or arising and regardless of where located: (i) all Accounts; (ii) all Chattel Paper; (iii) the Commercial Tort Claims described in Schedule 3; (iv) all Deposit Accounts; (v) all Documents; (vi) all Equipment; (vii) all General Intangibles (including any Equity Interests in other Persons that do not constitute Investment Property and any payments or other collections received in respect of the D&O Loans); (viii) all Instruments; (ix) all Inventory; (x) all Investment Property; (xi) all Letter-of-Credit Rights; (xii) all books and records (including customer lists, credit files, computer programs, printouts and other computer materials and records) of such Original Lien Grantor pertaining to any of its Collateral; (xiii) such Original Lien Grantor's ownership interest in (1)its Collateral Accounts, (2) all Financial Assets credited to its Collateral Accounts from time to time and all Security Entitlements in respect 15 thereof, (3) all cash held in its Collateral Accounts from time to time and (4) all other money in the possession of the Agent; and (xiv) all Proceeds of the Collateral described in the foregoing clauses (i) through (xiii); provided that the following property is excluded from the foregoing security interests: (A) motor vehicles the perfection of a security interest in which is excluded from the Uniform Commercial Code in the relevant jurisdiction, (B) voting Equity Interests in any Foreign Subsidiary, to the extent (but only to the extent) required to prevent the Collateral from including more than 65% of all voting Equity Interests in such Foreign Subsidiary, (C) Equipment leased by an Original Lien Grantor under a lease that prohibits the granting of a Lien on such Equipment, (D) Deposit Accounts and Securities Accounts that satisfy the applicable conditions set forth in the proviso to the first sentence of Section 6.15(c) of the Credit Agreement and (E) any general intangibles or other rights arising under any contract, instrument, license or other document if (but only to the extent that) the grant of a security interest therein would constitute a material violation of a valid and enforceable restriction in favor of a third party, unless and until all required consents shall have been obtained. Each Original Lien Grantor shall use commercially reasonable efforts to obtain any such required consent that is reasonably obtainable. (b) With respect to each right to payment or performance included in the Collateral from time to time, the Transaction Lien granted therein includes a continuing security interest in (i) any Supporting Obligation that supports such payment or performance and (ii) any Lien that (x) secures such right to payment or performance or (y) secures any such Supporting Obligation. (c) The Transaction Liens are granted as security only and shall not subject the Agent or any other Secured Party to, or transfer or in any way affect or modify, any obligation or liability of any Lien Grantor with respect to any of the Collateral or any transaction in connection therewith. (d) If the governmental body or official having jurisdiction over any Regulated Subsidiary determines that the pledge of the shares of capital stock of such Regulated Subsidiary hereunder constitutes the acquisition of or a change of control with respect to such Regulated Subsidiary as to which the prior approval of such governmental body or official was required, then, immediately upon the relevant Lien Grantor's (1) written memorialization of oral notice or (2) receipt of written notice from such governmental body or official of such determination and without any action on the part of the Agent or any other Person, such pledge shall be rendered void ab initio and of no effect. Upon any such occurrence, (i) the Agent shall, at such Lien Grantor's written request and expense, return all 16 certificates representing such capital stock to such Lien Grantor and execute and deliver such documents as such Lien Grantor shall reasonably request to evidence such Lien Grantor's retention of all rights in such capital stock and (ii) such Lien Grantor shall, if requested by the Agent or the Required Banks, promptly submit a request to the relevant governmental body or official for approval of the pledge of such shares to the Agent hereunder and, upon receipt of such approval, shall forthwith deliver to the Agent certificates representing all the outstanding shares of capital stock of such Regulated Subsidiary (subject to the limitation in Section 13(m) if such Regulated Subsidiary is a Foreign Subsidiary) to be held as Collateral hereunder. Section 4. General Representations and Warranties. Each Original Lien Grantor represents and warrants that: (a) Such Lien Grantor is duly organized, validly existing and in good standing under the laws of the jurisdiction identified as its jurisdiction of organization in its Perfection Certificate. (b) Schedule 1 lists all Equity Interests in Subsidiaries and Affiliates directly owned by such Lien Grantor as of the Effective Date. Such Lien Grantor holds all such Equity Interests directly (i.e., not through a Subsidiary, a Securities Intermediary or any other Person). (c) Schedule 2 lists, as of the Effective Date, (i) all Securities owned by such Lien Grantor (except Securities evidencing Equity Interests in Subsidiaries and Affiliates), (ii) all Securities Accounts to which Financial Assets are credited in respect of which such Lien Grantor owns Security Entitlements and (iii) all Commodity Accounts in respect of which such Lien Grantor is the Commodity Customer. (d) All Pledged Equity Interests owned by such Lien Grantor are owned by it free and clear of any Lien other than Permitted Liens. All shares of capital stock included in such Pledged Equity Interests (including shares of capital stock in respect of which such Lien Grantor owns a Security Entitlement) have been duly authorized and validly issued and are fully paid and non-assessable. None of such Pledged Equity Interests is subject to any option to purchase or similar right of any Person. Such Lien Grantor is not and will not become a party to or otherwise bound by any agreement (except the Loan Documents) which restricts in any manner the rights of any present or future holder of any Pledged Equity Interest with respect thereto. (e) Such Lien Grantor has good record and marketable title in fee simple to, or valid leasehold interests in, all its Collateral, except for such defects in title or interests as could not, individually or in the aggregate with respect to all 17 Lien Grantors, reasonably be expected to have a Material Adverse Effect. The property of such Lien Grantor is subject to no Liens, other than Permitted Liens. (f) Such Lien Grantor has not performed any acts that could reasonably be expected to prevent the Agent from enforcing any of the provisions of the Security Documents or that would limit the Agent in any such enforcement. No financing statement, security agreement, mortgage or similar or equivalent document or instrument covering all or part of the Collateral owned by such Lien Grantor is on file or of record in any jurisdiction in which such filing or recording would be effective to perfect or record a Lien on such Collateral, except financing statements, mortgages or other similar or equivalent documents with respect to Permitted Liens. After the Effective Date, no Collateral owned by such Lien Grantor will be in the possession or under the Control of any other Person having a claim thereto or security interest therein, other than a Permitted Lien. (g) The Transaction Liens on all Collateral owned by such Lien Grantor (i) have been validly created, (ii) will attach to each item of such Collateral on the Effective Date (or, if such Lien Grantor first obtains rights thereto on a later date, on such later date) and (iii) when so attached, will secure all the Secured Obligations or such Lien Grantor's Secured Guarantee, as the case may be. (h) Such Lien Grantor has delivered a Perfection Certificate to the Agent. The information set forth therein is correct and complete as of the Effective Date. Within 60 days after the Effective Date, such Lien Grantor will furnish (or cause to be furnished) to the Agent a file search report from each UCC filing office listed in its Perfection Certificate, showing the filing made at such filing office to perfect the Transaction Liens on its Collateral. (i) When UCC financing statements describing the Collateral as set forth in Schedule 3 to such Lien Grantor's Perfection Certificate have been filed in the offices specified in such Perfection Certificate, the Transaction Liens will constitute perfected security interests in the Collateral owned by such Lien Grantor to the extent that a security interest therein may be perfected by filing pursuant to the UCC, prior to all Liens and rights of others therein except Permitted Liens. When, in addition to the filing of such UCC financing statements, the applicable Intellectual Property Filings have been made with respect to such Lien Grantor's Recordable Intellectual Property (including any future filings required pursuant to Sections 5(a) and 11(a)), the Transaction Liens will constitute perfected security interests in all right, title and interest of such Lien Grantor in its Recordable Intellectual Property to the extent that security interests therein may be perfected by such filings, prior to all Liens and rights of others therein except Permitted Liens. Except for (i) the filing of such UCC financing statements and (ii) such Intellectual Property Filings, no registration, recordation or filing with any governmental body, agency or official is required in 18 connection with the execution or delivery of the Security Documents or is necessary for the validity or enforceability thereof or for the perfection or due recordation of the Transaction Liens or (except with respect to the capital stock of any Regulated Subsidiary) for the enforcement of the Transaction Liens. (j) Such Lien Grantor has taken, and will continue to take, all actions necessary under the UCC to perfect its interest in (i) any Accounts or Chattel Paper purchased or otherwise acquired by it, as against its assignors and creditors of its assignors and (ii) any Payment Intangibles or promissory notes purchased or otherwise acquired by it, as against its assignors and creditors of its assignors. (k) Such Lien Grantor's Collateral is insured as required by the Credit Agreement. (l) If such Lien Grantor is also a Subsidiary Guarantor, in executing and delivering this Agreement (including providing its Secured Guarantee), such Lien Grantor has (i) without reliance on the Agent or any other Secured Party or any information received from the Agent or any other Secured Party and based upon such documents and information it deems appropriate, made an independent investigation of the transactions contemplated by the Loan Documents and the Company, the Company's business, assets, operations, prospects and condition, financial or otherwise, and any circumstances which may bear upon such transactions, the Company or the obligations and risks undertaken herein with respect to the Secured Obligations, (ii) adequate means to obtain from the Company on a continuing basis information concerning the Company, (iii) full and complete access to the Loan Documents and any other documents executed in connection with the Loan Documents and (iv) not relied and will not rely upon any representations or warranties of the Agent or any other Secured Party not embodied herein or any acts heretofore or hereafter taken by the Agent or any other Secured Party (including any review by the Agent or any other Secured Party of the affairs of the Company). Section 5. Further Assurances; General Covenants. Each Lien Grantor covenants as follows: (a) Such Lien Grantor will, from time to time, at the Company's expense, execute, deliver, file and record any statement, assignment, instrument, document, agreement or other paper and take any other action (including any Intellectual Property Filing and any filing of financing or continuation statements under the UCC) that from time to time may be necessary, or that the Agent may reasonably request, in order to: (i) create, preserve, perfect, confirm or validate the Transaction Liens on such Lien Grantor's Collateral; 19 (ii) in the case of Pledged Deposit Accounts, Pledged Letter-of-Credit Rights, Pledged Electronic Chattel Paper and Pledged Investment Property, cause the Agent to have Control thereof; (iii) enable the Agent and the other Secured Parties to obtain the full benefits of the Security Documents; or (iv) enable the Agent to exercise and enforce any of its rights, powers and remedies with respect to any of such Lien Grantor's Collateral. To the extent permitted by applicable law, such Lien Grantor authorizes the Agent to execute and file such financing statements or continuation statements without such Lien Grantor's signature appearing thereon. Such Lien Grantor agrees that a carbon, photographic, photostatic or other reproduction of this Agreement or of a financing statement is sufficient as a financing statement. Such Lien Grantor constitutes the Agent its attorney-in-fact to execute and file all Intellectual Property Filings and other filings required or so requested for the foregoing purposes, all acts of such attorney being hereby ratified and confirmed; and such power, being coupled with an interest, shall be irrevocable until all the Transaction Liens granted by such Lien Grantor terminate pursuant to Section 27. The Company will pay the costs of, or incidental to, any Intellectual Property Filings and any recording or filing of any financing or continuation statements or other documents recorded or filed pursuant hereto. (b) Such Lien Grantor will not (i) change its name or corporate structure, (ii) change its location (determined as provided in UCC Section 9-307) or (iii) become bound, as provided in UCC Section 9-203(d) or otherwise, by a security agreement entered into by another Person, unless it shall have given the Agent prior notice thereof and, if requested by the Agent pursuant to Section 5(c), delivered an Opinion of Counsel with respect thereto in accordance with Section 5(c); provided that no such opinion shall be required to be delivered in connection with any such action that is necessary to effect the Proposed CIHC Transactions or in connection with the change of the name of Conseco Capital Management, Inc. to 40/86 Advisors, Inc. (c) At least 30 days before it takes any action contemplated by Section 5(b) (other than any action contemplated by the proviso thereto), such Lien Grantor will, if reasonably requested by the Agent, at the Company's expense, cause to be delivered to the Agent an Opinion of Counsel, in form and substance reasonably satisfactory to the Agent, to the effect that (i) all financing statements and amendments or supplements thereto, continuation statements and other documents required to be filed or recorded in order to perfect and protect the Transaction Liens against all creditors of and purchasers from such Lien Grantor 20 after it takes such action (except any continuation statements specified in such Opinion of Counsel that are to be filed more than six months after the date thereof) have been filed or recorded in each office necessary for such purpose, (ii) all fees and taxes, if any, payable in connection with such filings or recordations have been paid in full and (iii) except as otherwise agreed by the Required Banks, such action will not adversely affect the perfection or priority of the Transaction Lien on any Collateral to be owned by such Lien Grantor after it takes such action or the accuracy of such Lien Grantor's representations and warranties herein relating to such Collateral. (d) If any of its Collateral is in the possession or control of a warehouseman, bailee or agent at any time, such Lien Grantor will (i) notify such warehouseman, bailee or agent of the relevant Transaction Liens, (ii) instruct such warehouseman, bailee or agent to hold all such Collateral for the Agent's account subject to the Agent's instructions (which shall permit such Collateral to be removed by such Lien Grantor in the ordinary course of business until the Agent notifies such warehouseman, bailee or agent that an Event of Default has occurred and is continuing), (iii) cause such warehouseman, bailee or agent to Authenticate a Record acknowledging that it holds possession of such Collateral for the Agent's benefit and (iv) make such Authenticated Record available to the Agent. (e) Such Lien Grantor will not sell, lease, exchange, assign or otherwise dispose of, or grant any option with respect to, any of its Collateral; provided that such Lien Grantor may do any of the foregoing unless (i) doing so would violate a covenant in the Credit Agreement or (ii) an Event of Default shall have occurred and be continuing and the Agent shall have notified such Lien Grantor that its right to do so is terminated, suspended or otherwise limited. (f) Such Lien Grantor will, promptly upon request, provide to the Agent all information and evidence concerning such Lien Grantor's Collateral that the Agent may reasonably request from time to time to enable it to enforce the provisions of the Security Documents. (g) From time to time upon request by the Agent, such Lien Grantor will, at the Company's expense, cause to be delivered to the Secured Parties an Opinion of Counsel reasonably satisfactory to the Agent as to such matters relating to the transactions contemplated hereby as the Agent may reasonably request; provided that such Lien Grantor shall not be required to cause more than one such Opinion of Counsel to be delivered during any calendar year unless (i) an Event of Default has occurred and is continuing or (ii) a change in Article 9 (or any other applicable law governing the creation, perfection or priority of security interests) occurs and the Required Banks request such an Opinion of Counsel. 21 Section 6. Accounts. Each Lien Grantor represents, warrants and covenants as follows: (a) Such Lien Grantor will use commercially reasonable efforts to cause to be collected from its account debtors, when due, all amounts owing under its Accounts (including delinquent Accounts, which will be collected in accordance with lawful collection procedures) and will apply all amounts collected thereon, forthwith upon receipt thereof, to the outstanding balances of such Accounts. Subject to the rights of the Agent and the other Secured Parties hereunder if an Event of Default shall have occurred and be continuing, such Lien Grantor may allow in the ordinary course of business as adjustments to amounts owing under its Accounts (i) any extension or renewal of the time or times for payment, or settlement for less than the total unpaid balance, that such Lien Grantor finds appropriate in accordance with sound business judgment and (ii) refunds or credits, all in the ordinary course of business and consistent with such Lien Grantor's historical collection practices. The costs and expenses (including attorney's fees) of collection, whether incurred by such Lien Grantor or the Agent, shall be paid by such Lien Grantor. (b) If payments with respect to any of such Lien Grantor's Accounts are received in a lockbox or similar account, such Lien Grantor will (i) at all times cause such account to be a Controlled Deposit Account and (ii) use commercially reasonable efforts to cause the relevant depositary bank to subordinate to the relevant Transaction Lien all its claims to such account (except its right to deduct its customary operating charges and any uncollected funds previously credited thereto). The Agent will instruct the relevant depositary bank to transfer funds credited to any such account, as promptly as practicable after receipt thereof, to a Controlled Deposit Account designated by such Lien Grantor; provided that, if an Event of Default shall have occurred and be continuing, the Agent may designate the Controlled Deposit Account to which such funds are transferred. (c) If an Event of Default shall have occurred and be continuing, such Lien Grantor will, if requested to do so by the Agent, promptly notify (and such Lien Grantor authorizes the Agent so to notify) each account debtor in respect of any of its Accounts that such Accounts have been assigned to the Agent hereunder, and that any payments due or to become due in respect of such Accounts are to be made directly to the Agent or its designee. Section 7. Chattel Paper and Instruments. Except as to actions to be taken by the Agent, each Lien Grantor represents, warrants and covenants as follows: (a) On the Effective Date (in the case of an Original Lien Grantor) or the date on which it signs and delivers its first Security Agreement Supplement 22 (in the case of any other Lien Grantor), such Lien Grantor will deliver to the Agent as Collateral hereunder all Pledged Tangible Chattel Paper and Pledged Instruments then owned by such Lien Grantor. Thereafter, whenever such Lien Grantor acquires any other Pledged Tangible Chattel Paper or Pledged Instrument, such Lien Grantor will immediately deliver such Pledged Tangible Chattel Paper or Pledged Instrument to the Agent as Collateral hereunder. (b) So long as no Event of Default shall have occurred and be continuing, the Agent will, promptly upon request by the relevant Lien Grantor, make appropriate arrangements for making any Pledged Tangible Chattel Paper or Pledged Instrument available to it for purposes of presentation, collection or renewal (any such arrangement to be effected, to the extent deemed appropriate by the Agent, against trust receipt or like document). (c) All Pledged Tangible Chattel Paper and Pledged Instruments owned by such Lien Grantor, when delivered to the Agent, will be indorsed to the order of the Agent, or accompanied by duly executed instruments of assignment, all in form and substance reasonably satisfactory to the Agent. (d) Upon the delivery of any Pledged Tangible Chattel Paper or Pledged Instrument owned by such Lien Grantor to the Agent, the Transaction Lien on such Collateral will be perfected, subject to no prior Liens or rights of others. (e) Each Lien Grantor will take (or cause others to take) all actions required under UCC Section 9-105 to cause the Agent to obtain and maintain Control of any and all Electronic Chattel Paper owned by such Lien Grantor from time to time. Section 8. Commercial Tort Claims. Each Lien Grantor represents, warrants and covenants as follows: (a) In the case of an Original Lien Grantor, Schedule 3 accurately describes, with the specificity required to satisfy Official Comment 5 to UCC Section 9-108, each Material Commercial Tort Claim with respect to which such Original Lien Grantor is the claimant as of the Effective Date. In the case of any other Lien Grantor, Schedule 3 to its first Security Agreement Supplement will accurately describe, with the specificity required to satisfy said Official Comment 5, each Material Commercial Tort Claim with respect to which such Lien Grantor is the claimant as of the date on which it signs and delivers such Security Agreement Supplement. (b) If any Lien Grantor acquires a Material Commercial Tort Claim after the Effective Date (in the case of an Original Lien Grantor) or the date on which it signs and delivers its first Security Agreement Supplement (in the case of 23 any other Lien Grantor), such Lien Grantor will promptly sign and deliver to the Agent a Security Agreement Supplement granting a security interest in such Commercial Tort Claim (which shall be described therein with the specificity required to satisfy said Official Comment 5) to the Agent for the benefit of the Secured Parties. (c) Upon the filing of a UCC financing statement in the jurisdiction under the laws of which the relevant Lien Grantor is organized, the Transaction Lien on each Commercial Tort Claim described pursuant to subsection (a) or (b) above will be perfected, subject to no prior Liens or rights of others. Section 9. Equipment. (a) Each Lien Grantor covenants that it will (i) within 30 days after it becomes a party hereto, in the case of Pledged Equipment now owned by it, and (ii) within 10 days after it acquires any other Pledged Equipment, deliver to the Agent any and all certificates of title, applications for title or similar evidence of ownership of such Equipment and will cause the Agent to be named as lienholder on any such certificate of title or other evidence of ownership. Such Lien Grantor will promptly inform the Agent of any additions to or deletions from its Pledged Equipment and will not permit any of its Pledged Equipment to become a fixture to real estate or an accession to any personal property that is not included in the Collateral. (b) The Lien Grantors have the right not to comply with subsection (a) with respect to Pledged Equipment having a fair market value that does not at any time exceed $250,000 in the aggregate for all Lien Grantors. However, if an Event of Default occurs and is continuing, the Agent may terminate the foregoing right not