-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JvPH7UTDrWtVxLzZR8Xyazf0Qd//e4FHNZsIWqHeYkCoplywJxQAjWzwo3pk88kX VK/z5pA6YcxT89JskvubNQ== 0000719241-98-000005.txt : 19980331 0000719241-98-000005.hdr.sgml : 19980331 ACCESSION NUMBER: 0000719241-98-000005 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: CONSECO INC CENTRAL INDEX KEY: 0000719241 STANDARD INDUSTRIAL CLASSIFICATION: ACCIDENT & HEALTH INSURANCE [6321] IRS NUMBER: 351468632 STATE OF INCORPORATION: IN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-09250 FILM NUMBER: 98578920 BUSINESS ADDRESS: STREET 1: 11825 N PENNSYLVANIA ST CITY: CARMEL STATE: IN ZIP: 46032 BUSINESS PHONE: 3175736100 MAIL ADDRESS: STREET 1: 11825 N PENNSYLVANIA ST CITY: CARMEL STATE: IN ZIP: 46032 FORMER COMPANY: FORMER CONFORMED NAME: SECURITY NATIONAL OF INDIANA CORP DATE OF NAME CHANGE: 19840207 10-K 1 1997 FORM 10-K OF CONSECO, INC. UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K [X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 1997 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 [No Fee Required] 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 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered ------------------- ------------------- Common Stock, No Par Value New York Stock Exchange, Inc. 8-1/8% Senior Notes due 2003 New York Stock Exchange, Inc. 10-1/2% Senior Notes due 2004 New York Stock Exchange, Inc. 7% PRIDES Convertible Preferred Stock New York Stock Exchange, Inc. 9.16% Trust Originated Preferred Securities New York Stock Exchange, Inc. 7% FELINE PRIDES Stock Purchase Contracts New York Stock Exchange, Inc. Securities registered pursuant to Section 12(g) of the Act: Common Stock, No Par Value Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days: Yes [ x ] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Aggregate market value of common stock held by nonaffiliates (computed as of March 13, 1998): $9,615,452,117 Shares of common stock outstanding as of March 13, 1998: 185,805,838 DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Registrant's definitive proxy statement for the annual meeting of shareholders to be held May 14, 1998 are incorporated by reference into Part III of this Report. - -------------------------------------------------------------------------------- PART I ITEM 1. BUSINESS OF CONSECO. Conseco, Inc. is a financial services holding company. Conseco develops, markets and administers supplemental health insurance, annuity, life insurance, individual and group major medical insurance and other insurance products. As used in this report, the terms "We," "Conseco" or the "Company" refer to Conseco, Inc. and its consolidated subsidiaries, unless the context requires otherwise. Since 1982, Conseco has acquired 19 insurance groups. See "Insurance Subsidiaries and Recent Acquisitions" for a description of our insurance subsidiaries and recent acquisitions. Our operating strategy is to grow the insurance business within our subsidiaries by focusing our resources on the development and expansion of profitable products and strong distribution channels. We have supplemented such growth by acquiring companies that have profitable niche products and strong distribution systems. Once a company has been acquired, our operating strategy has been to consolidate and streamline management and administrative functions where appropriate, to realize superior investment returns through active asset management, to eliminate unprofitable products and distribution channels, and to expand and develop the profitable distribution channels and products. Conseco was organized in 1979 as an Indiana corporation and commenced operations in 1982. Our executive offices are located at 11825 N. Pennsylvania Street, Carmel, Indiana 46032, and our telephone number is (317) 817-6100. MARKETING AND DISTRIBUTION Conseco seeks to retain the loyalty of its agency force by providing marketing and sales support; electronic and automated access to account and commission information; and marketing and training tools. We also have introduced new products like equity-indexed annuities (1996), indexed universal life (1997) and multi-year-guarantee annuities (1998). We are also looking for ways to lighten our agents' administrative burden, increase their productive sales time and get them the information they need faster and more reliably. In 1997, we introduced the Conseco Online Information System ("COINS"), which enables agents to track policy and commission information and order materials at their convenience. Many of our marketing companies and agents are already using COINS; we expect it to be available to all agents by 1999. In 1997, Conseco launched a comprehensive effort to transform its name into a recognized brand. We believe that in a competitive marketplace like financial services, companies that can differentiate themselves through a familiar brand can obtain full value for their products; sell more efficiently and command greater customer loyalty; recruit and retain talent more easily; better withstand and weather inevitable business crises; and have better access to the financial markets and the capital they need in order to grow. In 1998, our advertising campaign is designed to introduce consumers to the Conseco brand, to our product line and to the benefits of doing business with Conseco. Our insurance subsidiaries are collectively licensed to market our insurance products in all fifty states, the District of Columbia, and certain protectorates of the United States. Sales to residents of the following states accounted for at least 5 percent of our 1997 collected premiums: Florida (9.4 percent), Illinois (9.0 percent), California (8.4 percent) , Texas (8.1 percent) and Michigan (5.0 percent). We believe that people purchase most types of life insurance, accident and health insurance and annuity products only after being contacted and solicited by an insurance agent. Accordingly, the success of our distribution system is largely dependent on our ability to attract and retain agents who are experienced and highly motivated. In order to encourage agents to place a high volume of life, accident and health and annuity business with our subsidiaries, we offer commission rate bonuses and compensation awards which increase with the volume of new business written. We formed a subsidiary to focus on the coordination of the marketing, distribution and cross marketing activities of our products. A description of our primary distribution channels follows: Career Agents. This agency force of approximately 4,100 agents working from 185 branch offices, permits one-on-one contacts with potential policyholders and promotes strong personal relationships with existing policyholders. The career agents sell primarily Medicare supplement and long-term care insurance policies. This distribution channel also includes group major medical business marketed through a small field force of representatives. Since December 1, 1997, this segment includes the career agents of WNIC who sell specialty health insurance products for educators. In 1997, this distribution channel accounted for $1,593.2 million, or 32 percent, of our total collected premiums. Most of these agents sell only Conseco policies and typically visit the prospective policyholder's home to conduct personalized "kitchen-table" sales presentations. After the sale of an insurance policy, the agent serves as a contact person for policyholder questions, claims assistance and additional insurance needs. The personalized marketing and service efforts of the career field agents, supported by home office persistency programs, have contributed to a persistency rate of approximately 83 percent on Medicare supplement policies sold through this channel. 2 Professional Independent Producers. This distribution channel consists of a general agency and insurance brokerage distribution system comprised of approximately 190,000 independent licensed agents doing business in all fifty states. In 1997, this channel accounted for $3,433.7 million, or 68 percent, of our total collected premiums. Professional independent producers are a diverse network of independent agents, insurance brokers and marketing organizations. Marketing companies typically recruit agents for Conseco by advertising our products and commission structure through direct mail advertising or through seminars for insurance agents and brokers. These organizations bear most of the costs incurred in marketing our products. We compensate the marketing organizations by paying them a percentage of the commissions earned on new sales generated by the agents recruited by such organizations. Certain of these marketing organizations are specialty organizations that have a marketing expertise or a distribution system relating to a particular product, such as flexible-premium annuities for educators. A portion of our business is distributed through a "Client Company" marketing system, whereby agents and other insurance companies have entered into agreements to market Conseco's products through their professional independent producer distribution systems. Under the agreements, such groups assume up to 50 percent of the business each writes (through agent owned reinsurance companies or existing life insurance companies). We retain assets equal to the reserves of each Client Company and provide substantially all administrative services for a fee. Of the premiums collected by professional independent producers in 1997, 3.2 percent were collected by groups participating in the Client Company program. Direct marketing. This distribution channel was added on September 30, 1997 with the acquisition of Colonial Penn Life Insurance Company ("Colonial Penn"), which is engaged primarily in the sale of "graded benefit life" insurance policies through direct marketing. We intend to market other Conseco products through this distribution channel. In 1997, this channel accounted for $28.8 million, or less than 1 percent, of our total collected premiums. OPERATING SEGMENTS We conduct and manage our business through five segments, reflecting our major lines of insurance business and target markets: (i) supplemental health insurance; (ii) annuities; (iii) life insurance; (iv) individual and group major medical insurance; and (v) other. Supplemental Health This segment includes Medicare supplement, long-term care and specified-disease insurance. For periods prior to January 1, 1997, this segment consists solely of the Medicare supplement and long-term care products distributed through a career agency force. For periods after January 1, 1997, this segment includes the specified-disease products of the former subsidiaries of Transport Holdings Inc. ("THI") and Capitol American Financial Corporation ("CAF") and the long-term care products of the former subsidiaries of ATC which are distributed through professional independent producers. For periods after April 1, 1997, this segment also includes various supplemental health products of Pioneer Financial Services, Inc. ("PFS") which are distributed through professional independent producers. During 1997, we collected Medicare supplement premiums of $796.4 million and long-term care premiums of $663.9 million, up 29 percent and 244 percent, respectively, over 1996. We collected specified-disease premiums of $383.4 million in 1997. The following describes the major products of this segment: Medicare supplement. Medicare supplement products accounted for $796.4 million, or 16 percent, of our total collected premiums in 1997. Medicare is a two-part federal health insurance program for disabled persons and senior citizens (age 65 and older). Part A of the program provides protection against the costs of hospitalization and related hospital and skilled nursing home care, subject to an initial deductible, related coinsurance amounts and specified maximum benefit levels. The deductible and coinsurance amounts are subject to change each year by the federal government. Part B of Medicare covers doctors bills and a number of other medical costs not covered by Part A, subject to deductible and coinsurance amounts for "approved" charges. Medicare supplement policies provide coverage for many of the medical expenses which the Medicare program does not cover, such as deductibles, coinsurance costs (in which the insured and Medicare share the costs of medical expenses) and specified losses which exceed the federal program's maximum benefits. Our Medicare supplement plans automatically adjust coverage to reflect changes in Medicare benefits. In marketing these products, we concentrate on individuals who have recently become eligible for Medicare by reaching the age of 65. We offer a higher first-year commission for sales to these policyholders and competitive premium pricing. Approximately one-half of new sales of Medicare supplement policies are to individuals who are 65 years old. 3 Long-term care. Long-term care products accounted for $663.9 million, or 13 percent, of our total collected premiums in 1997. Long-term care products provide coverage, within prescribed limits, for nursing home, home healthcare, or a combination of both nursing home and home health care expenses. The long-term care plans are sold primarily to retirees, and to a lesser degree, to older self-employed individuals and others in middle-income levels. Current nursing home care policies cover incurred and daily fixed-dollar benefits available with an elimination period (which, similar to a deductible, requires the insured to pay for a certain number of days of nursing home care before the insurance coverage begins), subject to a maximum benefit. Home healthcare policies cover the usual and customary charges after a deductible and are subject to a daily or weekly maximum dollar amount, and an overall benefit maximum. We monitor the loss experience on our long-term care products and, when necessary, apply for rate increases in the states in which we sell such products. Specified-disease products. Beginning in 1997, the supplemental health segment includes specified-disease products such as cancer and heart/stroke insurance. Specified-disease products accounted for $383.4 million, or 7.6 percent, of our total collected premiums in 1997. These policies generally provide fixed or limited benefits. Cancer insurance and heart/stroke products are guaranteed renewable individual accident and health insurance policies. Payments under cancer insurance policies are generally made directly to, or at the direction of, the policyholder following diagnosis of, or treatment for, a covered type of cancer. Heart/stroke policies provide for payments directly to the policyholder for treatment of a covered heart disease, heart attack or stroke. The benefits provided under the specified-disease policies do not necessarily reflect the actual cost incurred by the insured as a result of the illness; benefits are not reduced by any other medical insurance payments made to or on behalf of the insured. Approximately 65 percent of our specified-disease policies in force (based on a count of policies) are sold with return of premium or cash value riders. The return of premium rider generally provides that after a policy has been in force for a specified number of years or upon the policyholder reaching a specified age, the Company will pay to the policyholder, or a beneficiary under the policy, the aggregate amount of all premiums paid under the policy, without interest, less the aggregate amount of all claims incurred under the policy. Annuities This segment includes traditional fixed rate annuity products, market value-adjusted annuity products, equity-indexed annuity products, and variable annuity products sold through both career agents and professional independent producers. During 1997, this segment collected total premiums of $1,689.6 million, up 1.2 percent from 1996. The following describes the major products of this segment: Traditional fixed rate annuity products. These products include single-premium deferred annuities ("SPDAs"), flexible-premium deferred annuities ("FPDAs") and single-premium immediate annuities ("SPIAs"). SPDAs (excluding the equity-indexed and market value-adjusted products described below) accounted for $366.8 million, or 7.3 percent, of our total collected premiums in 1997. An SPDA is a savings vehicle in which the policyholder, or annuitant, makes a single-premium payment to the insurance company; the insurer guarantees the principal and accrues a stated rate of interest. After a number of years, as specified in the annuity contract, the annuitant may elect to take the proceeds of the annuity either in a single payment or in a series of payments for life, for a fixed number of years, or for a combination thereof. Our SPDAs typically have an interest rate (the "crediting rate") that is guaranteed by the Company for the first policy year, after which, we have the discretionary ability to change the crediting rate to any rate not below a guaranteed minimum rate. The guaranteed rate recently written on annuities is 3.0 percent, and the rate on all policies in force ranges from 3.0 percent to 5.5 percent. The initial crediting rate is largely a function of: (i) the interest rate we can earn on invested assets acquired with the new annuity fund deposits; and (ii) the rates offered on similar products by our competitors. For subsequent adjustments to crediting rates, we take into account the yield on our investment portfolio, annuity surrender assumptions, competitive industry pricing and the crediting rate history for particular groups of annuity policies with similar characteristics. Approximately 80 percent of our new annuity sales have been "bonus" products. The initial crediting rate on these products specifies a bonus crediting rate ranging from 1 percent to 8 percent of the annuity deposit for the first policy year only. After the first year, the bonus interest portion of the initial crediting rate is automatically discontinued, and the renewal crediting rate is established. Commissions to agents are generally reduced by an amount comparable to the bonus interest to partially compensate the Company for the higher initial crediting rate on these products. As of December 31, 1997, crediting rates on our outstanding SPDAs generally ranged from 4.0 percent to 5.5 percent, excluding bonuses guaranteed for the first year of the annuity contract. The average crediting rate including interest bonuses was 5.0 percent, and the average rate excluding bonuses was 4.8 percent. The policyholder is typically permitted to withdraw all or part of the premium paid plus the accumulated interest credited to his account (the "accumulation value"), subject in virtually all cases to the assessment of a surrender charge for withdrawals in excess of specified limits. Most of our SPDAs provide for penalty-free withdrawals of up to 10 percent of the accumulation value each year, 4 subject to limitations. Withdrawals in excess of allowable penalty-free amounts are assessed a surrender charge during a penalty period which generally ranges from five to 12 years after the date a policy is issued. The surrender charge is initially 6 percent to 12 percent of the accumulation value and generally decreases by approximately 1 to 2 percentage points per year during the penalty period. Surrender charges are set at levels to protect the Company from loss on early terminations and to reduce the likelihood of policyholders terminating their policies during periods of increasing interest rates. This practice lengthens the effective duration of policy liabilities and enables the Company to maintain profitability on such policies. FPDAs (excluding the equity-indexed and market value-adjusted products described below) accounted for $362.3 million, or 7.2 percent, of our total collected premiums in 1997. FPDAs are similar to SPDAs in many respects, except that FPDAs allow more than one premium payment. Our FPDAs have a crediting rate that is guaranteed by the Company for the first year. After the first year, the crediting rate may be changed at least annually, subject to a minimum annual guaranteed rate. The policyholder is permitted to withdraw all or part of the accumulation value, less a surrender charge for withdrawals during an initial penalty period of up to 15 years. The initial surrender charges range from 5 percent to 22 percent of the first-year premium and decline over the penalty period. Interest rates credited on our outstanding FPDAs at December 31, 1997, generally ranged from 4.5 percent to 5.5 percent, excluding bonuses guaranteed for the first year of the annuity contract. The average crediting rate including interest bonuses was 5.0 percent, and the average rate excluding bonuses was 4.8 percent. SPIAs accounted for $208.1 million, or 4.1 percent, of our total collected premiums in 1997. SPIAs are designed to provide a series of periodic payments for a fixed period of time or for life, according to the policyholder's choice at the time of issue. Once the payments begin, the amount, frequency and length of time for which they are payable are fixed. SPIAs often are purchased by persons at or near retirement age who desire a steady stream of payments over a future period of years. The single premium is often the payout from a terminated annuity contract. The implicit interest rate on SPIAs is based on market conditions when the policy is issued. The implicit interest rate on the Company's outstanding SPIAs at December 31, 1997, averaged 6.0 percent. Market value-adjusted annuity products. In September 1995, we began offering a deferred annuity product with a "market value adjustment" feature. This feature is designed to provide the Company with additional protection from early terminations during a period of rising interest rates by reducing the surrender value payable upon a full or partial surrender of the policy in excess of the allowable penalty-free withdrawal amount. Conversely, during a period of declining interest rates, the feature would increase the surrender value payable to the policyholder. In 1997, we collected premiums of $41.4 million from SPDAs with this feature. We also offer FPDAs with a "market value adjustment" feature. In 1997, we collected premiums of $138.1 million from sales of FPDAs with this feature. Equity-indexed annuity products. In response to consumers' desire for alternative investment products with returns linked to those of common stocks, we introduced an equity-indexed SPDA product in June 1996 and an equity-indexed FPDA product in January 1997. These products accounted for $387.7 million, or 7.7 percent, of our total premiums collected in 1997. The annuity's contract value is equal to the premium paid increased for returns based upon a percentage (the "participation rate") of the change in the S&P 500 Index during each year of its term, subject to a minimum guaranteed value. The Company has the discretionary ability to annually change the participation rate (which currently ranges from 70 percent to 75 percent plus a first-year "bonus", similar to the bonus previously described, of 25 percent), generally subject to a minimum of 50 percent. The minimum guaranteed values are equal to: (i) 90 percent of premiums collected for SPDAs (75 percent of first year and 87.5 percent of renewal premiums collected for FPDAs); plus (ii) interest credited at an annual rate of 3 percent. The annuity provides for penalty-free withdrawals of up to 10 percent of premium in each year after the first year of the annuity's term. Other withdrawals from SPDA products are subject to a surrender charge of 9 percent over the eight year contract term at which time the contract must be renewed or withdrawn. Other withdrawals from FPDA products are subject to a surrender charge of 12 percent to 20 percent in the first year, declining 1.2 percent to 1.3 percent each year, to zero over a 10 to 15 year period, depending on issue age. We purchase Standard & Poor's 500 Index Call Options (the "S&P 500 Call Options") to hedge potential increases to policyholder benefits resulting from increases in the S&P 500 Index to which the product's return is linked. Variable annuity products. Variable annuities accounted for $185.2 million, or 3.7 percent, of our total premiums collected in 1997. Variable annuities, sold on a single-premium or flexible-premium basis, differ from fixed annuities in that the original principal value may fluctuate, depending on the performance of assets allocated pursuant to various investment options chosen by the contract owner. Variable annuities offer contract owners a fixed or variable rate of return based upon the specific investment portfolios into which premiums may be directed. Life This segment includes traditional, universal life and other life insurance products. Beginning with the third quarter of 1996, the largest single component of this segment is the universal life business of Life Partners Group, Inc. ("LPG"). This segment's 5 products are currently sold through career agents, professional independent producers and direct response marketing. During 1997, this segment collected total premiums of $709.0 million, up 76 percent, over premiums collected during 1996. Interest-sensitive life products. These products include universal life products that provide whole life insurance with adjustable rates of return related to current interest rates. They accounted for $450.9 million, or 8.9 percent, of our total collected premiums in 1997 and are marketed through professional independent producers and to a lesser extent, career agents. The principal differences between universal life products and other interest-sensitive life insurance products are policy provisions affecting the amount and timing of premium payments. Universal life policyholders may vary the frequency and size of their premium payments, and policy benefits may also fluctuate according to such payments. Premium payments under other interest-sensitive policies may not be varied by the policyholders, and as a result, are designed to reduce the administrative costs typically associated with monitoring universal life premium payments and policy benefits. Traditional life. These products accounted for $258.1 million, or 5.1 percent, of our total collected premiums in 1997. Traditional life policies, including whole life, graded benefit life and term life products, are marketed through professional independent producers, career agents and direct response marketing. Under whole life policies, the policyholder generally pays a level premium over the policyholder's expected lifetime. The annual premium in a whole life policy is generally higher than the premium for comparable term insurance coverage in the early years of the policy's life, but is generally lower than the premium for comparable term insurance coverage in the later years of the policy's life. These policies, which continue to be marketed by the Company on a limited basis, combine insurance protection with a savings component that increases in amount gradually over the life of the policy. The policyholder may borrow against the savings generally at a rate of interest lower than that available from other lending sources. The policyholder may also choose to surrender the policy and receive the accumulated cash value rather than continuing the insurance protection. Term life products offer pure insurance protection for a specified period of time -- typically 5, 10 or 20 years. Beginning October 1, 1997, the life insurance segment includes the graded benefit life insurance products of Colonial Penn. Graded benefit life products accounted for $28.8 million or .6 percent of our total collected premiums in 1997. Graded benefit life insurance products are offered on an individual basis primarily to persons age 50 to 80, principally in face amounts of $350 to $10,000, without medical examination or evidence of insurability. Premiums are paid as frequently as monthly. Benefits paid are less than the face amount of the policy during the first two years, except in cases of accidental death. Graded benefit life policies are marketed using direct response marketing techniques. New policyholder leads are generated primarily from television and print advertisements. Individual and Group Major Medical Insurance This segment includes individual and group major medical health insurance products. The size of this segment increased significantly as a result of the acquisition of PFS. This segment underwrites and markets group and individual comprehensive major medical products targeted primarily to self-employed individuals, small business owners and early retirees. Several deductible and coinsurance options are available, and most policies require certain utilization review procedures. The profitability of this business depends largely on the overall persistency of the business in force, claim experience and expense management. During 1997, this segment collected total premiums of $744.2 million, up 118 percent over premiums collected during 1996. Insurance premium rates on these products may be adjusted subject to applicable regulation by class, policy form and state in which the policy is issued. We monitor the loss experience on these products, and when necessary, apply for rate increases in the states in which we sell such products. Other This segment includes various other health insurance products. The profitability of this business depends largely on the overall persistency of the business in force, claim experience and expense management. During 1997, this segment collected total premium of $69.2 million, up 27 percent over premiums collected during 1996. After December 1, 1997, the other segment includes the specialty health insurance products for educators sold by a subsidiary of WNIC. These products are sold by career agents and accounted for $9.1 million of Conseco's collected premiums since the acquisition of WNIC. This segment also includes fee revenue generated by Conseco's nonlife subsidiaries, including the investment advisory fees earned by Conseco Capital Management, Inc. ("CCM") and commissions earned for insurance product marketing and distribution. Fee revenues and commissions from Conseco's consolidated subsidiaries are excluded from segment results. CCM had approximately $5.1 billion of assets (at fair value) under management at December 31, 1997, for unaffiliated parties. Total fees earned from nonaffiliates during 1997 were $65.8 million, up 32 percent over 1996. 6 INSURANCE SUBSIDIARIES AND RECENT ACQUISITIONS Conseco owned the following life insurance companies at December 31, 1997: - Bankers Life and Casualty Company ("Bankers Life"), Bankers Life Insurance Company of Illinois and Certified Life Insurance Company, formerly subsidiaries of Bankers Life Holding Corporation ("BLH"); - Great American Reserve Insurance Company ("Great American Reserve"), Beneficial Standard Life Insurance Company ("Beneficial Standard") and Jefferson National Life Insurance Company of Texas ("Jefferson-Texas"), in which Conseco has had an ownership interest since 1990 and which became wholly owned subsidiaries in August 1995; - the subsidiaries of American Life Holdings, Inc. ("ALH", formerly The Statesman Group, Inc.), including American Life and Casualty Insurance Company and Vulcan Life Insurance Company; - the subsidiaries of LPG, including Philadelphia Life Insurance Company, Conseco Life Insurance Company (formerly Massachusetts General Life Insurance Company prior to its name change in 1997), Lamar Life Insurance Company and Wabash Life Insurance Company; - the former subsidiaries of ATC, including American Travellers Life Insurance Company ("American Travellers"), United General Life Insurance Company and Conseco Life Insurance Company of New York (formerly American Travellers Insurance Company of New York prior to its name change in 1997); - the former subsidiaries of THI, including TLIC Life Insurance Company (which was merged into Jefferson-Texas in 1997), Transport Life Insurance Company (which was merged into American Travellers in 1997), and Continental Life Insurance Company; - the former subsidiaries of CAF, including Capitol American Life Insurance Company, Capitol National Life Insurance Company and Frontier National Life Insurance Company; - the subsidiaries of PFS, including Continental Life and Accident Insurance Company, Connecticut National Life Insurance Company, Health and Life Insurance Company of America, Manhattan National Life Insurance Company, Pioneer Life Insurance Company and National Group Life Insurance Company; - certain former subsidiaries of Leucadia National Corporation ("Leucadia"), including Colonial Penn and Providential Life Insurance Company; - the subsidiaries of Washington National Corporation ("WNIC"), including Washington National Insurance Company and United Presidential Life Insurance Company; and - Bankers National Life Insurance Company, National Fidelity Life Insurance Company and Lincoln American Life Insurance Company. Since 1982, Conseco has acquired 19 insurance groups and related businesses. We continue to regularly investigate acquisition opportunities in the insurance industry and other industries in which we operate. We evaluate potential acquisitions based on a variety of factors, including the operating results and financial condition of the business to be acquired, its growth potential, management and personnel and the potential return on such acquisition in relation to other acquisition opportunities and the internal development of our existing business operations. No assurances can be given as to when, if at all, or upon what terms Conseco will make any such acquisition. Our first acquisition partnership, Conseco Capital Partners, L.P. ("Partnership I"), was dissolved in 1993 after distributing to its partners the securities of the companies it had acquired. Conseco Capital Partners II, L.P. ("Partnership II"), our second acquisition partnership, was liquidated in 1996 after Conseco purchased from the other partners all of the common shares of ALH not already owned by Conseco. We terminated its partnership activity in 1996 because changes in the regulatory and rating agency environment made it difficult to structure leveraged acquisitions of life insurance companies. On August 31, 1995, we purchased (the "CCP Merger") all of the shares of common stock of CCP Insurance, Inc. ("CCP") not previously owned (representing 51 percent of CCP's outstanding shares). In the transaction, CCP was merged into Conseco, with Conseco being the surviving corporation. As a result of the CCP Merger, CCP's subsidiaries, Great American Reserve and Beneficial 7 Standard, became wholly owned subsidiaries of Conseco. The accounts of CCP's subsidiaries are consolidated with Conseco's accounts effective January 1, 1995. On August 2, 1996, we acquired LPG (the "LPG Merger"). LPG became a wholly owned subsidiary of Conseco. In the LPG Merger, we issued a total of 32.6 million shares of Conseco common stock (or common stock equivalents) with a value of $586.8 million. We also assumed $253.1 million of notes payable of LPG. LPG's subsidiaries sell a diverse portfolio of universal life insurance and, to a lesser extent, annuity products to individuals. On September 30, 1996, we acquired the remaining 62 percent of the common shares of ALH (the "ALH Stock Purchase") not already owned by Conseco or its affiliates for approximately $166 million in cash. ALH is a provider of retirement savings annuities. ALH has been included in our consolidated financial statements since ALH's acquisition by Partnership II in September 1994. On December 17, 1996, we acquired ATC (the "ATC Merger"). ATC was merged with and into Conseco, with Conseco being the surviving corporation. In the ATC Merger, we issued a total of 21.0 million shares of Conseco common stock (or common stock equivalents) with a value of $630.9 million. In addition, we assumed $102.8 million of ATC's convertible subordinated debentures, which became convertible into 7.9 million shares of Conseco common stock with a value of $248.3 million. ATC is a leading marketer and underwriter of long-term care insurance. ATC also markets and underwrites other supplemental accident and health insurance policies, as well as life insurance. On December 23, 1996, we acquired THI (the "THI Merger"). THI was merged with and into Conseco, with Conseco being the surviving corporation. In the THI Merger, we issued a total of 4.9 million shares of Conseco common stock (or common stock equivalents) with a value of $121.7 million. In addition, pursuant to an exchange offer, all of THI's subordinated convertible notes were exchanged for 4.2 million shares of Conseco common stock with a value of $106.2 million, plus a cash premium of $11.9 million. THI is principally engaged in the underwriting and distribution of supplemental health insurance. On December 31, 1996, we acquired the 9.6 percent of the common shares of BLH (the "BLH Merger") not already owned by Conseco or its affiliates. BLH was merged into a wholly owned subsidiary of Conseco. In the BLH Merger, we issued a total of 3.9 million shares of Conseco common stock (or common stock equivalents) with a value of $123.0 million. BLH is one of the nation's largest writers of individual health insurance products, based on collected premiums. BLH also markets a variety of annuity, life and group insurance products. BLH has been included in our consolidated financial statements since November 1992, when BLH was acquired by Partnership I. On March 4, 1997, we acquired CAF (the "CAF Merger"). CAF became a wholly owned subsidiary of Conseco. In the CAF Merger, we paid $552.8 million in cash and issued 3.0 million shares of Conseco common stock (or common stock equivalents) with a value of $117.4 million. In addition, we assumed a $31.0 million note payable of CAF, which was repaid on the merger date. CAF, through its insurance subsidiaries, underwrites, markets and distributes individual and group supplemental health and accident insurance. On May 30, 1997, we acquired PFS (the "PFS Merger"). PFS became a wholly owned subsidiary of Conseco. In the PFS Merger, we issued 9.0 million shares of Conseco common stock (or common stock equivalents) with a value of $354.1 million. In addition, we assumed PFS's convertible subordinated notes, which became convertible into 3.1 million shares of Conseco common stock, with a value of $130.6 million. We also assumed a $21.3 million note payable of PFS, which was repaid on the merger date. PFS, through its insurance subsidiaries, underwrites, markets and distributes life insurance, annuities and health insurance in selected niche markets throughout the United States. On September 30, 1997, we acquired Colonial Penn (the "Colonial Penn Purchase") and certain other assets (collectively referred to as "Colonial Penn") from Leucadia. Colonial Penn became a wholly owned subsidiary of Conseco. In the Colonial Penn Purchase, we paid $60.0 million in cash and issued $400.0 million of notes payable to Leucadia. Colonial Penn is principally engaged in the underwriting and sale of "graded benefit life" insurance policies through direct marketing and Medicare supplement insurance through independent agents. On December 5, 1997, we acquired WNIC (the "WNIC Merger"). WNIC became a wholly owned subsidiary of Conseco. In the WNIC Merger, we paid $400.6 million in cash, of which $73.7 million was funded through a dividend to Conseco from WNIC. WNIC is principally engaged in marketing and underwriting life insurance and annuities for individuals and specialty health insurance for educators. 8 ADMINISTRATION We minimize operating expenses by centralizing, standardizing and more efficiently performing many functions common to most life insurance companies. These functions include underwriting and policy administration, accounting and financial reporting, marketing, regulatory compliance, actuarial services and asset management. The administration of our individual and group health insurance products involves higher volumes of claims, contacts with policyholders and operational costs, compared to the administration of life insurance or annuity policies. We have developed an efficient and highly automated policyholder administration operation to minimize the costs of such large volume processing and deliver a high level of service to our policyholders, with special emphasis on the prompt payment of claims. In many cases, we mail a check within a week of receiving a claim from a policyholder. INVESTMENTS CCM, a registered investment adviser wholly owned by Conseco, manages the investment portfolios of Conseco's subsidiaries. CCM had approximately $32.1 billion of assets (at fair value) under management at December 31, 1997, of which $27.0 billion were assets of Conseco's subsidiaries and $5.1 billion were assets of unaffiliated parties. CCM's investment philosophy is to maintain a largely investment-grade fixed-income portfolio, provide adequate liquidity for expected liability durations and other requirements and maximize total return through active investment management. Investment activities are an integral part of our business; investment income is a significant component of our total revenues. Profitability of many of our products is significantly affected by spreads between interest yields on investments and rates credited on insurance liabilities. Although substantially all credited rates on SPDAs and FPDAs may be changed annually, changes in crediting rates may not be sufficient to maintain targeted investment spreads in all economic and market environments. In addition, competition and other factors, including the impact of the level of surrenders and withdrawals, may limit our ability to adjust or to maintain crediting rates at levels necessary to avoid narrowing of spreads under certain market conditions. As of December 31, 1997, the average yield, computed on the cost basis of our investment portfolio, was 7.5 percent, and the average interest rate credited or accruing to our total insurance liabilities, excluding interest bonuses guaranteed for the first year of the annuity contract only, was 5.2 percent. We seek to balance the duration of our invested assets with the expected duration of benefit payments arising from our insurance liabilities. At December 31, 1997, the adjusted modified duration of fixed maturities and short-term investments was approximately 5.8 years and the duration of our insurance liabilities was approximately 6.7 years. For information regarding the composition and diversification of the investment portfolio of our subsidiaries, see "Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations - Investments" and note 3 to the consolidated financial statements. COMPETITION Our businesses operate in a highly competitive environment. The financial services industry consists of a large number of companies, some of which are larger and have greater financial resources, broader and more diversified product lines and larger staffs than those of Conseco. An expanding number of banks, securities brokerage firms and other financial intermediaries also market insurance products or offer competing products, such as mutual fund products, traditional bank investments and other investment and retirement funding alternatives. We also compete with many of these companies and others in providing services for fees. In most areas, competition is based on a number of factors, including pricing, service provided to distributors and policyholders, and ratings. Conseco's subsidiaries must also compete with other insurers to attract and retain the allegiance of agents. 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. Substantially all of our primary life insurance companies have received: (i) an "A" (Excellent) insurance company rating by A.M. Best Company ("A.M. Best"); (ii) an "AA-" claims-paying ability rating from Duff & Phelps' Credit Rating Company ("Duff & Phelps"); and (iii) an "A+" claims-paying ability rating from Standard & Poor's Corporation ("Standard & Poor's"). A.M. Best insurance company ratings for the industry currently range from "A++ (Superior)" to "F (In Liquidation)". Publications of A.M. Best indicate that the "A" and "A-" ratings are assigned to those companies that, in A.M. Best's opinion, have demonstrated excellent overall performance when compared to the standards established by A.M. Best and have demonstrated a strong 9 ability to meet their obligations to policyholders over a long period of time. A.M. Best's rating procedure includes quantitative and qualitative evaluations of a company's financial condition and operating performance. Its quantitative evaluation is based on an analysis of a company's financial performance in the areas of profitability, leverage/capitalization and liquidity. A.M. Best's review also includes a qualitative evaluation of a company's spread of risk, quality and appropriateness of reinsurance programs, quality and diversification of assets, adequacy of policy or loss reserves, management experience and objectives, market presence and policyholders' confidence. In recent years, A.M. Best upgraded the ratings of several of our subsidiaries to "A" (Excellent) from "A-" (Excellent). Among the reasons A.M. Best cited for the ratings upgrades and reaffirmations were the benefits Conseco will derive as a result of recent acquisitions including: (i) improved unit costs arising from the integration of administrative, financial, investment, marketing and underwriting functions; (ii) expanded distribution capacity and increased cross-selling opportunities; and (iii) a more diversified product portfolio that should generate more balanced and predictable revenue and earnings sources. A.M. Best also views favorably the continuing improvement in Conseco's financial leverage and our target ratio of debt to total capital of not more than 35 percent. Duff & Phelps' claims-paying ability ratings range from "AAA (Highest claims-paying ability)" to "DD (Company is under an order of liquidation)." An "AA-" rating represents "Very high claims-paying ability." A plus or minus sign attached to a Duff & Phelps claims paying rating shows relative standing within a ratings category. Standard & Poor's claims-paying ability ratings range from "AAA (Superior)" to "R (Regulatory Action)". An "A" is assigned by Standard & Poor's to those companies which, in its opinion, have a secure claims-paying ability and whose financial capacity to meet policyholder obligations is viewed on balance as sound, but their capacity to meet such policyholder obligations is somewhat more susceptible to adverse changes in economic or underwriting conditions than more highly rated insurers. According to Standard & Poor's, a plus or minus sign attached to a Standard & Poor's claims-paying rating shows relative standing within a ratings category. A "q" subscript indicates that the rating is based solely on quantitative analysis of publicly available financial data. Generally, rating agencies base their ratings upon information furnished to them by the insurer and upon their own investigations, studies and assumptions. A.M. Best's ratings, Duff & Phelps' claims-paying ratings and Standard & Poor's claims-paying ratings are principally based upon factors of concern to policyholders, agents and intermediaries and are not directed toward the protection of investors. Given the competitive nature of our business and the increasing focus placed on the aforementioned ratings, we manage our business with the objective of preserving existing ratings and, where possible, achieving more favorable ratings. There can be no assurance that any particular rating will continue for any given period of time, or that it will not be changed or withdrawn entirely if, in the judgement of the rating agency, circumstances so warrant. If our ratings were downgraded from their current levels, sales of our products and the persistency of our in-force policies could be adversely affected in a material way. In the individual health insurance business, insurance companies compete primarily on the basis of marketing, service and price. The provisions of the Omnibus Budget Reconciliation Act of 1984 and the work of the National Association of Insurance Commissioners ("NAIC") (an association of state regulators and their staffs) have resulted in standardized policy features for Medicare supplement products. This increases the comparability of such policies and may intensify competition based on factors other than product features. See "Underwriting" and "Governmental Regulation." In addition to the products of other insurance companies, our health insurance products compete with health maintenance organizations, preferred provider organizations and other health care- related institutions which provide medical benefits based on contractual agreements. We believe that we are able to compete effectively because: (i) we emphasize a number of specialized distribution channels, where the ability to respond rapidly to changing customer needs yields a competitive edge; (ii) we are experienced in establishing and cultivating relationships with the unique distribution networks and the independent marketing companies operating in these specialized markets; (iii) we can offer competitive rates as a result of our lower-than-average operating costs and higher-than-average investment yields achieved by applying active investment portfolio management techniques; and (iv) we have reliable policyholder administrative services, supported by customized information technology systems. UNDERWRITING Under regulations promulgated by the NAIC and adopted as a result of the Omnibus Budget Reconciliation Act of 1990, we are prohibited from underwriting our Medicare supplement policies for certain first-time purchasers. If a person applies for insurance within six months after becoming eligible by reason of age, or disability in certain limited circumstances, the application may not be rejected due to medical conditions. Some states prohibit underwriting of all Medicare supplement policies. For other prospective Medicare supplement policyholders, such as senior citizens who are transferring to Conseco's products, the underwriting procedures are relatively limited, except for policies providing prescription drug coverage. 10 Before issuing long-term care or comprehensive major medical products to individuals and groups, we generally apply detailed underwriting procedures designed to assess and quantify the insurance risks. We require medical examinations of applicants (including blood and urine tests, where permitted) for certain health insurance products and for life insurance products which exceed prescribed policy amounts. These requirements are graduated according to the applicant's age and may vary by type of policy or product. We also rely on medical records and the potential policyholder's written application. In recent years, there has been significant regulatory changes with respect to underwriting individual and group major medical plans. An increasing number of states prohibit underwriting and/or charging higher premiums for substandard risks. We monitor changes in state regulation that affect our products, and consider these regulatory developments in determining where we market our products. Most of our life insurance policies are underwritten individually, although standardized underwriting procedures have been adopted for certain low face-amount life insurance coverages. After initial processing, insurance underwriters review each file and obtain the information needed to make an underwriting decision (such as medical examinations, doctors' statements and special medical tests). After collecting and reviewing the information, the underwriter either: (i) approves the policy as applied for, or with an extra premium charge because of unfavorable factors; or (ii) rejects the application. We underwrite group insurance policies based on the characteristics of the group and its past claim experience. Graded benefit life insurance policies are issued without medical examination or evidence of insurability. There is minimal underwriting on annuities. REINSURANCE Consistent with the general practice of the life insurance industry, our subsidiaries enter into both facultative and treaty agreements of indemnity reinsurance with other insurance companies in order to reinsure portions of the coverage provided by our insurance products. Indemnity reinsurance agreements are intended to limit a life insurer's maximum loss on a large or unusually hazardous risk or to diversify its risk. Indemnity reinsurance does not discharge the original insurer's primary liability to the insured. The Company's reinsured business is ceded to numerous reinsurers. We believe the assuming companies are able to honor all contractual commitments, based on our periodic review of their financial statements, insurance industry reports and reports filed with state insurance departments. As of December 31, 1997, the policy risk retention limit was $.8 million or less on all of the policies of our subsidiaries. Reinsurance ceded by Conseco represented 27 percent of gross combined life insurance in force and reinsurance assumed represented 4.0 percent of net combined life insurance in force. At December 31,1997, the total ceded business in force of $36.7 billion included: (i) $5.3 billion ceded to Client Companies for which we retain assets equal to the reserves on the business ceded; and (ii) $25.8 billion ceded to insurance companies rated "A- (Excellent)" or better by A.M. Best. Our principal reinsurers at December 31, 1997 (which assume approximately 65 percent of the total ceded business in force, excluding business ceded to the Client Companies) were American Equity Investment Life Insurance Company, Cologne Life, Connecticut General Life Insurance Company, Employers Re, Life Reassurance Corporation of America, Lincoln National Life Insurance Company, RGA Reinsurance Company, Security Life of Denver and Swiss Re Life and Health America. No other single reinsurer assumes greater than 5 percent of the total ceded business in force. EMPLOYEES At December 31, 1997, Conseco had approximately 6,800 employees, including: (i) 3,000 home office employees; (ii) 1,400 employees in our Chicago office (primarily involved with our supplemental health operations); (iii) 1,900 employees in various locations serving as administrative centers for its insurance operations; and (iv) 500 employees in branch offices (primarily supporting our career agency force). None of our employees is covered by a collective bargaining agreement. We believe that we have excellent relations with our employees. GOVERNMENTAL REGULATION General Our insurance subsidiaries are subject to regulation and supervision by the states in which they transact business. State laws generally establish supervisory agencies with broad regulatory authority, including the power to: (i) grant and revoke business licenses; (ii) regulate and supervise trade practices and market conduct; (iii) establish guaranty associations; (iv) license agents; (v) approve policy forms; (vi) approve premium rates for some lines of business; (vii) establish reserve requirements; (viii) prescribe the form and content of required financial statements and reports; (ix) determine the reasonableness and adequacy of statutory capital and surplus; (x) perform financial, market conduct and other examinations; (xi) define acceptable accounting principles; (xii) regulate the type and amount of permitted investments; and (xiii) limit the amount of dividends and surplus debenture payments that can be paid without obtaining regulatory approval. Our insurance subsidiaries are subject to periodic examinations by state regulatory authorities. We do not expect the results of any ongoing examinations to have a material effect on the Company's financial condition. 11 Most states have also enacted regulations on the activities of insurance holding company systems, including acquisitions, extraordinary dividends, the terms of surplus debentures, the terms of affiliate transactions and other related matters. Currently, the Company and its insurance subsidiaries have registered as holding company systems pursuant to such legislation in the domiciliary states of the insurance subsidiaries (Alabama, Arizona, Arkansas, California, Illinois, Indiana, Kentucky, Mississippi, Missouri, New York, Ohio, Pennsylvania, Tennessee and Texas), and they routinely report to other jurisdictions. Recently, a number of state legislatures have considered or have enacted legislative proposals that alter, and in many cases increase, the authority of state agencies to regulate insurance companies and holding company systems. For further information on state laws regulating the payment of dividends by insurance company subsidiaries, see "Management's Discussion and Analysis of Consolidated Financial Position and Results of Operations - Consolidated Financial Condition" and note 12 to Conseco's consolidated financial statements. The federal government does not directly regulate the insurance business. However, federal legislation and administrative policies in several areas, including pension regulation, age and sex discrimination, financial services regulation, securities regulation and federal taxation, do affect the insurance business. In recent years, the Office of the Comptroller of the currency has issued a number of rulings which have expanded the ability of banks to sell certain insurance products. The United States House of Representatives is currently considering the Financial Services Act (H.R.10), which would (among other things) eliminate existing restrictions on affiliations between insurance companies, banks and securities firms. This proposed legislation in its current form would allow insurance companies and securities firms to directly own banks and each other while banks could own insurance companies and securities firms indirectly through a holding company. Other provisions of the act would define insurance products and retain jurisdiction over their regulation in the states. Such legislation, if enacted, could result in increased competition, as well as new opportunities, for the Company. In addition, legislation has been introduced from time to time in recent years which, if enacted, could result in the federal government assuming a more direct role in the regulation of the insurance industry. The Securities and Exchange Commission has requested comments as to whether equity-indexed annuities, such as those sold by the Company, should be treated as securities under the Federal securities laws rather than as insurance products. Treatment of these products as securities would likely require additional registration and licensing of these products and the agents selling them, as well as cause the Company to seek additional marketing relationships for these products. The Risk-Based Capital for Life and/or Health Insurers Model Act (the "Model Act") adopted by the NAIC provides a tool for insurance regulators to determine the levels of capital and surplus an insurer must maintain in relation to its insurance and investment risks and whether there is a need for possible regulatory attention. The Model Act (or similar legislation or regulation) has been adopted in states where our insurance subsidiaries are domiciled. The Model Act provides for four levels of regulatory attention, varying with the ratio of the company's total adjusted capital (defined as the total of its statutory capital, surplus, asset valuation reserve and certain other adjustments) to its risk-based capital ("RBC"). If a company's total adjusted capital is less than 100 percent but greater than or equal to 75 percent of its RBC, or if a negative trend (as defined by the regulators) has occurred and total adjusted capital is less than 125 percent of RBC (the "Company Action Level"), the company must submit a comprehensive plan to the regulatory authority proposing corrective actions aimed at improving its capital position. If a company's total adjusted capital is less than 75 percent but greater than or equal to 50 percent of its RBC (the "Regulatory Action Level") , the regulatory authority will perform a special examination of the company and issue an order specifying corrective actions that must be followed. If a company's total adjusted capital is less than 50 percent but greater than or equal to 35 percent of its RBC (the "Authorized Control Level"), the regulatory authority may take any action it deems necessary, including placing the company under regulatory control. If a company's total adjusted capital is less than 35 percent of its RBC (the "Mandatory Control Level") the regulatory authority must place the company under its control. At December 31, 1997, the average ratio of total adjusted capital to RBC for our insurance subsidiaries was greater than twice the levels at which regulatory attention is triggered. The Texas Insurance Department has adopted its own RBC requirements, the stated purpose of which is to require a minimum level of capital and surplus to absorb the financial, underwriting, and investment risks assumed by an insurer. Texas' RBC requirements differ from those adopted by the NAIC in two principal respects: (i) they use different elements to determine minimum RBC levels in their calculation formulas; and (ii) they do not stipulate "Action Levels" (like those described in the previous paragraph) where corrective actions are required. However, the Commissioner of the Texas Insurance Department does have the power to take similar corrective actions if a company does not maintain the required minimum level of capital and surplus. Under the Texas Regulations, an insurer also meets RBC requirements if its admitted assets exceed its liabilities by at least 6 percent. Five of our insurance subsidiaries are domiciled in Texas and all of them were in compliance with Texas RBC requirements at December 31, 1997. Most states have either enacted legislation or adopted administrative regulations which affect the acquisition of control of insurance companies as well as transactions between insurance companies and persons controlling them. The nature and extent of such legislation and regulations vary from state to state. Most states, however, require administrative approval of: (i) the acquisition 12 of 10 percent or more of the outstanding shares of an insurance company domiciled in the state; or (ii) the acquisition of 10 percent or more of the outstanding stock of an insurance holding company whose insurance subsidiary is domiciled in the state. The acquisition of 10 percent of such shares is generally deemed to be the acquisition of control for the purpose of the holding company statutes. These regulations require the acquirer to file detailed information concerning the acquiring parties and the plan of acquisition, and to obtain administrative approval prior to the acquisition. In many states, however, an insurance authority may determine that control does not exist, even in circumstances in which a person owns or controls 10 percent or a greater amount of securities. On the basis of statutory statements filed with state regulators annually, the NAIC calculates eleven financial ratios to assist state regulators in monitoring the financial condition of insurance companies. A "usual range" of results for each ratio is used as a benchmark. In the past, variances in certain ratios of our insurance subsidiaries have resulted in inquiries from insurance departments to which we have responded. Such inquiries did not lead to any restrictions affecting our operations. Under the solvency or guaranty laws of most states in which we do business, our insurance subsidiaries may be required to pay guaranty fund assessments (up to certain prescribed limits). Guaranty funds are established by various states to fund policyholder losses or the liabilities of insolvent or rehabilitated insurance companies. These assessments may be deferred or forgiven under most guaranty laws if they would threaten an insurer's financial strength. In certain instances, the assessments may be offset against future premium taxes. We establish a reserve to provide for assessments related to known insolvencies. This reserve is based upon our current expectation of the availability of the right of offset and state guaranty fund assessment bases. However, changes in the basis whereby assessments are charged to individual companies or changes to the availability of the right to offset assessments against premium tax payments could materially affect our results of operations. Our insurance subsidiaries' statutory financial statements for the year ended December 31, 1997, include $7.2 million of expenses as a result of such assessments. Health Care Most states mandate minimum benefit standards and loss ratios for accident and health insurance policies. We are generally required to maintain, with respect to our individual long-term care policies, minimum anticipated loss ratios over the entire period of coverage of not less than 60 percent. With respect to our Medicare supplement policies, we are generally required to attain and maintain an actual loss ratio, after three years, of not less than 65 percent. We provide, to the insurance departments of all states in which we conduct business, annual calculations that demonstrate compliance with required minimum loss ratios for both long-term care and Medicare supplement insurance. These calculations are prepared utilizing statutory lapse and interest rate assumptions. In the event we have failed to maintain minimum mandated loss ratios, our insurance subsidiaries could be required to provide retrospective refunds and/or prospective rate reductions. We believe that our insurance subsidiaries currently comply with all applicable mandated minimum loss ratios. NAIC model regulations, adopted in substantially all states, created 10 standard Medicare supplement plans (Plans A through J). Plan A provides the least extensive coverage, while Plan J provides the most extensive coverage. Under NAIC regulations, Medicare insurers must offer Plan A, but may offer any of the other plans at their option. Conseco currently offers nine of the model plans. We have declined to offer Plan J, due in part to its high benefit levels and, consequently, high costs to the consumer. The Health Insurance Portability and Accountability Act of 1996 ("HIPAA") was enacted in 1996. HIPAA sets forth minimum federal standards for group and individual health insurance, including requirements relating to the availability, portability and renewability of health coverage. Numerous proposals to reform the current health care system have been introduced in Congress and the state legislatures. Proposals have included, among other things, modifications to the existing employer-based insurance system, a quasi-regulated system of "managed competition" among health plans, and a single-payer, public program. Changes in health care policy could significantly affect our business. Federal comprehensive major medical or long-term care programs, if proposed and implemented, could partially or fully replace some of Conseco's current products, for example. A number of states have passed or are considering legislation that would limit the differentials in rates that insurers could charge for health care coverages between new business and renewal business for similar demographic groups. State legislation has also been adopted or is being considered that would make health insurance available to all small groups by requiring coverage of all employees and their dependents, by limiting the applicability of pre-existing conditions exclusions, by requiring insurers to offer a basic plan exempt from certain benefits as well as a standard plan, or by establishing a mechanism to spread the risk of high risk employees to all small group insurers. The NAIC recently adopted model long-term care policy language providing nonforfeiture benefits and has proposed a rate stabilization standard for long-term care policies. Various bills proposed in the U.S. Congress would provide for the implementation of certain minimum consumer protection standards for inclusion in all long-term care policies, including guaranteed renewability, 13 protection against inflation and limitations on waiting periods for pre-existing conditions. Other recently adopted legislation permits premiums paid for qualified long-term care insurance to be treated as tax-deductible medical expenses and for benefits received on such policies to be excluded from taxable income. We cannot predict with certainty the effect that any proposals, if adopted, or legislative developments could have on our business and operations. FEDERAL INCOME TAXATION The annuity and life insurance products marketed and issued by our insurance subsidiaries generally provide the policyholder with an income tax advantage, as compared to other savings investments such as certificates of deposit and bonds, in that income taxation on the increase in value of the product is deferred until it is received by the policyholder. With other savings investments, the increase in value is taxed as earned. Annuity benefits and life insurance benefits, which accrue prior to the death of the policyholder, are generally not taxable until paid. Life insurance death benefits are generally exempt from income tax. Also, benefits received on immediate annuities (other than structured settlements) are recognized as taxable income ratably, as opposed to the methods used for some other investments which tend to accelerate taxable income into earlier years. The tax advantage for annuities and life insurance is provided in the Internal Revenue Code (the "Code"), and is generally followed in all states and other United States taxing jurisdictions. Accordingly, the tax advantage is subject to change by Congress and by the legislatures of the respective taxing jurisdictions. In February of 1998, President Clinton released various revenue proposals and tax changes to be considered in the current federal budget. Such proposals contained numerous tax increases directed at the insurance industry, of which the more significant ones were as follows: taxing asset reallocations within variable annuities and exchanges of variable annuities, reducing the tax basis of insurance and annuity contracts for mortality charges and modifying tax reserving rules for annuity contracts. We have joined the insurance industry and other groups opposing these taxes upon savings, and we expect that these proposed changes will not be enacted into legislation. Our insurance company subsidiaries are taxed under the life insurance company provisions of the Code. Provisions in the Code require a portion of the expenses incurred in selling insurance products to be deducted over a period of years, as opposed to immediate deduction in the year incurred. This provision increases the tax for statutory accounting purposes, which reduces statutory surplus and, accordingly, decreases the amount of cash dividends that may be paid by the life insurance subsidiaries. As of December 31, 1997, the cumulative taxes paid by our insurance subsidiaries as a result of this provision were $327.8 million. The Company had tax loss carryforwards at December 31, 1997, of approximately $737.1 million, portions of which begin expiring in 1999. However, the amount of such loss that may be offset against current taxable income is subject to the following limitations: (i) losses may be offset against income of other corporate entities only if such entities are included in the same consolidated tax return (insurance companies are currently not eligible for inclusion in Conseco's consolidated tax return until five years after they are acquired); (ii) losses incurred in non-life companies (which comprise most of the loss carryforwards) may offset only a portion of income from life companies in the same consolidated tax return; and (iii) some loss carryforwards may not be used to offset taxable income of entities acquired after the loss was incurred. We, however, believe we will be able to utilize all current loss carryforwards before they expire. ITEM 2. PROPERTIES. Our principal operations are located on a 170-acre corporate campus in Carmel, Indiana, immediately north of Indianapolis. The 11 buildings on the campus (all but one of which are owned) contain approximately 810,000 square feet of space and house Conseco's executive offices and certain administrative operations of its subsidiaries. The campus has ample room for additional buildings to support future growth. Our supplemental health products are primarily administered from a single facility of 300,000 square feet in downtown Chicago, Illinois, leased under an agreement having a remaining life of 10 years. We also lease approximately 130,000 square feet of warehouse space in a second Chicago facility; this lease has a remaining life of five years. Conseco owns an office building in Kokomo, Indiana (100,000 square feet), and two office buildings in Rockford, Illinois (total of 169,000 square feet), which serve as administrative centers for portions of our insurance operations. Conseco owns one office building in Philadelphia, Pennsylvania (127,000 square feet), which serves as the administrative center for our direct response life insurance operations; approximately 60 percent of this space is occupied by the Company, with the remainder leased to tenants. Conseco leases 24,000 square feet of office space in Bensalem, Pennsylvania, and 4,000 square feet of office space in Sarasota, Florida, for use by our long-term care insurance marketing operations; these leases expire in 2000 and 1998, respectively. Conseco leases 22,000 square feet of office space in Schaumburg, Illinois, for use by our major medical marketing and certain information technology operations. Conseco also leases 14 210 sales offices in various states totaling approximately 363,000 square feet; these leases are short-term in length, with remaining lease terms ranging from one to five years. ITEM 3. LEGAL PROCEEDINGS. Conseco and its subsidiaries are involved in lawsuits primarily related to their operations. Most of these lawsuits involve claims under insurance policies or other contracts of the Company. None of the lawsuits currently pending, either individually or in the aggregate, is expected to have a material adverse effect on Conseco's consolidated financial condition or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. 15
OPTIONAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT. Officer Positions with Conseco, principal name and age (a) Since occupation and business experience (b) ------------ ----- ---------------------------------- Stephen C. Hilbert, 52......... 1979 Since 1979, Chairman of the Board and Chief Executive Officer and, since 1988, President of Conseco. Ngaire E. Cuneo, 47 ........... 1992 Since 1992, Executive Vice President, Corporate Development and, since 1994, Director of Conseco; from 1986 to 1992, Senior Vice President and Corporate Officer of General Electric Capital Corporation. Rollin M. Dick, 66............. 1986 Since 1986, Executive Vice President, Chief Financial Officer and Director of Conseco. Donald F. Gongaware, 62........ 1985 Since 1985, Executive Vice President and Director of Conseco; since 1989, Chief Operations Officer of Conseco; and, since 1996, President of Conseco Marketing, LLC. Mr. Gongaware is resigning from these positions (other than as director of Conseco) effective March 31, 1998. John J. Sabl, 46............... 1997 Since 1997, Executive Vice President, General Counsel and Secretary of Conseco; from 1983 to 1997 Partner in the law firm of Sidley & Austin. James S. Adams, 38............. 1997 Since 1997, Senior Vice President, Chief Accounting Officer and Treasurer of Conseco; from 1989 to present, Senior Vice President and Treasurer of various Conseco subsidiaries. Thomas J. Kilian, 47........... 1998 Effective March 31, 1998, Executive Vice President and Chief Operations Officer of Conseco and President of Conseco Marketing, LLC; from 1996 to March 31, 1998, President of Conseco Services, LLC (responsible for insurance operations, data processing, human resources and administrative services for various Conseco subsidiaries); from 1989 to 1996, Senior Vice President of data processing for various Conseco subsidiaries. - ------------------- (a) The executive officers serve as such at the discretion of the Board of Directors and are elected annually. (b) Business experience is given for at least the last five years.
16 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS. MARKET INFORMATION The common stock of Conseco (trading symbol "CNC") has been listed for trading on the New York Stock Exchange (the "NYSE") since 1986. The following table sets forth the quarterly dividends paid per share and the ranges of high and low sales prices per share on the NYSE for the last two fiscal years, based upon information supplied by the NYSE. All applicable per share data have been adjusted for the two-for-one stock splits distributed April 1, 1996, and February 11, 1997.
