CNO FINANCIAL GROUP, INC.
10-Ks and 10-Qs
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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,
2009
or
[ ]
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the
transition period from _________ to _________
Commission
file number: 001-31792
Conseco,
Inc.
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Delaware
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75-3108137
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State
of Incorporation
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IRS
Employer Identification No.
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11825
N. Pennsylvania Street
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Carmel,
Indiana 46032
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(317)
817-6100
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Address
of principal executive offices
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Telephone
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Securities
registered pursuant to Section 12(b) of the Act:
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Title of each class
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Name of Each Exchange on which
Registered
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Common
Stock, par value $0.01 per share
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New
York Stock Exchange
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Rights
to purchase Series A Junior Participating Preferred Stock
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New
York Stock Exchange
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Securities
registered pursuant to Section 12(g) of the Act:
None
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
Yes
[ ] No [ X ]
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act.
Yes
[ ] No [ X ]
Indicate
by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days: Yes [ X ] No [ ]
Indicate by check mark whether the
registrant has submitted electronically and posted on its corporate Website, if
any, every Interactive Data File required to be submitted and posted pursuant to
Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12
months (or for such shorter period that the registrant was required to submit
and post such files). Yes [ ] 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. [ ]
Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act. Large accelerated filer
[ ] Accelerated filer [ X ] Non-accelerated
filer [ ] Smaller reporting company [ ]
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act): Yes [ ] No [ X ]
At June
30, 2009, the last business day of the Registrant’s most recently completed
second fiscal quarter, the aggregate market value of the Registrant’s common
equity held by nonaffiliates was approximately $430 million.
Indicate
by check mark whether the Registrant has filed all documents and reports
required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act
of 1934 subsequent to the distribution of securities under a plan confirmed by a
court. Yes [ X ] No [ ]
Shares of
common stock outstanding as of February 12,
2010: 250,786,216
DOCUMENTS
INCORPORATED BY
REFERENCE: Portions of the Registrant’s definitive proxy statement
for the 2010 annual meeting of shareholders are incorporated by reference into
Part III of this report.
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TABLE
OF CONTENTS
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Page
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PART
I
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Item
1.
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Business
of
Conseco
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3
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Item
1A.
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Risk
Factors
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22
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Item
1B.
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Unresolved
Staff
Comments
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40
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Item
2.
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Properties
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40
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Item
3.
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Legal
Proceedings
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40
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Item
4.
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Submission
of Matters to a Vote of Security
Holders
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40
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Executive
Officers of the
Registrant
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41
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PART
II
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Item
5.
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Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
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42
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Item
6.
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Selected
Consolidated Financial
Data
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45
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Item
7.
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Management’s
Discussion and Analysis of Consolidated Financial Condition and Results of
Operations
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46
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Item
7A.
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Quantitative
and Qualitative Disclosures About Market
Risk
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117
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Item
8.
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Consolidated
Financial Statements and Supplementary
Data
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117
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Item
9.
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Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
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204
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Item
9A.
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Controls
and
Procedures
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204
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Item
9B.
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Other
Information
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206
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PART
III
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Item
10.
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Directors,
Executive Officers and Corporate
Governance
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206
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Item
11.
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Executive
Compensation
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206
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Item
12.
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Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
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206
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Item
13.
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Certain
Relationships and Related Transactions, and Director
Independence
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206
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Item
14.
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Principal
Accountant Fees and
Services
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206
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PART
IV
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Item
15.
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Exhibits
and Financial Statement
Schedules
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207
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2
Conseco,
Inc., a Delaware corporation (“CNO”), is the holding company for a group of
insurance companies operating throughout the United States that develop, market
and administer supplemental health insurance, annuity, individual life insurance
and other insurance products. CNO became the successor to Conseco,
Inc., an Indiana corporation (our “Predecessor”), in connection with our
bankruptcy reorganization which became effective on September 10, 2003 (the
“Effective Date”). The terms “Conseco,” the “Company,” “we,” “us,”
and “our” as used in this report refer to CNO and its subsidiaries or, when the
context requires otherwise, our Predecessor and its subsidiaries.
We focus
on serving the senior and middle-income markets, which we believe are
attractive, underserved, high growth markets. We sell our products
through three distribution channels: career agents, professional independent
producers (some of whom sell one or more of our product lines exclusively) and
direct marketing. As of December 31, 2009, we had shareholders’
equity of $3.5 billion and assets of $30.3 billion. For the year
ended December 31, 2009, we had revenues of $4.3 billion and net income of $85.7
million. See our consolidated financial statements and accompanying
footnotes for additional financial information about the Company and its
segments.
We manage
our business through the following: three primary operating segments,
Bankers Life, Colonial Penn and Conseco Insurance Group, which are defined on
the basis of product distribution, and corporate operations, which consists of
holding company activities and certain noninsurance company businesses that are
not part of our other segments. Our segments are described
below:
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·
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Bankers
Life,
which consists of
the business of Bankers Life and Casualty Company (“Bankers Life”),
markets and distributes health and life insurance products and annuities
to the middle-income senior market through a dedicated field force of over
5,600 career agents and sales managers supported by a network of over 150
community-based branch offices. Products include Medicare
supplement insurance, life insurance, fixed annuities and long-term care
insurance. Bankers Life also markets and distributes Medicare
Part D prescription drug plans through a distribution and reinsurance
arrangement with Coventry Health Care (“Coventry”) and Medicare Advantage
plans primarily through a distribution arrangement with Humana Inc.
(“Humana”).
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·
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Colonial
Penn
, which consists of the business of Colonial Penn Life
Insurance Company (“Colonial Penn”), markets primarily graded benefit and
simplified issue life insurance directly to customers through television
advertising, direct mail, the internet and
telemarketing. Colonial Penn markets its products under its own
brand name.
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·
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Conseco
Insurance Group,
which markets and distributes specified disease
insurance, accident, disability, life insurance and annuities to
middle-income consumers at home and at the worksite. These
products are marketed through Performance Matters Associates, Inc., a
wholly owned subsidiary, and through independent marketing organizations
and insurance agencies. Products being marketed by Conseco
Insurance Group are underwritten by Conseco Insurance Company, Conseco
Health Insurance Company (“Conseco Health”) and Washington National
Insurance Company (“Washington National”). This segment also
includes blocks of long-term care and other insurance business, in these
companies and in Conseco Life Insurance Company (“Conseco Life”), which we
no longer market.
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On November 12, 2008, Conseco and CDOC,
Inc. (“CDOC”), a wholly owned subsidiary of Conseco, completed the transfer (the
“Transfer”) of the stock of Senior Health Insurance Company of Pennsylvania
(“Senior Health”) to Senior Health Care Oversight Trust, an independent trust
(the “Independent Trust”) for the exclusive benefit of Senior Health’s long-term
care policyholders. Consummation of the transaction was subject to
the approval of the Pennsylvania Insurance Department. As a result of
the Transfer, a substantial portion of our long-term care business is presented
as a discontinued operation.
In connection with the Transfer, the
Company entered into a $125.0 million Senior Note due November 12, 2013 (the
“Senior Note”), payable to Senior Health. The note has a five-year
maturity date; a 6 percent interest rate; and requires annual principal payments
of $25.0 million. As a condition of the order from the Pennsylvania
Insurance Department approving the Transfer, Conseco agreed that it would not
pay cash dividends on its common stock while any portion of the $125.0 million
note remained outstanding.
3
OUR
STRATEGIC DIRECTION AND 2010 PRIORITIES
Our
mission is to be a premier provider of life insurance, supplemental health
products and annuities to America’s middle-income consumers with a focus on
seniors and to provide value to our shareholders. We believe we can
accomplish this mission through the effective execution of the following
strategies:
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Remain focused on the Needs of
Our Middle Income Market Customers.
We define our
business by our target markets and not by our products. We
continue to adapt our distribution, product offerings and product features
to the evolving needs of our middle income and senior
customers. We provide a broad range of middle market products
to meet the protection needs of our customers and to provide them with
longevity solutions. We are able to reach our customers through
our career agents and independent agent relationships, directly, through
our Colonial Penn direct distribution platform, and at work, through our
worksite marketing channel.
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·
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Expand and Improve the
Efficiency of our Distribution Channels.
The continued
development and maintenance of our distribution channels is critical to
our continued sales growth. We dedicate substantial resources
to the recruitment, development and retention of our Bankers Life career
agents and seek to maximize their productivity by providing them with high
quality leads for new business opportunities. Investments in
our Colonial Penn direct distribution platform have enabled us to achieve
significant sales growth since 2004. In our Conseco Insurance
Group segment, we have refocused efforts on supplemental health and life
insurance products to utilize the competitive strengths of our wholly
owned distributor, Performance Matters Associates,
Inc.
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Seek Profitable
Growth.
We continue to pursue profitable growth
opportunities in the middle income market. We focus on
marketing and selling products that meet the needs of our customers and we
believe it will enable us to provide long-term value for our
shareholders. As part of this strategy, we have de-emphasized
products with return characteristics that we consider to be
inadequate.
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·
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Pursue Operational
Efficiencies and Cost Reduction Opportunities.
We seek
to strengthen our competitive position with a focus on cost control and
enhanced operational efficiency. Our efforts
include:
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·
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improvements
to our policy administration processes and procedures to reduce costs and
improve customer service;
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continued
consolidation of policy processing systems, including conversions and
elimination of systems;
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·
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streamlining
administrative procedures and consolidating processes across the
enterprise to reduce personnel
costs; and
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·
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eliminating
expenses associated with the marketing of those products that do not meet
our return objectives.
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·
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Strengthen Our Financial
Profile.
In response to the challenging economic
environment and to our financial situation, our management team has taken
several capital and risk management initiatives to enhance our capital and
liquidity position and to improve our profitability. These
initiatives included the private placement of new convertible debentures
and shares of our common stock and warrants and the public offering of our
common stock. The proceeds from these recapitalization
transactions were used to refinance our 3.5% Convertible Debentures
due September 30, 2035 (the “3.5% Debentures”) and to decrease the
outstanding indebtedness under our senior credit agreement, with the
remaining amounts available for general corporate purposes. In
addition, we have pursued several reinsurance transactions that have
improved the capitalization of our life insurance subsidiaries and have
served to offset the negative effects of the adverse economic and
investment environment.
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·
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Continue to manage and reduce
the risk profile of our business where possible.
We
actively manage the risks associated with our business and have taken
several steps to reduce the risk profile of our business. In
the fourth quarter of 2007, we completed a transaction to coinsure
100 percent of a block of inforce equity-indexed annuity and fixed
annuity business sold through our independent distribution
channel. Such business was largely out of the surrender charge
periods and had policyholder account balances in excess of
$2.5 billion. This transaction significantly reduced the
asset and liability risks associated with this business. In the
fourth quarter of 2008, we
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4
transferred
the stock of Senior Health to an independent trust, eliminating our exposure to
a substantial block of long-term care business previously included in our
run-off segment. In 2009, we began coinsuring a significant portion
of the new long-term care business written through our Bankers Life
segment. These transactions have reduced our exposure to long-term
care business that has produced volatile earnings in the past.
We have
purposefully avoided products like variable life, variable annuity and
guaranteed investment contracts that we believe would expose us to risks that
are not commensurate with potential profits. We plan to continue to
emphasize products that are straight forward and have a lower risk
profile. We believe such products meet various needs of the middle
income markets we serve. We will continue to manage the investment
risks associated with our insurance business by:
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·
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maintaining
a largely investment-grade, diversified fixed-income
portfolio;
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·
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maximizing
the spread between the investment income we earn and the yields we pay on
investment products within acceptable levels of
risk; and
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continually
tailoring our investment portfolio to consider expected liability
durations, cash flows and other
requirements.
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·
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Capitalize on favorable trends
in our markets.
It is our vision to be a premier
provider of insurance products to America’s middle-income families and
seniors. We believe our middle-income target market is
underserved by the financial services industry. In addition,
our focus on seniors provides us with significant growth opportunities as
an estimated 78 million “baby boomer” Americans born between 1946 and
1964 plan for retirement and become eligible for Medicare. Our
middle-income market consumers are impacted by a number of trends,
including:
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·
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increased
life expectancy;
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·
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discontinuance
or reduction in employer-sponsored benefit
programs;
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·
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rising
healthcare costs; and
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·
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projected
gaps between the needs of seniors and amounts provided by
government-sponsored plans such as Social Security and
Medicare.
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We
believe that our focus on middle-income families and seniors will position us
favorably to capitalize on the future growth in these markets.
Our major
goals for 2010 include:
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·
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Continuing
to improve the focus and profitability mix of sales at Conseco Insurance
Group.
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·
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Maintaining
strong growth at Bankers Life.
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·
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Improving
earnings stability and reducing
volatility.
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·
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Determining
that improved controls implemented in 2009 have operated for a period of
time sufficient to demonstrate their effectiveness and thereby remediating
our material weakness in internal
controls.
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Continuing
to actively manage our enterprise exposure to long-term care
business.
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·
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Improving
profitability of existing lines of business or disposing of
underperforming blocks of business.
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OTHER
INFORMATION
CNO is
the successor to our Predecessor. We emerged from bankruptcy on the
Effective Date. Our Predecessor 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. Our annual reports on
Form
5
10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to
those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act are available free of charge on our website at
www.conseco.com
as
soon as reasonably practicable after they are electronically filed with, or
furnished to, the Securities and Exchange Commission (the
“SEC”). These filings are also available on the SEC’s website at
www.sec.gov
. In
addition, the public may read and copy any document we file at the SEC’s Public
Reference Room located at 100 F Street, NE, Room 1580, Washington, D.C.
20549. The public may obtain information on the operation of the
Public Reference Room by calling the SEC at 1-800-SEC-0330. Copies of
these filings are also available, without charge, from Conseco Investor
Relations, 11825 N. Pennsylvania Street, Carmel,
IN 46032.
Our
website also includes the charters of our Audit and Enterprise Risk Committee,
Executive Committee, Governance and Strategy Committee, Human Resources and
Compensation Committee and Investment Committee, as well as our Corporate
Governance Operating Principles and our Code of Business Conduct and Ethics that
applies to all officers, directors and employees. Copies of these
documents are available free of charge on our website at
www.conseco.com
or
from Conseco Investor Relations at the address shown above. Within
the time period specified by the SEC and the New York Stock Exchange, we will
post on our website any amendment to our Code of Business Conduct and Ethics and
any waiver applicable to our principal executive officer, principal financial
officer or principal accounting officer.
In June
2009, we filed with the New York Stock Exchange the Annual CEO Certification
regarding the Company’s compliance with their Corporate Governance listing
standards as required by Section 303A.12(a) of the New York Stock Exchange
Listed Company Manual. In addition, we have filed as exhibits to this
2009 Form 10-K the applicable certifications of the Company’s Chief Executive
Officer and Chief Financial Officer required under Section 302 of the
Sarbanes-Oxley Act of 2002 regarding the Company’s public
disclosures.
Data in
Item 1 are provided as of or for the year ended December 31, 2009 (as the
context implies), unless otherwise indicated.
MARKETING
AND DISTRIBUTION
Insurance
Our
insurance subsidiaries develop, market and administer supplemental health
insurance, annuity, individual life insurance and other insurance
products. We sell these products through three primary distribution
channels: career agents, professional independent producers (some of
whom sell one or more of our product lines exclusively) and direct
marketing. We had premium collections of $4.1 billion, $4.5 billion
and $4.0 billion in 2009, 2008 and 2007, respectively.
Our
insurance subsidiaries collectively hold licenses 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 five percent of our 2009 collected
premiums: Florida (7.6 percent), California (6.9 percent),
Pennsylvania (6.4 percent) and Texas (6.1 percent).
We
believe that most purchases of life insurance, accident and health insurance and
annuity products occur only after individuals are contacted and solicited by an
insurance agent. Accordingly, the success of our distribution system
is largely dependent on our ability to attract and retain experienced and highly
motivated agents. A description of our primary distribution channels
is as follows:
Career
Agents
. This agency force of approximately 5,600 agents and
sales managers working from over 150 branch offices establishes one-on-one
contact with potential policyholders and promotes strong personal relationships
with existing policyholders. The career agents sell primarily
supplemental health and long-term care insurance policies, life insurance and
annuities. In 2009, this distribution channel accounted for $3,000.9
million, or 73 percent, of our total collected premiums. These agents
sell Bankers Life and Casualty policies, as well as Coventry’s Medicare Part D
and Medicare Advantage products, 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.
Professional Independent
Producers
. Professional independent producers are a diverse
network of independent agents, insurance brokers and marketing
organizations. The general agency and insurance brokerage
distribution system is comprised of independent licensed agents doing business
in all fifty states, the District of Columbia, and certain protectorates of the
United States. In 2009, this distribution channel in our Conseco
Insurance Group segment collected $919.1 million, or
6
22
percent, of our total premiums.
Marketing
organizations typically recruit agents for the Conseco Insurance Group segment
by advertising our products and commission structure through direct mail
advertising or through seminars for 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 agents recruited
by such organizations. Certain of these marketing organizations are
specialty organizations that have a marketing expertise or a distribution system
related to a particular product or market, such as worksite and individual
supplemental health products. During 1999 and 2000, the Conseco
Insurance Group segment purchased three organizations that specialize in
marketing and distributing supplemental health products and combined them under
the name PMA. In 2009, the PMA distribution channel accounted for
$212.6 million, or 5 percent, of our total collected premiums.
Direct
Marketing.
This distribution channel is engaged primarily in
the sale of graded benefit life insurance policies through Colonial
Penn. In 2009, this channel accounted for $194.8 million, or 5
percent, of our total collected premiums.
Products
The
following table summarizes premium collections by major category and segment for
the years ended December 31, 2009, 2008 and 2007 (dollars in
millions):
Total
premium collections
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2009
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2008
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2007
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Supplemental
health:
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Bankers
Life
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$ | 1,711.7 | $ | 1,887.0 | $ | 1,546.1 | ||||||
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Colonial
Penn
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7.5 | 8.9 | 10.4 | |||||||||
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Conseco
Insurance Group
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600.4 | 621.8 | 633.4 | |||||||||
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Total
supplemental health
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2,319.6 | 2,517.7 | 2,189.9 | |||||||||
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Annuities:
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||||||||||||
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Bankers
Life
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1,060.4 | 1,224.1 | 885.5 | |||||||||
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Conseco
Insurance Group
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78.4 | 129.8 | 368.6 | |||||||||
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Total
annuities
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1,138.8 | 1,353.9 | 1,254.1 | |||||||||
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Life:
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||||||||||||
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Bankers
Life
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228.8 | 209.4 | 200.0 | |||||||||
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Colonial
Penn
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187.3 | 174.1 | 113.7 | |||||||||
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Conseco
Insurance Group
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240.3 | 269.8 | 287.3 | |||||||||
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Total
life
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656.4 | 653.3 | 601.0 | |||||||||
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Total
premium
collections
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$ | 4,114.8 | $ | 4,524.9 | $ | 4,045.0 | ||||||
In addition,
the
long-term care business included in our discontinued operations had collected
premiums of $225.9 million and $269.1 million in 2008 and 2007,
respectively.
7
Our
insurance companies collected premiums from the following products:
Supplemental
Health
Supplemental
Health Premium Collections (dollars in millions)
|
2009
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2008
|
2007
|
||||||||||
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Medicare
supplement:
|
||||||||||||
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Bankers
Life
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$ | 653.7 | $ | 636.6 | $ | 636.1 | ||||||
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Colonial
Penn
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7.0 | 8.1 | 9.4 | |||||||||
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Conseco
Insurance
Group
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177.8 | 203.8 | 225.9 | |||||||||
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Total
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838.5 | 848.5 | 871.4 | |||||||||
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Long-term
care:
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||||||||||||
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Bankers
Life
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601.6 | 625.7 | 622.4 | |||||||||
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Conseco
Insurance
Group
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31.4 | 33.7 | 36.7 | |||||||||
|
Total
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633.0 | 659.4 | 659.1 | |||||||||
|
Prescription
Drug Plan and Medicare Advantage products included in Bankers
Life
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444.4 | 614.0 | 277.8 | |||||||||
|
Specified
disease products included in Conseco Insurance Group
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383.3 | 374.6 | 359.2 | |||||||||
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Other:
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||||||||||||
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Bankers
Life
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12.0 | 10.7 | 9.8 | |||||||||
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Colonial
Penn
|
.5 | .8 | 1.0 | |||||||||
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Conseco
Insurance
Group
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7.9 | 9.7 | 11.6 | |||||||||
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Total
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20.4 | 21.2 | 22.4 | |||||||||
|
Total
supplemental health premium
collections
|
$ | 2,319.6 | $ | 2,517.7 | $ | 2,189.9 | ||||||
The
following describes our major supplemental health products:
Medicare
Supplement.
Medicare supplement collected premiums were $838.5
million during 2009 or 20 percent of our total collected
premiums. Medicare is a federal health insurance program for disabled
persons and seniors (age 65 and older). Part A of the program
provides protection against the costs of hospitalization and related hospital
and skilled nursing facility 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 doctor’s bills and a
number of other medical costs not covered by Part A, subject to deductible and
coinsurance amounts for charges approved by Medicare. The deductible
amount is subject to change each year by the federal government.
Medicare
supplement policies provide coverage for many of the hospital and 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 currently concentrate on individuals who have recently become eligible for
Medicare by reaching the age of 65. Approximately 55 percent of new
sales of Medicare supplement policies in 2009 were to individuals who had
recently reached the age of 65.
Both
Bankers Life and Conseco Insurance Group sell Medicare supplement
insurance.
Long-Term
Care.
Long-term care collected premiums were $633.0 million
during 2009, or 15 percent of our total collected premiums. Long-term
care products provide coverage, within prescribed limits, for nursing homes,
home healthcare, or a combination of both. We sell the long-term care
plans primarily to retirees and, to a lesser degree, to older self-employed
individuals in the middle-income market.
8
Current
nursing home care policies cover incurred charges up to a daily fixed-dollar
limit 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 incurred charges after a deductible or elimination
period and are subject to a weekly or monthly maximum dollar amount, and an
overall benefit maximum. Comprehensive policies cover both nursing
home care and home healthcare. We monitor the loss experience on our
long-term care products and, when necessary, apply for rate increases in the
jurisdictions in which we sell such products. Regulatory filings are made before
we increase our premiums on these products.
A small
portion of our long-term care business resides in the Conseco Insurance Group
segment. This business was sold through the independent producer
distribution channel and was largely underwritten by certain of our subsidiaries
prior to their acquisitions by our Predecessor in 1996 and 1997. The
performance of these blocks of business did not meet the expectations we had
when the blocks were acquired. As a result, we ceased selling new
long-term care policies through this distribution channel in 2003.
We
continue to sell long-term care insurance through the Bankers Life career agent
distribution channel. This business is underwritten using stricter
underwriting and pricing standards than had previously been used on our acquired
blocks of long-term care business included in the Conseco Insurance Group
segment.
Prescription Drug
Plan and Medicare Advantage.
The Medicare Prescription Drug,
Improvement and Modernization Act of 2003 (“MMA”) provided for the introduction
of a prescription drug program under Medicare Part D. Persons
eligible for Medicare can receive their Part D coverage through a stand-alone
Prescription Drug Plan (“PDP”). In order to offer a PDP product to
our current and potential future policyholders without investment in management
and infrastructure, we entered into a national distribution agreement with
Coventry to use our career and independent agents to distribute Coventry’s PDP
product, Advantra Rx. We receive a fee based on the number of PDP
plans sold through our distribution channels. In addition, Conseco
has a quota-share reinsurance agreement with Coventry for Conseco enrollees that
provides Conseco with a specified percentage of net premiums and related profits
subject to a risk corridor. The Part D program was effective January
1, 2006. PDP collected premiums were $75.4 million during 2009 or 2
percent of our total collected premiums.
Conseco
expanded its strategic alliance with Coventry by entering into national
distribution agreements under which our career agents began distributing
Coventry’s Private-Fee-For-Service (“PFFS”) plan, with coverage beginning
January 1, 2007. The PFFS product, Advantra Freedom, is a Medicare
Advantage plan designed to provide seniors with more choices and better coverage
at lower cost than original Medicare and Medicare Advantage plans offered
through HMOs. Under the agreement, we received a fee based on the
number of PFFS plans sold through our distribution channels. In
addition, Conseco had a quota-share reinsurance agreement with Coventry for
Conseco enrollees that provided Conseco with a specified percentage of the net
premiums and related profits. Coventry decided to cease selling PFFS
plans effective January 1, 2010. On July 22, 2009, Bankers Life
announced a strategic alliance under which it will offer Humana’s Medicare
Advantage plans to its policyholders and consumers nationwide through its career
agency force and will receive marketing fees based on
sales. Effective January 1, 2010, the Company will no longer be
assuming the underwriting risk related to PFFS business.
During
2007 and 2008, Conseco entered into three quota-share reinsurance agreements
with Coventry related to the PFFS business written by Coventry under certain
group policies. Conseco received a specified percentage of the net
premiums and related profits associated with this business as long as the ceded
revenue margin is less than or equal to five percent. In order to
reduce the required statutory capital associated with the assumption of this
business, Conseco terminated two group policy quota-share agreements as of
December 31, 2008 and terminated the last agreement on June 30,
2009. Premiums assumed through these reinsurance agreements totaled
$47.5 million in 2009. The income before income taxes related to the
assumed business was $14.0 million during the year ended December 31,
2009.
PFFS
collected premiums were $369.0 million in 2009 or 9 percent of our total
collected premiums.
Specified Disease
Products.
Specified disease collected premiums were $383.3
million during 2009, or 9 percent of our total collected
premiums. 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. Accident products combine insurance for accidental
death with limited benefit disability
9
income
insurance. Hospital indemnity products provide a fixed dollar amount
per day of confinement in a hospital. 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, or accident, and benefits are not
reduced by any other medical insurance payments made to or on behalf of the
insured.
Approximately
75 percent of the total number of our specified disease policies inforce was
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, we
will pay to the policyholder, or in some cases, 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. For some policies, the return of premium rider does not have
any claim offset. The cash value rider is similar to the return of
premium rider, but also provides for payment of a graded portion of the return
of premium benefit if the policy terminates before the return of premium benefit
is earned.
Other
Supplemental Health Products.
Other supplemental health
product collected premiums were $20.4 million during 2009. This
category includes various other health products such as major medical health
insurance, senior hospital indemnity and disability income products which are
sold in small amounts or other products which are no longer actively
marketed.
Annuities
Annuity
premium collections (dollars in millions)
|
2009
|
2008
|
2007
|
||||||||||
|
Equity-indexed
annuity:
|
||||||||||||
|
Bankers
Life
|
$ | 350.1 | $ | 522.8 | $ | 437.4 | ||||||
|
Conseco
Insurance Group
|
76.6 | 123.7 | 344.6 | |||||||||
|
Total
equity-indexed annuity premium collections
|
426.7 | 646.5 | 782.0 | |||||||||
|
Other
fixed annuity:
|
||||||||||||
|
Bankers
Life
|
710.3 | 701.3 | 448.1 | |||||||||
|
Conseco
Insurance Group
|
1.8 | 6.1 | 24.0 | |||||||||
|
Total
fixed annuity premium collections
|
712.1 | 707.4 | 472.1 | |||||||||
|
Total
annuity premium collections
|
$ | 1,138.8 | $ | 1,353.9 | $ | 1,254.1 | ||||||
During
2009, we collected annuity premiums of $1,138.8 million or 28 percent of our
total premiums collected. Annuity products include equity-indexed
annuity, traditional fixed rate annuity and single premium immediate annuity
products sold through both Bankers Life and Conseco Insurance
Group. Annuities offer a tax-deferred means of accumulating savings
for retirement needs, and provide a tax-efficient source of income in the payout
period. Our major source of income from fixed rate annuities is the
spread between the investment income earned on the underlying general account
assets and the interest credited to contractholders’ accounts. For
equity-indexed annuities, our major source of income is the spread between the
investment income earned on the underlying general account assets and the cost
of the index options purchased to provide index-based credits to the
contractholders’ accounts.
Sales of
many of our annuity products have been affected by the financial strength
ratings assigned to our insurance subsidiaries by independent rating
agencies. The current financial strength rating of our primary
insurance subsidiaries from A.M. Best Company (“A.M. Best”) is “B” which was
downgraded from “B+” on March 4, 2009. During 2009, we continued to
reduce the emphasis on the sale of annuities through professional independent
agents, who are more sensitive in the near-term to A.M. Best
ratings. Career agents selling annuity products in the Bankers Life
segment are less sensitive in the near-term to A.M. Best ratings, since these
agents only sell our products.
In 2009,
the change in mix of premium collections between Bankers Life’s equity-indexed
products and fixed annuity products has fluctuated due to volatility in the
financial markets in recent periods. In addition, premium collections
from Bankers Life’s fixed annuity products decreased in the fourth quarter of
2009 as continuing decreases in new money interest rates resulted in a reduction
to the bonus on our bonus interest annuity. A new product, which will
provide more flexibility in setting the bonus interest rate is expected to
launch in early 2010.
10
Premium
collections from Bankers Life’s fixed annuity products increased sharply in the
last half of 2008 due to volatility in the financial markets which made these
products more attractive to customers.
The
following describes the major annuity products:
Equity-Indexed
Annuities.
These products accounted for $426.7 million, or 11
percent, of our total premium collections during 2009. The account
value (or “accumulation value”) of these annuities is credited in an amount that
is based on changes in a particular index during a specified period of
time. Within each contract issued, each equity-indexed annuity
specifies:
|
·
|
The
index to be used;
|
|
·
|
The
time period during which the change in the index is measured and, at the
end of which, the change in the index is applied to the account
value. The time period of the contract ranges from 1 to 4
years.
|
|
·
|
The
method used to measure the change in the
index.
|
|
·
|
The
measured change in the index may be multiplied by a “participation rate”
(percentage of change in the index) before the credit is
applied. Some policies guarantee the initial participation rate
for the life of the contract, and some vary the rate for each
period.
|
|
·
|
The
measured change in the index may also be limited to a “cap” before the
credit is applied. Some policies guarantee the initial cap for
the life of the contract, and some vary the cap for each
period.
|
|
·
|
The
measured change in the index may also be limited to the excess in the
measured change over a “margin” before the credit is
applied. Some policies guarantee the initial margin for the
life of the contract, and some vary the margin for each
period.
|
These
products have guaranteed minimum cash surrender values, regardless of actual
index performance and the resulting indexed-based interest credits
applied.
We
generally buy call options and similar investments on the applicable indices in
an effort to hedge potential increases to policyholder benefits resulting from
increases in the indices to which the product’s return is linked.
Fixed Rate
Annuities.
These products include fixed rate single-premium
deferred annuities (“SPDAs”), flexible premium deferred annuities (“FPDAs”) and
single-premium immediate annuities (“SPIAs”). These products
accounted for $712.1 million, or 17 percent, of our total premium collections
during 2009. Our fixed rate SPDAs and FPDAs 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 rates on annuities written recently range from 2.5 percent to 3.0
percent, and the rates, on all policies inforce range from 2.5 percent to 6.0
percent. The initial crediting rate is largely a function
of:
|
·
|
the
interest rate we can earn on invested assets acquired with the new annuity
fund deposits;
|
|
·
|
the
costs related to marketing and maintaining the annuity products;
and
|
|
·
|
the
rates offered on similar products by our
competitors.
|
For
subsequent adjustments to crediting rates, we take into account current and
prospective yields on investments, annuity surrender assumptions, competitive
industry pricing and the crediting rate history for particular groups of annuity
policies with similar characteristics.
In 2009,
a significant portion of our new annuity sales were “bonus interest”
products. The initial crediting rate on these products specifies a
bonus crediting rate of 1.0 to 3.0 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. As of December 31, 2009, the average
crediting rate, excluding bonuses, on our outstanding traditional
11
annuities
was 3.7 percent.
Withdrawals
from deferred annuities (including equity-indexed annuities) are generally
subject to a surrender charge of 3 percent to 19 percent in the first year,
declining to zero over a 4 to 16 year period, depending on issue age and
product. Surrender charges are set at levels intended to protect us from loss on
early terminations and to reduce the likelihood that policyholders will
terminate their policies during periods of increasing interest
rates. This practice is intended to lengthen the duration of policy
liabilities and to enable us to maintain profitability on such
policies.
Penalty-free
withdrawals from deferred annuities of up to 10 percent of either premiums or
account value are available in most plans after the first year of the annuity’s
term.
Some
deferred annuity products apply a market value adjustment during the surrender
charge period. This adjustment is determined by a formula specified
in the annuity contract, and may increase or decrease the cash surrender value
depending on changes in the amount and direction of market interest rates or
credited interest rates at the time of withdrawal. The resulting cash surrender
values will be at least equal to the guaranteed minimum values.
SPIAs
accounted for $14.5 million, or .4 percent, of our total premiums collected in
2009. 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 issuance. Once the payments begin, the amount, frequency
and length of time over 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 our outstanding SPIAs averaged
7.0 percent at December 31, 2009.
Life
Insurance
Life
insurance premium collections (dollars in millions)
|
2009
|
2008
|
2007
|
||||||||||
|
Interest-sensitive
life products:
|
||||||||||||
|
Bankers
Life
|
$ | 63.2 | $ | 63.7 | $ | 63.4 | ||||||
|
Colonial
Penn
|
.5 | .5 | .5 | |||||||||
|
Conseco
Insurance
Group
|
180.6 | 202.5 | 214.0 | |||||||||
|
Total
interest-sensitive life premium collections
|
244.3 | 266.7 | 277.9 | |||||||||
|
Traditional
life:
|
||||||||||||
|
Bankers
Life
|
165.6 | 145.7 | 136.6 | |||||||||
|
Colonial
Penn
|
186.8 | 173.6 | 113.2 | |||||||||
|
Conseco
Insurance
Group
|
59.7 | 67.3 | 73.3 | |||||||||
|
Total
traditional life premium collections
|
412.1 | 386.6 | 323.1 | |||||||||
|
Total
life insurance premium
collections
|
$ | 656.4 | $ | 653.3 | $ | 601.0 | ||||||
Life
products include traditional and interest-sensitive life insurance
products. These products are currently sold through Bankers Life,
Conseco Insurance Group and Colonial Penn. During 2009, we collected
life insurance premiums of $656.4 million, or 16 percent, of our total collected
premiums. Sales of life products are affected by the financial
strength ratings assigned to our insurance subsidiaries by independent rating
agencies. See “Competition” below.
Interest-Sensitive
Life Products.
These products include universal life and other
interest-sensitive life products that provide whole life insurance with
adjustable rates of return related to current interest rates. They
accounted for $244.3 million, or 5.9 percent, of our total collected premiums in
2009. These products are marketed by professional independent
producers and, to a lesser extent, career agents (including professional
independent producers and career agents specializing in worksite
sales). The principal differences between universal life products and
other interest-sensitive life 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. Universal life products include
12
equity-indexed
universal life products. The account value of these policies is
credited with interest at a guaranteed rate, plus additional interest credits
based on changes in a particular stock index during a specified time
period.
Traditional
Life.
These products accounted for $412.1 million, or 10
percent, of our total collected premiums in 2009. Traditional life
policies, including whole life, graded benefit life, term life and single
premium whole 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 an agreed
period or the policyholder’s 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 combine insurance protection with a
savings component that gradually increases in amount over the life of the
policy. The policyholder may borrow against the savings component
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
life with a guaranteed level premium for a specified period of time — typically
10, 15, 20 or 30 years. In some instances, these products offer an
option to return the premium at the end of the guaranteed period.
Traditional
life products also include graded benefit life insurance
products. Graded benefit life products accounted for $180.5 million,
or 4.4 percent, of our total collected premiums in 2009. 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 $30,000, 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. Our Colonial Penn segment markets graded benefit life policies
under its own brand name using direct response marketing
techniques. New policyholder leads are generated primarily from
television, print advertisements and direct response mailings.
Traditional
life products also include single premium whole life insurance. This
product requires one initial lump sum payment in return for providing life
insurance protection for the insured’s entire lifetime. Single
premium whole life products accounted for $35.3 million, or .9 percent, of our
total collected premiums in 2009.
INVESTMENTS
40|86
Advisors, Inc. (“40|86 Advisors”), a registered investment adviser and
wholly-owned subsidiary of Conseco, Inc., manages the investment portfolios of
our insurance subsidiaries. 40|86 Advisors had approximately $21.9
billion of assets (at fair value) under management at December 31, 2009, of
which $21.2 billion were assets of our subsidiaries and $.7 billion were assets
managed for third parties. Our general account investment strategies
are to:
|
·
|
maintain
a largely investment-grade, diversified fixed-income
portfolio;
|
|
·
|
maximize
the spread between the investment income we earn and the yields we pay on
investment products within acceptable levels of
risk;
|
|
·
|
provide
adequate liquidity;
|
|
·
|
construct
our investment portfolio considering expected liability durations, cash
flows and other requirements; and
|
|
·
|
maximize
total return through active investment
management.
|
During
2009, 2008 and 2007, we recognized net realized investment losses of $60.5
million, $262.4 million and $158.0 million, respectively, excluding any such
amounts included in discontinued operations. During 2009, net
realized investment losses were comprised of: (i) $134.9 million of
net gains from the sales of investments (primarily fixed maturities); and (ii)
$195.4 million of writedowns of investments for other than temporary declines in
fair value recognized through net income ($385.0 million, prior to the $189.6
million of impairment losses recognized through other comprehensive
loss). During 2008, net realized investment losses were comprised
of: (i) $100.1 million of net losses from the sales of investments
(primarily fixed maturities); and (ii) $162.3 million of writedowns of
investments for other than temporary declines in fair value. A
substantial portion of the net investment losses realized on sales of
investments in 2007 were recognized on the sale of securities collateralized by
sub prime residential mortgage loans. We decided to sell these
securities given our evaluation regarding the potential effect of future adverse
developments on the value and recoverable amount of these
securities. For further information on our sub prime holdings, refer
to the caption entitled “Other Investments” in the “Investments” section of
Management’s Discussion and Analysis of Financial Condition and Results
of
13
Operations.
Investment
activities are an integral part of our business because investment income is a
significant component of our revenues. The profitability of many of
our insurance products is significantly affected by spreads between interest
yields on investments and rates credited on insurance
liabilities. Although substantially all credited rates on SPDAs,
FPDAs and interest sensitive life products may be changed annually (subject to
minimum guaranteed rates), changes in crediting rates may not be sufficient to
maintain targeted investment spreads in all economic and market
environments. In addition, competition, minimum guaranteed rates and
other factors, including the impact 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, 2009, the average yield, computed on the cost basis of our actively managed
fixed maturity portfolio, was 5.7 percent, and the average interest rate
credited or accruing to our total insurance liabilities was 4.5
percent.
We manage
the equity-based risk component of our equity-indexed annuity products
by:
|
·
|
purchasing
equity-based options with similar payoff characteristics;
and
|
|
·
|
adjusting
the participation rate to reflect the change in the cost of such options
(such cost varies based on market
conditions).
|
The price
of the options we purchase to manage the equity-based risk component of our
equity-indexed annuities varies based on market conditions. The price
of the options generally increases with increases in the volatility of the
applicable indices, which may either reduce the profitability of the
equity-indexed products or cause us to lower participation
rates. Accordingly, volatility of the indices adds uncertainty
regarding the profitability of our equity-indexed products. We
attempt to mitigate this risk by adjusting the participation rates to reflect
the change in the cost of such options.
We seek
to manage the interest rate risk inherent in our invested assets with the
interest rate characteristics of our insurance liabilities. We
attempt to minimize this exposure by managing the durations and cash flows of
our fixed maturity investments and insurance liabilities. For
example, duration measures the expected change in the fair value of assets and
liabilities for a given change in interest rates. If interest rates
increase by 1 percent, the fair value of a fixed maturity security with a
duration of 5 years is typically expected to decrease in value by approximately
5 percent. When the estimated durations of assets and liabilities are
similar, a change in the value of assets should be largely offset by a change in
the value of liabilities.
We
calculate asset and liability durations using our estimates of future asset and
liability cash flows. At December 31, 2009, the duration of our fixed
maturity investments (as modified to reflect prepayments and potential calls)
was approximately 9.0 years and the duration of our insurance liabilities was
approximately 8.1 years. These durations indicate that while our
investment portfolio had a longer duration and, consequently, was more sensitive
to interest rate fluctuations than our liabilities at that date, this
sensitivity was within corporate guidelines. We generally seek to
minimize the gap between asset and liability durations.
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.”
COMPETITION
The
markets in which we operate are highly competitive. Our current
ratings have had an adverse impact on our ability to compete in certain
markets. Compared to Conseco, many companies in the financial
services industry are larger, have greater capital, technological and marketing
resources, have better access to capital and other sources of liquidity at a
lower cost, offer broader and more diversified product lines and have larger
staffs. 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 to attract and
retain the allegiance of agents, insurance brokers and marketing
companies.
In the
individual health insurance business, companies compete primarily on the bases
of marketing, service and price. Pursuant to federal regulations, the Medicare
supplement products offered by all companies have standardized policy
features. This increases the comparability of such policies and
intensifies competition based on other factors. See
“Insurance
14
Underwriting”
and “Governmental Regulation” for additional information. In addition
to competing with the products of other insurance companies, commercial banks,
thrifts, mutual funds and broker dealers, our 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 the volatility experienced in the financial markets in recent
periods, its impact on the capital position of many competitors, and subsequent
actions by regulators and rating agencies have altered the competitive
environment. In particular, these factors have emphasized financial
strength as a significant differentiator from the perspective of
consumers. The effects of the current market conditions may also lead
to consolidation in the insurance industry. Although we can not
predict the ultimate impact of these conditions, we believe that the strongest
companies will have a competitive advantage as a result of the current
circumstances.
An
important competitive factor for life insurance companies is the ratings they
receive from nationally recognized rating organizations. Agents,
insurance brokers and marketing companies who market our products and
prospective purchasers of our products use the ratings of our insurance
subsidiaries as one factor in determining which insurer’s products to market or
purchase. Ratings have the most impact on our annuity,
interest-sensitive life insurance and long-term care
products. Insurance financial strength ratings are opinions regarding
an insurance company's financial capacity to meet the obligations of its
insurance policies in accordance with their terms. They are not
directed toward the protection of investors, and such ratings are not
recommendations to buy, sell or hold securities.
On
October 16, 2009, A.M. Best affirmed the financial strength rating of “B” of our
primary insurance subsidiaries and the ratings outlook as
negative. Also, A.M. Best removed the ratings from under review with
negative implications. On March 4, 2009, A.M. Best downgraded the
financial strength ratings of our primary insurance subsidiaries to “B” from
“B+” and such ratings had been placed under review with negative
implications. The “B” rating is assigned to companies that have a
fair ability, in A.M. Best’s opinion, to meet their current obligations to
policyholders, but are financially vulnerable to adverse changes in underwriting
and economic conditions. A.M. Best ratings for the industry currently
range from “A++ (Superior)” to “F (In Liquidation)” and some companies are not
rated. An “A++” rating indicates a superior ability to meet ongoing
obligations to policyholders. A.M. Best has sixteen possible
ratings. There are six ratings above our “B” rating and nine ratings
that are below our rating.
On
October 14, 2009, Standard & Poor’s Corporation (“S&P”) affirmed the
financial strength rating of “BB-” of our primary insurance subsidiaries and
revised the outlook to stable from credit watch with negative
implications. On March 2, 2009, S&P had placed the financial
strength ratings of our primary insurance subsidiaries on credit watch with
negative implications. On February 26, 2009, S&P downgraded the
financial strength ratings of our primary insurance subsidiaries to “BB-” from
“BB+” and the outlook remained negative for our primary insurance
subsidiaries. A “stable” designation means that a rating is not
likely to change. S&P financial strength ratings range from “AAA”
to “R” and some companies are not rated. Rating categories from “BB”
to “CCC” are classified as “vulnerable”, and pluses and minuses show the
relative standing within a category. In S&P’s view, an insurer
rated “BB” has marginal financial security characteristics and although positive
attributes exist, adverse business conditions could lead to an insufficient
ability to meet financial commitments. S&P has twenty-one
possible ratings. There are twelve ratings above our “BB-” rating and
eight ratings that are below our rating.
On
October 14, 2009, Moody’s Investor Services, Inc. (“Moody’s”) affirmed the
financial strength rating of “Ba2” of our primary insurance subsidiaries and
revised the outlook to positive from negative. On March 3, 2009,
Moody’s downgraded the financial strength ratings of our primary insurance
subsidiaries to “Ba2” from “Ba1” and the outlook remained negative for our
primary insurance subsidiaries. Moody’s financial strength ratings
range from “Aaa” to “C”. Rating categories from “Aaa” to “Baa” are
classified as “secure” by Moody’s and rating categories from “Ba” to “C” are
considered “vulnerable” and these ratings may be supplemented with numbers “1”,
“2”, or “3” to show relative standing within a category. In Moody’s
view, an insurer rated “Ba2” offers questionable financial security and, often,
the ability of these companies to meet policyholders’ obligations may be very
moderate and thereby not well safeguarded in the future. Moody’s has
twenty-one possible ratings. There are eleven ratings above our “Ba2”
rating and nine ratings that are below our rating.
A.M.
Best, S&P and Moody’s review our ratings from time to time. We
cannot provide any assurance that the ratings of our insurance subsidiaries will
remain at their current levels or predict the impact of any future rating
changes on our business.
15
INSURANCE
UNDERWRITING
Under
regulations promulgated by the National Association of Insurance Commissioners
(“NAIC”) (an association of state regulators and their staffs) 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 our products, the
underwriting procedures are relatively limited, except for policies providing
prescription drug coverage.
Before
issuing long-term care products, we generally apply detailed underwriting
procedures 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 vary
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 have been
significant regulatory changes with respect to underwriting certain types of
health insurance. 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 the products
we market and where we market them.
Our
specified disease policies are individually underwritten using a simplified
issue application. Based on an applicant’s responses on the
application, the underwriter either: (i) approves the policy as
applied for; (ii) approves the policy with reduced benefits; or (iii) rejects
the application.
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
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; (ii) approves the policy with an extra
premium charge because of unfavorable factors; or (iii) 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.
LIABILITIES
FOR INSURANCE PRODUCTS
At
December 31, 2009, the total balance of our liabilities for insurance products
was $24.3 billion. These liabilities are generally payable over an
extended period of time. The profitability of our insurance products
depends on pricing and other factors. Differences between our
expectations when we sold these products and our actual experience could result
in future losses.
Liabilities
for insurance products are calculated using management’s best judgments, based
on our past experience and standard actuarial tables, of mortality, morbidity,
lapse rates, investment experience and expense levels. For all of our
insurance products, we establish an active life reserve, a liability for due and
unpaid claims, claims in the course of settlement and incurred but not reported
claims. In addition, for our supplemental health insurance business,
we establish a reserve for the present value of amounts not yet due on incurred
claims. Many factors can affect these reserves and liabilities, such
as economic and social conditions, inflation, hospital and pharmaceutical costs,
changes in doctrines of legal liability and extra-contractual damage
awards. Therefore, our reserves and liabilities are necessarily based
on extensive estimates, assumptions and historical
experience. Establishing reserves is an uncertain process, and it is
possible that actual claims will materially exceed our reserves and have a
material adverse effect on our results of operations and financial
condition. Our financial results depend significantly upon the extent
to which our actual claims experience is consistent with the assumptions we used
in determining our reserves and pricing our products. If our
assumptions with respect to future claims are incorrect, or our reserves are
insufficient to cover our actual losses and expenses, we would be required to
increase our liabilities, which would negatively affect our operating
results.
16
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. Our reinsured
business is ceded to numerous reinsurers. Based on our periodic
review of their financial statements, insurance industry reports and reports
filed with state insurance departments, we believe the assuming companies are
able to honor all contractual commitments.
As of
December 31, 2009, the policy risk retention limit of our insurance subsidiaries
was generally $.8 million or less. Reinsurance ceded by Conseco represented 26
percent of gross combined life insurance inforce and reinsurance assumed
represented .9 percent of net combined life insurance inforce. Our
principal reinsurers at December 31, 2009 were as follows (dollars in
millions):
|
Ceded
life
|
A.M.
Best
|
|||||||
|
Name of Reinsurer
|
insurance inforce
|
rating
|
||||||
|
Wilton
Reassurance Company (“Wilton Re”)
|
$ | 3,994.8 | A | - | ||||
|
Swiss
Re Life and Health America
Inc.
|
3,335.4 | A | ||||||
|
Security
Life of Denver Insurance
Company
|
2,762.5 | A | ||||||
|
Reassure
America Life Insurance Company
(“REALIC”)
(a)
|
1,360.4 | A | ||||||
|
RGA
Reinsurance
Company
|
906.4 | A | + | |||||
|
Munich
American Reassurance
Company
|
858.4 | A | + | |||||
|
Lincoln
National Life Insurance
Company
|
591.5 | A | + | |||||
|
Scor
Global Life Re Insurance Co of
Texas
|
506.9 | A | - | |||||
|
Hannover
Life Reassurance
Company
|
371.4 | A | ||||||
|
General
Re Life
Corporation
|
367.6 | A | ++ | |||||
|
All
others
(b)
|
1,406.2 | |||||||
| $ | 16,461.5 | |||||||
____________________
|
(a)
|
In
addition to the life insurance business summarized above, REALIC has
assumed certain annuity business from our insurance subsidiaries through a
coinsurance agreement. Such business had total insurance policy
liabilities of $2.0 billion at December 31,
2009.
|
|
(b)
|
No
other single reinsurer assumed greater than 2 percent of the total ceded
business inforce.
|
EMPLOYEES
At
December 31, 2009, we had approximately 3,500 full time employees, including
1,175 employees supporting our Bankers Life segment, 350 employees supporting
our Colonial Penn segment and 1,975 employees supporting our Conseco Insurance
Group segment and corporate segment. None of our employees are
covered by a collective bargaining agreement. We believe that we have
good relations with our employees.
GOVERNMENTAL
REGULATION
Our
insurance businesses are subject to extensive regulation and supervision by the
insurance regulatory agencies of the jurisdictions in which they
operate. This regulation and supervision is primarily for the benefit
and protection of customers, and not for the benefit of investors or
creditors. State laws generally establish supervisory agencies that
have broad regulatory authority, including the power to:
|
·
|
grant
and revoke business licenses;
|
|
·
|
regulate
and supervise sales practices and market
conduct;
|
|
·
|
establish
guaranty associations;
|
17
|
·
|
license
agents;
|
|
·
|
approve
policy forms;
|
|
·
|
approve
premium rates and premium rate increases for some lines of business such
as long-term care and Medicare
supplement;
|
|
·
|
establish
reserve requirements;
|
|
·
|
prescribe
the form and content of required financial statements and
reports;
|
|
·
|
determine
the reasonableness and adequacy of statutory capital and
surplus;
|
|
·
|
perform
financial, market conduct and other
examinations;
|
|
·
|
define
acceptable accounting principles;
and
|
|
·
|
regulate
the types and amounts of permitted
investments.
|
In
addition, the NAIC issues model laws and regulations, many of which have been
adopted by state insurance regulators, relating to:
|
·
|
reserve
requirements;
|
|
·
|
risk-based
capital (“RBC”) standards;
|
|
·
|
codification
of insurance accounting principles;
|
|
·
|
investment
restrictions;
|
|
·
|
restrictions
on an insurance company’s ability to pay dividends;
and
|
|
·
|
product
illustrations.
|
In
addition to the regulations described above, most states have also enacted laws
or regulations regarding the activities of insurance holding company systems,
including acquisitions, the terms of surplus debentures, the terms of
transactions between insurance companies and their affiliates and other related
matters. Various notice and reporting requirements generally apply to
transactions between insurance companies and their affiliates within an
insurance holding company system, depending on the size and nature of the
transactions. These requirements may include prior regulatory
approval or prior notice for certain material
transactions. Currently, the Company and its insurance subsidiaries
are registered as a holding company system pursuant to such laws and regulations
in the domiciliary states of the insurance subsidiaries. In addition,
the Company’s insurance subsidiaries routinely report to other
jurisdictions.
Insurance
regulators may prohibit the payment of dividends or other payments by our
insurance subsidiaries to parent companies if they determine that such payment
could be adverse to our policyholders or contract holders. Otherwise,
the ability of our insurance subsidiaries to pay dividends is subject to state
insurance department regulations and is based on the financial statements of our
insurance subsidiaries prepared in accordance with statutory accounting
practices prescribed or permitted by regulatory authorities, which differ from
generally accepted accounting principles (“GAAP”). These regulations
generally permit dividends to be paid from statutory earned surplus of the
insurance company for any 12-month period in amounts equal to the greater of, or
in a few states, the lesser of:
|
·
|
statutory
net gain from operations or statutory net income for the prior year;
or
|
|
·
|
10
percent of statutory capital and surplus at the end of the preceding
year.
|
18
Any
dividends in excess of these levels require the approval of the director or
commissioner of the applicable state insurance department.
In
accordance with an order from the Florida Office of Insurance Regulation,
Washington National may not distribute funds to any affiliate or shareholder
without prior notice to the Florida Office of Insurance
Regulation. In addition, the RBC and other capital requirements
described below can also limit, in certain circumstances, the ability of our
insurance subsidiaries to pay dividends.
Our
insurance subsidiaries that have long-term care business have made insurance
regulatory filings seeking actuarially justified rate increases on our long-term
care policies. Most of our long-term care business is guaranteed
renewable, and, if necessary rate increases are not approved, we may be required
to write off all or a portion of the insurance acquisition costs and establish a
premium deficiency reserve. If we are unable to raise our premium
rates because we fail to obtain approval for actuarially justified rate
increases in one or more states, our financial condition and results of
operations could be adversely affected.
During
2006, the Florida legislature enacted a statute, known as House Bill
947, intended to provide new protections to long-term care insurance
policyholders. Among other requirements, this statute requires: (i)
claim experience of affiliated long-term care insurers to be pooled in
determining justification for rate increases for Florida policyholders; and
(ii) insurers with closed blocks of long-term care insurance to not raise
rates above the comparable new business premium rates offered by affiliated
insurers. The manner in which the requirements of this statute are
applied to our long-term care policies in Florida (including policies subject to
the order from the Florida Office of Insurance Regulation as described in
“Management’s Discussion and Analysis of Consolidated Financial Condition and
Results of Operations”) may affect our ability to achieve our anticipated rate
increases on this business.
Most
states have also enacted legislation or adopted administrative regulations that
affect the acquisition (or sale) of control of insurance
companies. The nature and extent of such legislation and regulations
vary from state to state. Generally, these regulations require an
acquirer of control to file detailed information and the plan of acquisition,
and to obtain administrative approval prior to the acquisition of
control. “Control” is generally defined as the direct or indirect
power to direct or cause the direction of the management and policies of a
person and is rebuttably presumed to exist if a person or group of affiliated
persons directly or indirectly owns or controls 10 percent or more of the voting
securities of another person.
Using
statutory statements filed with state regulators annually, the NAIC calculates
certain 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. These inquiries have not led
to any restrictions affecting our operations.
The
NAIC’s RBC requirements provide a tool for insurance regulators to determine the
levels of statutory capital and surplus an insurer must maintain in relation to
its insurance and investment risks and the need for possible regulatory
attention. The RBC requirements provide four levels of regulatory
attention, varying with the ratio of the insurance company’s total adjusted
capital (defined as the total of its statutory capital and surplus, asset
valuation reserve and certain other adjustments) to its RBC (as measured on
December 31 of each year), as follows:
|
·
|
if
a company’s total adjusted capital is less than 100 percent but greater
than or equal to 75 percent of its 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 authority will
perform a special examination of the company and issue an order specifying
the corrective actions that must be
taken;
|
|
·
|
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;
and
|
|
·
|
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.
|
19
In
addition, the RBC requirements provide for a trend test if a company’s total
adjusted capital is between 100 percent and 125 percent of its RBC at the end of
the year. The trend test calculates the greater of the decrease in
the margin of total adjusted capital over RBC:
|
·
|
between
the current year and the prior year;
and
|
|
·
|
for
the average of the last 3 years.
|
It
assumes that such decrease could occur again in the coming year. Any
company whose trended total adjusted capital is less than 95 percent of its RBC
would trigger a requirement to submit a comprehensive plan as described above
for the Company Action Level.
In
January 2009, the NAIC considered, but declined, a number of reserve and capital
relief requests made by the American Council of Life Insurers, acting on behalf
of its member companies. These requests, if adopted, would have
generally resulted in lower statutory reserve and capital requirements,
effective December 31, 2008, for life insurance companies. However,
notwithstanding the NAIC’s action on these requests, insurance companies have
the right to approach the insurance regulator in their respective state of
domicile and request relief. Insurance subsidiaries of the Company
requested and were granted certain permitted practices, with a beneficial impact
on statutory capital as of December 31, 2008.
The 2009
statutory annual statements filed with the state insurance regulators of each of
our insurance subsidiaries reflected total adjusted capital in excess of the
levels subjecting the subsidiaries to any regulatory action. No
assurances can be given that we will make future contributions or otherwise make
capital available to our insurance subsidiaries.
In
addition to the RBC requirements, certain states have established minimum
capital requirements for insurance companies licensed to do business in their
state. These additional requirements generally have not had a
significant impact on the Company’s insurance subsidiaries, but the capital
requirements in Florida have caused Conseco Health to maintain a higher level of
capital and surplus than it would otherwise maintain and have thus limited its
ability to pay dividends. Refer to the note entitled “Statutory
Information (Based on Non-GAAP Measures)” in our notes to consolidated financial
statements for more information on our RBC ratios.
In
addition, although we are under no obligation to do so, we may elect to
contribute additional capital to strengthen the surplus of certain insurance
subsidiaries. Any election regarding the contribution of additional
capital to our insurance subsidiaries could affect the ability of our insurance
subsidiaries to pay dividends to the holding company. The ability of
our insurance subsidiaries to pay dividends is also impacted by various criteria
established by rating agencies to maintain or receive higher ratings and by the
capital levels that we target for our insurance subsidiaries.
The NAIC
has adopted model long-term care policy language providing nonforfeiture
benefits and has proposed a rate stabilization standard for long-term care
policies. Various bills are introduced from time to time in the U.S.
Congress which propose the implementation of certain minimum consumer protection
standards in all long-term care policies, including guaranteed renewability,
protection against inflation and limitations on waiting periods for pre-existing
conditions. Federal legislation permits premiums paid for qualified
long-term care insurance to be tax-deductible medical expenses and for benefits
received on such policies to be excluded from taxable income.
Our
insurance subsidiaries are required, under guaranty fund laws of most states, to
pay assessments up to prescribed limits to fund policyholder losses or
liabilities of insolvent insurance companies. Assessments can be
partially recovered through a reduction in future premium taxes in some
states.
Most
states mandate minimum benefit standards and benefit ratios for accident and
health insurance policies. We are generally required to maintain,
with respect to our individual long-term care policies, minimum anticipated
benefit 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 benefit 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 benefit ratios for both long-term
care and Medicare supplement insurance. These calculations are
prepared utilizing statutory lapse and interest rate assumptions. In
the event that we fail to maintain minimum mandated benefit 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 benefit
ratios.
20
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, privacy laws and federal
taxation, do affect the insurance business. Legislation has been
introduced from time to time in Congress that could result in the federal
government assuming some direct role in the regulation of
insurance. In view of recent events involving certain financial
institutions, it is possible that the federal government will heighten its
oversight of insurers, possibly through a federal system of insurance
regulation.
Numerous
proposals to reform the current health care system (including Medicare) have
been introduced in Congress and in various 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. For example, Federal comprehensive major medical or
long-term care programs, if proposed and implemented, could partially or fully
replace some of Conseco’s current products. Recent federal and state
legislation and legislative proposals relating to healthcare reform contain
features that could severely limit or eliminate our ability to vary our pricing
terms or apply medical underwriting standards, which could have the effect of
increasing our benefit ratios and adversely affecting our financial
results. Also, Medicare reform and legislation concerning
prescription drugs could affect our ability to price or sell our
products.
The
United States Department of Health and Human Services has issued regulations
under the Health Insurance Portability and Accountability Act relating to
standardized electronic transaction formats, code sets and the privacy of member
health information. These regulations, and any corresponding state
legislation, affect our administration of health insurance.
A number
of states have passed or are considering legislation that limits 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. Congress and various state legislators have
from time to time proposed changes to the health care system that could affect
the relationship between health insurers and their customers, including external
review. We cannot predict with certainty the effect of any
legislative proposals on our insurance businesses and operation.
The asset
management activities of 40|86 Advisors are subject to various federal and state
securities laws and regulations. The SEC and certain state securities
commissions are the principal regulators of our asset management
operations. In addition, Conseco has a subsidiary that is registered
as a broker/dealer, which is regulated by the Financial Industry Regulatory
Authority and by state securities commissioners.
FEDERAL
INCOME TAXATION
Our
annuity and life insurance products generally provide policyholders with an
income tax advantage, as compared to other savings investments such as
certificates of deposit and bonds, because taxes on the increase in value of the
products are deferred until received by policyholders. With other
savings investments, the increase in value is generally 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.
In recent
years, Congress enacted legislation to lower marginal tax rates, reduce the
federal estate tax gradually over a ten-year period, with total elimination of
the federal estate tax in 2010, and increase contributions that may be made to
individual retirement accounts and 401(k) accounts. While these tax
law changes will sunset at the beginning of 2011 absent future congressional
action, they could in the interim diminish the appeal of our annuity and life
insurance products. Additionally, Congress has considered, from time
to time, other possible changes to the U.S. tax laws, including elimination of
the tax deferral on the accretion of value of certain annuities and life
insurance products. It is possible that further tax legislation will
be enacted which would contain provisions with possible adverse effects on our
annuity and life insurance products.
21
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 earnings and surplus and, accordingly,
decreases the amount of cash dividends that may be paid by the life insurance
subsidiaries.
Our
income tax expense includes deferred income taxes arising from temporary
differences between the financial reporting and tax bases of assets and
liabilities, capital loss carryforwards and net operating loss carryforwards
(“NOLs”). In evaluating our deferred income tax assets, we consider
whether it is more likely than not that the deferred income tax assets will be
realized. The ultimate realization of our deferred income tax assets
depends upon generating future taxable income during the periods in which our
temporary differences become deductible and before our NOLs
expire. In addition, the use of our NOLs is dependent, in part, on
whether the Internal Revenue Service (“IRS”) ultimately agrees with the tax
position we plan to take in our current and future tax
returns. Accordingly, with respect to our deferred tax assets, we
assess the need for a valuation allowance on an ongoing basis.
Based
upon information existing at the time of our emergence from bankruptcy, we
established a valuation allowance equal to our entire balance of net deferred
income tax assets because, at that time, the realization of such deferred tax
assets in future periods was uncertain. As of December 31, 2009, 2008
and 2007, we determined that a full valuation allowance was no longer
necessary. However, as further discussed in the note to the
consolidated financial statements entitled “Income Taxes”, we continue to
believe that it is necessary to have a valuation allowance on a portion of our
deferred tax asset. This determination was made by evaluating each
component of the deferred tax assets and assessing the effects of limitations or
issues on the value of such component to be fully recognized in the
future.
Conseco
and its businesses are subject to a number of risks including general business
and financial risk factors. Any or all of such factors could have a
material adverse effect on the business, financial condition or results of
operations of Conseco. In addition, please refer to the “Cautionary
Statement Regarding Forward-Looking Statements” included in “Item 7 –
Management’s Discussion and Analysis of Consolidated Financial Condition and
Results of Operations”.
We
have substantial indebtedness that will require a significant portion of the
cash available to CNO, restricting our ability to take advantage of business,
strategic or financing opportunities.
As of
December 31, 2009, we had aggregate principal amount of indebtedness of $1,045.1
million, consisting of the following (dollars in millions):
|
Second
Amended and Restated Credit Agreement dated as of
October
10, 2006 among Conseco, Bank of America, N.A. as Agent, J.P. Morgan Chase
Bank, N.A., as Syndication Agent and other parties (“Senior Credit
Agreement”)
|
$ | 652.1 | ||
|
3.5%
Debentures
|
116.5 | |||
|
7.0%
Convertible Senior Debentures due 2016 (“7.0% Debentures”)
|
176.5 | |||
|
Senior
Note
|
100.0 | |||
| $ | 1,045.1 |
CNO’s
indebtedness will require over $218 million in cash to service in 2010 (assuming
the holders of our 3.5% Debentures require the Company to repurchase their 3.5%
Debentures on September 30, 2010 pursuant to their put right). See
“Liquidity of the Holding Companies” section of Management’s Discussion and
Analysis of Financial Condition and Results of Operations for additional
information regarding the sources and uses of cash by CNO.
22
The
principal payments on our direct corporate obligations (including payments
required under the Senior Credit Agreement, the Senior Note, the 3.5% Debentures
and the 7.0% Debentures) are as follows (dollars in millions):
|
2010
|
$ | 141.5 |
(a)
|
||
|
2011
|
60.0 | ||||
|
2012
|
65.0 | ||||
|
2013
|
602.1 | ||||
|
2016
|
176.5 | ||||
| $ | 1,045.1 |
_____________
|
|
(a)
|
Includes
$116.5 million of the 3.5% Debentures. The holders of our 3.5%
Debentures have the right to require the Company to repurchase their 3.5%
Debentures for cash on September 30, 2010. This amount assumes
that all remaining holders of our 3.5% Debentures exercise that
right. In February 2010, as further discussed in the note to
the consolidated financial statements entitled “Subsequent Events”, we
repurchased $64 million of the 3.5% Debentures and issued $64 million of
the 7.0% Debentures.
|
The
payment of principal and interest on our outstanding indebtedness will require a
substantial portion of CNO’s available cash each year, which, as a holding
company, is limited, as further described in the risk factor entitled “We are a
holding company and our liquidity and ability to meet our obligations may be
constrained by the ability of our insurance subsidiaries to distribute cash to
us”
below. Our
debt obligations may restrict our ability to take advantage of business,
strategic or financing opportunities.
We expect to
fund our obligation to repurchase the 3.5% Debentures that we may be required to
repurchase on September 30, 2010 primarily by the issuance of additional 7.0%
Debentures pursuant to the purchase agreement described in the note to the
consolidated financial statements entitled “Notes Payable – Direct Corporate
Obligations.” The purchase agreement for the sale of the 7.0%
Debentures may be terminated by Morgan Stanley & Co. Incorporated (“Morgan
Stanley”), as the initial purchaser, if with respect to any closing date for the
offering of the 7.0% Debentures, any Form 10-Q or 10-K that we are required
to file with the SEC on or before October 5, 2010 (or such earlier closing
date by which all $293.0 million aggregate principal amount of debentures
have been issued and delivered) is not filed on or before the date we are
required to file such Form 10-Q or Form 10-K, as the case may be, with
the SEC; our financial statements included in such Form 10-Q have not been
subjected to a completed SAS 100 review or our independent registered public
accountants have not issued an audit report on our financial statements included
in such Form 10-K, as the case may be; and we fail to deliver an officer’s
certificate to the initial purchaser by the business day following the deadline
for filing such Form 10-Q or Form 10-K, as the case may be, stating
that our failure to file such Form 10-Q or Form 10-K, as the case may
be, within the SEC’s deadlines pertains to something other than in connection
with the conclusion of our management or our independent registered public
accountants that there is a substantial doubt about our ability to continue as a
going concern;
provided
, that, if we fail to
file such Form 10-Q or Form 10-K, as the case may be, and fail to
deliver such officer’s certificate, the initial purchaser may, upon prior
written notice, elect to terminate the purchase agreement, and thus each forward
purchase agreement, prior to such subsequent closing date.
As
disclosed in the note to the consolidated financial statements entitled “Notes
Payable – Direct Corporate Obligations” and in the following risk factor, our
Senior Credit Agreement contains various restrictive covenants and required
financial ratios that we must meet or maintain and that limit our operating
flexibility. If we default under any of these covenants, the lenders
could declare all outstanding borrowings, accrued interest and fees to be
immediately due and payable. In such event, the holders of our 3.5%
Debentures, our 7.0% Debentures and the Senior Note could elect to take similar
action with respect to those debts. If that were to occur, we would
not have sufficient liquidity to repay our indebtedness. Absent
sufficient liquidity to repay our indebtedness, our management may conclude that
there is substantial doubt regarding our ability to continue as a going
concern.
If we
fail to pay interest or principal on the 3.5% Debentures or the 7.0% Debentures,
we will be in default under the applicable indenture governing such
debentures. A default under either indenture could also lead to a
default under agreements governing our existing and future indebtedness,
including under our Senior Credit Agreement. If the repayment of the
related indebtedness were to be accelerated after any applicable notice or grace
periods, we likely would not have sufficient funds to repay our
indebtedness.
23
Our Senior Credit
Agreement contains various restrictive covenants and required
financial ratios
that limit our operating flexibility. The violation of one or
more loan
covenant requirements would entitle our lenders to
declare all
outstanding amounts under the Senior Credit Agreement to be due and
payable.
As of
December 31, 2009, we had $652.1 million principal amount of debt
outstanding under our Senior Credit Agreement. Pursuant to our Senior
Credit Agreement, we agreed to a number of covenants and other provisions that
restrict our ability to borrow money and pursue some operating activities
without the prior consent of the lenders. We also agreed to meet or
maintain various financial ratios and balances. Our ability to meet
these financial tests and maintain ratings may be affected by events beyond our
control. There are several conditions or circumstances that could
lead to an event of default under our Senior Credit Agreement, as described
below. In the event of an event of default, management would likely
conclude there is substantial doubt regarding our ability to continue as a going
concern, which would have material adverse consequences to our financial
condition and results of operations, as further described below.
The
Senior Credit Agreement prohibits or restricts, among other things:
|
·
|
the
payment of cash dividends on our common
stock;
|
|
·
|
the
repurchase of our common stock;
|
|
·
|
the
issuance of additional debt or capital
stock;
|
|
·
|
liens;
|
|
·
|
the
transfer or sale of assets unless the net proceeds are reinvested in our
insurance operations or used to reduce the amount due under the Senior
Credit Agreement;
|
|
·
|
certain
affiliate transactions;
|
|
·
|
certain
investment activities;
|
|
·
|
change
in business; and
|
|
·
|
prepayment
of indebtedness (other than the Senior Credit
Agreement).
|
The
Senior Credit Agreement also requires that our annual audited consolidated
financial statements be accompanied by an opinion from a nationally-recognized
independent public accounting firm stating that such audited consolidated
financial statements present fairly, in all material respects, our financial
position and results of operations in conformity with GAAP for the periods
indicated. For us to remain in compliance with the Senior Credit
Agreement, such opinion cannot include an explanatory paragraph regarding our
ability to continue as a going concern or similar
qualification. Although we were in compliance with the provisions of
the Senior Credit Agreement as of December 31, 2009, these provisions represent
significant restrictions on the manner in which we may operate our
business. If we default under any of these provisions, the lenders
could declare all outstanding borrowings, accrued interest and fees to be due
and payable. If that were to occur, we would likely not have
sufficient liquidity to repay amounts due under the Senior Credit Agreement in
full or any of our other debts.
Pursuant
to the Senior Credit Agreement, as long as the debt to total capitalization
ratio (as defined in the Senior Credit Agreement) is greater than 20% or certain
insurance subsidiaries (as defined in the Senior Credit Agreement) have
financial strength ratings of less than A- from A.M. Best, we are required
to make mandatory prepayments with all or a portion of the proceeds from the
following transactions or events: (i) the issuance of certain indebtedness;
(ii) certain equity issuances; and (iii) certain asset sales or
casualty events. Pursuant to the terms of the Senior Credit
Agreement, we made payments of: (i) $36.8 million (equal to half
of the net proceeds from the issuance and sale of shares of our common stock and
warrants to Paulson & Co. Inc. (“Paulson”)); and (ii) $161.4 million (equal
to $150 million plus half of the net proceeds in excess of $200 million from the
public offering of 49.5 million shares of our common stock) in
2009.
24
The
following chart summarizes: (i) the most significant financial ratios
and balances we must maintain pursuant to our Senior Credit Agreement; (ii) the
current ratios and balances as of December 31, 2009; and (iii) the margins for
adverse developments before such ratio or balance requirement is not met
(dollars in millions):
|
Balance
or
|
||||||
|
ratio
as of
|
Margin
for adverse
|
|||||
|
Covenant
under the
|
December 31,
|
development
from
|
||||
|
Senior Credit Agreement
|
2009
|
December 31, 2009 levels
|
||||
|
Aggregate
risk-based capital ratio
|
Greater
than or equal to 200% from March 31, 2009 through December 31, 2010;
greater than or equal to 225% from March 31, 2011 through December 31,
2011; and thereafter, greater than 250%.
|
309% |
Reduction
to total adjusted capital (defined as combined statutory capital and
surplus plus the asset valuation reserve and 50 percent of the balance of
the provision of policyholder dividends) of approximately $507 million, or
an increase to required risk-based capital of approximately $253
million.
|
|||
|
Combined
statutory capital and surplus
|
Greater
than $1,100 from March 31, 2009 through December 31, 2010; greater than
$1,200 million from March 31, 2011 through December 31, 2011; and
thereafter, $1,300 million.
|
$1,439
million
|
Reduction
to combined statutory capital and surplus of approximately $339
million.
|
|||
|
Debt
to total capitalization ratio
|
Not
more than 32.5% from March 31, 2009 through December 31, 2009 and
thereafter, not more than 30%.
|
21.6% |
Reduction
to shareholders’ equity of approximately $1,620 million or additional debt
of $780 million.
|
|||
|
Interest
coverage ratio
|
Greater
than or equal to 1.50 to 1 for rolling four quarters from March 31, 2009
through December 31, 2010; greater than or equal to 1.75 to 1 for rolling
four quarters from March 31, 2011 through December 31, 2011; and
thereafter, 2.00 to 1.
|
2.38
to 1
|
Reduction
in cash flows to the holding company of approximately $58
million.
|
|||
These
covenants place significant restrictions on the manner in which we may operate
our business and our ability to meet these financial covenants may be affected
by events beyond our control. If we default under any of these
covenants, the lenders could declare all outstanding borrowings, accrued
interest and fees to be immediately due and payable, which would have material
adverse consequences to us. If the lenders under our Senior Credit
Agreement would elect to accelerate the amounts due, the holders of our 3.5%
Debentures, 7.0% Debentures and Senior Note could elect to take similar action
with respect to those debts. If that were to occur, we would not have
sufficient liquidity to repay our indebtedness.
We are
required to assess our ability to continue as a going concern as part of our
preparation of financial statements at each quarter-end. The
assessment includes, among other things, consideration of our plans to address
our liquidity and capital needs during the following 12 months and our
ability to comply with the future loan covenant and financial ratio requirements
under our Senior Credit Agreement, including the covenant regarding minimum
risk-based capital ratios. The calculation of risk-based capital
ratios is based on rules established by the NAIC. Recently the NAIC
has modified the calculation of our required capital for commercial mortgages
based on the Mortgage Experience Adjustment Factor
25
(“MEAF”)
and the calculation of risked-based capital requirements for investments in
residential mortgage-backed securities (“RMBS”). The NAIC could
further modify these or other RBC requirements in the future. Any
such modifications would result from a regulatory process over which we have no
control and which is not required to take our specific circumstances into
account and could negatively impact our ability to remain in compliance with our
Senior Credit Agreement and, therefore, impact management’s assessment of our
ability to continue as a going concern in conjunction with the completion of our
future financial statements, as further described below. Any
modifications to the RBC requirements may be effective for a limited period of
time which could limit our ability to consider them when assessing our ability
to continue as a going concern. Our RBC ratio may suffer future
deterioration as a result of future realized losses on investments (including
other-than-temporary impairments), decreases in the ratings of certain of our
investments, net statutory losses from the operations of our insurance
subsidiaries, changes in statutory regulations with respect to RBC requirements
or the valuation of assets or liabilities, or for other
reasons.
Accordingly,
in connection with the preparation of our financial statements for future
periods, we, or our independent registered public accountants, may conclude that
there is not a sufficient likelihood that we will be able to comply with the RBC
ratio, statutory capital and surplus and other covenants in our Senior Credit
Agreement. In such event, we may be required to conclude that there
is substantial doubt regarding our ability to continue as a going concern in our
financial statements for subsequent periods. If we were to conclude
there was substantial doubt regarding our ability to continue as a going concern
in our financial statements for subsequent periods, we may be required to
increase the valuation allowance for deferred tax assets, which could result in
the violation of one or more loan covenant requirements under the Senior Credit
Agreement.
If in
future periods we are not able to demonstrate that we will be in compliance with
the financial covenant requirements in the Senior Credit Agreement for at least
12 months following the date of the financial statements, management would
conclude there is substantial doubt about our ability to continue as a going
concern and the audit opinion that we would receive from our independent
registered public accounting firm would include an explanatory paragraph
regarding our ability to continue as a going concern. Such an opinion
would be in breach of the covenants in the Senior Credit
Agreement. If the circumstances leading to the substantial doubt were
not cured prior to the issuance of the audit opinion, or we were unable to
obtain a waiver on the going concern opinion requirement within 30 days
after notice from the lenders, it would be an event of default entitling the
lenders to declare all outstanding borrowings, accrued interest and fees to be
due and payable. If an event of default were to occur, it is highly
probable that we would not have sufficient liquidity to repay our bank
indebtedness in full or any of our other indebtedness which could also be
accelerated as a result of the default.
The
obligations under our Senior Credit Agreement are guaranteed by our current and
future domestic subsidiaries, other than our insurance subsidiaries and certain
immaterial subsidiaries. CDOC’s guarantee under our Senior Credit
Agreement is secured by a lien on substantially all of the assets of the
guarantors, including the stock of Conseco Life Insurance Company of Texas
(“Conseco Life of Texas”) (which is the parent of Bankers Life and Casualty
Company, Bankers Conseco Life Insurance Company (“Bankers Conseco Life”) and
Colonial Penn), Washington National (which is the parent of Conseco Insurance
Company and Conseco Life) and Conseco Health. If we fail to make the
required payments, do not meet the financial covenants or otherwise default on
the terms of our Senior Credit Agreement, the stock of Conseco Life of Texas,
Washington National and Conseco Health could be transferred to the lenders under
such agreement. Any such transfer would have a material adverse
effect on our business, financial condition and results of operations, and would
have a significant adverse effect on the market value of our common
stock.
Our current
credit ratings may
adversely affect
our ability to access capital and the cost of such capital, which
could have a
material adverse effect on our financial condition and results of
operations.
On
December 17, 2009, S&P upgraded the rating on our senior secured debt, to
“B-” from “CCC”. In S&P’s view, an obligation rated “B” is more
vulnerable to nonpayment than obligations rated “BB”, but the obligor currently
has the capacity to meet its financial commitment on the
obligation. Adverse business, financial, or economic conditions will
likely impair the obligor’s capacity or willingness to meet its financial
commitment on the obligation. A “negative” designation means that a
rating may be lowered. S&P has a total of 22 separate categories
rating senior debt, ranging from “AAA (Extremely Strong)” to “D (Payment
Default).” There are fifteen ratings above our “B-” rating and six ratings that
are below our rating. Moody’s has assigned a “Caa1” rating on our
senior secured debt with a positive outlook. In Moody’s view, an
obligation rated “Caa1” is in poor standing and there may be present elements of
danger with respect to principal or interest. Moody’s has a total of
21 separate categories in which to rate senior debt, ranging from “Aaa
(Exceptional)” to “C (Lowest Rated).” There are 16 ratings above our “Caa1”
rating and four ratings that are below our rating. If we were to
require additional capital, either to refinance our existing indebtedness or for
any other reason, our current senior debt ratings, as well as economic
conditions in the credit markets generally, could severely restrict our access
to and the cost of such capital.
26
We are a holding
company and our liquidity and ability to meet our obligations may be
constrained
by the ability of our insurance subsidiaries to distribute cash to
us.
We and
CDOC, a wholly owned subsidiary of ours and a guarantor under our Senior Credit
Agreement, are holding companies with no business operations of our
own. We and CDOC depend on our operating subsidiaries for cash to
make principal and interest payments on debt and to pay administrative expenses
and income taxes. We and CDOC receive cash from insurance
subsidiaries, consisting of dividends and distributions, principal and interest
payments on surplus debentures and tax-sharing payments, as well as cash from
our non-insurance subsidiaries consisting of dividends, distributions, loans and
advances. A deterioration in the financial condition, earnings or
cash flow of our significant subsidiaries for any reason could hinder the
ability of such subsidiaries to pay cash dividends or other disbursements to us
and/or CDOC, which would limit our ability to meet our debt service requirements
and satisfy other financial obligations. In addition, we may elect to
contribute additional capital to certain insurance subsidiaries to strengthen
their surplus for covenant compliance or regulatory purposes or to provide the
capital necessary for growth, in which case it is less likely that our insurance
subsidiaries would pay dividends to us. Accordingly, this could limit
our ability to meet debt service requirements and satisfy other holding company
financial obligations.
We
receive dividends and other payments from CDOC and from certain non-insurance
subsidiaries. CDOC receives dividends and surplus debenture interest
payments from our insurance subsidiaries and payments from certain of our
non-insurance subsidiaries. Payments from our non-insurance
subsidiaries to us or CDOC, and payments from CDOC to us, do not require
approval by any regulatory authority or other third party. However,
the payment of dividends or surplus debenture interest by our insurance
subsidiaries to CDOC is subject to state insurance department regulations and
may be prohibited by insurance regulators if they determine that such dividends
or other payments could be adverse to our policyholders or contract
holders. Insurance regulations generally permit dividends to be paid
from statutory earned surplus of the insurance company without regulatory
approval for any 12-month period in amounts equal to the greater of (or in a few
states, the lesser of):
|
·
|
statutory
net gain from operations or statutory net income for the prior
year, or
|
|
·
|
10%
of statutory capital and surplus as of the end of the preceding
year.
|
This type
of dividend is referred to as “ordinary dividends.” Any dividends in excess of
these levels require the approval of the director or commissioner of the
applicable state insurance department. This type of dividend is
referred to as “extraordinary dividends.” During 2009, our insurance
subsidiaries paid extraordinary dividends of $35.0 million to
CDOC. Each of the immediate insurance subsidiaries of CDOC had
negative earned surplus at December 31, 2009. Accordingly, any
dividend payments from the insurance subsidiaries to the holding company will
require the prior approval of the director or commissioner of the applicable
state insurance department.
During
2010, we are expecting our insurance subsidiaries to pay approximately
$105 million of extraordinary dividends to CDOC (subject to approval by the
applicable state insurance department). In addition, we are expecting
Conseco Life of Texas to pay interest on surplus debentures of $49 million
in 2010, which will not require additional approval
provided
the RBC ratio of
Conseco Life of Texas exceeds 100 percent (but will require prior written
notice to the Texas state insurance department).
Furthermore,
RBC requirements and other capital requirements can also limit, in certain
circumstances, the ability of our insurance subsidiaries to pay dividends to
CDOC. For example, certain states have established minimum capital
requirements for insurance companies licensed to do business in their
state. These additional requirements generally have not had a
significant impact on our insurance subsidiaries, but the capital requirements
in Florida have caused Conseco Health to maintain a higher level of capital and
surplus than it would otherwise maintain and have thus limited its ability to
pay dividends.
In
addition, although we are under no obligation to do so, we may elect to
contribute additional capital to strengthen the surplus of certain insurance
subsidiaries for covenant compliance or regulatory purposes or to provide the
capital necessary for growth. Any election regarding the contribution
of additional capital to our insurance subsidiaries could affect the ability of
our top tier insurance subsidiaries to pay dividends. The ability of
our insurance subsidiaries to pay dividends is also impacted by various criteria
established by rating agencies to maintain or receive higher ratings and by the
capital levels that we target for our insurance subsidiaries, as well as RBC and
statutory capital compliance requirements under our Senior Credit
Agreement.
27
In
addition, our insurance subsidiary Washington National may not distribute funds
to any affiliate or shareholder, without prior notice to the Florida Office of
Insurance Regulation, in accordance with an order from the Florida Office of
Insurance Regulation.
The
following table sets forth the aggregate amount of dividends and other
distributions that our insurance subsidiaries paid to us in each of the last
three fiscal years:
|
Years
ended
December 31,
|
||||||||||||
|
|
2009
|
2008
|
2007
|
|||||||||
|
(dollars
in millions)
|
||||||||||||
|
Dividends
|
$ | 35.0 | $ | 20.0 | $ | 50.0 | ||||||
|
Surplus
debenture interest
|
59.3 | 56.4 | 69.9 | |||||||||
|
Fees
for services provided pursuant to service agreements
|
77.8 | 83.2 | 92.9 | |||||||||
|
Tax
sharing payments
|
3.4 | 1.1 | 1.9 | |||||||||
|
Total
paid
|
$ | 175.5 | $ | 160.7 | $ | 214.7 | ||||||
There
are risks to our business associated with the current economic
environment.
Over the
past two years, the U.S. economy has experienced unprecedented credit and
liquidity issues and entered into a recession. Following several
years of rapid credit expansion, a contraction in mortgage lending coupled with
substantial declines in home prices, rising mortgage defaults and increasing
home foreclosures, resulted in significant write-downs of asset values by
financial institutions, including government-sponsored entities and major
commercial and investment banks. These write-downs, initially of
mortgage-backed securities but spreading to many sectors of the related credit
markets, and to related credit default swaps and other derivative securities,
have caused many financial institutions to seek additional capital, to merge
with larger and stronger institutions, to be subsidized by the
U.S. government and, in some cases, to fail. These factors,
combined with declining business and consumer confidence and increased
unemployment, have precipitated an economic slowdown and the potential of a
prolonged recession.
Even
under more favorable market conditions, general factors such as the availability
of credit, consumer spending, business investment, capital market conditions and
inflation affect our business. For example, in an economic downturn,
higher unemployment, lower family income, lower corporate earnings, lower
business investment and lower consumer spending may depress the demand for life
insurance, annuities and other insurance products. In addition, this
type of economic environment may result in higher lapses or surrenders of
policies. Accordingly, the risks we face related to general economic
and business conditions are more pronounced given the severity and magnitude of
the recent adverse economic and market conditions experienced.
More
specifically, our business is exposed to the performance of the debt and equity
markets. Adverse market conditions can affect the liquidity and value
of our investments. The manner in which debt and equity market
performance and changes in interest rates have affected, and will continue to
affect, our business, financial condition, growth and profitability include, but
are not limited to, the following:
|
·
|
The
value of our investment portfolio has been materially affected in recent
periods by changes in market conditions which have resulted in, and may
continue to result in, substantial realized and/or unrealized
losses. For example, in 2008 the value of our investments
decreased by $2.5 billion due to net unrealized losses on
investments. A widening of credit spreads, such as the market
has experienced in 2008, increases the net unrealized loss position of our
investment portfolio and may ultimately result in increased realized
losses. The value of our investment portfolio can also be
affected by illiquidity and by changes in assumptions or inputs we use in
estimating fair value. Further, certain types of securities in
our investment portfolio, such as structured securities supported by
residential and commercial mortgages, have been disproportionately
affected. Although the value of our investments increased on an
aggregate basis in 2009, there can be no assurance that higher realized
and/or unrealized losses will not occur in the future. Future
adverse capital market conditions could result in additional realized
and/or unrealized losses.
|
|
·
|
Changes
in interest rates also affect our investment portfolio. In
periods of increasing interest rates, life insurance policy loans,
surrenders and withdrawals could increase as policyholders seek
investments with higher returns. This could require us to sell
invested assets at a time when their prices are depressed by the increase
in interest rates,
|
28
which
could cause us to realize investment losses. Conversely, during
periods of declining interest rates, we could experience increased premium
payments on products with flexible premium features, repayment of policy loans
and increased percentages of policies remaining in-force. We would
obtain lower returns on investments made with these cash flows. In
addition, borrowers may prepay or redeem bonds in our investment portfolio so
that we might have to reinvest those proceeds in lower yielding
investments. As a consequence of these factors, we could experience a
decrease in the spread between the returns on our investment portfolio and
amounts credited to policyholders and contract owners, which could adversely
affect our profitability.
|
·
|
The
attractiveness of certain of our products may decrease because they are
linked to the equity markets and assessments of our financial strength,
resulting in lower profits. Increasing consumer concerns about
the returns and features of our products or our financial strength may
cause existing customers to surrender policies or withdraw assets, and
diminish our ability to sell policies and attract assets from new and
existing customers, which would result in lower sales and fee
revenues.
|
These
extraordinary economic and market conditions have materially and adversely
affected us. It is difficult to predict how long the current economic
and market conditions will continue, whether the financial markets will continue
to deteriorate and which aspects of our products and/or business will be
adversely affected. However, the lack of credit, lack of confidence
in the financial sector, increased volatility in the financial markets and
reduced business activity are likely to continue to materially and adversely
affect our business, financial condition and results of operations.
Our investment
portfolio is subject to several risks that may diminish the value of
our
invested assets and negatively impact our profitability, our financial
condition,
our liquidity and
our ability to continue to comply with the financial covenants
under our Senior
Credit Agreement.
The value
of our investment portfolio is subject to numerous factors, which may be
difficult to predict, and are often beyond our control. These factors
include, but are not limited to, the following:
|
·
|
changes
in interest rates and credit spreads can reduce the value of our
investments as further discussed in the risk factor below entitled
“— Changing interest rates may adversely affect our results of
operations;”
|
|
·
|
changes
in patterns of relative liquidity in the capital markets for various asset
classes;
|
|
·
|
changes
in the ability of issuers to make timely repayments can reduce the value
of our investments. This risk is significantly greater with
respect to below-investment grade securities, which comprised 8% of our
actively managed fixed maturity investments as of December 31, 2009;
and
|
|
·
|
changes
in the estimated timing of receipt of cash flows. For example,
our structured security investments, which comprised 17% of our actively
managed fixed maturity investments at December 31, 2009, are subject to
risks relating to variable prepayment on the assets underlying such
securities, such as mortgage loans. When structured securities
prepay faster than expected, investment income may be adversely affected
due to the acceleration of the amortization of purchase premiums or the
inability to reinvest at comparable yields in lower interest rate
environments.
|
We have
recorded writedowns of fixed maturity investments, equity securities and other
invested assets as a result of conditions which caused us to conclude a decline
in the fair value of the investment was other than temporary as follows
(excluding any such amounts included in discontinued operations):
$195.4 million in 2009 ($385.0 million of which was recognized through
net income and $189.6 million of which was recognized through accumulated
other comprehensive loss); $162.3 million in 2008; and $105.5 million
in 2007 (including $73.7 million of writedowns of investments which were
subsequently transferred pursuant to a coinsurance agreement as further
discussed in the note to our consolidated financial statements entitled “Summary
of Significant Accounting Policies”). 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.
