10-Q 1 0001.txt 6/30/00 FORM 10-Q OF CONSECO, INC. ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2000 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____ to _____ Commission File Number 1-9250 Conseco, Inc. Indiana No. 35-1468632 ---------------------- ------------------------------- State of Incorporation IRS Employer Identification No. 11825 N. Pennsylvania Street Carmel, Indiana 46032 (317) 817-6100 ------------------------------- ------------- Address of principal executive offices Telephone Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes [ X ] No [ ] Shares of common stock outstanding as of July 31, 2000: 325,292,186 ================================================================================ PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS.
CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (Dollars in millions) ASSETS June 30, December 31, 2000 1999 ---- ---- (unaudited) Investments: Actively managed fixed maturities at fair value (amortized cost: 2000 - $23,429.9; 1999 - $23,690.4)........................................................................ $21,574.1 $22,203.8 Interest-only securities at fair value (amortized cost: 2000 - $897.4; 1999 - $916.2)...... 852.8 905.0 Equity securities at fair value (cost: 2000 - $316.0; 1999 - $323.7)....................... 305.4 312.7 Mortgage loans............................................................................. 1,470.4 1,274.5 Policy loans............................................................................... 660.5 664.1 Venture capital investments at fair value (cost: 2000 - $140.8; 1999 - $142.5)............. 561.7 527.5 Other invested assets ..................................................................... 607.4 544.0 --------- --------- Total investments...................................................................... 26,032.3 26,431.6 Cash and cash equivalents..................................................................... 1,515.8 1,686.9 Accrued investment income..................................................................... 480.4 436.0 Finance receivables........................................................................... 5,680.6 5,104.1 Finance receivables - securitized............................................................. 8,942.1 4,730.5 Cost of policies purchased.................................................................... 2,103.5 2,258.5 Cost of policies produced..................................................................... 2,423.7 2,087.4 Reinsurance receivables....................................................................... 707.4 728.6 Income tax assets............................................................................. 389.9 209.8 Goodwill...................................................................................... 3,874.4 3,927.8 Assets held in separate accounts and investment trust ........................................ 2,750.6 2,231.4 Cash held in segregated accounts for investors in securitizations............................. 731.6 853.0 Cash held in segregated accounts related to servicing agreements and securitization transactions............................................................................... 982.8 274.0 Other assets.................................................................................. 1,436.3 1,226.3 --------- --------- Total assets........................................................................... $58,051.4 $52,185.9 ========= =========
(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 June 30, December 31, 2000 1999 ---- ---- (unaudited) Liabilities: Liabilities for insurance and asset accumulation products: Interest-sensitive products.............................................................. $16,738.4 $17,322.4 Traditional products..................................................................... 7,818.3 7,537.3 Claims payable and other policyholder funds.............................................. 1,058.2 1,042.3 Liabilities related to separate accounts and investment trust............................ 2,750.6 2,231.4 Liabilities related to certificates of deposit........................................... 1,398.9 870.5 Investor payables.......................................................................... 731.6 853.0 Other liabilities.......................................................................... 1,569.2 1,498.7 Investment borrowings...................................................................... 230.7 828.9 Notes payable and commercial paper: Corporate................................................................................ 3,628.4 2,481.8 Finance.................................................................................. 5,679.1 4,682.5 Related to securitized finance receivables structured as collateralized borrowings....... 9,136.4 4,641.8 --------- --------- Total liabilities.................................................................... 50,739.8 43,990.6 --------- --------- Minority interest: Company-obligated mandatorily redeemable preferred securities of subsidiary trusts......... 2,399.2 2,639.1 Shareholders' equity: Preferred stock............................................................................ 482.5 478.4 Common stock and additional paid-in capital (no par value, 1,000,000,000 shares authorized, shares issued and outstanding: 2000 - 325,288,857; 1999 - 327,678,638)...................................................................... 2,905.6 2,987.1 Accumulated other comprehensive loss....................................................... (970.7) (771.6) Retained earnings.......................................................................... 2,495.0 2,862.3 --------- --------- Total shareholders' equity........................................................... 4,912.4 5,556.2 --------- --------- Total liabilities and shareholders' equity........................................... $58,051.4 $52,185.9 ========= =========
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 amounts) (unaudited) Three months ended Six months ended June 30, June 30, -------------------- ------------------- 2000 1999 2000 1999 ---- ---- ---- ---- Revenues: Insurance policy income........................................... $1,072.4 $1,020.0 $2,121.1 $2,027.4 Net investment income............................................. 882.4 735.9 1,943.3 1,403.6 Gain on sale: Securitization transactions..................................... - 169.4 - 368.6 Other loan sales................................................ 2.6 - 2.6 - Net investment losses ............................................ (118.2) (22.9) (153.5) (21.9) Fee revenue and other income...................................... 126.0 121.3 257.6 232.6 -------- -------- -------- -------- Total revenues................................................ 1,965.2 2,023.7 4,171.1 4,010.3 -------- -------- -------- -------- Benefits and expenses: Insurance policy benefits......................................... 1,019.2 920.5 2,086.7 1,810.2 Provision for losses.............................................. 152.7 27.2 234.7 48.5 Interest expense.................................................. 338.6 125.5 596.3 236.1 Amortization...................................................... 185.2 153.2 383.5 304.6 Other operating costs and expenses................................ 409.9 352.2 816.0 660.8 Special charges................................................... 327.2 - 327.2 - Impairment charges................................................ 9.6 71.6 12.1 83.8 --------- -------- -------- -------- Total benefits and expenses................................... 2,442.4 1,650.2 4,456.5 3,144.0 -------- -------- -------- -------- Income (loss) before income taxes, minority interest and extraordinary charge........................................ (477.2) 373.5 (285.4) 866.3 Income tax expense (benefit)......................................... (108.3) 129.9 (32.9) 304.7 -------- -------- -------- -------- Income (loss) before minority interest and extraordinary charge ....................................... (368.9) 243.6 (252.5) 561.6 Minority interest: Distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts, net of income taxes.. 35.7 30.3 74.7 60.5 -------- -------- -------- -------- Income (loss) before extraordinary charge..................... (404.6) 213.3 (327.2) 501.1 Extraordinary charge on extinguishment of debt, net of taxes...... .1 - .1 - --------- -------- -------- -------- Net income (loss)............................................. (404.7) 213.3 (327.3) 501.1 Preferred stock dividends............................................ 2.5 - 6.7 .6 --------- -------- -------- -------- Net income (loss) applicable to common stock.................. $ (407.2) $ 213.3 $ (334.0) $ 500.5 ======== ======== ======== ======== Earnings (loss) per common share: Basic: Weighted average shares outstanding.............................325,259,000 323,576,000 326,602,000 322,111,000 =========== =========== =========== =========== Net income (loss)............................................... $(1.25) $.66 $(1.02) $1.55 ====== ==== ====== ===== Diluted: Weighted average shares outstanding.............................325,259,000 331,201,000 326,602,000 331,155,000 =========== =========== =========== =========== Net income (loss)............................................... $(1.25) $.64 $(1.02) $1.51 ====== ==== ====== =====
The accompanying notes are an integral part of the consolidated financial statements. 4
CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (Dollars in millions) (unaudited) Common stock Accumulated other Preferred and additional comprehensive Retained Total stock paid-in capital loss earnings ----- ----- ---------------- ---- -------- Balance, January 1, 2000............................. $5,556.2 $ 478.4 $2,987.1 $(771.6) $2,862.3 Comprehensive loss, net of tax: Net loss........................................ (327.3) - - - (327.3) Change in unrealized depreciation of investments (net of applicable income tax benefit of $87.0)............................. (199.1) - - (199.1) - -------- Total comprehensive loss.................... (526.4) Issuance of shares for stock options and for employee benefit plans.......................... .1 - .1 - Issuance of convertible preferred shares.......... 4.1 4.1 - - - Issuance of warrants.............................. 21.0 - 21.0 - - Cost of shares acquired........................... (102.6) - (102.6) - - Dividends on common stock......................... (33.3) - - - (33.3) Dividends on preferred stock...................... (6.7) - - - (6.7) --------- -------- -------- ------- -------- Balance, June 30, 2000............................... $4,912.4 $ 482.5 $2,905.6 $(970.7) $2,495.0 ======== ======= ======== ======= ======== Balance, January 1, 1999............................. $5,273.6 $ 105.5 $2,736.5 $ (28.4) $2,460.0 Comprehensive income, net of tax: Net income...................................... 501.1 - - - 501.1 Change in unrealized depreciation of investments (net of applicable income tax benefit of $250.1)............................ (466.1) - - (466.1) - -------- Total comprehensive income.................. 35.0 Conversion of preferred stock into common shares .................................. - (105.5) 105.5 - - Issuance of shares for stock options and for employee benefit plans.......................... 163.5 - 163.5 - - Tax benefit related to issuance of shares under stock option plans.............................. 24.4 - 24.4 - - Cost of shares acquired........................... (89.4) - (89.4) - - Dividends on common stock......................... (90.6) - - - (90.6) Dividends on preferred stock...................... (.6) - - - (.6) --------- ------- -------- ------- -------- Balance, June 30, 1999............................... $5,315.9 $ - $2,940.5 $(494.5) $2,869.9 ======== ======= ======== ======= ========
The accompanying notes are an integral part of the consolidated financial statements. 5
CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (Dollars in millions) (unaudited) Six months ended June 30, ------------------ 2000 1999 ---- ---- Cash flows from operating activities: Insurance policy income....................................................................... $ 1,949.6 $ 1,809.1 Net investment income......................................................................... 1,936.5 1,449.5 Points and origination fees................................................................... - 243.2 Fee revenue and other income.................................................................. 265.5 237.6 Insurance policy benefits..................................................................... (1,568.2) (1,442.6) Interest expense.............................................................................. (550.6) (257.8) Policy acquisition costs...................................................................... (442.8) (386.8) Special charges............................................................................... (188.4) - Other operating costs......................................................................... (860.8) (704.8) Taxes......................................................................................... (21.9) (235.2) --------- --------- Net cash provided by operating activities................................................... 518.9 712.2 --------- --------- Cash flows from investing activities: Sales of investments.......................................................................... 2,969.1 8,620.5 Maturities and redemptions of investments..................................................... 422.9 598.6 Purchases of investments...................................................................... (4,148.2) (10,687.2) Cash received from the sale of finance receivables, net of expenses........................... 1,774.6 5,737.4 Principal payments received on finance receivables............................................ 4,485.1 3,960.3 Finance receivables originated................................................................ (11,198.2) (11,793.4) Other......................................................................................... (117.6) (76.5) --------- --------- Net cash used by investing activities ...................................................... (5,812.3) (3,640.3) --------- --------- Cash flows from financing activities: Repurchase of Company-obligated mandatorily redeemable preferred securities of subsidiary trusts........................................................................ (250.0) - Issuance of common and convertible preferred shares........................................... .5 101.5 Issuance of notes payable and commercial paper................................................ 16,077.4 10,182.7 Payments on notes payable and commercial paper................................................ (9,488.3) (8,438.0) Change in cash held in restricted accounts for settlement of collateralized borrowings.................................................................................. (749.8) - Payments for settlement of forward contract and to repurchase equity securities............... (102.6) (29.5) Investment borrowings......................................................................... (598.2) 393.1 Amounts received for deposit products......................................................... 2,595.8 1,746.4 Withdrawals from deposit products............................................................. (2,181.8) (1,425.7) Dividends and distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts............................................................. (180.7) (170.6) --------- --------- Net cash provided by financing activities................................................. 5,122.3 2,359.9 --------- --------- Net decrease in cash and cash equivalents................................................. (171.1) (568.2) Cash and cash equivalents, beginning of period................................................... 1,686.9 1,704.7 --------- --------- Cash and cash equivalents, end of period......................................................... $ 1,515.8 $ 1,136.5 ========= =========
The accompanying notes are an integral part of the consolidated financial statements. 6 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- The following notes should be read together with the notes to the consolidated financial statements included in the 1999 Form 10-K of Conseco, Inc. ("we", "Conseco" or the "Company"). Conseco is a financial services holding company with subsidiaries operating throughout the United States. Our insurance subsidiaries develop, market and administer supplemental health insurance, annuity, individual life insurance, individual and group major medical insurance and other insurance products. Our finance subsidiaries originate, purchase, sell and service consumer and commercial finance loans. Conseco's operating strategy is to grow its business by focusing its resources on the development and expansion of profitable products and strong distribution channels, to seek to achieve superior investment returns through active asset management and to control expenses. The Company has debt and guarantees at the parent company level of approximately $1.4 billion which are expected to become due on or before September 30, 2000. Because of the time required to complete the sale of assets and other contemplated activities described in the paragraph which follows, extension of the Company's bank credit facilities will be required if the Company is to meet its September debt maturities. The Company is currently in discussions with its bank lenders and management is optimistic appropriate extensions can be negotiated. However, there can be no assurance that these negotiations will be successful, or as to the amount, maturity, cost or terms associated with any such extension. See "Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity of Conseco (parent company)." On July 27, 2000, we announced several courses of action with respect to Conseco Finance Corp. ("Conseco Finance"), a wholly owned subsidiary of Conseco, as well as an asset disposition program with respect to certain non-strategic assets held at the parent company level, which are designed to allow us to reduce parent company debt over time. These actions with respect to Conseco Finance, include: (i) the sale, closing or runoff of five units (i.e., asset-based lending, vendor finance, bankcards, transportation and park construction); (ii) efforts to better utilize existing assets so as to increase cash; and (iii) cost savings and restructuring of ongoing businesses such as the streamlining of the field force in the manufactured housing and home equity lending divisions. The Company believes these contemplated actions offer better opportunities than the previously announced plan to explore the sale of Conseco Finance and are designed to provide a business model which will result in positive cash flow at Conseco Finance. In addition, we plan to sell certain non-strategic assets, such as our investment in the wireless communication company, Tritel, Inc. ("Tritel"), our interest in the riverboat casino in Lawrenceberg, Indiana, and our subprime auto loan portfolio. The Company believes the sale of non-strategic assets and the actions contemplated at Conseco Finance will generate cash proceeds of approximately $2.0 billion over the next 12 to 15 months. We are already well underway with these actions, and have completed the sale of the bankcard business and our subprime auto loan portfolio, generating cash proceeds of over $300 million. However, no assurance can be provided as to the timing, proceeds, or other terms related to the possible disposition of assets, the timing or extent of the cost savings to be achieved, or the amount of the restructuring or other charges to be incurred with respect to these actions. Furthermore, the Company's ability to use cash generated from the actions being undertaken at Conseco Finance is substantially limited by restrictions in agreements with Lehman Brothers Holdings, Inc. and its affiliates (collectively, with its direct and indirect subsidiaries, referred to as "Lehman"). In connection with the negotiations with our banks relating to the extension of the maturity dates of our debt, we are also engaged in discussions with Lehman concerning a modification of these restrictions and are optimistic an acceptable modification can be obtained. However, there can be no assurance that these negotiations will be successful, or as to the terms of any such modification. See the note entitled "Changes in Corporate Notes Payable and Commercial Paper." BASIS OF PRESENTATION Our unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring items, that are necessary to present fairly Conseco's financial position and results of operations on a basis consistent with that of our prior audited consolidated financial statements. As permitted by rules and regulations of the Securities and Exchange Commission applicable to quarterly reports on Form 10-Q, we have condensed or omitted certain information and disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles ("GAAP"). We have also reclassified certain amounts from the prior periods to conform to the 2000 presentation. Results for interim periods are not necessarily indicative of the results that may be expected for a full year. When we prepare financial statements in conformity with GAAP, we are required to make estimates and assumptions that significantly affect various reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting periods. For example, we use significant estimates and assumptions in calculating values for certain fixed maturity securities, interest-only securities, certain venture capital investments, the cost of policies produced, the cost of policies purchased, servicing rights, goodwill, liabilities for insurance and deposit products, liabilities related to litigation, guaranty fund assessment accruals, gain on sale of finance receivables, provision for losses and deferred income taxes. If our future experience differs from these estimates and assumptions, our financial statements could be materially affected. 7 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- Net income and diluted earnings per share, as previously reported in our Form 10-Q, as amended, for the three and six months ended June 30, 1999, have been restated to reflect adjustments, principally related to: (i) impairment charges relating to interest-only securities and servicing rights; (ii) delaying the recognition of revenue from sales of loans to certain commercial paper conduit trusts until the loans were subsequently placed in their final securitization structures; and (iii) adjusting loan origination cost deferrals. These changes reduced previously reported net income by $84.2 million, or $.26 per diluted share, and by $93.5 million, or $.29 per diluted share, in the three and six months ended June 30, 1999, respectively. Our consolidated financial statements exclude the results of material transactions between us and our consolidated affiliates, or among our consolidated affiliates. ACCOUNTING FOR INVESTMENTS We classify our fixed maturity securities into three categories: (i) "actively managed" (which we carry at estimated fair value); (ii) "trading" (which we carry at estimated fair value); and (iii) "held to maturity" (which we carry at amortized cost). We held $78.1 million of trading securities at June 30, 2000, which we included in "other invested assets." We had no fixed maturity securities in the "held to maturity" category at June 30, 2000. Accumulated other comprehensive loss is primarily comprised of unrealized losses on actively managed fixed maturity investments. Such amounts, included in shareholders' equity as of June 30, 2000 and December 31, 1999, were as follows:
June 30, December 31, 2000 1999 ---- ---- (Dollars in millions) Unrealized losses on investments...................................................... $(1,907.4) $(1,504.3) Adjustments to cost of policies purchased and cost of policies produced............... 406.5 291.2 Deferred income tax benefit........................................................... 530.4 443.4 Other................................................................................. - (1.7) --------- --------- Net unrealized losses on investments............................................. (970.5) (771.4) Minimum pension liability adjustment, net of income tax benefit....................... (.2) (.2) ----------- --------- Accumulated other comprehensive loss............................................. $ (970.7) $ (771.6) ========= =========
VENTURE CAPITAL INVESTMENTS Venture capital investments include equity and equity-type investments made by our subsidiary which engages in venture capital investment activity. At the time we enter into these investments, we believe they have high growth or appreciation potential. These investments are carried at estimated fair value, with changes in fair value recognized as investment income. When these venture capital investments are publicly traded, the fair value is generally based upon market prices. When liquidity is limited because of thinly traded securities, limited partnership structures, large-block holdings, restricted shares or other special situations, we adjust quoted market prices to produce an estimate of the attainable fair values. We estimate the fair values of securities that are not publicly traded based upon transactions which directly affect the value of such securities and consideration of the investee's financial results, conditions and prospects. During 1999, we invested $53.2 million in Tritel, a company in the wireless communication business. The market values of many companies in this sector increased significantly in 1999 and early 2000. In the fourth quarter of 1999, our investee sold shares of common stock to the public in an initial public offering. As a result, an ascertainable market value was established for our investment, which we adjusted to recognize liquidity restrictions. We recognized venture capital income of $3.2 million in the first six months of 2000 related to this investment (consisting of $105.1 million of income recognized in the first quarter of 2000 and a loss of $101.9 million in the second quarter of 2000), bringing the total carrying value of our investment to $443.3 million. 8 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- FINANCE RECEIVABLES AND INTEREST-ONLY SECURITIES On September 8, 1999, we announced that we would no longer structure our securitizations in a manner that results in recording a sale of the loans. Instead, we are using the portfolio method to account for securitization transactions structured after that date. Our new securitizations are structured to include provisions that entitle the Company to repurchase assets transferred to the special purpose entity when the aggregate unpaid principal balance reaches a specified level. Until these assets are repurchased, however, the assets are the property of the special purpose entity and are not available to satisfy claims of creditors of the Company. Pursuant to Financial Accounting Standards Board Statement No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" ("SFAS 125"), such securitization transactions are accounted for under the portfolio method, whereby the loans and securitization debt remain on our balance sheet, rather than as sales. We classify the finance receivables transferred to the securitization trusts and held as collateral for the notes issued to investors as "finance receivables-securitized." We are generally able to repurchase these receivables from the trust when the aggregate unpaid principal balance reaches 20 percent of the initial principal balance of the finance receivables. The average interest rate earned on these receivables at June 30, 2000, was approximately 11.8 percent. We classify the notes issued to investors in the securitization trusts as "notes payable related to securitized finance receivables structured as collateralized borrowings." After the March 31, 2000 announcement that we planned to explore the sale of Conseco Finance and the other events described elsewhere herein, it was difficult to complete new securitization transactions for a period of time. However, these markets eventually became available to the Company. During the second quarter of 2000, we completed five transactions, securitizing over $2.5 billion of finance receivables. In May 2000, we sold $1.3 billion of finance receivables to Lehman. The proceeds from such sale were used to repay various warehouse credit lines, creating increased warehousing capacity for Conseco Finance. Lehman also amended its repurchase and other financing facilities with Conseco Finance to expand the types of assets financed. We continue to be able to finance loans through: (i) our warehouse and bank credit facilities; (ii) the sale of securities through securitization transactions; and (iii) whole-loan sales. Finance receivables-securitized, summarized by type, were as follows at June 30, 2000 and December 31, 1999:
June 30, December 31, 2000 1999 ---- ---- (Dollars in millions) Manufactured housing.................................................................. $3,216.9 $ 953.0 Mortgage services..................................................................... 4,190.6 2,077.3 Consumer/credit card.................................................................. 256.5 1,076.9 Commercial............................................................................ 1,330.5 637.0 -------- -------- 8,994.5 4,744.2 Less allowance for credit losses...................................................... 52.4 13.7 -------- -------- Net finance receivables-securitized........................................... $8,942.1 $4,730.5 ======== ========
9 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- The other finance receivables, summarized by type, were as follows:
June 30, December 31, 2000 1999 ---- ---- (Dollars in millions) Manufactured housing.................................................................. $ 834.4 $ 795.8 Mortgage services..................................................................... 1,404.4 1,277.0 Consumer/credit card.................................................................. 1,668.2 824.7 Commercial............................................................................ 1,874.4 2,281.3 -------- ------- 5,781.4 5,178.8 Less allowance for credit losses...................................................... 100.8 74.7 -------- -------- Net other finance receivables................................................. $5,680.6 $5,104.1 ======== ========
The changes in the allowance for credit losses included in finance receivables were as follows:
Three months ended Six months ended June 30, June 30, ------------------ ------------------ 2000 1999 2000 1999 ---- ---- ---- ---- (Dollars in millions) Allowance for credit losses, beginning of period..................... $119.1 $ 53.1 $ 88.4 $ 43.0 Provision for losses................................................. 84.1 27.2 142.7 48.5 Credit losses........................................................ (50.0) (25.1) (77.9) (36.3) ------ ------ ------ ------ Allowance for credit losses, end of period........................... $153.2 $ 55.2 $153.2 $ 55.2 ====== ====== ====== ======
The securitizations structured prior to our September 8, 1999 announcement met the applicable criteria to be accounted for as sales. At the time the loans were securitized and sold, we recognized a gain and recorded our retained interest represented by the interest-only security. The interest-only security represents the right to receive, over the life of the pool of receivables, the excess of the principal and interest received on the receivables transferred to the special purpose entity over the sum of: (i) principal and interest paid to the holders of other interests in the securitization; and (ii) contractual servicing fees. In some of those securitizations, we also retained certain lower-rated securities that are senior in payment priority to the interest-only securities. Such retained securities had a par value, fair market value and amortized cost of $769.8 million, $468.9 million and $714.7 million, respectively, at June 30, 2000, and were classified as "actively managed fixed maturity securities." During the first six months of 1999, the Company sold $6.5 billion of finance receivables in various securitized transactions and recognized gains of $368.6 million. We recognized no gain on sale related to securitized transactions during the first six months of 2000. The interest-only securities on our consolidated balance sheet represent an allocated portion of the cost basis of the finance receivables in the securitization transactions accounted for as sales related to transactions structured prior to September 8, 1999. We used the following assumptions to adjust the amortized cost to estimated fair value at June 30, 2000 and December 31, 1999. We include the difference between estimated fair value and the amortized cost of the interest-only securities in "accumulated other comprehensive loss, net of taxes." 10 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------
Manufactured Home equity/ Consumer/ June 30, 2000 housing home improvement equipment Total ------------- ------- ---------------- --------- ----- (Dollars in millions) Interest-only securities at fair value............. $ 522.2 $ 280.7 $ 49.9 $ 852.8 Cumulative principal balance of sold finance receivables at June 30, 2000.................... 21,451.5 7,590.6 2,386.1 31,428.2 Weighted average stated customer interest rate on sold finance receivables..................... 10.0% 11.5% 10.9% Assumptions to determine estimated fair value of interest-only securities at June 30, 2000: Expected weighted average annual constant prepayment rate as a percentage of principal balance of related finance receivables (a).. 9.6% 21.0% 22.2% Expected nondiscounted credit losses as a percentage of principal balance of related finance receivables (a)............. 8.7% 5.9% 5.1% Weighted average discount rate ............... 14.0% 14.0% 14.0% Manufactured Home equity/ Consumer/ December 31, 1999 housing home improvement equipment Total ----------------- ------- ---------------- --------- ----- (Dollars in millions) Interest-only securities at fair value............. $ 528.3 $ 318.0 $ 58.7 $ 905.0 Cumulative principal balance of sold finance receivables at December 31, 1999................ 22,854.6 8,804.8 3,049.4 34,708.8 Weighted average stated customer interest rate on sold finance receivables........................ 10.0% 11.5% 11.0% Assumptions to determine estimated fair value of interest-only securities at December 31, 1999: Expected weighted average annual constant prepayment rate as a percentage of principal balance of related finance receivables (a).. 9.4% 21.7% 22.4% Expected nondiscounted credit losses as a percentage of principal balance of related finance receivables (a)..................... 9.0% 5.8% 5.1% Weighted average discount rate................ 14.0% 14.0% 14.0% ---------- (a) The valuation of interest-only securities is affected not only by the projected level of prepayments of principal and net credit losses, but also by the projected timing of such prepayments and net credit losses. Should such timing differ materially from our projections, it could have a material effect on the valuation of our interest-only securities. Additionally, such valuation is determined by discounting cash flows over the entire expected life of the receivables sold.
