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, 2008 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
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Commission file number: 001-31792
Conseco, Inc.
Delaware No. 75-3108137
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State of Incorporation IRS Employer Identification No.
11825 N. Pennsylvania Street
Carmel, Indiana 46032 (317) 817-6100
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Address of principal executive offices Telephone
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of Each Exchange on which Registered
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Common Stock, par value $0.01 per New York Stock Exchange
share
Rights to purchase Series A Junior New York Stock Exchange
Participating Preferred Stock
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Securities registered pursuant to Section 12(g) of the Act:
3.50% Convertible Debentures due September 30, 2035
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 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 [X] Accelerated filer [ ] 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, 2008, 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 $1.8 billion.
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 March 6, 2009: 184,753,758
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Registrant's definitive proxy statement for the 2009 annual meeting of shareholders are incorporated by reference into Part III of this report.
TABLE OF CONTENTS
Page
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PART I
Item 1. Business of Conseco......................................................... 3
Item 1A. Risk Factors................................................................ 21
Item 1B. Unresolved Staff Comments................................................... 35
Item 2. Properties.................................................................. 35
Item 3. Legal Proceedings........................................................... 35
Item 4. Submission of Matters to a Vote of Security Holders......................... 35
Executive Officers of the Registrant........................................ 36
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities................................... 37
Item 6. Selected Consolidated Financial Data........................................ 40
Item 7. Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations............................... 41
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.................. 109
Item 8. Consolidated Financial Statements and Supplementary Data.................... 110
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure........................................................ 193
Item 9A. Controls and Procedures..................................................... 193
Item 9B. Other Information........................................................... 195
PART III
Item 10. Directors, Executive Officers and Corporate Governance...................... 195
Item 11. Executive Compensation...................................................... 195
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters................................................. 195
Item 13. Certain Relationships and Related Transactions, and Director Independence... 195
Item 14. Principal Accountant Fees and Services...................................... 195
PART IV
Item 15. Exhibits and Financial Statement Schedules.................................. 196
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ITEM 1. BUSINESS OF CONSECO.
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, 2008, we had shareholders' equity of $1.6 billion and assets of $28.8 billion. For the year ended December 31, 2008, we had revenues of $4.2 billion and a net loss of $1.1 billion. 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. Prior to the fourth quarter of 2008, we had a fourth segment comprised of other business in run-off. The other business in run-off segment had included blocks of business that we no longer market or underwrite and were managed separately from our other businesses. Such segment had consisted of: (i) long-term care insurance sold in prior years through independent agents; and (ii) major medical insurance. As a result of the Transfer, as further discussed below, a substantial portion of the long-term care business in the other business in run-off segment is presented as discontinued operations in our consolidated financial statements. The remaining business that was included in our former other business in run-off segment is now reflected in our Conseco Insurance Group segment. Accordingly, we have restated all prior year segment disclosures to conform to management's current view of the Company's operating segments. Our segments are described below:
o Bankers Life, which consists of the business of Bankers Life and Casualty Company, markets and distributes Medicare supplement insurance, life insurance, long-term care insurance, Medicare Part D prescription drug program, Medicare Advantage products and certain annuity products to the senior market through approximately 5,500 career agents and sales managers. Bankers Life and Casualty Company markets its products under its own brand name and Medicare Part D and Medicare Advantage products primarily through marketing agreements with Coventry Health Care ("Coventry").
o 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.
o Conseco Insurance Group, which markets and distributes specified disease insurance, Medicare supplement insurance, and certain life and annuity products to the senior and middle-income markets through approximately 400 independent marketing organizations ("IMOs") that represent over 2,400 independent producing agents, including approximately 575 from Performance Matters Associates, Inc. ("PMA"), a wholly owned marketing company. This segment markets its products under the "Conseco" and "Washington National" brand names. Conseco Insurance Group includes primarily the business of Conseco Health Insurance Company ("Conseco Health"), Conseco Life Insurance Company ("Conseco Life"), Conseco Insurance Company and Washington National Insurance Company ("Washington National"). This segment also includes blocks of long-term care and other health business of these companies that we no longer market or underwrite.
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, completed the transfer (the "Transfer") of the stock of Senior Health Insurance Company of Pennsylvania ("Senior Health", formerly known as Conseco Senior Health Insurance Company prior to its name change in October 2008) 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.
During 2008, Conseco recorded accounting charges totaling $1.0 billion related to the Transfer, 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.
OUR STRATEGIC DIRECTION AND 2009 PRIORITIES
It is our vision to be a premier provider of insurance products to America's middle-income families and seniors. Our insurance companies help protect them from financial adversity: Medicare supplement, long-term care, cancer, heart/stroke and accident policies protect people against unplanned expenses; annuities and life products help people plan for their financial future. We believe our products meet the needs of our target markets.
We believe our middle market target is underserved by a majority of financial service providers and that the aging population will create strong growth in these target markets. Important trends impacting middle market consumers include:
o Increased life expectancy.
o Discontinuance or reduction in employer-sponsored benefit programs.
o Rising healthcare costs.
o Projected gaps between the annual costs and revenues of government-sponsored plans such as Social Security and Medicare.
We believe our multiple distribution channels provide broad reach across the market since consumers can access our products through an agent (Bankers Life or Conseco Insurance Group), without an agent (Colonial Penn), and at the worksite (Conseco Insurance Group).
Our major goals for 2009 include:
o Managing capital and liquidity to maintain compliance with debt covenants.
o Maintaining strong growth at Bankers Life.
o Continuing to improve the focus and profitability mix of sales at Conseco Insurance Group.
o Improving earnings stability and reducing volatility.
o Completing the remediation project relating to our material weakness in internal controls.
o Continuing to reduce our enterprise exposure to long-term care business.
o Improving profitability of existing lines of business or disposing of underperforming blocks of business.
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 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 2008, 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 2008 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, 2008 (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 $4.5 billion, $4.0 billion and $4.0 billion in 2008, 2007 and
2006, 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 2008 collected premiums: Florida (7.4 percent), California (7.1 percent), Pennsylvania (6.3 percent) and Texas (5.9 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 5,500 agents and sales managers working from 156 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 2008, this distribution channel accounted for $3,320.5 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 2008, this distribution channel in our Conseco Insurance Group segment collected $1,021.4 million, or 23 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 2008, the PMA distribution channel accounted for $233.4 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 2008, this channel accounted for $183.0 million, or 4 percent, of our total collected premiums.
Products
The following table summarizes premium collections by major category and segment for the years ended December 31, 2008, 2007 and 2006 (dollars in millions):
Total premium collections
2008 2007 2006
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Supplemental health:
Bankers Life............................................................ $1,887.0 $1,546.1 $1,308.3
Colonial Penn........................................................... 8.9 10.4 12.0
Conseco Insurance Group................................................. 621.8 633.4 655.8
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Total supplemental health............................................ 2,517.7 2,189.9 1,976.1
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Annuities:
Bankers Life............................................................ 1,224.1 885.5 997.5
Conseco Insurance Group................................................. 129.8 368.6 433.3
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Total annuities...................................................... 1,353.9 1,254.1 1,430.8
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Life:
Bankers Life............................................................ 209.4 200.0 184.2
Colonial Penn........................................................... 174.1 113.7 97.2
Conseco Insurance Group................................................. 269.8 287.3 314.6
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Total life........................................................... 653.3 601.0 596.0
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Total premium collections.................................................. $4,524.9 $4,045.0 $4,002.9
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In addition, the long-term care business included in our discontinued operations had collected premiums of $225.9 million, $269.1 million and $283.6 million in 2008, 2007 and 2006, respectively.
Our insurance companies collected premiums from the following products:
Supplemental Health
Supplemental Health Premium Collections (dollars in millions)
2008 2007 2006
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Medicare supplement:
Bankers Life................................................................. $ 636.6 $ 636.1 $ 629.1
Colonial Penn................................................................ 8.1 9.4 10.9
Conseco Insurance Group...................................................... 203.8 225.9 244.2
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Total..................................................................... 848.5 871.4 884.2
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Long-term care:
Bankers Life ................................................................ 625.7 622.4 592.4
Conseco Insurance Group ..................................................... 33.7 36.7 39.4
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Total..................................................................... 659.4 659.1 631.8
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Prescription Drug Plan and Medicare Advantage products
included in Bankers Life..................................................... 614.0 277.8 76.7
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Specified disease products included in
Conseco Insurance Group...................................................... 374.6 359.2 357.7
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Other:
Bankers Life ................................................................ 10.7 9.8 10.1
Colonial Penn................................................................ .8 1.0 1.1
Conseco Insurance Group...................................................... 9.7 11.6 14.5
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Total..................................................................... 21.2 22.4 25.7
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Total supplemental health premium collections.................................... $2,517.7 $2,189.9 $1,976.1
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The following describes our major supplemental health products:
Medicare Supplement. Medicare supplement collected premiums were $848.5 million during 2008 or 19 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 2008 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 $659.4 million during 2008, 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.
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 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 (the "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 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 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 $71.6 million during 2008 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 receive a fee based on the number of PFFS 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 the net premiums and related profits.
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 receives 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 will terminate the last agreement on June 30, 2009. Premiums assumed through these reinsurance agreements totaled $313.5 million in 2008 (including $185.3 million assumed through the agreement to be terminated on June 30, 2009). The income before income taxes related to the assumed business was $.4 million during the year ended December 31, 2008.
PFFS collected premiums were $542.4 million in 2008 or 12 percent of our total collected premiums.
Specified Disease Products. Specified disease collected premiums were $374.6 million during 2008, or 8 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 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 79 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 $21.2 million during 2008. 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)
2008 2007 2006
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Equity-indexed annuity:
Bankers Life............................................................. $ 522.8 $ 437.4 $ 276.5
Conseco Insurance Group.................................................. 123.7 344.6 378.5
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Total equity-indexed annuity premium collections...................... 646.5 782.0 655.0
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Other fixed annuity:
Bankers Life............................................................. 701.3 448.1 721.0
Conseco Insurance Group.................................................. 6.1 24.0 54.8
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Total fixed annuity premium collections............................... 707.4 472.1 775.8
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Total annuity premium collections........................................... $1,353.9 $1,254.1 $1,430.8
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During 2008, we collected annuity premiums of $1,353.9 million or 30 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 the second half of 2007, we changed the pricing of specific products and we no longer emphasized the sale of certain products sold by professional independent agents resulting in a decrease in collected premiums, partially offset by the sales of several new products distributed through new national partners. 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.
We believe the sales of our equity-indexed products in Bankers Life were favorably impacted in 2007 and the first half of 2008 due in part to general stock market conditions which made these products attractive relative to fixed annuities.
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 increase in short-term interest rates in 2007 resulted in lower first-year fixed annuity sales as certain other competing products, such as certificates
of deposits, had become attractive relative to fixed annuities.
The following describes the major annuity products:
Equity-Indexed Annuities. These products accounted for $646.5 million, or 14 percent, of our total premium collections during 2008. 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:
o The index to be used;
o 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.
o The method used to measure the change in the index.
o 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.
o 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.
o 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 $707.4 million, or 16 percent, of our total premium collections during 2008. 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:
o the interest rate we can earn on invested assets acquired with the new annuity fund deposits;
o the costs related to marketing and maintaining the annuity products; and
o 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 2008, 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 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, 2008, the average crediting rate, excluding bonuses, on our outstanding traditional annuities was 3.6 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 $33.1 million, or .7 percent, of our total premiums collected in 2008. 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 6.8 percent at December 31, 2008.
Life Insurance
Life insurance premium collections (dollars in millions)
2008 2007 2006
---- ---- ----
Interest-sensitive life products:
Bankers Life............................................................... $ 63.7 $ 63.4 $ 62.2
Colonial Penn.............................................................. .5 .5 .6
Conseco Insurance Group.................................................... 202.5 214.0 235.0
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Total interest-sensitive life premium collections....................... 266.7 277.9 297.8
------ ------ ------
Traditional life:
Bankers Life............................................................... 145.7 136.6 122.0
Colonial Penn.............................................................. 173.6 113.2 96.6
Conseco Insurance Group.................................................... 67.3 73.3 79.6
------ ------ ------
Total traditional life premium collections.............................. 386.6 323.1 298.2
------ ------ ------
Total life insurance premium collections...................................... $653.3 $601.0 $596.0
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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 2008, we collected life insurance premiums of $653.3 million, or 14 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 $266.7 million, or 5.9 percent, of our total collected premiums in 2008. 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 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 $386.6 million, or 8.5 percent, of our total collected premiums in 2008. 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, which we continue to market on a limited basis, 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 $168.5 million, or 3.7 percent, of our total collected premiums in 2008. 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 $32.1 million, or .7 percent, of our total collected premiums in 2008.
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 $18.9 billion of assets (at fair value) under management at December 31, 2008, of which $18.1 billion were assets of our subsidiaries and $.8 billion were assets managed for third parties. Our general account investment strategies are to:
o maintain a largely investment-grade, diversified fixed-income portfolio;
o maximize the spread between the investment income we earn and the yields we pay on investment products within acceptable levels of risk;
o provide adequate liquidity;
o construct our investment portfolio considering expected liability durations, cash flows and other requirements; and
o maximize total return through active investment management.
During 2008, 2007 and 2006, we recognized net realized investment losses of $262.4 million, $158.0 million and $46.6 million, respectively, excluding any such amounts included in discontinued operations. 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 concerns regarding the effect future adverse developments could have on the value 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 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, 2008, the average yield, computed on the cost basis of our actively managed fixed maturity portfolio, was 6.0 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:
o purchasing equity-based options with similar payoff characteristics; and
o 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, 2008, the duration of our fixed maturity investments (as modified to reflect prepayments and potential calls) was approximately 7.6 years and the duration of our insurance liabilities was approximately 7.8 years. The difference between these durations indicates that our investment portfolio had a shorter duration and, consequently, was less sensitive to interest rate fluctuations than that of our liabilities at that date. 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 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 in the financial markets in the second half of 2008, 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 March 4, 2009, A.M. Best downgraded the financial strength ratings of our primary insurance subsidiaries to "B" from "B+" and such ratings have 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 February 26, 2009, Standard & Poor's Ratings Services ("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. On March 2, 2009, S&P placed the financial strength ratings of our primary insurance subsidiaries on credit watch with negative implications. A rating on credit watch with negative implications highlights the potential direction of a rating focusing on identifiable events and short-term trends that cause ratings to be placed under special surveillance by S&P. A "negative" designation means that a rating may be lowered. 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 March 3, 2009, Moody's Investors Service ("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.
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, 2008, the total balance of our liabilities for insurance products was $24.2 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.
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, 2008, the policy risk retention limit of our insurance subsidiaries was generally $.8 million or less. Reinsurance ceded by Conseco represented 21 percent of gross combined life insurance inforce and reinsurance assumed represented 2.1 percent of net combined life insurance inforce. Our principal reinsurers at December 31, 2008 were as follows (dollars in millions):
Ceded life A.M. Best
Name of Reinsurer insurance inforce rating
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Swiss Re Life and Health America Inc.................................... $ 3,682.3 A
Security Life of Denver Insurance Company............................... 3,083.9 A+
Reassure America Life Insurance Company ("REALIC") (a).................. 1,482.1 A
RGA Reinsurance Company................................................. 946.9 A+
Munich American Reassurance Company..................................... 914.4 A+
Lincoln National Life Insurance Company................................. 676.1 A+
Scor Global Life Re Insurance Co of Texas............................... 562.9 A-
Hannover Life Reassurance Company....................................... 416.1 A
General Re Life Corporation............................................. 408.4 A++
All others (b).......................................................... 1,632.8
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$13,805.9
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(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 $2.3 billion at December 31, 2008.
(b) No other single reinsurer assumed greater than 3 percent of the total
ceded business inforce.
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EMPLOYEES
At December 31, 2008, we had approximately 3,700 full time employees, including 1,150 employees supporting our Bankers Life segment, 350 employees supporting our Colonial Penn segment and 2,200 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:
o grant and revoke business licenses;
o regulate and supervise sales practices and market conduct;
o establish guaranty associations;
o license agents;
o approve policy forms;
o approve premium rates and premium rate increases for some lines of business such as long-term care and Medicare supplement;
o establish reserve requirements;
o prescribe the form and content of required financial statements and reports;
o determine the reasonableness and adequacy of statutory capital and surplus;
o perform financial, market conduct and other examinations;
o define acceptable accounting principles; and
o 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:
o reserve requirements;
o risk-based capital ("RBC") standards;
o codification of insurance accounting principles;
o investment restrictions;
o restrictions on an insurance company's ability to pay dividends; and
o 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:
o statutory net gain from operations or statutory net income for the prior year; or
o 10 percent of statutory capital and surplus at the end of the preceding year.
Any dividends in excess of these levels require the approval of the director or commissioner of the applicable state insurance department.
In 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:
o 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;
o 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;
o 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
o 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.
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:
o between the current year and the prior year; and
o 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 2008 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.
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.
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, 2008, 2007 and 2006, 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.
ITEM 1A. RISK FACTORS.
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".
Our Second Amended Credit Facility contains various restrictive covenants and required financial ratios that limit our operating flexibility; 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.
As of December 31, 2008, we had $911.8 million principal amount of debt outstanding under our secured credit agreement (the "Second Amended Credit Facility"). The Second Amended Credit Facility imposes a number of covenants and financial ratios as defined in the Second Amended Credit Facility that we must meet or maintain. The following describes the financial ratios and amounts as of December 31, 2008:
Covenant under the Balance or Margin for adverse
Second Amended ratio as of development from
Credit Facility December 31, 2008 December 31, 2008 levels
--------------- ----------------- ------------------------
Aggregate risk-based capital ratio......... greater than or equal 255% Reduction to
to 250% statutory capital and
surplus of
approximately $25
million, or an
increase to the risk-
based capital of
approximately $10
million.
Combined statutory capital and surplus..... greater than $1,270 $1,366 million Reduction to
million combined statutory
capital and surplus
of approximately
$96 million.
Debt to total capitalization ratio......... not more than 30% 28% Reduction to
shareholders' equity
of approximately
$273 million or
additional debt of
$117 million.
Interest coverage ratio.................... greater than or equal 2.35 to 1 Reduction in cash
to 2.00 to 1 for each flows to the holding
rolling four quarters company of
approximately
$20 million.
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As described in the note to the consolidated financial statements entitled "Subsequent Events", on March 30, 2009, we completed an amendment to our Second Amended Credit Facility, which provides 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 lenders to appoint a financial advisor at the Company's expense.
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. If the lenders under our Second Amended Credit Facility would elect to accelerate the amounts due, the holders of our 3.50% Convertible Debentures due September 30, 2035 (the "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.
Our Second Amended Credit Facility also imposes restrictions that limit our ability to take certain actions, including the following:
o incur additional indebtedness or refinance existing indebtedness;
o transfer or sell assets unless the net proceeds are reinvested in our
insurance operations or used to reduce the amount due under the Second
Amended Credit Facility;
o enter into mergers or other business combinations;
o pay cash dividends or repurchase stock; and
o make certain investments and capital expenditures.
Absent a waiver or modification by the senior credit facility lenders, these restrictions impact the manner in which we operate our business and could limit the ability of the Company to be able to raise sufficient funds to repay the Debentures when due. The Debentures are putable to the Company on September 30, 2010. See the note to the consolidated financial statements entitled "Notes Payable - Direct Corporate Obligations" for further information related to the Debentures.
S&P has assigned a "CCC" rating on our senior secured debt with a negative outlook. In S&P's view, an obligation rated "CCC" is currently vulnerable to nonpayment and is dependent upon favorable business, financial and economic conditions to meet its financial commitment on the obligation. S&P has a total of twenty-two separate categories rating senior debt, ranging from "AAA (Extremely Strong)" to "D (Payment Default)." There are seventeen ratings above our "CCC" rating and four ratings that are below our rating. Moody's has assigned a "Caa1" rating on our senior secured debt with a negative 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 twenty-one separate categories in which to rate senior debt, ranging from "Aaa (Exceptional)" to "C (Lowest Rated)." There are sixteen ratings above our "Caa1" rating and four ratings that are below our rating. A negative outlook by S&P and Moody's is an opinion regarding the likely direction of a rating over the medium term. 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.
See "Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations - Consolidated Financial Condition; Liquidity of the Holding Companies" for additional information regarding the Company's liquidity.
Our liquidity and ability to meet our holding company obligations may be constrained by the ability of our insurance subsidiaries to distribute cash to us.
CNO and CDOC, a guarantor under the Second Amended Credit Facility, are holding companies with no business operations of their own; they depend on their operating subsidiaries for cash to make principal and interest payments on debt and to pay administrative expenses and income taxes. CNO 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 CNO and/or CDOC which would limit the ability of CNO to meet its 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 and this could limit the amount available at our insurance
subsidiaries to pay dividends. Accordingly, this could limit our ability to meet debt service requirements and satisfy other holding company financial obligations.
The obligations under our Second Amended Credit Facility are guaranteed by our current and future domestic subsidiaries, other than our insurance subsidiaries and certain immaterial subsidiaries. CDOC's guarantee under the Second Amended Credit Facility 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 the Second Amended Credit Facility, the stock of Conseco Life of Texas, Washington National and Conseco Health could be transferred to the lenders under such facility. 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.
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. 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 2008, our insurance subsidiaries paid cash dividends of $20 million to CDOC. Each of the immediate insurance subsidiaries of CDOC has negative earned surplus at December 31, 2008. 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 2009, we are expecting our insurance subsidiaries to pay approximately $60 million of extraordinary dividends to CDOC ($25 million of which has been approved). In addition, during 2009, we are expecting our insurance subsidiaries to pay interest of $44.5 million on surplus debentures ($21.2 million of which has been approved). The remaining dividends and surplus debenture interest payments will require prior regulatory approval. Although we believe the dividends and surplus debenture interest payments we are expecting to pay during 2009 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 unlikely. 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.
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.
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 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.
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.
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 two fiscal years (dollars in millions):
Years ended December 31,
------------------------
2008 2007
---- ----
Dividends................................................................... $ 20.0 $ 50.0
Surplus debenture interest.................................................. 56.4 69.9
Fees for services provided pursuant to service agreements................... 83.2 92.9
Tax sharing payments........................................................ 1.1 1.9
------ ------
Total paid................................................................ $160.7 $214.7
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Risks associated with current economic environment
Over the past year, the U.S. economy has experienced unprecedented credit and liquidity issues and entered into a recession. Following several years of rapid credit expansion, a sharp contraction in mortgage lending coupled with dramatic 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 most sectors of the credit markets, and to 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. Reflecting concern about the stability of the financial markets, generally, and the strength of counterparties, many lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers, including other financial institutions. These factors, combined with declining business and consumer confidence and increased unemployment, have precipitated an economic slowdown and fears 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, which have been materially and adversely affected by recent economic developments. Adverse conditions, including but not limited to, a lack of buyers in the marketplace, volatility, credit spread changes, and benchmark interest rate changes, have affected and will continue to impact the liquidity and value of our investments. The manner in which poor debt and equity market performance and changes in interest rates have adversely affected, and will continue to adversely affect, our business, financial condition, growth and profitability include, but are not limited to, the following:
o The value of our investment portfolio has declined, which has resulted in, and may continue to result in, higher 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 recently, 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 asset-backed securities supported by residential and commercial mortgages, have been disproportionately affected. Continued adverse capital market conditions could result in further realized and/or unrealized losses.
o Changes in interest rates also have other effects related to 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, 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.
o 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 Second Amended Credit Facility.
The value of our investment portfolio is subject to numerous factors, which are difficult to predict, and are often beyond our control. These factors include, but are not limited to, the following:
o Changes in interest rates and interest rate spreads can reduce the value of our investments as further discussed in the risk factor entitled "Changing interest rates may adversely affect our results of operations".
o Changes in patterns of relative liquidity in the capital markets for various asset classes.
o Changes in the ability of issuers to make timely repayments on actively managed fixed maturity investments can reduce the value of our investments. This risk is significantly greater with respect to below-investment grade securities, which comprised 9.1 percent of our actively managed fixed maturity investments as of December 31, 2008.
o Changes in the estimated timing of receipt of cash flows. For example, our structured security investments, which comprised 22 percent of our actively managed fixed maturity investments at December 31, 2008, 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.
o Changes in the relative risk premium required in the market for a given level of risk.
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): $162.3 million in 2008; $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 the consolidated financial statements entitled "Summary of Significant Accounting Policies"); and $21.1 million in 2006. 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 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 Second Amended Credit Facility as described in the first risk factor above.
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 the amount of realized investment losses recorded as impairments vary by investment type and is based upon our periodic evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available. Management updates its evaluations regularly and reflects changes in realized investment gains and losses from impairments in operating results as such evaluations are revised. Our assessment of whether unrealized losses are 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 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 management's case-by-case evaluation of the underlying reasons for the decline in fair value.
The determination of the fair value 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, 2008, our total unrealized net investment losses were $3.0 billion.
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 the Company's 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. The Company intends 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. The Company's exposure, 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. 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, however, 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.
For a description of current legal proceedings, see the note to the consolidated financial statements entitled "Commitments and Contingencies".
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 inforce 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 of Senior Health to an independent trust, we continue to hold long-term care business acquired through previous acquisitions. The premiums collected from this block totaled $33.7 million in 2008. 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 169.6 percent in 2008, 192.4 percent in 2007 and 224.4 percent in 2006. If future claims experience proves to be worse than anticipated as our long-term care blocks continue to age, our financial results could be adversely affected. In addition, such 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 2008, the financial statements of three of our subsidiaries prepared in accordance with statutory accounting practices prescribed or permitted by regulatory authorities reflected the establishment of asset adequacy or premium deficiency reserves primarily related to long-term care and annuity policies. Total asset adequacy or premium deficiency reserves for Washington National, Conseco Insurance Company and Bankers Conseco Life were $53.3 million, $20.0 million and $19.5 million, respectively, at December 31, 2008. 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.
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 inforce. 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 169.6 percent during 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 inforce 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 continued in 2008 and the control deficiencies in the actuarial reporting process related to the design of controls over the completeness and accuracy of certain inforce policies in our Bankers Life and long-term care business reflected in discontinued operations were remediated, and the new controls were determined to be effective. However, a material weakness relating to the actuarial
reporting process in our Conseco Insurance Group segment continued to exist as of December 31, 2008.
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, 2006, December 31, 2007 and December 31, 2008. 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 operation. See Item 9A of this annual report for additional information.
Future issuances or repurchases of our equity, or transfers of our equity by third parties, may impair our future ability to use a substantial amount of our existing NOLs.
As of December 31, 2008, we had approximately $4.8 billion of federal tax
NOLs and $1.2 billion of capital loss carryforwards, resulting in a gross
deferred tax asset of approximately $2.1 billion, expiring in years 2009 through
2028. The timing and manner in which Conseco will be able to utilize some of its
NOLs is limited by Section 382 of the Internal Revenue Code of 1986, as amended.
Section 382 imposes limitations on a corporation's ability to use its NOLs when
it undergoes an "ownership change." Because Conseco underwent an ownership
change as the result of its reorganization, the Section 382 limitation applies
to the Company. Losses that are subject to the current Section 382 limitation
may only be utilized by the Company up to approximately $142 million per year,
with any unused amounts carried forward to the following year. Absent an
additional ownership change, our Section 382 limitation for 2009 will be
approximately $662 million (including $520 million of unused amounts carried
forward from prior years).
Future transactions and the timing of such transactions could cause an additional 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 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 a new annual restriction (which would supersede the current $142 million annual limit) on the use of our NOLs to offset future taxable income and that new limitation would apply to all of our NOLs (as compared to our current limitation which only applies to a portion of our carryforwards). The new 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 (currently approximately 5.4 percent), and the new annual restriction could effectively eliminate our ability to use a substantial portion of our NOLs to offset future taxable income. The writedown of our deferred tax assets that would occur in the event of an ownership change for purposes of Section 382 would likely cause us to breach the debt to equity covenant of our Second Amended Credit Facility. We regularly monitor ownership change (as calculated for purposes of Section 382) and, as of December 31, 2008, we were below the 50 percent ownership change level that would trigger further impairment of our ability to utilize our NOLs. In January 2009, the Company's Board of Directors adopted a Section 382 Rights Plan (the "Rights Plan") which is designed to protect shareholder value by preserving the value of our NOLs. See the "Income Taxes" footnote to our financial statements contained herein for additional information regarding the Rights Plan, our tax loss carryforwards and other tax matters.
The value of our deferred tax asset 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, 2008, we had deferred tax assets of $2.1 billion. During 2008, we increased the deferred tax valuation allowance by $856.2 million. 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 Second Amended Credit Facility as described in the note to these consolidated financial statements entitled "Subsequent Events." 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. 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 carryforwards and NOLs expire. This assessment 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 and reduce shareholders' equity, and such an increase could have a material adverse effect upon our earnings in the future.
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 Conseco seeks 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:
o grant and revoke business licenses;
o regulate and supervise sales practices and market conduct;
o establish guaranty associations;
o license agents;
o approve policy forms;
o approve premium rates for some lines of business such as long-term
care and Medicare supplement;
o establish reserve requirements;
o prescribe the form and content of required financial statements and
reports;
o determine the reasonableness and adequacy of statutory capital and
surplus;
o perform financial, market conduct and other examinations;
o define acceptable accounting principles; and
o regulate the types and amounts of permitted investments.
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 2008 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 inforce 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 107.6 percent, 102.0 percent and 94.5 percent in 2008, 2007 and 2006, respectively. The benefit ratios for our long-term care products in our Conseco Insurance Group segment were 169.6 percent, 192.4 percent and 224.4 percent in 2008, 2007 and 2006, 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 inforce 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 inforce at the Effective Date represents the value assigned to the right to receive future cash flows from contracts existing at September 10, 2003. The balances of these accounts are amortized over the expected lives of the underlying insurance contracts. Management, on an ongoing basis, tests 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 inforce 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, 2008, approximately 20 percent of our total insurance liabilities, or approximately $4.8 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. 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 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, 2008, approximately 41 percent of our insurance liabilities were subject to interest rates that may be reset annually; 40 percent had a fixed explicit interest rate for the duration of the contract; 14 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 market 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. These simulations help us measure the potential gain or loss in fair value of our interest-sensitive financial instruments. 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, 2008, the duration of our fixed maturity investments (as modified to reflect prepayments and potential calls) was approximately 7.6 years, and the duration of our insurance liabilities was approximately 7.8 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 $185 million if interest rates were to increase by 10 percent from rates as of December 31, 2008. This compares to a decline in fair value of $490 million based on amounts and rates at December 31, 2007. 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.
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 inforce business. Many of our initiatives address issues resulting from the substantial number of acquisitions of our Predecessor. Between 1982 and 1997, our Predecessor 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 there can be no assurance that these adjustments will not have a material adverse effect on future earnings.
Our financial position may be negatively impacted if we are unable to achieve our goals for 2009.