In the
event of substantial product surrenders or policy claims, we may choose to
maintain highly liquid, and potentially lower-yielding, assets or to sell assets
at a loss, thereby eroding the performance of our portfolio.
Because a
substantial portion of our operating results are derived from returns on our
investment portfolio, significant losses in the portfolio may have a direct and
materially adverse impact on our results of operations. In addition,
losses on our
29
investment
portfolio could reduce the investment returns that we are able to credit to our
customers of certain products, thereby impacting our sales and eroding our
financial performance. Investment losses may also reduce the capital
of our insurance subsidiaries, which may cause us to make additional capital
contributions to those subsidiaries or may limit the ability of the insurance
subsidiaries to make dividend payments to the holding company. In
addition, future investment losses could cause us to be in violation of the
financial covenants under our Senior Credit Agreement.
Deteriorating
financial performance of securities collateralized by mortgage loans
and
commercial mortgage loans may lead to writedowns, which could have a
material
adverse effect on
our results of operations and financial condition.
Changes
in mortgage delinquency or recovery rates, declining real estate prices, changes
in credit or bond insurer credit ratings and the quality of service provided by
service providers on securities in our portfolios could lead us to determine
that writedowns are appropriate in the future.
The determination
of the amount of realized investment losses recorded as impairments
of our
investments is highly subjective and could have a material adverse effect
on
our operating
results and financial condition.
The
determination of realized investment losses recorded as impairments varies by
investment type and is based upon our ongoing evaluation and assessment of known
risks. Such evaluations and assessments are revised as conditions
change and new information becomes available. We update our
evaluations regularly and reflect changes in realized investment gains and
losses from impairments in operating results as such evaluations are
revised. Our assessment of whether unrealized losses are
other-than-temporary impairments requires significant judgment and future events
may occur, or additional information may become available, which may necessitate
future impairments of securities in our portfolio. Historical trends
may not be indicative of future other-than-temporary impairments. For
example, the cost of our fixed maturity and equity securities is adjusted for
impairments in value deemed to be other than temporary in the period in which
the determination is made. The assessment of whether impairments have
occurred is based on our case-by-case evaluation of the underlying reasons for
the decline in fair value.
The determination
of our fixed maturity securities results in
unrealized net
investment gains and losses and is highly subjective and could
materially impact
our operating results and financial condition.
In
determining fair value, we generally utilize market transaction data for the
same or similar instruments. The degree of management judgment
involved in determining fair values is inversely related to the availability of
market observable information. The fair value of financial assets and
financial liabilities may differ from the amount actually received to sell an
asset or the amount paid to transfer a liability in an orderly transaction
between market participants at the measurement date. Moreover, the
use of different valuation assumptions may have a material effect on the fair
values of the financial assets and financial liabilities. As of
December 31, 2009, our total unrealized net investment losses before adjustments
for insurance intangibles and deferred income taxes were
$473.4 million.
Litigation and
regulatory investigations are inherent in our business, may harm our
financial
strength and reputation and negatively impact our financial
results.
Insurance
companies historically have been subject to substantial
litigation. In addition to the traditional policy claims associated
with their businesses, insurance companies face policyholder suits and class
action suits. We also face significant risks related to regulatory
investigations and actions. The litigation and regulatory
investigations we are, have been, or may become subject to include matters
related to sales or underwriting practices, payment of contingent or other sales
commissions, claim payments and procedures, product design, product disclosure,
administration, additional premium charges for premiums paid on a periodic
basis, calculation of cost of insurance charges, changes to certain
non-guaranteed policy features, denial or delay of benefits, charging excessive
or impermissible fees on products and recommending unsuitable products to
customers. Certain of our insurance policies allow or require us to
make changes based on experience to certain non-guaranteed elements such as cost
of insurance charges, expense loads, credited interest rates and policyholder
bonuses. We intend to make changes to certain non-guaranteed elements
in the future. In some instances in the past, such action has
resulted in litigation and similar litigation may arise in the
future. Our exposure (including the potential adverse financial
consequences of delays or decisions not to pursue changes to certain
non-guaranteed elements), if any, arising from any such action cannot presently
be determined. Our pending legal and regulatory actions include
matters that are specific to us, as well as matters faced by other insurance
companies. State insurance departments focus on sales and claims
payment practices and product issues in their market conduct
examinations. Negotiated settlements of class action and other
lawsuits have had a material adverse effect on the business, financial condition
and results of operations of our insurance companies.
30
We are,
in the ordinary course of our business, a plaintiff or defendant in actions
arising out of our insurance business, including class actions and reinsurance
disputes, and, from time to time, we are also involved in various governmental
and administrative proceedings and investigations and inquiries such as
information requests, subpoenas and books and record examinations, from state,
federal and other authorities. The ultimate outcome of these lawsuits
and investigations cannot be predicted with certainty. In the event
of an unfavorable outcome in one or more of these matters, the ultimate
liability may be in excess of liabilities we have established and could have a
material adverse effect on our business, financial condition, results of
operations or cash flows. We could also suffer significant
reputational harm as a result of such litigation, regulatory action or
investigation which could have a material adverse effect on our business,
financial condition, results of operations or cash flows.
The limited
historical claims experience on our long-term care products could
negatively impact
our operations if our estimates prove wrong and we have not
adequately set
premium rates.
In
setting premium rates, we consider historical claims information and other
factors, but we cannot predict future claims with certainty. This is
particularly applicable to our long-term care insurance products, for which we
(as well as other companies selling these products) have relatively limited
historical claims experience. Long-term care products tend to have
fewer claims than other health products such as Medicare supplement, but when
claims are incurred, they tend to be much higher in dollar amount and longer in
duration. Also, long-term care claims are incurred much later in the
life of the policy than most other supplemental health products. As a
result of these traits, it is difficult to appropriately price this
product. For our long-term care insurance, actual persistency in
later policy durations that is higher than our persistency assumptions could
have a negative impact on profitability. If these policies remain
in-force longer than we assumed, then we could be required to make greater
benefit payments than anticipated when the products were
priced. Mortality is a critical factor influencing the length of time
a claimant receives long-term care benefits. Mortality continues to
improve for the general population, and life expectancy has
increased. Improvements in actual mortality trends relative to
assumptions may adversely affect our profitability.
Our
Bankers Life segment has offered long-term care insurance since
1985. Recently, the claims experience on our Bankers Life long-term
care blocks has generally been higher than our pricing expectations and, the
persistency of these policies has been higher than our pricing expectations
which may result in higher benefit ratios in the future.
After the
Transfer, we continue to hold long-term care business acquired through previous
acquisitions in our Conseco Insurance Group segment. The premiums
collected from this block totaled $31.4 million in 2009. The
experience on this acquired block has generally been worse than the acquired
companies’ original pricing expectations. We have received regulatory
approvals for numerous premium rate increases in recent years pertaining to
these blocks. Even with these rate increases, this block experienced
benefit ratios of 186.7% in 2009, 169.6% in 2008, and 192.4% in
2007. If future claims experience continues to be worse than
anticipated as our long-term care blocks continue to age, our financial results
could be adversely affected. In addition, rate increases may cause
existing policyholders to allow their policies to lapse.
The results of
operations of our insurance business will decline if our premium rates
are not
adequate or if we are unable to obtain regulatory approval to increase
rates.
We set
the premium rates on our health insurance policies based on facts and
circumstances known at the time we issue the policies and on assumptions about
numerous variables, including the actuarial probability of a policyholder
incurring a claim, the probable size of the claim, maintenance costs to
administer the policies and the interest rate earned on our investment of
premiums. In setting premium rates, we consider historical claims
information, industry statistics, the rates of our competitors and other
factors, but we cannot predict with certainty the future actual claims on our
products. If our actual claims experience proves to be less favorable
than we assumed and we are unable to raise our premium rates to the extent
necessary to offset the unfavorable claims experience, our financial results
will be adversely affected.
We review
the adequacy of our premium rates regularly and file proposed rate increases on
our health insurance products when we believe existing premium rates are too
low. It is possible that we will not be able to obtain approval for
premium rate increases from currently pending requests or from future
requests. If we are unable to raise our premium rates because we fail
to obtain approval in one or more states, our financial results will be
adversely affected. Moreover, in some instances, our ability to exit
unprofitable lines of business is limited by the guaranteed renewal feature of
the policy. Due to this feature, we cannot exit such business without
regulatory approval, and accordingly, we may be required to continue to service
those products at a loss for an extended period of time. Most of our
long-term care business is guaranteed renewable, and, if necessary rate
increases are not approved, we would be required to recognize a loss and
establish a premium deficiency reserve. During 2009, the financial
statements of three of our subsidiaries prepared in accordance with
statutory
31
accounting
practices prescribed or permitted by regulatory authorities reflected asset
adequacy or premium deficiency reserves. Total asset adequacy or
premium deficiency reserves for Washington National, Conseco Life and Bankers
Conseco Life were $79.1 million, $257.1 million and
$21.2 million, respectively, at December 31, 2009. Due to
differences between statutory and GAAP insurance liabilities, we were not
required to recognize a similar premium deficiency reserve in our consolidated
financial statements prepared in accordance with GAAP. The
determination of the need for and amount of asset adequacy reserves is subject
to numerous actuarial assumptions, including our ability to change
non-guaranteed elements related to certain products consistent with contract
provisions.
If,
however, we are successful in obtaining regulatory approval to raise premium
rates, the increased premium rates may reduce the volume of our new sales and
cause existing policyholders to allow their policies to lapse. This
could result in a significantly higher ratio of claim costs to premiums if
healthier policyholders who get coverage elsewhere allow their policies to
lapse, while policies of less healthy policyholders continue
in-force. This would reduce our premium income and profitability in
future periods.
Most of
our supplemental health policies allow us to increase premium rates when
warranted by our actual claims experience. These rate increases must
be approved by the applicable state insurance departments, and we are required
to submit actuarial claims data to support the need for such rate
increases. The re-rate application and approval process on
supplemental health products is a normal recurring part of our business
operations and reasonable rate increases are typically approved by the state
departments as long as they are supported by actual claims experience and are
not unusually large in either dollar amount or percentage
increase. For policy types on which rate increases are a normal
recurring event, our estimates of insurance liabilities assume we will be able
to raise rates if experience on the blocks warrants such increases in the
future.
The
benefit ratio for our long-term care products included in the Conseco Insurance
Group segment has increased in recent periods and was 186.7% in 2009 and 169.6%
in 2008. We will have to continue to raise rates or take other
actions with respect to some of these policies or our financial results will be
adversely affected.
As a
result of higher persistency and resultant higher claims in our long-term care
block in the Bankers Life segment than assumed in the original pricing, our
premium rates were too low. Accordingly, we have been seeking
approval from regulatory authorities for rate increases on portions of this
business. Many of the rate increases have been approved by regulators
and implemented. However, it is possible that we will not be able to
obtain approval for all or a portion of the premium rate increases from
currently pending requests or future requests. If we are unable to
obtain these rate increases, the profitability of these policies and the
performance of this block of business will be adversely affected. In
addition, such rate increases may reduce the volume of our new sales and cause
existing policyholders to allow their policies to lapse, resulting in reduced
profitability.
We have
implemented and will continue to implement from time to time and when
actuarially justified, premium rate increases in our long-term care
business. In some cases, we offer policyholders the opportunity to
reduce their coverage amounts or accept non-forfeiture benefits as alternatives
to increasing their premium rates. The financial impact of our rate
increase actions could be adversely affected by policyholder anti-selection,
meaning that policyholders who are less likely to incur claims may lapse their
policies or reduce their benefits, while policyholders who are more likely to
incur claims may maintain full coverage and accept their rate
increase.
We have
identified a material weakness in our internal control over financial
reporting,
and our business and stock price may be adversely affected if we have not
adequately
addressed the weakness or if we have other material weaknesses or
significant
deficiencies in our internal controls over financial
reporting.
We did
not maintain effective controls over the accounting and disclosure of insurance
policy benefits and the liabilities for some of our insurance
products. We previously identified a material weakness in internal
controls over the actuarial reporting processes related to the design of
controls to ensure the completeness and accuracy of certain in-force policies in
our Bankers Life segment, Conseco Insurance Group segment, and the long-term
care business reflected in discontinued operations. Remediation
efforts to enhance controls over the actuarial reporting process have been
continuing over the last several years under the direction of the chief
financial officer, and a number, but not all, of the weaknesses have been
addressed. Material control deficiencies in the actuarial reporting
process related to the design and operating effectiveness of controls over
completeness and accuracy of inforce policies in all insurance blocks other than
certain specified disease policies were remediated, and the new controls were
determined to be effective at December 31, 2009. However, a material
weakness relating to the actuarial reporting process over certain specified
disease policies in our Conseco Insurance Group segment continued to exist as of
December 31, 2009, and our remediation efforts are continuing.
32
These
control deficiencies resulted in adjustments to insurance policy benefits and
the liabilities for insurance products in the consolidated financial statements
for the years ended December 31, 2007, December 31, 2008 and December
31, 2009. If we cannot produce reliable financial reports, investors
could lose confidence in our reported financial information, the market price of
our stock could decline significantly, we may be unable to obtain additional
financing to operate and expand our business, and our business and financial
condition could be harmed. In addition, we face the risk that,
notwithstanding our efforts to date to identify and remedy all material errors
in those financial statements, we may discover other errors in the future and
that the cost of identifying and remedying the errors and remediating our
material weakness in internal controls will be high and have a material adverse
effect on our financial condition and results of operations.
Our ability to
use our existing NOLs may be limited by this or other transactions,
and any
impairment of existing NOLs would likely breach the debt to total
capitalization
covenant of our Senior Credit Agreement.
As of
December 31, 2009, we had approximately $4.7 billion of federal tax NOLs
and $1.1 billion of capital loss carry-forwards, resulting in a deferred
tax asset of approximately $2.0 billion, expiring in years 2010 through
2029. Section 382 of the Code imposes limitations on a
corporation’s ability to use its NOLs when it undergoes a 50% “ownership change”
over a three year period. Although we underwent an ownership change
in 2003 as the result of our reorganization, the timing and manner in which we
will be able to utilize our NOLs is not currently limited by
Section 382.
We
regularly monitor ownership changes (as calculated for purposes of
Section 382) based on available information and, as of December 31,
2009, our analysis indicated that we were below the 50% ownership change
threshold that would limit our ability to utilize our NOLs. However,
taking into account the common stock issuance to Paulson and our public offering
of common stock in 2009, we are close to the 50% ownership change
level. As a result, any future transaction or transactions and the
timing of such transaction or transactions could trigger an additional ownership
change under Section 382. Such transactions may include, but are
not limited to, additional repurchases or issuances of common stock (including
upon conversion of our outstanding 3.5% Debentures or 7.0% Debentures (including
conversion pursuant to a make whole adjustment event), or exercise of the
warrants sold to Paulson, as discussed above), or acquisitions or sales of
shares of our stock by certain holders of our shares, including persons who have
held, currently hold or may accumulate in the future 5% or more of our
outstanding common stock (“5% Shareholders”) for their own
account. In January 2009, our board of directors adopted a
Section 382 Rights Agreement, which is designed to protect shareholder
value by preserving the value of our NOLs. See the note to the
consolidated financial statements entitled “Income Taxes”. The rights
agreement provides a strong economic disincentive for any one shareholder
knowingly, and without the approval of our board, to become a 5% Shareholder and
for any of the 5% Shareholders as of the date of the rights agreement to
increase their ownership stake by more than 1% of the shares of our common stock
then outstanding — and thus limits the uncertainty with regard to the
potential for future ownership changes. However, despite the strong
economic disincentives of the Section 382 Rights Agreement, shareholders
may elect to increase their ownership, including beyond the limits set by the
rights agreement, and thus adversely affect our ownership shift
calculations.
Additionally,
based on the advice of our tax advisor, we have taken the position that, upon
issuance, the 7.0% Debentures are not treated as stock for purposes of
Section 382 and do not trigger an ownership change. However, the
IRS may not agree with our position. If the IRS were to succeed in
challenging this position, the issuance of the 7.0% Debentures would push us
above the 50% ownership change level described above and trigger an ownership
change under Section 382.
If an
ownership change were to occur for purposes of Section 382, we would be
required to calculate an annual limitation on the amount of our taxable income
that may be offset by NOLs arising prior to such ownership
change. That limitation would apply to all of our current
NOLs. The annual limitation would be calculated based upon the fair
market value of our equity at the time of such ownership change, multiplied by a
federal long-term tax exempt rate (4.16 percent at December 31, 2009), and the
annual restriction would eliminate our ability to use a substantial portion of
our NOLs to offset future taxable income. Additionally, the writedown
of our deferred tax assets that would occur in the event of an ownership change
for purposes of Section 382 could cause us to breach the debt to total
capitalization covenant of our Senior Credit Agreement.
The value of our
deferred tax assets may be impaired to the extent our future profits
are less
than we have projected and such impairment may have a material adverse
effect on
our results of operations and our financial condition.
As of
December 31, 2009, we had deferred tax assets of
$1.1 billion. In 2009, we increased the deferred tax valuation
allowance by $27.8 million, of which $23 million related to our
reassessment of the recovery of our deferred tax assets following the completion
of reinsurance transactions in 2009; and $4.8 million was associated with
capital loss carry-
33
forwards
recognized in 2009.
Our
income tax expense includes deferred income taxes arising from temporary
differences between the financial reporting and tax bases of assets and
liabilities, capital loss carry-forwards and NOLs. We evaluate the
realizability of our deferred income tax assets and assess the need for a
valuation allowance on an ongoing basis. In evaluating our deferred
income tax assets, we consider whether it is more likely than not that the
deferred income tax assets will be realized. The ultimate realization
of our deferred income tax assets depends upon generating sufficient future
taxable income during the periods in which our temporary differences become
deductible and before our capital loss carry-forwards and NOLs
expire. Additionally, the value of our deferred tax assets would be
significantly impaired if we were to undergo a 50% “ownership change” for
purposes of Section 382 of the Code, as discussed in the risk factor
immediately above. Our assessment of the realizability of our
deferred income tax assets requires significant judgment. However,
recovery is dependent on achieving such projections and failure to do so would
result in an increase in the valuation allowance in a future
period. Any future increase in the valuation allowance would result
in additional income tax expense which could have a material adverse effect upon
our earnings in the future, and reduce shareholders’ equity.
Concentration of
our investment portfolios in any particular sector of the economy or
type of
asset may have an adverse effect on our financial position or results of
operations.
The
concentration of our investment portfolios in any particular industry, group of
related industries, asset classes (such as residential mortgage-backed
securities and other asset-backed securities), or geographic area could have an
adverse effect on its value and performance and, consequently, on our results of
operations and financial position. While we seek to mitigate this
risk by having a broadly diversified portfolio, events or developments that have
a negative impact on any particular industry, group of related industries or
geographic area may have an adverse effect on the investment portfolios to the
extent that the portfolios are concentrated.
Our business is
subject to extensive regulation, which limits our operating
flexibility and
could result in our insurance subsidiaries being placed under
regulatory
control or otherwise negatively impact our financial
results.
Our
insurance business is subject to extensive regulation and supervision in the
jurisdictions in which we operate. Our insurance subsidiaries are
subject to state insurance laws that establish supervisory
agencies. Such agencies have broad administrative powers including
the power to:
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·
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grant
and revoke business licenses;
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·
|
regulate
and supervise sales practices and market
conduct;
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·
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establish
guaranty associations;
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·
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license
agents;
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·
|
approve
policy forms;
|
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·
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approve
premium rates for some lines of business such as long-term care and
Medicare supplement;
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·
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establish
reserve requirements;
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·
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prescribe
the form and content of required financial statements and
reports;
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·
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determine
the reasonableness and adequacy of statutory capital and
surplus;
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·
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perform
financial, market conduct and other
examinations;
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·
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define
acceptable accounting
principles; and
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·
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regulate
the types and amounts of permitted
investments.
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34
The
regulations issued by state insurance agencies can be complex and subject to
differing interpretations. If a state insurance regulatory agency
determines that one of our insurance company subsidiaries is not in compliance
with applicable regulations, the subsidiary is subject to various potential
administrative remedies including, without limitation, monetary penalties,
restrictions on the subsidiary’s ability to do business in that state and a
return of a portion of policyholder premiums. In addition, regulatory
action or investigations could cause us to suffer significant reputational harm,
which could have an adverse effect on our business, financial condition and
results of operations.
Our
insurance subsidiaries are also subject to RBC requirements. These
requirements were designed to evaluate the adequacy of statutory capital and
surplus in relation to investment and insurance risks associated with asset
quality, mortality and morbidity, asset and liability matching and other
business factors. The requirements are used by states as an early
warning tool to discover companies that may be weakly-capitalized for the
purpose of initiating regulatory action. Generally, if an insurer’s
RBC falls below specified levels, the insurer is subject to different degrees of
regulatory action depending upon the magnitude of the deficiency. The
2009 statutory annual statements filed with the state insurance regulators of
each of our insurance subsidiaries reflected total adjusted capital in excess of
the levels subjecting the subsidiaries to any regulatory action.
Our reserves for
future insurance policy benefits and claims may prove to be
inadequate,
requiring us to increase liabilities which results in reduced net income
and
shareholders’ equity.
Liabilities
for insurance products are calculated using management’s best judgments, based
on our past experience and standard actuarial tables of mortality, morbidity,
lapse rates, investment experience and expense levels. For our health
insurance business, we establish an active life reserve, a liability for due and
unpaid claims, claims in the course of settlement, incurred but not reported
claims, and a reserve for the present value of amounts on incurred claims not
yet due. We establish reserves based on assumptions and estimates of
factors either established at the fresh-start date for business in-force then or
considered when we set premium rates for business written after that
date.
Many
factors can affect these reserves and liabilities, such as economic and social
conditions, inflation, hospital and pharmaceutical costs, changes in life
expectancy, regulatory actions, changes in doctrines of legal liability and
extra-contractual damage awards. Therefore, the reserves and
liabilities we establish are necessarily based on estimates, assumptions,
industry data and prior years’ statistics. It is possible that actual
claims will materially exceed our reserves and have a material adverse effect on
our results of operations and financial condition. We have incurred
significant losses beyond our estimates as a result of actual claim costs and
persistency of our long-term care business included in our Bankers Life and
Conseco Insurance Group segments. The benefit ratios for our
long-term care products in our Bankers Life segment were 105.2%, 107.6% and
102.0% in 2009, 2008 and 2007, respectively. The benefit ratios for
our long-term care products in our Conseco Insurance Group segment were 186.7%,
169.6% and 192.4% in 2009, 2008 and 2007, respectively. Our financial
performance depends significantly upon the extent to which our actual claims
experience and future expenses are consistent with the assumptions we used in
setting our reserves. If our assumptions with respect to future
claims are incorrect, and our reserves prove to be insufficient to cover our
actual losses and expenses, we would be required to increase our liabilities,
and our financial results could be adversely affected.
We may be
required to accelerate the amortization of the cost of policies produced
or
the value of
policies in-force at the Effective Date.
Cost of
policies produced represent the costs that vary with, and are primarily related
to, producing new insurance business. The value of policies in-force
at the Effective Date represents the value assigned to the right to receive
future cash flows from contracts existing at September 10, 2003, the
effective date of our predecessor company’s plan of
reorganization. The balances of these accounts are amortized over the
expected lives of the underlying insurance contracts. On an ongoing
basis, we test these accounts recorded on our balance sheet to determine if
these amounts are recoverable under current assumptions. In addition,
we regularly review the estimates and assumptions underlying these accounts for
those products for which we amortize the cost of policies produced or the value
of insurance in-force at the Effective Date in proportion to gross profits or
gross margins. If facts and circumstances change, these tests and
reviews could lead to reduction in the balance of those accounts that could have
an adverse effect on the results of our operations and our financial
condition.
Our operating
results will suffer if policyholder surrender levels differ
significantly
from our assumptions.
Surrenders
of our annuities and life insurance products can result in losses and decreased
revenues if surrender levels differ significantly from assumed
levels. At December 31, 2009, approximately 20 percent of our
total insurance liabilities,
35
or
approximately $5.0 billion, could be surrendered by the policyholder
without penalty. The surrender charges that are imposed on our fixed
rate annuities typically decline during a penalty period, which ranges from five
to twelve years after the date the policy is issued. Surrender
charges are eliminated after the penalty period. Surrenders and
redemptions could require us to dispose of assets earlier than we had planned,
possibly at a loss. Moreover, surrenders and redemptions require
faster amortization of either the acquisition costs or the commissions
associated with the original sale of a product, thus reducing our net
income. We believe policyholders are generally more likely to
surrender their policies if they believe the issuer is having financial
difficulties, or if they are able to reinvest the policy’s value at a higher
rate of return in an alternative insurance or investment product.
Changing
interest rates may adversely affect our results of operations.
Our
profitability is affected by fluctuating interest rates. While we
monitor the interest rate environment and, in some cases, employ asset/liability
and hedging strategies to mitigate such impact, our financial results could be
adversely affected by changes in interest rates. Our spread-based
insurance and annuity business is subject to several inherent risks arising from
movements in interest rates, especially if we fail to anticipate or respond to
such movements. First, interest rate changes can cause compression of
our net spread between interest earned on investments and interest credited to
customer deposits. Our ability to adjust for such a compression is
limited by the guaranteed minimum rates that we must credit to policyholders on
certain products, as well as the terms on most of our other products that limit
reductions in the crediting rates to pre-established intervals. As of
December 31, 2009, approximately 41 percent of our insurance liabilities
were subject to interest rates that may be reset annually; 41 percent had a
fixed explicit interest rate for the duration of the contract; 13 percent had
credited rates that approximate the income we earn; and the remainder had no
explicit interest rates. Second, if interest rate changes produce an
unanticipated increase in surrenders of our spread-based products, we may be
forced to sell invested assets at a loss in order to fund such
surrenders. Third, the profits from many non-spread-based insurance
products, such as long-term care policies, can be adversely affected when
interest rates decline because we may be unable to reinvest the cash from
premiums received at the interest rates anticipated when we sold the
policies. Finally, changes in interest rates can have significant
effects on the fair value and performance of our investments in general and
specifically on the performance of our structured securities portfolio,
including collateralized mortgage obligations, as a result of changes in the
prepayment rate of the loans underlying such securities.
We employ
asset/liability strategies that are designed to mitigate the effects of interest
rate changes on our profitability but do not currently extensively employ
derivative instruments for this purpose. We may not be successful in
implementing these strategies and achieving adequate investment
spreads.
We use
computer models to simulate our cash flows expected from existing business under
various interest rate scenarios. With such estimates, we seek to
manage the relationship between the duration of our assets and the expected
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, 2009, the duration of our
fixed maturity investments (as modified to reflect prepayments and potential
calls) was approximately 9.0 years, and the duration of our insurance
liabilities was approximately 8.1 years. We estimate that our
fixed maturity securities and short-term investments, net of corresponding
changes in insurance acquisition costs, would decline in fair value by
approximately $455 million if interest rates were to increase by 10% from
rates as of December 31, 2009. This compares to a decline in
fair value of $185 million based on amounts and rates at December 31,
2008. The calculations involved in our computer simulations
incorporate numerous assumptions, require significant estimates and assume an
immediate change in interest rates without any management reaction to such
change. Consequently, potential changes in the values 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, our net exposure to interest rates can vary over
time.
General
market conditions affect investments and investment income.
The
performance of our investment portfolio depends in part upon the level of and
changes in interest rates, risk spreads, real estate values, market volatility,
the performance of the economy in general, the performance of the specific
obligors included in our portfolio and other factors that are beyond our
control. Changes in these factors can affect our net investment
income in any period, and such changes can be substantial.
Financial
market conditions can also affect our realized and unrealized investment gains
(losses). During periods of rising interest rates, the fair values of
our investments will typically decline. Conversely, during periods of
falling interest rates, the fair values of our investments will typically
rise.
36
Our results of
operations may be negatively impacted if our initiatives to
restructure our
insurance operations are unsuccessful or if our planned conversions
result in
valuation differences.
Our
Conseco Insurance Group segment has experienced decreases in premium revenues
and new annualized premiums in recent years as well as expense levels that
exceed product pricing expense assumptions. We have implemented
several initiatives to improve operating results, including: (i) focusing
sales efforts on higher margin products; (ii) reducing operating expenses
by eliminating or reducing marketing costs of certain products;
(iii) streamlining administrative procedures and reducing personnel; and
(iv) increasing retention rates on our more profitable blocks of in-force
business. Many of our initiatives address issues resulting from the
substantial number of acquisitions of our predecessor
company. Between 1982 and 1997, our predecessor company completed 19
transactions involving the acquisitions of 44 separate insurance
companies. Our efforts involve improvements to our policy
administration procedures and significant systems conversions, such as the
elimination of duplicate processing systems for similar
business. These initiatives may result in unforeseen expenses,
complications or delays, and may be inadequate to address all
issues. Some of these initiatives have only recently begun to be
executed, and may not ultimately be successfully completed. While our
future operating performance depends greatly on the success of these efforts,
even if we successfully implement these measures, they alone may not
sufficiently improve our results of operations.
Conversions
to new systems can result in valuation differences between the prior system and
the new system. We have recognized such differences in the
past. Our planned conversions could result in future valuation
adjustments, and these adjustments may have a material adverse effect on future
earnings.
Our financial
position may be negatively impacted if we are unable to achieve our
goals.
We have
identified a number of goals, including maintaining strong growth at Bankers
Life, improving earnings stability and reducing volatility and reducing our
enterprise exposure to long-term care business. The most consistent
components of our operations in recent years have been Bankers Life and Colonial
Penn, and the continued growth and profitability of those businesses is critical
to our overall results. The failure to achieve these and our other
goals could have a material adverse effect on our results of operations,
financial condition and the price of our common stock.
A failure to
improve the financial strength ratings of our insurance subsidiaries or
a decline
from the current ratings could cause us to experience decreased sales,
increased
agent attrition and increased policyholder lapses and
redemptions.
An
important competitive factor for our insurance subsidiaries is the ratings they
receive from nationally recognized rating organizations. Agents,
insurance brokers and marketing companies who market our products, and
prospective policyholders view ratings as an important factor in evaluating an
insurer’s products. This is especially true for annuity,
interest-sensitive life insurance and long-term care products. The
current financial strength ratings of our primary insurance subsidiaries from
A.M. Best, S&P and Moody’s are “B (Fair),” “BB-” and “Ba2,”
respectively. A.M. Best has 16 possible
ratings. There are six ratings above our “B” rating and nine ratings
that are below our rating. S&P has 21 possible
ratings. There are twelve ratings above our
“BB -” rating and eight ratings that are below our
rating. Moody’s has 21 possible ratings. There are 11
ratings above our “Ba2” rating and nine ratings that are below our
rating. Most of our competitors have higher financial strength
ratings and, to be competitive over the long term, we believe it is critical to
achieve improved ratings.
If we
fail to achieve ratings upgrades from A.M. Best or if our ratings are
further downgraded, we may experience declining sales of certain of our
insurance products, defections of our independent and career sales force, and
increased policies being redeemed or allowed to lapse. These events
would adversely affect our financial results, which could then lead to ratings
downgrades.
Competition from
companies that have greater market share, higher ratings, greater
financial
resources and stronger brand recognition, may impair our ability to
retain
existing
customers and sales representatives, attract new customers and sales
representatives
and maintain or improve our financial results.
The
supplemental health insurance, annuity and individual life insurance markets are
highly competitive. Competitors include other life and accident and
health insurers, commercial banks, thrifts, mutual funds and
broker-dealers.
Our
principal competitors vary by product line. Our main competitors for
agent sold long-term care insurance products include Genworth Financial, John
Hancock Financial Services and MetLife. Our main competitors for
agent sold Medicare supplement insurance products include United HealthCare,
Blue Cross and Blue Shield Plans, Mutual of Omaha
37
and
United American.
In some
of our product lines, such as life insurance and fixed annuities, we have a
relatively small market share. Even in some of the lines in which we
are one of the top five writers, our market share is relatively
small. For example, while our Bankers Life segment ranked fourth in
annualized premiums of individual long-term care insurance in 2008 with a market
share of approximately 4.6%, the top three writers of individual long-term care
insurance had annualized premiums with a combined market share of approximately
57% during the period. In addition, while our Bankers Life segment
was ranked fourth in direct premiums earned for individual Medicare supplement
insurance in 2008 with a market share of 3.7%, the top writer of individual
Medicare supplement insurance had direct premiums with a market share of 16.1%
during the period.
Virtually
all of our major competitors have higher financial strength ratings than we
do. Many of our competitors are larger companies that have greater
capital, technological and marketing resources and have access to capital at a
lower cost. Recent industry consolidation, including business
combinations among insurance and other financial services companies, has
resulted in larger competitors with even greater financial
resources. Furthermore, changes in federal law have narrowed the
historical separation between banks and insurance companies, enabling
traditional banking institutions to enter the insurance and annuity markets and
further increase competition. This increased competition may harm our
ability to maintain or improve our profitability.
In
addition, because the actual cost of products is unknown when they are sold, we
are subject to competitors who may sell a product at a price that does not cover
its actual cost. Accordingly, if we do not also lower our prices for
similar products, we may lose market share to these competitors. If
we lower our prices to maintain market share, our profitability will
decline.
We must
attract and retain sales representatives to sell our insurance and annuity
products. Strong competition exists among insurance and financial
services companies for sales representatives. We compete for sales
representatives primarily on the basis of our financial position, financial
strength ratings, support services, compensation, products and product
features. Our competitiveness for such agents also depends upon the
relationships we develop with these agents. Our predecessor company’s
bankruptcy continues to be an adverse factor in developing relationships with
certain agents. If we are unable to attract and retain sufficient
numbers of sales representatives to sell our products, our ability to compete
and our revenues and profitability would suffer.
Volatility in the
securities markets, and other economic factors, may adversely
affect our
business, particularly our sales of certain life insurance products and
annuities.
Fluctuations
in the securities markets and other economic factors may adversely affect sales
and/or policy surrenders of our annuities and life insurance
policies. For example, volatility in the equity markets may deter
potential purchasers from investing in equity-indexed annuities and may cause
current policyholders to surrender their policies for the cash value or to
reduce their investments. In addition, significant or unusual
volatility in the general level of interest rates could negatively impact sales
and/or lapse rates on certain types of insurance products.
Federal and state
legislation could adversely affect the financial performance of our
insurance
operations.
During
recent years, the health insurance industry has experienced substantial changes,
including those caused by healthcare legislation. Recent federal and
state legislation and pending legislative proposals concerning healthcare reform
contain features that could severely limit, or eliminate, our ability to vary
pricing terms or apply medical underwriting standards to individuals, thereby
potentially increasing our benefit ratios and adversely impacting our financial
results. In particular, Medicare reform could affect our ability to
price or sell our products or profitably maintain our blocks
in-force. For example, the Medicare Advantage program provides
incentives for health plans to offer managed care plans to
seniors. The growth of managed care plans under this program could
decrease sales of the traditional Medicare supplement products we
sell. Some current proposals contain government provided long-term
care insurance which could affect the sales of our long-term care
products.
Proposals
currently pending in Congress and some state legislatures may also affect our
financial results. These proposals include the implementation of
minimum consumer protection standards in all long-term care policies, including:
guaranteed premium rates; protection against inflation; limitations on waiting
periods for pre-existing conditions; setting standards for sales practices for
long-term care insurance; and guaranteed consumer access to information about
insurers, including information regarding lapse and replacement rates for
policies and the percentage of claims denied. Enactment of any
proposal that would limit the amount we can charge for our products, such as
guaranteed premium rates, or that would
38
increase
the benefits we must pay, such as limitations on waiting periods, or that would
otherwise increase the costs of our business, could adversely affect our
financial results.
Tax
law changes could adversely affect our insurance product sales and
profitability.
We sell
deferred annuities and some forms of life insurance that are attractive, in
part, because policyholders generally are not subject to U.S. federal
income tax on increases in policy values until some form of distribution is
made. Congress has enacted legislation to lower marginal tax rates,
to reduce the U.S. federal estate tax gradually over a ten-year period
(with total elimination of the U.S. federal estate tax in 2010) and to
increase contributions that may be made to individual retirement accounts and
401(k) accounts. While these tax law changes are scheduled to expire
at the beginning of 2011 absent future congressional action, they could in the
interim diminish the appeal of our annuity and life insurance products because
the benefit of tax deferral is lessened when tax rates are lower and because
fewer people may purchase these products when they can contribute more to
individual retirement accounts and 401(k) accounts. Additionally,
Congress has considered, from time to time, other possible changes to
U.S. tax laws, including elimination of the tax deferral on the accretion
of value within certain annuities and life insurance products. Such a
change would make these products less attractive to prospective purchasers and
therefore would likely cause our sales of these products to
decline.
We
face risk with respect to our reinsurance agreements.
We
transfer exposure to certain risks to others through reinsurance
arrangements. Under these arrangements, other insurers assume a
portion of our losses and expenses associated with reported and unreported
claims in exchange for a portion of policy premiums. The
availability, amount and cost of reinsurance depend on general market conditions
and may vary significantly. As of December 31, 2009, our
reinsurance receivables totaled $3.6 billion. Our ceded life
insurance in-force totaled $16.5 billion. Our ten largest
reinsurers accounted for 91% of our ceded life insurance in-force. We
face credit risk with respect to reinsurance. When we obtain
reinsurance, we are still liable for those transferred risks if the reinsurer
cannot meet its obligations. Therefore, the inability of our
reinsurers to meet their financial obligations may require us to increase
liabilities, thereby reducing our net income and shareholders’
equity.
Our insurance
subsidiaries may be required to pay assessments to fund other
companies’
policyholder losses or liabilities and this may negatively impact our
financial
results.
The
solvency or guaranty laws of most states in which an insurance company does
business may require that company to pay assessments up to certain prescribed
limits to fund policyholder losses or liabilities of other insurance companies
that become insolvent. Insolvencies of insurance companies increase
the possibility that these assessments may be required. These
assessments may be deferred or forgiven under most guaranty laws if they would
threaten an insurer’s financial strength and, in certain instances, may be
offset against future premium taxes. We cannot estimate the
likelihood and amount of future assessments. Although past
assessments have not been material, if there were a number of large
insolvencies, future assessments could be material and could have a material
adverse effect on our operating results and financial position.
39
None.
Our
headquarters and the administrative operations of our Conseco Insurance Group
segment and certain administrative operations of our subsidiaries are located on
a Company-owned corporate campus in Carmel, Indiana, immediately north of
Indianapolis. We
currently occupy five buildings on the campus with approximately 526,000 square
feet of space.
Our
Bankers Life segment is primarily administered from a facility in downtown
Chicago, Illinois. Bankers Life has approximately 222,000 square feet
leased under an agreement which expires in 2018. In addition, Bankers
Life leases approximately 114,000 square feet of space in its former location,
the Merchandise Mart. Approximately 75 percent of that space is
subleased through November 2013, the early termination date of the
lease.
We
also lease 238 sales offices in various states totaling approximately 718,000
square feet. These leases generally are short-term in length, with
remaining lease terms expiring between 2010 and 2017.
Our
Colonial Penn segment is administered from a Company-owned office building in
Philadelphia, Pennsylvania, with approximately 127,000 square
feet. We occupy approximately 60 percent of this space, with unused
space leased to tenants.
Management
believes that this office space is adequate for our needs.
Information
required for Item 3 is incorporated by reference to the discussion under the
heading “Legal Proceedings” in note 9 “Commitments and Contingencies” to our
consolidated financial statements included in Item 8 of this Form
10-K.
None.
40
Executive
Officers of the Registrant
|
Officer
|
Positions
with Conseco, Principal
|
|||
|
Name and Age (a)
|
Since
|
Occupation and Business Experience
(b)
|
||
|
C.
James Prieur,
58
|
2006
|
Since
September 2006, chief executive officer. From April 1999 until
September 2006, president and chief operating officer of Sun Life
Financial, Inc. and chief operating officer of its principal subsidiary,
Sun Life Assurance Company.
|
||
|
Edward
J. Bonach,
56
|
2007
|
Since
May 2007, executive vice president and chief financial
officer. From 2002 until 2007, Mr. Bonach served as chief
financial officer of National Life Group.
|
||
|
Russell
M. Bostick,
53
|
2005
|
Since
August 2008, executive vice president of technology and
operations. From 2005 until August 2008, executive vice
president and chief information officer. From 1998 until 2005,
chief technology officer of Chase Insurance and its
predecessors.
|
||
|
Eric
R. Johnson,
49
|
1997
|
Since
September 2003, chief investment officer of Conseco and president and
chief executive officer of 40|86 Advisors, Conseco’s wholly-owned
registered investment advisor. Mr. Johnson has held various
investment management positions since joining Conseco in
1997.
|
||
|
John
R. Kline,
52
|
1990
|
Since
July 2002, senior vice president and chief accounting
officer. Mr. Kline has served in various accounting and finance
capacities with Conseco since 1990.
|
||
|
Susan
L. Menzel,
44
|
2005
|
Since
May 2005, executive vice president, human resources. From 2004
to May 2005, senior vice president, human resources of APAC Customer
Services. From 1997 to 2004, vice president, human resources of
Sears Roebuck.
|
||
|
Christopher
J. Nickele,
53
|
2005
|
Since
October 2005, executive vice president, product
management. From 2002 until September 2005, vice president –
product development of Lincoln National Corporation.
|
||
|
Scott
R. Perry,
47
|
2001
|
Since
2006, president of Bankers Life. Employed in various capacities
for Bankers Life since 2001.
|
||
|
Steven
M. Stecher,
49
|
2004
|
Since
August 2008, president of Conseco Insurance Group. From January
2007 until August 2008, executive vice president,
operations. From August 2004 until January 2007, executive vice
president of Conseco Insurance Group. From 2003 until May 2004
chief information officer of Orix Financial Services. From 1997
until 2002, Mr. Stecher held several executive positions with ING
Americas, including chief information officer, vice president of strategic
marketing and head of shared services.
|
||
|
Matthew
J. Zimpfer,
42
|
1998
|
Since
June 2008, executive vice president and general counsel. Mr. Zimpfer has
held various legal positions since joining Conseco in
1998.
|
____________________
|
|
(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.
|
41
|
|
ITEM
5.
|
MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES.
|
MARKET
INFORMATION
The
following table sets forth the ranges of high and low sales prices per share for
our common stock on the New York Stock Exchange for the quarterly periods
beginning January 1, 2008. There have been no dividends paid or
declared on our common stock during this period.
|
Period
|
Market
price
|
|||||||
|
High
|
Low
|
|||||||
|
2008:
|
||||||||
|
First
Quarter
|
$ | 12.64 | $ | 8.71 | ||||
|
Second
Quarter
|
12.34 | 9.62 | ||||||
|
Third
Quarter
|
10.16 | 3.06 | ||||||
|
Fourth
Quarter
|
5.21 | 1.31 | ||||||
|
2009:
|
||||||||
|
First
Quarter
|
$ | 5.10 | $ | .26 | ||||
|
Second
Quarter
|
3.90 | .82 | ||||||
|
Third
Quarter
|
6.31 | 1.79 | ||||||
|
Fourth
Quarter
|
7.03 | 4.41 | ||||||
As of
February 19, 2010, there were approximately 40,000 holders of the outstanding
shares of common stock, including individual participants in securities position
listings.
42
PERFORMANCE
GRAPH
The
Performance Graph below compares Conseco’s cumulative total shareholder return
on its common stock for the period from December 31, 2004 through
December 31, 2009 with the cumulative total return of the
Standard & Poor’s 500 Composite Stock Price Index (the “S&P 500
Index”) and the Dow Jones Life Insurance Index. The comparison for
each of the periods assumes that $100 was invested on December 31, 2004 in
each of Conseco common stock, the stocks included in the S&P 500 Index and
the stocks included in the Dow Jones Life Insurance Index and that all dividends
were reinvested. The stock performance shown in this graph represents
past performance and should not be considered an indication of future
performance of Conseco’s common stock.
COMPARISON
OF CUMULATIVE TOTAL RETURN
AMONG
CONSECO, S&P 500 INDEX AND DOW JONES LIFE INSURANCE INDEX
|
Cumulative
Total Returns
|
12/31/04
|
12/31/05
|
12/31/06
|
12/31/07
|
12/31/08
|
12/31/09
|
||||||||||||||||||
|
DJ
Life Insurance Index
|
$ | 100 | $ | 122 | $ | 138 | $ | 147 | $ | 72 | $ | 86 | ||||||||||||
|
S&P
500 Index
|
$ | 100 | $ | 105 | $ | 121 | $ | 128 | $ | 81 | $ | 102 | ||||||||||||
|
Conseco,
Inc.
|
$ | 100 | $ | 116 | $ | 100 | $ | 63 | $ | 26 | $ | 25 | ||||||||||||
DIVIDENDS
The
Company does not anticipate declaring or paying cash dividends on its common
stock in the foreseeable future, and is currently limited in doing so pursuant
to our debt agreements. Please refer to “Management’s Discussion and
Analysis of Consolidated Financial Condition and Results of Operations –
Liquidity of the Holding Companies” for further discussion of these
restrictions.
43
ISSUER
PURCHASES OF EQUITY SECURITIES
|
Period
|
Total
number of
shares (or
units)
|
Average
price paid per share
(or
unit)
|
Total
number of
shares
(or units) purchased as part of publicly announced
plans or programs
|
Maximum
number (or approximate dollar value)
of
shares (or units) that
may
yet be purchased
under the plans or
programs
(a)
|
||||||||||||
|
(dollars
in millions)
|
||||||||||||||||
|
October
1 through October 31
|
- | - | - | $ | 262.8 | |||||||||||
|
November
1 through November 30
|
- | - | - | 262.8 | ||||||||||||
|
December
1 through December 31
|
- | - | - | 262.8 | ||||||||||||
|
Total
|
- | - | - | 262.8 | ||||||||||||
____________
|
(a)
|
On
December 21, 2006, the Company announced a common share repurchase program
of up to $150 million. On May 8, 2007, the Company announced
that the maximum amount that was authorized under the common share
repurchase program had been increased to $350
million.
|
EQUITY
COMPENSATION PLAN INFORMATION
The
following table summarizes information, as of December 31, 2009, relating to our
common stock that may be issued under the Conseco, Inc. Amended and Restated
Long-Term Incentive Plan.
|
Number
of securities
to
be issued upon exercise of outstanding options,
warrants or rights
|
Weighted-average
exercise price of outstanding options,
warrants or rights
|
Number
of securities remaining available for future issuance under equity
compensation plans (excluding securities
reflected in first column)
|
||||||||||
|
Equity
compensation plans approved by
security
holders
|
8,559,700 | $ | 11.65 | 12,565,204 | ||||||||
|
Equity
compensation plans not approved
by
security
holders
|
- | - | - | |||||||||
|
Total
|
8,559,700 | $ | 11.65 | 12,565,204 | ||||||||
44
|
Years
ended December 31,
|
||||||||||||||||||||
|
2009
|
2008
(a)
|
2007
(a)
|
2006
(a)
|
2005
(a)
|
||||||||||||||||
|
(Amounts
in millions, except per share data)
|
||||||||||||||||||||
|
STATEMENT
OF OPERATIONS DATA (b)
|
||||||||||||||||||||
|
Insurance
policy income
|
$ | 3,093.6 | $ | 3,253.6 | $ | 2,895.7 | $ | 2,696.4 | $ | 2,620.9 | ||||||||||
|
Net
investment income
|
1,292.7 | 1,178.8 | 1,369.8 | 1,350.8 | 1,222.8 | |||||||||||||||
|
Net
realized investment gains (losses)
|
(60.5 | ) | (262.4 | ) | (158.0 | ) | (46.6 | ) | (3.3 | ) | ||||||||||
|
Total
revenues
|
4,341.4 | 4,189.7 | 4,131.3 | 4,019.8 | 3,865.1 | |||||||||||||||
|
Interest
expense
|
117.9 | 106.5 | 125.3 | 81.0 | 61.0 | |||||||||||||||
|
Total
benefits and expenses
|
4,167.8 | 4,186.0 | 4,149.3 | 3,860.6 | 3,462.1 | |||||||||||||||
|
Income
(loss) before income taxes and discontinued operations
|
173.6 | 3.7 | (18.0 | ) | 159.2 | 403.0 | ||||||||||||||
|
Income
tax expense
|
87.9 | 413.3 | 61.1 | 58.3 | 143.1 | |||||||||||||||
|
Income
(loss) before discontinued operations
|
85.7 | (409.6 | ) | (79.1 | ) | 100.9 | 259.9 | |||||||||||||
|
Discontinued
operations, net of income taxes
|
- | (722.7 | ) | (105.9 | ) | .3 | 51.1 | |||||||||||||
|
Net
income (loss)
|
85.7 | (1,132.3 | ) | (185.0 | ) | 101.2 | 311.0 | |||||||||||||
|
Preferred
stock dividends
|
- | - | 14.1 | 38.0 | 38.0 | |||||||||||||||
|
Net
income (loss) applicable to common stock
|
85.7 | (1,132.3 | ) | (199.1 | ) | 63.2 | 273.0 | |||||||||||||
|
PER SHARE DATA
(b)
|
||||||||||||||||||||
|
Income
(loss) before discontinued operations, basic
|
$ | .45 | $ | (2.22 | ) | $ | (.54 | ) | $ | .42 | $ | 1.47 | ||||||||
|
Income
(loss) before discontinued operations, diluted
|
.45 | (2.22 | ) | (.54 | ) | .41 | 1.40 | |||||||||||||
|
Net
income, basic
|
.45 | (6.13 | ) | (1.15 | ) | .42 | 1.81 | |||||||||||||
|
Net
income, diluted
|
.45 | (6.13 | ) | (1.15 | ) | .41 | 1.68 | |||||||||||||
|
Book
value per common share outstanding
|
14.09 | 8.82 | 23.03 | 26.64 | 25.45 | |||||||||||||||
|
Weighted
average shares outstanding for basic earnings
|
188.4 | 184.7 | 173.4 | 151.7 | 151.2 | |||||||||||||||
|
Weighted
average shares outstanding for diluted earnings
|
193.3 | 184.7 | 173.4 | 152.5 | 185.0 | |||||||||||||||
|
Shares
outstanding at period-end
|
250.8 | 184.8 | 184.7 | 152.2 | 151.5 | |||||||||||||||
|
BALANCE SHEET DATA
-
AT PERIOD END
(b)
|
||||||||||||||||||||
|
Total
investments
|
$ | 21,530.2 | $ | 18,647.5 | $ | 21,324.5 | $ | 23,768.8 | $ | 23,424.6 | ||||||||||
|
Total
assets
|
30,343.8 | 28,763.3 | 33,961.5 | 33,580.2 | 32,871.0 | |||||||||||||||
|
Corporate
notes payable
|
1,037.4 | 1,311.5 | 1,167.6 | 966.4 | 809.4 | |||||||||||||||
|
Total
liabilities
|
26,811.4 | 27,133.3 | 29,709.2 | 28,858.6 | 28,347.4 | |||||||||||||||
|
Shareholders’
equity
|
3,532.4 | 1,630.0 | 4,252.3 | 4,721.6 | 4,523.6 | |||||||||||||||
|
STATUTORY
DATA – AT PERIOD END (c)
|
||||||||||||||||||||
|
Statutory
capital and surplus
|
$ | 1,410.7 | $ | 1,311.5 | $ | 1,336.2 | $ | 1,554.5 | $ | 1,603.8 | ||||||||||
|
Asset
valuation reserve (“AVR”)
|
28.2 | 55.0 | 161.3 | 179.1 | 142.7 | |||||||||||||||
|
Total
statutory capital and surplus and AVR
|
1,438.9 | 1,366.5 | 1,497.5 | 1,733.6 | 1,746.5 | |||||||||||||||
____________________
|
(a)
|
Selected
amounts have been restated to reflect the retrospective application of the
adoption of authoritative guidance that specifies that issuers of
convertible debt instruments that may be settled in cash upon conversion
(including partial cash settlement) should separately account for the
liability and equity components in a manner that will reflect the entity’s
nonconvertible debt borrowing rate when interest cost is recognized in
subsequent periods. The guidance has been applied
retrospectively to the years ended December 31, 2008, 2007, 2006 and
2005.
|
|
(b)
|
As
a result of the Transfer, as further discussed in the note to the
consolidated financial statements entitled “Transfer of Senior Health
Insurance Company of Pennsylvania to an Independent Trust”, a substantial
portion of our long-term care business is presented as discontinued
operations in our consolidated financial statements and prior periods have
been restated to conform with the current year
presentation.
|
45
|
(c)
|
We
have derived the statutory data from statements filed by our insurance
subsidiaries with regulatory authorities which are prepared in accordance
with statutory accounting principles, which vary in certain respects from
GAAP, and include amounts related to our discontinued operations in 2007,
2006 and 2005.
|
|
|
ITEM
7.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
|
In this
section, we review the consolidated financial condition of Conseco at December
31, 2009, and the consolidated results of operations for the years ended
December 31, 2009, 2008 and 2007 and, where appropriate, factors that may affect
future financial performance. Please read this discussion in
conjunction with the consolidated financial statements and notes included in
this Form 10-K.
CAUTIONARY
STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Our
statements, trend analyses and other information contained in this report and
elsewhere (such as in filings by Conseco with the SEC, press releases,
presentations by Conseco or its management or oral statements) relative to
markets for Conseco’s products and trends in Conseco’s operations or financial
results, as well as other statements, contain forward-looking statements within
the meaning of the federal securities laws and the Private Securities Litigation
Reform Act of 1995. Forward-looking statements typically are
identified by the use of terms such as “anticipate,” “believe,” “plan,”
“estimate,” “expect,” “project,” “intend,” “may,” “will,” “would,”
“contemplate,” “possible,” “attempt,” “seek,” “should,” “could,” “goal,”
“target,” “on track,” “comfortable with,” “optimistic” and similar words,
although some forward-looking statements are expressed
differently. You should consider statements that contain these words
carefully because they describe our expectations, plans, strategies and goals
and our beliefs concerning future business conditions, our results of
operations, financial position, and our business outlook or they state other
“forward-looking” information based on currently available
information. The “Risk Factors” in Item 1A provide examples of risks,
uncertainties and events that could cause our actual results to differ
materially from the expectations expressed in our forward-looking
statements. Assumptions and other important factors that could cause
our actual results to differ materially from those anticipated in our
forward-looking statements include, among other things:
|
·
|
our
ability to continue to satisfy the financial ratio and balance
requirements and other covenants of our debt
agreements;
|
|
·
|
general
economic, market and political conditions, including the performance and
fluctuations of the financial markets which may affect our ability to
raise capital or refinance existing indebtedness and the cost of doing
so;
|
|
·
|
our
ability to generate sufficient liquidity to meet our debt service
obligations and other cash needs;
|
|
·
|
our
ability to obtain adequate and timely rate increases on our supplemental
health products, including our long-term care
business;
|
|
·
|
the
receipt of any required regulatory approvals for dividend and surplus
debenture interest payments from our insurance
subsidiaries;
|
|
·
|
mortality,
morbidity, the increased cost and usage of health care services,
persistency, the adequacy of our previous reserve estimates and other
factors which may affect the profitability of our insurance
products;
|
|
·
|
changes
in our assumptions related to the cost of policies produced or the value
of policies in force at the effective
date;
|
|
·
|
the
recoverability of our deferred tax assets and the effect of potential
ownership changes and tax rate changes on its
value;
|
|
·
|
our
assumption that the positions we take on our tax return filings, including
our position that our 7.0% Debentures will not be treated as stock for
purposes of Section 382 of the Code and will not trigger an ownership
change, will not be successfully challenged by the
IRS;
|
46
|
·
|
changes
in accounting principles and the interpretation
thereof;
|
|
·
|
our
ability to achieve anticipated expense reductions and levels of
operational efficiencies including improvements in claims adjudication and
continued automation and rationalization of operating
systems,
|
|
·
|
performance
and valuation of our investments, including the impact of realized losses
(including other-than-temporary impairment
charges);
|
|
·
|
our
ability to identify products and markets in which we
can compete effectively against competitors with greater market
share, higher ratings, greater financial resources and stronger brand
recognition;
|
|
·
|
the
ultimate outcome of lawsuits filed against us and other legal and
regulatory proceedings to which we are
subject;
|
|
·
|
our
ability to complete the remediation of the material weakness in
internal controls over our actuarial reporting process and to maintain
effective controls over financial
reporting;
|
|
·
|
our
ability to continue to recruit and retain productive agents and
distribution partners and customer response to new products, distribution
channels and marketing initiatives;
|
|
·
|
our
ability to achieve eventual upgrades of the financial strength
ratings of Conseco and our insurance company subsidiaries as well as the
impact of rating downgrades on our business and our ability to access
capital;
|
|
·
|
the
risk factors or uncertainties listed from time to time in our filings with
the SEC;
|
|
·
|
regulatory
changes or actions, including those relating to regulation of the
financial affairs of our insurance companies, such as the payment of
dividends and surplus debenture interest to us, regulation of financial
services affecting (among other things) bank sales and underwriting of
insurance products, regulation of the sale, underwriting and pricing of
products, and health care regulation affecting health insurance products;
and
|
|
·
|
changes
in the Federal income tax laws and regulations which may affect or
eliminate the relative tax advantages of some of our
products.
|
Other
factors and assumptions not identified above are also relevant to the
forward-looking statements, and if they prove incorrect, could also cause actual
results to differ materially from those projected.
All
written or oral forward-looking statements attributable to us are expressly
qualified in their entirety by the foregoing cautionary
statement. Our forward-looking statements speak only as of the date
made. We assume no obligation to update or to publicly announce the
results of any revisions to any of the forward-looking statements to reflect
actual results, future events or developments, changes in assumptions or changes
in other factors affecting the forward-looking statements.
OVERVIEW
We are a
holding company for a group of insurance companies operating throughout the
United States that develop, market and administer supplemental health insurance,
annuity, individual life insurance and other insurance products. We
focus on serving the senior and middle-income markets, which we believe are
attractive, underserved, high growth markets. We sell our products
through three distribution channels: career agents, professional independent
producers (some of whom sell one or more of our product lines exclusively) and
direct marketing.
47
We manage
our business through the following: three primary operating segments,
Bankers Life, Colonial Penn and Conseco Insurance Group, which are defined on
the basis of product distribution; and corporate operations, which consists of
holding company activities and certain noninsurance company businesses that are
not part of our other segments. Our segments are described
below:
|
·
|
Bankers
Life,
which consists of
the business of Bankers Life and Casualty Company, markets and distributes
health and life insurance products and annuities to the middle-income
senior market through a dedicated field force of over 5,600 career agents
and sales managers supported by a network of over 150 community-based
branch offices. Products include Medicare supplement insurance,
life insurance, fixed annuities and long-term care
insurance. Bankers Life also markets and distributes Medicare
Part D prescription drug plans through a distribution and reinsurance
arrangement with Coventry and Medicare Advantage plans primarily through a
distribution arrangement with Humana.
|
|
·
|
Colonial
Penn
, which consists of the business of Colonial Penn, markets
primarily graded benefit and simplified issue life insurance directly to
customers through television advertising, direct mail, the internet and
telemarketing. Colonial Penn markets its products under its own
brand name.
|
|
·
|
Conseco
Insurance Group,
which markets and distributes specified disease
insurance, accident, disability, life insurance and annuities to
middle-income consumers at home and at the worksite. These
products are marketed through Performance Matters Associates, Inc., a
wholly owned subsidiary, and through independent marketing organizations
and insurance agencies. Products being marketed by Conseco
Insurance Group are underwritten by Conseco Insurance Company, Conseco
Health and Washington National. This segment also includes
blocks of long-term care and other insurance business, in these companies
and in Conseco Life, which we no longer
market.
|
48
The
following summarizes our earnings for the three years ending December 31, 2009
(dollars in millions, except per share data):
|
2009
|
2008
|
2007
|
||||||||||
|
Earnings
before net realized investment gains (losses), discontinued
operations,
corporate
interest, gain (loss) on extinguishment or modification of debt and income
taxes (“EBIT” a non-GAAP financial measure) (a):
|
||||||||||||
|
Bankers
Life
|
$ | 278.0 | $ | 171.5 | $ | 241.8 | ||||||
|
Colonial
Penn
|
29.4 | 25.2 | 18.1 | |||||||||
|
Conseco
Insurance Group
|
67.3 | 121.3 | (26.3 | ) | ||||||||
|
Corporate
Operations, excluding corporate interest expense
|
(37.7 | ) | (26.7 | ) | (49.0 | ) | ||||||
|
EBIT
|
337.0 | 291.3 | 184.6 | |||||||||
|
Corporate
interest expense
|
(84.7 | ) | (67.9 | ) | (80.3 | ) | ||||||
|
Income
before gain (loss) on extinguishment or modification of debt, net realized
investment losses, taxes and discontinued operations
|
252.3 | 223.4 | 104.3 | |||||||||
|
Tax
expense on operating income
|
87.7 | 86.4 | 35.9 | |||||||||
|
Income
before gain (loss) on extinguishment or modification of debt, net realized
investment losses, valuation allowance for deferred tax assets and
discontinued operations
|
164.6 | 137.0 | 68.4 | |||||||||
|
Preferred
stock dividends
|
- | - | (14.1 | ) | ||||||||
|
Net
operating income
|
164.6 | 137.0 | 54.3 | |||||||||
|
Gain
(loss) on extinguishment or modification of debt, net of income
taxes
|
(14.4 | ) | 13.8 | - | ||||||||
|
Net
realized investment losses (excluding the increase in unrealized losses on
those investments transferred to an independent trust and net of related
amortization and taxes and the establishment of a valuation allowance for
deferred tax assets related to such losses)
|
(41.5 | ) | (217.4 | ) | (79.5 | ) | ||||||
|
Net
income (loss) before valuation allowance for deferred tax assets and
discontinued operations
|
108.7 | (66.6 | ) | (25.2 | ) | |||||||
|
Valuation
allowance for deferred tax assets (excluding the establishment of a
valuation allowance for realized investment losses and discontinued
operations)
|
(23.0 | ) | (343.0 | ) | (68.0 | ) | ||||||
|
Discontinued
operations
|
- | (722.7 | ) | (105.9 | ) | |||||||
|
Net
income (loss) applicable to common stock
|
$ | 85.7 | $ | (1,132.3 | ) | $ | (199.1 | ) | ||||
|
Per
diluted share:
|
||||||||||||
|
Net
operating income
|
$ | .86 | $ | .74 | $ | .31 | ||||||
|
Gain
(loss) on extinguishment or modification of debt, net of income
taxes
|
(.08 | ) | .08 | - | ||||||||
|
Net
realized investment losses, net of related amortization and
taxes
|
(.21 | ) | (1.18 | ) | (.46 | ) | ||||||
|
Valuation
allowance for deferred tax assets
|
(.12 | ) | (1.86 | ) | (.39 | ) | ||||||
|
Discontinued
operations
|
- | (3.91 | ) | (.61 | ) | |||||||
|
Net
income (loss)
|
$ | .45 | $ | (6.13 | ) | $ | (1.15 | ) | ||||
____________
|
(a)
|
Management
believes that an analysis of EBIT provides a clearer comparison of the
operating results of the Company from period to period because it
excludes: (i) corporate interest expense; (ii) gain (loss) on
extinguishment or modification of debt; (iii) net realized investment
gains (losses) that are unrelated to the Company’s underlying
fundamentals; and (iv) discontinued operations and increases to our
valuation allowance for deferred tax assets, which are unrelated to our
continuing operations. The table above reconciles the non-GAAP
measure to the corresponding GAAP
measure.
|
49
Our major
goals for 2010 include:
|
·
|
Continuing
to improve the focus and profitability mix of sales at Conseco Insurance
Group.
|
|
·
|
Maintaining
strong growth at Bankers Life.
|
|
·
|
Improving
earnings stability and reducing
volatility.
|
|
·
|
Determining
that improved controls implemented in 2009 have operated for a period of
time sufficient to demonstrate their effectiveness and thereby remediating
our material weakness in internal
controls.
|
|
·
|
Continuing
to actively manage our enterprise exposure to long-term care
business.
|
|
·
|
Improving
profitability of existing lines of business or disposing of
underperforming blocks of business.
|
CRITICAL
ACCOUNTING POLICIES
The
preparation of financial statements in accordance with GAAP requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Management has made estimates in the
past that we believed to be appropriate but were subsequently revised to reflect
actual experience. If our future experience differs materially from
these estimates and assumptions, our results of operations and financial
condition could be affected.
We base
our estimates on historical experience and other assumptions that we believe are
reasonable under the circumstances. We continually evaluate the
information used to make these estimates as our business and the economic
environment change. The use of estimates is pervasive throughout our
financial statements. The accounting policies and estimates we
consider most critical are summarized below. Additional information
on our accounting policies is included in the note to our consolidated financial
statements entitled “Summary of Significant Accounting Policies”.
Investments
At
December 31, 2009, the carrying value of our investment portfolio was $21.5
billion.
We defer
any fees received or costs incurred when we originate investments. We
amortize fees, costs, discounts and premiums as yield adjustments over the
contractual lives of the investments. We consider anticipated
prepayments on structured securities when we estimate yields on such
securities. When actual prepayments differ from our estimates, the
adjustment to yield is recognized as investment income (loss).
We
regularly evaluate our investments for possible impairment based on current
economic conditions, credit loss experience and other investee-specific
circumstances and developments. When we conclude that a decline in a
security’s net realizable value is other than temporary, the decline is
recognized as a realized loss and the cost basis of the security is reduced to
its estimated fair value. During the year ended December 31, 2009,
writedowns of investments included $195.4 million of writedowns of investments
for other than temporary declines in fair value recognized through net
income.
Our
evaluation of investments for impairment requires significant judgments,
including: (i) the identification of potentially impaired securities; (ii) the
determination of their estimated fair value; and (iii) the assessment of whether
any decline in estimated fair value is other than temporary.
Our
assessment of whether unrealized losses are “other than temporary” requires
significant judgment. Factors considered include: (i) the extent to
which fair value is less than the cost basis; (ii) the length of time that the
fair value has been less than cost; (iii) whether the unrealized loss is
event-driven, credit-driven or a result of changes in market risk premium or
interest rates; (iv) the near-term prospects for improvement in the issuer
and/or its industry; (v) our view of the investment’s rating and whether the
investment is investment-grade and/or has been downgraded since its purchase;
(vi) whether the issuer is current on all payments in accordance with the
contractual terms of the investment and is expected to meet all of its
obligations under the terms of the investment; (vii) our ability and intent to
hold the investment for a period of time sufficient to allow for any anticipated
recovery; and (viii) the underlying current and prospective asset and
enterprise
50
values of
the issuer and the extent to which our investment may be affected by changes in
such values. At December 31, 2009, our net accumulated other
comprehensive income (loss) included gross unrealized losses on fixed maturity
securities of $.9 billion, which we consider to be temporary declines in
estimated fair value.
When the
cost basis of a security is written down to fair value due to an other than
temporary decline, we review the circumstances of that particular investment in
relation to other investments in our portfolio. If such circumstances
exist with respect to other investments, those investments may also be written
down to fair value. Future events may occur, or additional or updated
information may become available, which may necessitate future realized losses
of securities in our portfolio. If new information becomes available
or the financial condition of the investee changes, our judgments may change
resulting in the recognition of a realized investment loss at that
time. Significant realized losses on our investments could have a
material adverse effect on our earnings in future periods.
Fair
value is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date and, therefore, represents an exit price, not an entry
price. We hold fixed maturities, equity securities, derivatives and
separate account assets, which are carried at fair value.
The
degree of judgment utilized in measuring the fair value of financial instruments
is largely dependent on the level to which pricing is based on observable
inputs. Observable inputs reflect market data obtained from
independent sources, while unobservable inputs reflect our view of market
assumptions in the absence of observable market
information. Financial instruments with readily available active
quoted prices would be considered to have fair values based on the highest level
of observable inputs, and little judgment would be utilized in measuring fair
value. Financial instruments that rarely trade would be considered to
have fair value based on a lower level of observable inputs, and more judgment
would be utilized in measuring fair value.
There is
a three-level hierarchy for valuing assets or liabilities at fair value based on
whether inputs are observable or unobservable.
|
·
|
Level
1 – includes assets and liabilities valued using inputs that are quoted
prices in active markets for identical assets or
liabilities. Our Level 1 assets include exchange traded
securities and U.S. Treasury
securities.
|
|
·
|
Level
2 – includes assets and liabilities valued using inputs that are quoted
prices for similar assets in an active market, quoted prices for identical
or similar assets in a market that is not active, observable inputs, or
observable inputs that can be corroborated by market
data. Level 2 assets and liabilities include those financial
instruments that are valued by independent pricing services using models
or other valuation methodologies. These models are primarily
industry-standard models that consider various inputs such as interest
rate, credit spread, reported trades, broker/dealer quotes, issuer spreads
and other inputs that are observable or derived from observable
information in the marketplace or are supported by observable levels at
which transactions are executed in the marketplace. Financial
instruments in this category primarily include: certain public
and private corporate fixed maturity securities; certain government or
agency securities; certain mortgage and asset-backed securities; and
non-exchange-traded derivatives such as call options to hedge liabilities
related to our equity-indexed annuity
products.
|
|
·
|
Level
3 – includes assets and liabilities valued using unobservable inputs that
are used in model-based valuations that contain management
assumptions. Level 3 assets and liabilities include those
financial instruments whose fair value is estimated based on non-binding
broker prices or internally developed models or methodologies utilizing
significant inputs not based on, or corroborated by, readily available
market information. Financial instruments in this category
include certain corporate securities (primarily private placements),
certain mortgage and asset-backed securities, and other less liquid
securities. Additionally, the Company’s liabilities for
embedded derivatives (including embedded derivates related to our
equity-indexed annuity products and to a modified coinsurance arrangement)
are classified in Level 3 since their values include significant
unobservable inputs including actuarial
assumptions.
|
At each
reporting date, we classify assets and liabilities into the three input levels
based on the lowest level of input that is significant to the measurement of
fair value for each asset and liability reported at fair value. This
classification is impacted by a number of factors, including the type of
financial instrument, whether the financial instrument is new to the market and
not yet established, the characteristics specific to the transaction and overall
market conditions. Our assessment of the significance of a particular
input to the fair value measurement and the ultimate classification of each
asset and liability requires judgment. The vast majority of our fixed
maturity securities and separate account assets use Level 2 inputs for the
determination of fair value.
51
Below-investment
grade securities generally have different characteristics than investment grade
corporate debt securities. Based on historical performance,
likelihood of default by the borrower is significantly greater for
below-investment grade securities and in many cases, severity of loss is
relatively greater as such securities are often subordinated to other
indebtedness of the issuer. Also, issuers of below-investment grade
securities may be more financially leveraged hence, all other things being
equal, more sensitive to adverse economic conditions, such as recession or
increasing interest rates. The Company attempts to reduce the overall
risk related to its investment in below-investment grade securities, as in all
investments, through careful credit analysis, strict investment policy
guidelines, and diversification by issuer and/or guarantor and by
industry.
Our fixed
maturity investments are generally purchased in the context of a long-term
strategy to fund insurance liabilities, so we do not generally seek to purchase
and sell such securities to generate short-term realized gains. In
certain circumstances, including those in which securities are selling at prices
which exceed our view of their current fair value, and it is possible to
reinvest the proceeds to better meet our long-term asset-liability objectives,
we may sell certain securities. During 2009, we sold $1.3 billion of
fixed maturity investments which resulted in gross investment losses (before
income taxes) of $233.9 million. We sell securities at a loss for a
number of reasons including, but not limited to: (i) changes in the investment
environment; (ii) expectation that the fair value could deteriorate further;
(iii) desire to reduce our exposure to an issuer or an industry; (iv) changes in
credit quality; or (v) changes in expected liability cash flows.
We
generally seek to balance the duration and cash flows of our invested assets
with the estimated duration and cash flows of benefit payments arising from
contract liabilities. These efforts may cause us to sell investments
before their maturity date and could result in the realization of net realized
investment gains (losses). 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. In certain circumstances, a mismatch of the durations
or related cash flows of invested assets and insurance liabilities could have a
significant impact on our results of operations and financial
position. See “— Quantitative and Qualitative Disclosures About
Market Risks” for additional discussion of the duration of our invested assets
and insurance liabilities.
For more
information on our investment portfolio and our critical accounting policies
related to investments, see the note to our consolidated financial statements
entitled “Investments”.
Value
of Policies Inforce at the Effective Date and Cost of Policies
Produced
In
conjunction with the implementation of fresh start accounting, we eliminated the
historical balances of our Predecessor’s cost of policies purchased and cost of
policies produced as of the Effective Date and replaced them with the value of
policies inforce at the Effective Date.
The value
assigned to the right to receive future cash flows from contracts existing at
the Effective Date is referred to as the value of policies inforce at the
Effective Date. We also defer renewal commissions paid in excess of
ultimate commission levels related to the existing policies in this
account. The balance of this account is amortized, evaluated for
recovery, and adjusted for the impact of unrealized gains (losses) in the same
manner as the cost of policies produced described below. We expect to
amortize approximately 13 percent of the December 31, 2009 balance of value of
policies inforce in 2010, 11 percent in 2011, 10 percent in 2012, 9 percent in
2013 and 7 percent in 2014.
The cost
of policies produced are those costs that vary with, and are primarily related
to, producing new insurance business in the period after September 10,
2003. For universal life or investment products, we amortize these
costs using the interest rate credited to the underlying policy in relation to
the estimated gross profits. For other products, we amortize these
costs using the projected investment earnings rate in relation to future
anticipated premium revenue. The value of policies inforce and the
cost of policies produced are collectively referred to as “insurance acquisition
costs.”
Insurance
acquisition costs are amortized to expense over the lives of the underlying
policies in relation to future anticipated premiums or gross
profits. The insurance acquisition costs for policies other than
universal life and investment-type products are amortized with interest (using
the projected investment earnings rate) over the estimated premium-paying period
of the policies, in a manner which recognizes amortization expense in proportion
to each year’s premium income. The insurance acquisition costs for
universal life and investment-type products are amortized with interest (using
the interest rate credited to the underlying policy) in proportion to estimated
gross profits. The interest, mortality, morbidity and persistency
assumptions used to amortize insurance acquisition costs are consistent with
those assumptions used to estimate liabilities for insurance
products. For universal life and investment-type products, these
assumptions are reviewed on a regular basis.
52
When
actual profits or our current best estimates of future profits are different
from previous estimates, we adjust cumulative amortization of insurance
acquisition costs to maintain amortization expense as a constant percentage of
gross profits over the entire life of the policies.
The
blocks of universal life and interest-sensitive products in the Conseco
Insurance Group segment have not performed in accordance with prior estimates of
future gross profits, resulting in adjustments to amortization expense over the
last 3 years. For a description of these adjustments, see
“Management’s Discussion and Analysis of Consolidated Financial Condition and
Results of Operations – Results of Operations – Conseco Insurance Group –
Amortization Related to Operations”.
When we
realize a gain or loss on investments backing our universal life or
investment-type products, we adjust the amortization of insurance acquisition
costs to reflect the change in estimated gross profits from the products due to
the gain or loss realized and the effect on future investment
yields. We decreased amortization expense for such changes by $4.0
million, $21.5 million and $35.7 million during the years ended December 31,
2009, 2008 and 2007, respectively. We also adjust insurance
acquisition costs for the change in amortization that would have been recorded
if actively managed fixed maturity securities had been sold at their stated
aggregate fair value and the proceeds reinvested at current
yields. We include the impact of this adjustment in accumulated other
comprehensive income (loss) within shareholders’ equity. We limit the
total adjustment related to unrealized losses to the total of the costs
capitalized plus interest (or the total value of policies inforce recognized at
the Effective Date plus interest with respect to the value of policies inforce
at the Effective Date) related to insurance policies issued in a particular year
(or policies inforce at the Effective Date with respect to the value of policies
inforce at the Effective Date). The investment environment during the
fourth quarter of 2008 resulted in significant net unrealized losses in our
actively managed fixed maturity investment portfolio. The total
adjustment to accumulated other comprehensive income related to the change in
the cost of policies produced for the negative amortization that would have been
recorded if actively managed fixed maturity securities had been sold at their
stated aggregate fair value would have resulted in the balance of the cost of
policies produced exceeding the total of costs capitalized plus interest for
annuity blocks of business issued in certain years. Accordingly, the
adjustment made to the cost of policies produced and accumulated other
comprehensive income was reduced by $206 million. The total pre-tax
impact of such adjustments on accumulated other comprehensive income (loss) was
an increase of $70.5 million at December 31, 2009.
At
December 31, 2009, the balance of insurance acquisition costs was $3.0
billion. The recoverability of this amount is dependent on the future
profitability of the related business. Each year, we evaluate the
recoverability of the unamortized balance of insurance acquisition
costs. These evaluations are performed to determine whether estimates
of the present value of future cash flows, in combination with the related
liability for insurance products, will support the unamortized
balance. These future cash flows are based on our best estimate of
future premium income, less benefits and expenses. The present value
of these cash flows, plus the related balance of liabilities for insurance
products, is then compared with the unamortized balance of insurance acquisition
costs. In the event of a deficiency, such amount would be charged to
amortization expense. The determination of future cash flows involves
significant judgment. Revisions to the assumptions which determine
such cash flows could have a significant adverse effect on our results of
operations and financial position.
The table
presented below summarizes our estimates of cumulative adjustments to insurance
acquisition costs resulting from hypothetical revisions to certain
assumptions. Although such hypothetical revisions are not currently
required or anticipated, we believe they could occur based on past variances in
experience and our expectations of the ranges of future experience that could
reasonably occur. We have assumed that revisions to assumptions
resulting in the adjustments summarized below would occur equally among policy
types, ages and durations within each product classification. Any
actual adjustment would be dependent on the specific policies affected and,
therefore, may differ from the estimates summarized below. In
addition, the impact of actual adjustments would reflect the net effect of all
changes in assumptions during the period.
53
|
Estimated
adjustment to
|
||||
|
income
before
|
||||
|
income
taxes based on
|
||||
|
Change in assumptions
|
revisions to certain
assumptions
|
|||
|
(dollars
in millions)
|
||||
|
Universal
life-type products (a):
|
||||
|
5%
increase to assumed
mortality
|
$ | (99.4 | ) | |
|
5%
decrease to assumed
mortality
|
101.2 | |||
|
15%
increase to assumed
expenses
|
(22.6 | ) | ||
|
15%
decrease to assumed
expenses
|
23.7 | |||
|
10
basis point decrease to assumed
spread
|
(24.4 | ) | ||
|
10
basis point increase to assumed
spread
|
24.2 | |||
|
10%
increase to assumed
lapses
|
(7.5 | ) | ||
|
10%
decrease to assumed
lapses
|
7.4 | |||
|
Investment-type
products:
|
||||
|
20%
increase to assumed
surrenders
|
(52.5 | ) | ||
|
20%
decrease to assumed
surrenders
|
67.2 | |||
|
15%
increase to assumed
expenses
|
(5.8 | ) | ||
|
15%
decrease to assumed
expenses
|
5.8 | |||
|
10
basis point decrease to assumed
spread
|
(26.7 | ) | ||
|
10
basis point increase to assumed
spread
|
27.2 | |||
|
Other
than universal life and investment-type products (b):
|
||||
|
5%
increase to assumed
morbidity
|
(179.2 | ) | ||
|
50
basis point decrease to investment earnings rate
|
(125.7 | ) | ||
____________________
|
(a)
|
A
significant portion of our universal life-type products inforce are in
loss recognition status. A favorable change in experience on
such blocks may slow down future amortization; however, the current period
adjustment to insurance acquisition costs would be small. This
causes the downside sensitivities above to be lower in magnitude than the
upside results.
|
|
(b)
|
We
have excluded the effect of reasonably likely changes in mortality, lapse,
surrender and expense assumptions for policies other than universal life
and investment-type products. Our estimates indicate such
changes would not result in any portion of the $2.2 billion balance of
unamortized insurance acquisition costs related to these policies being
unrecoverable.
|
54
The following summarizes the
persistency of our major blocks of insurance business summarized by segment and
line of business:
|
Years
ended December 31,
|
||||||||||||
|
2009
|
2008
|
2007
|
||||||||||
|
Bankers
Life:
|
||||||||||||
|
Medicare
supplement
(1)
|
85.2 | % | 83.7 | % | 83.5 | % | ||||||
|
Long-term
care (1)
(4)
|
87.9 | % | 90.4 | % | 91.0 | % | ||||||
|
Equity-indexed
annuities
(2)
|
87.6 | % | 88.0 | % | 87.1 | % | ||||||
|
Other
annuities (2)
(5)
|
87.0 | % | 84.3 | % | 84.0 | % | ||||||
|
Life
(1)
(6)
|
87.4 | % | 87.3 | % | 87.7 | % | ||||||
|
Colonial
Penn:
|
||||||||||||
|
Life
(1)
(6)
|
86.4 | % | 86.0 | % | 87.3 | % | ||||||
|
Conseco
Insurance Group:
|
||||||||||||
|
Medicare
supplement (1)
(3)
|
78.9 | % | 77.8 | % | 75.6 | % | ||||||
|
Long-term
care (1)
(6)
|
92.2 | % | 92.1 | % | 92.7 | % | ||||||
|
Specified
disease (1)
(6)
|
89.6 | % | 90.3 | % | 91.9 | % | ||||||
|
Equity-indexed
annuities (2)
(7)
|
82.6 | % | 86.5 | % | 91.4 | % | ||||||
|
Other
annuities (2)
(5)
|
93.3 | % | 80.6 | % | 89.5 | % | ||||||
|
Life
(1)
(6)
|
92.4 | % | 93.4 | % | 93.7 | % | ||||||
____________
|
|
(1)
|
Based
on number of inforce policies.
|
|
|
(2)
|
Based
on the percentage of the inforce block
persisting.
|
|
|
(3)
|
The
persistency rates during 2009 are slightly higher than our expectations
for this block.
|
|
|
(4)
|
Bankers
Life has been implementing premium rate increases on certain policies in
this block. Some policyholders have chosen to lapse their
policies rather than pay the increased premium rate. Refer to
“Management’s Discussion and Analysis of Financial Condition and Results
of Operations – Bankers Life – Insurance Policy Benefits” for additional
information.
|
|
|
(5)
|
We
have noted an increase in persistency rates for other annuity products
(consisting primarily of fixed rate annuity policies). We
believe this increase is related to the lack of competing investment
products which would offer higher returns for
consumers.
|
|
|
(6)
|
These
persistency rates are generally in line with our
expectations.
|
|
|
(7)
|
This
block of business has experienced higher than anticipated surrenders
during 2009. The annuities which are experiencing higher
surrenders have a MVA feature, which effectively reduced (or in some cases
eliminated) the charges paid upon the surrender of these policies as the
10-year treasury rate dropped to historic lows. The impact of
both the historical experience and projected increased surrender activity
and higher MVA benefits has reduced our expectations on the profitability
of the annuity block of Conseco Insurance Group to approximately
break-even. Refer to “Management’s Discussion and Analysis of
Financial Condition and Results of Operations – Conseco Insurance Group –
Amortization Related to Operations” for additional
information.
|
Liabilities
for Insurance Products – reserves for the future payment of long-term care
policy claims
We
calculate and maintain reserves for the future payment of claims to our
policyholders based on actuarial assumptions. For all our insurance
products, we establish an active life reserve, a liability for due and unpaid
claims, claims in the course of settlement and incurred but not reported
claims. In addition, for our supplemental health insurance business,
we establish a reserve for the present value of amounts not yet due on
claims. Many factors can affect these reserves and liabilities, such
as economic and social conditions, inflation, hospital and pharmaceutical costs,
changes in doctrines of legal liability and extra-contractual damage
awards. Therefore, our reserves and liabilities are necessarily based
on numerous estimates and assumptions as well as historical
experience. Establishing reserves is an uncertain process, and it is
possible that actual claims will materially exceed our reserves and have a
material adverse effect on our results of operations and financial
condition. For example, our long-term care policy claims may be paid
over a long period of time and, therefore, loss estimates have a higher degree
of uncertainty. We have incurred significant losses beyond our
estimates as a result of actual claim costs and persistency of our long-term
care business of Senior Health and Washington National. The long-term
care business of Senior Health was transferred to an independent trust in 2008
and Conseco no longer has any liability for this business. Estimates
of unpaid losses related to long-term care business have a higher degree of
uncertainty than
55
estimates
for our other products due to the range of ultimate duration of these claims and
the resulting variability in their cost (in addition to the variations in the
lag time in reporting claims). We would not consider a variance of
5-10 percentage points from the initial expected loss ratio to be
unusual. As an example, an increase in the initial loss ratio of 5-10
percentage points for claims incurred in 2009 related to our long-term care
business (in both our Bankers Life and Conseco Insurance Group segments) would
result in a decrease in our earnings of approximately $35 to $70 million.
Our financial results
depend significantly upon the extent to which our actual claims experience is
consistent with the assumptions we used in determining our reserves and pricing
our products. If our assumptions with respect to future claims are
incorrect, and our reserves are insufficient to cover our actual losses and
expenses, we would be required to increase our liabilities, which would
negatively affect our operating results.
Accounting
for marketing and reinsurance agreements with Coventry
Prescription
Drug Benefit
The MMA
provided for the introduction of a PDP product. In order to offer
this product to our current and potential future policyholders without investing
in management and infrastructure, we entered into a national distribution
agreement with Coventry to use our career and independent agents to distribute
Coventry’s prescription drug plan, Advantra Rx. We receive a fee
based on the premiums collected on plans sold through our distribution
channels. In addition, Conseco has a quota-share reinsurance
agreement with Coventry for Conseco enrollees that provides Conseco with 50
percent of net premiums and related policy benefits subject to a risk
corridor. The Part D program was effective January 1,
2006.
The
following describes how we account for and report our PDP business:
Our
accounting for the national distribution agreement
|
·
|
For
contracts sold prior to 2009, we recognize distribution and licensing fee
income from Coventry based upon negotiated percentages of collected
premiums on the underlying Medicare Part D contracts. For
contracts sold in 2009 and thereafter, we recognize distribution income
based on a fixed fee per PDP contract. This fee income is
recognized over the calendar year term as premiums are
collected.
|
|
·
|
We
also pay commissions to our agents who sell the plans on behalf of
Coventry. These payments are deferred and amortized over the
remaining term of the initial enrollment period (the one-year life of the
initial policy).
|
Our
accounting for the quota-share agreement
|
·
|
We
recognize premium revenue evenly over the period of the underlying
Medicare Part D contracts.
|
|
·
|
We
recognize policyholder benefits and ceding commission expense as
incurred.
|
|
·
|
We
recognize risk-share premium adjustments consistent with Coventry’s
risk-share agreement with the Centers for Medicare and Medicaid
Services.
|
56
The
following summarizes the pre-tax income (loss) of the PDP business (dollars in
millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Insurance
policy
income
|
$ | 78.6 | $ | 67.1 | $ | 70.8 | ||||||
|
Fee
revenue and
other
|
2.8 | 2.6 | 2.4 | |||||||||
|
Total
revenues
|
81.4 | 69.7 | 73.2 | |||||||||
|
Insurance
policy
benefits
|
66.6 | 62.3 | 57.2 | |||||||||
|
Commission
expense
|
7.7 | 6.0 | 6.4 | |||||||||
|
Other
operating
expenses
|
.6 | 2.1 | 1.0 | |||||||||
|
Total
expense
|
74.9 | 70.4 | 64.6 | |||||||||
|
Pre-tax
income
(loss)
|
$ | 6.5 | $ | (.7 | ) | $ | 8.6 | |||||
Private-Fee-For-Service
Conseco
expanded its strategic alliance with Coventry by entering into a national
distribution agreement under which our career agents began distributing
Coventry’s PFFS plan, beginning January 1, 2007. The Advantra Freedom
product is a Medicare Advantage plan designed to provide seniors with more
choices and better coverage at lower cost than original Medicare and Medicare
Advantage plans offered through HMOs. Under the agreement, we
received a fee based on the number of PFFS plans sold through our distribution
channels. In addition, Conseco had a quota-share reinsurance
agreement with Coventry for Conseco enrollees that provided Conseco with a
specified percentage of the net premiums and related
profits. Coventry decided to cease selling PFFS plans effective
January 1, 2010. In July 2009, we announced a strategic alliance
under which we would offer Humana’s Medicare Advantage plans to our
policyholders and consumers through our career agency force and will receive
marketing fees based on sales. Effective January 1, 2010, we will no
longer be assuming the underwriting risk related to PFFS business.
We
received distribution fees from Coventry and we paid sales commissions to our
agents for these enrollments. In addition, we received a specified
percentage of the income (loss) related to this business pursuant to a
quota-share agreement with Coventry.
The
following summarizes our accounting and reporting practices for the PFFS
business.