Market price Period ------------ Dividend ------ High Low paid ---- --- ---- 1996: First Quarter.................................. $18-5/32 $14-15/16 $.00500 Second Quarter................................. 20-3/8 17-3/8 .01000 Third Quarter.................................. 24-11/16 17-5/8 .01000 Fourth Quarter................................. 33-1/8 24-7/16 .03125 1997: First Quarter.................................. $43-7/8 $30-3/4 $.03125 Second Quarter................................. 42-7/8 34-1/4 .03125 Third Quarter.................................. 50 35-1/8 .03125 Fourth Quarter................................. 50-1/16 39-7/8 .12500
As of March 13, 1998, there were approximately 74,000 holders of the outstanding shares of common stock, including individual participants in securities position listings. DIVIDENDS Cash dividends are paid quarterly at an amount determined by our Board of Directors. Our general policy is to retain most of our earnings. Retained earnings have been used: (i) to finance the growth and development of the Company's business through acquisitions or otherwise; (ii) to pay preferred stock dividends; (iii) to pay distributions on the Company-obligated mandatorily redeemable preferred stock of subsidiary trusts; (iv) to repurchase common stock on those occasions when we have determined that our shares were undervalued in the market and that the use of funds for stock repurchases would not interfere with other cash needs; and (v) to pay dividends on common stock. We have paid all cumulative dividends on our preferred stock and distributions on our Company-obligated mandatorily redeemable preferred securities of subsidiary trusts when due. We are prohibited from paying common stock dividends if such payments are not current. Certain Conseco financing agreements require the Company to maintain financial ratios which could also limit its ability to pay dividends. Our ability to pay dividends depends primarily on the receipt of cash dividends and other cash payments from our subsidiaries. The principal operating subsidiaries of Conseco are life insurance companies organized under state laws and subject to regulation by state insurance departments. These laws and regulations limit the ability of insurance subsidiaries to make cash dividends, loans or advances to a holding company such as Conseco. However, these laws generally permit the payment, without prior approval, of annual dividends which in the aggregate do not exceed the greater of (or in a few states, the lesser of): (i) the subsidiary's prior year net gain from operations; or (ii) 10 percent of surplus attributable to policyholders at the prior year-end, both computed on the statutory basis of accounting prescribed for insurance companies. See "Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations -- Liquidity of Conseco (Parent Company)." 17
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA (a). Years ended December 31, ---------------------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- (Amounts in millions, except per share data) STATEMENT OF OPERATIONS DATA Insurance policy income..................................... $3,410.8 $1,654.2 $1,465.0 $1,285.6 $1,293.8 Net investment income....................................... 1,825.3 1,302.5 1,142.6 385.7 896.2 Net investment gains (losses) .............................. 266.5 60.8 204.1 (30.5) 242.6 Total revenues.............................................. 5,568.4 3,067.3 2,855.3 1,862.0 2,636.0 Interest expense on notes payable........................... 109.4 108.1 119.4 59.3 58.0 Total benefits and expenses................................. 4,565.3 2,573.7 2,436.8 1,537.6 2,025.8 Income before income taxes, minority interest and extraordinary charge...................................... 1,003.1 493.6 418.5 324.4 610.2 Extraordinary charge on extinguishment of debt, net of tax.. 6.9 26.5 2.1 4.0 11.9 Net income.................................................. 567.3 252.4 220.4 150.4 297.0 Preferred stock dividends and charge related to induced conversions of convertible preferred stock................ 21.9 27.4 18.4 18.6 20.6 Net income applicable to common stock....................... 545.4 225.0 202.0 131.8 276.4 PER SHARE DATA (b) Net income, basic........................................... $2.94 $2.15 $ 2.48 $ 1.31 $ 2.74 Net income, diluted......................................... 2.64 1.82 2.12 1.22 2.20 Dividends declared per common share......................... .313 .083 .046 .125 .075 Book value per common share outstanding..................... 20.22 16.86 10.22 5.22 8.45 Shares outstanding at year-end.............................. 186.7 167.1 81.0 88.7 101.2 Weighted average shares outstanding for diluted earnings.... 210.2 138.9 103.9 123.4 133.8 BALANCE SHEET DATA - PERIOD END Total assets................................................ $35,914.8 $25,612.7 $17,297.5 $10,811.9 $13,749.3 Notes payable for which Conseco is directly liable.......... 1,906.7 1,094.9 871.4 191.8 413.0 Notes payable of affiliates, not direct obligations of Conseco.................................... - - 584.7 611.1 290.3 Commercial paper............................................ 448.2 - - - - Total liabilities........................................... 30,640.1 21,829.7 15,782.5 9,743.2 12,382.9 Minority interests in consolidated subsidiaries: Company-obligated mandatorily redeemable preferred securities of subsidiary trusts.............. 1,383.9 600.0 - - - Preferred stock........................................... - 97.0 110.7 130.1 - Common stock.............................................. .7 .7 292.6 191.6 223.8 Shareholders' equity ....................................... 3,890.1 3,085.3 1,111.7 747.0 1,142.6 OTHER FINANCIAL DATA (b) (c) Premiums collected (d)...................................... $5,055.7 $3,280.2 $3,106.5 $1,879.1 $2,140.1 Operating earnings (e)...................................... 574.9 267.7 131.3 151.7 162.0 Operating earnings per diluted common share (e)............. 2.74 1.93 1.26 1.23 1.20 Shareholders' equity excluding unrealized appreciation (depreciation) of fixed maturity securities (f)........... 3,712.9 3,045.5 999.1 884.7 1,055.2 Book value per common share outstanding, excluding unrealized appreciation (depreciation) of fixed maturity securities (f)................................... 19.27 16.62 8.83 6.77 7.58 (a) Comparison of selected consolidated financial data in the table above is significantly affected by: (i) the acquisitions consummated by Partnership I and Partnership II; (ii) the sale of Western National Life Insurance Company ("Western National") in 1994; (iii) the transactions affecting Conseco's ownership interest in BLH and CCP during 1993 through 1996; (iv) the LPG Merger (completed effective July 1, 1996); (v) the ATC Merger (December 31, 1996); (vi) the THI Merger (December 31, 1996); (vii) the CAF Merger (January 1, 1997); (viii) the PFS Merger (April 1, 1997); (ix) the Colonial Penn Purchase (September 30, 1997); and (x) the WNIC Merger (December 1, 1997). For periods beginning with their acquisitions by 18 Partnership I and ending June 30, 1992, Partnership I and its subsidiaries were consolidated with the financial statements of Conseco. Following the completion of the initial public offering by CCP in July 1992, Conseco did not have unilateral control to direct all of CCP's activities and, therefore, did not consolidate the financial statements of CCP with the financial statements of Conseco. As a result of the CCP Merger, the financial statements of CCP's subsidiaries were consolidated with the financial statements of Conseco, effective January 1, 1995. Conseco has included BLH in its financial statements since November 1, 1992. Through December 31, 1993, the financial statements of Western National were consolidated with the financial statements of Conseco. Following the completion of the initial public offering of Western National in early 1994 (and subsequent disposition of Conseco's remaining equity interest in Western National), the financial statements of Western National were no longer consolidated with the financial statements of Conseco. As of September 29, 1994, Conseco began to include in its financial statements the newly acquired Partnership II subsidiary, ALH. On September 30, 1996, Conseco acquired all of the common stock of ALH which Conseco did not already own from Partnership II. Business combinations completed in 1997 and 1996 are included in Conseco's financial statements on the effective date of the acquisition and are described in the notes to the consolidated financial statements. (b) All share and per-share amounts have been restated to reflect the two-for-one stock splits paid on February 11, 1997 and April 1, 1996. Prior period earnings per share amounts have been restated to comply with the new reporting standards as described in note 1 to the consolidated financial statements. (c) Amounts under this heading are included to assist the reader in analyzing the Company's financial position and results of operations. Such amounts are not intended to, and do not, represent insurance policy income, net income, net income per share, shareholders' equity or book value per share prepared in accordance with generally accepted accounting principles ("GAAP"). (d) Includes premiums received from universal life products and products without mortality or morbidity risk. Such premiums are not reported as revenues under GAAP and were $2,099.4 million in 1997; $1,881.3 million in 1996; $1,757.5 million in 1995; $634.6 million in 1994; and $891.9 million in 1993. (e) Represents income before extraordinary charge, excluding net investment gains (losses) (less that portion of change in future policy benefits, amortization of cost of policies purchased and cost of policies produced and income taxes relating to such gains (losses)) and nonrecurring charges (net of income taxes). (f) Excludes the effects of reporting fixed maturities at fair value and recording the unrealized gain or loss on such securities as a component of shareholders' equity, net of tax and other adjustments. Such adjustments are in accordance with Statement of Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"), as described in note 1 to the consolidated financial statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Management's discussion and analysis reviews the consolidated financial condition of Conseco at December 31, 1997 and 1996, the consolidated results of operations for the three years ended December 31, 1997, and where appropriate, factors that may affect future financial performance. This discussion should be read in conjunction with the accompanying consolidated financial statements, notes thereto and selected consolidated financial data. All statements, trend analyses and other information contained in this report and elsewhere (such as in other filings by the Company with the Securities and Exchange Commission, press releases, presentations by the Company or its management or oral statements) relative to markets for the Company's products and trends in the Company's operations or financial results, as well as other statements including words such as "anticipate," "believe," "plan," "estimate," "expect," "intend," 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 that 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 market performance and health care inflation, which may affect the ability of the Company to sell its products, the market value of the Company's investments and the lapse rate and profitability of the Company's policies; (ii) the Company's ability to achieve anticipated levels of operational efficiencies at recently acquired companies, as well as through other cost-saving initiatives; (iii) customer response to new products, distribution channels and marketing initiatives; (iv) mortality, morbidity, use of health care services and other factors that may affect the profitability of the Company's insurance products; (v) changes in the federal income tax laws and regulations that may affect the relative tax advantages of some of the Company's products; (vi) increasing competition in the sale of the Company's products; (vii) 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 insurance products, and health care regulation affecting the Company's health insurance products; (viii) 19 the availability and terms of future acquisitions; and (ix) the risk factors or uncertainties listed from time to time in the Company's other filings with the Securities and Exchange Commission. Consolidated results and analysis Our 1997 operating earnings were $574.9 million, or $2.74 per diluted share, up 115 percent and 42 percent, respectively, over 1996. Operating earnings increased as a result of the LPG Merger (completed effective July 1, 1996), the ALH Stock Purchase (September 30, 1996), the ATC Merger (December 31, 1996), the THI Merger (December 31, 1996), the BLH Merger (December 31, 1996), the CAF Merger (January 1, 1997), the PFS Merger (April 1, 1997), the Colonial Penn Purchase (September 30, 1997) and the WNIC Merger (December 1, 1997) and as a result of the increased business in force of these acquired companies and companies previously owned. The percentage increase in operating earnings was greater than the percentage increase in operating earnings per diluted share primarily because of the 51 percent increase in weighted average diluted common shares or equivalents outstanding during 1997. The increase in weighted average diluted shares resulted from shares issued in certain 1997 and 1996 acquisitions (the LPG Merger, the ATC Merger, the THI Merger, the BLH Merger, the CAF Merger and the PFS Merger), partially offset by repurchases of Conseco common stock. Our 1996 operating earnings were $267.7 million, or $1.93 per diluted share, up 104 percent and 53 percent, respectively, over 1995. Operating earnings increased as a result of the LPG Merger, the ALH Stock Purchase, the effect of increased ownership of BLH as a result of purchases of BLH common stock during 1995 and 1996, and profit improvements in each of our segments. Operating earnings for 1996 were not affected by the ATC Merger, the THI Merger or the BLH Merger, all of which were recorded as of December 31, 1996. The percentage increase in operating earnings was greater than the increase in operating earnings per diluted share primarily because of the additional common shares or equivalents outstanding in 1996 resulting from: (i) the LPG Merger; and (ii) the Company's January 1996 offering of Preferred Redeemable Increased Dividend Equity Securities, 7% PRIDES Convertible Preferred Stock ("PRIDES"), which are mandatorily convertible into shares of Conseco common stock. Net income of $567.3 million in 1997, or $2.64 per diluted share, included: (i) net investment gains (net of related costs, amortization and taxes) of $44.1 million, or 21 cents per diluted share; (ii) an extraordinary charge of $6.9 million, or 3 cents per share, related to early retirement of debt; (iii) a charge of 7 cents per share related to the induced conversion of preferred stock (treated as a preferred stock dividend); and (iv) nonrecurring charges totaling $44.8 million, or 21 cents per share. Nonrecurring charges include: (i) $40.5 million related to our Medicare supplement business in Massachusetts; and (ii) $4.3 million related to the death of an executive officer. Regulators in Massachusetts have not allowed premium increases for Medicare supplement products necessary to avoid losses on the business. We are currently seeking rate increases. We are no longer writing new Medicare supplement business in Massachusetts. We have written off the cost of policies purchased and produced and accrued additional claim reserves related to our in-force Massachusetts Medicare supplement business due to the estimated premium deficiencies. Net income of $252.4 million in 1996, or $1.82 per diluted share, included: (i) net investment gains (net of related costs, amortization and taxes) of $11.2 million, or 8 cents per diluted share; and (ii) an extraordinary charge of $26.5 million, or 19 cents per share, related to early retirement of debt. Net income of $220.4 million in 1995, or $2.12 per diluted share, included: (i) net investment gains (net of related costs, amortization and taxes) of $16.3 million, or 16 cents per share; (ii) restructuring income of $74.9 million, or 72 cents per share, arising from the release of deferred income taxes previously accrued on income related to CCP and BLH (such deferred tax was no longer required when Conseco's ownership of these companies exceeded 80 percent); and (iii) an extraordinary charge of $2.1 million, or 2 cents per share, related to early retirement of debt. Total revenues include net investment gains of $266.5 million in 1997, $60.8 million in 1996 and $204.1 million in 1995. Excluding net investment gains, total revenues were $5.3 billion in 1997, up 76 percent from $3.0 billion in 1996. Total revenues in 1997 include a full year of activity for acquisitions completed in 1996 and the revenues of CAF, PFS, Colonial Penn and WNIC in the periods subsequent to their acquisitions. Total revenues in 1996 include LPG revenues after July 1, 1996. Total revenues, excluding net investment gains, were up 13 percent in 1996 from $2.7 billion in 1995. 20 Results of operations by segment for the three years ended December 31, 1997: The following tables and narratives summarize the results of our operations by business segment. All amounts reported in these summaries relate solely to periods after the companies were included in our consolidated financial statements.
1997 1996 1995 ---- ---- ---- (Dollars in millions) Income before income taxes, minority interest and extraordinary charge: Supplemental health: Operating income...........................................................$ 408.0 $ 136.6 $ 96.0 Net investment gains, net of related costs................................. 26.3 .1 1.1 Nonrecurring charges....................................................... (62.4) - - --------- --------- -------- Income before income taxes, minority interest and extraordinary charge 371.9 136.7 97.1 --------- -------- -------- Annuities: Operating income .......................................................... 305.1 255.0 244.1 Net investment gains (losses), net of related costs and amortization ...... 53.2 (.7) 72.0 --------- -------- -------- Income before income taxes, minority interest and extraordinary charge 358.3 254.3 316.1 --------- -------- -------- Life insurance: Operating income........................................................... 304.7 126.8 74.8 Net investment gains (losses), net of related costs and amortization....... 2.4 (2.0) (4.6) --------- -------- --------- Income before income taxes, minority interest and extraordinary charge 307.1 124.8 70.2 --------- -------- -------- Individual and group major medical: Operating income........................................................... 40.2 32.1 35.1 Net investment gains, net of related costs................................. .1 - .1 --------- -------- -------- Income before income taxes, minority interest and extraordinary charge 40.3 32.1 35.2 --------- -------- --------- Other: Operating income........................................................... 58.3 30.7 31.5 Net investment gains (losses), net of related costs........................ 3.3 27.4 (6.3) --------- -------- -------- Income before income taxes, minority interest and extraordinary charge 61.6 58.1 25.2 --------- -------- -------- Corporate: Interest and other corporate expenses...................................... (126.8) (112.4) (140.5) Nonrecurring charges....................................................... (9.3) - - Net investment gains, net of related costs................................. - - 15.2 --------- -------- -------- Net corporate expenses................................................. (136.1) (112.4) (125.3) --------- -------- -------- Consolidated: Operating income........................................................... 989.5 468.8 341.0 Net investment gains, net of related costs and amortization ............... 85.3 24.8 77.5 Nonrecurring charges....................................................... (71.7) - - --------- -------- -------- Income before income taxes, minority interest and extraordinary charge 1,003.1 493.6 418.5 Income tax expense.............................................................. 376.6 179.8 87.0 --------- -------- -------- Income before minority interest and extraordinary charge............... 626.5 313.8 331.5 Minority interest in consolidated subsidiaries: Distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts............................................ 49.0 3.6 - Dividends on preferred stock of subsidiaries................................. 3.3 8.9 11.9 Equity in earnings of subsidiaries........................................... - 22.4 97.1 --------- -------- -------- Income before extraordinary charge.................................... 574.2 278.9 222.5 Extraordinary charge on extinguishment of debt, net of taxes and minority interest............................................................ 6.9 26.5 2.1 --------- -------- -------- Net income.............................................................$ 567.3 $ 252.4 $ 220.4 ========= ======== ========
21 Supplemental health:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Premiums collected: Medicare supplement (first-year)............................. $ 101.9 $ 72.5 $ 81.1 Medicare supplement (renewal)................................ 694.5 545.4 515.6 --------- ------- ------- Subtotal - Medicare supplement........................... 796.4 617.9 596.7 --------- ------- ------- Long-term care (first-year).................................. 143.4 51.6 44.4 Long-term care (renewal)..................................... 520.5 141.3 97.7 --------- ------- ------- Subtotal - long-term care................................ 663.9 192.9 142.1 --------- ------- ------- Specified-disease (first-year)............................... 44.7 - - Specified-disease (renewal).................................. 338.7 - - --------- ------- -------- Subtotal - specified-disease............................. 383.4 - - --------- ------- ------- Total supplemental health premiums collected............. $1,843.7 $ 810.8 $738.8 ======== ======= ====== Insurance policy income......................................... $1,858.1 $ 805.9 $756.9 Net investment income........................................... 273.8 66.6 66.9 -------- ------- ------- Total revenues (a)......................................... 2,131.9 872.5 823.8 --------- ------- ------- Insurance policy benefits and change in future policy benefits.. 1,217.5 531.8 525.6 Amortization related to operations.............................. 232.1 87.8 81.6 Interest expense on investment borrowings....................... 6.3 1.1 1.4 Other operating costs and expenses.............................. 268.0 115.2 119.2 --------- ------- ------- Total benefits and expenses................................ 1,723.9 735.9 727.8 --------- ------- ------- Operating income before income taxes, minority interest and extraordinary charge................................................... 408.0 136.6 96.0 Net investment gains, net of related costs...................... 26.3 .1 1.1 Nonrecurring charges............................................ (62.4) - - --------- ------- ------- Income before income taxes, minority interest and extraordinary charge...................... $ 371.9 $136.7 $97.1 ========= ====== ===== Loss ratios: Medicare supplement products................................. 69.1% 68.2% 71.7% Long-term care products...................................... 63.6 58.7 60.5 Specified-disease products................................... 61.6 - - (a) Revenues exclude net investment gains.
General: This segment includes Medicare supplement and long-term care insurance products, primarily sold to senior citizens, and effective January 1, 1997 (as a result of the acquisitions of CAF and THI), specified-disease products. Through December 31, 1996, the supplemental health operations consist solely of Bankers Life's Medicare supplement and long-term care products, distributed through a career agency force. The segment's 1997 results of operations are significantly affected by recent acquisitions (ATC, THI and CAF, effective January 1, 1997; PFS, effective April 1, 1997; and Colonial Penn, effective September 30, 1997). The supplemental health products of THI, CAF, ATC, PFS and Colonial Penn are all distributed through professional independent producers. The profitability of this segment largely depends on the overall level of sales, persistency of in-force business, claim experience and expense management. 22 Premiums collected by this segment in 1997 were $1,843.7 million, up 127 percent from 1996. Premiums collected in 1996 increased to $810.8 million, up 9.7 percent. Medicare supplement policies accounted for 43 percent of this segment's collected premiums in 1997, compared with more than 75 percent of this segment's collected premiums in 1996 and 1995. The change in the mix of premiums collected reflects the more diverse supplemental health lines sold by Conseco as a result of the recent acquisitions. Collected premiums on Medicare supplement policies increased 29 percent in 1997, to $796.4 million, and increased 3.6 percent in 1996, to $617.9 million. Such increases primarily reflect the recent acquisitions and a larger base of premiums due to rate increases. The sales of Medicare supplement policies have been affected by: (i) steps taken to improve profitability by increasing premium rates and changing both the commission structure and the underwriting criteria for these policies; and (ii) increased competition from alternative providers, including HMOs. Premiums collected on long-term care policies increased 244 percent in 1997, to $663.9 million, and 36 percent in 1996, to $192.9 million. First-year collected premiums in 1997, 1996 and 1995 were $143.4 million, $51.6 million and $44.4 million, respectively. The increase in long-term care premiums collected primarily reflects the acquisition of recently acquired companies. Premiums collected on specified-disease policies were $383.4 million in 1997, substantially all of which were collected by recently acquired companies. Insurance policy income comprises premiums earned on the segment's policies and has increased over the last three years consistent with the explanations provided above for premiums collected. Net investment income increased 311 percent in 1997, to $273.8 million, and did not change materially in 1996 compared with 1995. Such investment income fluctuates when changes occur in: (i) the amount of average invested assets supporting insurance liabilities; and (ii) the yield earned on invested assets. During 1997, the segment's average invested assets increased approximately 278 percent, to $3.4 billion, and the net yield on invested assets increased to 8.0 percent from 7.6 percent. During 1996, the segment's average invested assets increased approximately 5.0 percent, to $.9 billion, and the net yield on invested assets decreased from 8.0 percent to 7.6 percent. Invested assets grew as a result of the growth in insurance liabilities related to the segment's business. Insurance policy benefits and change in future policy benefits increased in 1997, reflecting recent acquisitions, the larger amount of business in force on which benefits are incurred, and a higher incidence of claims. This account increased in 1996 as a result of the larger amount of business in force on which benefits are incurred, net of the lower incidence of claims. In 1997, the ratio of policy benefits to insurance policy income for the Medicare supplement policies increased to 69.1 percent from 68.2 percent, reflecting the different characteristics of such policies in recently acquired companies as well as fluctuations in claim experience. In 1996, the ratio of policy benefits to insurance policy income for Medicare supplement policies fell 3.5 percentage points to 68.2 percent, reflecting the premium rate increases implemented in 1996 and 1995. Changes in the ratio of policy benefits to insurance policy income for long-term care policies reflect different characteristics of such policies in recently acquired companies as well as fluctuations in claim experience and reserve development. In 1997, the long-term care loss ratio increased by 4.9 percentage points, to 63.6 percent. In 1996, the long-term care loss ratio fell by 1.8 percentage points, to 58.7 percent. The ratio of policy benefits to insurance policy income for specified-disease policies was 61.6 percent in 1997. Such products were not sold by Conseco prior to the acquisitions of THI and CAF. Amortization related to operations includes amortization of: (i) the cost of policies produced; (ii) the cost of policies purchased; and (iii) goodwill related to this segment's business. The amount of amortization increased primarily because of the increase in balances subject to amortization as a result of recent acquisitions. Interest expense on investment borrowings was affected by changes in investment borrowing activities during the last three years and the changes in interest rates paid on such borrowings. Other operating costs and expenses increased in 1997 from the increased business of recently acquired companies. Such expenses did not change materially in 1996 compared with 1995. 23 Net investment gains, net of related costs, often fluctuate from period to period. Nonrecurring charges for 1997 represent an increase to claim reserves of $41.5 million and the write-off of cost of policies produced and cost of policies purchased of $20.9 million related to Medicare supplement business in the state of Massachusetts. Regulators in that state have not allowed premium increases for Medicare supplement products necessary to avoid losses on the business. We are currently seeking rate increases. We are no longer writing new Medicare supplement business in Massachusetts. 24
Annuities: 1997 1996 1995 ---- ---- ---- (Dollars in millions) Annuity premiums collected: Traditional fixed (first-year)................................ $ 857.8 $1,148.6 $1,536.4 Traditional fixed (renewal)................................... 79.4 92.7 62.8 --------- -------- -------- Subtotal - traditional fixed.............................. 937.2 1,241.3 1,599.2 --------- -------- -------- Market value - adjusted (first-year).......................... 165.7 237.2 27.7 Market value - adjusted (renewal)............................. 13.8 20.5 3.1 --------- -------- -------- Subtotal - market value - adjusted........................ 179.5 257.7 30.8 --------- -------- -------- Equity-indexed (all first-year)............................... 387.7 80.4 - --------- -------- -------- Variable annuities (first-year)............................... 127.4 37.9 17.2 Variable annuities (renewal).................................. 57.8 53.0 46.7 --------- -------- -------- Subtotal - variable annuities............................. 185.2 90.9 63.9 --------- -------- -------- Total annuity premiums collected.......................... $1,689.6 $1,670.3 $1,693.9 ======== ======== ======== Insurance policy income.......................................... $ 96.8 $ 77.6 $ 68.4 Net investment income: General account invested assets............................... 960.9 891.2 851.5 Change in fair value of S&P 500 Call Options.................. 39.4 - - Separate account assets....................................... 70.3 48.4 28.8 --------- -------- -------- Total revenues (a)...................................... 1,167.4 1,017.2 948.7 --------- -------- -------- Insurance policy benefits and change in future policy benefits... 74.1 67.3 61.8 Amounts added to policyholder account balances: Annuity products other than those listed below................ 542.2 523.2 505.0 Equity-indexed products based on S&P 500 Index................ 39.3 - - Variable annuity products..................................... 70.3 48.4 28.8 Amortization related to operations............................... 84.8 76.9 64.9 Interest expense on investment borrowings........................ 23.2 14.3 16.9 Other operating costs and expenses............................... 28.4 32.1 27.2 --------- -------- -------- Total benefits and expenses (a)......................... 862.3 762.2 704.6 --------- -------- -------- Operating income before income taxes, minority interest and extraordinary charge..................... 305.1 255.0 244.1 Net investment gains (losses), net of related costs and amortization.................................................. 53.2 (.7) 72.0 --------- -------- -------- Income before income taxes, minority interest and extraordinary charge.............................. $ 358.3 $ 254.3 $ 316.1 ========= ========= ======== Weighted average gross interest spread on annuity products (b)... 2.8% 2.9% 3.1% === === === Total traditional fixed and market value-adjusted annuity product insurance liabilities at end of period................ $13,007.4 $11,998.6 $10,169.1 ========= ========= ========= Total annuity product insurance liabilities at end of period..... $14,150.8 $12,421.8 $10,396.1 ========= ========= ========= (a) Revenues exclude net investment gains (losses); benefits and expenses exclude amortization related to net investment gains (losses). (b) Excludes variable annuity products where the credited amount is based on investment income from segregated investments.
General: This segment includes traditional fixed rate annuity products (SPDAs, FPDAs and SPIAs), market value-adjusted annuity products, equity-indexed annuity products and variable annuities sold through both career agents and professional independent producers. The profitability of this segment largely depends on the investment spread earned (i.e., the excess of investment earnings 25 over interest credited on annuity deposits), the persistency of in-force business, and expense management. In addition, comparability between periods is affected by: (i) the LPG Merger, effective July 1, 1996; and (ii) the ALH Stock Purchase, effective September 30, 1996. Premiums collected by this segment in 1997 were $1,689.6 million, up 1.2 percent over 1996. Premiums collected in 1996 were $1,670.3 million, down 1.4 percent from 1995. Increased competition from products such as mutual funds, traditional bank investments, variable annuities and other investment and retirement funding alternatives was a significant factor in the modest increase in annuity premiums collected, despite the full-year impact of the former LPG subsidiaries. Traditional fixed rate annuity products include SPDAs, FPDAs and SPIAs, which are credited with a guaranteed rate. SPDA and FPDA policies (which make up 78 percent, 84 percent and 90 percent of traditional fixed rate annuity premiums collected in 1997, 1996 and 1995, respectively) typically have an interest rate that is guaranteed for the first policy year, after which we have the discretionary ability to change the crediting rate to any rate not below a guaranteed minimum rate. The interest rate credited on SPIAs is based on market conditions existing when a policy is issued and remains unchanged over the life of the SPIA. 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. Annuity premiums on these products decreased 24 percent in 1997, to $937.2 million, and decreased 22 percent in 1996, to $1,241.3 million. We offer deferred annuity products with a "market value adjustment" feature designed to provide additional protection from early terminations during a period of rising interest rates by reducing the surrender value payable upon a full surrender of the policy in excess of the allowable penalty-free withdrawal amount. Conversely, during a period of declining interest rates, the market value adjustment feature would increase the surrender value payable to the policyholder. Annuity premiums collected with this feature represent 11 percent and 16 percent of total annuity premiums collected during 1997 and 1996, respectively. In response to consumers' desire for alternative investment products with returns linked to equities, we introduced an equity- indexed annuity product in June 1996. The accumulation value of these annuities is credited with interest at an annual minimum guaranteed rate of 3 percent, but the annuities provide for 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 potential increases to policyholder benefits resulting from increases in the S&P 500 Index to which the product's return is linked. Total collected premiums for this product were $387.7 million in 1997 compared with $80.4 million in 1996. Variable annuities offer contract holders a rate of return based on the specific investment portfolios into which premiums may be directed. The popularity of such annuities has increased recently as a result of the desire of investors to invest in common stocks. In addition, in 1996, we began to offer more investment options for variable annuity deposits, and we expanded our marketing efforts, which resulted in increased collected premiums. Profits on variable annuities are derived from the fees charged to contract holders rather than from the investment spread. Variable annuity collected premiums increased 104 percent in 1997, to $185.2 million, and increased 42 percent in 1996, to $90.9 million. Insurance policy income includes: (i) premiums received on SPIA policies that incorporate significant mortality features; (ii) cost of insurance and expenses charged to annuity policies; and (iii) surrender charges earned on annuity policy withdrawals. In accordance with GAAP, premiums on annuity contracts without mortality features are not reported as revenues, but rather are reported as deposits to insurance liabilities. Insurance policy income increased in 1997 and 1996 primarily because of increased surrender charges collected (changes in premiums received on policies with mortality features and cost of insurance and expenses charged to annuity policies were not significant). Surrender charges were $64.0 million in 1997, $41.2 million in 1996 and $28.6 million in 1995. Annuity policy withdrawals were $1.8 billion in 1997, compared with $1.7 billion in 1996 and $1.5 billion in 1995. The increase in policy withdrawals and surrender charges generally corresponds to the aging and the growth of our annuity business in force. In addition, policyholders are using the systematic withdrawal features available in several of our annuity policies, and more policyholders are surrendering in order to invest in alternative investments. Total withdrawals and surrenders were 15 percent, 16 percent and 16 percent of insurance liabilities related to surrenderable policies in 1997, 1996 and 1995, respectively. Net investment income on general account invested assets (excluding income on separate account assets related to variable annuities and the change in the fair value of S&P 500 Call Options related to equity-indexed products) increased 7.8 percent in 1997, to $960.9 million, and increased 4.7 percent in 1996, to $891.2 million. These increases primarily reflect the increase in general account invested assets acquired in conjunction with the recent acquisitions. The segment's average invested assets increased 11 percent to $12.8 billion in 1997, compared with 1996, and the annualized yield earned on average invested assets decreased from 7.9 percent to 7.5 percent in 1997. The segment's average invested assets increased 10 percent to $11.2 billion in 1996, and the annualized yield earned on average invested assets decreased from 8.4 percent to 7.9 percent in 1996. Cash flows received during 1997 and 1996 (including cash flows from the sales of investments) were invested in lower yielding securities due to a general decline in interest rates. 26 Net investment income from the change in fair value of S&P 500 Call Options is substantially offset by a corresponding charge to amounts added to policyholder account balances for equity-indexed products. Such income and related charge fluctuate based on the performance of the S&P 500 Index to which the returns on such products are linked. Net investment income on 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 fluctuate in relationship to total separate account assets and the return earned on such assets. Insurance policy benefits and change in future policy benefits relate solely to annuity policies that incorporate significant mortality features. The increase corresponds to the increase in the in-force block of such policies. Amounts added to policyholder account balances for interest expense on annuity products increased 3.6 percent in 1997 and 3.6 percent in 1996, primarily due to a larger block of annuity business in force in 1997, partially offset by a reduction in crediting rates. The weighted average crediting rates for these annuity liabilities were 4.8 percent in 1997, 5.0 percent in 1996 and 5.3 percent in 1995. Amortization related to operations increased 10 percent in 1997 and 18 percent in 1996. Amortization related to operations includes amortization of: (i) the cost of policies produced; (ii) the cost of policies purchased; and (iii) goodwill related to this segment's business. The amount of amortization increased primarily because of the increase in balances subject to amortization as a result of recent acquisitions. Interest expense on investment borrowings is affected by changes in investment borrowing activities during the last three years and the changes in interest rates paid on such borrowings. Other operating costs and expenses decreased 12 percent in 1997 and increased 18 percent in 1996. Other operating costs and expenses were favorably affected in 1997 by the consolidation of all annuity operations in Conseco's Carmel, Indiana facilities. The increase in 1996 corresponds to the increases in the total business in force primarily related to acquisition transactions described above under "General." Net investment gains (losses), net of related costs and amortization, often fluctuate from period to period. Selling securities at a gain and reinvesting the proceeds at lower yields may, absent other management action, tend to decrease future investment yields. We believe, however, that the following factors mitigate the adverse effect of such decreases on net income: (i) we recognized additional amortization of cost of policies purchased and cost of policies produced in order to reflect reduced future yields (thereby reducing such amortization in future periods); (ii) we can reduce interest rates credited to some products, thereby diminishing the effect of the yield decrease on the investment spread; and (iii) the investment portfolio grows as a result of reinvesting the realized gains. As a result of the sales of fixed maturity investments, the amortization of the cost of policies produced and the cost of policies purchased increased $132.0 million in 1997, $31.6 million in 1996 and $117.3 million in 1995. 27 Life insurance:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Premiums collected: Universal life (first-year).......................................$ 96.6 $ 62.2 $ 15.7 Universal life (renewal).......................................... 354.3 208.9 97.4 ---------- ------- --------- Subtotal - universal life..................................... 450.9 271.1 113.1 ---------- ------- --------- Traditional life (first-year)..................................... 49.0 17.0 16.1 Traditional life (renewal)........................................ 209.1 115.5 124.4 ---------- ------- --------- Subtotal - traditional life................................... 258.1 132.5 140.5 ---------- ------- --------- Total life premiums collected.............................$ 709.0 $ 403.6 $ 253.6 ========== ======= ========= Insurance policy income: Premiums earned on traditional life products......................$ 258.6 $ 141.1 $ 143.5 Mortality charges and administrative fees......................... 357.8 211.2 73.8 Surrender charges................................................. 14.1 8.2 5.1 ---------- ------- --------- Total insurance policy income................................... 630.5 360.5 222.4 Net investment income................................................ 448.2 279.7 176.9 ---------- ------- --------- Total revenues (a)........................................ 1,078.7 640.2 399.3 ---------- ------- --------- Insurance policy benefits and change in future policy benefits....... 456.9 270.5 182.5 Interest added to financial product policyholder account balances.... 154.9 97.0 51.6 Amortization related to operations................................... 61.3 48.1 33.4 Interest expense on investment borrowings............................ 11.6 6.3 3.5 Other operating costs and expenses................................... 89.3 91.5 53.5 ---------- ------- --------- Total benefits and expenses (a)........................... 774.0 513.4 324.5 ---------- ------- --------- Operating income before income taxes, minority interest and extraordinary charge................................................. 304.7 126.8 74.8 Net investment gains (losses), net of related costs and amortization.................................................. 2.4 (2.0) (4.6) ---------- ------- --------- Income before income taxes, minority interest and extraordinary charge......................$ 307.1 $ 124.8 $ 70.2 ========== ======= ========= Total life product insurance liabilities.............................$ 7,075.0 $4,992.7 $ 2,102.2 ========== ======== ========= Life insurance in force..............................................$104,144.5 $80,149.5 $33,783.2 ========== ========= ========= (a) Revenues exclude net investment gains (losses); benefits and expenses exclude amortization related to net investment gains (losses).
General: This segment includes traditional life and universal life products sold through career agents, professional independent producers and direct response distribution channels. This segment's operations were significantly affected by recent acquisitions (LPG effective July 1, 1996; PFS effective April 1, 1997; Colonial Penn effective September 30, 1997; and WNIC effective December 1, 1997). The profitability of this segment largely depends on the investment spread earned (for universal life), the persistency of in-force business, claim experience and expense management. 28 Premiums collected by this segment were up 76 percent in 1997, to $709.0 million. Premiums collected in 1996 were up 59 percent in 1996, to $403.6 million. Such increases relate primarily to premiums collected by recently acquired companies in periods after their acquisition. Universal life product collected premiums increased 66 percent in 1997, to $450.9 million, and increased 140 percent in 1996, to $271.1 million. Traditional life product collected premiums increased 95 percent in 1997, to $258.1 million, and decreased 5.7 percent in 1996, to $132.5 million. Insurance policy income includes: (i) premiums received on traditional life products; (ii) the mortality charges and administrative fees earned on universal life insurance; and (iii) surrender charges on terminated universal life insurance policies. In accordance with GAAP, premiums on universal life products are accounted for as deposits to insurance liabilities. Revenues are earned over time in the form of investment income on policyholder account balances, surrender charges, and mortality and other charges deducted from policyholders' account balances. All three components of insurance policy income have increased over the last three years primarily as a result of the acquisition transactions described above under "General." Net investment income increased 60 percent in 1997, to $448.2 million, and 58 percent in 1996, to $279.7 million. Investment income fluctuates with changes in: (i) the amount of average invested assets supporting insurance liabilities; and (ii) the yield earned on invested assets. During 1997, the segment's average invested assets increased 71 percent, to $6.0 billion, and the net yield on invested assets decreased from 7.9 percent to 7.5 percent. During 1996, the segment's average invested assets increased 66 percent, to $3.5 billion, and the net yield on invested assets decreased from 8.4 percent to 7.9 percent. Invested assets grew primarily as a result of the growth in insurance liabilities from the acquisition transactions described above under "General." Insurance policy benefits and change in future policy benefits increased in 1997 and 1996, reflecting the larger amount of business in force on which benefits are incurred as a result of the acquisition transactions described above under "General." There were no unusual fluctuations in claim experience during the periods. Interest added to financial product policyholder account balances increased 60 percent in 1997, to $154.9 million, and 88 percent in 1996, to $97.0 million. Such expense fluctuates with changes in: (i) the amount of insurance liabilities for universal life products; and (ii) the interest rate credited to such products. During 1997, such average liabilities increased 66 percent, to $3.3 billion, and the rate credited decreased from 5.0 percent to 4.8 percent. During 1996, such average liabilities increased 98 percent, to $2.0 billion, and the rate credited decreased from 5.2 percent to 5.0 percent. Universal life product liabilities increased primarily as a result of the acquisition transactions described above under "General." Amortization related to operations increased 27 percent in 1997, to $61.3 million, and 44 percent in 1996, to $48.1 million. Amortization related to operations includes amortization of: (i) the cost of policies produced; (ii) the cost of policies purchased; and (iii) goodwill related to this segment's business. The amount of amortization was primarily affected by the increases in balances subject to amortization as a result of the recent acquisitions, net of the effect of reductions in the balances of the cost of policies purchased and cost of policies produced resulting from net investment gains recognized during 1997 and 1996 (see "Net investment gains (losses)" below). Interest expense on investment borrowings is affected by changes in investment borrowing activities during the last three years and the changes in interest rates paid on such borrowings. Other operating costs and expenses decreased 2.4 percent in 1997, to $89.3 million, and increased 71 percent in 1996, to $91.5 million. The fluctuations correspond to the increases in this segment's business as a result of recent acquisitions, offset in 1997 by expense reductions realized as a result of the consolidation of certain operations. Net investment gains (losses), net of related costs and amortization, often fluctuate from period to period. Net investment gains (losses) affect the timing of the amortization of costs of policies purchased and the cost of policies produced. As a result of net investment gains (losses) from the sales of fixed maturity investments, amortization of cost of policies purchased and cost of policies produced increased $49.2 million in 1997, $4.4 million in 1996 and $9.3 million in 1995. 29 Individual and group major medical:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Premiums collected: Individual (first-year)...............................................$ 70.3 $ 6.0 $ 8.4 Individual (renewal).................................................. 147.4 44.9 56.1 ------- -------- -------- Subtotal - individual............................................. 217.7 50.9 64.5 ------- -------- -------- Group (first-year).................................................... 63.6 - - Group (renewal)....................................................... 462.9 290.1 289.1 ------- -------- -------- Subtotal - group.................................................. 526.5 290.1 289.1 ------- -------- -------- Total individual and group major medical premiums collected.......$ 744.2 $ 341.0 $ 353.6 ======= ======== ======== Insurance policy income..................................................$ 758.1 $ 357.0 $ 352.0 Net investment income.................................................... 17.3 8.8 9.5 ------- -------- -------- Total revenues (a)................................................ 775.4 365.8 361.5 ------- -------- -------- Insurance policy benefits and changes in future policy benefits.......... 579.5 300.3 300.8 Amortization related to operations....................................... 21.2 16.0 13.6 Interest expense on investment borrowings................................ .6 .1 .2 Other operating costs and expenses....................................... 133.9 17.3 11.8 ------- -------- -------- Total benefits and expenses....................................... 735.2 333.7 326.4 ------- -------- -------- Operating income before income taxes, minority interest and extraordinary charge............................................ 40.2 32.1 35.1 Net investment gains, net of related costs............................... .1 - .1 ------- -------- -------- Income before income taxes, minority interest and extraordinary charge..........................................................$ 40.3 $ 32.1 $ 35.2 ======= ======== ======== Benefit ratio ........................................................... 78.0% 85.7% 85.4% (a) Revenues exclude net investment gains.
General: This segment includes individual and group major medical health insurance products. The segment's operations were significantly affected by the PFS Merger, effective April 1, 1997, and to a lesser extent, by the LPG Merger, effective July 1, 1996. The profitability of this business depends largely on the overall persistency of the business in force, as well as claim experience and expense management. Premiums collected by this segment increased 118 percent in 1997, to $744.2 million, and decreased 3.6 percent in 1996, to $341.0 million. Individual health premiums increased 328 percent in 1997, to $217.7 million, and decreased 21 percent in 1996, to $50.9 million. Group premiums increased 81 percent in 1997, to $526.5 million, and did not change materially between 1995 and 1996. The recently acquired companies accounted for all of the 1997 increases. Insurance policy income comprises premiums earned on the segment's policies and fee income earned for group medical risk management services. Fluctuations in premiums earned have been consistent with the fluctuations in premiums collected described above. Fee income (which is earned by a subsidiary acquired in the LPG Merger) was $15.0 million in 1997 and $7.0 million in 1996. Net investment income increased 97 percent in 1997, to $17.3 million, and decreased 7.4 percent in 1996, to $8.8 million. Investment income fluctuates when changes occur in: (i) the amount of average invested assets supporting insurance liabilities; and (ii) the yield earned on invested assets. During 1997, the segment's average invested assets increased approximately 111 percent, to $244.0 million, and the net yield on invested assets decreased from 7.6 percent to 7.1 percent. During 1996, the segment's average 30 invested assets did not change significantly and the net yield on invested assets decreased from 7.9 percent to 7.6 percent. Average invested assets increased in 1997 as a result of the PFS Merger. Insurance policy benefits and change in future policy benefits increased in 1997, primarily as a result of the larger amount of segment business in force. In 1997, the ratio of policy benefits to insurance policy income decreased 7.7 percentage points, to 78.0 percent. In 1996, the ratio of policy benefits to insurance policy income increased from 85.4 percent to 85.7 percent. The lower benefit ratio in 1997 reflects: (i) the lower incidence of claims experienced on business written by the acquired companies compared with the business of other Conseco subsidiaries; and (ii) favorable claim developments. Amortization related to operations includes amortization of: (i) the cost of policies produced; (ii) the cost of policies purchased; and (iii) goodwill related to this segment's business. Amortization expense increased 33 percent in 1997, to $21.2 million, and 18 percent in 1996, to $16.0 million. The amount of amortization was primarily affected by the increase in balances subject to amortization as a result of the recent acquisitions. Interest expense on investment borrowings is affected by changes in investment borrowing activities during the last three years and the changes in interest rates paid on such borrowings. Other operating costs and expenses increased 674 percent in 1997, to $133.9 million, and 47 percent in 1996, to $17.3 million. Such increases correspond to the increases in the total business in force related primarily to the recently acquired companies. Net investment gains, net of related costs, realized by this segment were not material in 1997, 1996 or 1995. 31 Other:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Premiums collected: Other (first-year)................................................ $ 3.9 $ 2.2 $ 2.6 Other (renewal)................................................... 65.3 52.3 64.0 -------- -------- --------- Total other premiums collected................................ $ 69.2 $ 54.5 $ 66.6 ======== ======== ========= Insurance policy income.............................................. $ 67.3 $ 53.2 $ 65.3 Net investment income................................................ 15.4 7.8 9.0 Fee revenue and other income......................................... 65.8 49.8 43.6 -------- -------- --------- Total revenues (a)............................................ 148.5 110.8 117.9 -------- -------- --------- Insurance policy benefits and changes in future policy benefits...... 40.3 25.1 36.8 Amortization related to operations................................... 9.4 11.2 10.1 Interest expense on investment borrowings............................ .3 .2 .2 Other operating costs and expenses................................... 40.2 43.6 39.3 -------- -------- --------- Total benefits and expenses .................................. 90.2 80.1 86.4 -------- -------- --------- Operating income before income taxes, minority interest and extraordinary charge...................................................... 58.3 30.7 31.5 Net investment gains (losses), net of related costs and amortization. 3.3 27.4 (6.3) -------- -------- -------- Income before income taxes, minority interest and extraordinary charge........................... $ 61.6 $ 58.1 $ 25.2 ======== ======== ========= (a) Revenues exclude net investment gains (losses).
General: This segment includes: (i) various other health insurance products that are not currently being actively marketed; and (ii) beginning December 1, 1997, the specialty health insurance products of WNIC marketed to educators through career agents. The segment's operations were significantly affected by recent acquisitions (THI, effective January 1, 1997, and WNIC, effective December 1, 1997). The profitability of this business depends largely on the overall persistency of the business in force, claim experience and expense management. This segment also includes the fee revenue generated by our non-life subsidiaries, including the investment advisory fees earned by CCM and commissions earned for insurance and investment product marketing and distribution. Such amounts exclude the fees and commissions we charge to our consolidated subsidiaries. The profitability of the fee-based business depends on the total fees generated and on expense management. Premiums collected by this segment increased 27 percent in 1997, to $69.2 million, and decreased 18 percent in 1996, to $54.5 million. The increase in premiums collected in 1997 primarily relates to recent acquisitions. We do not emphasize the sale of many of the products in this segment, andcollected premiums are expected to decrease in future years. However, the in-force business continues to be profitable. Insurance policy income comprises premiums earned on the segment's policies, and has fluctuated over the last three years consistent with the explanations provided above for premiums collected. Net investment income increased 97 percent in 1997, to $15.4 million, and decreased 13 percent in 1996, to $7.8 million. Such investment income fluctuated primarily in relationship to the amount of average invested assets supporting this segment's insurance liabilities. During 1997, the segment's average invested assets increased 96 percent, to $199.5 million, and the net yield on invested assets did not change materially. During 1996, the segment's average invested assets decreased approximately 8.6 percent, to $101.6 million, and the net yield on invested assets decreased from 8.1 percent to 7.7 percent. 32 Fee revenue and other income includes: (i) fees for investment management and for mortgage origination and servicing; and (ii) commissions earned for insurance and investment product marketing and distribution. Such amounts exclude the fees and commissions we charge our consolidated subsidiaries. Fee revenue and other income increased 32 percent in 1997, to $65.8 million, primarily due to increased investment management fees. Fee revenue and other income increased 14 percent in 1996, to $49.8 million, primarily as a result of the acquisition of certain property and casualty insurance brokerage businesses. Insurance policy benefits and change in future policy benefits fluctuate in relationship to the amount of segment business in force and the incidence of claims. Amortization related to operations decreased 16 percent in 1997, to $9.4 million, and increased 11 percent in 1996, to $11.2 million. Amortization related to operations includes amortization of: (i) the cost of policies produced; (ii) the cost of policies purchased; and (iii) goodwill related to this segment's business. The decrease in amortization in 1997 is consistent with the declining balance of cost of policies purchased and cost of policies produced associated with the business included in this segment. The increase in 1996 was primarily due to the increases in such balances as a result of our purchase of additional shares of BLH common stock in 1995 and 1996. The acquisitions of THI and WNIC did not materially increase the balance of goodwill and cost of policies purchased of this segment (valuations of the acquired blocks indicated that such amounts were insignificant). Other components of income before income taxes, minority interest and extraordinary charge: In addition to the income of the five operating segments, income before income taxes, minority interest and extraordinary charge is affected by interest and other corporate expenses, nonrecurring charges and net investment gains not attributable to the operating segments. Interest and other corporate expenses were $126.8 million in 1997, $112.4 million in 1996, and $140.5 million in 1995. Interest expense included therein was $109.4 million in 1997, $108.1 million in 1996, and $119.4 million in 1995. Such expense fluctuates in relationship to the average debt outstanding during each period and the interest rate thereon. Nonrecurring charges of $9.3 million in 1997 represent expenses incurred related to the death of an executive officer. Net investment gains, net of related costs, of $15.2 million in 1995 primarily arose from the gain realized on the sale of Conseco's investment in Eagle Credit (a finance subsidiary of Harley-Davidson). SALES In accordance with GAAP, insurance policy income shown in our consolidated statement of operations consists of premiums received 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 rather are reported as deposits to insurance liabilities. Revenues for these products are recognized over time in the form of investment income and surrender or other charges assessed to the policy. 33 Total premiums collected by our business segments during the last three years were as follows:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Supplemental health: First-year....................................................................... $ 290.0 $ 124.1 $ 125.5 Renewal.......................................................................... 1,553.7 686.7 613.3 --------- --------- --------- Total supplemental health.................................................... 1,843.7 810.8 738.8 --------- --------- --------- Annuities: First-year ...................................................................... 1,538.6 1,504.1 1,581.3 Renewal.......................................................................... 151.0 166.2 112.6 --------- --------- --------- Total annuities.............................................................. 1,689.6 1,670.3 1,693.9 --------- --------- --------- Life insurance: First-year....................................................................... 145.6 79.2 31.8 Renewal.......................................................................... 563.4 324.4 221.8 --------- --------- --------- Total life insurance......................................................... 709.0 403.6 253.6 --------- --------- --------- Individual and group major medical: First-year....................................................................... 133.9 6.0 8.4 Renewal.......................................................................... 610.3 335.0 345.2 --------- --------- --------- Total individual and group major medical..................................... 744.2 341.0 353.6 --------- --------- --------- Other: First-year....................................................................... 3.9 2.2 2.6 Renewal.......................................................................... 65.3 52.3 64.0 --------- --------- --------- Total other.................................................................. 69.2 54.5 66.6 --------- --------- --------- Total: First-year....................................................................... 2,112.0 1,715.6 1,749.6 Renewal.......................................................................... 2,943.7 1,564.6 1,356.9 --------- --------- --------- Total collected premiums...................................................... $ 5,055.7 $ 3,280.2 $ 3,106.5 ========= ========= =========
34 Fluctuations in premiums collected are discussed above under "Results of operations by segment for the three years ended December 31, 1997." Our recent acquisitions will have a significant effect on future premiums collected. Total premiums collected for all currently consolidated companies (except subsidiaries of WNIC, which were acquired on December 1, 1997) for all periods (including periods prior to ownership by Conseco) are provided below:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Supplemental health: First-year....................................................................... $ 303.7 $ 306.0 $ 296.6 Renewal.......................................................................... 1,631.7 1,521.1 1,417.3 --------- --------- --------- Total supplemental health.................................................... 1,935.4 1,827.1 1,713.9 --------- --------- --------- Annuities: First-year....................................................................... 1,540.9 1,549.1 1,613.1 Renewal.......................................................................... 138.8 182.9 177.3 --------- --------- --------- Total annuities.............................................................. 1,679.7 1,732.0 1,790.4 --------- --------- --------- Life insurance: First-year....................................................................... 165.1 185.9 136.0 Renewal.......................................................................... 647.3 620.9 681.5 --------- --------- --------- Total life insurance......................................................... 812.4 806.8 817.5 --------- --------- --------- Individual and group major medical: First-year....................................................................... 172.4 145.6 137.0 Renewal.......................................................................... 691.4 630.8 652.3 --------- --------- --------- Total individual and group major medical..................................... 863.8 776.4 789.3 --------- --------- --------- Other: First-year....................................................................... 1.7 2.3 2.6 Renewal.......................................................................... 89.9 112.5 144.1 --------- --------- --------- Total other.................................................................. 91.6 114.8 146.7 --------- --------- --------- Total: First-year....................................................................... 2,183.8 2,188.9 2,185.3 Renewal.......................................................................... 3,199.1 3,068.2 3,072.5 --------- --------- --------- Total collected premiums..................................................... $ 5,382.9 $ 5,257.1 $ 5,257.8 ========= ========= =========
INVESTMENTS Our investment strategy is to: (i) maintain a predominately investment-grade fixed income portfolio; (ii) provide adequate liquidity to meet the cash flow requirements of policyholders and other obligations; and (iii) maximize current income and total investment return through active investment management. Consistent with this strategy, investments in fixed maturity securities, mortgage loans, credit-tenant loans, policy loans, separate accounts and short-term investments made up 97 percent of our $27.0 billion investment portfolio at December 31, 1997. The remainder of the invested assets were equity securities and other invested assets. Our insurance subsidiaries are regulated by insurance statutes and regulations as to the type of investments that they are permitted to make and the amount of funds that may be used for any one type of investment. In light of these statutes and regulations and our business and investment strategy, Conseco generally seeks to invest in United States government and government-agency securities and corporate securities rated investment grade by established nationally recognized rating organizations or, if not rated, in securities of comparable investment quality. 35 The following table summarizes investment yields earned over the past three years:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Weighted average invested assets: As reported ................................................................. $23,288.8 $16,356.3 $13,769.3 Excluding unrealized appreciation (depreciation) (a)......................... 23,177.7 16,278.8 13,690.6 Net investment income............................................................... 1,825.3 1,302.5 1,142.6 Yields earned: As reported.................................................................. 7.8% 8.0% 8.3% Excluding unrealized appreciation (depreciation) (a) ........................ 7.9% 8.0% 8.3% (a) Excludes the effect of reporting fixed maturities at fair value as described in note 1 to the consolidated financial statements.
Although investment income is a significant component of total revenues, the profitability of a portion of our insurance products is determined primarily by spreads between interest rates earned and rates credited or accruing to our insurance liabilities. At December 31, 1997, the average yield, computed on the cost basis of our investment portfolio, was 7.5 percent, and the average interest rate credited or accruing to our total insurance liabilities was 5.2 percent, excluding interest bonuses guaranteed only for the first year of the contract. Actively managed fixed maturities Our actively managed fixed maturity portfolio at December 31, 1997, included primarily debt securities of the United States government, public utilities and other corporations, and mortgage-backed securities. Mortgage-backed securities included collateralized mortgage obligations ("CMOs") and mortgage-backed pass-through securities. At December 31, 1997, our fixed maturity portfolio had net unrealized gains of $484.4 million (equal to approximately 2.1 percent of the portfolio's carrying value), consisting of $611.5 million of unrealized gains and $127.1 million of unrealized losses. Estimated fair values for fixed maturity investments were determined based on: (i) estimates from nationally recognized pricing services (82 percent of the portfolio); (ii) broker-dealer market makers (8 percent of the portfolio); and (iii) internally developed methods (10 percent of the portfolio). As discussed in the notes to the consolidated financial statements, when we adjust carrying values of actively managed fixed maturity securities for changes in fair value, we also adjust the cost of policies purchased, cost of policies produced and liabilities. These adjustments are made in order to reflect the change in amortization and liability accruals that would be needed if those fixed maturity investments had actually been sold at their fair values and the proceeds reinvested at current interest rates. At December 31, 1997, approximately 5.5 percent of our invested assets and 6.6 percent of fixed maturity investments were rated below-investment grade by nationally recognized statistical rating organizations (or, if not rated by such firms, with ratings below Class 2 assigned by the NAIC). We plan to maintain approximately the present level of below-investment-grade fixed maturities. These securities generally have greater risks than other corporate debt investments, including risk of loss upon default by the borrower, and are often unsecured and subordinated to other creditors. Below-investment-grade issuers usually have high levels of indebtedness and are more sensitive to adverse economic conditions, such as recession or increasing interest rates, than are investment grade issuers. We are aware of these risks and monitor our below-investment-grade securities closely. At December 31, 1997, our below- investment-grade fixed maturity investments had an amortized cost of $1,525.1 million and an estimated fair value of $1,496.2 million. We periodically evaluate the creditworthiness of each issuer whose securities the Company holds. Special attention is paid to those securities whose market values have declined materially for reasons other than changes in interest rates or other general market conditions. We consider available information to evaluate the realizable value of the investment, the specific condition of the issuer and the issuer's ability to comply with the material terms of the security. Information reviewed may include the recent operational results and financial position of the issuer, information about its industry, recent press releases and other information. Conseco employs a staff of experienced securities analysts in a variety of specialty areas. Among its other responsibilities, this staff is charged with compiling and reviewing such information. If evidence does not exist to support a realizable value equal to or greater than the carrying value of the investment, and such decline in market value is determined to be other than temporary, we reduce the carrying amount to its net realizable value, which becomes the new cost basis; the amount of the reduction is reported as a realized loss. We recognize any recovery of such reductions in the cost basis of an investment only upon the sale, repayment or other disposition of the investment. We recorded writedowns of fixed maturity investments and other invested assets totaling $1.2 million 36 in 1997, primarily as a result of: (i) changes in the financial condition of a private company in which we had an indirect equity investment; and (ii) changes in the value of the underlying collateral associated with certain notes. These changes caused us to conclude that the decline in fair value of such investments was other than temporary. Our investment portfolio is subject to the risks of further declines in realizable value. However, we attempt to mitigate this risk through the diversification and active management of our portfolio. As of December 31, 1997, fixed maturity investments in substantive default (i.e., in default due to nonpayment of interest or principal) had an amortized cost and carrying value of $2.1 million and $1.2 million, respectively. Fixed maturity investments in technical (but not substantive) default (i.e., in default, but not as to the payment of interest or principal) had an amortized cost and carrying value of $.3 million. There were no other fixed maturity investments about which we had serious doubts as to the ability of the issuer to comply on a timely basis with the material terms of the instruments. Our policy is to discontinue the accrual of interest and eliminate all previous interest accruals for defaulted securities, if it is determined that such amounts will not be ultimately realized in full. Investment income forgone due to defaulted securities was $.2 million in 1997, $3.8 million in 1996 and $1.6 million in 1995. At December 31, 1997, fixed maturity investments included $6.9 billion of mortgage-backed securities (or 30 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 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 the level of prevailing interest rates declines significantly relative to the interest rates on such loans. Mortgage-backed securities purchased at a discount to par will experience an increase in yield when the underlying mortgages prepay faster than expected. These securities purchased at a premium that prepay faster than expected will incur a reduction in yield. 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, because fewer underlying mortgages are refinanced. When this occurs, the average maturity and duration of the mortgage-backed securities increase, which decreases the yield on mortgage-backed securities purchased at a discount, because the discount is realized as income at a slower rate and increases the yield on those purchased at a premium as a result of a decrease in annual amortization of the premium. CMOs are securities backed by pools of pass-through securities and/or mortgages that are segregated into sections or "tranches" that provide for sequential retirement of principal, rather than the pro rata share of principal return that occurs through regular monthly principal payments on pass-through securities. All mortgage-backed securities are subject to risks associated with variable prepayments. As a result, these securities may have a different actual maturity than planned at the time of purchase. When securities having a cost greater than par are backed by mortgages that prepay faster than expected, we record a charge to investment income. When securities having a cost less than par prepay faster than expected, we record investment income. The degree to which a mortgage-backed security is susceptible to income fluctuations is influenced by: (i) the difference between its cost and par; (ii) the relative sensitivity of the underlying mortgages backing the security to prepayment in a changing interest rate environment; and (iii) the repayment priority of the security in the overall securitization structure. The Company seeks to limit the extent of these risks by: (i) purchasing securities that are backed by collateral with lower prepayment sensitivity (such as mortgages priced at a discount to par value and mortgages that are extremely seasoned); (ii) avoiding securities whose values are heavily influenced by changes in prepayments (such as interest-only and principal-only securities); (iii) investing in securities structured to reduce prepayment risk (such as planned amortization class ("PAC") and targeted amortization class ("TAC") CMOs); and (iv) actively managing the entire portfolio of mortgage-backed securities to dispose of those which are deemed more likely to be prepaid. PAC and TAC instruments represented approximately 24 percent of our mortgage-backed securities at December 31, 1997. The call-adjusted modified duration of our mortgage-backed securities at December 31, 1997, was 5.2 years. 37 The following table sets forth the par value, amortized cost and estimated fair value of mortgage-backed securities at December 31, 1997, summarized by interest rates on the underlying collateral:
Par Amortized Estimated value cost fair value ----- ---- ---------- (Dollars in millions) Below 7 percent............................................................ $2,025.5 $1,980.4 $2,014.7 7 percent - 8 percent...................................................... 3,568.0 3,546.5 3,638.2 8 percent - 9 percent...................................................... 712.9 716.1 730.5 9 percent and above........................................................ 445.1 455.5 467.0 -------- -------- -------- Total mortgage-backed securities............................... $6,751.5 $6,698.5 $6,850.4 ======== ======== ========
The amortized cost and estimated fair value of mortgage-backed securities at December 31, 1997, summarized by type of security, were as follows:
Estimated fair value -------------------- % of Amortized fixed Type cost Amount maturities - ---- ---- ------ ---------- (Dollars in millions) Pass-throughs and sequential and targeted amortization classes............ $4,599.7 $4,697.5 21% Planned amortization classes and accretion-directed bonds.................. 1,515.9 1,547.6 7 Support classes............................................................ 36.0 36.9 - Accrual (Z tranche) bonds.................................................. 27.9 28.8 - Subordinated classes....................................................... 519.0 539.6 2 -------- -------- -- $6,698.5 $6,850.4 30% ======== ======== ==
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 and provide the best price/performance ratio in a highly volatile interest rate environment. This type of security is also frequently used as collateral in the dollar-roll market. Sequential classes pay in a strict sequence; all principal payments received by the CMO are paid to the sequential tranches in order of priority. Targeted amortization classes provide a modest amount of prepayment protection when prepayments on the underlying collateral increase from those assumed at pricing. Thus, they offer slightly better call protection than sequential classes and pass-throughs. Planned amortization classes and accretion-directed bonds are some of the most stable and liquid instruments in the mortgage-backed securities market. Planned amortization class bonds adhere to a fixed schedule of principal payments as long as the underlying mortgage collateral experiences prepayments within a certain range. Changes in prepayment rates are first absorbed by support classes. This insulates the planned amortization classes from the consequences of both faster prepayments (average life shortening) and slower prepayments (average life extension). Support classes absorb the prepayment risk from which planned amortization and targeted amortization classes are protected. As such, they are usually extremely sensitive to prepayments. Most of our support classes are higher-average-life instruments that generally will not lengthen if interest rates rise further, and will have a tendency to shorten if interest rates decline. However, since these bonds have costs below their par values, higher prepayments will have the effect of increasing yields. Accrual bonds are CMOs structured such that the payment of coupon interest is deferred until principal payments begin. On each accrual date, the principal balance is increased by the amount of the interest (based on the stated coupon rate) that otherwise would have been payable. As such, these securities act much the same as zero-coupon bonds until cash payments begin. Cash payments typically do not commence until earlier classes in the CMO structure have been retired, which can be significantly influenced by the prepayment experience of the underlying mortgage loan collateral in the CMO structure. Because of the zero-coupon element of these securities and the potential uncertainty as to the timing of cash payments, their market values and yields are more sensitive to changing interest rates than are other CMOs, pass-through securities and coupon bonds. Subordinated CMO classes have both prepayment and credit risk. The subordinated classes are used to enhance the credit quality of the senior securities, and as such, rating agencies require that this support not deteriorate due to the prepayment of the subordinated securities. The credit risk of subordinated classes is derived from the negative leverage of owning a small percentage of the underlying mortgage loan collateral while bearing a majority of the risk of loss due to homeowner defaults. 38 If we determine that an investment held in the actively managed fixed maturity category will be sold, we will either sell the security or transfer it to the trading account at its fair value and recognize the gain or loss immediately. There were no material transfers in 1997. During 1997, we sold actively managed fixed maturity securities with a $17.8 billion book value, resulting in $342.6 million of investment gains and $41.4 million of investment losses (both before related expenses, amortization and taxes). Such securities were sold in response to changes in the investment environment, which created opportunities to enhance the total return of the investment portfolio without adversely affecting the quality of the portfolio or the matching of expected maturities of assets and liabilities. The realization of gains and losses affects the timing of the amortization of the cost of policies produced and the cost of policies purchased, as explained in note 10 to the consolidated financial statements. Other investments Credit-tenant loans are loans on commercial properties where the lease of the principal tenant is assigned to the lender. The principal tenant, or any guarantor of such tenant's obligations, must have a credit rating at the time of origination of the loan of at least BBB- or its equivalent. The underwriting guidelines consider such factors as: (i) the lease term of the property; (ii) the mortgagee's management ability, including business experience, property management capabilities and financial soundness; and (iii) economic, demographic or other factors that may affect the income generated by the property or its value. The underwriting guidelines also generally require a loan-to-value ratio of 75 percent or less. Credit-tenant loans are carried at amortized cost and totaled $558.6 million at December 31, 1997, or 2.1 percent of total invested assets. The total estimated fair value of credit-tenant loans was $587.2 million at December 31, 1997. At December 31, 1997, we held mortgage loan investments with a carrying value of $516.2 million (or 1.9 percent of total invested assets) and a fair value of $551.0 million. The balance of mortgage loans included 96 percent commercial loans, 2 percent residential loans and 2 percent residual interests in CMOs. The residual interests in CMOs entitle the Company to the excess cash flows arising from the difference between: (i) the cash flows required to make principal and interest payments on the related senior interests in the CMOs; and (ii) the actual cash flows received on the mortgage loan assets included in the CMO portfolios. If prepayments vary from projections on the mortgage loan assets included in such CMO portfolios, the total cash flows to the Company from such junior and residual interests could change from projected cash flows, resulting in a gain or loss. Noncurrent mortgage loans were insignificant at December 31, 1997. We recognized realized losses of $.8 million on mortgage loans for the year ended December 31, 1997. At December 31, 1997, we had a loan loss reserve of $9.0 million. Approximately 20 percent of the mortgage loans were on properties located in California, 11 percent in Texas and 9 percent in Florida. No other state accounted for more than 7 percent of the mortgage loan balance. At December 31, 1997, we held $64.8 million of trading securities that are included in other invested assets. Trading securities are investments that are held with the intent to be traded prior to their maturity, or are believed likely to be disposed of in the foreseeable future as a result of market or issuer developments. Trading securities are carried at estimated fair value, with the changes in fair value reflected in the statement of operations. Other invested assets include: (i) trading securities; (ii) S&P 500 Call Options; and (iii) certain nontraditional investments, including investments in venture capital funds, limited partnerships, mineral rights and promissory notes. Short-term investments totaled $990.5 million, or 3.7 percent of invested assets at December 31, 1997, and consisted primarily of commercial paper and repurchase agreements relating to government securities. As part of our investment strategy, we enter into reverse repurchase agreements and dollar-roll transactions to increase our return on investments and improve our liquidity. Reverse repurchase agreements involve a sale of securities and an agreement to repurchase the same securities at a later date at an agreed-upon price. Dollar rolls are similar to reverse repurchase agreements except that the repurchase involves securities that are only substantially the same as the securities sold. We enhance our investment yield by investing the proceeds from the sales in short-term securities pending the contractual repurchase of the securities at discounted prices in the forward market. We are able to engage in such transactions due to the market demand for mortgage-backed securities to form CMOs. Such investment borrowings averaged $719.3 million during 1997 and were collateralized by investment securities with fair values approximately equal to the loan value. The weighted average interest rate on short-term collateralized borrowings was 5.8 percent in 1997. The primary risk associated with short-term collateralized borrowings is that the counterparty will be unable to perform under the terms of the contract. Our exposure is limited to the excess of the net replacement cost of the securities over the value of the short-term investments (which was not material at December 31, 1997). We believe that the counterparties to our reverse repurchase and dollar-roll agreements are financially responsible and that the counterparty risk is minimal. 39 CONSOLIDATED FINANCIAL CONDITION Changes in the consolidated balance sheet of 1997 compared with 1996 Our consolidated balance sheet at December 31, 1997, compared with 1996, reflects growth through operations, changes in the fair value of actively managed fixed maturity securities, and the following capital and financing transactions described in the notes to the consolidated financial statements: (i) the CAF Merger; (ii) the issuance of $800 million of Company-obligated mandatorily redeemable preferred securities of subsidiary trusts; (iii) the repurchase of senior subordinated notes and senior notes with a par value of $130.1 million; (iv) the conversion of convertible debentures acquired in the ATC Merger into Conseco common stock; (v) the conversion of PRIDES into Conseco common stock; (vi) the repurchase of mandatorily redeemable preferred stock of a subsidiary; (vii) the PFS Merger; (viii) the Colonial Penn Purchase; (ix) the WNIC Merger; (x) common stock repurchases; and (xi) the issuance of commercial paper and notes payable. Our total capital at December 31, 1997 and 1996, was as follows:
1997 1996 ---- ---- (Dollars in millions) Notes payable...................................................... $1,906.7 $1,094.9 Commercial paper................................................... 448.2 - Minority interest: Company-obligated mandatorily redeemable preferred securities of subsidiary trusts............................. 1,383.9 600.0 Mandatorily redeemable preferred stock of subsidiary........... - 97.0 Common stock of subsidiary..................................... .7 .7 Shareholders' equity: Preferred stock................................................ 115.8 267.1 Common stock and additional paid-in capital.................... 2,382.0 2,029.6 Accumulated other comprehensive income......................... 182.0 38.9 Retained earnings.............................................. 1,210.3 749.7 -------- -------- Total shareholders' equity.................................. 3,890.1 3,085.3 --------- -------- Total capital of Conseco.................................... $7,629.6 $4,877.9 ======== ========
Notes payable increased during 1997 primarily as a result of: (i) debt issued or assumed in connection with the acquisitions of CAF, PFS, Colonial Penn and WNIC; (ii) debt used to finance common stock repurchases; and (iii) the redemption of mandatorily redeemable preferred stock of a subsidiary of ALH. The increase in notes payable was partially offset by the repayment of debt using the proceeds from the issuance of Company-obligated mandatorily redeemable preferred securities. We instituted a commercial paper program in April 1997 to lower our borrowing costs and improve our liquidity. Borrowings under our commercial paper program averaged approximately $525.9 million during the period of April 24, 1997 through December 31, 1997. The weighted average interest rate on such borrowings was 5.8 percent during 1997. Company-obligated mandatorily redeemable preferred securities of subsidiary trusts are classified as minority interest in accordance with GAAP. During 1997, we issued $300 million of Capital Securities and $500 million of FELINE PRIDES. See note 8 to the consolidated financial statements for a description of these securities. Minority interest, excluding the Company-obligated mandatorily redeemable preferred securities, at December 31, 1997, included a $.7 million interest in common stock of a subsidiary of ALH. At December 31, 1996, minority interest included: (i) $97.0 million of mandatorily redeemable preferred stock of a subsidiary of ALH; and (ii) $.7 million interest in the common stock of a subsidiary of ALH. During 1997, we repurchased all of the mandatorily redeemable preferred stock of a subsidiary of ALH formerly held by minority interests. As a result, gains of $3.7 million were realized from the sale of securities having an amortized cost of $47.7 million; such securities had been held in a segregated account to ensure the redemption of such preferred stock. 40 Shareholders' equity increased by $804.8 million in 1997, to $3.9 billion. Significant components of the increase included: (i) Conseco common stock issued in the CAF Merger with a value of $117.4 million; (ii) Conseco common stock issued in the PFS Merger with a value of $354.1 million; (iii) net income of $567.3 million; (iv) the conversion of convertible debentures into Conseco common stock with a value of $150.0 million; (v) the issuance of common stock related to stock options and employee benefit plans (including the tax benefit thereon) of $276.1 million; and (vi) the increase in net unrealized appreciation of $143.1 million. These increases were partially offset by: (i) repurchases of common stock for $711.7 million; and (ii) common and preferred stock dividends totaling $80.6 million. Book value per common share outstanding increased to $20.22 at December 31, 1997, from $16.86 at December 31, 1996. Such increase was primarily attributable to the factors discussed in the previous paragraph. Excluding unrealized appreciation of fixed maturity securities in accordance with SFAS 115, book value per common share outstanding was $19.27 at December 31, 1997, compared with $16.62 at December 31, 1996. Total assets increased by $10.3 billion in 1997, to $35.9 billion, primarily due to the assets acquired in the CAF Merger, the PFS Merger, the Colonial Penn Purchase and the WNIC Merger. In accordance with SFAS 115, Conseco records its actively managed fixed maturity investments at estimated fair value. At December 31, 1997 and 1996, such investments were increased by $484.4 million and $103.8 million, respectively, as a result of the SFAS 115 adjustment. Financial ratios
1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Ratio of earnings to fixed charges: As reported........................................................ 2.04X 1.61X 1.57X 2.26X 2.19X Excluding interest on annuities and financial products(a).......... 7.21X 4.55X 3.80X 4.55X 8.85X Ratio of earnings to fixed charges and preferred dividends: As reported........................................................ 1.95X 1.50X 1.50X 1.95X 2.04X Excluding interest on annuities and financial products(a).......... 5.77X 3.14X 3.06X 3.14X 6.00X Ratio of earnings to fixed charges, preferred dividends and distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts: As reported..................................................... 1.82X 1.49X 1.50X 1.95X 2.04X Excluding interest on annuities and financial products(a)....... 4.20X 3.06X 3.06X 3.14X 6.00X Ratio of debt to total capital: (b) As reported........................................................ .31X .22X .49X .43X .34X Excluding unrealized appreciation (depreciation)(c)................ .32X .23X .53X .39X .36X Ratio of debt and Company-obligated mandatorily redeemable preferred securities of subsidiary trusts to total capital:(b) (d) As reported..................................................... .49X .35X .49X .43X .34X Excluding unrealized appreciation (depreciation) (c)............ .50X .35X .53X .39X .36X Rating agency ratios: (c) (e) (f) (g) Debt to total capital.............................................. .28X .17X .37X .02X .20X Debt and preferred stock to total capital (h)...................... .47X .30X .37X .02X .20X (a) These ratios are included to assist the reader in analyzing the impact of interest on annuities and financial products (which is not generally required to be paid in cash in the period in which it is recognized). 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; the ratio of earnings to fixed charges and preferred dividends; and the ratio of earnings to fixed charges, preferred dividends and distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts. (b) For periods prior to 1996, debt includes obligations for which Conseco was not directly liable. (c) Excludes the effect of reporting fixed maturities at fair value. 41 (d) Represents the ratio of debt and the Company-obligated mandatorily redeemable preferred securities of subsidiary trusts to the sum of shareholders' equity, debt, minority interest and the Company-obligated mandatorily redeemable preferred securities of subsidiary trusts. (e) Consistent with our discussions with rating agencies, the Company has targeted: (i) the ratio of debt to total capital to be at or below 35 percent; and (ii) the ratio of debt and preferred stock to total capital to be at or below 49 percent. These ratios are calculated in a manner discussed with rating agencies. (f) Debt is reduced by cash and investments held by non-life companies and excludes, for periods prior to 1996, obligations for which Conseco was not directly liable. (g) Assumes conversion of all convertible debentures. (h) Assumes purchase of common shares under purchase contracts.