We have identified a number of goals for 2009, 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 for 2009 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 sixteen possible ratings. There are six ratings above our "B" rating and nine ratings that are below our rating. S&P has twenty-one possible ratings. There are twelve ratings above our "BB-" rating and eight ratings that are below our rating. Moody's has twenty-one possible ratings. There are eleven 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 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 2007 with a market share of approximately 5.4 percent, the top three writers of individual long-term care insurance had annualized premiums with a combined market share of approximately 57 percent during the period. In addition, while our Bankers Life segment was ranked fourth in direct premiums earned for individual Medicare supplement insurance in 2007 with a market share of 3.8 percent, the top writer of individual Medicare supplement insurance had direct premiums with a market share of 15.5 percent 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'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.
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 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 United States 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 federal estate tax gradually over a ten-year period (with total elimination of the 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, 2008, our reinsurance receivables totaled $3.3 billion. Our ceded life insurance inforce totaled $13.8 billion. Our nine largest reinsurers accounted for 88 percent of our ceded life insurance inforce. 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.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
ITEM 2. PROPERTIES.
Our headquarters and the administrative operations of our Conseco Insurance Group segment are located on a Company-owned 117-acre corporate campus in Carmel, Indiana, immediately north of Indianapolis. The six buildings on the campus contain approximately 626,000 square feet of space and house Conseco's executive offices and certain administrative operations of its subsidiaries. In May 2007, we entered into a listing agreement for the sale/lease of one of these buildings (approximately 100,000 square feet). Management believes that our remaining office space is adequate for our needs.
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 241 sales offices in various states totaling approximately 710,000 square feet. These leases are short-term in length, with remaining lease terms expiring between 2009 and 2015.
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 the remainder leased to tenants.
ITEM 3. LEGAL PROCEEDINGS.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
Executive Officers of the Registrant
Officer Positions with Conseco, Principal
Name and Age (a) Since Occupation and Business Experience (b)
---------------- ----- --------------------------------------
C. James Prieur, 57................................ 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, 55............................... 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, 52............................. 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, 48................................ 1997 Since September 2003, 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, 51.................................. 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, 43................................ 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, 52......................... 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, 46................................. 2001 Since 2006, president of Bankers Life. Employed in various capacities
for Bankers Life since 2001.
Steven M. Stecher, 48.............................. 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, 41............................. 2008 Since June 2008, executive vice president and general counsel. Mr.
Zimpfer has held various legal positions since joining Conseco in
1998.
|
Mr. Kline served as an officer of our Predecessor company, which filed a bankruptcy petition on December 17, 2002.
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, 2007. There have been no dividends paid or declared
on our common stock during this period.
Period Market price
------------------
High Low
---- ---
2007:
First Quarter........................................... $20.46 $16.56
Second Quarter.......................................... 21.25 17.25
Third Quarter........................................... 21.02 13.25
Fourth Quarter.......................................... 16.26 12.05
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
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As of February 19, 2009, there were approximately 55,700 holders of the outstanding shares of common stock, including individual participants in securities position listings.
PERFORMANCE GRAPH
The Performance Graph below compares Conseco's cumulative total shareholder return on its common stock for the period from December 31, 2003 through December 31, 2008 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, 2003 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
[GRAPHIC OMITTED]
Cumulative Total Returns 12/31/03 12/31/04 12/31/05 12/31/06 12/31/07 12/31/08
-------- -------- -------- -------- -------- --------
DJ Life Insurance Index $ 100 $ 121 $ 148 $ 167 $ 178 $ 88
S&P 500 Index $ 100 $ 111 $ 116 $ 135 $ 142 $ 90
Conseco, Inc. $ 100 $ 92 $ 106 $ 92 $ 58 $ 24
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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.
ISSUER PURCHASES OF EQUITY SECURITIES
Total number of Maximum number (or
shares (or units) approximate dollar value)
Total Average price purchased as part of shares (or units) that
number of shares paid per share of publicly announced may yet be purchased
Period (or units)(a) (or unit) plans or programs under the plans or programs(b)
------ ---------- --------- ----------------- ---------------------------
(dollars in millions)
October 1 through
October 31........ 10,648 $3.74 - $262.8
November 1 through
November 30....... - - - 262.8
December 1 through
December 31....... 918 3.39 - 262.8
----- -------
Total................. 11,566 3.71 - 262.8
====== =======
------------
(a) The Company purchased these shares in connection with employee benefit
compensation plans. Such purchases are not included against the
maximum number of shares that may be purchased as part of our publicly
announced share repurchase program.
(b) 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.
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EQUITY COMPENSATION PLAN INFORMATION
The following table summarizes information, as of December 31, 2008, relating to our common stock that may be issued under the Conseco, Inc. 2003 Amended and Restated Long-Term Incentive Plan.
Number of securities
remaining available for
Number of securities Weighted-average future issuance under
to be issued upon exercise exercise price of equity compensation
of outstanding options, outstanding options, plans (excluding securities
warrants or rights warrants or rights reflected in first column)
------------------ ------------------ --------------------------
Equity compensation plans
approved by security holders...... 5,864,451 $16.94 1,153,732
Equity compensation plans not
approved by security holders...... - - -
--------- ------ ---------
Total................................. 5,864,451 $16.94 1,153,732
========= ====== =========
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.
Years ended December 31,
-----------------------------------------------------
2008 2007 2006 2005 2004
---- ---- ---- ---- ----
(Amounts in millions, except per share data)
STATEMENT OF OPERATIONS DATA (a)
Insurance policy income................................. $3,253.6 $2,895.7 $2,696.4 $2,620.9 $2,611.2
Net investment income................................... 1,178.8 1,369.8 1,350.8 1,222.8 1,178.8
Net realized investment gains (losses) ................. (262.4) (158.0) (46.6) (3.3) 36.7
Total revenues.......................................... 4,189.7 4,131.3 4,019.8 3,865.1 3,848.2
Interest expense........................................ 97.8 117.3 73.5 58.3 79.5
Total benefits and expenses............................. 4,177.3 4,141.3 3,853.1 3,459.4 3,470.3
Income (loss) before income taxes, minority
interest, discontinued operations and
cumulative effect of accounting change................ 12.4 (10.0) 166.7 405.7 377.9
Income tax expense...................................... 416.4 64.0 61.0 144.1 132.5
Income (loss) before discontinued operations............ (404.0) (74.0) 105.7 261.6 245.4
Discontinued operations, net of income taxes............ (722.7) (105.9) .3 51.1 44.3
Net income (loss)....................................... (1,126.7) (179.9) 106.0 312.7 289.7
Preferred stock dividends .............................. - 14.1 38.0 38.0 65.5
Net income (loss) applicable to common stock............ (1,126.7) (194.0) 68.0 274.7 224.2
PER SHARE DATA
Income (loss) before discontinued operations, basic..... $(2.19) $ (.51) $ .45 $ 1.48 $ 1.36
Income (loss) before discontinued operations, diluted... (2.19) (.51) .45 1.41 1.31
Net income, basic....................................... (6.10) (1.12) .45 1.82 1.70
Net income, diluted..................................... (6.10) (1.12) .45 1.69 1.59
Book value per common share outstanding................. 8.76 22.94 26.50 25.27 21.34
Weighted average shares outstanding for
basic earnings........................................ 184.7 173.4 151.7 151.2 132.3
Weighted average shares outstanding for
diluted earnings...................................... 184.7 173.4 152.5 185.0 155.9
Shares outstanding at period-end........................ 184.8 184.7 152.2 151.5 151.1
BALANCE SHEET DATA - AT PERIOD END (a)
Total investments....................................... $18,647.5 $21,324.5 $23,768.8 $23,424.6 $22,169.5
Total assets............................................ 28,769.7 33,971.2 33,593.1 32,886.8 31,478.0
Corporate notes payable................................. 1,328.7 1,193.7 1,000.8 851.5 768.0
Total liabilities....................................... 27,150.5 29,735.3 28,893.0 28,389.5 27,586.1
Shareholders' equity.................................... 1,619.2 4,235.9 4,700.1 4,497.3 3,891.9
STATUTORY DATA(b) - AT PERIOD END
Statutory capital and surplus........................... $1,311.5 $1,336.2 $1,554.5 $1,603.8 $1,510.0
Asset valuation reserve ("AVR")......................... 55.0 161.3 179.1 142.7 117.0
Total statutory capital and surplus and AVR............. 1,366.5 1,497.5 1,733.6 1,746.5 1,627.0
--------------------
(a) 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.
(b) 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, 2005 and 2004.
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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, 2008, and the consolidated results of operations for the years ended December 31, 2008, 2007 and 2006 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:
o 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 our existing indebtedness and the cost of doing so;
o our ability to continue to satisfy the financial ratio and balance requirements and other covenants of our debt agreements;
o our ability to generate sufficient liquidity to meet our debt service obligations and other cash needs;
o our ability to obtain adequate and timely rate increases on our supplemental health products, including our long-term care business;
o the receipt of required regulatory approvals for dividend and surplus debenture interest payments from our insurance subsidiaries;
o 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;
o changes in our assumptions related to the cost of policies produced or the value of policies inforce at the Effective Date;
o the recoverability of our deferred tax assets and the effect of potential tax rate changes on its value;
o changes in accounting principles and the interpretation thereof;
o 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;
o performance and valuation of our investments, including the impact of realized losses (including other-than-temporary impairment charges);
o 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;
o the ultimate outcome of lawsuits filed against us and other legal and regulatory proceedings to which we are subject;
o 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;
o our ability to continue to recruit and retain productive agents and distribution partners and customer response to new products, distribution channels and marketing initiatives;
o our ability to achieve eventual upgrades of the financial strength ratings of Conseco and our insurance company subsidiaries as well as the potential impact of rating downgrades on our business;
o the risk factors or uncertainties listed from time to time in our filings with the SEC;
o 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
o 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.
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. Prior to the fourth quarter of 2008, we had a fourth segment comprised of other business in run-off. The other business in run-off segment had included blocks of business that we no longer market or underwrite and were managed separately from our other businesses. Such segment had consisted of: (i) long-term care insurance sold in prior years through independent agents; and (ii) major medical insurance. 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 the long-term care business in the other business in run-off segment is presented as discontinued operations in our consolidated financial statements. Accordingly, we have restated all prior year segment disclosures to conform to management's current view of the Company's operating segments. Our segments are described below:
o Bankers Life, which consists of the business of Bankers Life and Casualty Company, markets and distributes Medicare supplement insurance, life insurance, long-term care insurance, Medicare Part D prescription drug program, Medicare Advantage products and certain annuity products to the senior market through approximately 5,500 career agents and sales managers. Bankers Life and Casualty Company markets its products under its own brand name and Medicare Part D and Medicare Advantage products primarily through marketing agreements with Coventry.
o 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.
o Conseco Insurance Group, which markets and distributes specified disease insurance, Medicare supplement insurance, and certain life and annuity products to the senior and middle-income markets through approximately 400 IMOs that represent over 2,400 independent producing agents, including approximately 575 from PMA. This segment markets its products under the "Conseco" and "Washington National" brand names. Conseco Insurance Group includes the business of Conseco Health, Conseco Life, Conseco Insurance Company and Washington National. This segment also includes blocks of long-term care and other health business of these companies that we no longer market or underwrite.
For the year ended December 31, 2008, net loss applicable to common stock totaled $1,126.7 million, or $6.10 per diluted share.
Our major goals for 2009 include:
o Managing capital and liquidity to maintain compliance with debt covenants.
o Maintaining strong growth at Bankers Life.
o Continuing to improve the focus and profitability mix of sales at Conseco Insurance Group.
o Improving earnings stability and reducing volatility.
o Completing the remediation project relating to our material weakness in internal controls.
o Continuing to reduce our enterprise exposure to long-term care business.
o 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, 2008, the carrying value of our investment portfolio was $18.6 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, 2008, writedowns of investments included: (i) $162.3 million of
writedowns of investments for other than temporary declines in fair value; and
(ii) $380.5 million of writedowns of investments (classified as discontinued
operations - which were transferred 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") 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.
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 market value is less than the cost basis; (ii) the length of time that the
market value has been less than cost; (iii) whether the unrealized loss is
event-driven, credit-driven or a result of changes in market 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
values of the issuer and the extent to which our investment may be affected by
changes in such values. At December 31, 2008, our net accumulated other
comprehensive income (loss) included gross unrealized losses on fixed maturity
securities of $3.2 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.
As defined in Statement of Financial Accounting Standards No. 157 "Fair Value Measurements" ("SFAS 157"), 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.
SFAS 157 establishes a three-level hierarchy for valuing assets or liabilities at fair value based on whether inputs are observable or unobservable.
o 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.
o 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.
o 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.
Below-investment grade securities have different characteristics than investment grade corporate debt securities. Based on historical performance, risk 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 generally unsecured and often subordinated to other indebtedness of the issuer. Also, issuers of below-investment grade securities usually have higher levels of debt and 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 2008, we sold $.8 billion of fixed maturity investments which resulted in gross investment losses (before income taxes) of $177.3 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 market 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 14 percent of the December 31, 2008 balance of value of policies inforce in 2009, 12 percent in 2010, 11 percent in 2011, 9 percent in 2012 and 7 percent in 2013.
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. 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.
During the fourth quarter of 2008, we were required to accelerate the amortization of insurance acquisition costs related to a block of equity-indexed annuities. This block of business experienced higher than anticipated surrenders during the year. These annuities also have a market value adjustment ("MVA") feature, which effectively reduced (or in some cases, eliminated) the charges paid upon surrender in the fourth quarter of 2008 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 $5 million related to the actual and expected future changes in the experience of this block. We continue to hold insurance acquisition costs of approximately $80 million related to these products, which we determined are recoverable. Results for this block are expected to exhibit increased volatility in the future, because almost all of the difference between our assumptions and actual experience will be reflected in earnings in the period such differences occur.
During the fourth quarter of 2008, a detailed analysis was performed on a universal life block of business that led to the 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 changes in our estimates of future policyholder assumptions on our universal life business, net of planned increases to associated policyholder charges.
During 2007, we were required to accelerate the amortization of insurance acquisition costs related to our universal life products because the prior balance was not recoverable by the value of future estimated gross profits on this block. This additional amortization was necessary so that our insurance acquisition costs would not exceed the value of future estimated gross profits and is expected to continue to be recognized in subsequent periods. Because our insurance acquisition costs are now equal to the value of future estimated gross profits, this block is expected to generate break-even earnings in the future. We continue to hold insurance acquisition costs of approximately $140 million related to these products, which we determined are recoverable by the value of estimated gross profits. In addition, results for this block are expected to exhibit increased volatility in the future, because the entire difference between our assumptions and actual experience is expected to be reflected in earnings in the period such differences occur.
During the fourth quarter of 2007, we recognized additional amortization expense of $14.8 million to reflect changes in our estimates of future mortality rates on our universal life business, net of planned increases to associated policyholder charges.
During the fourth quarter of 2006, we recognized additional amortization expense of $7.8 million to reflect a change in an actuarial assumption related to a block of interest-sensitive life insurance policies based on a change in management's
intent on the administration of such policies. The policies affected by the adjustments described above were issued through a subsidiary prior to its acquisition by Conseco in 1996.
During the first quarter of 2006, we made certain adjustments to our assumptions of expected future profits for the annuity and universal life blocks of business in this segment related to investment returns, lapse rates, the cost of options underlying our equity-indexed products and other refinements. We recognized additional amortization expense of $12.4 million in 2006 due to these changes. This increase to amortization expense was offset by a reduction to insurance policy benefit expense of $11.5 million, to reflect the effect of the changes in these assumptions on the calculation of certain insurance liabilities, such as the liability to purchase future options underlying our equity-indexed products.
When lapses of our insurance products exceed levels assumed in determining the amortization of insurance intangibles, we adjust amortization to reflect the change in future premiums or estimated gross profits resulting from the unexpected lapses. We recognized additional amortization expense of $7.9 million during the first six months of 2006 as a result of higher than expected lapses of our Medicare supplement products. We believe the unexpected lapses were primarily related to premium rate increases and competition from companies offering Medicare Advantage products. During the first nine months of 2006, we changed our estimates of the future gross profits of certain universal life products, which under certain circumstances are eligible for interest bonuses in addition to the declared base rate. These interest bonuses are not required in the current crediting rate environment and our estimates of future gross profits have been changed to reflect the discontinuance of the bonus. We reduced amortization expense by $4.0 million during the first six months of 2006 as a result of this change. There have been no other significant changes to assumptions used to amortize insurance acquisition costs during 2008, 2007 or 2006. Revisions to assumptions in future periods could have a significant adverse or favorable effect on our results of operations and financial position.
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 $21.5 million, $35.7 million and $10.1 million during the years ended December 31, 2008, 2007 and 2006, 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 $265.8 million at December 31, 2008.
At December 31, 2008, the balance of insurance acquisition costs was $3.3 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.
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.................................. $ (80.5)
5% decrease to assumed mortality.................................. 103.3
15% increase to assumed expenses.................................. (22.1)
15% decrease to assumed expenses.................................. 22.1
10 basis point decrease to assumed spread......................... (21.5)
10 basis point increase to assumed spread......................... 21.2
10% increase to assumed lapses.................................... (7.3)
10% decrease to assumed lapses.................................... 7.8
Investment-type products:
20% increase to assumed surrenders................................ (33.0)
20% decrease to assumed surrenders................................ 44.7
15% increase to assumed expenses.................................. (3.8)
15% decrease to assumed expenses.................................. 4.0
10 basis point decrease to assumed spread......................... (21.9)
10 basis point increase to assumed spread......................... 21.9
Other than universal life and investment-type products (b):
5% increase to assumed morbidity.................................. (305.0)
50 basis point decrease to investment earnings rate............... (231.5)
15% increase to assumed expenses.................................. (13.9)
10% decrease to assumed lapses.................................... (27.4)
--------------------
(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.
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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
o We recognize distribution and licensing fee income from Coventry based upon negotiated percentages of collected premiums on the underlying Medicare Part D contracts. This fee income is recognized over the calendar year term as premiums are collected.
o 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
o We recognize premium revenue evenly over the period of the underlying Medicare Part D contracts.
o We recognize policyholder benefits and ceding commission expense as incurred.
o We recognize risk-share premium adjustments consistent with Coventry's risk-share agreement with the Centers for Medicare and Medicaid Services.
The following summarizes the pre-tax income (loss) of the PDP business (dollars in millions):
2008 2007 2006
---- ---- ----
Insurance policy income................................ $67.1 $70.8 $74.4
Fee revenue and other.................................. 2.6 2.4 5.3
----- ----- -----
Total revenues....................................... 69.7 73.2 79.7
----- ----- -----
Insurance policy benefits.............................. 62.3 57.2 59.6
Commission expense..................................... 6.0 6.4 8.7
Other operating expenses............................... 2.1 1.0 6.5
----- ----- -----
Total expense........................................ 70.4 64.6 74.8
----- ----- -----
Pre-tax income (loss)................................ $ (.7) $ 8.6 $ 4.9
===== ===== =====
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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 receive a fee based on the number of PFFS 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 the net premiums and related profits.
We receive distribution fees from Coventry and we pay sales commissions to our agents for these enrollments. In addition, we receive 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
o We receive distribution income from Coventry and other parties based on a fixed fee per PFFS contract. This income is deferred and recognized over the remaining calendar year term of the initial enrollment period.
o We also pay commissions to our agents who sell the plans on behalf of Coventry and other parties. 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
o We recognize revenue evenly over the period of the underlying PFFS contracts.
o We recognize policyholder benefits and ceding commission expense as incurred.
The following summarizes the pre-tax income (loss) of the PFFS business (dollars in millions):
2008 2007
---- ----
Insurance policy income............................ $229.0 $100.8
Fee revenue and other.............................. 8.3 8.6
------ ------
Total revenues................................. 237.3 109.4
------ ------
Insurance policy benefits.......................... 221.8 82.7
Commission expense................................. 8.0 4.2
Other operating expenses........................... 12.7 8.8
------ ------
Total expense.................................. 242.5 95.7
------ ------
Pre-tax income (loss).............................. $ (5.2) $ 13.7
====== ======
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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 receives 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. Conseco receives 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 will terminate 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):
2008 2007
---- ----
Premiums assumed................................... $313.5 $99.8
------ -----
Policy benefits.................................... 301.1 91.2
Commission expense................................. 12.0 4.1
------ -----
Total expenses................................. 313.1 95.3
------ -----
Pre-tax income..................................... $ .4 $ 4.5
====== =====
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Income Taxes
We account for income taxes in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, ("SFAS 109"). 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.
SFAS 109 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 SFAS 109 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.
Pursuant to SFAS 109, 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, 2008, 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, 2008, 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. 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, 2008, 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, 2008, we believe that we will, more likely than not, recover $2.1 billion of our deferred tax assets through reductions of our tax liabilities in future periods.
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).
In addition, the timing and manner in which the Company will be able to utilize some of its NOLs is limited by
Section 382 of the Code. Section 382 imposes limitations on a corporation's ability to use its NOLs when the company undergoes an ownership change. Because the Company underwent an ownership change pursuant to its reorganization, this limitation applies to the Company. Any losses that are subject to the Section 382 limitation will only be utilized by the Company up to approximately $142 million per year with any unused amounts carried forward to the following year. Absent an additional ownership charge, our Section 382 limitation for 2009 will be approximately $662 million (including $520 million of unused amounts carried forward from prior years).
Based upon information existing at the time of our emergence from bankruptcy, we established a valuation allowance against our entire balance of net deferred income tax assets because we believed that the realization of such net deferred income tax assets in future periods was uncertain. During 2006, we concluded that it was no longer necessary to hold certain portions of the previously established valuation allowance. Accordingly, we reduced our valuation allowance by $260.0 million in 2006. However, we are required to continue to hold a valuation allowance of $1.2 billion at December 31, 2008 because 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 or interpretations on the value of such component to be fully recognized in the future.
Changes in our valuation allowance are summarized as follows (dollars in millions):
Balance at December 31, 2005............................................. $1,043.8
Expiration of NOL and capital loss carryforwards....................... (6.0)
Release of valuation allowance (a)..................................... (260.0)
--------
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 (b)
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
========
--------------------
(a) There is a corresponding increase to additional paid-in capital.
(b) 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 Second Amended Credit Facility as described in the note to
these consolidated financial statements entitled "Subsequent Events."
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As of December 31, 2008, we had $4.8 billion of federal NOLs and $1.2 billion of capital loss carryforwards, which expire as follows (dollars in millions):
Net operating
loss carryforwards(a) Total loss carryforwards
--------------------- Capital loss Total loss ---------------------------------------
Year of expiration Life Non-life carryforwards carryforwards Subject to ss.382 Not subject to ss.382
------------------ ---- -------- ------------- ------------- ----------------- ---------------------
2009....... $ - $ - $ 86.2 $ 86.2 $ - $ 86.2
2010....... - .1 - .1 .1 -
2011....... - .1 - .1 .1 -
2012....... - - 63.6 63.6 - 63.6
2013....... - - 1,010.1 1,010.1 - 1,010.1
2017....... 12.2 - - 12.2 12.2 -
2018....... 2,152.4 (a) - - 2,152.4 38.1 2,114.3
2021....... 29.6 - - 29.6 - 29.6
2022....... 207.9 - - 207.9 - 207.9
2023....... - 2,073.7 (a) - 2,073.7 71.1 2,002.6
2024....... - 3.2 - 3.2 - 3.2
2025....... - 118.8 - 118.8 - 118.8
2026....... - 1.6 - 1.6 - 1.6
2027....... - 188.4 - 188.4 - 188.4
2028....... - .9 - .9 - .9
-------- -------- -------- -------- ------- --------
Total...... $2,402.1 $2,386.8 $1,159.9 $5,948.8 $ 121.6 $5,827.2
======== ======== ======== ======== ======= ========
--------------------
(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.
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The Company adopted FASB Interpretation No. 48 "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN 48") on January 1, 2007, which resulted in a $6 million increase to additional paid-in capital. As of January 1, 2007 and December 31, 2007, the amount of unrecognized tax benefits was not significant. While it is expected that the amount of unrecognized tax benefits will change in the next twelve months, the Company does not expect the change to have a significant impact on its results of operations.
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 FIN 48 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 2008 or 2007. The liability for accrued interest and penalties was not significant at December 31, 2008 or December 31, 2007.
Tax years 2005 through 2007 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 2005 through 2007 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% 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.
The Company adopted Statement of Financial Accounting Standards No. 123R "Accounting for Stock-Based Compensation" in calendar year 2006. Pursuant to this accounting rule, the Company is 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 $1.9 million related to deductions for stock options and restricted stock will be reflected in additional paid-in capital if realized.
Liabilities for Insurance Products
At December 31, 2008, the total balance of our liabilities for insurance products was $24.2 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:
o 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.
o 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.
o 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.
o 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:
o retention of their current policy with a rate increase of 50 percent in the first year and actuarially justified increases in subsequent years;
o 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
o 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, 2008, we have estimated that approximately $10.0 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, 2008, we had paid $19.3 million to the former holders of TOPrS and we have established a liability of $4.3 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.
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):
2008 2007 2006
---- ---- ----
Income (loss) before net realized investment gains (losses), net of related
amortization and income taxes (a non-GAAP measure) (a):
Bankers Life....................................................... $ 171.5 $ 241.8 $265.3
Colonial Penn...................................................... 25.2 18.1 21.6
Conseco Insurance Group............................................ 121.3 (26.3) (3.0)
Corporate operations............................................... (64.7) (121.3) (80.7)
------- ------- ------
253.3 112.3 203.2
------- ------- ------
Net realized investment gains (losses), net of related amortization:
Bankers Life....................................................... (100.9) (17.4) (16.3)
Colonial Penn...................................................... (1.6) (.2) .2
Conseco Insurance Group............................................ (87.6) (98.5) (20.0)
Corporate operations............................................... (50.8) (6.2) (.4)
------- ------- ------
(240.9) (122.3) (36.5)
------- ------- ------
Income (loss) before income taxes:
Bankers Life....................................................... 70.6 224.4 249.0
Colonial Penn...................................................... 23.6 17.9 21.8
Conseco Insurance Group............................................ 33.7 (124.8) (23.0)
Corporate operations............................................... (115.5) (127.5) (81.1)
------- ------- ------
Income (loss) before income taxes................................. $ 12.4 $ (10.0) $166.7
======= ======= ======
--------------------
(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 for purposes of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS
|
131"), 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 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 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.
Bankers Life (dollars in millions)
2008 2007 2006
---- ---- ----
Premium collections:
Annuities........................................................... $ 1,224.1 $ 885.5 $ 997.5
Supplemental health................................................. 1,887.0 1,546.1 1,308.3
Life................................................................ 209.4 200.0 184.2
--------- -------- --------
Total collections................................................. $ 3,320.5 $2,631.6 $2,490.0
========= ======== ========
Average liabilities for insurance products:
Annuities:
Mortality based................................................. $ 252.9 $ 281.6 $ 271.8
Equity-indexed.................................................. 1,203.0 787.4 500.2
Deposit based................................................... 4,464.3 4,507.4 4,435.4
Health.............................................................. 3,880.5 3,569.7 3,310.2
Life:
Interest sensitive.............................................. 385.9 364.2 341.5
Non-interest sensitive.......................................... 357.8 299.1 246.7
--------- -------- --------
Total average liabilities for insurance
products, net of reinsurance ceded........................... $10,544.4 $9,809.4 $9,105.8
========= ======== ========
Revenues:
Insurance policy income............................................. $ 2,109.9 $1,780.0 $1,545.5
Net investment income:
General account invested assets................................... 617.1 578.7 513.3
Equity-indexed products........................................... (49.4) (10.6) 12.3
Other special-purpose portfolios.................................. (9.5) 4.2 -
Fee revenue and other income........................................ 11.0 12.0 6.0
--------- -------- --------
Total revenues.................................................. 2,679.1 2,364.3 2,077.1
--------- -------- --------
Expenses:
Insurance policy benefits........................................... 1,879.9 1,480.6 1,216.2
Amounts added to policyholder account balances:
Annuity products and interest-sensitive life
products other than equity-indexed products..................... 175.7 180.9 173.6
Equity-indexed products........................................... 34.8 23.2 20.8
Amortization related to operations.................................. 234.8 264.0 241.0
Interest expense on investment borrowings........................... - - .1
Other operating costs and expenses.................................. 182.4 173.8 160.1
--------- -------- --------
Total benefits and expenses..................................... 2,507.6 2,122.5 1,811.8
--------- -------- --------
Income before net realized investment losses,
net of related amortization and income taxes........................ 171.5 241.8 265.3
--------- -------- --------
Net realized investment losses.................................... (116.7) (19.9) (19.5)
Amortization related to net realized investment losses............ 15.8 2.5 3.2
--------- -------- --------
Net realized investment losses,
net of related amortization................................. (100.9) (17.4) (16.3)
--------- -------- --------
Income before income taxes............................................... $ 70.6 $ 224.4 $ 249.0
========= ======== ========
|
(continued)
(continued from previous page)
2008 2007 2006
---- ---- ----
Health benefit ratios:
All health lines:
Insurance policy benefits.......................................... $1,709.4 $1,298.0 $1,058.8
Benefit ratio (a).................................................. 91.3% 84.4% 79.9%
Medicare supplement:
Insurance policy benefits.......................................... $452.3 $433.3 $436.6
Benefit ratio (a).................................................. 70.8% 67.2% 66.6%
PDP and PFFS:
Insurance policy benefits.......................................... $585.1 $231.1 $59.6
Benefit ratio (a).................................................. 96.0% 85.1% 80.0%
Long-term care:
Insurance policy benefits.......................................... $672.0 $633.6 $562.6
Benefit ratio (a).................................................. 107.6% 102.0% 94.5%
Interest-adjusted benefit ratio (b)................................ 74.0% 70.8% 64.9%
--------------------
(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 for purposes of SFAS 131 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 $210.1 million, $193.8 million and $175.9 million in
2008, 2007 and 2006, respectively.
|
Total premium collections were $3,320.5 million in 2008, up 26 percent from 2007, and $2,631.6 million in 2007, up 5.7 percent from 2006. Premium collections include $614.0 million, $277.8 million and $76.7 million in 2008, 2007, and 2006, 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.
Average liabilities for insurance products, net of reinsurance ceded were $10.5 billion in 2008, up 7.5 percent from 2007, and $9.8 billion in 2007, up 7.7 percent from 2006. 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 $609.6 million, $271.4 million and $74.4 million in 2008, 2007 and 2006, 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 6.6 percent, to $617.1 million, in 2008 and 13 percent, to $578.7 million, in 2007. The average balance of general account invested assets was $10.6 billion, $10.0 billion and $9.2 billion in 2008, 2007 and 2006, respectively. The average yield on these assets was 5.83 percent in 2008, 5.79 percent in 2007 and 5.59 percent in 2006. The increase in general account invested assets is primarily due to sales of our annuity and health products in recent periods.