to comply, or reduce the amount thereof, by giving at least five Business Days' notice of such termination or reduction to the relevant Lien Grantor. Section 10. Material Government Contracts. Except as to actions to be taken by the Agent, each Lien Grantor represents, warrants and covenants as follows: (a) In the case of an Original Lien Grantor, Exhibit H-1 lists all Material Government Contracts to which such Lien Grantor is a party as of the Effective Date. On or before the Effective Date such Lien Grantor will execute and deliver to the Agent assignments and notices of assignment, substantially in the forms of Exhibits H-2 and H-3, with respect to each of its Material Government Contracts with the Federal Government. (b) In the case of any other Lien Grantor, Exhibit K-1 to its first Security Agreement Supplement will list all Material Government Contracts to which such Lien Grantor is a party as of the date on which its signs and delivers such Security Agreement Supplement. On or before such date such Lien Grantor 24 will execute and deliver to the Agent assignments and notices of assignment, substantially in the forms of Exhibits H-2 and H-3 hereto, with respect to each of its Material Government Contracts with the Federal Government. (c) Each Lien Grantor will, from time to time, amend and supplement the relevant Exhibit H-1 or K-1 to include each Material Government Contract entered into by it after the Effective Date (in the case of an Original Lien Grantor) or the date on which it signs and delivers its first Security Agreement Supplement (in the case of any other Lien Grantor), by delivering to the Agent a supplemental schedule of Material Government Contracts. Concurrently therewith, such Lien Grantor will execute and deliver to the Agent assignments and notices of assignment, substantially in the forms of Exhibits H-2 and H-3, with respect to each Material Government Contract with the Federal Government listed on such supplemental schedule. (d) Each Lien Grantor will, from time to time, execute and deliver to the Agent all assignments, notices of assignment and other documents required to be filed with any state or local government or agency to insure that such Lien Grantor's Material Government Contracts with such government or agency are validly assigned to the Agent to the extent that such validity is governed by applicable provisions of state or local law. (e) If an Event of Default shall have occurred and be continuing for at least 10 days (or if the maturity of the Loans shall have been accelerated pursuant to Article 8 of the Credit Agreement), the Agent may, at the Company's expense: (i) file, deliver and record with the Federal Government in accordance with the Assignment of Claims Act of 1940, as amended, 31 U.S.C. Section 3727 and 41 U.S.C. Section 15 (the "Assignment of Claims Act") any or all assignments and/or notices of assignment executed and delivered to the Agent pursuant to subsection (a), (b) or (c) above; and (ii) file, deliver and/or record with the relevant state or local government or agency any or all assignments, notices of assignment and/or other documents executed and delivered to the Agent pursuant to subsection (d) above. (f) When the Agent files any notice of assignment referred to in subsection (a), (b) or (c) above with the governmental authority or agency or other office described therein, the relevant Transaction Lien will constitute a valid assignment of the Material Government Contract identified therein, to the extent that such validity is governed by the Assignment of Claims Act. 25 Section 11. Recordable Intellectual Property. Each Lien Grantor covenants as follows: (a) On the Effective Date (in the case of an Original Lien Grantor) or the date on which it signs and delivers its first Security Agreement Supplement (in the case of any other Lien Grantor), such Lien Grantor will sign and deliver to the Agent Intellectual Property Security Agreements with respect to all Recordable Intellectual Property then owned by it. Within 30 days after each March 31 thereafter, it will sign and deliver to the Agent any Intellectual Property Security Agreement necessary to grant Transaction Liens on all Recordable Intellectual Property owned by it on such March 31 that is not covered by any previous Intellectual Property Security Agreement so signed and delivered by it. In each case, it will promptly make all Intellectual Property Filings necessary to record the Transaction Liens on such Recordable Intellectual Property. (b) Such Lien Grantor will notify the Agent promptly if it knows that any application or registration relating to any Recordable Intellectual Property owned or licensed by it may become abandoned or dedicated to the public, or of any adverse determination or development (including the institution of, or any adverse determination or development in, any proceeding in the United States Copyright Office, the United States Patent and Trademark Office or any court) regarding such Lien Grantor's ownership of such Recordable Intellectual Property, its right to register or patent the same, or its right to keep and maintain the same; provided that the foregoing shall not apply to the extent that any such event, individually or together with all such events, could not reasonably be expected to interfere with the ordinary course of business of the Company and its Subsidiaries. If any of such Lien Grantor's rights to any Recordable Intellectual Property are infringed, misappropriated or diluted by a third party, such Lien Grantor will notify the Agent within 30 days after it learns thereof and will, unless such Lien Grantor shall reasonably determine that such action would be of negligible value, economic or otherwise, promptly sue for infringement, misappropriation or dilution and to recover any and all damages for such infringement, misappropriation or dilution, and take such other actions as such Lien Grantor shall reasonably deem appropriate under the circumstances to protect such Recordable Intellectual Property. Section 12. Proceeds of Letters of Credit. Except as to actions to be taken by the Agent, each Lien Grantor represents, warrants and covenants as follows: (a) On the Effective Date (in the case of an Original Lien Grantor) or the date on which it signs and delivers its first Security Agreement Supplement (in the case of any other Lien Grantor), such Lien Grantor will deliver to the Agent each letter of credit listed in Exhibit I (or in an exhibit to such Security Agreement Supplement) (the "Specified Letters of Credit"). 26 (b) Notwithstanding the foregoing, so long as no Event of Default shall have occurred and be continuing, the Agent will, promptly upon request by any Lien Grantor, make appropriate arrangements for making any Specified Letter of Credit delivered to the Agent pursuant to subsection (a) above available to such Lien Grantor to facilitate the administration thereof or the exercise of its rights thereunder (any such arrangement to be effected, to the extent deemed appropriate by the Agent, against trust receipt or like document). (c) Such Lien Grantor, by granting a security interest in its Letter-of-Credit Rights to the Agent, intends to (and hereby does) assign to the Agent its rights (including its contingent rights) to the proceeds of all letters of credit of which it is or hereafter becomes a beneficiary. If any such letter of credit is not a Supporting Letter of Credit, such Lien Grantor will promptly (i) use commercially reasonable efforts to cause the issuer of such letter of credit and each Nominated Person (if any) with respect thereto to consent to such assignment of the proceeds thereof and (ii) deliver written evidence of such consent to the Agent. (d) The Transaction Lien on the relevant Lien Grantor's rights to the proceeds of each letter of credit under which such Lien Grantor is a beneficiary will be perfected, subject to no prior Liens or rights of others, if either (i) such letter of credit is a Supporting Letter of Credit and the Transaction Lien on the item of Collateral supported thereby has been perfected or (ii) the relevant issuing bank and each relevant Nominated Person (if any) shall have consented to the assignment of the proceeds thereof set forth in subsection (c) above. (e) If an Event of Default shall have occurred and be continuing, such Lien Grantor will, promptly upon request by the Agent, notify (and such Lien Grantor authorizes the Agent to notify) the issuer and each Nominated Person with respect to each of its Pledged letters of credit that (i) the proceeds thereof have been assigned to the Agent hereunder and (ii) any payments due or to become due in respect thereof are to be made directly to the Agent or its designee. Section 13. Investment Property. Each Lien Grantor represents, warrants and covenants as follows: (a) Certificated Securities. On the Effective Date (in the case of an Original Lien Grantor) or the date on which it signs and delivers its first Security Agreement Supplement (in the case of any other Lien Grantor), such Lien Grantor will deliver to the Agent as Collateral hereunder all certificates representing Pledged Certificated Securities then owned by such Lien Grantor. Thereafter, whenever such Lien Grantor acquires any other certificate representing a Pledged Certificated Security, such Lien Grantor will promptly deliver such certificate to the Agent as Collateral hereunder. The provisions of this subsection are subject to 27 the limitation in Section 13(m) in the case of voting Equity Interests in a Foreign Subsidiary. (b) Uncertificated Securities. On the Effective Date (in the case of an Original Lien Grantor) or the date on which it signs and delivers its first Security Agreement Supplement (in the case of any other Lien Grantor), such Lien Grantor will enter into (and, if the relevant issuer is a Subsidiary, cause, or if the relevant issuer is not a Subsidiary, use commercially reasonable efforts to cause, the relevant issuer to enter into) an Issuer Control Agreement in respect of each Pledged Uncertificated Security then owned by such Lien Grantor and deliver such Issuer Control Agreement to the Agent (which shall enter into the same). Thereafter, whenever such Lien Grantor acquires any other Pledged Uncertificated Security, such Lien Grantor will enter into (and, if the relevant issuer is a Subsidiary, cause, or if the relevant issuer is not a Subsidiary, use commercially reasonable efforts to cause, the relevant issuer to enter into) an Issuer Control Agreement in respect of such Pledged Uncertificated Security and deliver such Issuer Control Agreement to the Agent (which shall enter into the same). The provisions of this subsection are subject to (i) the limitation in Section 13(m) in the case of voting Equity Interests in a Foreign Subsidiary and (ii) Sections 13(n) and 18(c). (c) Security Entitlements. On the Effective Date (in the case of an Original Lien Grantor) or the date on which it signs and delivers its first Security Agreement Supplement (in the case of any other Lien Grantor), such Lien Grantor will, with respect to each Security Entitlement then owned by it, enter into (and use commercially reasonable efforts to cause the relevant Securities Intermediary to enter into) a Securities Account Control Agreement in respect of such Security Entitlement and the Securities Account to which the underlying Financial Asset is credited and will deliver such Securities Account Control Agreement to the Agent (which shall enter into the same). Thereafter, whenever such Lien Grantor acquires any other Security Entitlement, such Lien Grantor will, as promptly as practicable, cause the underlying Financial Asset to be credited to a Controlled Securities Account. The provisions of this subsection are subject to Section 18(c). (d) Commodity Accounts. On the Effective Date (in the case of an Original Lien Grantor) or the date on which it signs and delivers its first Security Agreement Supplement (in the case of any other Lien Grantor), such Lien Grantor will enter into (and use commercially reasonable efforts to cause the relevant Commodity Intermediary to enter into) a Commodity Account Control Agreement in respect of each Commodity Account owned by it and will deliver such Commodity Account Control Agreement to the Agent (which shall enter into the same). Thereafter, such Lien Grantor will cause each Commodity Contract owned by it to be carried at all times in a Controlled Commodity Account. 28 (e) Regulated Subsidiaries. If the Collateral includes any capital stock of a Regulated Subsidiary that is not represented by certificates, the relevant Lien Grantor shall exercise its commercially reasonable efforts to cause such capital stock to be represented by certificates and, promptly upon receipt thereof, comply with Section 13(a) with respect thereto. No Lien Grantor shall hold any capital stock of a Regulated Subsidiary in a Securities Account. (f) Perfection as to Certificated Securities. When such Lien Grantor delivers the certificate representing any Pledged Certificated Security owned by it to the Agent and complies with Section 13(k) in connection with such delivery, (i) the Transaction Lien on such Pledged Certificated Security will be perfected, subject to no prior Liens or rights of others, (ii) the Agent will have Control of such Pledged Certificated Security and (iii) the Agent will be a protected purchaser (within the meaning of UCC Section 8-303) thereof. (g) Perfection as to Uncertificated Securities. When such Lien Grantor, the Agent and the issuer of any Pledged Uncertificated Security owned by such Lien Grantor enter into an Issuer Control Agreement with respect thereto, (i) the Transaction Lien on such Pledged Uncertificated Security will be perfected, subject to no prior Liens or rights of others, (ii) the Agent will have Control of such Pledged Uncertificated Security and (iii) the Agent will be a protected purchaser (within the meaning of UCC Section 8-303) thereof. (h) Perfection as to Security Entitlements. So long as the Financial Asset underlying any Security Entitlement owned by such Lien Grantor is credited to a Controlled Securities Account or to its Investment Property Collateral Account, (i) the Transaction Lien on such Security Entitlement will be perfected, subject to no prior Liens or rights of others (except Liens and rights of the relevant Securities Intermediary that are Permitted Liens), (ii) the Agent will have Control of such Security Entitlement and (iii) no action based on an adverse claim to such Security Entitlement or such Financial Asset, whether framed in conversion, replevin, constructive trust, equitable lien or other theory, may be asserted against the Agent or any other Secured Party. (i) Perfection as to Commodity Accounts. So long as any Commodity Account is subject to a Commodity Account Control Agreement, (i) the Transaction Liens on such Commodity Account and all Commodity Contracts carried therein will be perfected, subject to no prior Liens or rights of others (except Liens and rights of the relevant Commodity Intermediary permitted by such Commodity Account Control Agreement) and (ii) the Agent will have Control of such Commodity Account and all Commodity Contracts carried therein from time to time. 29 (j) Agreement as to Applicable Jurisdiction. In respect of all Security Entitlements owned by such Lien Grantor, and all Securities Accounts to which the related Financial Assets are credited, the Securities Intermediary's jurisdiction (determined as provided in UCC Section 8-110(e)) will at all times be located in the United States. In respect of all Commodity Contracts owned by such Lien Grantor and all Commodity Accounts in which such Commodity Contracts are carried, the Commodity Intermediary's jurisdiction (determined as provided in UCC Section 9-305(b)) will at all times be located in the United States. (k) Delivery of Pledged Certificates. All Pledged Certificates, when delivered to the Agent, will be in suitable form for transfer by delivery, or accompanied by duly executed instruments of transfer or assignment in blank, all in form and substance reasonably satisfactory to the Agent. (l) Communications. Each Lien Grantor will promptly give to the Agent copies of any notices and other communications received by it with respect to (i) Pledged Securities registered in the name of such Lien Grantor or its nominee and (ii) Pledged Security Entitlements as to which such Lien Grantor is the Entitlement Holder. (m) Foreign Subsidiaries. A Lien Grantor will not be obligated to comply with the provisions of this Section at any time with respect to any voting Equity Interest in a Foreign Subsidiary if and to the extent (but only to the extent) that such voting Equity Interest is excluded from the Transaction Liens at such time pursuant to clause (B) of the proviso at the end of Section 3(a) and/or the comparable provisions of one or more Security Agreement Supplements. (n) Compliance with Applicable Foreign Laws. If and so long as the Collateral includes (i) any Equity Interest in, or other Investment Property issued by, a Subsidiary (other than an Immaterial Subsidiary) organized under the laws of a jurisdiction outside the United States or (ii) any Security Entitlement in respect of a Financial Asset issued by such a Subsidiary (other than an Immaterial Subsidiary), the relevant Lien Grantor will take all such action as may be required under the laws of such foreign jurisdiction to ensure that the Transaction Lien on such Collateral ranks prior to all Liens and rights of others therein. If and so long as the Collateral includes any Pledged Uncertificated Security issued by such a Subsidiary (other than an Immaterial Subsidiary), the relevant Lien Grantor will comply with this subsection, and will not be required to comply with Section 13(b), with respect thereto. Section 14. Investment Property Collateral Accounts. (a) At any time when an Event of Default has occurred and is continuing, the Agent will establish, at an office located in the United States, a Securities Account with respect to each Lien Grantor (such Lien Grantor's "Investment Property Collateral Account"), 30 in the name and under the exclusive control of the Agent, to which there shall be credited from time to time (i) all Securities that are to be credited thereto pursuant to Section 18(a) or any other provision of any Security Document, (ii) any other Financial Assets that underlie Security Entitlements included in such Lien Grantor's Collateral and (iii) the cash proceeds thereof. Each Investment Property Collateral Account will be operated as provided in Section 17. (b) The Agent and each Lien Grantor agree (and will use commercially reasonable efforts to cause the relevant Securities Intermediary, if other than the Agent, to agree) that (i) such Lien Grantor's Investment Property Collateral Account will be a Securities Account, (ii) the Agent will be the Entitlement Holder with respect thereto and (iii) all property (whether Investment Property, financial asset, security, instrument, cash or other property) credited to such account will be treated as Financial Assets. Section 15. Controlled Deposit Accounts. Each Lien Grantor represents, warrants and covenants as follows: (a) Subject to paragraph (d), all cash owned by such Lien Grantor will be deposited, upon or promptly after the receipt thereof, in one or more Controlled Deposit Accounts. Each Controlled Deposit Account will be operated as provided in Section 17. (b) In respect of each Controlled Deposit Account, the Depositary Bank's jurisdiction (determined as provided in UCC Section 9-304) will at all times be a jurisdiction in which Article 9 is in effect. (c) So long as the Agent has Control of a Controlled Deposit Account, the Transaction Lien on such Controlled Deposit Account will be perfected, subject to no prior Liens or rights of others (except the Depositary Bank's right to deduct its customary operating charges and any uncollected funds previously credited thereto). (d) The Lien Grantors have the right not to comply with the foregoing provisions of this Section to the extent (but only to the extent) the Company is not required to comply with the first sentence of Section 6.15(c) of the Credit Agreement as a result of the operation of the proviso thereto. Section 16. Cash Collateral Accounts. (a) If and when required for purposes hereof or of any other Loan Document, the Agent will establish with respect to each Lien Grantor one or more accounts (each such account, its "Cash Collateral Account"), in the name and under the exclusive control of the Agent, into which all amounts owned by such Lien Grantor that are to be deposited therein pursuant to the Loan Documents shall be deposited from time to time. Each Cash Collateral Account will be operated as provided in this Section and Section 17. 31 (b) The Agent shall deposit the following amounts, as and when received by it, in the Company's Cash Collateral Account: (i) each Cash Distribution required by Section 20 to be deposited therein; and (ii) each amount realized or otherwise received by the Agent with respect to assets of the Company upon any exercise of remedies pursuant to any Security Document. (c) The Agent shall deposit in the Cash Collateral Account of each Lien Grantor (other than the Company): (i) each Cash Distribution required by Section 20 to be deposited therein; and (ii) each amount realized or otherwise received by the Agent with respect to assets of such Lien Grantor upon any exercise of remedies pursuant to any Security Document. (d) The Agent shall maintain such records and/or establish such accounts or sub-accounts as shall be required to enable it to identify the amounts held in each Cash Collateral Account from time to time pursuant to each clause of subsection (b) or (c) of this Section, as applicable, or to enable it to segregate any proceeds of or collections on 1999 Facility Collateral or D&O Loan Collateral. (e) Unless (x) an Event of Default shall have occurred and be continuing and the Required Banks shall have instructed the Agent to stop withdrawing amounts from the Cash Collateral Accounts pursuant to this subsection or (y) the maturity of the Loans shall have been accelerated pursuant to Article 8 of the Credit Agreement, any Cash Distribution deposited pursuant to Section 20 shall, at the relevant Lien Grantor's request, (x) be withdrawn and applied to pay Secured Obligations that are then due and payable or (y) if no Event of Default has occurred and is continuing, be withdrawn and returned to such Lien Grantor. Section 17. Operation of Collateral Accounts. (a) All Cash Distributions received with respect to assets held in any Collateral Account established in accordance with the terms hereof shall be deposited therein promptly upon receipt thereof. 