Our
accounting for the distribution agreement
|
·
|
We
received distribution income from Coventry and other parties based on a
fixed fee per PFFS contract. This income was deferred and
recognized over the remaining calendar year term of the initial enrollment
period.
|
|
·
|
We
also paid commissions to our agents who sell the plans on behalf of
Coventry and other parties. These payments were deferred and
amortized over the remaining term of the initial enrollment period (the
one-year life of the initial
policy).
|
Our
accounting for the quota-share agreement
|
·
|
We
recognized revenue evenly over the period of the underlying PFFS
contracts.
|
|
·
|
We
recognized policyholder benefits and ceding commission expense as
incurred.
|
57
The following summarizes the pre-tax
income (loss) of the PFFS business (dollars in millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Insurance
policy
income
|
$ | 318.2 | $ | 228.9 | $ | 100.8 | ||||||
|
Fee
revenue and
other
|
8.4 | 8.3 | 8.6 | |||||||||
|
Total
revenues
|
326.6 | 237.2 | 109.4 | |||||||||
|
Insurance
policy
benefits
|
286.4 | 221.7 | 82.7 | |||||||||
|
Commission
expense
|
12.4 | 8.0 | 4.2 | |||||||||
|
Other
operating
expenses
|
6.2 | 12.7 | 8.8 | |||||||||
|
Total
expense
|
305.0 | 242.4 | 95.7 | |||||||||
|
Pre-tax
income
(loss)
|
$ | 21.6 | $ | (5.2 | ) | $ | 13.7 | |||||
Large
Group Private-Fee-For-Service Blocks
During
2007 and 2008, Conseco entered into three quota-share reinsurance agreements
with Coventry related to the PFFS business written by Coventry under certain
group policies. Conseco received a specified percentage of the net
premiums and related profits associated with this business as long as the ceded
revenue margin was less than or equal to five percent. Conseco
received a specified percentage of the net premiums and related profits on the
ceded margin in excess of five percent. In order to reduce the
required statutory capital associated with the assumption of this business,
Conseco terminated two group policy quota-share agreements as of December 31,
2008 and terminated the last agreement on June 30, 2009. The
following summarizes the premiums assumed, related expenses and pre-tax income
of this business (dollars in millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Premiums
assumed
|
$ | 47.5 | $ | 313.5 | $ | 99.8 | ||||||
|
Policy
benefits
|
31.8 | 301.1 | 91.2 | |||||||||
|
Commission
expense
|
1.7 | 12.0 | 4.1 | |||||||||
|
Total
expenses
|
33.5 | 313.1 | 95.3 | |||||||||
|
Pre-tax
income
|
$ | 14.0 | $ | .4 | $ | 4.5 | ||||||
Income Taxes
Our
income tax expense includes deferred income taxes arising from temporary
differences between the financial reporting and tax bases of assets and
liabilities, capital loss carryforwards and NOLs. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply in the
years in which temporary differences are expected to be recovered or
paid. The effect of a change in tax rates on deferred tax assets and
liabilities is recognized in earnings in the period when the changes are
enacted.
Authoritative
guidance requires a reduction of the carrying amount of deferred tax assets by
establishing a valuation allowance if, based on the available evidence, it is
more likely than not that such assets will not be realized. We
evaluate the need to establish a valuation allowance for our deferred income tax
assets on an ongoing basis. In evaluating our deferred income tax
assets, we consider whether the deferred income tax assets will be realized,
based on the more-likely-than-not realization threshold
criterion. The ultimate realization of our deferred income tax assets
depends upon generating sufficient future taxable income during the periods in
which our temporary differences become deductible and before our capital loss
carryforwards and NOLs expire. This assessment requires significant
judgment. In assessing the need for a valuation allowance,
appropriate consideration is given to all positive and negative evidence related
to the realization of the deferred tax assets. This assessment
considers, among other matters, the nature, frequency and severity of current
and cumulative losses, forecasts of future profitability, excess appreciated
asset value over the tax basis of net assets, the duration of
58
carryforward
periods, our experience with operating loss and tax credit carryforwards
expiring unused, and tax planning alternatives.
Concluding
that a valuation allowance is not required is difficult when there has been
significant negative evidence, such as cumulative losses in recent
years. We utilize a three year rolling calculation of actual income
before income taxes as our primary measure of cumulative losses in recent
years. Our analysis of whether there needs to be further increases to
the deferred tax valuation allowance recognizes that as of December 31, 2009, we
have incurred a cumulative loss over the evaluation period, resulting from the
substantial loss during 2008 primarily related to the Transfer as described in
the note to these consolidated financial statements entitled “Transfer of Senior
Health Insurance Company of Pennsylvania to an Independent Trust”. As
a result of the cumulative losses recognized in recent years, our evaluation of
the need to increase the valuation allowance for deferred tax assets was
primarily based on our historical earnings. However, because a
substantial portion of the cumulative losses for the three-year period ended
December 31, 2009, relates to transactions to dispose of blocks of businesses,
we have adjusted the three-year cumulative results for the income and losses
from the blocks of business disposed of in the past and the business transferred
as further described in the note to these financial statements entitled
“Transfer of Senior Health Insurance Company of Pennsylvania to an Independent
Trust”. In addition, we have adjusted the three-year cumulative
results for a significant litigation settlement and the worthlessness of certain
loans made by our Predecessor. We consider these to be non-recurring
matters and have reflected our best estimates of when temporary differences will
reverse over the carryforward periods.
In order
to support the utilization of the tax benefits of NOLs that do not have an
offsetting valuation allowance, we project future taxable income based on our
historical earnings adjusted for the items described in the previous
paragraph. Based on these projections, we must generate approximately
$200 million for each year through 2018 in order to utilize the tax benefits of
our NOLs which expire through that date. The taxable income
requirements are substantially comprised of life insurance income, as the
potential tax benefits related to our non-life NOLs are substantially offset by
a valuation allowance. Our taxable income for 2009 was $308.1 million
before deductions related to the worthlessness of certain loans made by our
Predecessor, and we expect our future taxable income to be adequate to utilize
the remaining NOLs. The projections of future taxable income used to
support the recovery of our NOLs do not anticipate the use of any tax planning
strategies that we would consider to avoid a tax benefit from
expiring.
At
December 31, 2009, our valuation allowance for our net deferred tax assets was
$1.2 billion, as we have determined that it is more likely than not that a
portion of our deferred tax assets will not be realized. This
determination was made by evaluating each component of the deferred tax asset
and assessing the effects of limitations and/or interpretations on the value of
such component to be fully recognized in the future. We have also
evaluated the likelihood that we will have sufficient taxable income to offset
the available deferred tax assets based on evidence which we consider to be
objective and verifiable. Based upon our analysis completed at December 31,
2009, we believe that we will, more likely than not, recover $1.1 billion of our
deferred tax assets through reductions of our tax liabilities in future
periods.
Changes
in our valuation allowance are summarized as follows (dollars in
millions):
|
Balance
at December 31,
2006
|
$ | 777.8 | |||
|
Increase
in
2007
|
68.0 | ||||
|
Expiration
of capital loss
carryforwards
|
(157.6 | ) | |||
|
Write-off
of certain state NOLs (recovery is remote)
|
(15.3 | ) | |||
|
Balance
at December 31,
2007
|
672.9 | ||||
|
Increase
in
2008
|
856.2 |
(a)
|
|||
|
Expiration
of capital loss
carryforwards
|
(209.7 | ) | |||
|
Write-off
of capital loss carryforwards related to Senior Health
|
(133.2 | ) | |||
|
Write-off
of certain NOLs related to Senior Health
|
(5.5 | ) | |||
|
Balance
at December 31,
2008
|
1,180.7 | ||||
|
Increase
in
2009
|
27.8 |
(b)
|
|||
|
Expiration
of capital loss
carryforwards
|
(32.1 | ) | |||
|
Balance
at December 31,
2009
|
$ | 1,176.4 |
59
____________________
|
(a)
|
The
$856.2 million increase to our valuation allowance during 2008 included
increases of: (i) $452 million of deferred tax assets related
to Senior Health, which was transferred to an independent trust during
2008; (ii) $298 million related to our reassessment of the recovery of our
deferred tax assets in accordance with GAAP, following the additional
losses incurred as a result of the transaction to transfer Senior Health
to an independent trust; (iii) $60 million related to the recognition of
additional realized investment losses for which we are unlikely to receive
any tax benefit; and (iv) $45 million related to the projected additional
future expense following the modifications to our Senior Credit Agreement
as described in the note to these consolidated financial statements
entitled “Notes Payable – Direct Corporate
Obligations.”
|
|
(b)
|
The
$27.8 million increase to our valuation allowance during 2009 included
increases of: (i) $23.0 million related to our reassessment of
the recovery of our deferred tax assets following the completion of
reinsurance transactions in 2009; and (ii) $4.8 million related to the
recognition of additional realized investment losses for which we are
unlikely to receive any tax
benefit.
|
Recovery
of our deferred tax assets is dependent on achieving the projections of future
taxable income embedded in our analysis and failure to do so would result in an
increase in the valuation allowance in a future period. Any future
increase in the valuation allowance may result in additional income tax expense
and reduce shareholders’ equity, and such an increase could have a significant
impact upon our earnings in the future. In addition, the use of the
Company’s NOLs is dependent, in part, on whether the IRS does not take an
adverse position in the future regarding the tax position we have taken in our
tax returns with respect to the allocation of cancellation of indebtedness
income.
The Code
limits the extent to which losses realized by a non-life entity (or entities)
may offset income from a life insurance company (or companies) to the lesser
of: (i) 35 percent of the income of the life insurance company; or
(ii) 35 percent of the total loss of the non-life entities (including NOLs of
the non-life entities). There is no similar limitation on the extent
to which losses realized by a life insurance entity (or entities) may offset
income from a non-life entity (or entities).
Section
382 imposes limitations on a corporation’s ability to use its NOLs when the
company undergoes an ownership change. Future transactions and the
timing of such transactions could cause an ownership change for Section 382
income tax purposes. Such transactions may include, but are not
limited to, additional repurchases or issuances of common stock (including upon
conversion of our outstanding 3.5% Debentures or 7.0% Debentures), or
acquisitions or sales of shares of Conseco stock by certain holders of our
shares, including persons who have held, currently hold or may accumulate in the
future five percent or more of our outstanding common stock for their own
account. Many of these transactions are beyond our
control. If an additional ownership change were to occur for purposes
of Section 382, we would be required to calculate an annual restriction on the
use of our NOLs to offset future taxable income. The annual
restriction would be calculated based upon the value of Conseco’s equity at the
time of such ownership change, multiplied by a federal long-term tax exempt rate
(4.16 percent at December 31, 2009), and the annual restriction could
effectively eliminate our ability to use a substantial portion of our NOLs to
offset future taxable income. We regularly monitor ownership change
(as calculated for purposes of Section 382) and, as of December 31, 2009, we
were below the 50 percent ownership change level that would trigger further
impairment of our ability to utilize our NOLs.
60
As of December 31, 2009, we had $4.7
billion of federal NOLs and $1.1 billion of capital loss carryforwards, which
expire as follows (dollars in millions):
|
Year
of expiration
|
Net
operating loss carryforwards (a)
|
Capital
loss
|
Total
loss
|
|||||||||||||||
|
Life
|
Non-life
|
carryforwards
|
carryforwards
|
|||||||||||||||
|
2010
|
$ | - | $ | .1 | $ | - | $ | .1 | ||||||||||
|
2011
|
- | .1 | - | .1 | ||||||||||||||
|
2012
|
- | - | 63.6 | 63.6 | ||||||||||||||
|
2013
|
- | - | 1,034.2 | 1,034.2 | ||||||||||||||
|
2014
|
- | - | 27.3 | 27.3 | ||||||||||||||
|
2018
|
1,895.7 |
(a)
|
- | - | 1,895.7 | |||||||||||||
|
2021
|
29.6 | - | - | 29.6 | ||||||||||||||
|
2022
|
204.1 | - | - | 204.1 | ||||||||||||||
|
2023
|
- | 2,058.2 |
(a)
|
- | 2,058.2 | |||||||||||||
|
2024
|
- | 3.2 | - | 3.2 | ||||||||||||||
|
2025
|
- | 118.8 | - | 118.8 | ||||||||||||||
|
2026
|
- | 1.6 | - | 1.6 | ||||||||||||||
|
2027
|
- | 216.3 | - | 216.3 | ||||||||||||||
|
2028
|
- | 1.2 | - | 1.2 | ||||||||||||||
|
2029
|
- | 125.8 | - | 125.8 | ||||||||||||||
|
Total
|
$ | 2,129.4 | $ | 2,525.3 | $ | 1,125.1 | $ | 5,779.8 | ||||||||||
____________________
|
(a)
|
The
allocation of the NOLs summarized above assumes the IRS does not take an
adverse position in the future regarding the tax position we plan to take
in our tax returns with respect to the allocation of cancellation of
indebtedness income. If the IRS disagrees with the tax position
we plan to take with respect to the allocation of cancellation of
indebtedness income, and their position prevails, approximately $631
million of the NOLs expiring in 2018 would be characterized as non-life
NOLs.
|
As more
fully discussed below, the Company’s interpretation of the tax law, as it
relates to the application of the cancellation of indebtedness income to its
NOLs, is an uncertain tax position. Since all other life NOLs must be
utilized prior to this portion of the NOL, it has not yet been utilized nor is
it expected to be utilized within the next twelve months. As a
result, an uncertain tax position has not yet been taken on the Company’s tax
return.
Although
authoritative guidance allowed a change in accounting, the Company has chosen to
continue its past accounting policy of classifying interest and penalties as
income tax expense in the consolidated statement of operations. No
such amounts were recognized in 2009 or 2008. The liability for
accrued interest and penalties was not significant at December 31, 2009 or
December 31, 2008.
Tax years
2006 through 2008 are open to examination by the IRS, and tax year 2002 remains
open only for potential adjustments related to certain partnership
investments. The Company does not anticipate any material adjustments
related to these partnership investments. The Company’s various state
income tax returns are generally open for tax years 2006 through 2008 based on
the individual state statutes of limitation.
The
following paragraphs describe an open matter related to the classification of
our NOLs.
In July
2006, the Joint Committee of Taxation accepted the audit and the settlement
which characterized $2.1 billion of the tax losses on our Predecessor’s
investment in Conseco Finance Corp. as life company losses and the remaining
amount as non-life losses prior to the application of the cancellation of
indebtedness attribute reductions described below. As a result of the
approval of the settlement, we concluded it was appropriate to reduce our
valuation allowance by $260 million in the second quarter of 2006, which was
accounted for as an addition to paid-in capital.
The Code
provides that any income realized as a result of the cancellation of
indebtedness in bankruptcy (cancellation of debt income or “CODI”) must reduce
NOLs. We realized an estimated $2.5 billion of CODI when we emerged
from bankruptcy. Pursuant to the Company’s interpretation of the tax
law, the CODI reductions were all used to reduce non-life
NOLs. However, if the IRS were to disagree with our interpretation
and ultimately prevail, we believe approximately $631 million of NOLs classified
as life company NOLs would be re-characterized as non-life NOLs and subject to
the 35%
61
limitation
discussed above. Such a re-characterization would also extend the
year of expiration as life company NOLs expire after 15 years whereas non-life
NOLs expire after 20 years. The Company does not expect the IRS to
consider this issue for a number of years.
Liabilities
for Insurance Products
At
December 31, 2009, the total balance of our liabilities for insurance products
was $24.3 billion. These liabilities are generally payable over an
extended period of time and the profitability of the related products is
dependent on the pricing of the products and other
factors. Differences between our expectations when we sold these
products and our actual experience could result in future losses.
We
calculate and maintain reserves for the future payment of claims to our
policyholders based on actuarial assumptions. For all our insurance
products, we establish an active life reserve, a liability for due and unpaid
claims, claims in the course of settlement and incurred but not reported
claims. In addition, for our supplemental health insurance business,
we establish a reserve for the present value of amounts not yet due on
claims. Many factors can affect these reserves and liabilities, such
as economic and social conditions, inflation, hospital and pharmaceutical costs,
changes in doctrines of legal liability and extra-contractual damage
awards. Therefore, our reserves and liabilities are necessarily based
on numerous estimates and assumptions as well as historical
experience. Establishing reserves is an uncertain process, and it is
possible that actual claims will materially exceed our reserves and have a
material adverse effect on our results of operations and financial
condition. We have incurred significant losses beyond our estimates
as a result of actual claim costs and persistency of our long-term care business
of Senior Health and Washington National. Our financial results
depend significantly upon the extent to which our actual claims experience is
consistent with the assumptions we used in determining our reserves and pricing
our products. If our assumptions with respect to future claims are
incorrect, and our reserves are insufficient to cover our actual losses and
expenses, we would be required to increase our liabilities, which would
negatively affect our operating results.
Liabilities
for insurance products are calculated using management’s best judgments, based
on our past experience and standard actuarial tables, of mortality, morbidity,
lapse rates, investment experience and expense levels.
Accounting
for Long-term Care Premium Rate Increases
Many of
our long-term care policies were subject to premium rate increases in 2006 and
2007. In some cases, these premium rate increases were reasonably
consistent with the assumptions we used to value the particular block of
business at the fresh-start date. With respect to the 2006 premium
rate increases, some of our policyholders were provided an option to cease
paying their premiums and receive a non-forfeiture option in the form of a
paid-up policy with limited benefits. In addition, our policyholders
could choose to reduce their coverage amounts and premiums in the same
proportion, when permitted by our contracts or as required by
regulators. The following describes how we account for these premium
rate increases and related policyholder options:
|
·
|
Premium
rate increases – If premium rate increases reflect a change in our
previous rate increase assumptions, the new assumptions are not reflected
prospectively in our reserves. Instead, the additional premium
revenue resulting from the rate increase is recognized as earned and
original assumptions continue to be used to determine changes to
liabilities for insurance products unless a premium deficiency
exists.
|
|
·
|
Benefit
reductions – If there is a premium rate increase on one of our long-term
care policies, a policyholder may choose reduced coverage with a
proportionate reduction in premium, when permitted by our
contracts. This option does not require additional
underwriting. Benefit reductions are treated as a partial lapse
of coverage, and the balance of our reserves and deferred insurance
acquisition costs is reduced in proportion to the reduced
coverage.
|
|
·
|
Non-forfeiture
benefits offered in conjunction with a rate increase – In some cases,
non-forfeiture benefits are offered to policyholders who wish to lapse
their policies at the time of a significant rate increase. In
these cases, exercise of this option is treated as an extinguishment of
the original contract and issuance of a new contract. The
balance of our reserves and deferred insurance acquisition costs are
released, and a reserve for the new contract is
established.
|
|
·
|
Florida
Order – In 2004, the Florida Office of Insurance Regulation issued an
order to Washington National regarding its home health care
business in Florida. The order required Washington National to
offer a choice of three alternatives to holders of home health care
policies in Florida subject to premium rate increases as
follows:
|
62
|
·
|
retention
of their current policy with a rate increase of 50 percent in the first
year and actuarially justified increases in subsequent
years;
|
|
·
|
receipt
of a replacement policy with reduced benefits and a rate increase in the
first year of 25 percent and no more than 15 percent in subsequent years;
or
|
|
·
|
receipt
of a paid-up policy, allowing the holder to file future claims up to 100
percent of the amount of premiums paid since the inception of the
policy.
|
Reserves
for all three groups of policies under the order were prospectively adjusted
using the prospective revision methodology described above, as these
alternatives were required by the Florida Office of Insurance
Regulation. These policies had no insurance acquisition costs
established at the Effective Date.
Some of
our policyholders may receive a non-forfeiture benefit if they cease paying
their premiums pursuant to their original contract (or pursuant to changes made
to their original contract as a result of a litigation settlement made prior to
the Effective Date or an order issued by the Florida Office of Insurance
Regulation). In these cases, exercise of this option is treated as
the exercise of a policy benefit, and the reserve for premium paying benefits is
reduced, and the reserve for the non-forfeiture benefit is adjusted to reflect
the election of this benefit.
Liabilities
for Loss Contingencies Related to Lawsuits and Our Guarantees of Bank Loans and
Related Interest Loans
We are
involved on an ongoing basis in arbitrations and lawsuits, including purported
class actions. The ultimate outcome of these legal matters cannot be
predicted with certainty. We recognize an estimated loss from these
loss contingencies when we believe it is probable that a loss has been incurred
and the amount of the loss can be reasonably estimated. However, it
is difficult to measure the actual loss that might be incurred related to
litigation. The ultimate outcome of these lawsuits could have a
significant impact on our results of operations and financial
position.
In
conjunction with our bankruptcy reorganization in 2003, $481.3 million principal
amount of bank loans made to certain former directors and employees to enable
them to purchase common stock of our Predecessor were transferred to the
Company. These loans had been guaranteed by our
Predecessor. We received all rights to collect the balances due
pursuant to the original terms of these loans. In addition, we hold
loans to participants for interest on the loans. The loans and the
interest loans are collectively referred to as the “D&O
loans.” We regularly evaluate the collectibility of these loans in
light of the credit worthiness of the participants and the current status of
various legal actions we have taken to collect the D&O loans. At
December 31, 2009, we have estimated that approximately $3.8 million of the
D&O loan balance (which is included in other assets) is collectible (net of
the costs of collection). An allowance has been established to reduce
the total D&O loan balance to the amount we estimated was
recoverable.
Pursuant
to the settlement that was reached with the Official Committee of the Trust
Originated Preferred Securities (“TOPrS”) Holders and the Official Committee of
Unsecured Creditors in connection with our bankruptcy reorganization in 2003,
the former holders of TOPrS (issued by our Predecessor’s subsidiary trusts and
eliminated in our reorganization) who did not opt out of the bankruptcy
settlement will be entitled to receive 45 percent of any proceeds from the
collection of certain D&O loans in an aggregate amount not to exceed $30
million. As of December 31, 2009, we had paid $19.3 million to the
former holders of TOPrS and we have established a liability of $2.7 million
(which is included in other liabilities), representing our estimate of the
additional amount which will be paid to the former holders of TOPrS pursuant to
the settlement.
63
RESULTS
OF OPERATIONS:
We manage
our business through the following: three primary operating segments,
Bankers Life, Colonial Penn and Conseco Insurance Group which are defined on the
basis of product distribution; and corporate operations, which consists of
holding company activities and certain noninsurance businesses.
Please
read this discussion in conjunction with the consolidated financial statements
and notes included in this Form 10-K.
The
following tables and narratives summarize the operating results of our segments
(dollars in millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Income
(loss) before net realized investment gains (losses), net of related
amortization and income taxes (a non-GAAP measure) (a):
|
||||||||||||
|
Bankers
Life
|
$ | 278.0 | $ | 171.5 | $ | 241.8 | ||||||
|
Colonial
Penn
|
29.4 | 25.2 | 18.1 | |||||||||
|
Conseco
Insurance
Group
|
67.3 | 121.3 | (26.3 | ) | ||||||||
|
Corporate
operations
|
(144.6 | ) | (73.4 | ) | (129.3 | ) | ||||||
| 230.1 | 244.6 | 104.3 | ||||||||||
|
Net
realized investment gains (losses), net of related
amortization:
|
||||||||||||
|
Bankers
Life
|
(31.6 | ) | (100.9 | ) | (17.4 | ) | ||||||
|
Colonial
Penn
|
4.5 | (1.6 | ) | (.2 | ) | |||||||
|
Conseco
Insurance
Group
|
(22.0 | ) | (87.6 | ) | (98.5 | ) | ||||||
|
Corporate
operations
|
(7.4 | ) | (50.8 | ) | (6.2 | ) | ||||||
| (56.5 | ) | (240.9 | ) | (122.3 | ) | |||||||
|
Income
(loss) before income taxes and discontinued operations:
|
||||||||||||
|
Bankers
Life
|
246.4 | 70.6 | 224.4 | |||||||||
|
Colonial
Penn
|
33.9 | 23.6 | 17.9 | |||||||||
|
Conseco
Insurance
Group
|
45.3 | 33.7 | (124.8 | ) | ||||||||
|
Corporate
operations
|
(152.0 | ) | (124.2 | ) | (135.5 | ) | ||||||
|
Income
(loss) before income taxes and discontinued operations
|
$ | 173.6 | $ | 3.7 | $ | (18.0 | ) | |||||
____________________
|
(a)
|
These
non-GAAP measures as presented in the above table and in the following
segment financial data and discussions of segment results exclude net
realized investment gains (losses), net of related amortization and before
income taxes. These are considered non-GAAP financial
measures. A non-GAAP measure is a numerical measure of a
company’s performance, financial position, or cash flows that excludes or
includes amounts that are normally excluded or included in the most
directly comparable measure calculated and presented in accordance with
GAAP.
|
These
non-GAAP financial measures of “income (loss) before net realized investment
gains (losses), net of related amortization, and before income taxes” differ
from “income (loss) before income taxes” as presented in our consolidated
statement of operations prepared in accordance with GAAP due to the exclusion of
before tax realized investment gains (losses), net of related
amortization. We measure segment performance excluding realized
investment gains (losses) because we believe that this performance measure is a
better indicator of the ongoing businesses and trends in our
business. Our primary investment focus is on investment income to
support our liabilities for insurance products as opposed to the generation of
realized investment gains (losses), and a long-term focus is necessary to
maintain profitability over the life of the business. Realized
investment gains (losses) depend on market conditions and do not necessarily
relate to decisions regarding the underlying business of our
segments. However, “income (loss) before net realized investment
gains (losses), net of related amortization, and before income taxes” does not
replace “income (loss) before income taxes” as a measure of overall
profitability. We may experience realized investment gains (losses),
which will affect future earnings levels since our underlying business is
long-term
64
in nature
and we need to earn the assumed interest rates on the investments backing our
liabilities for insurance products to maintain the profitability of our
business. In addition, management uses this non-GAAP financial
measure in its budgeting process, financial analysis of segment performance and
in assessing the allocation of resources. We believe these non-GAAP
financial measures enhance an investor’s understanding of our financial
performance and allows them to make more informed judgments about the Company as
a whole. These measures also highlight operating trends that might
not otherwise be transparent. The table above reconciles the non-GAAP
measure to the corresponding GAAP measure.
General:
Conseco is the top tier holding company for a group of insurance
companies operating throughout the United States that develop, market and
administer supplemental health insurance, annuity, individual life insurance and
other insurance products. We distribute these products through our
Bankers Life segment, which utilizes a career agency force, through our Colonial
Penn segment, which utilizes direct response marketing and through our Conseco
Insurance Group segment, which utilizes professional independent
producers.
65
Bankers
Life (dollars in millions)
|
2009
|
2008
|
2007
|
||||||||||
|
Premium
collections:
|
||||||||||||
|
Annuities
|
$ | 1,060.4 | $ | 1,224.1 | $ | 885.5 | ||||||
|
Supplemental
health
|
1,711.7 | 1,887.0 | 1,546.1 | |||||||||
|
Life
|
228.8 | 209.4 | 200.0 | |||||||||
|
Total
collections
|
$ | 3,000.9 | $ | 3,320.5 | $ | 2,631.6 | ||||||
|
Average
liabilities for insurance products:
|
||||||||||||
|
Annuities:
|
||||||||||||
|
Mortality
based
|
$ | 250.9 | $ | 252.9 | $ | 281.6 | ||||||
|
Equity-indexed
|
1,506.3 | 1,203.0 | 787.4 | |||||||||
|
Deposit
based
|
4,789.9 | 4,464.3 | 4,507.4 | |||||||||
|
Health
|
4,122.1 | 3,880.5 | 3,569.7 | |||||||||
|
Life:
|
||||||||||||
|
Interest
sensitive
|
401.6 | 385.9 | 364.2 | |||||||||
|
Non-interest
sensitive
|
407.2 | 357.8 | 299.1 | |||||||||
|
Total
average liabilities for insurance products, net of reinsurance
ceded
|
$ | 11,478.0 | $ | 10,544.4 | $ | 9,809.4 | ||||||
|
Revenues:
|
||||||||||||
|
Insurance
policy
income
|
$ | 1,959.2 | $ | 2,109.9 | $ | 1,780.0 | ||||||
|
Net
investment income:
|
||||||||||||
|
General
account invested
assets
|
643.6 | 617.1 | 578.7 | |||||||||
|
Equity-indexed
products
|
24.5 | (49.4 | ) | (10.6 | ) | |||||||
|
Other
special-purpose
portfolios
|
10.0 | (9.5 | ) | 4.2 | ||||||||
|
Fee
revenue and other
income
|
10.2 | 11.0 | 12.0 | |||||||||
|
Total
revenues
|
2,647.5 | 2,679.1 | 2,364.3 | |||||||||
|
Expenses:
|
||||||||||||
|
Insurance
policy
benefits
|
1,667.5 | 1,879.9 | 1,480.6 | |||||||||
|
Amounts
added to policyholder account balances:
|
||||||||||||
|
Annuity
products and interest-sensitive life products other than equity-indexed
products
|
183.1 | 175.7 | 180.9 | |||||||||
|
Equity-indexed
products
|
54.4 | 34.8 | 23.2 | |||||||||
|
Amortization
related to
operations
|
267.9 | 234.8 | 264.0 | |||||||||
|
Other
operating costs and
expenses
|
196.6 | 182.4 | 173.8 | |||||||||
|
Total
benefits and
expenses
|
2,369.5 | 2,507.6 | 2,122.5 | |||||||||
|
Income
before net realized investment losses, net of related amortization and
income taxes
|
278.0 | 171.5 | 241.8 | |||||||||
|
Net
realized investment
losses
|
(31.4 | ) | (116.7 | ) | (19.9 | ) | ||||||
|
Amortization
related to net realized investment losses
|
(.2 | ) | 15.8 | 2.5 | ||||||||
|
Net
realized investment losses, net of related amortization
|
(31.6 | ) | (100.9 | ) | (17.4 | ) | ||||||
|
Income
before income
taxes
|
$ | 246.4 | $ | 70.6 | $ | 224.4 | ||||||
(continued)
66
(continued
from previous page)
|
2009
|
2008
|
2007
|
||||||||||
|
Health
benefit ratios:
|
||||||||||||
|
All
health lines:
|
||||||||||||
|
Insurance
policy
benefits
|
$ | 1,489.4 | $ | 1,709.4 | $ | 1,298.0 | ||||||
|
Benefit
ratio
(a)
|
87.0 | % | 91.3 | % | 84.4 | % | ||||||
|
Medicare
supplement:
|
||||||||||||
|
Insurance
policy
benefits
|
$ | 468.8 | $ | 452.3 | $ | 433.3 | ||||||
|
Benefit
ratio
(a)
|
70.7 | % | 70.8 | % | 67.2 | % | ||||||
|
PDP
and PFFS:
|
||||||||||||
|
Insurance
policy
benefits
|
$ | 384.8 | $ | 585.1 | $ | 231.1 | ||||||
|
Benefit
ratio
(a)
|
86.6 | % | 96.0 | % | 85.1 | % | ||||||
|
Long-term
care:
|
||||||||||||
|
Insurance
policy
benefits
|
$ | 635.8 | $ | 672.0 | $ | 633.6 | ||||||
|
Benefit
ratio
(a)
|
105.2 | % | 107.6 | % | 102.0 | % | ||||||
|
Interest-adjusted
benefit ratio (b)
|
67.9 | % | 74.0 | % | 70.8 | % | ||||||
____________________
|
(a)
|
We
calculate
benefit
ratios by dividing the related product’s insurance policy benefits
by insurance policy income.
|
|
(b)
|
We
calculate the interest-adjusted benefit ratio (a non-GAAP measure) for
Bankers Life’s long-term care products by dividing such product’s
insurance policy benefits less interest income on the accumulated assets
backing the insurance liabilities by policy income. These are
considered non-GAAP financial measures. A non-GAAP measure is a
numerical measure of a company’s performance, financial position, or cash
flows that excludes or includes amounts that are normally excluded or
included in the most directly comparable measure calculated and presented
in accordance with GAAP.
|
These
non-GAAP financial measures of “interest-adjusted benefit ratios” differ from
“benefit ratios” due to the deduction of interest income on the accumulated
assets backing the insurance liabilities from the product’s insurance policy
benefits used to determine the ratio. Interest income is an important
factor in measuring the performance of health products that are expected to be
inforce for a longer duration of time, are not subject to unilateral changes in
provisions (such as non-cancelable or guaranteed renewable contracts) and
require the performance of various functions and services (including insurance
protection) for an extended period of time. The net cash flows from
long-term care products generally cause an accumulation of amounts in the early
years of a policy (accounted for as reserve increases) that will be paid out as
benefits in later policy years (accounted for as reserve
decreases). Accordingly, as the policies age, the benefit ratio will
typically increase, but the increase in benefits will be partially offset by
interest income earned on the accumulated assets. The
interest-adjusted benefit ratio reflects the effects of the interest income
offset. Since interest income is an important factor in measuring the
performance of this product, management believes a benefit ratio that includes
the effect of interest income is useful in analyzing product
performance. We utilize the interest-adjusted benefit ratio in
measuring segment performance because we believe that this performance measure
is a better indicator of the ongoing businesses and trends in the
business. However, the “interest-adjusted benefit ratio” does not
replace the “benefit ratio” as a measure of current period benefits to current
period insurance policy income. Accordingly, management reviews both
“benefit ratios” and “interest-adjusted benefit ratios” when analyzing the
financial results attributable to these products.
The investment income
earned on the accumulated assets backing Bankers Life’s long-term care reserves
was $225.1 million, $210.1 million and $193.8 million in 2009, 2008 and 2007,
respectively.
Total premium
collections
were $3,000.9 million in 2009, down 9.6 percent from 2008,
and $3,320.5 million in 2008, up 26 percent from 2007. Premium
collections include $444.4 million, $614.0 million and $277.8 million in 2009,
2008, and 2007, respectively, of premiums collected pursuant to the quota-share
agreements with Coventry described above under “Accounting for marketing and
reinsurance agreements with Coventry”. See “Premium Collections” for
further analysis of Bankers Life’s premium collections.
67
Average
liabilities for insurance products, net of reinsurance ceded
were $11.5
billion in 2009, up 8.9 percent from 2008, and $10.5 billion in 2008, up 7.5
percent from 2007. The increase in such liabilities was primarily due
to increases in annuity and health reserves resulting from new sales of these
products.
Insurance
policy income
is comprised of premiums earned on policies which provide
mortality or morbidity coverage and fees and other charges assessed on other
policies. Insurance policy income includes $444.3 million, $609.5
million and $271.4 million in 2009, 2008 and 2007, respectively, of premium
income from the quota-share agreements with Coventry described above under
“Accounting for marketing and reinsurance agreements with
Coventry”.
Net investment
income on general account invested assets
(which excludes income on
policyholder accounts) increased 4.3 percent, to $643.6 million, in 2009 and 6.6
percent, to $617.1 million, in 2008. The average balance of general
account invested assets was $11.4 billion, $10.6 billion and $10.0 billion in
2009, 2008 and 2007, respectively. The average yield on these assets
was 5.64 percent in 2009, 5.83 percent in 2008 and 5.79 percent in
2007. The increase in general account invested assets is primarily
due to sales of our annuity and health products in recent
periods. The reduction in average yield in 2009 reflects lower new
money rates due to tighter credit spreads for many investments and a higher
amount of short-term investments with relatively lower yields.
Net investment
income related to equity-indexed products
represents the change in the
estimated fair value of options which are purchased in an effort to hedge
certain potential benefits accruing to the policyholders of our equity-indexed
products. Our equity-indexed products are designed so that the
investment income spread earned on the related insurance liabilities is expected
to be more than adequate to cover the cost of the options and other costs
related to these policies. Net investment income (losses) related to
equity-indexed products were $38.5 million, $(67.0) million and $(11.2) million
in 2009, 2008 and 2007, respectively. Net investment income related
to equity-indexed products also includes income (loss) on trading securities
which are held to act as hedges for embedded derivates related to equity-indexed
products. Such trading account income (loss) was $(14.0) million,
$17.6 million and $.6 million in 2009, 2008 and 2007,
respectively. Such amounts are generally offset by the corresponding
charge (credit) to
amounts added to
policyholder account balances for equity-indexed products
based on the
change in value of the indices. Such income and related charges
fluctuate based on the value of options embedded in the segment’s equity-indexed
annuity policyholder account balances subject to this benefit and to the
performance of the index to which the returns on such products are
linked.
Net investment
income on other special-purpose portfolios
includes the income related to
Company-owned life insurance (“COLI”) which was purchased as an investment
vehicle to fund the deferred compensation plan for certain agents. The COLI
assets are not assets of the agent deferred compensation plan, and as a result,
are accounted for outside the plan and are recorded in the consolidated balance
sheet as other invested assets. Changes in the cash surrender value
(which approximates net realizable value) of the COLI assets are recorded as net
investment income (loss) and totaled $7.1 million, $(9.5) million and $1.5
million in 2009, 2008 and 2007, respectively. We also recognized
death benefits of $2.9 million and $2.7 million under the COLI in 2009 and 2007,
respectively.
Fee revenue and
other income
was $10.2 million in 2009, compared to $11.0 million in 2008
and $12.0 million in 2007. We recognized fee income of $9.2 million,
$9.9 million and $11.0 million in 2009, 2008 and 2007, respectively, pursuant to
the agreements described above under “Accounting for marketing and reinsurance
agreements with Coventry”.
Insurance policy
benefits
fluctuated as a result of the factors summarized below for
benefit ratios. Benefit ratios are calculated by dividing the related
insurance product’s insurance policy benefits by insurance policy
income.
The
Medicare supplement business consists of both individual and group
policies. Government regulations generally require us to attain and
maintain a ratio of total benefits incurred to total premiums earned (excluding
changes in policy benefit reserves), after three years from the original
issuance of the policy and over the lifetime of the policy, of not less than 65
percent on individual products and not less than 75 percent on group products,
as determined in accordance with statutory accounting
principles. Since the insurance product liabilities we establish for
Medicare supplement business are subject to significant estimates, the ultimate
claim liability we incur for a particular period is likely to be different than
our initial estimate. Our insurance policy benefits reflected reserve
redundancies from prior years of $7.7 million, $.5 million and $3.7 million in
2009, 2008 and 2007, respectively. Excluding the effects of prior
year claim reserve redundancies, our benefit ratios would have been 71.9
percent, 70.8 percent and 67.8 percent in 2009, 2008 and 2007,
respectively. We experienced an increase in the number of incurred
claims in 2009 and 2008.
The
insurance policy benefits on our PDP and PFFS business result from our
quota-share reinsurance agreements with
68
Coventry
as described above under “Accounting for marketing and reinsurance agreements
with Coventry”. We began assuming the PDP business on January 1, 2006
and the PFFS business on January 1, 2007. During 2007 and 2008, we
entered into new PFFS quota-share reinsurance agreements to assume a specified
percentage of the business written by Coventry under three large group
policies. During 2008, we recognized a $3 million increase in
insurance policy benefits due to changes in our estimates of prior period claim
costs on the PFFS business we assume from Coventry. In order to
reduce the required statutory capital associated with the assumption of this
business, Conseco terminated two group policy quota-share agreements as of
December 31, 2008 and terminated the last agreement on June 30,
2009. Coventry has decided to cease selling PFFS plans effective
January 1, 2010. On July 22, 2009, Bankers Life announced a strategic
alliance under which it will offer Humana’s Medicare Advantage plans to its
policyholders and consumers nationwide through its career agency force and will
receive marketing fees based on sales. Effective January 1, 2010, the
Company will no longer be assuming the underwriting risk related to PFFS
business. Insurance margins (insurance policy income less insurance
policy benefits) on the PDP and PFFS business were $59.5 million, $24.4 million
and $40.3 million in 2009, 2008 and 2007, respectively. The increase
in margin in 2009 is primarily due to: (i) increases in our share of
risk adjustment premium payments made by the Center for Medicare and Medical
Services; and (ii) favorable reserve developments.
The net
cash flows from our long-term care products generally cause an accumulation of
amounts in the early years of a policy (accounted for as reserve increases)
which will be paid out as benefits in later policy years (accounted for as
reserve decreases). Accordingly, as the policies age, the benefit
ratio typically increases, but the increase in reserves is partially offset by
investment income earned on the accumulated assets. The benefit ratio
on our entire block of long-term care business in the Bankers Life segment was
105.2 percent, 107.6 percent and 102.0 percent in 2009, 2008 and 2007,
respectively. The interest-adjusted benefit ratio on this business
was 67.9 percent, 74.0 percent and 70.8 percent in 2009, 2008 and 2007,
respectively. Since the insurance product liabilities we establish
for long-term care business are subject to significant estimates, the ultimate
claim liability we incur for a particular period is likely to be different than
our initial estimate. Our insurance policy benefits reflected reserve
redundancies (deficiencies) from prior years of $10.0 million, $(6.0) million
and $(7.4) million in 2009, 2008 and 2007, respectively. Excluding
the effects of prior year claim reserve deficiencies, our benefit ratios would
have been 106.9 percent, 106.7 percent and 100.8 percent in 2009, 2008 and 2007,
respectively. The benefit ratio for 2009 reflected a reduction in
liabilities for insurance products of approximately $41.9 million due to our
estimates of: (i) the reduction in liabilities for policyholders
choosing to lapse their policies rather than paying higher rates; (ii) the
reduction in liabilities for policyholders choosing to reduce their coverages to
achieve a lower cost; offset by (iii) the increase in the reserves related to
waiver of premium benefits to reflect the higher premiums after the rate
increase. The aforementioned reduction in liabilities was partially
offset by increased amortization of insurance intangibles of $4.7 million
resulting from the increase in lapses. When policies lapse, active
life reserves for such lapsed policies are released, resulting in decreased
insurance policy benefits (although such decrease is somewhat offset by
additional amortization expense).
As a
result of higher persistency in our long-term care block in the Bankers Life
segment than assumed in the original pricing, our premium rates were too
low. Accordingly, we began a program in 2006 to seek approval from
regulatory authorities for rate increases on approximately 65 percent of this
block. As an alternative to the rate increase, policyholders were
offered the option: (i) to reduce their benefits to maintain their
previous premium rates; or (ii) to choose a nonforfeiture benefit equal to the
sum of accumulated premiums paid less claims received. We have
received all expected regulatory approvals and have implemented these rate
increases. In addition, another round of increases was filed during
the second and third quarters of 2007 on newer long-term care, home health care,
and short-term care policies not included in the first round of rate increases,
however, non-forfeiture benefits were only offered in accordance with the terms
of the policy. The policies in this round represent approximately 25
percent of the inforce block. As of December 31, 2009, all such
filings had been submitted for regulatory approval, and approximately 80 percent
of the expected rate increases had been approved by regulators and
implemented. Finally, an additional rate increase on the 65 percent
of the block that received an increase in 2006 was filed in the third quarter of
2008, however, non-forfeiture benefits were only offered in accordance with the
terms of the policy.
Amounts added to
policyholder account balances for annuity products and interest-sensitive life
products
were $183.1 million, $175.7 million and $180.9 million in 2009,
2008 and 2007, respectively. The weighted average crediting rates for
these products was 3.5 percent, 3.6 percent and 3.7 percent in 2009, 2008 and
2007, respectively. The average liabilities of the deposit-based
annuity block was $4.8 billion, $4.5 billon and $4.5 billion in 2009, 2008 and
2007, respectively.
Amounts added to
equity-indexed products
based on change in value of the indices
will
generally fluctuate with the corresponding related investment income accounts
described above. Such corresponding relationship did not exist in
2008 and 2007 due to a number of factors including variations in option costs
and changes in the value of the trading account
69
securities
which did not correspond to the changes in the value of the embedded derivatives
related to these products.
Amortization
related to operations
includes amortization of the value of policies
inforce at the Effective Date and the cost of policies produced (collectively
referred to as “amortization of insurance acquisition
costs”). Insurance acquisition costs are generally amortized
either: (i) in relation to the estimated gross profits for universal
life and investment-type products; or (ii) in relation to actual and expected
premium revenue for other products. In addition, for universal life
and investment-type products, we are required to adjust the total amortization
recorded to date through the statement of operations if actual experience or
other evidence suggests that earlier estimates of future gross profits should be
revised. Accordingly, amortization for universal life and
investment-type products is dependent on the profits realized during the period
and on our expectation of future profits. For other products, we
amortize insurance acquisition costs in relation to actual and expected premium
revenue, and amortization is only adjusted if expected premium revenue changes
or if we determine the balance of these costs is not recoverable from future
profits. Bankers Life’s amortization expense was $267.9 million,
$234.8 million and $264.0 million in 2009, 2008 and 2007,
respectively. Amortization expense related to our annuity block of
business increased $46.9 million in 2009, as compared to 2008, partially due to
changes in our lapse assumptions. We limit the total amortization
adjustments resulting from losses on a block of business issued in a particular
year to an amount which would not result in the balance of insurance acquisition
costs exceeding the total of costs capitalized plus interest. During
2009, amortization expense related to annuities decreased by $5.9 million due to
this limitation. During the first six months of 2008 and 2007, we
experienced higher lapses than we anticipated on our Medicare supplement
products. These lapses reduced our estimates of future expected
premium income and, accordingly, we recognized additional amortization expense
of $12.2 million and $25.4 million in 2008 and 2007, respectively. We
believe such increases were partially related to competition from Medicare
Advantage products.
Other operating
costs and expenses
in our Bankers Life segment were $196.6 million in
2009, up 7.8 percent from 2008 and were $182.4 million in 2008, up 5.0 percent
from 2007. Other operating costs and expenses include the following
(dollars in millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Expenses
related to the marketing and quota-share agreements with
Coventry
|
$ | 28.6 | $ | 40.8 | $ | 24.5 | ||||||
|
Commission
expense
|
18.0 | 20.5 | 20.8 | |||||||||
|
Other
operating
expenses
|
150.0 | 121.1 | 128.5 | |||||||||
|
Total
|
$ | 196.6 | $ | 182.4 | $ | 173.8 | ||||||
Net realized
investment losses
fluctuated each period. During 2009, net
realized investment losses in this segment included $65.0 million of net gains
from the sales of investments (primarily fixed maturities) and $96.4 million of
writedowns of investments for other than temporary declines in fair value
recognized through net income ($182.2 million, prior to the $85.8 million of
impairment losses recognized through accumulated other comprehensive
loss). During 2008, net realized investment losses in this segment
included $31.1 million of net losses from the sales of investments (primarily
fixed maturities) and $85.6 million of writedowns of investments resulting from
declines in fair value that we concluded were other than
temporary. During 2007, net realized investment losses in this
segment included $4.6 million of net losses from the sales of investments
(primarily fixed maturities) and $15.3 million of writedowns of investments
resulting from declines in fair value that we concluded were other than
temporary.
Amortization
related to net realized investment losses
is the increase or decrease in
the amortization of insurance acquisition costs which results from realized
investment gains or losses. When we sell securities which back our
universal life and investment-type products at a gain (loss) and reinvest the
proceeds at a different yield, we increase (reduce) the amortization of
insurance acquisition costs in order to reflect the change in estimated gross
profits due to the gains (losses) realized and the resulting effect on estimated
future yields. Sales of fixed maturity investments resulted in an
increase (decrease) in the amortization of insurance acquisition costs of $.2
million, $(15.8) million and $(2.5) million in 2009, 2008 and 2007,
respectively.
70
Colonial
Penn (dollars in millions)
|
2009
|
2008
|
2007
|
||||||||||
|
Premium
collections:
|
||||||||||||
|
Life
|
$ | 187.3 | $ | 174.1 | $ | 113.7 | ||||||
|
Supplemental
health
|
7.5 | 8.9 | 10.4 | |||||||||
|
Total
collections
|
$ | 194.8 | $ | 183.0 | $ | 124.1 | ||||||
|
Average
liabilities for insurance products:
|
||||||||||||
|
Annuities-mortality
based
|
$ | 81.7 | $ | 85.9 | $ | 88.7 | ||||||
|
Health
|
19.1 | 20.7 | 22.9 | |||||||||
|
Life:
|
||||||||||||
|
Interest
sensitive
|
23.2 | 25.0 | 25.9 | |||||||||
|
Non-interest
sensitive
|
569.6 | 562.9 | 558.9 | |||||||||
|
Total
average liabilities for insurance products, net of reinsurance
ceded
|
$ | 693.6 | $ | 694.5 | $ | 696.4 | ||||||
|
Revenues:
|
||||||||||||
|
Insurance
policy
income
|
$ | 196.1 | $ | 184.8 | $ | 125.8 | ||||||
|
Net
investment income:
|
||||||||||||
|
General
account invested
assets
|
38.7 | 40.1 | 37.8 | |||||||||
|
Trading
account income related to reinsurer accounts
|
- | (.5 | ) | (.2 | ) | |||||||
|
Change
in value of embedded derivative related to a modified coinsurance
agreement
|
- | - | .2 | |||||||||
|
Fee
revenue and other
income
|
.9 | 1.8 | .7 | |||||||||
|
Total
revenues
|
235.7 | 226.2 | 164.3 | |||||||||
|
Expenses:
|
||||||||||||
|
Insurance
policy
benefits
|
141.9 | 138.2 | 101.0 | |||||||||
|
Amounts
added to annuity and interest-sensitive life product account
balances
|
1.1 | 1.2 | 1.2 | |||||||||
|
Amortization
related to
operations
|
33.3 | 32.0 | 20.3 | |||||||||
|
Other
operating costs and
expenses
|
30.0 | 29.6 | 23.7 | |||||||||
|
Total
benefits and
expenses
|
206.3 | 201.0 | 146.2 | |||||||||
|
Income
before net realized investment gains (losses) and income
taxes
|
29.4 | 25.2 | 18.1 | |||||||||
|
Net
realized investment gains
(losses)
|
4.5 | (1.6 | ) | (.2 | ) | |||||||
|
Income
before income
taxes
|
$ | 33.9 | $ | 23.6 | $ | 17.9 | ||||||
Reinsurance
recapture
: In the fourth quarter of 2007, we completed the
recapture of a block of traditional life insurance inforce that had been ceded
under a coinsurance agreement with REALIC. The recapture of this
block resulted in a $2.8 million gain accounted for as a reduction to insurance
policy benefits.
Total premium
collections
increased 6.4 percent, to $194.8 million, in 2009 and 47
percent, to $183.0 million, in 2008. See “Premium Collections” for further
analysis of Colonial Penn’s premium collections.
Average
liabilities for insurance products, net of reinsurance ceded,
did not
fluctuate significantly during the three years ended December 31,
2009.
Insurance policy
income
is comprised of premiums earned on policies which provide
mortality or morbidity coverage
71
and fees
and other charges assessed on other policies. In 2009, insurance
policy income includes the recognition of a $3.4 million final distribution and
commutation amount following the termination of a group insurance pool that
Colonial Penn previously participated in. The increase in the 2009
periods also reflects the growth in this segment. The increase in
2008 reflects: (i) the additional premiums following the recapture of
the modified coinsurance agreement in the fourth quarter of 2007; and (ii) the
growth in this segment. See “Premium Collections” for further
analysis.
Net investment
income on general account invested assets
(which excludes income on
policyholder and reinsurer accounts) did not fluctuate significantly during the
three years ended December 31, 2009. The average balance of general
account invested assets was $659.9 million in 2009, $676.0 million in 2008 and
$660.6 million in 2007. The average yield on these assets was 5.86
percent in 2009, 5.94 percent in 2008 and 5.72 percent in 2007.
Trading account
income related to reinsurer accounts
represents the income on trading
securities, which were designed to act as hedges for embedded derivatives
related to a modified coinsurance agreement. The income on our
trading account securities was designed to be substantially offset by the change
in value of embedded derivatives related to the modified coinsurance agreement
described below. As a result of the recapture of a modified
coinsurance agreement in the fourth quarter of 2007, such trading account
securities were sold in the first quarter of 2008.
Change in value
of embedded derivative related to a modified coinsurance agreement
is
described
in the note to our consolidated financial statements entitled “Summary of
Significant Accounting Policies - Accounting for Derivatives.” We had
transferred the specific block of investments related to this agreement to our
trading account, which we carried at estimated fair value with changes in such
value recognized as trading account income. The change in the value
of the embedded derivative was largely offset by the change in value of the
trading securities. As a result of the recapture of the modified
coinsurance agreement in the fourth quarter of 2007 (as further discussed below
under
insurance policy
benefits
), the embedded derivative related to the agreement was
eliminated.
Insurance policy
benefits
fluctuated as a result of: (i) the additional
benefits incurred following the recapture of the modified coinsurance agreement
in the fourth quarter of 2007; and (ii) the growth in this segment in recent
periods. Insurance policy benefits were reduced by $2.8 million in
2007 as a result of completing the aforementioned recapture of a block of
traditional life insurance in force that had been ceded in 2002 to
REALIC. In the transaction, which had an effective date of October 1,
2007, Colonial Penn paid REALIC a recapture fee of $63
million. Colonial Penn recaptured 100 percent of the liability for
the future benefits previously ceded, and will recognize profits from the block
as they emerge over time. Colonial Penn already administered the
policies that were recaptured.
Amortization
related to operations
includes amortization of insurance acquisition
costs. Insurance acquisition costs in the Colonial Penn segment are
amortized in relation to actual and expected premium revenue, and amortization
is only adjusted if expected premium revenue changes or if we determine the
balance of these costs is not recoverable from future profits. Such
amounts were generally consistent with the related premium revenue and gross
profits for such periods and the assumptions we made when we established the
value of policies inforce as of the Effective Date. A revision to our
current assumptions could result in increases or decreases to amortization
expense in future periods.
Other operating
costs and expenses
in our Colonial Penn segment increased 1.4 percent, to
$30.0 million in 2009 as compared to 2008. Such expenses increased 25
percent, to $29.6 million, in 2008 as compared to 2007 primarily due
to: (i) the additional costs incurred following the recapture of the
modified coinsurance agreement in the fourth quarter of 2007; and (ii) the
growth in this segment in recent periods. Other operating costs and
expenses in our Colonial Penn segment in 2007 included $8.4 million of marketing
costs associated with a pilot program involving the distribution of Coventry’s
PFFS plan through our direct response distribution channel. Such
pilot program was discontinued in 2008.
Net realized
investment gains (losses)
fluctuated each period. During 2009,
net realized investment losses in this segment included $8.7 million of net
gains from the sales of investments (primarily fixed maturities) and $4.2
million of writedowns of investments for other than temporary declines in fair
value recognized through net income ($4.6 million, prior to the $.4 million of
impairment losses recognized through accumulated other comprehensive
loss). During 2008, net realized investment losses in this segment
included $.1 million of net gains from the sales of investments (primarily fixed
maturities) and $1.7 million of writedowns of investments resulting from
declines in fair value that we concluded were other than
temporary. During 2007, net realized investment gains in this segment
included $.4 million of net gains from the sales of investments (primarily fixed
maturities) and $.6 million of writedowns of investments resulting from declines
in fair value that we concluded were other than temporary.
72
Conseco
Insurance Group (dollars in millions)
|
2009
|
2008
|
2007
|
||||||||||
|
Premium
collections:
|
||||||||||||
|
Annuities
|
$ | 78.4 | $ | 129.8 | $ | 368.6 | ||||||
|
Supplemental
health
|
600.4 | 621.8 | 633.4 | |||||||||
|
Life
|
240.3 | 269.8 | 287.3 | |||||||||
|
Total
collections
|
$ | 919.1 | $ | 1,021.4 | $ | 1,289.3 | ||||||
|
Average
liabilities for insurance products:
|
||||||||||||
|
Annuities:
|
||||||||||||
|
Mortality
based
|
$ | 215.2 | $ | 220.7 | $ | 230.3 | ||||||
|
Equity-indexed
|
778.5 | 891.0 | 1,435.3 | |||||||||
|
Deposit
based
|
661.5 | 752.6 | 2,337.7 | |||||||||
|
Separate
accounts
|
18.2 | 23.6 | 28.4 | |||||||||
|
Health
|
3,004.1 | 2,993.1 | 2,927.5 | |||||||||
|
Life:
|
||||||||||||
|
Interest
sensitive
|
2,777.2 | 2,945.5 | 3,045.5 | |||||||||
|
Non-interest
sensitive
|
1,239.4 | 1,393.8 | 1,380.2 | |||||||||
|
Total
average liabilities for insurance products, net of reinsurance
ceded
|
$ | 8,694.1 | $ | 9,220.3 | $ | 11,384.9 | ||||||
|
Revenues:
|
||||||||||||
|
Insurance
policy
income
|
$ | 938.3 | $ | 958.9 | $ | 989.9 | ||||||
|
Net
investment income:
|
||||||||||||
|
General
account invested
assets
|
548.3 | 592.7 | 727.6 | |||||||||
|
Equity-indexed
products
|
7.0 | (28.4 | ) | (1.3 | ) | |||||||
|
Trading
account income related to policyholder and reinsurer
accounts
|
12.0 | (18.5 | ) | 1.4 | ||||||||
|
Change
in value of embedded derivatives related to modified coinsurance
agreements
|
(6.5 | ) | 6.7 | 1.4 | ||||||||
|
Other
trading
accounts
|
- | - | (12.8 | ) | ||||||||
|
Fee
revenue and other
income
|
1.5 | 1.7 | 1.0 | |||||||||
|
Total
revenues
|
1,500.6 | 1,513.1 | 1,707.2 | |||||||||
|
Expenses:
|
||||||||||||
|
Insurance
policy
benefits
|
842.2 | 820.9 | 850.9 | |||||||||
|
Amounts
added to policyholder account balances:
|
||||||||||||
|
Annuity
products and interest-sensitive life products other than equity-indexed
products
|
140.2 | 153.6 | 217.4 | |||||||||
|
Equity-indexed
products
|
36.3 | 8.2 | 60.7 | |||||||||
|
Amortization
related to
operations
|
135.5 | 122.6 | 178.2 | |||||||||
|
Interest
expense on investment
borrowings
|
20.5 | 22.4 | 17.6 | |||||||||
|
Costs
related to a litigation
settlement
|
- | - | 32.2 | |||||||||
|
Loss
related to an annuity coinsurance transaction
|
- | - | 76.5 | |||||||||
|
Other
operating costs and
expenses
|
258.6 | 264.1 | 300.0 | |||||||||
|
Total
benefits and
expenses
|
1,433.3 | 1,391.8 | 1,733.5 | |||||||||
|
Income
(loss) before net realized investment losses, net of related amortization
and income taxes
|
67.3 | 121.3 | (26.3 | ) | ||||||||
|
Net
realized investment
losses
|
(26.2 | ) | (93.3 | ) | (131.7 | ) | ||||||
|
Amortization
related to net realized investment losses
|
4.2 | 5.7 | 33.2 | |||||||||
|
Net
realized investment losses, net of related amortization
|
(22.0 | ) | (87.6 | ) | (98.5 | ) | ||||||
|
Income
(loss) before income
taxes
|
$ | 45.3 | $ | 33.7 | $ | (124.8 | ) | |||||
(continued)
73
(continued
from previous page)
|
2009
|
2008
|
2007
|
||||||||||
|
Health
benefit ratios:
|
||||||||||||
|
All
health lines:
|
||||||||||||
|
Insurance
policy
benefits
|
$ | 496.0 | $ | 494.3 | $ | 514.9 | ||||||
|
Benefit
ratio
(a)
|
82.2 | % | 79.8 | % | 80.4 | % | ||||||
|
Medicare
supplement:
|
||||||||||||
|
Insurance
policy
benefits
|
$ | 124.0 | $ | 139.8 | $ | 156.4 | ||||||
|
Benefit
ratio
(a)
|
68.3 | % | 68.4 | % | 67.6 | % | ||||||
|
Specified
disease:
|
||||||||||||
|
Insurance
policy
benefits
|
$ | 303.4 | $ | 285.4 | $ | 279.4 | ||||||
|
Benefit
ratio
(a)
|
79.5 | % | 77.1 | % | 77.8 | % | ||||||
|
Interest-adjusted
benefit ratio (b)
|
46.0 | % | 43.3 | % | 44.7 | % | ||||||
|
Long-term
care:
|
||||||||||||
|
Insurance
policy
benefits
|
$ | 59.9 | $ | 58.7 | $ | 72.5 | ||||||
|
Benefit
ratio
(a)
|
186.7 | % | 169.6 | % | 192.4 | % | ||||||
|
Interest-adjusted
benefit ratio (b)
|
107.9 | % | 93.5 | % | 128.5 | % | ||||||
|
Other:
|
||||||||||||
|
Insurance
policy
benefits
|
$ | 8.7 | $ | 10.4 | $ | 6.6 | ||||||
|
Benefit
ratio
(a)
|
104.9 | % | 100.5 | % | 54.2 | % | ||||||
____________________
|
(a)
|
We
calculate benefit ratios by dividing the related product’s insurance
policy benefits by insurance policy
income.
|
|
(b)
|
We
calculate the interest-adjusted benefit ratio (a non-GAAP measure) for
Conseco Insurance Group’s specified disease and long-term care products by
dividing such product’s insurance policy benefits less interest income on
the accumulated assets backing the insurance liabilities by policy
income. These are considered non-GAAP financial
measures. A non-GAAP measure is a numerical measure of a
company’s performance, financial position, or cash flows that excludes or
includes amounts that are normally excluded or included in the most
directly comparable measure calculated and presented in accordance with
GAAP.
|
These
non-GAAP financial measures of “interest-adjusted benefit ratios” differ from
“benefit ratios” due to the deduction of interest income on the accumulated
assets backing the insurance liabilities from the product’s insurance policy
benefits used to determine the ratio. Interest income is an important
factor in measuring the performance of health products that are expected to be
inforce for a longer duration of time, are not subject to unilateral changes in
provisions (such as non-cancelable or guaranteed renewable contracts) and
require the performance of various functions and services (including insurance
protection) for an extended period of time. The net cash flows from
specified disease and long-term care products generally cause an accumulation of
amounts in the early years of a policy (accounted for as reserve increases) that
will be paid out as benefits in later policy years (accounted for as reserve
decreases). Accordingly, as the policies age, the benefit ratio will
typically increase, but the increase in benefits will be partially offset by
interest income earned on the accumulated assets. The
interest-adjusted benefit ratio reflects the effects of the interest income
offset. Since interest income is an important factor in measuring the
performance of these products, management believes a benefit ratio that includes
the effect of interest income is useful in analyzing product
performance. We utilize the interest-adjusted benefit ratio in
measuring segment performance because we believe that this performance measure
is a better indicator of the ongoing businesses and trends in the
business. However, the “interest-adjusted benefit ratio” does not
replace the “benefit ratio” as a measure of current period benefits to current
period insurance policy income. Accordingly, management reviews both
“benefit ratios” and “interest-adjusted benefit ratios” when analyzing the
financial results attributable to these products.
The investment income
earned on the accumulated assets backing the specified disease reserves was
$127.7 million, $125.2 million and $118.9 million in 2009, 2008 and 2007,
respectively. The investment income earned on the accumulated assets
backing the long-term care reserves was $25.2 million, $26.3 million and $24.1
million in 2009, 2008 and 2007, respectively.
Annuity
coinsurance agreement.
On October 12, 2007, we completed a
transaction to coinsure 100 percent of most of the older inforce equity-indexed
annuity and fixed annuity business of three of our subsidiaries with
REALIC. The
74
transaction
was recorded in our financial statements on September 28, 2007, the date the
parties were bound by the coinsurance agreement and all regulatory approvals had
been obtained. In the transaction, REALIC: (i) paid a
ceding commission of $76.5 million; and (ii) assumed the investment and
persistency risk of these policies. Our insurance subsidiaries ceded
approximately $2.8 billion of policy and other reserves to REALIC, as well as
transferred the invested assets backing these policies on October 12,
2007. Our insurance subsidiaries remain primarily liable to the
policyholders in the event REALIC does not fulfill its obligations under the
agreements. The coinsurance transaction had an effective date of
January 1, 2007.
Pursuant
to the terms of the annuity coinsurance agreement, the ceding commission was
based on the January 1, 2007 value of the assets and liabilities related to the
ceded block. The earnings (loss) after income taxes on the business
from January 1, 2007 through September 28, 2007, were included in our
consolidated financial statements until the transaction was
completed. Upon completion, the earnings on this block of business
were included as a component of the loss on the transaction which was recognized
in the third quarter of 2007. Such after-tax earnings (loss) include
the fair value declines on invested assets transferred to the reinsurer
occurring during the first three quarters of 2007. As a result, the
comparison of this segment’s operating results between periods is impacted by
the coinsurance transaction.
Total premium
collections
were $919.1 million in 2009, down 10 percent from 2008, and
$1,021.4 million in 2008, down 21 percent from 2007. The decrease in
collected premiums was primarily due to lower sales of equity-indexed annuity
and Medicare supplement products. See “Premium
Collections” for further analysis of fluctuations in premiums collected by
product.
Average
liabilities for insurance products, net of reinsurance ceded
were $8.7
billion in 2009, down 5.7 percent from 2008, and $9.2 billion in 2008, down 19
percent from 2007. The decreases in such liabilities were primarily
due to: (i) the coinsurance transaction with Wilton Re completed in
September 2009, as further discussed in the note to the consolidated financial
statements entitled “Summary of Significant Accounting Policies - Reinsurance”;
(ii) the annuity coinsurance transaction completed in 2007 as described above;
and (iii) policyholder redemptions and lapses exceeding new sales.
Insurance policy
income
is comprised of premiums earned on traditional insurance policies
which provide mortality or morbidity coverage and fees and other charges
assessed on other policies. The decrease in insurance policy income
is primarily due to lower income from Medicare supplement products due to lapses
exceeding new sales and lower premiums from our life insurance
block. See “Premium Collections” for further analysis.
Net investment
income on general account invested assets
(which excludes income on
policyholder and reinsurer accounts) decreased 7.5 percent, to $548.3 million,
in 2009 and 19 percent, to $592.7 million, in 2008. The average
balance of general account invested assets decreased 5.0 percent in 2009, to
$9.6 billion, and 17 percent in 2008, to $10.1 billion. The average
yield on these assets was 5.71 percent in 2009, 5.89 percent in 2008 and 5.97
percent in 2007. The reduction in average yield in 2009 reflects
lower new money rates due to tighter credit spreads for many
investments.
Net investment
income related to equity-indexed products
represents the change in the
estimated fair value of options which are purchased in an effort to hedge
certain potential benefits accruing to the policyholders of our equity-indexed
products. Our equity-indexed products are designed so that the
investment income spread earned on the related insurance liabilities is expected
to be more than adequate to cover the cost of the options and other costs
related to these policies. Net investment income (losses) related to
equity-indexed products were $12.2 million, $(37.3) million and $2.7 million in
2009, 2008 and 2007, respectively. Such trading account income (loss)
was $(5.2) million, $8.9 million and $(4.0) million in 2009, 2008 and 2007,
respectively. Such amounts were mostly offset by the corresponding
charge (credit) to
amounts added to
policyholder account balances for equity-indexed
products
. Such income and related charges fluctuate based on
the value of options embedded in the segment’s equity-indexed annuity
policyholder account balances subject to this benefit and to the performance of
the indices to which the returns on such products are linked.
Trading account
income related to policyholder and reinsurer accounts
represents the
income on trading securities which are held to act as hedges for embedded
derivatives related to certain modified coinsurance agreements. In
addition, such income includes the income on investments backing the market
strategies of certain annuity products which provide for different rates of cash
value growth based on the experience of a particular market
strategy. The income on our trading account securities is designed to
substantially offset: (i) the change in value of embedded derivatives
related to modified coinsurance agreements described below; and (ii) certain
amounts included in insurance policy benefits related to the aforementioned
annuity products.
Change in value
of embedded derivatives related to modified coinsurance agreements
is
described in the note to our
75
consolidated
financial statements entitled “Summary of Significant Accounting Policies -
Accounting for Derivatives.” We have transferred the specific block of
investments related to these agreements to our trading securities account, which
we carry at estimated fair value with changes in such value recognized as
trading account income. The change in the value of the embedded
derivatives has largely been offset by the change in value of the trading
securities.
Net investment
income on other trading accounts
includes: (i) the change in
the fair value of a trading securities portfolio; and (ii) the change in fair
value of interest rate swaps. The trading securities were carried at
estimated fair value with changes in such value recognized as trading
income. The change in the value of the interest rate swaps was
recognized in trading income. Prior to December 31, 2007, these fixed
rate securities were sold and the associated interest rate swaps were
terminated.
Insurance policy
benefits
were affected by a number of items as summarized
below.
Insurance
margins (insurance policy income less insurance policy benefits) related to life
products were $(14.7) million, $3.6 million and $(.2) million in 2009, 2008 and
2007, respectively. Such fluctuations were primarily due to changes
in mortality. Earnings on our universal life products, which comprise
a significant part of this block, are subject to volatility since our insurance
acquisition costs are equal to the value of future estimated gross
profits. Accordingly, the entire difference between our assumptions
and actual experience is generally reflected in earnings in the period such
differences occur.
Insurance
policy benefits also fluctuated as a result of the factors summarized below for
benefit ratios. Benefit ratios are calculated by dividing the related
insurance product’s insurance policy benefits by insurance policy
income.
The
benefit ratios on Conseco Insurance Group’s Medicare supplement products have
been impacted by increases in policyholder lapses following our premium rate
increase actions and competition from companies offering Medicare Advantage
products. We establish active life reserves for these policies, which
are in addition to amounts required for incurred claims. When
policies lapse, active life reserves for such lapsed policies are released,
resulting in decreased insurance policy benefits (although such decrease is
substantially offset by additional amortization expense). In
addition, the insurance product liabilities we establish for our Medicare
supplement business are subject to significant estimates and the ultimate claim
liability we incur for a particular period is likely to be different than our
initial estimate. Our insurance policy benefits reflected claim
reserve redundancies from prior years of $4.6 million, $2.5 million and $1.0
million in 2009, 2008 and 2007, respectively. Excluding the effects
of prior year claim reserve redundancies, our benefit ratios for the Medicare
supplement block would have been 70.8 percent, 69.6 percent and 68.0 percent in
2009, 2008 and 2007, respectively. Governmental regulations generally
require us to attain and maintain a ratio of total benefits incurred to total
premiums earned (excluding changes in policy benefit reserves), after three
years from the original issuance of the policy and over the lifetime of the
policy, of not less than 65 percent on these products, as determined in
accordance with statutory accounting principles. Insurance margins
(insurance policy income less insurance policy benefits) on these products were
$57.6 million, $64.6 million and $74.9 million in 2009, 2008 and 2007,
respectively. Such decreases are primarily due to lower
sales.
Conseco
Insurance Group’s specified disease products generally provide fixed or limited
benefits. For example, 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. Approximately three-fourths of our specified disease policies
inforce (based on policy count) are sold with return of premium or cash value
riders. The return of premium rider generally provides that after a
policy has been inforce for a specified number of years or upon the policyholder
reaching a specified age, we 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. The cash value rider is similar to the return of premium
rider, but also provides for payment of a graded portion of the return of
premium benefit if the policy terminates before the return of premium benefit is
earned. Accordingly, the net cash flows from these products generally
result in the accumulation of amounts in the early years of a policy (accounted
for as reserve increases) which will be paid out as benefits in later policy
years (accounted for as reserve decreases). As the policies age, the
benefit ratio will typically increase, but the increase in benefits will be
partially offset by investment income earned on the accumulated
assets. The benefit ratio will fluctuate depending on the claim
experience during the year. Insurance margins (insurance policy
income less insurance policy benefits) on these products were $78.2 million,
$85.0 million and $79.7 million in 2009, 2008 and 2007,
respectively. The increase in the margin in 2008 includes a $12
million correction to insurance policy benefits resulting from our material
control weakness remediation procedures.
The
long-term care policies in this segment generally provide for indemnity and
non-indemnity benefits on a guaranteed renewable or non-cancellable
basis. The benefit ratio on our long-term care policies was 186.7
percent, 169.6
76
percent
and 192.4 percent in 2009, 2008 and 2007, respectively. Benefit
ratios are calculated by dividing the product’s insurance policy benefits by
insurance policy income. Since the insurance product liabilities we
establish for long-term care business are subject to significant estimates, the
ultimate claim liability we incur for a particular period is likely to be
different than our initial estimate. Our insurance policy benefits
reflected reserve redundancies (deficiencies) from prior years of $(2.1)
million, $1.1 million and $(6.3) million in 2009, 2008 and 2007,
respectively. Excluding the effects of prior year claim reserve
redundancies (deficiencies), our benefit ratios would have been 180.1 percent,
172.8 percent and 175.7 percent in 2009, 2008 and 2007,
respectively. These ratios reflect the level of incurred claims
experienced in recent periods, development on claims incurred in prior periods
and changes in policy income. The prior period deficiencies have
primarily resulted from the impact of paid claim experience being different than
prior estimates.
The net
cash flows from long-term care products generally cause an accumulation of
amounts in the early years of a policy (accounted for as reserve increases)
which will be paid out as benefits in later policy years (accounted for as
reserve decreases). Accordingly, as the policies age, the benefit
ratio will typically increase, but the increase in benefits will be partially
offset by investment income earned on the assets which have
accumulated. The interest-adjusted benefit ratio for long-term care
products is calculated by dividing the insurance product’s insurance policy
benefits less interest income on the accumulated assets backing the insurance
liabilities by insurance policy income. The interest-adjusted benefit
ratio on this business was 107.9 percent, 93.5 percent and 128.5 percent in
2009, 2008 and 2007, respectively. Excluding the effects of prior
year claim reserve redundancies (deficiencies), our interest-adjusted benefit
ratios would have been 101.5 percent, 96.7 percent and 111.9 percent in 2009,
2008 and 2007, respectively.
In each
quarterly period, we calculate our best estimate of claim reserves based on all
of the information available to us at that time, which necessarily takes into
account new experience emerging during the period. Our actuaries
estimate these claim reserves using various generally recognized actuarial
methodologies which are based on informed estimates and judgments that are
believed to be appropriate. As additional experience emerges and
other data become available, these estimates and judgments are reviewed and may
be revised. Significant assumptions made in estimating claim reserves
for long-term care policies include expectations about the: (i)
future duration of existing claims; (ii) cost of care and benefit utilization;
(iii) interest rate utilized to discount claim reserves; (iv) claims that have
been incurred but not yet reported; (v) claim status on the reporting date; (vi)
claims that have been closed but are expected to reopen; and (vii)
correspondence that has been received that will ultimately become claims that
have payments associated with them.
On July
1, 2004, the Florida Office of Insurance Regulation issued an order impacting
approximately 4,800 home health care policies issued in Florida by our
subsidiary, Washington National, and its predecessor
companies. Pursuant to the order, Washington National offered the
following three alternatives to holders of these policies subject to rate
increases as follows:
|
·
|
retention
of their current policy with a rate increase of 50 percent in the first
year and actuarially justified increases in subsequent years (which is
also the default election for policyholders who failed to make an election
by 30 days prior to the anniversary date of their policies) (“option
one”);
|
|
·
|
receipt
of a replacement policy with reduced benefits and a rate increase in the
first year of 25 percent and no more than 15 percent in subsequent years
(“option two”); or
|
|
·
|
receipt
of a paid-up policy, allowing the holder to file future claims up to 100
percent of the amount of premiums paid since the inception of the policy
(“option three”).
|
Policyholders
selecting option one or option two are entitled to receive a contingent
non-forfeiture benefit if their policy subsequently lapses. In
addition, policyholders could change their initial election any time up to 30
days prior to the anniversary date of their policies. We began to
implement premium adjustments with respect to policyholder elections in the
fourth quarter of 2005 and the implementation of these premium adjustments was
completed in 2007. We did not make any adjustments to the insurance
liabilities when these elections were made. Reserves for all three
groups of policies under the order were prospectively adjusted using the
prospective revision methodology described in the “Critical Accounting Policies
– Accounting for Long-term Care Premium Rate Increases” in “Management’s
Discussion and Analysis of Consolidated Financial Condition and Results of
Operations”.
The order
also requires Washington National to pursue a similar course of action with
respect to home health care policies in other states, subject to such actions
being justified based on the experience of the business and approval by the
other state insurance departments. If we are unsuccessful in
obtaining rate increases or other forms of relief in those states, or if the
policy changes approved by the Florida Office of Insurance Regulation prove
inadequate, our future results of operations could be adversely
affected.
77
The
benefit ratios on Conseco Insurance Group’s other products are subject to
fluctuations due to the smaller size of these blocks of business.
Amounts added to
policyholder account balances for annuity products and interest-sensitive life
products
were $140.2 million, $153.6 million and $217.4 million in 2009,
2008 and 2007, respectively. The decrease was primarily due to a
smaller block of annuity business inforce due to: (i) lapses
exceeding new sales in recent periods; and (ii) the smaller block of business
following the completion of the annuity coinsurance agreement in October 2007,
as discussed above. The weighted average crediting rates for these
products was 4.2 percent, 4.2 percent and 4.1 percent in 2009, 2008 and 2007,
respectively.
Amounts added to
equity-indexed products
generally fluctuate with the corresponding
related investment income accounts described above.
Amortization
related to operations
includes amortization of insurance acquisition
costs. Insurance acquisition costs are generally amortized either:
(i) in relation to the estimated gross profits for universal life and
investment-type products; or (ii) in relation to actual and expected premium
revenue for other products. In addition, for universal life and
investment-type products, we are required to adjust the total amortization
recorded to date through the statement of operations if actual experience or
other evidence suggests that earlier estimates of future gross profits should be
revised. Accordingly, amortization for universal life and
investment-type products is dependent on the profits realized during the period
and on our expectation of future profits. For other products, we
amortize insurance acquisition costs in relation to actual and expected premium
revenue, and amortization is only adjusted if expected premium revenue changes
or if we determine the balance of these costs is not recoverable from future
profits. The assumptions we use to estimate our future gross profits
and premiums involve significant judgment. A revision to our current
assumptions could result in increases or decreases to amortization expense in
future periods. The decrease in amortization expense in 2008, as
compared to 2007, was primarily a result of the coinsurance agreement discussed
above.
The blocks of universal life and
interest-sensitive products in the Conseco Insurance Group segment have not
performed in accordance with prior estimates of future gross profits, resulting
in adjustments to amortization expense over the last 3 years. We have
been required to accelerate the amortization of insurance acquisition costs
related to these blocks because the prior balance was not recoverable by the
current estimated value of future gross profits. These increases to
amortization expense were necessary so that our insurance acquisition costs
would not exceed the value of future estimated gross profits. Because
our insurance acquisition costs are now equal to the value of future estimated
gross profits, these blocks are expected to generate break-even earnings in the
future. In addition, results for these blocks have and are expected
to continue to exhibit increased volatility in the future, because the entire
difference between our assumptions and actual experience is reflected in
earnings in the period such differences occur.
During
2009, we were required to accelerate the amortization of insurance acquisition
costs by approximately $25 million for the changes in three assumptions related
to future profits from our universal life products in this
segment. The first change resulted in additional amortization expense
of $24 million and relates to the investment earnings assumption for the entire
interest-sensitive block of life insurance business. The average
yield on our general account invested assets decreased during 2009 reflecting
lower new money rates. Accordingly, the future weighted average
investment earnings assumptions were reduced reflecting the lower portfolio
earnings. The second change resulted from refinements to our
estimates of premium taxes expected to be incurred in the future, and resulted
in a reduction to amortization expense of $8 million. The third
change resulted in additional amortization expense of $9 million and relates to
the assumption of when we will ultimately increase certain non-guaranteed
premium rates related to the Lifetrend insurance products. As
described in the note to the consolidated financial statements entitled
“Litigation and Other Legal Proceedings – Regulatory Examinations and Fines,” we
have reached a settlement in principle with the regulators regarding this issue,
but we have not implemented the non-guaranteed premium rate increases pending
execution of the final settlement agreement.
We were
also required to accelerate the amortization of insurance acquisition costs due
to changes in our assumptions related to future profits on our universal life
products in this segment during 2008 and 2007. During 2008, an
analysis was performed on a universal life block of business that led to changes
in our assumptions of future mortality, surrenders, premium persistency,
expenses and investment income. We recognized additional amortization
expense of approximately $8 million to reflect these changes. During
2007, we recognized additional amortization expense of $14.8 million to reflect
changes in our estimates of future mortality rates. The additional
amortization expense in both 2007 and 2008 was net of planned increases to
associated policyholder charges.
78
During 2009 and 2008, we were required
to accelerate the amortization of insurance acquisition costs due to the
experience of a block of equity-indexed annuities. This block of
business has experienced higher than anticipated surrenders and we have
increased our expected surrender assumptions in future periods. These
annuities also have a MVA feature, which effectively reduced (or in some cases,
eliminated) the charges paid upon the surrender of these policies in the recent
periods as the 10-year treasury rate dropped. The impact of both the
historical experience and the projected increased surrender activity and higher
MVA benefits has reduced our expectations on the profitability of this block to
approximately break-even. We recognized additional amortization of
approximately $8.5 million in 2009 and approximately $5 million in 2008, related
to the actual and expected future changes in the experience of this
block. We continue to hold insurance acquisition costs of
approximately $68 million related to these products. Results for this
block are expected to exhibit increased volatility in the future, because the
difference between our assumptions and actual experience will be reflected in
earnings in the period such differences occur.
Interest expense
on investment borrowings
includes $20.3 million, $21.9 million and $16.7
million of interest expense on collateralized borrowings in 2009, 2008 and 2007,
respectively, as further described in the note to the consolidated financial
statements entitled “Summary of Significant Accounting Policies - Investment
Borrowings”.
Costs related to
a litigation settlement
include legal fees and estimated amounts related
to a settlement during 2006 in the class action case referred to as
In Re Conseco Life Insurance Company
Cost of Insurance Litigation
. The costs related to the
litigation settlement recognized in 2007 represent changes to our initial
estimates based on the ultimate cost of the settlement. For further
information related to this case, refer to the caption entitled “Cost of
Insurance Litigation” included in the note to our consolidated financial
statements entitled “Commitments and Contingencies”. A portion of the
legal and other costs related to this litigation were incurred by the Corporate
Operations segment to defend the non-insurance company allegations made in such
lawsuits.
Loss related to
an annuity coinsurance transaction
resulted from the completion of a
transaction to coinsure 100 percent of most of the older inforce equity-indexed
annuity and fixed annuity business of three of our insurance subsidiaries with
REALIC as further discussed above under
annuity
coinsurance transaction
.
Other operating
costs and expenses
were $258.6 million, $264.1 million and $300.0 million
in 2009, 2008 and 2007, respectively. Other operating costs and
expenses include commission expense of $71.6 million, $79.2 million and $82.2
million in 2009, 2008 and 2007, respectively. During 2009, the
Company recognized expenses of $14.5 million related to regulatory and legal
settlements. During 2007, the Company recognized expenses of $7.3
million related to the decision to abandon certain software that will not be
used consistent with our current business plan and $3.7 million of costs related
to other operational initiatives and consolidation activities.
Net realized
investment gains (losses)
fluctuate each period. During 2009,
net realized investment losses in this segment included $55.1 million of net
gains from the sales of investments (primarily fixed maturities) and $81.3
million of writedowns of investments for other than temporary declines in fair
value recognized through net income ($184.7 million, prior to the $103.4 million
of impairment losses recognized through accumulated other comprehensive
loss). During 2008, net realized investment losses included $33.0
million of net losses from the sales of investments (primarily fixed maturities)
and $60.3 million of writedowns of investments resulting from declines in fair
value that we concluded were other than temporary. During 2007, net
realized investment losses in this segment included: (i) $43.6
million from the sales of investments (primarily fixed maturities); (ii) $14.4
million of writedowns of investments resulting from declines in fair values that
we concluded were other than temporary; and (iii) $73.7 million of writedowns of
investments (which were subsequently transferred pursuant to a coinsurance
agreement as further discussed in the note to the consolidated financial
statements entitled “Summary of Significant Accounting Policies – Reinsurance”)
as a result of our intent not to hold such investments for a period of time
sufficient to allow for any anticipated recovery in value. The net
investment losses realized on sales of investments in 2007 were primarily
recognized on securities collateralized by sub prime residential mortgage
loans. We decided to sell these securities given our evaluation
regarding the potential effect of future adverse developments on the fair value
of these securities.
Amortization
related to net realized investment losses
is the increase or decrease in
the amortization of insurance acquisition costs which results from realized
investment gains or losses. When we sell securities which back our
universal life and investment-type products at a gain (loss) and reinvest the
proceeds at a different yield (or when we have the intent to sell the impaired
investments before an anticipated recovery in value occurs, we increase (reduce)
the amortization of insurance acquisition costs in order to reflect the change
in estimated gross profits due to the gains (losses) realized and the resulting
effect on estimated future yields. Sales of fixed maturity
investments resulted in a decrease in the amortization of insurance acquisition
costs of $4.2 million, $5.7 million and $33.2 million in 2009, 2008 and 2007,
respectively.
79
Corporate
Operations (dollars in millions)
|
2009
|
2008
|
2007
|
||||||||||
|
Corporate
operations:
|
||||||||||||
|
Interest
expense on corporate
debt
|
$ | (84.7 | ) | $ | (67.9 | ) | $ | (80.3 | ) | |||
|
Net
investment
income
|
1.7 | 4.9 | 6.6 | |||||||||
|
Fee
revenue and other
income
|
2.7 | 4.7 | 9.8 | |||||||||
|
Net
operating results of variable interest entity
|
.8 | 7.2 | 9.2 | |||||||||
|
Costs
related to a litigation settlement
|
- | - | (32.2 | ) | ||||||||
|
Other
operating costs and
expenses
|
(42.9 | ) | (43.5 | ) | (42.4 | ) | ||||||
|
Gain
(loss) on extinguishment or modification
of
debt
|
(22.2 | ) | 21.2 | - | ||||||||
|
Loss
before net realized investment losses and income taxes
|
(144.6 | ) | (73.4 | ) | (129.3 | ) | ||||||
|
Net
realized investment
losses
|
(7.4 | ) | (50.8 | ) | (6.2 | ) | ||||||
|
Loss
before income
taxes
|
$ | (152.0 | ) | $ | (124.2 | ) | $ | (135.5 | ) | |||
Net investment
income
primarily
included
income earned on short-term investments, changes in the underlying value of
certain investments held by the Corporate segment and miscellaneous other income
and fluctuated along with the change in the amount of invested assets in this
segment.
Fee revenue and
other income
includes: (i) revenues we receive for managing
investments for other companies; and (ii) fees received for marketing insurance
products of other companies. In 2007, our wholly owned investment
management subsidiary recognized performance-based fees of $2.4 million
resulting from the liquidation of two portfolios that were managed by the
subsidiary. Excluding such performance-based fees, fee revenue and
other income has decreased primarily as a result of a decrease in the fair value
of investments managed for others, upon which these fees are based.
Net operating
results of variable interest entity
represent the operating results of a
variable interest entity (“VIE”). The VIE is consolidated in
accordance with GAAP. Although we do not control this entity, we
consolidate it because we are the primary beneficiary. This entity
was established to issue securities and use the proceeds to invest in loans and
other permitted assets.
Costs related to
a litigation settlement
include legal and other costs incurred by the
Corporate Operations segment to defend the non-insurance company allegations
made in the class action case referred to as
In Re Conseco Life Insurance Company
Cost of Insurance Litigation
. Refer to the captions
entitled: (i) “Costs related to a litigation settlement”
included in the results of operations section for the Conseco Insurance Group
segment; and (ii) “Cost of Insurance Litigation” included in the note to our
consolidated financial statements entitled “Commitments and Contingencies” for
further information related to this case.
Other operating
costs and expenses
include general corporate expenses, net of amounts
charged to subsidiaries for services provided by the corporate
operations. These amounts fluctuate as a result of expenses such as
consulting, legal and severance costs which often vary from period to
period.
Gain (loss) on
extinguishment or modification of debt
in 2009 consisted of expenses
incurred and the write-off of unamortized discount or issuance costs totaling
$22.2 million related to the following transactions: (i) the Tender
Offer; (ii)
80
repayment
of principal amounts on the Senior Credit Agreement from the proceeds from the
issuance of common stock; and (iii) modifications to our Senior Credit Agreement
in March 2009 and December 2009. The gain on extinguishment of debt
of $21.2 million in 2008 resulted from the repurchase of $37.0 million par value
of 3.5% Debentures for $15.3 million plus accrued interest. These
transactions are further discussed in the note to the consolidated financial
statements entitled “Notes Payable – Direct Corporate Obligations”.
Net
realized investment losses
often fluctuate each
period.
During 2009, net realized investment losses in this
segment included $6.1 million of net gains from the sales of investments (of
which $.7 million were losses recognized by a VIE) and $13.5 million of
writedowns of investments (all of which were recognized by a VIE) due to
other-than-temporary declines in value. During 2008, net realized
investment losses included $36.1 million from the sale of investments ($14.1
million of such losses were recognized by a VIE) and $14.7 million of writedowns
($10.8 million of such writedowns were recognized by a VIE) of investments
resulting from declines in fair value that we concluded were other than
temporary due to declines in value on certain securities. During
2007, net realized investment losses in this segment included $4.7 million from
the sale of investments (primarily fixed maturities) and $1.5 million of
writedowns of investments resulting from declines in fair value that we
concluded were other than temporary
.
PREMIUM
COLLECTIONS
In accordance with GAAP,
insurance policy income in our consolidated statement of operations consists of
premiums earned for traditional insurance policies that have life contingencies
or morbidity features. For
annuity and universal life
contracts, premiums collected are not reported as revenues, but as deposits to
insurance liabilities. We recognize revenues for these products over
time in the form of investment income and surrender or other
charges.
Our insurance segments
sell products through three primary distribution channels — career agents (our
Bankers Life segment),
direct marketing (our Colonial Penn segment) and
independent
producers (our Conseco Insurance
Group segment). Our career agency force
in the Bankers Life segment sells primarily Medicare supplement and long-term
care insurance policies, Medicare Part D contracts, PFFS contracts, life
insurance and annuities. These agents visit the customer’s home,
which permits one-on-one contact with potential policyholders and promotes
strong personal relationships with existing policyholders. Our direct
marketing distribution channel in the Colonial Penn segment is engaged primarily
in the sale of “graded benefit life” and simplified issue life insurance
policies which are sold directly to the policyholder. Our independent
producer distribution channel in the Conseco Insurance Group segment consists of
a general agency and insurance brokerage distribution system comprised of
independent licensed agents doing business in all fifty states, the District of
Columbia, and certain protectorates of the United States. Independent
producers are a diverse network of independent agents, insurance brokers and
marketing organizations. Our independent producer distribution
channel sells primarily specified disease and Medicare supplement insurance
policies, universal life insurance and annuities.