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 gains (losses) related to equity-indexed products were $(67.0) million, $(11.2) million and $12.3 million in 2008, 2007 and 2006, 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 $17.6 million and $.6 million in 2008 and 2007, respectively. There was no such trading account income in 2006. 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.
Our results in 2008 were affected by a reduction to earnings of $21.0 million related to equity-indexed annuity products (such variance primarily resulted from the change in the value of the embedded derivative related to future indexed benefits reported at estimated fair value in accordance with accounting requirements, including a $2.0 million charge in the first quarter of 2008 related to the adoption of SFAS 157).
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 $(9.5) million and $1.5 million in 2008 and 2007, respectively. We also recognized a death benefit of $2.7 million under the COLI in 2007.
Fee revenue and other income was $11.0 million in 2008, compared to $12.0 million in 2007 and $6.0 million in 2006. We recognized fee income of $10.9 million, $11.0 million and $5.3 million in 2008, 2007 and 2006, 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 $.5 million, $3.7 million and $9.8 million in 2008, 2007 and 2006, respectively. Excluding the effects of prior year claim reserve redundancies, our benefit ratios would have been 70.8 percent, 67.8 percent and 68.3 percent in 2008, 2007 and 2006, respectively. We experienced an increase in the number of incurred claims in 2008.
The insurance policy benefits on our PDP and PFFS business result from our quota-share reinsurance agreements with 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. Effective May 1, 2008 and July 1, 2007, we entered into new PFFS quota-share reinsurance agreements to assume a specified percentage of the business written by Coventry under two 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 addition, our benefit ratio on this block has increased as a result of the recent addition of new PFFS groups through quota-share reinsurance agreements. The expected benefit ratio on the PFFS business is higher than the expected benefit ratio on the PDP business. Accordingly, the overall benefit ratio has increased since the PFFS business is now a larger percentage of the entire block. One group policy reinsurance agreement was terminated on December 31, 2008, and the other group policy reinsurance agreement will be terminated on June 30, 2009.
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 this business has increased over the last year, consistent with the aging of this block. In addition, the older policies have not lapsed at the rate we assumed in our pricing. The benefit ratio on our entire block of long-term care business in the Bankers Life segment was 107.6 percent, 102.0 percent and 94.5 percent in 2008, 2007 and 2006, respectively. The interest-adjusted benefit ratio on this business was 74.0 percent, 70.8 percent and 64.9 percent in 2008, 2007 and 2006, 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 deficiencies from prior years of $6.0 million, $7.4 million and $.5 million in 2008, 2007 and 2006, respectively. Excluding the effects of prior year claim reserve deficiencies, our benefit ratios would have been 106.7 percent, 100.8 percent and 94.4 percent in 2008, 2007 and 2006, respectively. We experienced an increase in the number of incurred claims in 2008 and 2007.
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. The policies in this round represent approximately 25 percent of the inforce block. As of December 31, 2008, all such filings had been submitted for regulatory approval, and approximately 65 percent of the rate increases had been approved by regulators and implemented. Remaining approvals and implementations are expected to occur over the next three to nine months. 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. As of December 31, 2008, approximately 65 percent of the rate increases had been approved by regulators and implemented. The remaining approvals and implementations of this rate increase are expected to occur by the end of 2009.
During the fourth quarter of 2007, we recognized additional insurance policy benefits of $6.7 million to reflect changes in our estimates of future surrender and premium persistency rates on our universal life insurance block of business.
Amounts added to policyholder account balances for annuity products and interest-sensitive life products were $175.7 million, $180.9 million and $173.6 million in 2008, 2007 and 2006, respectively. The weighted average crediting rates for these products were 3.6 percent, 3.7 percent and 3.6 percent in 2008, 2007 and 2006, respectively.
Amounts added to equity-indexed products based on change in value of the indices fluctuated with the corresponding related investment income accounts described above.
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 $234.8 million,
$264.0 million and $241.0 million in 2008, 2007 and 2006, respectively. During
the first six months of 2008, 2007 and 2006, 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 in the first half of 2008,
$25.4 million in the first half of 2007 and $7.9 million in the first half of
2006. We believe such increases were partially related to competition from
Medicare Advantage products.
Other operating costs and expenses in our Bankers Life segment were $182.4 million in 2008, up 5.0 percent from 2007 and were $173.8 million in 2007, up 8.6 percent from 2006. These fluctuations were largely due to the expenses related to the marketing and quota-share agreements with Coventry. Other operating costs and expenses include the following (dollars in millions):
2008 2007 2006
---- ---- ----
Expenses related to the marketing and quota-share
agreements with Coventry............................................ $ 40.8 $ 24.5 $ 15.2
Commission expense..................................................... 20.5 20.8 20.7
Other operating expenses............................................... 121.1 128.5 124.2
------ ------ ------
Total............................................................... $182.4 $173.8 $160.1
====== ====== ======
|
Net realized investment losses fluctuated each period. 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 values 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 values that we concluded were other than temporary. During 2006, net realized investment losses in this segment included $15.1 million of net losses from the sales of investments (primarily fixed maturities), and $4.4 million of writedowns of investments resulting from declines in fair values 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 a decrease in the amortization of insurance acquisition costs of $15.8 million, $2.5 million and $3.2 million in 2008, 2007 and 2006, respectively.
Colonial Penn (dollars in millions)
2008 2007 2006
---- ---- ----
Premium collections:
Life................................................................. $174.1 $113.7 $ 97.2
Supplemental health.................................................. 8.9 10.4 12.0
------ ------ -------
Total collections.................................................. $183.0 $124.1 $109.2
====== ====== ======
Average liabilities for insurance products:
Annuities-mortality based............................................ $ 85.9 $ 88.7 $ 90.8
Health............................................................... 20.7 22.9 25.6
Life:
Interest sensitive............................................... 25.0 25.9 27.6
Non-interest sensitive........................................... 562.9 558.9 553.6
------ ------ ------
Total average liabilities for insurance
products, net of reinsurance ceded........................... $694.5 $696.4 $697.6
====== ====== ======
Revenues:
Insurance policy income.............................................. $184.8 $125.8 $112.1
Net investment income:
General account invested assets.................................... 40.1 37.8 38.2
Trading account income related to reinsurer accounts............... (.5) (.2) (4.3)
Change in value of embedded derivative related
to a modified coinsurance agreement.............................. - .2 4.3
Fee revenue and other income......................................... 1.8 .7 .6
------ ------ ------
Total revenues................................................... 226.2 164.3 150.9
------ ------ ------
Expenses:
Insurance policy benefits............................................ 138.2 101.0 95.1
Amounts added to annuity and interest-sensitive life product
account balances................................................. 1.2 1.2 1.3
Amortization related to operations................................... 32.0 20.3 17.3
Other operating costs and expenses................................... 29.6 23.7 15.6
------ ------ ------
Total benefits and expenses...................................... 201.0 146.2 129.3
------ ------ ------
Income before net realized investment gains (losses) and
income taxes......................................................... 25.2 18.1 21.6
Net realized investment gains (losses)............................. (1.6) (.2) .2
------ ------ ------
Income before income taxes................................................ $ 23.6 $ 17.9 $ 21.8
====== ====== ======
|
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 47 percent, to $183.0 million, in 2008 and 14 percent, to $124.1 million, in 2007. 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, 2008.
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. The increase in 2008 reflects: (i) 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, 2008. The average balance of general account invested assets was $676.0 million in 2008, $660.6 million in 2007 and $688.5 million in 2006. The average yield on these assets was 5.94 percent in 2008, 5.72 percent in 2007 and 5.55 percent in 2006.
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 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. Amortization was negatively impacted in 2008 by a $1.3 million adjustment that is not expected to recur.
Other operating costs and expenses in our Colonial Penn segment increased 25 percent, to $29.6 million, in 2008 as compared to 2007 primarily due to: (i) 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 increased 52 percent, to $23.7 million, in 2007 as compared to 2006 primarily due to the initial 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. Excluding these costs, other operating costs and expenses were comparable in 2007 and 2006.
Net realized investment gains (losses) fluctuated each period. During 2008, net realized investment losses in this segment included $.1 million of net gains from the sales of investments (primarily fixed maturities), net of $1.7 million of writedowns of investments resulting from declines in fair values 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), net of $.6 million of writedowns of investments resulting from declines in fair values that we concluded were other than temporary. During 2006, net realized investment gains in this segment included $.4 million of net gains from the sales of investments (primarily fixed maturities), net of $.2 million of writedowns of investments resulting from declines in fair values that we concluded were other than temporary.
Conseco Insurance Group (dollars in millions)
2008 2007 2006
---- ---- ----
Premium collections:
Annuities........................................................... $ 129.8 $ 368.6 $ 433.3
Supplemental health................................................. 621.8 633.4 655.8
Life................................................................ 269.8 287.3 314.6
-------- --------- ---------
Total collections................................................. $1,021.4 $ 1,289.3 $ 1,403.7
======== ========= =========
Average liabilities for insurance products:
Annuities:
Mortality based................................................... $ 220.7 $ 230.3 $ 241.2
Equity-indexed.................................................... 891.0 1,435.3 1,376.4
Deposit based..................................................... 752.6 2,337.7 3,150.8
Separate accounts................................................. 23.6 28.4 29.3
Health.............................................................. 2,993.1 2,927.5 2,899.4
Life:
Interest sensitive................................................ 2,945.5 3,045.5 3,061.2
Non-interest sensitive............................................ 1,393.8 1,380.2 1,416.8
-------- --------- ---------
Total average liabilities for insurance products,
net of reinsurance ceded...................................... $9,220.3 $11,384.9 $12,175.1
======== ========= =========
Revenues:
Insurance policy income............................................. $ 958.9 $ 989.9 $ 1,038.8
Net investment income:
General account invested assets................................... 592.7 727.6 723.5
Equity-indexed products........................................... (28.4) (1.3) 26.0
Trading account income related to policyholder and
reinsurer accounts.............................................. (18.5) 1.4 6.9
Change in value of embedded derivatives related to
modified coinsurance agreements................................. 6.7 1.4 .8
Other trading accounts............................................ - (12.8) -
Fee revenue and other income........................................ 1.7 1.0 1.4
-------- --------- ---------
Total revenues.................................................... 1,513.1 1,707.2 1,797.4
-------- --------- ---------
Expenses:
Insurance policy benefits........................................... 820.9 850.9 862.9
Amounts added to policyholder account balances:
Annuity products and interest-sensitive life products
other than equity-indexed products.............................. 153.6 217.4 251.9
Equity-indexed products........................................... 8.2 60.7 55.8
Amortization related to operations.................................. 122.6 178.2 175.1
Interest expense on investment borrowings........................... 22.4 17.6 .8
Costs related to a litigation settlement............................ - 32.2 165.8
Loss related to an annuity coinsurance transaction.................. - 76.5 -
Other operating costs and expenses.................................. 264.1 300.0 288.1
-------- --------- ---------
Total benefits and expenses....................................... 1,391.8 1,733.5 1,800.4
-------- --------- ---------
Income (loss) before net realized investment losses,
net of related amortization and income taxes........................ 121.3 (26.3) (3.0)
-------- --------- ---------
Net realized investment losses.................................... (93.3) (131.7) (26.9)
Amortization related to net realized investment losses............ 5.7 33.2 6.9
-------- --------- ---------
Net realized investment losses,
net of related amortization................................... (87.6) (98.5) (20.0)
-------- --------- ---------
Income (loss) before income taxes........................................ $ 33.7 $ (124.8) $ (23.0)
======== ========= =========
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(continued)
(continued from previous page)
2008 2007 2006
---- ---- ----
Health benefit ratios:
All health lines:
Insurance policy benefits.......................................... $494.3 $514.9 $538.7
Benefit ratio (a).................................................. 79.8% 80.4% 80.5%
Medicare supplement:
Insurance policy benefits.......................................... $139.8 $156.4 $158.9
Benefit ratio (a).................................................. 68.4% 67.6% 61.9%
Specified disease:
Insurance policy benefits.......................................... $285.4 $279.4 $277.1
Benefit ratio (a).................................................. 77.1% 77.8% 77.4%
Interest-adjusted benefit ratio (b)................................ 43.3% 44.7% 45.4%
Long-term care:
Insurance policy benefits.......................................... $58.7 $72.5 $91.2
Benefit ratio (a).................................................. 169.6% 192.4% 224.4%
Interest-adjusted benefit ratio (b)................................ 93.5% 128.5% 171.3%
Other:
Insurance policy benefits.......................................... $10.4 $6.6 $11.5
Benefit ratio (a).................................................. 100.5% 54.2% 80.6%
--------------------
(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 for purposes of SFAS
131 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 $125.2 million, $118.9 million and $114.7 million in
2008, 2007 and 2006, respectively. The investment income earned on the
accumulated assets backing the long-term care reserves was $26.3
million, $24.1 million and $21.6 million in 2008, 2007 and 2006,
respectively.
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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
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 market 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 $1,021.4 million in 2008, down 21 percent from 2007, and $1,289.3 million in 2007, down 8.1 percent from 2006. The decrease in 2007 collected premiums was primarily due to lower equity-indexed annuity sales as we changed the pricing of specific products and we no longer emphasized the sale of certain products. See "Premium Collections" for further analysis of fluctuations in premiums collected by product.
Average liabilities for insurance products, net of reinsurance ceded were $9.2 billion in 2008, down 19 percent from 2007, and $11.4 billion in 2007, down 6.5 percent from 2006. The decreases in such liabilities were primarily due to the coinsurance transaction discussed above and 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 19 percent, to $592.7 million, in 2008 and increased .6 percent, to $727.6 million, in 2007. The average balance of general account invested assets decreased 17 percent in 2008, to $10.1 billion, and 2.8 percent in 2007, to $12.2 billion. Net investment income and the average balance of general account invested assets both decreased as a result of the coinsurance agreement discussed above. The average yield on these assets was 5.89 percent in 2008, 5.97 percent in 2007 and 5.77 percent in 2006.
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 gains (losses) related to equity-indexed products were $(37.3) million, $2.7 million and $28.1 million in 2008, 2007 and 2006, respectively. Such amounts also include income on trading securities which are held to act as hedges for embedded derivatives related to equity-indexed products. Such trading account income (loss) was $8.9 million, $(4.0) million and $(2.1) million in 2008, 2007 and 2006, 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.
Our results in 2008, were affected by a reduction to earnings of $4.4 million related to equity-indexed annuity products (such variance primarily resulted from the change in the value of the embedded derivative related to future indexed benefits reported at estimated fair value in accordance with accounting requirements, including a $.8 million charge in the first quarter of 2008 related to the adoption of SFAS 157).
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 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 $3.6 million, $(.2) million and $28.9 million in 2008, 2007 and 2006, respectively. Such fluctuations were primarily due to changes in mortality.
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 were impacted by an increase 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 $2.5 million, $1.0 million and $5.4 million in 2008, 2007 and 2006, respectively. Excluding the effects of prior year claim reserve redundancies, our benefit ratios for the Medicare supplement block would have been 69.6 percent, 68.0 percent and 64.1 percent in 2008, 2007 and 2006, 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 $64.6 million, $74.9 million and $97.6 million in 2008, 2007 and 2006, respectively. Such decreases are primarily due to lower sales and higher incurred claims.
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 $85.0 million, $79.7 million and $80.8 million in 2008, 2007 and 2006, respectively. The increase in the margin in 2008 is due to 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 169.6 percent, 192.4 percent and 224.4 percent in 2008, 2007 and 2006, 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 $1.1 million, $6.3 million and $12.8 million in 2008, 2007 and 2006, respectively. Excluding the effects of prior year claim reserve deficiencies, our benefit ratios would have been 166.6 percent, 175.7 percent and 192.5 percent in 2008, 2007 and 2006, respectively. These ratios reflect the level of incurred claims experienced in recent periods, adverse development on claims incurred in prior periods 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.
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 93.5 percent, 128.5 percent and 171.3 percent in 2008, 2007 and 2006, respectively. Excluding the effects of prior year claim reserve deficiencies, our interest-adjusted benefit ratios would have been 90.4 percent, 111.9 percent and 139.8 percent in 2008, 2007 and 2006, 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:
o 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");
o 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
o 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.
The benefit ratios on Conseco Insurance Group's other products are subject to fluctuations due to the smaller size of these blocks of business.
During the fourth quarter of 2007, we recognized additional insurance policy benefits of $2.0 million to increase our insurance product liabilities. This increase primarily affects our best estimate of the costs associated with enhancing certain benefits related to a block of excess interest whole life policies in response to various issues in how the policies had been administered. We recognized additional insurance policy benefits of $8.0 million during the fourth quarter of 2006 based on our prior estimate of the enhanced benefits associated with these same policies and administrative issues. The policies affected by the adjustments described above were issued through a subsidiary prior to its acquisition by Conseco in 1997.
Amounts added to policyholder account balances for annuity products and interest-sensitive life products were $153.6 million, $217.4 million and $251.9 million in 2008, 2007 and 2006, 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 completion of the annuity coinsurance agreement discussed above. The weighted average crediting rates for these products were 4.2 percent, 4.1 percent and 4.1 percent in 2008, 2007 and 2006, respectively. In addition, amounts added to policyholder account balances for annuity products in the first quarter of 2008 includes a $3.0 million out-of-period expense to reflect previously unrecognized benefits on certain annuity policies.
Amounts added to equity-indexed products generally fluctuate with the corresponding related investment income accounts described above. In addition, in 2006, we reduced such amounts by $8.5 million to reflect a change in the assumptions for the cost of options underlying our equity-indexed products as described below under amortization related to operations. Such decreases were partially offset by a $4.7 million increase in amortization of insurance acquisition costs related to the assumption changes.
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. Lapse rates on our Medicare
supplement products have impacted our estimates of future expected premium
income and, accordingly, we recognized increased (decreased) amortization
expense of $(5.5) million, $(3.9) million and $7.1 million in 2008, 2007 and
2006, respectively. 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.
During the fourth quarter of 2008, we were required to accelerate the amortization of insurance acquisition costs related to a block of equity-indexed annuities. This block of business experienced higher than anticipated surrenders during the year. These annuities also have a MVA feature, which effectively reduced (or in some cases, eliminated) the charges paid upon surrender in the fourth quarter of 2008 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 $5 million related to the actual and expected future changes in the experience of this block. This increase to amortization expense was offset by a reduction to the insurance policy option benefit reserve. We continue to hold insurance acquisition costs of approximately $80 million related to these products, which we determined are recoverable. Results for this block are expected to exhibit increased volatility in the future, because almost all of the difference between our assumptions and actual experience will be reflected in earnings in the period such differences occur.
During the fourth quarter of 2008, a detailed analysis was performed on a universal life block of business that led to
the 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 changes in our estimates of future policyholder assumptions on our universal life business, net of planned increases to associated policyholder charges.
During 2007, we were required to accelerate the amortization of insurance acquisition costs related to our universal life products because the prior balance was not recoverable by the value of future estimated gross profits on this block. This additional amortization was necessary so that our insurance acquisition costs would not exceed the value of future estimated gross profits and is expected to continue to be recognized in subsequent periods. Because our insurance acquisition costs are now equal to the value of future estimated gross profits, this block is expected to generate break-even earnings in the future. In addition, results for this block are expected to exhibit increased volatility in the future, because the entire difference between our assumptions and actual experience is expected to be reflected in earnings in the period such differences occur.
During the fourth quarter of 2007, we recognized additional amortization expense of $14.8 million to reflect changes in our estimates of future mortality rates on our universal life business, net of planned increases to associated policyholder charges.
During the fourth quarter of 2006, we recognized additional amortization expense of $7.8 million to reflect a change in an actuarial assumption related to a block of interest-sensitive life insurance policies based on a change in management's intent on the administration of such policies. The policies affected by the adjustments described above were issued through a subsidiary prior to its acquisition by Conseco in 1996.
During the first quarter of 2006, we made certain adjustments to our assumptions of expected future profits for the annuity and universal life blocks of business in this segment related to investment returns, lapse rates, the cost of options underlying our equity-indexed products and other refinements. We recognized additional amortization expense of $12.4 million in the first quarter of 2006 due to these changes. This increase to amortization expense was offset by a reduction to insurance policy benefit expense of $11.5 million, to reflect the effect of the changes in these assumptions on the calculation of certain insurance liabilities, such as the liability to purchase future options underlying our equity-indexed products. Also, during the second quarter of 2006, we changed our estimates of the future gross profits of certain universal life products, which under certain circumstances are eligible for interest bonuses in addition to the declared base rate. These interest bonuses are not required in the current crediting rate environment and our estimates of future gross profits have been changed to reflect the discontinuance of the bonus. We reduced amortization expense by $4.0 million during the second quarter of 2006 as a result of this change.
Interest expense on investment borrowings includes $21.9 million and $16.7 million of interest expense on collateralized borrowings in 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, including the effect of the sale of shares of our common stock distributed for the benefit of the plaintiffs pursuant to the bankruptcy plan of our Predecessor at lower market prices than previously reflected. 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 $264.1 million, $300.0 million and $288.1 million in 2008, 2007 and 2006, respectively. Other operating costs and expenses include commission expense of $79.2 million, $82.2 million and $90.6 million in 2008, 2007 and 2006, respectively. 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. The decrease in expenses in 2008 is also due to lower litigation expenses and lower sales and marketing costs.
Net realized investment gains (losses) fluctuate each period. 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 values 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 concerns regarding the effect future adverse developments could have on the future value 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 Consolidated Financial Condition and Results of Operations. During 2006, net realized investment losses included $10.4 million of net losses from the sales of investments (primarily fixed maturities), and $16.5 million of writedowns of investments resulting from declines in fair values that we concluded were other than temporary.
Amortization related to net realized investment gains (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 no longer have the intent to hold impaired investments for a period of time sufficient to allow for a full recovery in value), 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 $5.7 million, $33.2 million and $6.9 million in 2008, 2007 and 2006, respectively.
Corporate Operations (dollars in millions)
2008 2007 2006
---- ---- ----
Corporate operations:
Interest expense on corporate debt................................... $ (59.2) $ (72.3) $(52.9)
Net investment income................................................ 4.9 6.6 4.6
Fee revenue and other income......................................... 4.7 9.8 10.9
Net operating results of variable interest entity.................... 7.2 9.2 4.9
Costs related to a litigation settlement............................. - (32.2) (8.9)
Other operating costs and expenses................................... (43.5) (42.4) (38.6)
Gain (loss) on extinguishment of debt................................ 21.2 - (.7)
------- ------- ------
Loss before net realized investment losses
and income taxes................................................ (64.7) (121.3) (80.7)
Net realized investment losses....................................... (50.8) (6.2) (.4)
------- ------- ------
Loss before income taxes........................................... $(115.5) $(127.5) $(81.1)
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Interest expense on corporate debt has been impacted by: (i) the repayment or amendment of the Company's credit facilities in 2007 and 2006; (ii) the issuance in 2008 of a $125.0 million Senior Note; (iii) borrowings in 2008 pursuant to our revolving credit facility; and (iv) the repurchase of $37.0 million par value of our Debentures. These transactions are further discussed in the note to the consolidated financial statements entitled "Notes Payable - Direct Corporate Obligations". Our average corporate debt outstanding was $1,219.3 million, $1,111.8 million and $864.3 million in 2008, 2007 and 2006, respectively. The average interest rate on our debt was 4.6 percent, 6.2 percent and 5.7 percent in 2008, 2007 and 2006, respectively.
Net investment income primarily included income earned on short-term 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 market 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 Financial Accounting Standards Board Interpretation No. 46 "Consolidation of Variable Interest Entities", revised December 2003. 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. In 2008, we recognized a $9.6 million charge related to the consolidation of our Chicago facilities. In 2006, other operating costs and expenses are net of a recovery of $3.0 million related to our evaluation of the collectibility of the D&O loans.
Gain (loss) on extinguishment of debt of $21.2 million in 2008 resulted from the repurchase of $37.0 million par value of Debentures for $15.3 million plus accrued interest. The $(.7) million loss in 2006 resulted from the write-off of certain issuance costs and other costs incurred related to the Second Amended Credit Facility.
Net realized investment losses often fluctuate each period. 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) due to other-than-temporary 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 due to other-than-temporary declines in value on certain securities. During 2006, net realized investment losses in this segment included $.4 million from the sale of investments.
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:
Bankers Life (dollars in millions)
2008 2007 2006
---- ---- ----
Premiums collected by product:
Annuities:
Equity-indexed (first-year).......................................... $ 522.8 $ 437.4 $ 276.5
-------- -------- --------
Other fixed (first-year)............................................. 697.8 445.3 718.1
Other fixed (renewal)................................................ 3.5 2.8 2.9
-------- -------- --------
Subtotal - other fixed annuities................................... 701.3 448.1 721.0
-------- -------- --------
Total annuities.................................................... 1,224.1 885.5 997.5
-------- -------- --------
Supplemental health:
Medicare supplement (first-year)..................................... 81.3 82.5 97.8
Medicare supplement (renewal)........................................ 555.3 553.6 531.3
-------- -------- --------
Subtotal - Medicare supplement..................................... 636.6 636.1 629.1
-------- -------- --------
Long-term care (first-year).......................................... 42.7 47.0 51.2
Long-term care (renewal)............................................. 583.0 575.4 541.2
-------- -------- --------
Subtotal - long-term care.......................................... 625.7 622.4 592.4
-------- -------- --------
PDP and PFFS (first year)............................................ 353.3 206.4 76.7
PDP and PFFS (renewal)............................................... 260.7 71.4 -
-------- -------- --------
Subtotal - PDP and PFFS............................................ 614.0 277.8 76.7
-------- -------- --------
Other health (first-year)............................................ 2.1 .9 1.0
Other health (renewal)............................................... 8.6 8.9 9.1
-------- -------- --------
Subtotal - other health............................................ 10.7 9.8 10.1
-------- -------- --------
Total supplemental health.......................................... 1,887.0 1,546.1 1,308.3
-------- -------- --------
Life insurance:
First-year........................................................... 80.7 89.2 90.3
Renewal.............................................................. 128.7 110.8 93.9
-------- -------- --------
Total life insurance............................................... 209.4 200.0 184.2
-------- -------- --------
Collections on insurance products:
Total first-year premium collections on insurance
products.......................................................... 1,780.7 1,308.7 1,311.6
Total renewal premium collections on insurance
products........................................................... 1,539.8 1,322.9 1,178.4
-------- -------- --------
Total collections on insurance products............................ $3,320.5 $2,631.6 $2,490.0
======== ======== ========
|
Annuities in this segment include equity-indexed and other fixed annuities sold to the senior market through our career agents. Annuity collections in this segment increased 38 percent, to $1,224.1 million, in 2008 and decreased 11 percent to $885.5 million, in 2007. Premium collections from our equity-indexed products were favorably impacted in 2007 and the first half of 2008 by the general stock market performance made these products attractive to certain customers. Premium collections from our equity-indexed products declined in the second half of 2008 due to declines in the stock market. Premium collections from our 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.
Supplemental health products include Medicare supplement, Medicare Part D contracts, PFFS contracts, long-term care and other insurance products distributed through our career agents. 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 increased .1 percent, to $636.6 million, in 2008 and 1.1 percent, to $636.1 million, in 2007. The increase in premium collections of our Medicare supplement products in 2007 was primarily due to higher persistency, partially offset by lower new sales.
Premiums collected on Bankers Life's long-term care policies increased .5 percent, to $625.7 million, in 2008 and 5.1 percent, to $622.4 million, in 2007. The increase in premium collections of our long-term care products in 2007 was primarily due to higher premiums associated with the policies that were impacted by the rate increases which became effective in 2007 and 2006.
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. 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 4.7 percent, to $209.4 million, in 2008 and 8.6 percent, to $200.0 million, in 2007. Collected premiums have been impacted by an increased focus on life products.
Colonial Penn (dollars in millions)
2008 2007 2006
---- ---- ----
Premiums collected by product:
Life insurance:
First-year........................................................... $ 35.0 $ 28.7 $ 22.9
Renewal.............................................................. 139.1 85.0 74.3
------ ------ ------
Total life insurance............................................... 174.1 113.7 97.2
------ ------ ------
Supplemental health (all of which are renewal premiums):
Medicare supplement.................................................. 8.1 9.4 10.9
Other health......................................................... .8 1.0 1.1
------ -------- ------
Total supplemental health.......................................... 8.9 10.4 12.0
------ ------ ------
Collections on insurance products:
Total first-year premium collections on insurance
products........................................................... 35.0 28.7 22.9
Total renewal premium collections on insurance
products........................................................... 148.0 95.4 86.3
------ ------ ------
Total collections on insurance products............................ $183.0 $124.1 $109.2
====== ====== ======
|
Life products in this segment are sold primarily to the senior market. Life premiums collected in this segment increased 53 percent, to $174.1 million, in 2008 and 17 percent, to $113.7 million, in 2007. Graded benefit life products sold through our direct response marketing channel accounted for $168.5 million, $108.8 million and $92.3 million of collected premiums in 2008, 2007 and 2006, respectively. Collected premiums have been impacted by: (i) the recapture in the fourth quarter of 2007 of a block of traditional life insurance inforce that had been ceded in 2002 to REALIC; and (ii) an increased investment in marketing activities in 2008.
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.
Conseco Insurance Group (dollars in millions)
2008 2007 2006
---- ---- ----
Premiums collected by product:
Annuities:
Equity-indexed (first-year)......................................... $ 116.1 $ 336.4 $ 369.4
Equity-indexed (renewal)............................................ 7.6 8.2 9.1
-------- -------- --------
Subtotal - equity-indexed annuities............................... 123.7 344.6 378.5
-------- -------- --------
Other fixed (first-year)............................................ 3.8 18.0 46.1
Other fixed (renewal)............................................... 2.3 6.0 8.7
-------- -------- --------
Subtotal - other fixed annuities.................................. 6.1 24.0 54.8
-------- -------- --------
Total annuities................................................... 129.8 368.6 433.3
-------- -------- --------
Supplemental health:
Medicare supplement (first-year).................................... 9.6 19.4 30.6
Medicare supplement (renewal)....................................... 194.2 206.5 213.6
-------- -------- --------
Subtotal - Medicare supplement.................................... 203.8 225.9 244.2
-------- -------- --------
Specified disease (first-year)...................................... 39.4 31.4 28.1
Specified disease (renewal)......................................... 335.2 327.8 329.6
-------- -------- --------
Subtotal - specified disease...................................... 374.6 359.2 357.7
-------- -------- --------
Long-term care (all of which are renewal)........................... 33.7 36.7 39.4
-------- -------- --------
Other health (first-year)........................................... .1 .3 -
Other health (renewal).............................................. 9.6 11.3 14.5
-------- -------- --------
Subtotal - other health........................................... 9.7 11.6 14.5
-------- -------- --------
Total supplemental health......................................... 621.8 633.4 655.8
-------- -------- --------
Life insurance:
First-year.......................................................... 4.3 4.7 6.7
Renewal............................................................. 265.5 282.6 307.9
-------- -------- --------
Total life insurance.............................................. 269.8 287.3 314.6
-------- -------- --------
Collections on insurance products:
Total first-year premium collections on
insurance products............................................... 173.3 410.2 480.9
Total renewal premium collections on
insurance products................................................ 848.1 879.1 922.8
-------- -------- --------
Total collections on insurance products........................... $1,021.4 $1,289.3 $1,403.7
======== ======== ========
|
Annuities in this segment include equity-indexed and other fixed annuities sold through professional independent producers. Total annuity collected premiums in this segment decreased 65 percent, to $129.8 million, in 2008 and 15 percent, to $368.6 million, in 2007.