32 (b) Funds held in any Controlled Securities Account or Investment Property Collateral Account may, until withdrawn, be invested and reinvested in such Cash Equivalents as the relevant Lien Grantor shall request from time to time; provided that, if an Event of Default shall have occurred and be continuing, the Agent may select such Cash Equivalents. (c) Funds held in any Controlled Deposit Account or Cash Collateral Account may, until withdrawn, be invested and reinvested in such Liquid Investments as the relevant Lien Grantor shall request from time to time; provided that (i) if an Event of Default shall have occurred and be continuing, the Agent may select such Liquid Investments and (ii) if such Liquid Investments are to be held in a Securities Account, either (x) the Agent is the Entitlement Holder with respect to such Liquid Investments or (y) the relevant Entitlement Holder and the relevant Securities Intermediary shall have theretofore entered into a Securities Account Control Agreement with respect to such Securities Account and delivered it to the Agent (which shall enter into the same). (d) With respect to each Collateral Account (except a Cash Collateral Account, as to which Section 16 applies), the Agent will instruct the relevant Securities Intermediary or Depositary Bank that the relevant Lien Grantor may withdraw, or direct the disposition of, funds held therein unless and until the Agent rescinds such instruction. The Agent will not rescind such instructions (or provide any other instructions to the applicable Securities Intermediary or Depositary Bank) unless an Event of Default shall have occurred and be continuing and, upon the cure or waiver thereof, the Agent will again instruct the relevant Securities Intermediary or Depositary Bank that the relevant Lien Grantor may withdraw, or direct the disposition of, funds held therein unless and until the Agent rescinds such instruction. (e) No Lien Grantor will cause funds to be transferred from a Collateral Account to any other account owned by the Company or any of its Subsidiaries or Affiliates unless (i) such other account is a Collateral Account or (ii) such transfer is permitted by the Credit Agreement. (f) If an Event of Default shall have occurred and be continuing, the Agent may (i) retain, or instruct the relevant Securities Intermediary or Depositary Bank to retain, all cash and investments then held in any Collateral Account, (ii) liquidate, or instruct the relevant Depositary Bank to liquidate, any or all investments held therein and/or (iii) withdraw any amounts held therein and apply such amounts as provided in Section 22. (g) If immediately available cash on deposit in all Collateral Accounts is not sufficient to make any distribution or withdrawal to be made pursuant hereto, the Agent will cause to be liquidated, as promptly as practicable, such 33 investments held in or credited to one or more such Collateral Account as shall be required to obtain sufficient cash to make such distribution or withdrawal and, notwithstanding any other provision hereof, such distribution or withdrawal shall not be made until such liquidation has taken place. Section 18. Transfer of Record Ownership. (a) At any time when an Event of Default shall have occurred and be continuing, the Agent may (and to the extent that action by it is required, the relevant Lien Grantor, if directed to do so by the Agent, will as promptly as practicable): (i) cause each of the Pledged Securities (or any portion thereof specified in such direction) to be (x) transferred of record into the name of the Agent or its nominee or (y) credited to the relevant Lien Grantor's Investment Property Collateral Account; and (ii) cause the Financial Asset underlying each Pledged Security Entitlement to be credited to the relevant Lien Grantor's Investment Property Collateral Account; provided that no such action shall be taken with respect to any capital stock of any Regulated Subsidiary unless any and all regulatory approvals required under applicable law shall have been obtained. Each Lien Grantor will take any and all actions reasonably requested by the Agent to facilitate compliance with this subsection. (b) Perfection upon Transfer of Record Ownership. If and when any Pledged Security (whether certificated or uncertificated) owned by such Lien Grantor is transferred of record into the name of the Agent or its nominee pursuant to Section 18(a), (i) the Transaction Lien on such Pledged Security will be perfected, subject to no prior Liens or rights of others, (ii) the Agent will have Control of such Pledged Security and (iii) the Agent will be a protected purchaser (within the meaning of UCC Section 8-303) thereof. If and when any Pledged Security owned by such Lien Grantor is credited to its Investment Property Collateral Account pursuant to Section 18(a), Section 13(h) will apply to the resulting Security Entitlement. (c) Provisions Inapplicable after Transfer of Record Ownership. If the provisions of Section 18(a) are implemented, Sections 13(b) and 13(c) shall not thereafter apply to (i) any Pledged Security that is registered in the name of the Agent or its nominee or (ii) any Security Entitlement in respect of which the Agent or its nominee is the Entitlement Holder. (d) Communications after Transfer of Record Ownership. The Agent will promptly give to the relevant Lien Grantor copies of any notices and other 34 communications received by the Agent with respect to (i) Pledged Securities registered in the name of the Agent or its nominee and (ii) Pledged Security Entitlements as to which the Agent or its nominee is the Entitlement Holder. Section 19. Right to Vote Securities. (a) Unless an Event of Default shall have occurred and be continuing, each Lien Grantor will have the right, from time to time, to vote and to give consents, ratifications and waivers with respect to any Pledged Security owned by it and the Financial Asset underlying any Pledged Security Entitlement owned by it, and the Agent will, upon receiving a written request from such Lien Grantor, promptly deliver (or cause to be delivered) to such Lien Grantor or as specified in such request such proxies, powers of attorney, consents, ratifications and waivers in respect of any such Pledged Security that is registered in the name of the Agent or its nominee or any such Pledged Security Entitlement as to which the Agent or its nominee is the Entitlement Holder, in each case as shall be specified in such request and be in form and substance reasonably satisfactory to the Agent. Unless an Event of Default shall have occurred and be continuing, the Agent will have no right to take any action which the owner of a Pledged Partnership Interest or Pledged LLC Interest is entitled to take with respect thereto, except the right to receive payments and other distributions to the extent provided herein. (b) If an Event of Default shall have occurred and be continuing, the Agent will have the right to the extent permitted by law (and, in the case of a Pledged Partnership Interest or Pledged LLC Interest, by the relevant partnership agreement, limited liability company agreement, operating agreement or other governing document) to vote, to give consents, ratifications and waivers and to take any other action with respect to the Pledged Investment Property, the other Pledged Equity Interests (if any) and the Financial Assets underlying the Pledged Security Entitlements, with the same force and effect as if the Agent were the absolute and sole owner thereof, and each Lien Grantor will take all such action as the Agent may reasonably request from time to time to give effect to such right; provided that the Agent will not have the right to vote, to give consents, ratifications or waivers or to take any other action with respect to the capital stock of any Regulated Subsidiary, in each case to the extent that such action would require prior regulatory approval under applicable law, unless such approval shall have been granted. Section 20. Certain Cash Distributions. Cash Distributions with respect to assets held in a Collateral Account shall be deposited and held therein, or withdrawn therefrom, as provided in Section 17. Cash Distributions with respect to any Pledged Equity Interest or Pledged Debt that is not held in a Collateral Account (whether held in the name of a Lien Grantor or in the name of the Agent or its nominee) shall be deposited, promptly upon receipt thereof, in a Controlled Deposit Account of the relevant Lien Grantor; provided that, if an Event of 35 Default shall have occurred and be continuing, the Agent may deposit, or direct the recipient thereof to deposit, each such Cash Distribution in the relevant Lien Grantor's Cash Collateral Account. Section 21. Remedies upon Event of Default. (a) If an Event of Default shall have occurred and be continuing, the Agent may exercise (or cause its sub-agents to exercise) any or all of the remedies available to it (or to such sub-agents) under the Security Documents. (b) Without limiting the generality of the foregoing, if an Event of Default shall have occurred and be continuing, the Agent may exercise on behalf of the Secured Parties all the rights of a secured party under the UCC (whether or not in effect in the jurisdiction where such rights are exercised) with respect to any Collateral and, in addition, the Agent may, without being required to give any notice, except as herein provided or as may be required by mandatory provisions of law, withdraw all cash held in the Collateral Accounts and apply such cash as provided in Section 22 and, if there shall be no such cash or if such cash shall be insufficient to pay all the Secured Obligations in full, sell, lease, license or otherwise dispose of the Collateral or any part thereof; provided that the right of the Agent to sell or otherwise dispose of the capital stock of any Regulated Subsidiary shall be subject to the Agent or the relevant Lien Grantor obtaining, to the extent necessary under applicable law, the prior approval of such sale or other disposition by the governmental body or official having jurisdiction with respect to such Regulated Subsidiary. Notice of any such sale or other disposition shall be given to the relevant Lien Grantor(s) as required by Section 24. (c) Without limiting the generality of the foregoing, if an Event of Default shall have occurred and be continuing: (i) the Agent may license or sublicense, whether general, special or otherwise, and whether on an exclusive or non-exclusive basis, any Pledged intellectual property (including any Pledged Recordable Intellectual Property) throughout the world for such term or terms, on such conditions and in such manner as the Agent shall in its sole discretion determine; provided that such licenses or sublicenses do not conflict with any existing license of which the Agent shall have received a copy; (ii) the Agent may (without assuming any obligation or liability thereunder), at any time and from time to time, in its sole and reasonable discretion, enforce (and shall have the exclusive right to enforce) against any licensee or sublicensee all rights and remedies of any Lien Grantor in, to and under any of its Pledged intellectual property and take or refrain from taking any action under any thereof, and each Lien Grantor releases the Agent and each other Secured Party from liability for, and agrees to 36 hold the Agent and each other Secured Party free and harmless from and against any claims and expenses arising out of, any lawful action so taken or omitted to be taken with respect thereto, except for claims and expenses arising from the Agent's or such Secured Party's gross negligence or willful misconduct; and (iii) upon request by the Agent (which shall not be construed as implying any limitation on its rights or powers), each Lien Grantor will execute and deliver to the Agent a power of attorney, in form and substance satisfactory to the Agent, for the implementation of any sale, lease, license or other disposition of any of such Lien Grantor's Pledged intellectual property or any action related thereto. In connection with any such disposition, but subject to any confidentiality restrictions imposed on such Lien Grantor in any license or similar agreement, such Lien Grantor will supply to the Agent its know-how and expertise relating to the relevant intellectual property or the products or services made or rendered in connection with such intellectual property, and its customer lists and other records relating to such intellectual property and to the distribution of said products or services. Section 22. Application of Proceeds. (a) If an Event of Default shall have occurred and be continuing, the Agent may apply (i) any cash held in the Collateral Accounts and (ii) the proceeds of any sale or other disposition of, or any collections (including in the form of interest, dividends, redemption payments and other distributions in respect of any D&O Loan Collateral or any Equity Interests) on, all or any part of the Collateral, in the following order of priorities: first, to pay the expenses of such sale or other disposition or collection, including reasonable compensation to agents of and counsel for the Agent, and all expenses, liabilities and advances incurred or made by the Agent in connection with the Security Documents, and any other amounts then due and payable to the Agent pursuant to Section 23 or pursuant to Sections 10.04 or 10.05 of the Credit Agreement; second, (x) if such proceeds or collections are received in respect of all or any part of the 1999 Facility Collateral, to pay the unpaid Secured Obligations in respect of the Tranche A-2 Term Borrowings and Tranche B-2 Term Borrowings, ratably to the extent of proceeds or collections so received until payment in full of all such Secured Obligations shall have been made and (y) if such proceeds or collections are received in respect of any of the D&O Loan Collateral, to pay the unpaid Secured Obligations in respect of the Tranche A-2 Term Borrowings, Tranche A-3 Term Borrowings, Tranche B-2 Term Borrowings and Tranche B-3 Term Borrowings, ratably to the extent of proceeds or collections so received 37 until payment in full of all such Secured Obligations shall have been made; third, until such time as the Tranche A-2 Term Borrowings and the Tranche B-2 Term Borrowings shall have been repaid in an aggregate principal amount equal to $32,500,000 pursuant to Section 2.08(d) of the Credit Agreement or pursuant to this clause third, to pay unpaid Secured Obligations in respect of the Tranche A-2 Term Borrowings and Tranche B-2 Term Borrowings ratably to the extent of proceeds so received until payment in full of such Secured Obligations shall have been made; fourth, to pay the unpaid principal of the Secured Obligations ratably, until payment in full of the principal of all Secured Obligations shall have been made; fifth, to pay ratably all interest (including Post-Petition Interest) on the Secured Obligations; sixth, to pay all other Secured Obligations ratably, until payment in full of all such other Secured Obligations shall have been made; and finally, to pay to the relevant Lien Grantor, or as a court of competent jurisdiction may direct, any surplus then remaining from the proceeds of the Collateral owned by it; provided that Collateral owned by a Subsidiary Guarantor and any proceeds thereof shall be applied pursuant to the foregoing clauses first, second, third, fourth, fifth and sixth only to the extent permitted by the limitation in Section 2(i). The Agent may make such distributions hereunder in cash or in kind or, on a ratable basis, in any combination thereof. (b) In making the payments and allocations required by this Section, the Agent may rely upon information supplied to it pursuant to Section 26(h). All distributions made by the Agent pursuant to this Section shall be final (except in the event of manifest error) and the Agent shall have no duty to inquire as to the application by any Secured Party of any amount distributed to it. Section 23. Fees and Expenses; Indemnification. (a) The Company will promptly upon demand (together with, in the case of clauses (i), (ii) and (iv) below, if requested by the Company, backup documentation supporting such demand) pay to the Agent: (i) the amount of any taxes that the Agent may have been required to pay by reason of the Transaction Liens or to free any Collateral from any other Lien thereon; 38 (ii) the amount of any and all reasonable out-of-pocket expenses, including transfer taxes and reasonable fees and expenses of counsel and other experts, that the Agent may incur in connection with (x) the administration or enforcement of the Security Documents, including such expenses as are incurred to preserve the value of the Collateral or the validity, perfection, rank or value of any Transaction Lien, (y) the collection, sale or other disposition of any Collateral or (z) the exercise by the Agent of any of its rights or powers under the Security Documents; (iii) the amount of any fees that the Company shall have agreed in writing to pay to the Agent and that shall have become due and payable in accordance with such written agreement; and (iv) the amount required to indemnify the Agent for, or hold it harmless and defend it against, any loss, liability or expense (including the reasonable fees and expenses of its counsel and any experts or sub-agents appointed by it hereunder) incurred or suffered by the Agent in connection with the Security Documents, except to the extent that such loss, liability or expense arises from the Agent's gross negligence or willful misconduct or a breach of any duty that the Agent has under this Agreement (after giving effect to Sections 25 and 26). Any such amount not paid to the Agent on demand will bear interest for each day thereafter until paid at a rate per annum equal to 5.25% plus the Base Rate. (b) If any transfer tax, documentary stamp tax or other tax is payable in connection with any transfer or other transaction provided for in the Security Documents, the Company will pay such tax and provide any required tax stamps to the Agent or as otherwise required by law. (c) The Company shall indemnify each of the Secured Parties, their respective affiliates and the respective directors, officers, agents and employees of the foregoing (each an "Indemnitee") against, and hold each Indemnitee harmless from, any and all liabilities, losses, damages, costs and expenses of any kind (including reasonable expenses of investigation by engineers, environmental consultants and similar technical personnel and reasonable fees and disbursements of counsel) arising out of, or in connection with any and all Environmental Claims. Without limiting the generality of the foregoing, each Lien Grantor waives all rights for contribution and all other rights of recovery with respect to liabilities, losses, damages, costs and expenses arising under or related to Environmental Laws that it might have by statute or otherwise against any Indemnitee. 39 Section 24. Authority to Administer Collateral. Each Lien Grantor irrevocably appoints the Agent its true and lawful attorney, with full power of substitution, in the name of such Lien Grantor, any Secured Party or otherwise, for the sole use and benefit of the Secured Parties, but at the Company's expense, to the extent permitted by law to exercise, at any time and from time to time while an Event of Default shall have occurred and be continuing, all or any of the following powers with respect to all or any of such Lien Grantor's Collateral: (a) to demand, sue for, collect, receive and give acquittance for any and all monies due or to become due upon or by virtue thereof, (b) to settle, compromise, compound, prosecute or defend any action or proceeding with respect thereto, (c) to sell, lease, license or otherwise dispose of the same or the proceeds or avails thereof, as fully and effectually as if the Agent were the absolute owner thereof, and (d) to extend the time of payment of any or all thereof and to make any allowance or other adjustment with reference thereto; provided that, except in the case of Collateral that is perishable or threatens to decline speedily in value or is of a type customarily sold on a recognized market, the Agent will give the relevant Lien Grantor at least ten days' prior written notice of the time and place of any public sale thereof or the time after which any private sale or other intended disposition thereof will be made. Any such notice shall (i) contain the information specified in UCC Section 9-613, (ii) be Authenticated and (iii) be sent to the parties required to be notified pursuant to UCC Section 9-611(c); provided that, if the Agent fails to comply with this sentence in any respect, its liability for such failure shall be limited to the liability (if any) imposed on it as a matter of law under the UCC. Section 25. Limitation on Duty in Respect of Collateral. Beyond the exercise of reasonable care in the custody and preservation thereof, the Agent will have no duty as to any Collateral in its possession or control or in the possession or control of any sub-agent or bailee or any income therefrom or as to the preservation of rights against prior parties or any other rights pertaining thereto. The Agent will be deemed to have exercised reasonable care in the custody and preservation of the Collateral in its possession or control if such Collateral is accorded treatment substantially equal to that which it accords its own property, and will not be liable or responsible for any loss or damage to any Collateral, or for any diminution in the value thereof, by reason of any act or omission of any sub-agent or bailee selected by the Agent in good faith, except to the extent that such liability arises from the Agent's gross negligence or willful misconduct. 40 Section 26. General Provisions Concerning the Agent. (a) Appointment and Authorization; "Agent". The Agent is hereby irrevocably appointed, designated and authorized to take such actions under the provisions of this Agreement and each other Security Document and to exercise such powers and perform such duties as are expressly delegated to it by the terms of this Agreement or any other Security Document, together with such actions and powers as are reasonably incidental thereto. Notwithstanding any provision to the contrary contained elsewhere herein or in any other Security Document, the Agent shall not have any duties or responsibilities, except those expressly set forth herein, nor shall the Agent have or be deemed to have any fiduciary relationship with any Secured Party, and no implied covenants, functions, responsibilities, duties, obligations or liabilities shall be read into this Agreement or any other Security Document or otherwise exist against the Agent. Without limiting the generality of the foregoing sentence, the use of the term "agent" herein and in the other Security Documents with reference to the Agent is not intended to connote any fiduciary or other implied (or express) obligations arising under agency doctrine of any applicable law. Instead, such term is used merely as a matter of market custom, and is intended to create or reflect only an administrative relationship between independent contracting parties. (b) Delegation of Duties. The Agent may execute any of its duties under this Agreement or any other Security Document by or through agents, employees or attorneys-in-fact and shall be entitled to advice of counsel and other consultants or experts concerning all matters pertaining to such duties. The Agent shall not be responsible for the negligence or misconduct of any agent or attorney-in-fact that it selects in the absence of gross negligence or willful misconduct. The exculpatory provisions of Section 25 and this Section shall apply to any such agent, employee or attorney-in-fact. (c) Liability of Agent. No Agent-Related Person shall (i) be liable for any action taken or omitted to be taken by any of them under or in connection with this Agreement or any other Security Document or the transactions contemplated hereby (except for its own gross negligence or willful misconduct in connection with its duties expressly set forth herein) or (ii) be responsible in any manner to any Secured Party for any recital, statement, representation or warranty made by the Company or any Subsidiary or Affiliate thereof, or any officer thereof, contained herein or in any other Security Document, or in any certificate, report, statement or other document referred to or provided for in, or received by the Agent under or in connection with, this Agreement or any other Security Document, or the validity, effectiveness, genuineness, enforceability or sufficiency of this Agreement or any other Security Document, or for any failure of the Company or any Subsidiary or Affiliate thereof or any other party to any Security Document to perform its obligations hereunder or thereunder. No Agent-Related Person shall be under any obligation to any Secured Party to ascertain or 41 to inquire as to the observance or performance of any of the agreements contained in, or conditions of, this Agreement or any other Security Document, or to inspect the properties, books or records of the Company or any Subsidiary or Affiliate thereof. The Agent shall not be responsible for the existence, genuineness or value of any Collateral or for the validity, perfection, priority or enforceability of any Transaction Lien, whether impaired by operation of law or by reason of any action or omission to act on its part under the Security Documents. (d) Reliance by Agent. The Agent shall be entitled to rely, and shall be fully protected in relying, upon any writing, communication, signature, resolution, representation, notice, consent, certificate, affidavit, letter, telegram, facsimile, telex or telephone message, electronic mail message, statement or other document or conversation believed by it to be genuine and correct and to have been signed, sent or made by the proper Person or Persons, and upon advice and statements of legal counsel (including counsel to the Company or any Subsidiary), independent accountants and other experts selected by the Agent. The Agent shall be fully justified in failing or refusing to take any action under any Security Document unless it shall first receive such advice or concurrence of the Required Banks as it deems appropriate and, if it so requests, it shall first be indemnified to its satisfaction by the Secured Parties against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any such action. The Agent shall in all cases be fully protected in acting, or in refraining from acting, under this Agreement or any other Security Document in accordance with a request or consent of the Required Banks (or such other number of Banks as may be expressly required hereby or by the Credit Agreement in any instance) and such request and any action taken or failure to act pursuant thereto shall be binding upon all the Secured Parties. (e) Notice of Default. The Agent shall not be deemed to have knowledge or notice of the occurrence of any Default, except with respect to defaults in the payment of principal, interest and fees required to be paid to the Agent for the account of the Banks, unless the Agent shall have received written notice from a Secured Party or the Company referring to the Credit