11 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- Activity in the interest-only securities account was as follows:
Six months ended June 30, ------------------ 2000 1999 ---- ---- (Dollars in millions) Balance, beginning of period................................................................... $ 905.0 $1,305.4 Additions resulting from securitizations during the period.................................. - 266.4 Additions resulting from clean-up calls (a)................................................. 64.9 - Investment income........................................................................... 56.1 91.5 Cash received............................................................................... (126.5) (234.1) Impairment charge to reduce carrying value.................................................. (13.3) (83.2) Change in unrealized depreciation charged to shareholders' equity........................... (33.4) 3.5 ------- -------- Balance, end of period......................................................................... $ 852.8 $1,349.5 ======= ======== ---------- (a) During the first six months of 2000, clean-up calls were exercised for five securitizations that were previously recognized as sales. The interest-only securities related to these securitizations had previously been separately securitized with other interest-only securities in transactions recognized as sales. The repurchase of the collateral underlying the five securitizations triggered a requirement for the Company to repurchase a portion of the interest-only securities.
Credit quality of managed finance receivables was as follows:
June 30, December 31, 2000 1999 --- ---- 60-days-and-over delinquencies as a percentage of managed finance receivables at period end................................................. 1.47% 1.42% ==== ==== Net credit losses incurred during the last twelve months as a percentage of average managed finance receivables during the period.................. 1.49% 1.31% ==== ==== Repossessed collateral inventory as a percentage of managed finance receivables at period end................................................. 1.41% 1.34% ==== ====
12 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- EARNINGS PER SHARE A reconciliation of income (loss) and shares used to calculate basic and diluted earnings per share is as follows:
Three months ended Six months ended June 30, June 30, ------------------ ------------------ 2000 1999 2000 1999 ---- ---- ---- ---- (Dollars in millions and shares in thousands) Income (loss): Net income (loss).................................................. $(404.7) $213.3 $(327.3) $501.1 Preferred stock dividends.......................................... 2.5 - 6.7 .6 ------- ------ ------- ------ Income (loss) applicable to common ownership for basic earnings per share............................................. (407.2) 213.3 (334.0) 500.5 Effect of dilutive securities: Preferred stock dividends.......................................... - - - .6 ------- ------ ------- ------ Income (loss) applicable to common ownership and assumed conversions for diluted earnings per share..................... $(407.2) $213.3 $(334.0) $501.1 ======= ====== ======= ====== Shares: Weighted average shares outstanding for basic earnings per share... 325,259 323,576 326,602 322,111 Effect of dilutive securities on weighted average shares: Stock options.................................................... - 2,552 - 3,100 Employee benefit plans........................................... - 2,031 - 2,018 Convertible securities........................................... - 3,042 - 3,926 ------- ------- ----------- ------- Dilutive potential common shares............................... - 7,625 - 9,044 ------- ------- ----------- ------- Weighted average shares outstanding for diluted earnings per share.................................................. 325,259 331,201 326,602 331,155 ======= ======= ======= =======
There were no dilutive common stock equivalents during the 2000 periods because of the net loss realized by the Company during such periods. BUSINESS SEGMENTS We manage our business operations through two segments, based on the products offered, in addition to the corporate segment. Finance segment. Our finance segment provides a variety of finance products including: loans for the purchase of manufactured housing, home improvements and various consumer products; home equity loans; private label credit card programs; and commercial loans such as floorplan and equipment financing. These products are primarily marketed through intermediary channels such as dealers, vendors, contractors and retailers. Insurance and fee-based segment. Our insurance and fee-based segment provides supplemental health, annuity, life, and individual and group major medical products to a broad spectrum of customers through multiple distribution channels, each focused on a specific market segment. These products are primarily marketed through career agents, professional independent producers and direct marketing. Fee-based activities include services performed for other companies, including: (i) investment management; and (ii) insurance product marketing. 13 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- Corporate segment. Our corporate segment includes certain investment activities, such as our venture capital investment in the wireless communication company, Tritel, and our ownership interest in the riverboat casino in Lawrenceberg, Indiana. In addition, the corporate segment includes interest expense related to the Company's corporate debt, special corporate charges and other income and expenses. Corporate expenses are net of charges to our subsidiaries for services provided by the corporate operations. Segment operating information was as follows:
Three months ended Six months ended June 30, June 30, ------------------ ------------------ 2000 1999 2000 1999 ---- ---- ---- ---- (Dollars in millions) Revenues: Insurance and fee-based segment: Insurance policy income: Annuities..................................................... $ 34.2 $ 30.5 $ 67.2 $ 54.1 Supplemental health........................................... 533.5 513.8 1,060.6 1,029.7 Life.......................................................... 236.3 223.5 459.6 443.1 Individual and group major medical............................ 229.7 217.5 458.8 427.2 Other......................................................... 38.7 34.7 74.9 73.3 Net investment income (a)....................................... 500.1 550.5 1,043.4 1,064.5 Fee revenue and other income (a)................................ 35.1 32.2 65.9 59.4 Net losses from sale of investments (a)......................... (118.2) (22.9) (153.5) (21.9) -------- -------- --------- -------- Total insurance and fee-based segment revenues.............. 1,489.4 1,579.8 3,076.9 3,129.4 -------- -------- --------- -------- Finance segment: Net investment income: Interest-only securities (a).................................. 28.6 47.4 56.1 91.1 Manufactured housing.......................................... 109.3 22.4 191.4 41.4 Mortgage services............................................. 154.8 25.5 284.4 46.5 Consumer/credit card.......................................... 108.0 44.5 204.4 77.8 Commercial.................................................... 62.4 29.0 115.3 49.0 Other (a)..................................................... 16.6 11.9 37.7 25.5 Gain on sale: Securitization transactions: Manufactured housing........................................ - 93.5 - 210.2 Mortgage services........................................... - 63.9 - 138.0 Consumer/credit card........................................ - 4.6 - 4.6 Commercial.................................................. - 10.2 - 18.6 Other....................................................... - (2.8) - (2.8) Other loan sales - mortgage services.......................... 2.6 - 2.6 - Fee revenue and other income.................................... 94.9 87.6 194.1 170.2 -------- -------- --------- -------- Total finance segment revenues.............................. 577.2 437.7 1,086.0 870.1 -------- -------- --------- -------- Corporate: Net investment income........................................... 14.5 11.1 23.7 20.6 Venture capital income (loss) related to investment in Tritel... (101.9) - 3.2 - Other........................................................... (2.6) (.1) (2.6) (.1) -------- -------- --------- -------- Total corporate segment revenues (losses)................... (90.0) 11.0 24.3 20.5 -------- -------- --------- --------- Eliminations...................................................... (11.4) (4.8) (16.1) (9.7) -------- -------- -------- --------- Total revenues.............................................. 1,965.2 2,023.7 4,171.1 4,010.3 -------- -------- -------- --------- Expenses: Insurance and fee-based segment: Insurance policy benefits....................................... 1,019.2 920.5 2,086.7 1,810.2 Amortization.................................................... 213.6 152.4 382.1 303.0 Interest expense................................................ 5.0 16.6 10.0 28.4 Other operating costs and expenses.............................. 210.3 191.5 433.0 373.6 -------- -------- -------- --------- Total insurance and fee-based segment expenses................ 1,448.1 1,281.0 2,911.8 2,515.2 -------- -------- -------- ---------
(continued) 14 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- (continued from previous page)
Three months ended Six months ended June 30, June 30, ------------------ ------------------ 2000 1999 2000 1999 ---- ---- ---- ---- (Dollars in millions) Finance segment: Provision for losses............................................ 84.1 27.2 142.7 48.5 Interest expense................................................ 266.9 69.6 471.4 124.2 Special charges................................................. 63.4 - 63.4 - Impairment charges.............................................. 9.6 71.6 12.1 83.8 Other operating costs and expenses.............................. 198.1 156.9 408.0 317.6 -------- -------- -------- -------- Total finance segment expenses................................ 622.1 325.3 1,097.6 574.1 -------- -------- -------- -------- Corporate: Interest expense on corporate debt.............................. 75.8 44.1 127.8 93.2 Provision for losses............................................ 68.6 - 92.0 - Special charges................................................. 263.8 - 263.8 - General corporate expenses, less charges to subsidiaries for services provided......................................... (24.6) 4.6 (20.4) (28.8) -------- -------- -------- -------- Total corporate segment expenses.............................. 383.6 48.7 463.2 64.4 -------- -------- -------- -------- Eliminations...................................................... (11.4) (4.8) (16.1) (9.7) -------- -------- -------- -------- Total expenses................................................ 2,442.4 1,650.2 4,456.5 3,144.0 -------- -------- -------- -------- Income (loss) before income taxes and minority interest: Insurance operations............................................ 41.3 298.8 165.1 614.2 Finance operations.............................................. (44.9) 112.4 (11.6) 296.0 Corporate interest and other expenses........................... (473.6) (37.7) (438.9) (43.9) -------- -------- -------- -------- Income (loss) before income taxes, minority interest and extraordinary charge.................................. $ (477.2) $ 373.5 $ (285.4) $ 866.3 ======== ======== ======== ======== -------------------- (a) It is not practicable to provide additional components of revenue by product or service.
STANDARD & POOR'S 500 INDEX CALL OPTIONS AND INTEREST RATE SWAP AGREEMENTS Our equity-indexed annuity products provide a guaranteed base rate of return and a higher potential return linked to the performance of the Standard & Poor's 500 Index ("S&P 500 Index"). We buy S&P 500 Call Options in an effort to hedge potential increases to policyholder benefits resulting from increases in the S&P 500 Index to which the product's return is linked. We include the cost of the S&P 500 Call Options in the pricing of these products. Policyholder account balances for these annuities fluctuate in relation to changes in the values of these options. We reflect changes in the value of these options in net investment income. During the first six months of 2000 and 1999, net investment income included $6.6 million and $84.4 million, respectively, related to these changes. Such investment income was substantially offset by increases to policyholder account balances. The value of the S&P 500 Call Options was $103.2 million at June 30, 2000. We classify such instruments as other invested assets. We defer the premiums paid to purchase the S&P 500 Call Options and amortize them to investment income over their terms. Such amortization was $59.9 million and $43.4 million during the first six months of 2000 and 1999, respectively. The unamortized premium of the S&P 500 Call Options was $66.7 million at June 30, 2000. 15 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- We periodically use interest-rate swaps to hedge the interest rate risk associated with our borrowed capital. At June 30, 2000, we held instruments having an aggregate notional principal amount of $1.5 billion that effectively converted a portion of our fixed-rate borrowed capital into floating-rate instruments for specified periods of time. The agreements mature in various years through 2005 and have an average remaining life of 2.9 years (the average call date is 2.1 years). We record the difference between the rates as an adjustment to interest expense. During the first six months of 2000, interest expense was increased by $6.0 million as a result of these interest-rate swap agreements. At June 30, 2000, such agreements had a fair value of $(25.8) million, which is not recognized in the consolidated balance sheet because such agreements effectively hedge the interest rate risk associated with portions of the Company's fixed rate debt. During the second quarter of 2000, ratings agencies lowered their ratings on Conseco's debt (see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity of Conseco (parent company)"). These actions triggered requirements for Conseco to terminate several swap agreements, or provide cash collateral equal to the current fair value of certain swap agreements. We realized a $38.7 million net investment loss related to the termination of the swap agreements in the second quarter of 2000. In addition, Conseco provided $12.7 million of cash collateral related to certain other swap agreements. If the counterparties of these financial instruments fail to meet their obligations, Conseco may have to recognize a loss. Conseco limits its exposure to such a loss by diversifying among several counterparties believed to be strong and creditworthy. At June 30, 2000, all of the counterparties were rated "A" or higher by Standard & Poor's Corporation. GUARANTEES In conjunction with certain sales of finance receivables, we provided guarantees aggregating approximately $1.6 billion at June 30, 2000. We consider any potential payments related to these guarantees in the projected net cash flows used to determine the value of our interest-only securities. We believe the likelihood of a significant loss from such guarantees is remote. We have guaranteed bank loans totaling $570.2 million to approximately 170 directors, officers and key employees. The funds were used by the participants to purchase approximately 19.0 million shares of Conseco common stock in open market or negotiated transactions with independent parties. Such shares are held by the bank as collateral for the loans. During the second quarter of 2000, Conseco and certain participants in the stock purchase plan refinanced $144.4 million principal amount of the guaranteed bank loans. Conseco granted a security interest in most of its assets to secure the financing of such loans and for a new working capital facility (see "Changes in Corporate Notes Payable"). The bank loans we have guaranteed are scheduled to mature as follows: $144.4 million on September 1, 2000 and $425.8 million on August 30, 2001. The Company is currently negotiating with various financial institutions to refinance or extend the maturity dates of these loans. At June 30, 2000, the guaranteed bank loans exceeded the value of the common stock collateralizing the loans by $385.3 million. All participants have agreed to indemnify Conseco for any loss incurred on their loans. In addition, Conseco has provided loans to participants for interest on the bank loans totaling $64.8 million. We regularly evaluate these guarantees and loans in light of the collateral and the creditworthiness of the participants. In the second quarter of 2000, we established an additional noncash provision of $68.6 million in connection with these guarantees and loans, which was included as a component of the provision for losses. At June 30, 2000, the total reserve for losses on the loan guarantees was $110.9 million (which was established as follows: $68.6 million ($44.6 million after income taxes) in the second quarter of 2000; $23.4 million ($14.7 million after income taxes) in the first quarter of 2000; and $18.9 million ($11.9 million after income taxes) in the fourth quarter of 1999). REINSURANCE The cost of reinsurance ceded totaled $141.2 million and $232.7 million in the first six months of 2000 and 1999, respectively. We deducted this cost from insurance policy income. Conseco is contingently liable for claims reinsured if the assuming company is unable to pay. Reinsurance recoveries netted against insurance policy benefits totaled $141.7 million and $229.1 million in the first six months of 2000 and 1999, respectively. 16 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- INCOME TAXES A reconciliation of the U.S. statutory corporate income tax rate to the effective rate reflected in the consolidated statement of operations is as follows:
Six months ended June 30, ------------------- 2000 1999 ---- ---- U.S. statutory corporate rate.................................................................. (35.0)% 35.0% Nondeductible goodwill amortization............................................................ 6.8 2.1 Other nondeductible expenses................................................................... 5.8 - State taxes.................................................................................... 1.4 2.2 Settlement of tax issues....................................................................... - (3.3) Provision for tax issues and other............................................................. 9.5 (.8) ----- ---- Effective tax rate...................................................................... (11.5)% 35.2% ====== ====
CHANGES IN CORPORATE NOTES PAYABLE AND COMMERCIAL PAPER (EXCLUDING NOTES PAYABLE RELATED TO SECURITIZED FINANCE RECEIVABLES STRUCTURED AS COLLATERALIZED BORROWINGS) Notes payable and commercial paper (excluding notes payable related to securitized finance receivables structured as collateralized borrowings) were as follows (interest rates as of June 30, 2000):
June 30, December 31, 2000 1999 ---- ---- (Dollars in millions) $2.266 billion bank credit facilities (6.91%)................................ $2,256.0 $1,032.0 $155 million collateralized bank credit facility (9.16%)..................... 125.0 - Commercial paper (6.52%)..................................................... 51.7 898.4 Master repurchase agreements due on various dates in 2000 and 2001 (7.89%).............................................................. 2,525.3 1,620.9 Credit facility collateralized by retained interests in securitizations due 2001 (8.62%).............................................................. 525.0 499.0 Medium term notes due September 2002 and April 2003 (6.52%).................. 223.7 226.7 7.875% notes due December 2000............................................... 131.5 150.0 7.6% senior notes due 2001................................................... 118.9 118.9 6.4% notes due 2001 to 2003.................................................. 800.0 800.0 8.5% notes due 2002.......................................................... 450.0 450.0 10.25% senior subordinated notes due 2002.................................... 193.6 193.6 Notes payable due 2003 (7.18%)............................................... 250.0 250.0 8.75% notes due 2004......................................................... 788.0 - 6.8% senior notes due 2005................................................... 250.0 250.0 9.0% notes due 2006.......................................................... 550.0 550.0 Other........................................................................ 94.2 146.6 -------- -------- Total principal amount.................................................. 9,332.9 7,186.1 Unamortized net discount..................................................... 25.4 21.8 -------- -------- Total notes payable and commercial paper................................ $9,307.5 $7,164.3 ======== ======== Total allocated to: Corporate............................................................. $3,628.4 $2,481.8 Finance segment....................................................... 5,679.1 4,682.5 -------- -------- Total notes payable and commercial paper............................ $9,307.5 $7,164.3 ======== ========