Agents,
insurance brokers and marketing companies who market our products and
prospective purchasers of our products use the financial strength ratings of our
insurance subsidiaries as an important factor in determining
whether to market or
purchase. Ratings have the most impact on our annuity,
interest-sensitive life insurance and long-term care
products.
The current financial strength ratings of our
primary insurance subsidiaries from A.M. Best, S&P and Moody’s are “B
(Fair)”, “BB-” and “Ba2”, respectively. For a description of these
ratings and additional information on our ratings, see “Management’s Discussion
and Analysis of Consolidated Financial Condition and Results of Operations —
Liquidity for Insurance Operations.”
We set premium rates on
our health insurance policies based on facts and circumstances known at the time
we issue the policies using assumptions about numerous variables, including the
actuarial
probability of a policyholder incurring a claim, the probable
size of the claim, and the interest rate earned on our investment of
premiums. We also consider historical claims information, industry
statistics, the rates of our competitors and other factors. If our
actual claims experience is less favorable than we anticipated and we are unable
to raise our premium rates, our financial results may be adversely
affected. We generally cannot raise our health insurance premiums in
any state until we obtain the approval of the state insurance
regulator. We review the adequacy of our premium rates regularly and
file for rate increases on our products when we believe such rates are too
low. It is likely that we will not be able to obtain approval for all
requested premium rate increases. If such requests are denied in one or more
states, our net income may decrease. If such requests are approved,
increased premium rates may reduce the volume of our new sales and may cause
existing policyholders to lapse their policies. If the healthier
policyholders allow their policies to lapse, this would reduce our premium
income and profitability in the future.
Total
premiums collections were as follows:
81
Bankers
Life (dollars in millions)
|
2009
|
2008
|
2007
|
||||||||||
|
Premiums
collected by product:
|
||||||||||||
|
Annuities:
|
||||||||||||
|
Equity-indexed
(first-year)
|
$ | 350.1 | $ | 522.8 | $ | 437.4 | ||||||
|
Other
fixed
(first-year)
|
707.0 | 697.8 | 445.3 | |||||||||
|
Other
fixed
(renewal)
|
3.3 | 3.5 | 2.8 | |||||||||
|
Subtotal
- other fixed
annuities
|
710.3 | 701.3 | 448.1 | |||||||||
|
Total
annuities
|
1,060.4 | 1,224.1 | 885.5 | |||||||||
|
Supplemental
health:
|
||||||||||||
|
Medicare
supplement
(first-year)
|
91.7 | 81.3 | 82.5 | |||||||||
|
Medicare
supplement
(renewal)
|
562.0 | 555.3 | 553.6 | |||||||||
|
Subtotal
- Medicare
supplement
|
653.7 | 636.6 | 636.1 | |||||||||
|
Long-term
care
(first-year)
|
17.7 | 42.7 | 47.0 | |||||||||
|
Long-term
care
(renewal)
|
583.9 | 583.0 | 575.4 | |||||||||
|
Subtotal
- long-term
care
|
601.6 | 625.7 | 622.4 | |||||||||
|
PDP
and PFFS (first
year)
|
96.0 | 353.3 | 206.4 | |||||||||
|
PDP
and PFFS
(renewal)
|
348.4 | 260.7 | 71.4 | |||||||||
|
Subtotal
– PDP and
PFFS
|
444.4 | 614.0 | 277.8 | |||||||||
|
Other
health
(first-year)
|
2.7 | 2.1 | .9 | |||||||||
|
Other
health
(renewal)
|
9.3 | 8.6 | 8.9 | |||||||||
|
Subtotal
- other
health
|
12.0 | 10.7 | 9.8 | |||||||||
|
Total
supplemental
health
|
1,711.7 | 1,887.0 | 1,546.1 | |||||||||
|
Life
insurance:
|
||||||||||||
|
First-year
|
82.6 | 80.7 | 89.2 | |||||||||
|
Renewal
|
146.2 | 128.7 | 110.8 | |||||||||
|
Total
life
insurance
|
228.8 | 209.4 | 200.0 | |||||||||
|
Collections
on insurance products:
|
||||||||||||
|
Total
first-year premium collections on insurance products
|
1,347.8 | 1,780.7 | 1,308.7 | |||||||||
|
Total
renewal premium collections on insurance products
|
1,653.1 | 1,539.8 | 1,322.9 | |||||||||
|
Total
collections on insurance
products
|
$ | 3,000.9 | $ | 3,320.5 | $ | 2,631.6 | ||||||
82
Annuities
in
this segment include equity-indexed and other fixed annuities sold to the
senior market. Annuity collections in this segment decreased 13
percent, to $1,060.4 million, in 2009 and increased 38 percent to $1,224.1
million, in 2008.
The change in mix of
premium collections between our equity-indexed products and our fixed annuity
products has fluctuated due to volatility in the financial markets in recent
periods
. In addition, premium collections from Bankers Life’s
fixed annuity products decreased in the fourth quarter of 2009 as continuing
decreases in new money interest rates resulted in a reduction to the bonus on
our bonus interest annuity. A new product, which will provide more
flexibility in setting the bonus interest rate is expected to launch in early
2010.
Supplemental
health
products include Medicare supplement, Medicare Part D contracts,
PFFS contracts, long-term care and other insurance products. Our
profits on supplemental health policies depend on the overall level of sales,
the length of time the business remains inforce, investment yields, claims
experience and expense management.
Collected premiums on
Medicare supplement policies in
the Bankers Life segment
in
creased 2.7
percent, to $653.7 million, in 2009 and .1 percent, to $636.6 million, in
2008.
Premiums
collected on Bankers Life’s long-term care policies decreased 3.9 percent, to
$601.6 million, in 2009 and increased .5 percent, to $625.7 million, in
2008. The decrease in 2009 was primarily attributable to a long-term
care reinsurance agreement pursuant to which we are reinsuring 70 percent of
Bankers Life’s new 2009 long-term care business. Under the
reinsurance agreement, the amount reinsured decreases to 50 percent in the first
quarter of 2010 and to 25 percent thereafter.
Premiums
collected on PDP and PFFS business relate to various quota-share reinsurance
agreements with Coventry. Effective May 1, 2008 and July 1, 2007, we
entered into new PFFS quota-share reinsurance agreements with
Coventry. In order to reduce the required statutory capital
associated with the assumption of group PFFS business, we terminated two group
policy quota-share agreements as of December 31, 2008 and terminated the last
agreement on June 30, 2009. Fluctuations in first-year and renewal
premiums are generally due to the timing of the contracts we entered into with
Coventry. Coventry has decided to cease selling PFFS plans effective
January 1, 2010. On July 22, 2009, the Company announced a strategic
alliance under which the Bankers Life segment will offer Humana’s Medicare
Advantage plans to its policyholders and consumers nationwide through its career
agency force and will receive marketing fees based on
sales. Effective January 1, 2010, the Company will no longer be
assuming the underwriting risk related to PFFS business.
These
agreements are described in “Management’s Discussion and Analysis of
Consolidated Financial Condition and Results of Operations - Critical Accounting
Policies”.
Other
health products relate to collected premiums on other health products which we
no longer actively market.
Life
products in this segment are sold primarily to the senior market through
our career agents. Life premiums collected in this segment increased
9.3 percent, to $228.8 million, in 2009 and 4.7 percent, to $209.4 million, in
2008. Collected premiums have been impacted by
higher
persistency
.
83
Colonial
Penn (dollars in millions)
|
2009
|
2008
|
2007
|
||||||||||
|
Premiums
collected by product:
|
||||||||||||
|
Life
insurance:
|
||||||||||||
|
First-year
|
$ | 33.0 | $ | 35.0 | $ | 28.7 | ||||||
|
Renewal
|
154.3 | 139.1 | 85.0 | |||||||||
|
Total
life
insurance
|
187.3 | 174.1 | 113.7 | |||||||||
|
Supplemental
health (all of which are renewal premiums):
|
||||||||||||
|
Medicare
supplement
|
7.0 | 8.1 | 9.4 | |||||||||
|
Other
health
|
.5 | .8 | 1.0 | |||||||||
|
Total
supplemental
health
|
7.5 | 8.9 | 10.4 | |||||||||
|
Collections
on insurance products:
|
||||||||||||
|
Total
first-year premium collections on insurance products
|
33.0 | 35.0 | 28.7 | |||||||||
|
Total
renewal premium collections on insurance products
|
161.8 | 148.0 | 95.4 | |||||||||
|
Total
collections on insurance
products
|
$ | 194.8 | $ | 183.0 | $ | 124.1 | ||||||
Life
products in this segment are sold primarily to the senior
market. Life premiums collected in this segment increased 7.6
percent, to $187.3 million, in 2009 and 53 percent, to $174.1 million, in
2008. Graded benefit life products sold through our direct response
marketing channel accounted
for $180.5 million, $168.5
million and $108.8 million of collected premiums in 2009, 2008 and 2007,
respectively. In 2009, renewal premiums for our life insurance
products include the receipt of a $3.4 million final distribution and
commutation payment following the termination of a group insurance pool that
Colonial Penn previously participated in. Also, c
ollected
premiums have been impacted by the recapture in the fourth quarter of 2007 of a
block of traditional life insurance inforce that had been ceded in 2002 to
REALIC.
Supplemental
health
products include Medicare supplement and other insurance
products. Our profits on supplemental health policies depend on the
overall level of sales, the length of time the business remains inforce,
investment yields, claims experience and expense management. Premiums
collected on these products have decreased as we do not currently market these
products through this segment.
84
Conseco
Insurance Group (dollars in millions)
|
2009
|
2008
|
2007
|
||||||||||
|
Premiums
collected by product:
|
||||||||||||
|
Annuities:
|
||||||||||||
|
Equity-indexed
(first-year)
|
$ | 71.0 | $ | 116.1 | $ | 336.4 | ||||||
|
Equity-indexed
(renewal)
|
5.6 | 7.6 | 8.2 | |||||||||
|
Subtotal
- equity-indexed annuities
|
76.6 | 123.7 | 344.6 | |||||||||
|
Other
fixed
(first-year)
|
.8 | 3.8 | 18.0 | |||||||||
|
Other
fixed
(renewal)
|
1.0 | 2.3 | 6.0 | |||||||||
|
Subtotal
- other fixed
annuities
|
1.8 | 6.1 | 24.0 | |||||||||
|
Total
annuities
|
78.4 | 129.8 | 368.6 | |||||||||
|
Supplemental
health:
|
||||||||||||
|
Medicare
supplement
(first-year)
|
7.2 | 9.6 | 19.4 | |||||||||
|
Medicare
supplement
(renewal)
|
170.6 | 194.2 | 206.5 | |||||||||
|
Subtotal
- Medicare
supplement
|
177.8 | 203.8 | 225.9 | |||||||||
|
Specified
disease
(first-year)
|
45.4 | 39.4 | 31.4 | |||||||||
|
Specified
disease
(renewal)
|
337.9 | 335.2 | 327.8 | |||||||||
|
Subtotal
- specified
disease
|
383.3 | 374.6 | 359.2 | |||||||||
|
Long-term
care (all of which are renewal)
|
31.4 | 33.7 | 36.7 | |||||||||
|
Other
health
(first-year)
|
- | .1 | .3 | |||||||||
|
Other
health
(renewal)
|
7.9 | 9.6 | 11.3 | |||||||||
|
Subtotal
– other
health
|
7.9 | 9.7 | 11.6 | |||||||||
|
Total
supplemental
health
|
600.4 | 621.8 | 633.4 | |||||||||
|
Life
insurance:
|
||||||||||||
|
First-year
|
3.0 | 4.3 | 4.7 | |||||||||
|
Renewal
|
237.3 | 265.5 | 282.6 | |||||||||
|
Total
life
insurance
|
240.3 | 269.8 | 287.3 | |||||||||
|
Collections
on insurance products:
|
||||||||||||
|
Total
first-year premium collections on insurance products
|
127.4 | 173.3 | 410.2 | |||||||||
|
Total
renewal premium collections on insurance products
|
791.7 | 848.1 | 879.1 | |||||||||
|
Total
collections on insurance products
|
$ | 919.1 | $ | 1,021.4 | $ | 1,289.3 | ||||||
Annuities
in this segment include equity-indexed and other fixed
annuities. We are no longer actively pursuing sales of annuity
products in this segment. Total annuity collected premiums in this
segment decreased 40 percent, to $78.4 million, in 2009 and 65 percent, to
$129.8 million, in 2008.
Our
equity-indexed annuities have guaranteed minimum cash surrender values, but have
potentially higher returns based on a percentage of the change in one of several
equity market indices during each year of their term. We purchase
options in an effort to hedge increases to policyholder benefits resulting from
increases in the indices. Collected premiums for these products
decreased 38 percent, to $76.6 million, in 2009 and 64 percent, to $123.7
million, in 2008. During the second half of 2007, we changed the
pricing of specific products and we no longer emphasized the sale of certain
products resulting in a decrease in collected premiums.
Annuity
premiums on fixed products were $1.8 million, $6.1 million and $24.0 million in
2009, 2008 and 2007, respectively. Such decreases are primarily due
to a focus on the sale of more profitable products.
85
Supplemental
health
products in the Conseco Insurance Group segment include Medicare
supplement, specified disease, long-term care and other insurance
products. Our profits on supplemental health policies depend on the
overall level of sales, the length of time the business remains inforce,
investment yields, claim experience and expense management.
Collected
premiums on Medicare supplement policies in the Conseco Insurance Group segment
decreased 13 percent, to $177.8 million, in 2009 and 9.8 percent, to $203.8
million, in 2008. We have experienced lower sales and higher lapses
of these products due to premium rate increases implemented in recent periods
and competition from companies offering Medicare Advantage
products.
Premiums
collected on specified disease products increased 2.3 percent, to $383.3
million, in 2009 and 4.3 percent, to $374.6 million, in 2008. Such
increases reflect higher new sales in each year and a slight improvement in
persistency in 2009 and 2008.
The
long-term care premiums in this segment relate to blocks of business that we no
longer market or underwrite. As a result, we expect this segment’s
long-term care premiums to continue to decline, reflecting additional policy
lapses in the future, partially offset by premium rate increases.
Life
products in the Conseco Insurance Group
segment
include
universal life and traditional life products. Life premiums collected
decreased 11 percent, to $240.3 million, in 2009 and 6.1 percent, to $269.8
million, in 2008.
INVESTMENTS
Our
investment strategy is to: (i) maintain a predominately investment-grade fixed
income portfolio; (ii) provide liquidity to meet our cash obligations to
policyholders and others; and (iii) generate stable and predictable investment
income through active investment management. Consistent with this
strategy, investments in fixed maturity securities, mortgage loans and policy
loans made up 97 percent of our $21.5 billion investment portfolio at December
31, 2009. The remainder of the invested assets was trading
securities, equity securities and other invested assets.
The
following table summarizes the composition of our investment portfolio as of
December 31, 2009 (dollars in millions):
|
Carrying
|
Percent
of
|
|||||||
|
value
|
total investments
|
|||||||
|
Actively
managed fixed maturities
|
$ | 18,528.4 | 86 | % | ||||
|
Equity
securities
|
31.0 | - | ||||||
|
Mortgage
loans
|
1,965.5 | 9 | ||||||
|
Policy
loans
|
295.2 | 2 | ||||||
|
Trading
securities
|
293.3 | 1 | ||||||
|
Securities
lending
collateral
|
180.0 | 1 | ||||||
|
Partnership
investments
|
22.0 | - | ||||||
|
Other
invested
assets
|
214.8 | 1 | ||||||
|
Total
investments
|
$ | 21,530.2 | 100 | % | ||||
Insurance
statutes regulate the types of investments that our insurance subsidiaries are
permitted to make and limit 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, we generally seek to invest in United
States government and government-agency securities and corporate securities
rated investment grade by established nationally recognized rating organizations
or in securities of comparable investment quality, if not rated.
86
The
following table summarizes the carrying value of our actively managed fixed
maturity securities by category as of December 31, 2009 (dollars in
millions):
|
Percent
of
|
||||||||||||||||
|
Gross
|
gross
|
|||||||||||||||
|
Percent
of
|
unrealized
|
unrealized
|
||||||||||||||
|
Carrying value
|
fixed maturities
|
losses
|
losses
|
|||||||||||||
|
Collateralized
mortgage obligations
|
$ | 2,015.2 | 10.9 | % | $ | (185.1 | ) | 21.3 | % | |||||||
|
Utilities
|
1,928.8 | 10.4 | (32.1 | ) | 3.7 | |||||||||||
|
Energy/pipelines
|
1,687.1 | 9.1 | (19.9 | ) | 2.3 | |||||||||||
|
Healthcare/pharmaceuticals
|
1,420.9 | 7.7 | (23.1 | ) | 2.7 | |||||||||||
|
Food/beverage
|
1,247.5 | 6.7 | (16.9 | ) | 1.9 | |||||||||||
|
States
and political
subdivisions
|
853.6 | 4.6 | (80.5 | ) | 9.3 | |||||||||||
|
Banks
|
848.6 | 4.6 | (97.6 | ) | 11.2 | |||||||||||
|
Insurance
|
845.8 | 4.6 | (63.0 | ) | 7.2 | |||||||||||
|
Cable/media
|
792.9 | 4.3 | (22.0 | ) | 2.5 | |||||||||||
|
Commercial
mortgage-backed securities
|
766.0 | 4.1 | (109.5 | ) | 12.6 | |||||||||||
|
Capital
goods
|
689.0 | 3.7 | (12.0 | ) | 1.4 | |||||||||||
|
Aerospace/defense
|
563.2 | 3.0 | (10.9 | ) | 1.2 | |||||||||||
|
Telecom
|
547.7 | 2.9 | (12.3 | ) | 1.4 | |||||||||||
|
Real
estate/REITs
|
542.4 | 2.9 | (27.6 | ) | 3.2 | |||||||||||
|
Transportation
|
473.9 | 2.6 | (4.9 | ) | .6 | |||||||||||
|
Building
materials
|
344.6 | 1.9 | (7.6 | ) | .9 | |||||||||||
|
Consumer
products
|
283.1 | 1.5 | (5.7 | ) | .6 | |||||||||||
|
Technology
|
282.1 | 1.5 | (9.6 | ) | 1.1 | |||||||||||
|
U.S.
Treasury and
Obligations
|
269.6 | 1.5 | (3.5 | ) | .4 | |||||||||||
|
Chemicals
|
214.1 | 1.2 | (3.9 | ) | .4 | |||||||||||
|
Entertainment/hotels
|
198.9 | 1.1 | (6.2 | ) | .7 | |||||||||||
|
Asset-backed
securities
|
192.1 | 1.0 | (54.6 | ) | 6.3 | |||||||||||
|
Other
|
1,521.3 | 8.2 | (61.6 | ) | 7.1 | |||||||||||
|
Total
actively managed fixed maturities
|
$ | 18,528.4 | 100.0 | % | $ | (870.1 | ) | 100.0 | % | |||||||
Our fixed
maturity securities consist predominantly of publicly traded
securities. We classify securities issued in the Rule 144A market as
publicly traded. Securities not publicly traded comprise
approximately 13 percent of our total fixed maturity securities
portfolio.
Fair
Value of Investments
Fair
value is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date and, therefore, represents an exit price, not an entry
price. We hold fixed maturities, equity securities, derivatives and
separate account assets, which are carried at fair value.
The
degree of judgment utilized in measuring the fair value of financial instruments
is largely dependent on the level to which pricing is based on observable
inputs. Observable inputs reflect market data obtained from
independent sources, while unobservable inputs reflect our view of market
assumptions in the absence of observable market
information. Financial instruments with readily available active
quoted prices would be considered to have fair values based on the highest level
of observable inputs, and little judgment would be utilized in measuring fair
value. Financial instruments that rarely trade would be considered to
have fair value based on a lower level of observable inputs, and more judgment
would be utilized in measuring fair value.
There is
a three-level hierarchy for valuing assets or liabilities at fair value based on
whether inputs are observable or unobservable.
|
·
|
Level
1 – includes assets and liabilities valued using inputs that are quoted
prices in active markets for identical assets or
liabilities. Our Level 1 assets include exchange traded
securities and U.S. Treasury
securities.
|
87
|
·
|
Level
2 – includes assets and liabilities valued using inputs that are quoted
prices for similar assets in an active market, quoted prices for identical
or similar assets in a market that is not active, observable inputs, or
observable inputs that can be corroborated by market
data. Level 2 assets and liabilities include those financial
instruments that are valued by independent pricing services using models
or other valuation methodologies. These models are primarily
industry-standard models that consider various inputs such as interest
rate, credit spread, reported trades, broker/dealer quotes, issuer spreads
and other inputs that are observable or derived from observable
information in the marketplace or are supported by observable levels at
which transactions are executed in the marketplace. Financial
instruments in this category primarily include: certain public
and private corporate fixed maturity securities; certain government or
agency securities; certain mortgage and asset-backed securities; and
non-exchange-traded derivatives such as call options to hedge liabilities
related to our equity-indexed annuity
products.
|
|
·
|
Level
3 – includes assets and liabilities valued using unobservable inputs that
are used in model-based valuations that contain management
assumptions. Level 3 assets and liabilities include those
financial instruments whose fair value is estimated based on non-binding
broker prices or internally developed models or methodologies utilizing
significant inputs not based on, or corroborated by, readily available
market information. Financial instruments in this category
include certain corporate securities (primarily private placements),
certain mortgage and asset-backed securities, and other less liquid
securities. Additionally, the Company’s liabilities for
embedded derivatives (including embedded derivates related to our
equity-indexed annuity products and to a modified coinsurance arrangement)
are classified in Level 3 since their values include significant
unobservable inputs including actuarial
assumptions.
|
At each
reporting date, we classify assets and liabilities into the three input levels
based on the lowest level of input that is significant to the measurement of
fair value for each asset and liability reported at fair value. This
classification is impacted by a number of factors, including the type of
financial instrument, whether the financial instrument is new to the market and
not yet established, the characteristics specific to the transaction and overall
market conditions. Our assessment of the significance of a particular
input to the fair value measurement and the ultimate classification of each
asset and liability requires judgment.
The vast
majority of our fixed maturity securities and separate account assets use Level
2 inputs for the determination of fair value. These fair values are
obtained primarily from independent pricing services, which use Level 2 inputs
for the determination of fair value. Substantially all of our Level 2
fixed maturity securities and separate account assets were valued from
independent pricing services. Third party pricing services normally
derive the security prices through recently reported trades for identical or
similar securities making adjustments through the reporting date based upon
available market observable information. If there are no recently
reported trades, the third party pricing services may use matrix or model
processes to develop a security price where future cash flow expectations are
developed and discounted at an estimated risk-adjusted market
rate. The number of prices obtained is dependent on the Company’s
analysis of such prices as further described below.
For
securities that are not priced by pricing services and may not be reliably
priced using pricing models, we obtain broker quotes. These broker
quotes are non-binding and
represent an exit price,
but assumptions used to establish the fair value may not be observable and
therefore represent Level 3 inputs. Approximately 6 percent and 1
percent of our Level 3 fixed maturity securities were valued using broker quotes
or independent pricing services, respectively. The remaining Level 3
fixed maturity investments do not have readily determinable market prices and/or
observable inputs. For these securities, we use internally developed
valuations. Key assumptions used to determine fair value for these
securities may include risk-free rates, risk premiums, performance of underlying
collateral and other factors involving significant assumptions which may not be
reflective of an active market. For certain investments, we use a
matrix or model process to develop a security price where future cash flow
expectations are developed and discounted at an estimated market
rate. The pricing matrix utilizes a spread level to determine the
market price for a security. The credit spread generally incorporates
the issuer’s credit rating and other factors relating to the issuer’s industry
and the security’s maturity. In some instances, issuer-specific
spread adjustments, which can be positive or negative, are made based upon
internal analysis of security specifics such as liquidity, deal size and time to
maturity.
Privately
placed securities comprise approximately 79 percent of our actively managed
fixed maturities classified as Level 3. Privately placed securities
are classified as Level 3 when their valuation is based on internal valuation
models which rely on significant inputs that are not observable in the
market. Our model applies spreads above the risk-free rate which are
determined based on comparison to securities with similar ratings, maturities
and industries that are rated by independent third party rating
agencies. Our process also considers the ratings assigned by the NAIC
to the Level 3 securities on an annual basis. Each quarter, a review
is performed to determine the reasonableness of the initial
valuations
88
from the
model. If an initial valuation appears unreasonable based on our
knowledge of a security and current market conditions, we make appropriate
adjustments to our valuation inputs. The remaining securities
classified as Level 3 are primarily valued based on non-binding broker quotes or
internally developed models using estimated future cash flows.
For
certain Level 3 assets, we have increased our default assumptions based on our
review of the underlying collateral. The changes in our assumptions
resulted in lower cash flow estimates for some of our subordinated tranches and
have resulted in such securities being impaired. The default rate we
expect to experience related to the collateral underlying the subordinated
tranches increased from 1.7 percent to 7.6 percent for the experience expected
in 2009; from .8 percent to 3.2 percent for 2010; and from .8 percent to 1.5
percent for each year subsequent to 2010. However, the changes in
assumptions did not change our cash flow estimates for the non-subordinated
tranches within our Level 3 investments. We recognized
other-than-temporary impairments on securities classified as Level 3 investments
of $26.7 million (including $16.1 million of impairment losses recognized
through accumulated other comprehensive loss) during 2009.
As the
Company is responsible for the determination of fair value, we perform monthly
quantitative and qualitative analysis on the prices received from third parties
to determine whether the prices are reasonable estimates of fair
value. The Company’s analysis includes: (i) a review of
the methodology used by third party pricing services; (ii) a comparison of
pricing services’ valuation to other pricing services’ valuations for the same
security; (iii) a review of month to month price fluctuations; (iv) a review to
ensure valuations are not unreasonably stale; and (v) back testing to compare
actual purchase and sale transactions with valuations received from third
parties. As a result of such procedures, the Company may conclude the
prices received from third parties are not reflective of current market
conditions. In those instances, we may request additional pricing
quotes or apply internally developed valuations. However, the number
of instances is insignificant and the aggregate change in value of such
investments is not materially different from the original prices
received.
The
categorization of the fair value measurements of our investments priced by
independent pricing services was based upon the Company’s judgment of the inputs
or methodologies used by the independent pricing services to value different
asset classes. Such inputs include: benchmark yields,
reported trades, broker dealer quotes, issuer spreads, benchmark securities,
bids, offers and reference data. The Company categorizes such fair
value measurements based upon asset classes and the underlying observable or
unobservable inputs used to value such investments.
The
classification of fair value measurements for derivative instruments, including
embedded derivatives requiring bifurcation, is determined based on the
consideration of several inputs including closing exchange or over-the-counter
market price quotations; time value and volatility factors underlying options;
market interest rates; and non-performance risk. For certain embedded
derivatives, we may use actuarial assumptions in the determination of fair
value.
The
categorization of fair value measurements, by input level, for our fixed
maturity securities, equity securities, trading securities, certain other
invested assets and assets held in separate accounts at December 31, 2009 is as
follows (dollars in millions):
|
Quoted
prices
|
||||||||||||||||||
|
in
active
|
Significant
|
|||||||||||||||||
|
markets
for
|
other
|
Significant
|
||||||||||||||||
|
identical
assets
|
observable
|
unobservable
|
||||||||||||||||
|
or
liabilities
|
inputs
|
inputs
|
||||||||||||||||
|
(Level 1)
|
(Level 2)
|
(Level 3)
|
Total
|
|||||||||||||||
|
Assets:
|
||||||||||||||||||
|
Actively
managed fixed maturities
|
$ | 56.5 | $ | 16,074.0 | $ | 2,397.9 | $ | 18,528.4 | ||||||||||
|
Equity
securities
|
.1 | - | 30.9 | 31.0 | ||||||||||||||
|
Trading
securities
|
4.3 | 285.3 | 3.7 | 293.3 | ||||||||||||||
|
Securities
lending collateral
|
- | 97.2 | 36.6 | 133.8 | ||||||||||||||
|
Other
invested assets
|
- | 192.6 |
(a)
|
2.4 |
(b)
|
195.0 | ||||||||||||
|
Assets
held in separate accounts
|
- | 17.3 | - | 17.3 | ||||||||||||||
_____________
|
(a)
|
Includes
company-owned life insurance and
derivatives.
|
|
(b)
|
Includes
equity-like holdings in special-purpose
entities.
|
89
The
following table presents additional information about assets measured at fair
value on a recurring basis and for which we have utilized significant
unobservable (Level 3) inputs to determine fair value for the year ended
December 31, 2009 (dollars in millions):
|
Actively
|
||||||||||||||||||||
|
managed
|
Securities
|
Other
|
||||||||||||||||||
|
fixed
|
Equity
|
Trading
|
lending
|
invested
|
||||||||||||||||
|
maturities
|
securities
|
securities
|
collateral
|
assets
|
||||||||||||||||
|
Assets:
|
||||||||||||||||||||
|
Beginning
balance as of
December
31,
2008
|
$ | 1,876.1 | $ | 32.4 | $ | 2.7 | $ | 48.1 | $ | 2.3 | ||||||||||
|
Purchases,
sales, issuances and settlements, net
|
199.1 | (.3 | ) | - | (17.1 | ) | - | |||||||||||||
|
Total
realized and unrealized gains (losses):
|
||||||||||||||||||||
|
Included
in net loss
|
(15.2 | ) | - | 1.0 | (.9 | ) | (3.4 | ) | ||||||||||||
|
Included
in other comprehensive income
(loss)
|
327.5 | (1.2 | ) | - | (9.4 | ) | 3.5 | |||||||||||||
|
Transfers
into Level 3
|
32.2 | - | - | 20.4 | - | |||||||||||||||
|
Transfers
out of Level 3 (a)
|
(21.8 | ) | - | - | (4.5 | ) | - | |||||||||||||
|
Ending
balance as of December 31, 2009
|
$ | 2,397.9 | $ | 30.9 | $ | 3.7 | $ | 36.6 | $ | 2.4 | ||||||||||
|
Amount
of total gains (losses) for the year ended December 31, 2009 included in
our net loss relating to assets and liabilities still held as
of
the reporting
date
|
$ | (3.9 | ) | $ | - | $ | 1.0 | $ | (.9 | ) | $ | (3.4 | ) | |||||||
___________
|
|
(a)
|
Transfers
out of Level 3 are reported as having occurred at the beginning of the
period.
|
At December
31, 2009, 86 percent of our Level 3 actively managed fixed maturities were
investment grade and 94 percent of our Level 3 actively managed fixed maturities
consisted of corporate securities.
Realized
and unrealized investment gains and losses presented in the preceding table
represent gains and losses during the time the applicable financial instruments
were classified as Level 3.
Realized
and unrealized gains (losses) on Level 3 assets are primarily reported in either
net investment income for policyholder and reinsurer accounts and other special
purpose portfolios, net realized investment gains (losses) or insurance policy
benefits within the consolidated statement of operations or other comprehensive
income (loss) within shareholders’ equity based on the appropriate accounting
treatment for the instrument.
Purchases,
sales, issuances and settlements, net, represent the activity that occurred
during the period that results in a change of the asset or liability but does
not represent changes in fair value for the instruments held at the beginning of
the period. Such activity primarily consists of purchases and sales
of fixed maturity, equity and trading securities and purchases and settlements
of derivative instruments.
We review
the fair value hierarchy classifications each reporting
period. Transfers in and/or (out) of Level 3 in 2009 were primarily
due to changes in the observability of the valuation attributes resulting in a
reclassification of certain financial assets or liabilities. Such
reclassifications are reported as transfers in and out of Level 3 at the
beginning fair value for the reporting period in which the changes
occur.
90
Investment
ratings are assigned the second lowest rating by a nationally recognized
statistical rating organization (primarily Moody’s, S&P or Fitch Ratings
(“Fitch”)), or if not rated by such firms, the rating assigned by the
NAIC. NAIC designations of “1” or “2” include fixed maturities
generally rated investment grade (rated “Baa3” or higher by Moody’s or rated
“BBB-” or higher by S&P and Fitch. NAIC designations of “3”
through “6” are referred to as below investment grade (which generally are rated
“Ba1” or lower by Moody’s or rated “BB+” or lower by S&P and
Fitch). References to investment grade or below investment grade
throughout our consolidated financial statements are based on such nationally
recognized statistical ratings. The following table sets forth fixed
maturity investments at December 31, 2009, classified by ratings (dollars in
millions):
|
Estimated fair value
|
||||||||||||||
|
Percent
of
|
||||||||||||||
|
Amortized
|
fixed
|
|||||||||||||
|
Investment rating
|
cost
|
Amount
|
maturities
|
|||||||||||
|
AAA
|
$ | 2,764.7 | $ | 2,700.9 | 15 | % | ||||||||
|
AA
|
1,270.2 | 1,230.3 | 7 | |||||||||||
| A | 5,619.3 | 5,555.4 | 30 | |||||||||||
|
BBB+
|
2,295.2 | 2,297.9 | 12 | |||||||||||
|
BBB
|
2,952.3 | 2,916.7 | 16 | |||||||||||
|
BBB-
|
2,314.0 | 2,304.1 | 12 | |||||||||||
|
Investment
grade
|
17,215.7 | 17,005.3 | 92 | |||||||||||
|
BB+
|
210.6 | 183.1 | 1 | |||||||||||
|
BB
|
257.2 | 226.9 | 1 | |||||||||||
|
BB-
|
550.7 | 504.0 | 3 | |||||||||||
|
B+
and below
|
763.8 | 609.1 | 3 | |||||||||||
|
Below-investment
grade (a)
|
1,782.3 | 1,523.1 | 8 | |||||||||||
|
Total
fixed maturity securities
|
$ | 18,998.0 | $ | 18,528.4 | 100 | % | ||||||||
_________
|
(a)
|
Below-investment
grade fixed maturity securities with an amortized cost of $284.7 million
and an estimated fair value of $262.3 million are held by a VIE that we
are required to consolidate. These fixed maturity securities
are legally isolated and are not available to the Company. The
liabilities of such VIE will be satisfied from the cash flows generated by
these securities and are not obligations of the Company. Refer
to the note to the consolidated financial statements entitled “Investment
in a Variable Interest Entity” concerning the Company’s investment in the
VIE.
|
The
following table summarizes investment yields earned over the past three years on
the general account invested assets of our insurance
subsidiaries. General account investments exclude the value of
options (dollars in millions).
|
2009
|
2008
|
2007
|
||||||||||
|
Weighted
average general account invested assets as defined:
|
||||||||||||
|
As
reported
|
$ | 20,196.7 | $ | 19,597.9 | $ | 22,469.2 | ||||||
|
Excluding
unrealized appreciation (depreciation) (a)
|
21,667.7 | 21,323.3 | 22,835.4 | |||||||||
|
Net
investment income on general account invested assets
|
1,230.6 | 1,249.9 | 1,344.1 | |||||||||
|
Yields
earned:
|
||||||||||||
|
As
reported
|
6.09 | % | 6.38 | % | 5.98 | % | ||||||
|
Excluding
unrealized appreciation (depreciation) (a)
|
5.68 | % | 5.86 | % | 5.89 | % | ||||||
____________________
|
|
(a)
|
Excludes
the effect of reporting fixed maturities at fair value as described in the
note to our consolidated financial statements entitled
“Investments”.
|
Although
investment income is a significant component of total revenues, the
profitability of certain of our insurance products is determined primarily by
the spreads between the interest rates we earn and the rates we credit or accrue
to our
91
insurance
liabilities. At December 31, 2009 and 2008, the average yield,
computed on the cost basis of our actively managed fixed maturity portfolio, was
5.7 percent and 6.0 percent, respectively, and the average interest rate
credited or accruing to our total insurance liabilities (excluding interest rate
bonuses for the first policy year only and excluding the effect of credited
rates attributable to variable or equity-indexed products) was 4.5 percent and
4.5 percent, respectively.
Actively
Managed Fixed Maturities
Our
actively managed fixed maturity portfolio at December 31, 2009, included
primarily debt securities of the United States government, various corporations,
and structured securities. Asset-backed securities, collateralized
debt obligations, commercial mortgage-backed securities, mortgage pass-through
securities and collateralized mortgage obligations are collectively referred to
as “structured securities”.
At
December 31, 2009, our fixed maturity portfolio had $400.5 million of unrealized
gains and $870.1 million of unrealized losses, for a net unrealized loss of
$469.6 million. Estimated fair values of fixed maturity investments
were determined based on estimates from: (i) nationally recognized pricing
services (85 percent of the portfolio); (ii) broker-dealer market makers (3
percent of the portfolio); and (iii) internally developed methods (12 percent of
the portfolio).
At
December 31, 2009, approximately 7.1 percent of our invested assets (8.2 percent
of fixed maturity investments) were fixed maturities rated below-investment
grade. Our level of investments in below-investment-grade fixed
maturities could change if market conditions change. Below-investment
grade corporate debt securities have different characteristics than investment
grade corporate debt securities. Based on historical performance,
probability of default by the borrower is significantly greater for
below-investment grade securities and in many cases severity of loss is
relatively greater as such securities are often subordinated to other
indebtedness of the issuer. Also, issuers of below-investment grade
securities frequently have higher levels of debt relative to investment-grade
issuers, hence, all other things being equal, are more sensitive to adverse
economic conditions, such as recession or increasing interest
rates. The Company attempts to reduce the overall risk related to its
investment in below-investment grade securities, as in all investments, through
careful credit analysis, strict investment policy guidelines, and
diversification by issuer and/or guarantor and by industry. At
December 31, 2009, our below-investment-grade fixed maturity investments had an
amortized cost of $1,782.3 million and an estimated fair value of $1,523.1
million.
We
continually evaluate the creditworthiness of each issuer whose securities we
hold. We pay special attention to large investments and to those
securities whose fair values have declined materially for reasons other than
changes in interest rates or other general market conditions. We
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. We review the recent operational results and financial
position of the issuer, information about its industry, information about
factors affecting the issuer’s performance and other
information. 40|86 Advisors employs experienced securities analysts
in a variety of specialty areas who compile and review such data. If
evidence does not exist to support a realizable value equal to or greater than
the amortized cost of the investment, and such decline in fair value is
determined to be other than temporary, we reduce the amortized cost to its fair
value, which becomes the new cost basis. We report the amount of the
reduction as a realized loss. We recognize any recovery of such reductions as
investment income over the remaining life of the investment (but only to the
extent our current valuations indicate such amounts will ultimately be
collected), or upon the repayment of the investment. During 2009, we
recognized net realized investment losses of $60.5 million, which were comprised
of $134.9 million of net gains from the sales of investments (primarily fixed
maturities) with proceeds of $10.7 billion and $195.4 million of writedowns of
investments for other than temporary declines in fair value recognized through
net income ($385.0 million, prior to the $189.6 million of impairment losses
recognized through other comprehensive loss). 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.
Our
investment strategy is to maximize, over a sustained period and within
acceptable parameters of risk, investment income and total investment return
through active investment management. Accordingly, we may sell
securities at a gain or a loss to enhance the total return of the portfolio as
market opportunities change or to better match certain characteristics of our
investment portfolio with the corresponding characteristics of our insurance
liabilities. While we do not have the intent to sell securities with
unrealized losses and it is not more likely than not that we will be required to
sell securities with unrealized losses prior to their anticipated recovery, we
may sell securities at a loss in the future because of actual or expected
changes in our view of the particular investment, its industry, its type or the
general investment environment.
As of
December 31, 2009, we had investments in substantive default (i.e., in default
due to nonpayment of interest or principal) that had an estimated fair value of
$39.8 million. 40|86 Advisors employs experienced professionals to
manage
92
non-performing
and impaired investments. There were no other fixed maturity
investments about which we had serious doubts as to the recoverability of the
carrying value of the investment.
When a
security defaults or securities (other than structured securities) are
other-than-temporarily impaired, our policy is to discontinue the accrual of
interest and eliminate all previous interest accruals, if we determine that such
amounts will not be ultimately realized in full. Investment income
forgone on nonperforming investments was $6.7 million, $.9 and nil for the years
ended December 31, 2009, 2008 and 2007, respectively.
At
December 31, 2009, fixed maturity investments included structured securities
with an estimated fair value of $3.1 billion (or 17 percent of all fixed
maturity securities). The yield characteristics of structured
securities differ in some respects from those of traditional fixed-income
securities. For example, interest and principal payments on
structured securities may occur more frequently, often monthly. In
many instances, we are subject to the risk that the amount and timing of
principal and interest payments may vary from expectations. For
example, prepayments may occur at the option of the issuer and prepayment rates
are influenced by a number of factors that cannot be predicted with certainty,
including: the relative sensitivity of the underlying assets backing the
security to changes in interest rates; a variety of economic, geographic and
other factors; and various security-specific structural considerations (for
example, the repayment priority of a given security in a securitization
structure).
In
general, the rate of prepayments on structured securities increases when
prevailing interest rates decline significantly in absolute terms and also
relative to the interest rates on the underlying assets. The yields
recognized on structured securities purchased at a discount to par will increase
(relative to the stated rate) when the underlying assets prepay faster than
expected. The yield recognized on structured securities purchased at
a premium will decrease (relative to the stated rate) when the underlying assets
prepay faster than expected. When interest rates decline, the
proceeds from prepayments may be reinvested at lower rates than we were earning
on the prepaid securities. When interest rates increase, prepayments
may decrease. When this occurs, the average maturity and duration of
the structured securities increase, which decreases the yield on structured
securities purchased at a discount because the discount is realized as income at
a slower rate, and it increases the yield on those purchased at a premium
because of a decrease in the annual amortization of the premium.
For
structured securities included in actively managed fixed maturities that were
purchased at a discount or premium, we recognize investment income using an
effective yield based on anticipated future prepayments and the estimated final
maturity of the securities. Actual prepayment experience is
periodically reviewed and effective yields are recalculated when differences
arise between the prepayments originally anticipated and the actual prepayments
received and currently anticipated. For credit sensitive
mortgage-backed and asset-backed securities, and for securities that can be
prepaid or settled in a way that we would not recover substantially all of our
investment, the effective yield is recalculated on a prospective
basis. Under this method, the amortized cost basis in the security is
not immediately adjusted and a new yield is applied
prospectively. For all other structured and asset-backed securities,
the effective yield is recalculated when changes in assumptions are made, and
reflected in our income on a retrospective basis. Under this method,
the amortized cost basis of the investment in the securities is adjusted to the
amount that would have existed had the new effective yield been applied since
the acquisition of the securities. Such adjustments were not
significant in 2009.
93
The
following table sets forth the par value, amortized cost and estimated fair
value of structured securities, summarized by interest rates on the underlying
collateral at December 31, 2009 (dollars in millions):
|
Par
|
Amortized
|
Estimated
|
||||||||||
|
value
|
cost
|
fair value
|
||||||||||
|
Below
4
percent
|
$ | 102.4 | $ | 84.1 | $ | 84.7 | ||||||
|
4
percent – 5
percent
|
571.8 | 561.4 | 539.1 | |||||||||
|
5
percent – 6
percent
|
2,083.2 | 2,058.5 | 1,867.9 | |||||||||
|
6
percent – 7
percent
|
589.3 | 567.9 | 482.3 | |||||||||
|
7
percent – 8
percent
|
129.8 | 126.8 | 90.9 | |||||||||
|
8
percent and
above
|
49.9 | 49.7 | 43.8 | |||||||||
|
Total
structured
securities
|
$ | 3,526.4 | $ | 3,448.4 | $ | 3,108.7 | ||||||
The
amortized cost and estimated fair value of structured securities at December 31,
2009, summarized by type of security, were as follows (dollars in
millions):
|
Estimated
fair value
|
||||||||||||
|
Percent
|
||||||||||||
|
Amortized
|
of
fixed
|
|||||||||||
|
Type
|
cost
|
Amount
|
maturities
|
|||||||||
|
Pass-throughs,
sequential and equivalent securities
|
$ | 1,425.9 | $ | 1,361.1 | 7.4 | % | ||||||
|
Planned
amortization classes, target amortization classes and accretion-directed
bonds
|
759.3 | 649.8 | 3.5 | |||||||||
|
Commercial
mortgage-backed
securities
|
869.3 | 766.0 | 4.1 | |||||||||
|
Asset-backed
securities
|
245.0 | 192.1 | 1.0 | |||||||||
|
Collateralized
debt
obligations
|
96.9 | 92.8 | .5 | |||||||||
|
Other
|
52.0 | 46.9 | .3 | |||||||||
|
Total
structured
securities
|
$ | 3,448.4 | $ | 3,108.7 | 16.8 | % | ||||||
Pass-throughs,
sequentials and equivalent securities have unique prepayment variability
characteristics. Pass-through securities typically return principal
to the holders based on cash payments from the underlying mortgage
obligations. Sequential securities return principal to tranche
holders in a detailed hierarchy. Planned amortization classes,
targeted amortization classes and accretion-directed bonds adhere to fixed
schedules of principal payments as long as the underlying mortgage loans
experience prepayments within certain estimated ranges. Changes in
prepayment rates are first absorbed by support or companion classes insulating
the timing of receipt of cash flows from the consequences of both faster
prepayments (average life shortening) and slower prepayments (average life
extension).
Commercial
mortgage-backed securities are secured by commercial real estate mortgages,
generally income producing properties that are managed for
profit. Property types include multi-family dwellings including
apartments, retail centers, hotels, restaurants, hospitals, nursing homes,
warehouses, and office buildings. Most commercial mortgage-backed
securities have call protection features whereby underlying borrowers may not
prepay their mortgages for stated periods of time without incurring prepayment
penalties.
During
2009, we sold $1.3 billion of fixed maturity investments which resulted in gross
investment losses (before income taxes) of $233.9 million. We sell
securities at a loss for a number of reasons including, but not limited
to: (i) changes in the investment environment; (ii) expectation that
the fair value could deteriorate further; (iii) desire to reduce our exposure to
an asset class, an issuer or an industry; (iv) changes in credit quality; or (v)
changes in expected liability cash flows. As discussed in the notes
to our consolidated financial statements, the realization of gains and losses
affects the timing of the amortization of insurance acquisition costs related to
universal life and investment products.
94
Other
Investments
At
December 31, 2009, we held commercial mortgage loan investments with a carrying
value of $1,965.5 million (or 9 percent of total invested assets) and a fair
value of $1,756.8 million. Noncurrent commercial mortgage loans were
insignificant at December 31, 2009. During 2009, we recognized $40.9
million of writedowns of commercial mortgage loans resulting from declines in
fair value that we concluded were other than temporary. During 2008,
we recognized $5.8 million of writedowns of commercial mortgage loans for
other-than-temporary declines in fair value and recognized losses of $22.1
million from the liquidation of several delinquent commercial mortgage
loans. Realized losses on commercial mortgage loans were not
significant in 2007. We had no allowance for loss on mortgage loans
at both December 31, 2009 and 2008. Approximately 7 percent, 7
percent, 7 percent, 6 percent and 6 percent of the mortgage loan balance were on
properties located in Indiana, Minnesota, Ohio, California and Arizona,
respectively. No other state comprised greater than five percent of
the mortgage loan balance.
The
following table shows the distribution of our commercial mortgage loan portfolio
by property type as of December 31, 2009 (dollars in millions):
|
Number
of
|
Carrying
|
|||||||
|
loans
|
value
|
|||||||
|
Retail
|
341 | $ | 797.7 | |||||
|
Office
building
|
174 | 758.0 | ||||||
|
Industrial
|
70 | 298.3 | ||||||
|
Multi-family
|
38 | 94.5 | ||||||
|
Other
|
6 | 17.0 | ||||||
|
Total
commercial mortgage loans
|
629 | $ | 1,965.5 | |||||
The
following table shows our commercial mortgage loan portfolio by loan size as of
December 31, 2009 (dollars in millions):
|
Number
|
Carrying
|
|||||||
|
of loans
|
value
|
|||||||
|
Under
$5
million
|
523 | $ | 1,030.6 | |||||
|
$5
million but less than $10 million
|
83 | 559.7 | ||||||
|
$10
million but less than $20 million
|
15 | 197.0 | ||||||
|
Over
$20
million
|
8 | 178.2 | ||||||
|
Total
commercial mortgage loans
|
629 | $ | 1,965.5 | |||||
The
following table summarizes the distribution of maturities of our commercial
mortgage loans as of December 31, 2009 (dollars in millions):
|
Number
|
Carrying
|
|||||||
|
of loans
|
value
|
|||||||
|
2010
|
12 | $ | 52.2 | |||||
|
2011
|
19 | 74.7 | ||||||
|
2012
|
22 | 48.3 | ||||||
|
2013
|
26 | 158.0 | ||||||
|
2014
|
27 | 93.5 | ||||||
|
after
2014
|
523 | 1,538.8 | ||||||
|
Total
commercial mortgage loans
|
629 | $ | 1,965.5 | |||||
95
The
following table provides the weighted average loan-to-value ratio for our
outstanding mortgage loans as of December 31, 2009 (dollars in
millions):
|
Estimated
fair
|
||||||||
|
Loan-to-value ratio
(a)
|
Carrying
value
|
value
|
||||||
|
Less
than
60%
|
$ | 694.8 | $ | 668.5 | ||||
|
60%
to
70%
|
736.8 | 622.2 | ||||||
|
70%
to
80%
|
407.4 | 353.7 | ||||||
|
80%
to
90%
|
28.0 | 24.2 | ||||||
|
Greater
than
90%
|
98.5 | 88.2 | ||||||
|
Total
|
$ | 1,965.5 | $ | 1,756.8 | ||||
__________
|
(a)
|
Loan-to-value
ratios are calculated as the ratio of: (i) the carrying value
of the commercial mortgage loans; to (ii) the estimated fair value of the
underlying commercial property.
|
At
December 31, 2009, we held $293.3 million of trading securities. We
carry trading securities at estimated fair value; changes in fair value are
reflected in the statement of operations. Our trading securities are
held to act as hedges for embedded derivatives related to our equity-indexed
annuity products and certain modified coinsurance agreements. See the
note to the consolidated financial statements entitled “Summary of Significant
Accounting Policies - Accounting for Derivatives” for further discussion
regarding the embedded derivatives and the trading accounts. In
addition, the trading account includes investments backing the market strategies
of our multibucket annuity products.
Other
invested assets also include options backing our equity-indexed products,
futures, credit default swaps, forward contracts and certain nontraditional
investments, including investments in limited partnerships, promissory notes and
real estate investments held for sale.
The
Company participates in a securities lending program whereby certain fixed
maturity securities from our investment portfolio are loaned to third parties
via a lending agent for a short period of time. We maintain ownership
of the loaned securities. We require collateral equal to 102 percent
of the fair value of the loaned securities. The collateral is
invested by the lending agent in accordance with our guidelines. The
fair value of the loaned securities is monitored on a daily basis with
additional collateral obtained as necessary. Under the terms of the
securities lending program, the lending agent indemnifies the Company against
borrower defaults. As of December 31, 2009 and 2008, the fair value
of the loaned securities was $178.5 million and $389.3 million,
respectively. As of December 31, 2009 and 2008, the Company had
received collateral of $185.7 million and $408.8 million,
respectively. Income generated from the program, net of expenses is
recorded as net investment income and totaled $1.2 million, $2.4 million and
$1.3 million in 2009, 2008 and 2007, respectively.
96
CONSOLIDATED
FINANCIAL CONDITION
Changes
in our consolidated balance sheet between December 31, 2009 and December 31,
2008, primarily reflect: (i) our net income for 2009; (ii) changes in
the fair value of actively managed fixed maturity securities; and (iii) the
issuances of common stock and the changes to corporate notes payable as further
described in the notes to the consolidated financial statements entitled “Notes
Payable – Direct Corporate Obligations” and “Shareholders’ Equity”.
In
accordance with GAAP, we record our actively managed fixed maturity investments,
equity securities and certain other invested assets at estimated fair value with
any unrealized gain or loss (excluding impairment losses, which are recognized
through earnings), net of tax and related adjustments, recorded as a component
of shareholders’ equity. At December 31, 2009, we decreased the
carrying value of such investments by $.5 billion as a result of this fair value
adjustment.
Our
capital structure as of December 31, 2009 and 2008 was as follows (dollars in
millions):
|
2009
|
2008
|
|||||||
|
Total
capital:
|
||||||||
|
Corporate
notes
payable
|
$ | 1,037.4 | $ | 1,311.5 | ||||
|
Shareholders’
equity:
|
||||||||
|
Common
stock
|
2.5 | 1.9 | ||||||
|
Additional
paid-in
capital
|
4,408.8 | 4,104.0 | ||||||
|
Accumulated
other comprehensive loss
|
(264.3 | ) | (1,770.7 | ) | ||||
|
Accumulated
deficit
|
(614.6 | ) | (705.2 | ) | ||||
|
Total
shareholders’
equity
|
3,532.4 | 1,630.0 | ||||||
|
Total
capital
|
$ | 4,569.8 | $ | 2,941.5 | ||||
The
following table summarizes certain financial ratios as of and for the years
ended December 31, 2009 and 2008:
|
2009
|
2008
|
|||||||
|
Book
value per common
share
|
$ | 14.09 | $ | 8.82 | ||||
|
Book
value per common share, excluding accumulated other comprehensive income
(loss) (a)
|
15.14 | 18.41 | ||||||
|
Ratio
of earnings to fixed
charges
|
1.38 | X | 1.01 | X | ||||
|
Debt
to total capital ratios:
|
||||||||
|
Corporate
debt to total capital
(b)
|
23 | % | 45 | % | ||||
|
Corporate
debt to total capital, excluding accumulated other comprehensive income
(loss) (a)
|
21 | % | 28 | % | ||||
____________________
|
(a)
|
This
non-GAAP measure differs from the corresponding GAAP measure presented
immediately above, because accumulated other comprehensive income (loss)
has been excluded from the value of capital used to determine this
measure. Management believes this non-GAAP measure is useful
because it removes the volatility that arises from changes in accumulated
other comprehensive income (loss). Such volatility is often
caused by changes in the estimated fair value of our investment portfolio
resulting from changes in general market interest rates rather than the
business decisions made by management. However, this measure
does not replace the corresponding GAAP
measure.
|
|
(b)
|
Such
ratio differs from the debt to total capitalization ratio required by our
Senior Credit Agreement, primarily because the credit agreement ratio
excludes accumulated other comprehensive income (loss) from total
capital.
|
97
Contractual Obligations
The
Company’s significant contractual obligations as of December 31, 2009, were as
follows (dollars in millions):
|
Payment
due in
|
||||||||||||||||||||
|
Total
|
2010
|
2011-2012 | 2013-2014 |
Thereafter
|
||||||||||||||||
|
Insurance
liabilities
(a)
|
$ | 53,441.6 | $ | 3,563.9 | $ | 6,921.1 | $ | 6,341.0 | $ | 36,615.6 | ||||||||||
|
Notes
payable
(b)
|
1,358.4 | 153.7 | 260.1 | 670.4 | 274.2 | |||||||||||||||
|
Investment
borrowings
(c)
|
831.4 | 28.6 | 159.6 | 43.3 | 599.9 | |||||||||||||||
|
Postretirement
plans
(d)
|
155.3 | 4.1 | 8.8 | 10.0 | 132.4 | |||||||||||||||
|
Operating
leases and certain other
|
||||||||||||||||||||
|
contractual
commitments
(e)
|
205.8 | 41.0 | 63.3 | 41.3 | 60.2 | |||||||||||||||
|
Total
|
$ | 55,992.5 | $ | 3,791.3 | $ | 7,412.9 | $ | 7,106.0 | $ | 37,682.3 | ||||||||||
____________________
|
|
(a)
|
These
cash flows represent our estimates of the payments we expect to make to
our policyholders, without consideration of future premiums or reinsurance
recoveries. These estimates are based on numerous assumptions
(depending on the product type) related to mortality, morbidity, lapses,
withdrawals, future premiums, future deposits, interest rates on
investments, credited rates, expenses and other factors which affect our
future payments. The cash flows presented are undiscounted for
interest. As a result, total outflows for all years exceed the
corresponding liabilities of $24.3 billion included in our consolidated
balance sheet as of December 31, 2009. As such payments are
based on numerous assumptions, the actual payments may vary significantly
from the amounts shown.
|
In
estimating the payments we expect to make to our policyholders, we considered
the following:
|
·
|
For
products such as immediate annuities and structured settlement annuities
without life contingencies, the payment obligation is fixed and
determinable based on the terms of the
policy.
|
|
·
|
For
products such as universal life, ordinary life, long-term care, specified
disease and fixed rate annuities, the future payments are not due until
the occurrence of an insurable event (such as death or disability) or a
triggering event (such as a surrender or partial
withdrawal). We estimated these payments using actuarial models
based on historical experience and our expectation of the future payment
patterns.
|
|
·
|
For
short-term insurance products such as Medicare supplement insurance, the
future payments relate only to amounts necessary to settle all outstanding
claims, including those that have been incurred but not reported as of the
balance sheet date. We estimated these payments based on our
historical experience and our expectation of future payment
patterns.
|
|
·
|
The
average interest rate we assumed would be credited to our total insurance
liabilities (excluding interest rate bonuses for the first policy year
only and excluding the effect of credited rates attributable to variable
or equity-indexed products) over the term of the contracts was 4.5
percent.
|
|
(b)
|
Includes
projected interest payments based on market rates, as applicable, as of
December 31, 2009 and reflects the repurchase of $64 million aggregate
principal amount of the 3.5% Debentures and the issuance of $64 million
aggregate principal amount of the 7.0% Debentures in February 2010 as
further discussed in the note to the consolidated financial statements
entitled “Subsequent Events”. Refer to the note to the
consolidated financial statements entitled “Notes Payable – Direct
Corporate Obligations” for additional information on notes
payable.
|
|
(c)
|
These
borrowings primarily represent: (i) the securities issued by a VIE and
include projected interest payments based on market rates, as applicable,
as of December 31, 2009; and (ii) collateralized borrowings from the
Federal Home Loan Bank of Indianapolis
(“FHLBI”).
|
|
(d)
|
Includes
benefits expected to be paid pursuant to our deferred compensation plan
and postretirement plans based on numerous actuarial assumptions and
interest credited at 5.75 percent.
|
|
(e)
|
Refer
to the notes to the consolidated financial statements entitled
“Commitments and Contingencies” for additional information on operating
leases and certain other contractual
commitments.
|
98
It is
possible that the ultimate outcomes of various uncertainties could affect our
liquidity in future periods. For example, the following events could
have a material adverse effect on our cash flows:
|
·
|
An
adverse decision in pending or future
litigation.
|
|
·
|
An
inability to obtain rate increases on certain of our insurance
products.
|
|
·
|
Worse
than anticipated claims experience.
|
|
·
|
Lower
than expected dividends and/or surplus debenture interest payments from
our insurance subsidiaries (resulting from inadequate earnings or capital
or regulatory requirements).
|
|
·
|
An
inability to meet and/or maintain the covenants in our Senior Credit
Agreement.
|
|
·
|
A
significant increase in policy surrender
levels.
|
|
·
|
A
significant increase in investment
defaults.
|
|
·
|
An
inability of our reinsurers to meet their financial
obligations.
|
While we
seek to balance the duration and cash flows of our invested assets with the
estimated duration and cash flows of benefit payments arising from contract
liabilities, there could be significant variations in the timing of such cash
flows. Although we believe our current estimates properly project
future claim experience, if these estimates prove to be wrong, and our
experience worsens (as it did in some prior periods), our future liquidity could
be adversely affected.
Liquidity
for Insurance Operations
Our
insurance companies generally receive adequate cash flows from premium
collections and investment income to meet their obligations. Life
insurance and annuity liabilities are generally long-term in
nature. Policyholders may, however, withdraw funds or surrender their
policies, subject to any applicable penalty provisions. We seek to
balance the duration of our invested assets with the estimated duration of
benefit payments arising from contract liabilities.
One of
the Company’s subsidiaries (Conseco Life) is a member of the
FHLBI. As a member of the FHLBI, Conseco Life has the ability to
borrow on a collateralized basis from FHLBI. Conseco Life is required
to hold a certain minimum amount of FHLBI common stock as a requirement of
membership in the FHLBI, and additional amounts based on the amount of
collateralized borrowings. At December 31, 2009, the carrying value
of the FHLBI common stock was $22.5 million. Collateralized
borrowings totaled $450.0 million as of December 31, 2009, and the proceeds were
used to purchase fixed maturity securities. The borrowings are
classified as investment borrowings in the accompanying consolidated balance
sheet. The borrowings are collateralized by investments with an estimated fair
value of $508.2 million at December 31, 2009, which are maintained in a
custodial account for the benefit of the FHLBI. The following
summarizes the terms of the borrowings (dollars in millions):
|
Amount
|
Maturity
|
Interest
rate
|
|||
|
borrowed
|
date
|
at December 31, 2009
|
|||
| $ | 54.0 |
May
2012
|
Variable
rate – .267%
|
||
| 37.0 |
July
2012
|
Fixed
rate – 5.540%
|
|||
| 13.0 |
July
2012
|
Variable
rate – .344%
|
|||
| 146.0 |
November
2015
|
Fixed
rate – 5.300%
|
|||
| 100.0 |
November
2015
|
Fixed
rate – 4.890%
|
|||
| 100.0 |
December
2015
|
Fixed
rate – 4.710%
|
|||
State
laws generally give state insurance regulatory agencies broad authority to
protect policyholders in their jurisdictions. Regulators have used
this authority in the past to restrict the ability of our insurance subsidiaries
to pay any dividends or other amounts without prior approval. We
cannot be assured that the regulators will not seek to assert greater
supervision and control over our insurance subsidiaries’ businesses and
financial affairs.
99
During
2009, the financial statements of three of our subsidiaries prepared in
accordance with statutory accounting practices prescribed or permitted by
regulatory authorities reflected asset adequacy or premium deficiency
reserves. Total asset adequacy and premium deficiency reserves for
Washington National, Conseco Life and Bankers Conseco Life were $79.1 million,
$257.1 million and $21.2 million, respectively at December 31,
2009. Due to differences between statutory and GAAP insurance
liabilities, we were not required to recognize a similar premium deficiency
reserve in our consolidated financial statements prepared in accordance with
GAAP. The determination of the need for and amount of asset adequacy
reserves is subject to numerous actuarial assumptions, including the Company’s
ability to change nonguaranteed elements related to certain products consistent
with contract provisions.
Financial
Strength Ratings of our Insurance Subsidiaries
Financial
strength ratings provided by A.M. Best, S&P and Moody’s are the rating
agency’s opinions of the ability of our insurance subsidiaries to repay
policyholder claims and obligations when due.
On
October 16, 2009, A.M. Best affirmed the financial strength rating of “B” of our
primary insurance subsidiaries and the ratings outlook as
negative. Also, A.M. Best removed the ratings from under review with
negative implications. On March 4, 2009, A.M. Best downgraded the
financial strength ratings of our primary insurance subsidiaries to “B” from
“B+” and such ratings had been placed under review with negative
implications. The “B” rating is assigned to companies that have a
fair ability, in A.M. Best’s opinion, to meet their current obligations to
policyholders, but are financially vulnerable to adverse changes in underwriting
and economic conditions. A.M. Best ratings for the industry currently
range from “A++ (Superior)” to “F (In Liquidation)” and some companies are not
rated. An “A++” rating indicates a superior ability to meet ongoing
obligations to policyholders. A.M. Best has sixteen possible
ratings. There are six ratings above our “B” rating and nine ratings
that are below our rating.
On
October 14, 2009, S&P affirmed the financial strength rating of “BB-” of our
primary insurance subsidiaries and revised the outlook to stable from credit
watch with negative implications. On March 2, 2009, S&P had
placed the financial strength ratings of our primary insurance subsidiaries on
credit watch with negative implications. On February 26, 2009,
S&P downgraded the financial strength ratings of our primary insurance
subsidiaries to “BB-” from “BB+” and the outlook remained negative for our
primary insurance subsidiaries. A “stable” designation means that a
rating is not likely to change. S&P financial strength ratings
range from “AAA” to “R” and some companies are not rated. Rating
categories from “BB” to “CCC” are classified as “vulnerable”, and pluses and
minuses show the relative standing within a category. In S&P’s
view, an insurer rated “BB” has marginal financial security characteristics and
although positive attributes exist, adverse business conditions could lead to an
insufficient ability to meet financial commitments. S&P has
twenty-one possible ratings. There are twelve ratings above our “BB-”
rating and eight ratings that are below our rating.
On
October 14, 2009, Moody’s affirmed the financial strength rating of “Ba2” of our
primary insurance subsidiaries and revised the outlook to positive from
negative. On March 3, 2009, Moody’s downgraded the financial strength
ratings of our primary insurance subsidiaries to “Ba2” from “Ba1” and the
outlook remained negative for our primary insurance
subsidiaries. Moody’s financial strength ratings range from “Aaa” to
“C”. Rating categories from “Aaa” to “Baa” are classified as “secure”
by Moody’s and rating categories from “Ba” to “C” are considered “vulnerable”
and these ratings may be supplemented with numbers “1”, “2”, or “3” to show
relative standing within a category. In Moody’s view, an insurer
rated “Ba2” offers questionable financial security and, often, the ability of
these companies to meet policyholders’ obligations may be very moderate and
thereby not well safeguarded in the future. Moody’s has twenty-one
possible ratings. There are eleven ratings above our “Ba2” rating and
nine ratings that are below our rating.
In light
of the difficulties experienced recently by many financial institutions,
including insurance companies, rating agencies have increased the frequency and
scope of their credit reviews and requested additional information from the
companies that they rate, including us. They may also adjust upward
the capital and other requirements employed in the rating agency models for
maintenance of certain ratings levels. We cannot predict what actions
rating agencies may take, or what actions we may take in
response. Accordingly, further downgrades and outlook revisions
related to us or the life insurance industry may occur in the future at any time
and without notice by any rating agency. These could increase policy
surrenders and withdrawals, adversely affect relationships with our distribution
channels, reduce new sales, reduce our ability to borrow and increase our future
borrowing costs.
100
Liquidity
of the Holding Companies
Availability
and Sources and Uses of Holding Company Liquidity; Limitations on Ability of
Insurance Subsidiaries to Make Dividend and Surplus Debenture Interest Payments
to the Holding Companies
At
December 31, 2009, CNO, CDOC (our wholly owned subsidiary and a guarantor under
the Senior Credit Agreement) and our other non-insurance subsidiaries held
unrestricted cash of $146 million. CNO and CDOC are holding companies
with no business operations of their own; they depend on their operating
subsidiaries for cash to make principal and interest payments on debt, and to
pay administrative expenses and income taxes. CNO and CDOC receive
cash from insurance subsidiaries, consisting of dividends and distributions,
interest payments on surplus debentures and tax-sharing payments, as well as
cash from non-insurance subsidiaries consisting of dividends, distributions,
loans and advances. The principal non-insurance subsidiaries that
provide cash to CNO and CDOC are 40|86 Advisors, which receives fees from the
insurance subsidiaries for investment services, and Conseco Services, LLC which
receives fees from the insurance subsidiaries for providing administrative
services. The agreements between our insurance subsidiaries and
Conseco Services, LLC and 40|86 Advisors, respectively, were previously approved
by the domestic insurance regulator for each insurance company, and any payments
thereunder do not require further regulatory approval.
A
deterioration in the financial condition, earnings or cash flow of the material
subsidiaries of CNO or CDOC for any reason could hinder such subsidiaries’
ability to pay cash dividends or other disbursements to CNO and/or CDOC, which,
in turn, would limit Conseco’s ability to meet debt service requirements and
satisfy other financial obligations. In addition, we may choose to
retain capital in our insurance subsidiaries or to contribute additional capital
to our insurance subsidiaries to strengthen their surplus, and these decisions
could limit the amount available at our top tier insurance subsidiaries to pay
dividends to the holding companies. In the past, we have made capital
contributions to our insurance subsidiaries to meet debt covenants and minimum
capital levels required by certain regulators and it is possible we will be
required to do so in the future. We did not make any contributions to
our insurance subsidiaries in 2009, however, a $29.4 million capital
contribution was accrued at December 31, 2009, and paid in February
2010.
The
following summarizes the legal ownership structure of Conseco’s primary
subsidiaries at December 31, 2009:
101
The
ability of our insurance subsidiaries to pay dividends is subject to state
insurance department regulations and is based on the financial statements of our
insurance subsidiaries prepared in accordance with statutory accounting
practices prescribed or permitted by regulatory authorities, which differ from
GAAP. These regulations generally permit dividends to be paid from
statutory earned surplus of the insurance company for any 12-month period in
amounts equal to the greater of (or in a few states, the lesser
of): (i) statutory net gain from operations or net income for the
prior year; or (ii) 10 percent of statutory capital and surplus as of the end of
the preceding year (excluded from this calculation would be the $61.2 million of
additional surplus recognized due to temporary modifications in statutory
prescribed practices related to certain deferred tax assets). These
types of dividends are referred to as “ordinary dividends”. Any dividends in
excess of these levels require the approval of the director or commissioner of
the applicable state insurance department. These types of dividends
are referred to as “extraordinary dividends”. Each of the direct
insurance subsidiaries of CDOC had negative earned surplus at December 31, 2009
as summarized below (dollars in millions):
|
Earned
surplus
|
|||||
|
Subsidiary of CDOC
|
(deficit) (a)
|
Additional information
|
|||
|
Conseco
Life of
Texas
|
$ | (1,195.1 | ) |
(b)
|
|
|
Washington
National
|
(1,183.2 | ) |
(c)
|
||
|
Conseco
Health
|
(6.2 | ) | |||
|
|
______________
|
|
|
(a)
|
As
calculated pursuant to the state insurance department of each company’s
domiciliary state.
|
|
|
(b)
|
During
2008, Conseco Life of Texas transferred the ownership of Senior Health,
Washington National and Conseco Health to CDOC. As a result of
this transaction, the $1,574.7 million of accumulated unrealized losses of
Conseco Life of Texas’ former subsidiaries were realized by Conseco Life
of Texas, reducing its earned surplus to $(1,206.4) million at December
31, 2008, pursuant to the manner earned surplus is calculated under the
regulations of the Texas Department of
Insurance.
|
|
|
(c)
|
Pursuant
to the regulations of the Illinois Division of Insurance, the accumulated
earnings and losses of Washington National’s subsidiaries are reflected in
the earned surplus of Washington National. Conseco Life, a
subsidiary of Washington National, incurred aggregate costs in excess of
$265 million during the three years ended December 31, 2007 related to
litigation regarding a change made in 2003 and 2004 in the manner cost of
insurance charges are calculated for certain life insurance
policies. In addition, significant dividend payments have been
made from Washington National and its subsidiaries in the past which have
increased its earned deficit, including payments made following
significant reductions in the business of Washington National and its
subsidiaries pursuant to a reinsurance transaction completed in
2007.
|
As
described above, any current dividend payments from the subsidiaries of CDOC
would be considered extraordinary dividends and therefore require the approval
of the director or commissioner of the applicable state insurance
department. During the next twelve months, we are expecting our
insurance subsidiaries to pay approximately $105 million of extraordinary
dividends to CDOC (subject to approval by the applicable state insurance
department). Although we believe the dividends we are expecting to
pay during the twelve months ending December 31, 2010, are consistent with
payments that have been approved by insurance regulators in prior years, there
can be no assurance that such payments will be approved or that the financial
condition of our insurance subsidiaries will not change, making future approvals
less likely. In addition, we are expecting Conseco Life of Texas to pay interest
on surplus debentures of $49 million in the next twelve months, which will not
require additional approval provided the RBC ratio of Conseco Life of Texas
exceeds 100 percent (but will require prior written notice to the Texas state
insurance department). Dividends and other payments from our
non-insurance subsidiaries, including 40|86 Advisors and Conseco Services, LLC,
to CNO or CDOC do not require approval by any regulatory authority or other
third party. However, insurance regulators may prohibit payments by
our insurance subsidiaries to parent companies if they determine that such
payments could be adverse to our policyholders or contractholders.
102
The
insurance subsidiaries of CDOC receive funds to pay dividends primarily
from: (i) the earnings of their direct businesses; (ii) tax sharing
payments received from subsidiaries (if applicable); and (iii) dividends
received from subsidiaries (if applicable). At December 31, 2009,
these subsidiaries had earned surplus (deficit) as summarized below (dollars in
millions):
|
Earned
surplus
|
|||||
|
Subsidiary of CDOC
|
(deficit) (a)
|
Additional information
|
|||
|
Subsidiaries
of Conseco Life of Texas:
|
|||||
|
Bankers
Life and Casualty Company
|
$ | 109.0 |
(b)
|
||
|
Colonial
Penn
|
(228.7 | ) |
(c)
|
||
|
Subsidiaries
of Washington National:
|
|||||
|
Conseco
Insurance
Company
|
(6.6 | ) |
(d)
|
||
|
Conseco
Life
|
(401.8 | ) |
(e)
|
||
|
|
__________
|
|
|
(a)
|
As
calculated pursuant to the state insurance department of each company’s
domiciliary state.
|
|
|
(b)
|
Bankers
Life and Casualty Company’s ability to pay ordinary dividends is currently
limited to its statutory net income in 2009 of $86.7
million.
|
|
|
(c)
|
For
tax planning purposes, Colonial Penn paid dividends to its parent of $150
million during 2006. In addition, Colonial Penn issued a
surplus debenture to CDOC in exchange for $160 million of
cash. The 2006 dividend payment reduced Colonial Penn’s earned
surplus by $150 million (even though total capital and surplus increased
by $10 million after the issuance of the surplus debenture). In
2007, Colonial Penn recaptured a block of traditional life business
previously ceded to an unaffiliated insurer in 2002. The
Company’s earned surplus was reduced by $63 million as a result of the fee
paid to recapture this business.
|
|
|
(d)
|
Conseco
Insurance Company will not be able to pay ordinary dividends until its
future earnings result in a positive earned surplus
balance.
|
|
|
(e)
|
We
have no plans for Conseco Life to pay dividends to Washington National at
any time in the foreseeable future.
|
In
assessing Conseco’s current financial position and operating plans for the
future, management made significant judgments and estimates with respect to the
potential financial and liquidity effects of Conseco’s risks and uncertainties,
including but not limited to:
|
·
|
the
receipt of any required approvals for dividend payments and surplus
debenture interest payments from our insurance subsidiaries by the
director or commissioner of the applicable state insurance departments
when required and our ability to make such
payments;
|
|
·
|
the
potential adverse effects on Conseco’s businesses from downgrades by
rating agencies;
|
|
·
|
our
ability to achieve our operating
plan;
|
|
·
|
the
potential for future declines in the bond and commercial mortgage loan
markets and the potential for further significant recognition of
other-than-temporary impairments;
|
|
·
|
the
potential need to provide additional capital to our insurance
subsidiaries;
|
|
·
|
our
ability to continue to achieve compliance with our loan covenants
including the financial ratios we are required to
maintain;
|
|
·
|
the
potential loss of key personnel that could impair our ability to achieve
our operating plan;
|
|
·
|
the
potential impact of an ownership change or a decrease in our operating
earnings on the valuation allowance related to our deferred tax
assets;
|
103
|
·
|
the
potential impact on the RBC ratio of our insurance subsidiaries if
regulators do not modify the calculation of the required capital for
commercial mortgages based on the use of the MEAF in a manner that results
in a capital requirement that is the same or similar to the requirement
calculated pursuant to temporary modifications effective for
2009;
|
|
·
|
the
potential impact on the RBC ratio of our insurance subsidiaries if
regulators do not modify the calculation of the required capital for
investments in RMBS in a manner that results in a capital requirement that
is the same or similar to the requirement calculated pursuant to temporary
modifications effective for 2009;
and
|
|
·
|
the
potential impact on certain of Conseco’s insurance subsidiaries if
regulators do not allow us to continue to recognize certain deferred tax
assets pursuant to temporary modifications in statutory prescribed
practices.
|
CNO has
significant indebtedness which will require over $218 million in cash to service
in the next twelve months (assuming the holders of our 3.5% Debentures require
the Company to repurchase their 3.5% Debentures on September 30, 2010 pursuant
to their put right). Achievement of our operating and capital plans
is a critical factor in having sufficient income and liquidity to meet our debt
service requirements for the next twelve months and other holding company
obligations and failure to do so would have material adverse consequences for
the Company. These items are discussed further below.
The
principal payments on our direct corporate obligations (including payments
required under the Senior Credit Agreement, the Senior Health Note, the 3.5%
Debentures and the 7.0% Debentures) are as follows (dollars in
millions):
|
2010
|
$ | 141.5 |
(a)
|
||
|
2011
|
60.0 | ||||
|
2012
|
65.0 | ||||
|
2013
|
602.1 | ||||
|
2016
|
176.5 | ||||
| $ | 1,045.1 |
_____________
|
|
(a)
|
Includes
$116.5 million of the 3.5% Debentures. The holders of our 3.5%
Debentures have the right to require the Company to repurchase their 3.5%
Debentures for cash on September 30, 2010. This amount assumes
that all remaining holders of our 3.5% Debentures exercise that
right. In February 2010, as further discussed in the note to
the consolidated financial statements entitled “Subsequent Events”, we
repurchased $64 million of the 3.5% Debentures and issued $64 million of
the 7.0% Debentures.
|
104
The
following summarizes the projected sources and uses of cash of CDOC and CNO
during the twelve months ending December 31, 2010 (dollars in
millions):
|
From
our operations or surplus debenture
interest
payments
|
From
extraordinary dividends requiring approval and expected
capital contributions
|
Related
to previously announced capital
transactions
|
Total
|
|||||||||||||
|
Sources
of holding company cash:
|
||||||||||||||||
|
Dividends
from our insurance subsidiaries:
|
||||||||||||||||
|
Conseco
Life of
Texas
|
$ | - | $ | 75.0 | $ | - | $ | 75.0 | ||||||||
|
Washington
National
|
- | 20.0 | - | 20.0 | ||||||||||||
|
Conseco
Health
|
- | 10.0 | - | 10.0 | ||||||||||||
|
Surplus
debenture
interest
|
48.8 | - | - | 48.8 | ||||||||||||
|
Proceeds
from issuance of 7.0% Debentures (b)
|
- | - | 110.3 | 110.3 | ||||||||||||
|
Administrative
services and investment management fees
|
60.0 | - | - | 60.0 | ||||||||||||
|
Total
sources of cash expected to be available to service our debt and other
obligations
|
108.8 | 105.0 | 110.3 | 324.1 | ||||||||||||
|
Uses
of holding company cash:
|
||||||||||||||||
|
Debt
service commitments of CNO:
|
||||||||||||||||
|
Estimated
interest
payments
|
76.6 | - | - | 76.6 | ||||||||||||
|
Scheduled
principal payments under the Senior Note
|
25.0 | - | - | 25.0 | ||||||||||||
|
Capital
contributions to our insurance subsidiaries
|
29.4 | 85.0 | - | 114.4 | ||||||||||||
|
Repurchase
of 3.5% Debentures (c)
|
- | - | 116.5 | 116.5 | ||||||||||||
|
Corporate
expense and
other
|
36.9 | - | - | 36.9 | ||||||||||||
|
Total
expected uses of
cash
|
167.9 | 85.0 | 116.5 | 369.4 | ||||||||||||
|
Net
expected increase (decrease) in cash
|
(59.1 | ) | $ | 20.0 | $ | (6.2 | ) | (45.3 | ) | |||||||
|
Cash
balance, beginning of year
(a)
|
146.1 | 146.1 | ||||||||||||||
|
Projected
cash balance, end of year (a)
|
$ | 87.0 | $ | 100.8 | ||||||||||||
_________
|
(a)
|
Includes
cash balances of our other non-insurance subsidiaries, which are available
to CDOC or CNO.
|
|
(b)
|
Amount
includes the issuance, in February 2010, of $64.0 million of 7.0%
Debentures. We received aggregate net proceeds of $61.4 million
(after taking into account the discounted offering price less the initial
purchaser’s discounts and commissions). The remaining amount
represents the 7.0% Debentures that are expected to be issued on the date
that the remaining 3.5% Debentures are
repurchased.
|
|
(c)
|
Amount
includes the repurchase, in February 2010, of $64.0 million of 3.5%
Debentures. The remaining amount represents the 3.5% Debentures
that will be repurchased later in
2010.
|
In
connection with the Transfer further discussed in the note to the consolidated
financial statements entitled “Transfer of Senior Health Insurance Company of
Pennsylvania to an Independent Trust”, the Company issued a $125.0 million
Senior Note due November 12, 2013 payable to Senior Health. The
Senior Note has a 6 percent interest rate and requires annual principal payments
of $25.0 million. Such amounts are expected to be funded by the
Company’s operating activities. Conseco agreed that it would not pay
cash dividends on its common stock while any portion of the Senior Note remained
outstanding.
105
Senior Credit Agreement
On March
30, 2009, we completed Amendment No. 2 to our Senior Credit Agreement, which
provided for, among other things: (i) additional margins between our
current financial status and certain financial covenant requirements through
June 30, 2010; (ii) higher interest rates and the payment of a fee; (iii) new
restrictions on the ability of the Company to incur additional indebtedness; and
(iv) the ability of the lender to appoint a financial advisor at the Company’s
expense.
Pursuant
to its amended terms, the applicable interest rate on the Senior Credit
Agreement (based on either a Eurodollar or base rate) was
increased. The Eurodollar rate was equal to LIBOR plus 4 percent with
a minimum LIBOR rate of 2.5 percent (such rate was previously LIBOR plus 2
percent with no minimum rate). The base rate was equal to 2.5 percent
plus the greater of: (i) the Federal funds rate plus .50 percent; or
(ii) Bank of America’s prime rate. In addition, the amended agreement
required the Company to pay a fee equal to 1 percent of the outstanding
principal balance under the Senior Credit Agreement, which fee was added to the
principal balance outstanding and was payable at the maturity of the
facility. This 1 percent fee was reported as non-cash interest
expense.
The
modifications to the Senior Credit Agreement also placed new restrictions on the
ability of the Company to incur additional indebtedness. The
amendment: (i) deleted the provision that allowed the Company to
borrow up to an additional $330 million under the Senior Credit Agreement (the
lenders under the facility having had no obligation to lend any amount under
that provision); (ii) reduced the amount of secured indebtedness that the
Company can incur from $75 million to $2.5 million; and (iii) limited the
ability of the Company to incur additional unsecured indebtedness, except as
provided below, to $25 million, and eliminated the provision that would have
allowed the Company to incur additional unsecured indebtedness to the extent
that principal payments were made on existing unsecured
indebtedness.
The
Company was permitted to issue unsecured indebtedness that is used solely to pay
the holders of the 3.5% Debentures, provided that such
indebtedness: (i) had a maturity date that is no earlier than October
10, 2014; (ii) contained covenants and events of default that are no more
restrictive than those in the Senior Credit Agreement; (iii) did not contain any
covenants or events of default based on maintenance of the Company’s financial
condition; (iv) did not amortize; and (v) did not have a put date or otherwise
be callable prior to April 10, 2014, and provided that the amount of such
unsecured indebtedness incurred under this provision did not exceed the $293
million of 3.5% Debentures outstanding on March 30, 2009; and provided further
that the amount of cash interest payable annually on any new issuance of such
indebtedness, together with the cash interest payable on the outstanding 3.5%
Debentures, did not exceed twice the amount of cash interest currently payable
on the outstanding 3.5% Debentures.
The
amendment prohibited the Company from redeeming or purchasing the 3.5%
Debentures with cash from sources other than those described in the previous
paragraph. The amendment permitted the Company to amend, modify or
refinance the Convertible Indebtedness so long as such new indebtedness complied
with the restrictions set forth in the previous paragraph.
In
addition, pursuant to the terms of the amended credit agreement, the agent
(acting on behalf of the lenders) has the right to appoint a financial advisor
at the Company’s expense to, among other things, review financial projections
and other financial information prepared by or on behalf of the Company, perform
valuations of the assets of the Company and take other actions as are customary
or reasonable for an advisor acting in such capacity. A financial
advisor has been appointed by the agent and has been reviewing the
Company.
On
December 22, 2009, the Company entered into Amendment No. 3 to our Senior
Credit Agreement, which provides for, among other things:
|
|
(i)
|
the
minimum risk-based capital ratio requirement will remain at 200% through
December 31, 2010 and will increase to 225% for 2011 and 250% for 2012
(the risk-based capital requirement was previously scheduled to return to
250% after June 30, 2010);
|
|
|
(ii)
|
the
required minimum level of statutory capital and surplus will remain at
$1.1 billion through December 31, 2010 and will increase to $1.2 billion
for 2011 and $1.3 billion for 2012 (the required minimum level of
statutory capital and surplus was previously scheduled to return to $1.27
billion after June 30, 2010);
|
|
|
(iii)
|
the
interest coverage ratio requirement will remain at 1.50 through December
31, 2010 and will increase to 1.75 for 2011 and 2.00 for 2012 (the
interest coverage ratio requirement was previously scheduled to return to
2.00 after June 30, 2010); and
|
106
|
|
(iv)
|
the
debt to total capital ratio requirement will remain at 32.5% though
December 31, 2009 and will decrease to 30% thereafter (the debt to
total capital ratio requirement was previously scheduled to return to 30%
after June 30, 2010).
|
The
Company also agreed to pay $150 million of the first $200 million of net
proceeds from its public offering of common stock (as further discussed below)
to the lenders and, in addition, to pay 50% of any net proceeds in excess of
$200 million from the offering. The credit facility previously
required the Company to pay 50% of the net proceeds of any equity issuance to
the lenders.
The
amendment modifies the Company’s principal repayment schedule to eliminate any
principal payments in 2010 and provides for principal payments of $35 million in
2011, $40 million in 2012 and $40 million in 2013. The Company was
previously required to make principal repayments equal to 1% of the initial
principal balance each year, subject to certain adjustments, and to make
additional principal repayments from excess cash flow.
The
amendment also provides that the 1% payment in kind, or PIK, interest that has
accrued since March 30, 2009 as an addition to the principal balance under the
Senior Credit Agreement will be replaced with a payment of an equal amount of
cash interest. The amount of accrued PIK interest ($6.3 million) was
paid in cash when the amendment became effective. The deletion of the
1% PIK interest and the payment of an equal amount of cash interest will not
impact reported interest expense.
On
November 13, 2009, we repaid $36.8 million of outstanding principal on the
Senior Credit Agreement from the proceeds of the issuance of common stock and
warrants to Paulson. On December 22, 2009, the Company repaid $161.4
million of outstanding principal on the Senior Credit Agreement from proceeds of
an equity offering. These transactions are further discussed in the
note to the consolidated financial statements entitled “Shareholders’
Equity.”
During
2009, we made scheduled principal payments totaling $5.3 million on our Senior
Credit Agreement. Also, during 2009, we made a mandatory prepayment
of $1.2 million based on the Company’s excess cash flows at December 31, 2008 as
defined in the Senior Credit Agreement.
In
accordance with Amendment No. 3 to our Senior Credit Agreement, the amounts
outstanding under the Senior Credit Agreement bear interest, payable at least
quarterly, based on either a Eurodollar rate or a base rate. The
Eurodollar rate is equal to LIBOR plus 5 percent with a minimum LIBOR rate of
2.5 percent. The base rate is equal to 4 percent plus the greater
of: (i) the Federal funds rate plus .50 percent; or (ii) Bank of
America’s prime rate. Under the terms of the Senior Credit Agreement,
if the Company’s senior secured long-term debt is rated at least “Ba2” by
Moody’s and “BB” by S&P, in each case with a stable outlook, the margins on
the Eurodollar rate or the base rate would each be reduced by .25
percent. At December 31, 2009, the interest rate on our Senior Credit
Agreement was 7.5 percent.
Pursuant
to the Senior Credit Agreement, as long as the debt to total capitalization
ratio (as defined in the Senior Credit Agreement) is greater than 20 percent and
certain insurance subsidiaries (as defined in the Senior Credit Agreement) have
financial strength ratings of less than A- from A.M. Best, the Company is
required to make mandatory prepayments with all or a portion of the proceeds
from the following transactions or events including: (i) the issuance
of certain indebtedness; (ii) certain equity issuances; and (iii) certain asset
sales or casualty events. The Company may make optional prepayments
at any time in minimum amounts of $3.0 million or any multiple of $1.0 million
in excess thereof.
107
The
following chart summarizes: (i) the most significant financial ratios
and balances we must maintain pursuant to our Senior Credit Agreement; (ii) the
current ratios and balances as of December 31, 2009; and (iii) the margins for
adverse developments before such ratio or balance requirement is not met
(dollars in millions):
|
Balance
or
|
||||||
|
ratio
as of
|
Margin
for adverse
|
|||||
|
Covenant
under the
|
December 31,
|
development
from
|
||||
|
Senior Credit Agreement
|
2009
|
December 31, 2009 levels
|
||||
|
Aggregate
risk-based capital ratio
|
Greater
than or equal to 200% from March 31, 2009 through December 31, 2010;
greater than or equal to 225% from March 31, 2011 through December 31,
2011; and thereafter, greater than 250%.
|
309% |
Reduction
to total adjusted capital (defined as combined statutory capital and
surplus plus the asset valuation reserve and 50 percent of the balance of
the provision of policyholder dividends) of approximately $507 million, or
an increase to required risk-based capital of approximately $253
million.
|
|||
|
Combined
statutory capital and surplus
|
Greater
than $1,100 from March 31, 2009 through December 31, 2010; greater than
$1,200 million from March 31, 2011 through December 31, 2011; and
thereafter, $1,300 million.
|
$1,439
million
|
Reduction
to combined statutory capital and surplus of approximately $339
million.
|
|||
|
Debt
to total capitalization ratio
|
Not
more than 32.5% from March 31, 2009 through December 31, 2009 and
thereafter, not more than 30%.
|
21.6% |
Reduction
to shareholders’ equity of approximately $1,620 million or additional debt
of $780 million.
|
|||
|
Interest
coverage ratio
|
Greater
than or equal to 1.50 to 1 for rolling four quarters from March 31, 2009
through December 31, 2010; greater than or equal to 1.75 to 1 for rolling
four quarters from March 31, 2011 through December 31, 2011; and
thereafter, 2.00 to 1.
|
2.38
to 1
|
Reduction
in cash flows to the holding company of approximately $58
million.
|
|||
The
Senior Credit Agreement included an $80.0 million revolving credit facility that
could be used for general corporate purposes and that would mature on June 22,
2009. In October 2008, the Company borrowed $75.0 million under the
revolving credit facility to assure the future availability of this additional
liquidity given our concerns with the ability of certain financial institutions
to be able to provide funding in the future. In December 2008, we
repaid $20.0 million of the revolving facility and reduced the maximum amount
available under the revolving facility to $60.0 million. At December
31, 2008, there was $55.0 million outstanding under the revolving
facility. In April 2009, we repaid the remaining $55.0 million that
was outstanding under the revolving facility portion of our Senior Credit
Agreement. The Company paid a commitment fee equal to .50 percent of
the unused portion of the revolving credit facility on an annualized
basis. The revolving credit facility interest was based on either a
Eurodollar rate or a base rate in the same manner as described above for the
Senior Credit Agreement.