Liquidity for insurance 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 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. Of our total insurance liabilities at December 31, 1997, approximately 17 percent could be surrendered by the policyholder without a penalty. Approximately 59 percent could be surrendered by the policyholder subject to penalty or the release of an insurance liability in excess of surrender benefits paid. The remaining 24 percent are not subject to surrender. Payment characteristics of the insurance liabilities at December 31, 1997, were as follows (dollars in millions): Payments under contracts containing fixed payment dates: Due in one year or less.............................................. $ 339.6 Due after one year through five years................................ 819.0 Due after five years through ten years............................... 415.9 Due after ten years.................................................. 852.4 --------- Total gross payments whose payment dates are fixed by contract.. 2,426.9 Less amounts representing future interest on such contracts.......... 879.0 --------- Insurance liabilities whose payment dates are fixed by contract 1,547.9 Insurance liabilities whose payment dates are not fixed by contract....... 24,352.2 --------- Total insurance liabilities..................................... $25,900.1 =========
Of the above insurance liabilities under contracts containing fixed payment dates, approximately 59 percent relate to payments that will be made for the lifetime of the contract holder. We consider expected mortality in determining the amount of this liability. The remaining insurance liabilities having fixed payment dates are payable regardless of the contract holder's survival. Approximately 30 percent of insurance liabilities were contracts subject to a fixed interest rate for the life of the contract. The remaining liabilities generally were subject to interest rates that could be reset annually. The following summarizes insurance liabilities for investment contracts by credited rate (excluding interest rate bonuses for the first policy year only) at December 31, 1997 (dollars in millions): Below 4.75 percent......................................................... $ 2,627.0 4.75 percent - 5.00 percent................................................ 2,533.0 5.00 percent - 5.25 percent................................................ 3,588.0 5.25 percent - 5.50 percent................................................ 1,703.0 5.50 percent - 5.75 percent................................................ 676.0 5.75 percent and above..................................................... 1,597.0 --------- Total insurance liabilities on investment contracts.................. $12,724.0 =========
42 We believe that the diversity of our investment portfolio and the concentration of investments in high quality liquid securities provide sufficient liquidity to meet foreseeable cash requirements. Our investment portfolio at December 31, 1997, included $1.0 billion of short-term investments and $19.2 billion of publicly traded investment grade bonds, including $.6 billion of United States government and agency securities. Although there is no present need or intent to dispose of such investments, our life insurance subsidiaries could readily liquidate portions of their investments, if such a need arose. In addition, investments could be used to facilitate borrowings under reverse repurchase agreements or dollar-roll transactions. Such borrowings have been used by the life companies from time to time to increase their return on investments and to improve liquidity. At December 31, 1997, our portfolio of bonds and redeemable preferred stocks had an aggregate unrealized gain of $484.4 million. 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 needs cash for: (i) principal and interest on debt; (ii) dividends on preferred and common stock; (iii) distributions on the Company-obligated mandatorily redeemable preferred stock of subsidiary trusts; (iv) holding company administrative expenses; (v) income taxes; and (vi) investments in subsidiaries. The primary sources of cash to meet these obligations include statutorily permitted payments from our life insurance subsidiaries, including: (i) dividend payments; (ii) surplus debenture interest and principal payments; (iii) tax sharing payments; and (iv) fees for services provided. 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 note 7 to the consolidated financial statements; or (iii) selling all or a portion of its subsidiaries. These sources have historically provided adequate cash flow to fund: (i) the needs of the parent company's normal operations; (ii) internal expansion, acquisitions and investment opportunities; and (iii) the retirement of debt and equity. In 1997, we also issued new shares of Conseco common stock for a portion of the cost to acquire CAF and the entire cost to acquire PFS. 43 The following table shows the cash flow activity of the parent company and its wholly owned non-life subsidiaries:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Items relating to operations: Dividends and surplus debenture interest payments from life subsidiaries..... $ 166.1 $109.9 $ 80.6 Tax sharing payments from life subsidiaries.................................. 9.3 4.6 2.7 Fees from life subsidiaries.................................................. 89.1 74.8 34.7 Fees from unaffiliated companies............................................. 35.2 39.3 39.0 Parent and non-life subsidiary costs......................................... (74.1) (39.8) (64.5) Interest on debt of Conseco, including direct and indirect obligations....... (117.4) (71.3) (41.6) Interest on amounts due to life subsidiaries................................. (26.5) (7.3) (8.8) Income taxes................................................................. (2.3) 2.2 (7.7) Other........................................................................ 8.9 (4.7) - ------- ------ ------ Total items relating to operations....................................... 88.3 107.7 34.4 ------- ------ ------ Items relating to investing: Purchase of investments...................................................... (140.7) (71.1) (70.8) Sales and maturities of investments.......................................... 70.2 45.3 125.6 Cash held by non-life subsidiaries prior to acquisition...................... 4.1 40.9 17.0 Investment in consolidated subsidiaries...................................... (939.7) (226.1) (552.3) Surplus debenture principal payments......................................... 73.9 36.5 - Expense incurred in terminated merger........................................ - - (5.5) ------- ------ ------ Total items relating to investing......................................... (932.2) (174.5) (486.0) ------- ------ ------ Items relating to financing: Proceeds from issuance of Company-obligated mandatorily redeemable preferred securities of subsidiary trusts, net of issuance costs.......... 780.4 587.7 - Proceeds from the issuance of equity securities.............................. 52.3 20.6 1.8 Proceeds from the issuance of debt, net of issuance costs.................... 2,578.8 856.0 827.2 Commercial paper, net........................................................ 448.2 - - Common and preferred dividends............................................... (76.8) (34.3) (24.6) Dividends on stock held by subsidiaries...................................... (53.8) (38.1) (38.7) Distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts........................................... (65.7) (2.9) - Payments on debt, including prepayments and acquired debt.................... (2,218.8) (1,467.2) (330.0) Payments to retire redeemable preferred stock of a non-life subsidiary....... (72.4) (.3) - Repurchases of Conseco common stock ......................................... (593.3) (21.5) (92.4) Proceeds from the issuance of convertible preferred stock, net of issuance costs..................................................................... - 257.7 - ------- ------ ------ Total items relating to financing......................................... 778.9 157.7 343.3 ------- ------ ------ Change in short-term investments of parent and its non-life subsidiaries......................................... (65.0) 90.9 (108.3) Short-term investments, beginning of year................................. 115.1 24.2 132.5 ------- ------ ------ Short-term investments, end of year....................................... $ 50.1 $115.1 $ 24.2 ======= ====== ======
44 At December 31, 1997, the parent company and its non-life subsidiaries had short-term investments of $50.1 million, of which $28.7 million was expended in January 1998 for accrued interest and dividends. The parent company and its non-life subsidiaries had additional investments in fixed maturities, equity securities and other invested assets of $155.0 million at December 31, 1997, which, if needed, could be liquidated or contributed to the insurance subsidiaries. The ability of our insurance subsidiaries to pay dividends is subject to state insurance department regulations. These regulations generally permit dividends to be paid 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. The amount of dividends that our insurance subsidiaries could pay to non-life parent companies in 1998 without prior approval is approximately $165.1 million. Statutory operating results and statutory surplus are determined according to accounting practices prescribed or permitted by each state in which the subsidiaries do business. Statutory surplus bears no direct relationship to equity as determined under GAAP. With respect to new business, statutory accounting practices require acquisition costs and reserves for future guaranteed benefit payments and interest in excess of statutory rates to be expensed as the new business is written. These items cause a statutory loss ("surplus strain") on many insurance policies in the year in which they are issued. We manage the effect of such statutory surplus strain by designing our products to minimize such first-year losses, and by controlling the amount of new premiums written. Note 12 to the consolidated financial statements shows the difference between pretax income reported using statutory accounting practices and GAAP. Insurance departments in the states where our life insurance subsidiaries are domiciled or do business require insurance companies to make annual and quarterly filings. The interest maintenance reserve ("IMR") and the asset valuation reserve ("AVR") are required to be appropriated and reported as liabilities. The IMR captures all investment gains and losses resulting from changes in interest rates and provides for such amounts to be amortized into statutory net income on a basis reflecting the remaining lives of the assets sold. The AVR captures investment gains and losses related to changes in creditworthiness; it is also adjusted each year based on a formula related to the quality and loss experience of the Company's investment portfolio. These reserves affect the ability of our insurance subsidiaries to reflect investment gains and losses in statutory earnings and surplus. Our debt agreements require the Company to maintain minimum working capital and RBC ratios and limit the Company's ability to incur additional indebtedness. They also restrict the amount of retained earnings that is available for dividends and require Conseco to maintain certain minimum ratings at its insurance subsidiaries. INFLATION Inflation does not have a significant effect on Conseco's balance sheet; we have minimal investments in property, equipment or inventories. Medical cost inflation has had a significant impact on our supplemental health operations. Generally, these costs have increased more rapidly than the Consumer Price Index. Medical costs will likely continue to rise. The impact of medical cost inflation on our operations depends on our ability to increase premium rates. Such increases are subject to approval by state insurance departments. Before Medicare supplement plans were standardized, approximately two-thirds of the states permitted rate plans with automatic escalation clauses. This permitted Conseco, in periods following initial approval, to adjust premium rates for changes in Medicare deductibles and increases in medical cost inflation without refiling with the regulators. Currently, rate changes for all Medicare supplement plans must be individually approved by each state. We seek to price our new standardized supplement plans to reflect the impact of these filings and the lengthening of the period required to implement rate increases. YEAR 2000 CONVERSION COSTS We have initiated a corporate-wide program designed to ensure that our computer systems will function properly in the year 2000. For some of our operations, the most effective solution will be to ensure timely completion of the previously planned conversions of their older systems to more modern, year 2000 - compliant systems used in other areas of the Company. In some cases, our most effective solution will be to purchase new, more modern systems; these costs will be capitalized as assets and amortized over their expected useful lives. In other cases, we will modify existing systems, thereby incurring costs that will be charged to operating expense. To date, we have incurred $11.6 million in costs related to year 2000 projects. We expect to spend approximately an additional $35 million on these projects over the next two years. We began to incur expenses related to this program several years ago. We expect our year 2000 program to be completed on a timely basis. 45 MARKET-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT We seek to invest our available funds in a manner that will maximize shareholder value and fund future obligations to policyholders and debtors, subject to appropriate risk considerations. We seek to meet this objective through investments that: (i) have similar characteristics to the liabilities they support; (ii) are diversified among industries, issuers and geographic locations; and (iii) make up a predominantly investment-grade fixed maturity securities portfolio. Many of our products incorporate surrender charges, market interest rate adjustments or other features to encourage persistency. Approximately 59 percent of our total insurance liabilities at December 31, 1997, had surrender penalties or other restrictions and approximately 24 percent are not subject to surrender. We seek to maximize the total return on our investments through active investment management. Accordingly, we have determined that our entire portfolio of fixed maturity securities is available to be sold in response to: (i) changes in market interest rates; (ii) changes in relative values of individual securities and asset sectors; (iii) changes in prepayment risks; (iv) changes in credit quality outlook for certain securities; (v) liquidity needs; and (vi) other factors. From time to time, we invest in securities for trading purposes, although such investments account for a relatively small portion of our total portfolio. Profitability of many of our products is significantly affected by the spreads between interest yields on investments and rates credited on insurance liabilities. Although substantially all credited rates on our annuity products may be changed annually (subject to minimum guaranteed rates), changes in competition and other factors, including the impact of the level of surrenders and withdrawals, may limit our ability to adjust or to maintain crediting rates at levels necessary to avoid narrowing of spreads under certain market conditions. As of December 31, 1997, the average yield, computed on the cost basis of our investment portfolio, was 7.5 percent, and the average interest rate credited or accruing to our total insurance liabilities was 5.2 percent, excluding interest bonuses guaranteed for the first year of the annuity contract only. We use computer models to perform simulations of the cash flows generated from our existing business under various interest rate scenarios. These simulations enable us to measure the potential gain or loss in fair value of our interest rate-sensitive financial instruments. With such estimates, we seek to closely match the duration of our assets to the duration of our liabilities. When the estimated durations of assets and liabilities are similar, exposure to interest rate risk is minimized because a change in the value of assets should be largely offset by a change in the value of liabilities. At December 31, 1997, the adjusted modified duration of our fixed maturity securities and short-term investments was approximately 5.8 years and the duration of our insurance liabilities was approximately 6.7 years. If interest rates were to increase by 10 percent from their December 31, 1997 levels, our fixed maturity securities and short-term investments (net of corresponding changes in the value of cost of policies purchased, cost of policies produced and insurance liabilities) would decline in fair value by approximately $545 million. The calculations involved in our computer simulations incorporate numerous assumptions, require significant estimates and assume an immediate change in interest rates without any management of the investment portfolio in reaction to such change. Consequently, potential changes in value of our financial instruments indicated by the simulations will likely be different from the actual changes experienced under given interest rate scenarios, and the differences may be material. Because we actively manage our investments and liabilities, actual losses could be less than those estimated above. We manage the composition of our borrowed capital by considering factors such as the ratio of borrowed capital to total capital, the portion of our outstanding capital subject to fixed and variable rates, the current interest rate environment and other market conditions. Our borrowed capital at December 31, 1997, includes commercial paper, notes payable and Company-obligated mandatorily redeemable preferred securities of subsidiary trusts totaling $3.7 billion ($1.8 billion of which is at floating rates and $1.9 billion of which is at fixed rates). Based on the interest rate exposure and prevalent rates at December 31, 1997, a relative 10 percent decrease in interest rates would increase the fair value of our fixed-rate borrowed capital by approximately $75 million. Our interest expense on floating-rate debt will fluctuate as prevailing interest rates change. We periodically use options and interest rate swaps to hedge interest rate risk associated with our investments and borrowed capital. Although we had no such agreements outstanding at December 31, 1997, we entered into four interest rate swap agreements in March 1998. The Company entered into such agreements to create a hedge that effectively converts a portion of its fixed-rate borrowed capital into floating-rate instruments for the period during which the agreements are outstanding. Such interest rate swap agreements have an aggregate notional principal amount of $1.0 billion, mature in various years through 2008, and have an average remaining life of seven years. If the counterparties of these interest rate swaps do not meet their obligations, Conseco could have a loss. Conseco limits its exposure to such a loss by diversifying among several counterparties believed to be financially sound and creditworthy. At March 13, 1998, all of the counterparties were rated "A" or higher by Standard & Poor's Corporation. These swap agreements, if in existence when the assumed 10 percent decrease in interest rates occurred (see 46 preceding paragraph), would cause the increase in the fair value of our borrowed capital to be $55.0 million, or $20.0 million less than indicated in the preceding paragraph. OUTLOOK As indicated in this report, Conseco intends to continue to grow its life and health insurance operations. Conseco's operations in 1998 and in future years will be significantly affected by its recently completed acquisitions. After completing an acquisition, Conseco generally seeks to improve results of operations by centralizing, standardizing and more efficiently performing many functions common to most life insurance companies and by focusing on the sale of profitable products. In the case of Colonial Penn, which is engaged primarily in the sale of life insurance through direct marketing, many activities remain at its Philadelphia facility. Conseco believes that a number of life insurance companies will become available for acquisition in the next 10 years as a result of strategic restructuring and industry consolidation. The Company may participate in those acquisitions which fit Conseco's strategic growth plan. We evaluate a potential acquisition based on a variety of factors, including its operating results and financial condition, growth potential, management and personnel, potential return on the acquisition in relation to other investment opportunities and internal development of our existing business operations. Conseco's ability to complete acquisitions that achieve those objectives depends on a number of external factors, including: (i) the attitudes of rating agencies toward Conseco's strategic plan and capital structure; (ii) the availability and cost of both debt and equity capital; (iii) pressures that motivate companies to seek to be acquired at a reasonable cost; and (iv) competition from other acquirers, which affects the cost of acquisitions. Conseco believes it has the resources and capabilities to continue being a successful acquirer of life insurance companies. It also believes that its past record of successfully acquiring, financing and operating life insurance companies will be an advantage compared with others who may attempt to acquire available candidates. However, many acquisition targets that have been available recently did not appear to provide significant strategic benefits and their asking prices were high relative to their expected value. Management believes it is more beneficial to use Conseco's resources to improve the value of its products, distribution capabilities and operating systems rather than to complete acquisitions that do not offer comparable potential returns on its investment. Conseco continually reviews its capital structure, including the need and desirability of restructuring the existing debt and equity of the Company. As a result of its recent acquisitions, Conseco has significant in-force business and marketing activity in multiple segments of the life insurance industry, including universal life, whole life, term life, single-premium and flexible-premium deferred and immediate annuities (including variable, indexed and fixed), Medicare supplement insurance, long-term care coverage, specified- disease coverage, and individual and group health insurance. Conseco will continue to concentrate on opportunities to improve the effectiveness of its distribution systems in marketing these products. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The information included under the caption "Market-Sensitive Instruments and Risk Management" in "Item 7. Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations" is incorporated herein by reference. 47 ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Index to Consolidated Financial Statements
Page ---- Report of Management...................................................................................................49 Report of Independent Accountants......................................................................................50 Consolidated Balance Sheet at December 31, 1997 and 1996...............................................................51 Consolidated Statement of Operations for the years ended December 31, 1997, 1996 and 1995...................................................................................53 Consolidated Statement of Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995...............................................................55 Consolidated Statement of Cash Flows for the years ended December 31, 1997, 1996 and 1995...................................................................................57 Notes to Consolidated Financial Statements.............................................................................59
48 REPORT OF MANAGEMENT To Our Shareholders Management of Conseco, Inc. is responsible for the reliability of the financial information in this annual report. The financial statements are prepared in accordance with generally accepted accounting principles, and the other financial information in this annual report is consistent with that of the financial statements (except for such information described as being in accordance with regulatory or statutory accounting requirements). The integrity of the financial information relies in large part on maintaining a system of internal control that is established by management to provide reasonable assurance that assets are safeguarded and transactions are properly authorized, recorded and reported. Reasonable assurance is based upon the premise that the cost of controls should not exceed the benefits derived from them. The Company's internal auditors continually evaluate the adequacy and effectiveness of this system of internal control and actions are taken to correct deficiencies as they are identified. Certain financial information presented depends upon management's estimates and judgments regarding the ultimate outcome of transactions which are not yet complete. Management believes these estimates and judgments are fair and reasonable in view of present conditions and available information. The Company engages independent accountants to audit its financial statements and express their opinion thereon. They have full access to each member of management in conducting their audits. Such audits are conducted in accordance with generally accepted auditing standards and include a review of internal controls, tests of the accounting records, and such other auditing procedures as they consider necessary to express an opinion on the Company's financial statements. The Audit Committee of the Board of Directors, composed solely of nonmanagement directors, meets periodically with management, internal auditors and the independent accountants to review internal accounting control, audit activities and financial reporting matters. The internal auditors and the independent accountants have full and free access to the Audit Committee. Stephen C. Hilbert Rollin M. Dick Chairman of the Board, Executive Vice President and President and Chief Financial Officer Chief Executive Officer 49 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders Conseco, Inc. We have audited the accompanying consolidated balance sheet of Conseco, Inc. and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Conseco, Inc. and Subsidiaries as of December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. /S/ COOPERS & LYBRAND L.L.P. ---------------------------- COOPERS & LYBRAND L.L.P. Indianapolis, Indiana March 23, 1998 50
CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET December 31, 1997 and 1996 (Dollars in millions) ASSETS 1997 1996 ---- ---- Investments: Actively managed fixed maturities at fair value (amortized cost: 1997 - $22,289.3; 1996 - $17,203.3)............................................. $22,773.7 $17,307.1 Equity securities at fair value (cost: 1997 - $227.6; 1996 - $97.6)................ 228.9 99.7 Mortgage loans..................................................................... 516.2 356.0 Credit-tenant loans................................................................ 558.6 447.1 Policy loans....................................................................... 692.4 542.4 Other invested assets ............................................................. 518.1 259.6 Short-term investments............................................................. 990.5 281.6 Assets held in separate accounts................................................... 682.8 337.6 --------- --------- Total investments............................................................ 26,961.2 19,631.1 Accrued investment income.............................................................. 379.3 296.9 Cost of policies purchased............................................................. 2,466.4 2,015.0 Cost of policies produced.............................................................. 915.2 544.3 Reinsurance receivables................................................................ 849.1 504.2 Income tax assets...................................................................... 85.6 8.8 Goodwill (net of accumulated amortization: 1997 - $167.7; 1996 - $83.2)............... 3,637.3 2,200.8 Property and equipment (net of accumulated depreciation: 1997 - $83.8; 1996 - $69.7)... 171.6 110.5 Other assets........................................................................... 449.1 301.1 --------- --------- Total assets................................................................. $35,914.8 $25,612.7 ========= ========= (continued on next page) The accompanying notes are an integral part of the consolidated financial statements.
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CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (Continued) December 31, 1997 and 1996 (Dollars in millions) LIABILITIES AND SHAREHOLDERS' EQUITY 1997 1996 ---- ---- Liabilities: Insurance liabilities: Interest sensitive products..................................................... $17,357.6 $14,795.5 Traditional products............................................................ 5,784.8 3,251.5 Claims payable and other policyholder funds..................................... 1,668.8 984.9 Unearned premiums............................................................... 406.1 272.4 Liabilities related to separate accounts ....................................... 682.8 337.6 Investment borrowings.............................................................. 1,389.5 383.4 Other liabilities.................................................................. 995.6 709.5 Commercial paper................................................................... 448.2 - Notes payable...................................................................... 1,906.7 1,094.9 --------- --------- Total liabilities.......................................................... 30,640.1 21,829.7 --------- --------- Minority interest: Company-obligated mandatorily redeemable preferred securities of subsidiary trusts............................................................ 1,383.9 600.0 Mandatorily redeemable preferred stock of subsidiary............................... - 97.0 Common stock of subsidiary......................................................... .7 .7 Shareholders' equity: Preferred stock.................................................................... 115.8 267.1 Common stock and additional paid-in capital (no par value, 1,000,000,000 shares authorized, shares issued and outstanding: 1997 - 186,665,591; 1996 - 167,128,228)............................................................. 2,382.0 2,029.6 Accumulated other comprehensive income: Unrealized appreciation of fixed maturity securities (net of applicable deferred income taxes: 1997 - $95.5; 1996 - $21.5)................................... 177.2 39.8 Unrealized appreciation (depreciation) of other investments (net of applicable deferred income taxes: 1997 - $2.6; 1996 - $(.5))........................... 4.8 (.9) Retained earnings.................................................................. 1,210.3 749.7 --------- --------- Total shareholders' equity................................................. 3,890.1 3,085.3 --------- --------- Total liabilities and shareholders' equity................................. $35,914.8 $25,612.7 ========= ========= The accompanying notes are an integral part of the consolidated financial statements.
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CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS for the years ended December 31, 1997, 1996 and 1995 (Dollars in millions, except per share data) 1997 1996 1995 ---- ---- ---- Revenues: Insurance policy income: Traditional products............................................. $2,954.1 $1,384.3 $1,355.6 Interest sensitive products...................................... 456.7 269.9 109.4 Net investment income............................................... 1,825.3 1,302.5 1,142.6 Net investment gains................................................ 266.5 60.8 204.1 Fee revenue and other income........................................ 65.8 49.8 43.6 -------- -------- -------- Total revenues.............................................. 5,568.4 3,067.3 2,855.3 -------- -------- -------- Benefits and expenses: Insurance policy benefits........................................... 2,185.7 1,173.3 1,075.5 Change in future policy benefits.................................... 182.6 21.7 32.0 Amounts added to annuity and financial product policyholder account balances: Interest...................................................... 697.1 620.2 556.6 Other amounts added to variable and equity-indexed annuity products........................................... 109.6 48.4 28.8 Interest expense on notes payable................................... 109.4 108.1 119.4 Interest expense on short-term investment borrowings................ 42.0 22.0 22.2 Amortization related to operations.................................. 408.8 240.0 203.6 Amortization related to investment gains............................ 181.2 36.0 126.6 Nonrecurring charges................................................ 71.7 - - Other operating costs and expenses.................................. 577.2 304.0 272.1 -------- -------- -------- Total benefits and expenses................................... 4,565.3 2,573.7 2,436.8 -------- -------- -------- Income before income taxes, minority interest and extraordinary charge ................................. 1,003.1 493.6 418.5 Income tax expense...................................................... 376.6 179.8 87.0 -------- -------- -------- Income before minority interest and extraordinary charge ..................................... 626.5 313.8 331.5 Minority interest: Distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts, net of income taxes... 49.0 3.6 - Dividends on preferred stock of subsidiaries........................ 3.3 8.9 11.9 Equity in earnings of subsidiaries.................................. - 22.4 97.1 -------- -------- ------- Income before extraordinary charge ......................... 574.2 278.9 222.5 Extraordinary charge on extinguishment of debt, net of taxes and minority interest............................ 6.9 26.5 2.1 -------- -------- ------- Net income.................................................. 567.3 252.4 220.4 Less amounts applicable to preferred stock: Charge related to induced conversions............................... 13.2 - - Preferred stock dividends........................................... 8.7 27.4 18.4 -------- -------- ------- Net income applicable to common stock....................... $ 545.4 $ 225.0 $ 202.0 ======== ======== ======= (continued on next page) The accompanying notes are an integral part of the consolidated financial statements.
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CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS (Continued) for the years ended December 31, 1997, 1996 and 1995 (Dollars in millions, except per share data) 1997 1996 1995 ---- ---- ---- Earnings per common share: Basic: Weighted average shares outstanding............................ 185,751,000 104,584,000 81,405,000 Net income before extraordinary charge ........................ $2.98 $2.40 $2.51 Extraordinary charge .......................................... .04 .25 .03 ----- ----- ----- Net income................................................ $2.94 $2.15 $2.48 ===== ===== ===== Diluted: Weighted average shares outstanding............................ 210,179,000 138,860,000 103,881,000 Net income before extraordinary charge ........................ $2.67 $2.01 $2.14 Extraordinary charge........................................... .03 .19 .02 ----- ----- ----- Net income................................................ $2.64 $1.82 $2.12 ===== ===== ===== The accompanying notes are an integral part of the consolidated financial statements.
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CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY for the years ended December 31, 1997, 1996 and 1995 (Dollars in millions) Common stock Accumulated other Preferred and additional comprehensive Retained Total stock paid-in capital income earnings ----- ----- --------------- ------ -------- Balance, January 1, 1995.................................. $ 747.0 $ 283.5 $ 165.8 $(139.7) $ 437.4 Comprehensive income, net of tax: Net income........................................... 220.4 - - - 220.4 Change in unrealized appreciation (depreciation) of securities (net of applicable income taxes of $132.8 million).................................... 252.4 - - 252.4 - --------- Total comprehensive income....................... 472.8 Issuance of shares for stock options and employee benefit plans........................................ 6.0 - 6.0 - - Tax benefit related to issuance of shares under stock option plans......................................... .4 - .4 - - Cost of shares acquired................................ (92.4) - (15.0) - (77.4) Dividends on preferred stock........................... (18.4) - - - (18.4) Dividends on common stock.............................. (3.7) - - - (3.7) ---------- ------- -------- ------- --------- Balance, December 31, 1995................................ 1,111.7 283.5 157.2 112.7 558.3 Comprehensive income, net of tax: Net income........................................... 252.4 - - - 252.4 Change in unrealized appreciation (depreciation) of securities (net of applicable income tax benefit of $45.9 million)..................................... (73.8) - - (73.8) - --------- Total comprehensive income....................... 178.6 Issuance of convertible preferred stock................ 267.1 267.1 - - - Conversion of preferred stock into common shares....... - (283.2) 283.2 - - Redemption of preferred stock for cash................. (.3) (.3) - - - Issuance of shares in merger transactions.............. 1,568.6 - 1,568.6 - - Issuance of shares for stock options and employee benefit plans........................................ 29.5 - 29.5 - - Tax benefit related to issuance of shares under stock option plans......................................... 15.9 - 15.9 - - Cost of issuance of preferred stock.................... (21.7) - (21.7) - - Cost of shares acquired................................ (26.0) - (3.1) - (22.9) Dividends on preferred stock........................... (27.4) - - - (27.4) Dividends on common stock.............................. (10.7) - - - (10.7) --------- ------- -------- ------- --------- Balance, December 31, 1996................................ 3,085.3 267.1 2,029.6 38.9 749.7 (continued on following page) The accompanying notes are an integral part of the consolidated financial statements.
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CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY, continued for the years ended December 31, 1997, 1996 and 1995 (Dollars in millions) Common stock Accumulated other Preferred and additional comprehensive Retained Total stock paid-in capital income earnings ----- ----- --------------- ------ -------- Balance, December 31, 1996 (carried forward from prior page)............................................$3,085.3 $ 267.1 $2,029.6 $ 38.9 $ 749.7 Comprehensive income, net of tax: Net income........................................... 567.3 - - - 567.3 Change in unrealized appreciation (depreciation) of securities (net of applicable income taxes of $77.1 million)..................................... 143.1 - - 143.1 - -------- Total comprehensive income....................... 710.4 Conversion of preferred stock into common shares....... - (151.3) 151.3 - - Issuance of shares in merger transactions.............. 471.5 - 471.5 - - Issuance of shares for stock options and agent and employee benefit plans............................... 190.9 - 190.9 - - Tax benefit related to issuance of shares under stock option plans......................................... 85.2 - 85.2 - - Conversion of convertible debentures into common shares............................................... 150.0 - 150.0 - - Cost of shares acquired................................ (711.7) - (685.6) - (26.1) Value of stock purchase contracts, a component of the FELINE PRIDES........................................ (3.4) - (3.4) - - Other.................................................. (7.5) - (7.5) - - Amounts applicable to preferred stock: Charge related to induced conversion of convertible preferred stock.................................... (13.2) - - - (13.2) Dividends on preferred stock......................... (8.7) - - - (8.7) Dividends on common stock.............................. (58.7) - - - (58.7) -------- --------- -------- ------- -------- Balance, December 31, 1997................................$3,890.1 $ 115.8 $2,382.0 $ 182.0 $1,210.3 ======== ========= ======== ======= ======== The accompanying notes are an integral part of the consolidated financial statements.
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CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS for the years ended December 31, 1997, 1996 and 1995 (Dollars in millions) 1997 1996 1995 ---- ---- ---- Cash flows from operating activities: Net income......................................................... $ 567.3 $ 252.4 $ 220.4 Adjustments to reconcile net income to net cash provided by operating activities: Amortization and depreciation................................ 604.1 336.3 339.4 Income taxes................................................. 181.0 13.6 (34.7) Insurance liabilities........................................ (344.4) (123.8) (3.0) Amounts added to annuity and financial product policyholder account balances........................................... 806.7 668.6 585.4 Fees charged to insurance liabilities........................ (456.7) (269.9) (109.4) Accrual and amortization of investment income................ (70.5) (29.5) (71.8) Deferral of cost of policies produced........................ (602.6) (308.4) (282.1) Nonrecurring charges......................................... 71.7 - - Minority interest............................................ 75.4 26.8 91.9 Extraordinary charge on extinguishment of debt............... 10.6 36.9 3.7 Net investment gains......................................... (266.5) (60.8) (204.1) Other........................................................ (15.6) (73.9) (28.9) --------- --------- -------- Net cash provided by operating activities.................. 560.5 468.3 506.8 --------- --------- -------- Cash flows from investing activities: Sales of investments............................................... 18,459.4 8,394.1 7,900.9 Maturities and redemptions......................................... 750.7 614.3 417.1 Purchases of investments........................................... (20,043.8) (9,409.7) (9,112.3) Acquisition of subsidiaries, net of cash held at the date of the mergers......................................................... (759.7) (21.7) (586.3) Short-term investments held by CCP Insurance, Inc. before consolidation at January 1, 1995................................ - - 123.0 Repurchase of equity securities by CCP Insurance, Inc.............. - - (44.5) Cash paid in reinsurance transactions.............................. - - (71.1) Other.............................................................. - (.7) (3.3) --------- --------- -------- Net cash used by investing activities...................... (1,593.4) (423.7) (1,376.5) --------- --------- -------- (continued on next page) The accompanying notes are an integral part of the consolidated financial statements.
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CONSECO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (Continued) for the years ended December 31, 1997, 1996 and 1995 (Dollars in millions) 1997 1996 1995 ---- ---- ---- Cash flows from financing activities: Issuance of notes payable of Conseco, net.......................... $ 2,578.8 $ 856.0 $ 795.2 Issuance of Company-obligated mandatorily redeemable preferred securities of subsidiary trusts....................... 780.4 587.7 - Issuance of commercial paper, net.................................. 448.2 - - Investment borrowings.............................................. 962.5 30.6 298.1 Issuance of notes payable of affiliates, net - not direct obligations of Conseco ......................................... - 459.4 233.4 Payments on notes payable of Conseco............................... (2,273.3) (1,207.9) (330.0) Payments on notes payable of affiliates - not direct obligations of Conseco.......................................... - (926.4) (269.0) Purchase of preferred stock of a subsidiary........................ (98.4) (12.6) - Deposits to insurance liabilities.................................. 2,099.4 1,881.3 1,757.5 Withdrawals from insurance liabilities............................. (2,072.3) (1,842.5) (1,622.6) Issuance of shares for employee benefit plans...................... 52.3 20.6 1.8 Issuance of convertible preferred stock............................ - 257.7 - Issuance of equity interests in subsidiaries, net.................. - 2.2 16.8 Payments to repurchase equity securities of Conseco ............... (593.3) (21.5) (92.4) Payments related to the induced conversion of convertible preferred stock................................................. (13.2) - - Redemption of preferred stock...................................... - (.3) - Distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts....................... (65.7) (2.9) - Dividends paid..................................................... (63.6) (34.3) (24.6) --------- -------- -------- Net cash provided by financing activities.................. 1,741.8 47.1 764.2 --------- -------- -------- Net increase (decrease) in short-term investments.......... 708.9 91.7 (105.5) Short-term investments, beginning of year.............................. 281.6 189.9 295.4 --------- -------- -------- Short-term investments, end of year.................................... $ 990.5 $ 281.6 $ 189.9 ========= ======== ======== The accompanying notes are an integral part of the consolidated financial statements.
58 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ 1. SIGNIFICANT ACCOUNTING POLICIES: Basis of Presentation The following summary explains the accounting policies we use to arrive at the more significant numbers in our financial statements. We have restated all share and per-share amounts for the two-for-one stock splits distributed February 11, 1997 and April 1, 1996. We prepare our financial statements in accordance with generally accepted accounting principles ("GAAP"). We follow the accounting standards established by the Financial Accounting Standards Board, the American Institute of Certified Public Accountants and the Securities and Exchange Commission. Conseco, Inc. ("We," "Conseco" or "the Company" ) is a financial services holding company. The Company develops, markets and administers supplemental health insurance, annuity, individual life insurance, individual and group major medical insurance and other insurance products. Conseco's operating strategy is to grow the insurance business within its subsidiaries by focusing its resources on the development and expansion of profitable products and strong distribution channels. Conseco has supplemented such growth by acquiring companies that have profitable niche products and strong distribution systems. Once a company is acquired, our operating strategy has been to consolidate and streamline management and administrative functions where appropriate, to realize superior investment returns through active asset management, to eliminate unprofitable products and distribution channels and to expand and develop the profitable distribution channels and products. Consolidation issues. Conseco Capital Partners, L.P. ("Partnership I"), an investment partnership formed by Conseco with other investors, was the Company's vehicle for acquiring four insurance companies: Great American Reserve Insurance Company ("Great American Reserve") in June 1990, Jefferson National Life Insurance Company in November 1990 (it was merged with Great American Reserve in 1994), Beneficial Standard Life Insurance Company ("Beneficial Standard") in March 1991 and Bankers Life and Casualty Company ("Bankers Life") in November 1992. CCP Insurance, Inc. ("CCP"), a newly organized holding company for Partnership I's first three acquisitions, completed an initial public offering ("IPO") in July 1992. In August 1995, we completed the purchase of all the shares of CCP common stock we did not previously own in a transaction pursuant to which CCP was merged with Conseco, with Conseco being the surviving corporation (the merger and related transactions are referred to herein as the "CCP Merger"). As a result, CCP's subsidiaries (Great American Reserve and Beneficial Standard) became wholly owned subsidiaries of the Company. The accounts of CCP are consolidated with Conseco's for all periods in the accompanying financial statements. We were required to use step-basis accounting when we acquired the shares of CCP common stock in various transactions. As a result, the assets and liabilities of CCP included in our consolidated balance sheet represent the following combination of values: (i) the portion of CCP's net assets acquired by Conseco in the initial acquisitions of CCP's subsidiaries made by Partnership I is valued as of those respective acquisition dates; and (ii) the portion of CCP's net assets acquired in the CCP Merger is valued as of August 31, 1995. Bankers Life Holding Corporation ("BLH"), a company formed by Partnership I to acquire Bankers Life, completed an IPO in March 1993. As a result of the IPO and the acquisition of additional BLH common shares in September 1993, we owned 56 percent of BLH at January 1, 1995. In June 1995, we purchased additional common shares of BLH, increasing the Company's ownership of BLH to 85 percent. Conseco's ownership of BLH increased to 88 percent at December 31, 1995, and 90.5 percent at March 5, 1996, as a result of share repurchases by BLH. On December 31, 1996, we completed the purchase of all of the shares of BLH common stock we did not already own in a transaction pursuant to which BLH merged with a wholly owned subsidiary of Conseco (the "BLH Merger"). The accounts of BLH are consolidated with Conseco's accounts for all periods in the accompanying consolidated financial statements. We were required to use step-basis accounting when we acquired the BLH common shares at the various acquisition dates. The assets and liabilities of BLH included in our consolidated balance sheet represent the following combination of values: (i) the portion of BLH's net assets acquired by Conseco in the November 1992 acquisition made by Partnership I is valued as of that acquisition date; (ii) the portion of BLH's net assets acquired in 1993, 1995 and the first quarter of 1996 is valued as of the dates of their purchase; and (iii) the portion of BLH's net assets acquired in the BLH Merger is valued as of December 31, 1996. Conseco Capital Partners II, L.P. ("Partnership II"), Conseco's second investment partnership, acquired American Life Holdings, Inc. ("ALH" and the parent of American Life and Casualty Insurance Company) on September 29, 1994. Because Conseco was the sole general partner of Partnership II, Conseco controlled Partnership II and ALH even though our ownership interest was 59 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ less than 50 percent. Because of this control, Conseco's consolidated financial statements were required to include the accounts of ALH. On January 1, 1995, Conseco had a 27 percent ownership interest in ALH. On November 30, 1995, ALH issued 2,142,857 shares of its common stock for $30.0 million (including $13.2 million paid by Conseco and its subsidiaries) in a private placement transaction. Conseco's ownership interest in ALH increased to 36 percent at December 31, 1995, as a result of this transaction and changes in our ownership of affiliated companies with ownership interests in ALH. On September 30, 1996, we purchased all of the common shares of ALH we did not previously own from Partnership II for $166.0 million in cash (the "ALH Stock Purchase") and Partnership II was terminated. We were required to use step-basis accounting when we acquired the shares of ALH common stock in the ALH Stock Purchase and for our previous acquisitions. As a result, the assets and liabilities of ALH included in the December 31, 1996, consolidated balance sheet represent the following combination of values: (i) the portion of ALH's net assets acquired by Conseco in the initial acquisition of ALH made by Partnership II is valued as of September 29, 1994; (ii) the portion of ALH's net assets acquired on November 30, 1995 is valued as of that date; and (iii) the portion of ALH's net assets acquired in the ALH Stock Purchase is valued as of September 30, 1996. On August 2, 1996, we completed the acquisition (the "LPG Merger") of Life Partners Group, Inc. ("LPG") and LPG became a wholly owned subsidiary of Conseco. On December 17, 1996, we completed the acquisition (the "ATC Merger") of American Travellers Corporation ("ATC") and ATC was merged with and into Conseco, with Conseco being the surviving corporation. On December 23, 1996, we completed the acquisition (the "THI Merger") of Transport Holdings Inc. ("THI") and THI was merged with and into Conseco, with Conseco being the surviving corporation. On March 4, 1997, we completed the acquisition (the "CAF Merger") of Capitol American Financial Corporation ("CAF") and CAF became a wholly owned subsidiary of Conseco. On May 30, 1997, we completed the acquisition (the "PFS Merger") of Pioneer Financial Services, Inc. ("PFS") and PFS became a wholly owned subsidiary of Conseco. On September 30, 1997, we completed the acquisition (the "Colonial Penn Purchase") of Colonial Penn Life Insurance Company and Providential Life Insurance Company and certain other assets (collectively referred to as "Colonial Penn"). Colonial Penn became a wholly owned subsidiary of Conseco. On December 5, 1997, we completed the acquisition (the "WNIC Merger") of Washington National Corporation ("WNIC") and WNIC became a wholly owned subsidiary of Conseco. The accounts of LPG are consolidated with Conseco effective July 1, 1996; the accounts of ATC and THI are consolidated effective December 31, 1996; the accounts of CAF are consolidated effective January 1, 1997; the accounts of PFS are consolidated effective April 1, 1997; the accounts of Colonial Penn are consolidated effective September 30, 1997; and the accounts of WNIC are consolidated effective December 1, 1997. Neither "consolidation" nor "non-consolidation" methods of accounting for partially owned subsidiaries affect our reported net income or shareholders' equity. Our consolidated financial statements do not include the results of material transactions between us and our consolidated affiliates, or among our consolidated affiliates. We reclassified some amounts in our 1996 and 1995 consolidated financial statements and notes to conform with the 1997 presentation. 60 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ Investments Fixed maturities are securities that mature more than one year after issuance. They include bonds, notes receivable and preferred stocks with mandatory redemption features and are classified as follows: Actively managed - fixed maturity securities that we may sell prior to maturity in response to changes in interest rates, issuer credit quality or our liquidity requirements. We carry actively managed securities at estimated fair value. We record any unrealized gain or loss, net of tax and the related adjustments described below, as a component of shareholders' equity. Trading - fixed maturity securities that we buy principally for the purpose of selling in the near term. We carry trading securities at estimated fair value. We include any unrealized gain or loss in net investment gains (losses). We held $64.8 million of trading securities at December 31, 1997, which are included in other invested assets. We did not hold any trading securities at December 31, 1996 or 1995. Held to maturity - fixed maturity securities that we have the ability and positive intent to hold to maturity. When we own such securities, we carry them at amortized cost. We may dispose of these securities if the credit quality of the issuer deteriorates, if regulatory requirements change or under other unforeseen circumstances. We have not held any held to maturity securities since implementing SFAS 115 in 1993. We consider the anticipated returns from investing policyholder balances, including investment gains and losses, in determining the amortization of the cost of policies purchased and the cost of policies produced. When we state actively managed fixed maturities at fair value, we also adjust the cost of policies purchased and the cost of policies produced to reflect the change in cumulative amortization that we would have recorded if we had sold these securities at their fair value and reinvested the proceeds at current yields. If future yields on such securities decline, it may be necessary to increase certain of our insurance liabilities. We are required to adjust such liabilities when their balances and future net cash flows (including investment income) are insufficient to cover future benefits and expenses. The unrealized gains and losses and the related adjustments described above have no effect on our earnings. We record them, net of tax and other adjustments, to shareholders' equity. The following table summarizes the effect of these adjustments on the related balance sheet accounts as of December 31, 1997:
Effect of fair value adjustment to Balance actively managed before fixed maturity Reported adjustment securities amount ---------- ---------- ------ (Dollars in millions) Actively managed fixed maturity securities.................... $22,289.3 $ 484.4 $22,773.7 Other balance sheet items: Cost of policies purchased................................. 2,639.0 (172.6) 2,466.4 Cost of policies produced.................................. 949.9 (34.7) 915.2 Other...................................................... - (4.4) (4.4) Income tax assets.......................................... 181.1 (95.5) 85.6 ------- Unrealized appreciation of fixed maturity securities, net................................................. $ 177.2 =======
When there are changes in conditions that cause us to transfer a fixed maturity investment to a different category (i.e., actively managed, trading or held to maturity), we transfer it at its fair value on that date. We account for the security's unrealized gain or loss (such amounts were immaterial in 1997) as follows: For a transfer to the trading category - we recognize the unrealized gain or loss immediately in earnings. For a transfer from the trading category - we do not reverse the unrealized gain or loss already recognized in earnings. 61 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ For a transfer to actively managed from held to maturity - we recognize the unrealized gain or loss immediately in shareholders' equity. For a transfer to held to maturity from actively managed - we continue to report the unrealized gain or loss at the date of transfer in shareholders' equity, but we amortize the gain or loss over the remaining life of the security as an adjustment of yield. Equity securities include investments in common stocks and non-redeemable preferred stock. We treat them like actively managed fixed maturities (as described above). Credit-tenant loans ("CTLs") are loans for commercial properties. When we make these loans: (i) the lease of the principal tenant must be assigned to Conseco; (ii) the lease must produce adequate cash flow to fund substantially all the requirements of the loan; and (iii) the principal tenant or the guarantor of such tenant's obligations must have an investment-grade credit rating when the loan is made. These loans also must be collateralized by the value of the related property. Our underwriting guidelines take into account such factors as: (i) the lease term of the property; (ii) the borrower's management ability, including business experience, property management capabilities and financial soundness; and (iii) such economic, demographic or other factors that may affect the income generated by the property, or its value. The underwriting guidelines generally require a loan-to-value ratio of 75 percent or less. We carry both CTLs and traditional mortgage loans at amortized cost. As part of our investment strategy, we may enter into reverse repurchase agreements and dollar-roll transactions to increase our investment return or to improve our liquidity. We account for these transactions as collateral borrowings, where the amount borrowed is equal to the sales price of the underlying securities. Other invested assets include: (i) trading securities; (ii) Standard & Poor's 500 Call Options ("S&P 500 Call Options"); and (iii) certain non-traditional investments. Trading securities are carried at estimated fair value as described above. The S&P 500 Call Options are also carried at estimated fair value and are further described below under "Financial Instruments." Non-traditional investments include investments in venture capital funds, limited partnerships, mineral rights and promissory notes and are accounted for using either the cost method, or for investments in partnerships over whose operations the Company exercises significant influence, the equity method. Policy loans are stated at their current unpaid principal balances. Short-term investments include commercial paper, invested cash and other investments purchased with maturities of less than three months. We carry them at amortized cost, which approximates their estimated fair value. We consider all short-term investments to be cash equivalents. We defer any fees received or costs incurred when we originate investments--principally CTLs and mortgages. We amortize fees, costs, discounts and premiums as yield adjustments over the contractual lives of the investments. We consider anticipated prepayments on mortgage-backed securities in determining estimated future yields on such securities. When we sell a security (other than a trading security), we report the difference between our sale proceeds and its amortized cost as an investment gain or loss. We regularly evaluate all of our CTLs, mortgage loans and other investments based on current economic conditions, credit loss experience and other investee-specific developments. If there is a decline in a security's net realizable value that is other than temporary, we treat it as a realized loss and we reduce our cost basis of the security to its estimated fair value. Separate Accounts Separate accounts are funds on which investment income and gains or losses accrue directly to certain policyholders. The assets of these accounts are legally segregated. They are not subject to the claims that may arise out of any other business of Conseco. We report separate account assets at market value; the underlying investment risks are assumed by the contract holders. We record the related liabilities at amounts equal to the underlying assets; the fair value of these liabilities equals their carrying amount. 62 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ Cost of Policies Purchased When we acquire an insurance company, we assign a portion of its cost to the right to receive future cash flows from insurance contracts existing at the date of the acquisition. This cost of policies purchased represents the actuarially determined present value of the projected future cash flows from the acquired policies. To determine this value, we use a method that is consistent with methods commonly used to value blocks of insurance business and with the basic methodology generally used to value assets. It can be summarized as follows: - Identify the expected future cash flows from the blocks of business. - Identify the risks to realizing those cash flows (i.e., assess the probability that the cash flows will be realized). - Identify the rate of return that we must earn in order to accept these risks, based on consideration of the factors summarized below. - Determine the value of the policies purchased by discounting the expected future cash flows by the discount rate we need to earn. The expected future cash flows we use in determining such value are based on actuarially determined projections of future premium collections, mortality, surrenders, operating expenses, changes in insurance liabilities, investment yields on the assets held to back the policy liabilities and other factors. These projections take into account all factors known or expected at the valuation date, based on the collective judgment of Conseco's management. Our actual experience on purchased business may vary from projections due to differences in renewal premiums collected, investment spread, investment gains or losses, mortality and morbidity costs and other factors. The discount rate we use to determine the value of the cost of policies purchased is the rate of return we need to earn in order to invest in the business being acquired. In determining this required rate of return, we consider the following factors: - The magnitude of the risks associated with each of the actuarial assumptions used in determining expected future cash flows (as described above). - The cost of our capital required to fund the acquisition. - The likelihood of changes in projected future cash flows that might occur if there are changes in insurance regulations and tax laws. - The acquired company's compatibility with other Conseco activities that may favorably affect future cash flows. - The complexity of the acquired company. - Recent prices (i.e., discount rates used in determining valuations) paid by others to acquire similar blocks of business. After we determine the cost of policies purchased, we amortize that amount and evaluate recoverability in the same manner as cost of policies produced as described below. The cost of policies purchased related to acquisitions completed prior to November 19, 1992 (representing 8 percent of the balance of cost of policies purchased at December 31, 1997) is amortized under a slightly different method than that described above. However, the effect of the different method on 1997 net income was insignificant. 63 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ Cost of Policies Produced The costs that vary with and are primarily related to producing new business are referred to as cost of policies produced. They consist primarily of commissions, first-year bonus interest and certain costs of policy issuance and underwriting, net of fees charged to the policy in excess of ultimate fees charged. To the extent that they are recoverable from future profits, we defer these costs and amortize them, using the interest rate credited to the underlying policies, as follows: - For universal life-type contracts and investment-type contracts, in relation to the present value of expected gross profits from the contracts. - For immediate annuities with mortality risks, in relation to the present value of benefits to be paid. - For traditional life and accident and health products, in relation to future anticipated premium revenue, using the same assumptions that are used in calculating the insurance liabilities. Each year, we evaluate the recoverability of the unamortized balance of the cost of policies produced. For universal life-type contracts and investment-type contracts, we increase or decrease the accumulated amortization whenever there is a material change in the estimated gross profits expected over the life of a block of business. We do this in order to maintain a constant relationship between the cumulative amortization and the present value (discounted at the rate of interest that accrues to the policies) of expected gross profits. For most other contracts, we reduce the unamortized asset balance (by a charge to income) only when the present value of future cash flows, net of the policy liabilities, is insufficient to recover the asset balance. Goodwill Goodwill is the excess of the amount we paid to acquire a company over the fair value of its net assets. We amortize goodwill on the straight-line basis over a 40-year period. We continually monitor the value of our goodwill based on our estimates of future earnings. We determine whether goodwill is fully recoverable from projected undiscounted net cash flows from earnings of the subsidiaries over the remaining amortization period. If we were to determine that changes in such projected cash flows no longer supported 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 business segment that acquired the business if such earnings are not separately identifiable. Property and Equipment We carry property and equipment at depreciated cost. We depreciate property and equipment on a straight-line basis over the estimated useful lives of the assets, which average approximately 13 years. Our depreciation expense was $19.2 million in 1997, $11.9 million in 1996 and $9.3 million in 1995. Insurance Liabilities, Recognition of Insurance Policy Income and Related Benefits and Expenses Our reserves for universal life-type and investment-type contracts are based either on the contract account balance (if future benefit payments in excess of the account balance are not guaranteed) or on the present value of future benefit payments (if such payments are guaranteed). We make additions to insurance liabilities if we determine that future cash flows (including investment income) are insufficient to cover future benefits and expenses. For investment contracts without mortality risk (such as deferred annuities and immediate annuities with benefits paid for a period certain) and for contracts that permit either Conseco or the insured to make changes in the contract terms (such as single- premium whole life and universal life), we are required to record premium deposits and benefit payments as increases or decreases in a liability account, rather than as revenue and expense. We record as revenue any amounts charged against the liability account for the cost of insurance, policy administration and surrender penalties. We record as expense any interest credited to the liability account and any benefit payments that exceed the contract liability account balance. 64 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ We calculate our reserves for traditional and limited-payment life contracts generally using the net-level-premium method, based on assumptions as to investment yields, mortality, withdrawals and dividends. We make these assumptions at the time we issue the contract or, in the case of contracts acquired by purchase, at the purchase date. We base these assumptions on projections from past experience, modified as necessary to reflect anticipated trends and making allowance for possible unfavorable deviation. For traditional life insurance contracts, we recognize premiums as income when due or, for short-duration contracts, over the period to which the premiums relate. We recognize benefits and expenses as a level percentage of earned premiums. We accomplish this by providing for future policy benefits and by amortizing deferred policy acquisition costs. For contracts with mortality risk, but with premiums paid for only a limited period (such as single-premium immediate annuities with benefits paid for the life of the annuitant), we use an accounting treatment similar to that used for traditional contracts. An exception is that we defer the excess of the gross premium over the net premium and recognize it in relation to the present value of expected future benefit payments (when accounting for annuity contracts) or in relation to insurance in force (when accounting for life insurance contracts). We establish reserves for the estimated present value of the remaining net cost of all reported and unreported claims. We base our estimates on past experience and on published tables for disabled lives. We believe that the reserves we have established are adequate. Final claim payments, however, may differ from the established reserves, particularly when those payments may not occur for several years. Any adjustments we make to reserves are reflected in the results for the year during which the adjustments are made. The liability for future policy benefits for accident and health policies consists of active life reserves and the estimated present value of the remaining ultimate net cost of incurred claims. Active life reserves include unearned premiums and additional reserves. The additional reserves are computed on the net level premium method using assumptions for future investment yield, mortality and morbidity experience. Our assumptions are based on projections of past experience and include provisions for possible adverse deviation. For participating policies, we determine annually the amount of dividends to be paid. We include as an insurance liability the portion of the earnings allocated to participating policyholders. Reinsurance In the normal course of business, Conseco seeks to limit its exposure to loss on any single insured and to recover a portion of the benefits paid over such limits. We do this by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage and coinsurance contracts. We limit how much risk per policy we will retain. We currently retain no more than $.8 million of risk on any one policy. We report assets and liabilities related to insurance contracts before the effects of reinsurance. We report reinsurance receivables and prepaid reinsurance premiums (including amounts related to insurance liabilities) as assets. We recognize estimated reinsurance receivables in a manner consistent with the liabilities related to the underlying reinsured contracts. Income Taxes Our income tax expense includes deferred income taxes arising from temporary differences between the tax and financial reporting bases of assets and liabilities. This liability method of accounting for income taxes also requires us to reflect in income the effect of a tax-rate change on accumulated deferred income taxes in the period in which the change is enacted. In assessing the realization of deferred income tax assets, we consider whether it is more likely than not that the deferred income tax assets will be realized. The ultimate realization of deferred income tax assets depends upon generating future taxable income during the periods in which temporary differences become deductible. If future income is not generated as expected, deferred income tax assets may need to be written off. 65 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ Minority Interest Our consolidated financial statements for 1995 and 1996 include all of the assets, liabilities, revenues and expenses of BLH and ALH, even though we did not own all of the common stock of these subsidiaries until December 1996. We make a charge against consolidated income for: (i) the share of earnings allocable to minority interests; (ii) dividends on preferred stock of subsidiaries; and (iii) distributions on the Company-obligated mandatorily redeemable preferred securities of subsidiary trusts. We show the shareholders' equity of such entities allocable to the minority interests separately on our consolidated balance sheet. We report Company-obligated mandatorily redeemable preferred securities of subsidiary trusts at their book value under minority interest. We charge the distributions on these securities against consolidated income. Earnings Per Share As of December 31, 1997, we adopted Statement of Financial Accounting Standards No. 128, "Earnings Per Share"("SFAS 128"). SFAS 128 provides new accounting and reporting standards for earnings per share. It replaces primary and fully diluted earnings per share with basic and diluted earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share represents the potential dilution that could occur if all convertible securities, warrants and stock options were exercised and converted into common stock if their effect is dilutive. The diluted earnings per share calculation assumes that the proceeds received upon the conversion of all dilutive options and warrants are used to repurchase the Company's common shares at the average market price of such shares during the period. Prior period earnings per share amounts have been restated. We have also restated all share and per-share amounts for the two-for-one stock splits distributed February 11, 1997 and April 1, 1996. Comprehensive Income As of December 31, 1997, we adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes standards for reporting and presentation of comprehensive income and its components in a full set of financial statements. Comprehensive income includes all changes in shareholders' equity (except those arising from transactions with shareholders) and includes net income and net unrealized gains (losses) on securities. The new standard requires only additional disclosures in the consolidated financial statements; it does not affect our financial position or results of operations. Comprehensive income excludes net investment gains (losses) included in net income of: (i) $42.1 million (after income taxes of $22.6 million) in 1997; (ii) $(2.0) million (after income tax benefit of $1.0 million) in 1996; and (iii) $48.1 million (net of income taxes of $25.9 million) in 1995. Use of Estimates Our financial statements have been prepared in accordance with GAAP. As such, they include amounts based on our informed estimates and judgment, with consideration given to materiality. We use many estimates and assumptions calculating amortized value and recoverability of securities, cost of policies produced, cost of policies purchased, goodwill, insurance liabilities, guaranty fund assessment accruals, liabilities for litigation, and deferred income taxes. Actual results could differ from reported results using those estimates. Financial Instruments In 1996, we introduced equity-indexed annuity products, which provide a guaranteed base rate of return with a higher potential return linked to the performance of a broad-based equity 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 the equity-indexed annuity products. We reflect changes in the values of the S&P 500 Call Options, which fluctuate in relation to changes in policyholder account balances for these annuities, in net investment income. Premiums paid to purchase these instruments are deferred and amortized over their term. During the year ended December 31, 1997, net investment income increased by $39.4 million as a result of changes in the value of the S&P 500 Call Options. Such investment income was substantially offset by amounts added to policyholder account balances 66 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ for annuities and financial products. The value of the S&P 500 Call Options was $41.4 million at December 31, 1997. We classify such instruments as other invested assets. If the counterparties of the aforementioned financial instruments do not 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 December 31, 1997, all of the counterparties were rated "A"or higher by Standard & Poor's Corporation. In conjunction with its investment in a consumer financing company, Conseco has guaranteed up to $10.0 million of the financing company's indebtedness to its primary lender through 1998. Conseco believes the likelihood of a significant loss from the guarantee is remote. Fair Values of Financial Instruments We use the following methods and assumptions to determine the estimated fair values of financial instruments: Investment securities. For fixed maturity securities (including redeemable preferred stocks) and for equity and trading securities, we use quotes from independent pricing services, where available. For investment securities for which such quotes are not available, we use values obtained from broker-dealer market makers or by discounting expected future cash flows using a current market rate appropriate for the yield, credit quality, and for fixed maturity securities, the maturity of the investment being priced. Short-term investments. We use quoted market prices. The carrying amount reported on our consolidated balance sheet for these instruments approximates their estimated fair value. Mortgage loans, credit-tenant loans and policy loans. We discount future expected cash flows based on interest rates currently being offered for similar loans to borrowers with similar credit ratings. We aggregate loans with similar characteristics in our calculations. Other invested assets. We use quoted market prices, where available. For other invested assets, which are not material, we have assumed a market value equal to carrying value. Other assets. The portion of other assets in 1996 representing the value attributable to the U.S. Treasury securities held in escrow for the future redemption of mandatorily redeemable preferred stock of a subsidiary of ALH are based on quoted market prices. In 1997, the redeemable preferred stock was redeemed and the securities held in escrow were released. Insurance liabilities for investment contracts. We use discounted cash flow calculations based on interest rates currently being offered for similar contracts having maturities consistent with the contracts being valued. Investment borrowings and notes payable. We use either: (i) discounted cash flow analyses based on our current incremental borrowing rates for similar types of borrowing arrangements; or (ii) current market values for publicly traded debt. Other liabilities. The portion of other liabilities representing the value attributable to the conversion features of subordinated convertible debentures acquired in conjunction with the ATC Merger and the PFS Merger are valued at estimated fair value. Company-obligated mandatorily redeemable preferred securities of subsidiary trusts. We use quoted market prices. Mandatorily redeemable preferred stock of a subsidiary of ALH (a component of minority interest). The estimated fair value of redeemable preferred stock which is publicly-traded is based on quoted market prices. The estimated fair value of the privately placed redeemable preferred stock is determined by discounting expected future cash flows using assumed incremental dividend rates for similar duration securities. These securities were redeemed in 1997. 67 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ Here are the estimated fair values of our financial instruments:
1997 1996 ------------------------ ------------------------- Carrying Fair Carrying Fair Amount Value Amount Value ------ ----- ------ ----- (Dollars in millions) Financial assets held for purposes other than trading: Actively managed fixed maturities...................... $22,773.7 $22,773.7 $17,307.1 $17,307.1 Equity securities ..................................... 228.9 228.9 99.7 99.7 Mortgage loans......................................... 516.2 551.0 356.0 356.1 Credit-tenant loans.................................... 558.6 587.2 447.1 446.3 Policy loans........................................... 692.4 692.4 542.4 542.4 Other invested assets.................................. 453.3 453.3 259.6 259.6 Short-term investments................................. 990.5 990.5 281.6 281.6 Other assets........................................... - - 45.6 49.1 Financial liabilities held for purposes other than trading: Insurance liabilities for investment contracts (1)..... 12,724.0 12,724.0 11,491.6 11,491.6 Investment borrowings.................................. 1,389.5 1,389.5 383.4 383.4 Other liabilities...................................... 72.6 95.1 145.5 145.5 Commercial paper....................................... 448.2 448.2 - - Notes payable.......................................... 1,906.7 1,950.6 1,094.9 1,140.8 Company-obligated mandatorily redeemable preferred securities of subsidiary trusts........... 1,383.9 1,491.6 600.0 604.3 Mandatorily redeemable preferred stock of a subsidiary (a component of minority interest).................. - - 97.0 97.0 (1) The estimated fair value of the liabilities for investment contracts was approximately equal to its carrying value at December 31, 1997 and 1996. This was because interest rates credited on the vast majority of account balances approximate current rates paid on similar investments and because these rates are not generally guaranteed beyond one year. We are not required to disclose fair values for insurance liabilities, other than those for investment contracts. However, we take into consideration the estimated fair values of all insurance liabilities in our overall management of interest rate risk. We attempt to minimize exposure to changing interest rates by matching investment maturities with amounts due under insurance contracts.