Total collected premiums for these products decreased 64 percent, to $123.7 million, in 2008 and 9.0 percent, to $344.6 million, in 2007. 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 decreased 75 percent, to $6.1 million, in 2008 primarily due to a focus on the sale of more profitable products and decreased 56 percent, to $24.0 million, in 2007. The increase in short-term interest rates in 2007 resulted in lower first-year fixed annuity sales as certain other competing products had become attractive.
Supplemental health products in the Conseco Insurance Group segment include Medicare supplement, specified disease, long-term care and other insurance products distributed through professional independent producers. Our profits on supplemental health policies depend on the overall level of sales, the length of time the business remains inforce, investment yields, claim experience and expense management.
Collected premiums on Medicare supplement policies in the Conseco Insurance Group segment decreased 9.8 percent, to $203.8 million, in 2008 and 7.5 percent, to $225.9 million, in 2007. 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 4.3 percent, to $374.6 million, in 2008 and .4 percent, to $359.2 million, in 2007. Such increases reflect higher new sales in each year and a slight improvement in persistency in 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 are sold through professional independent producers. Life premiums collected decreased 6.1 percent, to $269.8 million, in 2008 and 8.7 percent, to $287.3 million, in 2007.
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 95 percent of our $18.6 billion investment portfolio at December 31, 2008. 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, 2008 (dollars in millions):
Carrying Percent of
value total investments
----- -----------------
Actively managed fixed maturities............................................... $15,277.0 82%
Equity securities............................................................... 32.4 -
Mortgage loans.................................................................. 2,159.4 12
Policy loans.................................................................... 363.5 2
Trading securities.............................................................. 326.5 2
Securities lending collateral................................................... 393.7 2
Partnership investments......................................................... 23.1 -
Other invested assets........................................................... 71.9 -
--------- ---
Total investments............................................................ $18,647.5 100%
========= ===
|
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.
The following table summarizes the carrying value of our actively managed fixed maturity securities by category as of December 31, 2008 (dollars in millions):
Percent of
Gross gross
Percent of unrealized unrealized
Carrying value fixed maturities losses losses
-------------- ---------------- ------ ------
Collateralized mortgage obligations........... $2,438.1 16.0% $ (533.7) 16.8%
Utilities..................................... 1,428.0 9.3 (194.2) 6.1
Energy/pipelines.............................. 1,323.0 8.7 (258.4) 8.2
Food/beverage................................. 1,069.2 7.0 (118.5) 3.7
Banks......................................... 820.3 5.4 (219.0) 6.9
Healthcare/pharmaceuticals.................... 808.5 5.3 (84.0) 2.7
Insurance..................................... 716.1 4.7 (228.7) 7.2
Cable/media................................... 589.4 3.9 (123.0) 3.9
Commercial mortgage-backed securities......... 567.2 3.7 (265.7) 8.4
Real estate/REITs............................. 462.6 3.0 (211.5) 6.7
Telecom....................................... 460.6 3.0 (63.0) 2.0
Brokerage..................................... 432.6 2.8 (78.0) 2.5
Capital goods................................. 403.0 2.6 (44.4) 1.4
States and political subdivisions............. 382.6 2.5 (53.8) 1.7
Aerospace/defense............................. 365.0 2.4 (11.7) .4
Transportation................................ 357.5 2.3 (41.3) 1.3
Building materials............................ 278.5 1.8 (103.0) 3.2
Technology.................................... 242.2 1.6 (41.4) 1.3
Asset-backed securities....................... 203.7 1.3 (87.6) 2.8
Consumer products............................. 179.1 1.2 (26.6) .8
Other......................................... 1,749.8 11.5 (380.3) 12.0
--------- ----- --------- -----
Total actively managed fixed maturities.... $15,277.0 100.0% $(3,167.8) 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
As defined in SFAS 157, 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.
SFAS 157 establishes a three-level hierarchy for valuing assets or liabilities at fair value based on whether inputs are observable or unobservable.
o 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.
o 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.
o 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 5 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.
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, 2008 is as follows (dollars in millions):
Quoted prices
in active markets Significant other Significant
for 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
-------------
(a) Includes corporate-owned life insurance and derivatives.
(b) Includes equity-like holdings in special-purpose entities.
|
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):
Actively Securities Other
managed fixed Equity Trading lending invested
maturities securities securities collateral assets
---------- ---------- ---------- ---------- ------
Assets:
Beginning balance as of
December 31, 2007............................. $1,753.3 $34.5 $11.8 $105.7 $ 4.3
Purchases, sales, issuances and
settlements, net.............................. 465.4 (3.0) (6.3) (18.7) (1.4)
Total realized and unrealized gains (losses):
Included in net loss.......................... (18.9) - (2.3) - .9
Included in other comprehensive
income (loss)............................... (247.9) .9 - (2.6) (1.5)
Transfers in and/or (out) of Level 3 (a)........ (75.8) - (.5) (36.3) -
-------- ----- ----- ------ ------
Ending balance as of December 31, 2008............ $1,876.1 $32.4 $ 2.7 $ 48.1 $ 2.3
======== ===== ===== ====== =====
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) $ - $ - $ - $.9
===== ===== ===== ===== ===
-----------
(a) Net transfers out of Level 3 are reported as having occurred at the
beginning of the period.
|
At December 31, 2008, 80 percent of our Level 3 actively managed fixed maturities were investment grade and 91 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 2008 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 Securities Valuation Office ("SVO") of the NAIC evaluates fixed maturity investments for regulatory reporting purposes and assigns securities to one of six investment categories called "NAIC Designations". The NAIC ratings are similar to the rating agency descriptions of the Nationally Recognized Statistical Rating Organization ("NRSROs"). 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 Ratings ("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). As a result of time lags between the funding of investments, the finalization of legal documents and the completion of the SVO filing process, our fixed maturities generally include securities that have not yet been rated by the SVO as of each balance sheet date. Pending receipt of the SVO ratings, the classification of these securities by NAIC Designation is based on the expected ratings as determined by the Company. References to investment grade or below investment grade are based on NAIC Designations. The following table sets forth fixed maturity investments at December 31, 2008, classified by NAIC Designation and the equivalent NRSRO rating (dollars in millions):
Estimated fair value
--------------------------
Percent of
NRSRO equivalent Amortized fixed
NAIC rating rating cost Amount maturities
----------- ------ ---- ------ ----------
1........................................... AAA/AA/A $ 9,609.2 $ 8,510.0 56%
2........................................... BBB 6,683.5 5,375.1 35
--------- --------- --
Investment grade........................ 16,292.7 13,885.1 91
--------- --------- ---
3........................................... BB 1,395.0 992.4 7
4........................................... B 498.7 339.5 2
5........................................... CCC and lower 73.0 45.6 -
6........................................... In or near default 16.9 14.4 -
--------- --------- ---
Below-investment grade (a).............. 1,983.6 1,391.9 9
--------- --------- ---
Total fixed maturity securities...... $18,276.3 $15,277.0 100%
========= ========= ===
---------
(a) Below-investment grade fixed maturity securities with an amortized
cost of $379.2 million and an estimated fair value of $261.7 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. At December 31, 2008, our total
investment in the VIE was $83.8 million. Our investments in the VIE
were rated as follows: $25.2 million was rated NAIC 4, $56.7 million
was rated NAIC 6 and $1.9 million was not rated as it was an
equity-type security.
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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).
2008 2007 2006
---- ---- ----
Weighted average general account invested assets as defined:
As reported........................................................ $19,597.9 $22,469.2 $21,718.7
Excluding unrealized appreciation
(depreciation) (a)............................................... 21,323.3 22,835.4 22,420.7
Net investment income on general account
invested assets........................................................ 1,249.9 1,344.1 1,275.0
Yields earned:
As reported........................................................ 6.38% 5.98% 5.87%
Excluding unrealized appreciation
(depreciation) (a)............................................... 5.86% 5.89% 5.69%
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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 insurance liabilities. At December 31, 2008 and 2007, the average yield, computed on the cost basis of our actively managed fixed maturity portfolio, was 6.0 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 4.7 percent, respectively.
Actively Managed Fixed Maturities
Our actively managed fixed maturity portfolio at December 31, 2008, included primarily debt securities of the United States government, public utilities and other corporations, and structured securities. Asset-backed securities, collateralized debt obligations, commercial mortgage-backed securities, mortgage pass-through securities and collateralized mortgage obligations are collectively referenced to as "structured securities".
At December 31, 2008, our fixed maturity portfolio had $168.5 million of unrealized gains and $3,167.8 million of unrealized losses, for a net unrealized loss of $2,999.3 million. Estimated fair values of fixed maturity investments were determined based on estimates from: (i) nationally recognized pricing services (87 percent of the portfolio); (ii) broker-dealer market makers (1 percent of the portfolio); and (iii) internally developed methods (12 percent of the portfolio).
At December 31, 2008, approximately 7.5 percent of our invested assets (9.1 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 securities have different characteristics than investment grade corporate debt securities. Based on historical performance, risk 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 generally unsecured and often subordinated to other indebtedness of the issuer. Also, issuers of below-investment grade securities usually have higher levels of debt and 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. At December 31, 2008, our below-investment-grade fixed maturity investments had an amortized cost of $1,983.6 million and an estimated fair value of $1,391.9 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 market 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 market 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 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. 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 have both the ability and intent to hold securities with unrealized losses until they mature or recover in value, we may sell securities at a loss in the
future because of actual or expected changes in our view of the particular investment, its industry, its type or the general investment environment. In making investment decisions, we consider the impact on the capital and surplus of the insurance company and the corresponding impact of the Company's ability to maintain compliance with the financial covenants under the Second Amended Credit Facility.
As of December 31, 2008, we had investments in substantive default (i.e., in default due to nonpayment of interest or principal) that had an estimated fair value of $3.4 million. 40|86 Advisors employs experienced professionals to manage 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, 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 due to defaulted securities was $.9 million, nil and nil for the years ended December 31, 2008, 2007 and 2006, respectively.
At December 31, 2008, fixed maturity investments included $3.4 billion of structured securities (or 22 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 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 2008.
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, 2008 (dollars in millions):
Par Amortized Estimated
value cost fair value
----- ---- ----------
Below 4 percent..................................................................... $ 61.9 $ 49.8 $ 45.0
4 percent - 5 percent............................................................... 85.4 81.7 79.7
5 percent - 6 percent............................................................... 3,097.6 3,021.6 2,544.9
6 percent - 7 percent............................................................... 870.6 842.7 544.4
7 percent - 8 percent............................................................... 190.5 186.9 121.2
8 percent and above................................................................. 66.6 62.9 46.7
-------- -------- --------
Total structured securities.................................................. $4,372.6 $4,245.6 $3,381.9
======== ======== ========
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The amortized cost and estimated fair value of structured securities at December 31, 2008, 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..................... $1,525.9 $1,406.8 9.2%
Planned amortization classes, target amortization classes and
accretion-directed bonds............................................. 1,388.2 1,059.3 7.0
Commercial mortgage-backed securities................................... 832.2 567.2 3.7
Asset-backed securities................................................. 291.3 203.7 1.3
Collateralized debt obligations......................................... 134.3 96.6 .6
Other................................................................... 73.7 48.3 .3
-------- -------- ----
Total structured securities...................................... $4,245.6 $3,381.9 22.1%
======== ======== ====
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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 CMBS have call protection features whereby underlying borrowers may not prepay their mortgages for stated periods of time without incurring prepayment penalties.
During 2008, we sold $.8 billion of fixed maturity investments which
resulted in gross investment losses (before income taxes) of $177.3 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 market
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. 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.
Other Investments
Our investment portfolio includes structured securities collateralized by sub prime residential loans with a market
value of $58.2 million and a book value of $81.4 million at December 31, 2008. These securities represent less than .3 percent of our consolidated investment portfolio. Of these securities, $49.5 million (85 percent) were rated NAIC 1, $8.2 million (14 percent) were rated NAIC 2 and $.5 million (1 percent) were rated NAIC 3. Sub prime structured securities issued in 2006 and 2007 have experienced higher delinquency and foreclosure rates than originally expected. The Company's investment portfolio includes sub prime structured securities collateralized by residential mortgage loans extended over several years, primarily from 2003 to 2007. At December 31, 2008, we held no sub prime securities collateralized by loans extended in 2006 and we held $5.8 million extended in 2007.
At December 31, 2008, we held commercial mortgage loan investments with a carrying value of $2,159.4 million (or 12 percent of total invested assets) and a fair value of $2,122.1 million. The mortgage loan balance was primarily comprised of commercial loans. Noncurrent commercial mortgage loans were insignificant at December 31, 2008. 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 or 2006. Our allowance for loss on mortgage loans was nil and $2.4 million at December 31, 2008 and 2007, respectively. Approximately 7 percent, 7 percent, 7 percent, 6 percent , 6 percent and 6 percent of the mortgage loan balance were on properties located in Indiana, California, Florida, Ohio, Minnesota, and Arizona, respectively. No other state comprised greater than 5 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, 2008 (dollars in millions):
Number of Carrying
loans value
----- -----
Retail.......................................................................... 372 $ 905.5
Office building................................................................. 188 818.9
Industrial...................................................................... 75 316.8
Multi-family.................................................................... 39 100.7
Other........................................................................... 7 17.5
--- --------
Total commercial mortgage loans.............................................. 681 $2,159.4
=== ========
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The following table shows our commercial mortgage loan portfolio by loan size as of December 31, 2008 (dollars in millions):
Number Principal
of loans balance
-------- -------
Under $5 million................................................................ 566 $1,145.3
$5 million but less than $10 million............................................ 91 622.1
$10 million but less than $20 million........................................... 15 196.1
Over $20 million................................................................ 9 201.7
--- --------
Total commercial mortgage loans.............................................. 681 $2,165.2
=== ========
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The following table summarizes the distribution of maturities of our commercial mortgage loans as of December 31, 2008 (dollars in millions):
Number Principal
of loans balance
-------- -------
2009............................................................................ 25 $ 78.6
2010............................................................................ 6 3.2
2011............................................................................ 19 71.0
2012............................................................................ 24 54.9
2013............................................................................ 32 171.8
after 2013...................................................................... 575 1,785.7
--- --------
Total commercial mortgage loans.............................................. 681 $2,165.2
=== ========
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At December 31, 2008, we held $326.5 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 market 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, 2008 and 2007, the fair value of the loaned securities was $389.3 million and $450.3 million, respectively. As of December 31, 2008 and 2007, the Company had received collateral of $408.8 million and $460.4 million, respectively. Income generated from the program, net of expenses is recorded as net investment income and totaled $2.4 million, $1.3 million and $1.4 million in 2008, 2007 and 2006, respectively.
CONSOLIDATED FINANCIAL CONDITION
Changes in the Consolidated Balance Sheet
Changes in our consolidated balance sheet between December 31, 2008 and December 31, 2007, primarily reflect: (i) the Transfer; (ii) our net loss for 2008; and (iii) changes in the fair value of actively managed fixed maturity securities.
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, 2008, we decreased the carrying value of such investments by $3.0 billion as a result of this fair value adjustment.
Our capital structure as of December 31, 2008 and 2007 was as follows (dollars in millions):
2008 2007
---- ----
Total capital:
Corporate notes payable....................................... $ 1,328.7 $1,193.7
Shareholders' equity:
Common stock............................................... 1.9 1.9
Additional paid-in capital................................. 4,076.0 4,068.6
Accumulated other comprehensive loss....................... (1,770.7) (273.3)
Retained earnings (accumulated deficit).................... (688.0) 438.7
--------- --------
Total shareholders' equity............................. 1,619.2 4,235.9
--------- --------
Total capital.......................................... $ 2,947.9 $5,429.6
========= ========
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The following table summarizes certain financial ratios as of and for the years ended December 31, 2008 and 2007:
2008 2007
---- ----
Book value per common share................................................................... $ 8.76 $22.94
Book value per common share, excluding accumulated other
comprehensive income (loss) (a)............................................................ 18.35 24.42
Ratio of earnings to fixed charges............................................................ 1.03X (b)
Ratio of earnings to fixed charges and preferred dividends.................................... 1.03X (c)
Debt to total capital ratios:
Corporate debt to total capital (d)...................................................... 45% 22%
Corporate debt to total capital, excluding accumulated other
comprehensive income (loss) (a)........................................................ 28% 21%
--------------------
(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) For such ratio, earnings were $10.0 million less than fixed charges.
(c) For such ratio, earnings were $33.5 million less than fixed charges.
(d) Such ratio differs from the debt to total capitalization ratio
required by our Second Amended Credit Facility, primarily because the
credit agreement ratio excludes accumulated other comprehensive income
(loss) from total capital.
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Contractual Obligations
The Company's significant contractual obligations as of December 31, 2008,
were as follows (dollars in millions):
Payment due in
--------------------------------------------------------
Total 2009 2010-2011 2012-2013 Thereafter
----- ---- --------- --------- ----------
Insurance liabilities (a)............ $52,616.6 $3,643.1 $6,912.1 $6,326.3 $35,735.1
Notes payable (b).................... 1,679.3 165.9 490.8 1,022.6 -
Investment borrowings (c)............ 1,044.3 39.4 77.1 554.3 373.5
Postretirement plans (d)............. 176.6 3.9 8.1 9.3 155.3
Operating leases and certain other
contractual commitments (e)...... 222.8 46.2 61.3 41.0 74.3
--------- -------- -------- -------- ---------
Total............................ $55,739.6 $3,898.5 $7,549.4 $7,953.5 $36,338.2
========= ======== ======== ======== =========
--------------------
(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 $24.2 billion included in our
consolidated balance sheet as of December 31, 2008. 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:
o 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.
o 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.
o 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.
o 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, 2008 and reflects the modification to
the Second Amended Credit Facility. Refer to the notes to the
consolidated financial statements entitled "Notes Payable - Direct
Corporate Obligations" and "Subsequent Events" 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, 2008; 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 6.03 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.
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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:
o An adverse decision in pending or future litigation.
o An inability to obtain rate increases on certain of our insurance products.
o Worse than anticipated claims experience.
o Lower than expected dividends and/or surplus debenture interest payments from our insurance subsidiaries (resulting from inadequate earnings or capital or regulatory requirements).
o An inability to meet and/or maintain the covenants in our Second Amended Credit Facility.
o A significant increase in policy surrender levels.
o A significant increase in investment defaults.
o 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.
In the first quarter of 2007, Conseco Life became 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, 2008, the carrying value of the FHLBI common stock was $22.5 million. Collateralized borrowings totaled $450.0 million as of December 31, 2008, 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 $504.6 million at December 31, 2008, 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, 2008 -------- ---- -------------------- $ 54.0 May 2012 Variable rate - 2.153% 37.0 July 2012 Fixed rate - 5.540% 13.0 July 2012 Variable rate - 4.810% 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.
During 2008, the financial statements of three of our subsidiaries prepared in accordance with statutory accounting practices prescribed or permitted by regulatory authorities reflected the establishment of asset adequacy or premium deficiency reserves primarily related to long-term care and annuity policies. Total asset adequacy and premium deficiency reserves for Washington National, Conseco Insurance Company and Bankers Conseco Life were $53.3 million, $20.0 million and $19.5 million, respectively at December 31, 2008. 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 March 4, 2009, A.M. Best downgraded the financial strength ratings of our primary insurance subsidiaries to "B" from "B+" and such ratings have been placed under review with negative implications. On November 20, 2008, A.M. Best affirmed: (i) the financial strength ratings of "B+" of our primary insurance subsidiaries; and (ii) the outlook was negative for our primary insurance subsidiaries. On August 7, 2007, A.M. Best downgraded the financial strength ratings of our primary insurance subsidiaries to "B+ (Good)" from "B++ (Good)". 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 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. On March 2, 2009, S&P placed the financial strength ratings of our primary insurance subsidiaries on credit watch with negative implications. A rating on credit watch with negative implications highlights the potential direction of a rating focusing on identifiable events and short-term trends that cause ratings to be placed under special surveillance by S&P. A "negative" designation means that a rating may be lowered. 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 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.
Liquidity of the Holding Companies
We have significant indebtedness which will require over $165 million in cash to service in 2009 (including the additional interest expense required after the modification to our Second Amended Credit Facility described in the note to the consolidated financial statements entitled "Subsequent Events"). Pursuant to our Second Amended Credit Facility, we must maintain certain financial ratios. The levels of margin between the financial covenant requirements and our financial status, both at year-end 2008 and the projected levels during 2009, are relatively small and a failure to satisfy any of our financial covenants at the end of a fiscal quarter would trigger a default under our Second Amended Credit Facility. Achievement of our 2009 operating plan is a critical factor in having sufficient income and liquidity to meet all of our 2009 debt service requirements and other holding company obligations and failure to do so would have material adverse consequences for the Company. These items are discussed further below.
As described below, we completed an amendment to our Second Amended Credit
Facility, which provides 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.
At December 31, 2008, CNO, CDOC (our wholly owned subsidiary and a guarantor under the Second Amended Credit Facility) and our other non-insurance subsidiaries held unrestricted cash of $59.0 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. Our holding companies made capital contributions totaling $79.4 million to our insurance subsidiaries in 2008, primarily in connection with the transfer of Senior Health. We currently do not expect that contributions to our insurance subsidiaries will be required in 2009. If contributions were required, our holding companies would have limited available capital for such contributions.
The following summarizes the legal ownership structure of Conseco's primary subsidiaries at December 31, 2008:
[GRAPHIC OMITTED]
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 $61.9 million of additional surplus recognized due to the approval of a permitted practice by insurance regulators related to certain deferred tax assets as further described below in this section discussing actions we have taken to improve our capitalization and ratios). 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 2008, our insurance subsidiaries paid extraordinary dividends of $20.0 million to CDOC. Each of the direct insurance subsidiaries of CDOC have negative earned surplus at December 31, 2008 as summarized below (dollars in millions):
Earned
surplus
Subsidiary of CDOC (deficit) (a) Additional information
------------------ ------------- ----------------------
Conseco Life of Texas $(1,206.4) (b)
Washington National (1,111.3) (c)
Conseco Health (23.2) (d)
-----------
(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.
(d) Based on our 2009 business plan, Conseco Health's 2009 earnings are
expected to result in a positive earned surplus balance later in the
year, enabling it to pay ordinary dividends. Such ordinary dividend
payments would be limited to the lesser of $12.9 million (10 percent
of its statutory surplus balance at December 31, 2008) or its positive
earned surplus balance.
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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 2009, we are expecting our insurance subsidiaries to pay approximately $60.0 million of extraordinary dividends to CDOC ($25.0 million of which has been approved by the Texas Department of Insurance for payment and $35.0 million of which is expected to be approved by the Texas Department of Insurance and paid later in 2009). In addition, we are expecting Conseco Life of Texas to pay interest on surplus debentures of $44.5 million ($21.2 million of which has been approved by the Texas Department of Insurance and $23.3 million of which is expected to be approved by the Texas Department of Insurance and paid later in 2009). Although we believe the dividends and surplus debenture interest payments we are expecting to pay during 2009 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. 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.
The insurance subsidiaries of CDOC receive funds to pay dividends 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, 2008, these subsidiaries had negative or low levels of earned surplus 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 $ (23.2) (b)
Colonial Penn (221.3) (c)
Subsidiaries of Washington National:
Conseco Insurance Company 7.4 (d)
Conseco Life (355.0) (e)
-----------
(a) As calculated pursuant to the state insurance department of each
company's domiciliary state.
(b) Based on our 2009 business plan, Bankers Life and Casualty Company's
earnings during 2009 are expected to result in a positive earned
surplus later in the year, enabling it to pay ordinary dividends. Such
ordinary dividend payments would be limited to the lesser of $57.2
million (10 percent of Bankers Life and Casualty Company's statutory
capital and surplus balance at December 31, 2008) or its positive
earned surplus balance.
(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) As of December 31, 2008, Conseco Insurance Company may pay ordinary
dividends of $7.4 million. Based on our 2009 business plan, Conseco
Insurance Company's 2009 earnings are expected to increase later in
the year enabling it to pay additional ordinary dividends. Such
ordinary dividend payments would be limited to the lesser of $18.7
million (Conseco Insurance Company's statutory net income for the year
ended December 31, 2008) or its 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.
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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:
o the approval of dividend payments and surplus debenture interest payments from our insurance subsidiaries by the director or commissioner of the applicable state insurance departments;
o the potential adverse effects on Conseco's businesses from recent downgrades or further downgrades by rating agencies;
o our ability to achieve our operating plan;
o the potential for continued declines in the bond and equity markets and the potential for further significant recognition of other-than-temporary impairments;
o the potential need to provide additional capital to our insurance subsidiaries;
o our ability to continue to achieve compliance with our loan covenants and the financial ratios we are required to maintain;
o the potential loss of key personnel that could impair our ability to achieve our operating plan;
o the potential impact of an ownership change or a decrease in our operating earnings on the valuation allowance related to our deferred tax assets; and
o 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 permitted statutory accounting practices.
The following summarizes the projected sources and uses of cash of CDOC and CNO during 2009 (dollars in millions):
From our operations From surplus From
or approved dividends debenture interest extraordinary
and surplus debenture payments requiring dividends
interest payments approval requiring approval Total
----------------- -------- ------------------ -----
Sources of holding company cash:
Dividends from our insurance subsidiaries:
Conseco Life of Texas........................ $ 25.0 $ - $20.0 $ 45.0
Washington National.......................... - - 5.0 5.0
Conseco Health............................... - - 10.0 10.0
Surplus debenture interest..................... 21.2 23.3 - 44.5
Administrative services fees................... 46.0 - - 46.0
Investment services fees....................... 24.0 - - 24.0
Amount received in conjunction with the
termination of commission financing
agreement with Conseco Insurance
Company...................................... 17.0 - - 17.0
Intercompany loan from a non-life subsidiary... 14.0 - - 14.0
------ ----- ----- ------
Total sources of cash expected to be available
to service our debt and other obligations.. 147.2 23.3 35.0 205.5
------ ----- ----- ------
Uses of holding company cash:
Debt service commitments of CNO and CDOC:
Estimated interest payments (b)................ 66.8 - - 66.8
Scheduled principal payments under
our secured credit agreement................. 10.0 - - 10.0
Repayment of amounts borrowed under
revolving credit facility maturing
on June 22, 2009............................. 55.0 - - 55.0
Fees to amend the Credit Facility.............. 9.1 - - 9.1
Scheduled principal payment under the
Senior Note payable to Senior Health......... 25.0 - - 25.0
Corporate expense and other.................... 32.2 - - 32.2
------ ----- ----- ------
Total expected uses of cash.................. 198.1 - - 198.1
------ ----- ----- ------
Net expected increase (decrease) in cash....... (50.9) $23.3 $35.0 7.4
===== =====
Cash balance, beginning of year (a)............ 59.0 59.0
------ ------
Expected cash balance, end of year (a)......... $ 8.1 $ 66.4
====== ======
---------
(a) Includes cash balances of our other non-insurance subsidiaries, which
are available to CDOC or CNO.
(b) Includes additional interest expense required after the modification
to our Second Amended Credit Facility on March 30, 2009, as further
described below.
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If an insurance company subsidiary were to be liquidated, that liquidation would be conducted following the insurance law of its state of domicile with such state's insurance regulator as the receiver for such insurer's property and business. In the event of a default on our debt or our insolvency, liquidation or other reorganization, our creditors and stockholders would have no right to proceed against the assets of our insurance subsidiaries or to cause their liquidation under federal and state
bankruptcy laws.
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 five-year maturity date; 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.
The Second Amended Credit Facility includes an $80.0 million revolving credit facility that can be used for general corporate purposes and that will mature on June 22, 2009. In October 2008, the Company borrowed $75.0 million under the revolving credit facility. The Company also requested borrowings of $5.0 million which were not funded. 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. The Company pays a commitment fee equal to .50 percent of the unused portion of the revolving credit facility on an annualized basis. The revolving credit facility bears interest based on either a Eurodollar rate or a base rate in the same manner as the balance of the Second Amended Credit Facility.
During 2008, we made scheduled principal payments totaling $8.7 million on our Second Amended Credit Facility. The scheduled repayment of our direct corporate obligations (including payments required under the Second Amended Credit Facility, the revolving credit facility, the Senior Note and the Debentures) is as follows (dollars in millions):
2009.......................................... $ 90.0
2010.......................................... 326.8
2011.......................................... 33.7
2012.......................................... 33.8
2013.......................................... 845.5
--------
$1,329.8
========
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Pursuant to our Second Amended Credit Facility, 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. The Second Amended Credit Facility 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) certain asset dispositions; (vi) affiliate transactions; (vii) certain investment activities; (viii) change in business; and (ix) prepayment of indebtedness (other than the Second Amended Credit Facility). The Second Amended Credit Facility also requires that the Company's 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, the financial position and results of operations of the Company in conformity with GAAP for the periods indicated. Such opinion shall not include an explanatory paragraph regarding the Company's ability to continue as a going concern or similar qualification. Although we were in compliance with the provisions of the Second Amended Credit Facility as of December 31, 2008, 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, no assurance can be given that we would have sufficient liquidity to repay our bank indebtedness in full or any of our other debts.
Pursuant to the Second Amended Credit Facility, as long as the debt to total capitalization ratio (as defined in the Second Amended Credit Facility) is greater than 20 percent or certain insurance subsidiaries (as defined in the Second Amended Credit Facility) 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; (iii) certain asset sales or casualty events; and (iv) excess cash flows as defined in the Second Amended Credit Facility (the first such payment, of approximately $1.3 million, is expected to be paid in March 2009). 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.
Under our Second Amended Credit Facility, we have agreed to a number of covenants and other provisions that restrict our ability to engage in various financing transactions and pursue certain operating activities without the prior consent
of the lenders. The following describes the financial ratios and amounts as of December 31, 2008:
Covenant under the Balance or Margin for adverse
Second Amended ratio as of development from
Credit Facility (a) December 31, 2008 December 31, 2008 levels
--------------- ----------------- ------------------------
Aggregate risk-based capital ratio......... greater than or equal 255% Reduction to
to 250% statutory capital and
surplus of
approximately $25
million, or an
increase to the risk-
based capital of
approximately $10
million.