17 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- Our current bank credit facilities allow us to borrow up to $2.3 billion, of which $1.5 billion may be borrowed until 2003 and $.8 billion may be borrowed until September 22, 2000. Borrowings under these facilities averaged $1,332.0 million during the first six months of 2000, at a weighted average interest rate of 6.58 percent. At June 30, 2000, the available borrowings under our bank credit facilities were $40 million and we held approximately $450 million of cash at the parent company level. The credit facility requires us to maintain various financial ratios, as defined in the agreement, including: (i) a debt-to-total capitalization ratio less than .45:1 (such ratio was .43:1 at June 30, 2000); and (ii) an interest coverage ratio greater than 2.25:1 for the period October 1, 1999 through September 30, 2001 and greater than 2.50:1 thereafter (such ratio was 2.86:1 for the period ended June 30, 2000). Our current plans to restructure our finance operations could adversely affect such financial ratios. The interest rates on our bank credit facilities are based on a LIBOR rate plus a margin based on the credit rating of Conseco's senior unsecured notes. During the second quarter of 2000, rating agencies lowered their ratings on Conseco's senior unsecured debt (see "Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity of Conseco (parent company)"). Accordingly, the weighted average interest rates under these bank credit facilities increased .15 percent. During the second quarter of 2000, we entered into a collateralized bank credit facility which allows us to borrow up to $155 million until September 1, 2000. The interest rate on the new facility is based on LIBOR plus 2.5 percent. The proceeds from the credit facility were used to repay a similar credit facility entered into in April 2000. Conseco granted a collateral interest in most of its assets to secure the new credit facility and a portion of the loans to directors, officers and key employees, guaranteed by Conseco, related to the purchase of shares of Conseco common stock (see "Guarantees"). The covenants of the collateralized bank credit facility and the guarantee related to the directors, officers and key employee loans limit additional collateralized debt of the Company to $50 million, excluding certain collateralized indebtedness (such as the collateralized finance segment indebtedness). This debt is due and is expected to be repaid or refinanced in September 2000. The parent company has debt and guarantees of approximately $1.4 billion which are expected to become due on or before September 30, 2000. See "Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity of Conseco (parent company)" for additional information on the alternatives the Company is exploring to meet these obligations and related risks. The covenants of certain of the Company's unsecured debt agreements generally limit the amount of collateralized debt the Company can incur, issue, assume or guarantee, without providing that existing indebtedness is similarly collateralized in terms of ranking, as long as the other indebtedness is collateralized. Such limit does not apply to certain excluded collateralized indebtedness (such as the collateralized finance segment indebtedness) and is equal to 10 percent of consolidated capitalization, as defined. At June 30, 2000, the most restrictive covenant related to collateralized indebtedness (excluding: (i) the aforementioned covenant related to the collateralized bank credit facility and Conseco guarantee; and (ii) $88 million of debt which provides that it will be collateralized equally with any collateralized debt) would have permitted additional collateralized indebtedness of approximately $400 million (excluding the $325 million of collateralized debt and guarantees outstanding at June 30, 2000). The credit facility collateralized by retained interests in securitizations requires the Company's finance subsidiary to maintain various financial ratios, as defined in the agreement, including: (i) an adjusted tangible net worth of at least $1.8 billion (such amount was $2.0 billion at June 30, 2000); (ii) a fixed charge coverage ratio of not less than 1.10:1.0 (such ratio was 1.11:1 at June 30, 2000); (iii) a debt to equity ratio of not more than 12.0:1.0 (such ratio was 9.0:1.0 at June 30, 2000); and (iv) a net worth equal to averaged managed receivables ratio of not less than .0375:1 (such ratio was .0393:1 at June 30, 2000). Our current plans to restructure our finance operations could adversely affect such financial ratios. In connection with the modification of certain master repurchase agreements and other transactions with Lehman described in the note entitled "Special Charges and Recent Events", Conseco Finance agreed that it will not pay dividends until 2001 and then pay such dividends only to the extent certain financial covenants are met. In addition, Conseco Finance agreed that without Lehman's consent, it will limit additional prepayments on the intercompany note payable to 18 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- Conseco (with a balance of $2,210.8 million at June 30, 2000) to $50 million, as long as certain financing arrangements with Lehman remain outstanding. Borrowings under our commercial paper program averaged $678.2 million during the first six months of 2000, at a weighted average interest rate of 6.1 percent. The actions by rating agencies which occurred after March 31, 2000 (see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity of Conseco"), have affected our ability to issue commercial paper. Accordingly, we have curtailed its issuance in favor of borrowing under our bank credit facilities. On February 7, 2000, the Company completed the public offering of $800.0 million of 8.75 percent notes due February 9, 2004. The notes are unsecured and rank equally with all other unsecured senior indebtedness of Conseco. Proceeds from the offering of approximately $794.3 million (after underwriting discounts and estimated offering expenses) were used to repay outstanding indebtedness. Notes payable due 2003 bear interest at LIBOR plus .5 percent. Such notes are putable by the holder prior to the maturity date at a 1-to-3 percent discount to par. The notes and accrued interest thereon are secured by standby letters of credit, which expire on September 30, 2000. During the second quarter of 2000, we repurchased: (i) $18.5 million par value of the 7.875 percent notes due 2000 for $16.7 million; and (ii) $12 million par value of the 8.75 percent notes due 2004 for $8.7 million. We recognized an extraordinary gain of $3.2 million (net of income taxes of $1.7 million) related to these repurchases. At June 30, 2000, we had $5.7 billion in master repurchase agreements, commercial paper conduit facilities and other facilities with various banking and investment banking firms for the purpose of financing our consumer and commercial finance loan production. These facilities typically provide financing of a certain percentage of the underlying collateral and are subject to the availability of eligible collateral and, in many cases, the willingness of the banking firms to continue to provide financing. These agreements generally provide for annual terms, some of which are extended either quarterly or semi-annually by mutual agreement of the parties for an additional annual term based upon receipt of updated quarterly financial information. At June 30, 2000, we had borrowed $3.3 billion of the $5.7 billion available under such agreements. NOTES PAYABLE RELATED TO SECURITIZED FINANCE RECEIVABLES STRUCTURED AS COLLATERALIZED BORROWINGS Notes payable related to securitized finance receivables structured as collateralized borrowings were $9,136.4 million at June 30, 2000. The principal and interest on these notes are paid using the cash flows from the underlying finance receivables which serve as collateral for the notes. Accordingly, the timing of the principal payments on these notes is dependent on the payments received on the underlying finance receivables which back the notes. The average interest rate on these notes at June 30, 2000 was 8.0 percent. CHANGES IN MINORITY INTEREST In April 2000, the Company and the holder of the Redeemable Hybrid Income Overnight Shares ("RHINOS") agreed to the repurchase by the Company of the RHINOS at their $250 million par value. The Company recognized an extraordinary loss of $3.3 million (net of income taxes of $1.8 million) in the second quarter of 2000 related to the redemption. CHANGES IN PREFERRED STOCK On December 15, 1999, we issued $500.0 million (2.6 million shares) of Series F Common-Linked Convertible Preferred Stock (the "Series F Preferred Stock") to Thomas H. Lee Company and affiliated investors. The Series F Preferred Stock is convertible into Conseco common stock at a common equivalent rate of $19.25 per share. The Series F Preferred Stock pays a 4 percent dividend, of which an amount at least equal to the common dividend will be payable in 19 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- cash, and the remainder may be paid in additional Series F shares valued at $19.25 per share. The Series F Preferred Stock ranks senior to the common stock outstanding and has a liquidation preference of $192.50 per share plus all declared and unpaid dividends. In February 1999, we redeemed all $105.5 million (carrying value) of outstanding shares of Preferred Redeemable Increased Dividend Equity Securities, 7% PRIDES Convertible Preferred Stock ("PRIDES") in exchange for 5.9 million shares of Conseco common stock. CHANGES IN COMMON STOCK Changes in the number of shares of common stock outstanding were as follows:
Six months ended June 30, ------------------- 2000 1999 ---- ---- (Shares in thousands) Balance, beginning of period................................................................... 327,679 315,844 Stock options exercised..................................................................... 65 4,718 Issuance of shares.......................................................................... - 3,115 Common shares converted from PRIDES......................................................... - 5,904 Settlement of forward contract and common stock acquired.................................... (4,246) (2,900) Shares issued under employee benefit compensation plans..................................... 1,791 50 ------- ------- Balance, end of period......................................................................... 325,289 326,731 ======= =======
On June 30, 1999, we sold 3.1 million shares of our common stock to an unaffiliated party (the "Buyer") at the then-current market value of $29.0625 per share. Simultaneous with the issuance of the common stock, we entered into a forward transaction with the Buyer to be settled at $29.0625 per share in a method of our choosing (i.e. cash settlement, transfer of net shares to or from the Buyer, or transfer of net cash to or from the Buyer). We settled the contract in March 2000 by repurchasing the shares held by the Buyer. RECENTLY ISSUED ACCOUNTING STANDARDS Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), as amended by Statement of Financial Accounting Standards No. 137, "Deferral of the Effective Date of FASB Statement No. 133" requires all derivative instruments to be recorded on the balance sheet at estimated fair value. Changes in the fair value of derivative instruments are to be recorded each period either in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, on the type of hedge transaction. We are currently evaluating the impact of SFAS 133, which is required to be implemented in 2001. Because of ongoing changes to implementation guidance, we do not plan on adopting the new standard until the first quarter of 2001. LITIGATION Conseco Finance was served with various related lawsuits filed in the United States District Court for the District of Minnesota. These lawsuits were generally filed as purported class actions on behalf of persons or entities who purchased common stock or options to purchase common stock of Conseco Finance during alleged class periods that generally run from February 1995 to January 1998. One action (Florida State Board of Admin. v. Green Tree Financial Corp., Case No. 98-1162) did not include class action claims. In addition to Conseco Finance, certain current and former officers and directors of Conseco Finance are named as defendants in one or more of the lawsuits. Conseco Finance and other defendants obtained an order consolidating the lawsuits seeking class action status into two actions, one of which pertains to a purported class of common stockholders (In re Green Tree Financial Corp. Stock Litig., Case No. 97-2666) and the other which pertains to a purported class action of stock option traders (In re Green Tree Financial Corp. Options Litig., Case No. 97-2679). Plaintiffs in the lawsuits assert claims under Sections 10(b) and 20(a) of the Securities Exchange Act 20 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- of 1934. In each case, plaintiffs allege that Conseco Finance and the other defendants violated federal securities laws by, among other things, making false and misleading statements about the current state and future prospects of Conseco Finance (particularly with respect to prepayment assumptions and performance of certain loan portfolios of Conseco Finance) which allegedly rendered Conseco Finance's financial statements false and misleading. On August 24, 1999, the United States District Court for the District of Minnesota issued an order to dismiss with prejudice all claims alleged in the lawsuits. The plaintiffs subsequently appealed the decision to the U.S. Court of Appeals for the 8th Circuit, and the appeal is currently pending. The Company believes that the lawsuits are without merit and intends to continue to defend them vigorously. The ultimate outcome of these lawsuits cannot be predicted with certainty. A total of forty-five suits have been filed against the Company in the United States District Court for the Southern District of Indiana. Nineteen of these cases are putative class actions on behalf of persons or entities that purchased the Company's common stock during alleged class periods that generally run from April 1999 through April 2000. Luisi v. Conseco, Inc., et al., Case No. IP00-C-0593-Y/S; Sechrist v. Conseco, Inc., et al., Case No. IP00-C-0585-Y/S; Klein v. Conseco, Inc., et al., Case No. IP00-C-0602-Y/S; Brody v. Conseco, Inc., et al., Case No. IP00-C-0609-Y/S; Dana v. Conseco, Inc., et al., Case No. IP00-C-0623-Y/S; Krim v. Conseco, Inc., et al., Case No. IP00-C-0631-Y/S; Nadaf v. Conseco, Inc., et al., Case No. IP00-C-0628-Y/S; Greiner v. Conseco, Inc., et al., Case No. IP00-C-0639-Y/S (naming as a defendant only one officer/director); Sedgwick v. Conseco, Inc., et al., Case No. IP00-C-0657-Y/S; Irle v. Conseco, Inc., et al., Case No. IP00-C-0746-Y/S; Schwartz v. Conseco, Inc., et al., Case No. IP00-C-0770-Y/S; Leopold v. Conseco, Inc., et al., Case No. IP00-C-0843-Y/S; Slovacek v. Conseco, Inc., et al., Case No. IP00-C-0858-Y/S (naming as a defendant only one officer/director); Swei v. Conseco, Inc., et al., Case No. IP00-C-0839-Y/S (naming as a defendant only one officer/director); Nicholson v. Conseco, Inc., et al., Case No. IP00-C-0826-Y/S; Browne v. Conseco, Inc., et al., Case No. IP00-C-0897-Y/S; Chacharone v. Conseco, Inc., et al., Case No. IP00-C-0885-Y/S; Muhlenfeld v. Conseco, Inc., et al., Case No. IP00-C-0933-Y/S; Young v. Conseco, Inc., et al. (case number pending; originally filed in the United States District Court for the Eastern District Michigan, Case No. 00-72939, and now in the process of transferred by stipulation). Two cases are putative class actions on behalf of persons or entities that purchased the Company's bonds during the same alleged class periods. Waring v. Conseco, Inc., et al., Case No. IP00-C-0793-Y/S; Lutt v. Conseco, Inc., et al., Case No. IP00-C-0905-Y/S. Three cases are putative class actions on behalf of persons or entities that purchased or sold option contracts, not issued by the Company, on the Company's common stock during the same alleged class periods. Syndicated Fin. Servs., Inc. v. Conseco, Inc., et al., Case No. IP00-C-0795-Y/S (naming as a defendant only one officer/director); Joel Mandel v. Conseco, Inc., et al., Case No. IP00-C-0815-Y/S; Avi Mandel v. Conseco, Inc., et al., Case No. IP00-C-0884- Y/S. One case is a putative class action on behalf of persons or entities that purchased the Company's "Feline Pride" convertible preferred stock instruments during the same alleged class periods. Kelly v. Conseco, Inc., et al., Case No. IP00- C-0789-Y/S. With the four exceptions noted, in each of these twenty-five cases two former officers/directors of the Company are named as defendants. In each case, the plaintiffs assert claims under Section 10(b) and 20(a) of the Securities Exchange Act of 1934. In each case, plaintiffs allege that the Company and the individual defendants violated the federal securities laws by, among other things, making false and misleading statements about the current state and future prospects of Conseco Finance (particularly with respect to performance of certain loan portfolios of Conseco Finance) which allegedly rendered the Company's financial statements false and misleading. The Company believes that these lawsuits are without merit and intends to defend them vigorously. The ultimate outcome of these lawsuits cannot be predicted with certainty. Eleven of the cases in the United States District Court were filed as purported class actions on behalf of persons or entities that purchased preferred securities issued by various Conseco Financing Trusts, including Conseco Financing Trust V, Griffin v. Conseco, Inc., et al., Case No. IP00-C-0663-Y/S; Stifnagle v. Conseco, Inc., et al., Case No. IP00-C-0754- Y/S (Stifnagle also asserts claims regarding Conseco Financing Trust VII); Gastfriend v. Conseco, Inc., et al., Case No. IP00-C-0883-Y/S; Powers v. Conseco Financing Trust V, et al., Case No. IP00-C-0953-Y/S (also naming Conseco Financing Trusts VI and VII) (each of the preceding make allegations with respect to an August 24, 1998 offering for Conseco Financing Trust V); Gabora v. Conseco, Inc., et al., Case No. IP00-C-0852-Y/S (also naming Conseco Financing Trust VII, but containing allegations relating only to notes issued by the Company on October 18, 1999, unrelated to the Conseco Financing Trusts named); Schmidt v. Conseco, Inc., et al., Case No. IP00-C-0823-Y/S (also naming Conseco Financing Trust VII, but containing allegations relating only to Conseco Financing Trusts VI and VII), Conseco Financing Trust VI, Costello v. Conseco, Inc., et al., Case No. IP00-C-0705-Y/S (October 8, 1998 offering), and Conseco Financing Trust VII, Zinno v. Conseco, Inc., et al., Case No. IP00-C-0622-Y/S; Shapiro v. Conseco, Inc., et al., Case No. IP00-C- 21 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- 0650-Y/S; Kosseff v. Conseco, Inc., et al., Case No. IP00-C-0753-Y/S; Harris v. Conseco, Inc., et al., Case No. IP00-C- 0797-Y/S (August 26, 1999 offering). Each of these complaints names as defendants the Company, the relevant trust (except Shapiro and Kosseff), two former officers/directors of the Company, and underwriters for the particular issuance (except Shapiro). The Kosseff complaint also names an officer and all of the Company's directors at the time of issuance of the preferred stock by Conseco Financing Trust VII. In each case, plaintiffs assert claims under Section 11 and Section 15 of the Securities Act of 1933, and the Zinno, Shapiro, Stifnagle, Harris, Gabora, Gastfriend, Powers and Schmidt complaints also assert claims under Section 12(a)(2) of that Act. Gabora and Gastfriend also assert claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Powers also asserts a claim under Section 10(b) of that Act. In each case, plaintiffs allege that the defendants violated the federal securities laws by, among other things, making false and misleading statements, in Prospectuses and/or Registration Statements related to the issuance of preferred securities by the Trust involved, regarding the current state and future prospects of Conseco Finance (particularly with respect to performance of certain loan portfolios of Conseco Finance) which allegedly rendered the disclosure documents false and misleading. The Company also intends to defend these lawsuits vigorously. The ultimate outcome of these lawsuits cannot be predicted with certainty. Nine shareholder derivative suits have been filed in United States District Court. Rogney v. Decatur, et al., Case No. IP00-C-0655-Y/S; Fletcher v. Hilbert, et al., Case No. IP00-C-0693-Y/S; Gold v. Decatur, et al., Case No. IP00-C-0747- Y/S; Batcheldor v. Hilbert, Case No. IP00-C-0743-Y/S; Youssef v. Decatur, et al., Case No. IP00-C-0809-Y/S; Gintel v. Hilbert, Case No. IP00-C-0987-Y/S; Frankel v. Coss, et al. (case number pending; originally filed in the Evansville Division of United States District Court for the Southern District of Indiana, Case No. EV00-134-C-Y/H, and now in the process of transfer); Evans v. Hilbert, Case No. IP00-C-1019-Y/S; Marks v. Hilbert, Case No. IP00-C-0877-Y/S. The complaints name as defendants the current directors, certain former directors, certain non-director officers of the Company (in Fletcher), and, alleging aiding and abetting liability, certain banks which allegedly made loans in relation to the Company's "Stock Purchase Plan" (in Batcheldor, Gintel and Evans). The Company is also named as a nominal defendant in each complaint. Plaintiffs allege that the defendants breached their fiduciary duties by, among other things, intentionally disseminating false and misleading statements concerning the acquisition, performance and proposed sale of Conseco Finance, and engaged in corporate waste by causing the Company to guarantee loans that certain officers, directors and key employees of the Company used to purchase stock under the Stock Purchase Plan. Three similar cases have been filed in the Hamilton County Superior Court in Indiana. Schweitzer v. Hilbert, et al., Cause No. 29001-0004CP251; Evans v. Hilbert, et al., Cause No. 29001-0005CP308 (both Schweitzer and Evans name as defendants certain non-director officers); Gintel v. Hilbert, et al., Cause No. 29003-0006CP393 (naming as defendants, and alleging aiding and abetting liability as to, banks which allegedly made loans in relation to the Stock Purchase Plan). The Company believes that these lawsuits are without merit and intends to defend them vigorously. The ultimate outcome of these lawsuits cannot be predicted with certainty. Conseco, Inc. and its subsidiaries, Conseco Services, LLC, Washington National Insurance Company and United Presidential Life Insurance Company are currently named defendants in a lawsuit filed in the Circuit Court of Claiborne County, Mississippi, Cause No. CV-99-0106, and captioned "Carla Beaugez, Lois Dearing, Lee Eaton and all other persons identified in the lawsuit v. Conseco, Inc., Conseco Services, Inc., Washington National Company, United Presidential Life Insurance Company and Larry Ratcliff." The claims of the eighty-seven plaintiffs arise out of allegedly wrongful increases of the cost of insurance and decrease in the credited interest rates on universal life policies issued to the plaintiffs by United Presidential Life. The plaintiffs asserted claims including negligent and intentional misrepresentation, fraudulent concealment, fraudulent inducement, common law fraud, and deceptive sales practices. Conseco believes this lawsuit is without merit and is defending it vigorously. The ultimate outcome of this lawsuit cannot be predicted with certainty. Conseco, Inc. and its subsidiaries, Conseco Life Insurance Company and Wabash Life Insurance Company, are currently named defendants in a certified nationwide class action lawsuit in the Superior Court for Santa Clara County (California, cause number CV768991) and captioned "John P. Dupell and the John P. Dupell 1992 Insurance Trust vs. Massachusetts General Life Insurance Company; Life Partners Group, Inc., Wabash Life Insurance Company, Conseco, Inc., Donovan R. Bolton, et al." The class, approximately 345,000 in number, consists of all persons who purchased universal life insurance policies from Conseco Life Insurance Company, formerly named Massachusetts General Life Insurance Company, between January 1, 1984 and July 23, 1999 (excluding policies where death benefits were paid). The claims involve the changing interest rate climate between the 1980s and the comparatively lower rates in the 1990s, and 22 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- the resulting lower rates credited to universal life products. The plaintiffs asserted claims of fraud, breach of the covenant of good faith and fair dealing, negligence, negligent misrepresentation, unjust enrichment and related matters. Conseco believes this lawsuit is without merit. We intend to continue defending this action vigorously unless the current settlement discussions and procedures produce a satisfactory outcome. The ultimate outcome of this lawsuit cannot be predicted with certainty. Conseco Finance is a defendant in two arbitration proceedings in South Carolina (Lackey v. Green Tree Financial Corporation, n/k/a Conseco Finance Corp. and Bazzle v. Green Tree Financial Corporation, n/k/a Conseco Finance Corp.) where the arbitrator, over Conseco Finance's objection, allowed the plaintiffs to pursue purported class action claims in arbitration. The two purported arbitration classes consist of South Carolina residents who obtained real estate secured credit from Conseco Finance's Manufactured Housing Division (Lackey) and Home Improvement Division (Bazzle) in the early and mid 1990s, and did not receive a South Carolina specific disclosure form relating to selection of attorneys in connection with the credit transactions. The arbitrator, in separate awards issued on July 24, 2000, awarded a total of $26.8 million in penalties and attorneys' fees. Plaintiffs have filed motions in South Carolina courts to have the awards confirmed as judgments. Conseco Finance intends to vigorously challenge the awards and believes that the arbitrator erred by, among other things, conducting class action arbitrations without the authority to do so and misapplying South Carolina law when awarding the penalties. The ultimate outcome of these proceedings cannot be predicted with certainty. In addition, the Company and its subsidiaries are involved on an ongoing basis in other lawsuits related to their operations. Although the ultimate outcome of certain of such matters cannot be predicted, such lawsuits currently pending against the Company or its subsidiaries are not expected, individually or in the aggregate, to have a material adverse effect on the Company's consolidated financial condition, cash flows or results of operations. CONSOLIDATED STATEMENT OF CASH FLOWS The following disclosures supplement our consolidated statement of cash flows:
Six months ended June 30, ------------------ 2000 1999 ---- ---- (Dollars in millions) Cash flows from operating activities: Net income (loss)........................................................................... $(327.3) $ 501.1 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Gain on sale of finance receivables..................................................... (2.6) (368.6) Points and origination fees received.................................................... - 243.2 Interest-only securities investment income.............................................. (56.1) (91.5) Cash received from interest-only securities............................................. 126.5 234.1 Servicing income........................................................................ (55.3) (81.1) Cash received from servicing activities................................................. 63.2 86.1 Provision for losses.................................................................... 234.7 48.5 Amortization and depreciation........................................................... 445.2 344.2 Income taxes............................................................................ (95.0) 122.1 Insurance liabilities................................................................... 347.0 149.3 Accrual and amortization of investment income........................................... (77.2) (96.7) Deferral of cost of policies produced and purchased..................................... (442.8) (386.8) Impairment charges...................................................................... 12.1 83.8 Special charges......................................................................... 138.8 - Minority interest....................................................................... 115.0 93.0 Net investment losses................................................................... 153.5 21.9 Other................................................................................... (60.8) (105.3) Payment of taxes in settlement of prior years........................................... - (85.1) ------- ------- Net cash provided by operating activities............................................... $ 518.9 $ 712.2 ======= =======