Agreement, describing such Default and stating that such notice is a "notice of default." The Agent will notify the Secured Parties of its receipt of any such notice. The Agent shall take such action with respect to such Default as may be directed by the Required Banks in accordance with Article 8 of the Credit Agreement; provided, however, that unless and until the Agent has received any such direction, the Agent may (but shall not be obligated to) take such action, or refrain from taking such action, with respect to such Default as it shall deem advisable or in the best interest of the Secured Parties. (f) Agent in Individual Capacity. BofA and its Affiliates may make loans to, issue letters of credit for the account of, accept deposits from, acquire 42 equity interests in and generally engage in any kind of banking, trust, financial advisory, underwriting or other business with the Company or any of its Subsidiaries and their respective Affiliates as though BofA were not the Agent hereunder and without notice to or consent of the Secured Parties. The Secured Parties acknowledge that, pursuant to such activities, BofA or its Affiliates may receive information regarding the Company or its Subsidiaries or Affiliates (including information that may be subject to confidentiality obligations in favor of the Company, such Subsidiary or such Affiliate) and acknowledge that the Agent shall be under no obligation to provide such information to them. With respect to its Loans, BofA shall have the same rights and powers under this Agreement as any other Secured Party and may exercise such rights and powers as though it were not the Agent, and the terms "Secured Party" and "Secured Parties" include BofA in its individual capacity. (g) Successor Agent. The Agent may resign as Agent upon 30 days' notice to the Banks. If the Agent resigns under this Agreement, the Required Banks shall appoint from among the Banks a successor administrative agent for the Secured Parties, which successor administrative agent shall be consented to by the Company at all times other than during the existence of an Event of Default (which consent of the Company shall not be unreasonably withheld or delayed). If no successor administrative agent is appointed prior to the effective date of the resignation of the Agent, the Agent may appoint, after consulting with the Banks and the Company, a successor administrative agent from among the Banks. Upon the acceptance of its appointment as successor administrative agent hereunder, the Person acting as such successor administrative agent shall succeed to all the rights, powers and duties of the retiring Agent and the term "Agent" shall mean such successor administrative agent and the retiring Agent's appointment, powers and duties as Agent shall be terminated. After any retiring Agent's resignation hereunder as Agent, the provisions of this Section, Article 9 of the Credit Agreement and Section 10.04 and 10.05 of the Credit Agreement shall inure to its benefit and to the benefit of the Agent-Related Persons as to any actions taken or omitted to be taken by it while it was Agent under this Agreement. If no successor administrative agent has accepted appointment as Agent by the date which is 30 days following a retiring Agent's notice of resignation, the retiring Agent's resignation shall nevertheless thereupon become effective and the Banks shall perform all of the duties of the Agent hereunder until such time, if any, as the Required Banks appoint a successor agent as provided for above. (h) Information as to Secured Obligations and Actions by Secured Parties. For all purposes of the Security Documents, including determining the amounts of the Secured Obligations or whether any action has been taken under any Secured Agreement, the Agent will be entitled to rely on information from (i) its own records for information as to the Banks, their Secured Obligations and actions taken by them; (ii) any Secured Party for information as to its Secured 43 Obligations and actions taken by it, to the extent that the Agent has not obtained such information from the foregoing sources; and (iii) the Company, to the extent that the Agent has not obtained information from the foregoing sources. (i) Within two Business Days after it receives or sends any notice referred to in this subsection, the Agent shall send to the Banks and each Secured Party Requesting Notice, copies of any notice given by the Agent to any Lien Grantor, or received by it from any Lien Grantor, pursuant to Section 21, 22, 24, 26(g), or 27. (j) The Agent may refuse to act on any notice, consent, direction or instruction from any Secured Parties or any agent, trustee or similar representative thereof that, in the Agent's opinion, (i) is contrary to law or the provisions of any Security Document, (ii) may expose the Agent to liability (unless the Agent shall have been indemnified, to its reasonable satisfaction, for such liability by the Secured Parties that gave such notice, consent, direction or instruction) or (iii) is unduly prejudicial to Secured Parties not joining in such notice, consent, direction or instruction. Section 27. Termination of Transaction Liens; Release of Collateral. (a) The Transaction Liens granted by each Subsidiary Guarantor shall terminate when its Secured Guarantee is released pursuant to Section 2(c). (b) The Transaction Liens granted by the Company shall terminate when all the Release Conditions are satisfied. (c) At any time before the Transaction Liens granted by the Company terminate, the Agent may, at the written request of the Company, (i) release any Collateral (but not all or any substantial part of the Collateral) with the prior written consent of the Required Banks or (ii) release all or any substantial part of the Collateral with the prior written consent of each Bank; provided that (w) any release of any 1999 Facility Collateral (but not all or any substantial part of the 1999 Facility Collateral) shall also require the prior written consent of the Required 1999 D&O Banks (provided that no such consent shall be required in connection with the Proposed CIHC Transactions), (x) any release of all or any substantial part of the 1999 Facility Collateral shall also require the prior written consent of each Tranche A-2 Bank and Tranche B-2 Bank, (y) any release of any D&O Loan Collateral (but not all or any substantial part of the D&O Loan Collateral) shall also require the prior written consent of the Required D&O Banks and (z) any release of all or any substantial part of the D&O Loan Collateral shall also require the prior written consent of each Tranche A-2 Bank, Tranche A-3 Bank, Tranche B-2 Bank and Tranche B-3 Bank. 44 (d) Concurrently with any sale, lease or other disposition (except a sale or disposition to another Lien Grantor or a lease) permitted by the proviso to Section 5(e), the Transaction Liens on the assets sold or disposed of (but not in any Proceeds arising from such sale or disposition) will cease immediately without any action by the Agent or any other Secured Party. (e) Upon any termination of a Transaction Lien or release of Collateral, the Agent will, at the expense of the relevant Lien Grantor, execute and deliver to such Lien Grantor such documents as such Lien Grantor shall reasonably request to evidence the termination of such Transaction Lien or the release of such Collateral, as the case may be. Section 28. Additional Subsidiary Guarantors and Lien Grantors. Any Subsidiary may become a party hereto by signing and delivering to the Agent a Security Agreement Supplement, whereupon such Subsidiary shall become a "Subsidiary Guarantor" and a "Lien Grantor" as defined herein. Section 29. Notices. (a) Unless otherwise expressly provided herein, all notices and other communications provided for hereunder shall be in writing (including by facsimile transmission). All such written notices shall be mailed, faxed or delivered to the applicable address, facsimile number (provided that any matter transmitted by the Company by facsimile (1) shall be immediately confirmed by a telephone call to the recipient at the number specified below and (2) shall be followed promptly by delivery of a hard copy original thereof) or (subject to subsection (c) below) electronic mail address, and all notices and other communications expressly permitted hereunder to be given by telephone shall be made to the applicable telephone number, as follows: (i) if to the Company or the Agent, to the address, facsimile number, electronic mail address or telephone number specified for such Person on Schedule 10.02 of the Credit Agreement or to such other address, facsimile number, electronic mail address or telephone number as shall be designated by such party in a notice to the other parties; (ii) if to any Bank, to the Agent to be forwarded to such Bank at its address, facsimile number, electronic mail address or telephone number specified in its administrative questionnaire or to such other address, facsimile number, electronic mail address or telephone number as shall be designated by such party in a notice to the Company and the Agent; (iii) if to any Subsidiary Guarantor listed on the signature pages hereof, to the Company as set forth above to be forwarded to such Subsidiary Guarantor at its address, facsimile number, electronic mail 45 address or telephone number designated by such party in a notice to the Company; (iv) if to any other Subsidiary Guarantor, to the address, facsimile number, electronic mail address or telephone number specified for such Person in its first Security Agreement Supplement or to such other address, facsimile number, electronic mail address or telephone number as shall be designated by such party in a notice to the other parties; and (v) if to any Secured Party Requesting Notice, to such address, facsimile number, electronic mail address or telephone number as such party may hereafter specify for the purpose by notice to the Agent. All such notices and other communications shall be deemed to be given or made upon the earlier to occur of (i) actual receipt by the relevant party hereto and (ii) (A) if delivered by hand or by courier, when signed for by or on behalf of the relevant party hereto; (B) if delivered by mail, four Business Days after deposit in the mails, postage prepaid; (C) if delivered by facsimile, when sent and receipt has been confirmed by telephone; and (D) if delivered by electronic mail (which form of delivery is subject to the provisions of subsection (c) below), when delivered. In no event shall a voicemail message be effective as a notice, communication or confirmation hereunder. (b) This Agreement and the other Security Documents may be transmitted and/or signed by facsimile. The effectiveness of any such documents and signatures shall, subject to applicable law, have the same force and effect as manually-signed originals and shall be binding on the Company, all Subsidiary Guarantors, the Secured Parties and the Agent. The Agent may also require that any such documents and signatures be confirmed by a manually-signed original thereof; provided, however, that the failure to request or deliver the same shall not limit the effectiveness of any facsimile document or signature. (c) Electronic mail and Internet and intranet websites may be used only to distribute routine communications and to distribute this Agreement and other Security Documents for execution by the parties thereto, and may not be used for any other purpose. (d) The Agent and the Banks shall be entitled to rely and act upon any notices purportedly given by or on behalf of the Company or any Subsidiary Guarantor even if (i) such notices were not made in a manner specified herein, were incomplete or were not preceded or followed by any other form of notice specified herein or (ii) the terms thereof, as understood by the recipient, varied from any confirmation thereof. The Company and the Subsidiary Guarantors 46 shall jointly and severally indemnify each Agent-Related Person and each Secured Party from all losses, costs, expenses and liabilities resulting from the reliance by such Person on each notice purportedly given by or on behalf of the Company or any Subsidiary Guarantor; provided that such indemnity shall not, as to any Person, be available to the extent that such losses, costs, expenses or liabilities are determined by a court of competent jurisdiction by final and nonappealable judgment to have resulted from the gross negligence or willful misconduct of such Person. All telephonic notices to and other communications with the Agent may be recorded by the Agent, and each of the parties hereto hereby consents to such recording. Section 30. No Implied Waivers; Remedies Not Exclusive. No failure by the Agent or any Secured Party to exercise, and no delay in exercising and no course of dealing with respect to, any right or remedy under any Security Document shall operate as a waiver thereof; nor shall any single or partial exercise by the Agent or any Secured Party of any right or remedy under any Loan Document preclude any other or further exercise thereof or the exercise of any other right or remedy. The rights and remedies specified in the Loan Documents are cumulative and are not exclusive of any other rights or remedies provided by law. Section 31. Successors and Assigns. This Agreement is for the benefit of the Agent and the Secured Parties. If all or any part of any Secured Party's interest in any Secured Obligation is assigned or otherwise transferred, the transferor's rights hereunder, to the extent applicable to the obligation so transferred, shall be automatically transferred with such obligation. This Agreement shall be binding on the Lien Grantors and their respective successors and assigns. Section 32. Amendments and Waivers. Neither this Agreement nor any provision hereof may be waived, amended, modified or terminated except pursuant to an agreement or agreements in writing entered into by the parties hereto, with the consent of such Banks as are required to consent thereto under Section 10.01 of the Credit Agreement; provided that in no event shall any waiver, amendment, modification or termination change any provision hereof in a manner that (i) by its terms adversely affects the rights of the Tranche A-2 Banks or Tranche B-2 Banks in respect of the 1999 Facility Collateral or pursuant to clause third of Section 22(a) without the prior written consent of the Required 1999 D&O Banks and (ii) by its terms adversely affects the rights of the Tranche A-2 Banks, Tranche A-3 Banks, Tranche B-2 Banks or Tranche B-3 Banks in respect of the D&O Loan Collateral without the prior written consent of the Required D&O Banks. 47 Section 33. Choice of Law. This Agreement shall be construed in accordance with and governed by the laws of the State of New York, except as otherwise required by mandatory provisions of law and except to the extent that remedies provided by the laws of any jurisdiction other than the State of New York are governed by the laws of such jurisdiction. Section 34. Waiver of Jury Trial. EACH PARTY TO THIS AGREEMENT HEREBY EXPRESSLY WAIVES ANY RIGHT TO TRIAL BY JURY OF ANY CLAIM, DEMAND, ACTION OR CAUSE OF ACTION ARISING UNDER ANY SECURITY DOCUMENT OR IN ANY WAY CONNECTED WITH OR RELATED OR INCIDENTAL TO THE DEALINGS OF THE PARTIES HERETO OR ANY OF THEM WITH RESPECT TO ANY SECURITY DOCUMENT, OR THE TRANSACTIONS RELATED THERETO, IN EACH CASE WHETHER NOW EXISTING OR HEREAFTER ARISING, AND WHETHER FOUNDED IN CONTRACT OR TORT OR OTHERWISE; AND EACH PARTY HEREBY AGREES AND CONSENTS THAT ANY SUCH CLAIM, DEMAND, ACTION OR CAUSE OF ACTION SHALL BE DECIDED BY COURT TRIAL WITHOUT A JURY, AND THAT ANY PARTY TO THIS AGREEMENT MAY FILE AN ORIGINAL COUNTERPART OR A COPY OF THIS SECTION WITH ANY COURT AS WRITTEN EVIDENCE OF THE CONSENT OF THE SIGNATORIES HERETO TO THE WAIVER OF THEIR RIGHT TO TRIAL BY JURY. THIS WAIVER SHALL APPLY TO ANY SUBSEQUENT AMENDMENTS, RENEWALS, SUPPLEMENTS OR MODIFICATIONS TO THIS AGREEMENT AND THE OTHER SECURITY DOCUMENTS. Section 35. Severability. If any provision of any Security Document is invalid or unenforceable in any jurisdiction, then, to the fullest extent permitted by law, (i) the other provisions of the Security Documents shall remain in full force and effect in such jurisdiction and shall be liberally construed in favor of the Agent and the Secured Parties in order to carry out the intentions of the parties thereto as nearly as may be possible and (ii) the invalidity or unenforceability of such provision in such jurisdiction shall not affect the validity or enforceability thereof in any other jurisdiction. 48 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed by their respective authorized officers as of the day and year first above written. CONSECO, INC. By:/s/William J. Shea -------------------------------------------- Name: William J. Shea Title: President and Chief Executive Officer BANK OF AMERICA, N.A., as Agent By:/s/Molly J. Oxford ----------------------------------------- Name: Molly J. Oxford Title: Vice President Subsidiary Guarantors: AMERICAN LIFE AND CASUALTY MARKETING DIVISION CO. CDOC, INC. CFIHC, INC. CIHC, INCORPORATED CONSECO GROUP RISK MANAGEMENT COMPANY CONSECO MANAGEMENT SERVICES COMPANY CONSECO MARKETING, L.L.C. CONSECO SERVICES, By:/s/ William J. Shea --------------------------------- Name: William J. Shea Title: President CODELINKS, LLC By: CIHC, Incorporated, its Manager By:/s/ William J. Shea --------------------------------- Name: William J. Shea Title: President CONSECO CAPITAL MANAGEMENT, INC. CONSECO MORTGAGE CAPITAL, INC. By:/s/ Maxwell E. Bublitz ---------------------------------- Name: Maxwell E. Bublitz Title: President and Chief Executive Officer CONSECO EQUITY SALES, INC. PERFORMANCE MATTERS ASSOCIATES, INC. PERFORMANCE MATTERS ASSOCIATES OF TEXAS, INC. By:/s/ Daniel J. Murphy ---------------------------------- Name: Daniel J. Murphy Title: Senior Vice President and Treasurer CONSECO SERVICES, LLC By: Conseco Management Services Company, its Manager By:/s/ William J. Shea ---------------------------------- Name: William J. Shea Title: President SCHEDULE 1 EQUITY INTERESTS IN SUBSIDIARIES AND AFFILIATES OWNED BY ORIGINAL LIEN GRANTORS (as of the Effective Date)
Number of Shares/Units Percentage Owned by Original Lien Grantor Issuer (jurisdiction) Held By Lien Grantor Lien Grantor - ---------------------------- ------------------------------ ------------------------- ------------------------- American Life and Casualty None N/A N/A Marketing Division Co. (IA) CDOC, Inc. (DE) CIHC, Incorporated of Texas 1,000 shares common stock 100 (TX) CFIHC, Inc. (DE) Conseco Global Investments, 100 shares common stock 100 Inc. (DE) Conseco Mortgage Capital, 100 shares common stock 100 Inc. (DE) Conseco Private Capital 100 shares common stock 100 Group, Inc. (IN) Marketing Distribution 3,000 shares common stock 100 Systems Consulting Group, Inc. (DE) Performance Matters 1,000 shares common stock 100 Associates, Inc. (DE) CIHC, Incorporated (DE) Administrators Service 1,000 shares common stock 100 Corporation (IL) American Life and Casualty 1,000 shares common stock 100 Marketing Division Co. (IA) Automobile Underwriters 438,000 shares common stock 100 Corporation (IA) Bankers National Life 250,000 shares common stock 100 Insurance Company (TX)
Number of Shares/Units Percentage Owned by Original Lien Grantor Issuer (jurisdiction) Held By Lien Grantor Lien Grantor - ---------------------------- ------------------------------ ------------------------- ------------------------- Business Information Group, 100,000 shares 100 Inc. (IL) common stock CFIHC, Inc. (DE) 100 shares common 100 stock CNC Entertainment Nevada, 500 shares common 100 Inc. (NV) stock CNC Real Estate, Inc. (DE) 100 shares common 100 stock CTIHC, Inc. (DE) 100 shares common 100 stock Codelinks Data Services 499,980 equity shares(3) 99.006 Private Limited (India)(7) Codelinks, LLC (IN) Uncertificated 100 Conseco Entertainment L.L.C. Uncertificated 1 (IN)(1) Conseco Group Risk 1,000 shares common 100 Management Company (MS) stock Conseco Health Services, 100 shares common stock 100 Inc. (PA) Conseco L.L.C. (DE)(2) Uncertificated 90 Conseco Life Insurance 250,000 shares common 100 (Bermuda) Limited (Bermuda) stock(3) - ------------------------- 1 CIHC, Incorporated holds 1% of the outstanding equity interests in Conseco Entertainment L.L.C. The remaining 99% is held by Conseco Entertainment, Inc., an Immaterial Subsidiary. 2 CIHC, Incorporated holds 90% of the outstanding equity interests in Conseco L.L.C. The remaining 10% is held by Conseco, Inc. 3 Under the terms of the Loan Documents, the Agent will only receive a pledge of 65% of the outstanding stock of this entity.
Number of Shares/Units Percentage Owned by Original Lien Grantor Issuer (jurisdiction) Held By Lien Grantor Lien Grantor - ---------------------------- ------------------------------ ------------------------- ------------------------- Conseco Life Insurance 700,000 shares 100 Company of Texas (TX) common stock Conseco Management Services 48,150 shares common 100 Company (TX) stock Conseco Securities, Inc. (DE) 1,500 shares common 100 stock Conseco Services, LLC (IN)(4) Uncertificated 89.1 Conseco Teleservices, Inc. 1,000 shares common 100 (DE) stock Conseco Travel and Event 1,000 shares common 100 Services, Inc. (CO) stock Consumer Acceptance 22,522,000 shares 100 Corporation (IN) common stock Design Benefit Plans, Inc. 1,000,000 shares of 100 (IL) voting common stock Design Securities 26,000 shares of 100 Corporation (DE) common stock Direct Financial Services, 1,000 shares common 100 Inc. (IL) stock Eagles' National Corporation 164,191 shares 100 (KY) common stock Geneva International 100,000 shares of 100 Insurance Company (Turks & common stock(3) Caicos) Hawthorne Advertising Agency 1,000 shares common 100 Incorporated (PA) stock Independent Processing 1,000 shares common 100 Services, Inc. (DE) stock - --------------------- 4 CIHC, Incorporated holds 89.1% of the outstanding equity interests in Conseco Services LLC. The remaining 10.9% of the interests are held by Conseco, Inc. (9.9%) and Conseco Management Services Company holds (1%).
Number of Shares/Units Percentage Owned by Original Lien Grantor Issuer (jurisdiction) Held By Lien Grantor Lien Grantor - ---------------------------- ------------------------------ ------------------------- ------------------------- Integrated Networks, Inc. 1,000 shares common 100 (IL) stock K.F. Agency, Inc. (IL) 500 shares common 100 stock K.F. Insurance Agency of 1,000 shares common 100 Massachusetts, Inc. (MA) stock NAL Financial Group, Inc. 1,000 shares class A 100 (DE) common stock 1,000 shares class B common stock 5,000,000 shares Series A preferred stock PL Holdings, Inc. (NV) 1000 shares common 100 stock ResortPort Holding of 100 shares common 100 Delaware, Inc. (DE) stock Target Ad Group, Inc. (IL) 1,000 shares of common 100 stock Codelinks, LLC (IN) None N/A N/A Conseco Capital None N/A N/A Management, Inc. (DE) Conseco Equity Sales, Inc. None N/A N/A (TX) Conseco Group Risk None N/A N/A Management Company (MS) Conseco Management Conseco Services, LLC Uncertificated 1 Services Company (IN)(4) (TX) Conseco Marketing, L.L.C. Uncertificated 1 (IN)(5)
Number of Shares/Units Percentage Owned by Original Lien Grantor Issuer (jurisdiction) Held By Lien Grantor Lien Grantor - ---------------------------- ------------------------------ ------------------------- ------------------------- Conseco Marketing, L.L.C. None N/A N/A (IN) Conseco Mortgage Capital, None N/A N/A Inc. (DE) Conseco Services, LLC (IN) Conseco Marketing, L.L.C. Uncertificated 90 (IN)(5) Conseco, Inc. (DE) CDOC, Inc. (DE) 100 shares common stock 100 CIHC, Incorporated (DE)(6) 1,000 shares common *6 stock Codelinks Data Services 20 equity shares(3) .004 Private Limited (India) (7) Conseco Capital Management, 100 shares common stock 100 Inc. (DE) Conseco Entertainment Inc. 100 shares common stock 100 (IN) Conseco Equity Sales, Inc. 10,000 shares common 100 (TX) stock Conseco HPLP, L.L.C. (IN)(8) Uncertificated 99 Conseco L.L.C. (DE)(2) Uncertificated 10 - --------------------------- 5 Conseco Management Services Company holds 1% of the outstanding equity interests in Conseco Marketing, L.L.C. The remaining 10% of the interests are held by Conseco, Inc. (9%) and Conseco Services, LLC (90%). 6 Conseco, Inc. (DE) holds 1,000 of the 1,001.041 shares of the outstanding common stock in CIHC, Incorporated. The remaining 1.041 shares of common stock are owned by Conseco Annuity Assurance Company. The following entities own preferred stock in CIHC, Incorporated: Bankers Life and Casualty Company; Conseco Annuity Assurance Company; Conseco Life Insurance Company; and, Washington National Insurance Company. 7 CIHC, Incorporated holds 99.006% of the outstanding equity interests in Codelinks Data Services Private Limited. The remaining .004% is held by Conseco, Inc. (DE). 8 Conseco, Inc. holds 99% of the outstanding equity interests in Conseco HPLP, L.L.C. The remaining 1% is held by Conseco Entertainment, Inc., an Immaterial Subsidiary.