Combined statutory capital and surplus..... greater than $1,270 $1,366 million Reduction to
million combined statutory
capital and surplus
of approximately
$96 million.
Debt to total capitalization ratio......... not more than 30% 28% Reduction to
shareholders' equity
of approximately
$273 million or
additional debt of
$117 million.
Interest coverage ratio.................... greater than or equal 2.35 to 1 Reduction in cash
to 2.00 to 1 for each flows to the holding
rolling four quarters company of
approximately
$20 million.
--------------
(a) Refer to the information provided below for a description of changes
to the covenant requirements as a result of the amendment to the
Second Amended Credit Facility on March 30, 2009.
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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. If the lenders under our Second Amended Credit Facility would elect to accelerate the amounts due, the holders of our 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.
The following summarizes the pro forma financial ratios and amounts as of December 31, 2008 as if the amendments made to the covenants on March 30, 2009 were effective on December 31, 2008:
Covenant under the
Second Amended Pro Forma margin for
Credit Facility as Balance or adverse development from
amended on ratio as of December 31, 2008
March 30, 2009 December 31, 2008 levels (a)
-------------- ----------------- ----------
Aggregate risk-based
capital ratio........... Greater than or equal to 255% Reduction to statutory capital
200% from March 31, 2009 and surplus of approximately
through June 30, 2010 and $290 million, or an increase
thereafter, greater than 250% to the risk-based capital of
(the same ratio required by approximately $145 million.
the facility prior to the
amendment).
Combined statutory
capital and surplus..... Greater than $1,100 million $1,366 Reduction to combined
from March 31, 2009 through statutory capital and surplus
June 30, 2010 and thereafter, of approximately $265 million.
$1,270 (the same amount
required by the facility prior
to the amendment).
Debt to total capitalization
ratio................... Not more than 32.5% from 28% Reduction to shareholders'
March 31, 2009 through equity of approximately $615
June 30, 2010 and thereafter, million or additional debt of
not more than 30% (the same $295 million.
ratio required by the facility
prior to the amendment).
Interest coverage ratio..... Greater than or equal to 1.50 2.35 to 1 Reduction in cash flows to
to 1 for rolling four quarters the holding company of
from March 31, 2009 through approximately $45 million.
June 30, 2010 and thereafter,
2.00 to 1 (the same ratio required
by the facility prior to the
amendment).
------------
(a) Calculated as if the amendments made to the financial covenants on
March 30, 2009 (applicable to the period March 31, 2009 through June
30, 2010) were effective on December 31, 2008.
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Pursuant to its amended terms, the applicable interest rate on the Second Amended Credit Facility (based on either a Eurodollar or base rate) has increased. The Eurodollar rate is now 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 is now 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 requires the Company to pay a fee equal to 1 percent of the outstanding principal balance under the Second Amended Credit Facility, which fee will be added to the principal balance outstanding and will be payable at the maturity of the facility. This 1 percent fee will be reported as non-cash interest expense.
The modifications to the Second Amended Credit Facility also place 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 Second Amended Credit Facility (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 is permitted to issue unsecured indebtedness that is used solely to pay the holders of the Debentures, provided that such indebtedness shall: (i) have a maturity date that is no earlier than October 10, 2014; (ii) contain covenants and events of default that are no more restrictive than those in the Second Amended Credit Facility; (iii) not amortize; and (iv) not have a put date or otherwise be callable prior to April 10, 2014, 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 Debentures, shall not exceed twice the amount of cash interest currently payable on the outstanding Debentures.
The amendment prohibits the Company from redeeming or purchasing the Debentures with cash from sources other than those described in the previous paragraph. The amendment permits the Company to amend, modify or refinance the Debentures so long as such new indebtedness complies with the restrictions set forth in the previous paragraph.
In addition, pursuant to the terms of the amended debt 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.
Pursuant to GAAP, the amendment to the Second Amended Credit Facility is required to be accounted for in accordance with Statement of Financial Accounting Standards No. 15, "Accounting by Debtors and Creditors for Troubled Debt Restructurings". Accordingly, the effects of the modifications will be accounted for prospectively from March 31, 2009, and we will not change the $911.8 million carrying amount of the Second Amended Credit Facility as a result of the modifications. However, the estimated $9.0 million of fees incurred in conjunction with the modifications of the facility will be expensed in the first quarter of 2009.
Our life insurance subsidiaries are subject to risk-based capital requirements. As described above, our Second Amended Credit Facility contains certain financial covenants which are based on our aggregate risk-based capital. The recent unprecedented economic and market conditions has both reduced the statutory capital of our insurance subsidiaries and increased the risk-based capital requirements of our insurance subsidiaries as further discussed below:
o We have incurred realized investment losses that reduced available capital and surplus. For example, during the fourth quarter of 2008, we incurred net capital losses pursuant to statutory accounting practices of approximately $113 million. These losses resulted in a reduction to our aggregate risk-based capital ratio of 21 percentage points.
o We have had adverse experience related to certain commercial mortgage loans which has resulted in an increase to our aggregate risk-based capital. In the second quarter of 2008, we began foreclosure proceedings on two delinquent commercial mortgage loans. Pursuant to statutory rules and regulations which are followed to determine the amount of required risk-based capital, our insurance subsidiaries are required to apply a "mortgage experience adjustment factor" to the entire portfolio of commercial mortgage loans based, in large part, on a comparison of our default and loss experience to the aggregate industry default and loss experience. The calculation is extremely sensitive to slight variations in our experience. For example, during the fourth quarter of 2008, our minimum aggregate risk-based capital increased by approximately $42 million due to these requirements and the foreclosure of these two loans which had a combined book value of approximately $20 million. The establishment of additional required risk-based capital related to the mortgage experience adjustment factor resulted in a reduction to the aggregate risk-based capital ratio of 23 percentage points in the fourth quarter of 2008.
o Certain of our fixed maturity investments have been subject to downgrades by nationally recognized statistical rating organizations, which have resulted in an increase to our aggregate risk-based capital. Pursuant to statutory rules and regulations which are followed to determine the amount of required risk-based capital, our insurance subsidiaries are required to apply factors to the carrying value of their fixed maturity investments which increase required risk-based capital based on current ratings of nationally recognized statistical rating organizations. Significant ratings downgrades increase these capital requirements. For example, during the fourth quarter of 2008 our required aggregate risk-based capital increased by approximately $19.1 million as a result of downgrades of certain of our fixed maturity investments. These downgrades resulted in a reduction to
the aggregate risk-based capital ratio of 9 percentage points. Additional downgrades in our portfolio during the first quarter of 2009 are expected to result in additional required risk-based capital. For example, through February 28, 2009, our required risk-based capital is estimated to have increased by approximately $20 million as a result of recent downgrades.
We have recently taken capital management actions to improve our capitalization and ratios and/or to improve our liquidity. In addition, our insurance subsidiaries have generated statutory operating income, excluding capital losses. The actions we have taken and our fourth quarter 2008 statutory operating income are discussed further below:
o We requested and obtained approval of a statutory permitted accounting practice as of December 31, 2008 for our insurance subsidiaries domiciled in Illinois and Indiana. The permitted practice modifies the accounting for deferred income taxes by increasing the realization period for deferred tax assets from within one year to within three years of the balance sheet date and increasing the asset recognition limit from 10 percent to 15 percent of adjusted capital and surplus as shown in the most recently filed statutory financial statements. The impact of the permitted practice was to increase the statutory consolidated capital and surplus of our insurance subsidiaries by $62 million as of December 31, 2008. In addition, the consolidated risk-based capital ratio increased by 11 percentage points and, as a result, the Company did not need to take additional actions in order to meet the risk-based capital financial covenant requirement at December 31, 2008. The benefit of this permitted practice may not be considered by our insurance subsidiaries when determining surplus available for dividends.
o We have entered into reinsurance agreements which have reduced the aggregate risk-based capital of our insurance subsidiaries. For example, during the fourth quarter of 2008 we entered into two reinsurance transactions which had the effect of increasing our aggregate risk-based capital ratio by 8 percentage points.
o During the fourth quarter of 2008, we completed a transaction pursuant to which our ownership of Senior Health was transferred to an independent trust. The completion of this transaction had the effect of increasing our aggregate risk-based capital ratio by 18 percentage points.
o In the first quarter of 2009, Conseco Insurance Company terminated an existing intercompany commission financing arrangement with a non-life subsidiary of the Company. In connection with the termination of the agreement, Conseco Insurance Company paid $17 million to the non-life subsidiary, representing the present value of the future commissions Conseco Insurance Company would have otherwise paid to the non-life subsidiary over the next several years. The termination of the commission financing agreement had the effect of reducing the statutory capital and surplus of Conseco Insurance Company. However, the current cash available to the holding company increased by the $17 million termination payment.
o Excluding capital losses, our insurance subsidiaries have generated statutory operating income which increases our aggregate risk-based capital ratio. For example, during the fourth quarter of 2008 our insurance subsidiaries generated $73.5 million of statutory operating income (excluding the effects of transactions related to the transfer of Senior Health to an independent trust). This income had the effect of increasing our aggregate risk-based capital ratio by 12 percentage points.
The Company's management believes there are additional actions that may be taken in 2009 to improve the capitalization and aggregate risked-based capital ratio including, but not limited to the sale of certain securities in our portfolio, sale leaseback transactions of one of our office buildings, and entry into additional reinsurance arrangements. Such additional actions that may be taken in the future are not reflected in our current 2009 operating plan or the projected sources and uses of cash summarized above. There can be no assurance that such actions can be completed or that the completion of any such actions would not result in other adverse effects such as the reduction of future profitability of the Company.
Pursuant to our Second Amended Credit Facility, we may repurchase Debentures subject to certain restrictions. During 2008, we repurchased $37.0 million par value of the Debentures for $15.3 million plus accrued interest. In 2008, we recognized a gain on the extinguishment of debt of $21.2 million related to such repurchases. Debentures with a par value of $293.0 million remain outstanding. We may elect to repurchase additional Debentures in the future. Refer to the information provided above related to changes as a result of the amendment to the Second Amended Credit Facility on March 30, 2009, for new restrictions on the Company's ability to redeem, purchase, amend, modify or refinance the Debentures.
Our financial condition and ratings, the degree of our leverage, the current credit market conditions and the restrictions
in our Second Amended Credit Facility present issues which could have material adverse consequences to us, including the following: (i) our ability to obtain additional financing is limited; (ii) all of our projected cash flow from the operations of our holding companies will be required to be used for the payment of interest expense and principal repayment obligations; (iii) the ability of our holding companies to receive cash dividends and surplus debenture interest payments from our insurance subsidiaries is subject to regulator approval; (iv) any new financing or any refinancing or modifications of our current indebtedness will likely be available only at interest rates that are significantly higher than we are currently paying; and (v) our ability to compete in certain markets and to sell certain products is severely limited by our current financial condition and ratings.
The current uncertainty or volatility in the financial markets has reduced our ability to obtain new financing on favorable terms, and eliminated our ability to access certain markets at all. As a result, we do not believe we will be able to replace our current revolving credit facility when it matures on June 22, 2009, or if a replacement is available it would likely have unattractive terms. In addition, if we would violate any loan covenants or financial ratios under our Second Amended Credit Facility, the cost of a waiver or modification would likely be unattractive, or may not be possible at all.
On March 4, 2009, A.M. Best downgraded the financial strength ratings of our primary insurance subsidiaries to "B" from "B+" and such ratings have been placed under review with negative implications. 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. 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.
On September 18, September 29, October 2 and October 10, 2008, A.M. Best, Fitch, Moody's, and S&P, respectively, each revised its outlook for the U.S. life insurance sector to negative from stable, citing, among other things, the significant deterioration and volatility in the credit and equity markets, economic and political uncertainty, and the expected impact of realized and unrealized investment losses on life insurers' capital levels and profitability.
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.
We believe that the existing cash available to CNO, 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 2009. Our cash flow may be 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.
Our principal repayments and other debt service requirements in 2010 currently exceed the cash flows expected to be available from our subsidiaries. We have the following debt repayment obligations in 2010 (dollars in millions):
3.50% convertible debentures.................. $293.0
Secured credit agreement...................... 8.8
6% Senior Note................................ 25.0
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$326.8
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We are continuing to explore various alternatives to address our 2010 debt service requirements, including, without limitation, financing transactions, reinsurance transactions, asset sales, transactions to improve statutory capital and debt modification. Failure to generate sufficient cash to meet our debt obligations in 2010 could have material adverse consequences on the Company.
The Second Amended Credit Facility, Debentures and Senior Note are discussed in further detail in the notes to the consolidated financial statements entitled "Notes Payable - Direct Corporate Obligations" and "Subsequent Events". Additional statutory information is included in the note to the consolidated financial statements entitled "Statutory Information (Based on Non-GAAP Measures)". 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, 2008, approximately 20 percent of our total insurance liabilities, or approximately $4.8 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, 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, 2008, approximately 41 percent of our insurance liabilities had interest rates that may be reset annually; 40 percent had a fixed explicit interest rate for the duration of the contract; 14 percent had credited rates which approximate the income earned by the Company; and the remainder had no explicit interest rates. At December 31, 2008, the average yield, computed on the cost basis of our actively managed fixed maturity portfolio, was 6.0 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, 2008, the adjusted modified duration of our fixed maturity investments (as modified to reflect payments and potential calls) was approximately 7.6 years and the duration of our insurance liabilities was approximately 7.8 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 $185 million if interest rates were to increase by 10 percent from their levels at December 31, 2008. This compares to a decline in fair value of $490 million based on amounts and rates at December 31, 2007. 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 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. During 2006, we recognized net realized investment losses of $46.6 million, which were comprised of $25.5 million of net losses from the sales of investments (primarily fixed maturities), and $21.1 million of writedowns of investments for other than temporary declines in the fair 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 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. Market 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 market 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 2006
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Premium collections (all of which are renewal premiums):
Long-term care....................................................... $ 225.9 $ 269.1 $ 283.6
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Average liabilities for insurance products, net of reinsurance ceded:
Long-term care....................................................... $2,881.2 $2,903.8 $2,787.1
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Revenues:
Insurance policy income.............................................. $ 227.9 $ 271.6 $ 292.6
Net investment income on general account
invested assets.................................................... 156.9 166.8 155.6
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Total revenues................................................... 384.8 438.4 448.2
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Expenses:
Insurance policy benefits............................................ 311.2 517.8 355.4
Amortization related to operations................................... 16.7 22.5 18.3
Gain on reinsurance recapture........................................ (29.7) - -
Loss on Transfer and transaction expenses............................ 363.6 - -
Other operating costs and expenses................................... 54.0 63.7 73.4
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Total benefits and expenses...................................... 715.8 604.0 447.1
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Income (loss) before net realized investment
gains (losses) and income taxes...................................... (331.0) (165.6) 1.1
Net realized investment gains (losses)............................... (380.1) 2.6 (.6)
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Income (loss) before income taxes...................................... $(711.1) $ (163.0) $ .5
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Health benefit ratios:
Insurance policy benefits.......................................... $311.2 $517.8 $355.4
Benefit ratio (a).................................................. 136.6% 190.6% 121.5%
Interest-adjusted benefit ratio (b)................................ 67.7% 129.2% 68.3%
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(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-
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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 for purposes of SFAS 131 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, $166.8 million and $155.6 million in 2008, 2007 and 2006, respectively.
Total premium collections were $225.9 million in 2008, down 16 percent from 2007 and $269.1 million in 2007, down 5.1 percent from 2006. 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, $2.9 billion and $2.8 billion in 2008, 2007 and 2006, respectively.
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 and increased 7.2 percent, to $166.8 million, in 2007. The average balance of general account invested assets was $2.5 billion, $2.9 billion and $2.7 billion in 2008, 2007 and 2006, respectively. The average yield on these assets was 6.22 percent, 5.73 percent and 5.78 percent in 2008, 2007 and 2006, 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; $517.8 million in 2007; and $355.4 million in 2006.
The benefit ratio on this block of business was 136.6 percent, 190.6 percent and 121.5 percent in 2008, 2007 and 2006, 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, $123.8 million and $48.9 million in 2008, 2007 and 2006, respectively. Excluding the effects of prior year claim reserve deficiencies, our benefit ratios would have been 127.0 percent, 145.0 percent and 104.8 percent in 2008, 2007 and 2006, respectively. These ratios reflect the significantly higher level of incurred claims experienced in 2007 and 2006 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.
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, 129.2 percent and 68.3 percent in 2008, 2007 and 2006, respectively. Excluding the effects of prior year claim reserve deficiencies, our interest-adjusted benefit ratios would have been 58.1 percent, 83.6 percent and 51.6 percent in 2008, 2007 and 2006, 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, 2007 and 2006.
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:
o 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.
o 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.
o 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.
o 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.
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.
During the fourth quarter of 2006, we increased claim liabilities for this long-term care insurance block by $49.1 million as a result of changes in our estimates of claim reserves incurred in prior periods. Approximately $22.2 million of this increase related to claims with incurrence dates in the first three quarters of 2006 and $26.9 million related to claims with incurrence dates prior to 2006.
The $49.1 million adjustment primarily related to two assumption changes reflecting recent trends we noted in our claims experience in the fourth quarter of 2006:
(i) Benefit utilization assumptions: Most of our long-term care policies provide for the payment of covered benefits up to a maximum daily benefit specified in the policy. When we estimate claim reserves for these policies, we make an assumption regarding the percentage of the maximum daily benefit that will be paid (since not all policyholders will incur claims at the maximum daily benefit level). We base our assumptions on studies of actual experience. Such assumptions are periodically adjusted to reflect current trends. In the fourth quarter of 2006, we updated our studies of benefit utilization. Recent experience reflected a trend that we did not observe in previous studies: policyholders are incurring claims closer to the maximum benefit level, and the ratio of incurred claims to maximum benefits is increasing faster as claims age.
Accordingly, we updated our assumptions to reflect these trends, which had the effect of increasing our claim reserves by approximately $23 million.
(ii) Liabilities for incurred but not reported claims: In determining the estimate of claims incurred in a particular period, we must make an assumption regarding the ultimate liability for claims that have been incurred but not yet reported to us. This assumption is based on historical studies related to claims that are reported to us after the date of our financial statements, but were incurred prior to the date of our financial statements. For the most recent incurral periods, we apply loss ratio adjustments to our estimates of liabilities for incurred but not reported claims in an effort to ensure the ratio of incurred claims to premiums (incurred loss ratio) related to these estimated unreported claims, reflects recent trends in our experience. During 2006, we experienced a significant increase in the incurred loss ratio for 2005 and 2006 incurral periods. We increased the aforementioned loss ratio adjustments in response to this experience, which had the effect of increasing our claim reserves by approximately $24 million.
In 2006, we experienced increases in our reserves for future benefits due to higher than expected persistency in this block of business. A small variance in persistency can have a significant impact on our earnings as reserves accumulated over the life of a policy are released when coverage terminates. The effect of changes in persistency will vary based on the mix of business that persists.
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:
o 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");
o 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
o 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; $63.7 million in 2007; and $73.4 million in 2006, respectively. Other operating costs and expenses, excluding commission expenses, for this segment were $29.7 million in 2008, $34.7 million in 2007 and $40.7 million in 2006.
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), net of $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 million from the sales of investments (primarily fixed maturities), net of $1.2 million of writedowns of investments resulting from declines in fair values that we concluded were other than temporary. During 2006, net realized investment gains included $.7 million of net gains from the sales of investments (primarily fixed maturities), net of $1.3 million of writedowns of investments resulting from declines in fair values that we concluded were other than temporary.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information included under the caption "Market-Sensitive Instruments and Risk Management" in Item 7. "Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations" is incorporated herein by reference.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Index to Consolidated Financial Statements
Page
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Report of Independent Registered Public Accounting Firm............................................................... 111
Consolidated Balance Sheet at December 31, 2008 and 2007.............................................................. 112
Consolidated Statement of Operations for the years ended December 31, 2008, 2007 and 2006............................. 114
Consolidated Statement of Shareholders' Equity for the years ended December 31, 2008, 2007 and 2006................... 115
Consolidated Statement of Cash Flows for the years ended December 31, 2008, 2007 and 2006............................. 117
Notes to Consolidated Financial Statements............................................................................ 118
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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, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 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, 2008, 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, amortization expense, the liabilities for insurance products and the value of policies inforce at the Effective Date 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 2008 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 18 to the consolidated financial statements, certain events occurred subsequent to December 31, 2008, which include an amendment to the Company's Second Amended Credit Facility, certain rating agency downgrades and the obtainment of certain insurance regulatory agency approvals.
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 31, 2009 |
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
December 31, 2008 and 2007
(Dollars in millions)
ASSETS
2008 2007
---- ----
Investments:
Actively managed fixed maturities at fair value (amortized cost:
2008 - $18,276.3; 2007 - $18,281.5)............................................... $15,277.0 $17,859.5
Equity securities at fair value (cost: 2008 - $31.0; 2007 - $34.0).................. 32.4 34.5
Mortgage loans...................................................................... 2,159.4 1,855.8
Policy loans........................................................................ 363.5 370.4
Trading securities.................................................................. 326.5 665.8
Securities lending collateral....................................................... 393.7 405.8
Other invested assets .............................................................. 95.0 132.7
--------- ---------
Total investments................................................................. 18,647.5 21,324.5
Cash and cash equivalents - unrestricted................................................. 894.5 361.9
Cash and cash equivalents - restricted................................................... 4.8 21.1
Accrued investment income................................................................ 298.7 281.0
Value of policies inforce at the Effective Date.......................................... 1,477.8 1,573.6
Cost of policies produced................................................................ 1,812.6 1,423.0
Reinsurance receivables.................................................................. 3,284.8 3,513.0
Income tax assets, net................................................................... 2,053.7 1,610.2
Assets held in separate accounts......................................................... 18.2 27.4
Other assets............................................................................. 277.1 283.1
Assets of discontinued operations........................................................ - 3,552.4
--------- ---------
Total assets...................................................................... $28,769.7 $33,971.2
========= =========
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(continued on next page)
The accompanying notes are an integral part of the consolidated financial statements.
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (Continued)
December 31, 2008 and 2007
(Dollars in millions)
LIABILITIES AND SHAREHOLDERS' EQUITY
2008 2007
---- ----
Liabilities:
Liabilities for insurance products:
Interest-sensitive products........................................................ $13,332.8 $13,169.4
Traditional products............................................................... 9,828.7 9,548.4
Claims payable and other policyholder funds........................................ 1,008.4 909.7
Liabilities related to separate accounts........................................... 18.2 27.4
Other liabilities.................................................................... 457.4 492.3
Investment borrowings................................................................ 767.5 913.0
Securities lending payable........................................................... 408.8 409.5
Notes payable - direct corporate obligations......................................... 1,328.7 1,193.7
Liabilities of discontinued operations............................................... - 3,071.9
--------- ---------
Total liabilities................................................................ 27,150.5 29,735.3
--------- ---------
Commitments and Contingencies (Note 9)
Shareholders' equity:
Common stock ($0.01 par value, 8,000,000,000 shares authorized,
shares issued and outstanding: 2008 - 184,753,758; 2007 - 184,652,017)............ 1.9 1.9
Additional paid-in capital........................................................... 4,076.0 4,068.6
Accumulated other comprehensive loss................................................. (1,770.7) (273.3)
Retained earnings (accumulated deficit).............................................. (688.0) 438.7
--------- ---------
Total shareholders' equity....................................................... 1,619.2 4,235.9
--------- ---------
Total liabilities and shareholders' equity....................................... $28,769.7 $33,971.2
========= =========
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The accompanying notes are an integral part of the consolidated financial statements.
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
for the years ended December 31, 2008, 2007 and 2006
(Dollars in millions, except per share data)
2008 2007 2006
---- ---- ----
Revenues:
Insurance policy income............................................ $ 3,253.6 $ 2,895.7 $ 2,696.4
Net investment income (loss):
General account assets.......................................... 1,254.5 1,350.5 1,279.6
Policyholder and reinsurer accounts and other special-purpose
portfolios.................................................... (75.7) 19.3 71.2
Net realized investment losses..................................... (262.4) (158.0) (46.6)
Fee revenue and other income....................................... 19.7 23.8 19.2
--------- --------- ---------
Total revenues.................................................. 4,189.7 4,131.3 4,019.8
--------- --------- ---------
Benefits and expenses:
Insurance policy benefits.......................................... 3,212.5 2,915.9 2,677.6
Interest expense................................................... 97.8 117.3 73.5
Amortization....................................................... 367.9 426.8 423.3
(Gain) loss on extinguishment of debt.............................. (21.2) - .7
Costs related to a litigation settlement........................... - 64.4 174.7
Loss related to an annuity coinsurance transaction................. - 76.5 -
Other operating costs and expenses................................. 520.3 540.4 503.3
--------- --------- ---------
Total benefits and expenses..................................... 4,177.3 4,141.3 3,853.1
--------- --------- ---------
Income (loss) before income taxes and discontinued operations... 12.4 (10.0) 166.7
Income tax expense (benefit):
Tax expense (benefit) on period income............................. 12.5 (4.0) 61.0
Valuation allowance for deferred tax assets........................ 403.9 68.0 -
--------- --------- ---------
Income (loss) before discontinued operations.................... (404.0) (74.0) 105.7
Discontinued operations, net of income taxes........................... (722.7) (105.9) .3
--------- --------- ---------
Net income (loss).................................................. (1,126.7) (179.9) 106.0
Preferred stock dividends.............................................. - 14.1 38.0
--------- --------- ---------
Net income (loss) applicable to common stock....................... $(1,126.7) $ (194.0) $ 68.0
========= ========= =========
Earnings (loss) per common share:
Basic:
Weighted average shares outstanding............................. 184,704,000 173,374,000 151,690,000
=========== =========== ===========
Income (loss) before discontinued operations.................... $(2.19) $(.51) $.45
Discontinued operations......................................... (3.91) (.61) -
------ ------ ----
Net income (loss)............................................. $(6.10) $(1.12) $.45
====== ====== ====
Diluted:
Weighted average shares outstanding............................. 184,704,000 173,374,000 152,509,000
=========== =========== ===========
Income (loss) before discontinued operations.................... $(2.19) $ (.51) $.45
Discontinued operations......................................... (3.91) (.61) -
------ ------ ---
Net income (loss)............................................. $(6.10) $(1.12) $.45
====== ====== ====
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The accompanying notes are an integral part of the consolidated financial statements.
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(Dollars in millions)
Retained
Common stock Accumulated other earnings
Preferred and additional comprehensive (accumulated
Total stock paid-in capital income (loss) deficit)
----- ----- --------------- ------------- --------
Balance, December 31, 2005........................... $4,497.3 $ 667.8 $3,190.4 $ 71.7 $567.4
Comprehensive loss, net of tax:
Net income...................................... 106.0 - - - 106.0
Change in unrealized appreciation (depreciation)
of investments (net of applicable income tax
benefit of $77.4)............................. (137.9) - - (137.9) -
--------
Total comprehensive loss.................... (31.9)
Adjustment to initially apply SFAS No. 158
related to the unrecognized net loss related
to deferred compensation plan (net of
applicable income tax benefit of $3.5).......... (6.4) - - (6.4) -
Reduction of deferred income tax valuation
allowance....................................... 260.0 - 260.0 - -
Stock option and restricted stock plans........... 12.4 - 12.4 - -
Reduction of tax liabilities related to various
contingencies recognized at the fresh-start
date............................................ 6.7 - 6.7 - -
Dividends on preferred stock...................... (38.0) - - - (38.0)
-------- ------- -------- ------- ------
Balance, December 31, 2006........................... 4,700.1 667.8 3,469.5 (72.6) 635.4
Comprehensive loss, net of tax:
Net loss........................................ (179.9) - - - (179.9)
Change in unrealized appreciation (depreciation)
of investments (net of applicable income tax
benefit of $113.0)............................ (202.4) - - (202.4) -
--------
Total comprehensive loss.................... (382.3)
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 FIN 48..... 6.0 - 6.0 - -
Cumulative effect of accounting change pursuant
to SOP 05-1..................................... (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........................... $4,235.9 $ - $4,070.5 $(273.3) $438.7
|
(continued on following page)
The accompanying notes are an integral part
of the consolidated financial statements.
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (Continued)
(Dollars in millions)
Retained
Common stock Accumulated other earnings
Preferred and additional comprehensive (accumulated
Total stock paid-in capital income (loss) deficit)
----- ----- --------------- ------------- --------
Balance, December 31, 2007 (carried forward
from prior page).................................. $ 4,235.9 $ - $4,070.5 $ (273.3) $ 438.7
Comprehensive loss, net of tax:
Net loss........................................ (1,126.7) - - - (1,126.7)
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.................... (2,624.1)
Stock option and restricted stock plans........... 7.4 - 7.4 - -
--------- ------- -------- --------- ---------
Balance, December 31, 2008........................... $ 1,619.2 $ - $4,077.9 $(1,770.7) $ (688.0)
========= ======= ======== ========= =========
|
The accompanying notes are an integral part of the consolidated financial statements.
CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
for the years ended December 31, 2008, 2007 and 2006
(Dollars in millions)
2008 2007 2006
---- ---- ----
Cash flows from operating activities:
Insurance policy income............................................... $ 3,140.7 $ 2,818.0 $ 2,633.4
Net investment income................................................. 1,339.6 1,610.0 1,500.5
Fee revenue and other income.......................................... 19.7 23.8 19.3
Net sales (purchases) of trading securities........................... 346.5 (114.3) 36.0
Insurance policy benefits............................................. (2,722.3) (2,339.6) (2,184.2)
Interest expense...................................................... (95.4) (114.7) (66.9)
Policy acquisition costs.............................................. (459.1) (545.9) (484.7)
Other operating costs................................................. (587.0) (631.3) (523.7)
Taxes................................................................. 4.1 (2.7) 1.5
--------- --------- ---------
Net cash provided by operating activities......................... 986.8 703.3 931.2
--------- --------- ---------
Cash flows from investing activities:
Sales of investments.................................................. 6,832.7 7,192.9 6,412.1
Maturities and redemptions of investments............................. 695.1 948.4 2,038.0
Purchases of investments.............................................. (8,193.7) (9,248.7) (9,490.8)
Change in restricted cash............................................. 16.3 2.9 11.2
Change in cash held by discontinued operations........................ 45.6 (30.9) (19.1)
Other................................................................. (25.8) (24.2) (21.7)
--------- --------- ---------
Net cash used by investing activities............................. (629.8) (1,159.6) (1,070.3)
--------- --------- ---------
Cash flows from financing activities:
Issuance of notes payable, net........................................ 75.0 200.0 196.7
Issuance of common stock.............................................. - 3.4 1.0
Payments to repurchase common stock................................... - (87.2) -
Payments on notes payable............................................. (44.0) (7.8) (48.0)
Amounts received for deposit products................................. 1,863.4 1,852.2 2,067.7
Withdrawals from deposit products..................................... (1,573.3) (1,989.3) (2,014.5)
Investment borrowings................................................. (145.5) 494.7 103.2
Dividends paid on preferred stock..................................... - (19.0) (38.0)
--------- --------- ---------
Net cash provided by financing activities......................... 175.6 447.0 268.1
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents.............. 532.6 (9.3) 129.0
Cash and cash equivalents, beginning of year............................. 361.9 371.2 242.2
--------- --------- ---------
Cash and cash equivalents, end of year................................... $ 894.5 $ 361.9 $ 371.2
========= ========= =========
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The accompanying notes are an integral part of the consolidated financial statements.