23 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------
Six months ended June 30, ------------------ 2000 1999 ---- ---- (Dollars in millions) Non-cash items not reflected in the consolidated statement of cash flows: Issuance of common stock under stock option and employee benefit plans....................... $ - $ 2.1 Issuance of convertible preferred shares..................................................... 4.1 - Issuance of warrants to Lehman............................................................... 48.1 - Issuance of warrants to General Electric Corporation......................................... 21.0 - Tax benefit related to the issuance of common stock under employee benefit plans............. - 24.4 Conversion of preferred stock into common stock.............................................. - 105.5
SPECIAL CHARGES AND RECENT EVENTS During the second quarter of 2000, the Company incurred the following charges which are further described in the paragraphs which follow (dollars in millions): Advisory fees and warrant paid and/or issued to Lehman and other investment banks................ $117.1 Exit from subprime automobile and bankcard business.............................................. 58.5 Executive termination payment.................................................................... 72.5 Chief Executive Officer signing payment.......................................................... 45.0 Warrants granted to General Electric Company..................................................... 21.0 Other .......................................................................................... 13.1 ------ Special charges before income tax benefit................................................. 327.2 Income tax benefit related to special charges.................................................... (98.6) ------ Special charges, net of income tax benefit................................................ $228.6 ======
Lehman transactions In May 2000, we sold approximately $1.3 billion of finance receivables to Lehman and its affiliates for cash and a right to share in future profits from a subsequent sale or securitization of the assets sold. We paid a $25.0 million transaction fee to Lehman in conjunction with the sale, which was included in special charges. Such loans were sold to Lehman at a value which approximated net book value, less the fee paid to Lehman. During the second quarter of 2000, we repurchased approximately $.7 billion of the finance receivables sold to Lehman. These finance receivables were subsequently included in securitization transactions structured as financings. The cost of the finance receivables purchased from Lehman did not differ materially from the book value of the loans prior to their sale to Lehman. Lehman has also amended its master repurchase financing facilities with our finance operations to expand the types of assets financed. As partial consideration for the financing transaction, Lehman received a warrant, with a nominal exercise price, for five percent of the common stock of Conseco Finance. The warrant has a five-year term. After three years, the holder of the warrant or Conseco Finance may cause the warrant and any stock issued upon its exercise to be purchased for cash at an appraised value. Since the warrant permits cash settlement at fair value at the option of the holder of the warrant, it has been classified as a liability measured at fair value, with changes in its value reported in earnings. The warrant would be cancelled in certain circumstances in the event the holder thereof or an affiliate participates in a group that purchases Conseco Finance. The initial $48.1 million estimated value of the warrant was recognized as an expense during the second quarter of 2000. 24 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- We also paid Lehman $20.0 million in fees for its efforts to form an investor group to purchase Conseco Finance. In addition, the Company paid other investment banks and financial institutions $24.0 million in advisory fees related to the potential sale of Conseco Finance and consultation regarding various other transactions. In connection with the transaction with Lehman, the intercompany demand note from Conseco Finance to Conseco was replaced with a one-year term note and Conseco Finance repaid $450.0 million of this note. At June 30, 2000, the one-year term note had a balance of $2,210.8 million. Conseco Finance agreed that without Lehman's consent, it will limit additional prepayments on this note to $50 million, as long as certain financing arrangements with Lehman remain outstanding. In addition, Conseco Finance has agreed that it will not pay dividends until 2001 and then pay such dividends only to the extent certain financial covenants are met. In 1999, the parent company contributed certain assets then having a book value of approximately $300 million to a subsidiary of Conseco Finance in exchange for additional shares of Conseco Finance common stock. The stock of this subsidiary was distributed back to Conseco in 2000 concurrently with the Lehman transaction at book value. Exit from subprime automobile and bankcard business Late in the second quarter of 2000, we decided to terminate the operations of our subprime automobile financing and servicing companies. A binding sale agreement for the operation's finance receivables was entered into on June 28, 2000. In addition, the Company sold substantially all of its bankcard (Visa and Mastercard) portfolio. We recognized a net loss on these sales of $58.5 million. Executive Termination On April 28, 2000, Conseco and Stephen C. Hilbert, the Company's former Chairman and Chief Executive Officer, entered into an agreement pursuant to which Mr. Hilbert's employment was terminated. As contemplated by the terms of his employment agreement, Mr. Hilbert received: (i) $72.5 million (prior to required withholdings for taxes), an amount equal to five times his salary and the non-discretionary bonus amount (as defined in his employment agreement) for this year; less (ii) the amount due under a secured loan of $23 million, plus accrued interest, made to Mr. Hilbert on April 6, 2000. Mr. Hilbert also received the bonus of $3,375,000 payable under his employment agreement for the first quarter of 2000. Conseco agreed to continue to treat Mr. Hilbert as though he were an employee/participant for purposes of the guaranteed bank loans and the loans for interest on such loans pursuant to the stock purchase program. Conseco also entered into a consulting agreement with Mr. Hilbert pursuant to which Mr. Hilbert has agreed to provide consulting services up to an average of 25 hours per month for a period of three years. Mr. Hilbert also agreed not to compete with Conseco during the term of the consulting agreement. On April 27, 2000, Mr. Hilbert was granted options to purchase an aggregate of 2,000,000 shares of Conseco common stock at a price of $5.75 per share (the average of the high and low sales prices on the New York Stock Exchange on such date). The options expire on April 26, 2003. On April 28, 2000, Conseco and Rollin M. Dick, the Company's former Chief Financial Officer, entered into an agreement pursuant to which Mr. Dick's employment was terminated. As contemplated by the terms of his employment agreement, Conseco agreed to pay Mr. Dick his salary of $250,000 per year through December 31, 2001, and he also received the bonus of $187,500 payable under his employment agreement for the first quarter of 2000. Conseco also agreed to continue to treat Mr. Dick as though he were an employee/participant for purposes of the guaranteed bank loans and the loans for interest on such loans pursuant to the stock purchase program. Conseco also entered into a consulting agreement with Mr. Dick pursuant to which Mr. Dick has agreed to provide consulting services up to an average of 25 hours per month for a period of three years. Mr. Dick also agreed not to compete with Conseco during the term of the consulting agreement. On April 27, 2000, Mr. Dick was granted options to purchase an aggregate of 600,000 shares of Conseco common stock at a price of $5.75 per share. The options expire on April 26, 2003. Executive Hiring On June 28, 2000, the Company hired Gary C. Wendt as its Chief Executive Officer. Pursuant to the terms of his employment agreement, Mr. Wendt received a payment of $45 million (prior to required withholdings for taxes) and was 25 CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------- granted options to purchase an aggregate of 10,000,000 shares of Conseco common stock at a price of $5.875 per share (the average of the high and low sales price on the New York Stock Exchange on the date on which the substantial terms of Mr. Wendt's employment were agreed to). The options vest over the next five years and expire on June 28, 2010. The Company also issued 3,200,000 shares of restricted stock to Mr. Wendt. The restrictions on the stock lapse if Mr. Wendt remains employed by Conseco through June 30, 2002, or upon a "change in control" of the Company. The value of the restricted shares ($18.8 million) will be recognized as an expense to the Company over the two year period ending June 30, 2002. Mr. Wendt is also being provided certain supplemental retirement, insurance and other benefits under the terms of his employment agreement. In conjunction with Mr. Wendt's hiring and his release from noncompete provisions of a prior agreement, the Company issued a warrant to a subsidiary of General Electric Company to purchase 10,500,000 shares of Conseco common stock at a purchase price of $5.75 per share. The estimated value of the warrant ($21.0 million) was recognized as a special charge in the second quarter of 2000. 26 CONSECO, INC. AND SUBSIDIARIES -------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. In this section, we review Conseco's consolidated results of operations for the three and six months ended June 30, 2000 and 1999, and significant changes in our consolidated financial condition. Please read this discussion in conjunction with the accompanying consolidated financial statements and notes. The parent company has debt and guarantees of approximately $1.4 billion which are expected to become due on or before September 30, 2000. Because of the time required to complete the sale of assets and other contemplated activities described in the paragraph which follows, extension of the Company's bank credit facilities will be required if the Company is to meet its September debt maturities. The Company is currently in discussions with its bank lenders and management is optimistic appropriate extensions can be negotiated. However, there can be no assurance that these negotiations will be successful, or as to the amount, maturity, cost or terms associated with any such extension. See "Liquidity of Conseco (parent company)." On July 27, 2000, we announced several courses of action with respect to Conseco Finance, as well as an asset disposition program with respect to certain non-strategic assets held at the parent company level, which are designed to allow us to reduce parent company debt over time. These actions with respect to Conseco Finance, include: (i) the sale, closing or runoff of five units (i.e., asset-based lending, vendor finance, bankcards, transportation and park construction); (ii) efforts to better utilize existing assets so as to increase cash; and (iii) cost savings and restructuring of ongoing businesses such as the streamlining of the field force in the manufactured housing and home equity lending divisions. The Company believes these contemplated actions offer better opportunities than the previously announced plan to explore the sale of Conseco Finance and are designed to provide a business model which will result in positive cash flow at Conseco Finance. In addition, we plan to sell certain non-strategic assets, such as our investment in the wireless communication company, Tritel, our interest in the riverboat casino in Lawrenceberg, Indiana, and our subprime auto loan portfolio. The Company believes the sale of non-strategic assets and the actions contemplated at Conseco Finance will generate cash proceeds of approximately $2.0 billion over the next 12 to 15 months. We are already well underway with these actions, and we have completed the sale of the bankcard business and our subprime auto loan portfolio, generating cash proceeds of over $300 million. However, no assurance can be provided as to the timing, proceeds, or other terms related to the possible disposition of assets, the timing or extent of the cost savings to be achieved, or the amount of the restructuring or other charges to be incurred with respect to these actions. Furthermore, the Company's ability to use cash generated from the actions being undertaken at Conseco Finance is substantially limited by restrictions in agreements with Lehman. In connection with the negotiations with our banks relating to the extension of the maturity dates of our debt, we are also engaged in discussions with Lehman concerning a modification of these restrictions and are optimistic an acceptable modification can be obtained. However, there can be no assurance that these negotiations will be successful, or as to the terms of any such modification. See the note entitled "Changes in Corporate Notes Payable and Commercial Paper." Consolidated results and analysis The net loss of $404.7 million in the second quarter of 2000, or $1.25 per diluted share, included: (i) net investment losses (including related costs, amortization and taxes) of $71.3 million, or 22 cents per share; (ii) special and impairment charges of $304.7 million, or 94 cents per share; and (iii) an extraordinary charge (net of taxes) of $.1 million, or nil cents per share, related to the early retirement of debt. Net income of $213.3 million in the second quarter of 1999, or 64 cents per diluted share, included: (i) net investment losses of $18.8 million, or 6 cents per share; and (ii) an impairment charge of $45.1 million, or 14 cents per share, to reduce the value of interest-only securities and servicing rights. The aforementioned special and impairment charges are explained in more detail in the notes to the accompanying consolidated financial statements. The net loss of $327.3 million in the first six months of 2000, or $1.02 per diluted share, included: (i) net investment losses (including related costs, amortization and taxes) of $84.6 million, or 26 cents per share; (ii) special and impairment charges of $321.0 million, or 98 cents per share; and (iii) an extraordinary charge (net of taxes) of $.1 million, or nil cents per share, related to the early retirement of debt. Net income of $501.1 million in the first six months of 1999, or $1.51 per diluted share, included: (i) net investment losses of $24.7 million, or 8 cents per share; and (ii) an impairment charge of $52.8 million, or 16 cents per share, to reduce the value of interest-only securities and servicing rights. The aforementioned special and impairment charges are explained in more detail in the notes to the accompanying consolidated financial statements. Total revenues in the second quarters of 2000 and 1999 included net investment losses of $118.2 million and $22.9 million, respectively. Excluding net investment losses, total revenues were $2,083.4 million in the second quarter of 2000, up 1.8 percent from $2,046.6 million in the second quarter of 1999. Total revenues in the first six months of 2000 and 27 CONSECO, INC. AND SUBSIDIARIES -------------------- 1999 included net investment losses of $153.5 million and $21.9 million, respectively. Excluding net investment losses, total revenues were $4,324.6 million in the first six months of 2000, up 7.3 percent from $4,032.2 million in the first six months of 1999. We evaluate performance and base management's incentives on operating earnings which is defined as income before extraordinary charge, net investment gains (losses) of our life insurance and corporate segments (less that portion of amortization of cost of policies purchased and cost of policies produced and income taxes relating to such gains (losses)), and unusual or infrequent items (net of income taxes). Operating earnings are determined by adjusting GAAP net income for the above mentioned items. While these items may be significant components in understanding and assessing our consolidated financial performance, we believe that the presentation of operating earnings enhances the understanding of our results of operations by highlighting net income attributable to the normal, recurring operations of the business and by excluding events that materially distort trends in net income. However, operating earnings are not a substitute for net income determined in accordance with GAAP. Results of operations by segment for the three and six months ended June 30, 2000 and 1999 The following tables and narratives summarize our results by segment.
Three months ended Six months ended June 30, June 30, ------------------ ------------------ 2000 1999 2000 1999 ---- ---- ---- ---- (Dollars in millions) Operating earnings (loss): Operating income of segments before income taxes and minority interest: Insurance and fee-based operations............................ $ 150.5 $327.8 $ 295.3 $ 652.2 Finance operations............................................ 28.1 184.0 63.9 379.8 ------- ------ ------- -------- Subtotal for: (i) insurance and fee-based operations; and (ii) finance operations................................ 178.6 511.8 359.2 1,032.0 ------- ------ ------- -------- Corporate operations: Venture capital income (loss) related to investment in Tritel, net of amortization and other expenses............ (75.5) - .6 - Interest expense on corporate debt.......................... (75.8) (44.1) (127.8) (93.2) Other, net.................................................. 10.1 6.4 44.1 49.3 ------- ------ ------- -------- Subtotal for corporate operations......................... (141.2) (37.7) (83.1) (43.9) ------- ------ ------- -------- Operating income before income taxes and minority interest...................................... 37.4 474.1 276.1 988.1 Income taxes related to operating income.......................... 30.3 166.6 123.0 349.0 ------- ------ ------- -------- Operating income before minority interest................. 7.1 307.5 153.1 639.1 Minority interest................................................. 35.7 30.3 74.7 60.5 ------- ------ ------- -------- Operating earnings (loss)................................. (28.6) 277.2 78.4 578.6 Nonoperating items: Net investment losses, net of tax and other items................. (71.3) (18.8) (84.6) (24.7) Special and impairment charges, net of taxes...................... (304.7) (45.1) (321.0) (52.8) Extraordinary charge, net of taxes................................ (.1) - (.1) - ------- ------ ------- -------- Net income (loss)......................................... $(404.7) $213.3 $(327.3) $ 501.1 ======= ====== ======= ========
28 CONSECO, INC. AND SUBSIDIARIES -------------------- Insurance and fee-based operations
Three months ended Six months ended June 30, June 30, ------------------- ------------------ 2000 1999 2000 1999 ---- ---- ---- ---- (Dollars in millions) Premiums and asset accumulation product collections: Annuities........................................................... $ 633.6 $ 772.3 $1,279.2 $1,283.3 Supplemental health................................................. 574.5 553.2 1,160.7 1,108.9 Life................................................................ 245.0 224.5 487.2 466.1 Individual and group major medical.................................. 240.2 206.9 473.7 416.0 Mutual funds........................................................ 143.1 82.8 432.7 165.0 -------- -------- -------- -------- Total premiums and asset accumulation product collections....... $1,836.4 $1,839.7 $3,833.5 $3,439.3 ======== ======== ======== ======== Average liabilities for insurance and asset accumulation products: Annuities: Mortality based................................................... $ 451.1 $ 691.5 $ 453.5 $ 689.3 Equity-linked..................................................... 2,562.2 1,581.1 2,483.5 1,485.8 Deposit based..................................................... 9,812.2 10,856.5 10,022.9 10,949.2 Separate accounts and investment trust liabilities.................. 2,718.5 1,622.5 2,588.7 1,546.8 Health.............................................................. 5,220.4 4,711.4 5,151.3 4,706.7 Life: Interest sensitive................................................ 4,269.8 4,076.2 4,257.5 4,103.9 Non-interest sensitive............................................ 2,703.7 2,855.3 2,716.8 2,846.8 --------- --------- --------- ---------- Total average liabilities for insurance and asset accumulation products, net of reinsurance ceded............... $27,737.9 $26,394.5 $27,674.2 $26,328.5 ========= ========= ========= ========= Revenues: Insurance policy income............................................. $ 1,072.4 $ 1,020.0 $ 2,121.1 $ 2,027.4 Net investment income: General account invested assets................................... 489.3 506.1 994.2 993.9 Equity-indexed products based on S&P 500 Index.................... (16.1) 50.8 6.6 84.4 Amortization of cost of S&P 500 Call Options...................... (31.1) (23.3) (59.9) (43.4) Separate account assets........................................... 58.0 16.9 102.5 29.6 Fee revenue and other income........................................ 35.1 32.2 65.9 59.4 --------- --------- --------- --------- Total revenues (a).............................................. 1,607.6 1,602.7 3,230.4 3,151.3 --------- --------- --------- --------- Expenses: Insurance policy benefits........................................... 832.5 681.0 1,664.2 1,350.6 Amounts added to policyholder account balances: Annuity products other than those listed below.................... 151.2 173.4 319.1 347.5 Equity-indexed products based on S&P 500 Index.................... (22.5) 49.2 .9 82.5 Separate account liabilities...................................... 58.0 16.9 102.5 29.6 Amortization related to operations.................................. 222.6 146.3 405.4 286.9 Interest expense on investment borrowings........................... 5.0 16.6 10.0 28.4 Other operating costs and expenses.................................. 210.3 191.5 433.0 373.6 --------- --------- --------- --------- Total benefits and expenses (a)................................. 1,457.1 1,274.9 2,935.1 2,499.1 --------- --------- ---------- ---------- Operating income before income taxes and minority interest...... 150.5 327.8 295.3 652.2 Net investment losses, including related costs and amortization........................................................ (109.2) (29.0) (130.2) (38.0) --------- --------- --------- --------- Income before income taxes and minority interest................ $ 41.3 $ 298.8 $ 165.1 $ 614.2 ========= ========= ========= =========
29 CONSECO, INC. AND SUBSIDIARIES -------------------- (continued from previous page)
Three months ended Six months ended June 30, June 30, ------------------ ------------------ 2000 1999 2000 1999 ---- ---- ---- ---- (Dollars in millions) Ratios: Investment income, net of interest credited on annuities and universal life products and interest expense on investment borrowings, as a percentage of average liabilities for insurance and asset accumulation products (b)................... 4.72% 4.71% 4.75% 4.57% Operating costs and expenses (excluding amortization of cost of policies produced and cost of policies purchased) as a percentage of average liabilities for insurance and asset accumulation products........................................... 2.96% 2.92% 3.06% 2.90% Health loss ratios: All health lines: Insurance policy benefits....................................... $652.6 $514.9 $1,287.2 1,018.0 Loss ratio...................................................... 81.49% 67.07% 80.63% 66.38% Medicare Supplement: Insurance policy benefits....................................... $170.5 $162.4 $351.1 $321.6 Loss ratio...................................................... 72.21% 68.76% 74.59% 68.68% Long-Term Care: Insurance policy benefits....................................... $191.8 $119.6 $343.6 $235.1 Loss ratio...................................................... 94.15% 65.22% 85.17% 63.33% Specified Disease: Insurance policy benefits....................................... $64.4 $55.0 $141.9 $110.9 Loss ratio...................................................... 68.75% 58.28% 76.07% 58.30% Major Medical: Insurance policy benefits....................................... $193.2 $152.6 $390.7 $300.5 Loss ratio...................................................... 84.84% 71.30% 86.09% 71.46% Other: Insurance policy benefits....................................... $32.7 $25.3 $59.9 $49.9 Loss ratio...................................................... 84.40% 73.16% 79.95% 68.08% ---------- (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.