Recently Issued Accounting Standards Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" ("SFAS 125") was issued in June 1996 and provides accounting and reporting standards for transfers of financial assets and extinguishments of liabilities. SFAS 125 is effective for 1997 financial statements; however, certain provisions relating to accounting for repurchase agreements and securities lending are not effective until January 1, 1998. Provisions effective in 1997 did not have any effect on our financial position or results of operations. The adoption of provisions effective in 1998 are not expected to have a material effect on our financial position or results of operations. Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131") establishes new standards for reporting about operating segments and products and services, geographic areas and major customers. Under SFAS 131, segments are to be defined consistent with the basis management uses internally to assess performance and allocate resources. Implementing SFAS 131 will have no impact on the consolidated amounts we report, and we do not expect any significant changes to our segment disclosures. SFAS 131 is effective for our December 31, 1998 financial statements. Statement of Financial Accounting Standards No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits" ("SFAS 132") was issued in February 1998 and revises current disclosure requirements for employers' pensions and other 68 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ retiree benefits. SFAS 132 will have no effect on our financial position or results of operations. SFAS 132 is effective for our December 31, 1998 financial statements. Statement of Position 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments" ("SOP 97-3") was issued by the American Institute of Certified Public Accountants in December 1997 and provides guidance for determining when an insurance company or other enterprise should recognize a liability for guaranty-fund assessments and guidance for measuring the liability. The statement is effective for 1999 financial statements with early adoption permitted. The adoption of this statement is not expected to have a material effect on our financial position or results of operations. 2. ACQUISITIONS/DISPOSITIONS: CCP Insurance, Inc. At January 1, 1995, we owned 45 percent of the common stock of CCP, which was acquired through several separate transactions beginning in 1990. In early 1995, CCP repurchased an additional 2.2 million shares under this program increasing our ownership interest to 49 percent. In August 1995, we completed the purchase of all of the shares of common stock of CCP that we did not previously own. A total of 11.8 million shares were purchased for $281.8 million (including transaction costs and the cost to settle outstanding stock options of CCP) in a transaction pursuant to which CCP was merged with Conseco, with Conseco being the surviving corporation. Income tax expense was reduced by $8.4 million in the third quarter of 1995 as a result of the release of deferred income taxes previously accrued on income related to CCP. Such deferred tax is no longer required because the CCP Merger was completed without incurring additional tax. We funded the CCP Merger with available cash and borrowings from our credit facility. Bankers Life Holding Corporation At January 1, 1995, we owned 58 percent of the common stock of BLH, which was acquired in various transactions beginning in 1992. During 1995, we acquired 12.8 million shares of BLH common stock for $262.4 million in open market and negotiated transactions, increasing our ownership of BLH to 85 percent. Income tax expense was reduced by $66.5 million in the second quarter of 1995 as a result of the release of deferred income taxes previously accrued on income related to BLH. Such deferred tax was no longer required since we were permitted to file a consolidated tax return with BLH. In addition, BLH repurchased 2.2 million shares of its common stock during 1995 at a cost of $42.1 million, increasing our ownership interest in BLH to 88 percent as of December 31, 1995. During the first three months of 1996, BLH repurchased 1.3 million shares of its common stock at a cost of $27.7 million. As a result of such repurchases, Conseco's ownership interest in BLH increased to 90.5 percent. On December 31, 1996, we completed the BLH Merger. Each outstanding share of BLH common stock not already owned by Conseco was exchanged for 0.7966 of a share of Conseco common stock. We issued 3.9 million shares of common stock (including .1 million common equivalent shares in exchange for BLH's outstanding options) with a value of $123.0 million. American Life Holdings, Inc. At January 1, 1995, we owned 27 percent of ALH through our direct investment and through our investment in Partnership II. On November 30, 1995, ALH issued 2,142,857 shares of its common stock for $30.0 million (including $13.2 million paid by Conseco and its subsidiaries) in a private placement transaction. Eighty percent of the shares were purchased by Partnership II and the remainder were purchased by the other holders of ALH common stock. The proceeds from the sale were used to reduce the amount of ALH's outstanding debt. In accordance with the Partnership II agreement, Conseco earned fees of $.2 million (net of taxes of $.1 million) for services in connection with such transaction. On September 30, 1996, we repurchased all of the common shares of ALH we did not already own for $166.0 million in cash in the ALH Stock Purchase. The Partnership II agreement provided that an additional ownership interest in ALH would be allocated to Conseco if returns to the limited partners were in excess of prescribed targets. Upon termination of Partnership II, such targets were exceeded and the additional ownership interest allocated to Conseco was recognized as follows: (i) $10.2 million, which represents Conseco's increased ownership interest in the previously reported net income of Partnership II, was recorded as a reduction of amounts that would otherwise be charged to the minority interest; and (ii) $16.6 million was recorded as net investment gains. Such income of Conseco 69 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ was offset by $16.2 million of expenses incurred in connection with the realization of the investment gains. Life Partners Group, Inc. Effective July 1, 1996, we completed the LPG Merger. Each of the issued and outstanding shares of LPG common stock was converted into 1.1666 shares of Conseco common stock. We issued 32.6 million shares of common stock (including .4 million common equivalent shares issued in exchange for LPG's outstanding options) with a value of $586.8 million. In connection with the LPG Merger, we also assumed notes payable of $253.1 million. The LPG Merger was accounted for under the purchase method of accounting. Under this method, we allocated the cost to acquire LPG to the assets and liabilities acquired based on their fair values as of July 1, 1996, and recorded the excess of the total purchase cost over the fair value of the liabilities we assumed as goodwill. The LPG Merger did not qualify to be accounted for under the pooling of interest method in accordance with Accounting Principles Board Opinion No. 16, Business Combinations ("APB No.16"), because of Conseco's significant common stock repurchases. American Travellers Corporation On December 17, 1996, we completed the ATC Merger. Each outstanding share of ATC common stock was exchanged for 1.1672 shares of Conseco common stock. We issued 21.0 million shares of common stock (including .9 million common equivalent shares issued in exchange for ATC's outstanding options) with a value of $630.9 million. We also assumed ATC's convertible subordinated debentures, which are convertible into 7.9 million shares of Conseco common stock with a value of $248.3 million (of which $102.8 million, representing the principal amount outstanding, was classified as notes payable and $145.5 million, representing the additional value attributable to the conversion feature, was classified as other liabilities). The ATC Merger was accounted for under the purchase method of accounting effective December 31, 1996. Under this method, we allocated the cost to acquire ATC to the assets and liabilities acquired based on fair values as of the date of the ATC Merger, and reported the excess of the total purchase cost over the fair value of the assets acquired less the fair value of the liabilities assumed as goodwill. The ATC Merger did not qualify to be accounted for under the pooling of interests method in accordance with APB No. 16 because an affiliate of ATC sold a portion of the Conseco common stock received in the ATC Merger shortly after the consummation of the ATC Merger. Transport Holdings Inc. On December 23, 1996, we completed the THI Merger. Each outstanding share of THI common stock was exchanged for 2.8 shares of Conseco common stock. We issued 4.9 million shares of common stock (including .4 million common equivalent shares issued in exchange for THI's outstanding options and warrants) with a value of $121.7 million. In addition, pursuant to an exchange offer, all of THI's convertible notes were exchanged for 4.2 million shares of Conseco common stock with a value of $106.2 million plus a cash premium of $11.9 million. The THI Merger was accounted for under the purchase method of accounting effective December 31, 1996. Under this method, we allocated the cost to acquire THI to the assets and liabilities acquired based on fair values as of the date of the THI Merger. There was no goodwill acquired with the THI Merger. The THI Merger did not qualify to be accounted for under the pooling of interests method in accordance with APB No. 16 because THI was a subsidiary of another corporation within two years of the transaction. Capitol American Financial Corporation On March 4, 1997, we completed the CAF Merger. Each outstanding share of CAF common stock was exchanged for $30.75 in cash plus 0.1647 of a share of Conseco common stock. We paid $552.8 million (including acquisition expenses of $14.2 million) in cash and issued 3.0 million shares of common stock (including .1 million common equivalent shares issued in exchange for CAF's outstanding options) with a value of $117.4 million. In addition, we assumed a $31.0 million note payable of CAF, which we repaid on the merger date. The CAF Merger was accounted for under the purchase method of accounting effective January 1, 1997. Under this method, we allocated the cost to acquire CAF to the assets and liabilities acquired based on fair values as of the date of the CAF Merger, and 70 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ reported the excess of the total purchase cost over the fair value of the assets acquired less the fair value of the liabilities assumed as goodwill. Pioneer Financial Services, Inc. On May 30, 1997, we completed the PFS Merger. Each outstanding share of PFS common stock was exchanged for .7077 of a share of Conseco common stock. We issued 9.0 million shares of common stock (including .6 million common equivalent shares issued in exchange for PFS's outstanding options) with a value of $354.1 million. We also assumed PFS's convertible subordinated notes, which are convertible into 3.1 million shares of Conseco common stock, with a value of $130.6 million (of which $86.3 million, representing the principal amount outstanding, was classified as notes payable and $44.3 million, representing the additional value attributable to the conversion feature, was classified as other liabilities). In addition, we assumed a $21.3 million note payable of PFS, which we repaid on the merger date. The PFS Merger was accounted for under the purchase method of accounting effective April 1, 1997. Under this method, we allocated the cost to acquire PFS to the assets and liabilities acquired based on fair values as of the date of the PFS Merger, and reported the excess of the total purchase cost over the fair value of the assets acquired less the fair value of the liabilities assumed as goodwill. The PFS Merger did not qualify to be accounted for under the pooling of interests method in accordance with APB No. 16 because an affiliate of PFS sold a portion of his holdings of PFS common stock after the PFS Merger was announced. Colonial Penn On September 30, 1997, we completed the Colonial Penn Purchase from Leucadia National Corporation ("Leucadia") for $460.0 million in cash and notes payable. The Colonial Penn Purchase was funded with: (i) $60.0 million in cash which was borrowed under our bank credit facility; and (ii) notes payable to Leucadia (the "Leucadia Notes") totaling $400.0 million. The Colonial Penn Purchase was accounted for under the purchase method of accounting effective September 30, 1997. Under this method, we allocated the cost to acquire Colonial Penn to the assets and liabilities acquired based on fair values as of the date of the Colonial Penn Purchase, and reported the excess of the total purchase cost over the fair value of the assets acquired less the fair value of the liabilities assumed as goodwill. Washington National Corporation On December 5, 1997, we completed the WNIC Merger. In the merger, each share of WNIC common stock was converted into the right to receive $33.25 in cash. We paid $400.6 million in cash, of which $73.7 million was funded through a dividend to Conseco from WNIC. The remaining purchase price was funded with amounts borrowed under our bank credit facilities. We accounted for the WNIC Merger under the purchase method of accounting effective December 1, 1997. Under this method, we allocated the cost to acquire WNIC to the assets and liabilities acquired based on fair values as of the date of the WNIC Merger, and reported the excess of the total purchase cost over the fair value of the assets acquired less the fair value of the liabilities assumed as goodwill. Effect of Merger Transactions on Consolidated Financial Statements We used purchase accounting to account for all our acquisitions during 1997, 1996 and 1995. We allocated the total purchase cost of acquisitions completed in 1997 to the assets and liabilities acquired, based on a preliminary determination of their fair values. We may adjust this allocation when we make a final determination of such values (within one year of the acquisition date). We don't expect any adjustment to be material, however. The following unaudited pro forma results of operations of the Company are presented as if the following had occurred as of January 1, 1995: (i) the LPG Merger; (ii) the call for redemption of Conseco's Series D Convertible Preferred Stock (the "Series D Call") completed on September 26, 1996; (iii) the ALH Stock Purchase; (iv) the issuance of $600.0 million of Company-obligated mandatorily redeemable preferred securities of subsidiary trusts (see note 8); (v) the ATC Merger; (vi) the THI Merger; (vii) the BLH Merger; (viii) the CCP Merger; (ix) the increase of Conseco's ownership in BLH to 90.4 percent, as a result of purchases of BLH common shares in 1995 and 1996; (x) the issuance of 4.37 million shares of Preferred Redeemable Increased Dividend Equity 71 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ Securities, 7% PRIDES Convertible Preferred Stock ("PRIDES") in January 1996; (xi) the BLH tender offer for and repurchase of its 13 percent senior subordinated notes due 2002 and related financing transactions completed in March 1996; and (xii) the debt restructuring of ALH in the fourth quarter of 1995. The pro forma data are not necessarily indicative of the results of Conseco's operations had these transactions occurred on January 1, 1995, nor the results of future operations. We have not presented pro forma data for the 1997 acquisitions because, in accordance with the disclosure requirements of the Securities and Exchange Commission, such acquisitions are not significant individually or in the aggregate.
1996 1995(1) ---- ------- (Dollars in millions, except per share data) Revenues...................................................................................... $3,967.8 $4,031.6 Income before extraordinary charge............................................................ 352.7 314.1 Income before extraordinary charge per common share: Basic.................................................................................... $2.10 $1.80 Diluted.................................................................................. 1.79 1.63 (1) We have excluded $74.9 million from pro forma income before extraordinary charge and $.39 from income before extraordinary charge per diluted common share. These amounts related to the release of deferred income taxes that are no longer required to be accrued as a result of the CCP Merger and the purchase of additional BLH common shares in 1995.
3. INVESTMENTS: At December 31, 1997, the amortized cost and estimated fair value of actively managed fixed maturities were as follows:
Gross Gross Estimated Amortized unrealized unrealized fair cost gains losses value ---- ----- ------ ----- (Dollars in millions) United States Treasury securities and obligations of United States government corporations and agencies.................. $ 541.4 $ 20.9 $ .1 $ 562.2 Obligations of states and political subdivisions........................ 277.1 8.3 .8 284.6 Debt securities issued by foreign governments........................... 204.3 4.4 9.6 199.1 Public utility securities............................................... 2,267.5 69.0 26.0 2,310.5 Other corporate securities.............................................. 12,300.5 352.9 86.5 12,566.9 Mortgage-backed securities ............................................. 6,698.5 156.0 4.1 6,850.4 --------- ------ ------ --------- Total actively managed fixed maturities.......................... $22,289.3 $611.5 $127.1 $22,773.7 ========= ====== ====== =========
At December 31, 1996, the amortized cost and estimated fair value of actively managed fixed maturities were as follows:
Gross Gross Estimated Amortized unrealized unrealized fair cost gains losses value ---- ----- ------ ----- (Dollars in millions) United States Treasury securities and obligations of United States government corporations and agencies.................. $ 509.9 $ 5.1 $ 1.2 $ 513.8 Obligations of states and political subdivisions........................ 103.5 2.8 .2 106.1 Debt securities issued by foreign governments........................... 144.4 1.4 2.2 143.6 Public utility securities............................................... 2,148.8 42.8 35.4 2,156.2 Other corporate securities.............................................. 8,808.3 145.1 81.2 8,872.2 Mortgage-backed securities ............................................. 5,488.4 64.5 37.7 5,515.2 --------- ------ ------ --------- Total actively managed fixed maturities.......................... $17,203.3 $261.7 $157.9 $17,307.1 ========= ====== ====== =========
72 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ At December 31, 1997, the amortized cost and estimated fair value of actively managed fixed maturities based upon the pricing source used to determine estimated fair value were as follows:
Estimated Amortized fair cost value ---- ----- (Dollars in millions) Nationally recognized pricing services............................................................ $18,272.9 $18,703.7 Broker-dealer market makers....................................................................... 1,808.9 1,831.8 Internally developed methods (calculated based on a weighted-average current market yield of 7.0 percent)........................................................... 2,207.5 2,238.2 --------- --------- Total actively managed fixed maturities.................................................... $22,289.3 $22,773.7 ========= =========
The following table sets forth fixed maturity investments at December 31, 1997, classified by rating categories. The category assigned is the highest rating by a nationally recognized statistical rating organization or, as to $651.2 million fair value of fixed maturities not rated by such firms, the rating assigned by the National Association of Insurance Commissioners ("NAIC"). For purposes of the table, NAIC Class 1 is included in the "A" rating; Class 2, "BBB-"; Class 3, "BB-"; and Classes 4-6, "B+ and below."
Percent of Percent of Investment rating fixed maturities total investments ----------------- ---------------- ----------------- AAA.................................. 35% 29% AA................................... 8 7 A.................................... 24 20 BBB+................................. 8 7 BBB.................................. 11 9 BBB- ................................ 7 6 ----- --- Investment grade................. 93 78 ----- --- BB+.................................. 2 2 BB................................... 1 1 BB-.................................. 1 1 B+ and below......................... 3 2 ----- --- Below-investment grade............ 7 6 ----- --- Total fixed maturities........ 100% 84% === ==
The following table sets forth below-investment-grade fixed maturity investments as of December 31, 1997, summarized by the amount their amortized cost exceeds fair value:
Estimated Amortized fair cost value ---- ----- (Dollars in millions) Amortized cost exceeds fair value by 30% or more.................................................$ 9.5 $ 4.7 Amortized cost exceeds fair value by 15%, but less than 30%...................................... 141.3 110.0 Amortized cost exceeds fair value by 5%, but less than 15%....................................... 158.7 142.3 All others....................................................................................... 1,215.6 1,239.2 -------- -------- Total below-investment-grade fixed maturity investments................................... $1,525.1 $1,496.2 ======== ========
73 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ The following table sets forth the amortized cost and estimated fair value of actively managed fixed maturities at December 31, 1997, by contractual maturity. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties and because most mortgage-backed securities provide for periodic payments throughout their lives.
Estimated Amortized fair cost value ---- ----- (Dollars in millions) Due in one year or less......................................................................... $ 238.9 $ 239.8 Due after one year through five years........................................................... 2,243.1 2,264.7 Due after five years through ten years.......................................................... 5,481.4 5,539.5 Due after ten years............................................................................. 7,627.4 7,879.3 --------- --------- Subtotal................................................................................... 15,590.8 15,923.3 Mortgage-backed securities...................................................................... 6,698.5 6,850.4 --------- --------- Total actively managed fixed maturities ................................................ $22,289.3 $22,773.7 ========= =========
Equity securities consisted of the following:
December 31, 1997 December 31, 1996 -------------------- -------------------- Estimated Estimated fair fair Cost value Cost value ---- ----- ---- ----- (Dollars in millions) Preferred stock, non-redeemable.......................................... $149.3 $152.5 $64.7 $66.3 Common stock............................................................. 78.3 76.4 32.9 33.4 ------ ------ ------ ----- Total equity securities........................................... $227.6 $228.9 $97.6 $99.7 ====== ====== ===== =====
Net investment income consisted of the following:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Fixed maturities..................................................................... $1,467.5 $1,109.5 $ 988.6 Equity securities.................................................................... 23.6 6.5 2.8 Mortgage loans....................................................................... 39.5 42.6 43.3 Credit-tenant loans.................................................................. 44.5 28.8 19.7 Policy loans......................................................................... 38.6 25.9 19.4 Equity-indexed products.............................................................. 39.4 - - Other invested assets................................................................ 74.8 27.8 17.5 Short-term investments............................................................... 39.6 15.6 26.4 Separate accounts.................................................................... 70.3 48.4 28.8 -------- -------- -------- Gross investment income........................................................ 1,837.8 1,305.1 1,146.5 Investment expenses.................................................................. 12.5 2.6 3.9 -------- -------- -------- Net investment income.......................................................... $1,825.3 $1,302.5 $1,142.6 ======== ======== ========
The carrying value of fixed maturity investments and mortgage loans not accruing investment income totaled $3.1 million, $2.1 million and $1.5 million at December 31, 1997, 1996 and 1995, respectively. 74 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ The proceeds from sales of fixed maturity investments were $18.1 billion in 1997, $8.2 billion in 1996, and $7.9 billion in 1995. Investment gains (losses), net of investment gain expenses, were included in revenue as follows:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Fixed maturities: Gross gains......................................................................... $342.6 $126.8 $270.8 Gross losses........................................................................ (41.4) (52.5) (17.5) Other than temporary decline in fair value.......................................... (1.2) (.6) (21.9) ------ ------ ------ Net investment gains from fixed maturities before expenses..................... 300.0 73.7 231.4 Equity securities....................................................................... 13.2 2.6 .4 Mortgages............................................................................... (.8) (.4) (2.1) Other than temporary decline in fair value of other invested assets..................... - (8.3) (3.0) Other................................................................................... (1.2) 29.9 13.9 ------ ------ ------ Net investment gains before expenses........................................... 311.2 97.5 240.6 Investment gain expenses................................................................ 44.7 36.7 36.5 ------ ------ ------ Net investment gains........................................................... $266.5 $ 60.8 $204.1 ====== ======= ======
Changes in unrealized appreciation (depreciation) on investments were as follows:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Investments carried at fair value: Actively managed fixed maturities .................................................. $380.6 $(504.4) $981.6 Equity securities................................................................... (.8) .1 5.4 Other investments................................................................... 9.6 (2.2) (2.7) ------ ------- ------- 389.4 (506.5) 984.3 Equity in unrealized appreciation of CCP's investments.................................. - - 46.2 Adjustment for effect on other balance sheet accounts: Cost of policies purchased ......................................................... (128.4) 141.6 (269.6) Cost of policies produced........................................................... (36.4) 45.4 (56.7) Other............................................................................... (4.4) - - Income taxes........................................................................ (77.1) 116.4 (246.5) Minority interest................................................................... - 129.3 (205.3) ------ ------- ------- Change in unrealized appreciation (depreciation) of investments ............... $143.1 $ (73.8) $ 252.4 ====== ======= =======
At December 31, 1997, net appreciation of equity securities (before income tax) was $1.3 million, consisting of $7.3 million of appreciation and $6.0 million of depreciation. At December 31, 1997, the amortized cost and fair value of fixed maturity investments in default as to the payment of principal and interest totaled $2.4 million and $1.5 million, respectively. Conseco recorded writedowns of fixed maturity investments and other invested assets of $1.2 million in 1997, $8.9 million in 1996 and $24.9 million in 1995. These writedowns were the result of changes in conditions that caused the Company to conclude that the decline in fair value of the investment was other than temporary. Investment income forgone due to defaulted securities was $.2 million in 1997, $3.8 million in 1996 and $1.6 million in 1995. 75 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ Investments in mortgage-backed securities at December 31, 1997, included collateralized mortgage obligations ("CMOs") of $3,210.2 million and mortgage-backed pass-through securities of $3,640.2 million. CMOs are securities backed by pools of pass-through securities and/or mortgages that are segregated into sections or "tranches." These securities provide for sequential retirement of principal, rather than the pro rata share of principal return that occurs through regular monthly principal payments on pass-through securities. The following table sets forth the par value, amortized cost and estimated fair value of investments in mortgage-backed securities including CMOs at December 31, 1997, summarized by interest rates on the underlying collateral:
Par Amortized Estimated value cost fair value ----- ---- ---------- (Dollars in millions) Below 7 percent .................................................................... $2,025.5 $1,980.4 $2,014.7 7 percent - 8 percent............................................................... 3,568.0 3,546.5 3,638.2 8 percent - 9 percent............................................................... 712.9 716.1 730.5 9 percent and above................................................................. 445.1 455.5 467.0 -------- -------- -------- Total mortgage-backed securities.................................. $6,751.5 $6,698.5 $6,850.4 ======== ======== ========
The amortized cost and estimated fair value of mortgage-backed securities including CMOs at December 31, 1997, 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................ $4,599.7 $4,697.5 21% Planned amortization classes and accretion directed bonds..................... 1,515.9 1,547.6 7 Support classes............................................................... 36.0 36.9 - Accrual (Z tranche) bonds..................................................... 27.9 28.8 - Subordinated classes ......................................................... 519.0 539.6 2 -------- -------- -- Total mortgage-backed securities............................. $6,698.5 $6,850.4 30% ======== ======== ==
At December 31, 1997, approximately 73 percent of the estimated fair value of Conseco's mortgage-backed securities was determined by nationally recognized pricing services, 8 percent was determined by broker-dealer market makers, and 19 percent was determined by internally developed methods. The call-adjusted modified duration of our mortgage-backed securities was 5.2 years at December 31, 1997. At December 31, 1997, the mortgage loan balance was primarily comprised of commercial loans, including multifamily residential loans. Approximately 20 percent, 11 percent and 9 percent of the mortgage loan balance were on properties located in California, Texas and Florida, respectively. No other state comprised greater than 7 percent of the mortgage loan balance. Less than 2 percent of the mortgage loan balance was noncurrent at December 31, 1997. At December 31, 1997, the Company had an allowance for loss on mortgage loans of $9.0 million. At December 31, 1997, we held $558.6 million of CTLs. CTLs are mortgage loans for commercial properties that we make based on the underwriting guidelines described in note 1. We classify CTLs as a separate class of securities because they are principally underwritten based on the creditworthiness of the tenant rather than the value of the underlying property. As with commercial mortgages, CTLs are additionally collateralized by liens on the underlying property. As part of its investment strategy, the Company enters into reverse repurchase agreements and dollar-roll transactions to increase its return on investments and improve its liquidity. Reverse repurchase agreements involve a sale of securities and an 76 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ agreement to repurchase the same securities at a later date at an agreed upon price. Dollar rolls are similar to reverse repurchase agreements except that, with dollar rolls, the repurchase involves securities that are only substantially the same as the securities sold. These transactions are accounted for as short-term collateralized borrowings. Such borrowings averaged approximately $719.3 million during 1997 (compared with an average of $424.7 million during 1996) and were collateralized by investment securities with fair values approximately equal to the loan value. The weighted average interest rate on short-term collateralized borrowings was 5.8 percent in 1997 and 5.2 percent in 1996. The primary risk associated with short-term collateralized borrowings is that the counterparty will be unable to perform under the terms of the contract. The Company's exposure is limited to the excess of the net replacement cost of the securities over the value of the short-term investments (which was not material at December 31, 1997). The Company believes that the counterparties to its reverse repurchase and dollar-roll agreements are financially responsible and that the counterparty risk is minimal. Other invested assets include: (i) trading securities of $64.8 million; (ii) S&P 500 Call Options issued in conjunction with equity-indexed annuities described in note 1 of $41.4 million; and (iii) certain non-traditional investments, including investments in venture capital funds, limited partnerships, mineral rights and promissory notes of $411.9 million. During 1996, Conseco sold its non-traditional investment in Noble Broadcast Group, Inc. and realized a gain of $30.0 million. During 1995, Conseco sold its non-traditional investment in Eagle Credit (a finance subsidiary of Harley-Davidson) and realized a gain of $20.6 million. Life insurance companies are required to maintain certain investments on deposit with state regulatory authorities. Such assets had an aggregate carrying value of $202.5 million at December 31, 1997. Conseco had no investments in any single entity in excess of 10 percent of shareholders' equity at December 31, 1997, other than investments issued or guaranteed by the United States government or a United States government agency. 4. INSURANCE LIABILITIES: Insurance liabilities consisted of the following:
Interest Withdrawal Mortality rate assumption assumption assumption 1997 1996 ---------- ---------- ---------- ---- ---- (Dollars in millions) Future policy benefits: Interest-sensitive products: Investment contracts............................ N/A N/A (c) $12,724.0 $11,491.6 Universal life-type contracts................... N/A N/A 5% 4,633.6 3,303.9 --------- --------- Total interest-sensitive products............. 17,357.6 14,795.5 --------- --------- Traditional products: Traditional life insurance contracts............ Company (a) 4% 1,925.0 1,234.7 experience Limited-payment contracts....................... None (b) 6% 968.4 761.5 Individual accident and health ................. Company Company 6% 2,820.4 1,184.0 experience experience Group life and health........................... N/A N/A N/A 71.0 71.3 --------- --------- Total traditional products.................... 5,784.8 3,251.5 --------- --------- Claims payable and other policyholder funds ........ N/A N/A N/A 1,668.8 984.9 Unearned premiums................................... N/A N/A N/A 406.1 272.4 Liabilities related to separate accounts............ N/A N/A N/A 682.8 337.6 --------- --------- Total insurance liabilities..................... $25,900.1 $19,641.9 ========= ========= (a) Principally modifications of the 1965 - 70 and 1975 - 80 Basic, Select and Ultimate Tables. 77 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ (b) Principally the 1984 United States Population Table and the NAIC 1983 Individual Annuitant Mortality Table. (c) In both 1997 and 1996: (i) approximately 95 percent of this liability represented account balances where future benefits are not guaranteed; and (ii) 5 percent represented the present value of guaranteed future benefits determined using an average interest rate of approximately 5 percent.
Participating policies represented approximately 2 percent, 2 percent and 12 percent of total life insurance in force at December 31, 1997, 1996 and 1995, respectively. Participating policies represented approximately 2 percent, 1 percent and 1 percent of premium income for the years ended December 31, 1997, 1996 and 1995, respectively. Dividends on participating policies amounted to $13.0 million, $13.4 million and $12.3 million in 1997, 1996 and 1995, respectively. 5. REINSURANCE: Cost of reinsurance ceded where the reinsured policy contains mortality risks totaled $499.0 million, $313.8 million and $72.6 million in 1997, 1996 and 1995, respectively. This cost was deducted from insurance premium revenue. Conseco is contingently liable for claims reinsured if the assuming company is unable to pay. Reinsurance recoveries netted against insurance policy benefits totaled $587.5 million, $281.4 million, and $59.8 million in 1997, 1996 and 1995, respectively. The Company has ceded certain policy liabilities under assumption reinsurance agreements. Since all of Conseco's obligations under these insurance contracts have been ceded to another company, insurance liabilities related to such policies were not reported in the balance sheet. We believe the assuming companies are able to honor all contractual commitments under the assumption reinsurance agreements, based on our periodic reviews of financial statements, insurance industry reports and reports filed with state insurance departments. The Company's reinsurance receivable at December 31, 1997, relates to approximately 181 reinsurers. Two major United States insurance companies rated "A (Excellent)" or better by A.M. Best Company, a recognized insurance rating agency, account for approximately 19 percent of such balance. Each of our other reinsurers (the majority of which are rated "A- (Excellent)" or better) accounts individually for less than 4 percent of reinsurance receivables. 6. INCOME TAXES: Income tax assets (liabilities) were comprised of the following:
1997 1996 ---- ---- (Dollars in millions) Deferred income tax assets (liabilities): Investments................................................................................... $ (95.9) $ 52.2 Cost of policies purchased and cost of policies produced...................................... (750.5) (573.7) Insurance liabilities......................................................................... 898.9 474.0 Unrealized appreciation....................................................................... (98.1) (21.0) Net operating loss carryforward............................................................... 258.0 154.4 Other......................................................................................... (136.6) (87.6) -------- -------- Deferred income tax assets (liabilities)................................................ 75.8 (1.7) Current income tax assets ........................................................................ 9.8 10.5 -------- -------- Income tax assets....................................................................... $ 85.6 $ 8.8 ======== ========
Income tax expense was as follows:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Current tax provision......................................................................... $174.0 $110.5 $121.0 Deferred tax provision (benefit).............................................................. 202.6 69.3 (34.0) ------ ------ ------ Income tax expense................................................................ $376.6 $179.8 $ 87.0 ====== ====== ======
78 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ Income tax expense differed from that computed at the applicable federal statutory rate (35 percent) for the following reasons:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Tax on income before income taxes at statutory rate........................................... $351.1 $172.8 $146.5 Goodwill ............................................................................... 29.6 12.3 7.9 State taxes................................................................................... 12.4 7.3 .3 Other......................................................................................... (16.5) (12.6) 7.2 Reversal of deferred tax liabilities as a result of increased ownership in certain subsidiaries...................................................................... - - (74.9) ------ ------ ------- Income tax expense................................................................ $376.6 $179.8 $ 87.0 ====== ====== =======
At December 31, 1997, Conseco had federal income tax loss carryforwards of $737.1 million available (subject to various statutory restrictions) for use on future tax returns. Portions of these carryforwards begin expiring in 1999. Of the loss carryforwards: (i) $25.3 million may be used only to offset income from the non-life insurance companies and, under certain circumstances, a portion of the income of life insurance companies; and (ii) $77.5 million are attributable to acquired companies and may be used only to offset the income from those companies. None of the carryforwards are available to reduce the tax provision for financial reporting purposes. With respect to determining that the Company's net operating loss carryforwards will be fully utilized, the Company is relying upon its past history of earnings. The IRS has completed its examination of Conseco's consolidated tax returns for years through 1994 and is currently conducting an examination for years 1995 through 1996. Certain companies acquired in the LPG Merger have been audited by the IRS through 1994. Colonial Penn Life Insurance Company is currently being examined for the tax years 1992 and 1993. Conseco believes the adjustment, if any, related to these audits will not be significant. 7. NOTES PAYABLE AND COMMERCIAL PAPER: Notes payable and commercial paper of the Company at December 31, 1997 and 1996, were as follows:
Interest rate 1997 1996 ------------- ---- ---- (Dollars in millions) Bank debt............................................................ 6.23% (1) $1,000.0 (2) $ 465.0 Leucadia Notes....................................................... 6.44% (1) 400.0 - Senior notes due 2003................................................ 8.125% 168.5 170.0 Senior notes due 2004................................................ 10.5% 184.9 200.0 Subordinated notes due 2004.......................................... 11.25% 10.9 98.1 Convertible subordinated notes due 2003.............................. 6.5% 86.1 - Convertible subordinated debentures due 2005......................... 6.5% 29.1 102.8 Other................................................................Various 21.3 45.2 -------- -------- Total principal amount.......................................... 1,900.8 1,081.1 Unamortized net premium.............................................. 5.9 13.8 -------- -------- Total........................................................... $1,906.7 $1,094.9 ======== ======== Commercial paper..................................................... 5.8% (3) $ 448.2 - ======== ======== (1) Current rate at December 31, 1997. (2) See note 15 for description of $248.0 million repayment in 1998 using proceeds from the offering of 6.4 percent notes due February 10, 2003. (3) Weighted average rate during 1997.
79 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ Maturities of notes payable at December 31, 1997, were as follows:
Maturity date Amount ------------- ------ (Dollars in millions) 1998....................................................................... $ 601.1 (1) 1999....................................................................... 1.1 2000....................................................................... 1.1 2001....................................................................... 401.1 2002....................................................................... 2.0 Thereafter................................................................. 894.4 -------- Total par value at December 31, 1997.................................. $1,900.8 ======== (1) See note 15 for description of $248.0 million repayment in 1998 using proceeds from the offering of 6.4 percent notes due February 10, 2003.
Bank debt. Bank debt is comprised of our revolving bank credit facility and various bank loans described below. The Company's current revolving credit agreement (the "Credit Facility"), executed in November 1996, permits borrowings up to $1.4 billion. Maximum permitted borrowings under the Credit Facility are reduced by any aggregate outstanding commercial paper of Conseco. At December 31, 1997, outstanding borrowings under the Credit Facility totaled $400.0 million. Borrowings bear interest at the bank's base rate, a Eurodollar rate or a rate determined based on a solicitation of bids from lenders. Eurodollar rates are equal to the reserve-adjusted LIBOR rate plus a margin of .225 percent to .75 percent, based on the credit rating of Conseco's senior notes. The current margin of .35 percent will increase by .125 percent after December 31, 1997, if Conseco's debt to total capitalization ratio exceeds 35 percent. Borrowings at December 31, 1997, bore interest at a weighted average rate of 6.21 percent. The Credit Facility also permits revolving Swingline loans up to $50.0 million. Such loans are due within 7 days and bear interest at the bank's base rate or a reserve adjusted three-month CD rate plus the Eurodollar rate margin and an assessment rate. Borrowings are due in November 2001. Mandatory prepayments, which reduce the maximum permitted borrowings, are required under the Credit Facility upon the sale or disposition of any significant assets other than in the ordinary course of business. The Credit Facility contains various restrictive covenants that primarily pertain to levels of indebtedness, limitations on payment of dividends, limitations on the quality and types of investments, and capital expenditures. Additionally, the Company must comply with several financial covenant restrictions, including maintaining: (i) shareholders' equity and Company-obligated mandatorily redeemable preferred securities of subsidiary trusts in excess of $2.4 billion in 1997 and 1998 and $3.5 billion thereafter; (ii) the interest coverage ratio in excess of 2.5:1 through December 1997 (escalating to 2.75:1 during the period January 1, 1998 through December 31, 1999; and 3.0:1 thereafter); and (iii) the debt to total capital ratio less than .45:1. As of December 31, 1997 the Company was in compliance with all covenants under its debt agreements. On the last day of each quarter, we pay a commitment fee that ranges from .08 percent to .25 percent per annum (depending on the credit rating of Conseco's senior debt) on the average daily unused commitments during the quarter. This fee was .125 percent per annum during 1997. During 1997, Conseco entered into various unsecured bank loans totaling $600 million. The proceeds from such bank loans were used: (i) to finance the WNIC Merger; (ii) to finance a portion of the Colonial Penn Purchase; (iii) to redeem all of the $2.16 Redeemable Cumulative Preferred Stock of a subsidiary formerly held by minority interest; and (iv) for general corporate purposes. The interest rates on these bank loans are based on LIBOR and averaged 6.25 percent at December 31, 1997. These bank loans mature at various dates through September 1998. We recognized an extraordinary loss of $12.9 million during 1996 (net of a $7.0 million tax benefit) as a result of prepaying our prior bank credit agreements and the bank credit agreements of BLH and ALH. Leucadia Notes. Conseco entered into these notes in conjunction with the Colonial Penn Purchase. The notes bear interest 80 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ at the one month LIBOR rate plus a margin of .50 percent payable semi-annually on March 31 and September 30. Such rate was 6.44 percent at December 31, 1997. The notes mature on January 2, 2003 and may be put back to Conseco by the holder at any time after December 31, 1997, in the event that: (i) all or substantially all of Leucadia's assets are sold; or (ii) there is an acquisition of beneficial ownership of 20 percent or more of Leucadia's voting securities. In addition, the notes are putable (in whole or in increments of $10 million of par value) at any time on or after September 30, 1999, at a discount to par. The discount rate is equal to (i) 3 percent of the then outstanding principal balance during the period September 30, 1999, through September 29, 2000; (ii) 2 percent of the then outstanding principal balance during the period September 30, 2000, through September 29, 2001; and (iii) 1 percent of the then outstanding principal balance thereafter prior to maturity. The notes and accrued interest thereon are secured by standby letters of credit totaling $420.0 million which Conseco may use to fund redemption of the notes. Such letters of credit expire on September 30, 1998, but may be extended in one-year increments through 2003. The Company pays a fee on the letters of credit based upon the credit rating of Conseco's senior debt. At December 31, 1997, such fee was .20 percent per annum on the $420.0 million of outstanding letters of credit. 8.125% senior notes due 2003 were issued to the public in 1993, are unsecured and rank pari passu with all other unsecured and unsubordinated indebtedness of the Company. The notes are not redeemable prior to maturity. We recognized an extraordinary charge of $.1 million during 1997 as a result of repurchasing $1.5 million par value of these notes. 10.5% senior notes due 2004 were issued to the public by CCP in 1994, are unsecured and rank pari passu with all other unsecured and unsubordinated indebtedness of Conseco. The notes are not redeemable prior to maturity. We recognized an extraordinary charge of $1.2 million (net of a $.6 million tax benefit) during 1997 as a result of repurchasing $15.1 million par value of these notes. 11.25% senior subordinated notes due 2004 were issued to the public by ALH in conjunction with its acquisition by Partnership II. Such notes are unsecured and will be subordinated in the right of payment to the prior payment in full of all senior indebtedness. The notes are redeemable at the Company's option, in whole or in part, at any time on or after September 15, 1999, initially at 105.625 percent of their principal amount, plus accrued interest, declining to 100 percent of their principal amount, plus accrued interest, on and after September 15, 2001. We recognized an extraordinary charge of $5.6 million (net of a $3.0 million tax benefit) during 1997 as a result of repurchasing $87.2 million par value of these notes. We recognized an extraordinary charge of $4.2 million (net of a $2.3 million tax benefit) during 1996 as a result of repurchasing $51.9 million par value of these notes. 6.5% convertible subordinated notes due 2003 were acquired in conjunction with the PFS Merger and bear interest at 6.5 percent payable semi-annually on April 1 and October 1. The notes are redeemable by Conseco, under certain conditions, at 103.3 percent of par value after April 1999 under certain conditions. The notes are convertible into Conseco common stock any time prior to maturity at a conversion rate of 35.38 Conseco common shares per $1,000 principal amount of notes. During 1997, $.2 million par value of the notes were converted into 6,613 shares of Conseco common stock. At December 31, 1997, the value of the remaining debentures in excess of the principal balance (the value attributable to the conversion feature) of $34.4 million is included in other liabilities. 6.5% convertible subordinated debentures due 2005 were acquired in conjunction with the ATC Merger and are convertible into Conseco common stock at any time prior to maturity, at a conversion ratio of 76.96 shares of Conseco common stock for each $1,000 principal amount of debentures. The convertible debentures may be redeemed at Conseco's option at a price equal to 103.25 percent after October 1998, declining to 100 percent after October 2001. During 1997, we induced the conversion of $64.8 million par value of the debentures into 5.0 million shares of Conseco common stock. Conseco paid $4.4 million to induce the holders to convert. In addition, during 1997, Conseco repurchased $7.5 million par value of the debentures for $24.8 million. An additional $1.4 million par value of the debentures was converted into .1 million shares of Conseco common stock at the option of the holders during 1997. At December 31, 1997, the value of the remaining debentures in excess of the principal balance (the value attributable to the conversion feature) of $38.2 million is included in other liabilities. Other debt. During the third quarter of 1997, we repurchased or called for redemption the remaining $23.2 million par value of 12.75 percent senior subordinated notes due 2002. Such notes had been assumed in connection with the LPG Merger. 81 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ In March 1996, BLH completed a tender offer in which it repurchased $148.3 million principal balance of its senior subordinated notes. In addition, Conseco repurchased $28.5 million of such notes during 1996. Conseco recognized an extraordinary charge of $9.0 million (net of a $4.9 million tax benefit) related to such repurchases. In conjunction with the LPG Merger and the THI Merger, Conseco repaid acquired debt in 1996 of $214.5 million and $78.5 million, respectively. Conseco also repurchased other debt of $65.8 million during 1996. Conseco recognized an extraordinary charge of $.4 million (net of $.2 million tax benefit) related to such repurchases. Conseco recognized extraordinary charges of $2.1 million (net of a $1.5 million tax benefit) in 1995 related to the repayment of notes payable. Commercial paper. We instituted a commercial paper program in April 1997 to lower our borrowing costs and improve our liquidity. Borrowings under our commercial paper program averaged approximately $525.9 million during the period April 24, 1997 through December 31, 1997. The weighted average interest rate on such borrowings was 5.8 percent during 1997. Conseco's commercial paper has maturities ranging from 2 to 37 days. However, the Company has the ability to refinance such obligations through its bank credit facility. 8. OTHER DISCLOSURES: Leases The Company rents office space, equipment and computer software under noncancellable operating leases. Rental expense was $35.1 million in 1997, $21.3 million in 1996 and $20.8 million in 1995. Future required minimum rental payments as of December 31, 1997, were as follows (dollars in millions): 1998.......................... $ 24.3 1999.......................... 21.1 2000.......................... 19.2 2001.......................... 17.7 2002.......................... 16.3 Thereafter.................... 55.5 ------ Total................... $154.1 ====== Employment Arrangements Some officers of the Company are employed under long-term employment agreements. One of these agreements provides for a base salary plus an annual bonus equal to 3 percent of the Company's consolidated defined pretax profits. This contract was modified to permit a reduction in such bonus amount for 1997. This agreement renews annually for a five-year period unless either party notifies the other, in which case the agreement expires five years from the last renewal date. In addition, a $1.9 million interest-free loan has been granted to the officer. Repayment is due two years after termination of the officer's employment contract. The agreements described above also include provisions under which the employees may elect to receive, in the event of a termination of the agreement following a change in control of the Company (as defined), a severance allowance equal to 60 months' salary, bonus and other benefits. The employee also may elect to have the Company purchase all Conseco stock and all options to purchase Conseco stock, without deduction of the applicable exercise prices, held by such person at a price per share equal to the highest market price in the preceding six months. The Company has qualified defined contribution plans in which substantially all employees are eligible to participate. Company contributions, which match certain voluntary employee contributions to the plan, totaled $3.8 million in 1997, $2.0 million in 1996, and $2.2 million in 1995. These contributions may be made either in cash or in Conseco common stock. The Company also has a stock bonus and deferred compensation program for certain officers and directors. Company contributions vary based on the profitability of the Company. Each year's contribution, which is fully funded in the form of Conseco 82 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ common stock, vests five years later or upon certain other events. The cost of the program is charged to expense over the vesting period and amounted to $14.4 million in 1997 ($10.3 million of which is a nonrecurring charge due to the death of an executive officer), $3.9 million in 1996 and $3.7 million in 1995. The market value of Conseco common stock held under the program (included in other assets and other liabilities) was $158.0 million and $101.7 million at December 31, 1997 and 1996, respectively. The Company has a noncontributory, unfunded deferred compensation plan for qualifying members of Bankers Life's career agency force. Benefits are based on years of service and career earnings. The liability recognized in the consolidated balance sheet for the agents' deferred compensation plan was $37.3 million and $34.5 million at December 31, 1997 and 1996, respectively. Substantially all of this liability represents vested benefits. Costs incurred on this plan, primarily representing interest on unfunded benefit costs, were $3.4 million, $3.2 million and $2.8 million during 1997, 1996 and 1995, respectively. The Company also provides certain health care and life insurance benefits for eligible retired employees of certain subsidiaries under partially funded and unfunded plans in existence at the date on which such subsidiaries were acquired. Benefits under the plans are provided on a contributory basis. Some of the benefits provided are subject to cost-sharing features determined at the discretion of management. Amounts related to the postretirement benefit plans (which increased in 1997 as a result of acquisitions) are as follows:
1997 1996 ---- ---- (Dollars in millions) Accumulated postretirement benefit obligations: Retirees, dependents and disabled participants.................... $23.1 $ 1.9 Fully eligible active plan participants........................... 2.1 4.6 Other active participants......................................... .5 .6 ----- ---- Total accumulated postretirement benefit obligations............ 25.7 7.1 Unrecognized net reduction in prior service cost.................... 1.6 2.8 Fair value of assets held for partially funded plan................. (5.9) - ----- ---- Accrued liability included in other liabilities................. $21.4 $9.9 ===== ====
The weighted average rate used in determining the accumulated postretirement benefit obligations under the plans was 7.25 percent. The weighted average after-tax expected rate of return on plan assets was 4.60 percent. The health care cost trend rate in 1997 was 11.1 percent for pre-age 65 and 9.3 percent for post-age 65 participants, graded evenly to 5.0 percent in 13 years. Increasing the trend rate by 1 percent would increase the accumulated postretirement benefit obligation by $1.5 million at December 31, 1997 (for plans without employer's maximum cost sharing provisions). Litigation The Company and its subsidiaries are involved in lawsuits related to their operations. In most cases, such lawsuits involve claims under insurance policies or other contracts of the Company. None of the lawsuits currently pending, either individually or in the aggregate, is expected to have a material effect on the Company's consolidated financial condition, cash flows or results of operations. Guaranty Fund Assessments From time to time, mandatory assessments are levied on the Company's insurance subsidiaries by life and health guaranty associations of most states in which these subsidiaries are licensed. These assessments are to cover losses to policyholders of insolvent or rehabilitated insurance companies. The associations levy assessments (up to prescribed limits) on all insurers in a particular state in order to pay claims on the basis of the proportionate share of premiums written by insurers in the lines of business in which the insolvent or rehabilitated insurer is engaged. These assessments may be deferred or forgiven in certain states if they would threaten an insurer's financial strength and, in some states, these assessments can be partially recovered through a reduction in future premium taxes. The balance sheet at December 31, 1997, includes accruals of $16.9 million, which approximate the Company's estimate of: (i) all known assessments that will be levied against the Company's insurance subsidiaries by various state guaranty associations based 83 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ on premiums that have been written through December 31, 1997; less (ii) amounts that would be recoverable through a reduction in future premium taxes as a result of such assessments. Such estimate is subject to change as the associations determine more precisely the losses that have occurred and how such losses will be allocated to insurance companies. The Company's cost for such assessments incurred by its insurance company subsidiaries was $3.7 million in 1997, $4.0 million in 1996 and $3.2 million in 1995. Minority Interest Minority interest represents the interest of investors other than Conseco in its subsidiaries. Minority interest at December 31, 1997, includes: (i) Company-obligated mandatorily redeemable preferred securities of subsidiary trusts with a carrying value of $1,383.9 million; and (ii) $.7 million interest in the common stock of a subsidiary of ALH. Minority interest at December 31, 1996, included: (i) $600.0 million par value of Company-obligated mandatorily redeemable preferred securities of subsidiary trusts; (ii) $97.0 million interest in the redeemable preferred stock of a subsidiary of ALH; and (iii) $.7 million interest in the common stock of a subsidiary of ALH. Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts Company-obligated mandatorily redeemable preferred securities of subsidiary trusts at December 31, 1997, were as follows :
Estimated Amount Carrying fair outstanding value value ----------- ----- ----- (Dollars in millions) 9.16% Trust Originated Preferred Securities ("TOPrS")................. $ 275.0 $ 275.0 $ 284.6 8.70% Capital Trust Pass-through Securities ("TruPS")................. 325.0 325.0 359.2 8.796% Capital Securities............................................. 300.0 300.0 335.3 FELINE PRIDES......................................................... 500.0 483.9 512.5 -------- -------- -------- $1,400.0 $1,383.9 $1,491.6 ======== ======== ========
On November 19, 1996, Conseco Financing Trust I ("Trust I"), a wholly owned subsidiary of Conseco, issued 11 million of the TOPrS at $25 per security. Each TOPrS security pays cumulative cash distributions at the annual rate of 9.16 percent of the stated $25 liquidation amount per security, payable quarterly. The TOPrS are fully and unconditionally guaranteed by Conseco. Proceeds from the offering of $266.1 million (after underwriting and associated costs) were used by the trust to purchase a subordinated debenture from Conseco. Conseco then used the net proceeds to repay bank debt. Conseco has the right to redeem the securities at any time, in whole or in part, on or after November 19, 2001, at the principal amount plus accrued and unpaid interest. The securities are subordinated to all senior indebtedness of Conseco and mature on November 30, 2026. Conseco may extend the maturity date by one or more periods, but in no event later than November 30, 2045. The terms of the TOPrS parallel the terms of Conseco's debentures held by Trust I, which debentures account for substantially all of the assets of Trust I. On November 27, 1996, Conseco Financing Trust II ("Trust II"), a wholly owned subsidiary of Conseco, issued 325,000 of the TruPS at $1,000 per security. Each TruPS security pays cumulative cash distributions at the annual rate of 8.70 percent of the stated $1,000 liquidation amount per security, payable semi-annually. The TruPS are fully and unconditionally guaranteed by Conseco. Proceeds from the offering of $321.6 million (after underwriting and associated costs) were used by the trust to purchase a subordinated debenture from Conseco. Conseco then used the net proceeds to repay bank debt. Conseco has the right to redeem the securities at the principal amount plus a premium equal to the excess, if any, of the sum of the discounted present values of the remaining scheduled payments of principal and interest over the principal amount of securities to be redeemed. The securities are subordinated to all senior indebtedness of Conseco and mature on November 15, 2026. The terms of the TruPS parallel the terms of Conseco's debentures held by Trust II, which debentures account for substantially all of the assets of Trust II. On March 31, 1997, Conseco Financing Trust III ("Trust III"), a wholly owned subsidiary of Conseco, issued 300,000 Capital Securities at $1,000 per security. Each Capital Security pays cumulative cash distributions at the annual rate of 8.796 percent of the stated $1,000 liquidation amount per security, payable semi-annually. The Capital Securities are fully and unconditionally guaranteed by Conseco. Proceeds from the offering of $296.7 million (after underwriting and associated costs) were used by the trust to purchase 84 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ a subordinated debenture from Conseco. Conseco then used the net proceeds to repay bank debt. Conseco has the right to redeem the securities at the principal amount plus a premium equal to the excess, if any, of the sum of the discounted present values of the remaining scheduled payments of principal and interest over the principal amount of securities to be redeemed. The securities are subordinated to all senior indebtedness of Conseco and mature on April 1, 2027. The terms of the Capital Securities parallel the terms of Conseco's debentures held by Trust III, which debentures account for substantially all of the assets of Trust III. On December 12, 1997, Conseco Financing Trust IV ("Trust IV"), a wholly owned subsidiary of Conseco, issued 10,000,000 FELINE PRIDES at $50 per security. Each FELINE PRIDES includes: (a) a stock purchase contract under which (i) the holder will purchase a number of shares of Conseco common stock on February 16, 2001 (ranging from .9363 and 1.1268 shares per FELINE PRIDES) under the terms specified in the stock purchase contract; and (ii) will receive a contract adjustment payment equal to .25 percent of the value of the security; and (b) a beneficial ownership of a 6.75 percent trust originated preferred security. Each holder will receive aggregate cumulative cash distributions at the annual rate of 7 percent of the $50 stated amount per security, payable quarterly. The applicable distribution rate on the trust originated preferred securities that remain outstanding during the period February 16, 2001 through February 16, 2003, will be reset so that the market value of the trust originated preferred securities will be equal to 100.5 percent of the par value. Conseco may limit the market rate reset to be no higher than the rate on the 2-year benchmark Treasury plus 200 basis points. The trust originated preferred securities are fully and unconditionally guaranteed by Conseco. Proceeds from the offering of approximately $483.7 million (after underwriting and associated costs) were used by the trust to purchase a subordinated debenture from Conseco. Conseco then used the net proceeds to repay bank debt and for other corporate purposes. The trust originated preferred securities are subordinated to all senior indebtedness of Conseco and mature on February 16, 2001. The terms of the trust originated preferred security parallel the terms of Conseco's debentures held by Trust IV, which debentures account for substantially all of the assets of Trust IV. Common Stock At December 31, 1997 and 1996, minority interest in common stock of Conseco's subsidiaries includes only the $.7 million interest in the common stock of a subsidiary. Changes in minority interest in common and preferred stock of consolidated subsidiaries during 1997 and 1996 are summarized below:
1997 1996 ---- ---- (Dollars in millions) Minority interest, beginning of year........................................................... $ 97.7 $ 403.3 Changes in investments held by minority interest: Repurchase of mandatorily redeemable preferred stock of a subsidiary.................... (93.4) - Mandatorily redeemable preferred stock of a subsidiary held by PFS prior to the PFS Merger........................................................................... (2.7) - Transactions resulting from ALH Stock Purchase, BLH Merger and related events........... - (224.9) Equity of minority interest in the change in financial position of the Company's subsidiaries: Dividends............................................................................... (3.3) (10.0) Amortization of value in excess of par of mandatorily redeemable preferred stock........ (.9) - Net income before extraordinary charge.................................................. 3.3 31.3 Extraordinary charge.................................................................... - (1.7) Unrealized depreciation of securities .................................................. - (100.3) ------ ------- Minority interest, end of year ................................................................ $ .7 $ 97.7 ====== =======
During 1997, we completed the purchase of all of the mandatorily redeemable preferred stock of a subsidiary formerly held by minority interests. 85 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ 9. SHAREHOLDERS' EQUITY: Authorized preferred stock is 20 million shares. On January 23, 1996, Conseco completed the offering of 4.37 million shares of PRIDES. Proceeds from the offering of $257.7 million (after underwriting and other associated costs) were used to repay notes payable of Conseco. Each share of PRIDES pays quarterly dividends at the annual rate of 7 percent of the $61.125 liquidation preference per share (equivalent to an annual amount of $4.279 per share). On February 1, 2000, unless either previously redeemed by Conseco or converted at the option of the holder, each share of PRIDES will mandatorily convert into four shares of Conseco common stock, subject to adjustment in certain events. Shares of PRIDES are not redeemable prior to February 1, 1999. From February 1, 1999 through February 1, 2000, the Company may redeem any or all of the outstanding shares of PRIDES. Upon such redemption, each holder will receive, in exchange for each share of PRIDES, the number of shares of Conseco common stock equal to (i) the sum of (a) $62.195, declining to $61.125; and (b) accrued and unpaid dividends divided by (ii) the market price of Conseco common stock at such date. In no event will a holder receive less than 3.42 shares of Conseco common stock. During 1996, 400 shares of PRIDES were converted by holders of such shares into 1,368 shares of Conseco common stock. In 1997, the holders of 2,374,300 shares of PRIDES converted such shares into 8.1 million shares of common stock. We paid $13.2 million to induce these conversions. We recorded this payment in the consolidated financial statements as a dividend paid to such holders. In addition, during 1997, 100,050 shares of PRIDES were converted by holders of such shares into 342,171 shares of Conseco common stock. Conseco issued 5.75 million shares of Series D Cumulative Convertible Preferred Stock ("Series D preferred stock") with annual dividends of $3.25 per share and with a total stated value of $287.5 million ($50 per share) in January 1993 in a public offering. Prior to January 1, 1995, Conseco had repurchased or the holders had converted 80,275 Series D preferred shares. In 1996, the Company exercised its right to redeem all outstanding Series D preferred stock. A total of 6,358 Series D shares were redeemed at $52.916 per share including $.641 per share of accrued and unpaid dividends. Holders of the remaining 5,666,559 Series D shares elected to convert their shares into 17,766,864 shares of Conseco common stock. Changes in the number of shares of common stock outstanding during the years ended December 31, 1997, 1996 and 1995 were as follows:
1997 1996 1995 ---- ---- ---- (Shares in thousands) Balance, beginning of year...................................................... 167,128 81,032 88,739 Stock options exercised..................................................... 12,341 4,893 366 Shares issued in conjunction with acquired companies........................ 11,264 60,560 - Common shares converted from convertible subordinated debentures............ 5,138 4,250 - Common shares converted from Series D preferred shares...................... - 17,767 - Common shares converted from PRIDES......................................... 8,463 1 - Shares issued under employee and agent benefit compensation plans........... 321 282 17 Treasury stock purchased.................................................... (17,989) (1,657) (8,090) ------- -------- ------ Balance, end of year............................................................ 186,666 167,128 81,032 ======= ======== ======
Dividends declared on common stock for 1997, 1996 and 1995, were $.313, $.083 and $.046 per common share, respectively. A liability was accrued for dividends declared but unpaid at December 31, 1997, totaling $23.5 million. Such dividends were paid in January 1998. The Company was authorized under its 1983 employee stock option plan to grant options to purchase up to 48 million shares of Conseco common stock at a price not less than its market value on the date the option was granted. The 1983 stock option plan continues to govern options granted thereunder, but expired in all other respects in December 1993. The 1994 Stock and Incentive Plan authorizes the granting of options to employees and directors of the Company to purchase up to 24 million shares of Conseco common stock at a price not less than its market value on the date the option is granted. The options may become exercisable immediately or over a period of time. The plan also permits granting of stock appreciation rights and certain other awards. In 1997, the Company adopted the 1997 Non-qualified Stock Option Plan which authorizes the granting of non-qualified options to employees of the Company to purchase shares of Conseco common stock. The aggregate number of shares of common stock for which options may be granted under the 1997 plan, when added to all outstanding, unexpired options under the Company's other employee benefit 86 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ plans, shall not exceed 20 percent of the total of shares of common stock outstanding plus the number of shares issuable upon conversion of any outstanding convertible security on the date of grant (calculated in the manner set forth in the 1997 plan). Conseco implemented two option exercise programs under which its chief executive officer and four of its executive vice presidents exercised outstanding options to purchase 9.1 million shares of Conseco common stock under the 1997 program (the "1997 Program") and 3.1 million shares under the 1996 program (the "1996 Program"). The options exercised would otherwise have remained exercisable until various dates through 2006 with respect to the 1997 Program and until the years 2000 through 2002 with respect to the 1996 Program. We implemented these programs in order to accelerate the recording of tax benefits we derived from the exercise of the options and to better manage our capital structure. With respect to both programs, no cash was exchanged as the executives paid for the exercise price of the options by tendering previously owned shares. The Company withheld shares or the executives tendered previously held shares to cover federal and state taxes owed by the executives as a result of the exercise transactions. The 1997 Program resulted in the following changes to common stock and additional paid-in capital: (i) an increase for a tax benefit of $81.9 million (net of payroll taxes incurred of $3.5 million); (ii) an increase for the exercise price of $120.0 million; and (iii) a decrease of $229.9 million related to shares withheld or tendered by the executives for the exercise price and for federal and state taxes. The 1996 Program resulted in the following changes to common stock and additional paid-in capital: (i) an increase for a tax benefit of $15.1 million (net of payroll taxes incurred of $.7 million); (ii) an increase for the exercise proceeds of $5.2 million; and (iii) a decrease of $20.8 million related to shares withheld or tendered by the executives for federal and state taxes. Net of shares withheld or tendered, the Company issued approximately 3.3 million and 1.6 million shares of common stock to the executives under the 1997 Program and the 1996 Program, respectively. As an inducement to encourage the exercise of options prior to their expiration date, we granted to the executive officers new options to purchase a total of 5.8 million shares at an average price of $39.52 per share and 1.6 million shares at $16.22 per share (in each case equal to the market price per share on the grant date) to replace the shares surrendered for taxes and the exercise price in connection with the 1997 and 1996 Programs, respectively. In 1997, 1996 and 1995, we repurchased approximately 17.9 million, 1.7 million and 8.1 million shares of our common stock for $711.7 million, $26.0 million and $92.4 million, respectively, in connection with our stock repurchase programs and shares withheld or tendered for the exercise price of options and for federal and state taxes. The cost of the common stock we repurchased in connection with these programs was allocated to the shareholders' equity accounts in 1997, 1996 and 1995 as follows: (i) $685.6 million, $3.1 million and $15.0 million, respectively, to common stock and additional paid-in capital (such allocation was based on the average common stock and paid-in capital balance per share) and (ii) $26.1 million, $22.9 million and $77.4 million, respectively, to retained earnings (representing the purchase price in excess of such average). Conseco's Director, Executive and Senior Officer Stock Purchase Plan was implemented to encourage direct, long-term ownership of Conseco stock by Board members, executive officers and certain senior officers. Under the program, 8 million shares of Conseco common stock have been purchased in open market or negotiated transactions with independent parties. Purchases are financed by personal loans to the participants from a bank. Such loans are collateralized by the Conseco stock purchased. Conseco has guaranteed the loans, but has recourse to the participants if we incur a loss under the guarantee. In addition, we provide loans to the participants for interest payments under the bank loans. A total of 39 directors and officers of Conseco participated in the plan. At December 31, 1997, the bank loans guaranteed by us totaled $247.4 million, and the loans provided by us for interest totaled $9.3 million. The common stock that collateralizes the loans had a fair value of $343.5 million on December 31, 1997. In December 1996, we granted options to selected key managers to purchase 1.1 million shares at a price of $30.41 per share (the "Key Manager Program"). These options contain lengthy vesting and non-compete requirements designed to encourage continuity of employment with these individuals. The options will become fully vested normally only upon both: (i) eleven years of continuous employment; and (ii) the earlier of: (a) two years following termination of employment during which time the individual is not in competition with the Company; (b) the grantee reaching age 65; or (c) death or disability of the grantee. In certain cases, the options remain exercisable throughout the lifetime of the grantee. We apply Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for our stock option plans. Accordingly, no compensation cost has been recognized for such plans. Had compensation cost been determined based on the fair value at the grant dates for awards granted after January 1, 1995, consistent with the method of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), the Company's pro forma net income and pro forma earnings per share for the years ended December 31, 1997, 1996 and 1995 would have been as follows: 87 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------