The
Senior Credit Agreement prohibits or restricts, among other
things: (i) the payment of cash dividends on our common stock; (ii)
the repurchase of our common stock; (iii) the issuance of additional debt or
capital stock; (iv) liens; (v)
108
certain
asset dispositions; (vi) affiliate transactions; (vii) certain investment
activities; (viii) change in business; and (ix) prepayment of indebtedness
(other than the Senior Credit Agreement). The obligations under our
Senior Credit Agreement are guaranteed by Conseco’s current and future domestic
subsidiaries, other than: (i) its insurance companies; (ii)
subsidiaries of the insurance companies; or (iii) certain immaterial
subsidiaries as defined in the Senior Credit Agreement. This
guarantee was secured by granting liens on substantially all the assets of the
guarantors, including the capital stock of Conseco Life of Texas, Washington
National and Conseco Health.
3.5%
Debentures
On
November 13, 2009, we completed the Tender Offer for $176.5 million
aggregate principal amount of the 3.5% Debentures. The aggregate
consideration for the 3.5% Debentures accepted by us in the Tender Offer, plus
accrued and unpaid interest thereon, was
$177.2 million. Following the settlement of the Tender Offer,
there is $116.5 million aggregate principal amount of the 3.5% Debentures
outstanding.
On or
after October 5, 2010, the Company may redeem for cash all or a portion of the
3.5% Debentures at any time at a redemption price equal to 100 percent of the
accreted principal amount of the 3.5% Debentures plus accrued and unpaid
interest. Holders may require the Company to repurchase in cash all
or any portion of the 3.5% Debentures on September 30, 2010 at a repurchase
price equal to 100 percent of the accreted principal amount of the 3.5%
Debentures to be repurchased, plus accrued and unpaid interest.
As
further discussed in the note to the consolidated financial statements entitled
“Subsequent Events”, we repurchased $64 million aggregate principal amount of
the 3.5% Debentures in February 2010.
7.0%
Debentures
On
November 13, 2009, we issued $176.5 million aggregate principal amount
of our 7.0% Debentures in the initial closing of our private offering of
7.0% Debentures to Morgan Stanley, as the initial purchaser of the 7.0%
Debentures. The net proceeds from the initial closing of the offering
of our 7.0% Debentures, after deducting the initial purchaser’s discounts and
commissions and before other offering expenses, totaled $172.0
million. The Company used the net proceeds to fund a substantial
portion of the consideration payable in connection with the Tender Offer for the
3.5% Debentures. We expect to issue additional 7.0% Debentures, and
Morgan Stanley, as the initial purchaser, is required to purchase these
additional 7.0% Debentures, subject to the satisfaction of certain conditions,
on the following dates:
|
·
|
the
settlement date of any subsequent tender offers we make for outstanding
3.5% Debentures that expire before October 5,
2010;
|
|
·
|
the
settlement date of any privately negotiated transactions that settle
before October 5, 2010;
|
|
·
|
September 30,
2010, the date on which we may be required by holders of the 3.5%
Debentures, if any, to repurchase such 3.5%
Debentures; and
|
|
·
|
October 5,
2010, if we elect to redeem any 3.5% Debentures that remain outstanding on
such date.
|
The net
proceeds from any subsequent closings of the 7.0% Debentures offering will be
used to fund a substantial portion of the aggregate consideration payable for
3.5% Debentures that we may repurchase or redeem in accordance with the terms of
the 3.5% Debentures.
The 7.0%
Debentures rank equally in right of payment with all of the Company’s unsecured
and unsubordinated obligations including the 3.5% Debentures. The
7.0% Debentures are governed by an Indenture dated as of October 16, 2009 (the
“7.0% Indenture”) between the Company and The Bank of New York Mellon Trust
Company, N.A., as trustee. The 7.0% Debentures bear interest at a
rate of 7.0% per annum, payable semi-annually on June 30 and December 30 of each
year, commencing on the interest payment date immediately succeeding the
issuance date of such series; provided, however, that if the issuance date of a
series of 7.0% Debentures is after the close of business on the interest record
for such interest payment date, the first interest payment date will instead be
the second interest payment date immediately succeeding the issuance date of
such series. The 7.0% Debentures will mature on December 30, 2016,
unless earlier converted. The 7.0% Debentures may not be redeemed at
the Company’s election prior to the stated maturity date and the holders may not
require the Company to repurchase the 7.0% Debentures at any
time. The 7.0% Debentures are not convertible prior to June 30,
2013, except under limited circumstances. Commencing on June 30,
2013, the 7.0% Debentures will be convertible into shares of
109
our
common stock at the option of the holder at any time, subject to certain
exceptions and subject to our right to terminate such conversion rights under
certain circumstances relating to the sale price of our common
stock. If the holders elect to convert their 7.0% Debentures upon the
occurrence of certain changes of control of Conseco or certain other events, we
will be required, under certain circumstances, to increase the conversion rate
for such holders of the 7.0% Debentures who convert in connection with such
events. Initially, the 7.0% Debentures will be convertible into
182.1494 shares of our common stock for each $1,000 principal amount of
7.0% Debentures, which is equivalent to an initial conversion price of
approximately $5.49 per share. The conversion rate is subject to
adjustment following the occurrence of certain events in accordance with the
terms of the 7.0% Indenture.
Except as
specified in the 7.0% Indenture, if an event of default (as defined in the 7.0%
Indenture), other than an event of default relating to certain events of
bankruptcy, insolvency or reorganization of the Company or any Significant
Subsidiary (as defined in the 7.0% Indenture), occurs and is continuing, the
trustee or holders of more than 50% in principal amount of the outstanding 7.0%
Debentures may declare the principal of and accrued but unpaid interest on all
of the 7.0% Debentures to be due and payable. If an event of default
relating to certain events of bankruptcy, insolvency or reorganization of the
Company or any Significant Subsidiary occurs, the principal of, and accrued but
unpaid interest on all the 7.0% Debentures will become immediately due and
payable without any declaration or other act on the part of the trustee or any
holders. The following are events of default with respect to the 7.0%
Debentures:
|
·
|
default
in payment of any interest due and payable on the 7.0% Debentures and such
default continues unremedied for 30
days;
|
|
·
|
default
in payment of principal of the 7.0% Debentures when the same becomes due
and payable, whether at maturity, upon declaration of acceleration or
otherwise;
|
|
·
|
default
by the Company or any of the Company’s subsidiaries under any instrument
or instruments evidencing indebtedness (other than the 7.0% Debentures)
having an outstanding principal amount exceeding $50.0 million (or its
equivalent in any other currency or currencies) that has caused the
holders thereof to declare such indebtedness to be due and payable prior
to its stated maturity;
|
|
·
|
default
in payment of indebtedness (other than in respect of swap contracts) for
money borrowed by the Company or any of the Company’s subsidiaries in an
aggregate principal amount exceeding $50.0 million (or its equivalent in
any other currency or currencies) when such indebtedness becomes due and
payable at final maturity;
|
|
·
|
a
final judgment for a payment exceeding $50.0 million (excluding any
amounts covered by insurance) rendered against the Company or any of the
Company’s subsidiaries, which judgment is not vacated, discharged or
stayed within 30 days after (1) the date on which the right to appeal
thereof has expired if no such appeal has commenced, or 920 the date on
which all rights to appeal have been
extinguished;
|
|
·
|
default
in the Company’s performance of any other covenants or agreements in
respect of the 7.0% Debentures contained in the 7.0% Indenture or the 7.0%
Debentures for 60 days (or (1) solely in the case of the reporting
covenant and, if applicable, the covenant set forth in Section 314(a) of
the Trust Indenture Act of 1939, as amended, 120 days and (2) solely in
the case of the Company’s failure to comply with its obligations to
convert 7% Debentures or perform its covenant to reserve and list the
common stock issuable upon conversion, 30 days) after written notice to
the Company by the trustee or to the Company and the trustee by the
holders of at least 25% in aggregate principal amount of all series of
7.0% Debentures then outstanding (acting together as a single
class);
|
|
·
|
the
occurrence of a change of control after written notice is received by the
Company not later than 90 days following the occurrence of such change of
control (or with respect to any change of control that occurs prior to the
issuance of the first series of 7.0% Debentures, 90 days following the
issuance date of such first series of 7.0% Debentures), to the Company by
the trustee or to the Company and the trustee by the holders of at least
10% in aggregate principal amount of all series of 7.0% Debentures then
outstanding (acting together as a single class);
or
|
|
·
|
certain
events of bankruptcy, insolvency and reorganization of the Company or one
of the Company’s “significant subsidiaries” (as defined in Rule 1-02(w) of
Regulation S-X under the Securities
Act).
|
The 7.0%
Indenture provides that on and after the date of the 7.0% Indenture, the Company
may not: (i) consolidate with or merge into any other person or sell,
convey, lease or transfer the Company’s consolidated properties and assets
substantially as an entirety to any other person in any one transaction or
series of related transactions; or (ii) permit any
110
person to
consolidate with or merge into the Company, unless:
|
·
|
if
the Company is not the surviving person, then the surviving person formed
by such consolidation or into which the Company is merged or the person to
which the Company’s properties and assets are so sold, conveyed, leased or
transferred shall be a corporation or limited liability company organized
and existing under the laws of the United States of America, any State
thereof or the District of Columbia; provided that the surviving person
(if not the Company) shall execute and deliver to the trustee a
supplemental indenture expressly assuming all of the Company’s obligations
with respect to the 7.0% Debentures, including, among other things, the
payment when due of the principal of and interest on the 7.0% Debentures
and the performance of each of the Company’s other covenants under the
7.0% Indenture; and
|
|
·
|
immediately
after giving effect to such transaction, no default or event of default
with respect to the 7.0% Debentures has occurred and is
continuing.
|
Upon any
such consolidation, merger or transfer, the surviving person (if not the
Company) shall succeed to, and may exercise every right and power of, the
Company under the 7.0% Indenture.
On
November 17, 2009, two investment funds managed by Paulson purchased
$120.5 million aggregate principal amount of 7.0% Debentures from Morgan
Stanley, and other purchasers purchased the remaining $56.0 million
aggregate principal amount of 7.0% Debentures from Morgan Stanley. We
have been informed by Morgan Stanley that the two funds managed by Paulson have
entered into agreements with Morgan Stanley to purchase up to a total of
$79.5 million additional aggregate principal amount of 7.0% Debentures, and
other purchasers have agreed to purchase up to the remaining $37.0 million
aggregate principal amount of 7.0% Debentures.
Holders
of the 3.5% Debentures that remain outstanding have the right to require us to
repurchase their debentures for cash on September 30, 2010. If
any 3.5% Debentures remain outstanding after September 30, 2010, we will
have the right to redeem such debentures on October 5, 2010 for
cash. As of December 31, 2009, there are $116.5 million in
aggregate principal amount of 3.5% Debentures outstanding. We have
commitments from Morgan Stanley to purchase an additional aggregate principal
amount of 7.0% Debentures equal to the aggregate principal amount of 3.5%
Debentures: (i) that we may purchase pursuant to any subsequent tender
offer that expires before October 5, 2010; (ii) that we may purchase in
privately negotiated transactions that settle before October 5, 2010;
(iii) that holders thereof require us to repurchase on September 30,
2010; or (iv) for any 3.5% Debentures that remain outstanding on
October 5, 2010 that we elect to redeem.
As
further discussed in the note to the consolidated financial statements entitled
“Subsequent Events”, we issued $64 million aggregate principal amount of the
7.0% Debentures in February 2010.
Outlook
We
believe that the existing cash available to the holding company, the cash flows
to be generated from operations and the other transactions summarized above will
be sufficient to allow us to meet our debt obligations through the next twelve
months. However, our cash flow is affected by a variety of factors,
many of which are outside of our control, including insurance regulatory issues,
competition, financial markets and other general business
conditions. We cannot provide assurance that we will possess
sufficient income and liquidity to meet all of our debt service requirements and
other holding company obligations. For additional discussion
regarding the liquidity and other risks that we face, see “Risk
Factors”.
MARKET-SENSITIVE
INSTRUMENTS AND RISK MANAGEMENT
Our
spread-based insurance business is subject to several inherent risks arising
from movements in interest rates, especially if we fail to anticipate or respond
to such movements. First, interest rate changes can cause compression
of our net spread between interest earned on investments and interest credited
on customer deposits, thereby adversely affecting our
results. Second, if interest rate changes produce an unanticipated
increase in surrenders of our spread-based products, we may be forced to sell
investment assets at a loss in order to fund such surrenders. Many of
our products include surrender charges, market interest rate adjustments or
other features to encourage persistency; however at December 31, 2009,
approximately 20 percent of our total insurance liabilities, or approximately
$5.0 billion, could be surrendered by the policyholder without
penalty. Finally, changes in interest rates can have significant
effects on the performance of our structured securities portfolio as a result of
changes in the prepayment rate of the loans underlying such
securities. We follow asset/liability strategies that are designed to
mitigate the effect of interest rate changes on our
profitability. However,
111
there can
be no assurance that management will be successful in implementing such
strategies and achieving adequate investment spreads.
We seek
to invest our available funds in a manner that will fund future obligations to
policyholders, subject to appropriate risk considerations. We seek to
meet this objective through investments that: (i) have similar cash
flow characteristics with the liabilities they support; (ii) are diversified
among industries, issuers and geographic locations; and (iii) are predominantly
investment-grade fixed maturity securities.
Our
investment strategy is to maximize, over a sustained period and within
acceptable parameters of risk, investment income and total investment return
through active investment management. Accordingly, 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 are a relatively
small portion of our total portfolio.
The
profitability of many of our products depends on the spread between the interest
earned on investments and the rates credited on our insurance
liabilities. In addition, changes in competition and other factors,
including 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, 2009,
approximately 41 percent of our insurance liabilities had interest rates that
may be reset annually; 41 percent had a fixed explicit interest rate for the
duration of the contract; 13 percent had credited rates which approximate the
income earned by the Company; and the remainder had no explicit interest
rates. At December 31, 2009, the average yield, computed on the cost
basis of our actively managed fixed maturity portfolio, was 5.7 percent, and the
average interest rate credited or accruing to our total insurance liabilities
(excluding interest rate bonuses for the first policy year only and excluding
the effect of credited rates attributable to variable or equity-indexed
products) was 4.5 percent.
We use
computer models to simulate the cash flows expected from our existing insurance
business under various interest rate scenarios. These simulations
help us to measure the potential gain or loss in fair value of our interest
rate-sensitive financial instruments and to manage the relationship between the
duration of our assets and the expected duration of our
liabilities. When the estimated durations of assets and liabilities
are similar, a change in the value of assets should be largely offset by a
change in the value of liabilities. At December 31, 2009, the
adjusted modified duration of our fixed maturity investments (as modified to
reflect payments and potential calls) was approximately 9.0 years and the
duration of our insurance liabilities was approximately 8.1 years. We
estimate that our fixed maturity securities and short-term investments (net of
corresponding changes in insurance acquisition costs) would decline in fair
value by approximately $455 million if interest rates were to increase by 10
percent from their levels at December 31, 2009. This compares to a
decline in fair value of $185 million based on amounts and rates at December 31,
2008. Our computer simulated calculations include 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, our net exposure to interest rates can vary over
time.
We are
subject to the risk that our investments will decline in value. This
has occurred in the past and may occur again. During 2009, we
recognized net realized investment losses of $60.5 million, which were comprised
of $134.9 million of net gains from the sales of investments (primarily fixed
maturities) and $195.4 million of writedowns of investments for other than
temporary declines in fair value recognized through net income ($385.0 million,
prior to the $189.6 million of impairment losses recognized through other
comprehensive loss). During 2008, we recognized net realized
investment losses of $262.4 million, which were comprised of: (i)
$100.1 million of net losses from the sales of investments (primarily fixed
maturities) and; (ii) $162.3 million of writedowns of investments for other than
temporary declines in fair value. During 2007, we recognized net
realized investment losses of $158.0 million, which were comprised
of: (i) $52.5 million of net losses from the sales of investments
(primarily fixed maturities); (ii) $31.8 million of writedowns of investments
for other than temporary declines in the fair value; and (iii) $73.7 million of
writedowns of investments (which were subsequently transferred pursuant to a
coinsurance agreement as further discussed in the note to the consolidated
financial statements entitled “Summary of Significant Accounting Policies”) as a
result of our intent not to hold such investments for a period of time
sufficient to allow for any anticipated recovery in value.
The
Company is subject to risk resulting from fluctuations in market prices of our
equity securities. In general, these investments have more year-to-year price
variability than our fixed maturity investments. However, returns
over longer time
112
frames
have been consistently higher. We manage this risk by limiting our
equity securities to a relatively small portion of our total
investments.
Our
investment in options backing our equity-linked products is closely matched with
our obligation to equity-indexed annuity holders. Fair value changes
associated with that investment are substantially offset by an increase or
decrease in the amounts added to policyholder account balances for
equity-indexed products.
Inflation
Inflation
rates may impact the financial statements and operating results in several
areas. Inflation influences interest rates, which in turn impact the
fair value of the investment portfolio and yields on new
investments. Inflation also impacts a portion of our insurance policy
benefits affected by increased medical coverage costs. Operating
expenses, including payrolls, are impacted to a certain degree by the inflation
rate.
RESULTS
OF DISCONTINUED OPERATIONS.
As
further discussed in the note to the consolidated financial statements entitled
“Transfer of Senior Health Insurance Company of Pennsylvania to an Independent
Trust”, the long-term care business of Senior Health is reflected as a
discontinued operation in all periods presented. As a result, the
comparison of the 2008 operating results to prior periods is impacted by the
Transfer. The following summarizes the operating results of our
discontinued operations (dollars in millions):
|
2008
|
2007
|
|||||||
|
Premium
collections (all of which are renewal premiums):
|
||||||||
|
Long-term
care
|
$ | 225.9 | $ | 269.1 | ||||
|
Average
liabilities for insurance products, net of reinsurance
ceded:
|
||||||||
|
Long-term
care
|
$ | 2,881.2 | $ | 2,903.8 | ||||
|
Revenues:
|
||||||||
|
Insurance
policy
income
|
$ | 227.9 | $ | 271.6 | ||||
|
Net
investment income on general account
|
||||||||
|
invested
assets
|
156.9 | 166.8 | ||||||
|
Total
revenues
|
384.8 | 438.4 | ||||||
|
Expenses:
|
||||||||
|
Insurance
policy
benefits
|
311.2 | 517.8 | ||||||
|
Amortization
related to
operations
|
16.7 | 22.5 | ||||||
|
Gain
on reinsurance
recapture
|
(29.7 | ) | - | |||||
|
Loss
on Transfer and transaction
expenses
|
363.6 | - | ||||||
|
Other
operating costs and
expenses
|
54.0 | 63.7 | ||||||
|
Total
benefits and
expenses
|
715.8 | 604.0 | ||||||
|
Income
(loss) before net realized investment
|
||||||||
|
gains
(losses) and income
taxes
|
(331.0 | ) | (165.6 | ) | ||||
|
Net
realized investment gains
(losses)
|
(380.1 | ) | 2.6 | |||||
|
Income
(loss) before income
taxes
|
$ | (711.1 | ) | $ | (163.0 | ) | ||
|
Health
benefit ratios:
|
||||||||
|
Insurance
policy
benefits
|
$ | 311.2 | $ | 517.8 | ||||
|
Benefit
ratio
(a)
|
136.6 | % | 190.6 | % | ||||
|
Interest-adjusted
benefit ratio (b)
|
67.7 | % | 129.2 | % | ||||
113
____________________
|
(a)
|
We
calculate benefit ratios by dividing the related product’s insurance
policy benefits by insurance policy
income.
|
|
(b)
|
We
calculate the interest-adjusted benefit ratio (a non-GAAP measure) for
long-term care products by dividing such product’s insurance policy
benefits less interest income on the accumulated assets backing the
insurance liabilities by policy income. These are considered
non-GAAP financial measures. A non-GAAP measure is a numerical
measure of a company’s performance, financial position, or cash flows that
excludes or includes amounts that are normally excluded or included in the
most directly comparable measure calculated and presented in accordance
with GAAP.
|
These
non-GAAP financial measures of “interest-adjusted benefit ratios” differ from
“benefit ratios” due to the deduction of interest income on the accumulated
assets backing the insurance liabilities from the product’s insurance policy
benefits used to determine the ratio. Interest income is an important
factor in measuring the performance of health products that are expected to be
inforce for a longer duration of time, are not subject to unilateral changes in
provisions (such as non-cancelable or guaranteed renewable contracts) and
require the performance of various functions and services (including insurance
protection) for an extended period of time. The net cash flows from
long-term care products generally cause an accumulation of amounts in the early
years of a policy (accounted for as reserve increases) that will be paid out as
benefits in later policy years (accounted for as reserve
decreases). Accordingly, as the policies age, the benefit ratio will
typically increase, but the increase in benefits will be partially offset by
interest income earned on the accumulated assets. The
interest-adjusted benefit ratio reflects the effects of the interest income
offset. Since interest income is an important factor in measuring the
performance of this product, management believes a benefit ratio that includes
the effect of interest income is useful in analyzing product
performance. We utilize the interest-adjusted benefit ratio in
measuring segment performance because we believe that this performance measure
is a better indicator of the ongoing businesses and trends in the
business. However, the “interest-adjusted benefit ratio” does not
replace the “benefit ratio” as a measure of current period benefits to current
period insurance policy income. Accordingly, management reviews both
“benefit ratios” and “interest-adjusted benefit ratios” when analyzing the
financial results attributable to these products.
The investment income
earned on the accumulated assets backing long-term care reserves in our
discontinued operations was $156.9 million and $166.8 million in 2008 and 2007,
respectively.
Total premium
collections
were $225.9 million in 2008, down 16 percent from
2007. We ceased marketing this long-term care business in
2003. Accordingly, collected premiums have decreased over time as
policies lapsed, partially offset by premium rate increases.
Average
liabilities for insurance products, net of reinsurance ceded
were
approximately $2.9 billion in both 2008 and 2007.
Insurance policy
income
is comprised of premiums earned on these long-term care
policies.
Net investment
income on general account invested assets
decreased 5.9 percent, to
$156.9 million, in 2008. The average balance of general account
invested assets was $2.5 billion and $2.9 billion in 2008 and 2007,
respectively. The average yield on these assets was 6.22 percent and
5.73 percent in 2008 and 2007, respectively. The increase in yield in
2008 reflects the decrease in the cost basis of investments as a result of the
recognition of other-than-temporary impairments as further discussed below under
net
realized investment gains (losses)
.
Insurance policy
benefits
fluctuated primarily as a result of the factors summarized
below.
Insurance
policy benefits were $311.2 million in 2008 and $517.8 million in
2007.
The
benefit ratio on this block of business was 136.6 percent and 190.6 percent in
2008 and 2007, respectively. Benefit ratios are calculated by
dividing the product’s insurance policy benefits by insurance policy
income. Since the insurance product liabilities we establish for
long-term care business are subject to significant estimates, the ultimate claim
liability we incur for a particular period is likely to be different than our
initial estimate. Our insurance policy benefits reflected reserve
deficiencies from prior years of $21.8 million and $123.8 million in 2008 and
2007, respectively. Excluding the effects of prior year claim reserve
deficiencies, our benefit ratios would have been 127.0 percent and 145.0 percent
in 2008 and 2007, respectively. These ratios reflect the
significantly higher level of incurred claims experienced in 2007 resulting in
increases in reserves for future benefits as discussed below, adverse
development on claims incurred in prior periods as discussed below, and
decreases in policy income. The prior period deficiencies have
resulted from the impact of paid claim experience being different than prior
estimates, changes in actuarial assumptions and refinements to claimant data
used to determine claim reserves.
114
The net
cash flows from long-term care products generally cause an accumulation of
amounts in the early years of a policy (accounted for as reserve increases)
which will be paid out as benefits in later policy years (accounted for as
reserve decreases). Accordingly, as the policies age, the benefit
ratio will typically increase, but the increase in benefits will be partially
offset by investment income earned on the assets which have
accumulated. The interest-adjusted benefit ratio for long-term care
products is calculated by dividing the insurance product’s insurance policy
benefits less interest income on the accumulated assets backing the insurance
liabilities by insurance policy income. The interest-adjusted benefit
ratio on this business was 67.7 percent and 129.2 percent in 2008 and 2007,
respectively. Excluding the effects of prior year claim reserve
deficiencies, our interest-adjusted benefit ratios would have been 58.1 percent
and 83.6 percent in 2008 and 2007, respectively.
This
long-term care business was primarily issued by Senior Health prior to its
acquisition by our Predecessor in 1996. The loss experience on these
products has been worse than we originally expected. Although we
anticipated a higher level of benefits to be paid on these products as the
policies aged, the paid claims have exceeded our expectations. In
addition, there has been an increase in the incidence and duration of claims in
recent periods. This adverse experience is reflected in the higher insurance
policy benefits experienced in 2008 and 2007.
In each
quarterly period, we calculated our best estimate of claim reserves based on all
of the information available to us at that time, which necessarily takes into
account new experience emerging during the period. Our actuaries
estimated these claim reserves using various generally recognized actuarial
methodologies which are based on informed estimates and judgments that are
believed to be appropriate. Additionally, an external actuarial firm
provided consulting services which involved a review of the Company’s judgments
and estimates for claim reserves on this long-term care block of business on a
periodic basis. As additional experience emerges and other data
become available, these estimates and judgments are reviewed and may be
revised. Significant assumptions made in estimating claim reserves
for long-term care policies include expectations about the: (i)
future duration of existing claims; (ii) cost of care and benefit utilization;
(iii) interest rate utilized to discount claim reserves; (iv) claims that have
been incurred but not yet reported; (v) claim status on the reporting date; (vi)
claims that have been closed but are expected to reopen; and (vii)
correspondence that has been received that will ultimately become claims that
have payments associated with them.
During
the second quarter of 2007, we increased claim liabilities for this long-term
care insurance block by $108 million as a result of changes in our estimates of
claim reserves incurred in prior periods. Approximately $18 million
of this increase related to claims with incurrence dates in the first quarter of
2007 and $90 million related to claims with incurrence dates prior to
2007.
The $108
million increase in estimates of claims incurred in prior periods included $100
million of adjustments related to updates to our reserve assumptions and
methodologies to reflect emerging trends in our claim experience. The
following assumption changes primarily contributed to the $100 million
adjustment:
|
·
|
We
increased our reserves by $32 million for changes to our assumptions
regarding the future duration of existing claims. We updated
these assumptions to reflect our current expectation that policyholders
will receive benefits for a longer period based on changing trends in the
duration of our claims.
|
|
·
|
We
increased our reserves by $31 million related to a block of long-term care
policies originally sold by Transport Life Insurance Company (“Transport”)
and acquired by our Predecessor. We estimate claim reserves for
this block of business using an aggregate paid loss development method,
which uses historical payment patterns to project ultimate losses for all
the claims in a given incurral period. We refined our loss
development assumptions by developing separate assumption tables for
claimants with and without lifetime benefit periods and for claimants with
and without inflationary benefits, since this block’s recent loss
experience has been extremely sensitive to the mix of its
business. This adjustment further improved the estimate that
was made during the first quarter of 2007, which is described in further
detail below. This adjustment relates to our assumption of
future duration of existing claims.
|
|
·
|
We
increased our claim reserves by $22 million to better reflect fluctuations
in claim inventories related to certain blocks of
business. This increase relates to our estimate of claim status
on the reporting date.
|
|
·
|
We
increased our claim reserves by $15 million for our estimate of incurred
but not reported claims, reflecting recent experience and the impact of
the other adjustments on waiver of premium
reserves.
|
115
During the first quarter of 2007, we
recorded a pre-tax adjustment that increased policy benefits for the Transport
block by $22 million. We found that our previous claim estimates on
this block were deficient because claims on policies with lifetime benefits and
inflation benefits had increased significantly in recent
periods. Since the policies with these benefits will have longer
average claim payout periods than similar policies without such benefits, a
shift in the mix of claimants can have a significant impact on incurred claims
that is not immediately reflected using a completion factor
methodology. We improved our methodologies to address this and other
shortcomings of the aggregate loss development methodology, which resulted in
the pre-tax adjustment.
We had
been aggressively seeking actuarially justified rate increases and pursuing
other actions on our long-term care policies. During the third
quarter of 2006, we began a new program to file requests for rate increases on
various long-term care products of Senior Health as we believed the existing
rates were too low to fund expected future benefits. These filings
were expected to be the first of three rounds of rate increase filings for many
of the same policies, and in some cases we requested three years of successive
rate increases. We chose to request a series of smaller rate
increases, rather than a single large increase, to limit the impact on a
policyholder’s premiums in any single year. The effects of the first
round of rate filings were partially realized in our premium
revenue. In the second quarter of 2007, we began filing requests for
the second round of rate increases on many of the same policies. The
full effect of all three rounds of rate increases was not expected to be fully
realized until 2011.
On April
20, 2004, the Florida Office of Insurance Regulation issued an order to Senior
Health, that affected approximately 12,600 home health care policies issued in
Florida by Senior Health and its predecessor companies. Pursuant to
the order, Senior Health offered the following three alternatives to holders of
these policies subject to rate increases as follows:
|
·
|
retention
of their current policy with a rate increase of 50 percent in the first
year and actuarially justified increases in subsequent years (which is
also the default election for policyholders who failed to make an election
by 30 days prior to the anniversary date of their policies) (“option
one”);
|
|
·
|
receipt
of a replacement policy with reduced benefits and a rate increase in the
first year of 25 percent and no more than 15 percent in subsequent years
(“option two”); or
|
|
·
|
receipt
of a paid-up policy, allowing the holder to file future claims up to 100
percent of the amount of premiums paid since the inception of the policy
(“option three”).
|
Policyholders
selecting option one or option two are entitled to receive a contingent
non-forfeiture benefit if their policy subsequently lapses. In
addition, policyholders could change their initial election any time up to 30
days prior to the anniversary date of their policies. We began to
implement premium adjustments with respect to policyholder elections in the
fourth quarter of 2005 and the implementation of these premium adjustments was
completed in 2007. We did not make any adjustments to the insurance
liabilities when these elections were made. Reserves for all three
groups of policies under the order were prospectively adjusted using the
prospective revision methodology described in the “Critical Accounting Policies
– Accounting for Long-term Care Premium Rate Increases” in “Management’s
Discussion and Analysis of Consolidated Financial Condition and Results of
Operations”.
Amortization
related to operations
includes amortization of insurance acquisition
costs. Fluctuations in amortization of insurance acquisition costs
generally correspond with changes in lapse experience.
Gain on
reinsurance recapture
resulted from the recapture of a block of
previously reinsured long-term care business in the third quarter of
2008. Such business was included in the Transfer.
Loss on Transfer
and transaction expenses
relates to the loss on the transfer of Senior
Health to an independent trust as further discussed in the note to the
consolidated financial statements entitled “Transfer of Senior Health Insurance
Company of Pennsylvania to an Independent Trust”.
Other operating
costs and expenses
were $54.0 million in 2008 and $63.7 million in
2007. Other operating costs and expenses, excluding commission
expenses, for this segment were $29.7 million in 2008 and $34.7 million in
2007.
Net realized
investment gains (losses)
fluctuated each period. During 2008,
net realized investment losses included $.4 million of net gains from the sales
of investments (primarily fixed maturities) and $380.5 million of writedowns of
investments (which were transferred to the Independent Trust) as a result of our
intent not to hold such investments for a period of time sufficient to allow for
a full recovery in value. During 2007, net realized investment gains
included $3.8
116
million
from the sales of investments (primarily fixed maturities), and $1.2 million of
writedowns of investments resulting from declines in fair values that we
concluded were other than temporary.
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.
|
Index
to Consolidated Financial Statements
|
|
|
Page
|
|
|
Report
of Independent Registered Public Accounting
Firm
|
118
|
|
Consolidated
Balance Sheet at December 31, 2009 and
2008
|
119
|
|
Consolidated
Statement of Operations for the years ended December 31, 2009, 2008 and
2007
|
121
|
|
Consolidated
Statement of Shareholders’ Equity for the years ended December 31, 2009,
2008 and 2007
|
122
|
|
Consolidated
Statement of Cash Flows for the years ended December 31, 2009, 2008 and
2007
|
124
|
|
Notes
to Consolidated Financial
Statements
|
125
|
117
Report of Independent
Registered Public Accounting Firm
To the
Shareholders and Board of Directors Conseco, Inc.:
In our
opinion, the consolidated financial statements listed in the accompanying index
present fairly, in all material respects, the financial position of Conseco Inc.
and its subsidiaries at December 31, 2009 and 2008, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2009 in conformity with accounting principles generally accepted in
the United States of America. Also in our opinion, the Company did not maintain,
in all material respects, effective internal control over financial reporting as
of December 31, 2009, based on criteria established in
Internal Control - Integrated
Framework
issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) because a material weakness in internal control over
financial reporting related to the accounting and disclosure of insurance policy
benefits and the liabilities for insurance products existed as of that date. A
material weakness is a deficiency, or a combination of deficiencies, in internal
control over financial reporting, such that there is a reasonable possibility
that a material misstatement of the annual or interim financial statements will
not be prevented or detected on a timely basis. The material weakness
referred to above is described in Management’s Report on Internal Control Over
Financial Reporting appearing under Item 9A. We considered this material
weakness in determining the nature, timing, and extent of audit tests applied in
our audit of the 2009 consolidated financial statements, and our opinion
regarding the effectiveness of the Company’s internal control over financial
reporting does not affect our opinion on those consolidated financial
statements. The Company's management is responsible for these financial
statements, for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting included in management's report referred to above. Our
responsibility is to express opinions on these financial statements and on the
Company's internal control over financial reporting based on our integrated
audits. We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audits of the financial statements included examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. Our audit of internal control over financial reporting
included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, and testing and
evaluating the design and operating effectiveness of internal control based on
the assessed risk. Our audits also included performing such other procedures as
we considered necessary in the circumstances. We believe that our audits provide
a reasonable basis for our opinions.
As
discussed in Note 4 to the consolidated financial statements, the Company
retrospectively adjusted its historical consolidated financial statements to
reflect the adoption of a new accounting standard effective January 1, 2009
regarding the accounting for convertible debt instruments that may be settled in
cash upon conversion (including partial cash settlement). Also, as
discussed in Note 4 to the consolidated financial statements, the Company
changed the manner in which it accounts for the non-credit portion of
other-than-temporary impairments of fixed maturity securities.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
/s/
PricewaterhouseCoopers LLP
Indianapolis,
Indiana
March 3,
2010
118
CONSECO,
INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEET
December
31, 2009 and 2008
(Dollars
in millions)
ASSETS
|
2009
|
2008
|
|||||||
|
Investments:
|
||||||||
|
Actively
managed fixed maturities at fair value (amortized cost:
2009
- $18,998.0; 2008 -
$18,276.3)
|
$ | 18,528.4 | $ | 15,277.0 | ||||
|
Equity
securities at fair value (cost: 2009 - $30.7; 2008 -
$31.0)
|
31.0 | 32.4 | ||||||
|
Mortgage
loans
|
1,965.5 | 2,159.4 | ||||||
|
Policy
loans
|
295.2 | 363.5 | ||||||
|
Trading
securities
|
293.3 | 326.5 | ||||||
|
Securities
lending
collateral
|
180.0 | 393.7 | ||||||
|
Other
invested
assets
|
236.8 | 95.0 | ||||||
|
Total
investments
|
21,530.2 | 18,647.5 | ||||||
|
Cash
and cash equivalents -
unrestricted
|
523.4 | 894.5 | ||||||
|
Cash
and cash equivalents -
restricted
|
3.4 | 4.8 | ||||||
|
Accrued
investment
income
|
309.0 | 298.7 | ||||||
|
Value
of policies inforce at the Effective
Date
|
1,175.9 | 1,477.8 | ||||||
|
Cost
of policies
produced
|
1,790.9 | 1,812.6 | ||||||
|
Reinsurance
receivables
|
3,559.0 | 3,284.8 | ||||||
|
Income
tax assets,
net
|
1,124.0 | 2,047.7 | ||||||
|
Assets
held in separate
accounts
|
17.3 | 18.2 | ||||||
|
Other
assets
|
310.7 | 276.7 | ||||||
|
Total
assets
|
$ | 30,343.8 | $ | 28,763.3 | ||||
(continued
on next page)
The
accompanying notes are an integral part
of the
consolidated financial statements.
119
CONSECO, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Continued)
December
31, 2009 and 2008
(Dollars
in millions)
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
2009
|
2008
|
|||||||
|
Liabilities:
|
||||||||
|
Liabilities
for insurance products:
|
||||||||
|
Interest-sensitive
products
|
$ | 13,219.2 | $ | 13,332.8 | ||||
|
Traditional
products
|
10,063.5 | 9,828.7 | ||||||
|
Claims
payable and other policyholder
funds
|
994.0 | 1,008.4 | ||||||
|
Liabilities
related to separate
accounts
|
17.3 | 18.2 | ||||||
|
Other
liabilities
|
610.4 | 457.4 | ||||||
|
Investment
borrowings
|
683.9 | 767.5 | ||||||
|
Securities
lending
payable
|
185.7 | 408.8 | ||||||
|
Notes
payable – direct corporate
obligations
|
1,037.4 | 1,311.5 | ||||||
|
Total
liabilities
|
26,811.4 | 27,133.3 | ||||||
|
Commitments
and Contingencies (Note 9)
|
||||||||
|
Shareholders'
equity:
|
||||||||
|
Common
stock ($0.01 par value, 8,000,000,000 shares authorized,
shares
issued and outstanding: 2009 – 250,786,216; 2008 –
184,753,758)
|
2.5 | 1.9 | ||||||
|
Additional
paid-in
capital
|
4,408.8 | 4,104.0 | ||||||
|
Accumulated
other comprehensive
loss
|
(264.3 | ) | (1,770.7 | ) | ||||
|
Accumulated
deficit
|
(614.6 | ) | (705.2 | ) | ||||
|
Total
shareholders'
equity
|
3,532.4 | 1,630.0 | ||||||
|
Total
liabilities and shareholders'
equity
|
$ | 30,343.8 | $ | 28,763.3 | ||||
The
accompanying notes are an integral part
of the
consolidated financial statements.
120
CONSECO,
INC. AND SUBSIDIARIES
for the
years ended December 31, 2009, 2008 and 2007
(Dollars
in millions, except per share data)
|
2009
|
2008
|
2007
|
||||||||||
|
Revenues:
|
||||||||||||
|
Insurance
policy income
|
$ | 3,093.6 | $ | 3,253.6 | $ | 2,895.7 | ||||||
|
Net
investment income (loss):
|
||||||||||||
|
General
account assets
|
1,232.3 | 1,254.5 | 1,350.5 | |||||||||
|
Policyholder
and reinsurer accounts and other special- purpose
portfolios
|
60.4 | (75.7 | ) | 19.3 | ||||||||
|
Realized
investment gains (losses):
|
||||||||||||
|
Net
realized investment gains (losses), excluding impairment
losses
|
134.9 | (100.1 | ) | (52.5 | ) | |||||||
|
Other-than-temporary
impairment losses:
|
||||||||||||
|
Total
other-than-temporary impairment losses
|
(385.0 | ) | (162.3 | ) | (105.5 | ) | ||||||
|
Other-than-temporary
impairment losses recognized
in
other comprehensive loss
|
189.6 | - | - | |||||||||
|
Net
impairment losses recognized
|
(195.4 | ) | (162.3 | ) | (105.5 | ) | ||||||
|
Total
realized gains
(losses)
|
(60.5 | ) | (262.4 | ) | (158.0 | ) | ||||||
|
Fee
revenue and other
income
|
15.6 | 19.7 | 23.8 | |||||||||
|
Total
revenues
|
4,341.4 | 4,189.7 | 4,131.3 | |||||||||
|
Benefits
and expenses:
|
||||||||||||
|
Insurance
policy benefits
|
3,066.7 | 3,212.5 | 2,915.9 | |||||||||
|
Interest
expense
|
117.9 | 106.5 | 125.3 | |||||||||
|
Amortization
|
432.7 | 367.9 | 426.8 | |||||||||
|
(Gain)
loss on extinguishment or modification of debt
|
22.2 | (21.2 | ) | - | ||||||||
|
Costs
related to a litigation settlement
|
- | - | 64.4 | |||||||||
|
Loss
related to an annuity coinsurance transaction
|
- | - | 76.5 | |||||||||
|
Other
operating costs and expenses
|
528.3 | 520.3 | 540.4 | |||||||||
|
Total
benefits and
expenses
|
4,167.8 | 4,186.0 | 4,149.3 | |||||||||
|
Income
(loss) before income taxes and discontinued operations
|
173.6 | 3.7 | (18.0 | ) | ||||||||
|
Income
tax expense (benefit):
|
||||||||||||
|
Tax
expense (benefit) on period
income
|
60.1 | 9.4 | (6.9 | ) | ||||||||
|
Valuation
allowance for deferred tax
assets
|
27.8 | 403.9 | 68.0 | |||||||||
|
Income
(loss) before discontinued operations
|
85.7 | (409.6 | ) | (79.1 | ) | |||||||
|
Discontinued
operations, net of income
taxes
|
- | (722.7 | ) | (105.9 | ) | |||||||
|
Net
income
(loss)
|
85.7 | (1,132.3 | ) | (185.0 | ) | |||||||
|
Preferred
stock
dividends
|
- | - | 14.1 | |||||||||
|
Net
income (loss) applicable to common stock
|
$ | 85.7 | $ | (1,132.3 | ) | $ | (199.1 | ) | ||||
|
Earnings
(loss) per common share:
|
||||||||||||
|
Basic:
|
||||||||||||
|
Weighted
average shares
outstanding
|
188,365,000 | 184,704,000 | 173,374,000 | |||||||||
|
Income
(loss) before discontinued operations
|
$ | .45 | $ | (2.22 | ) | $ | (.54 | ) | ||||
|
Discontinued
operations
|
- | (3.91 | ) | (.61 | ) | |||||||
|
Net
income
(loss)
|
$ | .45 | $ | (6.13 | ) | $ | (1.15 | ) | ||||
|
Diluted:
|
||||||||||||
|
Weighted
average shares
outstanding
|
193,340,000 | 184,704,000 | 173,374,000 | |||||||||
|
Income
(loss) before discontinued operations
|
$ | .45 | $ | (2.22 | ) | $ | (.54 | ) | ||||
|
Discontinued
operations
|
- | (3.91 | ) | (.61 | ) | |||||||
|
Net
income
(loss)
|
$ | .45 | $ | (6.13 | ) | $ | (1.15 | ) | ||||
The
accompanying notes are an integral part
of the
consolidated financial statements.
121
CONSECO,
INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENT OF SHAREHOLDERS' EQUITY
(Dollars
in millions)
|
Accumulated
|
Retained
|
|||||||||||||||||||
|
Common
stock
|
other
|
earnings
|
||||||||||||||||||
|
Preferred
|
and
additional
|
comprehensive
|
(accumulated
|
|||||||||||||||||
|
stock
|
paid-in capital
|
loss
|
deficit)
|
Total
|
||||||||||||||||
|
Balance,
December 31, 2006
|
$ | 667.8 | $ | 3,497.5 | $ | (72.6 | ) | $ | 628.9 | $ | 4,721.6 | |||||||||
|
Comprehensive
loss, net of tax:
|
||||||||||||||||||||
|
Net
loss
|
- | - | - | (185.0 | ) | (185.0 | ) | |||||||||||||
|
Change
in unrealized appreciation (depreciation) of investments (net of
applicable income tax benefit of $113.0)
|
- | - | (202.4 | ) | - | (202.4 | ) | |||||||||||||
|
Total
comprehensive loss
|
(387.4 | ) | ||||||||||||||||||
|
Cost
of shares acquired
|
- | (87.2 | ) | - | - | (87.2 | ) | |||||||||||||
|
Stock
option and restricted stock plans
|
- | 14.4 | - | - | 14.4 | |||||||||||||||
|
Change
in unrecognized net loss related to deferred compensation plan (net of
applicable income tax expense of $.9 million)
|
- | - | 1.7 | - | 1.7 | |||||||||||||||
|
Reduction
of tax liabilities related to various contingencies recognized at the
fresh-start date in conjunction with adoption of authoritative
guidance
|
- | 6.0 | - | - | 6.0 | |||||||||||||||
|
Cumulative
effect of accounting change pursuant to authoritative
guidance
|
- | - | - | (2.7 | ) | (2.7 | ) | |||||||||||||
|
Conversion
of preferred stock into common shares
|
(667.8 | ) | 667.8 | - | - | - | ||||||||||||||
|
Dividends
on preferred stock
|
- | - | - | (14.1 | ) | (14.1 | ) | |||||||||||||
|
Balance,
December 31, 2007
|
- | 4,098.5 | (273.3 | ) | 427.1 | 4,252.3 | ||||||||||||||
(continued
on following page)
The
accompanying notes are an integral part
of the
consolidated financial statements.
122
CONSECO,
INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF
SHAREHOLDERS' EQUITY
(Continued)
(Dollars
in millions)
|
Accumulated
|
Retained
|
|||||||||||||||||||
|
Common
stock
|
other
|
earnings
|
||||||||||||||||||
|
Preferred
|
and
additional
|
comprehensive
|
(accumulated
|
|||||||||||||||||
|
stock
|
paid-in capita
l
|
loss
|
deficit)
|
Total
|
||||||||||||||||
|
Balance,
December 31, 2007 (carried forward from prior page)
|
$ | - | $ | 4,098.5 | $ | (273.3 | ) | $ | 427.1 | $ | 4,252.3 | |||||||||
|
Comprehensive
loss, net of tax:
|
||||||||||||||||||||
|
Net
loss
|
- | - | - | (1,132.3 | ) | (1,132.3 | ) | |||||||||||||
|
Change
in unrealized appreciation (depreciation) of investments (net of
applicable income tax benefit of $833.9)
|
- | - | (1,496.9 | ) | - | (1,496.9 | ) | |||||||||||||
|
Change
in unrecognized net loss related to deferred compensation plan (net of
applicable income tax benefit of $.2 million)
|
- | - | (.5 | ) | - | (.5 | ) | |||||||||||||
|
Total
comprehensive loss
|
- | (2,629.7 | ) | |||||||||||||||||
|
Stock
option and restricted stock plans
|
- | 7.4 | - | - | 7.4 | |||||||||||||||
|
Balance,
December 31,
2008
|
- | 4,105.9 | (1,770.7 | ) | (705.2 | ) | 1,630.0 | |||||||||||||
|
Comprehensive
loss, net of tax:
|
||||||||||||||||||||
|
Net
income
|
- | - | - | 85.7 | 85.7 | |||||||||||||||
|
Change
in unrealized appreciation (depreciation) of investments (net of
applicable income tax expense of $879.6)
|
- | - | 1,576.5 | - | 1,576.5 | |||||||||||||||
|
Noncredit
component of impairment losses on actively managed fixed maturities (net
of applicable income tax benefit of $36.4)
|
- | - | (65.2 | ) | - | (65.2 | ) | |||||||||||||
|
Total
comprehensive loss
|
- | 1,597.0 | ||||||||||||||||||
|
Issuance
of common stock, net
|
- | 296.3 | - | - | 296.3 | |||||||||||||||
|
Stock
option and restricted stock plans
|
- | 9.1 | - | - | 9.1 | |||||||||||||||
|
Effect
of reclassifying noncredit component of previously recognized impairment
losses on actively managed fixed maturities (net of applicable income tax
benefit of $2.6)
|
- | - | (4.9 | ) | 4.9 | - | ||||||||||||||
|
Balance,
December 31,
2009
|
$ | - | $ | 4,411.3 | $ | (264.3 | ) | $ | (614.6 | ) | $ | 3,532.4 | ||||||||
The
accompanying notes are an integral part
of the
consolidated financial statements.
123
CONSECO,
INC. AND SUBSIDIARIES
for the
years ended December 31, 2009, 2008 and 2007
(Dollars
in millions)
|
2009
|
2008
|
2007
|
||||||||||
|
Cash
flows from operating activities:
|
||||||||||||
|
Insurance
policy income
|
$ | 2,747.1 | $ | 3,140.7 | $ | 2,818.0 | ||||||
|
Net
investment income
|
1,167.3 | 1,339.6 | 1,610.0 | |||||||||
|
Fee
revenue and other income
|
15.6 | 19.7 | 23.8 | |||||||||
|
Net
sales (purchases) of trading securities
|
32.3 | 346.5 | (114.3 | ) | ||||||||
|
Insurance
policy benefits
|
(2,298.8 | ) | (2,722.3 | ) | (2,339.6 | ) | ||||||
|
Interest
expense
|
(109.0 | ) | (95.4 | ) | (114.7 | ) | ||||||
|
Policy
acquisition costs
|
(407.5 | ) | (459.1 | ) | (545.9 | ) | ||||||
|
Other
operating costs
|
(495.8 | ) | (587.0 | ) | (631.3 | ) | ||||||
|
Taxes
|
(7.2 | ) | 4.1 | (2.7 | ) | |||||||
|
Net
cash provided by operating activities
|
644.0 | 986.8 | 703.3 | |||||||||
|
Cash
flows from investing activities:
|
||||||||||||
|
Sales
of investments
|
10,709.6 | 6,832.7 | 7,192.9 | |||||||||
|
Maturities
and redemptions of investments
|
917.3 | 695.1 | 948.4 | |||||||||
|
Purchases
of investments
|
(12,540.4 | ) | (8,193.7 | ) | (9,248.7 | ) | ||||||
|
Change
in restricted cash
|
1.4 | 16.3 | 2.9 | |||||||||
|
Change
in cash held by discontinued operations
|
- | 45.6 | (30.9 | ) | ||||||||
|
Other
|
(10.6 | ) | (25.8 | ) | (24.2 | ) | ||||||
|
Net
cash used by investing
activities
|
(922.7 | ) | (629.8 | ) | (1,159.6 | ) | ||||||
|
Cash
flows from financing activities:
|
||||||||||||
|
Issuance
of notes payable, net
|
172.0 | 75.0 | 200.0 | |||||||||
|
Issuance
of common stock
|
296.3 | - | 3.4 | |||||||||
|
Payments
to repurchase common stock
|
- | - | (87.2 | ) | ||||||||
|
Payments
on notes payable
|
(461.2 | ) | (44.0 | ) | (7.8 | ) | ||||||
|
Expenses
related to debt modification and extinguishment of debt
|
(14.7 | ) | - | - | ||||||||
|
Amounts
received for deposit products
|
1,668.9 | 1,863.4 | 1,852.2 | |||||||||
|
Withdrawals
from deposit products
|
(1,670.1 | ) | (1,573.3 | ) | (1,989.3 | ) | ||||||
|
Investment
borrowings
|
(83.6 | ) | (145.5 | ) | 494.7 | |||||||
|
Dividends
paid on preferred stock
|
- | - | (19.0 | ) | ||||||||
|
Net
cash provided (used) by financing activities
|
(92.4 | ) | 175.6 | 447.0 | ||||||||
|
Net
increase (decrease) in cash and cash equivalents
|
(371.1 | ) | 532.6 | (9.3 | ) | |||||||
|
Cash
and cash equivalents, beginning of
year
|
894.5 | 361.9 | 371.2 | |||||||||
|
Cash
and cash equivalents, end of
year
|
$ | 523.4 | $ | 894.5 | $ | 361.9 | ||||||
The
accompanying notes are an integral part
of the
consolidated financial statements.
124
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
1. DESCRIPTION
OF BUSINESS
Conseco,
Inc., a Delaware corporation (“CNO”), is a holding company for a group of
insurance companies operating throughout the United States that develop, market
and administer supplemental health insurance, annuity, individual life insurance
and other insurance products. CNO became the successor to Conseco,
Inc., an Indiana corporation (our “Predecessor”), in connection with our
bankruptcy reorganization which became effective on September 10, 2003 (the
“Effective Date”). The terms “Conseco”, the “Company”, “we”, “us”,
and “our” as used in this report refer to CNO and its subsidiaries or, when the
context requires otherwise, our Predecessor and its subsidiaries. We
focus on serving the senior and middle-income markets, which we believe are
attractive, underserved, high growth markets. We sell our products
through three distribution channels: career agents, professional independent
producers (some of whom sell one or more of our product lines exclusively) and
direct marketing.
We manage
our business through the following three primary operating
segments: Bankers Life, Colonial Penn and Conseco Insurance Group,
which are defined on the basis of product distribution; and corporate
operations, which consists of holding company activities and certain
noninsurance company businesses that are not part of our other
segments. Our segments are described below:
|
·
|
Bankers
Life,
which consists of
the business of Bankers Life and Casualty Company (“Bankers Life”),
markets and distributes health and life insurance products and annuities
to the middle-income senior market through a dedicated field force of over
5,600 career agents and sales managers supported by a network of over 150
community-based branch offices. Products include Medicare
supplement insurance, life insurance, fixed annuities and long-term care
insurance. Bankers Life also markets and distributes Medicare
Part D prescription drug plans through a distribution and reinsurance
arrangement with Coventry Health Care (“Coventry”) and Medicare Advantage
plans primarily through a distribution arrangement with Humana Inc
(“Humana”).
|
|
·
|
Colonial
Penn
, which consists of the business of Colonial Penn Life
Insurance Company (“Colonial Penn”), markets primarily graded benefit and
simplified issue life insurance directly to customers through television
advertising, direct mail, the internet and
telemarketing. Colonial Penn markets its products under its own
brand name.
|
|
·
|
Conseco
Insurance Group,
which markets and distributes specified disease
insurance, accident, disability, life insurance and annuities to
middle-income consumers at home and at the worksite. These
products are marketed through Performance Matters Associates, Inc., a
wholly owned subsidiary, and through independent marketing organizations
and insurance agencies. Products being marketed by Conseco
Insurance Group are underwritten by Conseco Insurance Company, Conseco
Health Insurance Company (“Conseco Health”) and Washington National
Insurance Company (“Washington National”). This segment also
includes blocks of long-term care and other insurance business, in these
companies and in Conseco Life Insurance Company (“Conseco Life”), which we
no longer market.
|
125
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
|
|
2.
|
TRANSFER
OF SENIOR HEALTH INSURANCE COMPANY OF PENNSYLVANIA TO AN INDEPENDENT
TRUST
|
On
November 12, 2008, Conseco and CDOC, Inc. (“CDOC”), a wholly owned subsidiary of
Conseco (and together with Conseco, the “Conseco Parties”), completed the
transfer (the “Transfer”) of the stock of Senior Health Insurance Company of
Pennsylvania (“Senior Health”) to Senior Health Care Oversight Trust, an
independent trust (the “Independent Trust”) for the exclusive benefit of Senior
Health’s long-term care policyholders. Consummation of the
transaction was subject to the approval of the Pennsylvania Insurance
Department.
In
connection with the Transfer, the Company entered into a $125.0 million Senior
Note due November 12, 2013 (the “Senior Note”), payable to Senior
Health. The note has a five-year maturity date; a 6 percent interest
rate; and requires annual principal payments of $25.0 million. As a
condition of the order from the Pennsylvania Insurance Department approving the
Transfer, Conseco agreed that it would not pay cash dividends on its common
stock while any portion of the $125.0 million note remained
outstanding.
Conseco
recorded accounting charges totaling $1.0 billion related to the transaction,
comprised of Senior Health’s equity (as calculated in accordance with generally
accepted accounting principles), an additional valuation allowance for deferred
tax assets, the capital contribution to Senior Health and the Independent Trust
and transaction expenses. The accounting charges are summarized as
follows (dollars in millions):
|
Recognition
of unrealized losses on investments transferred to the Independent
Trust
|
$ | 380.5 |
(a)
|
||
|
Gain
on reinsurance recapture, net of
tax
|
(19.3 | ) | |||
|
Increase
to deferred tax valuation allowance based on recent results which have had
a significant impact on taxable income and the effects of the
transaction
|
298.0 | ||||
|
Write-off
of remaining shareholder’s equity of Senior
Health
|
159.2 |
(a)
|
|||
|
Additional
capital contribution and transaction
expenses
|
204.4 |
(a)
|
|||
|
Total
charges
|
$ | 1,022.8 | |||
_________________
|
|
(a)
|
Amount
is before the potential tax benefit. A deferred tax valuation
allowance was established for all future potential tax benefits generated
by these charges since management had concluded that it is more likely
than not that such tax benefits would not be utilized to offset future
taxable income.
|
126
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
As a
result of the Transfer, Senior Health’s long-term care business is presented as
a discontinued operation for all periods presented. The operating
results from the discontinued operations are as follows (dollars in
millions):
|
2008
|
2007
|
|||||||
|
Revenues:
|
||||||||
|
Insurance
policy
income
|
$ | 227.9 | $ | 271.6 | ||||
|
Net
investment
income
|
156.9 | 166.8 | ||||||
|
Net
realized investment gains
(losses)
|
(380.1 | ) | 2.6 | |||||
|
Total
revenues
|
4.7 | 441.0 | ||||||
|
Benefits
and expenses:
|
||||||||
|
Insurance
policy
benefits
|
311.2 | 517.8 | ||||||
|
Amortization
|
16.7 | 22.5 | ||||||
|
Gain
on reinsurance recapture
(a)
|
(29.7 | ) | - | |||||
|
Loss
on Transfer and transaction
expenses
|
363.6 | - | ||||||
|
Other
operating costs and
expenses
|
54.0 | 63.7 | ||||||
|
Total
benefits and
expenses
|
715.8 | 604.0 | ||||||
|
Income
(loss) before income
taxes
|
(711.1 | ) | (163.0 | ) | ||||
|
Income
tax expense (benefit):
|
||||||||
|
Tax
expense (benefit) on period
income
|
(440.7 | ) | (57.1 | ) | ||||
|
Valuation
allowance for deferred tax
assets
|
452.3 | - | ||||||
|
Net
income (loss) from discontinued
operations
|
$ | (722.7 | ) | $ | (105.9 | ) | ||
_______________
|
(a)
|
In
the third quarter of 2008, Senior Health recaptured a block of previously
reinsured long-term care business which was included in the business
transferred to the Independent
Trust.
|
127
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
|
|
3.
|
BASIS
OF PRESENTATION
|
We
prepare our financial statements in accordance with accounting principles
generally accepted in the United States of America (“GAAP”). We
follow the accounting standards established by the Financial Accounting
Standards Board (“FASB”) and the Securities and Exchange Commission (the
“SEC”).
The
accompanying financial statements include the accounts of the Company and its
subsidiaries. Our consolidated financial statements exclude the
results of material transactions between us and our consolidated affiliates, or
among our consolidated affiliates.
When we
prepare financial statements in conformity with GAAP, we are required to make
estimates and assumptions that significantly affect reported amounts of various
assets and liabilities and the disclosure of contingent assets and liabilities
at the date of the financial statements and revenues and expenses during the
reporting periods. For example, we use significant estimates and
assumptions to calculate values for the cost of policies produced, the value of
policies inforce at the Effective Date, certain investments (including
derivatives), assets and liabilities related to income taxes, liabilities for
insurance products, liabilities related to litigation, guaranty fund assessment
accruals and amounts recoverable from loans to certain former directors and
former employees. If our future experience differs from these
estimates and assumptions, our financial statements would be materially
affected.
4. SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
The
following summary explains the significant accounting policies we use to prepare
our financial statements.
Investments
We
classify our
fixed maturity
securities
into one of three categories: (i) “actively managed” (which we
carry at estimated fair value with any unrealized gain or loss, net of tax and
related adjustments, recorded as a component of shareholders’ equity); (ii)
“trading” (which we carry at estimated fair value with changes in such value
recognized as trading income); or (iii) “held to maturity” (which we carry at
amortized cost). We had no fixed maturity securities classified as
held to maturity during the periods presented in these financial
statements.
Equity securities
include
investments in common stock and non-redeemable preferred stock. We
carry these investments at estimated fair value. We record any
unrealized gain or loss, net of tax and related adjustments, as a component of
shareholders’ equity. When declines in value considered to be other
than temporary occur, we reduce the amortized cost to estimated fair value and
recognize a loss in the statement of operations.
Mortgage loans
held in our
investment portfolio are carried at amortized unpaid balances, net of provisions
for estimated losses. Interest income is accrued on the principal
amount of the loan based on the loan’s contractual interest
rate. Payment terms specified for mortgage loans may include a
prepayment penalty for unscheduled payoff of the
investment. Prepayment penalties are recognized as investment income
when received.
Policy loans
are stated at
current unpaid principal balances.
Certain
of our
trading
securities
are held in an effort to offset the portion of the income
statement volatility caused by the effect of interest rate fluctuations on the
value of certain embedded derivatives related to our equity-indexed annuity
products and certain modified coinsurance agreements. See the
sections of this note entitled “Accounting for Derivatives” and “Investment
Borrowings” for further discussion regarding embedded derivatives and the
trading accounts. In addition, the trading account includes
investments backing the market strategies of our multibucket annuity
products. The change in fair value of these securities, which is
recognized currently in income from policyholder and reinsurer accounts and
other special-purpose portfolios (a component of investment income), is
substantially offset by the change in insurance policy benefits for these
products. Our trading securities totaled $293.3 million and $326.5
million at December 31, 2009 and 2008, respectively.
Securities lending collateral
primarily consists of fixed maturities, equity securities and cash and cash
equivalents. We carry these investments at estimated fair
value. We record any unrealized gain or loss, net of tax, as a
component of shareholders’ equity.
128
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
Other invested assets
include: (i) certain call options purchased in an effort to hedge the
effects of certain policyholder benefits related to our equity-indexed annuity
and life insurance products; and (ii) certain non-traditional
investments. We carry the call options at estimated fair value as
further described in the section of this note entitled “Accounting for
Derivatives”. Non-traditional investments include investments in
certain limited partnerships, which are accounted for using the equity method,
and promissory notes, which are accounted for using the cost
method.
We defer
any fees received or costs incurred when we originate investments. We
amortize fees, costs, discounts and premiums as yield adjustments over the
contractual lives of the investments without anticipation of
prepayments. We consider anticipated prepayments on mortgage-backed
securities in determining estimated future yields on such
securities.
When we
sell a security (other than trading securities), we report the difference
between the sale proceeds and amortized cost (determined based on specific
identification) as a realized investment gain or loss.
We
regularly evaluate our investments for possible impairment. When we
conclude that a decline in a security's net realizable value is other than
temporary, the decline is recognized as a realized loss and the cost basis of
the security is reduced to its estimated fair value.
Cash
and Cash Equivalents
Cash and
cash equivalents include commercial paper, invested cash and other investments
purchased with original maturities of less than three months. We
carry them at amortized cost, which approximates estimated fair
value.
Cost
of Policies Produced
The costs
that vary with, and are primarily related to, producing new insurance business
subsequent to September 10, 2003 are referred to as cost of policies
produced. For universal life or investment products, we amortize
these costs in relation to the estimated gross profits using the interest rate
credited to the underlying policies. For other products, we amortize
these costs in relation to future anticipated premium revenue using the
projected investment earnings rate.
When we
realize a gain or loss on investments backing our universal life or
investment-type products, we adjust the amortization to reflect the change in
estimated gross profits from the products due to the gain or loss realized and
the effect on future investment yields. We also adjust the cost of
policies produced for the change in amortization that would have been recorded
if actively managed fixed maturity securities had been sold at their stated
aggregate fair value and the proceeds reinvested at current
yields. We limit the total adjustment related to the impact of
unrealized losses to the total of costs capitalized plus interest related to
insurance policies issued in a particular year. We include the impact
of this adjustment in accumulated other comprehensive income within
shareholders’ equity.
The
investment environment during the fourth quarter of 2008 resulted in significant
net unrealized losses in our actively managed fixed maturity investment
portfolio. The total adjustment to accumulated other comprehensive
income related to the change in the cost of policies produced for the negative
amortization that would have been recorded if actively managed fixed maturity
securities had been sold at their stated aggregate fair value would have
resulted in the balance of the cost of policies produced exceeding the total of
costs capitalized plus interest for annuity blocks of business issued in certain
years. Accordingly, the adjustment made to the cost of policies
produced and accumulated other comprehensive income was reduced by $206
million.
As of
January 1, 2007, we adopted authoritative guidance on accounting by insurance
enterprises for the cost of policies produced on internal replacements of
insurance and investment contracts. As a result of the authoritative
guidance, if an internal replacement modification substantially changes a
contract, then the cost of policies produced is written off immediately through
the consolidated statement of operations and any new definable cost associated
with the new replacement are deferred as the cost of policies
produced. If a contract modification does not substantially change
the contract, the amortization of the cost of policies produced on the original
contract will continue and any acquisition costs associated with the related
modification are immediately expensed.
We
regularly evaluate the recoverability of the unamortized balance of the cost of
policies produced. We consider estimated future gross profits or
future premiums, expected mortality or morbidity, interest earned and credited
rates, persistency and expenses in determining whether the balance is
recoverable. If we determine a portion of the
unamortized
129
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
balance
is not recoverable, it is charged to amortization expense. In certain
cases, the unamortized balance of the cost of policies produced may not be
deficient in the aggregate, but our estimates of future earnings indicate that
profits would be recognized in early periods and losses in later
periods. In this case, we increase the amortization of the cost of
policies produced over the period of profits, by an amount necessary to offset
losses that are expected to be recognized in the later years.
Value
of Policies Inforce at the Effective Date
The value
assigned to the right to receive future cash flows from contracts existing at
September 10, 2003 is referred to as the value of policies inforce at the
Effective Date. We also defer renewal commissions paid in excess of
ultimate commission levels related to the existing policies in this
account. The balance of this account is amortized and evaluated for
recovery in the same manner as described above for the cost of policies
produced. We also adjust the value of policies inforce at the
Effective Date for the change in amortization that would have been recorded if
actively managed fixed maturity securities had been sold at their stated
aggregate fair value and the proceeds reinvested at current yields, similar to
the manner described above for the cost of policies produced. We
limit the total adjustment related to the impact of unrealized losses to the
total value of policies inforce recognized at the Effective Date plus
interest.
The
discount rate we used to determine the value of the value of policies inforce at
the Effective Date was 12 percent.
The
Company expects to amortize the balance of the value of policies inforce at the
Effective Date as of December 31, 2009 as follows: 13 percent in
2010, 11 percent in 2011, 10 percent in 2012, 9 percent in 2013 and 7 percent in
2014.
Assets Held in 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 fair value; the underlying investment risks are assumed by the
contractholders. We record the related liabilities at amounts equal
to the separate account assets. We record the fees earned for
administrative and contractholder services performed for the separate accounts
in insurance policy income.
Recognition
of Insurance Policy Income and Related Benefits and Expenses on Insurance
Contracts
For
universal life and investment contracts that do not involve significant
mortality or morbidity risk, the amounts collected from policyholders are
considered deposits and are not included in revenue. Revenues for
these contracts consist of charges for policy administration, cost of insurance
charges and surrender charges assessed against policyholders’ account
balances. Such revenues are recognized when the service or coverage
is provided, or when the policy is surrendered.
We
establish liabilities for investment and universal life products equal to the
accumulated policy account values, which include an accumulation of deposit
payments plus credited interest, less withdrawals and the amounts assessed
against the policyholder through the end of the period. Sales
inducements provided to the policyholders of these products are recognized as
liabilities over the period that the contract must remain in force to qualify
for the inducement. The options attributed to the policyholder
related to our equity-indexed annuity products are accounted for as embedded
derivatives as described in the section of this note entitled “Accounting for
Derivatives”.
Traditional
life and the majority of our accident and health products (including long-term
care, Medicare supplement and specified disease products) are long duration
insurance contracts. Premiums on these products are recognized as
revenues when due from the policyholders.
We also
have a small block of short duration accident and health
products. Premiums on these products are recognized as revenue over
the premium coverage period.
130
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
We
establish liabilities for traditional life, accident and health insurance, and
life contingent payment annuity products using mortality tables in general use
in the United States, which are modified to reflect the Company’s actual
experience when appropriate. We establish liabilities for accident
and health insurance products using morbidity tables based on the Company’s
actual or expected experience. These reserves are computed at amounts
that, with additions from estimated future premiums received and with interest
on such reserves at estimated future rates, are expected to be sufficient to
meet our obligations under the terms of the policy. Liabilities for
future policy benefits are computed on a net-level premium method based upon
assumptions as to future claim costs, investment yields, mortality, morbidity,
withdrawals, policy dividends and maintenance expenses determined when the
policies were issued (or with respect to policies inforce at August 31, 2003,
the Company’s best estimate of such assumptions on the Effective
Date). We make an additional provision to allow for potential adverse
deviation for some of our assumptions. Once established, assumptions
on these products are generally not changed unless a premium deficiency
exists. In that case, a premium deficiency reserve is recognized and
the future pattern of reserve changes are modified to reflect the relationship
of premiums to benefits based on the current best estimate of future claim
costs, investment yields, mortality, morbidity, withdrawals, policy dividends
and maintenance expenses, determined without an additional provision for
potential adverse deviation.
We
establish claim reserves based on our estimate of the loss to be incurred on
reported claims plus estimates of incurred but unreported claims based on our
past experience.
Accounting
for Long-term Care Premium Rate Increases
Many of
our long-term care policies were subject to premium rate increases in the three
years ending December 31, 2009. In some cases, these premium rate
increases were materially consistent with the assumptions we used to value the
particular block of business at the fresh-start date. With respect to
the 2006 premium rate increases, some of our policyholders were provided an
option to cease paying their premiums and receive a non-forfeiture option in the
form of a paid-up policy with limited benefits. In addition, our
policyholders could choose to reduce their coverage amounts and premiums in the
same proportion, when permitted by our contracts or as required by
regulators. The following describes how we account for these
policyholder options:
|
·
|
Premium
rate increases – If premium rate increases reflect a change in our
previous rate increase assumptions, the new assumptions are not reflected
prospectively in our reserves. Instead, the additional premium
revenue resulting from the rate increase is recognized as earned and
original assumptions continue to be used to determine changes to
liabilities for insurance products unless a premium deficiency
exists.
|
|
·
|
Benefit
reductions – A policyholder may choose reduced coverage with a
proportionate reduction in premium, when permitted by our
contracts. This option does not require additional
underwriting. Benefit reductions are treated as a partial lapse
of coverage, and the balance of our reserves and deferred insurance
acquisition costs is reduced in proportion to the reduced
coverage.
|
|
·
|
Non-forfeiture
benefits offered in conjunction with a rate increase – In some cases,
non-forfeiture benefits are offered to policyholders who wish to lapse
their policies at the time of a significant rate increase. In
these cases, exercise of this option is treated as an extinguishment of
the original contract and issuance of a new contract. The
balance of our reserves and deferred insurance acquisition costs are
released, and a reserve for the new contract is
established.
|
|
·
|
Florida
Order – In 2004, the Florida Office of Insurance Regulation issued an
order to Washington National, regarding home health care business in
Florida. The order required Washington National to offer a
choice of three alternatives to holders of home health care policies in
Florida subject to premium rate increases as
follows:
|
|
·
|
retention
of their current policy with a rate increase of 50 percent in the first
year and actuarially justified increases in subsequent
years;
|
|
·
|
receipt
of a replacement policy with reduced benefits and a rate increase in the
first year of 25 percent and no more than 15 percent in subsequent years;
or
|
|
·
|
receipt
of a paid-up policy, allowing the holder to file future claims up to 100
percent of the amount of premiums paid since the inception of the
policy.
|
131
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
Reserves
for all three groups of policies under the order were prospectively adjusted
using a prospective revision methodology, as these alternatives were required by
the Florida Office of Insurance Regulation. These policies had no
insurance acquisition costs established at the Effective Date.
Some of
our policyholders may receive a non-forfeiture benefit if they cease paying
their premiums pursuant to their original contract (or pursuant to changes made
to their original contract as a result of a litigation settlement made prior to
the Effective Date or an order issued by the Florida Office of Insurance
Regulation). In these cases, exercise of this option is treated as
the exercise of a policy benefit, and the reserve for premium paying benefits is
reduced, and the reserve for the non-forfeiture benefit is adjusted to reflect
the election of this benefit.
Accounting
for marketing and reinsurance agreements with Coventry
Prescription
Drug Benefit
The
Medicare Prescription Drug, Improvement and Modernization Act of 2003 provided
for the introduction of a prescription drug benefit (“PDP”). In order
to offer this product to our current and potential future policyholders without
investing in management and infrastructure, we entered into a national
distribution agreement with Coventry to use our career and independent agents to
distribute Coventry’s prescription drug plan, Advantra Rx. We receive
a fee based on the premiums collected on plans sold through our distribution
channels. In addition, Conseco has a quota-share reinsurance
agreement with Coventry for Conseco enrollees that provides Conseco with 50
percent of net premiums and related policy benefits subject to a risk
corridor. The Part D program was effective January 1,
2006.
The
following describes how we account for and report our PDP business:
Our
accounting for the national distribution agreement
|
·
|
For
contracts sold prior to 2009, we recognize distribution and licensing fee
income from Coventry based upon negotiated percentages of collected
premiums on the underlying Medicare Part D contracts. For
contracts sold in 2009 and thereafter, we recognize distribution income
based on a fixed fee per PDP contract. This fee income is
recognized over the calendar year term as premiums are
collected.
|
|
·
|
We
also pay commissions to our agents who sell the plans on behalf of
Coventry. These payments are deferred and amortized over the
remaining term of the initial enrollment period (the one-year life of the
initial policy).
|
Our
accounting for the quota-share agreement
|
·
|
We
recognize premium revenue evenly over the period of the underlying
Medicare Part D contracts.
|
|
·
|
We
recognize policyholder benefits and ceding commission expense as
incurred.
|
|
·
|
We
recognize risk-share premium adjustments consistent with Coventry’s
risk-share agreement with the Centers for Medicare and Medicaid
Services.
|
Private-Fee-For-Service
Conseco
expanded its strategic alliance with Coventry by entering into a national
distribution agreement under which our career agents began distributing
Coventry’s Private-Fee-For-Service (“PFFS”) plan, beginning January 1,
2007. The Advantra Freedom product is a Medicare Advantage plan
designed to provide seniors with more choices and better coverage at lower cost
than original Medicare and Medicare Advantage plans offered through
HMOs. Under the agreement, we received a fee based on the number of
PFFS plans sold through our distribution channels. In addition,
Conseco had a quota-share reinsurance agreement with Coventry for Conseco
enrollees that provided Conseco with a specified percentage of the net premiums
and related profits. Coventry decided to cease selling PFFS plans
effective January 1, 2010. In July 2009, we announced a strategic
alliance under which we would offer Humana’s Medicare Advantage plans to our
policyholders and consumers through our career agency force and will receive
marketing fees based on sales. Effective January 1, 2010, we will no
longer be assuming the underwriting risk related to PFFS
business.
132
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
We
received distribution fees from Coventry and we paid sales commissions to our
agents for these enrollments. In addition, we received a specified
percentage of the income (loss) related to this business pursuant to a
quota-share agreement with Coventry.
The
following summarizes our accounting and reporting practices for the PFFS
business.
Our
accounting for the distribution agreement
|
·
|
We
received distribution income from Coventry and other parties based on a
fixed fee per PFFS contract. This income was deferred and
recognized over the remaining calendar year term of the initial enrollment
period.
|
|
·
|
We
also paid commissions to our agents who sell the plans on behalf of
Coventry and other parties. These payments were deferred and
amortized over the remaining term of the initial enrollment period (the
one-year life of the initial
policy).
|
Our
accounting for the quota-share agreement
|
·
|
We
recognized revenue evenly over the period of the underlying PFFS
contracts.
|
|
·
|
We
recognized policyholder benefits and ceding commission expense as
incurred.
|
Large
Group Private-Fee-For-Service Blocks
During
2007 and 2008, Conseco entered into three quota-share reinsurance agreements
with Coventry related to the PFFS business written by Coventry under two large
group policies. Conseco received a specified percentage of the net
premiums and related profits associated with this business as long as the ceded
revenue margin (as defined in the quota-share reinsurance agreements) was less
than or equal to five percent. Conseco also received a specified
percentage of the net premiums and related profits on the ceded margin in excess
of five percent. In order to reduce the required statutory capital
associated with the assumption of this business, Conseco terminated two group
policy quota-share agreements as of December 31, 2008 and terminated the last
agreement on June 30, 2009. Premiums assumed through these
reinsurance agreements totaled $47.5 million in 2009. The income
before income taxes related to the assumed business was $14.0 million during the
year ended December 31, 2009.
Reinsurance
In the
normal course of business, we seek to limit our loss exposure on any single
insured or to certain groups of policies by ceding reinsurance to other
insurance enterprises. We currently retain no more than $.8 million
of mortality risk on any one policy. We diversify the risk of
reinsurance loss by using a number of reinsurers that have strong claims-paying
ratings. In each case, the ceding Conseco subsidiary is directly
liable for claims reinsured in the event the assuming company is unable to
pay.
The cost
of reinsurance on life and health coverages is recognized over the life of the
reinsured policies using assumptions consistent with those used to account for
the underlying policy. The cost of reinsurance ceded totaled $179.4
million, $164.0 million and $202.4 million in 2009, 2008 and 2007,
respectively. We deduct this cost from insurance policy
income. Reinsurance recoveries netted against insurance policy
benefits totaled $477.2 million, $536.3 million and $354.0 million in 2009, 2008
and 2007, respectively.
From
time-to-time, we assume insurance from other companies. Any costs
associated with the assumption of insurance are amortized consistent with the
method used to amortize the cost of policies produced described
above. Reinsurance premiums assumed totaled $475.5 million, $641.0
million and $307.8 million in 2009, 2008 and 2007, respectively. Reinsurance
premiums included amounts assumed pursuant to marketing and quota-share
agreements with Coventry of $444.3 million, $609.5 million and $271.4 million in
2009, 2008 and 2007, respectively. Such premiums assumed included
group policy quota-share agreements whereby we assumed: (i) a
specified percentage of the PFFS business written by Coventry under a large
group policy effective July 1, 2007 (which was terminated on June 30, 2009); and
(ii) a specified percentage of the PFFS business written by Coventry under
another large group policy effective May 1, 2008 (which was terminated on
December 31, 2008).
133
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
See the
section of this note entitled “Accounting for Derivatives” for a discussion of
the derivative embedded in the payable related to certain modified coinsurance
agreements.
On
October 12, 2007, we completed a transaction to coinsure 100 percent of most of
the older inforce equity-indexed annuity and fixed annuity business of three of
our insurance subsidiaries with Reassure America Life Insurance Company
(“REALIC”), a subsidiary of Swiss Re Life & Health America
Inc. The transaction was recorded in our financial statements on
September 28, 2007, the date the parties were bound by the coinsurance agreement
and all regulatory approvals had been obtained. In the transaction,
REALIC: (i) paid a ceding commission of $76.5 million; and (ii)
assumed the investment and persistency risk of these policies. Our
insurance subsidiaries ceded approximately $2.8 billion of policy and other
reserves to REALIC, as well as transferred the invested assets backing these
policies on October 12, 2007. Our insurance subsidiaries remain
primarily liable to the policyholders in the event REALIC does not fulfill its
obligations under the agreements. Accordingly, our insurance
liabilities continue to include the amounts ceded for these policies, which is
offset by a corresponding amount in reinsurance receivables. The
coinsurance transaction had an effective date of January 1, 2007.
Pursuant
to the terms of the annuity coinsurance agreement, the ceding commission was
based on the January 1, 2007 value of the assets and liabilities related to the
ceded block. The earnings (loss) after income taxes on the business
from January 1, 2007 through September 28, 2007, resulted in increases
(decreases) to the loss calculated as of January 1, 2007. Such
after-tax earnings (loss) include the fair value declines on invested assets
transferred to the reinsurer occurring during the first three quarters of
2007.
The
following summarizes the profits and losses recognized on this business in 2007
(dollars in millions):
|
2007
|
|||||
|
Net
earnings on the block before
tax
|
$ | 17.0 | |||
|
Realized
investment losses, net of amortization of insurance
intangibles
|
(40.6 | ) | |||
|
Loss
related to the annuity coinsurance
transaction
|
(76.5 | ) |
(a)
|
||
|
Net
loss before income
taxes
|
$ | (100.1 | ) | ||
____________
|
(a)
|
Amount
represents the net loss before income taxes recognized on the annuity
coinsurance transaction during 2007, including the earnings and losses on
the block during that period and the loss recognized upon completion of
the transaction. The following summarizes the components of the
loss before income taxes (dollars in
millions):
|
|
Assets
received (transferred)
|
||||
|
Investments
|
$ | (2,560.8 | ) | |
|
Accrued
investment
income
|
(28.7 | ) | ||
|
Value
of policies inforce at the Effective Date
|
(198.9 | ) | ||
|
Cost
of policies
produced
|
(20.5 | ) | ||
|
Reinsurance
receivables
|
2,764.3 | |||
|
Other
|
(31.9 | ) | ||
|
Net
loss before income
taxes
|
$ | (76.5 | ) | |
In 2007,
we completed the recapture of a block of traditional life insurance in force
that had been ceded in 2002 to REALIC. In the transaction, which had
an effective date of October 1, 2007, Colonial Penn paid REALIC a recapture fee
of $63 million. The recapture of this block resulted in a $2.8
million gain accounted for as a reduction to insurance policy
benefits. Colonial Penn recaptured 100 percent of the liability for
the future benefits previously ceded, and will recognize profits from the block
as they emerge over time. Colonial Penn already administers the
policies that were recaptured.
In 2008,
Bankers Life entered into a reinsurance agreement, as amended, pursuant to which
it ceded 70 percent of its new 2008 and 2009 long-term care business, excluding
certain business sold in the state of Florida. The amount reinsured
decreases to 50 percent in the first quarter of 2010 and to 25 percent
thereafter. The pre-tax impact of this reinsurance agreement was not
significant in 2008.
134
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
In
September 2009, we completed a transaction under which two insurance companies
in our Conseco Insurance Group unit coinsured, with an effective date of January
1, 2009, about 104,000 non-core life insurance policies with Wilton Reassurance
Company (“Wilton Re”). In the transaction, Wilton Re paid a ceding
commission of $55.8 million and will
coinsure
and administer 100 percent of these policies. The Conseco companies
transferred to Wilton Re $401.6 million in cash and policy loans and $457.4
million of policy and other reserves. Most of the policies involved
in the transaction were issued by companies prior to their acquisition by
Conseco. Approximately 70 percent of the policies being coinsured are
from Washington National; the remainder are from Conseco Insurance
Company. We recorded a deferred gain of approximately $26 million in
2009 which will be recognized over the remaining life of the block of insurance
policies coinsured with Wilton Re. We also increased our deferred tax valuation
allowance by $20 million in 2009 as a result of reassessing the recovery of our
deferred tax assets upon completion of the transaction.
In November 2009, we entered into a
transaction under which Bankers Life coinsured, with an effective date of
October 1, 2009, about 234,000 life insurance policies with Wilton
Re. In the transaction, Wilton Re paid a ceding commission of $44
million and will 50% coinsure these policies, which will continue to be
administered by Bankers Life. In the transaction, Bankers Life
transferred to Wilton Re $73 million in investment securities and policy loans
and $117 million of policy and other reserves. As a result of the
transaction, we recorded an increase to our deferred tax valuation allowance of
$18 million in 2009, as a result of reassessing the recovery of our deferred tax
assets upon completion of the transaction. We also recorded a pre-tax
deferred cost of reinsurance of $32 million, which, in accordance with GAAP,
will be amortized over the life of the block.
Income
Taxes
Our
income tax expense includes deferred income taxes arising from temporary
differences between the financial reporting and tax bases of assets and
liabilities, capital loss carryforwards and net operating loss carryforwards
(“NOLs”). Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply in the years in which temporary differences
are expected to be recovered or paid. The effect of a change in tax
rates on deferred tax assets and liabilities is recognized in earnings in the
period when the changes are enacted.
A
reduction of the carrying amount of deferred tax assets by establishing a
valuation allowance is required if, based on the available evidence, it is more
likely than not that such assets will not be realized. We evaluate
the need to establish a valuation allowance for our deferred income tax assets
on an ongoing basis. In evaluating our deferred income tax assets, we
consider whether the deferred income tax assets will be realized, based on the
more-likely-than-not realization threshold criterion. The ultimate
realization of our deferred income tax assets depends upon generating sufficient
future taxable income during the periods in which our temporary differences
become deductible and before our capital loss carryforwards and NOLs
expire. This assessment requires significant judgment. In
assessing the need for a valuation allowance, appropriate consideration is given
to all positive and negative evidence related to the realization of the deferred
tax assets. This assessment considers, among other matters, the
nature, frequency and severity of current and cumulative losses, forecasts of
future profitability, excess appreciated asset value over the tax basis of net
assets, the duration of carryforward periods, our experience with operating loss
and tax credit carryforwards expiring unused, and tax planning
alternatives.
At
December 31, 2009, our valuation allowance for our net deferred tax assets was
$1.2 billion as we have determined that it is more likely than not that a
portion of our deferred tax assets will not be realized. This
determination was made by evaluating each component of the deferred tax asset
and assessing the effects of limitations and/or interpretations on the value of
such component to be fully recognized in the future.
Investment
Borrowings
One of
the Company’s insurance subsidiaries (Conseco Life) is a member of the Federal
Home Loan Bank of Indianapolis (“FHLBI”). As a member of the FHLBI,
Conseco Life has the ability to borrow on a collateralized basis from
FHLBI. Conseco Life is required to hold a certain minimum amount of
FHLBI common stock as a requirement of membership in the FHLBI, and additional
amounts based on the amount of the borrowings. At December 31, 2009,
the carrying value of the FHLBI common stock was $22.5
million. Collateralized borrowings from the FHLBI totaled $450.0
million as of December 31, 2009, and the proceeds were used to purchase fixed
maturity securities. The borrowings are classified as investment
borrowings in the accompanying consolidated balance sheet. The
borrowings are collateralized by investments with an estimated fair value of
$508.2 million at December 31, 2009, which are maintained in a custodial account
for the benefit of the FHLBI. Such investments are classified as
actively managed fixed maturities in our
135
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
consolidated
balance sheet. Conseco Life recognized interest expense of $20.3
million, $21.9 million and $16.7 million in 2009, 2008 and 2007, respectively,
related to the borrowings.
The
following summarizes the terms of the borrowings (dollars in
millions):
|
Amount
|
Maturity
|
Interest
rate
|
||
|
borrowed
|
date
|
at December 31, 2009
|
||
| $ | 54.0 |
May
2012
|
Variable
rate – .267%
|
|
| 37.0 |
July
2012
|
Fixed
rate – 5.540%
|
||
| 13.0 |
July
2012
|
Variable
rate – .344%
|
||
| 146.0 |
November
2015
|
Fixed
rate – 5.300%
|
||
| 100.0 |
November
2015
|
Fixed
rate – 4.890%
|
||
| 100.0 |
December
2015
|
Fixed
rate – 4.710%
|
||
The
variable rate borrowings are pre-payable on each interest reset date without
penalty. The fixed rate borrowings are pre-payable subject to payment
of a yield maintenance fee based on current market interest rates. At
December 31, 2009, the aggregate fee to prepay all fixed rate borrowings was
$43.8 million.
At
December 31, 2009, investment borrowings consisted of: (i)
collateralized borrowings from the FHLBI of $450.0 million; (ii) $229.1 million
of securities issued to other entities by a variable interest entity (“VIE”)
which is consolidated in our financial statements as further discussed in the
note to the consolidated financial statements entitled “Investment in a Variable
Interest Entity”; and (iii) other borrowings of $4.8 million.
At
December 31, 2008, investment borrowings consisted of: (i)
collateralized borrowings of $450.0 million; (ii) $311.7 million of securities
issued to other entities by a VIE which is consolidated in our financial
statements; and (iii) other borrowings of $5.8 million.
Accounting
for Derivatives
Our
equity-indexed annuity products provide a guaranteed base rate of return and a
higher potential return that is based on a percentage (the “participation rate”)
of the amount of increase in the value of a particular index, such as the
Standard & Poor’s 500 Index, over a specified period. Typically,
on each policy anniversary date, a new index period begins. We are
generally able to change the participation rate at the beginning of each index
period during a policy year, subject to contractual minimums. We
typically buy call options or call spreads referenced to the applicable indices
in an effort to hedge potential increases to policyholder benefits resulting
from increases in the particular index to which the product’s return is
linked. We reflect changes in the estimated fair value of these
options in net investment income (classified as investment income from
policyholder and reinsurer accounts and other special-purpose
portfolios). Net investment gains (losses) related to equity-indexed
products were $50.7 million, $(104.3) million and $(8.5) million during 2009,
2008 and 2007, respectively. These amounts were substantially offset by a
corresponding charge to insurance policy benefits. The estimated fair
value of these options was $114.9 million and $17.6 million at December 31, 2009
and 2008, respectively. We classify these instruments as other
invested assets.