CONSECO, INC. AND SUBSIDIARIES
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, 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. Prior to the fourth quarter of 2008, we had a fourth segment comprised of other business in run-off. The other business in run-off segment had included blocks of business that we no longer market or underwrite and were managed separately from our other businesses. Such segment had consisted of: (i) long-term care insurance sold in prior years through independent agents; and (ii) major medical insurance. 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 the long-term care business in the other business in run-off segment is presented as discontinued operations in our consolidated financial statements. Accordingly, we have restated all prior year segment disclosures to conform to management's current view of the Company's operating segments. Our segments are described below:
o Bankers Life, which consists of the business of Bankers Life and Casualty Company, markets and distributes Medicare supplement insurance, life insurance, long-term care insurance, Medicare Part D prescription drug program, Medicare Advantage products and certain annuity products to the senior market through approximately 5,500 career agents and sales managers. Bankers Life and Casualty Company markets its products under its own brand name and Medicare Part D and Medicare Advantage products primarily through marketing agreements with Coventry Health Care ("Coventry").
o 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.
o Conseco Insurance Group, which markets and distributes specified disease insurance, Medicare supplement insurance, and certain life and annuity products to the senior and middle-income markets through approximately 400 independent marketing organizations that represent over 2,400 independent producing agents, including approximately 575 from Performance Matters Associates, Inc., a wholly owned marketing company. This segment markets its products under the "Conseco" and "Washington National" brand names. Conseco Insurance Group includes the business of Conseco Health Insurance Company ("Conseco Health"), Conseco Life Insurance Company ("Conseco Life"), Conseco Insurance Company and Washington National Insurance Company ("Washington National"). This segment also includes blocks of long-term care and other health business of these companies that we no longer market or underwrite.
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", formerly known as Conseco Senior Health Insurance Company prior to its name change in October 2008) 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 has concluded that it is
more likely than not that such tax benefits will not be utilized to
offset future taxable income.
|
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 2006
---- ---- ----
Revenues:
Insurance policy income....................................... $ 227.9 $ 271.6 $292.6
Net investment income......................................... 156.9 166.8 155.6
Net realized investment gains (losses)........................ (380.1) 2.6 (.6)
------- ------- ------
Total revenues............................................. 4.7 441.0 447.6
------- ------- ------
Benefits and expenses:
Insurance policy benefits..................................... 311.2 517.8 355.4
Amortization.................................................. 16.7 22.5 18.3
Gain on reinsurance recapture (a)............................. (29.7) - -
Loss on Transfer and transaction expenses..................... 363.6 - -
Other operating costs and expenses............................ 54.0 63.7 73.4
------- ------- ------
Total benefits and expenses................................ 715.8 604.0 447.1
------- ------- ------
Income (loss) before income taxes.......................... (711.1) (163.0) .5
Income tax expense (benefit):
Tax expense (benefit) on period income........................ (440.7) (57.1) .2
Valuation allowance for deferred tax assets................... 452.3 - -
------- ------- ------
Net income (loss) from discontinued operations............. $(722.7) $(105.9) $ .3
======= ======= ======
---------------
(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.
|
The assets and liabilities of the discontinued operations are as follows (dollars in millions):
December 31, 2007
-----------------
Investments.............................................................. $2,933.8
Cash and cash equivalents - unrestricted................................. 45.6
Accrued investment income................................................ 38.3
Value of policies inforce at the Effective Date.......................... 149.2
Reinsurance receivables.................................................. 79.8
Income tax assets, net................................................... 299.2
Other assets............................................................. 6.5
--------
Assets of discontinued operations........................................ $3,552.4
========
Liabilities for insurance products....................................... $3,007.3
Securities lending payable............................................... 50.9
Other liabilities........................................................ 13.7
--------
Liabilities of discontinued operations................................... $3,071.9
========
|
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"), the American Institute of Certified Public Accountants and the Securities and Exchange Commission (the "SEC"). We have reclassified certain amounts from prior periods to conform to the 2008 presentation. These reclassifications have no effect on net income or shareholders' equity.
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.
Consistent with our prior financial statements, these financial statements have been prepared assuming the Company will continue as a going concern.
However, we have significant indebtedness which will require over $165 million in cash to service in 2009 (including the additional interest expense required after the modification to our $675.0 million secured credit agreement (the "Second Amended Credit Facility") described in the note to these consolidated financial statements entitled "Subsequent Events"). Pursuant to our Second Amended Credit Facility, we must maintain certain financial ratios. The levels of margin between the financial covenant requirements and our financial status, both at year-end 2008 and the projected levels during 2009, are relatively small and a failure to satisfy any of our financial covenants at the end of a fiscal quarter would trigger a default under our Second Amended Credit Facility. Achievement of our 2009 operating plan is a critical factor in having sufficient income and liquidity to meet all of our 2009 debt service requirements and other holding company obligations and failure to do so would have material adverse consequences for the Company. These items are discussed further below.
At December 31, 2008, CNO, CDOC (our wholly owned subsidiary and a guarantor under the Second Amended Credit Facility) and our other non-insurance subsidiaries held unrestricted cash of $59.0 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. Additional information on the ability of our insurance subsidiaries to pay dividends is included in the note to these consolidated financial statements entitled "Statutory Information (Based on Non-GAAP Measures)". The principal non-insurance subsidiaries that provide cash to CNO and CDOC are 40|86 Advisors Inc. ("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.
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:
o the approval of dividend payments and surplus debenture interest payments from our insurance subsidiaries by the director or commissioner of the applicable state insurance departments;
o the potential adverse effects on Conseco's businesses from recent downgrades or further downgrades by rating
agencies;
o our ability to achieve our operating plan;
o the potential for continued declines in the bond and equity markets and the potential for further significant recognition of other-than-temporary impairments;
o the potential need to provide additional capital to our insurance subsidiaries;
o our ability to continue to achieve compliance with our loan covenants and the financial ratios we are required to maintain;
o the potential loss of key personnel that could impair our ability to achieve our operating plan;
o the potential impact of an ownership change or a decrease in our operating earnings on the valuation allowance related to our deferred tax assets; and
o 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 permitted statutory accounting practices.
Pursuant to our Second Amended Credit Facility, 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. Additional information on the covenant and other provisions of our Second Amended Credit Facility is included in the note to these consolidated financial statements entitled "Notes Payable - Direct Corporate Obligations."
The covenants and provisions of the Second Amended Credit Facility 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. If the lenders under our Second Amended Credit Facility would elect to accelerate the amounts due, the holders of our 3.50% Convertible Debentures due September 30, 2035 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.
Our life insurance subsidiaries are subject to risk-based capital requirements. As described above, our Second Amended Credit Facility contains certain financial covenants which are based on our aggregate risk-based capital. The recent unprecedented economic and market conditions has both reduced the statutory capital of our insurance subsidiaries and increased the risk-based capital requirements of our insurance subsidiaries as further discussed below:
o We have incurred realized investment losses that reduced available capital and surplus. For example, during the fourth quarter of 2008, we incurred net capital losses pursuant to statutory accounting practices of approximately $113 million. These losses resulted in a reduction to our aggregate risk-based capital ratio of 21 percentage points.
o We have had adverse experience related to certain commercial mortgage loans which has resulted in an increase to our aggregate risk-based capital. In the second quarter of 2008, we began foreclosure proceedings on two delinquent commercial mortgage loans. Pursuant to statutory rules and regulations which are followed to determine the amount of required risk-based capital, our insurance subsidiaries are required to apply a "mortgage experience adjustment factor" to the entire portfolio of commercial mortgage loans based, in large part, on a comparison of our default and loss experience to the aggregate industry default and loss experience. The calculation is extremely sensitive to slight variations in our experience. For example, during the fourth quarter of 2008, our minimum aggregate risk-based capital increased by approximately $42 million due to these requirements and the foreclosure of these two loans which had a combined book value of approximately $20 million. The establishment of additional required risk-based capital related to the mortgage experience adjustment factor resulted in a reduction to the aggregate risk-based capital ratio of 23 percentage points in the
fourth quarter of 2008.
o Certain of our fixed maturity investments have been subject to downgrades by nationally recognized statistical rating organizations, which have resulted in an increase to our aggregate risk-based capital. Pursuant to statutory rules and regulations which are followed to determine the amount of required risk-based capital, our insurance subsidiaries are required to apply factors to the carrying value of their fixed maturity investments which increase required risk-based capital based on current ratings of nationally recognized statistical rating organizations. Significant ratings downgrades increase these capital requirements. For example, during the fourth quarter of 2008 our required aggregate risk-based capital increased by approximately $19.1 million as a result of downgrades of certain of our fixed maturity investments. These downgrades resulted in a reduction to the aggregate risk-based capital ratio of 9 percentage points. Additional downgrades in our portfolio during the first quarter of 2009 are expected to result in additional required risk-based capital. For example, through February 28, 2009, our required risk-based capital is estimated to have increased by approximately $20 million as a result of recent downgrades.
The Company's management believes there are additional actions that may be taken in 2009 to improve the capitalization and aggregate risked-based capital ratio including, but not limited to the sale of certain securities in our portfolio, sale leaseback transactions of one of our office buildings, and entry into additional reinsurance arrangements. Such additional actions that may be taken in the future are not reflected in our current 2009 operating plan. There can be no assurance that such actions can be completed or that the completion of any such actions would not result in other adverse effects such as the reduction of future profitability of the Company.
The current uncertainty or volatility in the financial markets has reduced our ability to obtain new financing on favorable terms, and eliminated our ability to access certain markets at all. As a result, we do not believe we will be able to replace our current revolving credit facility when it matures on June 22, 2009, or if a replacement is available it would likely have unattractive terms. In addition, if we would violate any loan covenants or financial ratios under our Second Amended Credit Facility, the cost of a waiver or modification would likely be unattractive, or may not be possible at all.
We believe that the existing cash available to CNO, the cash flows to be generated from operations and the other potential transactions we could take will be sufficient to allow us to meet our debt obligations through 2009. Our cash flow may be 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.
We are continuing to explore various alternatives to address our 2010 debt service requirements, including, without limitation, financing transactions, reinsurance transactions, asset sales, transactions to improve statutory capital and debt modification. Failure to generate sufficient cash to meet our debt obligations in 2010 would have material adverse consequences on the Company.
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 market 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 $326.5 million and $665.8 million at December 31, 2008 and 2007, 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 gains or loss, net of tax, as a component of shareholders' equity.
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 Statement of Position 05-1, "Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts" ("SOP 05-1"). SOP 05-1 provides guidance on accounting by insurance enterprises for the cost of policies produced on internal replacements of insurance and investment contracts other than those specifically described in Statement of Financial Accounting Standards No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments". As a result of the adoption of SOP 05-1 and related 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 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, 2008 as follows: 14 percent in 2009, 12 percent in 2010, 11 percent in 2011, 9 percent in 2012 and 7 percent in 2013.
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.
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, 2008. 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:
o 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.
o 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.
o 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.
o Florida Order - In 2004, the Florida Office of Insurance Regulation issued orders to Washington National and Senior Health, regarding their home health care business in Florida. The orders required them to offer a choice of three alternatives to holders of home health care policies in Florida subject to premium rate increases as follows:
o retention of their current policy with a rate increase of 50 percent in the first year and actuarially justified increases in subsequent years;
o 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
o 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 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
o We recognize distribution and licensing fee income from Coventry based upon negotiated percentages of collected premiums on the underlying Medicare Part D contracts. This fee income is recognized over the calendar year term as premiums are collected.
o 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
o We recognize premium revenue evenly over the period of the underlying Medicare Part D contracts.
o We recognize policyholder benefits and ceding commission expense as incurred.
o 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 receive a fee based on the number of PFFS 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 the net premiums and related profits.
We receive distribution fees from Coventry and we pay sales commissions to our agents for these enrollments. In addition, we receive 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
o We receive distribution income from Coventry and other parties based on a fixed fee per PFFS contract. This income is deferred and recognized over the remaining calendar year term of the initial enrollment period.
o We also pay commissions to our agents who sell the plans on behalf of Coventry and other parties. 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
o We recognize revenue evenly over the period of the underlying PFFS contracts.
o We recognize 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 receives 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) is less than or equal to five percent. Conseco also receives 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 will terminate the last agreement on June 30, 2009. Premiums assumed through these reinsurance agreements totaled $313.5 million in 2008 (including $185.3 million assumed through the agreement to be terminated on June 30, 2009). The income before income taxes related to the assumed business was $.4 million during the year ended December 31, 2008.
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 even if 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 $164.0 million, $202.4 million and $212.4 million in 2008, 2007 and 2006, respectively. We deduct this cost from insurance policy income. Reinsurance recoveries netted against insurance policy benefits totaled $536.3 million, $354.0 million and $231.5 million in 2008, 2007 and 2006, 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 $641.0 million, $307.8 million and $115.1 million in 2008, 2007 and 2006, respectively. Reinsurance premiums included amounts assumed pursuant to marketing and quota-share agreements with Coventry of $609.6 million, $271.4 million and $74.4 million in 2008, 2007 and 2006, respectively. The increase in premiums assumed under these agreements in 2008 resulted from agreements whereby we are assuming: (i) a specified percentage of the PFFS business written by Coventry under a large group policy effective July 1, 2007 (which will be 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).
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 market 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)
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Net loss before income taxes............................................................ $(100.1)
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(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)
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Net loss before income taxes................ $ (76.5)
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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 pursuant to which it ceded 70 percent of its new 2008 long-term care business, excluding certain business sold in the state of Florida and 50 percent of such new long-term care business, excluding certain business sold in Florida commencing on January 1, 2009. The pre-tax impact of this reinsurance agreement was not significant in 2008.
Income Taxes
We account for income taxes in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, ("SFAS 109"). 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.
SFAS 109 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 SFAS 109 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.
Based upon information existing at the time of our emergence from bankruptcy, we established a valuation allowance against our entire balance of net deferred income tax assets as we believed that the realization of such net deferred income tax assets in future periods was uncertain. During 2006, we concluded that it was no longer necessary to hold certain portions of the previously established valuation allowance. Accordingly, we reduced our valuation allowance by $260.0 million in 2006. However, we are required to continue to hold a valuation allowance of $1.2 billion at December 31, 2008 because 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 or interpretations on the value of such component to be fully recognized in the future.
Investment Borrowings
In the first quarter of 2007, one of the Company's insurance subsidiaries (Conseco Life) became 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, 2008, 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, 2008, 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 $504.6 million at December 31, 2008, which are maintained in a custodial account for the benefit of the FHLBI. Conseco Life recognized interest expense of $21.9 million and $16.7 million in 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, 2008 -------- ---- -------------------- $ 54.0 May 2012 Variable rate - 2.153% 37.0 July 2012 Fixed rate - 5.540% 13.0 July 2012 Variable rate - 4.810% 146.0 November 2015 Fixed rate - 5.300% 100.0 November 2015 Fixed rate - 4.890% 100.0 December 2015 Fixed rate - 4.710% |
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 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 $5.8 million.
At December 31, 2007, investment borrowings consisted of: (i) collateralized borrowings of $450.0 million; (ii) $452.3 million of securities issued to other entities by a VIE which is consolidated in our financial statements; and (iii) other borrowings of $10.7 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, at the beginning of each policy anniversary date, a new index period
begins. We are typically 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 market value of these options in net
investment income (classified as investment income from policyholder and
reinsurer accounts and other special-purpose portfolios). Net investment income
(loss) related to equity-indexed products was $(104.3) million, $(8.5) million
and $40.4 million during
2008, 2007 and 2006, respectively. These amounts were substantially offset by a corresponding charge to insurance policy benefits. The estimated fair value of these options was $17.6 million and $51.2 million at December 31, 2008 and 2007, respectively. We classify these instruments as other invested assets. Pursuant to the annuity coinsurance agreement described above, we held $11.9 million of these options at December 31, 2007, for the benefit of the assuming company until such options expired. All cash flows (including any increases (decreases) in fair value) from these options were transferred to the assuming company in the first six months of 2008.
The Company accounts for the options attributed to the policyholder for the estimated life of the annuity contract as embedded derivatives as defined by Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended by Statement of Financial Accounting Standards No. 137, "Deferral of the Effective Date of FASB Statement No. 133" and Statement of Financial Accounting Standards No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities" (collectively referred to as "SFAS 138"). In accordance with these requirements, the expected future cost of options on equity-indexed annuity products is used to determine the value of embedded derivatives. The Company does not purchase options to hedge liabilities which may arise after the next policy anniversary date. The Company must value both the options and 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 Statement of Financial Accounting Standards No. 157 "Fair Value Measurements" ("SFAS 157") 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 SFAS 157. The fair value of these derivatives, which are classified as "liabilities for interest-sensitive products", was $430.6 million and $353.2 million at December 31, 2008 and 2007, 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 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, 2008, substantially 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 as
defined in SFAS No. 133 Implementation Issue No. B36, "Embedded Derivatives:
Modified Coinsurance Arrangements and Debt Instruments that Incorporate Credit
Risk Exposures that are Unrelated or Only Partially Related to the
Creditworthiness of the Obligor of Those Instruments". Such derivatives had an
estimated fair value of $6.6 million and $1.4 million at December 31, 2008 and
2007, respectively. The adoption of SFAS 157 had no impact on the valuation of
these embedded derivatives. 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 a fixed 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 currently in investment income (classified as income from policyholder and reinsurer accounts), which is substantially offset by the change in insurance policy benefits for these products. As of December 31, 2008, we hold insurance liabilities of $73.6 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 pursuant to Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations ("APB 25"). 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. Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") and Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" required disclosures of the pro forma effects of using the fair value method of accounting for stock options.
In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004) "Share-Based Payment" ("SFAS 123R"), which revised SFAS 123 and superseded APB 25. SFAS 123R 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 SFAS 123R 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 SFAS 123. In accordance with the modified prospective transition method, our consolidated financial statements for prior periods have not been restated to reflect compensation cost determined under the fair value method. SFAS 123R 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 2008 and 2007, 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 SFAS 157 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. SFAS 157 is intended to increase consistency and comparability among fair value estimates used in financial reporting. The disclosure requirements of SFAS 157 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 SFAS 157 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 liability.
Definition of Fair Value
As defined in SFAS 157, 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
SFAS 157 establishes a three-level hierarchy for valuing assets or liabilities at fair value based on whether inputs are observable or unobservable.
o 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.
o 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.
o 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 5 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.
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, 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 markets Significant other Significant
for 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:
Embedded derivative instruments........ - - 437.2 (c) 437.2
-------------
(a) Includes corporate-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.
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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
Actively Securities Other instruments included
managed fixed Equity Trading lending invested in liabilities for
maturities securities securities collateral assets insurance 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 in and/or (out) of Level 3 (a) (75.8) - (.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) $ - $ - $ - $ .9 $(72.0)
===== ===== ===== ====== ===== ======
-----------
(a) Net transfers out of Level 3 are reported as having occurred at the
beginning of the period.
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At December 31, 2008, 80 percent of our Level 3 actively managed fixed maturities were investment grade and 91 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, 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 2008 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 market 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 market values. For other notes, we use discounted cash flow analyses based on our current incremental borrowing rates for similar types of borrowing arrangements.
The estimated fair values of our financial instruments at December 31, 2008 and 2007, were as follows (dollars in millions):
2008 2007
--------------------- ---------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
Financial assets:
Actively managed fixed maturities............................... $15,277.0 $15,277.0 $17,859.5 $17,859.5
Equity securities............................................... 32.4 32.4 34.5 34.5
Mortgage loans.................................................. 2,159.4 2,122.1 1,855.8 1,901.9
Policy loans.................................................... 363.5 363.5 370.4 370.4
Trading securities.............................................. 326.5 326.5 665.8 665.8
Securities lending collateral................................... 393.7 393.7 405.8 405.8
Other invested assets........................................... 95.0 95.0 132.7 132.7
Cash and cash equivalents....................................... 899.3 899.3 383.0 383.0
Financial liabilities:
Insurance liabilities for interest-sensitive
products (a).................................................. $13,332.8 $13,332.8 $13,169.4 $13,169.4
Investment borrowings........................................... 767.5 767.5 913.0 913.0
Notes payable - direct corporate obligations.................... 1,328.7 1,162.5 1,193.7 1,156.8
--------------------
(a) The estimated fair value of insurance liabilities for
interest-sensitive products was approximately equal to its carrying
value at December 31, 2008 and 2007. 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.
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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 under Statement of Position 03-01 "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts". Such amounts are deferred and amortized in the same manner as the cost of policies produced. Sales inducements deferred totaled $47.1 million, $52.4 million and $64.0 million in 2008, 2007 and 2006, respectively. Amounts amortized totaled $16.7 million, $18.4 million and $19.1 million in 2008, 2007 and 2006, respectively. The unamortized balance of deferred sales inducements was $179.4 million and $149.0 million at December 31, 2008 and 2007, respectively. The balance of insurance
liabilities for persistency bonus benefits was $195.9 million and $252.8 million at December 31, 2008 and 2007, respectively.
Out-of-Period Adjustments
In 2008, we recorded the net effects of certain out-of-period adjustments which increased our net loss by $6.9 million (or 4 cents per diluted share). Of this amount, $6.1 million (or 3 cents per diluted share) related to our discontinued operations.
Recently Issued Accounting Standards
Pending Accounting Standards
In June 2008, the FASB issued Emerging Issues Task Force No. 07-5 "Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity's Own Stock" ("EITF 07-5"). Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities," ("SFAS 133") specifies that a contract (that would otherwise meet the definition of a derivative under SFAS 133) issued or held by the reporting entity that is both indexed to its own stock and classified in stockholders' equity in its statement of financial position should not be considered a derivative financial instrument for purposes of applying SFAS 133. EITF 07-5 provides guidance for determining whether an equity-linked financial instrument (or an embedded feature) is indexed to an entity's own stock, using a two-step approach. First, the instrument's contingent exercise provisions, if any, must be evaluated, followed by an evaluation of the instrument's settlement provisions. The guidance in EITF 07-5 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. EITF 07-5 is not expected to have a material impact on our consolidated financial statements.
In May 2008, the FASB issued FSP No. APB 14-1, "Accounting for Convertible Debt Instruments That May Be Settled In Cash Upon Conversion (Including Partial Cash Settlement)" ("FSP APB 14-1"). FSP APB 14-1 specifies that issuers of such instruments 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. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is not permitted. FSP APB 14-1 shall be applied retrospectively to all periods presented unless instruments were not outstanding during any period included in the financial statements. The adoption of FSP APB 14-1 will affect the accounting for our 3.5% convertible debentures due in 2035. Upon adoption of FSP APB 14-1, we expect the effective interest rate on our convertible debentures will range from 7 percent to 7.5 percent, which would result in the recognition of an approximate $40 million to $50 million discount to these notes with the offsetting after tax amount recorded to paid-in capital. Interest expense is expected to increase as summarized below (dollars in millions):
Range of increase
-----------------
2006.................................. $7 - $8 million
2007.................................. 7 - 8 million
2008.................................. 8 - 9 million
2009.................................. 9 - 10 million
2010.................................. 7 - 8 million
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In May 2008, the FASB issued Statement of Financial Accounting Standards No. 163, "Accounting for Financial Guarantee Insurance Contracts - an interpretation of FASB Statement No. 60" ("SFAS 163"). The scope of SFAS 163 is limited to financial guarantee insurance (and reinsurance) contracts issued by enterprises that are included within the scope of SFAS 60 and that are not accounted for as derivative instruments. SFAS 163 excludes from its scope insurance contracts that are similar to financial guarantee insurance such as mortgage guaranty insurance and credit insurance on trade receivables. SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years, except for certain disclosures about the insurance enterprise's risk-management activities, which are effective for the first period (including interim periods) beginning after May 2008. Except for certain disclosures, earlier application is not permitted. The Company does not have financial guarantee insurance products, and, accordingly does not expect the issuance of SFAS 163 to have an effect on the Company's consolidated financial condition and results of operations.
In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, "The Hierarchy of Generally
Accepted Accounting Principles" ("SFAS 162"). Under SFAS 162, the GAAP hierarchy will now reside in the accounting literature established by the FASB. SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements in conformity with GAAP. SFAS 162 is effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board Auditing amendments to AU Section 411, "The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles." SFAS 162 is not expected to have a material impact on our consolidated financial statements.
In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, "Disclosure about Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133" ("SFAS 161"). SFAS 161 requires enhanced disclosures about an entity's derivative and hedging activities. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. SFAS 161 is not expected to have a material impact on our consolidated financial statements.
In February 2008, the FASB issued FASB Staff Position FAS 157-2, "Effective Date of FASB Statement No. 157" ("FSP 157-2"). FSP 157-2 delays the effective date (to fiscal years beginning after November 15, 2008) of SFAS 157 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The Company does not expect it to have a material effect on its consolidated financial position, results of operations or cash flows.
In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51" ("SFAS 160"), which establishes new standards governing the accounting for and reporting of noncontrolling interests (previously referred to as minority interests). SFAS 160 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. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008 and early adoption is prohibited. We do not expect the initial adoption of SFAS 160 to be material to our financial position or results of operations.
In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), "Business Combinations" ("SFAS 141R"). SFAS 141R 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, SFAS 141R 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. SFAS 141R also provides for a substantial number of new disclosure requirements. SFAS 141R is effective for business combinations initiated on or after the first annual reporting period beginning after December 15, 2008 and early adoption is prohibited. We expect that SFAS 141R will have an impact on our accounting for future business combinations once the statement is adopted but the effect is dependent upon acquisitions, if any, that are made in the future. In addition, SFAS 141R 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 SFAS 141R.
Adopted Accounting Standards
In January 2009, the FASB issued FASB Staff Position No. EITF 99-20-1, "Amendments to the Impairment Guidance of EITF Issue No. 99-20," ("FSP EITF 99-20-1"). FSP EITF 99-20-1 amends the impairment guidance of Emerging Issues Task Force Issue No. 99-20, "Recognition of Interest Income and Impairment of Purchased Beneficial Interest and Beneficial Interest that Continue to Be Held by a Transferor in Securitized Financial Assets," by removing the exclusive reliance upon market participant assumptions about future cash flows when evaluating impairment of securities within its scope. FSP EITF 99-20-1 requires companies to follow the impairment guidance in Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"), which permits the use of reasonable management judgment of the probability that the holder will be unable to collect all amounts due. FSP EITF 99-20-1 is effective prospectively for interim and annual reporting periods ending after December 15, 2008. The Company adopted FSP EITF 99-20-1 on December 31, 2008 and the adoption did not have a material effect on the Company's consolidated financial statements.
In December 2008, the FASB issued FSP FAS 140-4 and FIN 46 (R) - 8, "Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities" ("FSP FAS 140-4 and FIN 46 (R)-8"). The purpose of FSP FAS 140-4 and FIN 46 (R)-8 is to promptly improve disclosures by public entities and enterprises until pending amendments to SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" ("SFAS 140") and FASB Interpretation No. 46 (R). "Consolidation of Variable Interest Entities" ("FIN 46 (R)") are finalized and approved by the FASB. The FSP amends SFAS 140 to require public entities to provide additional disclosures about transferors' continuing involvements with transferred financial assets. It also amends FIN 46 (R) to require public enterprises to provide additional disclosures about their involvement with variable interest entities. FSP 140-4 and FIN 46 (R)-8 are effective for financial statements issued for fiscal years and interim periods ending after December 15, 2008. We adopted FSP FAS 140-4 and FIN 46 (R)-8 on December 31, 2008.
In October 2008, the FASB issued FASB Staff Position FAS 157-3, "Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active" ("FSP 157-3"). FSP 157-3 clarifies the application of SFAS 157 in a market that is not active and applies to financial assets within the scope of accounting pronouncements that require or permit fair value measurements in accordance with SFAS 157. FSP 157-3 is effective upon issuance, including prior periods for which financial statements have not been issued. Accordingly, the Company adopted this guidance effective September 30, 2008. The Company's adoption of this guidance did not have a material effect on the Company's consolidated financial statements.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115" ("SFAS 159"). SFAS 159 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 SFAS 159 on January 1, 2008. We did not elect the fair value option for any of our financial assets or liabilities.
In September 2006, the FASB issued SFAS 157. SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures of fair value measurements. We adopted SFAS 157 on January 1, 2008, except as further described below. SFAS 157 required us to value the embedded derivatives associated with our equity-indexed annuity products 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 insurance acquisition costs and income taxes) attributable to changes in the fair value of the embedded derivative as a result of adopting SFAS 157.
In April 2007, FASB issued Interpretation 39-1 "Amendment of FASB Interpretation No. 39" ("FIN 39-1"). FIN 39-1 amends FIN 39, "Offsetting of Amounts Related to Certain Contracts", to allow 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. FIN 39-1 also requires an entity to disclose the accounting policy decision to offset, or not to offset, fair value amounts in accordance with FIN 39-1, as amended. 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 have been offset against derivative assets executed with the same counterparty under master netting arrangements. We adopted FIN 39-1 on January 1, 2008.
5. INVESTMENTS
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 (a):
Corporate securities................................................ $11,874.8 $ 76.5 $(1,797.4) $10,153.9
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....................... 4.8 .1 (.8) 4.1
Asset-backed securities............................................. 290.5 - (87.4) 203.1
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................................. 2,566.5 59.0 (322.2) 2,303.3
--------- ------ --------- ---------
Total investment grade actively managed fixed maturities........ 16,292.7 147.1 (2,554.7) 13,885.1
--------- ------ --------- ---------
Below-investment grade (a):
Corporate securities................................................ 1,587.2 21.4 (389.2) 1,219.4
States and political subdivisions................................... 8.6 - (1.6) 7.0
Debt securities issued by foreign governments....................... 5.6 - (1.1) 4.5
Asset-backed securities............................................. .8 - (.2) .6
Collateralized debt obligations..................................... 11.8 - (6.9) 4.9
Commercial mortgage-backed securities............................... 23.3 - (2.6) 20.7
Collateralized mortgage obligations................................. 346.3 - (211.5) 134.8
--------- ------ --------- ---------
Total below-investment grade actively
managed fixed maturities...................................... 1,983.6 21.4 (613.1) 1,391.9
--------- ------ --------- ---------
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
===== ==== ==== =====
---------------
(a) Investment ratings - The Securities Valuation Office ("SVO") of the
National Association of Insurance Commissioners (the "NAIC") evaluates
fixed maturity investments for regulatory reporting purposes and
assigns securities to one of six investment categories called "NAIC
Designations". The NAIC ratings are similar to the rating agency
descriptions of the Nationally Recognized Statistical Rating
Organization ("NRSROs"). NAIC designations of "1" or "2" include fixed
maturities generally rated investment grade (rated "Baaa3" or higher
by Moody's Investor Service, Inc. ("Moody's") or rated "BBB-" or
higher by S&P and Fitch Ratings ("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). As a result of time lags between the funding of investments,
the finalization of legal documents and the completion of the SVO
filing process, our fixed maturities generally include securities that
have not yet been rated by the SVO as of each balance sheet date.