Number of Shares/Units Percentage Owned by Original Lien Grantor Issuer (jurisdiction) Held By Lien Grantor Lien Grantor - ---------------------------- ------------------------------ ------------------------- ------------------------- Conseco Marketing, L.L.C. Uncertificated 9 (IN)(5) Conseco Risk Management, 100 shares common stock 100 Inc. (IN) Conseco Services, LLC (IN)(4) Uncertificated 9.9 Design Benefit Plans, Inc. Continental Marketing 1,000 shares common stock 100 (IL) Corporation of Illinois, Inc. (IL) Performance Matters Performance Matters 20,000 shares common 100 Associates, Inc. (DE) Associates of Kansas, Inc. stock (KS) Performance Matters 1,000 shares common stock 100 Associates of Ohio, Inc. (OH) Performance Matters 1,000 shares common stock 100 Associates of Texas, Inc. (TX) Performance Matters None N/A N/A Associates of Texas, Inc. (TX) Specialty Planners, Inc. None N/A N/A (CA)
SCHEDULE 2 OTHER INVESTMENT PROPERTY (other than Equity Interests in Subsidiaries and Affiliates) OWNED BY ORIGINAL LIEN GRANTORS (as of the Effective Date) PART 1 -- Securities
Location of Owner of Securities Issuer Security ----------------------------- ------------------------ ----------------- Conseco Capital Conseco Fund Group Book entry at Management, Inc. Mutual Funds Transfer Agent (US Bancorp) Conseco Capital Conseco StockCar Book entry at Management, Inc. Stock Fund Transfer Agent (US Bankcorp) Conseco, Inc. Conseco Strategic Book entry at Income Fund Transfer Agent (PFPC)
PART 2 -- Securities Accounts The Original Lien Grantors own Security Entitlements with respect to Financial Assets credited to the following Securities Accounts:
Owner Securities Intermediary Account Type - ------------------------------------- ------------------------------------ --------------------- American Life and Casualty The Bank of New York Custody Marketing Division Co. American Life & Casualty Marketing Mellon Bank, N.A. Custody Division Co. CDOC, Inc. The Bank of New York Custody CFIHC, Inc. The Bank of New York Custody CIHC, Incorporated The Bank of New York Custody CIHC, Incorporated Mellon Bank, N.A. Custody Conseco Capital Management, Inc. The Bank of New York Custody Conseco Capital Management, Inc. Mellon Bank, N.A. Custody Conseco Group Risk Management The Bank of New York Custody Company Conseco Mortgage Capital, Inc. The Bank of New York Custody Conseco Mortgage Capital, Inc. Mellon Bank, N.A. Custody Conseco Services, LLC The Bank of New York Custody Conseco Services, LLC Mellon Bank, N.A. Custody Conseco, Inc. The Bank of New York Custody Design Benefit Plans, Inc. BNY Midwest Trust Company Custody (formerly known as CTC Illinois Trust Company)
PART 3 -- Commodity Accounts The Original Lien Grantors are Commodity Customers with respect to the following Commodity Accounts: None. SCHEDULE 3 MATERIAL COMMERCIAL TORT CLAIMS None. SCHEDULE 4 1999 FACILITY COLLATERAL "1999 Facility Collateral" means: (i) all right, title and interest of the Company in, to and under the following property of the Company, whether now owned or existing or hereafter acquired or arising and regardless of where located: (a) prior to the consummation of the Proposed CIHC Transactions, all Equity Interests in CIHC; (b) following the consummation of the Proposed CIHC Transactions, all Equity Interests in New Holdco; and (c) all Equity Interests in Conseco Capital Management, Inc. ("CCM"). (ii) all right, title and interest of CCM in, to and under the following property of CCM, whether now owned or existing or hereafter acquired or arising and regardless of where located: all Accounts, Chattel Paper, any Commercial Tort Claims described in Schedule 3 to the Security Agreement, Deposit Accounts, Documents, Equipment, General Intangibles (including any Equity Interests in other Persons that do not constitute Investment Property), Instruments, Inventory, Investment Property, Letter-of-Credit Rights, books and records (including customer lists, credit files, computer programs, printouts and other computer materials and records) of CCM pertaining to any of its Collateral and CCM's ownership interest in (A) its Collateral Accounts, (B) all Financial Assets credited to its Collateral Accounts from time to time and all Security Entitlements in respect thereof, (C) all cash held in its Collateral Accounts from time to time and (D) all other money of CCM in the possession of the Agent; and (iii) all Proceeds of the Collateral described in the foregoing clauses (i) and (ii); provided that any property that is excluded from the security interests pursuant to the proviso at the end of Section 3(a) of the Security Agreement shall also be excluded from the definition of "1999 Facility Collateral". EX-10 4 shea.txt EXHIBIT 10.5 Exhibit 10.5 EMPLOYMENT AGREEMENT -------------------- This EMPLOYMENT AGREEMENT, dated as of the 27th day of May, 2003, is between CONSECO, INC., a Delaware corporation ("Company"), and William J. Shea ("Executive"). WHEREAS Executive and Conseco, Inc., an Indiana corporation ("Old Conseco") previously entered into an agreement dated September 10, 2001, which was subsequently replaced by an Amended Employment Agreement dated June 1, 2002, whereby Executive was employed in the capacity as the President, Chief Operating Officer and acting Chief Financial Officer of Old Conseco; and WHEREAS Executive was promoted as Old Conseco's Chief Executive Officer effective as of November 19, 2002; and WHEREAS Old Conseco filed a voluntary petition under the provisions of Chapter 11 of Title 11 of the United States Code with the United States Bankruptcy Court for the Northern District of Illinois on or about December 17, 2002; and WHEREAS the retention of Executive as Chief Executive Officer and President of the Company is vital to the success of the reorganization; and WHEREAS the Company desires to employ Executive as its Chief Executive Officer and President upon the terms and conditions set forth herein. NOW, THEREFORE, for good and valuable consideration and the mutual covenants contained herein, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: 1. Employment. The Company hereby employs Executive and Executive hereby accepts employment upon the terms and conditions hereinafter set forth. 2. Term. The effective date of this agreement (the "Agreement") shall be the "Effective Date" as defined in the document commonly known as "Reorganizing Debtors' Second Amended Joint Plan of Reorganization Pursuant to Chapter 11 of the United States Bankruptcy Code", dated March 18, 2003, as amended, as filed in the bankruptcy case of Old Conseco (the "Bankruptcy Plan") (the "Effective Date"). If the Effective Date does not occur, this Agreement shall be null and void and have no force or effect, and Executive shall have no rights hereunder and shall have no claims against the Company relating to this Agreement or arising out of or relating to the failure of the Agreement to become effective. Subject to the provisions for termination as provided in Section 10 hereof and to any extension to which the parties may hereafter agree, the term of Executive's employment under this Agreement shall be the period beginning on the Effective Date, and ending on the third anniversary of the Effective Date and it shall thereafter be automatically renewed for an indefinite number of one (1) year periods unless either party sends written notice to the other party of its intention not to renew at least ninety (90) days prior to expiration of said term. If the election not to renew is made, Executive's employment hereunder shall continue for the remaining original term ending on the third anniversary of the Effective Date, or any extension periods thereafter if the original term is renewed, subject to the provisions for termination as provided in Section 10 hereof. Notwithstanding anything to the contrary, Executive shall have the right to terminate his employment for any reason during a sixty (60) day period beginning on each anniversary of the Effective Date. The original term ending on the third anniversary of the Effective Date and any extension periods thereafter are hereinafter collectively referred to as the "Term." The Term shall end upon the termination of Executive's employment with the Company. 3. Duties. During the Term, Executive shall be engaged by the Company in the capacity of Chief Executive Officer and President. Executive shall report solely and directly to the Board of Directors of the Company (the "Board"), it being understood that, from time to time, as appropriate, Executive will consult with and advise the Non-Executive Chairman of the Board with respect to matters relating to the businesses and operations of the Company and its subsidiaries. Executive shall be a member of the Board during the entire Term. 4. Extent of Services. During the Term, subject to the direction and control of the Board, Executive shall have the power and authority commensurate with his officer status and necessary to perform his duties hereunder. During the Term, the Company agrees to provide to Executive such assistance and work accommodations as are suitable to the character of his positions with the Company and adequate for the performance of his duties. Executive shall devote his entire employable time, attention and best efforts to the business of the Company and, during the Term shall not, without the consent of the Company, be actively engaged in any other business activity, whether or not such business activity is pursued for gain, profit or other pecuniary advantage; provided, however, that, subject to Section 9 hereof, this shall not be construed as preventing Executive from serving on boards of professional, community, civic, education, charitable and corporate organizations on which he presently serves or may choose to serve or investing his assets in such form or manner as will not require any services on the part of Executive in the operation of the affairs of the companies in which such investments are made; and provided further that Executive may continue to serve on the board of Demoulas Supermarkets, Inc. and, if elected, the Board of Directors of AIG Sun America Funds beginning in 2004, provided that such service does not materially interfere with the performance of his duties under this Agreement. For purposes of this Agreement, full-time employment shall be the normal work week for individuals in comparable officer positions with the Company. 5. Compensation. During the Term: (a) As compensation for services hereunder rendered during the Term hereof, Executive shall receive a base salary ("Base Salary") of One Million Dollars ($1,000,000) per year payable in equal installments in accordance with the Company's payroll procedure for its salaried executives. Salary payments and other payments under this Agreement shall be subject to withholding of taxes and other appropriate and customary amounts. Executive and the Company shall review the Base Salary on or before January 31 of each year during the Term hereof, and Executive may receive increases in his Base Salary from time to time, based upon his performance, subject to approval of the Compensation Committee of the Board. (b) In addition to Base Salary, Executive will have an opportunity to earn a bonus each year as determined by the Compensation Committee or the Board, with a target 2 annual bonus equal to one times Executive's Base Salary (the "Target Bonus") and a maximum annual bonus of two times his Base Salary with respect to any calendar year. The Target Bonus will be based on financial and other objective targets that the Compensation Committee or the Board reasonably believes are reasonably attainable at the time that they are set. (c) The Company shall provide to Executive, and, as soon as practicable after the Effective Date, the Company, Conseco Services, LLC, CIHC, Incorporated and their successors and assigns shall guarantee payment of a nonqualified supplemental retirement benefit (the "Supplemental Retirement Benefit"). The Supplemental Retirement Benefit shall provide for annual payments in an amount equal to Five Hundred Thousand Dollars ($500,000) per year commencing February 9, 2013, and continuing until the later of the death of Executive or his spouse, Susan McConologue Shea, payable in such periodic installments as Executive or, if Executive is deceased, Susan McConologue Shea shall reasonably direct. The Supplemental Retirement Benefit shall not be reduced, suspended, or otherwise affected as a result of any termination of Executive's employment. The Company shall provide Executive with evidence of the guaranty by Conseco Services, LLC and CIHC, Incorporated. (d) Executive is currently entitled to an immediate cash bonus of One Million Dollars ($1,000,000) on the Effective Date under Old Conseco's Senior Management Key Employee Retention Program (the "KERP Bonus"). The KERP Bonus shall be paid in cash on the Effective Date pursuant to the terms of the Senior Management Key Employee Retention Program. (e) On the Effective Date, Executive shall receive an option (the "Initial Option") to purchase one-half of one percent (0.5%) of the common equity of the Company issued and outstanding immediately after the consummation of the Bankruptcy Plan (determined without regard to any options or restricted stock granted to employees of the Company as of the Effective Date), with an exercise price at a plan value based on a Three Billion Eight Hundred Million Dollar ($3.8 billion) valuation of the Company. In addition, effective as of the Effective Date, Executive shall receive a number of shares of restricted stock (the "Initial Restricted Stock") equal to one-half of one percent (0.5%) of the common equity of the Company issued and outstanding immediately after the consummation of the Bankruptcy Plan (determined without regard to any options or restricted stock granted to employees of the Company as of the Effective Date). Subject to Sections 7 and 11 hereof, the Initial Option and the Initial Restricted Stock shall be granted to Executive under, and governed by the terms and conditions of the 2003 Long-Term Equity Incentive Plan; provided that the options under the Initial Option shall vest and the restrictions on the Initial Restricted Stock shall lapse in twenty-five percent (25%) increments on the first four anniversaries of the Effective Date so long as Executive has remained an employee through each such anniversary. 3 (f) Subject to Executive providing the Board with reasonably sufficient documentation of the previous approval by Old Conseco's board of directors increasing Executive's base salary on and after November 19, 2002 in conjunction with Executive's promotion to Chief Executive Officer, on the Effective Date the Company shall pay Executive a cash lump sum payment equal to Two Hundred Fifty Thousand Dollars ($250,000) multiplied by a fraction, the numerator of which is the number of days from November 19, 2002 through the Effective Date and the denominator of which is Three Hundred Sixty Five (365). 6. Fringe Benefits. During the Term: (a) Executive shall be entitled to participate in such existing executive benefit plans and insurance programs offered by the Company, or which it may adopt from time to time, for its executive management or supervisory personnel generally, in accordance with the eligibility requirements for participation therein. Nothing herein shall be construed so as to prevent the Company from modifying or terminating any executive benefit plans or programs, or executive fringe benefits, that it may adopt from time to time. (b) The Company shall pay Executive a monthly automobile allowance in the amount of Six Hundred Dollars ($600), and the Company shall pay directly or shall reimburse Executive for the cost of fuel that he incurs in using his automobile. (c) Executive shall be entitled to four (4) weeks vacation with pay each year. (d) Executive may incur reasonable expenses for promoting the Company's business, including expenses for entertainment, travel, and similar items. The Company shall reimburse Executive for all such reasonable expenses upon Executive's periodic presentation of an itemized account of such expenditures. (e) The Company shall at its expense maintain a term life insurance policy or policies on the life of Executive with a face amount of One Million Five Hundred Thousand Dollars ($1,500,000), payable to such beneficiaries as Executive may designate. Executive may, at his expense, purchase additional insurance at the time the Company purchases said policy or policies. In the event Executive terminates employment for any reason, Executive shall have the right, at his expense, to begin paying the premiums required to continue such insurance coverage from and after the date of his termination. (f) The Company shall, upon periodic presentation of satisfactory evidence and up to a maximum of Ten Thousand Dollars ($10,000) per year, reimburse Executive for reasonable medical expenses incurred by Executive and his dependents which are not otherwise covered by health insurance provided to Executive under Section 6(a). 7. Disability. If Executive shall become physically or mentally disabled during the Term to the extent that his ability to perform his duties and services hereunder is materially and adversely impaired, his Base Salary, bonus and other compensation provided herein shall continue while he remains employed by the Company; provided, that if such disability (as 4 confirmed by competent medical evidence) continues for at least nine (9) consecutive months, the Company may terminate Executive's employment hereunder, in which case the Company immediately shall, subject to Section 22 hereof, pay Executive a cash lump sum payment equal to (i) his annual Base Salary as provided in Section 5(a) hereof to the extent earned but unpaid as of the date of termination, (ii) one and one-half (1.5) times his annual Base Salary, less applicable taxes, for the most recent fiscal year then ended and (iii) all other unpaid amounts to which Executive has become entitled under this Agreement. In addition, the Initial Option shall fully vest and the restrictions on any restricted stock issued pursuant to the Initial Restricted Stock shall fully lapse as of the date of termination. No such payment of items (i) through (iii) and no such accelerated vesting of the stock options and or lapsing of restrictions on restricted stock shall be required if such disability arises primarily from (a) chronic use of intoxicants, drugs or narcotics (other than drugs prescribed to Executive by a physician and used by Executive for their intended purpose for which they had been prescribed) or (b) intentionally self-inflicted injury or intentionally self-induced sickness. If Executive's employment is terminated as a result of disability in accordance with the terms of this paragraph and payment of amounts under (i), (ii) and (iii) above is made or precluded pursuant to the preceding sentence, Executive shall not be entitled to any additional amounts under Section 11 hereof. 8. Disclosure of Information. Executive acknowledges that in and as a result of his employment with the Company, he has been and will be making use of, acquiring and/or adding to confidential information of the Company and its subsidiaries of a special and unique nature and value. As a material inducement to the Company to enter into this Agreement and to pay to Executive the compensation stated in Section 5, as well as any additional benefits stated herein, Executive covenants and agrees that he shall not, at any time while he is employed by the Company or at any time thereafter, directly or indirectly, divulge or disclose for any purpose whatsoever, any confidential information (whether or not specifically labeled or identified as "confidential information"), in any form or medium, that has been obtained by or disclosed to him as a result of his employment with the Company and which the Company or any of its subsidiaries has taken appropriate steps to safeguard, except to the extent that such confidential information (a) becomes a matter of public record or is published in a newspaper, magazine or other periodical available to the general public, other than as a result of any act or omission of Executive, (b) is required to be disclosed by any law, regulation or order of any court or regulatory commission, department or agency, in which event Executive shall give prompt notice of such requirement to the Company to enable the Company to seek an appropriate protective order or confidential treatment, or (c) must be disclosed to enable Executive properly to perform his duties under this Agreement. Upon the termination of Executive's employment, Executive shall return such information (in whatever form) obtained from or belonging to the Company or any of its subsidiaries which he may have in his possession or control. 9. Covenants Against Competition and Solicitation. Executive acknowledges that the services he is to render to the Company and its subsidiaries are of a special and unusual character, with a unique value to the Company and its subsidiaries, the loss of which cannot adequately be compensated by damages or an action at law. In view of the unique value to the Company and its subsidiaries of the services of Executive for which the Company has contracted hereunder, because of the confidential information to be obtained by, or disclosed to, Executive as set forth in Section 8 above, and as a material inducement to the Company to enter into this Agreement and to pay to Executive the compensation stated in Section 5 hereof, as well as any 5 additional benefits stated herein, and other good and valuable consideration, Executive covenants and agrees that throughout the period Executive remains employed hereunder and for one year thereafter, Executive shall not, directly or indirectly, anywhere in the United States of America (i) render any services, as an agent, independent contractor, consultant or otherwise, or become employed or compensated by, any other corporation, person or entity that derives a non-incidental portion of its revenue from the business of selling or providing annuity, life, accident or health insurance products or services; (ii) in any manner compete with the Company or any of its subsidiaries with respect to lines of business that the Company and its subsidiaries derive more than a non-incidental portion of their revenue from or with respect to which the Company and its subsidiaries have made a significant investment in; (iii) solicit or attempt to convert to other insurance carriers or other corporations, persons or other entities providing these same or similar products or services provided by the Company and its subsidiaries, any customers or policyholders of the Company or any of its subsidiaries; or (iv) solicit for employment or employ any employee of the Company or any of its subsidiaries. Should any particular covenant or provision of this Section 9 be held unreasonable or contrary to public policy for any reason, including, without limitation, the time period, geographical area, or scope of activity covered by any restrictive covenant or provision, the Company and Executive acknowledge and agree that such covenant or provision shall automatically be deemed modified such that the contested covenant or provision shall have the closest effect permitted by applicable law to the original form and shall be given effect and enforced as so modified to whatever extent would be reasonable and enforceable under applicable law. 10. Termination. (a) Either the Company or Executive may terminate his employment at any time for any reason upon written notice to the other. The Company may terminate Executive's employment for "just cause" pursuant to Section 10(b) below and Executive may terminate his employment for "good reason" pursuant to Section 10(c) below. Executive's employment shall also terminate upon (i) the death of Executive, (ii) termination by the Company after disability of Executive pursuant to Section 7, (iii) non-renewal by the Company or Executive in accordance with Section 2 or (iv) termination by Executive for any reason during a sixty (60) day period beginning on any anniversary of the Effective Date. (b) (i) The Company may terminate Executive's employment at any time for "just cause." For purposes of this Agreement "just cause" shall mean: (A) a material breach by Executive of this Agreement or willful malfeasance or fraud or dishonesty of a substantial nature in performing Executive's services on behalf of the Company, which in each case is willful and deliberate on Executive's part and committed in bad faith or without reasonable belief that such breach or action is in the best interests of the Company; 6 (B) Executive's use of alcohol or drugs (other than drugs prescribed to Executive by a physician and used by Executive for their intended purpose for which they had been prescribed) which materially and repeatedly interferes with the performance of his duties hereunder or which results in material and tangible damage to the reputation of the Company; (C) Executive's conviction by a court of law, or admission that he is guilty, of a felony or other crime involving moral turpitude; or (D) Executive's unexcused absence from his employment duties other than as a result of disability, for whatever cause, for a period of more than 30 consecutive days, without prior consent from the Company. (ii) The Company may not terminate Executive's employment for "just cause" unless: (A) the Company provides Executive with at least thirty (30) days advance written notice (the "Notice of Consideration") of its intent to consider termination of Executive's employment for "just cause," including a description of the specific reasons which form the basis for such consideration; (B) for a period of not less than fifteen (15) days after the date Notice of Consideration is provided, Executive shall have the opportunity to appear before the Board, with or without legal representation, at Executive's election, to present arguments and evidence on his own behalf; and (C) following the presentation to the Board as provided in (B) above or Executive's failure to appear before the Board at a date and time specified in the Notice of Consideration (which date shall not be less than fifteen (15) days after the date the Notice of Consideration is provided), Executive may be terminated for "just cause" only if the Board, by the affirmative vote of all of its members (excluding Executive), determines that the actions or inactions of Executive specified in the Notice of Consideration occurred, that such actions or inactions constitute "just cause," and that Executive's employment should be terminated for "just cause." No termination of employment shall be deemed a termination by the Company for "just cause" unless the Company complies with the requirements of this Section 10(b)(ii). No termination shall be deemed to be a termination by the Company for "just cause" if the termination is as a result of Executive refusing to act in a manner that would be a violation of applicable law. 7 (c) Executive may terminate his employment at any time with "good reason"; provided, however, that Executive may not terminate his employment during the one year period immediately following the Effective Date due to "good reason" as a result of a violation of Section 10(c)(i), but Executive may terminate his employment at any time following