Premiums and asset accumulation product collections were $1.8 billion in the second quarter of 2000, down .2 percent from 1999. Premiums and asset accumulation product collections were $3.8 billion in the first six months of 2000, up 11 percent over 1999. Recent rating actions have adversely affected the marketing of our insurance products. See "Premium and Asset Accumulation Product Collections" for further analysis. Average liabilities for insurance and asset accumulation products, net of reinsurance receivables, were $27.7 billion in the second quarter of 2000, up 5.1 percent over 1999. Average liabilities for insurance and asset accumulation products, net of reinsurance receivables, were $27.7 billion in the first six months of 2000, up 5.1 percent over 1999. 30 CONSECO, INC. AND SUBSIDIARIES -------------------- Insurance policy income is comprised of: (i) premiums earned on policies which provide mortality or morbidity coverage; and (ii) fees and other charges made against other policies. See "Premium and Asset Accumulation Product Collections" for further analysis. Net investment income on general account invested assets (which excludes income on separate account assets related to variable annuities; and the income (loss), cost and change in the fair value of S&P 500 Call Options related to equity- indexed products) was $489.3 million in the second quarter of 2000, down 3.3 percent from the same period in 1999 and was $994.2 million in the first six months of 2000, virtually equal with the same period in 1999. The average balance of general account invested assets in the second quarter of 2000 was comparable to the same period in 1999. The yield on these assets was 7.4 percent in 2000 and 7.7 percent in 1999. The average balance of general account invested assets increased by 1.4 percent in the first six months of 2000 to $26.4 billion compared to the same period in 1999. The yield on these assets decreased by .2 percentage points to 7.4 percent during the first six months of 2000. Net investment income related to equity-indexed products based on the S&P 500 Index is substantially offset by a corresponding charge to amounts added to policyholder account balances for equity-indexed products. Such income and related charge fluctuated based on the policyholder account balances subject to this provision and the performance of the S&P 500 Index to which the returns on such products are linked. During the second quarter of 2000, we recorded losses from the S&P 500 Options of $16.1 million and deducted amounts from policyholders' account balances of the equity- indexed products of $22.5 million. During the first six months of 2000, we recorded income from the S&P 500 Options of $6.6 million and added amounts to policyholders' account balances of the equity-indexed products of $.9 million. Amortization of cost of S&P 500 Call Options represents the premiums paid to purchase S&P 500 Call Options related to our equity-linked products. We amortize these amounts over the terms of the options. Such amortization has increased because of the increase in our equity-linked product business, changes in the participation rate of such business in the S&P 500 Index, and the cost of the options. Our equity-indexed products are designed in an effort to have the investment income spread earned on the related insurance liabilities be adequate to cover the cost of the S&P 500 Call Options and other costs related to these policies. Net investment income from separate account assets is offset by a corresponding charge to amounts added to policyholder account balances for variable annuity products. Such income and related charge fluctuated in relationship to total separate account assets and the return earned on such assets. Fee revenue and other income includes: (i) revenues we receive for managing investments for other companies; and (ii) fees received for marketing insurance products of other companies. This amount has increased as a result of growth in both of these businesses. Insurance policy benefits increased in the first six months of 2000 as a result of the factors summarized in the explanations for loss ratio fluctuations related to specific products which follows. Loss ratios for Medicare supplement products increased in 2000 for the following reasons: (i) our year end reserves developed adversely; (ii) the mix of our Medicare supplement business in 2000 includes a higher percent of less profitable standard Medicare supplement policies than the prior year (and a lower percent of more profitable nonstandard policies that we are no longer able to offer to new policyholders); and (iii) Medicare supplement business has recently experienced higher persistency among older blocks of business. While the Company benefits from the additional profits earned on the larger blocks of business, the loss ratio will generally increase since the older policies have higher claim costs. Governmental regulations generally require us to attain and maintain a loss ratio, after three years, of not less than 65 percent. The loss ratios for long-term care products increased in 2000, reflecting: (i) unfavorable claims experience; (ii) refinements made to the reserve estimation process; and (iii) the effects of the asset accumulation phase of these products. The net cash flows from our long-term care products generally result in the accumulation of amounts in the early years of a policy (accounted for as reserve increases) which will be paid out as benefits in later policy years (accounted for as reserve decreases). Accordingly, during the asset accumulation phase of these policies, the loss ratio will increase, but the increase in the change in reserve will be partially offset by investment income earned on the assets which have 31 CONSECO, INC. AND SUBSIDIARIES -------------------- accumulated. In order to improve the profitability of the long-term care product line, we are currently selling products with higher margins and we have continued to apply for appropriate rate increases on older blocks of business. As a result of recent unfavorable claim experience in our long-term care insurance lines, we closely reviewed our reserving methodologies. Certain changes in estimates were made that adversely affected the loss ratio in the second quarter of 2000. The 2000 loss ratios for our specified disease policies reflect refinements we made to the reserve estimation process during the first quarter of 2000 and changes in estimates of period end claim liabilities. The 2000 loss ratios for major medical policies reflects unfavorable claims experience. We plan to increase our sales focus on the individual major medical product lines while decreasing our group blocks of business. Since individual products are expected to be more profitable than group products, this change should support our efforts to improve profitability. In addition, we are also raising rates on certain products and exiting certain product lines and states. The loss ratios on other products fluctuate due to the smaller size of these blocks of business. While the increase in the second quarter of 2000 reflects worse than expected experience, the loss ratios on this business over longer periods of time have generally been within our expectations. Amounts added to policyholder account balances for annuity products decreased by 13 percent in the second quarter of 2000 to $151.2 million and decreased by 8.2 percent in the first six months of 2000 to $319.1 million, primarily due to a smaller block of this type of annuity business in force, on the average, in the first six months of 2000. In addition, the average crediting rate on these annuities decreased slightly. The weighted average crediting rate for these annuity liabilities was 4.5 percent and 4.6 percent in the first six months of 2000 and 1999, respectively. Amortization related to operations includes amortization of: (i) the cost of policies produced; (ii) the cost of policies purchased; and (iii) goodwill. Amortization has increased in relationship to the total account balances subject to amortization. In addition, amortization increased in the second quarter of 2000 as a result of adjustments to the surrender and lapse assumptions to reflect our current estimate of future experience related to certain blocks of business. Interest expense on investment borrowings decreased along with our investment borrowing activities. Investment borrowings averaged approximately $369.3 million during the first six months of 2000 compared to $1,111.9 million during the same period of 1999. Borrowing rates increased 30 basis points to 5.4 percent during the first six months of 2000. Other operating costs and expenses increased in 2000 primarily as a result of our increased business and marketing initiatives. Such increased expenses are consistent with the increase in the ratio of operating expenses (excluding amortization of cost of policies produced and cost of policies purchased) as a percentage of average liabilities for insurance and asset accumulation products (3.06 percent for the six months ended June 30, 2000, compared to 2.90 percent for the same period in 1999). Net investment gains (losses), including related costs and amortization, fluctuate from period to period. During the first six months of 2000, we recorded $68.2 million of writedowns of fixed maturity securities and other invested assets as a result of conditions which caused us to conclude a decline in fair value of the investment was other than temporary. In addition, as described in the note to the consolidated financial statements entitled "Standard & Poor's 500 Index Call Options and Interest Rate Swap Agreements" we realized a $38.7 million loss related to the termination of certain swap agreements during the first six months of 2000. When we sell securities at a gain (loss) and reinvest the proceeds at a different yield, we increase (reduce) the amortization of cost of policies purchased and cost of policies produced in order to reflect the change in future yields. Sales of fixed maturity investments resulted in a reduction in the amortization of the cost of policies purchased and the cost of policies produced of $9.0 million and $23.3 million in the second quarter of 2000 and the first six months of 2000, respectively, and resulted in additional amortization of $6.1 million and $16.1 million in the second quarter of 1999 and the first six months of 1999, respectively. 32 CONSECO, INC. AND SUBSIDIARIES -------------------- Finance operations
Three months ended Six months ended June 30, June 30, ------------------ ------------------ 2000 1999 2000 1999 ---- ---- ---- ---- (Dollars in millions) Contract originations: Manufactured housing............................................... $ 1,478.7 $ 1,983.6 $ 2,662.4 $ 3,394.7 Mortgage services.................................................. 1,471.1 1,931.7 3,015.3 3,369.3 Consumer/credit card............................................... 1,066.4 742.6 1,840.9 1,281.2 Commercial......................................................... 1,404.1 2,152.0 2,910.8 4,138.9 --------- --------- --------- --------- Total............................................................ $ 5,420.3 $ 6,809.9 $10,429.4 $12,184.1 ========= ========= ========= ========= Sales of finance receivables: Manufactured housing............................................... $ 597.8 $ 1,681.1 $ 597.8 $ 3,481.1 Home equity/home improvement....................................... 824.0 1,687.7 824.0 2,648.8 Consumer/equipment................................................. - 600.0 - 600.0 Commercial and retail revolving credit............................. 409.0 92.5 409.0 92.5 Retained bonds..................................................... - (348.2) - (371.4) --------- --------- --------- --------- Total............................................................ $ 1,830.8 $ 3,713.1 $ 1,830.8 $ 6,451.0 ========= ========= ========= ========= Managed receivables (average): Manufactured housing............................................... $25,518.4 $22,362.8 $25,198.3 $21,905.1 Mortgage services.................................................. 13,340.2 9,725.0 12,962.4 9,205.3 Consumer/credit card............................................... 3,971.6 3,101.0 3,924.2 3,044.7 Commercial......................................................... 5,043.2 5,551.5 5,082.4 5,336.4 --------- --------- --------- --------- Total............................................................ $47,873.4 $40,740.3 $47,167.3 $39,491.5 ========= ========= ========= ========= Revenues: Net investment income: Finance receivables and other.................................... $ 451.1 $ 133.3 $ 833.2 $ 240.2 Interest-only securities......................................... 28.6 47.4 56.1 91.1 Gain on sale: Securitization transactions...................................... - 169.4 - 368.6 Whole-loan sales................................................. 2.6 - 2.6 - Fee revenue and other income....................................... 94.9 87.6 194.1 170.2 --------- --------- --------- --------- Total revenues................................................... 577.2 437.7 1,086.0 870.1 --------- --------- --------- --------- Expenses: Provision for losses............................................... 84.1 27.2 142.7 48.5 Finance interest expense........................................... 266.9 69.6 471.4 124.2 Other operating costs and expenses................................. 198.1 156.9 408.0 317.6 --------- --------- --------- --------- Total expenses................................................... 549.1 253.7 1,022.1 490.3 --------- --------- --------- --------- Operating income before special charges, impairment charges and income taxes............................................... 28.1 184.0 63.9 379.8 Special charges....................................................... 63.4 - 63.4 - Impairment charges.................................................... 9.6 71.6 12.1 83.8 --------- --------- --------- --------- Income (loss) before income taxes................................ $ (44.9) $ 112.4 $ (11.6) $ 296.0 ========= ========= ========= =========
33 CONSECO, INC. AND SUBSIDIARIES -------------------- General: Conseco's finance subsidiaries provide financing for manufactured housing, home equity, home improvements, consumer products and equipment, and provide consumer and commercial revolving credit. Finance products include both fixed-term and revolving loans and leases. Conseco also markets physical damage and term mortgage life insurance and other credit protection relating to the loans it services. On September 8, 1999, we announced that we would no longer structure our securitizations in a manner that results in recording a sale of the loans. Instead, new securitization transactions after that date are being structured to include provisions that entitle the Company to repurchase assets transferred to the special purpose entity when the aggregate unpaid principal balance reaches a specified level. Until these assets are repurchased, however, the assets are the property of the special purpose entity and are not available to satisfy the claims of creditors of the Company. Pursuant to SFAS 125, such securitization transactions are accounted for as secured borrowings whereby the loans and securitization debt remain on the consolidated balance sheet, rather than as sales. The change to the structure of our new securitizations will have no effect on the total profit we recognize over the life of each new loan, but it will change the timing of profit recognition. Under the portfolio method (the accounting method required for our securitizations which are structured as secured borrowings), we will recognize: (i) earnings over the life of new loans as interest revenues are generated; (ii) interest expense on the securities which are sold to investors in the loan securitization trusts; and (iii) provisions for losses. As a result, our reported earnings from new loans securitized in transactions accounted for under the portfolio method will be lower in the period in which the loans are securitized (compared to our historical method) and higher in later periods, as interest spread is earned on the loans. After the March 31, 2000 announcement that we planned to explore the sale of Conseco Finance and other events described elsewhere herein, it was difficult to complete new public securitization transactions for a period of time. However, these markets eventually became available to the Company. During the second quarter of 2000, we completed five transactions, securitizing over $2.5 billion of finance receivables. In May 2000, we sold $1.3 billion of finance receivables to Lehman. The proceeds from such sale were used to repay various warehouse credit lines, creating increased warehousing capacity for Conseco Finance. Lehman also amended its repurchase and other financing facilities with Conseco Finance to expand the types of assets financed. See the note to the accompanying consolidated financial statements entitled "Special Charges and Recent Events" for a further description of the transactions with Lehman. We continue to be able to finance loans through: (i) our warehouse and bank credit facilities; (ii) the sale of securities through securitization transactions; and (iii) whole-loan sales. Loan originations in the second quarter of 2000 were $5.4 billion, down 20 percent from 1999. Loan originations in the first six months of 2000 were $10.4 billion, down 14 percent over 1999. We believe there are several factors which contribute to the decrease in loan originations during the second quarter of 2000. General levels of interest rates have increased, which has resulted in a decrease in the demand for certain finance products. Sales of manufactured housing have also decreased recently. The Company has also limited the origination of certain loans, reflecting the cost and the limitations of our capital and efforts to control our growth. Manufactured housing loan originations decreased by $504.9 million, or 25 percent, in the second quarter of 2000 and by $732.3 million, or 22 percent, during the first six months of 2000. The decrease was primarily due to a decrease in the number of contracts written, which is consistent with the decrease in sales of manufactured housing during the second quarter of 2000. Mortgage services loan originations decreased by $460.6 million, or 24 percent, in the second quarter of 2000 and by $354.0 million, or 11 percent, during the first six months of 2000. The decrease was primarily due to a decrease in the number of contracts written, which is generally consistent with the reduced demand for these products in the rising interest rate environment. Consumer/credit card loan originations increased by $323.8 million, or 44 percent, in the second quarter of 2000 and by $559.7 million, or 44 percent, during the first six months of 2000. The increase is primarily the result of our successful marketing efforts, including a number of new private label credit card relationships with large retailers. During the second quarter of 2000, we entered into an agreement to sell our bankcard portfolio, which accounted for $203 million of our originations during the six months ended June 30, 2000. 34 CONSECO, INC. AND SUBSIDIARIES -------------------- Commercial loan originations decreased by $747.9 million, or 35 percent, in the second quarter of 2000 and by $1,228.1 million, or 30 percent, during the first six months of 2000. The decrease primarily reflects the sale of certain commercial lines in September 1999, and our decision in early 2000 to significantly limit additional transportation and certain other commercial loans. Sales of finance receivables decreased as a result of the change in the structure of our securitizations. The sales in the second quarter of 2000 include the previously described sale of finance receivables to Lehman and the sale of our bankcard portfolio. Managed receivables include finance receivables transferred to special purpose entities in securitization transactions (whether accounted for as sales or on the portfolio method) and finance receivables recorded on our consolidated balance sheet that have not been securitized. Average managed receivables increased to $47.9 billion in the second quarter of 2000, up 18 percent over 1999, and to $47.2 billion in the first six months of 2000, up 19 percent over the same period in 1999. Net investment income on finance receivables and other consists of: (i) interest earned on finance receivables; and (ii) interest income on short-term and other investments. Such income increased by 238 percent, to $451.1 million, in the second quarter of 2000 and by 247 percent, to $833.2 million, in the first six months of 2000, consistent with the increase in average on-balance sheet finance receivables. The weighted average yields earned on finance receivables and other investments were 13.0 percent and 11.0 percent during the second quarters of 2000 and 1999, respectively, and such weighted average yields were 13.0 percent and 11.3 percent during the first six months of 2000 and 1999, respectively. As a result of the change in the structure of our securitizations, future interest earned on finance receivables should increase as our average on-balance sheet finance receivables increase. Net investment income on interest-only securities is the accretion recognized on the interest-only securities we retain after we sell finance receivables. Such income decreased by 40 percent, to $28.6 million, in the second quarter of 2000 and by 38 percent, to $56.1 million, in the first six months of 2000. The decrease is consistent with the change in the average balance of interest-only securities. The weighted average yields earned on interest-only securities were 12.5 percent and 13.7 percent during the first six months of 2000 and 1999, respectively. As a result of the change in the structure of our securitizations, we will account for future securitizations as secured borrowings and we will not recognize gain-on-sale revenue or additions to interest-only securities from such transactions. Accordingly, future investment income accreted on the interest-only security will decrease, as cash remittances from the prior gain-on-sale securitizations reduce the interest-only security balances. The balance of the interest-only securities was reduced by $533.8 million during 1999 (of which only $83.2 million was incurred in the first six months of 1999) due to an impairment charge which will cause a reduction in interest income accreted to this security in future years. We regularly analyze future expected cash flows from this security to determine the appropriate interest accretion rate. If we determine that this rate should be lower, investment income accreted on the interest-only security will decrease in future periods. Gain on sale related to securitization transactions were nil in the 2000 periods, reflecting our decision to no longer structure our securitizations as sales. Our new securitizations are being structured as secured borrowings and no gain on sale is recognized. The gain recognized for our previous securitizations fluctuated when changes occurred in: (i) the amount of loans sold; (ii) market conditions (such as the market interest rates available on securities sold in these securitizations); (iii) the amount and type of interest we retained in the receivables sold; and (iv) assumptions used to calculate the gain. Conditions in the credit markets have frequently resulted in less-attractive pricing of certain lower-rated securities in our securitization structures. As a result, we have chosen to hold rather than sell some of the securities in the securitization trusts, particularly securities having corporate guarantee provisions. Prior to our September 8, 1999, announcement, the securities that we hold were treated as retained interests in the securitization trusts. We recognized no gain on the portion of the assets related to such securities, but we expect to recognize greater interest income, net of related interest expense, over the term we hold them. At June 30, 2000, we held $468.9 million of such securities which are classified as actively managed fixed maturities. Gain on whole-loan sales totaled $2.6 million during the second quarter of 2000. During the second quarter of 2000, we sold approximately $1.3 billion of finance receivables to Lehman for cash and a right to share in future profits from a 35 CONSECO, INC. AND SUBSIDIARIES -------------------- subsequent sale or securitization of the assets sold. We paid a $25.0 million transaction fee to Lehman in conjunction with the sale which was included in special charges. Such loans were sold to Lehman at a value which approximated net book value, less the fee paid to Lehman. Gain on whole-loan sales excludes the gain realized on the sale of our bankcard portfolio which is included in special charges. Fee revenue and other income includes servicing income, commissions earned on insurance policies written in conjunction with financing transactions, and other income from late fees. Such income increased by 8.3 percent, to $94.9 million, in the second quarter of 2000, and by 14 percent, to $194.1 million, in the first six months of 2000. Our net written insurance premiums and other income both grew with managed receivables. As a result of the change in the structure of our future securitizations announced on September 8, 1999, we no longer record an asset for servicing rights at the time of our securitizations, nor do we record servicing fee revenue; instead, the entire amount of interest income is recorded as investment income. Accordingly, the amount of servicing income has declined in the current period, and will decline further in future periods. Provision for losses related to finance operations increased by 209 percent, to $84.1 million, in the second quarter of 2000, and by 194 percent, to $142.7 million, in the first six months of 2000. The increase is principally due to the increase in loans held on our balance sheet. Under the portfolio method (which is used for securitizations structured as collateralized borrowings), we recognize the credit losses on the loans on our balance sheet as the losses are incurred. For loans previously recorded as sales, the anticipated discounted credit losses are reflected through a reduction in the gain-on- sale revenue recorded at the time of securitization. Finance interest expense increased by 283 percent, to $266.9 million, in the second quarter of 2000, and by 280 percent, to $471.4 million, in the first six months of 2000. Our borrowings grew in order to fund the increase in finance receivables. In addition, our average borrowing rate increased to 7.6 percent in the second quarter of 2000 from 5.4 percent in the second quarter of 1999. Our average borrowing rate during the first six months of 2000 was 7.3 percent compared to 5.6 percent during the first six months of 1999. Under the portfolio method, we recognize interest expense on the securities issued to investors in the securitization trusts. These securities typically have higher interest rates than our other debt, which increases our average borrowing rate as compared to prior periods. Other operating costs and expenses include the costs associated with servicing our managed receivables, and non- deferrable costs related to originating new loans. Such expense increased by 26 percent, to $198.1 million, in the second quarter of 2000, and by 28 percent, to $408.0 million, in the first six months of 2000, reflecting: (i) the growth in our servicing portfolio; and (ii) the growth in our loan origination offices and infrastructure. Special charges in the finance segment include: (i) the $25.0 million transaction fee paid to Lehman in conjunction with the previously described sale of $1.3 billion of finance receivables; (ii) the issuance of a warrant valued at $48.1 million related to the modification of the Lehman master repurchase financing facilities; and (iii) the $9.7 million gain realized on the sale of our bankcard portfolio and other items. Impairment charges represent reductions in the value of interest-only securities and servicing rights recognized as a loss in the statement of operations. We carry interest-only securities at estimated fair value, which is determined by discounting the projected cash flows over the expected life of the receivables sold using current prepayment, default, loss and interest rate assumptions. Estimates for prepayments, defaults and losses for manuafactured housing loans are determined based on a macroeconomic model developed by the Company with the assisstance of outside experts. We record any unrealized gain or loss determined to be temporary, net of tax, as a component of shareholders' equity. Declines in value are considered to be other than temporary when the present value of estimated future cash flows discounted at a risk- free rate using current assumptions is less than the amortized cost of the interest-only securities. When declines in value considered to be other than temporary occur, we reduce the amortized cost to estimated fair value and recognize a loss in the statement of operations. The assumptions used to determine new values are based on our internal evaluations and consultation with external advisors having significant experience in valuing these securities. 36 CONSECO, INC. AND SUBSIDIARIES -------------------- The Company continually evaluates its interest-only securities and servicing rights, including the underlying assumptions, in light of loss experience exceeding previous expectations. The principal change in the revised assumptions resulting from this process was an increase in expected future credit losses, relating primarily to reduced assumptions as to future housing price inflation, recent loss experience and refinements to the methodology of the model. The effect of this change in 1999 was offset somewhat by a revision to the estimation methodology to incorporate the value associated with the cleanup call rights held by the Company in securitizations. In the second quarters of 2000 and 1999, we recognized an impairment charge of $9.6 million and $71.6 million, respectively, to reduce the book value of the interest-only securities and servicing rights. Such impairment charge for the first six months of 2000 and 1999 was $12.1 million and $83.8 million, respectively. Corporate operations