The
Company accounts for the options attributed to the policyholder for the
estimated life of the annuity contract as embedded derivatives. The
expected future cost of options on equity-indexed annuity products is used to
determine the value of embedded derivatives. While the Company does
not purchase options to hedge liabilities which may arise after the current
policy anniversary date, the Company must value the related forward embedded
options in the policies at fair value. These accounting requirements
often create volatility in the earnings from these products. We
record the changes in the fair values of the embedded derivatives in current
earnings as a component of policyholder benefits. Effective January
1, 2008, we adopted authoritative guidance related to fair value measurements
which required us to value the embedded derivatives reflecting a hypothetical
market perspective for fair value measurement. We recorded a charge
of $1.8 million to net income (after the effects of the amortization of the
value of policies inforce at the Effective Date and the cost of policies
produced (collectively referred to as “amortization of insurance acquisition
costs”) and income taxes), attributable to changes in the fair value of the
embedded derivatives as a result of adopting such guidance. The fair
value of these derivatives, which are classified as “liabilities for
interest-sensitive products”, was $494.4 million and $430.6 million at December
31, 2009 and 2008, respectively. We maintain a specific block of
investments in our trading securities account, which we carry at estimated fair
value with changes in such value recognized as investment income (classified as
investment income from
136
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
policyholder
and reinsurer accounts and other special-purpose portfolios). The
change in value of these trading securities attributable to interest
fluctuations is intended to offset a portion of the change in the value of the
embedded derivative.
If the
counterparties for the derivatives we hold fail to meet their obligations, we
may have to recognize a loss. We limit our exposure to such a loss by
diversifying among several counterparties believed to be strong and
creditworthy. At December 31, 2009, all of our counterparties were
rated “A-” or higher by Standard & Poor’s Corporation
(“S&P”).
Certain
of our reinsurance payable balances contain embedded
derivatives. Such derivatives had an estimated fair value of $1.6
million and $6.6 million at December 31, 2009 and 2008,
respectively. We record the change in the fair value of these
derivatives as a component of investment income (classified as investment income
from policyholder and reinsurer accounts and other special-purpose
portfolios). We maintain a specific block of investments related to
these agreements in our trading securities account, which we carry at estimated
fair value with changes in such value recognized as investment income (also
classified as investment income from policyholder and reinsurer accounts and
other special-purpose portfolios). The change in value of these
trading securities attributable to interest fluctuations is intended to offset
the change in value of the embedded derivatives. However, differences
will occur as corporate spreads change.
Multibucket
Annuity Product
The
Company’s multibucket annuity is an annuity product that credits interest based
on the experience of a particular market strategy. Policyholders
allocate their annuity premium payments to several different market strategies
based on different asset classes within the Company’s investment
portfolio. Interest is credited to this product based on the market
return of the given strategy, less management fees, and funds may be moved
between different strategies. The Company guarantees a minimum return
of premium plus approximately 3 percent per annum over the life of the
contract. The investments backing the market strategies of these
products are designated by the Company as trading securities. The
change in the fair value of these securities is recognized as investment income
(classified as income from policyholder and reinsurer accounts and other
special-purpose portfolios), which is substantially offset by the change in
insurance policy benefits for these products. As of December 31,
2009, we hold insurance liabilities of $70.6 million related to multibucket
annuity products.
Stock
Based Compensation
Prior to
January 1, 2006, we measured compensation cost for our stock option plans using
the intrinsic value method. Under this method, compensation cost was
recorded when the quoted market price at the grant date exceeded the amount an
employee had to pay to acquire the stock. When the Company issued
employee stock options with an exercise price equal to or greater than the
market price of our stock on the grant date, no compensation cost was
recorded. Authoritative guidance required disclosures of the pro
forma effects of using the fair value method of accounting for stock
options.
In
December 2004, the FASB issued authoritative guidance which provided additional
guidance on accounting for share-based payments and required all such awards to
be measured at fair value with the related compensation cost recognized in the
statement of operations over the related service period. Conseco
implemented the guidance using the modified prospective method on January 1,
2006. Under this method, the Company began recognizing compensation
cost for all awards granted on or after January 1, 2006. In addition,
we are required to recognize compensation cost over the remaining requisite
service period for the portion of outstanding awards that were not vested as of
January 1, 2006 and were not previously expensed on a pro forma basis pursuant
to the guidance. The guidance also requires the benefits of tax
deductions in excess of recognized compensation cost to be reported as a
financing cash flow rather than as an operating cash flow, as previously
required. During 2009 and 2008, we did not capitalize any stock-based
compensation expense as cost of policies produced or any other asset
category.
Fair
Value Measurements
Effective
January 1, 2008, we adopted authoritative guidance which clarifies a number of
considerations with respect to fair value measurement objectives for financial
reporting and expands disclosures about the use of fair value
measurements. The guidance is intended to increase consistency and
comparability among fair value estimates used in financial reporting and the
disclosure requirements are intended to provide users of financial statements
with the ability to assess the reliability of an entity’s fair value
measurements. The initial adoption of the guidance resulted in a
charge of $1.8 million to net income (after the effects of the amortization of
insurance acquisition costs and income taxes) in the first quarter of 2008,
attributable to changes in the liability for the embedded derivatives associated
with our equity-indexed annuity products. The change resulted from
the incorporation of risk margins into the estimated fair value calculation for
this
137
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
liability.
Definition
of Fair Value
Fair
value is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date and, therefore, represents an exit price, not an entry
price. We hold fixed maturities, equity securities, derivatives,
separate account assets and embedded derivatives, which are carried at fair
value.
The
degree of judgment utilized in measuring the fair value of financial instruments
is largely dependent on the level to which pricing is based on observable
inputs. Observable inputs reflect market data obtained from
independent sources, while unobservable inputs reflect our view of market
assumptions in the absence of observable market
information. Financial instruments with readily available active
quoted prices would be considered to have fair values based on the highest level
of observable inputs, and little judgment would be utilized in measuring fair
value. Financial instruments that rarely trade would be considered to
have fair value based on a lower level of observable inputs, and more judgment
would be utilized in measuring fair value.
Valuation
Hierarchy
There is
a three-level hierarchy for valuing assets or liabilities at fair value based on
whether inputs are observable or unobservable.
|
·
|
Level
1 – includes assets and liabilities valued using inputs that are quoted
prices in active markets for identical assets or
liabilities. Our Level 1 assets include exchange traded
securities and U.S. Treasury
securities.
|
|
·
|
Level
2 – includes assets and liabilities valued using inputs that are quoted
prices for similar assets in an active market, quoted prices for identical
or similar assets in a market that is not active, observable inputs, or
observable inputs that can be corroborated by market
data. Level 2 assets and liabilities include those financial
instruments that are valued by independent pricing services using models
or other valuation methodologies. These models are primarily
industry-standard models that consider various inputs such as interest
rate, credit spread, reported trades, broker/dealer quotes, issuer spreads
and other inputs that are observable or derived from observable
information in the marketplace or are supported by observable levels at
which transactions are executed in the marketplace. Financial
instruments in this category primarily include: certain public
and private corporate fixed maturity securities; certain government or
agency securities; certain mortgage and asset-backed securities; and
non-exchange-traded derivatives such as call options to hedge liabilities
related to our equity-indexed annuity
products.
|
|
·
|
Level
3 – includes assets and liabilities valued using unobservable inputs that
are used in model-based valuations that contain management
assumptions. Level 3 assets and liabilities include those
financial instruments whose fair value is estimated based on non-binding
broker prices or internally developed models or methodologies utilizing
significant inputs not based on, or corroborated by, readily available
market information. Financial instruments in this category
include certain corporate securities (primarily private placements),
certain mortgage and asset-backed securities, and other less liquid
securities. Additionally, the Company’s liabilities for
embedded derivatives (including embedded derivates related to our
equity-indexed annuity products and to a modified coinsurance arrangement)
are classified in Level 3 since their values include significant
unobservable inputs including actuarial
assumptions.
|
At each
reporting date, we classify assets and liabilities into the three input levels
based on the lowest level of input that is significant to the measurement of
fair value for each asset and liability reported at fair value. This
classification is impacted by a number of factors, including the type of
financial instrument, whether the financial instrument is new to the market and
not yet established, the characteristics specific to the transaction and overall
market conditions. Our assessment of the significance of a particular
input to the fair value measurement and the ultimate classification of each
asset and liability requires judgment.
The vast
majority of our fixed maturity securities and separate account assets use Level
2 inputs for the determination of fair value. These fair values are
obtained primarily from independent pricing services, which use Level 2 inputs
for the determination of fair value. Substantially all of our Level 2
fixed maturity securities and separate account assets were valued from
independent pricing services. Third party pricing services normally
derive the security prices through recently reported trades for identical or
similar securities making adjustments through the reporting date based upon
available market
138
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
observable
information. If there are no recently reported trades, the third
party pricing services may use matrix or model processes to develop a security
price where future cash flow expectations are developed and discounted at an
estimated risk-adjusted market rate. The number of prices obtained is
dependent on the Company’s analysis of such prices as further described
below.
For
securities that are not priced by pricing services and may not be reliably
priced using pricing models, we obtain broker quotes. These broker
quotes are non-binding and
represent an exit price,
but assumptions used to establish the fair value may not be observable and
therefore represent Level 3 inputs. Approximately 6 percent and 1
percent of our Level 3 fixed maturity securities were valued using broker quotes
or independent pricing services, respectively. The remaining Level 3
fixed maturity investments do not have readily determinable market prices and/or
observable inputs. For these securities, we use internally developed
valuations. Key assumptions used to determine fair value for these
securities may include risk-free rates, risk premiums, performance of underlying
collateral and other factors involving significant assumptions which may not be
reflective of an active market. For certain investments, we use a
matrix or model process to develop a security price where future cash flow
expectations are developed and discounted at an estimated market
rate. The pricing matrix utilizes a spread level to determine the
market price for a security. The credit spread generally incorporates
the issuer’s credit rating and other factors relating to the issuer’s industry
and the security’s maturity. In some instances, issuer-specific
spread adjustments, which can be positive or negative, are made based upon
internal analysis of security specifics such as liquidity, deal size and time to
maturity.
Privately
placed securities comprise approximately 79 percent of our actively managed
fixed maturities classified as Level 3. Privately placed securities
are classified as Level 3 when their valuation is based on internal valuation
models which rely on significant inputs that are not observable in the
market. Our model applies spreads above the risk-free rate which are
determined based on comparison to securities with similar ratings, maturities
and industries that are rated by independent third party rating
agencies. Our process also considers the ratings assigned by the
National Association of Insurance Commissioners (the “NAIC”) to the Level 3
securities on an annual basis. Each quarter, a review is performed to
determine the reasonableness of the initial valuations from the
model. If an initial valuation appears unreasonable based on our
knowledge of a security and current market conditions, we make appropriate
adjustments to our valuation inputs. The remaining securities
classified as Level 3 are primarily valued based on internally developed models
using estimated future cash flows.
For
certain Level 3 assets, we have increased our default assumptions based on our
review of the underlying collateral. The changes in our assumptions resulted in
lower cash flow estimates for some of our subordinated tranches and have
resulted in such securities being impaired. The default rate we
expect to experience related to the collateral underlying the subordinated
tranches increased from 1.7 percent to 7.6 percent for the experience expected
in 2009; from .8 percent to 3.2 percent for 2010; and from .8 percent to 1.5
percent for each year subsequent to 2010. However, the changes in
assumptions did not change our cash flow estimates for the non-subordinated
tranches within our Level 3 investments. We recognized
other-than-temporary impairments on securities classified as Level 3 investments
of $26.7 million (including $16.1 million of impairment losses recognized
through accumulated other comprehensive loss) during 2009.
As the
Company is responsible for the determination of fair value, we perform monthly
quantitative and qualitative analysis on the prices received from third parties
to determine whether the prices are reasonable estimates of fair
value. The Company’s analysis includes: (i) a review of
the methodology used by third party pricing services; (ii) a comparison of
pricing services’ valuation to other pricing services’ valuations for the same
security; (iii) a review of month to month price fluctuations; (iv) a review to
ensure valuations are not unreasonably stale; and (v) back testing to compare
actual purchase and sale transactions with valuations received from third
parties. As a result of such procedures, the Company may conclude the
prices received from third parties are not reflective of current market
conditions. In those instances, we may request additional pricing
quotes or apply internally developed valuations. However, the number
of instances is insignificant and the aggregate change in value of such
investments is not materially different from the original prices
received.
The
categorization of the fair value measurements of our investments priced by
independent pricing services was based upon the Company’s judgment of the inputs
or methodologies used by the independent pricing services to value different
asset classes. Such inputs include: benchmark yields,
reported trades, broker dealer quotes, issuer spreads, benchmark securities,
bids, offers and reference data. The Company categorizes such fair
value measurements based upon asset classes and the underlying observable or
unobservable inputs used to value such investments.
The
classification of fair value measurements for derivative instruments, including
embedded derivatives requiring bifurcation, is determined based on the
consideration of several inputs including closing exchange or over-the-counter
market
139
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
price
quotations; time value and volatility factors underlying options; market
interest rates; and non-performance risk. For certain embedded
derivatives, we may use actuarial assumptions in the determination of fair
value.
The
categorization of fair value measurements, by input level, for our fixed
maturity securities, equity securities, trading securities, certain other
invested assets, assets held in separate accounts and embedded derivative
instruments included in liabilities for insurance products at December 31, 2009
is as follows (dollars in millions):
|
Quoted
prices
|
||||||||||||||||||
|
in
active
|
Significant
|
|||||||||||||||||
|
markets
for
|
other
|
Significant
|
||||||||||||||||
|
identical
assets
|
observable
|
unobservable
|
||||||||||||||||
|
or
liabilities
|
inputs
|
inputs
|
||||||||||||||||
|
(Level 1)
|
(Level 2)
|
(Level 3)
|
Total
|
|||||||||||||||
|
Assets:
|
||||||||||||||||||
|
Actively
managed fixed maturities
|
$ | 56.5 | $ | 16,074.0 | $ | 2,397.9 | $ | 18,528.4 | ||||||||||
|
Equity
securities
|
.1 | - | 30.9 | 31.0 | ||||||||||||||
|
Trading
securities
|
4.3 | 285.3 | 3.7 | 293.3 | ||||||||||||||
|
Securities
lending collateral
|
- | 97.2 | 36.6 | 133.8 | ||||||||||||||
|
Other
invested assets
|
- | 192.6 |
(a)
|
2.4 |
(b)
|
195.0 | ||||||||||||
|
Assets
held in separate accounts
|
- | 17.3 | - | 17.3 | ||||||||||||||
|
Liabilities:
|
||||||||||||||||||
|
Liabilities
for insurance products:
|
||||||||||||||||||
|
Interest-sensitive
products
|
496.0 |
(c)
|
496.0 | |||||||||||||||
|
(a)
|
Includes
company-owned life insurance and
derivatives.
|
|
(b)
|
Includes
equity-like holdings in special-purpose
entities.
|
|
(c)
|
Includes
$494.4 million of embedded derivatives associated with our equity-indexed
annuity products and $1.6 million of embedded derivatives associated with
a modified coinsurance
agreement.
|
140
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
The
categorization of fair value measurements, by input level, for our fixed
maturity securities, equity securities, trading securities, certain other
invested assets, assets held in separate accounts and embedded derivative
instruments included in liabilities for insurance products at December 31, 2008
is as follows (dollars in millions):
|
Quoted
prices
|
||||||||||||||||||
|
in
active
|
Significant
|
|||||||||||||||||
|
markets
for
|
other
|
Significant
|
||||||||||||||||
|
identical
assets
|
observable
|
unobservable
|
||||||||||||||||
|
or
liabilities
|
inputs
|
inputs
|
||||||||||||||||
|
(Level 1)
|
(Level 2)
|
(Level 3)
|
Total
|
|||||||||||||||
|
Assets:
|
||||||||||||||||||
|
Actively
managed fixed maturities
|
$ | 74.9 | $ | 13,326.0 | $ | 1,876.1 | $ | 15,277.0 | ||||||||||
|
Equity
securities
|
- | - | 32.4 | 32.4 | ||||||||||||||
|
Trading
securities
|
8.8 | 315.0 | 2.7 | 326.5 | ||||||||||||||
|
Securities
lending collateral
|
- | 170.3 | 48.1 | 218.4 | ||||||||||||||
|
Other
invested assets
|
- | 55.9 |
(a)
|
2.3 |
(b)
|
58.2 | ||||||||||||
|
Assets
held in separate accounts
|
- | 18.2 | - | 18.2 | ||||||||||||||
|
Liabilities:
|
||||||||||||||||||
|
Liabilities
for insurance products:
|
||||||||||||||||||
|
Interest-sensitive
products
|
- | - | 437.2 |
(c)
|
437.2 | |||||||||||||
_____________
|
|
(a)
|
Includes
company-owned life insurance and
derivatives.
|
|
|
(b)
|
Includes
equity-like holdings in special-purpose
entities.
|
|
|
(c)
|
Includes
$430.6 million of embedded derivatives associated with our equity-indexed
annuity products and $6.6 million of embedded derivatives associated with
a modified coinsurance
agreement.
|
141
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
The
following table presents additional information about assets and liabilities
measured at fair value on a recurring basis and for which we have utilized
significant unobservable (Level 3) inputs to determine fair value for the year
ended December 31, 2009 (dollars in millions):
|
Embedded
|
||||||||||||||||||||||||
|
derivative
|
||||||||||||||||||||||||
|
instruments
|
||||||||||||||||||||||||
|
Actively
|
included
in
|
|||||||||||||||||||||||
|
managed
|
Securities
|
Other
|
liabilities
for
|
|||||||||||||||||||||
|
fixed
|
Equity
|
Trading
|
lending
|
invested
|
insurance
|
|||||||||||||||||||
|
maturities
|
securities
|
securities
|
collateral
|
assets
|
products
|
|||||||||||||||||||
|
Assets:
|
||||||||||||||||||||||||
|
Beginning
balance as of December 31,
2008
|
$ | 1,876.1 | $ | 32.4 | $ | 2.7 | $ | 48.1 | $ | 2.3 | $ | (437.2 | ) | |||||||||||
|
Purchases,
sales, issuances and settlements, net
|
199.1 | (.3 | ) | - | (17.1 | ) | - | (63.8 | ) | |||||||||||||||
|
Total
realized and unrealized gains (losses):
|
||||||||||||||||||||||||
|
Included
in net loss
|
(15.2 | ) | - | 1.0 | (.9 | ) | (3.4 | ) | 5.0 | |||||||||||||||
|
Included
in other comprehensive income (loss)
|
327.5 | (1.2 | ) | - | (9.4 | ) | 3.5 | - | ||||||||||||||||
|
Transfers
into Level 3
|
32.2 | - | - | 20.4 | - | - | ||||||||||||||||||
|
Transfers
out of Level 3 (a)
|
(21.8 | ) | - | - | (4.5 | ) | - | - | ||||||||||||||||
|
Ending
balance as of December 31, 2009
|
$ | 2,397.9 | $ | 30.9 | $ | 3.7 | $ | 36.6 | $ | 2.4 | $ | (496.0 | ) | |||||||||||
|
Amount
of total gains (losses) for the year ended December 31, 2009 included in
our net loss relating to assets and liabilities still held as
of the reporting date
|
$ | (3.9 | ) | $ | - | $ | 1.0 | $ | (.9 | ) | $ | (3.4 | ) | $ | 7.3 | |||||||||
___________
|
|
(a)
|
Transfers
out of Level 3 are reported as having occurred at the beginning of the
period.
|
142
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
The
following table presents additional information about assets and liabilities
measured at fair value on a recurring basis and for which we have utilized
significant unobservable (Level 3) inputs to determine fair value for the year
ended December 31, 2008 (dollars in millions):
|
Embedded
|
||||||||||||||||||||||||
|
derivative
|
||||||||||||||||||||||||
|
instruments
|
||||||||||||||||||||||||
|
Actively
|
included
in
|
|||||||||||||||||||||||
|
managed
|
Securities
|
Other
|
liabilities
for
|
|||||||||||||||||||||
|
fixed
|
Equity
|
Trading
|
lending
|
invested
|
insurance
|
|||||||||||||||||||
|
maturities
|
securities
|
securities
|
collateral
|
assets
|
products
|
|||||||||||||||||||
|
Assets:
|
||||||||||||||||||||||||
|
Beginning
balance as of
December
31,
2007
|
$ | 1,753.3 | $ | 34.5 | $ | 11.8 | $ | 105.7 | $ | 4.3 | $ | (354.6 | ) | |||||||||||
|
Purchases,
sales, issuances and settlements, net
|
465.4 | (3.0 | ) | (6.3 | ) | (18.7 | ) | (1.4 | ) | (10.6 | ) | |||||||||||||
|
Total
realized and unrealized gains (losses):
|
||||||||||||||||||||||||
|
Included
in net loss
|
(18.9 | ) | - | (2.3 | ) | - | .9 | (72.0 | ) | |||||||||||||||
|
Included
in other comprehensive
income (loss)
|
(247.9 | ) | .9 | - | (2.6 | ) | (1.5 | ) | - | |||||||||||||||
|
Transfers
into Level 3
|
33.4 | - | - | - | - | - | ||||||||||||||||||
|
Transfers
out of Level 3 (a)
|
(109.2 | ) | - | (.5 | ) | (36.3 | ) | - | - | |||||||||||||||
|
Ending
balance as of December 31, 2008
|
$ | 1,876.1 | $ | 32.4 | $ | 2.7 | $ | 48.1 | $ | 2.3 | $ | (437.2 | ) | |||||||||||
|
Amount
of total gains (losses) for the year ended December 31, 2008 included in
our net loss relating to assets and liabilities still held as of the
reporting date
|
$ | (5.6 | ) | $ | - | $ | (1.6 | ) | $ | - | $ | .9 | $ | (72.0 | ) | |||||||||
___________
|
|
(a)
|
Transfers
out of Level 3 are reported as having occurred at the beginning of the
period.
|
At
December 31, 2009, 86 percent of our Level 3 actively managed fixed maturities
were investment grade and 94 percent of our Level 3 actively managed fixed
maturities consisted of corporate securities.
Realized
and unrealized investment gains and losses presented in the preceding tables
represent gains and losses during the time the applicable financial instruments
were classified as Level 3.
Realized
and unrealized gains (losses) on Level 3 assets are primarily reported in either
net investment income for policyholder and reinsurer accounts and other special
purpose portfolios, net realized investment gains (losses) or insurance policy
benefits within the consolidated statement of operations or other comprehensive
income (loss) within shareholders’ equity based on the appropriate accounting
treatment for the instrument.
143
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
Purchases,
sales, issuances and settlements, net, represent the activity that occurred
during the period that results in a change of the asset or liability but does
not represent changes in fair value for the instruments held at the beginning of
the period. Such activity primarily consists of purchases and sales
of fixed maturity, equity and trading securities, purchases and settlements of
derivative instruments, and changes to embedded derivative instruments related
to insurance products resulting from the issuance of new contracts, or changes
to existing contracts.
We review
the fair value hierarchy classifications each reporting
period. Transfers in and/or (out) of Level 3 in 2009 were primarily
due to changes in the observability of the valuation attributes resulting in a
reclassification of certain financial assets or liabilities. Such
reclassifications are reported as transfers in and out of Level 3 at the
beginning fair value for the reporting period in which the changes
occur.
The
amount presented for gains (losses) included in our net loss for assets and
liabilities still held as of the reporting date primarily represents impairments
for actively managed fixed maturities, changes in fair value of trading
securities and certain derivatives and changes in fair value of embedded
derivative instruments included in liabilities for insurance products that exist
as of the reporting date.
We use
the following methods and assumptions to determine the estimated fair values of
other financial instruments:
Cash and cash
equivalents.
The carrying amount for these instruments
approximates their estimated fair value.
Mortgage loans and policy
loans.
We discount future expected cash flows for loans
included in our investment portfolio 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. The fair value of policy loans approximates their
carrying value.
Other invested
assets.
We use quoted market prices, where
available. When quotes are not available, we estimate the fair value
based on discounted future expected cash flows or independent transactions which
establish a value for our investment.
Insurance liabilities for
interest-sensitive products.
We discount future expected cash
flows based on interest rates currently being offered for similar contracts with
similar maturities.
Investment borrowings and notes
payable.
For publicly traded debt, we use current fair
values. For other notes, we use discounted cash flow analyses based
on our current incremental borrowing rates for similar types of borrowing
arrangements.
144
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
The
estimated fair values of our financial instruments at December 31, 2009 and
2008, were as follows (dollars in millions):
|
2009
|
2008
|
|||||||||||||||
|
Carrying
|
Fair
|
Carrying
|
Fair
|
|||||||||||||
|
Amount
|
Value
|
Amount
|
Value
|
|||||||||||||
|
Financial
assets:
|
||||||||||||||||
|
Actively
managed fixed maturities
|
$ | 18,528.4 | $ | 18,528.4 | $ | 15,277.0 | $ | 15,277.0 | ||||||||
|
Equity
securities
|
31.0 | 31.0 | 32.4 | 32.4 | ||||||||||||
|
Mortgage
loans
|
1,965.5 | 1,756.8 | 2,159.4 | 2,122.1 | ||||||||||||
|
Policy
loans
|
295.2 | 295.2 | 363.5 | 363.5 | ||||||||||||
|
Trading
securities
|
293.3 | 293.3 | 326.5 | 326.5 | ||||||||||||
|
Securities
lending
collateral
|
180.0 | 180.0 | 393.7 | 393.7 | ||||||||||||
|
Other
invested
assets
|
236.8 | 236.8 | 95.0 | 95.0 | ||||||||||||
|
Cash
and cash
equivalents
|
526.8 | 526.8 | 899.3 | 899.3 | ||||||||||||
|
Financial
liabilities:
|
||||||||||||||||
|
Insurance
liabilities for interest-sensitive products (a)
|
$ | 13,219.2 | $ | 13,219.2 | $ | 13,332.8 | $ | 13,332.8 | ||||||||
|
Investment
borrowings
|
683.9 | 683.9 | 767.5 | 767.5 | ||||||||||||
|
Notes
payable – direct corporate obligations
|
1,037.4 | 1,041.7 | 1,311.5 | 777.3 | ||||||||||||
____________________
|
(a)
|
The
estimated fair value of insurance liabilities for interest-sensitive
products was approximately equal to its carrying value at December 31,
2009 and 2008. This was because interest rates credited on the
vast majority of account balances approximate current rates paid on
similar products and because these rates are not generally guaranteed
beyond one year.
|
Sales
Inducements
Certain
of our annuity products offer sales inducements to contract holders in the form
of enhanced crediting rates or bonus payments in the initial period of the
contract. Certain of our life insurance products offer persistency
bonuses credited to the contract holders balance after the policy has been
outstanding for a specified period of time. These enhanced rates and
persistency bonuses are considered sales inducements in accordance with
GAAP. Such amounts are deferred and amortized in the same manner as
the cost of policies produced. Sales inducements deferred totaled
$28.4 million, $47.1 million and $52.4 million in 2009, 2008 and 2007,
respectively. Amounts amortized totaled $30.2 million, $16.7 million
and $18.4 million in 2009, 2008 and 2007, respectively. The
unamortized balance of deferred sales inducements was $177.6 million and $179.4
million at December 31, 2009 and 2008, respectively. The balance of
insurance liabilities for persistency bonus benefits was $136.2 million and
$195.9 million at December 31, 2009 and 2008, respectively.
Out-of-Period
Adjustments
We
recorded the net effects of certain out-of-period adjustments which decreased
our net income by $2.7 million (or one cent per diluted share) in
2009. We evaluated these errors taking into account both qualitative
and quantitative factors and considered the impact of these errors in relation
to 2009, as well as the materiality to the periods in which they
originated. The impact of correcting these errors in prior years was
not significant to any individual period. Management believes these
errors are immaterial to the consolidated annual financial
statements.
Recently
Issued Accounting Standards
Pending
Accounting Standards
In January 2010, the FASB issued
authoritative guidance which requires new disclosures and clarifies existing
disclosure requirements related to fair value. An entity will be
required to disclose significant transfers in and out of Levels 1 and 2 of the
fair value hierarchy, and separately present information related to purchases,
sales, issuances and settlements in the reconciliation of fair value
measurements classified as Level 3. In addition, the guidance amends
the fair value disclosure
145
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
requirement
for pension and postretirement benefit plan assets to require this disclosure at
the investment class level. The guidance will be effective for
interim and annual reporting periods beginning after December 15, 2009, except
for the disclosures related to purchases, sales, issuances and settlements for
Level 3 fair value measurements, which are effective for reporting periods
beginning after December 15, 2010. We do not expect the adoption of
this guidance to have a material impact on our consolidated financial
statements.
In June
2009, the FASB issued authoritative guidance that requires an entity to perform
a qualitative analysis to determine whether a primary beneficiary interest is
held in a VIE. Under the new qualitative model, the primary
beneficiary must have both the power to direct the activities of the VIE and the
obligation to absorb either losses or gains that could be significant to the
VIE. The guidance also requires ongoing reassessments to determine
whether a primary beneficiary interest is held and additional disclosures,
including the financial statement effects of the entity’s involvement with
VIEs. The guidance will be effective as of the beginning of each
reporting entity’s first annual reporting period that begins after November 15,
2009, for interim periods within that first annual reporting period, and for
interim and annual reporting periods thereafter. Earlier application
is prohibited. The Company is in the process of evaluating the impact
the guidance will have on its consolidated financial statements.
In June
2009, the FASB issued authoritative guidance that is intended to improve the
relevance, representational faithfulness, and comparability of the information
that a reporting entity provides in its financial statements about a transfer of
financial assets; the effects of a transfer on its financial position, financial
performance, and cash flows; and a transferor’s continuing involvement, if any,
in transferred financial assets. The guidance must be applied as of
the beginning of each reporting entity’s first annual reporting period that
begins after November 15, 2009, for interim periods within that first annual
reporting period and for interim and annual reporting periods
thereafter. Earlier application is prohibited. The
guidance must be applied to transfers occurring on or after the effective
date. Additionally, on or after the effective date, the concept of a
qualifying special-purpose entity is no longer relevant for accounting
purposes. Therefore, formerly qualifying special-purpose entities (as
defined under previous accounting standards) should be evaluated for
consolidation by reporting entities on and after the effective date in
accordance with the applicable consolidation guidance. If the
evaluation on the effective date results in consolidation, the reporting entity
should apply the transition guidance provided in the pronouncement that requires
consolidation. We do not expect the adoption of this guidance to have
a material impact on our consolidated financial statements.
Adopted
Accounting Standards
In June
2009, the FASB issued “The FASB Accounting Standards Codification and the
Hierarchy of Generally Accepted Accounting Principles” which established the
FASB Accounting Standards Codification (“Codification”) as the single source of
authoritative accounting principles in the preparation of financial statements
in conformity with GAAP. Rules and interpretive releases of the SEC
under authority of federal securities laws are also sources of authoritative
GAAP for SEC registrants. The FASB will no longer issue new standards
in the form of Statements, FASB Staff Positions or Emerging Issues Task Force
Abstracts; instead the FASB will issue Accounting Standards
Updates. Accounting Standards Updates will not be authoritative in
their own right as they will only serve to update the
Codification. These changes and the Codification itself do not change
GAAP. Codification was effective for financial statements issued for
interim and annual periods ending after September 15, 2009. Other
than the manner in which new accounting guidance is referenced, the adoption of
Codification had no impact on our consolidated financial
statements.
In May
2009, the FASB issued authoritative guidance that established general standards
of accounting for and disclosure of events that occur after the balance sheet
date but before financial statements are issued or are available to be
issued. In particular, the guidance sets forth: (i) the
period after the balance sheet date during which management of a reporting
entity should evaluate events or transactions that may occur for potential
recognition or disclosure in the financial statements; (ii) the circumstances
under which an entity should recognize events or transactions occurring after
the balance sheet date in its financial statements; and (iii) the disclosures
that an entity should make about events or transactions that occurred after the
balance sheet date. The requirements of the guidance are applied on a
prospective basis to interim or annual financial periods ending after June 15,
2009. The adoption of this guidance did not have a material affect on
our consolidated financial statements.
On April
9, 2009, the FASB issued authoritative guidance regarding the recognition and
presentation of an other-than-temporary impairment and requires additional
disclosures. The recognition provision within this guidance applies
only to fixed maturity investments that are subject to the other-than-temporary
impairments. If an entity intends to sell or if it is more likely
than not that it will be required to sell an impaired security prior to recovery
of its cost basis, the security is other-
146
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
than-temporarily
impaired and the full amount of the impairment is recognized as a loss through
earnings. Otherwise, losses on securities which are
other-than-temporarily impaired are separated into: (i) the portion
of loss which represents the credit loss; and (ii) the portion which is due to
other factors. The credit loss portion is recognized as a loss
through earnings while the loss due to other factors is recognized in other
comprehensive loss, net of taxes and related amortization. The
guidance requires a cumulative effect adjustment to accumulated deficit and a
corresponding adjustment to accumulated other comprehensive loss to reclassify
the non-credit portion of previously other-than-temporarily impaired securities
which were held at the beginning of the period of adoption and for which we do
not intend to sell and it is more likely than not that we will not be required
to sell such securities before recovery of the amortized cost
basis. The guidance is effective for interim and annual periods
ending after June 15, 2009, with early adoption permitted for periods ending
after March 15, 2009. We adopted the guidance effective January 1,
2009. The cumulative effect of adopting this guidance was a $4.9
million net decrease to accumulated deficit and a corresponding increase to
accumulated other comprehensive loss.
On April
9, 2009, the FASB issued authoritative guidance which provided additional
guidance on estimating fair value when the volume and level of activity for an
asset or liability have significantly decreased in relation to normal market
activity for the asset or liability and clarifies that the use of multiple
valuation techniques may be appropriate. The guidance also discusses
circumstances that may indicate a transaction is not orderly. The
guidance re-emphasizes that fair value continues to be the exit price in an
orderly market. Further, this guidance requires additional
disclosures about fair value measurement in annual and interim reporting
periods. The guidance is effective for interim and annual reporting
periods ending after June 15, 2009 with early adoption permitted. We
adopted the guidance effective for the period ending March 31, 2009, and this
guidance did not have a material effect on our consolidated financial
statements.
On April
9, 2009, the FASB issued authoritative guidance which requires that the fair
value of financial instruments be disclosed in an entity’s financial statements
in both interim and annual periods. The guidance also requires
disclosure of methods and assumptions used to estimate fair
values. The guidance is effective for interim reporting periods
ending after June 15, 2009, with early adoption permitted for periods ending
after March 15, 2009. We adopted the guidance for the quarter ended
June 30, 2009, which did not have a material effect on our consolidated balance
sheet or statement of operations.
In May
2008, the FASB issued authoritative guidance that specifies that issuers of
convertible debt instruments that may be settled in cash upon conversion
(including partial cash settlement) should separately account for the liability
and equity components in a manner that will reflect the entity’s nonconvertible
debt borrowing rate when interest cost is recognized in subsequent
periods. The guidance is effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years. The guidance was applied retrospectively to all
periods presented unless instruments were not outstanding during any period
included in the financial statements. In October 2009, the Company
reissued its financial statements as December 31, 2008 and 2007, and for the
three years ended December 31, 2008, to reflect the adoption of this
authoritative guidance on a retrospective basis. The adoption of the
guidance affected the accounting for our 3.5% Convertible Debentures due
September 30, 2035 (the “3.5% Debentures”). Upon adoption of the
guidance, the effective interest rate on our 3.5% Debentures increased to 7.4
percent, which resulted in the recognition of a $45 million discount to these
notes with the offsetting after tax amount recorded to paid-in
capital. Such discount is amortized as interest expense over the
remaining life of the 3.5% Debentures.
Amounts
related to the 3.5% Debentures are reflected in our consolidated balance sheet
at December 31, 2009 and 2008, as follows (dollars in millions):
|
December 31,
|
||||||||
|
2009
|
2008
|
|||||||
|
Increase
to additional paid-in
capital
|
$ | 28.0 | $ | 28.0 | ||||
|
Par
value of 3.5%
Debentures
|
$ | 116.5 | $ | 293.0 | ||||
|
Unamortized
discount
|
(3.3 | ) | (18.3 | ) | ||||
|
Carrying
value of 3.5%
Debentures
|
$ | 113.2 | $ | 274.7 | ||||
147
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
Interest
expense related to the 3.5% Debentures includes the following at December 31,
2009, 2008 and 2007 (dollars in millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Contractual
interest
expense
|
$ | 9.4 | $ | 11.3 | $ | 11.5 | ||||||
|
Amortization
of
discount
|
9.4 | 9.5 | 8.9 | |||||||||
|
Amortization
of debt issue
costs
|
1.1 | 1.3 | 1.3 | |||||||||
|
Total
interest
expense
|
$ | 19.9 | $ | 22.1 | $ | 21.7 | ||||||
In
January 2009, the FASB issued authoritative guidance which amended certain
impairment guidance by removing the exclusive reliance upon market participant
assumptions about future cash flows when evaluating the impairment of certain
securities. The guidance permits the use of reasonable management
judgment of the probability that the holder will be unable to collect all
amounts due. The guidance is effective prospectively for interim and
annual reporting periods ending after December 15, 2008. The Company
adopted the guidance on December 31, 2008 and the adoption did not have a
material effect on our consolidated financial statements.
In March
2008, the FASB issued authoritative guidance regarding whether unvested share
based payment awards that contain non-forfeitable rights to dividends or
dividend equivalents (whether paid or unpaid) are to be treated as participating
securities prior to vesting and, therefore, must be included in the earnings
allocation in calculating earnings per share under the two-class
method. The guidance is effective for financial statements issued for
fiscal years beginning after December 15, 2008, and interim periods within those
years and requires retrospective application. Our adoption of the
guidance did not have a material effect on our earnings per share calculations
due to the immateriality of unvested restricted shares that are considered to be
participating securities.
In March
2008, the FASB issued authoritative guidance which required enhanced disclosures
about an entity’s derivative and hedging activities. The guidance is
effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008. The adoption of the guidance did
not have a material effect on our consolidated financial
statements.
In
December 2007, the FASB issued authoritative guidance which establishes new
standards governing the accounting for and reporting of noncontrolling interests
(previously referred to as minority interests). The guidance
establishes reporting requirements which include, among other things, that
noncontrolling interests be reflected as a separate component of equity, not as
a liability. It also requires that the interests of the parent and
the noncontrolling interest be clearly identifiable. Additionally,
increases and decreases in a parent’s ownership interest that leave control
intact shall be reflected as equity transactions, rather than step acquisitions
or dilution gains or losses. The guidance is effective for fiscal
years beginning on or after December 15, 2008. The initial adoption
of this guidance had no effect on our consolidated financial
statements.
In
December 2007, the FASB issued authoritative guidance which requires the
acquiring entity in a business combination to recognize all assets acquired and
liabilities assumed in a transaction at the acquisition date fair value, with
certain exceptions. Additionally, the guidance requires changes to
the accounting treatment of acquisition related items, including, among other
items, transaction costs, contingent consideration, restructuring costs,
indemnification assets and tax benefits. The guidance also provides
for a substantial number of new disclosure requirements. The guidance
is effective for business combinations initiated on or after the first annual
reporting period beginning after December 15, 2008. We expect that
the guidance will have an effect on our accounting for business combinations, if
any, that are made in the future. In addition, the guidance changes
the previous requirement that reductions in a valuation allowance for deferred
tax assets established in conjunction with the implementation of fresh-start
accounting be recognized as a direct increase to additional paid-in
capital. Instead, the revised standard requires that any such
reduction be reported as a decrease to income tax expense through the
consolidated statement of operations. Accordingly, any reductions to
our valuation allowance for deferred tax assets will be reported as a decrease
to income tax expense, after the effective date of the guidance.
In
December 2008, the FASB issued authoritative guidance which required public
entities to provide additional disclosures about transferors’ continuing
involvements with transferred financial assets and to provide additional
disclosures about their involvement with VIEs. The guidance was
effective for financial statements issued for fiscal years and interim periods
ending after December 15, 2008. We adopted the guidance on December
31, 2008 and it did not have a material
148
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
effect on
our consolidated financial statements.
In
February 2007, the FASB issued authoritative guidance which allows entities to
choose to measure many financial instruments and certain other items, including
insurance contracts, at fair value (on an instrument-by-instrument basis) that
are not currently required to be measured at fair value. The
objective is to improve financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex hedge
accounting provisions. We adopted the guidance on January 1,
2008. We did not elect the fair value option for any of our financial
assets or liabilities.
In April
2007, FASB issued authoritative guidance which allows fair value amounts
recognized for collateral to be offset against fair value amounts recognized for
derivative instruments that are executed with the same counterparty under
certain circumstances. The guidance also requires an entity to
disclose the accounting policy decision to offset, or not to offset, fair value
amounts. We do not, and have not previously, offset the fair value
amounts recognized for derivatives with the amounts recognized as
collateral. All collateral is maintained in a tri-party custodial
account. At December 31, 2008, $11.4 million of derivative
liabilities had been offset against derivative assets executed with the same
counterparty under master netting arrangements. There were no such
derivative liabilities offset against derivative assets at December 31,
2009. We adopted the guidance on January 1, 2008, and it did not have
a material effect on our consolidated financial statements.
|
|
5.
|
INVESTMENTS
|
At
December 31, 2009, the amortized cost and estimated fair value of actively
managed fixed maturities and equity securities were as follows (dollars in
millions):
|
Gross
|
Gross
|
Estimated
|
||||||||||||||
|
Amortized
|
unrealized
|
unrealized
|
fair
|
|||||||||||||
|
cost
|
gains
|
losses
|
value
|
|||||||||||||
|
Investment
grade (a):
|
||||||||||||||||
|
Corporate
securities
|
$ | 13,069.8 | $ | 371.9 | $ | (315.4 | ) | $ | 13,126.3 | |||||||
|
United
States Treasury securities and obligations of United States government
corporations and agencies
|
268.5 | 4.6 | (3.5 | ) | 269.6 | |||||||||||
|
States
and political subdivisions
|
924.2 | 3.0 | (78.4 | ) | 848.8 | |||||||||||
|
Debt
securities issued by foreign governments
|
4.8 | .3 | - | 5.1 | ||||||||||||
|
Asset-backed
securities
|
154.1 | 1.7 | (17.9 | ) | 137.9 | |||||||||||
|
Collateralized
debt obligations
|
84.1 | 1.2 | (.6 | ) | 84.7 | |||||||||||
|
Commercial
mortgage-backed securities
|
867.7 | 6.2 | (108.2 | ) | 765.7 | |||||||||||
|
Mortgage
pass-through securities
|
41.1 | 1.6 | (.1 | ) | 42.6 | |||||||||||
|
Collateralized
mortgage obligations
|
1,801.4 | 4.2 | (81.0 | ) | 1,724.6 | |||||||||||
|
Total
investment grade actively managed fixed maturities
|
17,215.7 | 394.7 | (605.1 | ) | 17,005.3 | |||||||||||
|
Below-investment
grade (a):
|
||||||||||||||||
|
Corporate
securities
|
1,275.4 | 5.8 | (116.1 | ) | 1,165.1 | |||||||||||
|
States
and political subdivisions
|
6.9 | - | (2.1 | ) | 4.8 | |||||||||||
|
Asset-backed
securities
|
90.9 | - | (36.7 | ) | 54.2 | |||||||||||
|
Collateralized
debt obligations
|
12.8 | - | (4.7 | ) | 8.1 | |||||||||||
|
Commercial
mortgage-backed securities
|
1.6 | - | (1.3 | ) | .3 | |||||||||||
|
Collateralized
mortgage obligations
|
394.7 | - | (104.1 | ) | 290.6 | |||||||||||
|
Total
below-investment grade actively managed fixed maturities
|
1,782.3 | 5.8 | (265.0 | ) | 1,523.1 | |||||||||||
|
Total
actively managed fixed
maturities
|
$ | 18,998.0 | $ | 400.5 | $ | (870.1 | ) | $ | 18,528.4 | |||||||
|
Equity
securities
|
$ | 30.7 | $ | .8 | $ | (.5 | ) | $ | 31.0 | |||||||
149
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
_______________
|
|
(a)
|
Investment
ratings – Investment ratings are assigned the second lowest rating by a
nationally recognized statistical rating organization (Moody’s Investor
Services, Inc. (“Moody’s”), S&P or Fitch Ratings (“Fitch”)), or if not
rated by such firms, the rating assigned by the NAIC. NAIC
designations of “1” or “2” include fixed maturities generally rated
investment grade (rated “Baa3” or higher by Moody’s or rated “BBB-” or
higher by S&P and Fitch. NAIC designations of “3” through
“6” are referred to as below investment grade (which generally are rated
“Ba1” or lower by Moody’s or rated “BB+” or lower by S&P and
Fitch). References to investment grade or below investment
grade throughout our consolidated financial statements are determined as
described above.
|
At
December 31, 2008, the amortized cost and estimated fair value of actively
managed fixed maturities and equity securities were as follows (dollars in
millions):
|
Gross
|
Gross
|
Estimated
|
||||||||||||||
|
Amortized
|
unrealized
|
unrealized
|
fair
|
|||||||||||||
|
cost
|
gains
|
losses
|
value
|
|||||||||||||
|
Investment
grade:
|
||||||||||||||||
|
Corporate
securities
|
$ | 11,963.9 | $ | 76.5 | $ | (1,819.2 | ) | $ | 10,221.2 | |||||||
|
United
States Treasury securities and obligations of United States government
corporations and agencies
|
122.3 | 8.7 | (.4 | ) | 130.6 | |||||||||||
|
States
and political subdivisions
|
427.4 | .4 | (52.2 | ) | 375.6 | |||||||||||
|
Debt
securities issued by foreign governments
|
6.2 | .1 | (.8 | ) | 5.5 | |||||||||||
|
Asset-backed
securities
|
291.3 | - | (87.6 | ) | 203.7 | |||||||||||
|
Collateralized
debt obligations
|
122.5 | .3 | (31.1 | ) | 91.7 | |||||||||||
|
Commercial
mortgage-backed securities
|
808.9 | .7 | (263.1 | ) | 546.5 | |||||||||||
|
Mortgage
pass-through securities
|
75.0 | 1.4 | (.1 | ) | 76.3 | |||||||||||
|
Collateralized
mortgage obligations
|
2,901.5 | 59.0 | (533.7 | ) | 2,426.8 | |||||||||||
|
Total
investment grade actively managed fixed maturities
|
16,719.0 | 147.1 | (2,788.2 | ) | 14,077.9 | |||||||||||
|
Below-investment
grade:
|
||||||||||||||||
|
Corporate
securities
|
1,498.1 | 21.4 | (367.4 | ) | 1,152.1 | |||||||||||
|
States
and political subdivisions
|
8.6 | - | (1.6 | ) | 7.0 | |||||||||||
|
Debt
securities issued by foreign governments
|
4.2 | - | (1.1 | ) | 3.1 | |||||||||||
|
Collateralized
debt obligations
|
11.8 | - | (6.9 | ) | 4.9 | |||||||||||
|
Commercial
mortgage-backed securities
|
23.3 | - | (2.6 | ) | 20.7 | |||||||||||
|
Collateralized
mortgage obligations
|
11.3 | - | - | 11.3 | ||||||||||||
|
Total
below-investment grade actively managed fixed maturities
|
1,557.3 | 21.4 | (379.6 | ) | 1,199.1 | |||||||||||
|
Total
actively managed fixed
maturities
|
$ | 18,276.3 | $ | 168.5 | $ | (3,167.8 | ) | $ | 15,277.0 | |||||||
|
Equity
securities
|
$ | 31.0 | $ | 1.5 | $ | (.1 | ) | $ | 32.4 | |||||||
150
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
At
December 31, 2009, the amortized cost, gross unrealized gains and losses,
other-than-temporary impairments in other comprehensive loss and estimated fair
value of actively managed fixed maturities were as follows (dollars in
millions):
|
Other-than-
|
||||||||||||||||||||
|
temporary
|
||||||||||||||||||||
|
impairments
|
||||||||||||||||||||
|
Gross
|
Gross
|
included
in other
|
||||||||||||||||||
|
Amortized
|
unrealized
|
unrealized
|
Estimated
|
comprehensive
|
||||||||||||||||
|
cost
|
gains
|
losses
|
fair value
|
loss
|
||||||||||||||||
|
Corporate
securities
|
$ | 14,345.2 | $ | 377.7 | $ | (431.5 | ) | $ | 14,291.4 | $ | - | |||||||||
|
United
States Treasury securities and obligations of United States government
corporations and agencies
|
268.5 | 4.6 | (3.5 | ) | 269.6 | - | ||||||||||||||
|
States
and political subdivisions
|
931.1 | 3.0 | (80.5 | ) | 853.6 | - | ||||||||||||||
|
Debt
securities issued by foreign governments
|
4.8 | .3 | - | 5.1 | - | |||||||||||||||
|
Asset-backed
securities
|
245.0 | 1.7 | (54.6 | ) | 192.1 | (35.1 | ) | |||||||||||||
|
Collateralized
debt obligations
|
96.9 | 1.2 | (5.3 | ) | 92.8 | - | ||||||||||||||
|
Commercial
mortgage-backed securities
|
869.3 | 6.2 | (109.5 | ) | 766.0 | (1.4 | ) | |||||||||||||
|
Mortgage
pass-through securities
|
41.1 | 1.6 | (.1 | ) | 42.6 | - | ||||||||||||||
|
Collateralized
mortgage obligations
|
2,196.1 | 4.2 | (185.1 | ) | 2,015.2 | (132.4 | ) | |||||||||||||
|
Total
investment grade actively
managed
fixed maturities
|
$ | 18,998.0 | $ | 400.5 | $ | (870.1 | ) | $ | 18,528.4 | $ | (168.9 | ) | ||||||||
Accumulated
other comprehensive loss is primarily comprised of the net effect of unrealized
appreciation (depreciation) on our investments. These amounts,
included in shareholders’ equity as of December 31, 2009 and 2008 were as
follows (dollars in millions):
|
2009
|
2008
|
|||||||
|
Net
unrealized depreciation on actively managed fixed maturity securities
on
which
an other-than-temporary impairment loss has been
recognized
|
$ | (133.5 | ) | $ | - | |||
|
Net
unrealized losses on all other
investments
|
(339.9 | ) | (3,015.9 | ) | ||||
|
Adjustment
to value of policies inforce at the Effective
Date
|
10.7 | 111.0 | ||||||
|
Adjustment
to cost of policies
produced
|
59.8 | 154.8 | ||||||
|
Unrecognized
net loss related to deferred compensation
plan
|
(8.2 | ) | (8.0 | ) | ||||
|
Deferred
income tax
asset
|
146.8 | 987.4 | ||||||
|
Accumulated
other comprehensive
loss
|
$ | (264.3 | ) | $ | (1,770.7 | ) | ||
151
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
Concentration
of Actively Managed Fixed Maturity Securities
The
following table summarizes the carrying values of our actively managed fixed
maturity securities by category as of December 31, 2009 (dollars in
millions):
|
Percent
of
|
||||||||||||||||
|
Gross
|
gross
|
|||||||||||||||
|
Percent
of
|
unrealized
|
unrealized
|
||||||||||||||
|
Carrying value
|
fixed maturities
|
losses
|
losses
|
|||||||||||||
|
Collateralized
mortgage obligations
|
$ | 2,015.2 | 10.9 | % | $ | (185.1 | ) | 21.3 | % | |||||||
|
Utilities
|
1,928.8 | 10.4 | (32.1 | ) | 3.7 | |||||||||||
|
Energy/pipelines
|
1,687.1 | 9.1 | (19.9 | ) | 2.3 | |||||||||||
|
Healthcare/pharmaceuticals
|
1,420.9 | 7.7 | (23.1 | ) | 2.7 | |||||||||||
|
Food/beverage
|
1,247.5 | 6.7 | (16.9 | ) | 1.9 | |||||||||||
|
States
and political
subdivisions
|
853.6 | 4.6 | (80.5 | ) | 9.3 | |||||||||||
|
Banks
|
848.6 | 4.6 | (97.6 | ) | 11.2 | |||||||||||
|
Insurance
|
845.8 | 4.6 | (63.0 | ) | 7.2 | |||||||||||
|
Cable/media
|
792.9 | 4.3 | (22.0 | ) | 2.5 | |||||||||||
|
Commercial
mortgage-backed securities
|
766.0 | 4.1 | (109.5 | ) | 12.6 | |||||||||||
|
Capital
goods
|
689.0 | 3.7 | (12.0 | ) | 1.4 | |||||||||||
|
Aerospace/defense
|
563.2 | 3.0 | (10.9 | ) | 1.2 | |||||||||||
|
Telecom
|
547.7 | 2.9 | (12.3 | ) | 1.4 | |||||||||||
|
Real
estate/REITs
|
542.4 | 2.9 | (27.6 | ) | 3.2 | |||||||||||
|
Transportation
|
473.9 | 2.6 | (4.9 | ) | .6 | |||||||||||
|
Building
materials
|
344.6 | 1.9 | (7.6 | ) | .9 | |||||||||||
|
Consumer
products
|
283.1 | 1.5 | (5.7 | ) | .6 | |||||||||||
|
Technology
|
282.1 | 1.5 | (9.6 | ) | 1.1 | |||||||||||
|
U.S.
Treasury and
Obligations
|
269.6 | 1.5 | (3.5 | ) | .4 | |||||||||||
|
Chemicals
|
214.1 | 1.2 | (3.9 | ) | .4 | |||||||||||
|
Entertainment/hotels
|
198.9 | 1.1 | (6.2 | ) | .7 | |||||||||||
|
Asset-backed
securities
|
192.1 | 1.0 | (54.6 | ) | 6.3 | |||||||||||
|
Other
|
1,521.3 | 8.2 | (61.6 | ) | 7.1 | |||||||||||
|
Total
actively managed fixed maturities
|
$ | 18,528.4 | 100.0 | % | $ | (870.1 | ) | 100.0 | % | |||||||
Below-Investment
Grade Securities
At
December 31, 2009, the amortized cost of the Company’s below-investment grade
fixed maturity securities was $1,782.3 million, or 9 percent of the Company’s
fixed maturity portfolio. The estimated fair value of the
below-investment grade portfolio was $1,523.1 million, or 85 percent of the
amortized cost.
Below-investment
grade fixed maturity securities with an amortized cost of $284.7 million and an
estimated fair value of $262.3 million are held by a VIE that we are required to
consolidate. These fixed maturity securities are legally isolated and
are not available to the Company. The liabilities of such VIE will be
satisfied from the cash flows generated by these securities and are not
obligations of the Company. Refer to the note to the consolidated
financial statements entitled “Investment in a Variable Interest Entity”
concerning the Company’s investment in the VIE.
Below-investment
grade corporate debt securities have different characteristics than investment
grade corporate debt securities. Based on historical performance,
probability of default by the borrower is significantly greater for
below-investment grade corporate debt securities and in many cases severity of
loss is relatively greater as such securities are generally unsecured and often
subordinated to other indebtedness of the issuer. Also, issuers of
below-investment grade corporate debt securities frequently have higher levels
of debt relative to investment-grade issuers, hence, all other things being
equal, are more sensitive to adverse economic conditions, such as recession or
increasing interest rates. The Company attempts to reduce the overall
risk related to its investment in below-investment grade securities, as in all
investments, through careful credit analysis, strict investment policy
guidelines, and diversification by issuer and/or guarantor and by
industry.
152
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
Contractual
Maturity
The
following table sets forth the amortized cost and estimated fair value of
actively managed fixed maturities at December 31, 2009, 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. Asset-backed securities,
collateralized debt obligations, commercial mortgage-backed securities, mortgage
pass-through securities and collateralized mortgage obligations are collectively
referred to as “structured securities”. Many of the structured
securities shown below provide for periodic payments throughout their lives
(dollars in millions):
|
Estimated
|
||||||||
|
Amortized
|
fair
|
|||||||
|
cost
|
value
|
|||||||
|
Due
in one year or
less
|
$ | 76.9 | $ | 77.4 | ||||
|
Due
after one year through five
years
|
1,357.9 | 1,359.2 | ||||||
|
Due
after five years through ten
years
|
4,874.1 | 4,932.4 | ||||||
|
Due
after ten
years
|
9,240.7 | 9,050.7 | ||||||
|
Subtotal
|
15,549.6 | 15,419.7 | ||||||
|
Structured
securities
|
3,448.4 | 3,108.7 | ||||||
|
Total
actively managed fixed maturities
|
$ | 18,998.0 | $ | 18,528.4 | ||||
Net
Investment Income
Net
investment income consisted of the following (dollars in millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Fixed
maturities
|
$ | 1,083.7 | $ | 1,094.4 | $ | 1,194.9 | ||||||
|
Trading
income related to policyholder and reinsurer accounts and other
special-purpose portfolios
|
9.7 | 28.6 | 27.8 | |||||||||
|
Equity
securities
|
1.5 | 1.4 | 1.6 | |||||||||
|
Mortgage
loans
|
130.8 | 126.1 | 109.3 | |||||||||
|
Policy
loans
|
21.2 | 23.6 | 26.5 | |||||||||
|
Options
related to equity-indexed products:
|
||||||||||||
|
Option
income
(loss)
|
(63.0 | ) | (71.9 | ) | 43.8 | |||||||
|
Change
in value of
options
|
113.7 | (32.4 | ) | (52.3 | ) | |||||||
|
Other
invested
assets
|
11.4 | 13.8 | 10.8 | |||||||||
|
Cash
and cash
equivalents
|
1.1 | 11.9 | 24.0 | |||||||||
|
Gross
investment
income
|
1,310.1 | 1,195.5 | 1,386.4 | |||||||||
|
Less
investment
expenses
|
17.4 | 16.7 | 16.6 | |||||||||
|
Net
investment
income
|
$ | 1,292.7 | $ | 1,178.8 | $ | 1,369.8 | ||||||
The
estimated fair value of fixed maturity investments and mortgage loans not
accruing investment income totaled $39.8 million and $15.5 million at December
31, 2009 and 2008, respectively.
153
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
Net
Realized Investment Gains (Losses)
The
following table sets forth the net realized investment gains (losses) for the
periods indicated (dollars in millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Actively
managed fixed maturity securities:
|
||||||||||||
|
Realized
gains on
sale
|
$ | 367.9 | $ | 110.3 | $ | 81.9 | ||||||
|
Realized
losses on
sale
|
(233.9 | ) | (177.3 | ) | (124.7 | ) | ||||||
|
Impairments:
|
||||||||||||
|
Total
other-than-temporary impairment
losses
|
(337.8 | ) | (152.7 | ) | (98.3 | ) | ||||||
|
Other-than-temporary
impairment losses recognized in other
comprehensive
loss
|
188.3 | - | - | |||||||||
|
Net
impairment losses
recognized
|
(149.5 | ) | (152.7 | ) | (98.3 | ) | ||||||
|
Net
realized investment losses from fixed maturities
|
(15.5 | ) | (219.7 | ) | (141.1 | ) | ||||||
|
Equity
securities
|
- | - | (5.0 | ) | ||||||||
|
Commercial
mortgage
loans
|
(13.5 | ) | (19.7 | ) | (.2 | ) | ||||||
|
Other-than-temporary
declines in fair value of mortgage loans and other invested
assets
|
(45.9 | ) | (9.6 | ) | (7.2 | ) | ||||||
|
Other
|
14.4 | (13.4 | ) | (4.5 | ) | |||||||
|
Net
realized investment
losses
|
$ | (60.5 | ) | $ | (262.4 | ) | $ | (158.0 | ) | |||
During
2009, we recognized net realized investment losses of $60.5 million, which were
comprised of $134.9 million of net gains from the sales of investments
(primarily fixed maturities) with proceeds of $10.7 billion and $195.4 million
of writedowns of investments for other than temporary declines in fair value
recognized through net income ($385.0 million, prior to the $189.6 million of
impairment losses recognized through other comprehensive loss).
During
2008, we recognized net realized investment losses of $262.4 million, which were
comprised of: (i) $100.1 million of net losses from the sales of
investments (primarily fixed maturities); and (ii) $162.3 million of writedowns
of investments for other than temporary declines in fair value (no single
investment accounted for more than $10 million of such
writedowns). During 2007, net realized investment losses
included: (i) $52.5 million of net losses from the sales of
investments (primarily fixed maturities); (ii) $31.8 million of writedowns of
investments for other than temporary declines in fair value (no single
investment accounted for more than $5.0 million of such writedowns); and (iii)
$73.7 million of writedowns of investments (which were subsequently transferred
pursuant to a coinsurance agreement as further discussed in the note to the
consolidated financial statements entitled “Summary of Significant Accounting
Policies - Reinsurance”) as a result of our intent not to hold such investments
for a period of time sufficient to allow for any anticipated recovery in
value.
At
December 31, 2009, fixed maturity securities in default as to the payment of
principal or interest had an aggregate amortized cost of $15.0 million and a
carrying value of $15.7 million. We also had mortgage loans with an
aggregate carrying value of $24.1 million that were in the process of
foreclosure at December 31, 2009.
During
2009, the $195.4 million of other-than-temporary impairments we recorded in
earnings included: (i) $83.6 million of losses related to
mortgage-backed and asset-backed securities, primarily reflecting changes
related to the performance of the underlying assets and, for certain securities,
changes in our intent regarding continuing to hold the securities; (ii) $40.9
million of losses related to commercial mortgage loans reflecting our concerns
regarding the issuers’ ability to continue to make contractual payments related
to these loans and our estimate of the value of the underlying properties; (iii)
$13.8 million of losses related to securities issued by a large commercial
lender that recently filed bankruptcy; and (iv) $57.1 million of additional
losses primarily related to various corporate securities following unforeseen
issue-specific events or conditions and shifts in risks or uncertainty of the
issuer.
During
2009, the $233.9 million of realized losses on sales of $1.3 billion of actively
managed fixed maturity securities included: (i) $178.3 million of
losses related to the sales of mortgage-backed securities and asset-backed
securities;
154
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
(ii)
$11.3 million of losses related to the sale of securities issued by providers of
financial guarantees and mortgage insurance; and (iii) $44.3 million of
additional losses primarily related to various corporate
securities. Securities are generally sold at a loss following
unforeseen issue-specific events or conditions and shifts in risks or
uncertainty of certain securities. These reasons include but are not
limited to: (i) changes in the investment environment; (ii)
expectation that the fair value could deteriorate further; (iii) desire to
reduce our exposure to an asset class, an issuer or an industry; (iv) changes in
credit quality; or (v) changes in expected liability cash flows.
During
2008, the $162.3 million of other-than-temporary impairments we recorded
included: (i) $54.0 million of losses related to mortgage-backed and
asset-backed securities, primarily reflecting changes related to the performance
of the underlying assets and, for certain securities, changes in our intent
regarding continuing to hold the securities; (ii) $20.7 million of losses
related to securities issued by a large investment bank and a financial
institution which filed for bankruptcy; (iii) $11.8 million of losses related to
securities issued by casino gaming companies which have significant debt
obligations which were expected to be difficult to refinance in the current
investment environment; (iv) $11.0 million related to securities issued by
publishers of telephone directories which are experiencing financial
difficulties; and (v) $64.8 million of additional losses primarily related to
various corporate securities following unforeseen issue-specific events or
conditions and shifts in risks or uncertainty of the issuer.
During
2008, the $177.3 million of losses on sales of actively managed fixed maturity
securities included: (i) $55.5 million of losses related to the sales
of mortgage-backed securities and asset-backed securities; (ii) $47.0 million of
losses related to the sales of securities issued by two large investment banks
and a large financial institution which filed for bankruptcy protection; and
(iii) $74.8 million of additional losses primarily related to various corporate
securities. Securities are generally sold at a loss following
unforeseen issue-specific events or conditions and shifts in risks or
uncertainty of certain securities. These reasons include, but are not
limited to: (i) changes in the investment environment; (ii)
expectation that the fair value could deteriorate further; (iii) desire to
reduce our exposure to an asset class, an issuer or an industry; (iv) changes in
credit quality; or (v) changes in expected liability cash flows.
Our fixed
maturity investments are generally purchased in the context of a long-term
strategy to fund insurance liabilities, so we do not generally seek to purchase
and sell such securities to generate short-term realized gains. In
certain circumstances, including those in which securities are selling at prices
which exceed our view of their underlying economic value, or when it is possible
to reinvest the proceeds to better meet our long-term asset-liability matching
objectives, we may sell certain securities.
The
following summarizes the investments sold at a loss during 2009 which had been
continuously in an unrealized loss position exceeding 20 percent of the
amortized cost basis prior to the sale for the period indicated (dollars in
millions):
|
At date of sale
|
||||||||||||
|
Number
of
|
Amortized
|
Fair
|
||||||||||
|
Period
|
issuers
|
cost
|
value
|
|||||||||
|
Less
than 6 months prior to
sale
|
8 | $ | 29.6 | $ | 22.7 | |||||||
|
Greater
than or equal to 6 and less than 12 months prior to sale
|
26 | 130.9 | 77.3 | |||||||||
|
Greater
than 12
months
|
43 | 224.7 | 109.4 | |||||||||
| 77 | $ | 385.2 | $ | 209.4 | ||||||||
During
the first quarter of 2009, we adopted newly issued authoritative guidance, which
changes the recognition and presentation of other-than-temporary
impairments. Refer to the note to the consolidated financial
statements entitled “Summary of Significant Accounting Policies - Adopted
Accounting Standards” for additional information. The recognition
provisions within this guidance apply only to our actively managed fixed
maturity investments.
Impairment
losses on equity securities are recognized in net income. The manner
in which impairment losses on actively managed fixed maturity securities are
recognized in the financial statements is dependent on the facts and
circumstances related to the specific security. If we intend to sell
a security or it is more likely than not that we would be required to sell a
security before the recovery of its amortized cost, the security is
other-than-temporarily impaired and the full amount of the impairment is
recognized as a loss through earnings. If we do not expect to recover
the amortized cost basis, we do not plan to sell the security and if it is not
more likely than not that we would be required to sell a security
before
155
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
the
recovery of its amortized cost, less any current period credit loss, the
recognition of the other-than-temporary impairment is bifurcated. We
recognize the credit loss portion in net income and the noncredit loss portion
in other comprehensive loss. Prior to 2009, such other-than-temporary
impairments were recognized in their entirety through earnings and the amount
recognized was the difference between amortized cost and estimated fair
value.
We
estimate the amount of the credit loss component of a fixed maturity security
impairment as the difference between amortized cost and the present value of the
expected cash flows of the security. The present value is determined
using the best estimate of future cash flows discounted at the effective
interest rate implicit to the security at the date of purchase or the current
yield to accrete an asset-backed or floating rate security. The
methodology and assumptions for establishing the best estimate of future cash
flows vary depending on the type of security. The asset-backed
securities cash flow estimates are based on bond specific facts and
circumstances that may include collateral characteristics, expectations of
delinquency and default rates, loss severity, prepayment speeds and structural
support, including subordination and guarantees. The corporate bond
cash flow estimates are derived from scenario-based outcomes of expected
corporate restructurings or the disposition of assets using bond specific facts
and circumstances including timing, secured interest and loss
severity. The remaining non-credit impairment, which is recorded in
accumulated other comprehensive income (loss), is the difference between the
security’s estimated fair value and our best estimate of future cash flows
discounted at the effective interest rate prior to impairment. The
remaining non-credit impairment typically represents changes in the market
interest rates, current market liquidity and risk premiums. The
previous amortized cost basis less the impairment recognized in net income
becomes the security’s new cost basis. We accrete the new cost basis
to the estimated future cash flows over the expected remaining life of the
security. As of December 31, 2009, other-than-temporary impairments
included in accumulated other comprehensive loss of $170.2 million (before taxes
and related amortization) primarily relate to asset-backed securities (including
collateralized debt obligations and collateralized mortgage
obligations).
We
regularly evaluate our investments for possible impairment. Our
assessment of whether unrealized losses are “other than temporary” requires
significant judgment. Factors considered include: (i) the
extent to which fair value is less than the cost basis; (ii) the length of time
that the fair value has been less than cost; (iii) whether the unrealized loss
is event driven, credit-driven or a result of changes in market interest rates
or risk premium; (iv) the near-term prospects for specific events, developments
or circumstances likely to affect the value of the investment; (v) the
investment’s rating and whether the investment is investment-grade and/or has
been downgraded since its purchase; (vi) whether the issuer is current on all
payments in accordance with the contractual terms of the investment and is
expected to meet all of its obligations under the terms of the investment; (vii)
whether or not we intend to retain the investment until its anticipated recovery
occurs; (viii) whether it is more likely than not that circumstances will
require us to sell the investment before recovery occurs; (ix) the underlying
current and prospective asset and enterprise values of the issuer and the extent
to which the recoverability of the carrying value of our investment may be
affected by changes in such values; (x) unfavorable changes in cash flows
on structured securities including mortgage-backed and asset-backed securities;
and (xi) other subjective factors.
Future
events may occur, or additional information may become available, which may
necessitate future realized losses of securities in our
portfolio. Significant losses in the estimated fair values of our
investments could have a material adverse effect on our earnings in future
periods.
The
following table summarizes the amount of credit losses recognized in earnings on
actively managed fixed maturity securities held at the beginning of the period,
for which a portion of the other-than-temporary impairment was also recognized
in other comprehensive loss for the year ended December 31, 2009 (dollars in
millions):
|
Year
ended
|
||||
|
December
31,
|
||||
|
2009
|
||||
|
Credit
losses on actively managed fixed maturity securities, beginning of
year
|
$ | (.6 | ) | |
|
Add: credit
losses on other-than-temporary impairments not previously
recognized
|
(20.7 | ) | ||
|
Less: credit
losses on securities sold
|
5.4 | |||
|
Less: credit
losses on securities impaired due to intent to sell
|
- | |||
|
Add: credit
losses on previously impaired securities
|
(11.3 | ) | ||
|
Less: increases
in cash flows expected on previously impaired securities
|
- | |||
|
Credit
losses on actively managed fixed maturity securities, end of
year
|
$ | (27.2 | ) | |
156
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
Investments
with Unrealized Losses
The
following table sets forth the amortized cost and estimated fair value of those
actively managed fixed maturities with unrealized losses at December 31, 2009,
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. Many of the
structured securities shown below provide for periodic payments throughout their
lives (dollars in millions):
|
Estimated
|
||||||||
|
Amortized
|
fair
|
|||||||
|
cost
|
value
|
|||||||
|
Due
in one year or
less
|
$ | 6.7 | $ | 6.6 | ||||
|
Due
after one year through five
years
|
549.1 | 514.2 | ||||||
|
Due
after five years through ten
years
|
2,021.4 | 1,923.1 | ||||||
|
Due
after ten
years
|
5,389.1 | 5,006.9 | ||||||
|
Subtotal
|
7,966.3 | 7,450.8 | ||||||
|
Structured
securities
|
2,763.2 | 2,408.6 | ||||||
|
Total
|
$ | 10,729.5 | $ | 9,859.4 | ||||
The
following summarizes the investments in our portfolio rated below-investment
grade which have been continuously in an unrealized loss position exceeding 20
percent of the cost basis for the period indicated as of December 31, 2009
(dollars in millions):
|
Number
|
Cost
|
Unrealized
|
Estimated
|
|||||||||||||
|
Period
|
of issuers
|
basis
|
loss
|
fair value
|
||||||||||||
|
Less
than 6
months
|
8 | $ | 29.6 | $ | (6.4 | ) | $ | 23.2 | ||||||||
|
Greater
than or equal to 6 months and less than 12 months
|
5 | 31.3 | (10.5 | ) | 20.8 | |||||||||||
|
Greater
than 12
months
|
46 | 496.4 | (157.6 | ) | 338.8 | |||||||||||
| 59 | $ | 557.3 | $ | (174.5 | ) | $ | 382.8 | |||||||||
157
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
The
following table summarizes the gross unrealized losses of our actively managed
fixed maturity securities by category and ratings category as of December 31,
2009 (dollars in millions):
|
Below investment grade
|
Total
gross
|
|||||||||||||||||||
|
Investment grade
|
B+
and
|
unrealized
|
||||||||||||||||||
|
AAA/AA/A
|
BBB
|
BB
|
below
|
losses
|
||||||||||||||||
|
Collateralized
mortgage obligations
|
$ | 73.4 | $ | 7.6 | $ | 22.2 | $ | 81.9 | $ | 185.1 | ||||||||||
|
Commercial
mortgage-backed securities
|
63.0 | 45.2 | - | 1.3 | 109.5 | |||||||||||||||
|
Banks
|
44.7 | 37.9 | 15.0 | - | 97.6 | |||||||||||||||
|
States
and political
subdivisions
|
43.0 | 35.4 | 1.8 | .3 | 80.5 | |||||||||||||||
|
Insurance
|
28.0 | 30.3 | 2.0 | 2.7 | 63.0 | |||||||||||||||
|
Asset-backed
securities
|
9.6 | 8.3 | 5.7 | 31.0 | 54.6 | |||||||||||||||
|
Utilities
|
14.1 | 12.6 | .5 | 4.9 | 32.1 | |||||||||||||||
|
Real
estate/REITs
|
.7 | 17.4 | 9.3 | .2 | 27.6 | |||||||||||||||
|
Healthcare/pharmaceuticals
|
14.8 | 5.5 | .8 | 2.0 | 23.1 | |||||||||||||||
|
Cable/media
|
1.7 | 11.3 | 2.2 | 6.8 | 22.0 | |||||||||||||||
|
Energy/pipelines
|
1.0 | 16.4 | 1.8 | .7 | 19.9 | |||||||||||||||
|
Food/beverage
|
4.1 | 10.3 | 1.2 | 1.3 | 16.9 | |||||||||||||||
|
Telecom
|
8.0 | .8 | 3.2 | .3 | 12.3 | |||||||||||||||
|
Capital
goods
|
6.6 | 4.1 | - | 1.3 | 12.0 | |||||||||||||||
|
Aerospace/defense
|
5.3 | 4.2 | .1 | 1.3 | 10.9 | |||||||||||||||
|
Technology
|
5.5 | 3.0 | .3 | .8 | 9.6 | |||||||||||||||
|
Paper
|
- | 1.1 | 7.2 | .3 | 8.6 | |||||||||||||||
|
Building
materials
|
- | 1.0 | 6.2 | .4 | 7.6 | |||||||||||||||
|
Entertainment/hotels
|
- | 3.3 | 2.0 | .9 | 6.2 | |||||||||||||||
|
Consumer
products
|
.7 | 3.6 | - | 1.4 | 5.7 | |||||||||||||||
|
Collateralized
debt
obligations
|
.4 | .2 | - | 4.7 | 5.3 | |||||||||||||||
|
Transportation
|
1.6 | 2.5 | .5 | .3 | 4.9 | |||||||||||||||
|
Retail
|
.7 | .3 | 2.0 | 1.5 | 4.5 | |||||||||||||||
|
Chemicals
|
- | 1.9 | .3 | 1.7 | 3.9 | |||||||||||||||
|
U.S.
Treasury and
Obligations
|
3.5 | - | - | - | 3.5 | |||||||||||||||
|
Brokerage
|
2.6 | .6 | - | .1 | 3.3 | |||||||||||||||
|
Textiles
|
2.4 | - | - | .7 | 3.1 | |||||||||||||||
|
Gaming
|
- | - | - | 3.0 | 3.0 | |||||||||||||||
|
Metals
and
mining
|
.1 | 1.0 | - | .2 | 1.3 | |||||||||||||||
|
Autos
|
.1 | - | - | .8 | .9 | |||||||||||||||
|
Mortgage
pass-through securities
|
.1 | - | - | - | .1 | |||||||||||||||
|
Other
|
1.0 | 2.6 | 24.4 | 3.5 | 31.5 | |||||||||||||||
|
Total
actively managed fixed maturities
|
$ | 336.7 | $ | 268.4 | $ | 108.7 | $ | 156.3 | $ | 870.1 | ||||||||||
We held
six below-investment grade collateralized mortgage obligations (backed by
residential mortgage loans) that had a cost basis of $215.3 million, an
estimated fair value of $152.3 million and unrealized losses of $63.0 million at
December 31, 2009. We also held three asset-backed securities (backed
primarily by home equity loans) that had a cost basis of $43.9 million, an
estimated fair value of $21.2 million and unrealized losses of $22.7 million at
December 31, 2009. These securities were subject to total
other-than-temporary impairment losses of $143.4 million in 2009, including
$129.5 million recognized in other comprehensive loss and $13.9 million
recognized in net income. As of December 31, 2009, these securities
had been in an unrealized loss position exceeding 20 percent of cost for over
one year and were rated from BB to CC. All of these securities are
senior tranches in their respective securitization structures. We
believe the declines in fair value are largely due to widening credit spreads
and increased premium for liquidity. Based on our estimates for the
performance of the underlying collateral, and our related estimate of future
cash flows expected to be collected from each of the securities, discounted at
the security’s original effective rate, the recoverable amount is equal to the
security’s cost basis at December 31, 2009.
Our
investment strategy is to maximize, over a sustained period and within
acceptable parameters of risk, investment income and total investment return
through active investment management. Accordingly, we may sell
securities at a gain or
158
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
a loss to
enhance the total return of the portfolio as market opportunities change or to
better match certain characteristics of our investment portfolio with the
corresponding characteristics of our insurance liabilities. While we
do not have the intent to sell securities with unrealized losses and it is not
more likely than not that we will be required to sell securities with unrealized
losses prior to their anticipated recovery, we may sell securities at a loss in
the future because of actual or expected changes in our view of the particular
investment, its industry, its type or the general investment
environment.
The
following table summarizes the gross unrealized losses and fair values of our
investments with unrealized losses that were not deemed to be
other-than-temporarily impaired, aggregated by investment category and length of
time that such securities had been in a continuous unrealized loss position, at
December 31, 2009 (dollars in millions):
|
Less
than 12 months
|
12
months or greater
|
Total
|
||||||||||||||||||||||
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
|||||||||||||||||||
|
Description of securities
|
value
|
losses
|
value
|
losses
|
value
|
losses
|
||||||||||||||||||
|
United
States Treasury securities and obligations of United States government
corporations and agencies
|
$ | 157.6 | $ | (3.5 | ) | $ | - | $ | - | $ | 157.6 | $ | (3.5 | ) | ||||||||||
|
States
and political subdivisions
|
375.1 | (18.0 | ) | 291.5 | (62.5 | ) | 666.6 | (80.5 | ) | |||||||||||||||
|
Debt
securities issued by foreign governments
|
- | - | - | - | - | - | ||||||||||||||||||
|
Corporate
securities
|
3,707.1 | (109.0 | ) | 2,919.5 | (322.5 | ) | 6,626.6 | (431.5 | ) | |||||||||||||||
|
Asset-backed
securities
|
7.2 | (.3 | ) | 133.1 | (54.3 | ) | 140.3 | (54.6 | ) | |||||||||||||||
|
Collateralized
debt obligations
|
34.5 | (.6 | ) | 5.7 | (4.7 | ) | 40.2 | (5.3 | ) | |||||||||||||||
|
Commercial
mortgage-backed securities
|
211.5 | (4.3 | ) | 250.8 | (105.2 | ) | 462.3 | (109.5 | ) | |||||||||||||||
|
Mortgage
pass-through securities
|
- | - | 4.2 | (.1 | ) | 4.2 | (.1 | ) | ||||||||||||||||
|
Collateralized
mortgage obligations
|
1,301.3 | (41.6 | ) | 460.3 | (143.5 | ) | 1,761.6 | (185.1 | ) | |||||||||||||||
|
Total
actively managed fixed maturities
|
$ | 5,794.3 | $ | (177.3 | ) | $ | 4,065.1 | $ | (692.8 | ) | $ | 9,859.4 | $ | (870.1 | ) | |||||||||
159
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
The
following table summarizes the gross unrealized losses and fair values of our
investments with unrealized losses that are not deemed to be
other-than-temporarily impaired, aggregated by investment category and length of
time that such securities have been in a continuous unrealized loss position, at
December 31, 2008 (dollars in millions):
|
Less
than 12 months
|
12
months or greater
|
Total
|
||||||||||||||||||||||
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
|||||||||||||||||||
|
Description of securities
|
value
|
losses
|
value
|
losses
|
value
|
losses
|
||||||||||||||||||
|
United
States Treasury securities and obligations of United States government
corporations and agencies
|
$ | 25.5 | $ | (.3 | ) | $ | 1.9 | $ | (.1 | ) | $ | 27.4 | $ | (.4 | ) | |||||||||
|
States
and political subdivisions
|
200.7 | (27.4 | ) | 148.8 | (26.4 | ) | 349.5 | (53.8 | ) | |||||||||||||||
|
Debt
securities issued by foreign governments
|
1.4 | - | 6.2 | (1.9 | ) | 7.6 | (1.9 | ) | ||||||||||||||||
|
Corporate
securities
|
5,125.7 | (787.9 | ) | 4,311.1 | (1,398.7 | ) | 9,436.8 | (2,186.6 | ) | |||||||||||||||
|
Asset-backed
securities
|
61.8 | (12.5 | ) | 141.9 | (75.1 | ) | 203.7 | (87.6 | ) | |||||||||||||||
|
Collateralized
debt obligations
|
54.9 | (11.4 | ) | 28.8 | (26.6 | ) | 83.7 | (38.0 | ) | |||||||||||||||
|
Commercial
mortgage-backed securities
|
137.1 | (27.3 | ) | 416.6 | (238.4 | ) | 553.7 | (265.7 | ) | |||||||||||||||
|
Mortgage
pass-through securities
|
13.7 | (.1 | ) | .3 | - | 14.0 | (.1 | ) | ||||||||||||||||
|
Collateralized
mortgage obligations
|
522.2 | (117.6 | ) | 547.8 | (416.1 | ) | 1,070.0 | (533.7 | ) | |||||||||||||||
|
Total
actively managed fixed maturities
|
$ | 6,143.0 | $ | (984.5 | ) | $ | 5,603.4 | $ | (2,183.3 | ) | $ | 11,746.4 | $ | (3,167.8 | ) | |||||||||
Based on
management’s current assessment of investments with unrealized losses at
December 31, 2009, the Company believes the issuers of the securities will
continue to meet their obligations (or with respect to equity-type securities,
the investment value will recover to its cost basis). While we do not
have the intent to sell securities with unrealized losses and it is not more
likely than not that we will be required to sell securities with unrealized
losses prior to their anticipated recovery, our intent on an individual security
may change, based upon market or other unforeseen developments. In
such instances, we sell securities in the ordinary course of managing our
portfolio to meet diversification, credit quality, yield, duration and liquidity
requirements. If a loss is recognized from a sale subsequent to a
balance sheet date due to these unexpected developments, the loss is recognized
in the period in which we had the intent to sell the securities before their
anticipated recovery.
Structured
Securities
At
December 31, 2009, fixed maturity investments included structured securities
with an estimated fair value of $3.1 billion (or 17 percent of all fixed
maturity securities). The yield characteristics of structured
securities differ in some respects from those of traditional fixed-income
securities. For example, interest and principal payments on
structured securities may occur more frequently, often monthly. In
many instances, we are subject to the risk that the amount and timing of
principal and interest payments may vary from expectations. For
example, prepayments may occur at the option of the issuer and prepayment rates
are influenced by a number of factors that cannot be predicted with certainty,
including: the relative sensitivity of the underlying assets backing
the security to changes in interest rates; a variety of economic, geographic and
other factors; and various security-specific structural considerations (for
example, the repayment priority of a given security in a securitization
structure).
In
general, the rate of prepayments on structured securities increases when
prevailing interest rates decline significantly in absolute terms and also
relative to the interest rates on the underlying assets. The yields
recognized on structured securities purchased at a discount to par will increase
(relative to the stated rate) when the underlying assets prepay faster than
expected. The yields recognized on structured securities purchased at
a premium will decrease (relative to the stated rate) when the underlying assets
prepay faster than expected. When interest rates decline, the
proceeds from prepayments may be reinvested at lower rates than we were earning
on the prepaid securities. When interest rates increase, prepayments
may decrease. When this occurs, the average maturity and duration of
the structured securities increase, which decreases the yield on structured
securities purchased at a discount because the discount is realized as income at
a slower rate, and it increases the yield on those purchased at a premium
because of a decrease in the annual amortization of the
premium.
160
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
For
structured securities included in actively managed fixed maturities that were
purchased at a discount or premium, we recognize investment income using an
effective yield based on anticipated future prepayments and the estimated final
maturity of the securities. Actual prepayment experience is
periodically reviewed and effective yields are recalculated when differences
arise between the prepayments originally anticipated and the actual prepayments
received and currently anticipated. For credit sensitive
mortgage-backed and asset-backed securities, and for securities that can be
prepaid or settled in a way that we would not recover substantially all of our
investment, the effective yield is recalculated on a prospective
basis. Under this method, the amortized cost basis in the security is
not immediately adjusted and a new yield is applied
prospectively. For all other structured and asset-backed securities,
the effective yield is recalculated when changes in assumptions are made, and
reflected in our income on a retrospective basis. Under this method,
the amortized cost basis of the investment in the securities is adjusted to the
amount that would have existed had the new effective yield been applied since
the acquisition of the securities. Such adjustments were not
significant in 2009.
The
following table sets forth the par value, amortized cost and estimated fair
value of structured securities, summarized by interest rates on the underlying
collateral, at December 31, 2009 (dollars in millions):
|
Par
|
Amortized
|
Estimated
|
||||||||||
|
value
|
cost
|
fair value
|
||||||||||
|
Below
4
percent
|
$ | 102.4 | $ | 84.1 | $ | 84.7 | ||||||
|
4
percent – 5
percent
|
571.8 | 561.4 | 539.1 | |||||||||
|
5
percent – 6
percent
|
2,083.2 | 2,058.5 | 1,867.9 | |||||||||
|
6
percent – 7
percent
|
589.3 | 567.9 | 482.3 | |||||||||
|
7
percent – 8
percent
|
129.8 | 126.8 | 90.9 | |||||||||
|
8
percent and
above
|
49.9 | 49.7 | 43.8 | |||||||||
|
Total
structured
securities
|
$ | 3,526.4 | $ | 3,448.4 | $ | 3,108.7 | ||||||
The
amortized cost and estimated fair value of structured securities at December 31,
2009, summarized by type of security, were as follows (dollars in
millions):
|
Estimated
fair value
|
||||||||||||
|
Percent
|
||||||||||||
|
Amortized
|
of
fixed
|
|||||||||||
|
Type
|
cost
|
Amount
|
maturities
|
|||||||||
|
Pass-throughs,
sequential and equivalent securities
|
$ | 1,425.9 | $ | 1,361.1 | 7.4 | % | ||||||
|
Planned
amortization classes, target amortization classes and accretion-directed
bonds
|
759.3 | 649.8 | 3.5 | |||||||||
|
Commercial
mortgage-backed
securities
|
869.3 | 766.0 | 4.1 | |||||||||
|
Asset-backed
securities
|
245.0 | 192.1 | 1.0 | |||||||||
|
Collateralized
debt
obligations
|
96.9 | 92.8 | .5 | |||||||||
|
Other
|
52.0 | 46.9 | .3 | |||||||||
|
Total
structured
securities
|
$ | 3,448.4 | $ | 3,108.7 | 16.8 | % | ||||||
Pass-throughs,
sequentials and equivalent securities have unique prepayment variability
characteristics. Pass-through securities typically return principal
to the holders based on cash payments from the underlying mortgage
obligations. Sequential securities return principal to tranche
holders in a detailed hierarchy. Planned amortization classes,
targeted amortization classes and accretion-directed bonds adhere to fixed
schedules of principal payments as long as the underlying mortgage loans
experience prepayments within certain estimated ranges. Changes in
prepayment rates are first absorbed by support or companion classes insulating
the timing of receipt of cash flows from the consequences of both faster
prepayments (average life shortening) and slower prepayments (average life
extension).
Commercial
mortgage-backed securities are secured by commercial real estate mortgages,
generally income producing properties that are managed for
profit. Property types include multi-family dwellings including
apartments, retail centers, hotels, restaurants, hospitals, nursing homes,
warehouses, and office buildings. Most commercial mortgage-backed
securities have call protection features whereby underlying borrowers may not
prepay their mortgages for stated periods of time
161
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
without
incurring prepayment penalties.
Commercial
Mortgage Loans
At
December 31, 2009, the mortgage loan balance was primarily comprised of
commercial loans. Approximately 7 percent, 7 percent, 7 percent, 6
percent and 6 percent of the mortgage loan balance were on properties located in
Indiana, Minnesota, Ohio, California and Arizona, respectively. No
other state comprised greater than 5 percent of the mortgage loan
balance. Less than one percent of the commercial mortgage loan
balance was noncurrent at December 31, 2009. We had no allowance for
losses on mortgage loans at both December 31, 2009 and 2008.
Securities Lending
The
Company participates in a securities lending program whereby certain fixed
maturity securities from our investment portfolio are loaned to third parties
via a lending agent for a short period of time. We maintain ownership
of the loaned securities. We require collateral equal to 102 percent
of the fair value of the loaned securities. The collateral is
invested by the lending agent in accordance with our guidelines. The
fair value of the loaned securities is monitored on a daily basis with
additional collateral obtained as necessary. Under the terms of the
securities lending program, the lending agent indemnifies the Company against
borrower defaults. As of December 31, 2009 and 2008, the fair value
of the loaned securities was $178.5 million and $389.3 million,
respectively. As of December 31, 2009 and 2008, the Company had
received collateral of $185.7 million and $408.8 million,
respectively. Income generated from the program, net of expenses is
recorded as net investment income and totaled $1.2 million, $2.4 million and
$1.3 million in 2009, 2008 and 2007, respectively.
Other
Investment Disclosures
Life
insurance companies are required to maintain certain investments on deposit with
state regulatory authorities. Such assets had aggregate carrying
values of $83.3 million and $76.2 million at December 31, 2009 and 2008,
respectively.
Conseco
had no fixed maturity investments that were in excess of 10 percent of
shareholders’ equity at December 31, 2009 and one fixed maturity investment,
with an amortized cost of $283.7 million and an estimated fair value of $305.0
million, that was in excess of 10 percent of shareholders’ equity at December
31, 2008 (other than investments issued or guaranteed by the United States
government or a United States government agency).