Pending receipt of the SVO ratings, the classification of these
securities by NAIC Designation is based on the expected ratings as
determined by the Company. References to investment grade or below
investment grade throughout our consolidated financial statements are
based on NAIC Designations.
|
At December 31, 2007, 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................................................ $11,036.6 $ 92.9 $(306.9) $10,822.6
United States Treasury securities and obligations of
United States government corporations and agencies................ 523.2 14.2 (1.5) 535.9
States and political subdivisions................................... 449.2 4.2 (8.2) 445.2
Debt securities issued by foreign governments....................... 6.7 .2 - 6.9
Asset-backed securities............................................. 399.6 .3 (39.6) 360.3
Collateralized debt obligations..................................... 44.6 - (4.2) 40.4
Commercial mortgage-backed securities............................... 840.5 4.9 (26.6) 818.8
Mortgage pass-through securities.................................... 89.6 .1 (.4) 89.3
Collateralized mortgage obligations................................. 3,152.3 7.2 (63.6) 3,095.9
--------- ------ ------- ---------
Total investment grade actively managed fixed maturities........ 16,542.3 124.0 (451.0) 16,215.3
--------- ------ ------- ---------
Below-investment grade:
Corporate securities................................................ 1,653.6 3.0 (88.8) 1,567.8
States and political subdivisions................................... 18.3 - (2.3) 16.0
Debt securities issued by foreign governments....................... 6.1 - (.1) 6.0
Collateralized debt obligations..................................... 10.4 - (2.4) 8.0
Commercial mortgage-backed securities............................... 23.2 - (1.0) 22.2
Collateralized mortgage obligations................................. 27.6 .1 (3.5) 24.2
--------- ------ ------- ---------
Total below-investment grade actively
managed fixed maturities...................................... 1,739.2 3.1 (98.1) 1,644.2
--------- ------ ------- ---------
Total actively managed fixed maturities............................. $18,281.5 $127.1 $(549.1) $17,859.5
========= ====== ======= =========
Equity securities...................................................... $34.0 $.5 $ - $34.5
===== === ===== =====
|
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, 2008 and 2007 were as follows (dollars in millions):
2008 2007
---- ----
Net unrealized depreciation on investments................................................ $(3,015.9) $(481.3)
Adjustment to value of policies inforce at the Effective Date............................. 111.0 18.3
Adjustment to cost of policies produced................................................... 154.8 43.7
Unrecognized net loss related to deferred compensation plan............................... (8.0) (7.3)
Deferred income tax asset................................................................. 987.4 153.3
--------- -------
Accumulated other comprehensive loss............................................... $(1,770.7) $(273.3)
========= =======
|
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, 2008 (dollars in
millions):
Percent of
Gross gross
Percent of unrealized unrealized
Carrying value fixed maturities losses losses
-------------- ---------------- ------ ------
Collateralized mortgage obligations........... $ 2,438.1 16.0% $ (533.7) 16.8%
Utilities..................................... 1,428.0 9.3 (194.2) 6.1
Energy/pipelines.............................. 1,323.0 8.7 (258.4) 8.2
Food/beverage................................. 1,069.2 7.0 (118.5) 3.7
Banks......................................... 820.3 5.4 (219.0) 6.9
Healthcare/pharmaceuticals.................... 808.5 5.3 (84.0) 2.7
Insurance..................................... 716.1 4.7 (228.7) 7.2
Cable/media................................... 589.4 3.9 (123.0) 3.9
Commercial mortgage-backed securities......... 567.2 3.7 (265.7) 8.4
Real estate/REITs............................. 462.6 3.0 (211.5) 6.7
Telecom....................................... 460.6 3.0 (63.0) 2.0
Brokerage..................................... 432.6 2.8 (78.0) 2.5
Capital goods................................. 403.0 2.6 (44.4) 1.4
States and political subdivisions............. 382.6 2.5 (53.8) 1.7
Aerospace/defense............................. 365.0 2.4 (11.7) .4
Transportation................................ 357.5 2.3 (41.3) 1.3
Building materials............................ 278.5 1.8 (103.0) 3.2
Technology.................................... 242.2 1.6 (41.4) 1.3
Asset-backed securities....................... 203.7 1.3 (87.6) 2.8
Consumer products............................. 179.1 1.2 (26.6) .8
Other......................................... 1,749.8 11.5 (380.3) 12.0
--------- ----- --------- -----
Total actively managed fixed maturities.... $15,277.0 100.0% $(3,167.8) 100.0%
========= ===== ========= =====
|
Below-Investment Grade Securities
At December 31, 2008, the amortized cost of the Company's below-investment grade fixed maturity securities was $1,983.6 million, or 11 percent of the Company's fixed maturity portfolio. The estimated fair value of the below-investment grade portfolio was $1,391.9 million, or 70 percent of the amortized cost.
Below-investment grade fixed maturity securities with an amortized cost of
$379.2 million and an estimated fair value of $261.7 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. At December 31, 2008, our total investment in
the VIE was $83.8 million. Our investments in the VIE were rated as follows:
$25.2 million was rated NAIC 4, $56.7 million was rated NAIC 6 and $1.9 million
was not rated as it was an equity-type security.
Below-investment grade securities have different characteristics than investment grade corporate debt securities. Based on historical performance, risk 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 generally unsecured and often subordinated to other indebtedness of the issuer. Also, issuers of below-investment grade securities usually have higher levels of debt and 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.
Contractual Maturity
The following table sets forth the amortized cost and estimated fair value of actively managed fixed maturities at December 31, 2008, 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...................................................................... $ 90.6 $ 88.9
Due after one year through five years........................................................ 1,553.5 1,324.5
Due after five years through ten years....................................................... 4,727.5 3,876.0
Due after ten years.......................................................................... 7,659.1 6,605.7
--------- ---------
Subtotal................................................................................. 14,030.7 11,895.1
Structured securities........................................................................ 4,245.6 3,381.9
--------- ---------
Total actively managed fixed maturities.............................................. $18,276.3 $15,277.0
========= =========
|
Net Investment Income
Net investment income consisted of the following (dollars in millions):
2008 2007 2006
---- ---- ----
Fixed maturities..................................................... $1,094.4 $1,194.9 $1,143.7
Trading income related to policyholder and
reinsurer accounts and other special-purpose portfolios........... 2.1 31.2 32.9
Equity securities.................................................... 1.4 1.6 1.8
Mortgage loans....................................................... 126.1 109.3 96.0
Policy loans......................................................... 23.6 26.5 25.0
Change in value of options
related to equity-indexed products................................ (77.8) (11.9) 38.3
Other invested assets................................................ 13.8 10.8 13.1
Cash and cash equivalents............................................ 11.9 24.0 17.8
-------- -------- --------
Gross investment income........................................... 1,195.5 1,386.4 1,368.6
Less investment expenses............................................. 16.7 16.6 17.8
-------- -------- --------
Net investment income............................................. $1,178.8 $1,369.8 $1,350.8
======== ======== ========
|
The estimated fair value of fixed maturity investments and mortgage loans not accruing investment income totaled $15.5 million at December 31, 2008. We had no fixed maturity investments or mortgage loans that were not accruing investment income at December 31, 2007.
Net Realized Investment Gains (Losses)
Net realized investment gains (losses) were included in revenue as follows
(dollars in millions):
2008 2007 2006
---- ---- ----
Fixed maturities:
Gross gains.......................................................... $ 110.3 $ 81.9 $ 58.1
Gross losses......................................................... (177.3) (124.7) (86.3)
Other-than-temporary declines in fair value.......................... (152.7) (98.3) (10.7)
------- ------- ------
Net realized investment gains (losses) from
fixed maturities.............................................. (219.7) (141.1) (38.9)
Equity securities........................................................ - (5.0) .2
Mortgages................................................................ (19.7) (.2) .1
Other-than-temporary declines in fair value of mortgage loans,
equity securities and other invested assets.......................... (9.6) (7.2) (10.4)
Other.................................................................... (13.4) (4.5) 2.4
------- ------- ------
Net realized investment losses.................................. $(262.4) $(158.0) $(46.6)
======= ======= ======
|
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. During 2006, we recognized net realized investment losses of $46.6 million, which were comprised of $25.5 million of net losses from the sales of investments (primarily fixed maturities), and $21.1 million of writedowns of investments for other than temporary declines in fair value. At December 31, 2008, fixed maturity securities in default as to the payment of principal or interest had both an aggregate amortized cost and carrying value of $7.2 million. At December 31, 2008, we had mortgage loans with an aggregate carrying value of $8.3 million that were 90 days or more past due as to the payment of principal or interest.
During 2008, we sold $.8 billion of fixed maturity investments which
resulted in gross investment losses (before income taxes) of $177.3 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 market
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.
The following summarizes the investments sold at a loss during 2008 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........................ 37 $151.7 $55.2
Greater than or equal to 6 and less than 12 months
prior to sale ........................................ 6 37.4 18.0
Greater than 12 months.................................. 2 7.5 1.5
-- ------ -----
45 $196.6 $74.7
== ====== =====
|
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.
Our assessment of whether unrealized losses are "other than temporary"
requires significant judgment. Factors considered include: (i) the extent to
which market value is less than the cost basis; (ii) the length of time that the
market value has been less than cost; (iii) whether the unrealized loss is event
driven, credit-driven or a result of changes in market interest rates or risk
premium; (iv) the near-term prospects for fundamental improvement in specific
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) our ability and
intent to hold the investment for a period of time sufficient to allow for a
full recovery in value; (viii) 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;
(ix) unfavorable changes in cash flows on structured securities including
mortgage-backed and asset-backed securities; and (x) 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 and on our financial condition and may require us to make additional capital contributions to our insurance subsidiaries.
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, 2008, 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................................................................... $ 77.7 $ 75.9
Due after one year through five years..................................................... 1,448.6 1,214.9
Due after five years through ten years.................................................... 4,392.0 3,521.4
Due after ten years....................................................................... 6,145.7 5,009.1
--------- ---------
Subtotal............................................................................... 12,064.0 9,821.3
Structured securities..................................................................... 2,850.2 1,925.1
--------- ---------
Total.................................................................................. $14,914.2 $11,746.4
========= =========
|
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, 2008 (dollars in millions):
Number Cost Unrealized Estimated
Period of issuers basis loss fair value
------ ---------- ----- ---- ----------
Less than 6 months............................. 240 $1,171.3 $(511.4) $659.9
Greater than or equal to
6 months and less
than 12 months............................... 57 104.9 (53.2) 51.7
Greater than 12 months......................... 4 3.2 (1.1) 2.1
--- -------- ------- ------
301 $1,279.4 $(565.7) $713.7
=== ======== ======= ======
|
The following table summarizes the gross unrealized losses of our actively managed fixed maturity securities by category and ratings category as of December 31, 2008 (dollars in millions):
Below investment grade
Investment grade ------------------------ Total gross
---------------------- NAIC 4 unrealized
NAIC 1 NAIC 2 NAIC 3 and below losses
------ ------ ------ --------- ------
Collateralized mortgage obligations.. $ 315.7 $ 6.5 $209.3 $ 2.2 $ 533.7
Commercial mortgage-backed
securities......................... 158.1 105.0 2.6 - 265.7
Energy/pipelines..................... 40.9 197.6 14.1 5.8 258.4
Insurance............................ 167.5 60.4 - .8 228.7
Banks................................ 178.2 32.7 4.3 3.8 219.0
Real estate/REITs.................... 31.4 169.7 7.1 3.3 211.5
Utilities............................ 51.4 131.5 4.0 7.3 194.2
Cable/media.......................... 17.7 60.4 18.2 26.7 123.0
Food/beverage........................ 35.9 65.8 5.6 11.2 118.5
Building materials................... .3 56.4 42.5 3.8 103.0
Asset-backed securities.............. 46.1 41.3 .2 - 87.6
Healthcare/pharmaceuticals........... 25.8 33.6 8.6 16.0 84.0
Brokerage............................ 47.4 30.6 - - 78.0
Telecom.............................. 15.8 19.2 23.5 4.5 63.0
States and political subdivisions.... 20.1 32.1 1.4 .2 53.8
Retail............................... 5.2 21.9 8.2 10.7 46.0
Capital goods........................ 9.8 31.3 1.7 1.6 44.4
Entertainment/hotels................. 2.7 28.3 9.5 3.1 43.6
Technology........................... 11.1 15.1 6.3 8.8 41.3
Transportation....................... 3.5 35.7 .6 1.5 41.3
Collateralized debt obligations...... 10.4 20.7 6.9 - 38.0
Chemicals............................ 2.2 11.3 7.7 11.0 32.2
Metals and mining.................... 4.8 17.3 7.4 .2 29.7
Paper................................ - 21.0 1.8 5.2 28.0
Consumer products.................... 5.3 14.9 - 6.4 26.6
Gaming............................... - - 5.0 18.1 23.1
Autos................................ 3.1 - .6 14.2 17.9
Aerospace/defense.................... .7 5.4 4.8 .8 11.7
Textiles............................. 7.9 .4 .7 2.5 11.5
Foreign governments.................. .8 - 1.1 - 1.9
U.S. Treasury and Obligations........ .4 - - - .4
Mortgage pass-through securities..... .1 - - - .1
Other................................ 8.2 60.1 20.3 19.4 108.0
-------- -------- ------ ------ --------
Total actively managed fixed
maturities....................... $1,228.5 $1,326.2 $424.0 $189.1 $3,167.8
======== ======== ====== ====== ========
|
At December 31, 2008, we held five individual non-investment grade collateralized mortgage-backed securities that had a cost basis of $319.6 million, an estimated fair value of $110.3 million and unrealized losses of $209.3 million. As of December 31, 2008, these securities had been in an unrealized loss position exceeding 30 percent of cost for one to five months. These securities are senior tranches in their respective securitization structures which hold standard and Alt-A residential mortgages originating in 2006 and 2007. These securities were rated NAIC 3 at December 31, 2008, following ratings downgrades by one nationally recognized rating agency. Given current market conditions, limited trading of these securities and the recent rating actions, the estimated fair value of these securities has declined. We believe the decline is largely due to widening credit spreads and high premium for liquidity that existed at December 31, 2008. The estimated fair value of these securities has increased by $38 million since December 31, 2008 based on February 27, 2009 estimates. We have examined the performance of the underlying collateral and expect that our investments will continue to perform in accordance with the contractual terms.
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 have both the ability and intent to hold securities with unrealized losses until they mature or recover in value, we may sell securities at a loss in the future because of actual or expected changes in our view of the particular investment, its industry, its type or the general investment environment.
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)
======== ======= ======== ========= ========= =========
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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, 2007 (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...... $ 18.7 $ (.1) $ 38.5 $ (1.4) $ 57.2 $ (1.5)
States and political subdivisions. 129.3 (5.4) 120.5 (5.1) 249.8 (10.5)
Debt securities issued by
foreign governments............ 4.0 (.1) - - 4.0 (.1)
Corporate securities.............. 5,666.5 (237.4) 2,214.3 (158.3) 7,880.8 (395.7)
Asset-backed securities........... 184.9 (13.2) 150.5 (26.4) 335.4 (39.6)
Collateralized debt obligations... 12.4 (3.0) 36.0 (3.6) 48.4 (6.6)
Commercial mortgage-backed
securities..................... 234.6 (22.5) 95.2 (5.1) 329.8 (27.6)
Mortgage pass-through securities.. 42.4 (.2) 26.8 (.2) 69.2 (.4)
Collateralized mortgage
obligations.................... 1,272.1 (40.0) 985.1 (27.1) 2,257.2 (67.1)
-------- ------- -------- ------- --------- -------
Total actively managed
fixed maturities............... $7,564.9 $(321.9) $3,666.9 $(227.2) $11,231.8 $(549.1)
======== ======= ======== ======= ========= =======
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Based on management's current assessment of investments with unrealized losses at December 31, 2008, 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 have both the ability and intent to hold securities in unrealized loss positions until they recover, 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 the intent to hold the securities to recovery no longer exists.
Structured Securities
At December 31, 2008, fixed maturity investments included $3.4 billion of structured securities (or 22 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.
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 2008.
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, 2008 (dollars in millions):
Par Amortized Estimated
value cost fair value
----- ---- ----------
Below 4 percent..................................................................... $ 61.9 $ 49.8 $ 45.0
4 percent - 5 percent............................................................... 85.4 81.7 79.7
5 percent - 6 percent............................................................... 3,097.6 3,021.6 2,544.9
6 percent - 7 percent............................................................... 870.6 842.7 544.4
7 percent - 8 percent............................................................... 190.5 186.9 121.2
8 percent and above................................................................. 66.6 62.9 46.7
-------- -------- --------
Total structured securities.................................................. $4,372.6 $4,245.6 $3,381.9
======== ======== ========
|
The amortized cost and estimated fair value of structured securities at
December 31, 2008, 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..................... $1,525.9 $1,406.8 9.2%
Planned amortization classes, target amortization classes and
accretion-directed bonds............................................. 1,388.2 1,059.3 7.0
Commercial mortgage-backed securities................................... 832.2 567.2 3.7
Asset-backed securities................................................. 291.3 203.7 1.3
Collateralized debt obligations......................................... 134.3 96.6 .6
Other................................................................... 73.7 48.3 .3
-------- -------- ----
Total structured securities...................................... $4,245.6 $3,381.9 22.1%
======== ======== ====
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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 ("CMBS") 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 CMBS have call protection features whereby underlying borrowers may not prepay their mortgages for stated periods of time without incurring prepayment penalties.
Structured Securities Collateralized by Sub Prime Residential Loans
Our investment portfolio includes structured securities collateralized by sub prime residential loans with a market value of $58.2 million and a book value of $81.4 million at December 31, 2008. These securities represent .3 percent of our consolidated investment portfolio. Of these securities, $49.5 million (85 percent) were rated NAIC 1, $8.2 million (14 percent) were rated NAIC 2 and $.5 million (1 percent) were rated NAIC 3. Sub prime structured securities issued in 2006 and 2007 have experienced higher delinquency and foreclosure rates than originally expected. The Company's investment portfolio includes sub prime structured securities collateralized by residential loans extended over several years, primarily from 2003 to 2007. At December 31, 2008, we held no sub prime securities collateralized by residential loans extended in 2006 and we held $5.8 million extended in 2007.
Commercial Mortgage Loans
At December 31, 2008, the mortgage loan balance was primarily comprised of commercial loans. Approximately 7 percent, 7 percent, 7 percent, 6 percent, 6 percent and 6 percent of the mortgage loan balance were on properties located in Indiana, California, Florida, Ohio, Minnesota 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, 2008. Our allowance for losses on mortgage loans was nil and $2.4 million at December 31, 2008 and 2007, respectively.
Other Investment Disclosures
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 market 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, 2008 and 2007, the fair value of the loaned securities was $389.3 million and $450.3 million, respectively. As of December 31, 2008 and 2007, the Company had received collateral of $408.8 million and $460.4 million, respectively. Income generated from the program, net of expenses is recorded as net investment income and totaled $2.4 million, $1.3 million and $1.4 million in 2008, 2007 and 2006, respectively. In 2008, we changed our presentation of collateral held in conjunction with the securities lending program to present such collateral as a separate asset, rather than as a reduction to investment borrowings. We reclassified amounts from prior periods to conform to the 2008 presentation. These reclassifications have no effect on net income or shareholders' equity.
Life insurance companies are required to maintain certain investments on deposit with state regulatory authorities. Such assets had aggregate carrying values of $76.2 million and $104.8 million at December 31, 2008 and 2007, respectively.
Conseco had 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). There were no fixed maturity investments in excess of 10 percent of shareholders' equity at December 31, 2007.
6. LIABILITIES FOR INSURANCE PRODUCTS
These liabilities consisted of the following (dollars in millions):
Interest
Withdrawal Mortality rate
assumption assumption assumption 2008 2007
---------- ---------- ---------- ---- ----
Future policy benefits:
Interest-sensitive products:
Investment contracts.................... N/A N/A (c) $ 9,612.9 $ 9,389.7
Universal life contracts................ N/A N/A N/A 3,719.9 3,779.7
--------- ---------
Total interest-sensitive products..... 13,332.8 13,169.4
--------- ---------
Traditional products:
Traditional life insurance contracts.... Company (a) 5% 2,300.2 2,289.0
experience
Limited-payment annuities............... Company (b) 5% 917.2 944.3
experience,
if applicable
Individual and group accident and
health................................ Company Company 6% 6,611.3 6,315.1
experience experience --------- ---------
Total traditional products............ 9,828.7 9,548.4
--------- ---------
Claims payable and other
policyholder funds........................ N/A N/A N/A 1,008.4 909.7
Liabilities related to separate accounts.... N/A N/A N/A 18.2 27.4
--------- ---------
Total................................. $24,188.1 $23,654.9
========= =========
--------------------
(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 2008 and 2007, 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.
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):
2008 2007 2006
---- ---- -----
Balance, beginning of the year....................................... $1,247.7 $1,129.0 $1,044.3
Incurred claims (net of reinsurance) related to:
Current year...................................................... 1,729.3 1,559.0 1,359.1
Prior years (a)................................................... (25.9) (18.8) (30.7)
-------- -------- --------
Total incurred................................................. 1,703.4 1,540.2 1,328.4
-------- -------- --------
Interest on claim reserves........................................... 61.4 56.7 52.6
-------- -------- --------
Paid claims (net of reinsurance) related to:
Current year...................................................... 1,001.1 900.9 778.6
Prior years....................................................... 609.5 541.9 512.4
-------- -------- --------
Total paid..................................................... 1,610.6 1,442.8 1,291.0
-------- -------- --------
Net change in balance for reinsurance assumed and ceded.............. (60.6) (35.4) (5.3)
-------- -------- --------
Balance, end of the year............................................. $1,341.3 $1,247.7 $1,129.0
======== ======== ========
-----------
(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.
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7. INCOME TAXES
The components of income tax expense (benefit) were as follows (dollars in
millions):
2008 2007 2006
---- ---- ----
Current tax expense...................................................... $ 3.8 $ 2.7 $ 1.4
Deferred tax provision (benefit)......................................... 8.7 (6.7) 59.6
------ ----- -----
Income tax expense (benefit) on period income................... 12.5 (4.0) 61.0
Valuation allowance...................................................... 403.9 68.0 -
------ ----- -----
Total income tax expense........................................ $416.4 $64.0 $61.0
====== ===== =====
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A reconciliation of the U.S. statutory corporate tax rate to the effective rate reflected in the consolidated statement of operations is as follows:
2008 2007 2006
---- ---- ----
U.S. statutory corporate rate............................................ 35.0% (35.0)% 35.0%
Valuation allowance...................................................... 3,257.3 680.0 -
Other nondeductible expenses............................................. 37.7 (5.9) 1.4
State taxes.............................................................. 23.8 (9.8) .3
Provision for tax issues, tax credits and other.......................... 4.3 10.7 (.1)
------- ----- ----
Effective tax rate.............................................. 3,358.1% 640.0% 36.6%
======= ===== ====
|
The components of the Company's income tax assets and liabilities were as follows (dollars in millions):
2008 2007
---- ----
Deferred tax assets:
Net federal operating loss carryforwards attributable to:
Life insurance subsidiaries...................................................... $ 840.7 $ 855.9
Non-life companies............................................................... 835.4 843.8
Net state operating loss carryforwards.............................................. 20.3 30.2
Tax credits......................................................................... 13.7 13.7
Capital loss carryforwards.......................................................... 406.0 255.6
Deductible temporary differences:
Insurance liabilities............................................................ 789.9 909.2
Unrealized depreciation of investments........................................... 987.4 129.7
Reserve for loss on loan guarantees.............................................. 68.2 71.9
Other............................................................................ 31.1 39.4
-------- --------
Gross deferred tax assets...................................................... 3,992.7 3,149.4
-------- --------
Deferred tax liabilities:
Actively managed fixed maturities................................................... (17.7) (143.1)
Value of policies inforce at the Effective Date and cost of policies produced....... (739.1) (725.6)
-------- --------
Gross deferred tax liabilities................................................. (756.8) (868.7)
-------- --------
Net deferred tax assets before valuation allowance............................. 3,235.9 2,280.7
Valuation allowance..................................................................... (1,180.7) (672.9)
-------- --------
Net deferred tax assets........................................................ 2,055.2 1,607.8
Current income taxes prepaid (accrued).................................................. (1.5) 2.4
-------- --------
Income tax assets, net......................................................... $2,053.7 $1,610.2
======== ========
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We account for income taxes in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, ("SFAS 109"). 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.
SFAS 109 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 SFAS 109 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.
Pursuant to SFAS 109, 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, 2008, 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, 2008, 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, 2008, 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, 2008, we believe that we will, more likely than not, recover $2.1 billion of our deferred tax assets through reductions of our tax liabilities in future periods.
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).
In addition, the timing and manner in which the Company will be able to utilize some of its NOLs is limited by Section 382 of the Code. Section 382 imposes limitations on a corporation's ability to use its NOLs when the company undergoes an ownership change. Because the Company underwent an ownership change pursuant to its reorganization, this limitation applies to the Company. Any losses that are subject to the Section 382 limitation will only be utilized by the Company up to approximately $142 million per year with any unused amounts carried forward to the following year. Absent an additional ownership change, our Section 382 limitation for 2009 will be approximately $662 million (including $520 million of unused amounts carried forward from prior years).
Future transactions and the timing of such transactions could cause an additional 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 3.50% convertible 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 a new annual restriction (which would supersede the current $142 million annual limit if lower) on the use of our NOLs to offset future taxable income. The new 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 (currently approximately 5.4 percent), and the new 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, 2008, 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 Plan (the "Rights Plan") which is designed to protect shareholder value by preserving the value of our tax assets primarily associated with tax NOLs under Section 382. The Rights Plan 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 Rights Plan, 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 Rights Plan 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 Rights Plan based on its review. Additionally, the Board of Directors has resolved to submit the continuation of the Rights Plan to a vote at the next annual meeting of the shareholders in May 2009. If the shareholders do not approve the Rights Plan, it will be terminated.
Based upon information existing at the time of our emergence from bankruptcy, we established a valuation allowance against our entire balance of net deferred income tax assets as we believed that the realization of such net deferred income tax assets in future periods was uncertain. During 2006, we concluded that it was no longer necessary to hold certain portions of the previously established valuation allowance. Accordingly, we reduced our valuation allowance by $260.0 million in 2006. However, we were required to continue to record a valuation allowance of $1.2 billion at December 31, 2008 because 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 or interpretations on the value of such component to be fully recognized in the future.
Changes in our valuation allowance are summarized as follows (dollars in
millions):
Balance at December 31, 2005............................................. $1,043.8
Expiration of NOL and capital loss carryforwards....................... (6.0)
Release of valuation allowance (a)..................................... (260.0)
--------
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 (b)
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
========
--------------------
(a) There is a corresponding increase to additional paid-in capital.
(b) 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 Second Amended Credit Facility as described in the note to
these consolidated financial statements entitled "Subsequent Events."
|
We have also evaluated the likelihood that we will have sufficient taxable income to offset the available deferred tax assets. This assessment required significant judgment. Based upon our current projections of future income that we completed at December 31, 2008, we believe that we will, more likely than not, recover $2.1 billion of our deferred tax assets through reductions of our tax liabilities in future periods. 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 and reduce shareholders' equity, and such an increase could have a significant impact upon our earnings in the future.
As of December 31, 2008, we had $4.8 billion of federal NOLs and $1.2
billion of capital loss carryforwards, which expire as follows (dollars in
millions):
Net operating
loss carryforwards(a) Total loss carryforwards
--------------------- Capital loss Total loss ---------------------------------------
Year of expiration Life Non-life carryforwards carryforwards Subject to ss.382 Not subject to ss.382
------------------ ---- -------- ------------- ------------- ----------------- ---------------------
2009....... $ - $ - $ 86.2 $ 86.2 $ - $ 86.2
2010....... - .1 - .1 .1 -
2011....... - .1 - .1 .1 -
2012....... - - 63.6 63.6 - 63.6
2013....... - - 1,010.1 1,010.1 - 1,010.1
2017....... 12.2 - - 12.2 12.2 -
2018....... 2,152.4 (a) - - 2,152.4 38.1 2,114.3
2021....... 29.6 - - 29.6 - 29.6
2022....... 207.9 - - 207.9 - 207.9
2023....... - 2,073.7 (a) - 2,073.7 71.1 2,002.6
2024....... - 3.2 - 3.2 - 3.2
2025....... - 118.8 - 118.8 - 118.8
2026....... - 1.6 - 1.6 - 1.6
2027....... - 188.4 - 188.4 - 188.4
2028....... - .9 - .9 - .9
-------- -------- -------- -------- ------- --------
Total...... $2,402.1 $2,386.8 $1,159.9 $5,948.8 $121.6 $5,827.2
======== ======== ======== ======== ====== ========
--------------------
(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 $20.3 million and $30.2 million at December 31, 2008 and 2007, respectively. The related state NOLs are available to offset future state taxable income in certain states through 2015.
The Company adopted FIN 48 on January 1, 2007, which resulted in a $6 million increase to additional paid-in capital. As of January 1, 2007 and December 31, 2007, the amount of unrecognized tax benefits was not significant. While it is expected that the amount of unrecognized tax benefits will change in the next twelve months, the Company does not expect the change to have a significant impact on its results of operations.
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 FIN 48 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 2008 or 2007. The liability for accrued interest and penalties was not significant at December 31, 2008 or December 31, 2007.
Tax years 2005 through 2007 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 2005 through 2007 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 $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.
The Company adopted SFAS 123R in calendar year 2006. Pursuant to this accounting rule, the Company is 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 $1.9 million related to deductions for stock options and restricted stock will be reflected in additional paid-in capital if realized.
Prior to January 1, 1984, life insurance subsidiaries of the Company were entitled to exclude certain amounts from taxable income and accumulate such amounts in a "Policyholders Surplus Account". The aggregate balance in this account at December 31, 2005 was $150.7 million, which could have resulted in federal income taxes payable of $52.7 million if such amounts had been distributed or deemed distributed from the Policyholders Surplus Account. No provision for taxes had ever been made for this item since the affected subsidiaries had no intention of distributing such amounts. Pursuant to provisions of the American Jobs Creation Act of 2004, our subsidiaries distributed amounts from the Policyholders Surplus Account in 2006 without incurring any tax liability, thereby permanently eliminating this potential tax liability.