Three months ended Six months ended June 30, June 30, -------------------- ------------------ 2000 1999 2000 1999 ---- ---- ---- ---- (Dollars in millions) Corporate operations: Venture capital income (loss) related to investment in Tritel, net of related expenses................................... $ (75.5) $ - $ .6 $ - Interest expense on corporate debt.................................. (75.8) (44.1) (127.8) (93.2) Investment income................................................... 14.5 11.1 23.7 20.6 Other items......................................................... (4.4) (4.7) 20.4 28.7 -------- ------ ------- ------ Operating loss before provision for loss on loan guarantees, special charges, income taxes and minority interest............................................. (141.2) (37.7) (83.1) (43.9) Provision for loss on loan guarantees............................... (68.6) - (92.0) - Special charges..................................................... (263.8) - (263.8) - ------- ------ ------- ------ Loss before income taxes and minority interest.................. $(473.6) $(37.7) $(438.9) $(43.9) ======= ====== ======= ======
Venture capital income (loss) relates to our investment in Tritel, a company in the wireless communication business. The market values of many companies in this sector increased significantly in 1999 and early 2000. In the fourth quarter of 1999, our investee sold shares of common stock to the public in an initial public offering. As a result, an ascertainable market value was established for our investment, which we adjusted to recognize liquidity restrictions. In the second quarter of 2000, we recognized a venture capital loss of $75.5 million related to this investment (net of a related reduction to expenses of $26.4 million). In the first six months of 2000, we recognized venture capital income of $.6 million related to this investment (net of related expenses of $12.6 million). Interest expense on corporate debt fluctuated due to the increase in the average interest rate on our outstanding debt. The average debt outstanding was $3.0 billion in both the first six months of 2000 and 1999. The average interest rate on such debt was 7.75 percent and 5.87 percent in the first six months of 2000 and 1999, respectively. General levels of interest rates have increased over the last twelve months. In addition, as a result of recent rating agency actions, the interest rates on our bank credit facility and new borrowings has increased (see the note to the consolidated financial statements entitled "Changes in Corporate Notes Payable and Commercial Paper"). Such interest expense includes affiliated interest expense (which is eliminated in consolidation) of: (i) $8.7 million and $2.9 million for the three months ended June 30, 2000 and 1999, respectively; and (ii) $11.8 million and $5.9 million for the six months ended June 30, 2000 and 1999, respectively. Investment income includes the income from our investment in a riverboat casino and miscellaneous other revenues. Other items include general corporate expenses, net of amounts charged to subsidiaries for services provided by the corporate operations. 37 CONSECO, INC. AND SUBSIDIARIES -------------------- Provision for loss on loan guarantees represents the noncash provision we established in connection with our guarantees of bank loans to approximately 170 directors, officers and key employees and our related loans for interest. The funds from the bank loans were used by the participants to purchase approximately 19.0 million shares of Conseco common stock. In 2000, we established a provision of $92.0 million (of which $68.6 million was established in the second quarter of 2000) in connection with these guarantees and loans. At June 30, 2000, the total reserve for losses on the loan guarantees was $110.9 million. Special charges in corporate operations include: (i) the advisory fees paid to investment banks of $44.0 million; (ii) the loss related to our exit from the subprime automobile business of $68.5 million; (iii) the amount paid to terminated executive pursuant to his employment agreement of $72.5 million; (iv) the amount paid to newly hired Chief Executive Officer of $45.0 million; (v) the value of warrants issued to release newly hired Chief Executive Officer from a noncompete provision of a prior agreement of $21.0 million; and (vi) other charges of $12.8 million. These charges are described in greater detail in the note to the accompanying consolidated financial statements entitled "Special Charges and Recent Events". PREMIUM AND ASSET ACCUMULATION PRODUCT COLLECTIONS In accordance with GAAP, insurance policy income as shown in our consolidated statement of operations consists of premiums earned for policies that have life contingencies or morbidity features. For annuity and universal life contracts without such features, premiums collected are not reported as revenues, but as deposits to insurance liabilities. We recognize revenues for these products over time in the form of investment income and surrender or other charges. Marketing companies, agents who market insurance products, school districts, financial institutions and policyholders use the financial strength ratings assigned to an insurer by independent rating agencies as one factor in determining which insurer's products to market or purchase. Following several recent events described in the note to the consolidated financial statements entitled "Special Charges and Recent Events" and elsewhere herein, rating agencies lowered their financial strength ratings, and many were placed on review as the agencies analyze the impact of the developing events. Our primary life insurance companies have received the following ratings as of August 10, 2000: (i) a "B++" rating, under review, by A.M. Best Company; (ii) an "A-" rating, from Fitch Rating Company; (iii) a "BBB" financial strength rating, watch negative, from Standard & Poor's; and (iv) a "Baa3" rating, from Moody's Investor Services. The recent rating actions are adversely affecting the marketing and persistency of our insurance products and other asset accumulation products. We are not able to predict the extent to which these or possible additional ratings actions will further affect the marketing and persistency of these products. 38 CONSECO, INC. AND SUBSIDIARIES -------------------- Total premiums and accumulation product collections were as follows:
Three months ended Six months ended June 30, June 30, ------------------- ------------------ 2000 1999 2000 1999 ---- ---- ---- ---- (Dollars in millions) Premiums collected by our insurance subsidiaries: Annuities: Equity-indexed (first-year)..................................... $ 173.2 $ 250.6 $ 394.5 $ 438.0 Equity-indexed (renewal)........................................ 10.5 10.8 28.9 27.3 -------- -------- -------- -------- Subtotal - equity-indexed annuities........................... 183.7 261.4 423.4 465.3 -------- -------- -------- -------- Other fixed (first-year)........................................ 159.2 346.7 305.6 517.4 Other fixed (renewal)........................................... 17.7 18.7 34.8 34.5 -------- -------- -------- -------- Subtotal - other fixed annuities.............................. 176.9 365.4 340.4 551.9 -------- -------- -------- -------- Variable (first-year)........................................... 225.7 128.1 443.8 219.5 Variable (renewal).............................................. 47.3 17.4 71.6 46.6 -------- -------- -------- -------- Subtotal - variable annuities................................. 273.0 145.5 515.4 266.1 -------- -------- -------- -------- Total annuities............................................... 633.6 772.3 1,279.2 1,283.3 -------- -------- -------- -------- Supplemental health: Medicare supplement (first-year)................................ 25.4 26.7 52.5 54.3 Medicare supplement (renewal)................................... 206.4 198.6 419.9 403.9 -------- -------- -------- -------- Subtotal - Medicare supplement................................ 231.8 225.3 472.4 458.2 -------- -------- -------- -------- Long-term care (first-year)..................................... 31.3 29.8 62.4 59.2 Long-term care (renewal)........................................ 179.6 171.1 363.6 334.4 -------- -------- -------- -------- Subtotal - long-term care..................................... 210.9 200.9 426.0 393.6 -------- -------- -------- -------- Specified disease (first-year).................................. 10.0 10.0 19.6 19.4 Specified disease (renewal)..................................... 86.1 84.4 172.1 171.1 -------- -------- -------- -------- Subtotal - specified disease.................................. 96.1 94.4 191.7 190.5 -------- -------- -------- -------- Other health (first-year)....................................... 10.4 6.4 18.5 11.6 Other health (renewal).......................................... 25.3 26.2 52.1 55.0 -------- -------- -------- -------- Subtotal - other health....................................... 35.7 32.6 70.6 66.6 -------- -------- -------- -------- Total supplemental health..................................... 574.5 553.2 1,160.7 1,108.9 -------- -------- -------- -------- Life insurance: First-year...................................................... 54.7 42.7 107.3 79.9 Renewal......................................................... 190.3 181.8 379.9 386.2 -------- -------- -------- -------- Total life insurance.......................................... 245.0 224.5 487.2 466.1 -------- -------- -------- -------- Individual and group major medical: Individual (first-year)......................................... 40.5 23.2 73.2 45.3 Individual (renewal)............................................ 62.0 54.8 122.0 114.2 -------- -------- -------- -------- Subtotal - individual......................................... 102.5 78.0 195.2 159.5 -------- -------- -------- -------- Group (first-year).............................................. 18.7 13.1 38.7 22.3 Group (renewal)................................................. 119.0 115.8 239.8 234.2 -------- -------- -------- -------- Subtotal - group.............................................. 137.7 128.9 278.5 256.5 -------- -------- -------- -------- Total major medical........................................... 240.2 206.9 473.7 416.0 -------- -------- -------- -------- Mutual funds (all first year, excludes variable annuities)........... 143.1 82.8 432.7 165.0 -------- -------- -------- -------- Total first-year premiums....................................... 892.2 960.1 1,948.8 1,631.9 Total renewal premiums.......................................... 944.2 879.6 1,884.7 1,807.4 -------- -------- -------- -------- Total collections............................................. $1,836.4 $1,839.7 $3,833.5 $3,439.3 ======== ======== ======== ========
39 CONSECO, INC. AND SUBSIDIARIES -------------------- Annuities include equity-indexed annuities, other fixed annuities and variable annuities sold through both career agents and professional independent producers. We introduced our first equity-indexed annuity product in 1996. The accumulation value of these annuities is credited with interest at an annual guaranteed minimum rate of 3 percent (or, including the effect of applicable sales loads, a 1.7 percent compound average interest rate over the term of the contracts). These annuities provide for potentially higher returns based on a percentage of the change in the S&P 500 Index during each year of their term. We purchase S&P 500 Call Options in an effort to hedge increases to policyholder benefits resulting from increases in the S&P 500 Index. Total collected premiums for this product were $183.7 million in the second quarter of 2000 compared with $261.4 million in the second quarter of 1999 and were $423.4 million in the first six months of 2000 compared with $465.3 million in the first six months of 1999. Other fixed rate annuity products include single-premium deferred annuities ("SPDAs"), flexible-premium deferred annuities ("FPDAs") and single-premium immediate annuities ("SPIAs"), which are credited with a declared rate. The demand for traditional fixed-rate annuity contracts has decreased in recent years, as relatively low interest rates have made other investment products more attractive. SPDA and FPDA policies typically have an interest rate that is guaranteed for the first policy year, after which we have the discretionary ability to change the crediting rate to any rate not below a guaranteed rate. The interest rate credited on SPIAs is based on market conditions existing when a policy is issued and remains unchanged over the life of the SPIA. Annuity premiums on these products decreased by 52 percent, to $176.9 million, in the second quarter of 2000 and by 38 percent, to $340.4 million, in the first six months of 2000. Fixed annuity collections in the second quarter of 1999 included $160.8 million of business reinsured from other insurers. Variable annuities offer contract holders the ability to direct premiums into specific investment portfolios; rates of return are based on the performance of the portfolio. Such annuities have become increasingly popular recently as a result of the desire of investors to invest in common stocks. In 1996, we began to offer more investment options for variable annuity deposits, and we expanded our marketing efforts, resulting in increased collected premiums. Our profits on variable annuities come from the fees charged to contract holders. Variable annuity collected premiums increased by 88 percent, to $273.0 million, in the second quarter of 2000 and by 94 percent, to $515.4 million, in the first six months of 2000. Supplemental health products include Medicare supplement, long-term care, specified disease and other insurance products distributed through a career agency force and professional independent producers. Our profits on supplemental health policies depend on the overall level of sales, persistency of in-force business, investment yields, claim experience and expense management. Collected premiums on Medicare supplement policies increased by 2.9 percent to $231.8 million, in the second quarter of 2000 and by 3.1 percent, to $472.4 million, in the first six months of 2000. Sales of Medicare supplement policies in recent periods have been affected by steps taken to improve profitability by increasing premium rates and changing our commission structure and underwriting criteria. Premiums collected on long-term care policies increased by 5.0 percent, to $210.9 million, in the second quarter of 2000 and by 8.2 percent, to $426.0 million, in the first six months of 2000 due to increases in premium rates and increased sales volume. Premiums collected on specified disease policies in the 2000 periods were comparable to the 1999 periods. Other health products include: (i) various health insurance products that are not currently being actively marketed; and (ii) in 1999, the specialty health insurance products sold to educators. Premiums collected in the 2000 periods were slightly higher than the 1999 periods. Since we no longer actively market these products, we expect collected premiums to decrease in future years. The in-force business continues to be profitable. Life products are sold through career agents, professional independent producers and direct response distribution channels. Life premiums collected increased by 9.1 percent to $245.0 million in the second quarter of 2000 and by 4.5 percent, to $487.2 million, in the first six months of 2000. In the first six months of 1999, life renewal premiums included $12.6 million of single premium life business acquired in a reinsurance transaction. 40 CONSECO, INC. AND SUBSIDIARIES -------------------- Individual and group major medical products include major medical health insurance products sold to individuals and groups. Group premiums increased by 6.8 percent, to $137.7 million, in the second quarter of 2000 and by 8.6 percent, to $278.5 million, in the first six months of 2000. Individual health premiums collected in the second quarter of 2000 increased 31 percent, to $102.5 million and by 22 percent, to $195.2 million, in the first six months of 2000. Our efforts to secure rate increases and write only profitable major medical business may restrict our ability to grow these premiums in future periods. Mutual fund sales have been very strong in 2000, reflecting our expanded distribution and new marketing programs. We also believe that these sales have been positively impacted by the recent strong investment performance of our funds. LIQUIDITY AND CAPITAL RESOURCES Changes in our consolidated balance sheet between June 30, 2000 and December 31, 1999, reflect: (i) our operating results; (ii) our origination of finance receivables; (iii) the transfer of finance receivables to securitization trusts and sale of notes to investors in transactions accounted for as secured borrowings; (iv) the sale of finance receivables to Lehman; (v) the sale of assets of our subprime automobile and bankcard businesses; (vi) changes in the fair value of actively managed fixed maturity securities and interest-only securities; and (vii) various financing transactions. Financing transactions (described in the notes to the accompanying consolidated financial statements) include: (i) the issuance and repurchase of common stock; and (ii) the issuance and repayment of notes payable and commercial paper. In accordance with GAAP, we record our actively managed fixed maturity investments, interest-only securities, equity securities and certain other invested assets at estimated fair value with any unrealized gain or loss, net of tax and related adjustments, recorded as a component of shareholders' equity. At June 30, 2000, primarily because of the recent increases in interest rates and related decrease in values of interest-bearing securities, we decreased the carrying value of such investments by $1,907.4 million as a result of this fair value adjustment. The fair value adjustment resulted in a $1,504.3 million decrease in carrying value at year-end 1999, for the same reasons. Total capital shown below excludes debt of the finance segment used to fund finance receivables. Total capital, before the fair value adjustment recorded in accumulated other comprehensive loss, increased $462.0 million, or 4.0 percent, to $11.9 billion.
June 30, December 31, 2000 1999 ---- ---- (Dollars in millions) Total capital, excluding accumulated other comprehensive loss: Corporate notes payable and commercial paper......................... $ 3,628.4 $ 2,481.8 Company-obligated mandatorily redeemable preferred securities of subsidiary trusts................................... 2,399.2 2,639.1 Shareholders' equity: Preferred stock................................................... 482.5 478.4 Common stock and additional paid-in capital....................... 2,905.6 2,987.1 Retained earnings................................................. 2,495.0 2,862.3 --------- --------- Total shareholders' equity, excluding accumulated other comprehensive loss.................................... 5,883.1 6,327.8 --------- --------- Total capital, excluding accumulated other comprehensive loss........................................................ 11,910.7 11,448.7 Accumulated other comprehensive loss..................................... (970.7) (771.6) --------- --------- Total capital.................................................. $10,940.0 $10,677.1 ========= =========
Corporate notes payable and commercial paper increased during the first six months of 2000 primarily due to: (i) the settlement of a forward contract described in the note to the accompanying consolidated financial statements entitled "Changes in Common Stock"; (ii) the settlement of certain intercompany accounts with Conseco Finance; (iii) the redemption of $250 million par value of Company-obligated mandatorily redeemable preferred securities of subsidiary trusts; (iv) the acquisition of 41 CONSECO, INC. AND SUBSIDIARIES -------------------- a long-term care insurance marketing organization for $32.9 million; (v) cash required for special charges of $163.4 million; and (vi) an increase in cash and cash equivalents held at the parent company of approximately $450 million. Shareholders' equity, excluding accumulated other comprehensive loss, decreased by $444.7 million in the first six months of 2000, to $5.9 billion. Significant components of the decrease included: (i) our net loss of $327.3 million; (ii) the settlement of the forward contract and repurchases of common stock of $102.6 million; and (iii) $40.0 million of common and preferred stock dividends. These decreases were partially offset by the issuance of warrants of $21.0 million. The accumulated other comprehensive loss increased by $199.1 million, principally related to the decreasing fair value of our insurance companies' investment portfolio as interest rates rose. Book value per common share outstanding decreased to $13.62 at June 30, 2000, from $15.50 at December 31, 1999, primarily due to the factors discussed in the previous paragraph. Excluding accumulated other comprehensive loss, book value per common share outstanding was $16.60 at June 30, 2000, and $17.85 at December 31, 1999. Goodwill (representing the excess of the amounts we paid to acquire companies over the fair value of net assets acquired in transactions accounted for as purchases) was $3,874.4 million and $3,927.8 million at June 30, 2000 and December 31, 1999, respectively. Goodwill as a percentage of shareholders' equity was 79 percent and 71 percent at June 30, 2000 and December 31, 1999, respectively. Goodwill as a percentage of total capital, excluding accumulated other comprehensive loss, was 33 percent and 34 percent at June 30, 2000 and December 31, 1999, respectively. We believe that the life of our goodwill is indeterminable and, therefore, have generally amortized its balance over 40 years as permitted by generally accepted accounting principles. Amortization of goodwill totaled $56.6 million and $55.0 million during the first six months of 2000 and 1999, respectively. If we had determined the estimated useful life of our goodwill was less than 40 years, amortization expense would have been higher. We continually monitor the value of our goodwill based on our best estimates of future earnings considering all available evidence. We determine whether goodwill is fully recoverable from projected undiscounted net cash flows from earnings of the business acquired over the remaining amortization period. If we were to determine that changes in such projected cash flows no longer support the recoverability of goodwill over the remaining amortization period, we would reduce its carrying value with a corresponding charge to expense or shorten the amortization period (no such changes have occurred). Cash flows considered in such an analysis are those of the business acquired, if separately identifiable, or the product line of the business acquired, if such earnings are not separately identifiable. Dividends declared on common stock for the six months ended June 30, 2000, were 10 cents per share. As part of our plan to strengthen our capital structure, the Board of Directors reduced the cash dividend on our common stock to a quarterly rate of 5 cents per share, beginning with the dividend paid in April of 2000. 42 CONSECO, INC. AND SUBSIDIARIES -------------------- The following table summarizes certain financial ratios as of and for the three months ended June 30, 2000, and as of and for the year ended December 31, 1999:
June 30, December 31, 2000 1999 ---- ---- Book value per common share: As reported............................................................................... $13.62 $15.50 Excluding accumulated other comprehensive income (loss) (a)............................... $16.60 $17.85 Ratio of earnings to fixed charges: As reported............................................................................... .53X(g) 2.98X Excluding interest expense on debt related to finance receivables and other investments (b)................................................... (g) 7.06X Ratio of operating earnings to fixed charges (c): As reported............................................................................... 1.44X 4.26X Excluding interest expense on debt related to finance receivables and other investments (b)................................................... 3.25X 10.99X Ratio of earnings to fixed charges, preferred dividends and distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts: As reported............................................................................. .44X(h) 2.20X Excluding interest expense on debt related to finance receivables and other investments (b)................................................. (h) 3.38X Ratio of operating earnings to fixed charges, preferred dividends and distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts (c): As reported............................................................................. 1.19X 3.14X Excluding interest expense on debt related to finance receivables and other investments (b)................................................. 1.56X 5.26X Rating agency ratios (a) (d) (e): Debt to total capital..................................................................... 31% 22% Debt and Company-obligated mandatorily redeemable preferred securities of subsidiary trusts to total capital (f)............................................... 51% 45% (a) Excludes accumulated other comprehensive income (loss). (b) We include these ratios to assist you in analyzing the impact of interest expense on debt related to finance receivables and other investments (which is generally offset by interest earned on finance receivables and other investments financed by such debt). Such ratios are not intended to, and do not, represent the following ratios prepared in accordance with GAAP: the ratio of earnings and operating earnings to fixed charges; and the ratio of earnings and operating earnings to fixed charges, preferred dividends and distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts. (c) Such ratios exclude the following items from earnings: (i) net investment gains (losses) (less that portion of amortization of cost of policies purchased and cost of policies produced relating to such gains (losses)); (ii) impairment charges; and (iii) charges that are considered to be unusual. Such ratios are not intended to, and do not, represent the following ratios prepared in accordance with GAAP: the ratio of earnings to fixed charges; and the ratio of earnings to fixed charges, preferred dividends and distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts. 43 CONSECO, INC. AND SUBSIDIARIES -------------------- (d) Excludes debt of the finance segment used to fund finance receivables and investment borrowings of the insurance segment. (e) These ratios are calculated in a manner discussed with rating agencies. (f) Total Company-obligated mandatorily redeemable preferred securities of subsidiary trusts exclude, and total capital includes: (i) amounts related to FELINE PRIDES which require the holders to purchase a number of shares of the Company's common stock under the terms specified in the stock purchase contracts; and (ii) at December 31, 1999, amounts related to RHINOS. In April 2000, the Company repurchased the RHINOS. (g) For such ratios, adjusted earnings were $285.4 million less than fixed charges. Adjusted earnings for the six months ended June 30, 2000, included special charges of $327.2 million as described in greater detail in the note to the accompanying consolidated financial statements entitled "Special Charges and Recent Events". (h) For such ratios, adjusted earnings were $410.8 million less than fixed charges. Adjusted earnings for the six months ended June 30, 2000, included special charges of $327.2 million as described in greater detail in the note to the accompanying consolidated financial statements entitled "Special Charges and Recent Events".