such one-year period for "good reason" as a result of an event described in Sections 10(c)(i), even where such "good reason" occurs during such one-year period. For purposes of this Agreement, "good reason" shall mean the occurrence of any of the following during the Term: (i) any diminution in the nature or scope of Executive's authority, duties, responsibilities from those Executive had as of the date hereof; or (ii) a failure to nominate, elect and maintain Executive as sole President and Chief Executive Officer and as a member of the Board; or (iii) the appointment of a Chairman of the Board (other than a Chairman who is not an executive or an officer) without Executive's consent; or (iv) causing or permitting any person other than Executive to present and recommend the business plan to the Board (it being understood, however, that Executive shall consult with the Non-Executive Chairman of the Board in connection with Executive's development and presentation of the business plan); or (v) causing or requiring Executive to report to anyone other than the full Board (subject to Section 3 hereof); or (vi) causing or permitting any officer of the Company or any Subsidiary (other than the Company's internal auditors) to report to the Board or the Non-Executive Chairman of the Board (it being understood that the members of the Board (including the Non-Executive Chairman) shall at all times have the right to require presentations and reports or other information from any employee of the Company or any Subsidiary); or (vii) reducing the hiring or firing authority of Executive as in effect as of the date hereof (it being understood, however, that Executive shall consult and collaborate with the Board and the Non-Executive Chairman of the Board prior to the hiring or firing of any senior manager of the Company or any Subsidiary); or (viii) requiring relocation without the consent of Executive; or (ix) the reduction or elimination of compensation or benefits provided for under this Agreement; or (x) a Change in Control occurs and, following Executive's written request made prior to the Change in Control, the ultimate parent entity or entities directly or indirectly gaining control of a majority of the Company's Board or outstanding securities entitled to vote with respect to the Company's Board fails 8 to affirm and guarantee the Company's current and future obligations under this Agreement; or (xi) any material breach of any provision of this Agreement by the Company which is not remedied by the Company within thirty (30) days after receipt of written notice from Executive specifying such breach. (d) The term "Control Termination" as used herein shall mean (A) termination of Executive's employment by the Company for any reason other than (x) death, (y) disability under Section 7, or (z) for "just cause," in anticipation of or not later than two years following a "Change in Control" of the Company (as defined below), or (B) termination of Executive's employment by Executive following a "Change in Control" of the Company (as defined below) upon the occurrence of any of the events specified in Section 10(c) constituting "good reason" not later than two years following a Change in Control. The term "Change in Control" shall mean the occurrence of any of the following: (i) the acquisition (other than an acquisition in connection with a "Non-Control Transaction" (as defined below)) by any "person" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended (the "1934 Act")) of "beneficial ownership" (as such term is defined in Rule 13d-3 promulgated under the 1934 Act), directly or indirectly, of securities of the Company representing 51% or more of the combined voting power of the then outstanding securities of the Company entitled to vote generally with respect to the election of the board of directors of the Company; provided, however, that following a transaction that results in an Ultimate Parent (as defined below), the references to the Company in this clause (i) shall also be deemed to refer to such Ultimate Parent; or (ii) as a result of or in connection with a tender or exchange offer or contest for election of directors, individual board members of the Company (identified as of the date of commencement of such tender or exchange offer, or the commencement of such election contest, as the case may be) cease to constitute at least a majority of the board of directors of the Company; or (iii) the consummation of a merger, consolidation or reorganization with or into the Company unless (x) the stockholders of the Company immediately before such transaction beneficially own, directly or indirectly, immediately following such transaction securities representing 51% or more of the combined voting power of the then outstanding securities entitled to vote generally with respect to the election of the board of directors of the Company (or its successor) or, if applicable, the Ultimate Parent and (y) individual board members of the Company (identified as of the date that a binding agreement providing for such transaction is signed) constitute at least a majority of the board of directors of the Company (or its successor) or, if applicable, the Ultimate Parent (a transaction to which clauses (x) and (y) apply, a "Non-Control Transaction"). 9 For purposes of this Agreement, "Ultimate Parent" shall mean the parent corporation (or if there is more than one parent corporation, the ultimate parent corporation) that, following a transaction, directly or indirectly beneficially owns a majority of the voting power of the outstanding securities entitled to vote with respect to the election of the board of directors of the Company (or its successor). (e) Upon termination of Executive's employment with the Company for any reason (whether voluntary or involuntary), Executive shall be deemed to have voluntarily resigned from the Board and from all other positions that Executive may then hold with the Company and any of its subsidiaries; provided that such deemed resignation shall not adversely affect Executive's rights to compensation or benefits under this Agreement. 11. Payments Following Termination. (a) In the event Executive's employment is terminated by the Company for "just cause" as so defined or if Executive voluntarily resigns (other than where such resignation (i) is for "good reason," (ii) is due to nonrenewal of the Term or (iii) is a termination pursuant to Section 10(a)(iv) hereof), then, subject to Section 22 hereof, (A) the Company immediately shall pay Executive a cash payment of his Base Salary as provided in Section 5(a) hereof earned but unpaid as of the date of termination plus the bonus payable pursuant to Section 5(d) hereof (to the extent not already paid); (B) no restrictions that remain as to any shares of restricted stock shall lapse after the date of termination, and Executive shall forfeit any still-restricted shares to the Company; and (C) no option previously awarded but not yet vested shall vest after the date of termination, and all previously awarded, vested options shall terminate unless exercised on or prior to the date of termination. (b) In the event Executive's employment is terminated by the death of Executive, then, subject to Section 22 hereof, the Company immediately shall pay Executive's estate a cash lump sum payment equal to (i) one times his annual Base Salary as provided in Section 5(a) hereof, less applicable taxes, for the most recent fiscal year then ended, (ii) his Base Salary as provided in Section 5(a) hereof earned but unpaid as of the date of termination plus the bonus payable pursuant to Section 5(d) hereof (to the extent not already paid) and (iii) and all other unpaid amounts to which Executive has become entitled under this Agreement. In addition, the Initial Option shall fully vest and the restrictions on the Initial Restricted Stock shall fully lapse as of the date of termination. (c) In the event Executive's employment is terminated (i) by the Company without "just cause," (ii) by Executive with "good reason" or (iii) by the Company due to non-renewal pursuant to Section 2 hereof, then, subject to Section 22 hereof, (A) the Company will pay Executive an immediate cash payment equal to Six Million Two Hundred Fifty Thousand Dollars ($6,250,000) plus the bonus payable pursuant to Section 5(d) (to the extent not already paid); (B) the Company immediately shall pay Executive a cash payment equal to his Base Salary as provided in Section 5(a) hereof earned but unpaid as of the date of termination and all unpaid amounts to which Executive has become entitled under this Agreement; (C) any options to purchase shares pursuant to the Initial Option shall vest and restrictions on the shares under the Initial Restricted Stock 10 shall lapse in accordance with the second from last sentence of this paragraph; (D) the Company shall pay Executive, at such time as annual bonus payments are paid to senior executives of the Company, a cash payment equal to a pro-rata portion of Executive's annual bonus (described in Section 5(b) hereof) for the year in which Executive's termination occurs determined by multiplying the greater of (i) the annual bonus to which Executive would have been entitled had he remained employed by the Company for the entirety of the calendar year (based on the actual results of the Company) (and all prerequisites that Executive remain employed through the date such bonuses are paid shall be deemed satisfied) and (ii) Five Hundred Thousand Dollars ($500,000) by a fraction, the numerator of which is the number of days Executive was employed by the Company in the calendar year in which the date of termination occurs and the denominator of which is three hundred sixty-five (365); and (E) Executive and his covered dependents will continue to participate (at the Company's expense) in the Company's health benefits for a period of twenty-four (24) months after the date of termination. Executive and his covered dependents shall have the option to continue health benefits after such twenty-four (24) month period in accordance with Section 4980B of the Internal Revenue Code ("COBRA") by paying directly to the Company an amount equal to the cost charged to active employees for such benefits. In addition, (i) if such termination occurs on or after the Effective Date and prior to the first anniversary of the Effective Date, the Initial Option shall immediately vest, and the restrictions that apply to the Initial Restricted Stock shall immediately lapse, in each case as to a number of shares determined by multiplying the total number of shares subject to each such award by a fraction, the numerator of which is three hundred sixty-five (365) plus the number of days on and following the Effective Date during which Executive was employed by the Company and the denominator of which is one thousand four hundred sixty (1,460); and (ii) if such termination occurs on or after the first anniversary of the Effective Date, the Initial Option shall immediately vest, and the restrictions that apply to the Initial Restricted Stock shall immediately lapse, in each case to the extent that the Initial Option would have vested and the restrictions that apply to the Initial Restricted Stock would have lapsed on the next following anniversary of the Effective Date if Executive had been employed by the Company continuously from the Effective Date through such date. Notwithstanding the preceding provisions of this paragraph, if the termination pursuant to this paragraph is a "Control Termination," then the Initial Option shall fully vest and restrictions on the Initial Restricted Stock shall fully lapse. (d) In the event that Executive's employment is terminated by Executive for a reason other than "good reason" during a sixty (60) day period beginning on any anniversary of the Effective Date, then, subject to Section 22 hereof, (A) (i) if the termination occurs with respect to the first anniversary of the Effective Date, the Company will pay Executive an immediate cash payment equal to Two Million Eighty Three Thousand Three Hundred Thirty Three Dollars ($2,083,333), (ii) if the termination occurs with respect to the second anniversary of the Effective Date, the Company will pay Executive an immediate cash payment equal to Four Million One Hundred Sixty-Six Thousand Six Hundred Sixty-Six Dollars ($4,166,666); and (iii) if the termination occurs with respect to the third anniversary of the Effective Date or any anniversary of the Effective Date thereafter, the Company will pay Executive an immediate cash payment equal to Six Million Two Hundred Fifty Thousand Dollars ($6,250,000), (B) the 11 Company immediately shall pay Executive a cash payment equal to his Base Salary as provided in Section 5(a) hereof earned but unpaid as of the date of termination and all unpaid amounts to which Executive has become entitled under this Agreement; and (C) any options to purchase shares pursuant to the Initial Option shall vest through the date of termination in accordance with Section 5(e) and the restrictions on the Initial Restricted Stock shall lapse as of the date of termination in accordance with Section 5(e). 12. Tax Indemnity Payments. (a) Anything in this Agreement to the contrary notwithstanding, in the event that it shall be determined that the aggregate payments or distributions by the Company or its affiliated companies to or for the benefit of Executive, whether paid or payable or distributed or distributable pursuant to the terms of the Agreement or otherwise but determined without regard to any additional payments required under this Section 12 (a "Payment"), constitute "parachute payments" (as such term is defined under Section 280G of the Internal Revenue Code of 1986, as amended (the "Code") or any successor provision, and the regulations promulgated thereunder (collectively, "Section 280G")) which exceed three times Executive's "base amount" (as such term is defined under Section 280G) by at least One Hundred Thousand Dollars ($100,000) and are therefore subject to the excise tax imposed by Section 4999 of the Code or any successor provision (collectively, "Section 4999") or any interest or penalties with respect to such excise tax (the total excise tax, together with any interest and penalties, are hereinafter collectively referred to as the "Excise Tax")), then Executive shall be entitled to receive an additional payment (a "Gross-Up Payment") in an amount such that after payment by Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any Federal, state or local income and employment taxes and Excise Tax (and any interest and penalties imposed with respect to any such taxes) imposed upon the Gross-Up Payment, Executive retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments. (b) Subject to the provisions of Section 12(c) hereof, all determinations required to be made under this Section 12, including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payment and the assumptions to be utilized in arriving at such determination, shall be made by the Company's public accounting firm (the "Accounting Firm") which shall provide detailed supporting calculations both to the Company and Executive within fifteen (15) business days of the receipt of notice from Executive that there has been a Payment, or such earlier time as is requested by the Company. In the event that the Accounting Firm is serving as accountant or auditor for the individual, entity or group effecting the Change in Control, Executive may appoint another nationally recognized public accounting firm to make the determinations required hereunder (which accounting firm shall then be deemed to be the Accounting Firm hereunder). All fees and expenses of the Accounting Firm shall be borne solely by the Company. Any Gross-Up Payment, as determined pursuant to this Section 12, shall be paid by the Company to Executive within five (5) days of the receipt of the Accounting Firm's determination (it being understood, however, that the Gross Up Payment may, if permitted by law, be paid directly to the applicable taxing authorities). If the Accounting Firm determines that no Excise Tax is payable by Executive, it shall furnish Executive 12 with a written opinion that failure to report the Excise Tax on Executive's applicable federal income tax return would not result in the imposition of a negligence or similar penalty. Any determination by the Accounting Firm shall be binding upon the Company and Executive. As a result of the uncertainty in the application of Section 4999 at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross-Up Payments which will not have been made by the Company should have been made by the Company ("Underpayment"), or that Gross-Up Payments will have been made by the Company which should not have been made ("Overpayment"), consistent with the calculations required to be made hereunder. In either such event, the Accounting Firm shall determine the amount of the Underpayment or Overpayment that has occurred. In the event that the Company exhausts its remedies pursuant to Section 12(c) and Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of Executive. In the case of an Overpayment, Executive shall, at the direction and expense of the Company, take such steps as are reasonably necessary (including, if reasonable, the filing of returns and claims for refund), and otherwise reasonably cooperate with the Company to correct such Overpayment; provided, however, that (i) Executive shall not in any event be obligated to return to the Company an amount greater than the net after-tax portion of the Overpayment that he has retained or has recovered as a refund from the applicable taxing authorities and (ii) this provision shall be interpreted in a manner consistent with the intent of Section 12(a) hereof to make Executive whole, on an after-tax basis, from the application of Section 4999. (c) Executive shall notify the Company in writing of any claim by the Internal Revenue Service that, if successful, would require a payment by the Company, or a change in the amount of the payment by the Company of, the Gross-Up Payment. Such notification shall be given as soon as practicable after Executive is informed in writing of such claim and shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid; provided that the failure to give any notice pursuant to this Section 12(c) shall not impair Executive's rights under this Section 12 except to the extent the Company is materially prejudiced thereby. Executive shall not pay such claim prior to the expiration of the 30-day period following the date on which Executive gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company notifies Executive in writing prior to the expiration of such period that it desires to contest such claim, Executive shall: (i) give the Company any information reasonably requested by the Company relating to such claim, (ii) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company, 13 (iii) cooperate with the Company in good faith in order effectively to contest such claim, and (iv) permit the Company to participate in any proceedings relating to such claim; provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold Executive harmless, on an after-tax basis, for any Excise Tax or income, employment or other tax (including interest and penalties with respect thereto) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 12(c) hereof, the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided further, that if the Company directs Executive to pay such claim and sue for a refund, the Company shall advance the amount of such payment to Executive on an interest-free basis and shall indemnify and hold Executive harmless, on an after-tax basis, from any Excise Tax or income, employment or other tax (including interest or penalties with respect to any such taxes) imposed with respect to such advance or with respect to any imputed income with respect to such advance; and provided further, that any extension of the statute of limitations relating to payment of taxes for the taxable year of Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority. (d) If, after the receipt by Executive of an amount advanced by the Company pursuant to Section 12(c) hereof, Executive becomes entitled to receive, and receives, any refund with respect to such claim, Executive shall (subject to the Company's complying with the requirements of Section 12(c) hereof) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by Executive of an amount advanced by the Company pursuant to Section 12(c), a determination is made that Executive shall not be entitled to any refund with respect to such claim and the Company does not notify Executive in writing of its intent to contest such denial of refund prior to the expiration of thirty (30) days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid. 14 13. Character of Termination Payments. The amounts payable to Executive upon any termination of his employment shall be considered severance pay in consideration of past services rendered on behalf of the Company and his continued service from the date hereof to the date he becomes entitled to such payments and shall be the sole amount of severance pay to which Executive is entitled from the Company and its subsidiaries upon termination of his employment (including, without limitation, under Old Conseco's Senior Management Key Employee Retention Program). Executive shall have no duty to mitigate his damages by seeking other employment and, should Executive actually receive compensation from any such other employment, the payments required hereunder shall not be reduced or offset by any such other compensation. 14. Representations of the Parties. (a) The Company represents and warrants to Executive that (i) this Agreement has been duly authorized, executed and delivered by the Company and constitutes valid and binding obligations of the Company; and (ii) the employment of Executive on the terms and conditions contained in this Agreement will not conflict with, result in a breach or violation of, constitute a default under, or result in the creation or imposition of any lien, charge or encumbrance upon any property or assets of the Company pursuant to: (A) the certificate of incorporation or by-laws of the Company, (B) the terms of any indenture, contract, lease, mortgage, deed of trust, note, loan agreement or other agreement, obligation, condition, covenant or instrument to which the Company is a party or bound or to which its property is subject, or (C) any statute, law, rule, regulation, judgment, order or decree applicable to the Company, or any regulatory body, administrative agency, governmental body, arbitrator or other authority having jurisdiction over the Company. (b) Executive represents and warrants to the Company that: (i) this Agreement has been duly executed and delivered by Executive and constitutes a valid and binding obligation of Executive; and (ii) neither the execution of this Agreement by Executive nor his employment by the Company on the terms and conditions contained herein will conflict with, result in a breach or violation of, or constitute a default under any agreement, obligation, condition, covenant or instrument to which Executive is a party or bound or to which his property is subject, or any statute, law, rule, regulation, judgment, order or decree applicable to Executive of any court, regulatory body, administrative agency, governmental body, arbitrator or other authority having jurisdiction over Executive or any of his property. 15. Arbitration of Disputes; Injunctive Relief. (a) Except as provided in subsection (b) below, any controversy or claim arising out of or relating to this Agreement or the breach thereof, shall be settled by binding arbitration in the City of Indianapolis, Indiana, in accordance with the laws of the State of Indiana by three arbitrators, one of whom shall be appointed by the Company, one by Executive, and the third of whom shall be appointed by the first two arbitrators. If the first two arbitrators cannot agree on the appointment of a third arbitrator, then the third arbitrator shall be appointed by the Chief Judge of the United States District Court for the 15 Southern District of Indiana. The arbitration shall be conducted in accordance with the rules of the American Arbitration Association, except with respect to the selection of arbitrators, which shall be as provided in this Section. Judgment upon the award rendered by the arbitrators may be entered in any court having jurisdiction thereof. In the event that it shall be necessary or desirable for Executive to retain legal counsel and/or incur other costs and expenses in connection with the enforcement of any and all of his rights under this Agreement, the Company shall pay (or Executive shall be entitled to recover from the Company, as the case may be) his reasonable attorneys' fees and costs and expenses in connection with the enforcement of any arbitration award in court, regardless of the final outcome, unless the arbitrators shall determine that under the circumstances recovery by Executive of all or a part of any such fees and costs and expenses would be unjust. (b) Executive acknowledges that a breach or threatened breach by Executive of Sections 8 or 9 of this Agreement will give rise to irreparable injury to the Company and that money damages will not be adequate relief for such injury. Notwithstanding paragraph (a) above, the Company and Executive agree that the Company may seek and obtain injunctive relief, including, without limitation, temporary restraining orders, preliminary injunctions and/or permanent injunctions, in a court of proper jurisdiction to restrain or prohibit a breach or threatened breach of Section 8 or 9 of this Agreement. Nothing herein shall be construed as prohibiting the Company from pursuing any other remedies available to the Company for such breach or threatened breach, including the recovery of damages from Executive. 16. Notices. Any notice required or permitted to be given under this Agreement shall be sufficient if in writing and if sent by registered mail to his residence, in the case of Executive, or to the business office of its General Counsel, in the case of the Company. 17. Waiver of Breach and Severability. The waiver by either party of a breach of any provision of this Agreement by the other party shall not operate or be construed as a waiver of any subsequent breach by either party. In the event any provision of this Agreement is found to be invalid or unenforceable, it may be severed from the Agreement, and the remaining provisions of the Agreement shall continue to be binding and effective. 18. Entire Agreement. This instrument contains the entire agreement of the parties and, effective as of the Effective Date, supersedes all prior agreements between Executive and Old Conseco, including that certain employment agreement between Executive and Old Conseco, dated September 10, 2001, as amended and restated on June 1, 2002. The compensation and benefits to be paid under the terms of this Agreement are in lieu of all other compensation or benefits to which Executive is entitled from the Company and its affiliates. This Agreement may not be changed orally, but only by an instrument in writing signed by the party against whom enforcement of any waiver, change, modification, extension or discharge is sought. 