162
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
6. LIABILITIES
FOR INSURANCE PRODUCTS
These
liabilities consisted of the following (dollars in millions):
|
Interest
|
||||||||||||||||||||
|
Withdrawal
|
Mortality
|
rate
|
||||||||||||||||||
|
assumption
|
assumption
|
assumption
|
2009
|
2008
|
||||||||||||||||
|
Future
policy benefits:
|
||||||||||||||||||||
|
Interest-sensitive
products:
|
||||||||||||||||||||
|
Investment
contracts
|
N/A | N/A |
(c)
|
$ | 9,676.1 | $ | 9,612.9 | |||||||||||||
|
Universal
life
contracts
|
N/A | N/A | N/A | 3,543.1 | 3,719.9 | |||||||||||||||
|
Total
interest-sensitive products
|
13,219.2 | 13,332.8 | ||||||||||||||||||
|
Traditional
products:
|
||||||||||||||||||||
|
Traditional
life insurance contracts
|
Company
experience
|
(a)
|
5 | % | 2,325.4 | 2,300.2 | ||||||||||||||
|
Limited-payment
annuities
|
Company
experience,
if
applicable
|
(b)
|
4 | % | 892.8 | 917.2 | ||||||||||||||
|
Individual
and group accident and health
|
Company
experience
|
Company
experience
|
6 | % | 6,845.3 | 6,611.3 | ||||||||||||||
|
Total
traditional
products
|
10,063.5 | 9,828.7 | ||||||||||||||||||
|
Claims
payable and other policyholder funds
|
N/A | N/A | N/A | 994.0 | 1,008.4 | |||||||||||||||
|
Liabilities
related to separate accounts
|
N/A | N/A | N/A | 17.3 | 18.2 | |||||||||||||||
|
Total
|
$ | 24,294.0 | $ | 24,188.1 | ||||||||||||||||
____________________
|
|
(a)
|
Principally,
modifications of the 1965 - 70 and 1975 - 80 Basic, Select and Ultimate
Tables.
|
|
|
(b)
|
Principally,
the 1984 United States Population Table and the NAIC 1983 Individual
Annuitant Mortality Table.
|
|
|
(c)
|
In
2009 and 2008, all of this liability represented account balances where
future benefits are not guaranteed.
|
The
Company establishes reserves for insurance policy benefits based on assumptions
as to investment yields, mortality, morbidity, withdrawals, lapses and
maintenance expenses. These reserves include amounts for estimated
future payment of claims based on actuarial assumptions. The balance
is based on the Company’s best estimate of the future policyholder benefits to
be incurred on this business, given recent and expected future changes in
experience.
163
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
Changes
in the unpaid claims reserve (included in claims payable) and disabled life
reserves related to accident and health insurance (included in individual and
group accident and health liabilities) were as follows (dollars in
millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Balance,
beginning of the
year
|
$ | 1,341.3 | $ | 1,247.7 | $ | 1,129.0 | ||||||
|
Incurred
claims (net of reinsurance) related to:
|
||||||||||||
|
Current
year
|
1,616.8 | 1,729.3 | 1,559.0 | |||||||||
|
Prior
years
(a)
|
(32.3 | ) | (25.9 | ) | (18.8 | ) | ||||||
|
Total
incurred
|
1,584.5 | 1,703.4 | 1,540.2 | |||||||||
|
Interest
on claim
reserves
|
69.3 | 61.4 | 56.7 | |||||||||
|
Paid
claims (net of reinsurance) related to:
|
||||||||||||
|
Current
year
|
910.7 | 1,001.1 | 900.9 | |||||||||
|
Prior
years
|
691.6 | 609.5 | 541.9 | |||||||||
|
Total
paid
|
1,602.3 | 1,610.6 | 1,442.8 | |||||||||
|
Net
change in balance for reinsurance assumed and ceded
|
51.2 | (60.6 | ) | (35.4 | ) | |||||||
|
Balance,
end of the
year
|
$ | 1,444.0 | $ | 1,341.3 | $ | 1,247.7 | ||||||
___________
|
|
(a)
|
The
reserves and liabilities we establish are necessarily based on estimates,
assumptions and prior years’ statistics. Such amounts will
fluctuate based upon the estimation procedures used to determine the
amount of unpaid losses. It is possible that actual claims will
exceed our reserves and have a material adverse effect on our results of
operations and financial condition.
|
7. INCOME
TAXES
The
components of income tax expense (benefit) were as follows (dollars in
millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Current
tax
expense
|
$ | 9.3 | $ | 3.8 | $ | 2.7 | ||||||
|
Deferred
tax provision
(benefit)
|
50.8 | 5.6 | (9.6 | ) | ||||||||
|
Income
tax expense (benefit) on period income
|
60.1 | 9.4 | (6.9 | ) | ||||||||
|
Valuation
allowance
|
27.8 | 403.9 | 68.0 | |||||||||
|
Total
income tax
expense
|
$ | 87.9 | $ | 413.3 | $ | 61.1 | ||||||
164
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
A
reconciliation of the U.S. statutory corporate tax rate to the effective rate
reflected in the consolidated statement of operations is as
follows:
|
2009
|
2008
|
2007
|
||||||||||
|
U.S.
statutory corporate
rate
|
35.0 | % | 35.0 | % | (35.0 | )% | ||||||
|
Valuation
allowance
|
16.0 | 10,916.2 | 377.8 | |||||||||
|
Other
nondeductible
expenses
|
(1.4 | ) | 125.9 | (3.3 | ) | |||||||
|
State
taxes
|
1.0 | 78.0 | (5.7 | ) | ||||||||
|
Provision
for tax issues, tax credits and other
|
- | 15.2 | 5.6 | |||||||||
|
Effective
tax
rate
|
50.6 | % | 11,170.3 | % | 339.4 | % | ||||||
The
components of the Company’s income tax assets and liabilities were as follows
(dollars in millions):
|
2009
|
2008
|
|||||||
|
Deferred
tax assets:
|
||||||||
|
Net
federal operating loss carryforwards attributable to:
|
||||||||
|
Life
insurance
subsidiaries
|
$ | 745.3 | $ | 840.7 | ||||
|
Non-life
companies
|
883.9 | 835.4 | ||||||
|
Net
state operating loss
carryforwards
|
19.1 | 20.3 | ||||||
|
Tax
credits
|
18.5 | 13.7 | ||||||
|
Capital
loss
carryforwards
|
393.8 | 406.0 | ||||||
|
Deductible
temporary differences:
|
||||||||
|
Insurance
liabilities
|
782.1 | 789.9 | ||||||
|
Unrealized
depreciation of
investments
|
146.8 | 987.4 | ||||||
|
Reserve
for loss on loan
guarantees
|
1.9 | 68.2 | ||||||
|
Other
|
42.1 | 25.1 | ||||||
|
Gross
deferred tax
assets
|
3,033.5 | 3,986.7 | ||||||
|
Deferred
tax liabilities:
|
||||||||
|
Actively
managed fixed
maturities
|
(38.1 | ) | (17.7 | ) | ||||
|
Value
of policies inforce at the Effective Date and cost of policies
produced
|
(694.0 | ) | (739.1 | ) | ||||
|
Gross
deferred tax
liabilities
|
(732.1 | ) | (756.8 | ) | ||||
|
Net
deferred tax assets before valuation
allowance
|
2,301.4 | 3,229.9 | ||||||
|
Valuation
allowance
|
(1,176.4 | ) | (1,180.7 | ) | ||||
|
Net
deferred tax
assets
|
1,125.0 | 2,049.2 | ||||||
|
Current
income taxes
accrued
|
(1.0 | ) | (1.5 | ) | ||||
|
Income
tax assets,
net
|
$ | 1,124.0 | $ | 2,047.7 | ||||
Our
income tax expense includes deferred income taxes arising from temporary
differences between the financial reporting and tax bases of assets and
liabilities, capital loss carryforwards and NOLs. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply in the
years in which temporary differences are expected to be recovered or
paid. The effect of a change in tax rates on deferred tax assets and
liabilities is recognized in earnings in the period when the changes are
enacted.
A
reduction of the carrying amount of deferred tax assets by establishing a
valuation allowance is required if, based on the available evidence, it is more
likely than not that such assets will not be realized. We evaluate
the need to establish a valuation allowance for our deferred income tax assets
on an ongoing basis. In evaluating our deferred income tax assets,
we
165
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
consider
whether the deferred income tax assets will be realized, based on the
more-likely-than-not realization threshold criterion. The ultimate
realization of our deferred income tax assets depends upon generating sufficient
future taxable income during the periods in which our temporary differences
become deductible and before our capital loss carryforwards and NOLs
expire. This assessment requires significant judgment. In
assessing the need for a valuation allowance, appropriate consideration is given
to all positive and negative evidence related to the realization of the deferred
tax assets. This assessment considers, among other matters, the
nature, frequency and severity of current and cumulative losses, forecasts of
future profitability, excess appreciated asset value over the tax basis of net
assets, the duration of carryforward periods, our experience with operating loss
and tax credit carryforwards expiring unused, and tax planning
alternatives.
Concluding
that a valuation allowance is not required is difficult when there has been
significant negative evidence, such as cumulative losses in recent
years. We utilize a three year rolling calculation of actual income
before income taxes as our primary measure of cumulative losses in recent
years. Our analysis of whether there needs to be further increases to
the deferred tax valuation allowance recognizes that as of December 31, 2009, we
have incurred a cumulative loss over the evaluation period, resulting from the
substantial loss during 2008 primarily related to the Transfer of Senior Health
to an independent trust as described in the note to these consolidated financial
statements entitled “Transfer of Senior Health Insurance Company of Pennsylvania
to an Independent Trust”. As a result of the cumulative losses
recognized in recent years, our evaluation of the need to increase the valuation
allowance for deferred tax assets was primarily based on our historical
earnings. However, because a substantial portion of the cumulative
losses for the three-year period ended December 31, 2009, relates to
transactions to dispose of blocks of businesses, we have adjusted the three-year
cumulative results for the income and losses from the blocks of business
disposed of in the past and the business transferred as further described in the
note to these financial statements entitled “Transfer of Senior Health Insurance
Company of Pennsylvania to an Independent Trust”. In addition, we
have adjusted the three-year cumulative results for a significant litigation
settlement, which we consider to be a non-recurring matter and have reflected
our best estimates of how temporary differences will reverse over the
carryforward periods.
At
December 31, 2009, our valuation allowance for our net deferred tax assets was
$1.2 billion, as we have determined that it is more likely than not that a
portion of our deferred tax assets will not be realized. This
determination was made by evaluating each component of the deferred tax asset
and assessing the effects of limitations and/or interpretations on the value of
such component to be fully recognized in the future. We have also
evaluated the likelihood that we will have sufficient taxable income to offset
the available deferred tax assets based on evidence which we consider to be
objective and verifiable. Based upon our analysis completed at December 31,
2009, we believe that we will, more likely than not, recover $1.1 billion of our
deferred tax assets through reductions of our tax liabilities in future
periods.
Changes in our valuation allowance are
summarized as follows (dollars in millions):
|
Balance
at December 31,
2006
|
$ | 777.8 | |||
|
Increase
in
2007
|
68.0 | ||||
|
Expiration
of capital loss
carryforwards
|
(157.6 | ) | |||
|
Write-off
of certain state NOLs (recovery is remote)
|
(15.3 | ) | |||
|
Balance
at December 31,
2007
|
672.9 | ||||
|
Increase
in
2008
|
856.2 |
(a)
|
|||
|
Expiration
of capital loss
carryforwards
|
(209.7 | ) | |||
|
Write-off
of capital loss carryforwards related to Senior Health
|
(133.2 | ) | |||
|
Write-off
of certain NOLs related to Senior Health
|
(5.5 | ) | |||
|
Balance
at December 31,
2008
|
1,180.7 | ||||
|
Increase
in
2009
|
27.8 |
(b)
|
|||
|
Expiration
of capital loss
carryforwards
|
(32.1 | ) | |||
|
Balance
at December 31,
2009
|
$ | 1,176.4 |
166
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
____________________
|
(a)
|
The
$856.2 million increase to our valuation allowance during 2008 included
increases of: (i) $452 million of deferred tax assets related
to Senior Health, which was transferred to an independent trust during
2008; (ii) $298 million related to our reassessment of the recovery of our
deferred tax assets in accordance with GAAP, following the additional
losses incurred as a result of the transaction to transfer Senior Health
to an independent trust; (iii) $60 million related to the recognition of
additional realized investment losses for which we are unlikely to receive
any tax benefit; and (iv) $45 million related to the projected additional
future expense following the modifications to our Senior Credit Agreement
as described in the note to these consolidated financial statements
entitled “Notes Payable - Direct Corporate
Obligations.”
|
|
(b)
|
The
$27.8 million increase to our valuation allowance during 2009 included
increases of: (i) $23.0 million related to our reassessment of
the recovery of our deferred tax assets following the completion of
reinsurance transactions in 2009; and (ii) $4.8 million related to the
recognition of additional realized investment losses for which we are
unlikely to receive any tax
benefit.
|
Recovery
of our deferred tax assets is dependent on achieving the projections of future
taxable income embedded in our analysis and failure to do so would result in an
increase in the valuation allowance in a future period. Any future
increase in the valuation allowance may result in additional income tax expense
and reduce shareholders’ equity, and such an increase could have a significant
impact upon our earnings in the future. In addition, the use of the
Company’s NOLs is dependent, in part, on whether the Internal Revenue Service
(the “IRS”) does not take an adverse position in the future regarding the tax
position we have taken in our tax returns with respect to the allocation of
cancellation of indebtedness income.
The
Internal Revenue Code (the “Code”) limits the extent to which losses realized by
a non-life entity (or entities) may offset income from a life insurance company
(or companies) to the lesser of: (i) 35 percent of the income of the
life insurance company; or (ii) 35 percent of the total loss of the non-life
entities (including NOLs of the non-life entities). There is no
similar limitation on the extent to which losses realized by a life insurance
entity (or entities) may offset income from a non-life entity (or
entities).
Section
382 imposes limitations on a corporation’s ability to use its NOLs when the
company undergoes an ownership change. Future transactions and the
timing of such transactions could cause an ownership change for Section 382
income tax purposes. Such transactions may include, but are not
limited to, additional repurchases or issuances of common stock (including upon
conversion of our outstanding 3.5% Debentures or 7.0% Debentures), or
acquisitions or sales of shares of Conseco stock by certain holders of our
shares, including persons who have held, currently hold or may accumulate in the
future five percent or more of our outstanding common stock for their own
account. Many of these transactions are beyond our
control. If an additional ownership change were to occur for purposes
of Section 382, we would be required to calculate an annual restriction on the
use of our NOLs to offset future taxable income. The annual
restriction would be calculated based upon the value of Conseco’s equity at the
time of such ownership change, multiplied by a federal long-term tax exempt rate
(4.16 percent at December 31, 2009), and the annual restriction could
effectively eliminate our ability to use a substantial portion of our NOLs to
offset future taxable income. We regularly monitor ownership change
(as calculated for purposes of Section 382) and, as of December 31, 2009, we
were below the 50 percent ownership change level that would trigger further
impairment of our ability to utilize our NOLs.
On
January 20, 2009, the Company’s Board of Directors adopted a Section 382 Rights
Agreement which is designed to protect shareholder value by preserving the value
of our tax assets primarily associated with tax NOLs under Section
382. The Section 382 Rights Agreement was adopted to reduce the
likelihood of this occurring by deterring the acquisition of stock that would
create “5 percent shareholders” as defined in Section 382.
Under the
Section 382 Rights Agreement, one right was distributed for each share of our
common stock outstanding as of the close of business on January 30,
2009. Effective January 20, 2009, if any person or group (subject to
certain exemptions) becomes a “5 percent shareholder” of Conseco without the
approval of the Board of Directors, there would be a triggering event causing
significant dilution in the voting power and economic ownership of that person
or group. Existing shareholders who currently are “5 percent
shareholders” will trigger a dilutive event only if they acquire additional
shares exceeding one percent of our outstanding shares without prior approval
from the Board of Directors.
The
Section 382 Rights Agreement will continue in effect until January 20, 2012,
unless earlier terminated or redeemed by the Board of Directors. The
Company’s Audit Committee will review our NOLs on an annual basis and will
recommend amending or terminating the Section 382 Rights Agreement based on its
review. The Section 382 Rights
167
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
Agreement
was approved by a vote at the annual meeting of shareholders on May 12,
2009.
As of
December 31, 2009, we had $4.7 billion of federal NOLs and $1.1 billion of
capital loss carryforwards, which expire as follows (dollars in
millions):
|
Year
of expiration
|
Net
operating loss carryforwards (a)
|
Capital
loss
|
Total
loss
|
|||||||||||||||
|
Life
|
Non-life
|
carryforwards
|
carryforwards
|
|||||||||||||||
|
2010
|
$ | - | $ | .1 | $ | - | $ | .1 | ||||||||||
|
2011
|
- | .1 | - | .1 | ||||||||||||||
|
2012
|
- | - | 63.6 | 63.6 | ||||||||||||||
|
2013
|
- | - | 1,034.2 | 1,034.2 | ||||||||||||||
|
2014
|
- | - | 27.3 | 27.3 | ||||||||||||||
|
2018
|
1,895.7 |
(a)
|
- | - | 1,895.7 | |||||||||||||
|
2021
|
29.6 | - | - | 29.6 | ||||||||||||||
|
2022
|
204.1 | - | - | 204.1 | ||||||||||||||
|
2023
|
- | 2,058.2 |
(a)
|
- | 2,058.2 | |||||||||||||
|
2024
|
- | 3.2 | - | 3.2 | ||||||||||||||
|
2025
|
- | 118.8 | - | 118.8 | ||||||||||||||
|
2026
|
- | 1.6 | - | 1.6 | ||||||||||||||
|
2027
|
- | 216.3 | - | 216.3 | ||||||||||||||
|
2028
|
- | 1.2 | - | 1.2 | ||||||||||||||
|
2029
|
- | 125.8 | - | 125.8 | ||||||||||||||
|
Total
|
$ | 2,129.4 | $ | 2,525.3 | $ | 1,125.1 | $ | 5,779.8 | ||||||||||
____________________
|
(a)
|
The
allocation of the NOLs summarized above assumes the IRS does not take an
adverse position in the future regarding the tax position we plan to take
in our tax returns with respect to the allocation of cancellation of
indebtedness income. If the IRS disagrees with the tax position
we plan to take with respect to the allocation of cancellation of
indebtedness income, and their position prevails, approximately $631
million of the NOLs expiring in 2018 would be characterized as non-life
NOLs.
|
We had
deferred tax assets related to NOLs for state income taxes of $19.1 million and
$20.3 million at December 31, 2009 and 2008, respectively. The
related state NOLs are available to offset future state taxable income in
certain states through 2015.
As more
fully discussed below, the Company’s interpretation of the tax law, as it
relates to the application of the cancellation of indebtedness income to its
NOLs, is an uncertain tax position. Since all other life NOLs must be
utilized prior to this portion of the NOL, it has not yet been utilized nor is
it expected to be utilized within the next twelve months. As a
result, an uncertain tax position has not yet been taken on the Company’s tax
return.
Although
authoritative guidance allowed a change in accounting, the Company has chosen to
continue its past accounting policy of classifying interest and penalties as
income tax expense in the consolidated statement of operations. No
such amounts were recognized in 2009 or 2008. The liability for
accrued interest and penalties was not significant at December 31, 2009 or
December 31, 2008.
Tax years
2006 through 2008 are open to examination by the IRS, and tax year 2002 remains
open only for potential adjustments related to certain partnership
investments. The Company does not anticipate any material adjustments
related to these partnership investments. The Company’s various state
income tax returns are generally open for tax years 2006 through 2008 based on
the individual state statutes of limitation.
The
following paragraphs describe an open matter related to the classification of
our NOLs.
In July
2006, the Joint Committee of Taxation accepted the audit and the settlement
which characterized $2.1 billion of the tax losses on our Predecessor’s
investment in Conseco Finance Corp. as life company losses and the remaining
amount as non-life losses prior to the application of the cancellation of
indebtedness attribute reductions described below. As a result of the
approval of the settlement, we concluded it was appropriate to reduce our
valuation allowance by $260 million in the
168
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
|
second
quarter of 2006, which was accounted for as an addition to paid-in
capital.
|
The Code
provides that any income realized as a result of the cancellation of
indebtedness in bankruptcy (cancellation of debt income or “CODI”) must reduce
NOLs. We realized an estimated $2.5 billion of CODI when we emerged
from bankruptcy. Pursuant to the Company’s interpretation of the tax
law, the CODI reductions were all used to reduce non-life
NOLs. However, if the IRS were to disagree with our interpretation
and ultimately prevail, we believe $631 million of NOLs classified as life
company NOLs would be re-characterized as non-life NOLs and subject to the 35%
limitation discussed above. Such a re-characterization would also
extend the year of expiration as life company NOLs expire after 15 years whereas
non-life NOLs expire after 20 years. The Company does not expect the
IRS to consider this issue for a number of years.
In
accordance with GAAP, we are precluded from recognizing the tax benefits of any
tax windfall upon the exercise of a stock option or the vesting of restricted
stock unless such deduction resulted in actual cash savings to the
Company. Because of the Company’s NOLs, no cash savings have
occurred. NOL carryforwards of $2.3 million related to deductions for
stock options and restricted stock will be reflected in additional paid-in
capital if realized.
8. NOTES
PAYABLE - DIRECT CORPORATE OBLIGATIONS
The
following notes payable were direct corporate obligations of the Company as of
December 31, 2009 and 2008 (dollars in millions):
|
2009
|
2008
|
|||||||
|
3.5%
Debentures
|
$ | 116.5 | $ | 293.0 | ||||
|
7.0%
Debentures
|
176.5 | - | ||||||
|
Secured
credit
agreement
|
652.1 | 911.8 | ||||||
|
6%
Senior
Note
|
100.0 | 125.0 | ||||||
|
Unamortized
discount on 3.5%
Debentures
|
(3.3 | ) | (18.3 | ) | ||||
|
Unamortized
discount on 7.0%
Debentures
|
(4.4 | ) | - | |||||
|
Direct
corporate
obligations
|
$ | 1,037.4 | $ | 1,311.5 | ||||
3.5%
Debentures
In August
2005, we completed the private offering of $330 million of 3.5%
Debentures. The terms of the 3.5% Debentures are governed by an
indenture dated as of August 15, 2005 between the Company and The Bank of New
York Trust Company, N.A., as trustee (the “3.5% Indenture”). During
2008, we repurchased $37.0 million par value of such 3.5% Debentures for $15.3
million plus accrued interest. On November 13, 2009, we
completed a cash tender offer (the “Tender Offer”) for $176.5 million aggregate
principal amount of the 3.5% Debentures. The aggregate consideration
for the 3.5% Debentures accepted by us in the Tender Offer, plus accrued and
unpaid interest thereon, was $177.2 million. Following the
settlement of the Tender Offer, there is $116.5 million aggregate principal
amount of the 3.5% Debentures outstanding. At December 31, 2009 and
2008, unamortized issuance costs (classified as other assets) related to the
3.5% Debentures were $.4 million and $2.1 million, respectively, and are
amortized as an increase to interest expense through September 30, 2010, which
is the earliest date the 3.5% Debenture holders may require the Company to
repurchase them.
The 3.5%
Debentures are senior, unsecured obligations and bear interest at a rate of 3.5
percent per year, payable semi-annually, beginning on March 31, 2006 and ending
on September 30, 2010. Thereafter, the principal balance of the 3.5%
Debentures will accrete at a rate that provides holders with an aggregate yield
to maturity of 3.50 percent, computed on a semi-annual, bond-equivalent
basis. Beginning with the six-month interest period commencing
September 30, 2010, the Company will pay contingent interest on the 3.5%
Debentures if the average trading price per 3.5% Debenture for the five trading
day period immediately preceding the six-month interest period equals or exceeds
a certain level, as described in the 3.5% Indenture.
Upon the
occurrence of certain specified events, the 3.5% Debentures will be convertible,
at the option of the holders, into cash or, under certain circumstances, cash
and shares of the Company’s common stock at an initial conversion price of
approximately $26.66 per share. The number of shares to be received
by a converting holder is subject to adjustment for certain dilutive
events. The amount of cash to be received upon conversion is equal to
the lesser of: (i) the accreted principal
169
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
amount of
the converting 3.5% Debenture; or (ii) the conversion value of such 3.5%
Debentures (as calculated in accordance with the 3.5% Indenture).
On or
after October 5, 2010, the Company may redeem for cash all or a portion of the
3.5% Debentures at any time at a redemption price equal to 100 percent of the
accreted principal amount of the 3.5% Debentures plus accrued and unpaid
interest, including additional interest and contingent interest, if any, to the
redemption date. Holders may require the Company to repurchase in
cash all or any portion of the 3.5% Debentures on September 30, 2010, 2015,
2020, 2025 and 2030 at a repurchase price equal to 100 percent of the accreted
principal amount of the 3.5% Debentures to be repurchased, plus accrued and
unpaid interest, including additional interest and contingent interest, if any,
to the applicable repurchase date.
If an
event of default occurs and is continuing with respect to the 3.5% Debentures,
either the trustee or the holders of at least 25 percent of the aggregate
accreted principal amount of the 3.5% Debentures then outstanding may declare
the accreted principal amount, plus accrued and unpaid interest, including
additional interest and contingent interest, if any, on the 3.5% Debentures to
be due and payable immediately. If an event of default relating to
certain events of bankruptcy, insolvency or reorganization occurs, the accreted
principal amount plus accrued and unpaid interest, including additional interest
and contingent interest, if any, on the 3.5% Debentures will become immediately
due and payable. The following are events of default with respect to
the 3.5% Debentures:
|
·
|
default
for 30 days in payment of any interest, contingent interest or additional
interest due and payable on the 3.5%
Debentures;
|
|
·
|
default
in payment of accreted principal of the 3.5% Debentures at maturity, upon
redemption, upon repurchase or following a fundamental change, when the
same becomes due and payable;
|
|
·
|
default
by the Company or any of its subsidiaries in the payment of principal,
interest or premium when due under any other instruments of indebtedness
having an aggregate outstanding principal amount of $50.0 million (or its
equivalent in any other currency or currencies) or more following a
specified period for cure;
|
|
·
|
default
in the Company’s conversion obligations upon exercise of a holder’s
conversion right, following a specified period for
cure;
|
|
·
|
default
in the Company’s obligations to give notice of the occurrence of a
fundamental change within the time required to give such
notice;
|
|
·
|
acceleration
of any of the Company’s indebtedness or the indebtedness of any of its
subsidiaries under any instrument or instruments evidencing indebtedness
(other than the 3.5% Debentures) having an aggregate outstanding principal
amount of $50.0 million (or its equivalent in any other currency or
currencies) or more, subject to certain exceptions;
and
|
|
·
|
certain
events of bankruptcy, insolvency and reorganization of the Company or any
of its subsidiaries.
|
As further discussed in the note to the
consolidated financial statements entitled “Subsequent Events”, we repurchased
$64 million aggregate principal amount of the 3.5% Debentures in February
2010.
7.0%
Debentures
On
November 13, 2009, we issued $176.5 million aggregate principal amount
of our 7.0% Convertible Senior Debentures due 2016 (the “7.0% Debentures”)
in the initial closing of our private offering of 7.0% Debentures to Morgan
Stanley & Co. Incorporated (“Morgan Stanley”), as the initial purchaser
of the 7.0% Debentures. The net proceeds from the initial closing of
the offering of our 7.0% Debentures, after deducting the initial purchaser’s
discounts and commissions and before other offering expenses, totaled
$172.0 million. The Company used the net proceeds to fund a
substantial portion of the consideration payable in connection with the Tender
Offer for the 3.5% Debentures. At December 31, 2009, unamortized
issuance costs (classified as other assets) related to the 7.0% Debentures were
$2.1 million, and are amortized as an increase to interest expense over the term
of the 7.0% Debentures. We expect to issue additional 7.0%
Debentures, and Morgan Stanley, as the initial purchaser, is required to
purchase these additional 7.0% Debentures, subject to the satisfaction of
certain conditions, on the following dates:
170
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
|
·
|
the
settlement date of any subsequent tender offers we make for outstanding
3.5% Debentures that expire before October 5,
2010;
|
|
·
|
the
settlement date of any privately negotiated transactions that settle
before October 5, 2010;
|
|
·
|
September 30,
2010, the date on which we may be required by holders of the 3.5%
Debentures, if any, to repurchase such 3.5%
Debentures; and
|
|
·
|
October 5,
2010, if we elect to redeem any 3.5% Debentures that remain outstanding on
such date.
|
The net
proceeds from any subsequent closings of the 7.0% Debentures offering will be
used to fund a substantial portion of the aggregate consideration payable for
3.5% Debentures that we may repurchase or redeem in accordance with the terms of
the 3.5% Debentures.
The 7.0%
Debentures rank equally in right of payment with all of the Company’s unsecured
and unsubordinated obligations including the 3.5% Debentures. The
7.0% Debentures are governed by an Indenture dated as of October 16, 2009 (the
“7.0% Indenture”) between the Company and The Bank of New York Mellon Trust
Company, N.A., as trustee. The 7.0% Debentures bear interest at a
rate of 7.0% per annum, payable semi-annually on June 30 and December 30 of each
year, commencing on the interest payment date immediately succeeding the
issuance date of such series; provided, however, that if the issuance date of a
series of 7.0% Debentures is after the close of business on the interest record
for such interest payment date, the first interest payment date will instead be
the second interest payment date immediately succeeding the issuance date of
such series. The 7.0% Debentures will mature on December 30, 2016,
unless earlier converted. The 7.0% Debentures may not be redeemed at
the Company’s election prior to the stated maturity date and the holders may not
require the Company to repurchase the 7.0% Debentures at any
time. The 7.0% Debentures are not convertible prior to June 30,
2013, except under limited circumstances. Commencing on June 30,
2013, the 7.0% Debentures will be convertible into shares of our common stock at
the option of the holder at any time, subject to certain exceptions and subject
to our right to terminate such conversion rights under certain circumstances
relating to the sale price of our common stock. If the holders elect
to convert their 7.0% Debentures upon the occurrence of certain changes of
control of Conseco or certain other events, we will be required, under certain
circumstances, to increase the conversion rate for such holders of the 7.0%
Debentures who convert in connection with such events. Initially, the
7.0% Debentures will be convertible into 182.1494 shares of our common
stock for each $1,000 principal amount of 7.0% Debentures, which is equivalent
to an initial conversion price of approximately $5.49 per share. The
conversion rate is subject to adjustment following the occurrence of certain
events in accordance with the terms of the 7.0% Indenture.
Except as
specified in the 7.0% Indenture, if an event of default (as defined in the 7.0%
Indenture), other than an event of default relating to certain events of
bankruptcy, insolvency or reorganization of the Company or any Significant
Subsidiary (as defined in the 7.0% Indenture), occurs and is continuing, the
trustee or holders of more than 50% in principal amount of the outstanding 7.0%
Debentures may declare the principal of and accrued but unpaid interest on all
of the 7.0% Debentures to be due and payable. If an event of default
relating to certain events of bankruptcy, insolvency or reorganization of the
Company or any Significant Subsidiary occurs, the principal of, and accrued but
unpaid interest on all the 7.0% Debentures will become immediately due and
payable without any declaration or other act on the part of the trustee or any
holders. The following are events of default with respect to the 7.0%
Debentures:
|
·
|
default
in payment of any interest due and payable on the 7.0% Debentures and such
default continues unremedied for 30
days;
|
|
·
|
default
in payment of principal of the 7.0% Debentures when the same becomes due
and payable, whether at maturity, upon declaration of acceleration or
otherwise;
|
|
·
|
default
by the Company or any of the Company’s subsidiaries under any instrument
or instruments evidencing indebtedness (other than the 7.0% Debentures)
having an outstanding principal amount exceeding $50.0 million (or its
equivalent in any other currency or currencies) that has caused the
holders thereof to declare such indebtedness to be due and payable prior
to its stated maturity;
|
|
·
|
default
in payment of indebtedness (other than in respect of swap contracts) for
money borrowed by the Company or any of the Company’s subsidiaries in an
aggregate principal amount exceeding $50.0 million (or its equivalent
in
|
171
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
any other
currency or currencies) when such indebtedness becomes due and payable at final
maturity;
|
·
|
a
final judgment for a payment exceeding $50.0 million (excluding any
amounts covered by insurance) rendered against the Company or any of the
Company’s subsidiaries, which judgment is not vacated, discharged or
stayed within 30 days after (1) the date on which the right to appeal
thereof has expired if no such appeal has commenced, or (2) the date on
which all rights to appeal have been
extinguished;
|
|
·
|
default
in the Company’s performance of any other covenants or agreements in
respect of the 7.0% Debentures contained in the 7.0% Indenture or the 7.0%
Debentures for 60 days (or (1) solely in the case of the reporting
covenant and, if applicable, the covenant set forth in Section 314(a) of
the Trust Indenture Act of 1939, as amended, 120 days and (2) solely in
the case of the Company’s failure to comply with its obligations to
convert 7% Debentures or perform its covenant to reserve and list the
common stock issuable upon conversion, 30 days) after written notice to
the Company by the trustee or to the Company and the trustee by the
holders of at least 25% in aggregate principal amount of all series of
7.0% Debentures then outstanding (acting together as a single
class);
|
|
·
|
the
occurrence of a change of control after written notice is received by the
Company not later than 90 days following the occurrence of such change of
control (or with respect to any change of control that occurs prior to the
issuance of the first series of 7.0% Debentures, 90 days following the
issuance date of such first series of 7.0% Debentures), to the Company by
the trustee or to the Company and the trustee by the holders of at least
10% in aggregate principal amount of all series of 7.0% Debentures then
outstanding (acting together as a single class);
or
|
|
·
|
certain
events of bankruptcy, insolvency and reorganization of the Company or one
of the Company’s “significant subsidiaries” (as defined in Rule 1-02(w) of
Regulation S-X under the Securities
Act).
|
The 7.0%
Indenture provides that on and after the date of the 7.0% Indenture, the Company
may not: (i) consolidate with or merge into any other person or sell,
convey, lease or transfer the Company’s consolidated properties and assets
substantially as an entirety to any other person in any one transaction or
series of related transactions; or (ii) permit any person to consolidate with or
merge into the Company, unless:
|
·
|
if
the Company is not the surviving person, then the surviving person formed
by such consolidation or into which the Company is merged or the person to
which the Company’s properties and assets are so sold, conveyed, leased or
transferred shall be a corporation or limited liability company organized
and existing under the laws of the United States of America, any State
thereof or the District of Columbia; provided that the surviving person
(if not the Company) shall execute and deliver to the trustee a
supplemental indenture expressly assuming all of the Company’s obligations
with respect to the 7.0% Debentures, including, among other things, the
payment when due of the principal of and interest on the 7.0% Debentures
and the performance of each of the Company’s other covenants under the
7.0% Indenture; and
|
|
·
|
immediately
after giving effect to such transaction, no default or event of default
with respect to the 7.0% Debentures has occurred and is
continuing.
|
Upon any
such consolidation, merger or transfer, the surviving person (if not the
Company) shall succeed to, and may exercise every right and power of, the
Company under the 7.0% Indenture.
On
November 17, 2009, two investment funds managed by Paulson & Co.
Inc. (“Paulson”) purchased $120.5 million aggregate principal amount of
7.0% Debentures from Morgan Stanley, and other purchasers purchased the
remaining $56.0 million aggregate principal amount of 7.0% Debentures from
Morgan Stanley. We have been informed by Morgan Stanley that the two
funds managed by Paulson have entered into agreements with Morgan Stanley to
purchase up to a total of $79.5 million additional aggregate principal
amount of 7.0% Debentures, and other purchasers have agreed to purchase up to
the remaining $37.0 million aggregate principal amount of 7.0%
Debentures.
Holders
of the 3.5% Debentures that remain outstanding have the right to require us to
repurchase their debentures for cash on September 30, 2010. If
any 3.5% Debentures remain outstanding after September 30, 2010, we will
have the right to redeem such debentures on October 5, 2010 for
cash. As of December 31, 2009, there are $116.5 million in
aggregate principal amount of 3.5% Debentures outstanding. We have
commitments from Morgan Stanley to purchase an additional aggregate principal
amount of 7.0% Debentures equal to the aggregate principal amount of 3.5%
Debentures: (i) that we may purchase pursuant to any subsequent tender
offer that expires before October 5, 2010; (ii) that we may purchase in
privately
172
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
negotiated
transactions that settle before October 5, 2010; (iii) that holders thereof
require us to repurchase on September 30, 2010; or (iv) for any 3.5%
Debentures that remain outstanding on October 5, 2010 that we elect to
redeem.
In
accordance with GAAP, we are required to consider on each issuance date whether
the debentures issued on such date are issued with a beneficial conversion
feature. A beneficial conversion feature will exist if the debentures
may be convertible into common stock at an effective conversion price
(calculated by dividing the proceeds from the issuance of 7.0% Debentures issued
on that date (per $1,000 principal amount of debentures) by the then effective
conversion rate) that is lower than the market price of a share of common stock
on the date when all significant terms, including the quantity and timing of the
issuance, are known. When a beneficial conversion feature exists, we
are required to separately recognize the beneficial conversion feature at
issuance by allocating a portion of the proceeds to the intrinsic value of that
feature. The value of the beneficial conversion feature is recorded,
net of taxes, as an increase to additional paid-in capital.
If a
beneficial conversion feature exists on the actual date(s) of issuance, a
discount equal to the intrinsic value of the beneficial conversion feature will
be recorded against the carrying value of the 7.0% Debentures. Such
discount will be amortized from the actual date(s) of issuance to the stated
maturity date of the 7.0% Debentures using the effective interest
method. Accordingly, the interest expense we recognize related to the
7.0% Debentures will be dependent upon whether a beneficial conversion feature
exists on the actual date(s) of issuance and the amount by which the market
price(s) of our common stock exceeds the effective conversion price on such
actual date(s) of issuance.
On
November 13, 2009, the market price of our common stock was $5.33 (the
closing market price on November 12, 2009). Because this amount
was less than the effective conversion price of $5.35 on that date, a beneficial
conversion feature did not exist with respect to the 7.0% Debentures issued on
that date. We cannot predict the subsequent date(s) of issuance or
the market price of a share of our common stock on such date(s) of issuance, and
accordingly, we cannot predict whether a beneficial conversion feature will
exist on such date(s) of issuance and, if so, what value(s) would be
recorded.
As
further discussed in the note to the consolidated financial statements entitled
“Subsequent Events”, we issued $64 million aggregate principal amount of the
7.0% Debentures in February 2010. There was no beneficial conversion
feature associated with the 7.0% Debentures issued in February
2010.
Senior
Credit Agreement
On March
30, 2009, we completed Amendment No. 2 to our Second Amended and Restated Credit
Agreement dated as of October 10, 2006 among Conseco, Bank of America, N.A. as
Agent, J.P. Morgan Chase Bank, N.A., as Syndication Agent and other parties (the
“Senior Credit Agreement”), which provided for, among other
things: (i) additional margins between our current financial status
and certain financial covenant requirements through June 30, 2010; (ii) higher
interest rates and the payment of a fee; (iii) new restrictions on the ability
of the Company to incur additional indebtedness; and (iv) the ability of the
lender to appoint a financial advisor at the Company’s expense.
Pursuant
to its amended terms, the applicable interest rate on the Senior Credit
Agreement (based on either a Eurodollar or base rate) was
increased. The Eurodollar rate was equal to LIBOR plus 4 percent with
a minimum LIBOR rate of 2.5 percent (such rate was previously LIBOR plus 2
percent with no minimum rate). The base rate was equal to 2.5 percent
plus the greater of: (i) the Federal funds rate plus .50 percent; or
(ii) Bank of America’s prime rate. In addition, the amended agreement
required the Company to pay a fee equal to 1 percent of the outstanding
principal balance under the Senior Credit Agreement, which fee was added to the
principal balance outstanding and was payable at the maturity of the
facility. This 1 percent fee was reported as non-cash interest
expense.
The
modifications to the Senior Credit Agreement also placed new restrictions on the
ability of the Company to incur additional indebtedness. The
amendment: (i) deleted the provision that allowed the Company to
borrow up to an additional $330 million under the Senior Credit Agreement (the
lenders under the facility having had no obligation to lend any amount under
that provision); (ii) reduced the amount of secured indebtedness that the
Company can incur from $75 million to $2.5 million; and (iii) limited the
ability of the Company to incur additional unsecured indebtedness, except as
provided below, to $25 million, and eliminated the provision that would have
allowed the Company to incur additional unsecured indebtedness to the extent
that principal payments were made on existing unsecured
indebtedness.
The
Company was permitted to issue unsecured indebtedness that is used solely to pay
the holders of the 3.5% Debentures, provided that such
indebtedness: (i) had a maturity date that is no earlier than October
10, 2014; (ii) contained covenants and events of default that are no more
restrictive than those in the Senior Credit Agreement; (iii) did not
contain
173
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
any
covenants or events of default based on maintenance of the Company’s financial
condition; (iv) did not amortize; and (v) did not have a put date or otherwise
be callable prior to April 10, 2014, and provided that the amount of such
unsecured indebtedness incurred under this provision did not exceed the $293
million of 3.5% Debentures outstanding on March 30, 2009; and provided further
that the amount of cash interest payable annually on any new issuance of such
indebtedness, together with the cash interest payable on the outstanding 3.5%
Debentures, did not exceed twice the amount of cash interest currently payable
on the outstanding 3.5% Debentures.
The
amendment prohibited the Company from redeeming or purchasing the 3.5%
Debentures with cash from sources other than those described in the previous
paragraph. The amendment permitted the Company to amend, modify or
refinance the Convertible Indebtedness so long as such new indebtedness complied
with the restrictions set forth in the previous paragraph.
In
addition, pursuant to the terms of the amended credit agreement, the agent
(acting on behalf of the lenders) has the right to appoint a financial advisor
at the Company’s expense to, among other things, review financial projections
and other financial information prepared by or on behalf of the Company, perform
valuations of the assets of the Company and take other actions as are customary
or reasonable for an advisor acting in such capacity. A financial
advisor has been appointed by the agent and has been reviewing the
Company.
On
December 22, 2009, the Company entered into Amendment No. 3 to our Senior
Credit Agreement, which provides for, among other things:
|
|
(i)
|
the
minimum risk-based capital ratio requirement will remain at 200% through
December 31, 2010 and will increase to 225% for 2011 and 250% for 2012
(the risk-based capital requirement was previously scheduled to return to
250% after June 30, 2010);
|
|
|
(ii)
|
the
required minimum level of statutory capital and surplus will remain at
$1.1 billion through December 31, 2010 and will increase to $1.2 billion
for 2011 and $1.3 billion for 2012 (the required minimum level of
statutory capital and surplus was previously scheduled to return to $1.27
billion after June 30, 2010);
|
|
|
(iii)
|
the
interest coverage ratio requirement will remain at 1.50 through December
31, 2010 and will increase to 1.75 for 2011 and 2.00 for 2012 (the
interest coverage ratio requirement was previously scheduled to return to
2.00 after June 30, 2010); and
|
|
|
(iv)
|
the
debt to total capital ratio requirement will remain at 32.5% though
December 31, 2009 and will decrease to 30% thereafter (the debt to
total capital ratio requirement was previously scheduled to return to 30%
after June 30, 2010).
|
The
Company also agreed to pay $150 million of the first $200 million of net
proceeds from its public offering of common stock (as further discussed below)
to the lenders and, in addition, to pay 50% of any net proceeds in excess of
$200 million from the offering. The credit facility previously
required the Company to pay 50% of the net proceeds of any equity issuance to
the lenders.
The
amendment modifies the Company’s principal repayment schedule to eliminate any
principal payments in 2010 and provides for principal payments of $35 million in
2011, $40 million in 2012 and $40 million in 2013. There were no
changes to the maturity date of October 10, 2013. The Company was
previously required to make principal repayments equal to 1% of the initial
principal balance each year, subject to certain adjustments, and to make
additional principal repayments from excess cash flow.
The
amendment also provides that the 1% payment in kind, or PIK, interest that has
accrued since March 30, 2009 as an addition to the principal balance under the
Senior Credit Agreement will be replaced with a payment of an equal amount of
cash interest. The amount of accrued PIK interest ($6.3 million) was
paid in cash when the amendment became effective. The deletion of the
1% PIK interest and the payment of an equal amount of cash interest will not
impact reported interest expense.
On
November 13, 2009, we repaid $36.8 million of outstanding principal on the
Senior Credit Agreement from the proceeds of the issuance of common stock and
warrants to Paulson. On December 22, 2009, the Company repaid $161.4
million of outstanding principal on the Senior Credit Agreement from proceeds of
an equity offering. Such transactions are further discussed in the
note to the consolidated financial statements entitled “Shareholders’
Equity.”
174
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
During
2009, 2008 and 2007, we made scheduled principal payments totaling $5.3 million,
$8.7 million and $7.8 million, respectively, on our Senior Credit
Agreement. Also, during 2009, we made a mandatory prepayment of $1.2
million based on the Company’s excess cash flows at December 31, 2008 as defined
in the Senior Credit Agreement. There were $5.4 million and $5.8
million of unamortized issuance costs (classified as other assets) related to
our Senior Credit Agreement at December 31, 2009 and 2008,
respectively.
In
accordance with Amendment No. 3 to our Senior Credit Agreement, the amounts
outstanding under the Senior Credit Agreement bear interest, payable at least
quarterly, based on either a Eurodollar rate or a base rate. The
Eurodollar rate is equal to LIBOR plus 5 percent with a minimum LIBOR rate of
2.5 percent. The base rate is equal to 4 percent plus the greater
of: (i) the Federal funds rate plus .50 percent; or (ii) Bank of
America’s prime rate. Under the terms of the Senior Credit Agreement,
if the Company’s senior secured long-term debt is rated at least “Ba2” by
Moody’s and “BB” by S&P, in each case with a stable outlook, the margins on
the Eurodollar rate or the base rate would each be reduced by .25
percent. At December 31, 2009, the interest rate on our Senior Credit
Agreement was 7.5 percent.
Pursuant
to the Senior Credit Agreement, as long as the debt to total capitalization
ratio (as defined in the Senior Credit Agreement) is greater than 20 percent and
certain insurance subsidiaries (as defined in the Senior Credit Agreement) have
financial strength ratings of less than A- from A.M. Best Company, the Company
is required to make mandatory prepayments with all or a portion of the proceeds
from the following transactions or events including: (i) the issuance
of certain indebtedness; (ii) certain equity issuances; and (iii) certain asset
sales or casualty events. The Company may make optional prepayments
at any time in minimum amounts of $3.0 million or any multiple of $1.0 million
in excess thereof.
175
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
The
following chart summarizes: (i) the most significant financial ratios
and balances we must maintain pursuant to our Senior Credit Agreement; (ii) the
current ratios and balances as of December 31, 2009; and (iii) the margins for
adverse developments before such ratio or balance requirement is not met
(dollars in millions):
|
Balance
or
|
||||||
|
ratio
as of
|
Margin
for adverse
|
|||||
|
Covenant
under the
|
December 31,
|
development
from
|
||||
|
Senior Credit Agreement
|
2009
|
December 31, 2009 levels
|
||||
|
Aggregate
risk-based capital ratio
|
Greater
than or equal to 200% from March 31, 2009 through December 31, 2010;
greater than or equal to 225% from March 31, 2011 through December 31,
2011; and thereafter, greater than 250%.
|
309% |
Reduction
to total adjusted capital (defined as combined statutory capital and
surplus plus the asset valuation reserve and 50 percent of the balance of
the provision of policyholder dividends) of approximately $507 million, or
an increase to required risk-based capital of approximately $253
million.
|
|||
|
Combined
statutory capital and surplus
|
Greater
than $1,100 from March 31, 2009 through December 31, 2010; greater than
$1,200 million from March 31, 2011 through December 31, 2011; and
thereafter, $1,300 million.
|
$1,439
million
|
Reduction
to combined statutory capital and surplus of approximately $339
million.
|
|||
|
Debt
to total capitalization ratio
|
Not
more than 32.5% from March 31, 2009 through December 31, 2009 and
thereafter, not more than 30%.
|
21.6% |
Reduction
to shareholders’ equity of approximately $1,620 million or additional debt
of $780 million.
|
|||
|
Interest
coverage ratio
|
Greater
than or equal to 1.50 to 1 for rolling four quarters from March 31, 2009
through December 31, 2010; greater than or equal to 1.75 to 1 for rolling
four quarters from March 31, 2011 through December 31, 2011; and
thereafter, 2.00 to 1.
|
2.38
to 1
|
Reduction
in cash flows to the holding company of approximately $58
million.
|
|||
The
Senior Credit Agreement included an $80.0 million revolving credit facility that
could be used for general corporate purposes and that would mature on June 22,
2009. In October 2008, the Company borrowed $75.0 million under the
revolving credit facility to assure the future availability of this additional
liquidity given our concerns with the ability of certain financial institutions
to be able to provide funding in the future. In December 2008, we
repaid $20.0 million of the revolving facility and reduced the maximum amount
available under the revolving facility to $60.0 million. At December
31, 2008, there was $55.0 million outstanding under the revolving
facility. In April 2009, we repaid the remaining $55.0 million that
was outstanding under the revolving facility portion of our Senior Credit
Agreement. The Company paid a commitment fee equal to .50 percent of
the unused portion of the revolving credit facility on an annualized
basis. The revolving credit facility interest was based on either a
Eurodollar rate or a base rate in the same manner as described above for the
Senior Credit Agreement.
The
Senior Credit Agreement prohibits or restricts, among other
things: (i) the payment of cash dividends on our
176
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
common
stock; (ii) the repurchase of our common stock; (iii) the issuance of additional
debt or capital stock; (iv) liens; (v) certain asset dispositions; (vi)
affiliate transactions; (vii) certain investment activities; (viii) change in
business; and (ix) prepayment of indebtedness (other than the Senior Credit
Agreement). The obligations under our Senior Credit Agreement are
guaranteed by Conseco’s current and future domestic subsidiaries, other
than: (i) its insurance companies; (ii) subsidiaries of the insurance
companies; or (iii) certain immaterial subsidiaries as defined in the Senior
Credit Agreement. This guarantee was secured by granting liens on
substantially all the assets of the guarantors, including the capital stock of
Conseco Life Insurance Company of Texas, Washington National and Conseco
Health.
Senior
Note
In
connection with the Transfer, the Company issued the Senior Note payable to
Senior Health. The Senior Note is unsecured and bears interest at a
rate of 6.00 percent per year payable quarterly, beginning on March 15,
2009. We are required to make annual principal payments of $25.0
million beginning on November 12, 2009. The Company made a $25.0
million scheduled payment on the Senior Note in 2009. The Company may
redeem the Senior Note, in whole or in part, at any time by giving the holder 30
days notice (unless a shorter notice is satisfactory to the
holder). The redemption amount is equal to the principal amount
redeemed plus any accrued and unpaid interest thereon. Any
outstanding amount under the Senior Note will be due and payable immediately if
an event of default (as defined in the Senior Note) occurs and continues without
remedy. As a condition of the order from the Pennsylvania Insurance
Department approving the Transfer, we agreed that we would not pay cash
dividends on our common stock while any portion of the Senior Note remained
outstanding.
Gain
(Loss) on Extinguishment or Modification of Debt
In 2009,
we recognized an aggregate loss on the extinguishment or modification of debt
totaling $22.2 million resulting from expenses incurred and the write-off of
unamortized discount or issuance costs related to the following transactions
which are described above: (i) the Tender Offer; (ii) repayment of
principal amounts on the Senior Credit Agreement from the issuance of common
stock; and (iii) modifications to our Senior Credit Agreement in March 2009 and
December 2009.
In 2008,
we repurchased $37.0 million par value of the 3.5% Debentures for $15.3 million
plus accrued interest and recognized a gain on the extinguishment of debt of
$21.2 million related to such repurchases.
Scheduled
Debt Repayments
The
scheduled repayment of our direct corporate obligations is as follows (dollars
in millions):
|
2010
|
$ | 141.5 |
(a)
|
||
|
2011
|
60.0 | ||||
|
2012
|
65.0 | ||||
|
2013
|
602.1 | ||||
|
2016
|
176.5 | ||||
| $ | 1,045.1 |
_____________
|
|
(a)
|
Includes
$116.5 million of the 3.5% Debentures. The holders of our 3.5%
Debentures have the right to require the Company to repurchase their 3.5%
Debentures for cash on September 30, 2010. This amount assumes
that all remaining holders of our 3.5% Debentures exercise that
right. In February 2010, as further discussed in the note to
the consolidated financial statements entitled “Subsequent Events”, we
repurchased $64 million of the 3.5% Debentures and issued $64 million of
the 7.0% Debentures.
|
177
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
|
9.
|
COMMITMENTS
AND CONTINGENCIES
|
Litigation
Legal
Proceedings
The
Company and its subsidiaries are involved in various legal actions in the normal
course of business, in which claims for compensatory and punitive damages are
asserted, some for substantial amounts. Some of the pending matters
have been filed as purported class actions and some actions have been filed in
certain jurisdictions that permit punitive damage awards that are
disproportionate to the actual damages incurred. Although there can
be no assurances, at the present time the Company does not anticipate that the
ultimate liability from either pending or threatened legal actions, after
consideration of existing loss provisions, will have a material adverse effect
on the financial condition, operating results or cash flows of the
Company. The amounts sought in certain of these actions are often
large or indeterminate and the ultimate outcome of certain actions is difficult
to predict. In the event of an adverse outcome in one or more of
these matters, the ultimate liability may be in excess of the liabilities we
have established and could have a material adverse effect on our business,
financial condition, results of operations and cash flows. In
addition, the resolution of pending or future litigation may involve
modifications to the terms of outstanding insurance policies, which could
adversely affect the future profitability of the related insurance
policies.
In the
cases described below, we have disclosed any specific dollar amounts sought in
the complaints. In our experience, monetary demands in complaints
bear little relation to the ultimate loss, if any, to the
Company. However, for the reasons stated above, it is not possible to
make meaningful estimates of the amount or range of loss that could result from
some of these matters at this time. The Company reviews these matters
on an ongoing basis and when assessing reasonably possible and probable
outcomes, the Company bases its decisions on its assessment of the ultimate
outcome following all appeals.
Securities
Litigation
After our
Predecessor announced its intention to restructure on August 9, 2002, eight
purported securities fraud class action lawsuits were filed in the United States
District Court for the Southern District of Indiana. The complaints
named us as a defendant, along with certain of our former
officers. These lawsuits were filed on behalf of persons or entities
who purchased our Predecessor’s common stock on various dates between October
24, 2001 and August 9, 2002. The plaintiffs allege claims under
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and
allege material omissions and dissemination of materially misleading statements
regarding, among other things, the liquidity of our Predecessor and alleged
problems in Conseco Finance Corp.’s manufactured housing division, allegedly
resulting in the artificial inflation of our Predecessor’s stock
price. These cases were consolidated into one case in the United
States District Court for the Southern District of Indiana, captioned
Franz Schleicher, et al. v. Conseco,
Inc., Gary Wendt, William Shea, Charles Chokel and James Adams, et al.
,
Case No. 02-CV-1332
DFH-TAB
. The complaint seeks an unspecified amount of
damages. The plaintiffs filed an amended consolidated class action
complaint with respect to the individual defendants on December 8,
2003. Our liability with respect to this lawsuit was discharged in
our Predecessor’s plan of reorganization and our obligation to indemnify
individual defendants who were not serving as an officer or director on the
Effective Date is limited to $3 million in the aggregate under such
plan. Our liability to indemnify individual defendants who were
serving as an officer or director on the Effective Date, of which there is one
such defendant, is not limited by such plan. Our current estimate of
the maximum loss that we could reasonably incur on this case is approximately
$2.0 million. A motion to dismiss was filed on behalf of defendants
Shea, Wendt and Chokel and on July 14, 2005, this matter was
dismissed. Plaintiffs filed a second amended complaint on August 24,
2005. Plaintiffs filed their motion for class certification on May 2,
2008, and on March 20, 2009 the court granted that motion. On April
24, 2009, certain defendants initiated a request to appeal the class
certification ruling to the U.S. Circuit Court of Appeals which was adopted by
the 7th Circuit. Oral argument on the appeal was held on September
22, 2009, and the matter was taken under advisement. We believe this
lawsuit is without merit and intend to defend it vigorously; however, the
ultimate outcome cannot be predicted with certainty. We do not
believe that our potential loss related to the individual defendant who served
as an officer on the Effective Date is material.
On August
6, 2009, a purported class action complaint was filed in the United States
District Court for the Southern District of New York,
Plumbers and Pipefitters Local Union
No. 719 Pension Trust Fund, on behalf of itself and all others similarly
situated v. Conseco, Inc., et al., Case No. 09-CIV-6966
, on behalf of
purchasers of Conseco Inc. common stock during the period from August 4, 2005 to
March 17, 2008 (the “Class Period”). The complaint charges Conseco
and certain
178
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
of its
officers and directors with violations of the Securities Exchange Act of
1934. The complaint alleges that, during the Class Period, the
defendants issued numerous statements regarding the Company’s financial
performance. As alleged in the complaint, these statements were materially false
and misleading because the defendants misrepresented and/or failed to disclose
the following adverse facts, among others: (i) that the Company was reporting
materially inaccurate revenue figures; (ii) that the Company’s reported
financial results were materially misstated and did not present the true
operating performance of the Company; (iii) that the Company’s shareholders’
equity was materially overstated during the Class Period, including the
overstatement of shareholders’ equity by $20.6 million at December 31, 2006; and
(iv) as a result of the foregoing, the defendants lacked a reasonable basis for
their positive statements about the Company, its corporate governance practices,
its prospects and earnings growth. On January 12, 2010, plaintiffs
filed an amended complaint. We believe the action is without merit
and intend to defend it vigorously. The ultimate outcome of the
action cannot be predicted with certainty.
Cost
of Insurance Litigation
The
Company and certain subsidiaries, including principally Conseco Life, have been
named in numerous purported class action and individual lawsuits alleging, among
other things, breach of contract, fraud and misrepresentation with regard to a
change made in 2003 and 2004 in the way
cost of insurance
charges are calculated for life insurance policies sold primarily under the
names “Lifestyle” and “Lifetime”. Approximately 86,500 of these
policies were subject to the change, which resulted in increased monthly charges
to the policyholders’ accounts. Many of the purported class action
lawsuits were filed in Federal courts across the United States. In
June 2004, the Judicial Panel on Multidistrict Litigation consolidated these
lawsuits into the action now referred to as
In Re Conseco Life Insurance Co.
Cost of Insurance Litigation, Cause No. MDL 1610 (Central District,
California)
. In September 2004, plaintiffs in the
multi-district action filed an amended consolidated complaint and, at that time,
added Conseco, Inc. as a defendant. The amended complaint sought
unspecified compensatory, punitive and exemplary damages as well as an
injunction that would require the Company to reinstate the prior method of
calculating cost of insurance charges and refund any increased charges that
resulted from the change. On April 26, 2005, the Judge in the
multi-district action certified a nationwide class on the claims for breach of
contract and injunctive relief. On April 27, 2005, the Judge issued
an order certifying a statewide California class for injunctive and
restitutionary relief pursuant to California Business and Professions Code
Section 17200 and breach of the duty of good faith and fair dealing, but denied
certification on the claims for fraud and intentional misrepresentation and
fraudulent concealment. The Company announced on August 1, 2006, that
it had reached a proposed settlement of this case. Under the
settlement, inforce policyholders were given an option to choose a form of
policy benefit enhancement and certain former policyholders will share in a
settlement fund by either receiving cash or electing to reinstate their policies
with enhanced benefits. The settlement was subject to court review
and approval, a fairness hearing, notice to all class members, election of
options by the class members, implementation of the settlement and other
conditions. The Court entered final judgment in the case on July 5,
2007. We previously recognized costs related to this litigation
totaling $267.2 million (none of which was recognized in 2009 or
2008).
Two
lawsuits are pending in Hawaii captioned
AE Ventures for Archie Murakami, et
al. v. Conseco, Inc., Conseco Life Insurance Company; and Doe Defendants 1-100,
Case No. CV05-00594 and Clifford S. Arakaki et al. v. Conseco Life Insurance
Company, Doe Defendants 1-100, Case No. CV05-00026 (United States District
Court, District of Hawaii).
These suits involve an aggregate
of approximately 700 plaintiffs all of whom purport to have opted out of the In
Re Conseco Life Insurance Co. Cost of Insurance Litigation multi-district
action. The complaints allege nondisclosure, breach of fiduciary
duty, violations of HRS 480 (unfair and/or deceptive business practices),
declaratory and injunctive relief, insurance bad faith, punitive damages, and
seeks to impose alter ego liability. Trial has been set for August
20, 2010. A settlement in principle has been reached. The
court entered a 90 day stay of the case pending finalization of the
settlement. The ultimate outcome of these lawsuits cannot be
predicted with certainty and an adverse outcome could exceed the amount we have
accrued and could have a material adverse impact on the Company’s consolidated
financial condition, cash flows or results of operations.
Agent
Litigation
On
December 17, 2003, a complaint was filed in the 19th Judicial District Court,
Parish of East Baton Rouge, Louisiana,
Southern Capitol Enterprises
,
Inc. and F. David Tutt v.
Conseco Services, LLC and Conseco Health Insurance Company, Case No.
515105
.
Plaintiffs are a former
Conseco Health agency and its principal that allege in the complaint that they
were damaged by Conseco Health’s termination of their Executive Marketing
Agreement (“EMA”) and Business Continuation Plan (“BCP”). Plaintiffs
sought a declaratory judgment declaring the parties’ rights and obligations
under plaintiffs’ EMA and BCP including definitions of terms within those
contracts. Plaintiffs also demanded a full accounting
of
179
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
all
commissions allegedly due and a preliminary injunction stopping Conseco from
reducing or stopping commission payments during the pendency of this
action. At Conseco Health’s request, the case was removed to the
United States District Court for the Middle District of Louisiana,
Case No.
04CV40-D-M1
. On September 30, 2004, Mr. Tutt filed a separate
complaint for breach of contract and damages against defendants in federal court
which includes claims for: (1) breach of the EMA and BCP; (2) tortuous
interference with the EMA and BCP; (3) unjust enrichment related to the EMA and
BCP; and (4) requests an accounting of back commissions under the EMA and
BCP. The court consolidated the two cases on October 20,
2004. Plaintiff later filed an amended and restated complaint for
damages on March 15, 2006, which added our subsidiary, Performance Matters
Associates, Inc., as a defendant. Mr. Tutt’s motion for partial
summary judgment, which sought to invalidate the non-competition and
non-solicitation provisions in the EMA and the non-competition provision of the
BCP, was granted by the court on December 15, 2004. The court did not
decide the issue of the BCP's continued validity. After that issue
was tried in April 2007, the court ruled that the BCP was valid and
enforceable. The court further ruled that the issues of breach of
contract relating to plaintiffs’ exclusive rights and due to improper commission
payments, breach of the duty of good faith and fair dealing as to the EMA and
plaintiffs’ single business enterprise theory remain to be tried to a
jury. We believe the action is without merit, and intend to defend it
vigorously. The ultimate outcome of the action cannot be predicted
with certainty.
On
January 16, 2008, a purported class action was filed in the Superior Court of
the State of California for the County of Alameda,
Robin Fletcher individually, and on
behalf of all others similarly situated vs. Bankers Life and Casualty Company,
and Does 1 through 100, Case No. RG08366328.
In her original
complaint, plaintiff alleged nonpayment by Bankers Life of overtime wages,
failure to provide meal and rest periods, failure to reimburse expenses, and
failure to provide accurate wage statements to its sales representatives in the
State of California for the time period January 16, 2004 to
present. Additionally, the complaint alleges failure to pay wages on
termination and unfair business practices. On October 7, 2008, the
plaintiff filed a first amended complaint which changes the proposed scope of
the putative class from all agents in California for the subject time period to
all agents at a single branch office in Alameda, California. This
would reduce the putative class from hundreds of members to approximately 100
members. The class certification motion has not yet been filed, but
the court set such motion for hearing on April 16, 2010. We believe
the action is without merit and we intend to defend the case
vigorously. The ultimate outcome of the action cannot be predicted
with certainty.
Other
Litigation
On
November 17, 2005, a complaint was filed in the United States District Court for
the Northern District of California,
Robert H. Hansen, an individual, and
on behalf of all others similarly situated v. Conseco Insurance Company, an
Illinois corporation f/k/a Conseco Annuity Assurance Company, Cause No.
C0504726
. Plaintiff
in this putative class action purchased an annuity in 2000 and is claiming
relief on behalf of the proposed national class for alleged violations of the
Racketeer Influenced and Corrupt Organizations Act; elder abuse; unlawful,
deceptive and unfair business practices; unlawful, deceptive and misleading
advertising; breach of fiduciary duty; aiding and abetting of breach of
fiduciary duty; and unjust enrichment and imposition of constructive
trust. On January 27, 2006, a similar complaint was filed in the same
court entitled
Friou P. Jones,
on Behalf of Himself and All Others Similarly Situated v. Conseco Insurance
Company, an Illinois company f/k/a Conseco Annuity Assurance Company, Cause No.
C06-00537.
Mr. Jones had purchased an annuity in
2003. Each case alleged that the annuity sold was inappropriate and
that the annuity products in question are inherently unsuitable for seniors age
65 and older.
On
March 3, 2006 a first amended complaint was filed in the
Hansen
case adding causes of
action for fraudulent concealment and breach of the duty of good faith and fair
dealing. In an order dated April 14, 2006, the court consolidated the
two cases under the original Hansen cause number and retitled the consolidated
action:
In re
Conseco Insurance Co. Annuity Marketing & Sales Practices
Litig.
A motion to dismiss the amended complaint was granted
in part and denied in part, and the plaintiffs filed a second amended complaint
on April 27, 2007, which has added as defendants Conseco Services, LLC and
Conseco Marketing, LLC. The court has not yet made a determination
whether the case should go forward as a class action, and we intend to oppose
any form of class action treatment of these claims. We believe the
action is without merit, and intend to defend it vigorously. The
ultimate outcome of the action cannot be predicted with certainty.
On
September 24, 2004, a purported statewide class action was filed in the 18th
Judicial District Court, Parish of Iberville, Louisiana,
Diana Doiron, Individually And On
Behalf of All Others Similarly Situated v. Conseco Health Insurance Company,
Case No. 61,534
. In her complaint, plaintiff claims that she
was damaged due to Conseco Health’s failure to pay claims made under her cancer
policy, and seeks compensatory and statutory damages in an unspecified amount
along with declaratory and injunctive relief. Conseco Health
Insurance Company caused the case to be removed to the United States District
Court for the Middle District of Louisiana on November 3, 2004, and it was
assigned Case No. 04-784-D-M2. An order was issued on February 15,
2007 granting plaintiff’s motion for class certification. The order
certified two sub-classes,
180
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
identifying
them as the radiation treatment sub-class and the chemotherapy treatment
sub-class. We appealed the certification order to the 5th Circuit
Court of Appeals, and by order entered May 28, 2008, the 5th Circuit Court of
Appeals vacated the certification order and remanded to the District Court for
redefinition of the sub-classes. On April 7, 2009, the District Court
entered an order denying recertification of the proposed classes. The
parties have agreed to settle this case, subject to court
approval. The settlement of this case will not have a significant
impact on our business, financial condition, results of operations or cash
flows.
On August
7, 2006, an action was filed in the United States District Court for the
Southern District of New York,
Sheldon H. Solow v. Conseco, Inc. and Carmel Fifth, LLC, Case No. 06-CV-5988
(BSJ)
. The plaintiff alleges breach of duty to hold a fair
auction, fraud, promissory estoppel, unjust enrichment and a declaratory
judgment with respect to the sale by defendants of the GM Building in New York
City in 2003. The plaintiff was a losing bidder on the
building. In the complaint, the plaintiff seeks damages of $35
million on the unjust enrichment count and damages in an amount to be determined
at trial on the remaining counts. Defendants filed a motion to
dismiss the complaint on September 18, 2006. On January 11, 2008, the
court ruled on the motion to dismiss, granting the motion with respect to the
unjust enrichment and declaratory judgment counts, and denying the motion with
respect to the remaining three counts. On December 9, 2009, the court
granted the Company’s motion for summary judgment and dismissed the
case. On December 22, 2009, the plaintiff filed a motion to alter
judgment and for reconsideration. On January 5, 2010, the Company
filed its response in opposition to this motion. On January 7, 2010,
the plaintiff filed a notice of appeal. The Company believes the
action is without merit and intends to defend it vigorously. The
ultimate outcome of the action cannot be predicted with certainty.
On March
4, 2008, a complaint was filed in the United States District Court for the
Central District of California,
Celedonia X. Yue, M. D. on behalf of
the class of all others similarly situated, and on behalf of the General Public
v. Conseco Life Insurance Company, successor to Philadelphia Life Insurance
Company and formerly known as Massachusetts General Life Insurance
Company
, Cause
No.
CV08-01506 CAS
. Plaintiff in this putative class action owns a
Valulife universal life policy insuring the life of Ruth S. Yue originally
issued by Massachusetts General Life Insurance Company in
1995. Plaintiff is claiming breach of contract on behalf of the
proposed national class and seeks injunctive and restitutionary relief pursuant
to California Business & Professions Code Section 17200 and declaratory
relief. The putative class consists of all owners of Valulife and
Valuterm universal life insurance policies issued by either Massachusetts
General or Philadelphia Life and that were later acquired and serviced by
Conseco Life. Plaintiff alleges that members of the class will be
damaged by increases in the cost of insurance that are set to take place in the
twenty first policy year of Valulife and Valuterm policies. No such increases
have yet been applied to the subject policies, and none is scheduled to take
effect until 2011 when the oldest of these policies reaches its twenty-first
anniversary. Plaintiff filed a motion for certification of the class
and on December 7, 2009, the court granted that motion. The case is
set for trial commencing July 6, 2010. We believe the action is
without merit, and intend to defend it vigorously. The ultimate
outcome of the action cannot be predicted with certainty.
On June
4, 2008, a purported class action complaint was filed in the Cook County
Illinois Circuit Court Chancery Division,
Sheldon Langendorf, et. al.
individually and on behalf of themselves and all others similarly situated v.
Conseco Senior Health Insurance Company, and Conseco, Inc., et. al. Case No.
08CH20571
. Plaintiff is claiming breach of contract and
consumer fraud and seeks a declaratory judgment, claiming that Senior Health
(formerly Conseco Senior Health Insurance Company prior to its name change in
October 2008) and other affiliated companies routinely and improperly refuse to
accept Medicare explanations of benefits as documentation in support of proofs
of claim on individual hospital indemnity and other policies of health
insurance. Senior Health subsequently removed the action to the U.S.
District Court for the Northern District of Illinois, where it is now pending as
Case No.
08-CV-3914
. By stipulation of the parties, Conseco, Inc. was
dismissed as a party on September 29, 2008. Senior Health filed a
motion to dismiss and/or for summary judgment on August 22, 2008, which the
court granted in part and denied in part by entry dated December 18, 2008,
dismissing the claim for Illinois statutory consumer fraud. We agreed
to assume liability for this litigation in connection with the separation of
Senior Health. The parties have agreed to settle this case, subject
to court approval. On August 6, 2009, the court granted preliminary
approval of the settlement. Final order and judgment approving
settlement was entered on November 18, 2009. The settlement of this
case will not have a significant impact on our business, financial condition,
results of operations or cash flows.
On
December 8, 2008, a purported class action was filed in the U.S. District Court
for the Southern District of Florida,
Sydelle Ruderman individually and on
behalf of all other similarly situated v. Washington National Insurance Company,
Case No. 08-23401-CIV-Cohn/Selzer.
In the complaint, plaintiff alleges
that the inflation escalation rider on her policy of long-term care insurance
operates to increase the policy’s lifetime maximum benefit, and that Washington
National breached the contract by stopping her benefits when they reached the
lifetime maximum. The Company takes the position that
the
181
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
inflation
escalator only affects the per day maximum benefit. The court has
scheduled a jury trial on January 25, 2010. Plaintiffs filed their
motion for class certification, and the motion has been fully briefed by both
sides. The court has not yet ruled on the motion or set it for
hearing. Additional parties have asked the court to allow them to
intervene in the action, and the existing parties opposed their
motion. On January 5, 2010, the court granted the motion to intervene
and granted the plaintiff’s motion for class certification. The case
is set for trial commencing on June 7, 2010. We believe the action is
without merit, and intend to defend it vigorously. The ultimate
outcome of the action cannot be predicted with certainty.
On
December 24, 2008, a purported class action was filed in the U.S. District Court
for the Northern District of California,
Cedric Brady, et. al. individually
and on behalf of all other similarly situated v. Conseco, Inc. and Conseco Life
Insurance Company Case No. 3:08-cv-05746.
In their complaint,
plaintiffs allege that Conseco Life and Conseco, Inc. committed breach of
contract and insurance bad faith and violated various consumer protection
statutes in the administration of various interest sensitive whole life products
sold primarily under the name “Lifetrend” by requiring the payment of additional
cash amounts to maintain the policies in force. On April 23, 2009,
the plaintiffs filed an amended complaint adding the additional counts of breach
of fiduciary duty, fraud, negligent misrepresentation, conversion and
declaratory relief. On May 29, 2009, Conseco, Inc. and Conseco Life filed
a motion to dismiss the amended complaint. On July 29, 2009, the court
granted in part and denied in part the motion to dismiss. The court
dismissed the allegations that Conseco Life violated various consumer protection
statutes, the breach of fiduciary duty count, and dismissed Conseco, Inc. for
lack of personal jurisdiction. On October 15, 2009, Conseco Life
filed a motion with the Judicial Panel on Multidistrict Litigation (“MDL”),
seeking the establishment of an MDL proceeding consolidating this case and the
McFarland case described below into a single action. On February 3,
2010, the Judicial Panel on MDL ordered this case be consolidated for pretrial
proceedings. The Company believes the action is without merit and
intends to defend it vigorously. The ultimate outcome of the action
cannot be predicted with certainty.
On July
2, 2009, a purported class action was filed in the U.S. District Court for the
Middle District of Florida,
Bill W. McFarland, and all those
similarly situated v. Conseco Life Insurance Company, Case No.
3:09-cv-598-J-32MCR.
In his complaint, plaintiff alleges that
Conseco Life committed breach of contract and has been unjustly enriched in the
administration of various interest sensitive whole life products sold primarily
under the name “Lifetrend.” The plaintiff seeks declaratory and
injunctive relief, compensatory damages, punitive damages and attorney
fees. Plaintiff filed a motion for class certification on October 6,
2009. On October 15, 2009, Conseco Life filed a motion with the
Judicial Panel on Multidistrict Litigation, seeking the establishment of an MDL
proceeding consolidating this case and the Brady case described above into a
single action in the Northern District of California Federal
Court. On February 3, 2010, the Judicial Panel on MDL ordered this
case be consolidated for pretrial proceedings in the Northern District of
California Federal Court. The Company believes the action is without
merit and intends to defend it vigorously. The ultimate outcome of
the action cannot be predicted with certainty.
On
January 26, 2009, a purported class action complaint was filed in the United
States District Court for the Northern District of Illinois,
Samuel Rowe and Estella Rowe,
individually and on behalf of themselves and all others similarly situated v.
Bankers Life & Casualty Company and Bankers Life Insurance Company of
Illinois, Case No. 09CV491
. The plaintiffs are alleging violation
of California Business and Professions Code Sections 17200 et seq. and 17500 et
seq., breach of common law fiduciary duty, breach of implied covenant of good
faith and fair dealing, negligent misrepresentation and violation of California
Welfare and Institutions Code Section 15600 on behalf of the proposed national
class and seek injunctive relief, compensatory damages, punitive damages and
attorney fees. The plaintiff alleges that the defendants used an improper
and misleading sales and marketing approach to seniors that fails to disclose
all facts, misuses consumers’ confidential financial information, uses
misleading sales and marketing materials, promotes deferred annuities that are
fundamentally inferior and less valuable than readily available alternative
investment products and fails to adequately disclose other principal risks
including maturity dates, surrender penalties and other restrictions which limit
access to annuity proceeds to a date beyond the applicants actuarial life
expectancy. Plaintiffs have amended their complaint attempting to convert
this from a California only class action to a national class
action. In addition, the amended complaint adds causes of action
under the Racketeer Influenced and Corrupt Organization Act (“RICO”); aiding and
abetting breach of fiduciary duty and for unjust enrichment. They
dropped their claim that Bankers made negligent
misrepresentations. On November 20, 2009, Bankers Life filed a motion
to dismiss the plaintiff’s RICO claims. The plaintiffs’ opening brief
on class certification is due by May 31, 2010. We believe the action
is without merit, and intend to defend it vigorously. The ultimate outcome
of the action cannot be predicted with certainty.
In
addition, the Company and its subsidiaries are involved on an ongoing basis in
other lawsuits, including purported class actions, related to their
operations. The ultimate outcome of all of these other legal matters
pending against the
182
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
Company
or its subsidiaries cannot be predicted, and, although such lawsuits are not
expected individually to have a material adverse effect on the Company, such
lawsuits could have, in the aggregate, a material adverse effect on the
Company’s consolidated financial condition, cash flows or results of
operations.
Director
and Officer Loan Program Litigation
The
Company and Conseco Services, LLC have settled all litigation related to the
1996-1999 director and officer loan programs. As part of our
Predecessor’s plan of reorganization, we are required to pay 45 percent of any
net proceeds recovered in connection with these lawsuits, in an aggregate amount
not to exceed $30 million, to former holders of our Predecessor’s trust
preferred securities that did not opt out of a settlement reached with the
committee representing holders of these securities. As of December
31, 2009, we had paid $19.3 million to the former holders of trust preferred
securities under this arrangement. At December 31, 2009, we estimated
that approximately $3.8 million, net of collection costs, of the remaining
amounts due under the loan program will be collected (amounts that remain to be
collected from borrowers with whom we have settled), of which $2.7 million will
be paid to the former holders of our Predecessor’s trust preferred
securities.
Regulatory
Examinations and Fines
Insurance
companies face significant risks related to regulatory investigations and
actions. Regulatory investigations generally result from matters
related to sales or underwriting practices, payment of contingent or other sales
commissions, claim payments and procedures, product design, product disclosure,
additional premium charges for premiums paid on a periodic basis, denial or
delay of benefits, charging excessive or impermissible fees on products,
changing the way cost of insurance charges are calculated for certain life
insurance products or recommending unsuitable products to
customers. We are, in the ordinary course of our business, subject to
various examinations, inquiries and information requests from state, federal and
other authorities. The ultimate outcome of these regulatory actions
cannot be predicted with certainty. In the event of an unfavorable
outcome in one or more of these matters, the ultimate liability may be in excess
of liabilities we have established and we could suffer significant reputational
harm as a result of these matters, which could also have a material adverse
effect on our business, financial condition, results of operations or cash
flows.
The
states of Pennsylvania, Illinois, Texas, Florida and Indiana led a multistate
examination of the long-term care claims administration and complaint handling
practices of Senior Health and Bankers Life, as well as the sales and marketing
practices of Bankers Life. This examination commenced in July 2007
and on May 7, 2008, Conseco announced a settlement among the state insurance
regulators and Senior Health and Bankers Life. This examination
covered the years 2005, 2006 and 2007. More than 40 states are
parties to the settlement, which included a Senior Health fine of up to $2.3
million, with up to an additional $10 million payable in the event the process
improvements and benchmarks, on the part of either Senior Health and/or Bankers
Life, are not met over an 18 month period for Bankers Life or a two-and-a-half
year period for Senior Health, which time started with the
settlement. The process improvement plan is being monitored by the
lead states.
In late
October 2008, Conseco Life mailed notice to approximately 12,000 holders of its
“Lifetrend” life insurance products to inform them of: (i) changes to
certain “non-guaranteed elements” (“NGEs”) of their policies; and (ii) the fact
that certain policyholders who were not paying premiums may have failed to
receive a notice that their policy was underfunded and that additional premiums
were required in order for the policyholders to maintain their guaranteed cash
values. In December 2008, Conseco Life mailed notice to approximately
16,000 holders of its CIUL3+ universal life policies to inform them of an
increase in certain NGEs with respect to their policies. Prior to or
around the time that the notices were sent, Conseco Life had informed the
insurance regulators in a number of states, including among others Indiana, Iowa
and Florida, of these matters and the planned communication with the impacted
policyholders. Conseco Life received a cease and desist order from
the Iowa Department of Insurance dated December 9, 2008, directing that it cease
any further activity with respect to the matters that had been communicated in
the notice to the Lifetrend policyholders. In December 2008, in
response to communications received from certain regulators and policyholders,
Conseco Life unilaterally agreed to enter into a nationwide temporary moratorium
through March 31, 2009 with regard to the proposed Lifetrend
changes. Conseco agreed to extend that moratorium to June 30,
2009. In addition, Conseco Life entered into a stipulation and
standstill with the Iowa Department of Insurance pursuant to which Conseco Life
also agreed to take no further action with respect to the Lifetrend and CIUL3+
policyholders in Iowa.
On
December 22, 2008, Conseco Life also received an order to show cause relating to
the Lifetrend changes from the Florida Office of Insurance Regulation (“OIR”),
and Conseco Life entered into an agreement in January 2009 with the Florida OIR
preserving Conseco Life’s right to a hearing while Conseco Life and the Florida
OIR engaged in settlement
183
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
discussions
regarding the Lifetrend and CIUL3+ policies. In January 2009, the
Florida OIR commenced a market conduct examination involving Conseco
Life. After working with various state insurance regulators to review
the terms of the Lifetrend and CIUL3+ policies, Conseco Life has reached a
settlement in principle with the regulators regarding these issues. During this
process, Conseco has been allowed to move forward with implementing the NGE
changes in its CIUL3+ policies while the regulators continued their
review. Conseco has also resumed the administration of its Lifetrend
policies with administrative changes in place but, at this time, it has not
implemented the NGE changes pending execution of the final settlement agreement
with the regulators. The ultimate outcome of these regulatory
proceedings cannot be predicted with certainty.
Guaranty
Fund Assessments
The
balance sheet at December 31, 2009, included: (i) accruals of $22.1 million,
representing our estimate of all known assessments that will be levied against
the Company’s insurance subsidiaries by various state guaranty associations
based on premiums written through December 31, 2009; and (ii) receivables of
$16.9 million that we estimate will be recovered through a reduction in future
premium taxes as a result of such assessments. At December 31, 2008,
such guaranty fund assessment accruals were $9.5 million and such receivables
were $5.9 million. These estimates are subject to change when the
associations determine more precisely the losses that have occurred and how such
losses will be allocated among the insurance companies. We recognized
expense for such assessments of $.3 million, $3.1 million and $1.1 million in
2009, 2008 and 2007, respectively.
Guarantees
We hold
bank loans made to certain former directors and employees to enable them to
purchase common stock of our Predecessor. These loans, with a
principal amount of $481.3 million, had been guaranteed by our
Predecessor. We received all rights to collect the balances due
pursuant to the original terms of these loans. In addition, we hold
loans to participants for interest on the loans. The loans and the
interest loans are collectively referred to as the “D&O
loans.” We regularly evaluate the collectibility of these loans in
light of the credit worthiness of the participants and the current status of
various legal actions we have taken to collect the D&O loans. At
December 31, 2009, we have estimated that approximately $3.8 million of the
D&O loan balance (which is included in other assets) is collectible (net of
the costs of collection). An allowance has been established to reduce
the total D&O loan balance to the amount we estimated was
recoverable.
Pursuant
to the settlement that was reached with the Official Committee of the Trust
Originated Preferred Securities (“TOPrS”) Holders and the Official Committee of
Unsecured Creditors in the Plan, the former holders of TOPrS (issued by our
Predecessor’s subsidiary trusts and eliminated in our reorganization) who did
not opt out of the bankruptcy settlement, will be entitled to receive 45 percent
of any net proceeds from the collection of certain D&O loans in an aggregate
amount not to exceed $30 million. As of December 31, 2009, we had
paid $19.3 million to the former holders of TOPrS and we have established a
liability of $2.7 million (which is included in other liabilities), representing
our estimate of the amount which will be paid to the former holders of TOPrS
pursuant to the settlement.
In
accordance with the terms of the employment agreements of two of the Company’s
former chief executive officers, certain wholly-owned subsidiaries of the
Company are the guarantors of the former executives’ nonqualified supplemental
retirement benefits. The liability for such benefits was $22.0
million at both December 31, 2009 and 2008 and is included in the caption “Other
liabilities” in the consolidated balance sheet.
184
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
Leases
and Certain Other Long-Term Commitments
The
Company rents office space, equipment and computer software under noncancellable
operating lease agreements. In addition, the Company has entered into
certain sponsorship agreements which require future payments. Total
expense pursuant to these lease and sponsorship agreements was $42.3 million,
$44.1 million and $44.8 million in 2009, 2008 and 2007,
respectively. Future required minimum payments as of December 31,
2009, were as follows (dollars in millions):
|
2010
|
$ | 41.0 | ||
|
2011
|
34.1 | |||
|
2012
|
29.2 | |||
|
2013
|
23.6 | |||
|
2014
|
17.7 | |||
|
Thereafter
|
60.2 | |||
|
Total
|
$ | 205.8 |
|
10.
|
OTHER
DISCLOSURES
|
Agent
Deferred Compensation Plan
For our
agent deferred compensation plan and postretirement plans, it is our policy to
immediately recognize changes in the actuarial benefit obligation resulting from
either actual experience being different than expected or from changes in
actuarial assumptions.
One of
our insurance subsidiaries has a noncontributory, unfunded deferred compensation
plan for qualifying members of its career agency force. Benefits are
based on years of service and career earnings. The actuarial
measurement date of this deferred compensation plan is December
31. The liability recognized in the consolidated balance sheet for
the agents’ deferred compensation plan was $106.3 million and $99.3 million at
December 31, 2009 and 2008, respectively. Costs incurred on this plan
were $11.9 million, $7.7 million and $5.8 million during 2009, 2008 and 2007,
respectively (including the recognition of gains (losses) of $(3.3) million, $.6
million and $3.3 million in 2009, 2008 and 2007, respectively, resulting from
actual experience being different than expected or from changes in actuarial
assumptions). The estimated net loss for the agent deferred
compensation plan that will be amortized from accumulated other comprehensive
income into the net periodic benefit cost during 2010 is $.4
million. In 2006, we purchased Company-owned life insurance (“COLI”)
as an investment vehicle to fund the agent deferred compensation
plan. The COLI assets are not assets of the agent deferred
compensation plan, and as a result, are accounted for outside the plan and are
recorded in the consolidated balance sheet as other invested
assets. The carrying value of the COLI assets was $78.0 million and
$51.2 million at December 31, 2009 and 2008, respectively. Changes in
the cash surrender value (which approximates net realizable value) of the COLI
assets are recorded as net investment income.
We used
the following assumptions for the deferred compensation plan to
calculate:
|
2009
|
2008
|
|||||||
|
Benefit
obligations:
|
||||||||
|
Discount
rate
|
5.75 | % | 6.03 | % | ||||
|
Net
periodic cost:
|
||||||||
|
Discount
rate
|
6.03 | % | 6.02 | % | ||||
185
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
The
discount rate is based on the yield of a hypothetical portfolio of high quality
debt instruments which could effectively settle plan benefits on a present value
basis as of the measurement date. At December 31, 2009, for our
deferred compensation plan for qualifying members of our career agency force, we
assumed a 5 percent annual increase in compensation until the participant’s
normal retirement date (age 65 and completion of five years of
service).
The
benefits expected to be paid pursuant to our agent deferred compensation plan as
of December 31, 2009 were as follows (dollars in millions):
|
2010
|
$ | 4.1 | ||
|
2011
|
4.3 | |||
|
2012
|
4.5 | |||
|
2013
|
4.6 | |||
|
2014
|
5.4 | |||
|
2015
–
2019
|
34.0 |
The
Company has qualified defined contribution plans for which substantially all
employees are eligible. Company contributions, which match certain
voluntary employee contributions to the plan, totaled $4.2 million, $4.4 million
and $4.2 million in 2009, 2008 and 2007, respectively. Employer
matching contributions are discretionary.
Reclassification
Adjustments Included in Comprehensive Income (Loss)
The
changes in unrealized appreciation (depreciation) included in comprehensive
income (loss) are net of reclassification adjustments for after-tax net gains
(losses) from the sale of investments included in net income (loss) of
approximately $(593) million, $(19) million and $(4) million for the years ended
December 31, 2009, 2008 and 2007, respectively.
|
|
11.
|
SHAREHOLDERS’
EQUITY
|
In
December 2009, we completed the public offering, including underwriter
over-allotments, of 49.5 million shares of our common stock at an offering price
of $4.75 per share. The net proceeds to the Company from the
offering, after deducting underwriting commissions and discounts and offering
expenses totaled $222.7 million. The Company used $161.4 million of
the net proceeds from the offering to reduce its indebtedness under its Senior
Credit Agreement and the remaining net proceeds were used for general corporate
purposes.
In
November 2009, we completed the private sale of 16.4 million shares of our
common stock and warrants to purchase 5.0 million shares of our common stock to
Paulson on behalf of several investment funds and accounts managed by Paulson.
The net proceeds to the Company from the private placement, after deducting
financial advisory fees and other offering expenses, totaled $73.6
million. The Company used $36.8 million of the net proceeds from the
private placement to reduce its indebtedness under its Senior Credit Agreement
and used $10.5 million to fund the portion of the settlement of the Tender Offer
that was not funded by the issuance of the 7.0% Debentures, as further described
in the note to the consolidated financial statements entitled “Notes Payable –
Direct Corporate Obligations”. The remaining proceeds will be
used:
|
·
|
to
pay the portion of the purchase price, repurchase price or redemption
price of the 3.5% Debentures that are (i) tendered in any subsequent
issuer tender offer for the 3.5% Debentures, (ii) repurchased by us
in privately negotiated transactions that settle before October 5, 2010;
(iii) repurchased by us as required by the holders thereof on
September 30, 2010 or (iv) redeemed by us on October 5,
2010 respectively; and
|
|
·
|
for
general corporate purposes.
|
In
November 2009, concurrently with the completion of the private placement of
our common stock and warrants, we entered into an investor rights agreement with
Paulson, pursuant to which we granted to Paulson, among other things, certain
registration rights with respect to certain securities and certain preemptive
rights, and Paulson agreed to, among other things, certain restrictions on
transfer of certain securities, certain voting limitations and certain
standstill provisions.