We continually review our capital structure, including the need and desirability of modifying our existing debt and equity. Liquidity for insurance and fee-based operations Our insurance operating companies generally receive adequate cash flow from premium collections and investment income to meet their obligations. Life insurance and annuity liabilities are generally long-term in nature. Policyholders may, however, withdraw funds or surrender their policies, subject to any applicable surrender and withdrawal penalty provisions. We seek to balance the duration of our invested assets with the estimated duration of benefit payments arising from contract liabilities. We believe that the diversity of the investment portfolio and the concentration of investments in high-quality, liquid securities should provide sufficient liquidity to meet foreseeable cash requirements. Liquidity for finance operations After the March 31, 2000 announcement that we planned to explore the sale of Conseco Finance and other events described elsewhere herein, it was more difficult to complete new public securitization transactions for a period of time. However, these markets eventually became available to the Company. During the second quarter of 2000, we completed five transactions, securitizing over $2.5 billion of finance receivables. In May 2000, we sold $1.3 billion of finance receivables to Lehman. The proceeds from such sale were used to repay various warehouse credit lines, creating increased warehousing capacity for Conseco Finance. Lehman also amended its repurchase and other financing facilities with Conseco Finance to expand the types of assets financed. See the note to the accompanying consolidated financial statements entitled "Special Charges and Recent Events" for a further description of the transactions with Lehman. We continue to be able to finance loans through: (i) our warehouse and bank credit facilities; (ii) the sale of securities through securitization transactions; and (iii) whole-loan sales. At June 30, 2000, we had $5.7 billion in master repurchase agreements, commercial paper conduit facilities and other facilities with various banking and investment banking firms for the purpose of financing our consumer and commercial finance loan production. These facilities typically provide financing of a certain percentage of the underlying collateral and are subject to the availability of eligible collateral and, in many cases, the willingness of the banking firms to continue to provide financing. These agreements generally provide for annual terms, some of which are extended either quarterly or semi-annually by mutual agreement of the parties for an additional annual term based upon receipt of updated quarterly financial information. At June 30, 2000, we had borrowed $3.3 billion of the $5.7 billion available under such agreements. Our finance operations require cash to originate finance receivables. Our primary sources of cash are: (i) the collection of receivable balances; (ii) proceeds from the issuance of debt, certificates of deposit and securitization or sales of loans; (iii) cash provided by operations; and (iv) cash provided by the parent company from its credit sources. 44 CONSECO, INC. AND SUBSIDIARIES -------------------- The most significant source of liquidity for our finance operations has been our ability to finance the receivables we originate in the secondary markets through loan securitizations. Under certain securitization structures, we have provided a variety of credit enhancements, which generally take the form of corporate guarantees, but have also included bank letters of credit, surety bonds, cash deposits and over-collateralization or other equivalent collateral. When choosing the appropriate structure for a securitization of loans, we analyze the cash flows unique to each transaction, as well as its marketability and projected economic value. The structure of each securitized transaction depends, to a great extent, on conditions in the fixed-income markets at the time the transaction is completed, as well as on cost considerations and the availability and effectiveness of the various enhancement methods. The market for securities backed by receivables is a cost-effective source of funds. Conditions in the credit markets in certain periods during 1999 and early 2000 resulted in less-attractive pricing of certain lower-rated securities typically included in loan securitization transactions. As a result, we chose to hold rather than sell some of the securities in the securitization trusts, particularly securities having corporate guarantee provisions. Market conditions in the credit markets for loan securitizations and loan sales change from time to time. For example, during certain periods of 1999, the general levels of interest rates have increased on securities issued in securitizations, causing us to incur higher interest costs on securitizations completed during those periods. Changes in market conditions could affect the interest rate spreads we earn on the loans we originate and the cash provided by our finance operations. We have increased interest rates on our lending products as we strive to maintain our targeted spread in the current interest rate environment. We continually investigate and pursue alternative and supplementary methods to finance our lending operations. In late 1998, we began issuing certificates of deposit through our bank subsidiary. At June 30, 2000, we had $1,398.9 million of such deposits outstanding which are recorded as liabilities related to certificates of deposit. The average annual rate paid on these deposits was 6.3 percent during the first six months of 2000. Our finance segment generated cash flows from operating activities of $196.0 million during the first six months of 2000, compared to approximately $266.7 million in the same period of 1999. Such cash flows include cash received from the securitization trusts of $189.7 million in the 2000 period and $320.2 million in the 1999 period, representing distributions of excess interest and servicing fees. On September 8, 1999, we announced that, although we plan to continue to finance the receivables we originate through loan securitizations, we will no longer structure future securitizations in a manner that results in gain-on-sale revenues. This change is not expected to have any material effect on the amount or timing of cash flows we receive, but the change required us to classify certain activities differently on our cash flow statement (e.g., certain cash flows recorded as "operating cash flows" under the gain-on-sale method must be recorded as "investing activities" under the portfolio method and vice versa). Independent rating agencies, financial institutions, analysts and other interested parties monitor the leverage ratio of our finance segment. Such ratio (calculated, as discussed with independent rating agencies, as the ratio of debt to equity of our finance subsidiary calculated on a pro forma basis as if we had accounted for the securitizations of our finance receivables as financing transactions throughout the Company's history) was 29-to-1 and 22-to-1 at June 30, 2000, and December 31, 1999, respectively. Liquidity of Conseco (parent company) The parent company is a legal entity, separate and distinct from its subsidiaries, and has no business operations. The parent company uses cash for: (i) principal and interest payments on debt; (ii) dividends on preferred and common stock; (iii) payments to subsidiary trusts to be used for distributions on the Company-obligated mandatorily redeemable preferred securities of subsidiary trusts; (iv) holding company administrative expenses; (v) income taxes; and (vi) investments in subsidiaries and other investments. The primary sources of cash to meet these obligations are payments from our subsidiaries, including the statutorily permitted payments from our life insurance subsidiaries in the form of: (i) fees for services provided; (ii) tax sharing payments; (iii) dividend payments; and (iv) surplus debenture interest and principal payments. The parent company may also obtain cash by: (i) issuing debt or equity securities; (ii) borrowing additional amounts under its revolving credit agreement, as described in the notes to the consolidated financial statements; or (iii) selling all or a portion of its subsidiaries or its other investments. 45 CONSECO, INC. AND SUBSIDIARIES -------------------- The parent company has significant debt scheduled to become due on or before September 30, 2000, as follows (dollars in millions): Bank credit facility due September 1, 2000................................................... $ 155.0 Potential payment pursuant to guaranteed debt related to directors, officers and key employees stock purchase program due September 1, 2000.................................... 144.4 Bank credit facility due September 22, 2000.................................................. 766.0 Commercial paper due September 22, 2000...................................................... 50.0 Notes payable due 2003, but putable by the holder............................................ 250.0(a) -------- Total................................................................................... $1,365.4 ======== ------------ (a) Such notes payable are putable by the holder prior to the maturity date. The payment of the note is secured by standby letters of credit which may be drawn upon by the holder of the note on August 16, 2000 through September 30, 2000.
Because of the time required to complete the sale of assets and other contemplated activities described in paragraph which follows, extension of the Company's bank credit facilities will be required if the Company is to meet its September debt maturities. The Company is currently in discussions with its bank lenders and management is optimistic appropriate extensions can be negotiated. However, there can be no assurance that these negotiations will be successful, or as to the amount, maturity, cost or terms associated with any such extension. On July 27, 2000, we announced several courses of action with respect to Conseco Finance as well as an asset disposition program with respect to certain non-strategic assets held at the parent company level, which are designed to allow us to reduce parent company debt over time. These actions with respect to Conseco Finance, include: (i) the sale, closing or runoff of five units (i.e., asset-based lending, vendor finance, bankcards, transportation and park construction); (ii) efforts to better utilize existing assets so as to increase cash; and (iii) cost savings and restructuring of ongoing businesses such as the streamlining of the field force in the manufactured housing and home equity lending divisions. The Company believes these contemplated actions offer better opportunities than the previously announced plan to explore the sale of Conseco Finance and are designed to provide a business model which will result in positive cash flow at Conseco Finance. In addition, we plan to sell certain non-strategic assets, such as our investment in the wireless communication company, Tritel, our interest in the riverboat casino in Lawrenceberg, Indiana, and our subprime auto loan portfolio. The Company believes the sale of non-strategic assets and the actions contemplated at Conseco Finance will generate cash proceeds of approximately $2.0 billion over the next 12 to 15 months. We are already well underway with these actions, and have completed the sale of the bankcard business and our subprime auto loan portfolio, generating cash proceeds of over $300 million. However, no assurance can be provided as to the timing, proceeds, or other terms related to the possible disposition of assets, the timing or extent of the cost savings to be achieved, or the amount of the restructuring or other charges to be incurred with respect to these actions. Furthermore, the Company's ability to use cash generated from the actions being undertaken at Conseco Finance is substantially limited by restrictions in agreements with Lehman. In connection with the negotiations with our banks relating to the extension of the maturity dates of our debt, we are also engaged in discussions with Lehman concerning a modification of these restrictions and are optimistic an acceptable modification can be obtained. However, there can be no assurance that these negotiations will be successful, or as to the terms of any such modification. See the note to the accompanying financial statements entitled "Changes in Corporate Notes Payable and Commercial Paper." During the first six months of 2000, our insurance subsidiaries paid dividends to Conseco of $108.1 million and our finance subsidiary repurchased shares of its common stock for $126.0 million. The cash provided by operating activities at the parent company, including dividends received from our insurance subsidiaries, plus the amount paid to us to repurchase shares of common stock of our finance subsidiary totaled approximately $110 million during the first six months of 2000. In connection with the Lehman transaction described in the note to the accompanying consolidated financial statements entitled "Special Charges and Recent Events," Conseco Finance has agreed that it will not pay dividends until 2001 and then pay such dividends only to the extent certain financial covenants are met. In addition, Conseco Finance agreed that it will limit additional prepayments on the intercompany note payable to Conseco (with a balance of $2,210.8 million at June 30, 2000) to $50 million, as long as certain financing arrangements with Lehman remain outstanding. We are currently negotiating with Lehman to waive or modify this restriction to permit additional prepayments on the intercompany note. There can be no assurance as to the outcome of these negotiations. The ability of our insurance subsidiaries to pay dividends is subject to state insurance department regulations. These regulations generally permit dividends to be paid from earned surplus of the insurance company for any 12-month period in amounts equal to the greater of (or in a few states, the lesser of): (i) net gain from operations for the prior year; or (ii) 10 percent of surplus as of the end of the preceding year. Any dividends in excess of these levels require the approval of the director or commissioner of the applicable state insurance department. In addition to fees and interest, during the remainder of 2000, our insurance subsidiaries may pay "ordinary" dividends to Conseco of $96.5 million without permission from state regulatory authorities. 46 CONSECO, INC. AND SUBSIDIARIES -------------------- The ratings assigned to Conseco's senior debt, trust preferred securities and commercial paper are important factors in determining the Company's ability to access the public capital markets for additional liquidity. Following our March 31, 2000, announcement that we planned to explore the sale of Conseco Finance and other events described in the note to the accompanying consolidated financial statements entitled "Special Charges and Recent Events" and elsewhere herein, rating agencies lowered their ratings on Conseco's senior debt, trust preferred securities and commercial paper. As of August 10, 2000, the rating agencies have assigned the following ratings: (i) Standard & Poor's has assigned a "BB-" rating to Conseco's senior debt; a "B-" rating to trust preferred securities and a "B" rating to commercial paper; (ii) Fitch Rating Company has assigned a "BB-" rating to Conseco's senior debt; a "B" rating to trust preferred securities and a "B" rating to commercial paper; and (iii) Moody's Investor Services has assigned a "B1" rating to Conseco's senior debt; and a "ca" rating to trust preferred securities. These ratings make it difficult for the Company to issue additional securities in the public markets, although the Company does not believe additional issuances will be necessary in the near future. INVESTMENTS At June 30, 2000, the amortized cost and estimated fair value of fixed maturity securities (all of which were actively managed) were as follows:
Gross Gross Estimated Amortized unrealized unrealized fair cost gains losses value ---- ----- ------ ----- (Dollars in millions) Investment grade: Corporate securities................................................ $13,452.0 $ 60.0 $1,029.5 $12,482.5 United States Treasury securities and obligations of United States government corporations and agencies................ 302.9 2.8 5.4 300.3 States and political subdivisions................................... 143.4 - 9.0 134.4 Debt securities issued by foreign governments....................... 198.4 .8 12.9 186.3 Mortgage-backed securities ......................................... 7,597.8 6.6 589.9 7,014.5 Below-investment grade (primarily corporate securities)................ 1,735.4 30.8 310.1 1,456.1 --------- ------ -------- --------- Total actively managed fixed maturities........................... $23,429.9 $101.0 $1,956.8 $21,574.1 ========= ====== ======== =========
During the first six months of 2000 and 1999, we recorded $68.2 million and $1.2 million, respectively, of writedowns of fixed maturity securities and other invested assets as a result of changes in conditions which caused us to conclude that a decline in fair value of the investments was other than temporary. At June 30, 2000, fixed maturity securities in default as to the payment of principal or interest had an aggregate amortized cost of $112.9 million and a carrying value of $73.5 million. Sales of invested assets (primarily fixed maturity securities) during the first six months of 2000 generated proceeds of $3.0 billion, resulting in net investment losses of $46.6 million. At June 30, 2000, fixed maturity investments included $7.0 billion of mortgage-backed securities (or 33 percent of all fixed maturity securities). The yield characteristics of mortgage-backed securities differ from those of traditional fixed-income securities. Interest and principal payments for mortgage-backed securities occur more frequently, often monthly. Mortgage- backed securities are subject to risks associated with variable prepayments. Prepayment rates are influenced by a number of factors that cannot be predicted with certainty, including: the relative sensitivity of the underlying mortgages backing the assets to changes in interest rates; a variety of economic, geographic and other factors; and the repayment priority of the securities in the overall securitization structures. In general, prepayments on the underlying mortgage loans and the securities backed by these loans increase when prevailing interest rates decline significantly relative to the interest rates on such loans. The yields on mortgage-backed securities purchased at a discount to par will increase when the underlying mortgages prepay faster than expected. The yields on mortgage-backed securities purchased at a premium will decrease when they prepay faster than expected. When interest rates decline, the proceeds from the prepayment of mortgage-backed securities are likely to be reinvested at lower rates than we were earning on the prepaid securities. When interest rates increase, prepayments on mortgage-backed securities decrease as 47 CONSECO, INC. AND SUBSIDIARIES -------------------- fewer underlying mortgages are refinanced. When this occurs, the average maturity and duration of the mortgage-backed securities increase, which decreases the yield on mortgage-backed securities purchased at a discount, because the discount is realized as income at a slower rate, and increases the yield on those purchased at a premium as a result of a decrease in the annual amortization of the premium. The following table sets forth the par value, amortized cost and estimated fair value of mortgage-backed securities, summarized by interest rates on the underlying collateral at June 30, 2000:
Par Amortized Estimated value cost fair value ----- ---- ---------- (Dollars in millions) Below 7 percent..................................................................... $4,586.6 $4,551.5 $4,273.3 7 percent - 8 percent............................................................... 1,949.5 1,933.2 1,877.6 8 percent - 9 percent............................................................... 287.6 287.1 283.9 9 percent and above................................................................. 848.1 853.5 605.5 -------- -------- -------- Total mortgage-backed securities (a)......................................... $7,671.8 $7,625.3 $7,040.3 ======== ======== ======== (a) Includes below-investment grade mortgage-backed securities with an amortized cost and estimated fair value of $27.5 million and $25.8 million, respectively.
The amortized cost and estimated fair value of mortgage-backed securities at June 30, 2000, summarized by type of security, were as follows:
Estimated fair value ----------------------- Percent Amortized of fixed Type cost Amount maturities ---- ---- ------ ---------- (Dollars in millions) Pass-throughs and sequential and targeted amortization classes............ $3,993.7 $3,823.5 18% Planned amortization classes and accretion-directed bonds................. 1,970.7 1,847.7 9 Commercial mortgage-backed securities..................................... 788.7 748.4 3 Subordinated classes and mezzanine tranches............................... 835.5 587.5 3 Other..................................................................... 36.7 33.2 - -------- -------- -- Total mortgage-backed securities (a)............................... $7,625.3 $7,040.3 33% ======== ======== == ---------- (a) Includes below-investment grade mortgage-backed securities with an amortized cost and estimated fair value of $27.5 million and $25.8 million, respectively.