1997 1996 1995 ------------------------- ------------------------- ------------------------ As reported Pro forma As reported Pro forma As reported Pro forma ----------- --------- ----------- --------- ----------- --------- (Dollars in millions, except per share amounts) Net income........................ $567.3 $521.2 $252.4 $245.4 $220.4 $211.9 Basic earnings per share.......... 2.94 2.69 2.15 2.08 2.48 2.38 Diluted earnings per share........ 2.64 2.42 1.82 1.77 2.12 2.04
The fair value of each option grant used to determine the pro forma amounts summarized above is estimated on the date of grant using the Black-Scholes option valuation model with the following weighted average assumptions for 1997, 1996 and 1995:
1997 Grants 1996 Grants 1995 Grants --------------------- ------------------------------------ ----------- Option Option Key Traditional exercise Traditional exercise Manager Traditional grants program grants program Program grants ------ ------- ------ ------- ------- ------ Weighted average risk-free interest rates.. 6.0% 6.5% 6.1% 6.0% 6.8% 6.2% Weighted average dividend yields........... .9% .9% .1% .1% .1% .2% Volatility factors......................... .28 .28 .28 .28 .28 .43 Weighted average expected life............. 6 years 4 years 5 years 5 years 25 years 5 years Weighted average fair value per share...... $13.13 $11.95 $10.17 $5.54 $24.50 $5.53
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferrable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because our employee stock options have characteristics significantly different from those of traded options, and because changes in subjective assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not provide a reliable single measure of the fair value of our employee stock options. Because SFAS 123 is effective only for awards granted after January 1, 1995, the pro forma disclosures provided above may not be representative of the effects on reported net income for future years. 88 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ In conjunction with the CAF Merger and the PFS Merger in 1997 and the LPG Merger, the ATC Merger, the THI Merger and the BLH Merger in 1996, outstanding options to purchase common stock of the acquired companies were converted into options to purchase Conseco stock. These options, which were immediately exercisable, were for the number of shares and the price per share equal to what holders would have been entitled to receive at the dates of the mergers had the former options been exercised at that time and exchanged for Conseco shares in the mergers. The fair value of these options is included in the cost to acquire the companies (see note 2). A summary of options issued in connection with the mergers and, together with related information, is presented below:
Weighted Total value average at merger exercise price Shares date per share ------ ---- --------- (Shares in (Dollars in millions, except thousands) per share amounts) Options issued in 1997 in connection with the: CAF Merger............................................... 226 $ 3.5 $23.96 PFS Merger............................................... 1,132 22.4 19.78 ----- ------ 1,358 $25.9 20.48 ===== ===== Options issued in 1996 in connection with the: LPG Merger............................................... 1,133 $ 7.7 11.18 ATC Merger............................................... 2,049 26.9 16.87 THI Merger............................................... 644 6.5 14.90 BLH Merger............................................... 609 2.6 27.18 ----- ----- 4,435 $43.7 16.54 ===== =====
89 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ A summary of the Company's stock option activity and related information for the years ended December 31, 1997, 1996 and 1995, is presented below (shares in thousands):
1997 1996 1995 ----------------------- ---------------------- ---------------------- Weighted Weighted Weighted average average average exercise exercise exercise Shares price Shares price Shares price ------ ----- ------ ----- ------ ----- Outstanding at the beginning of year.. 28,720 $15.38 25,487 $11.76 22,029 $11.43 Granted or assumed in connection with: Traditional grants................. 1,212 40.02 1,206 28.54 4,117 12.60 Option exercise program............ 5,818 39.52 1,605 16.22 - - Key Manager Program................ - - 1,100 30.41 - - Mergers............................ 1,358 20.48 4,435 16.54 - - ------- ------ ------ Total granted................ 8,388 36.51 8,346 20.04 4,117 12.60 ------- ------ ------ Exercised............................. (12,341) 13.71 (4,893) 4.75 (366) 3.06 Forfeited............................. (339) 17.58 (220) 11.62 (293) 9.98 ------- ------ ------ Outstanding at the end of the year.... 24,428 23.45 28,720 15.38 25,487 11.76 ======= ====== ====== Options exercisable at year-end....... 9,765 9,554 7,352 ======= ====== ====== Available for future grant............ 17,206 2,933 8,399 ======= ======= =======
The following table summarizes information about fixed stock options outstanding at December 31, 1997 (shares in thousands):
Options outstanding Options exercisable ---------------------------------------- ----------------------- Weighted Weighted Weighted average average average Range of Number remaining exercise Number exercise exercise prices outstanding life (in years) price exercisable price - --------------- ----------- --------------- ----- ----------- ----- $ 1.36-1.56........................... 50 .6 $ 1.51 50 $ 1.51 2.61................................ 35 1.6 2.61 35 2.61 4.57-6.72........................... 190 1.6 6.01 190 6.01 6.91-10.28.......................... 109 1.9 8.20 109 8.20 10.47-15.47.......................... 13,210 5.3 14.27 1,637 13.22 16.06-23.67.......................... 995 6.5 19.53 963 19.55 25.11-30.41.......................... 1,890 5.6 29.17 903 28.62 30.41 (Key Manager Program)......... 1,100 24.0 30.41 - - 30.73-45.84.......................... 6,822 7.5 39.91 5,878 39.36 48.38................................ 27 9.9 48.38 - - ------ ----- 24,428 9,765 ====== =====
90 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ In connection with the THI Merger, the outstanding warrants to purchase shares of THI common stock were converted into warrants to purchase the same number of shares of Conseco common stock at the same total cost that the holders would have been entitled to receive if such warrants were exercised immediately prior to the THI Merger. Such warrants may be exercised to buy 700,000 shares of Conseco common stock for $13.8 million at anytime through September 29, 2005. Accordingly, 700,000 shares of common stock are reserved for issuance under the warrants. The value of the warrants on the THI Merger date of $3.8 million is included in the total cost to acquire THI (see note 2). A total of 69.0 million shares of common stock are reserved for issuance under the previously described convertible subordinated debentures, PRIDES, FELINE PRIDES, stock options granted and available for future grant, warrants, and stock bonus and deferred compensation plans. A reconciliation of income and shares used to calculate basic and diluted earnings per share is as follows:
1997 1996 1995 ---- ---- ---- (Dollars in millions and shares in thousands) Income: Net income before extraordinary charge.................................. $574.2 $278.9 $222.5 Preferred stock dividends............................................... 21.9 27.4 18.4 ------ ------ ------ Income before extraordinary charge applicable to common ownership for basic earnings per share........................................ 552.3 251.5 204.1 Effect of dilutive securities: Preferred stock dividends............................................. 8.7 27.4 18.4 ------ ------ ------ Income before extraordinary charge applicable to common ownership and assumed conversions for diluted earnings per share.............. $561.0 $278.9 $222.5 ====== ====== ====== Shares: Weighted average shares outstanding for basic earnings per share........ 185,751 104,584 81,405 Effect of dilutive securities on weighted average shares: Stock options......................................................... 9,767 6,013 2,921 Employee stock plans.................................................. 2,268 2,172 1,768 PRIDES................................................................ 6,936 14,042 - Convertible preferred stock........................................... - 12,049 17,787 Convertible debentures................................................ 5,457 - - ------- ------- ------- Dilutive potential common shares.................................. 24,428 34,276 22,476 ------- ------- ------- Weighted average shares outstanding for diluted earnings per share.................................................... 210,179 138,860 103,881 ======= ======= =======
91 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ 10. OTHER OPERATING STATEMENT DATA: Insurance policy income consisted of the following:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Traditional products: Direct premiums collected......................................................... $5,264.4 $3,528.2 $3,173.0 Reinsurance assumed............................................................... 290.3 65.8 6.1 Reinsurance ceded................................................................. (499.0) (313.8) (72.6) -------- -------- -------- Premiums collected, net of reinsurance...................................... 5,055.7 3,280.2 3,106.5 Change in unearned premiums....................................................... (2.2) (14.6) 6.6 Less premiums on universal life and products without mortality and morbidity risk which are recorded as additions to insurance liabilities ................................ 2,099.4 1,881.3 1,757.5 -------- -------- -------- Premiums on traditional products with mortality or morbidity risk, recorded as insurance policy income...................................... 2,954.1 1,384.3 1,355.6 Fees and surrender charges on interest sensitive products............................. 456.7 269.9 109.4 -------- -------- -------- Insurance policy income..................................................... $3,410.8 $1,654.2 $1,465.0 ======== ======== ========
The five states with the largest shares of premiums collected in 1997 were Florida (9.4 percent), Illinois (9.0 percent), California (8.4 percent), Texas (8.1 percent) and Michigan (5.0 percent). No other state accounted for more than 5 percent of total collected premiums. Other operating costs and expenses were as follows:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Commission expense.................................................................... $201.2 $ 72.5 $ 47.7 Other................................................................................. 376.0 231.5 224.4 ------ ------ ------ Other operating costs and expenses........................................... $577.2 $304.0 $272.1 ====== ====== ======
Conseco considers anticipated returns from the investment of policyholder balances in determining the amortization of the cost of policies purchased and cost of policies produced for universal life-type and investment-type contracts. Sales of fixed maturity investments change the incidence of profits on such policies because gains (losses) are recognized currently and, if the sale proceeds are reinvested at the current market yields, the expected future yields on the investment of policyholder balances are reduced (increased). Accordingly, amortization of the cost of policies purchased was increased by $151.4 million, $31.1 million and $106.4 million in the years ended December 31, 1997, 1996 and 1995, respectively. Amortization of the cost of policies produced was increased by $29.8 million, $4.9 million and $20.2 million in the years ended December 31, 1997, 1996 and 1995, respectively. 92 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ The changes in the cost of policies purchased were as follows:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Balance, beginning of year............................................................ $2,015.0 $1,030.7 $1,021.6 Additional acquisition expense on acquired policies............................... 93.9 - - Amortization related to operations: Cash flow realized............................................................. (436.5) (285.1) (252.0) Interest added................................................................. 174.7 127.6 133.2 Amortization related to sales of investments...................................... (151.4) (31.1) (106.4) Amounts related to fair value adjustment of actively managed fixed maturities........................................... (128.4) 141.6 (395.6) Transferred to cost of policies produced related to exchanged health policies...................................................... (16.1) (13.4) (13.5) Amounts acquired in mergers and acquisitions...................................... 914.2 1,042.0 643.4 Nonrecurring charge............................................................... (8.8) - - Reinsurance and other ............................................................ 9.8 2.7 - -------- -------- -------- Balance, end of year.................................................................. $2,466.4 $2,015.0 $1,030.7 ======== ======== ========
Based on current conditions and assumptions as to future events on all policies in force, the Company expects to amortize approximately 9 percent of the December 31, 1997, balance of cost of policies purchased in 1998, 9 percent in 1999, 8 percent in 2000, 7 percent in 2001, and 7 percent in 2002. The discount rates used to determine the cost of policies purchased ranged from 18 percent to 20 percent during the three-year period ended December 31, 1997. The discount rates used to determine the amortization of the cost of policies purchased averaged 7 percent in 1997, 10 percent in 1996, and 12 percent in 1995. The changes in the cost of policies produced were as follows:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Balance, beginning of year............................................................ $544.3 $391.0 $ 300.7 Additions......................................................................... 550.7 331.5 302.9 Amortization related to operations................................................ (110.4) (72.9) (62.0) Amortization of deferred revenue.................................................. 5.4 1.4 1.3 Amortization related to sales of investments...................................... (29.8) (4.9) (20.2) Amounts related to fair value adjustment of actively managed fixed maturities.............................................. (36.4) 45.4 (74.9) Transferred from cost of policies purchased related to exchanged health policies, net of related reserves............................. 3.5 4.0 1.6 Amounts related to BLH Merger and share repurchases............................... - (54.7) (107.5) Amounts related to ALH Stock Purchase............................................. - (96.5) - Amounts related to CCP Merger..................................................... - - (62.8) Consolidation of CCP, effective January 1, 1995................................... - - 111.9 Nonrecurring charge............................................................... (12.1) - - ------ ------ ------- Balance, end of year.................................................................. $915.2 $544.3 $ 391.0 ====== ====== =======
Nonrecurring charges in 1997 include an increase to claim reserves of $41.5 million and the write-off of cost of policies produced and cost of policies purchased of $20.9 million related to premium deficiencies on our Medicare supplement business in the state of Massachusetts. Regulators in that state have not allowed premium increases for Medicare supplement products necessary to avoid losses on the business. We are currently seeking rate increases. We are no longer writing new Medicare supplement business in Massachusetts. Nonrecurring charges in 1997 also include expenses of $9.3 million (net of proceeds from a life insurance policy) related to the death of an executive officer. 93 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ 11. CONSOLIDATED STATEMENT OF CASH FLOWS: The following disclosures are provided to support and/or supplement our consolidated statement of cash flows:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Impact of acquisition transactions (described in note 2) on the consolidated statement of cash flows: Total investments................................................................ $ 4,716.6 $ 5,022.8 $ 4,528.4 Cost of policies purchased....................................................... 914.2 1,046.4 493.7 Goodwill......................................................................... 1,133.9 1,747.2 241.6 Income taxes..................................................................... 6.4 134.9 (114.9) Insurance liabilities............................................................ (5,193.8) (5,943.6) (4,405.8) Notes payable.................................................................... (540.6) (448.2) (213.7) Minority interest................................................................ - 210.4 225.4 Common stock and additional paid-in capital...................................... (471.5) (1,568.6) - Other............................................................................ 194.5 (179.6) (168.4) --------- --------- --------- Net cash used.................................................................. $ 759.7 $ 21.7 $ 586.3 ========= ========= ========= Additional non-cash items not reflected in the consolidated statement of cash flows: Issuance of common stock under stock option and employee benefit plans............. $ 20.2 $ 12.2 $ 4.2 Tax benefit related to the issuance of common stock under employee benefit plans... 85.2 15.9 .4 Conversion of preferred stock into common stock.................................... 151.3 283.2 - Conversion of convertible debentures into common stock............................. 150.0 - - Redemption of convertible subordinated debentures of a subsidiary using segregated cash.................................................................. - - 9.2 Cash paid for: Interest expense on debt and commercial paper...................................... 117.4 111.3 112.0 Income taxes....................................................................... 200.0 122.5 90.3
12. STATUTORY INFORMATION: Statutory accounting practices prescribed or permitted for the Company's insurance subsidiaries by regulatory authorities differ from GAAP. The Company's life insurance subsidiaries reported the following amounts to regulatory agencies, after appropriate eliminations of intercompany accounts among such subsidiaries:
1997 1996 ---- ---- (Dollars in millions) Statutory capital and surplus.................................................................... $1,662.4 $1,170.8 Asset valuation reserve.......................................................................... 329.2 232.9 Interest maintenance reserve..................................................................... 414.9 272.6 Portion of surplus debenture carried as a liability ............................................. 99.2 98.8 -------- -------- Total...................................................................................... $2,505.7 $1,775.1 ======== ========
Combined statutory net income of the Company's life insurance subsidiaries for the periods during which such subsidiaries were included in our consolidated financial statements was $243.4 million, $215.0 million and $183.8 million in 1997, 1996 and 1995, respectively, after appropriate eliminations of intercompany amounts among such subsidiaries, but before elimination of intercompany amounts between such subsidiaries and non-life insurance subsidiaries and the parent company. The statutory capital and surplus of the insurance subsidiaries include surplus debentures issued to the parent holding companies totaling $793.4 million. Payments of interest and principal on such debentures are generally subject to the approval of the insurance 94 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ department of the subsidiary's state of domicile. Statutory accounting practices require the asset valuation reserve ("AVR") and the interest maintenance reserve ("IMR") be reported as liabilities. The purpose of these reserves is to stabilize statutory surplus against fluctuations in the market value of investments. The IMR captures all realized investment gains and losses, net of income taxes, on debt instruments resulting from changes in interest rates, and provides for subsequent amortization of such amounts into statutory net income on a basis reflecting the remaining lives of the assets sold. The AVR captures all realized and unrealized investment gains (losses), net of income taxes, related to equity investments and to changes in creditworthiness of debt instruments. AVR is also adjusted each year based on a formula related to the quality and loss experience of the Company's investment portfolio. Included in statutory capital and surplus shown above are the following investments in non-life insurance affiliates, all of which are eliminated in the consolidated financial statements prepared in accordance with GAAP:
1997 1996 -------------------- -------------------- Admitted Admitted asset asset Cost value Cost value ---- ----- ---- ----- (Dollars in millions) Common stock of Conseco purchased in open market transactions (1997 includes 39,823,149 shares and 1996 includes 39,021,822 shares)......................................... $ 99.8 $152.4 $ 89.6 $ 80.9 Notes payable of Conseco and its non-life subsidiaries................. 275.0 275.7 261.3 245.2 Common stock of ALH (463,649 shares in 1997 and 614,057 shares in 1996) .................................................... 2.4 6.3 5.8 9.8 Preferred stock of a non-life subsidiary............................... 900.0 - 900.0 - Investment in ALH 1994 Series PIK Preferred Stock...................... 72.2 72.2 62.8 62.8 Preferred stock of American Life Holding Company....................... 6.5 6.5 6.5 6.5
95 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ The following table compares the consolidated pretax income determined on a statutory accounting basis with such income reported in accordance with GAAP:
1997 1996 1995 ---- ---- ---- (Dollars in millions) Life insurance subsidiaries: Pretax income as reported on a statutory accounting basis before deduction of investment management fees paid to affiliates and transfers to and from and amortization of the IMR......................................................................... $ 606.3 $332.2 $370.4 GAAP adjustments: Change in difference in carrying values of investments............................. 111.7 51.9 185.9 Changes in cost of policies purchased and produced and insurance liabilities....... 256.2 70.1 (52.0) Other adjustments, net............................................................. (7.9) (.1) (7.7) -------- ------ ------ GAAP pretax income of life insurance subsidiaries.......................... 966.3 454.1 496.6 Non-life companies: Interest expense..................................................................... (109.4) (108.1) (119.4) All other income and expense, net (excluding investment management fees received from affiliates).................... 146.2 147.6 41.3 -------- ------ ------ GAAP consolidated pretax income............................................ $1,003.1 $493.6 $418.5 ======== ====== ======
State insurance laws generally restrict the ability of insurance companies to pay dividends or make other distributions. Net assets of the Company's wholly owned life insurance subsidiaries, determined in accordance with GAAP, aggregated approximately $7.8 billion at December 31, 1997, of which approximately $165.1 million is available for distribution to Conseco in 1998 without the permission of state regulatory authorities. Most states have adopted risk-based capital ("RBC") rules to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks. The RBC formula is designed as an early warning tool to help state regulators identify possible weakly capitalized companies for the purpose of initiating regulatory action. At December 31, 1997, the average ratio of total adjusted capital to RBC (as defined by the rules) for our principal insurance subsidiaries was greater than twice the level at which regulatory attention is triggered. 13. BUSINESS SEGMENT AND DISTRIBUTION CHANNELS: Conseco conducts and manages its business through five segments, reflecting the Company's major lines of insurance business and target markets: (i) supplemental health; (ii) annuities; (iii) life insurance; (iv) individual and group major medical insurance; and (v) other. Summarized data for the Company's business segments follows: 96 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------
Income before Amortization income taxes, of cost of minority policies produced interest and Premiums Total and cost of policies extraordinary Total collected revenues purchased (a) charge assets --------- -------- ------------- ------ ------ (Dollars in millions) 1997 Supplemental health...................... $1,843.7 $2,160.2 $194.9 $ 371.9 $ 7,522.5 Annuities................................ 1,689.6 1,350.5 198.9 358.3 16,535.6 Life insurance........................... 709.0 1,130.3 87.8 307.1 9,771.1 Individual and group major medical....... 744.2 775.5 16.8 40.3 896.8 Other ................................... 69.2 151.9 7.3 61.6 577.4 Corporate................................ - - - (136.1) 611.4 -------- -------- ------ -------- --------- Total.................................. $5,055.7 $5,568.4 $505.7 $1,003.1 $35,914.8 ======== ======== ====== ======== ========= 1996 Supplemental health...................... $ 810.8 $ 873.2 $ 81.2 $ 136.7 $ 3,841.1 Annuities................................ 1,670.3 1,047.4 95.1 254.3 14,186.5 Life insurance........................... 403.6 642.6 41.5 124.8 6,512.4 Individual and group major medical....... 341.0 365.8 15.1 32.1 418.2 Other ................................... 54.5 138.3 7.9 58.1 170.0 Corporate ............................... - - - (112.4) 484.5 -------- -------- ------ -------- --------- Total.................................. $3,280.2 $3,067.3 $240.8 $ 493.6 $25,612.7 ======== ======== ====== ======= ========= 1995 Supplemental health...................... $ 738.8 $ 827.2 $ 78.3 $ 97.1 $ 1,759.6 Annuities................................ 1,693.9 1,135.5 169.9 316.1 12,152.8 Life insurance........................... 253.6 404.0 38.6 70.2 2,667.6 Individual and group major medical....... 353.6 361.7 13.1 35.2 269.4 Other ................................... 66.6 111.7 7.6 25.2 193.8 Corporate................................ - 15.2 - (125.3) 254.3 -------- -------- ------ ------- --------- Total.................................. $3,106.5 $2,855.3 $307.5 $ 418.5 $17,297.5 ======== ======== ====== ======= ========= (a) Includes additional amortization related to gains on sales of investments.
97 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------ 14. QUARTERLY FINANCIAL DATA (UNAUDITED): We compute earnings per common share for each quarter independently of earnings per share for the year. The sum of the quarterly earnings per share may not equal the earnings per share for the year because of: (i) transactions affecting the weighted average number of shares outstanding in each quarter; and (ii) the uneven distribution of earnings during the year.
1997 ---------------------------------------------- 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. -------- -------- -------- -------- (Dollars in millions, except per share data) Insurance policy income................................................... $ 670.1 $ 885.0 $ 885.8 $ 969.9 Revenues.................................................................. 1,099.0 1,360.5 1,483.5 1,625.4 Income before income taxes, minority interest and extraordinary charge .............................................. 195.4 231.2 275.2 301.3 Net income................................................................ 111.5 130.6 153.8 171.4 Net income per common share: Basic: Income before extraordinary charge .................................. $.57 $.68 $.81 $.91 Extraordinary charge................................................. .02 .01 - .01 ---- ---- ---- ---- Net income......................................................... $.55 $.67 $.81 $.90 ==== ==== ==== ==== Diluted: Income before extraordinary charge .................................. $.51 $.62 $.73 $.81 Extraordinary charge................................................. .02 .01 - - ---- ---- ---- ---- Net income......................................................... $.49 $.61 $.73 $.81 ==== ==== ==== ====
98 CONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ------------------------------------
1996 ----------------------------------------------- 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. -------- -------- -------- -------- (Dollars in millions, except per share data) Insurance policy income..................................................... $369.8 $371.6 $451.8 $461.0 Revenues.................................................................... 691.8 672.5 834.3 868.7 Income before income taxes, minority interest and extraordinary charge ................................................ 120.2 101.3 131.5 140.6 Net income.................................................................. 46.3 50.1 78.1 77.9 Net income per common share: Basic: Income before extraordinary charge .................................... $.68 $.49 $.62 $.61 Extraordinary charge................................................... .21 - .01 .06 ----- ---- ---- ---- Net income........................................................... $.47 $.49 $.61 $.55 ==== ==== ==== ==== Diluted: Income before extraordinary charge .................................... $.55 $.41 $.51 $.54 Extraordinary charge................................................... .15 - .01 .05 ---- ---- ---- ---- Net income........................................................... $.40 $.41 $.50 $.49 ==== ==== ==== ====
Our quarterly results of operations are based on numerous estimates, principally related to policy reserves, amortization of cost of policies purchased, amortization of cost of policies produced and income taxes. We revise all such estimates each quarter and we ultimately adjust them to year-end amounts. When we determine revisions are necessary, we report them as part of operations of the current quarter. 15. SUBSEQUENT EVENTS (UNAUDITED): On February 9, 1998, we completed the offering of $250.0 million of 6.4 percent Notes (the "Notes") due February 10, 2003. Proceeds from the offering of approximately $248.0 million (after original issue discount and other associated costs) were used to retire bank debt. Interest is paid semi-annually on February 10 and August 10 of each year. The Notes are redeemable in whole or in part at the option of Conseco at any time, at a redemption price equal to the sum of (a) the greater of: (i) 100 percent of the principal amount; and (ii) the sum of the present values of the remaining scheduled payments of principal and interest thereon from the redemption date to the maturity date, computed by discounting such payments, in each case, to the redemption date on a semi-annual basis at the Treasury rate (as defined in the Notes) plus 25 basis points, plus (b) accrued and unpaid interest on the principal amount thereof to the date of redemption. The Notes are unsecured and rank pari passu with all other unsecured and unsubordinated obligations of Conseco. We periodically use options and interest rate swaps to hedge interest rate risk associated with our investments and borrowed capital. Although we had no such agreements outstanding at December 31, 1997, we entered into four interest rate swap agreements in March 1998. The Company entered into such agreements to create a hedge that effectively converts a portion of its fixed-rate borrowed capital into floating-rate instruments for the period during which the agreements are outstanding. Such interest rate swap agreements have an aggregate notional principal amount of $1.0 billion, mature in various years through 2008 and have an average remaining life of 7 years. If the counterparties of these interest rate swaps do not meet their obligations, Conseco could have a loss. Conseco limits its exposure to such a loss by diversifying among several counterparties believed to be financially sound and creditworthy. At March 13, 1998, all of the counterparties were rated A or higher by Standard & Poor's Corporation. On March 3, 1998, we commenced a new program to repurchase up to 5 million Conseco common shares in open market or negotiated transactions. The timing and terms of the purchases are to be determined based on market conditions and other considerations. As of March 17, 1998, we had repurchased .5 million shares under the program for $26.4 million. In March 1998, we repurchased $139 million par value of our 10.5 percent senior notes due 2004 for $171 million. We will recognize an extraordinary charge of approximately $15.6 million (net of an $8.3 million tax benefit) related to the repurchases in the quarter ended March 31, 1998. 99 ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III The information required by Part III is hereby incorporated by reference from the Registrant's definitive proxy statement to be filed with the Commission pursuant to Regulation 14A within 120 days after December 31, 1997, except that the information required by Item 10 regarding Executive Officers is included herein under a separate caption at the end of Part I. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) 1. Financial Statements. See Index to Consolidated Financial Statements on page 48 for a list of financial statements included in this Report. 2. Financial Statement Schedules. The following financial statement schedules are included as part of this Report immediately following the signature page: Schedule II -- Condensed Financial Information of Registrant (Parent Company) Schedule III -- Supplementary Insurance Information Schedule IV -- Reinsurance All other schedules are omitted, either because they are not applicable, not required, or because the information they contain is included elsewhere in the consolidated financial statements or notes. 3. Exhibits. See Exhibit Index immediately preceding the Exhibits filed with this report (b) Reports on Form 8-K. - None 100 SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, this 27th day of March, 1998. CONSECO, INC. By: /s/ STEPHEN C. HILBERT ----------------------------- Stephen C. Hilbert, President Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
Signature Title (Capacity) Date --------- ---------------- ---- /s/ STEPHEN C. HILBERT Chairman of the Board, March 27, 1998 - ---------------------- President and Director Stephen C. Hilbert (Principal Executive Officer) /s/ ROLLIN M. DICK Executive Vice President and Director March 27, 1998 - ------------------------- (Principal Financial Officer) Rollin M. Dick /s/JAMES S. ADAMS Senior Vice President and Treasurer March 27, 1998 - ------------------------- (Principal Accounting Officer) James S. Adams /s/ NGAIRE CUNEO Director March 27, 1998 - ------------------------- Ngaire Cuneo /s/ DAVID R. DECATUR Director March 27, 1998 - ------------------------- David R. Decatur /s/ JOHN M. MUTZ Director March 27, 1998 - ------------------------- John M. Mutz /s/ DONALD F. GONGAWARE Director March 27, 1998 - ------------------------- Donald F. Gongaware /s/ M. PHIL HATHAWAY Director March 27, 1998 - ------------------------- M. Phil Hathaway /s/ DENNIS E. MURRAY, SR. Director March 27, 1998 - ------------------------- Dennis E. Murray, Sr. /s/ JAMES D. MASSEY Director March 27, 1998 - ------------------------- James D. Massey
101 REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES To the Shareholders and Board of Directors Conseco, Inc. Our report on the consolidated financial statements of Conseco, Inc. and Subsidiaries is included on page 50 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in the index on page 100 of this Form 10-K. In our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein. /s/COOPERS & LYBRAND L.L.P. --------------------------- COOPERS & LYBRAND L.L.P. Indianapolis, Indiana March 23, 1998 102 CONSECO, INC. AND SUBSIDIARIES SCHEDULE II
Condensed Financial Information of Registrant (Parent Company) Balance Sheet as of December 31, 1997 and 1996 (Dollars in millions) ASSETS 1997 1996 ---- ---- Short-term investments......................................................................... $ 17.4 $ 74.9 Actively managed fixed maturities ............................................................. 12.9 2.1 Equity securities.............................................................................. 14.0 7.9 Other invested assets.......................................................................... 128.1 55.3 Investment in wholly owned subsidiaries (eliminated in consolidation).......................... 6,734.6 3,811.9 Receivable from subsidiaries (eliminated in consolidation)..................................... 949.9 871.5 Income taxes................................................................................... 207.1 155.7 Other assets................................................................................... 231.9 188.6 -------- -------- Total assets............................................................................ $8,295.9 $5,167.9 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Notes payable............................................................................... $1,906.7 $1,094.9 Commercial paper............................................................................ 448.2 - Notes payable to subsidiaries (eliminated in consolidation)................................. 213.1 101.6 Other liabilities due to subsidiaries (eliminated in consolidation)......................... 210.5 93.5 Other liabilities........................................................................... 243.4 192.6 -------- -------- Total liabilities....................................................................... 3,021.9 1,482.6 -------- -------- Company-obligated mandatorily redeemable preferred securities of subsidiary trusts............. 1,383.9 600.0 Shareholders' equity: Preferred stock............................................................................. 115.8 267.1 Common stock and additional paid-in capital (no par value, 1,000,000,000 shares authorized, shares issued and outstanding: 1997 - 186,665,591 1996 - 167,128,228)....................................................................... 2,382.0 2,029.6 Accumulated other comprehensive income: Unrealized appreciation of fixed maturity securities (net of applicable deferred income taxes: 1997 - $95.5; 1996 - $21.5)...................................... 177.2 39.8 Unrealized appreciation (depreciation) of other investments (net of applicable deferred income taxes: 1997 - $2.6; 1996 - $(.5))................................................ 4.8 (.9) Retained earnings........................................................................... 1,210.3 749.7 -------- -------- Total shareholders' equity.............................................................. 3,890.1 3,085.3 -------- -------- Total liabilities and shareholders' equity.............................................. $8,295.9 $5,167.9 ======== ======== The accompanying note is an integral part of the condensed financial information.
103 CONSECO, INC. AND SUBSIDIARIES SCHEDULE II
Condensed Financial Information of Registrant (Parent Company) Statement of Operations for the years ended December 31, 1997, 1996 and 1995 (Dollars in millions) 1997 1996 1995 ---- ---- ---- Revenues: Net investment income.............................................................. $ 46.5 $ 5.5 $ 8.5 Dividends from subsidiaries (eliminated in consolidation).......................... 185.2 146.9 106.5 Fee and interest income from subsidiaries (eliminated in consolidation)............ 93.9 30.9 12.9 Net investment gains............................................................... - 30.1 20.6 Other income (losses).............................................................. 2.5 1.1 (6.4) ------ ------- ------- Total revenues................................................................. 328.1 214.5 142.1 ------ ------- ------- Expenses: Interest expense on notes payable.................................................. 109.1 69.2 42.6 Interest expense to subsidiaries (eliminated in consolidation)..................... 31.2 7.2 7.5 Operating costs and expenses....................................................... 24.7 10.2 27.8 ------ ------- ------- Total expenses................................................................. 165.0 86.6 77.9 ------ ------- ------- Income before income taxes, equity in undistributed earnings of subsidiaries, distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts and extraordinary charge..................................................... 163.1 127.9 64.2 Income tax expense (benefit).......................................................... (5.5) 1.2 (93.2) ------ ------- ------- Income before equity in undistributed earnings of subsidiaries, distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts and extraordinary charge..................................................... 168.6 126.7 157.4 Equity in undistributed earnings of subsidiaries (eliminated in consolidation)........ 454.6 155.8 65.1 ------- ------- ------- Income before distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts and extraordinary charge........... 623.2 282.5 222.5 Distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts............................................................... 49.0 3.6 - ------- ------- ------ Income before extraordinary charge............................................. 574.2 278.9 222.5 Extraordinary charge on extinguishment of debt, net of tax............................ 6.9 26.5 2.1 ------- ------- ------ Net income..................................................................... 567.3 252.4 220.4 Less amounts applicable to preferred stock: Charge related to induced conversions.............................................. 13.2 - - Preferred stock dividends.......................................................... 8.7 27.4 18.4 ------- ------- ------ Earnings applicable to common stock............................................ $545.4 $ 225.0 $202.0 ====== ======= ====== The accompanying note is an integral part of the condensed financial information.
104 CONSECO, INC. AND SUBSIDIARIES SCHEDULE II
Condensed Financial Information of Registrant (Parent Company) Statement of Cash Flows for the years ended December 31, 1997, 1996 and 1995 (Dollars in millions) 1997 1996 1995 ---- ---- ---- Cash flows from operating activities: Net income........................................................................... $ 567.3 $ 252.4 $ 220.4 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed earnings of consolidated subsidiaries.................... (454.6) (155.8) (65.1) Net investment gains............................................................. - (30.1) (20.6) Income taxes .................................................................... (62.0) (3.2) (101.3) Extraordinary charge on extinguishment of debt................................... 10.6 36.9 3.7 Distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts.............................................................. 75.4 5.5 - Other............................................................................ 7.0 (21.4) 10.8 -------- -------- ------- Net cash provided by operating activities...................................... 143.7 84.3 47.9 -------- -------- ------- Cash flows from investing activities: Sales and maturities of investments.................................................. 70.0 45.0 125.6 Investments in consolidated subsidiaries............................................. (983.1) (226.1) (556.9) Purchases of investments............................................................. (143.3) (66.0) (70.8) Investment in Conseco Capital Partners II, L.P....................................... - - (7.1) Expenses incurred in conjunction with terminated merger.............................. - - (5.5) Cash held by subsidiaries prior to acquisition....................................... 4.1 38.9 17.0 Payments from subsidiaries........................................................... 72.9 36.5 - -------- -------- ------- Net cash used by investing activities.......................................... (979.4) (171.7) (497.7) -------- -------- ------- Cash flows from financing activities: Issuance of equity securities, net................................................... 52.3 20.6 1.8 Issuance of convertible preferred stock.............................................. - 257.7 - Issuance of Company-obligated mandatorily redeemable preferred securities of subsidiary trusts............................................................... 780.4 587.7 - Issuance of notes payable, net....................................................... 2,577.0 856.0 827.2 Issuance of commercial paper......................................................... 448.2 - - Payments on notes payable............................................................ (2,217.7) (1,467.2) (330.0) Payments to repurchase equity securities of Conseco.................................. (593.3) (21.5) (92.4) Dividends paid ...................................................................... (76.8) (34.3) (24.6) Dividends on stock held by subsidiaries.............................................. (53.8) (38.1) (38.7) Distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts............................................................... (65.7) (2.9) - Payments to retire preferred stock................................................... (72.4) (.3) - -------- -------- ------- Net cash provided by financing activities...................................... 778.2 157.7 343.3 -------- -------- ------- Net increase (decrease) in short-term investments.............................. (57.5) 70.3 (106.5) Short term investments, beginning of year............................................ 74.9 4.6 111.1 -------- -------- ------- Short term investments, end of year.................................................. $ 17.4 $ 74.9 $ 4.6 ======== ======== ======= The accompanying note is an integral part of the condensed financial information.
105 CONSECO, INC. AND SUBSIDIARIES SCHEDULE II Note to Condensed Financial Information Basis of Presentation The condensed financial information should be read in conjunction with the consolidated financial statements of Conseco, Inc. The condensed financial information includes the accounts and activity of the Parent Company and its wholly-owned non-insurance subsidiaries which act as the holding companies for the Company's life insurance subsidiaries. 106 CONSECO, INC. AND SUBSIDIARIES SCHEDULE III
Supplementary Insurance Information (Dollars in millions) Amortization of Cost of policies Insurance cost of policies produced and Insurance Net policy benefits produced and Other cost of policies Insurance policy investment and cost of policies operating Segment purchased liabilities income income expenses(1) purchased(2) expenses(3) - ------- --------- ----------- ------ ------ ----------- ------------ ----------- 1997 Supplemental health operations.................. $1,527.8 $ 3,759.6 $1,858.1 $ 273.8 $1,217.5 $194.9 $313.5 Annuity operations............ 828.0 14,150.8 96.8 1,070.6 725.9 198.9 67.3 Life operations............... 921.7 7,075.0 630.5 448.2 611.8 87.8 123.6 Individual and group major medical............... 44.1 577.2 758.1 17.3 579.5 16.8 139.0 Other......................... 60.0 337.5 67.3 15.4 40.3 7.3 42.7 Corporate..................... - - - - - - 126.8 -------- --------- -------- -------- -------- ------ ------ Total..................... $3,381.6 $25,900.1 $3,410.8 $1,825.3 $3,175.0 $505.7 $812.9 ======== ========= ======== ======== ======== ====== ====== 1996 Supplemental health operations.................. $ 990.8 $ 1,891.9 $ 805.9 $ 66.6 $ 531.8 $ 81.2 $123.5 Annuity operations............ 858.6 12,421.8 77.6 939.6 638.9 95.1 59.1 Life operations............... 626.5 4,992.7 360.5 279.7 367.5 41.5 108.9 Individual and group major medical............... 49.4 227.4 357.0 8.8 300.3 15.1 18.3 Other......................... 34.0 108.1 53.2 7.8 25.1 7.9 47.1 Corporate..................... - - - - - - 112.4 -------- --------- -------- -------- -------- ------ ------ Total..................... $2,559.3 $19,641.9 $1,654.2 $1,302.5 $1,863.6 $240.8 $469.3 ======== ========= ======== ======== ======== ====== ====== 1995 Supplemental health operations.................. $ 571.9 $ 842.6 $ 756.9 $ 66.9 $ 525.6 $ 78.3 $126.2 Annuity operations............ 535.9 10,396.1 68.4 880.3 595.6 169.9 53.9 Life operations............... 220.9 2,102.2 222.4 176.9 234.1 38.6 61.1 Individual and group major medical............... 54.7 144.2 352.0 9.5 300.8 13.1 12.6 Other......................... 38.3 120.3 65.3 9.0 36.8 7.6 42.1 Corporate..................... - - - - - - 140.5 -------- --------- -------- -------- -------- ------ ------ Total..................... $1,421.7 $13,605.4 $1,465.0 $1,142.6 $1,692.9 $307.5 $436.4 ======== ========= ======== ======== ======== ====== ====== (1) Includes insurance policy benefits, change in future policy benefits and amounts added to annuity and financial product policyholder account balances. (2) Includes additional amortization related to gains on sales of investments. (3) Includes interest expense on notes payable, interest expense on short-term investment borrowings, change in future policy benefits related to realized gains, amortization of goodwill and other operating costs and expenses.
107 CONSECO, INC. AND SUBSIDIARIES SCHEDULE IV
Reinsurance for the years ended December 31, 1997, 1996 and 1995 (Dollars in millions) 1997 1996 1995 ---- ---- ---- Life insurance in force: Direct............................................................ $136,711.4 $98,835.5 $36,040.7 Assumed........................................................... 4,198.7 3,659.3 562.8 Ceded............................................................. (36,765.6) (22,345.3) (2,820.3) ---------- ---------- --------- Net insurance in force...................................... $104,144.5 $80,149.5 $33,783.2 ========== ========= ========= Percentage of assumed to net................................ 4.0% 4.6% 1.7% === === === Premiums recorded as revenue for generally accepted accounting principles: Direct............................................................ $3,162.8 $1,632.3 $1,422.1 Assumed........................................................... 290.3 65.8 6.1 Ceded............................................................. (499.0) (313.8) (72.6) -------- -------- -------- Net premiums................................................ $2,954.1 $1,384.3 $1,355.6 ======== ======== ======== Percentage of assumed to net................................ 9.8% 4.7% .4% === === ==
108 EXHIBIT INDEX Annual Report on Form 10-K of Conseco, Inc. Exhibit No. Document 2.4 Agreement and Plan of Merger dated as of May 19, 1995, by and between CCP Insurance, Inc. and Conseco, Inc. was filed with the Commission as Exhibit 2.4 to the Registrant's Report on Form 8-K dated August 31, 1995, and is incorporated herein by this reference. 2.5 Agreement and Plan of Merger dated as of March 11, 1996, by and among Conseco, Inc., LPG Acquisition Company and Life Partners Group, Inc. was filed with the Commission as Exhibit 2.5 to the Registrant's Report on Form 8-K dated March 11, 1996, and is incorporated herein by this reference. 2.6 Agreement and Plan of Merger dated as of August 25, 1996, by and between the Registrant and American Travellers Corporation was filed with the Commission as Exhibit 2.6 to the Registrant's Report on Form 8-K dated August 25, 1996, and is incorporated herein by this reference. 2.7 Agreement and Plan of Merger dated August 25, 1996, by and among the Registrant, CAF Acquisition Company and Capitol American Financial Corporation was filed with the Commission as Exhibit 2.7 to the Registrant's Report on Form 8-K dated August 25, 1996, and is incorporated herein by this reference. 2.8 Agreement and Plan of Merger dated as of September 25, 1996, by and between the Registrant and Transport Holdings Inc. was filed with the Commission as Exhibit 2.8 to the Registrant's Report on Form 8-K dated September 25, 1996, and is incorporated herein by this reference. 2.8.1 First Amendment to Agreement and Plan of Merger dated as of November 7, 1996, by and between the Registrant and Transport Holdings Inc. was filed with the Commission as Exhibit 2.8.1 to its Registration Statement on Form S-4, No. 333-14377 and is incorporated herein by this reference. 2.9 Agreement and Plan of Merger dated as of December 15, 1996, by and among the Registrant, Rock Acquisition Company and Pioneer Financial Services, Inc. was filed with the Commission as Exhibit 2.9 to the Registrant's Report on Form 8-K dated December 15, 1996, and is incorporated herein by this reference. *3.1 Amended and Restated Articles of Incorporation of the Registrant. *3.2 Amended and Restated By-Laws of the Registrant. 4.8 Indenture dated as of February 18, 1993, between the Registrant and Shawmut Bank Connecticut, National Association, as Trustee, for the 8 1/8 percent Senior Notes due 2003, was filed with the Commission as Exhibit 4.8 to the Registrant's Annual Report on Form 10-K for 1992, and is incorporated herein by this reference. Exhibit No. Document 4.12 Indenture dated as of September 29, 1994 between ALHC Merger Corporation and LTCB Trust Company and First Supplemental Indenture dated as of September 29, 1994 between American Life Holding Company and the Trustee for the 11 1/4% Senior Subordinated Notes due 2004 were filed with the Commission as Exhibit 4.12 to the Registrant's Report on Form 8-K dated September 29, 1994, and are incorporated herein by this reference. 4.13 Indenture dated as of December 15, 1994, between CCP Insurance, Inc., and LTCB Trust Company, as Trustee, for the $200,000,000 aggregate principal amount of 10 1/2% Senior Notes due 2004 was filed with the Commission as Exhibit 4.13 to the Registrant's Annual Report on Form 10-K for 1995, and is incorporated herein by this reference. 4.13.1 First Supplemental Indenture between Conseco, Inc., as Issuer, and LTCB Trust Company as Trustee, dated as of August 31, 1995, was filed with the Commission as Exhibit 4.13.1 to the Registrant's Report on Form 10-Q for the quarter ended September 30, 1995, and is incorporated herein by this reference. 4.14 Credit Agreement among the Registrant, Bank of America National Trust and Savings Association, First Union National Bank of North Carolina and Nationsbank, N.A. dated November 22, 1996 ("Credit Agreement"), was filed with the Commission as Exhibit 4.17 to the Registrant's Report on Form 8-K dated December 17, 1996, and is incorporated herein by this reference. 4.14.1 First Amendment dated as of March 10, 1997 to Credit Agreement was filed with the Commission as Exhibit 4.14.1 to the Registrant's Report on Form 8-K dated April 1, 1997, and is incorporated herein by this reference. 4.17.1 Subordinated Indenture, dated as of November 14, 1996, between the Registrant and Fleet National Bank, as Trustee, was filed with the Commission as Exhibit 4.17.1 to the Registrant's Report on Form 8-K dated November 19, 1996, and is incorporated herein by this reference. 4.17.2 First Supplemental Indenture, dated as of November 14, 1996, between the Registrant and Fleet National Bank, as Trustee, was filed with the Commission as Exhibit 4.17.2 to the Registrant's Report on Form 8-K dated November 19, 1996, and is incorporated herein by this reference. 4.17.3 9.16% Subordinated Deferrable Interest Debenture due 2006 was filed with the Commission as Exhibit 4.17.3 to the Registrant's Report on Form 8-K dated November 19, 1996, and is incorporated herein by this reference. 4.17.4 Second Supplemental Indenture, dated as of November 22, 1996, between Conseco, Inc. and Fleet National Bank, as Trustee was filed with the Commission as Exhibit 4.17.1 to the Registrant's Report on Form 8-K dated November 27, 1996, and is incorporated herein by this reference. 4.17.5 8.70% Subordinated Deferrable Interest Debenture due 2026 was filed with the Commission as Exhibit 4.17.4 to the Registrant's Report on Form 8-K dated November 27, 1996, and is incorporated herein by this reference. 4.17.6 Third Supplemental Indenture, dated as of March 26, 1997 between the Registrant and Fleet National Bank, as Trustee, was filed with the Commission as Exhibit 4.17.6 to the Registrant's Report on Form 8-K dated April 1, 1997, and is incorporated herein by this reference. 4.17.7 8.796% Subordinated Deferrable Interest Debenture due 2027 was filed with the Commission as Exhibit 4.17.7 to the Registrant's Report on Form 8-K dated April 1, 1997, and is incorporated herein by this reference. Exhibit No. Document 4.18.1 Amended and Restated Declaration of Trust of Conseco Financing Trust I, dated as of November 14, 1996, among Conseco, Inc., as sponsor, the Trustees named therein and the holders from time to time of undivided beneficial interests in the assets of Conseco Financing Trust I was filed with the Commission as Exhibit 4.18.1 to the Registrant's Report on Form 8-K dated November 19, 1996, and is incorporated herein by this reference. 4.18.2 Global Certificate for Preferred Security of Conseco Financing Trust I was filed with the Commission as Exhibit 4.18.2 to the Registrant's Report on Form 8-K dated November 19, 1996, and is incorporated herein by this reference. 4.18.3 Preferred Securities Guarantee Agreement, dated as of November 19, 1996, between the Registrant and Fleet National Bank was filed with the Commission as Exhibit 4.18.3 to the Registrant's Report on Form 8-K dated November 19, 1996, and is incorporated herein by this reference. 4.19.1 Amended and Restated Declaration of Trust of Conseco Financing Trust II, dated as of November 22, 1996, among Conseco, Inc., as sponsor, the Trustees named therein and the holders from time to time of undivided beneficial interests in the assets of Conseco Financing Trust II was filed with the Commission as Exhibit 4.19.1 to the Registrant's Report on Form 8-K dated November 27, 1996, and is incorporated herein by this reference. 4.19.2 Global Certificate for Preferred Security of Conseco Financing Trust II was filed with the Commission as Exhibit 4.19.2 to the Registrant's Report on Form 8-K dated November 27, 1996, and is incorporated herein by this reference. 4.19.3 Preferred Securities Guarantee Agreement, dated as of November 27, 1996, between Conseco, Inc. and Fleet National Bank was filed with the Commission as Exhibit 4.19.3 to the Registrant's Report on Form 8-K dated November 27, 1996, and is incorporated herein by this reference. 4.20 Indenture relating to the 6.5% Convertible Subordinated Debentures due October 1, 2005 issued by American Travellers Corporation was filed with the Commission as Exhibit 4(c) to the Annual Report on Form 10-K of American Travellers Corporation for the year ended December 31, 1995, and is incorporated herein by this reference. 4.20.1 First Supplemental Indenture between the Registrant and Firstar Bank of Minnesota, N.A. Trustee, as Trustee, relating to the 6.5% Convertible Subordinated Debentures due October 1, 2005 was filed with the Commission as Exhibit 4.20.1 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996, and is incorporated herein by this reference. 4.21.1 Amended and Restated Declaration of Trust of Conseco Financing Trust III, dated as of March 26, 1997, among the Registrant, as sponsor, the trustees named therein and the holders from time to time of undivided beneficial interests in the assets of Conseco Financing Trust III was filed with the Commission as Exhibit 4.20.1 to the Registrant's Report on Form 8-K dated April 1, 1997, and is incorporated herein by this reference. 4.21.2 Global Certificate for Capital Security of Conseco Financing Trust III was filed with the Commission as Exhibit 4.20.2 to the Registrant's Report on Form 8-K dated April 1, 1997, and is incorporated herein by this reference. Exhibit No. Document 4.21.3 Capital Securities Guarantee Agreement, dated as of April 1, 1997 between the Registrant and Fleet National Bank was filed with the Commission as Exhibit 4.20.3 to the Registrant's Report on Form 8-K dated April 1, 1997, and is incorporated herein by this reference. 4.22.1 Senior Indenture, dated November 13, 1997, by and between the Registrant and LTCB Trust Company, as Trustee (the "Senior Indenture"), was filed with the Commission as Exhibit 4.1 to Post-Effective Amendment No. 1 to the Registrant's Registration Statement on Form S-3, No. 333-27803, and is incorporated herein by this reference. *4.22.2 6.4% Note due February 10, 2003 issued under the Senior Indenture (one of several identical notes aggregating $250 million). 4.23.1 Subordinated Indenture between the Registrant and The First National Bank of Chicago, as Trustee, was filed with the Commission as Exhibit 4.2 to the Registrant's Registration Statement on Form S-3, No. 333-40423, and is incorporated herein by this reference. 4.24.1 Amended and Restated Declaration of Trust of Conseco Financing Trust IV was filed with the Commission as Exhibit 4.12 to the Registrant's Registration Statement on Form S-3, No. 333-40423, and is incorporated herein by this reference. 4.24.2 Preferred Securities Guarantee of the Registrant for the benefit of the holders of trust preferred securities of Conseco Financing Trust IV was filed with the Commission as Exhibit 4.13 to the Registrant's Registration Statement on Form S-3, No. 333-40423, and is incorporated herein by reference. 4.24.3 Purchase Contract Agreement between the Registrant and The First National Bank of Chicago, as Purchase Contract Agent, was filed with the Commission as Exhibit 4.20 to the Registrant's Registration Statement on Form S-3, No. 333-40423, and is incorporated herein by reference. 4.24.4 Pledge Agreement among the Registrant, The Chase Manhattan Bank, as Collateral Agent, and The First National Bank of Chicago, as Purchase Contract Agent, was filed with the Commission as Exhibit 4.21 to the Registrant's Registration Statement on Form S-3, No. 333-40423, and is incorporated herein by reference. The Registrant agrees to furnish the Commission upon its request a copy of any instrument defining the rights of holders of long-term debt of the Company and its consolidated subsidiaries. Exhibit No. Document 10.1.2 Employment Agreement dated January 1, 1987, between the Registrant and Stephen C. Hilbert was filed with the Commission as Exhibit 10.1.2 to the Registrant's Annual Report on Form 10-K for 1986, and Amendment No. 1 thereto were filed with the Commission as Exhibit 10.1.2 to the Registrant's Annual Report on Form 10-K for 1987; and are incorporated herein by this reference. 10.1.3 Employment Agreement dated July 1, 1991, between the Registrant and Rollin M. Dick was filed with the Commission as Exhibit 10.1.3 to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1991, and is incorporated herein by this reference. 10.1.3(a) Amendment No. 1 to Employment Agreement between the Registrant and Rollin M. Dick was filed with the Commission as Exhibit 10.1.3(a) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996, and is incorporated herein by this reference. 10.1.3(b) Amendment No.2 to Employment Agreement between the Registrant and Rollin M. Dick was filed with the Commission as Exhibit 10.1.3(b) to the Registrant's Report on Form 10-Q for the quarter ended September 30, 1997, and is incorporated herein by this reference. 10.1.4 Employment Agreement dated July 1, 1991, between the Registrant and Donald F. Gongaware was filed with the Commission as Exhibit 10.1.4 to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1991, and is incorporated herein by this reference. 10.1.4(a) Amendment No. 1 to Employment Agreement between the Registrant and Donald F. Gongaware was filed with the Commission as Exhibit 10.1.4(a) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996, and is incorporated herein by this reference. 10.1.4(b) Amendment No. 2 to Employment Agreement between the Registrant and Donald F. Gongaware was filed with the Commission as Exhibit 10.1.4(b) to the Registrant's Report on Form 10-Q for the quarter ended September 30, 1997, and is incorporated herein by this reference. 10.1.9 Unsecured Promissory Note of Stephen C. Hilbert dated May 13, 1996 was filed with the Commission as Exhibit 10.1.9 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996, and is incorporated herein by this reference. 10.1.10 Employment Agreement dated August 17, 1992, between the Registrant and Ngaire E. Cuneo was filed with the Commission as Exhibit 10.1.10 to the Registrant's Report on Form 10-Q for the quarter ended September 30, 1992, and is incorporated herein by this reference. 10.1.10(a) Amendment No. 1 to Employment Agreement between the Registrant and Ngaire E. Cuneo was filed with the Commission as Exhibit 10.1.10(a) to the Registrant's Report on Form 10-K for the year ended December 31, 1996, and is incorporated herein by this reference. 10.1.10(b) Amendment No. 2 to Employment Agreement between the Registrant and Ngaire E. Cuneo was filed with the Commission as Exhibit 10.1.10(b) to the Registrant's Report on Form 10-Q for the quarter ended September 30, 1997, and is incorporated herein by this reference. Exhibit No. Document 10.1.11 Employment Agreement dated September 8, 1997 between the Registrant and John J. Sabl was filed with the Commission as Exhibit 10.1.11 to the Registrant's Report on Form 10-Q for the quarter ended September 30, 1997, and is incorporated herein by this reference. 10.8 The Registrant's Stock Option Plan was filed with the Commission as Exhibit B to its definitive Proxy Statement dated December 10, 1983; Amendment No. 1 thereto was filed with the Commission as Exhibit 10.8.1 to its Report on Form 10-Q for the quarter ended June 30, 1985; Amendment No. 2 thereto was filed with the Commission as Exhibit 10.8.2 to its Registration Statement on Form S-1, No. 33-4367; Amendment No. 3 thereto was filed with the Commission as Exhibit 10.8.3 to the Registrant's Annual Report on Form 10-K for 1986; Amendment No. 4 thereto was filed with the Commission as Exhibit 10.8 to the Registrant's Annual Report on Form 10-K for 1987; Amendment No. 5 thereto was filed with the Commission as Exhibit 10.8 to the Registrant's Report on Form 10-Q for the quarter ended September 30, 1991; and are incorporated herein by this reference. 10.8.3 The Registrant's Cash Bonus Plan was filed with the Commission as Exhibit 10.8.3 to the Registrant's Report on Form 10-Q for the quarter ended March 31, 1989, and is incorporated herein by this reference. 10.8.4 Amended and Restated Conseco Stock Bonus and Deferred Compensation Program was filed with the Commission as Exhibit 10.8.4 to the Registrant's Annual Report on Form 10-K for 1992, and is incorporated herein by this reference. 10.8.6 Conseco Performance - Based Compensation Bonus Plan for Executive Vice Presidents was filed with the Commission as Exhibit B to the Registrant's definitive Proxy Statement dated April 29, 1994, and is incorporated herein by this reference. 10.8.7 Conseco, Inc. Amended and Restated Deferred Compensation Plan was filed with the Commission as Exhibit A to the Registrant's definitive Proxy Statement dated April 26, 1995, and is incorporated herein by this reference. 10.8.8 Amendment to the Amended and Restated Conseco Stock Bonus and Deferred Compensation Program was filed with the Commission as Exhibit 10.8.8 to the Registrant's Annual Report on Form 10-K for 1994, and is incorporated herein by this reference. 10.8.9 Conseco 1994 Stock and Incentive Plan was filed as Exhibit A to the Registrant's definitive Proxy Statement dated April 29, 1994 and is incorporated herein by this reference. 10.8.10 Amendment Number 2 to the Amended and Restated Conseco Stock Bonus and Deferred Compensation Program was filed with the Commission as Exhibit 10.8.10 to the Registrant's Annual Report on Form 10-K for 1995 and is incorporated herein by reference. *10.8.11 Amended and Restated Director, Executive and Senior Officer Stock Purchase Plan. 10.8.12 Guaranty regarding Director, Executive and Senior Officer Stock Purchase Plan was filed with the Commission as Exhibit 10.8.12 to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1996, and is incorporated herein by this reference. 10.8.13 Form of Promissory Note payable to the Registrant relating to the Registrant's Director, Executive and Senior Officer Stock Purchase Plan was filed with the Commission as Exhibit 10.8.13 to the Registrant's Report on Form 10-Q for the quarter ended September 30, 1996, and is incorporated herein by this reference. *10.8.14 Conseco, Inc. Amended And Restated 1997 Non-qualified Stock Option Plan. Exhibit No. Document 10.23 Aircraft Lease Agreement dated December 22, 1988, between General Electrical Capital Corporation and Conseco Investment Holding Company was filed with the Commission as Exhibit 10.23 to the Registrant's Annual Report on Form 10-K for 1988, and is incorporated herein by this reference. 10.23.1 Amendment to Aircraft Lease Agreement dated December 22, 1988, between General Electric Capital Corporation and Conseco Investment Holding Company was filed with the Commission as Exhibit 10.23.1 to the Registrant's Annual Report on Form 10-K for 1993, and is incorporated herein by this reference. 10.24 Aircraft Lease Agreement dated April 26, 1991 between General Electric Capital Corporation and Conseco Investment Holding Company was filed with the Commission as Exhibit 10.29 to the Registrant's Report on Form 10-Q for the quarter ended September 30, 1991, and is incorporated herein by this reference. 10.24.1 Amendment to Aircraft Lease Agreement dated April 26, 1991, between General Electric Capital Corporation and Conseco Investment Holding Company was filed with the Commission as Exhibit 10.24.1 to the Registrant's Annual Report on Form 10-K for 1993, and is incorporated herein by this reference. 10.25 Aircraft Lease Purchase Agreement dated December 28, 1993, between MetLife Capital Corporation and Conseco Investment Holding Company was filed with the Commission as Exhibit 10.25 to the Registrant's Annual Report on Form 10-K for 1993, and is incorporated herein by this reference. 10.31 Helicopter Lease Agreement dated April 9, 1992 between General Electric Capital Corporation and Conseco Investment Holding Company was filed with the Commission as Exhibit 10.31 to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1992, and is incorporated herein by this reference. 10.32 Aircraft Lease Agreement dated October 6, 1993, between General Electric Capital Corporation and Conseco Investment Holding Company and the associated Assignment Agreement dated October 25, 1993, between General Electric Capital Corporation and Nationsbanc Leasing Corporation were filed with the Commission as Exhibit 10.32 to the Registrant's Annual Report on Form 10-K for 1993, and are incorporated herein by this reference. 10.36 Lease dated as of December 18, 1992 between LaSalle National Trust, N.A. as trustee and Bankers Life and Casualty Company relating to the lease of executive office and administration space by BLH was filed with the Commission as Exhibit 10.17 to Amendment No. 1 to BLH's Registration Statement on Form S-1, No. 33-55026, and is incorporated herein by this reference. 10.37 Lease dated as of August 20, 1993 between REO Holding Corporation and Bankers Life and Casualty Company relating the lease of warehouse space by BLH was filed with the Commission as Exhibit 10.14 to BLH's Report on Form 10-K for 1994, and is incorporated herein by this reference. *12.1 Computation of Ratio of Earnings to Fixed Charges, Preferred Dividends and Distributions on Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts. *21 List of Subsidiaries. Exhibit No. Document *23 Consent of Independent Accountants. *27 Financial data schedule for Conseco, Inc. dated December 31, 1997 *Filed herewith Compensation Plans and Arrangements 10.1.2 Employment Agreement dated January 1, 1987, between the Registrant and Stephen C. Hilbert and Amendment No. 1 thereto. 10.1.3 Employment Agreement dated July 1, 1991, between the Registrant and Rollin M. Dick. 10.1.3(a) Amendment No. 1 to Employment Agreement between the Registrant and Rollin M. Dick. 10.1.3(b) Amendment No. 2 to Employment Agreement between the Registrant and Rollin M. Dick. 10.1.4 Employment Agreement dated July 1, 1991, between the Registrant and Donald F. Gongaware. 10.1.4(a) Amendment No. 1 to Employment Agreement between the Registrant and Donald F. Gongaware. 10.1.4(b) Amendment No. 2 to Employment Agreement between the Registrant and Donald F. Gongaware. 10.1.9 Unsecured Promissory Note of Stephen C. Hilbert. 10.1.10 Employment Agreement dated August 17, 1992, between the Registrant and Ngaire E. Cuneo. 10.1.10(a) Amendment No. 1 to Employment Agreement between the Registrant and Ngaire E. Cuneo. 10.1.10(b) Amendment No. 2 to Employment Agreement between the Registrant and Ngaire E. Cuneo. 10.11 Employment Agreement between the Registrant and John J. Sabl. 10.8 The Registrant's Stock Option Plan; Amendment No. 1 thereto; Amendment No. 2 thereto; Amendment No. 3 thereto; Amendment No. 4 thereto; and Amendment No. 5 thereto. 10.8.3 The Registrant's Cash Bonus Plan. 10.8.4 Amended and Restated Conseco Stock Bonus and Deferred Compensation Program. 10.8.6 Conseco Performance - Based Compensation Bonus Plan for Executive Vice Presidents. 10.8.7 Conseco, Inc. Amended and Restated Deferred Compensation Plan. 10.8.8 Amendment to the Amended and Restated Conseco Stock Bonus and Deferred Compensation Program. 10.8.9 Conseco 1994 Stock and Incentive Plan. 10.8.10 Amendment No. 2 to the Amended and Restated Stock Bonus and Deferred Compensation Program. *10.8.11 Amended and Restated Director, Executive and Senior Officer Stock Purchase Plan. 10.8.12 Guaranty regarding Director, Executive and Senior Officer Stock Purchase Plan. 10.8.13 Form of Promissory Note Payable to the Registrant relating to the Registrant's Director, Executive and Senior Officer Stock Purchase Plan. *10.8.14 Conseco, Inc. Amended and Restated 1997 Non-qualified Stock Option Plan. EX-3.1 2 EX-3.1 AMENDED AND RESTATED ARTICLES OF INCORPORATION OF CONSECO, INC. The undersigned officer of Conseco, Inc. (hereinafter referred to as the "Corporation") existing pursuant to the provisions of the Indiana Business Corporation Law, as amended (hereinafter referred to as the "Act"), desiring to give notice of certain corporate action effectuating amendment of provisions of its Articles of Incorporation, by the adoption of new Amended and Restated Articles of Incorporation, superseding and replacing all Articles of Incorporation, and amendments and restatements thereto heretofore existing, hereby certifies as follows: ARTICLE I Text of the Amended and Restated Articles The exact text of the entire Articles of Incorporation of the Corporation, as amended and restated (hereinafter referred to as the "Amended Articles"), is as follows: ARTICLE I NAME The name of the Corporation is Conseco, Inc. ARTICLE II Purpose The purposes for which the Corporation is formed are: to transact for pecuniary profit any lawful business or businesses as permitted by the Act. ARTICLE III Period of Existence The period during which the Corporation shall continue is perpetual. ARTICLE IV Resident Agent and Principal Office Section 1. Resident Agent. The name and address of the Corporation's Resident Agent for service of process is John J. Sabl, 11825 N. Pennsylvania Street, Carmel, Indiana 46032. Section 2. Principal Office. The post office address of the principal office of the Corporation is 11825 N. Pennsylvania Street, Carmel, Indiana 46032. ARTICLE V Terms of Authorized Shares Section 1. Designation. The authorized shares of the Corporation shall be divided into two (2) classes, as follows: (a) 1,000,000,000 shares of Common Stock without par value. The shares of Common Stock shall be identical with each other in all respects. (b) 20,000,000 shares of Preferred Stock without par value, which shares may, in the discretion of the Board of Directors of the Corporation, be issued in one or more classes or series having differing rights, preferences, restrictions and limitations. All shares of Preferred Stock of the same series shall be identical with each other in all respects. The Preferred Stock and any class or series thereof shall possess such relative rights, preferences, limitations and restrictions as may be established by resolution of the Board of Directors of the Corporation prior to the issuance thereof, which is vested to the fullest extent permitted by law with authority to fix the relative rights, preferences, qualifications, limitations or restrictions for the Preferred Stock or any class or any series thereof, including without limiting the generality of the foregoing, the following: (i) The number of shares which shall initially constitute each class or series of a class of Preferred Stock; (ii) The rate or rates and the time or times at which dividends and other distributions on the shares of each class or each series thereof shall be paid, the relationship or priority of such dividends to those 2 payable on Common Stock or to other classes or series of Preferred Stock, and whether or not any such dividends shall be cumulative; (iii) The amount payable on the shares of each class or series in the event of the voluntary or involuntary liquidation, dissolution or winding up of the affairs of the Corporation, and the relative priorities, if any, to be accorded such payments in liquidation; (iv) The terms and conditions upon which either the Corporation may exercise a right to redeem shares of each class or series or upon which the holder of such shares may exercise a right to require redemption of such Shareholder's Preferred Stock, including any premiums or penalties applicable to exercise of such rights; (v) Whether or not a sinking fund shall be created for the redemption of the shares of a class or series, and the terms and conditions of any such fund; (vi) Rights, if any, to convert any shares of Preferred Stock either into shares of Common Stock or into other classes or series of Preferred Stock and the prices, premiums or penalties, ratios and other terms applicable to any such conversion; (vii) Restrictions on acquisition, rights of first refusal or other limitations on transfer as may be applicable to any class or series, including any series intended to be offered to a special class or group; and (viii) Any other relative rights, preferences, limitations, qualifications or restrictions on the Preferred Stock or any class or series of such shares, including rights and remedies in the event of default in connection with dividends, other distributions or redemptions. Section 2. Preemptive Rights. No holder of any share of capital stock of the Corporation shall have any preemptive rights. 3 Section 3. Issuance of Shares. The shares of capital stock of the Corporation may be issued by the Corporation from time to time in the discretion of the Board of Directors to such persons for such consideration and upon such terms and conditions as it may determine, subject to the provisions of the Act and these Amended Articles. Such of its shares as the Corporation may reacquire may be resold or otherwise disposed of upon such terms and conditions and for such consideration as the Board of Directors may determine from time to time. The Board of Directors may from time to time grant or issue options, warrants or rights to purchase shares of capital stock of the Corporation upon such terms and conditions and for such consideration as it shall determine, subject to the provisions of the Act. Section 4. Dissolution Distribution on Common Stock. In the event of any voluntary or involuntary dissolution, liquidation or winding up of the Corporation, the holders of the outstanding shares of Common Stock shall be entitled, after due payment or provisions for payment of the debts and other liabilities of the Corporation, and after and subject to such distributions as may be required with respect to any class or series of Preferred Stock outstanding, to share ratably, share for share, in the remaining net assets of the Corporation. ARTICLE VI Directors Section 1. Number of Directors. The number of director(s) may be from time to time fixed by the Bylaws of the Corporation at any number. In the absence of a Bylaw fixing the number of directors, the number shall be seven (7). Section 2. Names and Post Office Addresses of the Board of Directors. The names and post office addresses of the Board of Directors of the Corporation holding office at the time of the adoption of these Amended Articles are:
Number and Name Street or Building City State Zip Code - ---- ------------------ ---- ----- -------- Stephen C. Hilbert 11825 N. Pennsylvania St., Carmel, Indiana 46032 Rollin M. Dick 11825 N. Pennsylvania St., Carmel, Indiana 46032 Donald F. Gongaware 11825 N. Pennsylvania St., Carmel, Indiana 46032 Ngaire E. Cuneo 11825 N. Pennsylvania St., Carmel, Indiana 46032 4 John M. Mutz 11825 N. Pennsylvania St., Carmel, Indiana 46032 M. Phil Hathaway 11825 N. Pennsylvania St., Carmel, Indiana 46032 David R. Decatur 11825 N. Pennsylvania St., Carmel, Indiana 46032 James D. Massey 11825 N. Pennsylvania St., Carmel, Indiana 46032 Dennis E. Murray, Sr. 11825 N. Pennsylvania St., Carmel, Indiana 46032
Section 3. Qualifications of Directors (if any). Qualifications for the directors, if any, shall be set out in the Bylaws. Section 4. Staggered Terms of Directors Authorized. At any time as such may be permitted under the laws of the State of Indiana applicable to and governing the Corporation, the Bylaws of the Corporation may provide for the staggering of the terms of office of the Directors of the Corporation by dividing the total number of Directors into groups and the election of the groups in alternate years for terms of more than one year. The number of groups, lengths of terms and other provisions for such staggering may be in any manner permitted by the laws of the State of Indiana, as such may be amended from time to time. Section 5. Amendment of Section 4. Notwithstanding any provisions of these Amended Articles to the contrary, the provisions of Section 4 above of this Article VI may not be amended, altered, changed or repealed, nor may any provision inconsistent with said provisions be added to these Amended Articles or to the Bylaws of the Corporation, except upon the affirmative vote of the holders of not less than 80% of the total voting power of all outstanding shares of the Voting Stock of the Corporation (as hereinafter defined in Article VIII, Section 5) voting as a single class. ARTICLE VII President and Secretary The names and post office addresses of the President and Secretary of the Corporation at the time of filing these Amended Articles are:
Number and Name Street or Building City State Zip Code ---- ------------------ ---- ----- -------- Stephen C. Hilbert 11825 N. Pennsylvania St., Carmel, Indiana 46032 President 5 John J. Sabl 11825 N. Pennsylvania St., Carmel, Indiana 46032 Secretary
ARTICLE VIII Provisions for Regulation of Business and Conduct of Affairs of Corporation Section 1. Bylaws. Bylaws will be adopted by the Directors from time to time. Section 2. Place of Meetings. Meetings of the Shareholders shall be held at such time or place as set out in the calls, notices or waivers for such meetings and may be either inside or outside the State of Indiana. Section 3. Purchase of Corporate Stock. By resolution of Directors to the extent required by any purchase of the Corporation's own stock, such purchase may be made out of unreserved and unrestricted capital surplus available therefor. Section 4. Distribution Out of Capital Surplus. The Directorsmay from time to time distribute to Shareholders out of capital surplus a portion of the Corporation's assets, in cash or property, as provided by the Act. Section 5. Minimum Price Provisions for Certain Business Combinations. This Section 5 shall govern the approval of certain business combination transactions involving the Corporation. Each capitalized term used in this Section 5 shall have the meaning ascribed to it in Clause (d) hereof. (a) Special Business Combination Transactions. Except as provided in subsection (b) of this Section 5, holders of Voting Stock shall not be entitled to vote on a Special Business Combination Transaction and such Special Business Combination Transaction shall not be effected unless the aggregate amount of the cash and the fair value of any consideration other than cash to be received per share by holders of the Corporation's Common Stock in such Special Business Combination Transaction shall be at least equal to the highest per share price (including any brokerage commissions, transfer taxes and soliciting dealers' fees and adjusted for any intervening stock splits and stock dividends) paid in order to acquire any shares of Common Stock beneficially owned by the Related Person, and the aggregate amount of the cash and the fair value of any consideration other than cash to be received per share by holders of any class or series of the Corporation's Preferred Stock in such Special Business Combination 6 Transaction shall be at least equal to the highest per share price (including any brokerage commissions, transfer taxes, and soliciting dealers' fees and adjusted for any intervening stock splits and stock dividends) paid in order to acquire any shares of such class or series of Preferred Stock beneficially owned by the Related Person. In the event of a Special Business Combination Transaction in which the Corporation survives, the phrase "any consideration other than cash to be received" as used in this subsection (a) of Section 5 shall include the shares of Common Stock or Preferred Stock retained by the holders thereof. (b) Exceptions for Approval by Continuing Directors. The provisions of subsection (a) of this Section 5 shall not apply to any Special Business Combination Transaction if such Special Business Combination Transaction shall have been approved by two-thirds of the Continuing Directors. (c) Definitions. For purposes of this Section 5, the following definitions shall apply: (1) The term "Special Business Combination Transaction" shall mean: (i) any merger or consolidation of the Corporation or any Subsidiary with (x) any Related Person or (y) any other corporation or entity (whether or not itself a Related Person) which is, or after each merger or consolidation would be, an Affiliate of a Related Person; or (ii) any sale, lease, exchange, mortgage, pledge, transfer or other disposition (in one transaction or in a series of transactions) to or with any Related Person or any Affiliate of any Related Person of all or a Substantial Part of the assets of the Corporation (including, without limitation, any securities of a Subsidiary) or any Subsidiary; or (iii) the adoption of any plan or proposal for the liquidation or dissolution of the Corporation proposed by or on behalf of a Related Person or any Affiliate of a Related Person; or (iv) the issuance or transfer by the Corporation or any Subsidiary (in one transaction or in a series of related transactions) of any securities of the 7 Corporation or any Subsidiary to a Related Person, or any Affiliate of a Related Person, in exchange for cash, securities or other property (or a combination thereof); or (v) any reclassification of securities (including any reverse stock split), or recapitalization or reorganization of the Corporation, or any merger or consolidation of the Corporation with any of its Subsidiaries, or any self tender offer for or repurchase of securities of the Corporation or any Subsidiary by the Corporation or any Subsidiary, or any other transaction (whether or not with or into or otherwise involving a Related Person) which in any such case has the effect, directly or indirectly, of increasing the proportionate shares of the outstanding shares of any class or series of stock or securities convertible into stock of the Corporation or any Subsidiary which is directly or indirectly beneficially owned by any Related Person or any Affiliate of any Related Person. (2) The term "Substantial Part" (as distinguished from the phrase "all or substantially all") shall mean more than 10% of the book value of the total assets of the person or entity in question, as of the end of its most recent fiscal year ending prior to the time of the determination. (3) The term "person" shall mean any individual, firm, corporation, partnership, group (within the meaning of Section 13(d)(3) of the Securities Exchange Act of 1934, as in effect on April 23, 1986) or other entity. (4) The term "Related Person" shall mean any person (other than the Corporation or Subsidiary or any employee benefit plan of the Corporation or any Subsidiary) who or which, as of the date on which such determination is made: (i) is the beneficial owner, directly or indirectly, of more than 10 percent of the combined voting power of the then outstanding shares of Voting Stock; or (ii) is an Affiliate of the Corporation and at any time within the two-year period immediately prior thereto was the beneficial owner, directly or 8 indirectly, of 10 percent or more of the combined voting power of the then outstanding shares of Voting Stock; or (iii) which is an assignee of or has otherwise succeeded to the beneficial ownership of any shares of Voting Stock that were at any time within the two-year period immediately prior thereto beneficially owned by a Related Person, if such assignment or succession shall have occurred in the course of a transaction or series of transactions not utilizing the facilities of a national securities exchange, occurring in the national over-the-counter market or involving a public distribution. (5) A person shall be a "beneficial owner" of any Voting Stock: (i) which such person or any of its Affiliates or Associates beneficially owns, directly or indirectly; or (ii) which such person or any of its Affiliates or Associates has (a) the right to acquire (whether such right is exercisable immediately or only after the passage of time), pursuant to any agreement, arrangement or understanding or upon the exercise of conversion rights, exchange rights, warrants or options, or otherwise, or (b) the right to vote or direct the vote pursuant to any agreement, arrangement or understanding; or (iii) which is beneficially owned, directly or indirectly, by any other person with which such person or any of its Affiliates or Associates has any agreement, arrangement or understanding for the purpose of acquiring, holding, voting or disposing of any shares of Voting Stock. (6) For the purposes of determining whether a person is a Related Person pursuant to subsection (c)(4) of this Section 5, the number of shares of Voting Stock deemed to be outstanding shall include shares deemed owned through application of subsection (c)(5) of this Section 5 but shall not include any other shares of Voting Stock that may be issuable pursuant to any agreement, arrangement or understanding, or upon exercise of conversion rights, warrants or options, or otherwise. 9 (7) The terms "Affiliate" and "Associate" shall have the respective meanings ascribed to such terms in Rule 12b-2 of the General Rules and Regulations under the Securities Exchange Act of 1934. (8) "Subsidiary" shall mean any corporation more than 50 percent of whose outstanding stock having ordinary voting power in the election of directors is owned, directly or indirectly, by the Corporation or by a Subsidiary or by the Corporation and one or more Subsidiaries; provided, however, that for the purposes of the definition of Related Person set forth in subsection (c)(4) of this Section 5, the term "Subsidiary" shall mean only a corporation of which a majority of each class of equity security is owned, directly or indirectly, by the Corporation. (9) "Continuing Director" shall mean any director who (i) was a member of the Corporation's Board of Directors on April 23, 1986, or (ii) was designated (before such person's initial election as a Director) by a majority of the Continuing Directors as a Continuing Director, or (iii) with respect to a Special Business Combination Transaction, was a member of the Board of Directors immediately prior to the date on which any Related Person involved, either directly or through an Affiliate or Associate, in such Special Business Combination Transaction first became a Related Person. (10) The term "Voting Stock" shall mean all outstanding shares of capital stock of all classes and series of the Corporation entitled to vote generally in the election of Directors of the Corporation, in each case voting together as a single class (it being understood that for purposes of this Section 5 each share of the Voting Stock shall have the number of votes granted to it pursuant to Article V of these Amended Articles). (d) Determinations by Continuing Directors. A majority of the Continuing Directors shall have the power and duty to determine, on the basis of information known to them after reasonable inquiry, all facts necessary to determine compliance with this Section 5, including, without limitation: (1) whether a person is a Related Person; (2) the number of shares of Voting Stock beneficially owned by any person; (3) whether a person is an Affiliate or Associate of another person; and 10 (4) the fair value of any consideration other than cash to be received by holders of shares of any class or series of Voting Stock in a Special Business Combination Transaction. The good faith determination of a majority of the Continuing Directors on such matters shall be conclusive and binding for all purposes of this Section 5. (e) Amendment of Section 5. Notwithstanding any provision of these Amended Articles to the contrary, the provisions set forth in Section 5 of Article VIII may not be amended, altered, changed or repealed, nor may any provision inconsistent with said provisions be added to these Amended Articles or to the Bylaws of the Corporation, except upon the affirmative vote of the holders of not less than 80% of the total voting power of all outstanding shares of the Voting Stock of the Corporation voting as a single class. ARTICLE IX Designations, Rights and Preferences of Series E Preferred Stock The designations, rights, preferences, limitations and restrictions of the shares of Preferred Stock, without par value, to be designated as Series E Redeemable Preferred Stock (in addition to those set forth elsewhere in these Amended Articles) are hereby fixed as follows: Section 1. Designation; Number of Shares; Stated Value. Ninety Thousand (90,000) shares of Preferred Stock shall be designated Series E Redeemable Preferred Stock (hereinafter referred to as the "Series E Preferred Stock"). Shares of the Series E Preferred Stock shall have a stated value of $10,000 per share. Section 2. Dividends. (a) The holders of the shares of Series E Preferred Stock shall be entitled to receive cumulative cash dividends, when and as declared by the Board of Directors out of funds legally available therefor, at a rate of $400.00 per share per annum and no more, before any dividend or distribution in cash or other property (other than dividends or distributions payable in stock ranking junior to the Series E Preferred Stock as to dividends or upon liquidation, dissolution or winding-up) on any class or series of stock of the Corporation ranking junior to the Series E Preferred Stock as to dividends or upon liquidation, dissolution or winding-up shall be declared or paid or set apart for 11 payment. (b) Dividends on the Series E Preferred Stock shall be declared by the Board of Directors on or prior to December 31 of each calendar year and payable on March 1 of the next calendar year, commencing March 1, 1995 (each such date being hereinafter individually a "Dividend Payment Date" and collectively the "Dividend Payment Dates"), except that if any such Dividend Payment Date is a Saturday, Sunday or legal holiday then such dividend shall be payable on the first immediately succeeding calendar day which is not a Saturday, Sunday or legal holiday, to holders of record as they appear on the books of the Corporation on December 31 of the year preceding such Dividend Payment Date or such other date as may be determined by the Board of Directors. Dividends in arrears may be declared and paid at any time, without reference to any regular Dividend Payment Date, to holders of record on such date as may be fixed by the Board of Directors of the Corporation. Dividends payable on the Series E Preferred Stock for the initial dividend period and for any period less than a yearly period shall be computed on the basis of a 360-day year of twelve 30-day months. (c) Dividends on the Series E Preferred Stock shall be cumulative and shall accrue from and after December 31, 1993, whether or not declared by the Board of Directors. Accruals of dividends shall not bear interest. (d) No dividend may be declared on any other class or series of stock ranking on a parity with the Series E Preferred Stock as to dividends in respect of any dividend period unless there shall also be or have been declared on the Series E Preferred Stock like dividends ratably in proportion to the respective annual dividend rates fixed therefor. Section 3. Redemption. (a) The Corporation, at its sole option, may redeem shares of the Series E Preferred Stock, in whole or in part, at any time or from time to time, at the stated value, plus in each case accrued and unpaid dividends thereon to the date fixed for redemption (the total sum so payable on any such redemption being herein referred to as the "redemption price"). In the case of the redemption of a part only of the shares of the Series E Preferred Stock at the time outstanding, the shares to be so redeemed shall be selected by lot, pro rata (as nearly as may be), or in such other equitable manner as the Board of Directors may determine. 12 (b) Notice of any redemption pursuant to this Section 3 shall be mailed at least 30, but not more than 60, days in advance of the date designated for such redemption (herein called the "redemption date") to the holders of record of shares of the Series E Preferred Stock so to be redeemed at their respective addresses as the same shall appear on the books of the Corporation; but no failure to mail such notice to particular shareholders or any defect therein or in the mailing thereof shall affect the validity of the proceedings for the redemption of any shares of the Series E Preferred Stock. In order to facilitate the redemption of shares of the Series E Preferred Stock, the Board of Directors may fix a record date for the determination of holders of shares of the Series E Preferred Stock to be redeemed not more than 60 days prior to the redemption date. Each such notice shall state: (1) the redemption date; (2) the number of shares of Series E Preferred Stock to be redeemed and, if less than all the shares held by such holder are to be redeemed, the number of such shares to be redeemed from such holder; (3) the redemption price; (4) the place or places where certificates for such shares are to be surrendered for payment of the redemption price; and (5) that dividends on the shares to be redeemed will cease to accrue on such redemption date. If less than all the shares represented by any such surrendered certificate are redeemed, a new certificate shall be issued representing the unredeemed shares. (c) The Corporation shall, on or prior to the date fixed for redemption of any shares, but not earlier than 45 days prior to the date fixed for redemption, deposit with a redemption agent selected by the Board of Directors of the Corporation, as a trust fund, a sum sufficient to redeem the shares called for redemption, with irrevocable instructions and authority to such redemption agent to give or complete the notice of redemption thereof and to pay the respective holders of such shares, as evidenced by a list of such holders certified by an officer of the Corporation, the redemption price upon surrender of their respective share certificates. Such deposit shall be deemed to constitute full payment of such shares to their holders; and from and after the date of such deposit, notwithstanding that any certificates for such shares shall not have been surrendered for cancellation, the shares represented thereby shall no longer be deemed outstanding, the rights to receive dividends and distributions shall cease to accrue from and after the redemption date, and all rights of the holders of the shares of the Series E Preferred Stock called for redemption, as shareholders of the Corporation with respect to such shares, shall cease and terminate, except the right to receive the redemption price, without interest, upon the surrender of their respective certificates. In case the holders of any shares shall not, within six years after such deposit, claim the amount deposited for redemption thereof, such 13 redemption agent shall, upon demand, pay over to the Corporation the balance of such amount so deposited. Thereupon, such transfer agent or other redemption agent shall be relieved of all responsibility to the holders thereof and the sole right of such holders shall be as general creditors of the Corporation. Any interest accrued on any funds so deposited shall belong to the Corporation, and shall be paid to it from time to time on demand. Section 4. No Conversion Rights. The holders of shares of Series E Preferred Stock shall not have the right to convert such shares into any other shares of capital stock of the Corporation. Section 5. Voting. The shares of the Series E Preferred Stock shall not have any voting powers, either general or special, except as set forth in this Amended and Restated Certificate or as otherwise provided by law. Section 6. Liquidation Rights. Upon the dissolution, liquidation or winding-up of the Corporation, whether voluntary or involuntary, the holders of the shares of the Series E Preferred Stock shall be entitled to receive, before any payment or distribution of the assets of the Corporation or proceeds thereof (whether capital or surplus) shall be made to or set apart for the holders of the Common Stock or any other class or series of stock ranking junior to the Series E Preferred Stock upon liquidation, dissolution or winding-up, the amount of $10,000 per share, plus a sum equal to all dividends on such shares (whether or not earned or declared) accrued and unpaid thereon to the date of final distribution, but such holders shall not be entitled to any further payment. If, upon any liquidation, dissolution or winding-up of the Corporation, the assets of the Corporation, or proceeds thereof, distributable among the holders of shares of the Series E Preferred Stock and any other class or series of Preferred Stock ranking on a parity with the Series E Preferred Stock as to payments upon liquidation, dissolution or winding-up shall be insufficient to pay in full the preferential amount aforesaid, then such assets or the proceeds thereof shall be distributed among such holders ratably in accordance with the respective amounts which would be payable on such shares if all amounts payable thereon were paid in full. For the purposes of this Section 6, the voluntary sale, conveyance, lease, exchange or transfer (for cash, shares of stock, securities or other consideration) of all or substantially all the property or assets of the Corporation to, or a consolidation or merger of the Corporation with, one or more other corporations (whether or not the Corporation is the corporation surviving such consolidation or merger) shall not be deemed to be a liquidation, dissolution or winding-up, voluntary or involuntary. 14 Section 7. No Purchase, Retirement or Sinking Fund. The shares of the Series E Preferred Stock shall not be subject to the operation of any purchase, retirement or sinking fund. Section 8. Status. Shares of the Series E Preferred Stock which have been issued and reacquired in any manner by the Corporation (excluding, until the Corporation elects to retire them, shares which are held as treasury shares, but including shares redeemed and shares purchased and retired) shall, upon compliance with any applicable provisions of the Indiana Business Corporation Law, have the status of authorized and unissued shares of Preferred Stock and may be reissued as a part of a new series of Preferred Stock to be established by the Board of Directors or as part of any other series of Preferred Stock the terms of which do not prohibit such reissue. Section 9. Priority. The Common Stock of the Corporation shall rank junior to and the Cumulative Convertible Preferred Stock of the Corporation shall rank on a parity with the Series E Preferred Stock as to dividends and distribution of assets upon liquidation, dissolution or winding-up. Section 10. Special Rights on Default. (a) If at any time the Corporation shall have failed to pay dividends in full on the Series E Preferred Stock, thereafter and until dividends in full, including all accumulated and unpaid dividends to the next preceding Dividend Payment Date on the Series E preferred Stock outstanding, shall have been declared and set apart for payment or paid, the Corporation shall not redeem any Preferred Stock, by operation of any sinking fund or otherwise, including shares of Series E Preferred Stock, unless all then outstanding shares of Preferred Stock are redeemed, and neither the Corporation nor any subsidiary may purchase any shares of Preferred Stock, including shares of Series E Preferred Stock, and neither the Corporation nor any subsidiary may redeem or purchase any shares of stock subordinate to the shares of Series E Preferred Stock in respect of dividends or distribution of assets upon liquidation, provided that nothing shall prevent the Corporation from completing the purchase or redemption of shares of Preferred Stock for which a purchase contract was entered into, or notice of redemption of which was initially given, prior to such default. (b) Whenever, at any time or times, dividends payable on the shares of Series E Preferred Stock shall be in arrears in an amount equal to at least two full annual dividends on the shares at the time outstanding, the holders of the outstanding shares of Series E 15 Preferred Stock shall have the exclusive right, voting separately as a class with holders of shares of any one or more other series of Preferred Stock ranking on a parity with Series E Preferred Stock either as to dividends or the distribution of assets upon liquidation, dissolution or winding-up and upon which like voting rights have been conferred and are exercisable, to elect two directors of the Corporation at the Corporation's next annual meeting of shareholders and at each subsequent annual meeting of shareholders. At meetings for election of such directors, the presence, in person or by proxy, of the holders of a majority of the outstanding shares of Series E Preferred Stock (together with the holders of shares of any one or more other series of Preferred Stock ranking on a parity with respect to the election of such additional directors) shall be required and be sufficient to constitute a quorum of such class for the election of such directors. At meetings for election of such directors or adjournments thereof, (1) the absence of a quorum of Series E Preferred Stock (together with the holders of shares of any one or more other series of Preferred Stock ranking on a parity with respect to the election of such additional directors) shall not prevent the election of the directors to be elected otherwise than pursuant to this subsection (b), and the absence of a quorum of the holders of stock other than holders of Series E Preferred Stock (together with the holders of shares of any one or more other series of Preferred Stock ranking on a parity with respect to the election of such additional directors) shall not prevent the election of the directors to be elected pursuant to this subsection (b), and (2) in the absence of such quorum either of holders of Series E Preferred Stock or of holders of stock other than Series E Preferred Stock, or both, a majority of the holders, present in person or by proxy, of the class or classes of stock which lack a quorum shall have a power to adjourn the meeting for the election of directors whom they are entitled to elect, from time to time without notice other than announcement at the meeting, until a quorum shall be present. Upon the vesting of such right of the holders of Series E Preferred Stock, the maximum authorized number of members of the Board of Directors shall automatically be increased by two and the two vacancies so created shall be filled by vote of the holders of the outstanding shares of Series E Preferred Stock (together with the holders of shares of any one or more other series of Preferred Stock ranking on a parity with respect to the election of such additional directors) as herein set forth. The right of the holders of Series E Preferred Stock, voting separately as a class, to elect (together with the holders of shares of any one or more other series of Preferred Stock ranking on a parity with respect to the election of such additional directors) members of the Board of Directors of the Corporation as aforesaid shall continue until such time as all dividends in arrears on this Series E Preferred Stock shall have been 16 paid in full, at which time such right shall immediately terminate, except as herein or by law expressly provided, subject to revesting in the event of each and every subsequent default of the character above mentioned. Each director elected by the holders of shares of Series E Preferred Stock shall continue to serve as such director until such time as all dividends in arrears on the Series E Preferred Stock shall have been paid in full, at which time the term of office of all persons elected as directors by the holders of shares of Series E Preferred Stock shall immediately terminate and the number of members of the Board of Directors of the Corporation shall be reduced accordingly. If the office of any director elected by the holders of Series E Preferred Stock voting as a class becomes vacant by reason of death, resignation, retirement, disqualification, removal from office, or otherwise, the remaining director elected by the holders of Series E Preferred Stock voting as a class may choose a successor who shall hold office for the unexpired term in respect of which such vacancy occurred. Whenever the term of office of the directors elected by the holders of Series E Preferred Stock as provided in this subsection (b) shall have expired, the number of directors shall be such number as may be provided for in the Bylaws irrespective of any increase made pursuant to the provisions of this subsection (b). Section 11. Relative Rights of Series E Preferred Stock. So long as any of the Series E Preferred Stock is outstanding, the Corporation will not: (a) Declare, or pay, or set apart for payment, any dividends (other than dividends or distributions payable in stock ranking junior to the Series A Preferred Stock as to dividends or upon liquidation, dissolution or winding-up) or make any distribution in cash or other property on any other class or series of stock of the Corporation ranking junior to the Series E Preferred Stock either as to dividends or upon liquidation, dissolution or winding-up, and will not redeem, purchase or otherwise acquire any shares of any such junior class or series of stock if at the time of making such declaration, payment or setting apart for payment, distribution, redemption, purchase or acquisition the Corporation shall be in default with respect to any dividend payable on, or any obligation to retire shares of Series E Preferred Stock; and (b) Without the affirmative vote or consent of the holders, given in person or by proxy, either in writing or by resolution adopted either at an annual meeting or special meeting called for the purpose, of at least (i) a majority of the shares of Series E Preferred Stock at 17 the time outstanding (the holders of Series E Preferred Stock consenting or voting separately as a class), authorize, create, or issue, or increase the authorized or issued amount, of any class or series of stock ranking prior to the Series E Preferred Stock, either as to dividends or upon liquidation, dissolution or winding-up, or (ii) 66 2/3% of the shares of Series E Preferred Stock at the time outstanding (the holders of Series E Preferred Stock consenting or voting separately as a class), amend, alter or repeal (whether by merger, consolidation or otherwise) any of the provisions of these Amended Articles so as to materially and adversely affect the preferences, special rights, privileges or powers of the Series E Preferred Stock; provided, however, that any increase in the authorized Preferred Stock or the creation and issuance of any other series of Preferred Stock ranking on a parity with or junior to the Series E Preferred Stock shall not be deemed to materially and adversely affect such preferences, rights, privileges or powers. ARTICLE X Designations, Rights and Preferences of 7% PRIDES (SM), Convertible Preferred Stock The designations, rights, preferences, limitations and restrictions of the shares of Preferred Stock, without par value, to be designated as 7% PRIDES (SM), Convertible Preferred Stock are hereby fixed as follows; Section 1. Designation and Amount. The designation of the series of Preferred Stock created by this Article X shall be "7% PRIDES (SM), Convertible Preferred Stock, no par value per share" (the "PRIDES"). The PRIDES are Preferred Redeemable Increased Dividend Equity Securities (SM). The authorized number of shares constituting the PRIDES shall be 4,370,000. (SM) Service mark of Merrill Lynch & Co., Inc. Section 2. Dividends. (a) The holders of outstanding shares of PRIDES shall be entitled to receive, when, as and if declared by the Board of Directors out of funds legally available therefor, cumulative preferential dividends from January 23, 1996, at the rate per share of $4.279 per annum, and no more, payable quarterly for each share of PRIDES, payable in arrears on the 1st day of each February, May, August and November, respectively (each such date being hereinafter referred to as a "Dividend Payment Date"), or, if any Dividend Payment Date is not a business day, then the Dividend Payment Date shall be the next succeeding business day; 18 provided, however, that, with respect to any dividend period during which a redemption occurs, the Corporation may, at its option, declare accrued dividends to, and pay such dividends on, the redemption date, in which case such dividends would be payable on the redemption date in cash to the holders of the shares of PRIDES as of the record date for such dividend payment and such accrued dividends would not be included in the calculation of the related Call Price (as hereinafter defined). Each dividend on the shares of PRIDES shall be payable to holders of record as they appear on the stock register of the Corporation on such record date, not less than 10 (except as otherwise provided with respect to the first dividend payment) nor more than 60 days preceding the payment dates thereof, as shall be fixed by the Board of Directors. The first dividend payment shall be for the period from January 23, 1996 to but excluding February 1, 1996 and the first dividend will be payable on February 1, 1996 to holders of record at the close of business on January 23, 1996. Dividends (or amounts equal to accrued and unpaid dividends) payable on shares of PRIDES for any period less than a full quarterly dividend period will be computed on the basis of a 360-day year of twelve 30-day months and the actual number of days elapsed in any period less than one month. Dividends on the shares of PRIDES will accrue whether or not there are funds legally available for the payment of such dividends and whether or not such dividends are declared on a daily basis from the previous Dividend Payment Date. Accumulated unpaid dividends shall not bear interest. Dividends will cease to accrue in respect of shares of PRIDES on the Mandatory Conversion Date (as hereinafter defined) or on the date of their earlier conversion or redemption. The shares of PRIDES will rank on a parity, both as to payment of dividends and distribution of assets upon liquidation, with the Cumulative Convertible Preferred Stock and with any future preferred stock issued by the Corporation (the "Preferred Stock") that by its terms ranks on a parity with the shares of PRIDES. (b) As long as any shares of PRIDES are outstanding, no dividends for any dividend period (other than dividends payable in shares of, or warrants, rights or options exercisable for or convertible into shares of, Common Stock (as defined below) or any other capital stock of the Corporation ranking junior to the shares of PRIDES as to the payment of dividends and the distribution of assets upon liquidation ("Junior Stock") and cash in lieu of fractional shares of such Junior Stock in connection with any such dividend) will be paid in cash or otherwise, nor will any other distribution be made (other than a distribution payable in Junior Stock and cash in lieu of fractional shares of such Junior Stock in connection with any such distribution), on any Junior 19 Stock unless: (i) full dividends on all outstanding shares of Preferred Stock (including the shares of PRIDES), that does not constitute Junior Stock ("Parity Preferred Stock") have been paid, or declared and set aside for payment, for all dividend periods terminating on or prior to the date of such Junior Stock dividend or distribution payment to the extent such dividends are cumulative; (ii) dividends in full, in the case of a dividend payment with respect to Junior Stock, for any Parity Preferred Stock dividend period commencing on or prior to the date of such Junior Stock dividend payment or, in the case of any other distribution with respect to Junior Stock, for the current quarterly dividend period, have been paid, or declared and set aside for payment, on all outstanding shares of Parity Preferred Stock to the extent such dividends are cumulative; (iii) the Corporation has paid or set aside all amounts, if any, then or theretofore required to be paid or set aside for all purchase, retirement, and sinking funds, if any, for any outstanding shares of Parity Preferred Stock; and (iv) the Corporation is not in default on any of its obligations to redeem any outstanding shares of Parity Preferred Stock. In addition, as long as any shares of PRIDES are outstanding, no shares of any Junior Stock may be purchased, redeemed, or otherwise acquired by the Corporation or any of its subsidiaries (except in connection with a reclassification or exchange of any Junior Stock through the issuance of other Junior Stock (and cash in lieu of fractional shares of such Junior Stock in connection therewith) or the purchase, redemption, or other acquisition of any Junior Stock with any Junior Stock (and cash in lieu of fractional shares of such Junior Stock in connection therewith)) nor may any funds be set aside or made available for any sinking fund for the purchase or redemption of any Junior Stock unless: (i) full dividends on all outstanding shares of Parity Preferred Stock have been paid, or declared and set aside for payment, for all dividend periods terminating on or prior to the date of such purchase, redemption or acquisition to the extent such dividends are cumulative; (ii) the Corporation has paid or set aside all amounts, if any, then or theretofore required to be paid or set aside for all purchase, retirement, and sinking funds, if any, for any outstanding shares of Parity Preferred Stock; and (iii) the Corporation is not in default on any of its obligations to redeem any outstanding shares of Parity Preferred Stock. Subject to the provisions described above, such dividends or other distributions (payable in cash, property, or Junior Stock) as may be determined by the Board of Directors may be declared and paid on the shares of any Junior Stock from time to time and Junior Stock may be purchased, redeemed or otherwise acquired by the Corporation or any of 20 its subsidiaries from time to time. In the event of the declaration and payment of any such dividends or other distributions, the holders of such Junior Stock will be entitled, to the exclusion of holders of any outstanding Parity Preferred Stock, to share therein according to their respective interests. As long as any shares of PRIDES are outstanding, dividends for any dividend period or other distributions may not be paid on any outstanding shares of Parity Preferred Stock (other than dividends or other distributions payable in Junior Stock and cash in lieu of fractional shares of such Junior Stock in connection therewith), unless either: (a) (i) full dividends on all outstanding shares of Parity Preferred Stock have been paid, or declared and set aside for payment, for all dividend periods terminating on or prior to the date of such Parity Preferred Stock dividend or distribution payment to the extent such dividends are cumulative; (ii) dividends in full, in the case of a dividend payment, for any Parity Preferred Stock dividend period commencing on or prior to the date of such dividend payment or, in the case of any other distribution, for the current quarterly dividend period, have been paid, or declared and set aside for payment, on all outstanding shares of Parity Preferred Stock to the extent such dividends are cumulative; (iii) the Corporation has paid or set aside all amounts, if any, then or theretofore required to be paid or set aside for all purchase, retirement and sinking funds, if any, for any outstanding shares of Parity Preferred Stock; and (iv) the Corporation is not in default on any of its obligations to redeem any outstanding shares of Parity Preferred Stock; or (b) any such dividends are declared and paid pro rata so that the amounts of any dividends declared and paid per share on outstanding shares of PRIDES and each other share of such Parity Preferred Stock will in all cases bear to each other the same ratio that accrued and unpaid dividends (including any accumulation with respect to unpaid dividends for prior dividend periods, if such dividends are cumulative) per share of outstanding shares of PRIDES and such other outstanding shares of Parity Preferred Stock bear to each other. In addition, as long as any shares of PRIDES are outstanding, the Corporation may not purchase, redeem or otherwise acquire any Parity Preferred Stock (except with any Junior Stock and cash in lieu of fractional shares of such Junior Stock in connection therewith) unless: (i) full dividends on Parity Preferred Stock have been paid, or declared and set aside for payment, for all dividend periods terminating on or prior to the date of such Parity Preferred Stock purchase, redemption or other acquisition payment to the extent such dividends are cumulative; (ii) the Corporation has paid or set aside all amounts, if any, then or theretofore required to be paid or set 21 aside for all purchase, retirement, and sinking funds, if any, for any Parity Preferred Stock; and (iii) the Corporation is not in default of any of its obligations to redeem any Parity Preferred Stock. (c) Any dividend payment made on the shares of PRIDES shall first be credited against the earliest accrued but unpaid dividend due with respect to the shares of PRIDES. (d) All dividends paid with respect to the shares of PRIDES shall be paid pro rata to the holders entitled thereto. (e) Holders of the shares of PRIDES shall be entitled to receive dividends in preference to and in priority over any dividends upon any shares of the Corporation ranking junior to the shares of PRIDES as to dividends, but subject to the rights of holders of shares of the Corporation having a preference and a priority over the payment of dividends on the shares of PRIDES. Section 3. Redemption and Conversion. (a) Mandatory Conversion. On February 1, 2000 (the "Mandatory Conversion Date"), each outstanding share of PRIDES shall convert automatically (the "Mandatory Conversion") into shares of Common Stock at the Common Equivalent Rate (as hereinafter defined) in effect on the Mandatory Conversion Date and the right to receive an amount in cash equal to all accrued and unpaid dividends on such share of PRIDES (other than previously declared dividends payable to a holder of record on a prior date) to the Mandatory Conversion Date, whether or not declared, out of funds legally available for the payment of dividends, subject to the right of the Corporation to redeem the shares of PRIDES on or after February 1, 1999 (the "Initial Redemption Date") and prior to the Mandatory Conversion Date, as described below, and subject to the conversion of the shares of PRIDES at the option of the holder at any time prior to the Mandatory Conversion Date. The Common Equivalent Rate is initially one share of Common Stock for each share of PRIDES and is subject to adjustment as set forth below. Dividends on the shares of PRIDES shall cease to accrue and such shares shall cease to be outstanding on the Mandatory Conversion Date. The Corporation shall make such arrangements as it deems appropriate for the issuance of certificates representing shares of Common Stock and for the payment of cash in respect of such accrued and unpaid dividends, if any, or cash in lieu of fractional shares, if any, in exchange for and contingent upon surrender of certificates representing the shares of PRIDES, and the Corporation may defer the payment of dividends on such shares of Common Stock and the voting thereof until, and make such payment and voting contingent upon, the surrender of such certificates representing 22 the shares of PRIDES, provided that the Corporation shall give the holders of the shares of PRIDES such notice of any such actions as the Corporation deems appropriate and upon such surrender such holders shall be entitled to receive such dividends declared and paid on such shares of Common Stock subsequent to the Mandatory Conversion Date. Amounts payable in cash in respect of the shares of PRIDES or in respect of such shares of Common Stock shall not bear interest. (b) Redemption by the Corporation. (i) Right to Redeem. Shares of PRIDES are not redeemable by the Corporation prior to the Initial Redemption Date. At any time and from time to time on or after the Initial Redemption Date and prior to the Mandatory Conversion Date, the Corporation shall have the right to redeem, in whole or in part, the outstanding shares of PRIDES. Upon any such redemption, the Corporation shall deliver to the holders of shares of PRIDES, in accordance with the provisions of this Article X, in exchange for each share so redeemed, the greater of (A) a number of shares of Common Stock equal to the Call Price in effect on the redemption date, divided by the Current Market Price (as hereinafter defined) of the Common Stock determined as of the second trading day immediately preceding the Notice Date (as hereinafter defined) or (B) .855 of a share of Common Stock (subject to adjustment in the same manner as the Optional Conversion Rate (as hereinafter defined) is adjusted). The public announcement of any call for redemption shall be made prior to, or at the time of, the mailing of the notice of such call to holders of shares of PRIDES as described below. If fewer than all the outstanding shares of PRIDES are to be redeemed, shares of PRIDES to be redeemed shall be selected by the Corporation from outstanding shares of PRIDES not previously redeemed by lot or pro rata (as nearly as may be practicable) or by any other method determined by the Board of Directors in its sole discretion to be equitable. As used in this subparagraph (b), the term "Notice Date" with respect to any notice given by the Corporation in connection with a redemption of shares of PRIDES means the date on which first occurs either the public announcement of such redemption or the commencement of mailing of such notice to the holders of shares of PRIDES. 23 (ii) Notice of Redemption. The Corporation shall provide notice of any redemption of the shares of PRIDES to holders of record of PRIDES to be called for redemption not less than 15 nor more than 60 days prior to the date fixed for such redemption. Such notice shall be provided by mailing notice of such redemption, first class postage prepaid, to each holder of record of shares of PRIDES to be redeemed, at such holder's address as it appears on the stock register of the Corporation; provided, however, that neither failure to give such notice nor any defect therein shall affect the validity of the proceeding for the redemption of any shares of PRIDES to be redeemed except as to the holders to whom the Corporation has failed to give said notice or whose notice was defective. Each such notice shall state, as appropriate, the following and may contain such other information as the Corporation deems advisable: (A) the redemption date; (B) that all outstanding shares of PRIDES are to be redeemed or, in the case of a call for redemption of fewer than all outstanding shares of PRIDES, the number of such shares held by such holder to be redeemed; (C) the number of shares of Common Stock deliverable upon redemption of each share of PRIDES to be redeemed and, if applicable, the Call Price and the Current Market Price used to calculate such number of shares of Common Stock; (D) the place or places where certificatesfor such shares are to be surrendered for redemption; and (E) that dividends on the shares of PRIDES to be redeemed shall cease to accrue on such redemption date (except as otherwise provided herein). 24 (iii) Deposit of Shares and Funds. The Corporation's obligation to deliver shares of Common Stock and provide funds upon redemption in accordance with this Section 3 shall be deemed fulfilled if, on or before a redemption date, the Corporation shall irrevocably deposit, with a bank or trust company, or an affiliate of a bank or trust company, having an office or agency in New York City and having a capital and surplus of at least $50,000,000, or shall set aside or make other reasonable provision for the issuance of such number of shares of Common Stock as are required to be delivered by the Corporation pursuant to this Section 3 upon the occurrence of the related redemption (and for the payment of cash in lieu of the issuance of fractional share amounts and accrued and unpaid dividends payable in cash on the shares to be redeemed as and to the extent provided by this Section 3). Any interest accrued on such funds shall be paid to the Corporation from time to time. Any shares of Common Stock or funds so deposited and unclaimed at the end of two years from such redemption date shall be repaid and released to the Corporation, after which the holder or holders of such shares of PRIDES so called for redemption shall look only to the Corporation for delivery of such shares of Common Stock or funds. (iv) Surrender of Certificates; Status. Each holder of shares of PRIDES to be redeemed shall surrender the certificates evidencing such shares (properly endorsed or assigned for transfer, if the Board of Directors shall so require and the notice shall so state) to the Corporation at the place designated in the notice of such redemption and shall thereupon be entitled to receive certificates evidencing shares of Common Stock and to receive any funds payable pursuant to this Section 3 following such surrender and following the date of such redemption. In case fewer than all the shares represented by any such surrendered certificate are called for redemption, a new certificate shall be issued at the expense of the Corporation representing the unredeemed shares. If such notice of redemption shall have been given, and if on the date fixed for redemption, shares of Common Stock and funds necessary for the redemption shall have been irrevocably either set aside by the Corporation separate and apart from its other funds or assets in 25 trust for the account of the holders of the shares to be redeemed or converted (and so as to be and continue to be available therefor) or deposited with a bank or a trust company or an affiliate thereof as provided herein or the Corporation shall have made other reasonable provision therefor, then, notwithstanding that the certificates evidencing any shares of PRIDES so called for redemption or subject to conversion shall not have been surrendered, the shares represented thereby so called for redemption shall be deemed no longer outstanding, dividends with respect to the shares so called for redemption shall cease to accrue on the date fixed for redemption (except that holders of shares of PRIDES at the close of business on a record date for any payment of dividends shall be entitled to receive the dividend payable on such shares on the corresponding Dividend Payment Date notwithstanding the redemption of such shares following such record date and prior to such Dividend Payment Date) and all rights with respect to the shares so called for redemption shall forthwith after such date cease and terminate, except for the rights of the holders to receive the shares of Common Stock and funds, if any, payable pursuant to this Section 3 without interest upon surrender of their certificates therefor (unless the Corporation defaults on the delivery of such shares or the payment of such funds). Holders of shares of PRIDES that are redeemed shall not be entitled to receive dividends declared and paid on such shares of Common Stock, and such shares of Common Stock shall not be entitled to vote, until such shares of Common Stock are issued upon the surrender of the certificates representing such shares of PRIDES and upon such surrender such holders shall be entitled to receive such dividends declared and paid on such shares of Common Stock subsequent to such redemption date without interest thereon. (c) Conversion at Option of Holder. Shares of PRIDES are convertible, in whole or in part, at the option of the holders thereof, at any time prior to the Mandatory Conversion Date, unless previously redeemed, into shares of Common Stock at a rate of .855 of a share of Common Stock for each share of PRIDES (the "Optional Conversion Rate") (equivalent to a conversion price of $71.49 per share of Common Stock), subject to adjustment as set forth below. The right to convert shares of PRIDES called for redemption shall terminate immediately prior to 26 the close of business on the redemption date. Conversion of shares of PRIDES at the option of the holder may be effected by delivering certificates evidencing such shares, together with written notice of conversion and a proper assignment of such certificates to the Corporation or in blank, to the office or agency to be maintained by the Corporation for that purpose (and, if applicable, cash payment of an amount equal to the dividend payable on such shares), and otherwise in accordance with conversion procedures established by the Corporation. Each optional conversion shall be deemed to have been effected immediately prior to the close of business on the date on which the foregoing requirements shall have been satisfied. The conversion shall be at the Optional Conversion Rate in effect at such time and on such date. Holders of shares of PRIDES at the close of business on a record date for any payment of declared dividends shall be entitled to receive the dividend payable on such shares on the corresponding Dividend Payment Date notwithstanding the conversion of such shares following such record date and prior to the corresponding Dividend Payment Date. However, shares of PRIDES surrendered for conversion after the close of business on a record date for any payment of dividends and before the opening of business on the next succeeding Dividend Payment Date must be accompanied by payment in cash of an amount equal to the dividend thereon which is to be paid on such Dividend Payment Date (unless such shares have been called for redemption on a redemption date between such record date and such Dividend Payment Date). A holder of shares of PRIDES called for redemption on February 1, 1999 or any other Dividend Payment Date thereafter will receive the dividend on such shares payable on that date without paying an amount equal to such dividend to the Corporation upon conversion. Except as provided above, upon any optional conversion of shares of PRIDES, the Corporation shall make no payment or allowance for unpaid dividends, whether or not in arrears, on converted shares of PRIDES or for previously declared dividends or distributions on the shares of Common Stock issued upon such conversion. (d) Common Equivalent Rate and Optional Conversion Rate Adjustments. The Common Equivalent Rate and the Optional Conversion Rate shall be each subject to adjustment from time to time as provided below in this section (d). (i) If the Corporation shall, after January 23, 1996: (A) pay a stock dividend or make a 27 distribution with respect to its Common Stock in shares of such Common Stock, (B) subdivide or split its outstanding Common Stock into a greater number of shares, (C) combine its outstanding shares of Common Stock into a smaller number of shares, or (D) issue by reclassification of its shares of Common Stock any shares of common stock of the Corporation, then, in any such event, the Common Equivalent Rate and the Optional Conversion Rate in effect immediately prior to such event shall each be adjusted so that the holder of any shares of PRIDES shall thereafter be entitled to receive, upon Mandatory Conversion or upon conversion at the option of the holder, the number of shares of Common Stock of the Corporation which such holder would have owned or been entitled to receive immediately following any event described above had such shares of PRIDES been converted immediately prior to such event or any record date with respect thereto. Such adjustment shall become effective at the opening of business on the business day next following the record date for determination of stockholders entitled to receive such dividend or distribution, in the case of a dividend or distribution, and shall become effective immediately after the effective date, in the case of a subdivision, split, combination or reclassification. Such adjustment shall be made successively. (ii) If the Corporation shall, after January 23, 1996, issue rights or warrants to all holders of its Common Stock entitling them (for a period not exceeding 28 45 days from the date of such issuance) to subscribe for or purchase shares of Common Stock at a price per share less than the Current Market Price of the Common Stock, then, in any such event unless such rights or warrants are issued to holders of shares of PRIDES on a pro rata basis with the shares of Common Stock based on the Common Equivalent Rate on the date immediately preceding such issuance, the Common Equivalent Rate and Optional Conversion Rate shall each be adjusted by multiplying the Common Equivalent Rate and the Optional Conversion Rate, in effect immediately prior to the date of issuance of such rights or warrants, by a fraction, of which the numerator shall be the number of shares of Common Stock outstanding on the date of issuance of such rights or warrants, immediately prior to such issuance, plus the number of additional shares of Common Stock offered for subscription or purchase pursuant to such rights or warrants, and of which the denominator shall be the number of shares of Common Stock outstanding on the date of issuance of such rights or warrants, immediately prior to such issuance, plus the number of additional shares of Common Stock which the aggregate offering price of the total number of shares of Common Stock so offered for subscription or purchase pursuant to such rights or warrants would purchase at such Current Market Price (determined by multiplying such total number of shares by the exercise price of such rights or warrants and dividing the product so obtained by such Current Market Price). Such adjustment shall become effective at the opening of business on the business day next following the record date for the determination of stockholders entitled to receive such rights or warrants. To the extent that shares of Common Stock are not delivered after the expiration of such rights or warrants, the Common Equivalent Rate and the Optional Conversion Rate shall each be readjusted to the Common Equivalent Rate and the Optional Conversion Rate which would then be in effect had the adjustments been made upon the issuance of such rights or warrants upon the basis of delivery of only the number of shares of Common Stock actually delivered. Such adjustment shall be made successively. (iii) If the Corporation shall, after January 23, 1996, pay a dividend or make a distribution to all holders of its Common Stock of evidences of its 29 indebtedness, cash or other assets (including capital stock of the Corporation but excluding any cash dividends or distributions, other than Extraordinary Cash Distributions (as hereinafter defined) and dividends referred to in subparagraph (i) above) or shall issue to all holders of its Common Stock rights or warrants to subscribe for or purchase any of its securities (other than Rights issued pursuant to the Rights Plan and those referred to in subparagraph (ii) above), then unless such dividend is paid or distribution is made to each holder of shares of PRIDES on a pro rata basis with the shares of Common Stock based on the Common Equivalent Rate on the date immediately preceding such payment or distribution, in any such event, the Common Equivalent Rate and the Optional Conversion Rate shall each be adjusted by multiplying the Common Equivalent Rate and the Optional Conversion Rate in effect on the record date mentioned below, by a fraction of which the numerator shall be the Current Market Price per share of the Common Stock on the record date for the determination of stockholders entitled to receive such dividend or distribution, and of which the denominator shall be such Current Market Price per share of Common Stock less the fair market value (as determined by the Board of Directors, whose determination shall be conclusive, and described in a resolution adopted with respect thereto) as of such record date of the portion of the assets or evidences of indebtedness so distributed or of such subscription rights or warrants applicable to one share of Common Stock. Such adjustment shall become effective on the opening of business on the business day next following the record date for the determination of stockholders entitled to receive such dividend or distribution. Such adjustment shall be made successively. As used in this section (d), the term "Extraordinary Cash Distributions" means, with respect to any cash dividend or distribution paid on any date, the amount, if any, by which all cash dividends and cash distributions on the Common Stock paid during the consecutive 12-month period ending on and including such date (other than cash dividends and cash distributions for which an adjustment to the Common Equivalent Rate and the Optional Conversion Rate was previously made) exceeds, on a per share of Common Stock basis, 10% of the average of the daily Closing 30 Prices of the Common Stock over such consecutive 12- month period. (iv) Any shares of Common Stock issuable in payment of a dividend shall be deemed to have been issued immediately prior to the close of business on the record date for such dividend for purposes of calculating the number of outstanding shares of Common Stock under subsection (ii) above. (v) The Corporation shall also be entitled to make upward adjustments in the Common Equivalent Rate, the Optional Conversion Rate and the Call Price, as it in its sole discretion shall determine to be advisable, in order that any stock dividends, subdivisions of shares, distribution of rights to purchase stock or securities, or distribution of securities convertible into or exchangeable for stock (or any transaction which could be treated as any of the foregoing transactions pursuant to Section 305 of the Internal Revenue Code of 1986, as amended) made by the Corporation to its stockholders after January 23, 1996 shall not be taxable. (vi) In any case in which subsection 3(d) shall require that an adjustment as a result of any event become effective at the opening of business on the business day next following a record date and the date fixed for conversion pursuant to subsection 3(a) or redemption pursuant to subsection 3(b) occurs after such record date, but before the occurrence of such event, the Corporation may, in its sole discretion, elect to defer the following until after the occurrence of such event: (A) issuing to the holder of any converted or redeemed shares of PRIDES the additional shares of Common Stock issuable upon such conversion or redemption over the shares of Common Stock issuable before giving effect to such adjustments and (B) paying to such holder any amount in cash in lieu of a fractional share of Common Stock pursuant to subsection 3(g). (vii) All adjustments to the Common Equivalent Rate and the Optional Conversion Rate shall be calculated to the nearest 1/100th of a share of Common Stock. No adjustment in the Common Equivalent Rate or 31 the Optional Conversion Rate shall be required unless such adjustment would require an increase or decrease of at least one percent therein; provided, however, that any adjustment which by reason of this subsection (vii) is not required to be made shall be carried forward and taken into account in any subsequent adjustment. (e) Adjustment for Consolidation or Merger. In case of any consolidation or merger to which the Corporation is a party (other than a merger or consolidation in which the Corporation is the surviving or continuing corporation and in which the Common Stock outstanding immediately prior to the merger or consolidation remains unchanged), or in case of any sale or transfer to another corporation of the property of the Corporation as an entirety or substantially as an entirety, or in case of any statutory exchange of securities with another corporation (other than in connection with a merger or acquisition), proper provision shall be made so that each share of PRIDES shall, after consummation of such transaction, be subject to (i) conversion at the option of the holder into the kind and amount of securities, cash or other property receivable upon consummation of such transaction by a holder of the number of shares of Common Stock into which such share of PRIDES might have been converted immediately prior to consummation of such transaction, (ii) conversion on the Mandatory Conversion Date into the kind and amount of securities, cash or other property receivable upon consummation of such securities, cash or other property receivable upon consummation of such transaction by a holder of the number of shares of Common Stock into which such share of PRIDES would have converted if the conversion on the Mandatory Conversion Date had occurred immediately prior to the date of consummation of such transaction, plus the right to receive cash in an amount equal to all accrued and unpaid dividends on such shares of PRIDES (other than previously declared dividends payable to a holder of record as of a prior date), (iii) redemption on any redemption date in exchange for the kind and amount of securities, cash or other property receivable upon consummation of such transaction by a holder of the number of shares of Common Stock that would have been issuable at the Call Price in effect on such redemption date upon a redemption of such share immediately prior to consummation of such transaction, assuming that, if the Notice Date for such redemption is not prior to such transaction, the Notice Date had been the date of such transaction and assuming in each case that such holder of Common Stock failed to exercise rights of election, if any, as to the kind or amount of securities, cash or other property receivable upon consummation of such transaction (provided that if the kind or amount of securities, cash or other property receivable upon consummation of such transaction is not 32 the same for each non-electing share, then the kind and amount of securities, cash or other property receivable upon consummation of such transaction for each non-electing share shall be deemed to be the kind and amount so receivable per share by a plurality of the non-electing shares). The kind and amount of securities into or for which the shares of PRIDES shall be convertible or redeemable after consummation of such transaction shall be subject to adjustment as described in the immediately preceding paragraph following the date of consummation of such transaction. The Corporation may not become a party to any such transaction unless the terms thereof are consistent with the foregoing or consistent with clause (iii) of Section 7(c). For purposes of the immediately preceding paragraph and subsection 3(g) (iii), any sale or transfer to another corporation of property of the Corporation which did not account for at least 50% of the consolidated net income of the Corporation for its most recent fiscal year ending prior to the consummation of such transaction shall not in any event be deemed to be a sale or transfer of the property of the Corporation as an entirety or substantially as an entirety. (f) Notice of Adjustments. Whenever the Common Equivalent Rate and Optional Conversion Rate are adjusted as herein provided, the Corporation shall: (i) forthwith compute the adjusted Common Equivalent Rate and Optional Conversion Rate in accordance herewith and prepare a certificate signed by an officer of the Corporation setting forth the adjusted Common Equivalent Rate and the Optional Conversion Rate, the method of calculation thereof in reasonable detail and the facts requiring such adjustment and upon which such adjustment is based, which certificate shall be conclusive, final and binding evidence of the correctness of the adjustment, and file such certificate forthwith with the transfer agent for the shares of PRIDES and the Common Stock; and (ii) make a prompt public announcement and mail a notice to the holders of the outstanding shares of PRIDES stating that the Common Equivalent Rate and the Optional Conversion Rate have been adjusted, the facts requiring such adjustment and upon which such adjustment is based and setting forth the adjusted Common Equivalent Rate and Optional Conversion Rate, such notice to be mailed at or prior to the time the 33 Corporation mails an interim statement to its stockholders covering the fiscal quarter during which the facts requiring such adjustment occurred, but in any event within 45 days of the end of such fiscal quarter. (g) Notices. In case, at any time while any of the shares of PRIDES are outstanding, (i) the Corporation shall declare a dividend (or any other distribution) on its Common Stock, excluding any cash dividends; or (ii) the Corporation shall authorize the issuance to all holders of its Common Stock of rights or warrants to subscribe for or purchase shares or its Common Stock or of any other subscription rights or warrants; or (iii) the Corporation shall authorize any reclassification of its Common Stock (other than a subdivision or combination thereof) or any consolidation or merger to which the Corporation is a party and for which approval of any stockholders of the Corporation is required (except for a merger of the Corporation into one of its subsidiaries solely for the purpose of changing the corporate domicile of the Corporation to another state of the United States and in connection with which there is no substantive change in the rights or privileges of any securities of the Corporation other than changes resulting from differences in the corporate statutes of the then existing and the new state of domicile), or the sale or transfer to another corporation of the property of the Corporation as an entirety or substantially as an entirety; or (iv) the Corporation shall authorize the voluntary or involuntary dissolution, liquidation or winding up of the Corporation; then the Corporation shall cause to be filed at each office or agency maintained for the purpose of conversion of the shares of PRIDES, and shall cause to be mailed to the holders of shares of PRIDES at their last addresses as they shall appear on the stock register, at least 10 days before the date hereinafter specified (or the 34 earlier of the dates hereinafter specified, in the event that more than one date is specified), a notice stating (A) the date on which a record is to be taken for the purpose of such dividend, distribution, rights or warrants, or, if a record is not to be taken, the date as of which the holders of Common Stock of record to be entitled to such dividend, distribution, rights or warrants are to be determined, or (B) the date on which any such reclassification, consolidation, merger, sale, transfer, dissolution, liquidation or winding up is expected to become effective, and the date as of which it is expected that holders of Common Stock of record shall be entitled to exchange their Common Stock for securities or other property (including cash), if any, deliverable upon such reclassification, consolidation, merger, sale, transfer, dissolution, liquidation or winding up. The failure to give or receive the notice required by this subsection (g) or any defect therein shall not affect the legality or validity of such dividend, distribution, right or warrant or other action. (h) Effect of Conversions and Redemptions. The person or persons in whose name or names any certificate or certificates for shares of Common Stock shall be issuable upon any conversion or redemption shall be deemed to have become on the date of any such conversion or redemption the holder or holders of record of the shares represented thereby; provided, however, that any such surrender on any date when the stock transfer books of the Corporation shall be closed shall constitute the person or persons in whose name or names the certificate or certificates for such shares are to be issued as the record holder or holders thereof for all purposes at the opening of business on the next succeeding day on which such stock transfer books are open. (i) No Fractional Shares. No fractional shares or script representing fractional shares of Common Stock shall be issued upon the redemption or conversion of any shares of PRIDES. In lieu of any fractional share otherwise issuable in respect of the aggregate number of shares of PRIDES of any holder which are redeemed or converted on any redemption date or upon Mandatory Conversion or any optional conversion, such holder shall be entitled to receive an amount in cash (computed to the nearest cent) equal to the same fraction of the (i) Current Market Price as of the second trading day immediately preceding the Notice Date, in the case of redemption, or (ii) Closing Price of the Common Stock determined (A) as of the fifth Trading Date immediately preceding the Mandatory Conversion Date, in the case of 35 Mandatory Conversion, or (B) as of the second Trading Date immediately preceding the effective date of conversion, in the case of an optional conversion by a holder. If more than one share shall be surrendered for conversion or redemption at one time by or for the same holder, the number of full shares of Common Stock issuable upon conversion thereof shall be computed on the basis of the aggregate number of shares of PRIDES so surrendered or redeemed. (j) Reissuance. Shares of PRIDES that have been issued and reacquired in any manner, including shares purchased, exchanged, redeemed or converted, shall not be reissued as part of PRIDES and shall (upon compliance with any applicable provisions of the laws of the State of Indiana) have the status of authorized and unissued shares of the Preferred Stock undesignated as to series and may be redesignated and reissued as part of any series of Preferred Stock. (k) Definitions. As used in this Article X: (i) the term "business day" shall mean any day other than a Saturday, Sunday, or a day on which banking institutions in the State of Indiana are authorized or obligated by law or executive order to close or are closed because of a banking moratorium or otherwise; (ii) the term "Call Price" of each share of PRIDES shall be the sum of (x) $62.195 on and after February 1, 1999, to and including April 30, 1999, $61.928 on and after May 1, 1999, to and including July 31, 1999, $61.660 on and after August 1, 1999, to and including October 31, 1999, $61.393 on and after November 1, 1999, to and including December 31, 1999, and $61.125 on and after January 1, 2000 to and including February 1, 2000 and (y) all accrued and unpaid dividends thereon to but not including the redemption date (other than previously declared dividends payable to a holder of record as of a prior date); (iii) the term "Closing Price" on any day shall mean the last reported sales price on such day or, in case no such sale takes place on such day, the average of the reported closing high and low quotations, in each case on the New York Stock Exchange or, if the Common Stock is not listed on the New York Stock 36 Exchange, on the Nasdaq National Market, or, if the Common Stock is not listed on the Nasdaq National Market, the average of the high bid and low-asked quotations of the Common Stock in the over-the-counter market on the day in question as reported by the National Quotation Bureau Incorporated, or a similarly generally accepted reporting service, or, if no such quotations are available, the fair market value of the Common Stock as determined by any New York Stock Exchange member firm selected from time to time by the Board of Directors for such purpose; (iv) the term "Current Market Price" per share of Common Stock at any date shall be deemed to be the lesser of (x) the average of the daily Closing Prices for the fifteen consecutive Trading Dates ending on and including the date in question or (y) the Closing Price of the Common Stock for such date of determination; provided, however, if any event that results in an adjustment of the Common Equivalent Rate occurs during such fifteen-day period, the Current Market Price as determined pursuant to the foregoing shall be appropriately adjusted to reflect the occurrence of such event; and (v) the term "Trading Date" shall mean a date on which the New York Stock Exchange (or any successor thereto) is open for the transaction of business. (l) Payment of Taxes. The Corporation shall pay any and all documentary, stamp or similar issue or transfer taxes payable in respect of the issue or delivery of shares of Common Stock on the redemption or conversion of shares of PRIDES pursuant to this Section 3; provided, however, that the Corporation shall not be required to pay any tax which may be payable in respect of any registration of transfer involved in the issue or delivery of shares of Common Stock in a name other than that of the registered holder of shares of PRIDES redeemed or converted or to be redeemed or converted, and no such issue or delivery shall be made unless and until the person requesting such issue has paid to the Corporation the amount of any such tax or has established, to the satisfaction of the Corporation, that such tax has been paid. (m) Reservation of Common Stock. The Corporation shall at all times reserve and keep available, free from preemptive rights, out of the aggregate of its authorized but unissued Common Stock and/or its 37 issued Common Stock held in its treasury, for the purpose of effecting any Mandatory Conversion of the shares of PRIDES or any conversion of the shares of PRIDES at the option of the holder, the full number of shares of Common Stock then deliverable upon any such conversion of all outstanding shares of PRIDES. Section 4. Liquidation Rights. (a) In the event of the liquidation, dissolution, or winding up of the business of the Corporation, whether voluntary or involuntary, the holders of shares of PRIDES then outstanding, after payment or provision for payment of the debts and other liabilities of the Corporation and the payment or provision for payment of any distribution on any shares of the Corporation having a preference and a priority over the shares of PRIDES on liquidation, and before any distribution to the holders of Junior Stock, shall be entitled to be paid out of the assets of the Corporation available for distribution to its stockholders an amount per share of PRIDES in cash equal to the sum of (i) $61.125 plus (ii) all accrued and unpaid dividends thereon. In the event the assets of the Corporation available for distribution to the holders of the shares of PRIDES upon any dissolution, liquidation or winding up of the Corporation shall be insufficient to pay in full the liquidation payments payable to the holders of outstanding shares of PRIDES and of all other series of Parity Preferred Stock, the holders of shares of PRIDES and of all other series of Parity Preferred Stock shall share ratably in such distribution of assets in proportion to the amount which would be payable on such distribution if the amounts to which the holders of outstanding shares of PRIDES and the holders of outstanding shares of such Parity Preferred Stock were paid in full. Except as provided in this Section 4, holders of PRIDES shall not be entitled to any distribution in the event of liquidation, dissolution or winding up of the affairs of the Corporation. (b) For the purposes of this Section 4, none of the following shall be deemed to be a voluntary or involuntary liquidation, dissolution or winding up of the Corporation: (i) the sale, lease, transfer or exchange of all or substantially all of the assets of the Corporation; or (ii) the consolidation or merger of the Corporation with one or more other corporations (whether or not the Corporation is the corporation surviving such consolidation or merger). 38 Section 5. Definition. As used in this Article XV, the term "Common Stock" shall mean any stock of any class of the Corporation which has no preference in respect of dividends or of amounts payable in the event of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation and which is not subject to redemption by the Corporation. However, shares of Common Stock issuable upon conversion of shares of PRIDES shall include only shares of the class designated as Common stock as of January 23, 1996, or shares of the Corporation of any class or classes resulting from any reclassification or reclassification thereof and which have no preference in respect of dividends or of amounts payable in the event of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation and which are not subject to redemption by the Corporation; provided, however, that, if at any time there shall be more than one such resulting class, the shares of each such class then so issuable shall be substantially in the proportion which the total number of shares of such class resulting from such reclassification bears to the total number of shares of all classes resulting from all such reclassification. Section 6. No Preemptive Rights. The holders of shares of PRIDES shall have no preemptive rights, including preemptive rights with respect to any shares of capital stock or other securities of the Corporation convertible into or carrying rights or options to purchase any such shares. Section 7. Voting Rights. (a) The holders of shares of PRIDES shall have the right with the holders of Common Stock to vote in the election of directors and upon each other matter coming before any meeting of the stockholders on the basis of 4/5 of a vote for each share held. The holders of shares of PRIDES and the holders of Common stock shall vote together as one class except as otherwise set forth herein or as otherwise provided by law or elsewhere in these Amended Articles. (b) If at any time dividends payable on the shares of PRIDES or any other series of Preferred Stock are in arrears and unpaid in an aggregate amount equal to or exceeding the aggregate amount of dividends payable thereon for six quarterly dividend periods, or if any other series of Preferred Stock shall be entitled for any other reason to exercise voting rights, separate from the Common Stock, to elect any Directors of the Corporation ("Preferred Stock Directors"), the holders of the shares of PRIDES, voting separately as a class with the holders of all other series of Preferred Stock upon which like voting rights have been conferred and are exercisable, with each share of PRIDES 39 entitled to vote on this and other matters upon which Preferred Stock votes as a group, shall have the right to vote for the election of two Preferred Stock Directors of the Corporation, such Directors to be in addition to the number of Directors constituting the Board of Directors immediately prior to the accrual of such right. Such right of the holders of shares of PRIDES to elect two Preferred Stock Directors shall, when vested, continue until all dividends in arrears on the shares of PRIDES and such other series of Preferred Stock shall have been paid in full and the right of any other series of Preferred Stock to exercise voting rights, separate from the Common Stock, to elect Preferred Stock Directors shall terminate or have terminated and, when so paid, and any such termination occurs or has occurred, such right of the holders of shares of PRIDES to elect two Preferred Stock Directors separately as a class shall cease, subject always to the same provisions for the vesting of such right of the holders of the shares of PRIDES to elect two Preferred Stock Directors in the case of future dividend defaults. The term of office of each Director elected pursuant to the preceding paragraph shall terminate on the earlier of (i) the next annual meeting of stockholders at which a successor shall have been elected and qualified or (ii) the termination of the right of the holders of shares of PRIDES and such other series of Preferred Stock to vote for Directors pursuant to the preceding paragraph. Vacancies on the Board of Directors resulting from the death, resignation or other cause of any such Director shall be filled exclusively by no less than two-thirds of the remaining Directors and the Director so elected shall hold office until a successor is elected and qualified. (c) For as long as any shares of PRIDES remain outstanding, the affirmative consent of the holders of at least two-thirds thereof actually voting (voting separately as a class) given in person or by proxy, at any annual meeting or special meeting of the shareholders called for such purpose, shall be necessary to (i) amend, alter or repeal any of the provisions of these Amended Articles of the Corporation which would adversely affect the powers, preferences or rights of the holders of the shares of PRIDES then outstanding or reduce the minimum time required for any notice to which holders of shares of PRIDES then outstanding may be entitled; provided, however, that any such amendment, alteration or repeal that would authorize, create or increase the authorized amount of any additional shares of Junior Stock or any other shares of stock (whether or not already authorized) ranking on a parity with the shares of PRIDES shall be deemed not to adversely affect such powers, preferences or rights and shall not be subject to approval by the holders of shares of PRIDES; and provided further that clause (i) shall not be applicable to the 40 amendment, alteration or repeal of any provisions of these Amended Articles of the Corporation approved at a meeting of the shareholders the record date of which is prior to the issuance of any shares of PRIDES; (ii) authorize or create, or increase the authorized amount of, any capital stock, or any security convertible into capital stock, of any class ranking senior to PRIDES as to payment of dividends or the distribution of assets upon liquidation, dissolution or winding up of the Corporation; or (iii) merge or consolidate with or into any other corporation, unless each holder of the shares of PRIDES immediately preceding such merger or consolidation shall have the right either to (A) receive or continue to hold in the resulting corporation the same number of shares, with substantially the same rights and preferences, as correspond to the shares of PRIDES so held or (B) convert into shares of Common Stock at the Common Equivalent Rate in effect on the date immediately preceding the announcement of any such merger or consolidation. There is no limitation on the issuance by the Corporation of Parity Preferred Stock or of any class ranking junior to the shares of PRIDES. Notwithstanding the provisions summarized in the preceding two paragraphs, however, no such approval described therein of the holders of the shares of PRIDES shall be required to authorize an increase in the number of authorized shares of Preferred Stock or if, at or prior to the time when such amendment, alteration, or repeal is to take effect or when the authorization, creation or increase of any such senior stock or security is to be made, or when such consolidation or merger, liquidation, dissolution or winding up is to take effect, as the case may be, provision is made for the redemption of all shares of PRIDES at the time outstanding." ARTICLE XI Manner of Adoption and Vote Section 1. Action by Directors. The Board of Directors of the Corporation or at a meeting thereof, duly called, constituted and held on March 23, 1998 at which a quorum of such Board of Directors was present, duly adopted a resolution that the provisions and terms of its Amended and Restated Articles of Incorporation, as amended, be amended and restated so as to read as set forth above. Section 2. Shareholder Vote Not Required. The Amended Articles set forth above were adopted by the Board of Directors without shareholder action and shareholder action was not required. 41 IN WITNESS WHEREOF, the undersigned Corporation has caused these Amended Articles to be signed and verified by a duly authorized officer, acting for and on behalf of such Corporation; and the undersigned verifies subject to the penalties of perjury that the facts contained herein are true. Dated this 23rd day of March, 1998. CONSECO, INC. BY:/S/STEPHEN C. HILBERT ------------------------- Stephen C. Hilbert, Chairman of the Board, Chief Executive Officer and President This instrument was prepared by John J. Sabl, General Counsel Conseco, Inc. 11825 N. Pennsylvania Street Carmel, IN 46032 42 EX-3.2 3 EX-3.2 AMENDED AND RESTATED BYLAWS OF CONSECO, INC. Effective March 23, 1998