19. Binding Agreement and Governing Law; Assignment Limited. This Agreement shall be binding upon and shall inure to the benefit of the parties and their lawful successors in interest (including, without limitation, Executive's estate, heirs and personal representatives) and, except for issues or matters as to which federal law is applicable, shall be construed in accordance with 16 and governed by the laws of the State of Indiana. This Agreement is personal to each of the parties hereto, and neither party may assign or delegate any of its rights or obligations hereunder without the prior written consent of the other. 20. No Third Party Beneficiaries. The terms and provisions of this Agreement are intended solely for the benefit of each party hereto and their respective successors or permitted assigns, and it is not intended to confer third-party beneficiary rights upon any other person. 21. Expenses of Executive. The Company agrees to reimburse Executive for all reasonable attorneys' fees he incurred in connection with the preparation and negotiation of this Agreement, up to Fifteen Thousand Dollars ($15,000). 22. Releases. In connection with any termination of Executive's employment, Executive and the Company will enter into the General Release in substantially the form attached hereto as Exhibit A. Notwithstanding anything to the contrary, no compensation or benefits shall be provided under Sections 7 or 11 of this Agreement unless Executive (or his estate or legal representative, as applicable) enters into such General Release and does not revoke it during the revocation period specified therein. 23. Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed to be an original, but all of which together shall constitute one and the same instrument. 17 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written, effective as of the Effective Date. COMPANY: CONSECO, INC. By:/s/Eugene M. Bullis ------------------------------- Name: Eugene M. Bullis Its: Executive Vice President and Chief Financial Officer EXECUTIVE: /s/William J. Shea ---------------------------------- William J. Shea The Conseco Creditors' Committee, as defined in the Bankruptcy Plan (the "Committee"), acknowledges that it has no objection to this Agreement, it being understood that the Committee, its members and professionals have no liability or obligation hereunder, and that the Committee shall continue to have the right to raise, appear and be heard on any issues in the bankruptcy case of Old Conseco (including, without limitation, the right to object to the Bankruptcy Plan), but hereby waives its right to object to or oppose this Agreement, it being understood that the Committee's objection to the Bankruptcy Plan on any grounds other than an objection to this Agreement shall not be deemed to be an objection or opposition to this Agreement. BANK OF AMERICA, N.A. By:/s/Bridget Garavalia ------------------------------ Name: Bridget Garavalia Its: Managing Director By:/s/David Tepper ------------------------------ Name: David Tepper Its: Co-Chair 18 Exhibit A GENERAL RELEASE 1. Release of Claims by Executive. (a) In consideration of the of the payments and benefits to be provided to William J. Shea ("Executive") pursuant to the employment agreement, dated __________, 2003, to which Executive and Conseco, Inc. (the "Company"), a Delaware corporation (the "Company"), are parties (the "Employment Agreement"), the sufficiency of which is acknowledged hereby, Executive, with the intention of binding himself and his heirs, executors, administrators and assigns, does hereby release, remise, acquit and forever discharge the Company and each of its subsidiaries and affiliates (the "Company Affiliated Group"), their present and former officers, directors, executives, agents, attorneys and employees, and the successors, predecessors and assigns of each of the foregoing (collectively, the "Company Released Parties"), of and from any and all claims, actions, causes of action, complaints, charges, demands, rights, damages, debts, sums of money, accounts, financial obligations, suits, expenses, attorneys' fees and liabilities of whatever kind or nature in law, equity or otherwise, whether accrued, absolute, contingent, unliquidated or otherwise and whether now known or unknown, suspected or unsuspected, which Executive, individually or as a member of a class, now has, owns or holds, or has at any time heretofore had, owned or held, against any Company Released Party in any capacity, including, without limitation, any and all claims (i) arising out of or in any way connected with Executive's service to any member of the Company Affiliated Group (or the predecessors thereof) in any capacity, or the termination of such service in any such capacity, (ii) for severance or vacation benefits, unpaid wages, salary or incentive payments, (iii) for breach of contract, wrongful discharge, impairment of economic opportunity, defamation, intentional infliction of emotional harm or other tort, (iv) for any violation of applicable state and local labor and employment laws (including, without limitation, all laws concerning unlawful and unfair labor and employment practices) and (v) for employment discrimination under any applicable federal, state or local statute, provision, order or regulation, and including, without limitation, any claim under Title VII of the Civil Rights Act of 1964 ("Title VII"), the Civil Rights Act of 1988, the Fair Labor Standards Act, the Americans with Disabilities Act ("ADA"), the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), the Age Discrimination in Employment Act ("ADEA") and any similar or analogous state statute, excepting only: (A) the rights of Executive under the Employment Agreement; (B) the rights of Executive (i) relating to any stock options and restricted stock held by Executive as of the date hereof (collectively, the "Equity Arrangements") and (ii) as a stockholder of the Company; (C) the right of Executive to receive COBRA continuation coverage in accordance with applicable law; (D) rights to indemnification Executive may have under (i) applicable corporate law, (ii) the by-laws or certificate of incorporation of any Company Released Party, (iii) any other agreement between Executive and a Company Released Party or (iv) as an insured under any director's and officer's liability insurance policy now or previously in force; (E) claims for benefits under any health, disability, retirement, life insurance or other, similar "employee benefit plan" (within the meaning of Section 3(3) of ERISA) of the Company Affiliated Group (the "Company Benefit Plans"); and (F) claims for the reimbursement of unreimbursed business expenses incurred prior to the date hereof pursuant to applicable Company policy. (b) Executive acknowledges and agrees that the release of claims set forth in this Section 1 is not to be construed in any way as an admission of any liability whatsoever by any Company Released Party, any such liability being expressly denied. (c) The release of claims set forth in this Section 1 applies to any relief no matter how called, including, without limitation, wages, back pay, front pay, compensatory damages, liquidated damages, punitive damages, damages for pain or suffering, costs, and attorney's fees and expenses. (d) Executive specifically acknowledges that his acceptance of the terms of the release of claims set forth in this Section 1 is, among other things, a specific waiver of his rights, claims and causes of action under Title VII, ADEA, ADA and any state or local law or regulation in respect of discrimination of any kind; provided, however, that nothing herein shall be deemed, nor does anything contained herein purport, to be a waiver of any right or claim or cause of action which by law Executive is not permitted to waive. (e) Executive shall have a period of 21 days to consider whether to execute this General Release. If Executive accepts the terms hereof and executes this General Release, he may thereafter, for a period of 7 days following (and not including) the date of execution, revoke this General Release. If no such revocation occurs, this General Release shall become irrevocable in its entirety, and binding and enforceable against Executive, on the day next following the day on which the foregoing seven-day period has elapsed. Any revocation of this General Release shall be deemed for all purposes a revocation of this General Release in its entirety. (f) Executive acknowledges and agrees that he has not, with respect to any transaction or state of facts existing prior to the date hereof, filed any complaints, charges or lawsuits against any Company Released Party with any governmental agency, court or tribunal. 2. Effect of Unenforceability of Release. In addition to any other remedy available to the Company hereunder, in the event that, as a result of a challenge brought by an Employee Released Party (as defined below), the release of claims set forth in Section 1 becomes null and void or is otherwise determined not to be enforceable, then the Company's obligation to make any additional payments or to provide any additional benefits under the Employment Agreement shall immediately cease to be of any force and effect, and Executive shall promptly return to the Company any payments or benefits the provision of which by the Company was conditioned on the enforceability of this General Release. 21 3. Release of Claims by the Company. (a) The Company, with the intention of binding itself and its predecessors and successors, does hereby release, remise, acquit and forever discharge Executive and his heirs, estate, executors, administrators and assigns (collectively, the "Employee Released Parties"), of and from any and all claims, actions, causes of action, complaints, charges, demands, rights, damages, debts, sums of money, accounts, financial obligations, suits, expenses, attorneys' fees and liabilities of whatever kind or nature in law, equity or otherwise, whether accrued, absolute, contingent, unliquidated or otherwise and whether now known or unknown, suspected or unsuspected, which the Company, individually or as a member of a class, now has, owns or holds, or has at any time heretofore had, owned or held, against any Employee Released Party, excepting only: (A) rights of the Company under this General Release, the Employment Agreement, the Equity Arrangements and the Company Benefit Plans; and (B) rights of the Company arising by reason of Executive having committed a crime or an act or omission to act which constitutes willful misconduct or gross negligence. (b) The Company acknowledges and agrees that the release of claims set forth in this Section 3 is not to be construed in any way as an admission of any liability whatsoever by any Employee Released Party, any such liability being expressly denied. (c) The release of claims set forth in this Section 3 applies to any relief no matter how called, including, without limitation, compensatory damages, liquidated damages, punitive damages, damages for pain or suffering, costs, and attorney's fees and expenses. (d) Nothing herein shall be deemed, nor does anything contained herein purport, to be a waiver of any right or claim or cause of action which by law the Company is not permitted to waive. (e) The Company acknowledges and agrees that it has not, with respect to any transaction or state of facts existing prior to the date hereof, filed any complaints, charges or lawsuits against any Employee Released Party with any governmental agency, court or tribunal. 4. Counterparts. This General Release may be executed in counterparts, each of which shall be deemed to be an original, but all of which together shall constitute one and the same instrument. 5. Successors. This General Release shall be binding upon any and all successors and assigns of Executive and the Company. 6. Governing Law. Except for issues or matters as to which federal law is applicable, this General Release shall be construed in accordance with and governed by the laws of the State of Indiana. 22 IN WITNESS WHEREOF, this General Release has been signed by or on behalf of each of the Parties, all as of _______________. CONSECO, INC. - ---------------------------- ---------------------------------- William J. Shea By: Its: Dated: Dated: ---------------------- ---------------------------- 23 EX-10 5 hilliard.txt EXHIBIT 10.6 Exhibit 10.6 AGREEMENT AGREEMENT made as of this 18th day of June, 2003, (the "Agreement"), by and between Conseco, Inc., a Delaware corporation (the "Company") and R. Glenn Hilliard (the "Director"). WHEREAS Conseco, Inc., an Indiana corporation ("Old Conseco") filed a voluntary petition under the provisions of Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") with the United States Bankruptcy Court for the Northern District of Illinois (the "Bankruptcy Court") on or about December 17, 2002; and WHEREAS, the Company wishes to appoint the Director as non-executive Chairman of the Board of Directors of the Company (the "Board") and enter into an agreement with the Director with respect to such appointment; and WHEREAS, the Director wishes to accept such appointment and to serve the Company on the terms set forth herein, and in accordance with, the provisions of this Agreement; and WHEREAS the retention of the Director as Non-Executive Chairman of the Board of Directors of the Company is vital to the success of the reorganization; and WHEREAS, the Director brings valuable experience in the insurance industry to the Company, and the Director would not have been willing to enter into this Agreement in the absence of the various promises made by the Company in this Agreement; NOW, THEREFORE, in consideration of the mutual covenants contained herein, the parties hereto agree as follows: 1. Term. The effective date of this Agreement shall be the "Effective Date" (the "Effective Date") as defined in the document commonly known as "Reorganizing Debtors' Second Amended Joint Plan of Reorganization Pursuant to Chapter 11 of the United States Bankruptcy Code", dated March 18, 2003, as amended, as filed in the bankruptcy case of Old Conseco (the "Bankruptcy Plan"). If the Effective Date does not occur, this Agreement shall be null and void and have no force or effect, and the Director shall have no rights hereunder and shall have no claims against the Company relating to this Agreement or arising out of or relating to the failure of the Agreement to become effective; provided, however, that the Director shall remain entitled to the Pre-Effective Date Compensation specified in Section 6 herein regardless of whether the Effective Date occurs. Subject to earlier termination as provided in Section 8, the term of the Director's service under this Agreement shall be the period beginning on the Effective Date, and ending on the fourth anniversary of the Effective Date (the "Term"). 2. Position. Subject to the terms and provisions of this Agreement, the Company shall cause the Director to be appointed, as of the Effective Date, as non-executive Chairman of the Board ("Non-Executive Chairman") and the Director hereby agrees to serve the Company in that position upon the terms and conditions hereinafter set forth. The Director shall initially be appointed as a Class II Director as defined in Article Ten, Section 1 of the Company's Amended and Restated Certificate of Incorporation. 3. Duties. During the Term, the Director shall serve as Non-Executive Chairman, and the Director shall regularly attend and preside at Board meetings, serve on and preside over appropriate committees as reasonably requested by the Board, set meeting schedules and agendas, manage information flow to the Board to assure appropriate understanding of and discussion regarding matters of interest or concern to the Board, make himself available to the Company at mutually convenient times and places, attend external meetings and presentations, as appropriate and convenient, and perform such duties, services and responsibilities and have the authority commensurate to such position. In addition, during the Term the Director's duties shall include the following: (a) Consulting with the Company's Chief Executive Officer (the "CEO") regarding the corporate strategy of the Company and its divisions and subsidiaries and monitoring that strategy on an ongoing basis; (b) Consulting with the CEO on how to improve the operating and financial performance of the Company and its divisions and subsidiaries (including but not limited to the development of appropriate incentive compensation policies); (c) Consulting with the CEO regarding the Company's business plan (it being understood that, consistent with the CEO's employment agreement, the CEO will present and recommend the business plan to the Board but will consult with the Director in developing the same); (d) In consultation with the CEO, taking an active role in the exploring the development of opportunities (both internal and external) for growing the Company's businesses; (e) Consulting with the CEO regarding the identification and recruitment of candidates for senior management positions (consistent with the CEO's employment agreement); (f) Assisting the CEO, in any manner that the CEO believes to be advisable, in managing the Company's relationship with regulatory and financial rating agencies; and (g) Consulting with the CEO regarding the Company's capital management, capital allocation and debt management plans as developed by the CEO. The Company and the Director agrees that final approval of the business plan and corporate strategy and other decisions relating to items (a) through (g) rest with the full Board, it being understood that the Director is authorized and expected to have a leading and active role in these matters independent of the Board and to organize and lead the Board in discussing and deciding these issues. It is expected, subject to the formal approval by the Board, that the Director will serve in a 2 leadership role on the key committees of the Board. The Company and the Director agree that the Director shall be permitted to engage in other business, civic and charitable activities (subject to the restrictions in Section 11), as long as such activities do not materially interfere with the performance of his duties hereunder. Notwithstanding the foregoing, the Director agrees that he shall not commence full-time employment outside of the Company during the 18-month period beginning on the Effective Date. 4. Monetary Remuneration. (a) Fees and Compensation. (i) During the first two years of the Term, the Director shall be entitled to receive an annual director's fee of One Million Dollars ($1,000,000), payable in advance in equal quarterly installments beginning as soon as practicable following the Effective Date. (ii) After the second anniversary of the Effective Date, to the extent that the Term is then in effect, the Director shall receive director's fees. Such fees shall be comparable to the director's fees paid to similarly situated non-executive Chairmen of other corporations as determined by the Board. (b) Retention Bonuses. As soon as practicable following the first anniversary of the Effective Date, the Company shall pay to the Director a retention bonus of One Million Five Hundred Thousand Dollars ($1,500,000) so long as the Director has continuously remained in the service of the Company as Non-Executive Chairman through that date (the "First Year Retention Bonus"). As soon as practicable following the second anniversary of the Effective Date, the Company shall pay to the Director a retention bonus of Seven Hundred Fifty Thousand Dollars ($750,000) so long as the Director has continuously remained in the service of the Company as Non-Executive Chairman through that date (the "Second Year Retention Bonus"). (c) Expense Reimbursements. During the Term, the Company shall reimburse the Director for all reasonable out-of-pocket expenses incurred by the Director in carrying out the Director's duties, services and responsibilities under this Agreement (including, without limitation, commuting expenses to and from the Company's offices) so long as the Director complies with the generally applicable policies, practices and procedures of the Company for submission of expense reports, receipts or similar documentation of such expenses. (d) Status. The Director's status during the Term shall be that of an independent contractor and not, for any purpose, that of an employee or agent with authority to bind the Company in any respect. All payments and other consideration made or provided to the Director under this Agreement shall be made or provided without withholding or deduction of any kind, and the Director shall have sole responsibility for discharging all of his tax or other obligations associated therewith. 3 (e) No Other Compensation. The Director agrees and acknowledges that, during the Term and thereafter, he will not be entitled to any compensation and/or benefits from the Company other than those items specifically provided for under this Agreement. 5. Equity Awards. (a) Signing Bonus. On the Effective Date, the Company shall grant to the Director a number of shares of fully vested common stock of the Company that would have been distributed to the Director under Old Conseco's Plan of Reorganization if the Director at that time held One Million Four Hundred Forty Nine Thousand Dollars ($1,449,000) in principal amount of exchanged bonds and One Million Three Hundred Thirteen Thousand Dollars ($1,313,000) in principal amount of unexchanged bonds. (b) First Year Awards. As soon as practicable following the Effective Date, the Company shall grant the Director the right and option (the "First Year Option") to purchase one-half of one percent (0.5%) of the common equity of the Company issued and outstanding immediately after the consummation of Old Conseco's Plan of Reorganization (determined without regard to any options or restricted stock granted on the Effective Date), with an exercise price equal to the average trading price (based on all trades) of the Company's common equity over the first ten (10) days following the Effective Date. In addition, as soon as practicable following the Effective Date, the Company shall grant the Director a number of shares of restricted stock (the "First Year Restricted Stock") equal to one-half of one percent (0.5%) of the common equity of the Company issued and outstanding immediately after the consummation of Old Conseco's Plan of Reorganization (determined without regard to any options or restricted stock granted on the Effective Date). (c) Second Year Awards. As soon as practicable following the first anniversary of the Effective Date, the Company shall grant the Director the right and option (the "Second Year Option") to purchase one-quarter of one percent (0.25%) of the common equity of the Company issued and outstanding on such date, with an exercise price equal to the closing price of the Company's common equity on the date of grant. In addition, as soon as practicable following the first anniversary of the Effective Date, the Company shall grant the Director a number of shares of restricted stock (the "Second Year Restricted Stock") equal to one-quarter of one percent (0.25%) of the common equity of the Company issued and outstanding on such date. (d) Terms of Options and Restricted Stock. The First Year Option, the First Year Restricted Stock, the Second Year Option and the Second Year Restricted Stock shall be granted to the Director under, and governed by the terms and conditions of, the 2003 Long-Term Equity Incentive Plan; provided that the options under the First Year Option shall vest and the restrictions on the First Year Restricted Stock shall lapse in equal increments on each of the first three anniversaries of the Effective Date, and the options under the Second Year Option shall vest and the restrictions on the Second Year Restricted Stock shall lapse in equal increments on each of the first three anniversaries of the first anniversary of the Effective Date, in each case so long as the Director has continuously remained in the service of the Company as Non-Executive Chairman through each such anniversary; and provided further that the vesting of options and lapsing of restrictions shall be subject to the provisions of Sections 8 hereof. 4 (e) Other Equity Awards. After the second anniversary of the Effective Date, to the extent that the Term is then in effect, the Director shall receive the same equity-based compensation (at the same time and on the same terms and conditions) as other non-employee members of the Board. (f) Effect of Change in Duties. In the event that the Board and/or the CEO request that the Director's duties materially expand from those described in Section 3, the Director will automatically be deemed to have resigned from his position on the Compensation Committee of the Board (if he is a member thereof), and the Compensation Committee and the Director will negotiate in good faith as to reasonable compensation arrangements for the Director in light of such expansion. 6. Pre-Effective Date Compensation. The Company or Old Conseco shall pay the Director the lump sum of Sixty Thousand Dollars ($60,000) per month (pro-rated for partial months) for each month of services performed by him for Old Conseco during the period beginning on May 15, 2003 and ending on the Effective Date; provided, that, if the Effective Date has not occurred by December 31, 2003, either party may terminate the obligations under this Section 6 upon written notice to the other party. The Company and the Official Committee of Unsecured Creditors (the "Committee") believe that the Director is not a "professional" as contemplated by Section 327 of the Bankruptcy Code and that the Company may incur the obligations of this Section 6 in the ordinary course of business. If required, however, by the Bankruptcy Court, Old Conseco, with the support of the Committee, will file an appropriate motion (in form and substance reasonably satisfactory to the Director) to retain the Director in accordance with Section 327 of the Bankruptcy Code retroactive to May 15, 2003. 7. Office Space/Assistant. During the Term, the Company will provide the Director with a monthly allowance for office space in Atlanta, Georgia and related expenses in the initial amount of Three Thousand Dollars ($3,000) per month, subject to upward modification by the Board. In addition, during the Term, at the Company's expense, the Company shall provide the Director with an assistant who shall be an employee of the Company. 8. Termination. The Director's service with the Company as Non-Executive Chairman and the Term shall terminate upon the expiration of the Term or upon the earlier occurrence of any of the following events: (a) The death of the Director. (b) The Director becomes Disabled. For the purposes of this Agreement, the Director will be deemed to be "Disabled" if, due to a physical or mental disability, his ability to perform his duties and services hereunder is materially and adversely impaired and such disability (as confirmed by competent medical evidence) continues for at least nine (9) consecutive months. (c) The removal of the Director from the Board pursuant to the Company's by-laws and/or certificate of incorporation other than for Cause (as defined below). 