Pass-throughs and sequential and targeted amortization classes have similar prepayment variability. Pass-throughs historically provide the best liquidity in the mortgage-backed securities market. Pass-throughs are also used frequently in the dollar roll market and can be used as the collateral when creating collateralized mortgage obligations. Sequential classes are a series of tranches that return principal to the holders in sequence. Targeted amortization classes offer slightly better structure in return of principal than sequentials when prepayment speeds are close to the speed at the time of creation. Planned amortization classes and accretion-directed bonds are some of the most stable and liquid instruments in the mortgaged-backed securities market. Planned amortization class bonds adhere to a fixed schedule of principal payments as long as the underlying mortgage collateral experiences prepayments within a certain range. Changes in prepayment rates are first absorbed by support or companion classes. This insulates the planned amortization class from the consequences of both faster prepayments (average life shortening) and slower prepayments (average life extension). 48 CONSECO, INC. AND SUBSIDIARIES -------------------- Commercial mortgage-backed securities ("CMBS") are bonds secured by commercial real estate mortgages. Commercial real estate encompasses income producing properties that are managed for economic profit. Property types include multi-family dwellings including apartments, retail centers, hotels, restaurants, hospitals, nursing homes, warehouses, and office buildings. The CMBS market currently offers high yields, strong credits, and call protection compared to similar rated corporate bonds. Most CMBS have strong call protection features where borrowers are locked out from prepaying their mortgages for a stated period of time. If the borrower does prepay any or all of the loan, they will be required to pay prepayment penalties. Subordinated and mezzanine tranches are classes that provide credit enhancement to the senior tranches. The rating agencies require that this credit enhancement not deteriorate due to prepayments for a period of time, usually five years of complete lockout followed by another period of time where prepayments are shared pro rata with senior tranches. The credit risk of subordinated and mezzanine tranches is derived from owning a small percentage of the mortgage collateral, while bearing a majority of the risk of loss due to property owner defaults. Subordinated bonds can be anything rated "AA" or lower, while typically we do not buy anything lower than "BB". At June 30, 2000, the mortgage loan balance was primarily comprised of commercial loans. Less than 1 percent of the mortgage loan balance was noncurrent (loans two or more scheduled payments past due) at June 30, 2000. At June 30, 2000, we held $78.1 million of trading securities; we included them in "other invested assets." Our investment borrowings averaged approximately $369.3 million during the first six months of 2000, compared with approximately $1,111.9 million during the same period of 1999 and were collateralized by investment securities with fair values approximately equal to the loan value. The weighted average interest rates on such borrowings were 5.4 percent and 5.1 percent during the first six months of 2000 and 1999, respectively. STATUTORY INFORMATION Statutory accounting practices prescribed or permitted by regulatory authorities for the Company's insurance subsidiaries differ from GAAP. The statutory income (loss) before net realized capital gains (losses) of our life insurance subsidiaries was $(2.5) million and $140.1 million in the first six months of 2000 and 1999, respectively. The Company's life insurance subsidiaries reported the following amounts to regulatory agencies at June 30, 2000, after appropriate eliminations of intercompany accounts among such subsidiaries (dollars in millions): Statutory capital and surplus .................................. $1,970.6 Asset valuation reserve......................................... 393.3 Interest maintenance reserve.................................... 463.0 -------- Total........................................................ $2,826.9 ========
The statutory capital and surplus shown above included investments in up-stream affiliates, all of which were eliminated in the consolidated financial statements prepared in accordance with GAAP, as follows:
June 30, 2000 ---- (Dollars in millions) Securitization debt issued by special purpose entities and guaranteed by our finance subsidiary, all of which was purchased by our insurance subsidiaries prior to the Merger (a)............................................................ $ 72.2 Preferred and common stock of intermediate holding company............................ 219.0 Common stock of Conseco (39.8 million shares)......................................... 32.4 Other ................................................................................ 2.5 ------ Total........................................................................... $326.1 ====== 49 CONSECO, INC. AND SUBSIDIARIES -------------------- -------------------- (a) Total par value, amortized cost and fair value of securities issued by special purpose entities which hold loans originated by our finance subsidiary (including the securities that are not guaranteed by Conseco Finance, and therefore are not considered affiliated investments) were $285.1 million, $280.1 million and $256.6 million, respectively.
State insurance laws generally restrict the ability of insurance companies to pay dividends or make other distributions. During the remainder of 2000, our insurance subsidiaries may pay dividends to Conseco of $96.5 million without permission from state regulatory authorities. During the first six months of 2000, our insurance subsidiaries paid dividends to Conseco totaling $108.1 million. In 1998, the National Association of Insurance Commissioners adopted codified statutory accounting principles, which are expected to constitute the only source of prescribed statutory accounting practices and are effective in 2001. The changes to statutory accounting practices resulting from the codification are not expected to have a material effect on the statutory capital and surplus or statutory operating earnings data shown above. FORWARD-LOOKING STATEMENTS All statements, trend analyses and other information contained in this report and elsewhere (such as in filings by Conseco with the Securities and Exchange Commission, press releases, presentations by Conseco or its management or oral statements) relative to markets for Conseco's products and trends in Conseco's operations or financial results, as well as other statements including words such as "anticipate," "believe," "plan," "estimate," "expect," "intend," "should," "could," "goal," "target," "on track," "comfortable with," "optimistic" and other similar expressions, constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors which may cause actual results to be materially different from those contemplated by the forward-looking statements. Such factors include, among other things: (i) general economic conditions and other factors, including prevailing interest rate levels, stock and credit market performance and health care inflation, which may affect (among other things) Conseco's ability to sell its products, its ability to make loans and access capital resources and the costs associated therewith, the market value of Conseco's investments, the lapse rate and profitability of policies, and the level of defaults and prepayments of loans made by Conseco; (ii) Conseco's ability to achieve anticipated synergies and levels of operational efficiencies; (iii) customer response to new products, distribution channels and marketing initiatives; (iv) mortality, morbidity, usage of health care services and other factors which may affect the profitability of Conseco's insurance products; (v) performance of our investments; (vi) changes in the Federal income tax laws and regulations which may affect the relative tax advantages of some of Conseco's products; (vii) increasing competition in the sale of insurance and annuities and in the finance business; (viii) regulatory changes or actions, including those relating to regulation of financial services affecting (among other things) bank sales and underwriting of insurance products, regulation of the sale, underwriting and pricing of products, and health care regulation affecting health insurance products; (ix) the outcome of Conseco's efforts to sell assets and reduce, refinance or modify indebtedness and the availability and cost of capital in connection with this process; (x) actions by rating agencies and the effects of past or future actions by these agencies on Conseco's business; and (xi) the risk factors or uncertainties listed from time to time in Conseco's filings with the Securities and Exchange Commission. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Our market risks, and the ways we manage them, are summarized in management's discussion and analysis of financial condition and results of operations as of December 31, 1999, included in the Company's Form 10-K for the year ended December 31, 1999. The fair value of our borrowed capital varies with credit ratings and other conditions in the capital markets. Following our March 31, 2000, announcement that we planned to explore the sale of Conseco Finance and other events described in the note to the accompanying consolidated financial statements entitled "Special Charges and Recent Events," the capital markets reacted by lowering the value of our publicly traded securities. In addition, the capital markets have also lowered the value of the securities issued in previous securitization transactions of Conseco Finance. See the note to the accompanying consolidated financial statements entitled "Standard & Poor's 500 Index Call Options and Interest Rate Swap Agreements" for information about several interest rate swap agreements that were terminated during the second quarter of 2000. 50 CONSECO, INC. AND SUBSIDIARIES -------------------- PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. Conseco Finance was served with various related lawsuits filed in the United States District Court for the District of Minnesota. These lawsuits were generally filed as purported class actions on behalf of persons or entities who purchased common stock or options to purchase common stock of Conseco Finance during alleged class periods that generally run from February 1995 to January 1998. One action (Florida State Board of Admin. v. Green Tree Financial Corp., Case No. 98-1162) did not include class action claims. In addition to Conseco Finance, certain current and former officers and directors of Conseco Finance are named as defendants in one or more of the lawsuits. Conseco Finance and other defendants obtained an order consolidating the lawsuits seeking class action status into two actions, one of which pertains to a purported class of common stockholders (In re Green Tree Financial Corp. Stock Litig., Case No. 97-2666) and the other which pertains to a purported class action of stock option traders (In re Green Tree Financial Corp. Options Litig., Case No. 97-2679). Plaintiffs in the lawsuits assert claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. In each case, plaintiffs allege that Conseco Finance and the other defendants violated federal securities laws by, among other things, making false and misleading statements about the current state and future prospects of Conseco Finance (particularly with respect to prepayment assumptions and performance of certain loan portfolios of Conseco Finance) which allegedly rendered Conseco Finance's financial statements false and misleading. On August 24, 1999, the United States District Court for the District of Minnesota issued an order to dismiss with prejudice all claims alleged in the lawsuits. The plaintiffs subsequently appealed the decision to the U.S. Court of Appeals for the 8th Circuit, and the appeal is currently pending. The Company believes that the lawsuits are without merit and intends to continue to defend them vigorously. The ultimate outcome of these lawsuits cannot be predicted with certainty. A total of forty-five suits have been filed against the Company in the United States District Court for the Southern District of Indiana. Nineteen of these cases are putative class actions on behalf of persons or entities that purchased the Company's common stock during alleged class periods that generally run from April 1999 through April 2000. Luisi v. Conseco, Inc., et al., Case No. IP00-C-0593-Y/S; Sechrist v. Conseco, Inc., et al., Case No. IP00-C-0585-Y/S; Klein v. Conseco, Inc., et al., Case No. IP00-C-0602-Y/S; Brody v. Conseco, Inc., et al., Case No. IP00-C-0609-Y/S; Dana v. Conseco, Inc., et al., Case No. IP00-C-0623-Y/S; Krim v. Conseco, Inc., et al., Case No. IP00-C-0631-Y/S; Nadaf v. Conseco, Inc., et al., Case No. IP00-C- 0628-Y/S; Greiner v. Conseco, Inc., et al., Case No. IP00-C-0639-Y/S (naming as a defendant only one officer/director); Sedgwick v. Conseco, Inc., et al., Case No. IP00-C-0657-Y/S; Irle v. Conseco, Inc., et al., Case No. IP00-C-0746-Y/S; Schwartz v. Conseco, Inc., et al., Case No. IP00-C-0770-Y/S; Leopold v. Conseco, Inc., et al., Case No. IP00-C-0843-Y/S; Slovacek v. Conseco, Inc., et al., Case No. IP00-C-0858-Y/S (naming as a defendant only one officer/director); Swei v. Conseco, Inc., et al., Case No. IP00-C-0839-Y/S (naming as a defendant only one officer/director); Nicholson v. Conseco, Inc., et al., Case No. IP00-C-0826-Y/S; Browne v. Conseco, Inc., et al., Case No. IP00-C-0897-Y/S; Chacharone v. Conseco, Inc., et al., Case No. IP00-C-0885-Y/S; Muhlenfeld v. Conseco, Inc., et al., Case No. IP00-C-0933-Y/S; Young v. Conseco, Inc., et al. (case number pending; originally filed in the United States District Court for the Eastern District Michigan, Case No. 00-72939, and now in the process of transferred by stipulation). Two cases are putative class actions on behalf of persons or entities that purchased the Company's bonds during the same alleged class periods. Waring v. Conseco, Inc., et al., Case No. IP00-C-0793- Y/S; Lutt v. Conseco, Inc., et al., Case No. IP00-C-0905-Y/S. Three cases are putative class actions on behalf of persons or entities that purchased or sold option contracts, not issued by the Company, on the Company's common stock during the same alleged class periods. Syndicated Fin. Servs., Inc. v. Conseco, Inc., et al., Case No. IP00-C-0795-Y/S (naming as a defendant only one officer/director); Joel Mandel v. Conseco, Inc., et al., Case No. IP00-C-0815-Y/S; Avi Mandel v. Conseco, Inc., et al., Case No. IP00-C-0884-Y/S. One case is a putative class action on behalf of persons or entities that purchased the Company's "Feline Pride" convertible preferred stock instruments during the same alleged class periods. Kelly v. Conseco, Inc., et al., Case No. IP00-C-0789-Y/S. With the four exceptions noted, in each of these twenty-five cases two former officers/directors of the Company are named as defendants. In each case, the plaintiffs assert claims under Section 10(b) and 20(a) of the Securities Exchange Act of 1934. In each case, plaintiffs allege that the Company and the individual defendants violated the federal securities laws by, among other things, making false and misleading statements about the current state and future prospects of Conseco Finance (particularly with respect to performance of certain loan portfolios of Conseco Finance) which allegedly rendered the Company's financial statements false and misleading. The Company believes that these lawsuits are without merit and intends to defend them vigorously. The ultimate outcome of these lawsuits cannot be predicted with certainty. 51 CONSECO, INC. AND SUBSIDIARIES -------------------- Eleven of the cases in the United States District Court were filed as purported class actions on behalf of persons or entities that purchased preferred securities issued by various Conseco Financing Trusts, including Conseco Financing Trust V, Griffin v. Conseco, Inc., et al., Case No. IP00-C-0663-Y/S; Stifnagle v. Conseco, Inc., et al., Case No. IP00-C-0754-Y/S (Stifnagle also asserts claims regarding Conseco Financing Trust VII); Gastfriend v. Conseco, Inc., et al., Case No. IP00-C-0883-Y/S; Powers v. Conseco Financing Trust V, et al., Case No. IP00-C-0953-Y/S (also naming Conseco Financing Trusts VI and VII) (each of the preceding make allegations with respect to an August 24, 1998 offering for Conseco Financing Trust V); Gabora v. Conseco, Inc., et al., Case No. IP00-C-0852-Y/S (also naming Conseco Financing Trust VII, but containing allegations relating only to notes issued by the Company on October 18, 1999, unrelated to the Conseco Financing Trusts named); Schmidt v. Conseco, Inc., et al., Case No. IP00-C-0823-Y/S (also naming Conseco Financing Trust VII, but containing allegations relating only to Conseco Financing Trusts VI and VII), Conseco Financing Trust VI, Costello v. Conseco, Inc., et al., Case No. IP00-C-0705-Y/S (October 8, 1998 offering), and Conseco Financing Trust VII, Zinno v. Conseco, Inc., et al., Case No. IP00- C-0622-Y/S; Shapiro v. Conseco, Inc., et al., Case No. IP00-C-0650-Y/S; Kosseff v. Conseco, Inc., et al., Case No. IP00-C- 0753-Y/S; Harris v. Conseco, Inc., et al., Case No. IP00-C-0797-Y/S (August 26, 1999 offering). Each of these complaints names as defendants the Company, the relevant trust (except Shapiro and Kosseff), two former officers/directors of the Company, and underwriters for the particular issuance (except Shapiro). The Kosseff complaint also names an officer and all of the Company's directors at the time of issuance of the preferred stock by Conseco Financing Trust VII. In each case, plaintiffs assert claims under Section 11 and Section 15 of the Securities Act of 1933, and the Zinno, Shapiro, Stifnagle, Harris, Gabora, Gastfriend, Powers and Schmidt complaints also assert claims under Section 12(a)(2) of that Act. Gabora and Gastfriend also assert claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Powers also asserts a claim under Section 10(b) of that Act. In each case, plaintiffs allege that the defendants violated the federal securities laws by, among other things, making false and misleading statements, in Prospectuses and/or Registration Statements related to the issuance of preferred securities by the Trust involved, regarding the current state and future prospects of Conseco Finance (particularly with respect to performance of certain loan portfolios of Conseco Finance) which allegedly rendered the disclosure documents false and misleading. The Company also intends to defend these lawsuits vigorously. The ultimate outcome of these lawsuits cannot be predicted with certainty. Nine shareholder derivative suits have been filed in United States District Court. Rogney v. Decatur, et al., Case No. IP00- C-0655-Y/S; Fletcher v. Hilbert, et al., Case No. IP00-C-0693-Y/S; Gold v. Decatur, et al., Case No. IP00-C-0747-Y/S; Batcheldor v. Hilbert, Case No. IP00-C-0743-Y/S; Youssef v. Decatur, et al., Case No. IP00-C-0809-Y/S; Gintel v. Hilbert, Case No. IP00-C-0987-Y/S; Frankel v. Coss, et al. (case number pending; originally filed in the Evansville Division of United States District Court for the Southern District of Indiana, Case No. EV00-134-C-Y/H, and now in the process of transfer); Evans v. Hilbert, Case No. IP00-C-1019-Y/S; Marks v. Hilbert, Case No. IP00-C-0877-Y/S. The complaints name as defendants the current directors, certain former directors, certain non-director officers of the Company (in Fletcher), and, alleging aiding and abetting liability, certain banks which allegedly made loans in relation to the Company's "Stock Purchase Plan" (in Batcheldor, Gintel and Evans). The Company is also named as a nominal defendant in each complaint. Plaintiffs allege that the defendants breached their fiduciary duties by, among other things, intentionally disseminating false and misleading statements concerning the acquisition, performance and proposed sale of Conseco Finance, and engaged in corporate waste by causing the Company to guarantee loans that certain officers, directors and key employees of the Company used to purchase stock under the Stock Purchase Plan. Three similar cases have been filed in the Hamilton County Superior Court in Indiana. Schweitzer v. Hilbert, et al., Cause No. 29001-0004CP251; Evans v. Hilbert, et al., Cause No. 29001- 0005CP308 (both Schweitzer and Evans name as defendants certain non-director officers); Gintel v. Hilbert, et al., Cause No. 29003-0006CP393 (naming as defendants, and alleging aiding and abetting liability as to, banks which allegedly made loans in relation to the Stock Purchase Plan). The Company believes that these lawsuits are without merit and intends to defend them vigorously. The ultimate outcome of these lawsuits cannot be predicted with certainty. Conseco, Inc. and its subsidiaries, Conseco Services, LLC, Washington National Insurance Company and United Presidential Life Insurance Company are currently named defendants in a lawsuit filed in the Circuit Court of Claiborne County, Mississippi, Cause No. CV-99-0106, and captioned "Carla Beaugez, Lois Dearing, Lee Eaton and all other persons identified in the lawsuit vs. Conseco, Inc., Conseco Services, Inc., Washington National Company, United Presidential Life Insurance Company and Larry Ratcliff." The claims of the eighty seven plaintiffs arise out of allegedly wrongful increases of the cost of insurance and decrease in the credited interest rates on universal life policies issued to the plaintiffs by United Presidential Life. The plaintiffs asserted claims including negligent and intentional misrepresentation, fraudulent concealment, fraudulent inducement, common law fraud, and deceptive sales practices. Conseco believes this lawsuit is without merit and is defending it vigorously. The ultimate outcome of this lawsuit cannot be predicted with certainty. 52 CONSECO, INC. AND SUBSIDIARIES -------------------- Conseco, Inc. and its subsidiaries, Conseco Life Insurance Company and Wabash Life Insurance Company, are currently named defendants in a certified nationwide class action lawsuit in the Superior Court for Santa Clara County (California, cause number CV768991) and captioned "John P. Dupell and the John P. Dupell 1992 Insurance Trust vs. Massachusetts General Life Insurance Company; Life Partners Group, Inc., Wabash Life Insurance Company, Conseco, Inc., Donovan R. Bolton, et al." The class, approximately 345,000 in number, consists of all persons who purchased universal life insurance policies from Conseco Life Insurance Company, formerly named Massachusetts General Life Insurance Company, between January 1, 1984 and July 23, 1999 (excluding policies where death benefits were paid). The claims involve the changing interest rate climate between the 1980s and the comparatively lower rates in the 1990s, and the resulting lower rates credited to universal life products. The plaintiffs asserted claims of fraud, breach of the covenant of good faith and fair dealing, negligence, negligent misrepresentation, unjust enrichment and related matters. Conseco believes this lawsuit is without merit. We intend to continue defending this action vigorously unless the current settlement discussions and procedures produce a satisfactory outcome. The ultimate outcome of this lawsuit cannot be predicted with certainty. Conseco Finance is a defendant in two arbitration proceedings in South Carolina (Lackey v. Green Tree Financial Corporation, n/k/a Conseco Finance Corp. and Bazzle v. Green Tree Financial Corporation, n/k/a Conseco Finance Corp.) where the arbitrator, over Conseco Finance's objection, allowed the plaintiffs to pursue purported class action claims in arbitration. The two purported arbitration classes consist of South Carolina residents who obtained real estate secured credit from Conseco Finance's Manufactured Housing Division (Lackey) and Home Improvement Division (Bazzle) in the early and mid 1990s, and did not receive a South Carolina specific disclosure form relating to selection of attorneys in connection with the credit transactions. The arbitrator, in separate awards issued on July 24, 2000, awarded a total of $26.8 million in penalties and attorneys' fees. Plaintiffs have filed motions in South Carolina courts to have the awards confirmed as judgments. Conseco Finance intends to vigorously challenge the awards and believes that the arbitrator erred by, among other things, conducting class action arbitrations without the authority to do so and misapplying South Carolina law when awarding the penalties. The ultimate outcome of these proceedings cannot be predicted with certainty. In addition, the Company and its subsidiaries are involved on an ongoing basis in other lawsuits related to its operations. Although the ultimate outcome of certain of such matters cannot be predicted, such lawsuits currently pending against the Company or its subsidiaries are not expected, individually or in the aggregate, to have a material adverse effect on the Company's consolidated financial condition, cash flows or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. At the Company's annual meeting on June 23, 2000, the shareholders elected Lawrence M. Coss, Thomas M. Hagerty, James D. Massey and Dennis E. Murray, Sr. to serve as directors for terms ending in 2003. Directors whose class was not up for election and whose term of office continued after the meeting are Ngaire E. Cuneo, David R. Decatur, Donald F. Gongaware, David V. Harkins, M. Phil Hathaway, John M. Mutz, and Robert S. Nickoloff. Gary C. Wendt was added to the Board of Directors on June 28, 2000. The results of the voting were as follows (there were no broker non-votes):
Lawrence M. Thomas M. James D. Dennis E. Coss Hagerty Massey Murray, Sr. ---- ------- ------ ----------- For 286,536,272 285,341,409 289,043,360 288,934,684 Withheld 16,800,538 17,995,401 14,293,450 14,402,126
At the annual meeting, the shareholders also defeated an advisory proposal advocating the elimination of the classification of the Board of Directors (there were 85,716,319 shares voted for the proposal, 130,095,934 shares voted against the proposal, 3,452,508 abstentions and 58,769,995 broker non-votes). 53 CONSECO, INC. AND SUBSIDIARIES -------------------- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. a) Exhibits. 10.45 Warrant to Purchase Common Stock of Conseco Finance Corp., dated May 11, 2000, by and between Conseco Finance Corp. and Lehman Brothers Holdings Inc. 10.46 Agreement, dated May 11, 2000, by and among Conseco, Inc., CIHC, Incorporated and Lehman Brothers Holdings Inc. 12.1 Computation of Ratio of Earnings to Fixed Charges, Preferred Dividends and Distributions on Company- obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts 27.0 Financial Data Schedule b) Reports on Form 8-K - None. 54 CONSECO, INC. AND SUBSIDIARIES -------------------- SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CONSECO, INC. Dated: August 14, 2000 By: /S/ JAMES S. ADAMS --------------------- James S. Adams Senior Vice President and Chief Accounting Officer (authorized officer and chief accounting officer) 55