TABLE OF CONTENTS PAGE ARTICLE 1 - Shares................................................................................................1 Section 1.1. Certificate for Shares.....................................................................1 Section 1.2. Transfer of Shares.........................................................................1 Section 1.3. Regulations................................................................................1 Section 1.4. Lost, Stolen or Destroyed Certificates.....................................................2 Section 1.5. Redemption of Shares Acquired in Control Share Acquisitions................................2 ARTICLE 2 - Shareholders..........................................................................................2 Section 2.1. Place of Meetings..........................................................................2 Section 2.2. Annual Meetings............................................................................2 Section 2.3. Special Meetings...........................................................................3 Section 2.4. Notice of Meeting..........................................................................3 Section 2.5. Addresses of Shareholders..................................................................3 Section 2.6. Quorum.....................................................................................3 Section 2.7. Voting.....................................................................................3 Section 2.8. Voting Lists...............................................................................4 Section 2.9. Fixing of Record Date......................................................................4 Section 2.10. Organization...............................................................................4 Section 2.11. Shareholder Proposals and Board Nominations................................................4 ARTICLE 3- Board of Directors.....................................................................................6 Section 3.1. Number, Election and Term of Office........................................................6 Section 3.2. Vacancies..................................................................................6 Section 3.3. Quorum; Action.............................................................................6 Section 3.4. Action by Consent..........................................................................6 Section 3.5. Telephonic Meetings........................................................................7 Section 3.6. Attendance and Failure to Object or Abstain................................................7 Section 3.7. Annual Meeting.............................................................................7 Section 3.8. Regular Meetings...........................................................................7 Section 3.9. Special Meetings...........................................................................7 Section 3.10. Place of Meeting...........................................................................8 Section 3.11. Compensation of Directors..................................................................8
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TABLE OF CONTENTS (continued) PAGE ARTICLE 4 - Committees............................................................................................8 Section 4.1. Committees.............................................................................8 Section 4.2. Quorum and Manner of Acting............................................................8 Section 4.3. Committee Chairman, Books and Records, Etc.............................................8 Section 4.4. Executive Committee....................................................................8 Section 4.5. Compensation Committee.................................................................8 Section 4.6. Audit Committee........................................................................9 ARTICLE 5 - Officers..............................................................................................9 Section 5.1. Officers, General Authority and Duties.................................................9 Section 5.2. Election, Term of Office, Qualifications...............................................9 Section 5.3. Other Officers, Elections or Appointment...............................................9 Section 5.4. Resignation...........................................................................10 Section 5.5. Removal...............................................................................10 Section 5.6. Vacancies.............................................................................10 Section 5.7. The Chairman of the Board.............................................................10 Section 5.8. The President.........................................................................10 Section 5.9. The Vice Presidents...................................................................10 Section 5.10. Second or Assistant Vice Presidents...................................................11 Section 5.11. The Secretary.........................................................................11 Section 5.12. The Assistant Secretaries.............................................................11 Section 5.13. The Treasurer.........................................................................12 Section 5.14. The Assistant Treasurers..............................................................12 Section 5.15. The Chief Accounting Officer..........................................................12 Section 5.16. The Salaries..........................................................................13 ARTICLE 6 - Corporate Instruments, Loans and Funds...............................................................13 Section 6.1. Execution of Instruments Generally....................................................13 Section 6.2. Execution and Endorsement of Negotiable Instruments...................................13 Section 6.3. Opening of Bank Accounts..............................................................13 Section 6.4. Voting of Stock Owned by Corporation..................................................13
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TABLE OF CONTENTS (continued) PAGE ARTICLE 7 - Indemnification......................................................................................14 Section 7.1. Indemnification of Officers, Directors and Other Eligible Persons.....................14 Section 7.2. Definition of Claim...................................................................14 Section 7.3. Definition of Eligible Person.........................................................15 Section 7.4. Definitions of Liability and Expense..................................................15 Section 7.5. Definition of Wholly Successful.......................................................15 Section 7.6. Definition of Change of Control.......................................................15 Section 7.7. Procedure for Determination of Entitlement to Indemnification.........................16 Section 7.8. Application to Court for Determination................................................17 Section 7.9. Nonexclusivity........................................................................17 Section 7.10. Advancement of Expenses...............................................................17 Section 7.11. Insurance, Contracts and Funding......................................................17 Section 7.12. Nature of Provisions..................................................................18 Section 7.13. Applicability of Provisions...........................................................18 ARTICLE 8 - Miscellaneous........................................................................................18 Section 8.1. Amendments............................................................................18 Section 8.2. Seal..................................................................................18 Section 8.3. Fiscal Year...........................................................................18
i ARTICLE 1 Shares Section 1.1. Certificate for Shares. Shares of the Corporation may be issued in book-entry form or evidenced by certificates. However, unless otherwise specified in the provisions of the Articles of Incorporation relating to the class of shares, every holder of shares of the Corporation shall be entitled upon request to have a certificate evidencing the shares owned by the shareholder, signed in the name of the Corporation by the Chairman of the Board, the President or a Vice President and the Secretary or an Assistant Secretary, certifying the number of shares owned by the shareholder in the Corporation. The signatures of the Chairman of the Board, the President, Vice President, Secretary and Assistant Secretary, the signature of the transfer agent and registrar, and the seal of the Corporation may be facsimiles. In case any officer or employee who shall have signed, or whose facsimile signature or signatures shall have been used on, any certificate shall cease to be an officer or employee of the Corporation before the certificate shall have been issued and delivered by the Corporation, the certificate may nevertheless be adopted by the Corporation and be issued and delivered as though the person or persons who signed the certificate or whose facsimile signature or signatures have been used thereon had not ceased to be such officer or employee of the Corporation; and the issuance and delivery by the Corporation of any such certificate shall constitute an adoption thereof. Subject to the foregoing provisions, certificates representing shares of the Corporation shall be in such form as shall be approved by the Board of Directors. There shall be entered upon the stock books of the Corporation at the time of the issuance or transfer of each share the number of the certificate representing such share (if any), the name of the person owning the shares represented thereby, the class of such share and the date of the issuance or transfer thereof. Section 1.2. Transfer of Shares. Shares of the Corporation shall be transferable only on the books of the Corporation and if the shares are evidenced by certificates, upon surrender of the certificate or certificates representing the same properly endorsed by the registered holder or by his or her duly authorized attorney, such endorsement or endorsements to be witnessed by one witness. The requirement for such witnessing may be waived in writing upon the form of endorsement by the Chairman of the Board, the President, a Vice President or the Secretary of the Corporation. The Corporation and its transfer agents and registrars shall be entitled to treat the holder of record of any shares the absolute owner thereof for all purposes, and accordingly shall not be bound to recognize any legal, equitable or other claim to or interest in such shares on the part of any other person whether or not it or they shall have express or other notice thereof, except as otherwise expressly provided by statute. Shareholders shall notify the Corporation in writing of any changes in their addresses from time to time. Section 1.3. Regulations. Subject to the provisions of this Article 1 the Board of Directors may make such rules and regulations as it may deem expedient concerning the issuance, transfer and regulation of certificates for shares or book-entry shares of the Corporation. 1 Section 1.4. Lost, Stolen or Destroyed Certificates. The Corporation may issue a new certificate for shares of the Corporation in the place of any certificate theretofore issued and alleged to have been lost, stolen or destroyed, but the Corporation may require the owner of such lost, stolen or destroyed certificate, or such holder's legal representative, to furnish affidavit as to such loss, theft, or destruction, and to give a bond in such form and substance, and with such surety or sureties, with fixed or open penalty, as it may direct, to indemnify the Corporation and its transfer agents and registrars against any claim that may be made on account of the alleged loss, theft or destruction of such certificate or the issuance of such new certificate. Section 1.5. Redemption of Shares Acquired in Control Share Acquisitions. Any or all control shares acquired in a control share acquisition shall be subject to Corporation's right to redeem, if either: (a) No acquiring person statement has been filed with the Corporation with respect to the control share acquisition; or (b) The control shares are not accorded full voting rights by the Corporation's shareholders as provided in IC 23-1-42-9. A redemption pursuant to Section 1.5(a) may be made at any time during the period ending sixty (60) days after the date of the last acquisition of control shares by the acquiring person. A redemption pursuant to Section 1.5(b) may be made at any time during the period ending two (2) years after the date of the shareholder vote with respect to the voting rights of the control shares in question. Any redemption pursuant to this Section 1.5 shall be made at the fair value of the control shares and pursuant to such procedures for the redemption as may be set forth in these Bylaws or adopted by resolution of the Board of Directors. As used in this Section 1.5, the terms "control shares," "control share acquisition," "acquiring person statement" and "acquiring person" shall have the meanings ascribed to them in IC 23-1-42. ARTICLE 2 Shareholders Section 2.1. Place of Meetings. Meetings of shareholders of the Corporation shall be held at the place within or without the State of Indiana, specified in the notices for such meetings. Section 2.2. Annual Meetings. The annual meeting of the shareholders of the Corporation for the election of directors and for the transaction of such other business as properly may come before the meeting shall be held prior to June 30 of each year on such date as the Board of Directors shall determine by resolution. The failure to hold an annual meeting in any year shall not affect otherwise valid corporate acts or work any forfeiture or a dissolution of the Corporation. 2 Section 2.3. Special Meetings. Special meetings of shareholders of the Corporation may be called by the Board of Directors, the Chairman of the Board or the President. The business transacted at a special meeting of shareholders shall be limited to the purpose or purposes specified in the notice for such meeting. Section 2.4. Notice of Meeting. A written or printed notice, stating the place, day and hour of the meeting, and in case of a special meeting, the purpose or purposes for which the meeting is called, shall be delivered or mailed by the Secretary of the Corporation, or by the officers or persons calling the meeting, to each shareholder of record entitled to vote on the business proposed to be transacted at such meeting, at such address as appears upon the records of the Corporation, at least ten (10) days, and not more than sixty (60) days, before the date of the meeting. Notice of any such meeting may be waived in writing by any shareholder before or after the meeting. Attendance at any meeting in person, or by proxy when the instrument of proxy sets forth in reasonable detail the purpose or purposes for which the meeting is called, shall constitute a waiver of notice of such meeting. Notice of any adjourned meeting of the shareholders of the Corporation shall not be required to be given unless required by statute. Section 2.5. Addresses of Shareholders. The address of any shareholder appearing upon the records of the Corporation shall be deemed to be the same address as the latest address of such shareholder appearing on the records maintained by the transfer agent for the class of shares held by such shareholder. Section 2.6. Quorum. At any meeting of the shareholders a majority of the outstanding shares entitled to vote on a matter at such meeting, represented in person or by proxy, shall constitute a quorum for action on that matter. In the absence of a quorum, the holders of a majority of the shares entitled to vote present in person or by proxy, or, if no shareholder entitled to vote is present in person or by proxy, any officer entitled to preside at or act as Secretary of such meeting, may adjourn such meeting from time to time, until a quorum shall be present. At any such adjourned meeting at which a quorum may be present any business may be transacted which might have been transacted at the meeting as originally called. Section 2.7. Voting. Except as otherwise provided by statute or by the Articles of Incorporation, at each meeting of the shareholders each holder of shares entitled to vote shall have the right to one vote for each share standing in the shareholder's name on the books of the Corporation on the record date fixed for the meeting under Section 2.9. Each shareholder entitled to vote shall be entitled to vote in person or by proxy executed in writing (which shall include telegraphing, cabling, facsimile, or electronic transmission) by the shareholder or a duly authorized attorney in fact. The vote of shareholders approving any matter to which the Articles of Incorporation, or any applicable statute, specifies a different percentage of affirmative vote shall require such percentage of affirmative vote. All other matters, except the election of directors, shall require that the votes cast in favor of the matter exceed the votes cast opposing the matter at a meeting at which a quorum is present. In the event that the Articles of Incorporation or any applicable statute shall require one or more classes of shares to vote as a separate voting class, the vote of each class shall be considered and decided separately. 3 Section 2.8. Voting Lists. The Secretary shall make or cause to be made after a record date for a meeting of shareholders has been fixed under Section 2.9 and at least five (5) business days before such meeting, a complete list of the shareholders entitled to vote at such meeting, arranged in alphabetical order, with the address of each such shareholder and the number of shares so entitled to vote held by each which list shall be on file at the principal office of the Corporation and subject to inspection by any shareholder entitled to vote at the meeting. Such list shall be produced and kept open at the time and place of the meeting and subject to the inspection of any such shareholder during the holding of such meeting or any adjournment. Except as otherwise required by law, such list shall be the only evidence as to who are the shareholders entitled to vote at any meeting of the shareholders. In the event that more than one group of shares is entitled to vote as a separate voting group at the meeting, there shall be a separate listing of the shareholders of each group. Section 2.9. Fixing of Record Date. For the purpose of determining shareholders entitled to notice of or to vote at any meeting of shareholders or any adjournment thereof, or entitled to receive payment of any dividend, or in order to make a determination of the shareholders for any other proper purpose, the Board of Directors shall fix in advance a date as the record date for any such determination of shareholders, not more than seventy (70) days prior to the date on which the particular action requiring this determination of shareholders is to be taken. When a determination of shareholders entitled to vote at any meeting of shareholders has been made as provided in this section, the determination shall, to the extent permitted by law, apply to any adjournment thereof. Section 2.10. Organization. Meetings of shareholders shall be presided over by the Chairman of the Board, or in his or her absence, by the President, or in his or her absence, by a chairman designated by the Board of Directors, or in the absence of such designation by a chairman chosen at the meeting. The Secretary shall act as secretary of the meeting, but in his or her absence, the chairman of the meeting may appoint any person or act as secretary of the meeting. Section 2.11. Shareholder Proposals and Board Nominations. (a) At any annual meeting of the Corporation's shareholders, only such business shall be conducted as shall have been properly brought before the meeting. To be properly brought before an annual meeting, business must be (i) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the Board of Directors, (ii) otherwise properly brought before the meeting by or at the direction of the Board of Directors, or (iii) otherwise properly brought before the meeting by a shareholder in accordance with these Bylaws. Business may be properly brought before an annual meeting by a shareholder only if written notice of the shareholder's intent to propose such business has been delivered, either by personal delivery, United States mail, first class postage prepaid, or other similar means, to the Secretary of the Corporation not later than ninety (90) calendar days in advance of the anniversary date of the release of the Corporation's proxy statement to shareholders in connection with the preceding year's annual meeting of shareholders, except that if no annual meeting was held in the previous year or the date of the annual meeting has been changed by more than thirty (30) calendar days from the anniversary of the annual meeting date stated in the previous year's proxy statement, a shareholder proposal shall be received by the Corporation a reasonable time before the solicitation is made. 4 (b) Each notice of new business must set forth: (i) the name and address of the shareholder who intends to raise the new business; (ii) the business desired to be brought forth at the meeting and the reasons for conducting such business at the meeting; (iii) a representation that the shareholder is a holder of record of shares of the Corporation entitled to vote with respect to such business and intends to appear in person or by proxy at the meeting to move the consideration of such business; (iv) such shareholder's total beneficial ownership of the Corporation's voting shares; and (v) such shareholder's interest in such business. The chairman of the meeting may refuse to acknowledge a motion to consider any business that he or she determines was not made in compliance with the foregoing procedures. (c) An adjourned meeting, if notice of the adjourned meeting is not required to be given to shareholders, shall be regarded as a continuation of the original meeting, and any notice of new business must have met the foregoing requirements as of the date of the original meeting. In the event of an adjourned meeting where notice of the adjourned meeting is required to be given to shareholders, any notice of new business made by a shareholder with respect to the adjourned meeting must meet the foregoing requirements based upon the date on which notice of the date of the adjourned meeting was given. (d) Nominations for the election of directors may be made by the Board of Directors or a committee appointed by the Board of Directors or by any shareholder entitled to vote in the election of directors generally. However, any shareholder entitled to vote in the election of directors may nominate one or more person for election as director(s) at a meeting only if written notice of such shareholder's intent to make such nomination or nominations has been delivered, either by personal delivery, United States mail, first class postage prepaid, or other similar means, to the Secretary of the Corporation not later than (i) with respect to an election to be held at an annual meeting of shareholders, ninety (90) calendar days in advance of the anniversary date of the release of the Corporation's proxy statement to shareholders in connection with the preceding year's annual meeting of shareholders, except that if no annual meeting was held in the previous year or the date of the annual meeting has been changed by more than thirty (30) calendar days from the anniversary of the annual meeting date stated in the previous year's proxy statement, a nominee proposal shall be received by the Corporation a reasonable time before the solicitation is made, and (ii) with respect to an election to be held at a special meeting of shareholders for the election of directors, the close of business on the tenth day following the date on which notice of such meeting is first given to shareholders. (e) Each such notice shall set forth: (i) the name and address of the shareholder who intends to make the nomination and of the person or persons to be nominated; (ii) a representation that the shareholder is a holder of record of shares of the Corporation entitled to vote at such meeting to nominate the person or persons specified in the notice; (iii) a description of all relationships, arrangements or understandings between the shareholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by the shareholder; (iv) such other information regarding each nominee proposed by such shareholder as would be required to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission had the nominee been nominated, or intended to be nominated, by the Board of Directors; and (v) the consent of each nominee to serve as a director of the Corporation if so elected. The chairman of the meeting may determine and declare to the meeting that a nomination was not made in compliance with the foregoing procedures in which case the nomination shall be disregarded. 5 ARTICLE 3 Board of Directors Section 3.1. Number, Election and Term of Office. The business of the Corporation shall be managed by a Board of Directors consisting of nine (9) members, which number may be increased or diminished by resolution adopted by not less than a majority of the Directors then in office; provided that the number may not be diminished below five (5) and no reduction in number shall have the effect of shortening the term of any incumbent Director. Directors need not be shareholders of the Corporation. Except as otherwise provided by law, the Articles of Incorporation or by these Bylaws, the Directors of the Corporation shall be elected at the annual meeting of shareholders in each year by a plurality of the votes cast by shareholders entitled to vote in the election at the meeting, provided a quorum is present. The Board of Directors shall be divided into three classes, as nearly equal in number as the then total number of Directors constituting the whole Board permits, with the term of office of one class expiring each year. At each annual meeting of shareholders the successors to the class of Directors whose term shall then expire shall be elected and each Director so elected shall hold office until such Director's successor is elected and qualified, or until his or her earlier resignation or removal. If the number of Directors is changed, any increase or decrease in the number of Directors shall be apportioned among the three classes so as to make all classes as nearly equal in number as possible. Notwithstanding the foregoing, whenever holders of any Preferred Stock, or any series thereof, shall be entitled, voting separately as a class, to elect any Directors, all Directors so elected shall be allocated, each time they are so elected, to the class whose term expires at the next succeeding annual meeting of shareholders and the terms of all Directors so elected by such holders shall expire at the next succeeding annual meeting of shareholders, in each case except to the extent otherwise provided in the Articles of Incorporation. Section 3.2. Vacancies. Except as may be otherwise provided in the Articles of Incorporation, any vacancy which may occur in the Board of Directors may be filled by a majority vote of the remaining members of the Board of Directors. Each replacement or new Director shall serve for the balance of the term of the class of the Director he or she succeeds or, in the event of an increase in the number of directors, of the class to which he or she is assigned. Section 3.3. Quorum; Action. A majority of the actual number of Directors elected and qualified, from time to time, shall be necessary to constitute a quorum for the transaction of any business, except for any matters which the Articles of Incorporation, these Bylaws or any applicable statute specifies may be approved by a lesser number. If a quorum is present when a vote is taken, the affirmative vote of a majority of the Directors present is the act of the Board of Directors, unless the Articles of Incorporation or these Bylaws provide otherwise. Section 3.4. Action by Consent. Any action required or permitted to be taken at any meeting of the Board of Directors may be taken without a meeting, if taken by all members of the Board of Directors, as the case may be, evidenced by one or more written consents signed by all such members and effective on the date, either prior or subsequent to the date of the consent, specified in the written consent, or if no effective date is specified in the written consent, the date on which the consent is filed with the minutes of proceedings of the Board of Directors. 6 Section 3.5. Telephonic Meetings. Directors, or any committee of Directors designated by the Board of Directors, may participate in a meeting of the Board of Directors or such committee by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting pursuant to this Section 3.5 shall constitute presence in person at such meeting. Section 3.6. Attendance and Failure to Object or Abstain. A Director who is present at a meeting of the Board of Directors or a committee of the Board of Directors when corporate action is taken is deemed to have assented to the action taken unless: (a) The Director objects at the beginning of the meeting (or promptly upon the Director's arrival) to holding it or transacting business at the meeting; (b) The Director's dissent or abstention from the action taken is entered in the minutes of the meeting; or (c) The Director delivers written notice of the Director's dissent or abstention to the presiding officer of the meeting before its adjournment or to the Secretary of the Corporation immediately after adjournment of the meeting. The right of dissent or abstention is not available to a Director who votes in favor of the action taken. Section 3.7. Annual Meeting. Unless otherwise provided by resolution of the Board of Directors, the Board of Directors shall meet each year immediately after the annual meeting of the shareholders, at the place where such meeting of the shareholders has been held, for the purpose of appointment of committees, election of officers, and consideration of any other business that may properly be brought before the meeting. No notice of any kind to either old or new members of the Board of Directors for such annual meeting shall be necessary. Section 3.8. Regular Meetings. Regular meetings of the Board of Directors may be held without any notice whatever at such places and times, as may be fixed from time to time by resolution of the Board of Directors. Section 3.9. Special Meetings. Special meetings of the Board of Directors may be called at any time by the Chairman of the Board or the President, and shall be called on the written request of any two Directors. Notice of the date, time and place of such a special meeting shall be sent by the Secretary or an Assistant Secretary to each Director at his or her residence or usual place of business by letter, telegram or facsimile, at such time that, in regular course, such notice would reach such place not later than during the day immediately preceding the day for such meeting; or may be delivered by the Secretary or an Assistant Secretary to a Director personally at any time during such preceding day. The notice need not describe the purpose of the special meeting. In lieu of such notice, a Director may sign a written waiver of notice either before the time of the meeting, at the time of the meeting, or after the time of the meeting. Any meeting of the Board of Directors for which notice is required shall be a legal meeting, without notice thereof having been given, if all the Directors, who do not waive notice thereof in writing, shall be present in person. 7 Section 3.10. Place of Meeting. The Directors may hold their meetings, within and without the State of Indiana. Section 3.11. Compensation of Directors. The Board of Directors is empowered and authorized to fix and determine the compensation of Directors for attendance at meetings of the Board and additional compensation for such additional services any of such Directors may perform for the Corporation. ARTICLE 4 Committees Section 4.1. Committees. The Board of Directors may from time to time, in its discretion, by resolution passed by a majority of the entire Board of Directors, designate committees of the Board of Directors consisting of such number of directors as the Board of Directors shall determine, which shall have and may exercise such lawfully delegable powers and duties of the Board of Directors as shall be conferred or authorized by such resolution. The Board of Directors shall have the power to change at any time the members of any such committee, to fill vacancies and to dissolve any such committee. Section 4.2. Quorum and Manner of Acting. A majority of the members of any committee of the Board of Directors shall constitute a quorum for the transaction of business at any meeting of such committee, and the act of a majority of the members present at any meeting at which a quorum is present shall be the act of such committee. Section 4.3. Committee Chairman, Books and Records, Etc. The chairman of each committee of the Board of Directors shall be selected from among the members of such committee by the Board of Directors. Each committee shall keep a record of its acts and proceedings, and all actions of each committee shall be reported to the Board of Directors when required. Except to the extent inconsistent with the resolutions of the Board of Directors creating a committee, the provisions of these Bylaws concerning meetings of the Board of Directors, actions without meetings, notice and waiver of notice and telephonic participation apply to each committee. Section 4.4. Executive Committee. Two or more Directors of the Corporation shall be appointed by the Board of Directors to act as an Executive Committee. The Executive Committee shall have and exercise all power and authority of the Board of Directors in the management of the Corporation to the fullest extent permitted by statute. Section 4.5. Compensation Committee. Two or more Directors of the Corporation shall be appointed by the Board of Directors to act as a Compensation Committee, each of whom shall be a director who is not an employee of the Corporation or any subsidiary thereof. The Compensation Committee shall have the power and authority to set the compensation of the officers of the Corporation and to act with respect to the compensation, option and other benefit plans of the Corporation. 8 Section 4.6. Audit Committee. Two or more Directors of the Corporation shall be appointed by the Board of Directors to act as an Audit Committee, each of whom shall be a director who is not an employee of the Corporation or any subsidiary thereof. The Audit Committee shall have general oversight responsibility with respect to the Corporation's accounting and financial reporting activities, including meeting with the Corporation's independent auditors and its chief financial and accounting officers to review the scope, cost and results of the independent audit and to review internal accounting controls, policies and procedures. The Audit Committee also shall make recommendations to the Board of Directors as to the selection of independent auditors. In addition, the Audit Committee shall oversee the compliance programs of the Corporation and its subsidiaries where such oversight is delegated to the Audit Committee by either the Board of Directors or embodied in an agreement executed by the Corporation or the applicable subsidiary. In undertaking the foregoing responsibilities, the Audit Committee shall have unrestricted access, if necessary, to the Corporation's personnel and documents and shall be provided with the resources and assistance necessary to discharge its responsibilities, including periodic reports from management assessing the impact of regulation, accounting, and reporting of other significant matters that may affect the Corporation. ARTICLE 5 Officers Section 5.1. Officers, General Authority and Duties. The officers of the Corporation shall be a Chairman of the Board, a President, one (1) or more Vice Presidents, a Secretary, a Treasurer, a Chief Accounting Officer, and such other officers as may be elected or appointed in accordance with the provisions of Section 5.3. One (1) or more of the Vice Presidents may be designated by the Board to serve as an Executive Vice President. Any two (2) or more offices may be held by the same person. All officers and agents of the Corporation, as between themselves and the Corporation, shall have such authority and perform such duties in the management of the Corporation as may be provided in these Bylaws or as may be determined by resolution of the Board of Directors not inconsistent with these Bylaws. Section 5.2. Election, Term of Office, Qualifications. Each officer (except such officers as may be appointed in accordance with the provisions of Section 5.3) shall be elected by the Board of Directors. Each such officer (whether elected at an annual meeting of the Board of Directors or to fill a vacancy or otherwise) shall hold office until the officer's successor is chosen and qualified, or until death, or until the officer shall resign in the manner provided in Section 5.4 or be removed in the manner provided in Section 5.5. The Chairman of the Board shall be chosen from among the Directors. Any other officer may but need not be a Director of the Corporation. Election or appointment of an officer shall not of itself create contract rights. Section 5.3. Other Officers, Election or Appointment. The Board of Directors from time to time may elect such other officers or agents (including one or more Second or Assistant Vice Presidents, one or more Assistant Secretaries and one or more Assistant Treasurers) as it may deem necessary or advisable. The Board of Directors may delegate to any officer the power to appoint any such officers or agents and to prescribe their respective terms of office, powers and duties. 9 Section 5.4. Resignation. Any officer may resign at any time by giving written notice of such resignation to the Board of Directors, the Chairman of the Board, the President or the Secretary of the Corporation. Unless otherwise specified in such written notice, such resignation shall take effect upon receipt thereof and unless otherwise specified in it, the acceptance of the resignation shall not be necessary to make it effective. Section 5.5. Removal. The officers specifically designated in Section 5.1 may be removed, either for or without cause, at any meeting of the Board of Directors called for such purpose, by the vote of a majority of the actual number of Directors elected and qualified. The officers and agents elected or appointed in accordance with the provisions of Section 5.3 may be removed, either for or without cause, at any meeting of the Board of Directors at which a quorum be present, by the vote of a majority of the Directors present at such meeting, by any superior officer upon whom such power of removal shall have been conferred by the Board of Directors, or by any officer to whom the power to appoint such officer has been delegated by the Board of Directors pursuant to Section 5.3. Any removal shall be without prejudice to the contract rights, if any, of the person so removed. Section 5.6. Vacancies. A vacancy in any office by reason of death, resignation, removal, disqualification or any other cause, may be filled by the Board of Directors or by an officer authorized under Section 5.3 to appoint to such office. Section 5.7. The Chairman of the Board. The Chairman of the Board, who shall be chosen from among the Directors, shall have general supervision and direction over the business and affairs of the Corporation and shall exercise executive management of the day-to-day operations of the Corporation, subject however to the control of the Board of Directors, shall preside at all meetings of the Board of Directors and the shareholders, and shall perform such other duties as, from time to time, may be assigned to him or her by the Board of Directors. The Chairman of the Board shall be the Chief Executive Officer. Section 5.8. The President. The President shall perform all the duties ordinarily connected with the office of President and shall perform such other duties as, from time to time, may be assigned to him or her by the Board of Directors. In the case of the absence or inability to act of the Chairman of the Board, the President shall perform the duties of the Chairman of the Board, and, when so acting, shall have all the powers of the Chairman of the Board. Section 5.9. The Vice Presidents. Each Vice President shall have such powers and perform such duties as the Board of Directors may from time to time prescribe or as the Chairman of the Board or the President may from time to time delegate to him or her. The Board of Directors may designate certain Vice Presidents as being in charge of designated divisions or functions of the Corporation's business and add appropriate descriptions to their titles. At the request of the President, any Executive Vice President may, in the case of the absence or inability to act of the President, temporarily act in such officer's place, and, when so acting, shall have all the powers of the President. In the case of the death of the President, or in the case of his or her absence or inability to act without having designated an Executive Vice President to act temporarily in his or her place, the Executive Vice President so to perform the duties of the President shall be designated by the Board of Directors. 10 Section 5.10. Second or Assistant Vice Presidents. Each Second or Assistant Vice President (if one or more Second or Assistant Vice Presidents be elected or appointed) shall perform such other duties as are from time to time delegated to him or her by the Chairman of the Board, the President, a Vice President, or the Board of Directors. At the request of one of the Vice Presidents, or in his or her absence or inability to act, a Second or Assistant Vice President designated by the Vice President shall perform the duties of such Vice President, and when so acting shall have all the powers of the Vice President. In the case of the death of a Vice President, or in the case of his or her absence or inability to act without having designated a Second or Assistant Vice President to act temporarily in his or her place, the Second or Assistant Vice President so to perform the duties of the Vice President shall be designated by the Board of Directors, the Chairman of the Board or the President. Section 5.11. The Secretary. The Secretary shall: (a) record all the proceedings of the meetings of the shareholders and of the Board of Directors in books to be kept for such purposes; (b) cause all notices to be duly given in accordance with the provisions of these Bylaws and as required by statute; (c) be custodian of the seal of the Corporation, and cause the seal to be affixed to all certificates representing shares of the Corporation prior to the issuance thereof (subject, however, to the provisions of Article 1) and to all instruments the execution of which on behalf of the Corporation under its seal shall have been duly authorized in accordance with these Bylaws; (d) subject to the provisions of Article 1, sign certificates representing shares of the Corporation the issuance of which shall have been authorized by the Board of Directors; and, (e) in general, perform all duties incident to the office of Secretary and such other duties as may, from time to time, be given to him or her by these Bylaws, the Board of Directors, the Chairman of the Board, the President or any Vice President. Section 5.12. The Assistant Secretaries. Each Assistant Secretary (if one or more Assistant Secretaries be elected or appointed) shall assist the Secretary in his or her duties, and shall perform such other duties as the Board of Directors may from time to time prescribe or the Chairman of the Board, the President, any Vice President or the Secretary may from time to time delegate to him or her. At the request of the Secretary, any Assistant Secretary may, in the case of the absence or inability to act of the Secretary, temporarily act in the Secretary's place. In the case of the death of the Secretary, or in the case of his or her absence or inability to act without having designated an Assistant Secretary to act temporarily in his or her place, the Assistant Secretary so to perform the duties of the Secretary shall be designated by the Board of Directors, Chairman of the Board or the President. 11 Section 5.13. The Treasurer. The Treasurer shall: (a) have charge of the funds, securities, receipts and disbursements of the Corporation; (b) cause the moneys and other valuable effects of the Corporation to be deposited or invested in the name and to the credit of the Corporation in such banks or trust companies or with such bankers or other depositories or investments as shall be selected in accordance with resolutions adopted by the Board of Directors; (c) cause the funds of the Corporation to be disbursed from the authorized depositories of the Corporation, and cause to be taken and preserved proper records of all moneys disbursed; and, (d) in general, shall perform all the duties incident to the office of Treasurer and such other duties as, from time to time, may be assigned to him by the Board of Directors, the Chairman of the Board, the President or any Vice President. Section 5.14. The Assistant Treasurers. Each Assistant Treasurer (if one or more Assistant Treasurers be elected or appointed) shall assist the Treasurer in his or her duties, and shall perform such other duties as the Board of Directors, the Chairman of the Board, the President, any Vice President or Treasurer may from time to time delegate to him or her. At the request of the Treasurer, any Assistant Treasurer may, in the case of the absence or inability to act of the Treasurer, temporarily act in his or her place. In the case of the death of the Treasurer, or in the case of his or her absence or inability to act without having designated an Assistant Treasurer to act temporarily in his or her place, the Assistant Treasurer so to perform the duties of the Treasurer shall be designated by the Board of Directors, the Chairman of the Board or the President. Section 5.15. The Chief Accounting Officer. The Chief Accounting Officer shall: (a) keep or cause to be kept full and accurate accounts of all assets, liabilities, commitments, receipts, disbursements, costs and expenses and other financial transactions of the Corporation in books belonging to the Corporation, and conform them to sound accounting principles with adequate internal control; (b) cause regular audits of such books and records to be made; (c) see that all expenditures are made in accordance with procedures duly established, from time to time, by the Corporation; (d) render financial statements upon the request of the Board of Directors, and a full financial report prior to the annual meeting of shareholders, as well as such other financial statements as are required by law or regulation; and (e) in general, perform all the duties ordinarily connected with the office of Chief Accounting Officer and such other duties as, from time to time, may be assigned to him or her by the Board of Directors, the Chairman of the Board, the President or any Vice President. 12 Section 5.16. Salaries. The salaries of the officers shall be fixed, from time to time, by the Board of Directors or the Compensation Committee. No officer shall be prevented from receiving such salary by reason of the fact he is also a Director of the Corporation. ARTICLE 6 Corporate Instruments, Loans and Funds Section 6.1. Execution of Instruments Generally. All deeds, contracts, notes, bonds and other instruments requiring execution by the Corporation may be signed by the Chairman of the Board, the President, any Vice President, Treasurer or the Secretary. Authority to sign any deed, contract, note, bond or other instrument requiring execution by the Corporation may be conferred by the Board of Directors upon any person or person whether or not such person or persons be officers of the Corporation. Such person or person may delegate, from time to time, by instrument in writing, all or any part of such authority to any other person or persons if authorized so to do by the Board of Directors. Section 6.2. Execution and Endorsement of Negotiable Instruments. All checks, drafts, bills of exchange and orders for the payment of money of the Corporation shall, unless otherwise directed by the Board of Directors, or unless otherwise required by law, be signed or endorsed for deposit in its behalf by any one of the following officers: the Chairman of the Board, the President, any Vice President, the Treasurer, any Assistant Treasurer or the Secretary. Checks payable to the Corporation may also be endorsed for deposit in one of the bank accounts of the Corporation by the affixation of a rubber stamp bearing the legend "For Deposit Only -- CONSECO, INC.". Authority to sign any checks, drafts, bills of exchange and orders for payment of money requiring execution by the Corporation may be conferred by the Board of Directors upon any person or persons whether or not such person or persons be officers of the Corporation. Such person or persons may delegate, from time to time, by instrument in writing, all or any part of such authority to any other person or persons if authorized to do so by the Board of Directors. Section 6.3. Opening of Bank Accounts. Bank accounts shall be opened in the name of the Corporation by any one of the following officers: The Chairman of the Board, the President, any Vice President, the Chief Accounting Officer, the Treasurer or any Assistant Treasurer of the Corporation. Each of such officers shall have power to open bank accounts in the name of the Corporation, singly, without necessity of countersignature. The Board of Directors may designate officers and employees of the Corporation, other than those named above, who may open bank accounts in the name of the Corporation. The term "bank accounts" shall include, without limiting the generality thereof, accounts with banks, banking associations, trust companies, building and loan associations, savings and loan associations, cooperative banks, investment bankers and brokerage firms. Section 6.4. Voting of Stock Owned by Corporation. Subject always to the further orders and directions of the Board of Directors, any share or shares of stock issued by any other corporation and owned or controlled by the Corporation may be voted at any shareholders' meeting of such other corporation by the Chairman of the Board, the President, any Vice President or the Treasurer of the Corporation. Whenever, in the judgment of the Chairman of the Board, the President or Treasurer, it is desirable for the Corporation to execute a proxy or give a stockholders' consent in respect to any 13 share or shares of stock issued by any other corporation and owned by the Corporation, such proxy or consent shall be executed in the name of the Corporation by the Chairman of the Board, the President, any Vice President or the Treasurer. Any person or persons designated in the manner above stated as the proxy or proxies of the Corporation shall have full right, power and authority to vote shares of stock issued by such other corporation and owned by the Corporation the same as such shares might be voted by the Corporation. ARTICLE 7 Indemnification Section 7.1. Indemnification of Officers, Directors and Other Eligible Persons. To the fullest extent not inconsistent with applicable law, every Eligible Person shall be indemnified by the Corporation against all Liability and Expense that may be incurred by him or her in connection with or resulting from any Claim, (a) if such Eligible Person is Wholly Successful with respect to the Claim, or (b) if not Wholly Successful, then if such Eligible Person is determined, as provided in either Section 7.7 or 7.8, to have acted in good faith, in what he or she reasonably believed to be the best interests of the Corporation or at least not opposed to its best interests and, in addition, with respect to any criminal claim, is determined to have had reasonable cause to believe that his or her conduct was lawful or had no reasonable cause to believe that his or her conduct was unlawful. The termination of any Claim, by judgment, order, settlement (whether with or without court approval), or conviction or upon a plea of guilty or of nolo contendere, or its equivalent, shall not create a presumption that an Eligible Person did not meet the standards of conduct set forth in clause (b) of this Section 7.1. The actions of an Eligible Person with respect to an employee benefit plan shall be deemed to have been taken in what the Eligible Person reasonably believed to be the best interests of the Corporation or at least not opposed to its best interests if the Eligible Person acted in good faith and in a manner he or she reasonably believed to be in the interest of the participants or beneficiaries of the employee benefit plan. To the extent an Eligible Person has the right to receive indemnity from another entity (including, but not limited to, a subsidiary of the Corporation), the indemnity obligations of the Corporation under this Article 7 to the Eligible Person are (as between the Corporation and such other entity) subordinate and junior to the indemnity obligations of such entity to the Eligible Person. If the Corporation indemnifies an Eligible Person entitled to indemnity from another entity (including, but not limited to, a subsidiary of the Corporation), the Corporation shall have the right of subrogation to be reimbursed from such other entity the amount of indemnity payments the Eligible Person was otherwise entitled to receive from such other entity. Section 7.2. Definition of Claim. The term "Claim" as used in this Article 7 shall include every pending, threatened or completed claim, action, suit or proceeding and all appeals thereof (whether brought by or in the right of the Corporation or any other corporation or otherwise, and whether civil, criminal, administrative or investigative, formal or informal), in which an Eligible Person may become involved, as a party or otherwise (including, without limitation, as a witness): (a) by reasons of his or her being or having been an Eligible Person, or 14 (b) by reason of any action taken or not taken by such Eligible Person in his or her capacity as an Eligible Person, whether or not such Eligible Person continued in such capacity at the time any Liability or Expense related to such Claim shall have been incurred. Section 7.3. Definition of Eligible Person. The term "Eligible Person" as used in this Article 7 shall mean every person (and the estate, heirs and personal representatives of such person) who is or was a director, officer or employee of the Corporation or a wholly-owned subsidiary of the Corporation (including, but not limited to, Conseco Services, LLC) or who, while a director, officer or employee of the Corporation or a wholly-owned subsidiary of the Corporation, is or was serving at the request of the Corporation or a wholly-owned subsidiary of the Corporation as a director, officer, employee, partner, member, manager, trustee or fiduciary of another foreign or domestic corporation, partnership, joint venture, limited liability company, trust, employee benefit plan or other organization or entity, whether for profit or not. An Eligible Person shall also be considered to have been serving an employee benefit plan at the request of the Corporation or a wholly-owned subsidiary of the Corporation if his or her duties to the Corporation or a wholly-owned subsidiary of the Corporation also imposed duties on, or otherwise involved services by, him or her to the plan or to participants in or beneficiaries of the plan. The Corporation shall not be required to indemnify a person in connection with a proceeding initiated by such person, including a counterclaim or cross claim, unless the proceeding was authorized by the Board of Directors or commenced following a Change of Control with respect to actions or failure to act prior to such Change of Control. Section 7.4. Definitions of Liability and Expense. The Terms "Liability" and "Expense" as used in this Article 7 shall include, but shall not be limited to, reasonable counsel fees and disbursements and amounts of judgments, fines or penalties against (including excise taxes assessed with respect to an employee benefit plan), and amounts paid in settlement by or on behalf of, an Eligible Person. Section 7.5. Definition of Wholly Successful. The term "Wholly Successful" as used in this Article 7 shall mean (i) termination of any Claim against the Eligible Person in question without any finding of liability or guilt against him or her, (ii) approval by a court, with knowledge of the indemnity herein provided, of a settlement of any Claim, or (iii) the expiration of a reasonable period of time after the making or threatened making of any Claim without the institution of the same, without any payment or promise made to induce a settlement. Section 7.6. Definition of Change of Control. The term "Change of Control" as used in this Article 7 shall mean a change of control of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A promulgated under the Securities and Exchange Act of 1934 (the "1934 Act") as revised effective January 20, 1987, or, if Item 6(e) is no longer in effect, any regulations issued by the Securities and Exchange Commission pursuant to the 1934 Act which serve similar purposes; provided, that, without limitation, (x) such a change of control shall be deemed to have occurred if and when either (A) except as provided in (y) below, any "person" (as such term is used in Sections 13(d) and 14(d) of the 1934 Act) is or becomes a "beneficial owner" (as such term is defined in Rule 13d-3 promulgated under the 1934 Act), directly or indirectly, of securities of the Corporation representing 25% or more of the combined voting power of the Corporation's then outstanding securities entitled to vote with respect to the election of its Board of Directors or (B) as the result of a tender offer, merger, consolidation, sale of assets, 15 or contest for election of directors, or any combination of the foregoing transactions or events, individuals who were members of the Board of Directors of the Corporation immediately prior to any such transaction or event shall not constitute a majority of the Board of Directors following such transaction or event, and (y) no such change of control shall be deemed to have occurred if and when either (A) any such change is the result of a transaction which constitutes a "Rule 13e-3 transaction" as such term is defined in Rule 13e-3 promulgated under the 1934 Act or (B) any such person becomes, with the approval of the Board of Directors of the Corporation, the beneficial owner of securities of the Corporation representing 25% or more but less than 50% of the combined voting power of the Corporation's then outstanding securities entitled to vote with respect to the election of its Board of Directors and in connection therewith represents, and at all times continues to represent, in a filing, as amended, with the Securities and Exchange Commission on Schedule 13D or Schedule 13G (or any successor Schedule thereto) that "such person has acquired such securities for investment and not with the purpose nor with the effect of changing or influencing the control of the Corporation, nor in connection with or as a participant in any transaction having such purpose or effect," or words of comparable meaning and import. The designation by any such person, with the approval of the Board of Directors of the Corporation, of a single individual to serve as a member of, or observer at meetings of, the Corporation's Board of Directors, shall not be considered "changing or influencing the control of the Corporation" within the meaning of the meaning of the immediately preceding clause (B), so long as such individual does not constitute at any time more than one-third of the total number of directors serving on such Board. Section 7.7. Procedure for Determination of Entitlement to Indemnification. The determination of whether an Eligible Person who is or at the time of Claim was a Director (other than one who has been Wholly Successful with respect to any Claim or one who has requested indemnification following a Change of Control with respect to actions or failure to act prior to such Change of Control) is entitled to indemnification shall be made by any one of the following methods, such method to be selected by the Board of Directors: (a) by the Board of Directors by a majority vote of a quorum consisting of Directors who are not and have not been parties to the Claim; (b) if a quorum cannot be obtained under (a), by the majority vote of a committee duly designated by the Board of Directors (in which designation Directors who are or who have been parties to the Claim may participate), consisting solely of two or more Directors who are not and have not been parties to the Claim; (c) by special legal counsel (which may be regular counsel of the Corporation) (i) selected by the Board of Directors or a committee thereof in the manner prescribed in (a) or (b); or (ii) if a quorum of the Board of Directors cannot be obtained under (a) and a committee cannot be designated under (b), selected by a majority vote of the full Board of Directors (in which selection Directors who are or who have been parties to the Claim may participate). If a Change in Control shall have occurred, the Eligible Person who is or at the time of Claim was a Director shall be presumed to be entitled to indemnification (with respect to actions or failures to act occurring prior to such Change in Control) upon submission of a request for indemnification, and thereafter the Corporation shall have the burden of proof to overcome that presumption in reaching a contrary determination. The method for determining entitlement to indemnification shall 16 be by special legal counsel selected by the Eligible Person, but only such special legal counsel to which a majority of the Directors who are not and have not been parties to the Claim do not object. In the case of Eligible Persons who are not or were not Directors of the Corporation, the determination of whether the Eligible Person (other than one who has been Wholly Successful with respect to any Claim) is entitled to indemnification shall be made (a) by the Chairman of the Board or (b) if the Chairman of the Board so directs or in his or her absence, in the manner such determination would have been made if the Eligible Person was a Director of the Corporation. Section 7.8. Application to Court for Determination. If an Eligible Person claiming indemnification pursuant to Section 7.7 is found not to be entitled thereto, the Eligible Person may apply for indemnification with respect to a Claim to a court of competent jurisdiction, including a court in which the Claim is pending against the Eligible Person. On receipt of an application, the court, after giving notice to the Corporation and giving the Corporation opportunity to present to the court any information or evidence relating to the claim for indemnification that the Corporation deems appropriate, may order indemnification if it determines that the Eligible Person is entitled to indemnification with respect to the Claim because such Eligible Person met the standards of conduct set forth in Section 7.1(b). If the court determines that the Eligible Person is entitled to indemnification, the court shall also determine the reasonableness of the Eligible Person's Expenses. Section 7.9. Nonexclusivity. The rights of indemnification provided in this Article 7 shall be in addition to any rights to which any Eligible Person may otherwise be entitled. Irrespective of the provisions of this Article 7, the Board of Directors may, at any time and from time to time, (a) approve indemnification of any Eligible Person to the fullest extent permitted by the provisions of applicable law at the time in effect, whether on account of past or future transactions, and (b) authorize the Corporation to purchase and maintain insurance on behalf of any Eligible Person against any Liability asserted against him or her and incurred by him or her in any such capacity, or arising out of his or her status as such, whether or not the Corporation would have the power to indemnify him or her against such Liability. Section 7.10. Advancement of Expenses. The Corporation shall advance to an Eligible Person who is a director or officer of the Corporation the Expenses incurred by such Eligible Person with respect to any Claim. The Corporation may advance to an Eligible Person who is not a director or officer of the Corporation the Expenses incurred by such Eligible Person with respect to any Claim. The Corporation shall advance such Expenses within sixty (60) days after the receipt by the Corporation of a statement or statements from the Eligible Person requesting such advance or advances from time to time, whether prior to or after final disposition of such Claim unless a determination has been made pursuant to Section 7.1 that such Eligible Person is not entitled to indemnification. Any such statement or statements shall reasonably evidence the expenses incurred by the Eligible Person and shall include a written affirmation or undertaking to repay advances if it is ultimately determined that the Eligible Person is not entitled to indemnification under this Article. Section 7.11. Insurance, Contracts and Funding. The Corporation may purchase and maintain insurance to protect itself and any Eligible Person against any expense, judgments, fines and amounts relating to any Claim or incurred by any Eligible Person in connection with any Claim, to the fullest extent permitted by applicable law now or hereafter in effect. The Corporation may enter into agreements with any Eligible Person supplemental to or in furtherance of the provisions 17 of this Article and may create a trust fund or use other means (including, without limitation, a letter of credit) to ensure the payment of such amounts as may be necessary to effect indemnification and advancement of expenses as provided in this Article. Section 7.12. Nature of Provisions. The provisions of this Article 7 shall be deemed to be a contract between the Corporation and each Eligible Person, and an Eligible Person's rights hereunder shall not be diminished or otherwise adversely affected by any repeal, amendment or modification of this Article 7 that occurs subsequent to such person becoming an Eligible Person with respect to acts occurring prior to such repeal, amendment or modification. Section 7.13. Applicability of Provisions. The provisions of this Article 7 shall be applicable to Claims made or commenced after the adoption hereof, whether arising from acts or omissions to act occurring before or after the adoption hereof. ARTICLE 8 Miscellaneous Section 8.1. Amendments. The power to make, alter, amend, or repeal these Bylaws is vested in the Board of Directors, but the affirmative vote of a majority of the actual number of Directors elected and qualified, from time to time, shall be necessary to effect any alteration, amendment or repeal of these Bylaws. Section 8.2. Seal. The seal of the Corporation shall be circular in form and mounted on a metal die, suitable for impressing the same upon paper. About the upper periphery of the seal shall appear the words "CONSECO, INC.," and about the lower periphery thereof, the word "Indiana." In the center of the seal shall appear the word "Seal." Section 8.3. Fiscal Year. The fiscal year of the Corporation shall begin on the first day of January of each year and end upon the last day of December in the same year. 18 EX-4.22.2 4 EX-4.22.2 Unless this certificate is presented by an authorized representative of The Depository Trust Company, a New York corporation (the "Depository"), to the Company or its agent for registration of transfer, exchange, or payment, and any certificate issued is registered in the name of Cede & Co. or in such other name as is requested by an authorized representative of the Depository (and any payment is made to Cede & Co. or to such other entity as is requested by an authorized representative of the Depository), ANY TRANSFER, PLEDGE, OR OTHER USE HEREOF FOR VALUE OR OTHERWISE BY OR TO ANY PERSON IS WRONGFUL inasmuch as the registered owner hereof, Cede & Co., has an interest herein. REGISTERED REGISTERED CONSECO, INC. 6.4% NOTE DUE FEBRUARY 10, 2003 CUSIP 208464 AG 2 No. 1 US$200,000,000 CONSECO, INC., a corporation duly organized and existing under the laws of Indiana (herein called the "Company," which term includes any successor corporation under the Indenture hereinafter referred to), for value received, hereby promises to pay to Cede & Co. or registered assigns, the principal sum of Two Hundred Million Dollars ($200,000,000) on February 10, 2003, and to pay interest thereon from February 9, 1998 or from the most recent Interest Payment Date (as hereinafter defined) to which interest has been paid or duly provided for, as the case may be. Interest will be payable on February 10 and August 10 of each year (each an "Interest Payment Date"), at the rate of 6.4% per annum, commencing August 10, 1998 (except as provided below) until the principal hereof becomes due and payable. Interest payments will be made in an amount equal to the amount accrued from and including the immediately preceding Interest Payment Date in respect of which interest has been paid or duly made available for payment (or from and including the date of issue, if no interest has been paid or duly made available for payment) to but excluding the applicable Interest Payment Date or Maturity. The interest so payable and punctually paid or duly provided for, on any Interest Payment Date will, as provided in the Indenture, be paid to the Person in whose name this Note (or one or more predecessor Notes) is registered at the close of business on the Regular Record Date for such interest payment, which shall be the February 1 or August 1 (whether or not a Business Day), as the case may be, next preceding such Interest Payment Date. Except as otherwise provided in the Indenture, any such interest not so punctually paid or duly provided for will forthwith cease to be payable to the Holder on such Regular Record Date by virtue of their having been such Holder and may either be paid to the Person in whose name this Note (or one or more predecessor Notes) is registered at the close of business on a Special Record Date for the payment of such Defaulted Interest to be fixed by the Trustee, notice whereof is to be given to Holders of Notes not less than 10 calendar days prior to such Special Record Date, or be paid at any time in any other lawful manner not inconsistent with the requirements of any securities exchange on which Notes of this series may be listed, and upon such notice as may be required by such exchange, all as more fully provided in said Indenture. 