5 (d) The termination of the Director by the Company for Cause. Termination of the Director for "Cause" shall mean termination based on: (i) the Director's conviction of, or plea of guilty or nolo contendere to, any felony, (ii) the Director's willful misconduct in the performance of the duties set forth in Section 3, or (iii) the Director's material breach of this Agreement which breach is not cured within fifteen (15) days of receipt of written notice from the Board specifying the actions constituting Cause. (e) The resignation by the Director from the Board. (f) The failure of the Company's shareholders to approve the reelection of the Director to the Board as set forth in the Company's by-laws and/or certificate of incorporation. 9. Effect of Termination. (a) Upon the termination of the Director's service with the Company as Non-Executive Chairman (whether voluntary or involuntary), the Director shall be deemed to have voluntarily resigned from the Board and from all other positions that the Director may then hold with the Company and any of its subsidiaries, effective upon the date of termination of the Director's service as Non-Executive Chairman (the "Termination Date"). (b) If the Director's service with the Company as Non-Executive Chairman is terminated pursuant to Section, 8(d) (termination for Cause) or 8(e) (resignation), the obligation of the Company to make any future payments pursuant to Section 4 of this Agreement shall cease; provided that the Director will be entitled to receive payment of all unpaid amounts to which the Director has become entitled under this Agreement. In addition, no restrictions that remain as to any shares of restricted stock shall lapse after the Termination Date, and the Director shall forfeit any still-restricted shares to the Company, and no option previously awarded but not yet vested shall vest after the Termination Date. (c) If the Director's service with the Company as Non-Executive Chairman is terminated pursuant to Section 8(a) (death), Section 8(b) (disability), Section 8(c) (removal) or 8(f) (failure to re-elect) (each a "Qualifying Termination"), the obligation of the Company to make any future payments pursuant to Section 4 of this Agreement shall cease; provided that the Director will be entitled to receive payment of all unpaid amounts to which the Director has become entitled under this Agreement, and provided further that (i) if the Qualifying Termination occurs before the first anniversary of the Effective Date, the Director shall be entitled to a pro-rata portion of the First Year Retention Bonus determined by multiplying the amount of such retention bonus by a fraction, the numerator of which is the number of days after the Effective Date through the Termination Date and the denominator of which is three hundred sixty-five (365), and (ii) if the Qualifying Termination occurs on or after the first anniversary of the Effective Date, but before the second anniversary of the Effective Date, the Director shall be entitled to (x) the First Year Retention Bonus, to the extent not already paid, and (y) a pro-rata portion of the Second Year Retention Bonus determined by multiplying the amount of such retention bonus by a fraction, the numerator of which is the number of days after the first anniversary of the Effective Date through the Termination Date and the denominator of which is 6 three hundred sixty-five (365). In addition, upon a Qualifying Termination (i) the restrictions remaining as to any shares of the First Year Restricted Stock and the Second Year Restricted Stock (if already granted prior to the Termination Date) shall lapse as if the Termination Date had occurred on the day after the next anniversary of the Effective Date, but no other restrictions that remain as to any shares of restricted stock shall lapse after the Termination Date, and the Director shall forfeit any other still-restricted shares to the Company, and (ii) a portion of any outstanding unvested First Year Options or Second Year Options (if already granted prior to the Termination Date) shall vest as if the Termination Date had occurred on the day after the next anniversary of the Effective Date, but no other options previously awarded but not yet vested shall vest after the Termination Date. (d) If the Director's service with the Company as Non-Executive Chairman is terminated pursuant to Section 8(c) (removal) or 8(f) (failure to re-elect), the Director shall receive the lesser of (i) the office allowance as provided for in Section 7 until the next following expiration date of the lease and (ii) a payment in respect of the three months immediately following the Termination Date. 10. Director's Representation and Acknowledgment. The Director represents to the Company that his execution and performance of this Agreement shall not be in violation of any agreement or obligation (whether or not written) that he may have with or to any person or entity, including without limitation, any prior employer. 11. Director Covenants. (a) Unauthorized Disclosure. The Director acknowledges that in and as a result of his service with the Company as Non-Executive Chairman, he will be making use of, acquiring and/or adding to confidential information of the Company and its subsidiaries of a special and unique nature and value. As a material inducement to the Company to enter into this Agreement and to pay to the Director the compensation stated in Sections 4 and 5, the Director covenants and agrees that he shall not, at any time while he is Non-Executive Chairman or at any time thereafter, directly or indirectly, divulge or disclose for any purpose whatsoever, any confidential information (whether or not specifically labeled or identified as "confidential information"), in any form or medium, that has been obtained by or disclosed to him as a result of his service with the Company and which the Company or any of its subsidiaries has taken appropriate steps to safeguard, except to the extent that such confidential information (a) becomes a matter of public record or is published in a newspaper, magazine or other periodical available to the general public, other than as a result of any act or omission of the Director, (b) is required to be disclosed by any law, regulation or order of any court or regulatory commission, department or agency, in which event the Director shall give prompt notice of such requirement to the Company to enable the Company to seek an appropriate protective order or confidential treatment, or (c) must be disclosed to enable the Director properly to perform his duties under this Agreement. Upon the termination of the Director's service with the Company as Non-Executive Chairman, the Director shall return such information (in whatever form) obtained from or belonging to the Company or any of its subsidiaries which he may have in his possession or control. 7 (b) Covenants Against Competition and Solicitation. The Director acknowledges that the services he is to render to the Company and its subsidiaries are of a special and unusual character, with a unique value to the Company and its subsidiaries, the loss of which cannot adequately be compensated by damages or an action at law. In view of the unique value to the Company and its subsidiaries of the services of the Director for which the Company has contracted hereunder, because of the confidential information to be obtained by, or disclosed to, the Director as set forth in Section 11(a) above, and as a material inducement to the Company to enter into this Agreement and to pay to the Director the compensation stated in Sections 4 and 5 hereof, as well as any additional benefits stated herein, and other good and valuable consideration, the Director covenants and agrees that throughout the Term and for one year thereafter, the Director shall not, directly or indirectly, anywhere in the United States of America (i) render any services, as an agent, independent contractor, consultant or otherwise, or become employed or compensated by, any other corporation, person or entity that derives a material portion of its revenue from any Restricted Business (as defined below); (ii) solicit any customers or policyholders of the Company or any of its subsidiaries with whom the Director had material business contact as the result of his service as Non-Executive Chairman of the Company, for the purpose of offering insurance products or services competitive with those offered by the Company; or (iii) solicit for employment or employ any employee of the Company or any of its subsidiaries. For the purposes of this agreement, the term "Restricted Business" shall mean the businesses of selling or providing annuity, life, health, or accident insurance products or services directed primarily at the senior market, except that "Restricted Business" on any date shall not include any of the foregoing lines of business to the extent that the Company is no longer actively involved in such business line on such date. (c) Remedies. The Director agrees that any breach of the terms of this Section 11 would result in irreparable injury and damage to the Company for which the Company would have no adequate remedy at law; the Director therefore also agrees that in the event of said breach or any threat of breach, the Company shall be entitled to an immediate injunction and restraining order to prevent such breach and/or threatened breach and/or continued breach by the Director and/or any and all entities acting for and/or with the Director, without having to prove damages, in addition to any other remedies to which the Company may be entitled at law or in equity. The terms of this paragraph shall not prevent the Company from pursuing any other available remedies for any breach or threatened breach hereof, including but not limited to the recovery of damages from the Director. The Director acknowledges that the Company would not have entered into this Agreement had the Director not agreed to the provisions of this Section 11. The Director and the Company agree that the provisions of the covenant not to compete set forth in this Section 11 are reasonable. Should a court or arbitrator determine, however, that any provision of the covenant not to compete is unreasonable or unenforceable, either in period of time, geographical area, or otherwise, the parties hereto agree that the covenant should be interpreted and enforced to the maximum extent possible in accordance with law. 12. Tax Indemnity Payments. (a) Anything in this Agreement to the contrary notwithstanding, in the event that it shall be determined that the aggregate payments or distributions by the Company or its affiliated companies to or for the benefit of the Director, whether paid or payable or 8 distributed or distributable pursuant to the terms of the Agreement or otherwise but determined without regard to any additional payments required under this Section 12 (a "Payment"), constitute "parachute payments" (as such term is defined under Section 280G of the Internal Revenue Code of 1986, as amended (the "Code") or any successor provision, and the regulations promulgated thereunder (collectively, "Section 280G")) which exceed three times the Director's "base amount" (as such term is defined under Section 280G) by at least One Hundred Thousand Dollars ($100,000) and are therefore subject to the excise tax imposed by Section 4999 of the Code or any successor provision (collectively, "Section 4999") or any interest or penalties with respect to such excise tax (the total excise tax, together with any interest and penalties, are hereinafter collectively referred to as the "Excise Tax")), then the Director shall be entitled to receive an additional payment (a "Gross-Up Payment") in an amount such that after payment by the Director of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any Federal, state or local income and self-employment taxes and Excise Tax (and any interest and penalties imposed with respect to any such taxes) imposed upon the Gross-Up Payment, the Director retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments. (b) Subject to the provisions of Section 12(c) hereof, all determinations required to be made under this Section 12, including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payment and the assumptions to be utilized in arriving at such determination, shall be made by the Company's public accounting firm (the "Accounting Firm") which shall provide detailed supporting calculations both to the Company and the Director within fifteen (15) business days of the receipt of notice from the Director that there has been a Payment, or such earlier time as is requested by the Company. All fees and expenses of the Accounting Firm shall be borne solely by the Company. Any Gross-Up Payment, as determined pursuant to this Section 12, shall be paid by the Company to the Director within five (5) days of the receipt of the Accounting Firm's determination (it being understood, however, that the Gross Up Payment may, if permitted by law, be paid directly to the applicable taxing authorities). If the Accounting Firm determines that no Excise Tax is payable by the Director, it shall furnish the Director with a written opinion that failure to report the Excise Tax on the Director's applicable federal income tax return would not result in the imposition of a negligence or similar penalty. Any determination by the Accounting Firm shall be binding upon the Company and the Director. As a result of the uncertainty in the application of Section 4999 at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross-Up Payments which will not have been made by the Company should have been made by the Company ("Underpayment"), or that Gross-Up Payments will have been made by the Company which should not have been made ("Overpayment"), consistent with the calculations required to be made hereunder. In either such event, the Accounting Firm shall determine the amount of the Underpayment or Overpayment that has occurred. In the event that the Company exhausts its remedies pursuant to Section 12(c) and the Director thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Director. In the case of an Overpayment, the Director shall, at the direction and expense of the Company, take such steps as are reasonably necessary (including, if reasonable, the filing of returns and claims for refund), and otherwise reasonably 9 cooperate with the Company to correct such Overpayment; provided, however, that (i) the Director shall not in any event be obligated to return to the Company an amount greater than the net after-tax portion of the Overpayment that he has retained or has recovered as a refund from the applicable taxing authorities and (ii) this provision shall be interpreted in a manner consistent with the intent of Section 12(a) hereof to make the Director whole, on an after-tax basis, from the application of Section 4999. (c) The Director shall notify the Company in writing of any claim by the Internal Revenue Service that, if successful, would require a payment by the Company, or a change in the amount of the payment by the Company of, the Gross-Up Payment. Such notification shall be given as soon as practicable after the Director is informed in writing of such claim and shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid; provided that the failure to give any notice pursuant to this Section 12(c) shall not impair the Director's rights under this Section 12 except to the extent the Company is materially prejudiced thereby. The Director shall not pay such claim prior to the expiration of the 30-day period following the date on which the Director gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company notifies the Director in writing prior to the expiration of such period that it desires to contest such claim, the Director shall: (i) give the Company any information reasonably requested by the Company relating to such claim, (ii) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company, (iii) cooperate with the Company in good faith in order effectively to contest such claim, and (iv) permit the Company to participate in any proceedings relating to such claim; provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold the Director harmless, on an after-tax basis, for any Excise Tax or income, self-employment or other tax (including interest and penalties with respect thereto) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 12(c) hereof, the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct the Director to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Director agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided further, that if the Company directs the Director to pay such claim and sue for a refund, the Company shall advance the amount of such payment to the Director on an interest-free basis 10 and shall indemnify and hold the Director harmless, on an after-tax basis, from any Excise Tax or income, self-employment or other tax (including interest or penalties with respect to any such taxes) imposed with respect to such advance or with respect to any imputed income with respect to such advance; and provided further, that any extension of the statute of limitations relating to payment of taxes for the taxable year of the Director with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and the Director shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority. (d) If, after the receipt by the Director of an amount advanced by the Company pursuant to Section 12(c) hereof, the Director becomes entitled to receive, and receives, any refund with respect to such claim, the Director shall (subject to the Company's complying with the requirements of Section 12(c) hereof) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by the Director of an amount advanced by the Company pursuant to Section 12(c), a determination is made that the Director shall not be entitled to any refund with respect to such claim and the Company does not notify the Director in writing of its intent to contest such denial of refund prior to the expiration of thirty (30) days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid. 13. Indemnification. The Company agrees to indemnify the Director for his activities as a director and non-executive Chairman of the Company to the fullest extent permitted by law. The Company shall use commercially reasonable efforts to seek and obtain directors and officers liability insurance (which includes a six (6) year "discovery period" following the Director's service as a director for the Company) under which the Director will be a covered person throughout the Director's service as a director for the Company. Such liability insurance shall be obtained prior to the Effective Date, and the terms and policy limits of such coverage shall be subject to approval by the Board. 14. Non-Waiver of Rights. The failure to enforce at any time the provisions of this Agreement or to require at any time performance by the other party of any of the provisions hereof shall in no way be construed to be a waiver of such provisions or to affect either the validity of this Agreement or any part hereof, or the right of either party to enforce each and every provision in accordance with its terms. No waiver by either party hereto of any breach by the other party hereto of any provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions at that time or at any prior or subsequent time. 15. Notices. Any notice required or permitted to be given under this Agreement shall be sufficient if in writing and if sent by registered mail to his residence, in the case of the Director, or to the business office of its General Counsel, in the case of the Company. 16. Binding Effect/Assignment. This Agreement shall inure to the benefit of and be binding upon the parties hereto and their respective heirs, executors, personal 11 representatives, estates, successors (including, without limitation, by way of merger) and assigns. Notwithstanding the provisions of the immediately preceding sentence, neither the Director nor the Company shall assign all or any portion of this Agreement without the prior written consent of the other party. 17. Entire Agreement. This Agreement sets forth the entire understanding of the parties hereto with respect to the subject matter hereof and supersedes all prior agreements, written or oral, between them as to such subject matter. 18. Severability. If any provision of this Agreement, or any application thereof to any circumstances, is invalid, in whole or in part, such provision or application shall to that extent be severable and shall not affect other provisions or applications of this Agreement. 19. Governing Law. This Agreement shall be governed by and construed in accordance with the internal laws of the State of Indiana, without reference to the principles of conflict of laws. 20. Arbitration of Disputes. Except as set forth in Section 11(c), the parties hereto agree that any controversy or claim arising out of or relating to this Agreement or the breach thereof, shall be settled by binding arbitration in the City of Indianapolis, Indiana, in accordance with the laws of the State of Indiana by three arbitrators, who shall be selected in accordance with the then-current arbitrator selection procedures of the American Arbitration Association. The arbitration shall be conducted in accordance with the commercial arbitration rules of the American Arbitration Association. Judgment upon the award rendered by the arbitrators may be entered in any court having jurisdiction thereof. In the event that it shall be necessary or desirable for the Director to retain legal counsel and/or incur other costs and expenses in connection with the enforcement of any and all of his rights under this Agreement, the Company shall pay (or the Director shall be entitled to recover from the Company, as the case may be) his reasonable attorneys' fees and costs and expenses in connection with the enforcement of any arbitration award in court, regardless of the final outcome, unless the arbitrators shall determine that under the circumstances recovery by the Director of all or a part of any such fees and costs and expenses would be unjust. 21. Expenses of the Director. The Company agrees to reimburse the Director for all reasonable attorneys' fees he incurred in connection with the preparation of this Agreement, up to Twenty-Five Thousand Dollars ($25,000). 22. Modifications. Neither this Agreement nor any provision hereof may be modified, altered, amended or waived except by an instrument in writing duly signed by the party to be charged. 23. Tense and Headings. Whenever any words used herein are in the singular form, they shall be construed as though they were also used in the plural form in all cases where they would so apply. The headings contained herein are solely for the purposes of reference, are not part of this Agreement, and shall not in any way affect the meaning or interpretation of this Agreement. 12 24. Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed to be an original but all of which together shall constitute one and the same instrument. [signature page follows] 13 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written, effective as of the Effective Date. THE COMPANY (Conseco, Inc., a Delaware Corporation) By:/s/William J. Shea -------------------------------------- Name: William J. Shea Title: President OLD CONSECO (Conseco, Inc., an Indiana Corporation) (for purposes of only Section 6 hereof) By:/s/William J. Shea -------------------------------------- Name: William J. Shea Title: President THE DIRECTOR /s/R. Glenn Hilliard ----------------------------------------- R. Glenn Hilliard EX-12 6 exhibit12.txt EXHIBIT 12.1 Exhibit 12.1 Computation of Ratio of Earnings to Fixed Charges and Preferred Dividends (Dollars in millions)
Successor --------- One month ended September 30, 2003 ---- Pretax income from operations: Net income........................................................................... $24.2 Add income tax expense............................................................... 13.6 ----- Pretax income from operations..................................................... 37.8 ----- Add fixed charges: Interest expense..................................................................... 6.4 Interest expense on investment borrowings............................................ .6 Interest added to policyholder account balances ..................................... 38.1 Portion of rental (a)................................................................ 1.2 ----- Fixed charges..................................................................... 46.3 ----- Adjusted earnings................................................................. $84.1 ===== Ratio of earnings to fixed charges............................................ 1.82X ===== Fixed charges.......................................................................... $46.3 Add dividends on preferred stock, including dividends on preferred stock of subsidiaries (divided by the ratio of income before minority interest to pretax income)........................................................... 8.2 ----- Fixed charges plus preferred dividends and distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts............................................... $54.5 ===== Adjusted earnings................................................................. $84.1 ===== Ratio of earnings to fixed charges, preferred dividends and distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts................................... 1.54X ===== - -------------------- (a) Interest portion of rental is estimated to be 33 percent.
EX-31 7 exhibit311.txt EXHIBIT 31.1 Exhibit 31.1 CERTIFICATION I, William J. Shea, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Conseco, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 19, 2003 /s/ William J. Shea - --------------------------- William J. Shea, President and Chief Executive Officer EX-31 8 exhibit312.txt EXHIBIT 31.2 Exhibit 31.2 CERTIFICATION I, Eugene M. Bullis, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Conseco, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 19, 2003 /s/ Eugene M. Bullis - --------------------------- Eugene M. Bullis, Executive Vice President and Chief Financial Officer EX-32 9 exhibit321.txt EXHIBIT 32.1 Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Conseco, Inc. (the "Company") on Form 10-Q for the period ending September 30, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, William J. Shea, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ William J. Shea - -------------------------- William J. Shea President and Chief Executive Officer November 19, 2003 A signed original of this written statement required by Section 906 has been provided to Conseco, Inc. and will be retained by Conseco, Inc. and furnished to the Securities and Exchange Commission upon request. EX-32 10 exhibit322.txt EXHIBIT 32.2 Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Conseco, Inc. (the "Company") on Form 10-Q for the period ending September 30, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Eugene M. Bullis, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Eugene M. Bullis - ----------------------- Eugene M. Bullis Executive Vice President and Chief Financial Officer November 19, 2003 A signed original of this written statement required by Section 906 has been provided to Conseco, Inc. and will be retained by Conseco, Inc. and furnished to the Securities and Exchange Commission upon request. -----END PRIVACY-ENHANCED MESSAGE-----