The
warrants have an exercise price of $6.50 per share of common stock, subject to
customary anti-dilution adjustments. Prior to June 30, 2013, the warrants
are not exercisable, except under limited circumstances. Commencing on
June 30, 2013, the warrants will be exercisable for shares of our common
stock at the option of the holder at any time, subject
186
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
to
certain exceptions. The warrants expire on December 30, 2016.
Prior to
completing the private placement with Paulson, our board of directors deemed
Paulson an “Exempted Entity” and therefore not an “Acquiring Person” for
purposes of our Section 382 Rights Agreement, with respect to the
16.4 million shares of common stock, any shares of common stock issued upon
exercise of the warrants, any common stock issued upon conversion of the 7.0%
Debentures owned by Paulson, as well as the shares of common stock Paulson owned
prior to the private placement. See the note to the consolidated
financial statements entitled “Income Taxes” for more information on the Section
382 Rights Agreement.
In the
second quarter of 2004, we completed the public offerings, including underwriter
over-allotments, of 50.6 million shares of our common stock at an offering price
of $18.25 per share and 27.6 million shares of our 5.5 percent Class B
mandatorily convertible preferred stock (the “Preferred Stock”) at an offering
price of $25 per share. In May 2007, all of our Preferred Stock was
converted into shares of Conseco common stock in accordance with the terms of
issuance. Under those terms, each of the 27.6 million shares of
Preferred Stock outstanding was converted into 1.3699 shares of common
stock. As a result of the conversion, our common shares outstanding
increased by 37.8 million.
Pursuant
to the Plan, we issued warrants to purchase 6.0 million shares of our common
stock (the “Series A Warrants”) entitling the holders to purchase shares of CNO
common stock at a price of $27.60 per share. The Series A Warrants
expired on September 10, 2008.
In
December 2006, the Company’s board of directors authorized a common share
repurchase program of up to $150 million. In May 2007, the Company’s
board of directors increased the authorized common share repurchase program to a
maximum of $350 million. With respect to $25 million of the program,
the Company entered into an accelerated share buy back agreement (“ASB”) to
repurchase 1.2 million shares. The initial price paid per share as
part of the ASB transaction was $20.12. The repurchased shares were
subject to a settlement price adjustment based upon the difference
between: (i) the volume weighted average price of Conseco common
stock (as defined in the ASB); and (ii) $20.12. The settlement price
adjustment was calculated to be $.3 million and was paid to the
Company. The Company recognized a reduction in common stock and
additional paid-in capital of $24.7 million in the first quarter of 2007 related
to the ASB transaction.
During
2007, the Company repurchased an additional 4.5 million shares of its common
stock for $62.5 million. No repurchases were made in 2009 or
2008.
Changes
in the number of shares of common stock outstanding were as follows (shares in
thousands):
|
2009
|
2008
|
2007
|
||||||||||||
|
Balance,
beginning of
year
|
184,754 | 184,652 | 152,165 | |||||||||||
|
Issuance
of common
stock
|
65,900 | - | - | |||||||||||
|
Treasury
stock purchased and
retired
|
- | - | (5,699 | ) | ||||||||||
|
Conversion
of preferred stock into common shares
|
- | - | 37,809 | |||||||||||
|
Stock
options
exercised
|
- | - | 207 | |||||||||||
|
Shares
issued under employee benefit compensation plans
|
132 | 102 |
(a)
|
177 |
(a)
|
|||||||||
|
Other
|
- | - | (7 | ) | ||||||||||
|
Balance,
end of
year
|
250,786 | 184,754 | 184,652 | |||||||||||
____________________
|
(a)
|
In
2008 and 2007, such amounts were reduced by 16 thousand shares and 24
thousand shares, respectively, which were tendered for the payment of
federal and state taxes owned on the issuance of restricted
stock.
|
The
Company has a long-term incentive plan which permits the grant of CNO incentive
or non-qualified stock options, restricted stock awards, stock appreciation
rights, performance shares or units and certain other equity-based awards to
certain directors, officers and employees of the Company and certain other
individuals who perform services for the Company. In April 2009, the
shareholders of the Company approved an increase in the number of shares
authorized to be issued under the plan to a maximum of 25.8 million shares from
10 million shares. As of December 31, 2009, 12.6
million
187
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
shares
remained available for issuance under the plan. Our stock option
awards are generally granted with an exercise price equal to the market price of
the Company’s stock on the date of grant. For options granted in 2006
and prior years, our stock option awards generally vest on a graded basis over a
four year service term and expire ten years from the date of
grant. Our stock option awards granted since 2006 generally vest on a
graded basis over a three year service term and expire five years from the date
of grant. The vesting periods for our restricted stock awards range
from immediate vesting to a period of four years.
A summary
of the Company’s stock option activity and related information for 2009 is
presented below (shares in thousands; dollars in millions, except per share
amounts):
|
Weighted
|
Weighted
|
||||||||||||
|
average
|
average
|
Aggregate
|
|||||||||||
|
exercise
|
remaining
|
intrinsic
|
|||||||||||
|
Shares
|
price
|
life
|
value
|
||||||||||
|
Outstanding
at the beginning of the year
|
5,864 | $ | 16.94 | ||||||||||
|
Options
granted
|
3,219 | 2.64 | |||||||||||
|
Exercised
|
- | - | $ | - | |||||||||
|
Forfeited
or
terminated
|
(523 | ) | 15.52 | ||||||||||
|
Outstanding
at the end of the
year
|
8,560 | 11.65 |
4.1
years
|
$ | 31.6 | ||||||||
|
Options
exercisable at the end of the year
|
2,992 |
4.4
years
|
$ | 19.4 | |||||||||
|
Available
for future
grant
|
12,565 | ||||||||||||
A summary
of the Company’s stock option activity and related information for 2008 is
presented below (shares in thousands; dollars in millions, except per share
amounts):
|
Weighted
|
Weighted
|
||||||||||||
|
average
|
average
|
Aggregate
|
|||||||||||
|
exercise
|
remaining
|
intrinsic
|
|||||||||||
|
Shares
|
price
|
life
|
value
|
||||||||||
|
Outstanding
at the beginning of the year
|
4,828 | $ | 19.82 | ||||||||||
|
Options
granted
|
1,863 | 10.27 | |||||||||||
|
Exercised
|
- | - | $ | - | |||||||||
|
Forfeited
or
terminated
|
(827 | ) | 18.69 | ||||||||||
|
Outstanding
at the end of the
year
|
5,864 | 16.94 |
4.8
years
|
$ | 27.9 | ||||||||
|
Options
exercisable at the end of the year
|
2,412 |
5.5
years
|
$ | 16.6 | |||||||||
|
Available
for future
grant
|
1,154 | ||||||||||||
188
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
A summary
of the Company’s stock option activity and related information for 2007 is
presented below (shares in thousands; dollars in millions, except per share
amounts):
|
Weighted
|
Weighted
|
||||||||||||
|
average
|
average
|
Aggregate
|
|||||||||||
|
exercise
|
remaining
|
intrinsic
|
|||||||||||
|
Shares
|
price
|
life
|
value
|
||||||||||
|
Outstanding
at the beginning of the year
|
4,217 | $ | 20.76 | ||||||||||
|
Options
granted
|
1,671 | 17.37 | |||||||||||
|
Exercised
|
(207 | ) | 16.31 | $ | 1.3 | ||||||||
|
Forfeited
or
terminated
|
(853 | ) | 20.54 | ||||||||||
|
Outstanding
at the end of the
year
|
4,828 | 19.82 |
5.9
years
|
$ | 28.1 | ||||||||
|
Options
exercisable at the end of the year
|
2,462 |
6.0
years
|
$ | 16.6 | |||||||||
|
Available
for future grant
|
2,794 | ||||||||||||
We
recognized compensation expense related to stock options totaling $6.9 million
($4.5 million after income taxes) in 2009, $6.0 million ($3.9 million after
income taxes) in 2008 and $7.4 million ($4.8 million after income taxes) in
2007. Compensation expense related to stock options reduced both
basic and diluted earnings (loss) per share by 2 cents, 2 cents and 3 cents in
2009, 2008 and 2007, respectively. At December 31, 2009, the
unrecognized compensation expense for non-vested stock options totaled $8.7
million which is expected to be recognized over a weighted average period of 1.7
years. Cash received from the exercise of stock options was nil, nil
and $3.4 million during 2009, 2008 and 2007, respectively.
The fair
value of each stock option grant is estimated on the date of grant using the
Black-Scholes option valuation model with the following weighted average
assumptions:
|
2009 Grants
|
2008 Grants
|
2007 Grants
|
||||||||||
|
Weighted
average risk-free interest rates
|
1.6 | % | 2.5 | % | 4.4 | % | ||||||
|
Weighted
average dividend
yields
|
0.0 | % | 0.0 | % | 0.0 | % | ||||||
|
Volatility
factors
|
108 | % | 24 | % | 22 | % | ||||||
|
Weighted
average expected
life
|
3.8
years
|
3.7
years
|
3.7
years
|
|||||||||
|
Weighted
average fair value per share
|
$ | 1.89 | $ | 2.25 | $ | 4.22 | ||||||
The
risk-free interest rate is based on the U.S. Treasury yield curve in effect at
the time of grant. The dividend yield is based on the Company’s
history and expectation of dividend payouts. Volatility factors are
based on the weekly historical volatility of the Company’s common stock equal to
the expected life of the option or since our emergence from bankruptcy in
September 2003. The expected life is based on the average of the
graded vesting period and the contractual terms of the option.
The
exercise price was equal to the market price of our stock for all options
granted in 2009, 2008 and 2007.
189
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
The
following table summarizes information about stock options outstanding at
December 31, 2009 (shares in thousands):
|
Options outstanding
|
Options exercisable
|
|||||||||||||||||||||
|
Number
|
Remaining
|
Average
exercise
|
Number
|
Average
exercise
|
||||||||||||||||||
|
Range of exercise prices
|
outstanding
|
life (in years)
|
price
|
exercisable
|
price
|
|||||||||||||||||
| $ | 1.13 | 697 | 4.3 | $ | 1.13 | - | $ | - | ||||||||||||||
| $ | 2.24 - $3.11 | 2,482 | 4.4 | 3.04 | - | - | ||||||||||||||||
| $ | 5.26 - $5.39 | 29 | 4.8 | 5.28 | - | - | ||||||||||||||||
| $ | 8.91 - $12.96 | 1,615 | 3.3 | 10.57 | 15 | 12.96 | ||||||||||||||||
| $ | 14.78 - $21.67 | 3,234 | 3.9 | 19.34 | 2,598 | 19.63 | ||||||||||||||||
| $ | 22.42 - $25.45 | 503 | 6.4 | 23.18 | 379 | 23.18 | ||||||||||||||||
| 8,560 | 2,992 | |||||||||||||||||||||
During
2009, 2008 and 2007, the Company granted .8 million, .1 million and .1 million
restricted shares, respectively, of CNO common stock to certain directors,
officers and employees of the Company at a weighted average fair value of $1.67
per share, $9.75 per share and $18.39 per share, respectively. The
fair value of such grants totaled $1.4 million, $.8 million and $1.7 million in
2009, 2008 and 2007, respectively. Such amounts are recognized as
compensation expense over the vesting period of the restricted
stock. A summary of the Company’s non-vested restricted stock
activity for 2009 is presented below (shares in thousands):
|
Weighted
|
||||||||
|
average
|
||||||||
|
grant
date
|
||||||||
|
Shares
|
fair value
|
|||||||
|
Non-vested
shares, beginning of
year
|
70 | $ | 14.41 | |||||
|
Granted
|
820 | 1.67 | ||||||
|
Vested
|
(132 | ) | 5.67 | |||||
|
Forfeited
|
(10 | ) | 1.12 | |||||
|
Non-vested
shares, end of
year
|
748 | 2.15 | ||||||
At
December 31, 2009, the unrecognized compensation expense for non-vested
restricted stock totaled $1.1 million which is expected to be recognized over a
weighted average period of 1.9 years. At December 31, 2008, the
unrecognized compensation expense for non-vested restricted stock totaled $.6
million. We recognized compensation expense related to restricted
stock awards totaling $.9 million, $1.4 million and $3.2 million in 2009, 2008
and 2007, respectively. The fair value of restricted stock that
vested during 2009, 2008 and 2007 was $.8 million, $1.9 million and $3.9
million, respectively.
Authoritative
guidance also requires us to estimate the amount of unvested stock-based awards
that will be forfeited in future periods and reduce the amount of compensation
expense recognized over the applicable service period to reflect this estimate.
We periodically evaluate our forfeiture assumptions to more accurately reflect
our actual forfeiture experience.
The
Company does not currently recognize tax benefits resulting from tax deductions
in excess of the compensation expense recognized because of NOLs which are
available to offset future taxable income.
As
further discussed in the footnote to the consolidated financial statements
entitled “Income Taxes”, the Company’s Board of Directors adopted the Section
382 Rights Agreement on January 20, 2009, which is designed to protect
shareholder value by preserving the value of our tax assets primarily associated
with NOLs. As a result, the Company declared a dividend of one
preferred share purchase right (a “Right”) for each outstanding share of common
stock. The dividend was payable on January 30, 2009, to the
shareholders of record as of the close of business on that date. Each
Right entitles the shareholder to purchase from the Company one one-thousandth
of a share of Series A Junior Participating Preferred Stock, par value $.01 per
share (the “Junior Preferred Stock”) of the Company at a price of $20.00 per one
one-thousandth of a share of Junior Preferred Stock. The description
and terms of the Rights are set forth in the Section 382 Rights
Agreement. The Rights would become exercisable in the event any
person or group (subject to certain exemptions) becomes a “5
percent
190
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
shareholder”
of Conseco without the approval of the Board of Directors or an existing
shareholder who is currently a “5 percent shareholder” acquires additional
shares exceeding one percent of our outstanding shares without prior approval
from the Board of Directors.
A
reconciliation of net income (loss) and shares used to calculate basic and
diluted earnings (loss) per share is as follows (dollars in millions and shares
in thousands):
|
2009
|
2008
|
2007
|
||||||||||
|
Income
(loss) before discontinued operations
|
$ | 85.7 | $ | (409.6 | ) | $ | (79.1 | ) | ||||
|
Discontinued
operations
|
- | (722.7 | ) | (105.9 | ) | |||||||
|
Net
income (loss)
|
85.7 | (1,132.3 | ) | (185.0 | ) | |||||||
|
Preferred
stock dividends
|
- | - | (14.1 | ) | ||||||||
|
Net
income (loss) applicable to common stock for basic earnings per
share
|
85.7 | (1,132.3 | ) | (199.1 | ) | |||||||
|
Add: interest
expense on 7.0% Debentures, net of income taxes
|
1.1 | - | - | |||||||||
|
Net
income (loss) applicable to common stock for diluted earnings per
share
|
$ | 86.8 | $ | (1,132.3 | ) | $ | (199.1 | ) | ||||
|
Shares:
|
||||||||||||
|
Weighted
average shares outstanding for basic earnings per share
|
188,365 | 184,704 | 173,374 | |||||||||
|
Effect
of dilutive securities on weighted average shares:
|
||||||||||||
|
7%
Debentures
|
4,281 | - | - | |||||||||
|
Stock
option and restricted stock plans
|
694 | - | - | |||||||||
|
Dilutive
potential common shares
|
4,975 | - | - | |||||||||
|
Weighted
average shares outstanding for diluted earnings per share
|
193,340 | 184,704 | 173,374 | |||||||||
There
were no dilutive common stock equivalents during 2008 or 2007 because of the net
loss recognized by the Company during such period. Therefore, all
potentially dilutive shares are excluded in the weighted average shares
outstanding for diluted earnings per share, and the preferred stock dividends on
the Class B mandatorily convertible preferred stock (related to the period prior
to their conversion) are not added back to net income (loss) applicable to
common stock.
The
following summarizes the equivalent common shares for securities that were not
included in the computation of diluted earnings per share, because doing so
would have been antidilutive in such periods (shares in thousands).
|
2008
|
2007
|
|||||||
|
Equivalent
common shares that were antidilutive during the year:
|
||||||||
|
Class
B mandatorily convertible preferred
stock
|
- | 14,334 | ||||||
|
Stock
option and restricted stock
plans
|
32 | 144 | ||||||
|
Antidilutive
equivalent common
shares
|
32 | 14,478 | ||||||
In August
2005, we completed the private offering of the 3.5% Debentures. In
future periods, our diluted shares outstanding may include incremental shares
issuable upon conversion of all or part of such 3.5%
Debentures. Since the remaining outstanding principal amount of the
3.5% Debentures can only be redeemed for cash, it has no impact on the diluted
earnings per share calculation. In accordance with the conversion
feature of these 3.5% Debentures, we may be required to pay a stock premium
along with redeeming the accreted principal amount for cash, if our common stock
reaches a certain market price. We will include the dilutive effect
of our 3.5% Debentures in the calculation of diluted earnings per share when the
impact is dilutive. During 2009, 2008 and 2007, the conversion
feature of the 3.5% Debentures did not have a dilutive effect because the
weighted average market price of our common stock did not exceed the initial
conversion price
191
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
of
$26.66. Therefore, the 3.5% Debentures had no effect on our diluted
shares outstanding or our diluted earnings per share in 2009, 2008 or
2007.
Basic
earnings (loss) per common share is computed by dividing net income (loss)
applicable to common stock by the weighted average number of common shares
outstanding for the period. Restricted shares (including our
performance shares) are not included in basic earnings (loss) per share until
vested. Diluted earnings (loss) per share reflect the potential
dilution that could occur if outstanding stock options were exercised and
restricted stock was vested. The dilution from options and restricted
shares is calculated using the treasury stock method. Under this
method, we assume the proceeds from the exercise of the options (or the
unrecognized compensation expense with respect to restricted stock) will be used
to purchase shares of our common stock at the average market price during the
period, reducing the dilutive effect of the exercise of the options (or the
vesting of the restricted stock).
In 2009,
2008 and 2007, the Company granted performance shares totaling 620,225, 645,100
and 420,900, respectively, pursuant to its long-term incentive plan to certain
officers of the Company. The criteria for payment related to a
portion of such awards is based upon the cumulative return on the Company’s
stock with dividends reinvested (“total shareholder return”) compared to the
total shareholder return of a group of Conseco’s peers (represented by the
companies comprising the Standard & Poor’s Life and Health Index and the
Russell 3000 Health and Life Index) over a three year performance measurement
period. If the Company’s results are below the 50
th
percentile of the comparison group, no portion of the award is
earned. If the Company’s results are equal to or greater than the
75
th
percentile, then the maximum award is earned. The criteria for
payment of the remaining performance shares is based upon the Company’s
operating return on equity, as defined in the award agreement. If the
Company’s operating return on equity is less than 10.0 percent, no portion of
the award is earned. If the Company’s operating return on equity is
equal to or greater than 12.0 percent, then the maximum award is
earned. Unless antidilutive, the diluted weighted average shares
outstanding would reflect the number of performance shares expected to be
issued, using the treasury stock method.
A summary
of the Company’s performance shares is presented below (shares in
thousands):
|
Total
shareholder
|
Operating
return
|
|||||||
|
return award
|
on equity award
|
|||||||
|
Granted
in
2007
|
253 | 168 | ||||||
|
Forfeited
|
(35 | ) | (22 | ) | ||||
|
Awards
outstanding at December 31, 2007
|
218 | 146 | ||||||
|
Granted
in
2008
|
387 | 258 | ||||||
|
Forfeited
|
(54 | ) | (37 | ) | ||||
|
Awards
outstanding at December 31, 2008
|
551 | 367 | ||||||
|
Granted
in
2009
|
- | 620 | ||||||
|
Forfeited
|
(220 | ) | (162 | ) | ||||
|
Awards
outstanding at December 31, 2009
|
331 | 825 | ||||||
The grant
date fair value of the total shareholder return awards was $1.6 million and $1.7
million in 2008 and 2007, respectively. The grant date fair value of
the operating return on equity awards was $1.9 million, $2.7 million and $3.0
million in 2009, 2008 and 2007, respectively. We recognized
compensation expense of $1.3 million, $.1 million and $1.1 million in 2009, 2008
and 2007, respectively, related to the performance shares.
192
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
12. OTHER
OPERATING STATEMENT DATA
Insurance
policy income consisted of the following (dollars in millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Traditional
products:
|
||||||||||||
|
Direct
premiums
collected
|
$ | 4,128.1 | $ | 4,313.5 | $ | 4,291.4 | ||||||
|
Reinsurance
assumed
|
476.5 | 642.8 | 314.0 | |||||||||
|
Reinsurance
ceded
|
(185.7 | ) | (164.3 | ) | (199.8 | ) | ||||||
|
Premiums
collected, net of
reinsurance
|
4,418.9 | 4,792.0 | 4,405.6 | |||||||||
|
Change
in unearned
premiums
|
(2.1 | ) | (13.5 | ) | (2.1 | ) | ||||||
|
Less
premiums on universal life and products without mortality and morbidity
risk which are recorded as
additions
to insurance
liabilities
|
(1,668.9 | ) | (1,863.5 | ) | (1,852.2 | ) | ||||||
|
Premiums
on traditional products with mortality or morbidity risk
|
2,747.9 | 2,915.0 | 2,551.3 | |||||||||
|
Fees
and surrender charges on interest-sensitive products
|
345.7 | 338.6 | 344.4 | |||||||||
|
Insurance
policy
income
|
$ | 3,093.6 | $ | 3,253.6 | $ | 2,895.7 | ||||||
The four
states with the largest shares of 2009 collected premiums were Florida (7.6
percent), California (6.9 percent), Pennsylvania (6.4 percent) and Texas (6.1
percent). No other state accounted for more than five percent of
total collected premiums.
Other
operating costs and expenses were as follows (dollars in millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Commission
expense
|
$ | 114.3 | $ | 128.2 | $ | 118.3 | ||||||
|
Salaries
and
wages
|
173.5 | 160.5 | 169.3 | |||||||||
|
Other
|
240.5 | 231.6 | 252.8 | |||||||||
|
Total
other operating costs and expenses
|
$ | 528.3 | $ | 520.3 | $ | 540.4 | ||||||
Changes
in the value of policies inforce at the Effective Date were as follows (dollars
in millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Balance,
beginning of
year
|
$ | 1,477.8 | $ | 1,573.6 | $ | 1,964.8 | ||||||
|
Additional
acquisition expense
|
- | - | 1.9 | |||||||||
|
Amortization
|
(177.5 | ) | (187.3 | ) | (246.2 | ) | ||||||
|
Cumulative
effect of accounting change related to the
adoption
of authoritative guidance
|
- | - | (2.6 | ) | ||||||||
|
Effect
of reinsurance transactions
|
(24.1 | ) | - | (134.9 | ) | |||||||
|
Amounts
related to fair value adjustment of actively
managed
fixed
maturities
|
(100.3 | ) | 92.7 | (9.4 | ) | |||||||
|
Other
|
- | (1.2 | ) | - | ||||||||
|
Balance,
end of
year
|
$ | 1,175.9 | $ | 1,477.8 | $ | 1,573.6 | ||||||
193
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
Based on
current conditions and assumptions as to future events on all policies inforce,
the Company expects to amortize approximately 13 percent of the December 31,
2009 balance of the value of policies inforce at the Effective Date in 2010, 11
percent in 2011, 10 percent in 2012, 9 percent in 2013 and 7 percent in
2014. The discount rate used to determine the amortization of the
value of policies inforce at the Effective Date averaged approximately 5 percent
in the years ended December 31, 2009, 2008 and 2007.
In
accordance with authoritative guidance, we are required to amortize the value of
policies inforce in relation to estimated gross profits for universal life
products and investment-type products. Such guidance also requires
that estimates of expected gross profits used as a basis for amortization be
evaluated regularly, and that the total amortization recorded to date be
adjusted by a charge or credit to the statement of operations, if actual
experience or other evidence suggests that earlier estimates should be
revised.
Changes
in the cost of policies produced were as follows (dollars in
millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Balance,
beginning of
year
|
$ | 1,812.6 | $ | 1,423.0 | $ | 1,106.7 | ||||||
|
Additions
|
407.5 | 459.1 | 487.6 | |||||||||
|
Amortization
|
(255.2 | ) | (180.6 | ) | (180.6 | ) | ||||||
|
Cumulative
effect of accounting change related to the adoption of
authoritative
guidance
|
- | - | (1.6 | ) | ||||||||
|
Effect
of reinsurance
transactions
|
(79.0 | ) | - | (19.3 | ) | |||||||
|
Amounts
related to fair value adjustment of actively managed fixed
maturities
|
(95.0 | ) | 111.1 | 30.2 | ||||||||
|
Balance,
end of
year
|
$ | 1,790.9 | $ | 1,812.6 | $ | 1,423.0 | ||||||
194
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
13. CONSOLIDATED
STATEMENT OF CASH FLOWS
The
following disclosures supplement our consolidated statement of cash flows
(dollars in millions):
Non-cash items not reflected in the
investing and financing activities sections of the consolidated statement of
cash flows (dollars in millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Stock
option and restricted stock
plans
|
$ | 9.1 | $ | 7.4 | $ | 11.0 | ||||||
|
Conversion
of preferred stock into common shares
|
- | - | 667.8 | |||||||||
|
Reduction
of tax liabilities related to various
contingencies
recognized at the fresh-start date
|
- | - | 6.0 | |||||||||
|
Change
in securities lending
collateral
|
223.1 | 51.6 | 408.3 | |||||||||
|
Change
in securities lending
payable
|
(223.1 | ) | (51.6 | ) | (408.3 | ) | ||||||
The
following reconciles net income to net cash provided by operating activities
(dollars in millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Cash
flows from operating activities:
|
||||||||||||
|
Net
income (loss)
|
$ | 85.7 | $ | (1,132.3 | ) | $ | (185.0 | ) | ||||
|
Adjustments
to reconcile net income (loss) to net cash provided by operating
activities:
|
||||||||||||
|
Amortization
and depreciation
|
460.9 | 420.7 | 491.2 | |||||||||
|
Income
taxes
|
80.7 | 429.0 | 1.3 | |||||||||
|
Insurance
liabilities
|
421.4 | 460.6 | 744.8 | |||||||||
|
Accrual
and amortization of investment income
|
(125.4 | ) | 3.9 | 73.4 | ||||||||
|
Deferral
of policy acquisition costs
|
(407.5 | ) | (459.1 | ) | (545.9 | ) | ||||||
|
Net
realized investment losses
|
60.5 | 642.5 | 155.4 | |||||||||
|
(Gain)
loss on extinguishment of debt
|
22.2 | (21.2 | ) | - | ||||||||
|
Net
sales (purchases) of trading securities
|
32.3 | 346.5 | (114.3 | ) | ||||||||
|
Loss
related to an annuity coinsurance transaction
|
- | - | 76.5 | |||||||||
|
Loss
on Transfer
|
- | 319.9 | - | |||||||||
|
Gain
on reinsurance recapture
|
- | (29.7 | ) | - | ||||||||
|
Other
|
13.2 | 6.0 | 5.9 | |||||||||
|
Net
cash provided by operating
activities
|
$ | 644.0 | $ | 986.8 | $ | 703.3 | ||||||
Our
consolidated statement of cash flows for 2008 and 2007 combines the cash flows
from discontinued operations with the cash flows from continuing operations
within each major category (operating, investing and financing) of the cash flow
statement.
At
December 31, 2009, restricted cash and cash equivalents consisted of $3.4
million held by a VIE.
At
December 31, 2008, restricted cash and cash equivalents consisted of $4.8
million held by a VIE.
195
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
14. STATUTORY
INFORMATION (BASED ON NON-GAAP MEASURES)
Statutory
accounting practices prescribed or permitted by regulatory authorities for the
Company’s insurance subsidiaries differ from GAAP. The Company’s
insurance subsidiaries reported the following amounts to regulatory agencies,
after appropriate elimination of intercompany accounts among such subsidiaries
(dollars in millions):
|
2009
|
2008
|
|||||||
|
Statutory
capital and
surplus
|
$ | 1,410.7 | $ | 1,311.5 | ||||
|
Asset
valuation
reserve
|
28.2 | 55.0 | ||||||
|
Interest
maintenance
reserve
|
290.6 | 147.7 | ||||||
|
Total
|
$ | 1,729.5 | $ | 1,514.2 | ||||
Statutory
capital and surplus included investments in upstream affiliates of $52.4 million
and $52.2 million at December 31, 2009 and 2008, respectively, which were
eliminated in the consolidated financial statements prepared in accordance with
GAAP.
Statutory
earnings build the capital required by ratings agencies and
regulators. Statutory earnings, fees and interest paid by the
insurance companies to the parent company create the “cash flow capacity” the
parent company needs to meet its obligations, including debt
service. The consolidated statutory net income (loss) (a non-GAAP
measure) of our insurance subsidiaries was $77.5 million, $(96.9) million and
$(321.3) million in 2009, 2008 and 2007, respectively. Included in
such net income (loss) were net realized capital losses, net of income taxes, of
$186.5 million, $217.1 million and $38.5 million in 2009, 2008 and 2007,
respectively. In addition, such net income (loss) included pre-tax
amounts for fees and interest to Conseco or its non-life subsidiaries totaling
$137.1 million, $139.6 million and $162.8 million in 2009, 2008 and 2007,
respectively.
Insurance
regulators may prohibit the payment of dividends or other payments by our
insurance subsidiaries to parent companies if they determine that such payment
could be adverse to our policyholders or contract holders. Otherwise,
the ability of our insurance subsidiaries to pay dividends is subject to state
insurance department regulations. Insurance regulations generally
permit dividends to be paid from statutory earned surplus of the insurance
company without regulatory approval for any 12-month period in amounts equal to
the greater of (or in a few states, the lesser of): (i) statutory net gain from
operations or statutory net income for the prior year; or (ii) 10 percent of
statutory capital and surplus as of the end of the preceding year, excluding
$61.2 million of additional surplus recognized due to temporary modifications in
statutory prescribed practices related to certain deferred tax
assets. This type of dividend is referred to as “ordinary
dividends”. Any dividends in excess of these levels require the
approval of the director or commissioner of the applicable state insurance
department. This type of dividend is referred to as “extraordinary
dividends”. During 2009, our insurance subsidiaries paid cash
dividends of $35.0 million to CDOC (which is the immediate parent of Washington
National, Conseco Health and Conseco Life Insurance Company of
Texas).
Each of
the immediate subsidiaries of CDOC have negative earned surplus at December 31,
2009. Accordingly, any dividend payments from these subsidiaries
require the approval of the director or commissioner of the applicable state
insurance department. During 2010, we are expecting our insurance
subsidiaries to pay approximately $105 million of extraordinary dividends to
CDOC (subject to approval by the applicable state insurance
department). In addition, we are expecting our insurance subsidiaries
to pay interest on surplus debentures of $49 million in 2010, which will not
require additional approval provided the risk-based capital (“RBC”) ratio of
Conseco Life Insurance Company of Texas exceeds 100 percent (but will require
prior written notice to the Texas state insurance
department). Dividends and other payments from our non-insurance
subsidiaries to CNO or CDOC do not require approval by any regulatory authority
or other third party. Also, during 2009, CDOC made no capital
contributions to our insurance subsidiaries, however, a $29.4 million capital
contribution was accrued at December 31, 2009, and paid in February
2010.
In
accordance with an order from the Florida Office of Insurance Regulation,
Washington National may not distribute funds to any affiliate or shareholder
without prior notice to the Florida Office of Insurance
Regulation. In addition, the RBC and other capital requirements
described below can also limit, in certain circumstances, the ability of our
insurance subsidiaries to pay dividends.
RBC
requirements provide a tool for insurance regulators to determine the levels of
statutory capital and surplus an
196
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
insurer
must maintain in relation to its insurance and investment risks and the need for
possible regulatory attention. The RBC requirements provide four
levels of regulatory attention, varying with the ratio of the insurance
company’s total adjusted capital (defined as the total of its statutory capital
and surplus, AVR and certain other adjustments) to its RBC (as measured on
December 31 of each year) as follows: (i) if a company’s total
adjusted capital is less than 100 percent but greater than or equal to 75
percent of its RBC, the company must submit a comprehensive plan to the
regulatory authority proposing corrective actions aimed at improving its capital
position (the “Company Action Level”); (ii) 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 authority will perform a special examination of the company
and issue an order specifying the corrective actions that must be taken; (iii)
if a company’s total adjusted capital is less than 50 percent but greater than
or equal to 35 percent of its RBC, the regulatory authority may take any action
it deems necessary, including placing the company under regulatory control; and
(iv) if a company’s total adjusted capital is less than 35 percent of its RBC,
the regulatory authority must place the company under its control. In
addition, the RBC requirements provide for a trend test if a company’s total
adjusted capital is between 100 percent and 125 percent of its RBC at the end of
the year. The trend test calculates the greater of the decrease in
the margin of total adjusted capital over RBC: (i) between the
current year and the prior year; and (ii) for the average of the last 3
years. It assumes that such decrease could occur again in the coming
year. Any company whose trended total adjusted capital is less than
95 percent of its RBC would trigger a requirement to submit a comprehensive plan
as described above for the Company Action Level.
In
addition to the RBC requirements, certain states have established minimum
capital requirements for insurance companies licensed to do business in their
state. These additional requirements generally have not had a
significant impact on the Company’s insurance subsidiaries, but the capital
requirements in Florida have caused Conseco Health to maintain a higher level of
capital and surplus than it would otherwise maintain and have thus limited its
ability to pay dividends.
In
addition, although we are under no obligation to do so, we may elect to
contribute additional capital to strengthen the surplus of certain insurance
subsidiaries. Any election regarding the contribution of additional
capital to our insurance subsidiaries could affect the ability of our insurance
subsidiaries to pay dividends to the holding company. The ability of
our insurance subsidiaries to pay dividends is also impacted by various criteria
established by rating agencies to maintain or receive higher ratings and by the
capital levels that we target for our insurance subsidiaries.
During
2009, the financial statements of three of our subsidiaries prepared in
accordance with statutory accounting practices prescribed or permitted by
regulatory authorities reflected asset adequacy or premium deficiency
reserves. Total asset adequacy and premium deficiency reserves for
Washington National, Conseco Life and Bankers Conseco Life Insurance Company
were $79.1 million, $257.1 million and $21.2 million, respectively at December
31, 2009. The determination of the need for and amount of asset
adequacy reserves is subject to numerous actuarial assumptions, including the
Company’s ability to change nonguaranteed elements related to certain products
consistent with contract provisions.
At
December 31, 2009, the consolidated RBC ratio of our insurance subsidiaries
exceeded the minimum RBC requirement included in our Senior Credit
Agreement. See the note to the consolidated financial statements
entitled “Notes Payable - Direct Corporate Obligations” for further discussion
of various financial ratios and balances we are required to
maintain. We calculate the consolidated RBC ratio by assuming all of
the assets, liabilities, capital and surplus and other aspects of the business
of our insurance subsidiaries are combined together in one insurance subsidiary,
with appropriate intercompany eliminations.
|
15.
|
BUSINESS
SEGMENTS
|
We manage
our business through the following: three primary operating segments,
Bankers Life, Colonial Penn and Conseco Insurance Group, which are defined on
the basis of product distribution; and corporate operations, which consists of
holding company activities and certain noninsurance businesses.
We
measure segment performance by excluding realized investment gains (losses)
because we believe that this performance measure is a better indicator of the
ongoing business and trends in our business. Our primary investment
focus is on investment income to support our liabilities for insurance products
as opposed to the generation of realized investment gains (losses), and a
long-term focus is necessary to maintain profitability over the life of the
business. Realized investment gains (losses) depend on market
conditions and do not necessarily relate to the underlying business of our
segments. Realized investment gains (losses), may affect future
earnings levels since our underlying business is long-term in nature and changes
in our investment portfolio may impact our ability to earn the assumed interest
rates needed to maintain the profitability of our business.
197
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
Operating
information by segment was as follows (dollars in millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Revenues:
|
||||||||||||
|
Bankers
Life:
|
||||||||||||
|
Insurance
policy income:
|
||||||||||||
|
Annuities
|
$ | 41.4 | $ | 49.2 | $ | 67.6 | ||||||
|
Supplemental
health
|
1,711.7 | 1,872.9 | 1,537.0 | |||||||||
|
Life
|
206.1 | 187.8 | 175.4 | |||||||||
|
Net
investment income
(a)
|
678.1 | 558.2 | 572.3 | |||||||||
|
Fee
revenue and other income
(a)
|
10.2 | 11.0 | 12.0 | |||||||||
|
Total
Bankers Life
revenues
|
2,647.5 | 2,679.1 | 2,364.3 | |||||||||
|
Colonial
Penn:
|
||||||||||||
|
Insurance
policy income:
|
||||||||||||
|
Supplemental
health
|
8.1 | 9.5 | 10.8 | |||||||||
|
Life
|
188.0 | 175.3 | 115.0 | |||||||||
|
Net
investment income
(a)
|
38.7 | 39.6 | 37.8 | |||||||||
|
Fee
revenue and other income
(a)
|
.9 | 1.8 | .7 | |||||||||
|
Total
Colonial Penn
revenues
|
235.7 | 226.2 | 164.3 | |||||||||
|
Conseco
Insurance Group:
|
||||||||||||
|
Insurance
policy income:
|
||||||||||||
|
Annuities
|
29.5 | 14.1 | 14.3 | |||||||||
|
Supplemental
health
|
595.3 | 609.4 | 628.1 | |||||||||
|
Life
|
305.2 | 325.0 | 335.3 | |||||||||
|
Other
|
8.3 | 10.4 | 12.2 | |||||||||
|
Net
investment income
(a)
|
560.8 | 552.5 | 716.3 | |||||||||
|
Fee
revenue and other income
(a)
|
1.5 | 1.7 | 1.0 | |||||||||
|
Total
Conseco Insurance Group revenues
|
1,500.6 | 1,513.1 | 1,707.2 | |||||||||
|
Corporate
operations:
|
||||||||||||
|
Net
investment income
(a)
|
15.1 | 28.5 | 43.4 | |||||||||
|
Fee
and other
income
|
3.0 | 5.2 | 10.1 | |||||||||
|
Total
corporate
revenues
|
18.1 | 33.7 | 53.5 | |||||||||
|
Total
revenues
|
4,401.9 | 4,452.1 | 4,289.3 | |||||||||
(continued
on next page)
198
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
(continued
from previous page)
|
2009
|
2008
|
2007
|
||||||||||
|
Expenses:
|
||||||||||||
|
Bankers
Life:
|
||||||||||||
|
Insurance
policy
benefits
|
$ | 1,905.0 | $ | 2,090.4 | $ | 1,684.7 | ||||||
|
Amortization
|
267.9 | 234.8 | 264.0 | |||||||||
|
Other
operating costs and
expenses
|
196.6 | 182.4 | 173.8 | |||||||||
|
Total
Bankers Life
expenses
|
2,369.5 | 2,507.6 | 2,122.5 | |||||||||
|
Colonial
Penn:
|
||||||||||||
|
Insurance
policy
benefits
|
143.0 | 139.4 | 102.2 | |||||||||
|
Amortization
|
33.3 | 32.0 | 20.3 | |||||||||
|
Other
operating costs and
expenses
|
30.0 | 29.6 | 23.7 | |||||||||
|
Total
Colonial Penn
expenses
|
206.3 | 201.0 | 146.2 | |||||||||
|
Conseco
Insurance Group:
|
||||||||||||
|
Insurance
policy
benefits
|
1,018.7 | 982.7 | 1,129.0 | |||||||||
|
Amortization
|
135.5 | 122.6 | 178.2 | |||||||||
|
Interest
expense on investment
borrowings
|
20.5 | 22.4 | 17.6 | |||||||||
|
Costs
related to a litigation
settlement
|
- | - | 32.2 | |||||||||
|
Loss
related to an annuity coinsurance transaction
|
- | - | 76.5 | |||||||||
|
Other
operating costs and
expenses
|
258.6 | 264.1 | 300.0 | |||||||||
|
Total
Conseco Insurance Group
expenses
|
1,433.3 | 1,391.8 | 1,733.5 | |||||||||
|
Corporate
operations:
|
||||||||||||
|
Interest
expense on corporate
debt
|
84.7 | 67.9 | 80.3 | |||||||||
|
Interest
expense on variable interest
entity
|
12.7 | 16.2 | 27.4 | |||||||||
|
Costs
related to a litigation
settlement
|
- | - | 32.2 | |||||||||
|
Other
operating costs and
expenses
|
43.1 | 44.2 | 42.9 | |||||||||
|
(Gain)
loss on extinguishment or modification of debt
|
22.2 | (21.2 | ) | - | ||||||||
|
Total
corporate
expenses
|
162.7 | 107.1 | 182.8 | |||||||||
|
Total
expenses
|
4,171.8 | 4,207.5 | 4,185.0 | |||||||||
|
Income
(loss) before net realized investment losses (net of related
amortization), income taxes and discontinued operations:
|
||||||||||||
|
Bankers
Life
|
278.0 | 171.5 | 241.8 | |||||||||
|
Colonial
Penn
|
29.4 | 25.2 | 18.1 | |||||||||
|
Conseco
Insurance
Group
|
67.3 | 121.3 | (26.3 | ) | ||||||||
|
Corporate
operations
|
(144.6 | ) | (73.4 | ) | (129.3 | ) | ||||||
|
Income
(loss) before net realized investment losses (net of related
amortization), income taxes and discontinued operations
|
$ | 230.1 | $ | 244.6 | $ | 104.3 | ||||||
____________________
|
|
(a)
|
It
is not practicable to provide additional components of revenue by product
or services.
|
199
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
A
reconciliation of segment revenues and expenses to consolidated revenues and
expenses is as follows (dollars in millions):
|
2009
|
2008
|
2007
|
||||||||||
|
Total
segment
revenues
|
$ | 4,401.9 | $ | 4,452.1 | $ | 4,289.3 | ||||||
|
Net
realized investment
losses
|
(60.5 | ) | (262.4 | ) | (158.0 | ) | ||||||
|
Consolidated
revenues
|
$ | 4,341.4 | $ | 4,189.7 | $ | 4,131.3 | ||||||
|
Total
segment
expenses
|
$ | 4,171.8 | $ | 4,207.5 | $ | 4,185.0 | ||||||
|
Amortization
related to net realized investment losses
|
(4.0 | ) | (21.5 | ) | (35.7 | ) | ||||||
|
Consolidated
expenses
|
$ | 4,167.8 | $ | 4,186.0 | $ | 4,149.3 | ||||||
Segment
balance sheet information was as follows (dollars in millions):
|
2009
|
2008
|
|||||||
|
Assets:
|
||||||||
|
Bankers
Life
|
$ | 14,655.6 | $ | 12,927.5 | ||||
|
Colonial
Penn
|
975.8 | 916.3 | ||||||
|
Conseco
Insurance
Group
|
14,545.4 | 14,703.7 | ||||||
|
Corporate
operations
|
167.0 | 215.8 | ||||||
|
Total
assets
|
$ | 30,343.8 | $ | 28,763.3 | ||||
|
Liabilities:
|
||||||||
|
Bankers
Life
|
$ | 12,983.3 | $ | 12,102.6 | ||||
|
Colonial
Penn
|
823.8 | 808.5 | ||||||
|
Conseco
Insurance
Group
|
11,560.1 | 12,370.7 | ||||||
|
Corporate
operations
|
1,444.2 | 1,851.5 | ||||||
|
Total
liabilities
|
$ | 26,811.4 | $ | 27,133.3 | ||||
The
following table presents selected financial information of our segments (dollars
in millions):
|
Value
of policies
|
||||||||||||
|
inforce
at the
|
Cost
of
|
|||||||||||
|
Effective
|
policies
|
Insurance
|
||||||||||
|
Segment
|
Date
|
produced
|
liabilities
|
|||||||||
|
2009
|
||||||||||||
|
Bankers
Life
|
$ | 569.5 | $ | 1,179.1 | $ | 12,384.8 | ||||||
|
Colonial
Penn
|
92.4 | 199.8 | 713.8 | |||||||||
|
Conseco
Insurance
Group
|
514.0 | 412.0 | 11,195.4 | |||||||||
|
Total
|
$ | 1,175.9 | $ | 1,790.9 | $ | 24,294.0 | ||||||
|
2008
|
||||||||||||
|
Bankers
Life
|
$ | 761.7 | $ | 1,216.2 | $ | 11,622.3 | ||||||
|
Colonial
Penn
|
105.3 | 174.8 | 708.9 | |||||||||
|
Conseco
Insurance
Group
|
610.8 | 421.6 | 11,856.9 | |||||||||
|
Total
|
$ | 1,477.8 | $ | 1,812.6 | $ | 24,188.1 | ||||||
200
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
16. 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. Quarterly
financial data (unaudited) were as follows (dollars in millions, except per
share data).
|
2009
|
1st Qtr.
|
2nd Qtr.
|
3rd Qtr.
|
4th Qtr.
|
||||||||||||
|
Revenues
|
$ | 1,069.5 | $ | 1,095.6 | $ | 1,118.6 | $ | 1,057.7 | ||||||||
|
Income
before income
taxes
|
$ | 42.2 | $ | 49.6 | $ | 64.1 | $ | 17.7 | ||||||||
|
Income
tax expense
(benefit)
|
17.7 | 22.0 | 48.7 | (.5 | ) | |||||||||||
|
Net
income
|
$ | 24.5 | $ | 27.6 | $ | 15.4 | $ | 18.2 | ||||||||
|
Income
per common share:
|
||||||||||||||||
|
Basic:
|
||||||||||||||||
|
Net
income
|
$ | .13 | $ | .15 | $ | .08 | $ | .09 | ||||||||
|
Diluted:
|
||||||||||||||||
|
Net
income
|
$ | .13 | $ | .15 | $ | .08 | $ | .09 | ||||||||
|
2008
|
1st Qtr.
|
2nd Qtr.
|
3rd Qtr.
|
4th Qtr. (a)
|
||||||||||||
|
Revenues
|
$ | 1,027.5 | $ | 1,094.7 | $ | 1,021.9 | $ | 1,045.6 | ||||||||
|
Income
(loss) before income taxes and discontinued operations
|
$ | (11.9 | ) | $ | 16.1 | $ | 5.7 | $ | (6.2 | ) | ||||||
|
Income
tax expense
(benefit)
|
(4.2 | ) | 306.3 | 31.6 | 79.6 | |||||||||||
|
Loss
before discontinued
operations
|
(7.7 | ) | (290.2 | ) | (25.9 | ) | (85.8 | ) | ||||||||
|
Income
(loss) from discontinued operations, net of tax
|
.5 | (198.3 | ) | (157.4 | ) | (367.5 | ) | |||||||||
|
Net
loss
|
$ | (7.2 | ) | $ | (488.5 | ) | $ | (183.3 | ) | $ | (453.3 | ) | ||||
|
Loss
per common share:
|
||||||||||||||||
|
Basic:
|
||||||||||||||||
|
Loss
before discontinued
operations
|
$ | (.04 | ) | $ | (1.57 | ) | $ | (.14 | ) | $ | (.46 | ) | ||||
|
Discontinued
operations
|
- | (1.08 | ) | (.85 | ) | (1.99 | ) | |||||||||
|
Net
loss
|
$ | (.04 | ) | $ | (2.65 | ) | $ | (.99 | ) | $ | (2.45 | ) | ||||
|
Diluted:
|
||||||||||||||||
|
Loss
before discontinued
operations
|
$ | (.04 | ) | $ | (1.57 | ) | $ | (.14 | ) | $ | (.46 | ) | ||||
|
Discontinued
operations
|
- | (1.08 | ) | (.85 | ) | (1.99 | ) | |||||||||
|
Net
loss
|
$ | (.04 | ) | $ | (2.65 | ) | $ | (.99 | ) | $ | (2.45 | ) | ||||
_____________
|
(a)
|
In
the fourth quarter of 2008, our net loss reflected the following: (i)
losses from discontinued operations of $367.5 million primarily related to
losses and transaction costs associated with the Transfer; and (ii) net
realized investment losses of $93.0
million.
|
201
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
|
|
17.
|
INVESTMENT
IN A VARIABLE INTEREST ENTITY
|
The
Company has an investment in a special purpose entity that is a variable
interest entity. The following is description of our significant
investment in a variable interest entity:
Fall
Creek CLO Ltd.
Fall
Creek CLO Ltd. (“Fall Creek”) is a collateralized loan trust that was
established to issue securities and use the proceeds to invest in loans and
other permitted investments. The assets held by the trust are legally
isolated and are not available to the Company. The liabilities of
Fall Creek are expected to be satisfied from the cash flows generated by the
underlying loans, not from the assets of the Company. The investment
borrowings were issued pursuant to an indenture between Fall Creek and a
trustee. The investment borrowings of Fall Creek may become due and
payable if certain threshold ratios (based on the entity’s leverage and the fair
value of its assets) are not met for a specified period of
time. During the first quarter of 2008, such threshold ratio was not
met and the indenture was amended. As a result of the amendment, Fall
Creek sold assets of $90 million (which resulted in net realized investment
losses of $11.2 million), and paid down investment borrowings of $88.0
million. Pursuant to the amendment, we committed to provide
additional capital to Fall Creek for up to $25 million (under defined
circumstances), all of which was contributed in 2008. In addition,
the indenture was amended and restated in November 2008, to change certain terms
related to the investment borrowings, cease future reinvesting activities of
Fall Creek, provide for an additional investment in Fall Creek and remove the
provision related to threshold ratios. In conjunction with the
amendment and restatement of the indenture, Fall Creek repaid $17.5 million of
investment borrowings and the Company purchased: (i) $25.2 million of borrowings
previously held by others; and (ii) $9.7 million of newly issued borrowings of
Fall Creek. Repayment of the remaining principal balance of the
investment borrowings of Fall Creek is based on available cash flows from the
assets and such borrowings mature in 2017. Repayments totaling $82.4
million were made in 2009 and a $10.0 million repayment was made in December
2008 based on such excess cash flows. The Company has no further
commitments to Fall Creek. The carrying value of our investment in
Fall Creek was $72.5 million and $83.5 million at December 31, 2009 and 2008,
respectively. The following tables provide supplemental information
about the assets, liabilities, revenues and expenses of Fall Creek which have
been consolidated in accordance with authoritative guidance, after giving effect
to the elimination of our investment in Fall Creek and investment management
fees earned by a subsidiary of the Company (dollars in millions):
|
December 31,
|
||||||||
|
2009
|
2008
|
|||||||
|
Assets:
|
||||||||
|
Actively
managed fixed
maturities
|
$ | 268.0 | $ | 269.7 | ||||
|
Cash
and cash equivalents –
restricted
|
3.4 | 4.8 | ||||||
|
Accrued
investment
income
|
1.2 | 2.8 | ||||||
|
Other
assets
|
8.0 | 7.2 | ||||||
|
Total
assets
|
$ | 280.6 | $ | 284.5 | ||||
|
Liabilities:
|
||||||||
|
Other
liabilities
|
$ | 7.4 | $ | 7.8 | ||||
|
Investment
borrowings due to
others
|
224.1 | 306.5 | ||||||
|
Investment
borrowings due to the
Company
|
81.9 | 81.9 | ||||||
|
Total
liabilities
|
313.4 | 396.2 | ||||||
|
Equity
(deficit):
|
||||||||
|
Capital
provided by the
Company
|
16.6 | 16.6 | ||||||
|
Capital
provided by
others
|
3.8 | 3.8 | ||||||
|
Accumulated
other comprehensive
loss
|
(22.5 | ) | (118.4 | ) | ||||
|
Accumulated
deficit
|
(30.7 | ) | (13.7 | ) | ||||
|
Total
equity
(deficit)
|
(32.8 | ) | (111.7 | ) | ||||
|
Total
liabilities and equity
(deficit)
|
$ | 280.6 | $ | 284.5 | ||||
202
CONSECO,
INC. AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
__________________
|
Years
ended
|
||||||||||||
|
December 31,
|
||||||||||||
|
2009
|
2008
|
2007
|
||||||||||
|
Revenues:
|
||||||||||||
|
Net
investment income – deposit
accounts
|
$ | 13.4 | $ | 23.6 | $ | 36.8 | ||||||
|
Fee
revenue and other
income
|
.3 | .5 | .3 | |||||||||
|
Total
revenues
|
13.7 | 24.1 | 37.1 | |||||||||
|
Expenses:
|
||||||||||||
|
Interest
expense
|
12.7 | 16.2 | 27.4 | |||||||||
|
Other
operating
expenses
|
.2 | .7 | .5 | |||||||||
|
Total
expenses
|
12.9 | 16.9 | 27.9 | |||||||||
|
Income
(loss) before net realized investment losses
and
income
taxes
|
.8 | 7.2 | 9.2 | |||||||||
|
Net
realized investment
losses
|
(14.2 | ) | (24.9 | ) | (.4 | ) | ||||||
|
Income
(loss) before income
taxes
|
$ | (13.4 | ) | $ | (17.7 | ) | $ | 8.8 | ||||
During
2009, net realized investment losses included: (i) $.7 million of net
losses from the sales of investments; and (ii) $13.5 million of writedowns of
investments resulting from declines in fair values that we concluded were other
than temporary. During 2008, net realized investment losses
included: (i) $14.1 million of net losses from the sales of
investments; and (ii) $10.8 million of writedowns of investments resulting from
declines in fair values that we concluded were other than
temporary.
18. SUBSEQUENT
EVENTS
In
February 2010, we repurchased $64 million aggregate principal amount of our 3.5%
Debentures in a privately-negotiated transaction. In connection with
the repurchase of the 3.5% Debentures, we completed a second closing of $64
million aggregate principal amount of our 7.0% Debentures as part of our
previously-announced private offering of 7.0% Debentures. The first
closing of $176.5 million of the 7.0% Debentures was completed on November 13,
2009, upon settlement of a tender offer for the 3.5% Debentures.
The
purchase price for the $64 million of 3.5% Debentures was equal to 100 percent
of the aggregate principal amount plus accrued and unpaid
interest. As a result of the repurchase, we expect to realize a loss
on the extinguishment of debt of approximately $2 million, representing the
write-off of unamortized discount and issuance costs associated with 3.5%
Debentures that were repurchased.
The
issuance of the $64 million of 7.0% Debentures was made pursuant to the purchase
agreement that we entered into in October 2009 relating to the private offering
of up to $293 million of 7.0% Debentures. We received aggregate net
proceeds of approximately $61.4 million in the second closing of the 7.0%
Debentures (after taking into account the discounted offering price less the
initial purchaser’s discounts and commissions, but before
expenses). An aggregate of $52.5 million of the 3.5% Debentures
remain outstanding.
203
|
|
ITEM
9.
|
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
|
None.
Evaluation of Disclosure Controls
and Procedures
. Conseco’s management, under the supervision
and with the participation of the Chief Executive Officer and the Chief
Financial Officer, evaluated the effectiveness of Conseco’s disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended). Disclosure controls and procedures
are designed to ensure that information required to be disclosed in reports
filed or submitted under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in SEC rules and forms and that such
information is accumulated and communicated to management, including the Chief
Executive Officer and Chief Financial Officer, to allow timely decisions
regarding required disclosures.
During
the evaluation of disclosure controls and procedures as of December 31, 2006,
conducted during the preparation of Conseco’s financial statements to be
included in the Annual Report on Form 10-K for the year ended December 31, 2006,
a material weakness in internal control was identified relating to the actuarial
reporting process and the design of controls to ensure the completeness and
accuracy of certain inforce policies. Remediation efforts to enhance
controls over the actuarial reporting process have been continuing over the last
three years under the direction of the Chief Financial Officer, and a number,
but not all, of the weaknesses have been addressed. As a result of
the unremediated weaknesses, Conseco’s Chief Executive Officer and Chief
Financial Officer concluded that, as of December 31, 2006, 2007, 2008 and 2009,
Conseco’s disclosure controls and procedures were not effective.
The
status of the remediation efforts was regularly reviewed with management and the
Company’s Audit and Enterprise Risk Committee of the Board of
Directors. This committee was advised of issues encountered and key
decisions reached by management relating to the remediation
efforts. Material control deficiencies in the actuarial reporting
process related to the design and operating effectiveness of controls over the
completeness and accuracy of inforce policies in all insurance policy blocks
other than certain specified disease policies were remediated, and the new
controls were determined to be effective as of December 31, 2009.
A
material weakness relating to the actuarial reporting process over certain
specified disease policies in our Conseco Insurance Group segment continued to
exist as of December 31, 2009. As a result, the Chief Executive
Officer and Chief Financial Officer concluded that, as of December 31, 2009,
Conseco’s disclosure controls and procedures were not effective.
Management’s Report on Internal
Control over Financial Reporting.
Management is responsible
for establishing and maintaining adequate internal control over financial
reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Securities Exchange Act of 1934. A company’s internal control over
financial reporting is a process designed by, or under the supervision of our
Chief Executive Officer and Chief Financial Officer, to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles in the United States.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
Conseco’s
management assessed the effectiveness of the Company’s internal control over
financial reporting as of December 31, 2009. In making this
assessment, management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) in
Internal Control – Integrated
Framework
.
A
material weakness is a deficiency, or a combination of deficiencies, in internal
control over financial reporting, such that there is a reasonable possibility
that a material misstatement of the Company’s annual or interim financial
statements will not be prevented or detected on a timely
basis. Conseco’s management has concluded that, as of December 31,
2009, the following material weakness relating to the controls over the
actuarial reporting process existed:
Conseco
did not maintain effective controls over the accounting and disclosure of
insurance policy benefits and the liabilities for insurance
products. Specifically, the design and operating efficiency of
controls over the actuarial reporting process to ensure the accuracy of certain
inforce specified disease policies in our Conseco Insurance Group segment were
not
204
effective. These
control deficiencies resulted in a reasonable possibility that a material
misstatement could occur in the liabilities for traditional insurance products
and insurance policy benefits account balances in our annual or interim
consolidated financial statements that would not be prevented or detected on a
timely basis. Accordingly, Conseco’s management has determined that
these control deficiencies constitute a material weakness. Because of
this material weakness, management concluded that Conseco did not maintain
effective internal controls over financial reporting as of December 31, 2009,
based on criteria in the
Internal Control – Integrated
Framework
issued by COSO.
The
effectiveness of our internal control over financial reporting as of December
31, 2009, has been audited by PricewaterhouseCoopers LLP, an independent
registered public accounting firm, as stated in their report which is included
herein.
Remediation
Efforts.
Conseco has devoted significant efforts and resources
towards remediation of the material weakness relating to the actuarial reporting
process. Significant improvements have been made to controls over
actuarial reporting for all insurance policy blocks other than certain specified
disease policies. The material weakness related to the design and
operating effectiveness of controls to ensure the completeness and accuracy of
certain specified disease inforce policies in our Conseco Insurance Group
segment continued to exist as of December 31, 2009. Conseco’s
management continues to assign the highest priority to Conseco’s remediation
efforts, with the goal of remediating the material weakness by the end of
2010. However, due to the nature of the remediation process and the
need to allow adequate time after implementation to evaluate and test the
effectiveness of the revised controls, no assurance can be given as to the
timing of achievement of remediation. Conseco recognizes that further
improvement in its internal control over the actuarial reporting process in our
Conseco Insurance Group segment is essential. The remaining weakness
to be addressed by the Company’s remediation efforts relates to the flow of
information from the administrative systems to the actuarial valuation processes
for certain specified disease policies in our Conseco Insurance Group
segment. Remediating this weakness will allow Conseco to reduce its
reliance on manual controls and other procedures. Conseco intends to
continue to develop improved systems and processes which will allow it to rely
on front-end preventative automated controls which will be more
sustainable. Conseco recognizes that further investment is needed to
improve the actuarial reporting processes in our Conseco Insurance Group segment
and is committed to making the investments for these improvements.
Changes to Internal Control Over
Financial Reporting.
Other than the improvements that have
been made to controls over actuarial reporting described above under the title
Remediation Efforts, there were no other changes in the Company’s internal
control over financial reporting (as defined in Rule 13a-15(f) under the
Securities Exchange Act of 1934) during the quarter ended December 31, 2009,
that have materially affected, or are reasonably likely to materially affect,
Conseco’s internal control over financial reporting.
205
None.
We will
provide information that is responsive to this Item 10 in our definitive proxy
statement or in an amendment to this Annual Report not later than 120 days after
the end of the fiscal year covered by this Annual Report. That
information is incorporated by reference into this Item
10. Additional information called for by this item is contained in
Part I of this Annual Report under the caption “Executive Officers of the
Registrant.”
We will
provide information that is responsive to this Item 11 in our definitive proxy
statement or in an amendment to this Annual Report not later than 120 days after
the end of the fiscal year covered by this Annual Report. That
information is incorporated by reference into this Item 11.
We will
provide information that is responsive to this Item 12 in our definitive proxy
statement or in an amendment to this Annual Report not later than 120 days after
the end of the fiscal year covered by this Annual Report. That
information is incorporated by reference into this item 12.
We will
provide information that is responsive to this Item 13 in our definitive proxy
statement or in an amendment to this Annual Report not later than 120 days after
the end of the fiscal year covered by this Annual Report. That
information is incorporated by reference into this Item 13.
We will
provide information that is responsive to this Item 14 in our definitive proxy
statement or in an amendment to this Annual Report not later than 120 days after
the end of the fiscal year covered by this Annual Report. That
information is incorporated by reference into this Item 14.
206
|
(a)
|
1.
|
Financial
Statements. See Index to Consolidated Financial Statements on
page 117 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
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.
207
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 3rd day of March,
2010.
CONSECO,
INC.
By:
/s/ C. James
Prieur
C. James
Prieur
Chief
Executive Officer
208
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 / C. JAMES PRIEUR
|
Director
and Chief Executive Officer
|
March
3, 2010
|
|
C.
James Prieur
|
(Principal
Executive Officer)
|
|
|
/s / EDWARD J. BONACH
|
Executive
Vice President
|
March
3, 2010
|
|
Edward
J. Bonach
|
and
Chief Financial Officer
|
|
|
(Principal
Financial Officer)
|
||
|
/s / JOHN R. KLINE
|
Senior
Vice President
|
March
3, 2010
|
|
John
R. Kline
|
and
Chief Accounting Officer
|
|
|
(Principal
Accounting Officer)
|
||
|
/s / R. GLENN HILLIARD
|
Director
|
March
3, 2010
|
|
R.
Glenn Hilliard
|
||
|
/s / DONNA A. JAMES
|
Director
|
March
3, 2010
|
|
Donna
A. James
|
||
|
/s / R. KEITH LONG
|
Director
|
March
3, 2010
|
|
R.
Keith Long
|
||
|
/s / CHARLES W. MURPHY
|
Director
|
March
3, 2010
|
|
Charles
W. Murphy
|
||
|
/s / DEBRA J. PERRY
|
Director
|
March
3, 2010
|
|
Debra
J. Perry
|
||
|
/s / NEAL C. SCHNEIDER
|
Director
|
March
3, 2010
|
|
Neal
C. Schneider
|
||
|
/s / MICHAEL T. TOKARZ
|
Director
|
March
3, 2010
|
|
Michael
T. Tokarz
|
||
|
/s / JOHN G. TURNER
|
Director
|
March
3, 2010
|
|
John
G. Turner
|
||
|
/s / DOREEN A. WRIGHT
|
Director
|
March
3, 2010
|
|
Doreen
A. Wright
|
209
Report of Independent
Registered Public Accounting Firm on
Financial Statement
Schedules
To the
Shareholders and Board of Directors
Conseco,
Inc.:
Our
audits of the consolidated financial statements and of the effectiveness of
internal control over financial reporting of Conseco, Inc. and subsidiaries
referred to in our report dated March 3, 2010
appearing under Item 8
of this Form 10-K also included an audit of the financial statement schedules at
December 31, 2009 and 2008 and for the years ended December 31, 2009, 2008 and
2007 listed in Item 15(a)(2) of this Form 10-K. In our opinion, these
financial statement schedules present fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements.
As
discussed in Note 4 to the consolidated financial statements, the Company
retrospectively adjusted its historical consolidated financial statements to
reflect the adoption of a new accounting standard effective January 1, 2009
regarding the accounting for convertible debt instruments that may be settled in
cash upon conversion (including partial cash settlement). Also, as
discussed in Note 4 to the consolidated financial statements, the Company
changed the manner in which it accounts for the non-credit portion of
other-than-temporary impairments of fixed maturity securities.
/s/
PricewaterhouseCoopers LLP
Indianapolis,
Indiana
March 3,
2010
210
CONSECO,
INC. AND SUBSIDIARIES
SCHEDULE
II
Condensed
Financial Information of Registrant (Parent Company)
Balance
Sheet
as of
December 31, 2009 and 2008
(Dollars
in millions)
|
ASSETS
|
||||||||
|
2009
|
2008
|
|||||||
|
Cash
and cash equivalents -
unrestricted
|
$ | 145.3 | $ | 56.5 | ||||
|
Other
invested
assets
|
.2 | .1 | ||||||
|
Investment
in wholly-owned subsidiaries (eliminated in consolidation)
|
4,902.4 | 3,261.6 | ||||||
|
Receivable
from subsidiaries (eliminated in
consolidation)
|
.9 | .8 | ||||||
|
Other
assets
|
16.1 | 23.1 | ||||||
|
Total
assets
|
$ | 5,064.9 | $ | 3,342.1 | ||||
|
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
||||||||
|
Liabilities:
|
||||||||
|
Notes
payable
|
$ | 1,037.4 | $ | 1,311.5 | ||||
|
Payable
to subsidiaries (eliminated in
consolidation)
|
360.2 | 261.0 | ||||||
|
Income
tax liabilities,
net
|
76.2 | 75.8 | ||||||
|
Other
liabilities
|
58.7 | 63.8 | ||||||
|
Total
liabilities
|
1,532.5 | 1,712.1 | ||||||
|
Commitments
and Contingencies
|
||||||||
|
Shareholders’
equity:
|
||||||||
|
Common
stock and additional paid-in capital ($.01 par value,
8,000,000,000
shares
authorized, shares issued and outstanding: 2009 –
250,786,216;
2008
–
184,753,758)
|
4,411.3 | 4,105.9 | ||||||
|
Accumulated
other comprehensive
loss
|
(264.3 | ) | (1,770.7 | ) | ||||
|
Accumulated
deficit
|
(614.6 | ) | (705.2 | ) | ||||
|
Total
shareholders’
equity
|
3,532.4 | 1,630.0 | ||||||
|
Total
liabilities and shareholders’
equity
|
$ | 5,064.9 | $ | 3,342.1 | ||||
The
accompanying notes are an integral part
of the
condensed financial information.
211
CONSECO,
INC. AND SUBSIDIARIES
SCHEDULE
II
Condensed
Financial Information of Registrant (Parent Company)
Statement
of Operations
for the
years ended December 31, 2009, 2008 and 2007
(Dollars
in millions)
|
2009
|
2008
|
2007
|
||||||||||
|
Revenues:
|
||||||||||||
|
Net
investment
income
|
$ | - | $ | 2.3 | $ | 3.6 | ||||||
|
Net
realized investment
losses
|
(.2 | ) | (25.9 | ) | - | |||||||
|
Fee
and interest income from subsidiaries (eliminated in
consolidation)
|
- | .7 | 3.1 | |||||||||
|
Total
revenues
|
(.2 | ) | (22.9 | ) | 6.7 | |||||||
|
Expenses:
|
||||||||||||
|
Interest
expense on notes payable
|
84.7 | 67.9 | 80.3 | |||||||||
|
Intercompany
expenses (eliminated in consolidation)
|
2.4 | 8.3 | 15.8 | |||||||||
|
Costs
related to a litigation settlement
|
- | - | 32.2 | |||||||||
|
Operating
costs and expenses
|
45.6 | 34.2 | 41.2 | |||||||||
|
(Gain)
loss on extinguishment or modification of debt
|
22.2 | (21.2 | ) | - | ||||||||
|
Total
expenses
|
154.9 | 89.2 | 169.5 | |||||||||
|
Loss
before income taxes and equity in undistributed
earnings
of
subsidiaries
|
(155.1 | ) | (112.1 | ) | (162.8 | ) | ||||||
|
Income
tax expense (benefit):
|
||||||||||||
|
Income
tax benefit on period
income
|
(57.8 | ) | (39.1 | ) | (65.0 | ) | ||||||
|
Valuation
allowance for deferred tax
assets
|
- | 54.1 | - | |||||||||
|
Loss
before equity in undistributed earnings of subsidiaries and
discontinued
operations
|
(97.3 | ) | (127.1 | ) | (97.8 | ) | ||||||
|
Equity
in undistributed earnings of subsidiaries
(eliminated
in
consolidation)
|
183.0 | (282.5 | ) | 18.7 | ||||||||
|
Income
(loss) before discontinued
operations
|
85.7 | (409.6 | ) | (79.1 | ) | |||||||
|
Discontinued
operations, net of income taxes:
|
||||||||||||
|
Parent
company
|
- | (166.3 | ) | - | ||||||||
|
Subsidiary
|
- | (556.4 | ) | (105.9 | ) | |||||||
|
Net
income
(loss)
|
85.7 | (1,132.3 | ) | (185.0 | ) | |||||||
|
Preferred
stock
dividends
|
- | - | 14.1 | |||||||||
|
Income
(loss) applicable to common
stock
|
$ | 85.7 | $ | (1,132.3 | ) | $ | (199.1 | ) | ||||
The
accompanying notes are an integral part
of the
condensed financial information.
212
CONSECO,
INC. AND SUBSIDIARIES
SCHEDULE
II
Condensed
Financial Information of Registrant (Parent Company)
Statement
of Cash Flows
for the
years ended December 31, 2009, 2008 and 2007
(Dollars
in millions)
|
2009
|
2008
|
2007
|
||||||||||
|
Cash
flows used by operating
activities
|
$ | (110.7 | ) | $ | (97.4 | ) | $ | (126.6 | ) | |||
|
Cash
flows from investing activities:
|
||||||||||||
|
Sales
of
investments
|
- | 13.9 | - | |||||||||
|
Purchases
of
investments
|
- | (39.8 | ) | - | ||||||||
|
Investments
and advances to consolidated subsidiaries*
|
- | (24.0 | ) | (86.0 | ) | |||||||
|
Change
in restricted
cash
|
- | 1.9 | (1.8 | ) | ||||||||
|
Net
cash used by investing
activities
|
- | (48.0 | ) | (87.8 | ) | |||||||
|
Cash
flows from financing activities:
|
||||||||||||
|
Issuance
of notes payable,
net
|
172.0 | 75.0 | 200.0 | |||||||||
|
Issuance
of common
stock
|
296.3 | - | 3.4 | |||||||||
|
Payments
to repurchase common
stock
|
- | - | (87.2 | ) | ||||||||
|
Payments
on notes
payable
|
(461.2 | ) | (44.0 | ) | (7.8 | ) | ||||||
|
Expenses
related to debt modification and extinguishment of debt
|
(14.7 | ) | - | - | ||||||||
|
Issuance
of notes payable to
affiliates*
|
266.9 | 148.0 | 223.8 | |||||||||
|
Payments
on notes payable to
affiliates*
|
(59.8 | ) | (61.4 | ) | (110.3 | ) | ||||||
|
Dividends
paid on preferred
stock
|
- | - | (19.0 | ) | ||||||||
|
Net
cash provided by financing
activities
|
199.5 | 117.6 | 202.9 | |||||||||
|
Net
increase (decrease) in cash and cash equivalents
|
88.8 | (27.8 | ) | (11.5 | ) | |||||||
|
Cash
and cash equivalents, beginning of the
year
|
56.5 | 84.3 | 95.8 | |||||||||
|
Cash
and cash equivalents, end of the
year
|
$ | 145.3 | $ | 56.5 | $ | 84.3 | ||||||
* Eliminated
in consolidation
The
accompanying notes are an integral part
of the
condensed financial information.
213
CONSECO,
INC. AND SUBSIDIARIES
SCHEDULE
II
Notes to
Condensed Financial Information
1. 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.
214
CONSECO,
INC. AND SUBSIDIARIES
SCHEDULE
IV
Reinsurance
for the
years ended December 31, 2009, 2008 and 2007
(Dollars
in millions)
|
2009
|
2008
|
2007
|
||||||||||
|
Life
insurance inforce:
|
||||||||||||
|
Direct
|
$ | 61,814.4 | $ | 65,271.1 | $ | 67,831.1 | ||||||
|
Assumed
|
403.5 | 1,129.8 | 873.5 | |||||||||
|
Ceded
|
(16,461.5 | ) | (13,805.9 | ) | (14,717.2 | ) | ||||||
|
Net
insurance
inforce
|
$ | 45,756.4 | $ | 52,595.0 | $ | 53,987.4 | ||||||
|
Percentage
of assumed to
net
|
.9 | % | 2.1 | % | 1.6 | % | ||||||
|
2009
|
2008
|
2007
|
||||||||||
|
Insurance
policy income:
|
||||||||||||
|
Direct
|
$ | 2,451.8 | $ | 2,438.0 | $ | 2,445.9 | ||||||
|
Assumed
|
475.5 | 641.0 | 307.8 | |||||||||
|
Ceded
|
(179.4 | ) | (164.0 | ) | (202.4 | ) | ||||||
|
Net
premiums
|
$ | 2,747.9 | $ | 2,915.0 | $ | 2,551.3 | ||||||
|
Percentage
of assumed to
net
|
17.3 | % | 22.0 | % | 12.1 | % | ||||||
215
EXHIBIT
INDEX
Exhibit
No.
Description
|
2.1
|
Sixth
Amended Joint Plan of Reorganization of Conseco, Inc. and affiliated
Debtors, incorporated by reference to Exhibit 2.2 of our Current Report on
Form 8-K filed September 15, 2003.
|
|
2.2
|
Order
Confirming Reorganizing Debtors' Sixth Amended Joint Plan of
Reorganization, incorporated by reference to Exhibit 2.3 of our Current
Report on Form 8-K filed September 15,
2003.
|
|
3.1
|
Amended
and Restated Certificate of Incorporation of Conseco, Inc., incorporated
by reference to Exhibit 3.1 of our Quarterly Report on Form 10-Q for the
quarter ended June 30, 2008.
|
|
3.2
|
Amended
and Restated Bylaws of Conseco, Inc. dated as of February 2, 2010,
incorporated by reference to Exhibit 3.2 of our Current Report on Form 8-K
filed February 4, 2010.
|
|
4.1
|
Section
382 Rights Agreement, dated as of January 20, 2009, between the
Corporation and American Stock Transfer & Trust Company, LLC, as
Rights Agent, which includes the Certificate of Designations for the
Series A Junior Participating Preferred Stock as Exhibit A, the Form of
Right Certificate as Exhibit B and the Summary of Rights to Purchase
Preferred Shares as Exhibit C, incorporated by reference to Exhibit 4.1 of
our Current Report on Form 8-K filed January 20,
2009.
|
|
4.2
|
Form
of specimen stock certificate, incorporated by reference to Exhibit 4.1 of
our Registration Statement on Form S-1 (No. 333-129555) on November 8,
2005.
|
|
4.3
|
Form
of Warrant, incorporated by reference to Exhibit 10.13 of our Current
Report on Form 8-K filed October 13,
2009.
|
|
4.4
|
Indenture
dated as of August 15, 2005 for 3.50% Convertible Debentures due September
30, 2035 between Conseco, Inc. and The Bank of New York Trust Company,
N.A., as Trustee, incorporated by reference to Exhibit 4.4 of our Current
Report on Form 8-K filed August 16,
2005.
|
|
4.5
|
Indenture
dated as of October 16, 2009, between Conseco, Inc. and The Bank of New
York Mellon Trust Company, N.A., as trustee, incorporated by reference to
Exhibit 4.1 of our Current Report on Form 8-K filed October 19, 2009, as
amended by First Supplemental Indenture dated as of February 3, 2010,
incorporated by reference to Exhibit 4.2 of our Current Report on Form 8-K
filed February 5, 2010.
|
|
4.6
|
Form
of 7.0% Convertible Senior Debentures due 2016, incorporated by reference
to Exhibit 4.1 of our Current Report on Form 8-K filed October 19,
2009.
|
|
10.1
|
Second
Amended and Restated Credit Agreement dated as of October 10, 2006 among
Conseco, Inc., Bank of America, N.A., as Agent, J.P. Morgan Chase Bank,
N.A., as Syndication Agent, and other parties, incorporated by reference
to Exhibit 10.1 of our Current Report on Form 8-K filed October 11, 2006,
Amendment No. 1 thereto dated as of June 12, 2007, incorporated by
reference to Exhibit 10.1 of our Current Report on Form 8-K filed June 15,
2007, Amendment No. 2 thereto dated March 30, 2009, incorporated by
reference to Exhibit 10.1 of our Current Report on Form 8-K filed March
31, 2009 and Amendment No. 3 thereto dated December 8, 2009, incorporated
by reference to Exhibit 10.1 of our Current Report on Form 8-K filed
December 9, 2009.
|
|
10.2
|
Stock
and Warrant Purchase Agreement dated as of October 13, 2009 by and between
Conseco, Inc. and Paulson & Co. Inc. on behalf of several investment
funds and accounts managed by it, incorporated by reference to Exhibit
10.1 of our Current Report on Form 8-K filed October 13,
2009.
|
|
10.3
|
Investor
Rights Agreement dated as of November 13, 2009 by and between Conseco,
Inc. and Paulson & Co. Inc. on behalf of the several investment funds
and accounts managed by it.
|
|
10.4
|
Guarantee
and Security Agreement dated as of June 22, 2004 among Conseco, Inc., the
Subsidiary Guarantors Party Thereto and Bank of America, N.A., as Agent,
incorporated by reference to Exhibit 10.4 of our Current Report on Form
8-K filed June 23, 2004, and Amendment No. 1 to the Guarantee and Security
Agreement dated as of February 2, 2010 by and among Conseco, Inc., the
lenders signatory thereto and Wilmington Trust Company FSB, as
administrative agent for the lenders filed
herewith.
|
|
10.5
|
Purchase
Agreement, dated as of October 14, 2009, between Conseco, Inc. and Morgan
Stanley & Co. Incorporated, incorporated by reference to Exhibit
(b)(1) of our Schedule TO filed on October 15, 2009, as amended by
Amendment Number One dated as of February 3, 2010, incorporated by
reference to Exhibit 10.1 to our Current Report on Form 8-K filed February
5, 2010.
|
|
10.6
|
Underwriting
Agreement dated as of December 16, 2009 between Conseco, Inc. and Morgan
Stanley & Co. Incorporated.
|
|
10.11
|
Letter
of agreement dated as of August 3, 2007 between Conseco Services, LLC and
John R. Kline, incorporated by reference to Exhibit 10.11 of our Quarterly
Report on Form 10-Q for the quarter ended September 30,
2007.
|
|
10.12
|
Amended
and Restated Employment Agreement dated as of December 21, 2009 between
40|86 Advisors, Inc. and Eric R.
Johnson.
|
|
10.13
|
Conseco,
Inc. Amended and Restated Long-Term Incentive Plan, incorporated by
reference to Annex B to our Proxy Statement filed on April 23,
2009.
|
|
10.14
|
Form
of executive stock option agreement under Conseco, Inc. Amended and
Restated Long-Term Incentive Plan, incorporated by reference to Exhibit
10.14 of our Annual Report on Form 10-K for the year ended December 31,
2005.
|
|
10.15
|
Form
of executive restricted stock agreement under Conseco, Inc. Amended and
Restated Long-Term Incentive Plan, incorporated by reference to Exhibit
10.15 of our Annual Report on Form 10-K for the year ended December 31,
2004.
|
|
10.16
|
Form
of Indemnification Agreement among Conseco, Inc., CDOC, Inc., Conseco
Services, LLC and each director of Conseco, Inc., incorporated by
reference to Exhibit 10.16 of our Annual Report on Form 10-K for the year
ended December 31, 2008.
|
|
10.18
|
Closing
Agreement on Final Determination Covering Specific Matters, incorporated
by reference to Exhibit 10.14 of our Current Report on Form 8-K filed
September 14, 2004.
|
|
10.20
|
Conseco,
Inc. Pay for Performance Incentive Plan, as amended, incorporated by
reference to Exhibit 10.20 of our Annual Report on Form 10-K filed March
31, 2009.
|
|
10.21
|
Closing
Agreement on Final Determination Covering Specific Matters, incorporated
by reference to Exhibit 10.21 of our Current Report on Form 8-K filed
August 1, 2006.
|
|
10.22
|
Form
of performance unit award agreement under the Conseco, Inc. Amended and
Restated Long-Term Incentive Plan, incorporated by reference to Exhibit
10.22 of our Quarterly Report on Form 10-Q for the quarter ended June 30,
2006.
|
|
10.23
|
Employment
Agreement dated as of August 9, 2006 between Conseco, Inc. and C. James
Prieur, incorporated by reference to Exhibit 10.23 of our Current Report
on Form 8-K filed August 9, 2006.
|
|
10.24
|
Conseco
Inc. Deferred Compensation Plan effective January 1, 2007, incorporated by
reference to Exhibit 10.24 of our Quarterly Report on Form 10-Q for the
quarter ended September 30, 2006, as amended by First Amendment of the
Conseco Deferred Compensation Plan, effective January 1,
2007.
|
|
10.25
|
Amended
and Restated Employment Agreement dated as of August 17, 2007 between
Conseco Services, LLC and Susan L. Menzel, incorporated by reference to
Exhibit 10.25 of our Quarterly Report on Form 10-Q for the quarter ended
September 30, 2007.
|
|
10.26
|
Amended
and Restated Employment Agreement dated as of February 27, 2008 between
Conseco Services, LLC and Russell M. Bostick, incorporated by reference to
Exhibit 10.26 of our Annual Report on Form 10-K for the year ended
December 31, 2007, as amended by Amendment to Employment Agreement dated
April 16, 2009, incorporated by reference to Exhibit 10.26 of our
Quarterly Report on Form 10-Q for the quarter ended June 30,
2009.
|
|
10.27
|
Amended
and Restated Employment Agreement dated as of November 1, 2009 between
Conseco Services, LLC and Christopher J.
Nickele.
|
|
10.28
|
Employment
Agreement dated as of October 1, 2008 between Conseco Services, LLC and
Scott R. Perry, as amended by Amendment to Employment Agreement dated as
of December 29, 2009 filed
herewith.
|
|
10.31
|
Stipulation
of Settlement - In Re Conseco Life Insurance Co. Cost of Insurance
Litigation, Cause No. MDL 1610 (Central District, California),
incorporated by reference to Exhibit 10.31 of our Annual Report on Form
10-K for the year ended December 31,
2006.
|
|
10.32
|
Employment
Agreement dated as of April 23, 2007 between Conseco, Inc. and Edward J.
Bonach, incorporated by reference to Exhibit 10.32 of our Current Report
on Form 8-K filed April 27, 2007.
|
|
10.34
|
Coinsurance
and Administration Agreement between Conseco Insurance Company and
Reassure American Life Insurance Company, incorporated by reference to
Exhibit 10.34 of our Quarterly Report on Form 10-Q for the quarter ended
June 30, 2007.
|
|
10.36
|
Employment
Agreement dated as of May 27, 2008 between Conseco Services, LLC and
Steven M. Stecher, incorporated by reference to Exhibit 10.36 of our
Quarterly Report on Form 10-Q for the quarter ended June 30, 2008, as
amended by Amendment to Employment Agreement dated as of December 28, 2009
filed herewith.
|
|
10.37
|
Form
A Statement Regarding the Acquisition of Control of Conseco Senior Health
Insurance Company, including the Transfer Agreement dated as of August 11,
2008 by and among the Corporation, CDOC, Inc. and Senior Health Care
Transition Trust, incorporated by reference to Exhibit 10.37 of our
Current Report on Form 8-K filed August 11,
2008.
|
|
10.38
|
Employment
Agreement dated as of June 11, 2008 between Conseco Services, LLC and
Matthew J. Zimpfer, incorporated by reference to Exhibit 10.38 of our
Quarterly Report on Form 10-Q for the quarter ended June 30,
2008.
|
|
12.1
|
Computation
of Ratio of Earnings to Fixed Charges and Preferred
Dividends.
|
|
21
|
Subsidiaries
of the Registrant.
|
|
23.1
|
Consent
of PricewaterhouseCoopers LLP.
|
|
31.1
|
Certification
Pursuant to the Securities Exchange Act Rule 13a-14(a)/15d-14(a), as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|
|
31.2
|
Certification
Pursuant to the Securities Exchange Act Rule 13a-14(a)/15d-14(a), as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|
|
32.1
|
Certification
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
|
|
32.2
|
Certification
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
|
|
|
COMPENSATION
PLANS AND ARRANGEMENTS
|
|
10.11
|
Letter
of agreement dated as of August 3, 2007 between Conseco Services, LLC and
John R. Kline, incorporated by reference to Exhibit 10.11 of our Quarterly
Report on Form 10-Q for the quarter ended September 30,
2007.
|
|
10.12
|
Amended
and Restated Employment Agreement dated as of December 21, 2009 between
40|86 Advisors, Inc. and Eric R.
Johnson.
|
|
10.13
|
Conseco,
Inc. Amended and Restated Long-Term Incentive Plan, incorporated by
reference to Annex B to our Proxy Statement filed on April 23,
2009.
|
|
10.14
|
Form
of executive stock option agreement under Conseco, Inc. Amended and
Restated Long-Term Incentive Plan, incorporated by reference to Exhibit
10.14 of our Annual Report on Form 10-K for the year ended December 31,
2005.
|
|
10.15
|
Form
of executive restricted stock agreement under Conseco, Inc. Amended and
Restated Long-Term Incentive Plan, incorporated by reference to Exhibit
10.15 of our Annual Report on Form 10-K for the year ended December 31,
2004.
|
|
10.20
|
Conseco,
Inc. Pay for Performance Incentive Plan, as
amended.
|
|
10.22
|
Form
of performance unit award agreement under the Conseco, Inc. Amended and
Restated Long-Term Incentive Plan, incorporated by reference to Exhibit
10.22 of our Quarterly Report on Form 10-Q for the quarter ended June 30,
2006.
|
|
10.23
|
Employment
Agreement dated as of August 9, 2006 between Conseco, Inc. and C. James
Prieur, incorporated by reference to Exhibit 10.23 of our Current Report
on Form 8-K filed August 9, 2006.
|
|
10.24
|
Conseco
Inc. Deferred Compensation Plan effective January 1, 2007, incorporated by
reference to Exhibit 10.24 of our Quarterly Report on Form 10-Q for the
quarter ended September 30, 2006, as amended by First Amendment of the
Conseco Deferred Compensation Plan, effective January 1,
2007.
|
|
10.25
|
Amended
and Restated Employment Agreement dated as of August 17, 2007 between
Conseco Services, LLC and Susan L. Menzel, incorporated by reference to
Exhibit 10.25 of our Quarterly Report on Form 10-Q for the quarter ended
September 30, 2007.
|
|
10.26
|
Amended
and Restated Employment Agreement dated as of February 27, 2008 between
Conseco Services, LLC and Russell M. Bostick, incorporated by reference to
Exhibit 10.26 of our Annual Report on Form 10-K for the year ended
December 31, 2007, as amended by Amendment to Employment Agreement dated
April 16, 2009, incorporated by reference to Exhibit 10.26 of our
Quarterly Report on Form 10-Q for the quarter ended June 30,
2009.
|
|
10.27
|
Amended
and Restated Employment Agreement dated as of November 1, 2009 between
Conseco Services, LLC and Christopher J.
Nickele.
|
|
10.28
|
Employment
Agreement dated as of October 1, 2008 between Conseco Services, LLC and
Scott R. Perry, as amended by Amendment to Employment Agreement dated as
of December 29, 2009 filed
herewith.
|
|
10.32
|
Employment
Agreement dated as of April 23, 2007 between Conseco, Inc. and Edward J.
Bonach, incorporated by reference to Exhibit 10.32 of our Current Report
on Form 8-K filed April 27, 2007.
|
|
10.36
|
Employment
Agreement dated as of May 27, 2008 between Conseco Services, LLC and
Steven M. Stecher, incorporated by reference to Exhibit 10.36 of our
Quarterly Report on Form 10-Q for the quarter ended June 30, 2008, as
amended by Amendment to Employment Agreement dated as of December 28, 2009
filed herewith.
|
|
10.38
|
Employment
Agreement dated as of June 11, 2008 between Conseco Services, LLC and
Matthew J. Zimpfer, incorporated by reference to Exhibit 10.38 of our
Quarterly Report on Form 10-Q for the quarter ended June 30,
2008.
|
TABLE OF CONTENTS
Part IItem 1. Business Of ConsecoItem 1A. Risk FactorsItem 1B. Unresolved Staff CommentsItem 2. PropertiesItem 3. Legal ProceedingsItem 4. Submission Of Matters To A Vote Of Security HoldersPart IIItem 5. Market For Registrant S Common Equity, Related Stockholder Matters and Issuer Purchases Of Equity SecuritiesItem 6. Selected Consolidated Financial DataItem 7. Management S Discussion and Analysis Of Consolidated Financial Condition and Results Of OperationsItem 7A. Quantitative and Qualitative Disclosures About Market RiskItem 8. Consolidated Financial Statements and Supplementary DataItem 9. Changes in and Disagreements with Accountants on Accounting and Financial DisclosureItem 9A. Controls and ProceduresItem 9B. Other InformationPart IIIItem 10. Directors, Executive Officers and Corporate GovernanceItem 11. Executive CompensationItem 12. Security Ownership Of Certain Beneficial Owners and Management and Related Stockholder MattersItem 13. Certain Relationships and Related Transactions, and Director IndependenceItem 14. Principal Accountant Fees and ServicesPart IVItem 15. Exhibits and Financial Statement Schedules