1 If any Interest Payment Date(s) or the date of Maturity falls on a day that is not a Business Day, the required payment of principal, premium, if any, and/or interest will be made on the next succeeding Business Day as if made on the date such payment was due, and no interest will accrue on such payment for the period from and after such Interest Payment Date or the date of Maturity, as the case may be, to the date of such payment on the next succeeding Business Day. While this Note is represented by one or more global notes registered in the name of the Depository or its nominee, the Company will cause payments of principal of, premium, if any, and interest on this Note to be made to the Depository or its nominee, as the case may be, by wire transfer to the extent, in the funds and in the manner required by agreements with, or regulations or procedures prescribed from time to time by, the Depository or its nominee, and otherwise in accordance with such agreements, regulations and procedures. THIS NOTE MAY NOT BE TRANSFERRED EXCEPT AS A WHOLE BY THE DEPOSITORY OR BY A NOMINEE OF THE DEPOSITORY TO THE DEPOSITORY OR ANOTHER NOMINEE OF THE DEPOSITORY OR BY THE DEPOSITORY OR ANY SUCH NOMINEE TO A SUCCESSOR OF THE DEPOSITORY OR A NOMINEE OF SUCH SUCCESSOR. Unless the certificate of authentication hereon has been executed by the Trustee referred to herein, or its successor as Trustee, or its Authenticating Agent, by manual signature of an authorized signatory, this Note will not be entitled to any benefit under the Indenture or be valid or obligatory for any purpose. This Note is one of a duly authorized issue of securities of the Company (the "Securities") issued under an indenture, dated as of November 13, 1997, as amended from time to time (the "Indenture"), between the Company and LTCB Trust Company, as trustee (the "Trustee"), to which Indenture and all indentures supplemental thereto reference is hereby made for a statement of the respective rights, limitations of rights, duties and immunities thereunder of the Company, the Trustee and the Holders of the Notes and of the terms upon which the Securities are, and are to be, authenticated and delivered. This Note is one of the Securities designated on the face hereof limited in aggregate principal amount to $250,000,000. The Notes of this series will be redeemable as a whole or in part at the option of the Company at any time, at a redemption price equal to the sum of (a) the greater of (i) 100% of the principal amount of such Notes and (ii) the sum of the present values of the remaining scheduled payments of principal and interest thereon from the redemption date to the date of Maturity, computed by discounting such payments, in each case, to the redemption date on a semiannual basis (assuming a 360-day year consisting of twelve 30-day months) at the Treasury Rate, plus 25 basis points, plus (b) accrued interest on the principal amount thereof to the date of redemption. "Treasury Rate" means, with respect to any redemption date, the rate per annum equal to the semi-annual equivalent yield to maturity of the Comparable Treasury Issue, assuming a price for the Comparable Treasury Issue (expressed as a percentage of its principal amount) equal to the Comparable Treasury Price for such redemption date. 2 "Comparable Treasury Issue" means the United States Treasury security selected by an Independent Investment Banker as having a maturity comparable to the remaining term of this Note to be redeemed that would be utilized, at the time of selection and in accordance with customary financial practice, in pricing new issues of corporate debt securities of comparable maturity to the remaining term of this Note. "Independent Investment Banker" means one of the Reference Treasury Dealers appointed by the Trustee after consultation with the Company. "Comparable Treasury Price" means, with respect to any redemption date, (i) the average of the bid and asked prices for the Comparable Treasury Issue (expressed in each case as a percentage of its principal amount) on the third Business Day preceding such redemption date, as set forth in the daily statistical release (or any successor release) published by the Federal Reserve Bank of New York and designated "Composite 3:30 p.m. Quotations for U.S. Government Securities" or (ii) if such release (or any successor release) is not published or does not contain such prices on such Business Day, the average of the Reference Treasury Dealer Quotations actually obtained by the Trustee for such redemption date. "Reference Treasury Dealer Quotations" means, with respect to each Reference Treasury Dealer and any redemption date, the average, as determined by the Trustee, of the bid and asked prices for the Comparable Treasury Issue (expressed in each case as a percentage of its principal amount) quoted in writing to the Trustee by such Reference Treasury Dealer at 5:00 p.m. (New York City time) on the third Business Day preceding such redemption date. "Reference Treasury Dealer" means each of Merrill Lynch, Pierce, Fenner & Smith Incorporated, Deutsche Morgan Grenfell Inc., Salomon Brothers Inc and SBC Warburg Dillon Read Inc. and their respective successors; provided, however, that if any of the foregoing shall cease to be a primary U.S. Government securities dealer in New York City (a "Primary Treasury Dealer"), the Company may substitute therefor another Primary Treasury Dealer. Notice of any redemption will be mailed at least 30 days but no more than 60 days before the redemption date to each holder of Notes to be redeemed. If, at the time notice of redemption is given, the redemption moneys are not held by the Trustee, the redemption may be made subject to their receipt on or before the date fixed for redemption and such notice shall be of no effect unless such moneys are so received. Upon payment of the redemption price, on and after the redemption date interest will cease to accrue on this Note or portions hereof called for redemption. The Notes of this series contain the following covenants: Limitations on Issuance or Disposition of Stock of Significant Subsidiaries. The Company will not, nor will it permit any Significant Subsidiary to, issue, sell or otherwise dispose of any shares of Capital Stock (other than non-voting Preferred Stock) of any Significant Subsidiary, except for (i) directors' qualifying shares; (ii) sales or other dispositions to the Company or to one or more wholly owned Significant Subsidiaries; (iii) the sale or other disposition of all or any part of the Capital Stock of any Significant Subsidiary for consideration which is at least equal to the fair value 3 of such Capital Stock as determined by the Company's board of directors (acting in good faith); or (iv) any issuance, sale, assignment, transfer or other disposition made in compliance with an order of a court or regulatory authority of competent jurisdiction, other than an order issued at the request of the Company or any Significant Subsidiary. Limitation on Liens. Except as provided below, neither the Company nor any Significant Subsidiary may incur, issue, assume or guarantee any Indebtedness secured by a Lien on any property or assets of the Company or any Significant Subsidiary, or any shares of Capital Stock of any Significant Subsidiary, without effectively providing that the Notes (together with, if the Company shall so determine, any other Indebtedness which is not subordinated to the Notes) shall be secured equally and ratably with (or prior to) such Indebtedness, so long as such Indebtedness shall be so secured; provided, however, that this covenant shall not apply to Indebtedness secured by (i) Liens existing on the date of this Note; (ii) Liens on property of, or on any shares of stock of, any corporation existing at the time such corporation becomes a Significant Subsidiary or merges into or consolidates with the Company or a Significant Subsidiary; (iii) Liens on property or on shares of stock existing at the time of acquisition thereof by the Company or any Significant Subsidiary; (iv) Liens to secure the financing of the acquisition, construction or improvement of property, or the acquisition of shares of stock by the Company or any Significant Subsidiary, provided that such Liens are created not later than one year after such acquisition or, in the case of property, no later than one year after completion of construction or commencement of commercial operation, whichever is later, are limited to the property acquired, constructed or improved or the shares of stock acquired and do not secure indebtedness in excess of the cost of such acquisition, construction or improvement; (v) Liens in favor of the Company or any Subsidiary; (vi) Liens in favor of, or required by, governmental authorities; and (vii) any extension, renewal or replacement as a whole or in part, of any Lien referred to in the foregoing clauses (i) to (vi) inclusive; provided, however, that (a) such extension, renewal or replacement Lien shall be limited to all or a part of the same property or shares of stock that secured the Lien extended, renewed or replaced and (b) the Indebtedness secured by such Lien at such time is not so increased. The restrictions in the immediately preceding paragraph do not apply if, immediately after the incurrence, issuance, assumption or guarantee of any Indebtedness secured by a Lien, the aggregate principal amount of such secured Indebtedness, (other then Indebtedness secured by Liens described in clauses (i) to (vii), inclusive, of the immediately preceding paragraph) at that time would not exceed 10% of Consolidated Capitalization. "Capital Lease Obligations" of a Person means any obligation that is required to be classified and accounted for as a capital lease on the face of a balance sheet of such person prepared in accordance with generally accepted accounting principles; the amount of such obligations shall be the capitalized amount thereof, determined in accordance with generally accepted accounting principles; and the Stated Maturity thereof shall be the date of the last payment of rent or any other amount due under such lease prior to the first date upon which such lease may be terminated by the lessee without payment of a penalty. 4 "Capital Stock" means any and all shares, interests, rights to purchase, warrants, options, participations or other equivalents of or interest in (however designated) corporate stock, including any Preferred Stock. "Consolidated Capitalization" means the sum of the Company's consolidated shareholders' equity, redeemable preferred stock and preferred securities in any trust, partnership or other entities of which more than 50% of the voting equity is owned directly or indirectly by the Company, including, without limitation, the trust securities issued by Conseco Financing Trust I, Conseco Financing Trust II, Conseco Financing Trust III and Conseco Financing Trust IV. "Indebtedness" means (i) any liability of any Person (1) for borrowed money, or under any reimbursement obligation relating to a letter of credit (other than letters of credit obtained in the ordinary course of business), or (2) evidenced by a bond, note, debenture or similar instrument (including a purchase money obligation) given in connection with the acquisition of any businesses, properties or assets of any kind or with services incurred in connection with capital expenditures (other than accounts payable or other indebtedness to trade creditors arising in the ordinary course of business), or (3) for the payment of money relating to a Capital Lease Obligation; (ii) any liability of others described in the preceding clause (i) that the Person has guaranteed or that is otherwise its legal liability; and (iii) any amendment, supplement, modification, deferral, renewal, extension or refunding of any liability of types referred to in clauses (i) and (ii) above. "Lien" means any lien, mortgage, pledge, security interest, charge or encumbrance of any kind (including any conditional sale or other title retention agreement and any lease in the nature thereof). "Person" means any individual, corporation, partnership, joint venture, association, joint-stock or limited liability company, trust, unincorporated organization or government or any agency or political subdivision thereof. "Preferred Stock," as applied to the Capital Stock of any corporation, means Capital Stock of any class or classes (however designated) which is preferred as to the payment of dividends, or as to the distribution of assets upon any voluntary or involuntary liquidation or dissolution of such corporation, over shares of Capital Stock of any other class of such corporation. "Significant Subsidiary" means any Subsidiary with net earnings which constituted at least 20% of the Company's consolidated total net earnings, all as determined as of the date of the Company's most recently prepared quarterly financial statements for the 12-month period then ended. "Stated Maturity," when used with respect to any security or any installment of interest on any security, means the date specified in such security as the fixed date on which the principal of such security or such installment of interest, respectively, is finally due and payable, except as otherwise provided in the case of Capital Lease Obligations. 5 "Subsidiary" means a corporation of which a majority of the Capital Stock having voting power under ordinary circumstances to elect a majority of the board of directors is owned directly or indirectly by the Company or by one or more Subsidiaries, or by the Company and one or more Subsidiaries. If any Event of Default with respect to Notes of this series will occur and be continuing, the principal of the Notes of this series may be declared due and payable in the manner and with the effect provided in the Indenture. The Indenture permits, with certain exceptions as therein provided, the amendment thereof and the modification of the rights and obligations of the Company and the rights of the Holders of the Securities of each series to be affected under the Indenture at any time by the Company and the Trustee with the consent of the Holders of not less than a majority in principal amount of the outstanding Securities of each series to be affected. The Indenture also contains provisions permitting the Holders of specified percentages in principal amount of the outstanding Securities of each series, on behalf of the Holders of all Securities of such series, to waive, with respect to the Securities of such series, compliance by the Company with certain provisions of the Indenture and certain past defaults under the Indenture and their consequences. Any such consent or waiver by the Holder of this Note will be conclusive and binding upon such Holder and upon all future Holders of this Note and of any Note issued upon the registration of transfer hereof or in exchange herefor or in lieu hereof, whether or not notation of such consent or waiver is made upon this Note. Holders of Notes may not enforce their rights pursuant to the Indenture or the Notes except as provided in the Indenture. No reference herein to the Indenture and no provision of this Note or of the Indenture will alter or impair the obligation of the Company, which is absolute and unconditional, to pay the principal of, and premium, if any, and interest on this Note at the times, places and rates, herein prescribed. The Indenture contains provisions for defeasance at any time of (a) the entire indebtedness of the Company on this Note and (b) certain restrictive covenants and the related Events of Default upon compliance by the Company with certain conditions specified therein, which provisions apply to this Note. The Notes of this series are issuable only in global or certificated registered form, without coupons, in denominations of $1,000 and integral multiples thereof. As provided in the Indenture and subject to certain limitations therein specified and to the limitations described below, if applicable, Notes of this series are exchangeable for Notes of this series of like aggregate principal amount of a different authorized denomination, as requested by the Holder surrendering the same. As provided in the Indenture and subject to certain limitations therein specified and to the limitations described below, if applicable, the transfer of this Note is registerable in the Security Register upon surrender of this Note for registration of transfer at the office or agency of the 6 Company maintained for that purpose duly endorsed by, or accompanied by a written instrument of transfer in form satisfactory to the Company and the Security Registrar (which will initially be the Trustee at its principal corporate trust office located in the Borough of Manhattan, The City of New York) duly executed by the Holder hereof or his attorney duly authorized in writing, and thereupon one or more new Notes of this series with like terms and conditions, of authorized denominations and for the same aggregate principal amount, will be issued to the designated transferee or transferees. This Note is exchangeable for certificated Notes only upon the terms and conditions provided in the Indenture. Except as provided in the Indenture, owners of beneficial interests in this Note will not be entitled to receive physical delivery of Notes in certificated registered form and will not be considered the Holders thereof for any purpose under the Indenture. This Note is in the form of a Global Security as provided in the Indenture. If at any time the Depository notifies the Company that it is unwilling or unable to continue as Depository for this Note or if at any time the Depository for this series shall no longer be eligible or in good standing under the Securities Exchange Act of 1934, as amended, or other applicable statute or regulation, the Company shall appoint a successor Depository with respect to this Note. If a successor Depository for this Note is not appointed by the Company within 90 days after the Company receives notice or becomes aware of such ineligibility, the Company will execute, and the Trustee or its agent, upon receipt of a Company Request for the authentication and delivery of certificates representing Securities of this series in exchange for this Security will authenticate and deliver, certificates representing securities of this series of like tenor and terms in an aggregate principal amount equal to the principal amount of this Note in exchange for this Note. If specified by the Company pursuant to the Indenture with respect to this Note, the Depository may surrender this Note in exchange in whole or in part for certificates representing Securities of this series of like tenor and terms in definitive form on such terms as are acceptable to the Company and the Depository. Thereupon the Company shall execute, and the trustee or its agent shall authenticate and deliver, without a service charge, (1) to each Holder specified by the Security Registrar or the Depository a certificate or certificates representing Securities of this series of like tenor and terms and of any authorized denomination as requested by such person in an aggregate principal amount equal to and in exchange for such Holder's beneficial interest as specified by the security Registrar or the Depository in this Note; and (2) to the Depository a new Global Security of like tenor and terms and in an authorized denomination equal to the difference, if any, between the principal amount of the surrendered Note and the aggregate principal amount of certificates representing Notes delivered to Holders thereof. No service charge will be made for any such registration of transfer or exchange, but the Company may require payment of a sum sufficient to cover any tax or other governmental charge payable in connection therewith. Prior to due presentment of this Note for registration of transfer, the Company, the Trustee and any agent of the Company or the Trustee may treat the Person in whose name this Note 7 is registered as the owner hereof for all purposes, whether or not this Note be overdue and notwithstanding any notation of ownership or other writing hereon, and none of the Company, the Trustee or any such agent will be affected by notice to the contrary. The Indenture and the Notes will be governed by and construed in accordance with the laws of the State of New York. All terms used in this Note which are defined in the Indenture will have the meanings assigned to them in the Indenture unless otherwise defined herein; and all references in the Indenture to "Security" or "Securities" will be deemed to include this Note. 8 IN WITNESS WHEREOF, the Company has caused this instrument to be duly executed under its corporate seal. Date: February 9, 1998 CONSECO, INC. By /s/ ROLLIN M. DICK ----------------------------------- Rollin M. Dick [SEAL] Attest: By /s/ DONALD F. GONGAWARE ----------------------------------- Donald F. Gongaware This is one of the Securities of the series designated therein referred to in the within-mentioned Indenture. Dated: February 9, 1998 LTCB TRUST COMPANY, as Trustee By: /s/ BARBARA BEVELAQUA ---------------------------------- Authorized Officer 9 ----------------- ABBREVIATIONS The following abbreviations, when used in the inscription on the face of this instrument, shall be construed as though they were written out in full according to applicable laws or regulations: TEN COM - as tenants in common TEN ENT - as tenants by the entireties JT TEN - as joint tenants with right of survivorship and not as tenants in common UNIF GIFT MIN ACT - ..................Custodian................ (Cust) (Minor) Under Uniform Gifts to Minors Act .................................... (State) Additional abbreviations may also be used though not in the above list. ------------------ FOR VALUE RECEIVED, the undersigned hereby sell(s), assign(s) and transfer(s) unto PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER OF ASSIGNEE PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS INCLUDING POSTAL ZIP CODE OF ASSIGNEE - ------------------------------------- the within Security and all rights thereunder, hereby irrevocably constituting and appointing __________________ attorney to transfer said Security on the books of the Company, with full power of substitution in the premises. Date: ---------------------- Signature NOTICE: THE SIGNATURE TO THIS ASSIGNMENT MUST CORRESPOND WITH THE NAME AS WRITTEN UPON THE FACE OF THE WITHIN INSTRUMENT IN EVERY PARTICULAR, WITHOUT ALTERATION OR ENLARGEMENT OR ANY CHANGE WHATEVER. THE SIGNATURE(S) MUST BE GUARANTEED BY AN "ELIGIBLE GUARANTOR INSTITUTION" THAT IS A MEMBER OR PARTICIPANT IN A "SIGNATURE GUARANTEE PROGRAM" (E.G., THE SECURITIES TRANSFER AGENTS MEDALLION PROGRAM, THE STOCK EXCHANGE MEDALLION PROGRAM OR THE NEW YORK STOCK EXCHANGE, INC. MEDALLION SIGNATURE PROGRAM). 10 EX-10.8.11 5 EX-10.8.11 AMENDED AND RESTATED DIRECTOR, EXECUTIVE AND SENIOR OFFICER STOCK PURCHASE PLAN OF CONSECO, INC. 1. PURPOSE. The Amended and Restated Director, Executive and Senior Officer Stock Purchase Plan (the "Plan"), of Conseco, Inc. ("Conseco"), is adopted to facilitate the purchase, by the Directors, executives and senior managers of Conseco and its subsidiaries (collectively, the "Company"), of Conseco's common stock ("Common Stock") and Conseco's Preferred Redeemable Increased Dividend Equity Securities, 7% PRIDES, Convertible Preferred Stock ("PRIDES"). The purchases facilitated by the Plan are intended to achieve the following specific purposes: a) more closely align key employees' financial rewards with the financial rewards realized by all other shareholders of the Company; b) increase key employees' motivation to manage the Company as owners; and c) increase the ownership of Common Stock and PRIDES among senior management of the Company. 2. ELIGIBILITY. To be eligible to participate in the Plan, the individual must be a non-employee Director of the Company, an executive officer of the Company or a senior officer of the Company selected by the Directors ("Eligible Participant"). 3. PARTICIPATION. To become a Plan participant ("Participant"), an Eligible Participant must satisfy the following requirements: a) submit a completed, signed and irrevocable election to purchase all or, in the case of Directors and Executive Officers, a portion of the Common Stock or PRIDES which the Eligible Participant is eligible to purchase under the Plan along with a power of attorney authorizing such purchases on the Participant's behalf; b) complete and sign all necessary agreements and other documents relating to the loan described in Section 4 hereof including, but not limited to, personal financial statements, letters of instruction to brokers, transfer agents and banks as are necessary or appropriate under the loan described in Section 4 hereof, and a power of attorney authorizing borrowings under such loan; and c) satisfy all other conditions of participation specified in the Plan. The agreements and other documents specified in subsections 3 (a), (b) and (c) must be submitted at such times and to such Company offices as specified by the Company. No Eligible Participant is required to participate in the Plan. Directors and executive officers may purchase up to 2,500,000 shares of Common Stock under the Plan. Senior officers electing to become Participants must purchase at least 10,000 shares of Common Stock. Up to 8,000,000 shares of Common Stock may be purchased by all Participants. Directors and executive officers shall have the right to purchase shares not purchased by other Participants in such amount as is determined by the pro rata amount of their participation in the Plan compared to the participation of the other Participants electing to purchase additional shares. All such purchases may be made by the individual Participant or by a trust, corporation, partnership or limited liability company controlled by the Participant ("Participant Designee"; the term Participant shall include Participant Designee unless the context otherwise requires). 4. PURCHASE OF SHARES. Conseco, in its sole discretion subject to the terms and provisions of the Plan, will determine the timing, amount, price and mechanics of all of the purchases of shares of Common Stock (the "Purchased Shares") through open market and negotiated transactions. Purchases of Purchased Shares shall be effected through a broker in accordance with Rule 10b-18 under the Securities Exchange Act of 1934. The shares of Common Stock purchased pursuant to the Plan will be allocated proportionately among Participants at the end of each trading day based upon the percentage of all of the shares of Common Stock Participants have elected to purchase and the average price for all purchases of shares of Common Stock on that day. Conseco has arranged the opportunity for each Participant to obtain a loan through Bank of America National Trust and Savings Association and other participating financial institutions (collectively, the "Bank") to fund the purchase of the Purchased Shares (the "Loan"). Each Participant must sign a power of attorney authorizing loans under the Amended and Restated Credit Agreement with the Bank and the purchase of the Purchased Shares. Each Participant is responsible for satisfying all of the lending requirements specified by the Bank to qualify for the Loan including all collateral requirements. Each Participant is fully obligated to repay to 2 the Bank all principal, interest, and any prepayment fees on the Loan when due and payable. In the event a Participant does not wish to obtain the Loan, the Participant shall provide sufficient funds to fund the purchase of the Purchased Shares. Such Participant must execute a power of attorney authorizing the purchase of the Purchased Shares. If the Participant fails to fund the purchase of the Purchased Shares, the Participant may no longer participate in the Plan, and all of the Purchased Shares not paid for will be allocated to the other Participants. 5. REGISTRATION OF SHARES. The Purchased Shares will be registered in the name of the Participant or his or her designee and certificated. Each certificate will bear a legend referring to the Plan. The certificates for the Purchased Shares of each Participant who participates in the Loan will be held by the Bank as collateral for the Loan. Each such Participant must deliver to the Bank a stock power endorsed in blank with respect to the Purchased Shares. A Participant may be able to obtain a release of the Purchased Shares from the Bank provided that other collateral of equal value is substituted as collateral for the Loan. 6. SHAREHOLDER RIGHTS. Each Participant will have all of the rights of a shareholder with respect to the Purchased Shares, including the right to vote the shares and the right to receive dividends. Any dividends in excess of required interest payments will be deposited to the Participant's account at the Bank. 7. SALE OF PURCHASED SHARES. Each Participant is permitted to sell all or any portion of the Purchased Shares; provided, that any such sale does not violate any provision of a Loan. 8. DEATH OR DISABILITY. Upon the death of a Participant, her or his estate or the Participant Designee, as the case may be, may elect to cause Conseco to pay the estate or the Participant Designee, as the case may be, an amount equal to the purchase price paid for the Purchased Shares purchased by the deceased Participant minus the value of such shares on the date of the Participant's death based upon the average of the high and low trading prices per share for the Purchased Shares as reported by the principal national stock exchange upon which such shares are traded. The estate or the Participant Designee, as the case may be, of a deceased Participant must make such election, in writing, within 30 days after written notice from Conseco. Upon the total and permanent disability of a Participant who is an employee of the Company, such disabled Participant may elect to cause Conseco to pay the Participant an amount equal to the purchase price paid for the 3 Purchased Shares by the disabled Participant minus the value of such shares on the date of the determination of the Participant's total and permanent disability based upon the average of the high and low trading prices per share for the Purchased Shares as reported by the principal national stock market upon which such shares are traded. The Participant must make such election, in writing, within 30 days after written notice from Conseco. "Total and permanent disability" means the inability of a Participant to provide meaningful service for the Company due to a medically determinable physical or mental impairment. Such determination of total and permanent disability shall be made by the Company. Notwithstanding the above, if a Participant qualifies for Federal Social Security disability benefits or for payments under the Company's long-term disability income plan, based upon his physical or mental condition, he shall be deemed to suffer from a total and permanent disability hereunder. This Section 8 has no effect on a deceased or disabled Participant's sale of Purchased Shares before the Participant's death or disability. Payment by Conseco of amounts described in this Section 8 is conditioned on the payment in full of the Participant's Loan, if any, and the release of the Company's guarantee with respect thereto. This Section 8 will terminate January 1, 2002. 9. LOAN GUARANTEE. Conseco will guarantee repayment to the Bank of 100% of all principal, interest, prepayment fees and other obligations of each Participant under such Participant's Loan described in Section 4. The Conseco loan guaranty is a condition to the loan arrangement Conseco has made with the Bank. The terms and conditions of the guarantee are as agreed by Conseco and the Bank. If a Participant specifies a Participant Designee, the Participant shall enter into an indemnification agreement to indemnify Conseco for any losses under the guaranty of the Loan with respect to the Participant Designee. Each Participant is fully obligated to repay to the Bank all principal, interest, and other amounts on the Loan when due and payable. Conseco may take any action relating to the Participant and her or his assets, which the Board of Directors deems reasonable and necessary, (including, but not limited to, offsetting amounts owed to Conseco against wages, fees or other amounts owed to the Participant from Conseco) to obtain full reimbursement for amounts Conseco pays to the Bank under its guaranty related to the Participant's or a Participant Designee's Loan ("Loan Default"). Notwithstanding the foregoing, Conseco will not be subrogated to any right of the Bank as a holder of a security interest in the Purchased Shares. 10. LOAN OF INTEREST PAYMENTS. At the discretion of the Directors, Conseco or one of its subsidiaries (the "Lender") may loan funds to the Participants equal to the amount of 4 current interest payments owed by the Participants pursuant to the Amended and Restated Credit Agreement (the "Interest Payment Loans"). All Interest Payment Loans shall be evidenced by promissory notes, the terms and conditions of which shall be determined at the sole discretion of the Lender. If a Participant specifies a Participant Designee, the Participant shall enter into an indemnification agreement to indemnity the Lender for any losses under the Interest Payment Loan. 11. MARGIN REGULATIONS. (a) None of the obligations of the Participants to Conseco or one of its subsidiaries (collectively, Conseco and its subsidiaries shall be referred to as "Conseco" for the purposes of this Section 11) hereunder is or will be secured, directly or indirectly, by Margin Stock (as such term is defined in Regulation U and Regulation G promulgated by the Board of Governors of the Federal Reserve System); (b) Neither Conseco nor any third party acting on behalf of Conseco has taken or will take possession of a Participant's Margin Stock to secure, directly or indirectly, any of the obligations of such Participant to Conseco; (c) Conseco does not and will not have any right to prohibit such Participant from selling, pledging, encumbering or otherwise disposing of any Margin Stock owned by such Participant so long as the obligations of such Participant under this Plan remain outstanding; (d) Such Participant has not granted and will not grant Conseco or any third party acting on behalf of Conseco the right to accelerate repayment of any of the obligations under this Plan of such Participant if any of the Margin Stock owned by such Participant is sold by such Participant or otherwise; and (e) There is no agreement or other arrangement between such Participant and Conseco or any third party acting on behalf of Conseco (and no such agreement or arrangement shall be entered into so long as this Plan is in effect or any of the obligations of such Participant under this Plan remain outstanding) under which the Margin Stock of Participant would be made more readily available as security to Conseco than to other creditors of such Participant. 12. CHANGES OF CONTROL. A "Change of Control" of Conseco shall mean a change of control of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A promulgated under the Securities Exchange Act of 1934 (the "1934 Act") as revised effective January 20, 5 1987, or if Item 6(e) is no longer in effect, any regulations issued by the Securities and Exchange Commission pursuant to the 1934 Act which serve similar purposes; provided, that, without limitations, (x) such a change of control shall be deemed to have occurred if and when either (A) except as provided in (y) below, any "person" (as such terms is used in Sections 13(d) and 14(d) of the 1934 Act) is or becomes a "beneficial owner" (as such term is defined in Rule 13d-3 promulgated under the 1934 Act), directly or indirectly, of securities of Conseco representing 25% or more of the combined voting power of Conseco's then outstanding securities entitled to vote with respect to the election of its Board of Directors or (B) as the result of a tender offer, merger, consolidation, sale of assets, or contest for election of directors, or any combination of the foregoing transactions or events, individuals who were members of the Board of Directors of Conseco immediately prior to any such transaction or event shall not constitute a majority of the Board of Directors following such transaction or event, and (y) no such change of control shall be deemed to have occurred if and when either (A) any such change is the result of a transaction which constitutes a "Rule 13e-3 transaction" as such term is defined in Rule 13e-3 promulgated under the 1934 Act or (B) any such person becomes, with the approval of the Board of Directors of Conseco, the beneficial owner of securities of Conseco representing 25% or more but less than 50% of the combined voting power of Conseco's then outstanding securities entitled to vote with respect to the election of its Board of Directors and in connection therewith represents, and at all times continues to represent, in a filing, as amended, with the Securities and Exchange Commission on Schedule 13D or Schedule 13G (or any successor Schedule thereto) that "such person has acquired such securities for investment and not with the purpose nor with the effect of changing or influencing the control of the Company, nor in connection with or as a participant in any transaction having such purpose or effect" or words of comparable meaning and import. The designation by any such person, with the approval of the Board of Directors of Conseco, of a single individual to serve as a member of, or observer at meetings of, Conseco's Board of Directors, shall not be considered "changing or influencing the control of the Company" within the meaning of the immediately preceding clause (B), so long as such individual does not constitute at any time more than one-third of the total number of directors serving on such Board. In the event of a Change of Control, each Participant will receive in exchange for the Purchased Shares the higher of (i) the purchase price paid for all of each Participant's Purchased Shares, respectively, plus all interest paid by each respective Participant under the Loan or (ii) the amount of the consideration to be paid for the Purchased Shares in connection with the Change of Control. Such amount shall be paid to the Participants upon 6 consummation of the event resulting in a Change of Control. 13. OTHER TERMINATION. If a Participant ceases to be a Director or officer of Conseco in circumstances other than as described in section 12, Conseco shall notify the Participant or Participant Designee that such Participant or Participant Designee shall have the option to either (i) within 30 days of the notice, retire the Loan and release Conseco's guaranty or (ii) continue the Loan and the Interest Payment Loan until their maturity date with Conseco's guaranty, but commence paying all future interest payments on such Loans as due. If the Participant desires Conseco's guaranty to continue, he or she agrees that, as compensation for continuing such guaranty beyond the termination of such Participant's employment or directorship, as the case may be, the former Participant shall pay to Conseco the following fees: (a) A continuing guaranty fee on the outstanding note balance at each calendar quarter end to be paid at the rate of .5% each quarter. (b) A settlement fee equal to half of the "Exit Profit". The Exit Profit shall be the excess, if any, of (i) the proceeds received from the sale of the Related Shares (as defined herein) or the market value of the Related Shares on the date the guaranty is released, whichever occurs first minus (ii) the sum of (x) the market value of the Related Shares at the Participant's termination date and (y) the interest accrued on the Loan since the termination date for the Related Shares. The "Related Shares" means the number of Purchased Shares acquired with the proceeds of the remaining principal amount of the loan at the date of termination of employment. 14. ADMINISTRATION. The Board of Directors of Conseco shall be charged with the administration and interpretation of the Plan but may delegate the ministerial duties hereunder to such persons as it determines. The Board of Directors of Conseco may adopt such rules as may be necessary or appropriate for the proper administration of the Plan. The decision of the Board of Directors of Conseco in all matters involving the interpretation and application of the Plan shall be final and shall be given the maximum possible deference allowed by law. 15. PAYMENT OF EXPENSES. The expenses of administering the Plan shall be paid by the Company except those expenses which are expenses of the Participants. 7 16. EMPLOYER-EMPLOYEE RELATIONSHIP. The establishment of this Plan shall not be construed as conferring any legal or other rights upon any employee or any person for a continuation of employment, nor shall it interfere with the rights of the Company to discharge any employee or otherwise act with relation to the employee. The Company may take any action (including discharge) with respect to any employee or other person and may treat such person without regard to the effect which such action or treatment might have upon such person as a Participant of this Plan. 17. AMENDMENT AND TERMINATION. The Company reserves the right to change or discontinue this Plan by action of the Board of Directors in its discretion; provided, however, that in the case of any person to whom benefits under this Plan had accrued upon termination of employment prior to such Board of Directors action, or in the case of any Participant who would have been entitled to benefits under this Plan had the Participant's employment ceased prior to such change or discontinuance, the benefits such person had accrued under this Plan prior to such change or discontinuance shall not be adversely affected thereby. Notwithstanding anything herein to the contrary, nothing contained herein shall restrict the Company's right to terminate the Plan. This Plan completely supersedes and replaces the Conseco, Inc. Director, Executive and Senior Officer Stock Purchase Plan dated April 4, 1996. 18. WITHHOLDING. The Company shall have the right to deduct in cash (whether under this Plan or otherwise) in connection with all payments by the Company to a Participant under this Plan any taxes required by law to be withheld and to require any payments required to enable it to satisfy its withholding obligations. 19. GOVERNING LAW. This Plan shall be construed in accordance with the laws of the State of Indiana. 20. APPROVAL. If a Participant purchases Purchased Shares, such purchase shall constitute formal approval of this Plan by the Participant and such Participant's agreement to be bound by the terms and conditions of the Plan. Effective Date: August 21, 1997 8 EX-10.8.14 6 EX-10.8.14 CONSECO, INC. AMENDED AND RESTATED 1997 NON-QUALIFIED STOCK OPTION PLAN ARTICLE I. Purpose The purpose of the CONSECO, INC. 1997 NON-QUALIFIED STOCK OPTION PLAN (the "Plan") is to provide a means through which CONSECO, INC., an Indiana corporation (the "Company"), may provide incentives to increase the personal financial identification of key personnel with the long-term growth of the Company and the interests of the Company's shareholders through the ownership and performance of the common stock of the Company, to enhance the Company's ability to retain key personnel and to attract outstanding prospective executive employees. ARTICLE II. Definitions The following definitions shall be applicable throughout the Plan unless specifically modified by any paragraph: (a) "Board" means the Board of Directors of the Company. (b) A "Change of Control" of the Company shall mean a change of control of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A promulgated under the 1934 Act as revised effective January 20, 1987, or, if Item 6(e) is no longer in effect, any regulations issued by the Securities and Exchange Commission pursuant to the 1934 Act which serve similar purposes; provided, that, without limitation, (x) such a change of control shall be deemed to have occurred if and when either (A) except as provided in (y) below, any "person" (as such term is used in Sections 13(d) and 14(d) of the 1934 Act) is or becomes a "beneficial owner" (as such term is defined in Rule 13d-3 promulgated under the 1934 Act), directly or 1 indirectly, of securities of the Company representing 25% or more of the combined voting power of the Company's then outstanding securities entitled to vote with respect to the election of its Board of Directors or (B) as the result of a tender offer, merger, consolidation, sale of assets, or contest for election of directors, or any combination of the foregoing transactions or events, individuals who were members of the Board of Directors of the Company immediately prior to any such transaction or event shall not constitute a majority of the Board of Directors following such transaction or event, and (y) no such change of control shall be deemed to have occurred if and when either (A) any such change is the result of a transaction which constitutes a "Rule 13e-3 transaction" as such term is defined in Rule 13e-3 promulgated under the 1934 Act or (B) any such person becomes, with the approval of the Board of Directors of the Company, the beneficial owner of securities of the Company representing 25% or more but less than 50% of the combined voting power of the Company's then outstanding securities entitled to vote with respect to the election of its Board of Directors and in connection therewith represents, and at all times continues to represent, in a filing, as amended, with the Securities and Exchange Commission on Schedule 13D or Schedule 13G (or any successor Schedule thereto) that "such person has acquired such securities for investment and not with the purpose nor with the effect of changing or influencing the control of the Company, nor in connection with or as a participant in any transaction having such purpose or effect," or words or comparable meaning and import. The designation by any such person, with the approval of the Board of Directors of the Company, of a single individual to serve as a member of, or observer at meetings of, the Company's Board of Directors, shall not be considered "changing or influencing the control of the Company" within the meaning of the immediately preceding clause (B), so long as such individual does not constitute at any time more than one-third of the total number of directors serving on such Board. (c) "Code" means the Internal Revenue Code of 1986, as amended. Reference in the Plan to any section of the Code shall be deemed to include any amendments or successor provisions to any section and any regulations under such section. 2 (d) "Compensation Committee" means not less than two members of the Board who are selected by the Board as provided in Article IV, Section 4.01. (e) "Common Stock" means the common stock, no par value per share, of the Company. (f) "Company" means Conseco, Inc., an Indiana corporation, and any successor thereto. (g) "Director" means an individual elected to the Board by the shareholders of the Company or by the Board under applicable corporate law who is serving on the Board. (h) An "employee" means any person (including a Director) in an employment relationship with the Company or any parent or subsidiary corporation (as defined in Section 424 of the Code). (i) "1934 Act" means the Securities Exchange Act of 1934, as amended. (j) "Fair Market Value" means, as of any specified date, the mean of the reported high and low sales prices of the Common Stock on the stock exchange composite tape on that date, or if no prices are reported on that date, on the last preceding date on which such prices of the Common Stock are so reported. If the Common Stock is traded over the counter at the time a determination of its fair market value is required to be made hereunder, its fair market value shall be deemed to be equal to the average between the reported high and low or closing bid and asked prices of Common Stock on the most recent date on which Common Stock was publicly traded. In the event Common Stock is not publicly traded at the time a determination of this value is required to be made hereunder, the determination of its fair market value shall be made by the Compensation Committee in such manner as it deems appropriate. (k) "Holder" means an employee who has been granted an Option. 3 (l) "Option" means an Option granted under Article VII of the Plan and includes only Options to purchase Common Stock which do not constitute Incentive Stock Options under Section 422 of the Code. (m) "Option Agreement" means a written agreement between the Company and a Holder with respect to an Option. (n) "Plan" means Conseco, Inc. 1997 Non-Qualified Stock Option Plan, as amended from time to time. (o) "Rule 16b-3" means SEC Rule 16b-3 promulgated under the 1934 Act, as such may be amended from time to time, and any successor rule, regulation or statute fulfilling the same or a similar function. ARTICLE III. Effective Date and Duration of the Plan The Plan shall be effective as of April 1, 1997, the date of its adoption by the Board, provided the Plan is approved by the shareholders of the Company within twelve months thereafter. The Plan shall remain in effect until all Options granted under the Plan have been satisfied or expired or until the Plan is terminated in accordance with Article IX. 4 ARTICLE IV. Administration Section 4.01 Composition of Compensation Committee. The Plan shall be administered by a committee which shall be (i) appointed by the Board; and (ii) constituted solely of "outside directors," within the meaning of Section 162(m) of the Code and applicable interpretive authority thereunder. Section 4.02 Powers. Subject to the provisions of the Plan, the Compensation Committee shall have sole authority, in its discretion, to determine which employees shall receive an Option, the time or times when such Option shall be made, and the number of shares of Common Stock which may be issued under each Option. In making such determinations the Compensation Committee may take into account the nature of the services rendered by the respective individuals, their present and potential contribution to the Company's success and such other factors as the Compensation Committee in its discretion shall deem relevant. Section 4.03 Additional Powers. The Compensation Committee shall have such additional powers as are delegated to it by the other provisions of the Plan. Subject to the express provisions of the Plan, the Compensation Committee is authorized to construe the Plan and the respective agreements executed thereunder, to prescribe such rules and regulations relating to the Plan as it may deem advisable to carry out the Plan, to determine the terms, restrictions and provisions of each Award, and to make all other determinations necessary or advisable for administering the Plan. The Compensation Committee may correct any defect or supply any omission or reconcile any inconsistency in any agreement relating to an Option in the manner and to the extent it shall deem expedient to carry it into effect. The determinations of the Compensation Committee on the matters referred to in this Article IV shall be conclusive. 5 ARTICLE V. Grant of Options; Shares Subject to the Plan Section 5.01 Stock Option Limits. The Compensation Committee may from time to time grant Options to one or more individuals determined by it to be eligible for participation in the Plan in accordance with the provisions of Article VI. Subject to Article VIII, the aggregate number of shares of Common Stock for which Options may be granted under the Plan, when added to all outstanding, unexpired options under the Company's other employee benefit plans, shall not exceed 20% of the shares of Common Stock outstanding on the date of grant. In determining the number of shares outstanding on the date of grant, the Compensation Committee shall include the number of shares then issuable under any outstanding securities of the Company (other than options) which are then exchangable for or convertible into Common Stock. Notwithstanding any provision in the Plan to the contrary, the maximum number of shares of Common Stock that may be subject to Options under Article VII hereof granted to any one individual during any calendar year is: the sum (subject to adjustment in the same manner as provided in Article VIII with respect to shares of Common Stock subject to Options then outstanding) of (a) 1,000,000 plus (b) the number of shares (not to exceed 3,000,000) issued under a Reload Program as described below, plus (c) the number of options provided for in an employment contract that has been approved by a vote of the shareholders. As an inducement to holders of non-qualified stock options to exercise those options significantly before their expiration date, the Compensation Committee may offer a Reload Program to such holders. Under the Reload Program, new Options may be granted for a number of shares equal to (a) the sum of (i) the total exercise price of the prior options exercised in the Reload Program plus (ii) the taxes incurred by the holder as a result of such exercise (deemed to be 45% of the taxable income resulting from such exercise) divided by (b) the exercise price per share of the newly granted Option. The limitation set forth in the preceding sentence shall be applied in a manner which will permit compensation generated in connection with the exercise of Options to constitute "performance-based" compensation for purposes of Section 162(m) of the Code, including, without limitation, counting against such maximum number of shares, to the extent required under Section 162(m) of the Code and 6 applicable interpretive authority thereunder, any shares subject to Options that are canceled or repriced. Section 5.02 Stock Offered. The stock to be offered pursuant to the grant of an Option may be authorized but unissued Common Stock or Common Stock previously issued and outstanding and reacquired by the Company. ARTICLE VI. Eligibility Options may be granted only to persons who, at the time of grant, are employees. Options under this Plan may not be granted to any Director who is not an employee of the Company. An Award may be granted on more than one occasion to the same person. ARTICLE VII. Stock Options Section 7.01 Option Period. The term of each Option shall be as specified by the Compensation Committee at the date of grant. Section 7.02 Limitations on Exercise of Option. An Option shall be exercisable in whole or in such installments and at such times as determined by the Compensation Committee. Section 7.03 Option Agreement. Each Option shall be evidenced by an Option Agreement in such form and containing such provisions not inconsistent with the provisions of the Plan as the Compensation Committee from time to time shall approve. An Option Agreement may provide for the payment of the option price, in whole or in part, by the delivery of a number of shares of Common Stock (plus cash if necessary) having a Fair Market Value equal to such option price. Each Option Agreement shall provide that the Option may not be exercised earlier than six months from the date of grant and shall specify the effect of termination of employment on the exercisability of the Option. Moreover, an Option Agreement may provide for a "cashless exercise" of the Option by establishing procedures whereby the Holder, by a properly-executed written notice, directs (i) an immediate market sale or margin loan respecting all or a part of the shares of Common Stock to which he 7 is entitled upon exercise pursuant to an extension of credit by the Company to the Holder of the option price, (ii) the delivery of the shares of Common Stock from the Company directly to a brokerage firm and (iii) the delivery of the option price from sale or margin loan proceeds from the brokerage firm directly to the Company. Such Option Agreement may also include, without limitation, provisions relating to (i) subject to the provisions hereof accelerating such vesting on a Change of Control, vesting of Options, including a provision that Options shall continue to vest and remain exercisable for so long as a Holder who terminates employment with the Company remains an employee of any Company subsidiary or affiliate of the Company, (ii) tax matters (including provisions covering any applicable employee wage withholding requirements and requiring additional "gross-up" payments to Holders to meet any excise taxes or other additional income tax liability imposed as a result of a Change of Control payment resulting from the operation of the Plan or of such Option Agreement), and (iii) any other matters not inconsistent with the terms and provisions of this Plan that the Compensation Committee shall in its sole discretion determine. The terms and conditions of the respective Option Agreements need not be identical. Section 7.04 Option Price and Payment. The price at which a share of Common Stock may be purchased upon exercise of an Option shall be determined by the Compensation Committee, but such purchase price (i) for options granted to the chief executive officer of the Company and the other four most highly compensated executive officers of the Company, shall not be less than the Fair Market Value of a share of Common Stock on the date such Option is granted, and (ii) shall be subject to adjustment as provided in Article VIII. An option may not be granted at less than the Fair Market Value of a share of Common Stock on the date such Option is to be granted if the sum of (i) the number of shares of Common Stock which could be purchased under such Option plus (ii) the number of shares of Common Stock which could be purchased under all other Options which were granted under the Plan previously at less than the Fair Market Value of a share of Common Stock on the date of grant would exceed five percent of the maximum number of Options then available for grant under the second sentence of Section 5.01. The Option or portion thereof may be exercised by delivery of an irrevocable notice of exercise to the Company. The purchase price of the Option or portion thereof shall be paid in full in the manner prescribed by the Compensation Committee. 8 Section 7.05 Shareholder Rights and Privileges. The Holder shall be entitled to all the privileges and rights of a shareholder only with respect to such shares of Common Stock as have been purchased under the Option and for which certificates of stock have been registered in the Holder's name. Section 7.06 Options in Substitution for Stock Options Granted by Other Corporations. Options may be granted under the Plan from time to time in substitution for stock options held by individuals employed by corporations who become employees as a result of a merger or consolidation of the employing corporation with the Company or any subsidiary, or the acquisition by the Company or a subsidiary of the assets of the employing corporation, or the acquisition by the Company or a subsidiary of stock of the employing corporation with the result that such employing corporation becomes a subsidiary. ARTICLE VIII. Recapitalization or Reorganization Section 8.01 Stock Dividends, etc. The shares with respect to which Options may be granted are shares of Common Stock as presently constituted, but if, and whenever, prior to the expiration or exercise of an Option theretofore granted, the Company shall effect a subdivision or consolidation of shares of Common Stock or the payment of a stock dividend on Common Stock without receipt of consideration by the Company, the number of shares of Common Stock with respect to which such Option may thereafter be exercised, (i) in the event of an increase in the number of outstanding shares shall be proportionately increased, and the purchase price per share shall be proportionately reduced, and (ii) in the event of a reduction in the number of outstanding shares shall be proportionately reduced, and the purchase price per share shall be proportionately increased. Section 8.02 Recapitalizations. If the Company recapitalizes or otherwise changes its capital structure, thereafter upon any exercise of an Option theretofore granted the Holder shall be entitled to purchase under such Option, in lieu of the number of shares of Common Stock then covered by such Option, the number and class of shares of stock and securities to which the Holder would have been entitled pursuant to the terms of the recapitalization 9 if, immediately prior to such recapitalization, the Holder had been the holder of record of the number of shares of Common Stock then covered by such Option. Section 8.03 Change of Control. In the event of a Change of Control, all outstanding Options shall immediately vest and become exercisable or satisfiable, as applicable. The Compensation Committee, in its discretion, may determine that upon the occurrence of a Change of Control, each Option outstanding hereunder shall terminate within a specified number of days after notice to the Holder, and such Holder shall receive, with respect to each share of Common Stock subject to such Option, cash in an amount equal to the excess of (i) the higher of (x) the Fair Market Value of such share of Common Stock immediately prior to the occurrence of such Change of Control or (y) the value of the consideration to be received in connection with such Change of Control for one share of Common Stock over (ii) the exercise price per share, if applicable, of Common Stock set forth in such Option. The provisions contained in the preceding sentence shall be inapplicable to an Option granted within six (6) months before the occurrence of a Change of Control if the Holder of such Option is subject to the reporting requirements of Section 16(a) of the 1934 Act and such disposition is not exempt under Rule 16b-3 but shall be applicable to such Option after the expiration of six (6) months from the date of grant. If the consideration offered to shareholders of the Company in any transaction described in this paragraph consists of anything other than cash, the Compensation Committee shall determine the fair cash equivalent of the portion of the consideration offered which is other than cash. The provisions contained in this paragraph shall not terminate any rights of the Holder to further payments pursuant to any other agreement with the Company following a Change of Control. Section 8.04 Other Adjustments. In the event of changes in the outstanding Common Stock by reason of recapitalization, reorganizations, mergers, consolidations, combinations, exchanges or other relevant changes in capitalization occurring after the date of the grant of any Option and not otherwise provided for by this Article VIII, any outstanding Options and any agreements evidencing such Options shall be subject to adjustment by the Compensation Committee at its discretion as to the number and price of shares of Common Stock or other consideration subject to such Options. 10 Section 8.05 Impact of Plan. The existence of the Plan and the Options granted hereunder shall not affect in any way the right or power of the Board or the shareholders of the Company to make or authorize any adjustment, recapitalization, reorganization or other change in the Company's capital structure or its business, any merger or consolidation of the Company, any issue of debt or equity securities ahead of or affecting Common Stock or the rights thereof, the dissolution or liquidation of the Company or any sale, lease, exchange or other disposition of all or any part of its assets or business or any other corporate act or proceeding. Section 8.06 Shareholder Action. Any adjustment provided for in Sections 8.01, 8.02, 8.03 and 8.04 above shall be subject to any required shareholder action. Section 8.07 Other. Except as hereinbefore expressly provided, the issuance by the Company of shares of stock of any class or securities convertible into shares of stock of any class, for cash, property, labor or services, upon direct sale, upon the exercise of rights or warrants to subscribe therefor, or upon conversion of shares or obligations of the Company convertible into such shares or other securities, and in any case whether or not for fair value, shall not affect, and no adjustment by reason thereof shall be made with respect to the number of shares of Common Stock subject to Options theretofore granted or the purchase price per share. ARTICLE IX. Amendment and Termination of the Plan The Board in its discretion may terminate the Plan at any time with respect to any shares for which Options have not theretofore been granted. The Board shall have the right to alter or amend the Plan or any part thereof from time to time; provided that no change in any Option theretofore granted may be made which would impair the rights of the Holder without the consent of the Holder (unless such change is required in order to cause the benefits under the Plan to qualify as performance-based compensation within the meaning of Section 162(m) of the Code and applicable interpretive authority thereunder), and provided, further, that the Board may not, without approval of the shareholders, amend the Plan if such 11 approval is required under applicable law or stock exchange rule or in order for the Plan to continue to comply with Section 162(m) of the Code. ARTICLE X. Miscellaneous Section 10.01 No Right To An Option. Neither the adoption of the Plan by the Company nor any action of the Board or the Compensation Committee shall be deemed to give an employee any right to be granted an Option to purchase Common Stock except as may be evidenced by an Option or by an Option Agreement duly executed on behalf of the Company, and then only to the extent and on the terms and conditions expressly set forth therein. The Plan shall be unfunded. The Company shall not be required to establish any special or separate fund or to make any other segregation of funds or assets to assure the payment of any Option. Section 10.02 No Employment Rights Conferred. Nothing contained in the Plan shall (i) confer upon any employee any right with respect to continuation of employment with the Company or any subsidiary or (ii) interfere in any way with the right of the Company or any subsidiary to terminate his or her employment (or service as a Director, in accordance with applicable corporate law) at any time. Section 10.03 Other Laws; Withholding. The Company shall not be obligated to issue any Common Stock pursuant to any Option granted under the Plan at any time when the shares covered by such Award have not been registered under the Securities Act of 1933 and such other state and federal laws, rules or regulations as the Company or the Compensation Committee deems applicable and, in the opinion of legal counsel for the Company, there is no exemption from the registration requirements of such laws, rules or regulations available for the issuance and sale of such shares. No fractional shares of Common Stock shall be delivered, nor shall any cash in lieu of fractional shares be paid. The Company shall have the right to deduct in cash (whether under this Plan or otherwise) in connection with all Options any taxes required by law to be withheld and to require any payments required to enable it to satisfy its withholding obligations. In the case of any Option 12 satisfied in the form of Common Stock, no shares shall be issued unless and until arrangements satisfactory to the Company shall have been made to satisfy any withholding tax obligations applicable with respect to such Option. Subject to such terms and conditions as the Compensation Committee may impose, the Company shall have the right to retain, or the Compensation Committee may, subject to such terms and conditions as it may establish from time to time, permit Holders to elect to tender Common Stock (including Common Stock issuable in respect of an Option) to satisfy, in whole or in part, the amount required to be withheld. Section 10.04 No Restriction on Corporate Action. Nothing contained in the Plan shall be construed to prevent the Company or any subsidiary from taking any corporate action which is deemed by the Company or such subsidiary to be appropriate or in its best interest, whether or not such action would have an adverse effect on the Plan or any Option granted under the Plan. No employee, beneficiary or other person shall have any claim against the Company or any subsidiary as a result of any such action. Section 10.05 Restrictions on Transfer. An Option shall not be transferable except (i) by will or the laws of descent and distribution, or (ii) by gift to any member of the Holder's immediate family, to a partnership consisting only of members of the Holder's immediate family or to a trust for the benefit of such immediate family member or to such other persons or entities as the Compensation Committee determines in its discretion, if permitted in the applicable Option Agreement. An option may be exercisable during the lifetime of the Holder only by such Holder or the Holder's guardian or legal representative unless it has been transferred to a member of the Holder's immediate family, to a partnership consisting only of members of the Holder's immediate family or to a trust for the benefit of such immediate family member, in which case it shall be exercisable only by such transferee. For the purpose of this provision, a Holder's "immediate family" shall mean the Holder's spouse, children and grandchildren. Notwithstanding any such transfer, the Holder will continue to be subject to the withholding requirements provided for in Section 10.03 hereof. Section 10.06 Section 162(m). It is intended that the Plan comply fully with and meet all the requirements of Section 162(m) of the Code so that Options granted hereunder with an exercise 13 price not less than Fair Market Value of a share of Common Stock on the date of grant shall constitute "performance-based" compensation within the meaning of such section. If any provision of the Plan would disqualify the Plan or would not otherwise permit the Plan to comply with Section 162(m) as so intended, such provision shall be construed or deemed amended to conform to the requirements or provisions of Section 162(m); provided that no such construction or amendment shall have an adverse effect on the economic value to a Holder of any Option previously granted hereunder. Section 10.07 Governing Law. This Plan shall be construed in accordance with the laws of the State of Indiana. 14 EX-12.1 7 EX-12.1
CONSECO, INC. AND SUBSIDIARIES Computation of Ratio of Earnings to Fixed Charges, Preferred Dividends and Distributions on Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts - Consolidated Basis for the years ended December 31, 1997, 1996 and 1995 (Dollars in millions) 1997 1996 1995 ---- ---- ---- Pretax income from operations: Net income $ 567.3 $ 252.4 $ 220.4 Add income tax expense 376.6 179.8 87.0 Add extraordinary charge on extinguishment of debt 6.9 26.5 2.1 Add minority interest 52.3 34.9 109.0 -------- --------- -------- Pretax income from operations 1,003.1 493.6 418.5 -------- -------- -------- Add fixed charges: Interest expense on annuities and financial products 806.7 668.6 585.4 Interest expense on long-term debt, including amortization 109.4 108.1 119.4 Interest expense on investment borrowings 42.0 22.0 22.2 Other .7 .9 1.0 Portion of rental(1) 9.3 8.0 6.9 -------- -------- -------- Fixed charges 968.1 807.6 734.9 -------- -------- -------- Adjusted earnings $1,971.2 $1,301.2 $1,153.4 ======== ======== ======== Ratio of earnings to fixed charges 2.04X 1.61X 1.57X Ratio of earnings to fixed charges, excluding ===== ===== ===== interest on annuities and financial products 7.21X 4.55X 3.80X ===== ===== ===== Fixed charges $ 968.1 $ 807.6 $ 734.9 Add dividends on preferred stock, including dividends on preferred stock of subsidiaries (divided by the rate of income before minority interest and extraordinary charge to pretax income) 40.5 62.3 36.0 -------- -------- -------- Adjusted fixed charges $1,008.6 $ 869.9 $ 770.9 ======== ======== ======== Adjusted earnings $1,971.2 $1,301.2 $1,153.4 ======== ======== ======== Ratio of earnings to fixed charges and preferred dividends 1.95X 1.50X 1.50X Ratio of earnings to fixed charges and preferred ===== ===== ===== dividends, excluding interest on annuities and financial products 5.77X 3.14X 3.06X ===== ===== ===== Adjusted fixed charges $1,008.6 $ 869.9 $770.9 Add distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts 75.4 5.6 - -------- -------- -------- Fixed charges $1,084.0 $ 875.5 $ 770.9 ======== ======== ======== Adjusted earnings $1,971.2 $1,301.2 $1,153.4 ======== ======== ======== Ratio of earnings to fixed charges, preferred dividends and distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts 1.82X 1.49X 1.50X Ratio of earnings to fixed charges, preferred dividends ===== ===== ===== and distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts, excluding interest on annuities and financial products 4.20X 3.06X 3.06X ===== ===== ===== (1) Interest portion of rental is assumed to be 33 percent.
EX-21 8 EX-21 LIST OF SUBSIDIARIES
NAME (1) JURISDICTION - -------- ------------ CIHC, Incorporated Delaware American Life Holdings, Inc. Delaware American Life Holding Company Delaware American Life and Casualty Insurance Company Illinois Vulcan Life Insurance Company (2) Alabama American Life and Casualty Marketing Division Co. Iowa Wabash Life Insurance Company Kentucky Philadelphia Life Insurance Company Pennsylvania Lamar Life Insurance Company Mississippi Conseco Life Insurance Company Indiana Providential Life Insurance Company Arkansas Colonial Penn Life Insurance Company Pennsylvania Capitol American Financial Corporation Ohio Capitol American Life Insurance Company Arizona Frontier National Life Insurance Company Ohio Capitol National Life Insurance Company Ohio Pioneer Financial Services, Inc. Delaware Pioneer Life Insurance Company Illinois Health and Life Insurance Company of America Illinois Manhattan National Life Insurance Company Illinois Connecticut National Life Insurance Company Illinois United Group Holdings, Inc. Nevada National Group Life Insurance Company Illinois Continental Life and Accident Company Illinois Bankers Life Insurance Company of Illinois Illinois Bankers Life and Casualty Company Illinois Certified Life Insurance Company Illinois Conseco Financial Services, Inc. Pennsylvania Jefferson National Life Insurance Company of Texas Texas Beneficial Standard Life Insurance Company California Great American Reserve Insurance Company Texas American Travellers Life Insurance Company Pennsylvania Continental Life Insurance Company Texas United General Life Insurance Company Texas Conseco Life Insurance Company of New York New York Bankers National Life Insurance Company Texas National Fidelity Life Insurance Company Missouri CNC Entertainment Nevada, Inc. Nevada Conseco Services, L.L.C. Indiana Conseco Marketing, L.L.C. Indiana Conseco Private Capital Group, Inc. Indiana Conseco Equity Sales, Inc. Texas Lincoln American Life Insurance Company Tennessee Conseco Global Investments, Inc. Delaware CNC Real Estate, Inc. Delaware Conseco Entertainment, Inc. Indiana Conseco Entertainment, L.L.C. Indiana Marketing Distribution Systems Consulting Group, Inc. Delaware Conseco Risk Management, Inc. Indiana Wells & Company, Inc. Indiana Wellsco, Inc. Indiana Conseco Mortgage Capital, Inc. Delaware Conseco Capital Management, Inc Delaware Washington National Corporation Delaware Washington National Financial Services, Inc. Illinois Washington National Insurance Company Illinois Washington National Development Company Delaware United Presidential Corporation Indiana United Presidential Life Insurance Company Indiana (1) Except otherwise indicated, each company is a direct or indirect wholly owned subsidiary of the indicated parent. (2) American Life and Casualty Insurance Company owns 98 percent of Vulcan Life Insurance Company.
EX-23 9 EX-23 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statements of Conseco, Inc. (File Nos. 33-57079, 33-56901, 33-57931, 33-40556, 33-58710, 33-58712, 333-10297, 333-18037, 333-18581, 333-19783, 333-23251, 333-27803, 333-28305, 333-32615, 333-32617 and 333-32621) of our report dated March 23, 1998, on our audits of the consolidated financial statements and financial statement schedules of Conseco, Inc. as of December 31, 1997 and 1996, and for the years ended December 31, 1997, 1996 and 1995, which report is included in this Annual Report on Form 10-K. /S/COOPERS & LYBRAND L.L.P. ----------------------------- Coopers & Lybrand L.L.P. Indianapolis, Indiana March 23, 1998 EX-27 10 ARTICLE 7 FDS 12/31/97 10-K OF CONSECO, INC.
7 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-K FOR CONSECO, INC. DATED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1997 DEC-31-1997 22,773,700 0 0 228,900 1,074,800 0 26,961,200 0 849,100 3,381,600 35,914,800 23,142,400 406,100 1,303,900 364,900 1,906,700 1,383,900 115,800 2,382,000 1,392,300 35,914,800 3,410,800 1,825,300 266,500 65,800 3,175,000 548,000 577,200 1,003,100 376,600 626,500 0 (6,900) 0 567,300 2.94 2.64 0 0 0 0 0 0 0 Includes $558,600 of credit-tenant loans. Includes $2,466,400 of cost of policies purchased. Includes retained earnings of $1,210,300, and other comprehensive income of $182,000. Includes insurance policy benefits of $2,185,700, change in future policy benefits of $182,600 and amounts added to annuity and financial product policyholder account balances of $806,700. Includes amortization of cost of policies purchased of $261,800 and cost of policies produced of $105,000 and amortization related to realized gains of $181,200.
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