8. NOTES PAYABLE - DIRECT CORPORATE OBLIGATIONS
The following notes payable were direct corporate obligations of the Company as of December 31, 2008 and 2007 (dollars in millions):
2008 2007
---- ----
3.50% convertible debentures............................................................ $ 293.0 $ 330.0
Secured credit agreement................................................................ 911.8 865.5
6% Senior Note.......................................................................... 125.0 -
Unamortized discount on convertible debentures.......................................... (1.1) (1.8)
-------- --------
Direct corporate obligations....................................................... $1,328.7 $1,193.7
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In August 2005, we completed the private offering of $330 million of 3.50% Convertible Debentures due September 30, 2035 (the "Debentures"). The net proceeds from the offering of approximately $320 million were used to repay term loans outstanding under the Company's $800.0 million secured credit facility (the "Credit Facility"). The terms of the 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 "Indenture"). At December 31, 2008 and 2007, unamortized issuance costs (classified as other assets) related to the Debentures were $2.5 million and $4.4 million, respectively, and are amortized as an increase to interest expense through September 30, 2010, which is the earliest date the Debenture holders may require the Company to repurchase them.
The Debentures are senior, unsecured obligations and bear interest at a rate of 3.50 percent per year, payable semi-annually, beginning on March 31, 2006 and ending on September 30, 2010. Thereafter, the principal balance of the 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 Debentures if the average trading price per Debenture for the five trading day period immediately preceding the six-month interest period equals or exceeds a certain level, as described in the Indenture.
Upon the occurrence of certain specified events, the 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 amount of the converting Debenture; or (ii) the conversion value of such Debentures (as calculated in accordance with the Indenture).
On or after October 5, 2010, the Company may redeem for cash all or a portion of the Debentures at any time at a redemption price equal to 100 percent of the accreted principal amount of the 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 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 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 Debentures, either the trustee or the holders of at least 25 percent of the aggregate accreted principal amount of the Debentures then outstanding may declare the accreted principal amount, plus accrued and unpaid interest, including additional interest and contingent interest, if any, on the 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 Debentures will become immediately due and payable. The following are events of default with respect to the Debentures:
o default for 30 days in payment of any interest, contingent interest or additional interest due and payable on the Debentures;
o default in payment of accreted principal of the Debentures at maturity, upon redemption, upon repurchase or following a fundamental change, when the same becomes due and payable;
o 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;
o default in the Company's conversion obligations upon exercise of a holder's conversion right, following a specified period for cure;
o default in the Company's obligations to give notice of the occurrence of a fundamental change within the time required to give such notice;
o 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 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
o certain events of bankruptcy, insolvency and reorganization of the Company or any of its subsidiaries.
During 2008, we repurchased $37.0 million par value of such Debentures for $15.3 million plus accrued interest. In 2008, we recognized a gain on the extinguishment of debt of $21.2 million related to such repurchases. Debentures with a par value of $293.0 million remain outstanding. Refer to the note to these consolidated financial statements entitled "Subsequent Events" for a description of new restrictions on the Company's ability to redeem, purchase, amend, modify or refinance the Debentures as a result of the amendment to the Second Amended Credit Facility on March 30, 2009.
The Company's credit facility was amended during 2006 and 2007 as further described below and on March 30, 2009, as described in the note to these consolidated financial statements entitled "Subsequent Events".
On October 10, 2006, we entered into the Second Amended Credit Facility. As a result of the refinancing, the principal amount outstanding under the previous credit facility was increased from $478.3 million to $675.0 million. Approximately $195 million of the proceeds were used to strengthen the capital of our insurance subsidiaries. The Company recognized a $.7 million loss on the extinguishment of debt during the fourth quarter of 2006 for the write off of certain debt issuance costs and other costs incurred related to the transaction. The Second Amended Credit Facility extended the maturity date from June 22, 2010 to October 10, 2013. On June 12, 2007, Conseco amended its current credit facility. The amendment of the credit facility provided for, among other things:
o an increase of $200.0 million in the principal amount of the facility;
o an increase in the general basket for restricted payments in an aggregate amount of up to $300 million over the term of the facility; and
o the Company to be able to request the addition of up to two new facilities or up to two increases in the credit facility of up to $330 million, subject to compliance with certain financial covenants and other conditions. Such increases would be effective as of a date that is at least 90 days prior to the scheduled maturity date.
No changes were made to the interest rate or the maturity schedule of the amounts borrowed under the credit facility. We are required to make minimum quarterly principal payments of $2.2 million through September 30, 2013. The remaining unpaid principal balance is due on October 10, 2013. There were no changes to the various financial ratios and balances that are required to be maintained by the Company. The additional borrowings were used for general corporate purposes, including the repurchase of Conseco common stock and the strengthening of the Company's insurance subsidiaries.
During 2008, 2007 and 2006, we made scheduled principal payments totaling $8.7 million, $7.8 million and $1.7 million, respectively, on our Second Amended Credit Facility. Also, during 2006, we made scheduled principal payments totaling $1.3 million on our previous credit facility as well as a mandatory prepayment of $45.0 million based on the Company's excess cash flows at December 31, 2005, as defined in the previous credit facility. There were $5.8 million and $6.8 million of unamortized issuance costs (classified as other assets) related to our Second Amended Credit Facility at December 31, 2008 and 2007, respectively.
The amounts outstanding under the Second Amended Credit Facility bear interest, payable at least quarterly, based on either a Eurodollar rate or a base rate. The Eurodollar rate is equal to LIBOR plus 2 percent. The base rate is equal to 1 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 Second Amended Credit Facility, 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, 2008, the interest rate on our Second Amended Credit Facility was 3.8 percent. Refer to the note to these consolidated financial statements entitled "Subsequent Events" for a description of changes to the interest rate as a result of the amendment to the Second Amended Credit Facility on March 30, 2009.
Pursuant to the Second Amended Credit Facility, as long as the debt to total capitalization ratio (as defined in the Second Amended Credit Facility) is greater than 20 percent and certain insurance subsidiaries (as defined in the Second Amended Credit Facility) 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; (iii) certain asset sales or casualty events; and (iv) excess cash flows as defined in the Second Amended Credit Facility (the first such payment, of approximately $1.3 million, is expected to be paid in March 2009). 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.
The following chart summarizes: (i) the most significant financial ratios
and balances we must maintain pursuant to our Second Amended Credit Facility;
(ii) the current ratios and balances as of December 31, 2008; and (iii) the
margins for adverse developments before such ratio or balance requirement is not
met (dollars in millions):
Covenant under the Balance or Margin for adverse
Second Amended ratio as of development from
Credit Facility December 31, 2008 December 31, 2008 levels
--------------- ----------------- ------------------------
Aggregate risk-based capital ratio......... greater than or equal Reduction to
to 250% 255% statutory capital and
surplus of
approximately $25
million, or an
increase to the risk-
based capital of
approximately $10
million.
Combined statutory capital and surplus..... greater than $1,270 Reduction to
million $1,366 million combined statutory
capital and surplus
of approximately
$96 million.
Debt to total capitalization ratio......... not more than 30% 28% Reduction to
shareholders' equity
of approximately
$273 million or
additional debt of
$117 million.
Interest coverage ratio.................... greater than or equal Reduction in cash
to 2.00 to 1 for each flows to the holding
rolling four quarters 2.35 to 1 company of
approximately
$20 million.
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As described in the note to the consolidated financial statements entitled "Subsequent Events", on March 30, 2009, we completed an amendment to our Second Amended Credit Facility, which provides 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.
The Second Amended Credit Facility also requires that the Company's 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, the financial position and results of operations of the Company in conformity with GAAP for the periods indicated. Such opinion shall not include an explanatory paragraph regarding the Company's ability to continue as a going concern or similar qualification. The Company was in compliance with all covenants as defined in the Second Amended Credit Facility as of December 31, 2008.
The Second Amended Credit Facility 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. The Company also requested borrowings of $5.0 million which were not funded. 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. There were no amounts outstanding under the revolving credit facility at December
31, 2007. The Company pays a commitment fee equal to .50 percent of the unused portion of the revolving credit facility on an annualized basis. The revolving credit facility bears interest based on either a Eurodollar rate or a base rate in the same manner as described above for the Second Amended Credit Facility.
The Second Amended Credit Facility 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) certain asset dispositions; (vi) affiliate transactions;
(vii) certain investment activities; (viii) change in business; and (ix)
prepayment of indebtedness (other than the Second Amended Credit Facility). The
obligations under our Second Amended Credit Facility are guaranteed by Conseco's
current and future domestic subsidiaries, other than: (i) its insurance
companies; (ii) subsidiaries of the insurance companies; or (iii) certain
immaterial subsidiaries as defined in the Second Amended Credit Facility. 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 Insurance Company and Conseco Health Insurance
Company. Under the Second Amended Credit Facility, we were permitted to pay cash
dividends on our common stock or repurchase our common stock in an aggregate
amount of up to $300.0 million over the term of the facility. However, 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 $125.0 million Senior Note (as described in the
following paragraph) remained outstanding. As further discussed in the note to
the consolidated financial statements entitled "Shareholders' Equity", we
repurchased $87.2 million of our common stock in 2007. No repurchases were made
in 2008.
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 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.
The scheduled repayment of our direct corporate obligations is as follows (dollars in millions):
2009.......................................... $ 90.0
2010.......................................... 326.8
2011.......................................... 33.7
2012.......................................... 33.8
2013.......................................... 845.5
--------
$1,329.8
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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 follows the provisions of Statement of Financial Accounting Standards No. 5, "Accounting for Contingencies", when making accrual and disclosure decisions. 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. We filed a motion to dismiss the second amended complaint on November 7, 2005. This motion was denied on September 12, 2007. Plaintiffs filed their motion for class certification on May 2, 2008, and on March 20, 2009 the court granted that motion. The matter is scheduled for a jury trial on May 10, 2010. 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.
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 proposed 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 began implementing the settlement with the inforce and certain former policyholders in the last half of 2007. We previously recognized costs related to this litigation totaling $267.2 million (none
of which was recognized in 2008).
A lawsuit was filed on September 14, 2005 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 (United States District Court, District of Hawaii). This suit involves approximately 800 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 complaint alleges 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. The ultimate outcome of this lawsuit cannot be predicted with certainty and an adverse outcome could exceed the amount we have accrued and could have a material 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 Insurance Company agency and its principal that allege in the complaint that they were damaged by Conseco Health Insurance Company'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 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 Insurance Company'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, as a defendant. Mr. Tutt moved for partial summary judgment in July 2004, asking the court to invalidate the non-competition and non-solicitation provisions in the EMA and the non-competition provision of the BCP. Defendants opposed this motion, but plaintiffs' motion was granted by the court on December 15, 2004. The court did not decide the issue of the BCP's continued validity. After discovery, defendants filed a partial motion for summary judgment on January 1, 2006, reasserting that the entire BCP was invalidated because the non-competition provision had been stricken from the agreement. Plaintiff filed a cross-motion for partial summary judgment regarding the validity of the BCP on May 31, 2006. Both motions were denied by the court, and the court set that issue for a bench trial. 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 and Casualty Company 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. 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 Insurance Company'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 specifically certifies two sub-classes 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 affirmed class certification but made modifications to the class definitions. Our subsequent petition for rehearing was denied by order dated June 27, 2008. Briefing in the district court on remand, to determine the appropriate revised class definition, is scheduled to be concluded in March 2009. 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.
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. Plaintiff was a losing bidder on the building. In the complaint, 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. Discovery will now be proceeding in the matter. The plaintiff filed a motion for summary judgment on July 16, 2008, to which the Company responded with a cross-motion for summary judgment on August 29, 2008. 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 on September 26, 1995. Plaintiff is
claiming breach of contract on behalf of the proposed national class and seeks
injunctive and restitutionary relief pursuant to 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 around 2011. We filed a motion to dismiss the complaint on June 25,
2008, which was denied by the court. Plaintiff has not yet filed a motion for
certification of the class, and we intend to oppose any form of class 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 June 4, 2008, a purported class action complaint was filed in the United States District Court for the Northern District of Illinois, Ruby Sandock, individually and on behalf of herself and all others similarly situated v. Bankers Life and Casualty Company Case No. 08-CV-3218. Plaintiff is claiming breach of contract, consumer fraud and deceptive business practices, and unjust enrichment on behalf of the proposed national class and seeks compensatory and punitive damages, injunctive and restitutionary relief. Plaintiff alleges that Bankers Life and Casualty systematically and intentionally failed to comply with standard contractual waiver of premium provisions that are included in its long-term care insurance policy contracts that it offers and sells to consumers. Plaintiffs allege that Bankers Life and Casualty has a policy or practice of continuing to charge and/or bill its insureds for policy premiums after the insured has received 90 days of benefits. Our answer was filed on July 3, 2008, denying liability and denying that the action is properly maintainable as a class action. We also filed a motion to dismiss the complaint. On September 26, 2008, the district court entered an order dismissing two out of the three claims asserted by the plaintiff. After the court's ruling dismissing portions of the complaint, plaintiff elected to dismiss the entire action without prejudice to its refiling and the court therefore entered an order of dismissal without prejudice on November 12, 2008. The settlement of this case was not significant to our business, financial condition, results of operations or cash flows.
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. The court has also established a schedule for briefing on class certification, which will be concluded by July 20, 2009. We agreed to assume liability for this litigation in connection with the separation of Senior Health. 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 July 22, 2008, a purported class action was filed in the U.S. District Court for the Southern District of Florida, Anna M. Cohen individually and on behalf of herself and all others similarly situated v. Washington National Insurance Corporation Case No. 08-CV-61153-JIC. Plaintiff is claiming breach of contract alleging that the 8% annual inflation adjustment rider, which is part of her Washington National policy of long-term care insurance, acts to increase the lifetime maximum benefit above the stated $150,000 benefit and not just the stated per day benefit, such that Washington National prematurely stops paying benefits before the correct lifetime maximum benefit amount is paid. On September 26, 2008, Washington National filed a motion to dismiss the complaint. While the motion to dismiss was pending, a settlement was reached with the individual plaintiff, without certification of a class. The court entered an order of dismissal with prejudice based on the settlement on January 12, 2009. The settlement of this case was not significant to 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 breached the contract by stopping her benefits when they reached the lifetime maximum. The Company takes the position that the inflation escalator only affects the per day maximum benefit. The court has scheduled a jury trial on November 2, 2009. 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 the Company 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 "Lifetrends" by requiring the payment of additional cash amounts to maintain the policies in force. 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.
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 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
Collection efforts by the Company and Conseco Services related to the
1996-1999 director and officer loan programs are ongoing against two past board
members with outstanding loan balances, James D. Massey and Dennis E. Murray,
Sr. In addition, these directors have sued the companies for declaratory relief
concerning their liability for the loans. The specific lawsuits now pending
include: Murray and Massey v. Conseco, Case No. 1:03-CV-1701-LJM-VSS (Southern
District, Indiana); Conseco Services v. Murray, Case No. 29D02-0404-CC-381
(Superior Court, Hamilton County, Indiana); Conseco Services v. Massey, Case No.
29D01-0406-CC-477 (Superior Court, Hamilton County, Indiana); Conseco, Inc. v.
Massey, Case No. 2005-L-011316 (Circuit Court, Cook County, Illinois) and
Conseco and Conseco Services v. J. David Massey et al., Case No.
29D02-0611-PL-1169 (Superior Court, Hamilton County, Indiana). On June 21, 2006,
in the Hamilton County case, the Company obtained a partial summary judgment
against Mr. Massey in the sum of $4.4 million plus interest at 11.5 percent from
June 30, 2002. The trial court stayed execution of the judgment pending appeal.
The trial which was set for October 22, 2007, has been continued without date.
On January 22, 2008, the Indiana Court of Appeals, in Massey v. Conseco
Services, LLC Case No. 29A05-0610-CV-565, affirmed the judgment entered in the
Hamilton County case in favor of the Company and the dismissal of Massey's
counterclaims. Mr. Massey has filed a petition for rehearing with the Court of
Appeals. Mr. Massey filed for bankruptcy on October 10, 2008. A bench trial on
the Company's motion to set aside certain transfers to Mr. Massey's family
members was held in the Hamilton County, Indiana, Superior Court in January 2009
but no decision has been made by the court. The Murray U.S. District Court case
is currently set for trial on May 18, 2009.
The Company and Conseco Services believe that all amounts due under the director and officer loan programs, including all applicable interest, are valid obligations owed to the companies. As part of our Predecessor's plan of reorganization, we have agreed 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, 2008, we have paid $19.3 million to the former holders of trust preferred securities under this arrangement. We intend to prosecute these claims to obtain the maximum recovery possible. Further, with regard to the various claims brought against the Company and Conseco Services by certain former directors and officers, we believe that these claims are without merit and intend to defend them vigorously. The ultimate outcome of the lawsuits cannot be predicted with certainty. At December 31, 2008, we estimated that approximately $10.0 million, net of collection costs, of the remaining amounts due under the loan program will be collected (including amounts that remain to be collected from borrowers with whom we have settled) and that $4.3 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 and Casualty Company, as well as the sales and marketing practices of Bankers Life and Casualty Company. 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 and Casualty Company. 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 and Casualty, are not met over an 18 month period for Bankers Life and Casualty or a two-and-a-half year period for Senior Health, which time starts with the settlement. The process improvement plan will be 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 has 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 discussions regarding the Lifetrend and CIUL3+ policies. Conseco continues to work with various state insurance regulators to review the terms of the Lifetrend policies, the administrative changes and the adjustment of certain NGEs. The ultimate outcome of these regulatory proceedings involving the Lifetrend policies cannot be predicted with certainty.
Guaranty Fund Assessments
The balance sheet at December 31, 2008, included: (i) accruals of $9.5 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, 2008; and (ii) receivables of $5.9 million that we estimate will be recovered through a reduction in future premium taxes as a result of such assessments. At December 31, 2007, such guaranty fund assessment accruals were $7.0 million and such receivables were $3.4 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 $3.1 million, $1.1 million and $2.4 million in 2008, 2007 and 2006, 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, 2008, we have estimated that approximately $10.0 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. In 2006, other operating costs and expenses are net of recoveries of $3.0 million related to our evaluation of the collectibility of the D&O loans.
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, 2008, we had paid $19.3 million to the former holders of TOPrS and we have
established a liability of $4.3 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 and $22.5 million at December 31, 2008 and 2007, respectively, and is included in the caption "Other liabilities" in the consolidated balance sheet.
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 $44.1 million, $44.8 million and $43.3 million in 2008, 2007 and 2006, respectively. Future required minimum payments as of December 31, 2008, were as follows (dollars in millions):
2009.............................................................................. $ 46.2
2010.............................................................................. 34.2
2011.............................................................................. 27.1
2012.............................................................................. 22.7
2013.............................................................................. 18.3
Thereafter........................................................................ 74.3
------
Total..................................................................... $222.8
======
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10. OTHER DISCLOSURES
Agent Deferred Compensation Plan and Postretirement Plans
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 $99.3 million and $94.5 million at December 31, 2008 and 2007, respectively. Costs incurred on this plan were $7.7 million, $5.8 million and $8.9 million during 2008, 2007 and 2006, respectively (including the recognition of gains (losses) of $.6 million, $3.3 million and $(.1) million in 2008, 2007 and 2006, 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 2009 is $.1 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 $51.2 million and $40.9 million at December 31, 2008 and 2007, respectively. Changes in the cash surrender value (which approximates net realizable value) of the COLI assets are recorded as net investment income.
Effective December 31, 2005, the Company terminated certain postretirement benefit plans. Prior to the termination of such plans, we provided certain health care and life insurance benefits for certain eligible retired employees under partially funded and unfunded plans in existence at the date on which certain subsidiaries were acquired. Certain postretirement benefit plans were contributory, with participants' contributions adjusted annually. Actuarial measurement dates of September 30 and December 31 were used for those postretirement benefit plans. The remaining liability at December 31, 2006, related to benefits paid in 2007. Amounts related to the postretirement benefit plans were as follows (dollars in millions):
2007
----
Benefit obligation, beginning of year.............................................. $ .3
Benefits paid.................................................................. (.3)
----
Benefit obligation, end of year.................................................... $ -
====
Funded status - accrued benefit cost............................................... $ -
====
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We used the following assumptions for the deferred compensation plan to calculate:
2008 2007
---- ----
Benefit obligations:
Discount rate................................................ 6.03% 6.02%
Net periodic cost:
Discount rate................................................ 6.02% 5.75%
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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, 2008, 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).
There was no expense recognized in 2006 or 2007 related to the postretirement benefit plans which were terminated in 2005.
The benefits expected to be paid pursuant to our agent deferred compensation plan and postretirement benefit plans as of December 31, 2008 were as follows (dollars in millions):
2009.................................................... $ 3.9 2010.................................................... 3.9 2011.................................................... 4.2 2012.................................................... 4.4 2013.................................................... 4.9 2014 - 2017............................................. 31.9 |
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 $4.4 million, $4.2 million and $4.1 million in 2008, 2007 and 2006, 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 $(19) million, $(4) million and $70 million for the
years ended December 31, 2008, 2007 and 2006, respectively.
11. SHAREHOLDERS' EQUITY
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. As further discussed in the note to the consolidated financial statements entitled "Notes Payable - Direct Corporate Obligations," we currently may pay cash dividends on our common stock or repurchase our common stock in an aggregate amount of up to $300 million over the term of our credit facility. However, 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. Our share repurchase program may be implemented through purchases made from time to time in either the open market or through private transactions. 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 2008.
Changes in the number of shares of common stock outstanding were as follows (shares in thousands):
2008 2007 2006
---- ---- ----
Balance, beginning of year.............................................. 184,652 152,165 151,513
Treasury stock purchased and retired................................ - (5,699) -
Conversion of preferred stock into common shares.................... - 37,809 -
Stock options exercised............................................. - 207 48
Shares issued under employee benefit
compensation plans............................................... 102(a) 177 (a) 645 (a)
Other............................................................... - (7) (41)
------- ------- -------
Balance, end of year.................................................... 184,754 184,652 152,165
======= ======= =======
--------------------
(a) In 2008, 2007 and 2006, such amounts were reduced by 16 thousand
shares, 24 thousand shares and 220 thousand shares, respectively,
which were tendered for the payment of federal and state taxes owned
on the issuance of restricted stock.
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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. A maximum of 10 million shares may be issued 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 in 2007 and 2008 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 2008 is presented below (shares in thousands):
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
=====
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A summary of the Company's stock option activity and related information for 2007 is presented below (shares in thousands):
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
=====
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A summary of the Company's stock option activity and related information for 2006 is presented below (shares in thousands):
Weighted Weighted
average average Aggregate
exercise remaining intrinsic
Shares price life value
------ ----- ---- -----
Outstanding at the beginning of
the year....................................................... 3,536 $19.89
Options granted................................................... 1,295 22.57
Exercised......................................................... (48) 20.80 $.3
Forfeited or terminated........................................... (566) 19.47
----
Outstanding at the end of the year................................ 4,217 20.76 7.6 years $27.4
===== ===
Options exercisable at the end of the year........................ 2,257 6.4 years $14.9
===== ===
Available for future grant........................................ 4,020
=====
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We recognized compensation expense related to stock options totaling $6.0 million ($3.9 million after income taxes) in 2008, $7.4 million ($4.8 million after income taxes) in 2007 and $6.5 million ($4.2 million after income taxes) in 2006. Compensation expense related to stock options reduced both basic and diluted earnings (loss) per share by 2 cents, 3 cents and 3 cents in 2008, 2007 and 2006. At December 31, 2008, the unrecognized compensation expense for non-vested stock options totaled $10.2 million which is expected to be recognized over a weighted average period of 1.6 years. Cash received from the exercise of stock options was nil, $3.4 million and $1.0 million during 2008, 2007 and 2006, 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:
2008 Grants 2007 Grants 2006 Grants
----------- ----------- -----------
Weighted average risk-free interest rates.............................. 2.5% 4.4% 5.0%
Weighted average dividend yields....................................... 0.0% 0.0% 0.0%
Volatility factors..................................................... 24% 22% 22%
Weighted average expected life......................................... 3.7 years 3.7 years 6.2 years
Weighted average fair value per share.................................. $2.25 $4.22 $7.90
|
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 2008, 2007 and 2006.
The following table summarizes information about stock options outstanding at December 31, 2008 (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
------------------------ ----------- --------------- ----- ----------- -----
$2.83............................... 65 4.9 $ 2.83 - $ -
$8.91 - $12.96...................... 1,751 4.3 10.60 2 12.96
$14.78 - $21.67..................... 3,514 4.7 19.42 2,138 20.19
$22.42 - $25.45..................... 534 7.4 23.17 272 23.17
----- -----
5,864 2,412
===== =====
|
During 2008, 2007 and 2006, the Company granted .1 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 $9.75 per share, $18.39 per share and $22.68 per share, respectively. The fair value of such grants totaled $.8 million, $1.7 million and $1.3 million in 2008, 2007 and 2006, 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 2008 is presented below (shares in thousands):
Weighted
average
grant date
Shares fair value
------ ----------
Non-vested shares, beginning of year................................ 112 $19.38
Granted.......................................................... 78 9.75
Vested........................................................... (118) 21.67
Forfeited........................................................ (2) 15.89
----
Non-vested shares, end of year...................................... 70 14.41
====
|
At December 31, 2008, the unrecognized compensation expense for non-vested restricted stock totaled $.6 million which is expected to be recognized over a weighted average period of 1.6 years. At December 31, 2007, the unrecognized compensation expense for non-vested restricted stock totaled $1.3 million. We recognized compensation expense related to restricted stock awards totaling $1.4 million, $3.2 million and $10.2 million in 2008, 2007 and 2006, respectively. The fair value of restricted stock that vested during 2008, 2007 and 2006 was $1.9 million, $3.9 million and $16.1 million, respectively.
SFAS 123R 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. In accordance with SFAS 123R, 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 Rights Plan 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 Rights Plan. The Rights would become exercisable in the event any person or group (subject to certain exemptions) becomes a "5 percent 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):
2008 2007 2006
---- ---- ----
Income (loss) before discontinued operations............................ $ (404.0) $ (74.0) $ 105.7
Discontinued operations................................................. (722.7) (105.9) .3
--------- ------- -------
Net income (loss)....................................................... (1,126.7) (179.9) 106.0
Preferred stock dividends............................................... - (14.1) (38.0)
--------- ------- -------
Net income (loss) applicable to common
stock for basic earnings per share............................... $(1,126.7) $(194.0) $ 68.0
========= ======= =======
Shares:
Weighted average shares outstanding for basic
earnings per share................................................. 184,704 173,374 151,690
------- ------- -------
Effect of dilutive securities on weighted average shares:
Stock option and restricted stock plans............................ - - 819
------- ------- -------
Dilutive potential common shares................................... - - 819
------- ------- -------
Weighted average shares outstanding for diluted
earnings per share............................................... 184,704 173,374 152,509
======= ======= =======
|
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 potentially dilutive shares related to the Class B mandatorily convertible preferred stock were not dilutive during 2006, but the common stock equivalents related to stock option and restricted stock plans were dilutive.
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 2006
---- ---- ----
Equivalent common shares that were antidilutive during the year:
Class B mandatorily convertible preferred stock.................... - 14,334 32,178
Stock option and restricted stock plans............................ 32 144 -
-- ------ ------
Antidilutive equivalent common shares............................ 32 14,478 32,178
== ====== ======
|
In 2008 and 2007, the Company granted performance shares totaling 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 50th percentile of the comparison group, no portion of the award is earned. If the Company's results are equal to or greater than the 75th 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
=== ===
|
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 $2.7 million and $3.0 million in 2008 and 2007, respectively. We recognized compensation expense of $.1 million and $1.1 million in 2008 and 2007, respectively, related to the performance shares.
In August 2005, we completed the private offering of the Debentures. In future periods, our diluted shares outstanding may include incremental shares issuable upon conversion of all or part of such Debentures. Since the $330.0 million principal amount 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 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. In accordance with the consensus from EITF No. 04-8, "The Effect of Contingently Convertible Instruments on Diluted Earnings per Share", we will include the dilutive effect of our Debentures in the calculation of diluted earnings per share when the impact is dilutive. During 2008, 2007 and 2006, the conversion feature of these Debentures did not have a dilutive effect because the weighted average market price of our common stock did not exceed the initial conversion price of $26.66. Therefore, the Debentures had no effect on our diluted shares outstanding or our diluted earnings per share in 2008, 2007 or 2006.
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).
12. OTHER OPERATING STATEMENT DATA
Insurance policy income consisted of the following (dollars in millions):
2008 2007 2006
---- ---- ----
Traditional products:
Direct premiums collected............................................ $ 4,313.5 $ 4,291.4 $ 4,476.7
Reinsurance assumed.................................................. 642.8 314.0 108.9
Reinsurance ceded.................................................... (164.3) (199.8) (210.6)
--------- --------- ---------
Premiums collected, net of reinsurance......................... 4,792.0 4,405.6 4,375.0
Change in unearned premiums.......................................... (13.5) (2.1) 39.5
Less premiums on universal life and products
without mortality and morbidity risk which
are recorded as additions to insurance
liabilities ...................................................... (1,863.5) (1,852.2) (2,067.7)
--------- --------- ---------
Premiums on traditional products with
mortality or morbidity risk................................. 2,915.0 2,551.3 2,346.8
Fees and surrender charges on interest-sensitive
products............................................................. 338.6 344.4 349.6
--------- --------- ---------
Insurance policy income........................................ $ 3,253.6 $ 2,895.7 $ 2,696.4
========= ========= =========
|
The four states with the largest shares of 2008 collected premiums were Florida (7.4 percent), California (7.1 percent), Pennsylvania (6.3 percent) and Texas (5.9 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):
2008 2007 2006
---- ---- ----
Commission expense....................................................... $128.2 $118.3 $118.7
Salaries and wages....................................................... 160.5 169.3 168.3
Other.................................................................... 231.6 252.8 216.3
------ ------ ------
Total other operating costs and expenses.......................... $520.3 $540.4 $503.3
====== ====== ======
|
Changes in the value of policies inforce at the Effective Date were as follows (dollars in millions):
2008 2007 2006
---- ---- ----
Balance, beginning of year............................................... $1,573.6 $1,964.8 $2,209.5
Additional acquisition expense....................................... - 1.9 2.1
Amortization......................................................... (187.3) (246.2) (276.1)
Cumulative effect of accounting change related to the adoption
of SOP 05-1....................................................... - (2.6) -
Effect of annuity coinsurance transaction............................ - (191.2) -
Effect of reinsurance recapture...................................... - 56.3 -
Amounts related to fair value adjustment of actively managed
fixed maturities.................................................. 92.7 (9.4) 29.3
Other................................................................ (1.2) - -
-------- -------- --------
Balance, end of year..................................................... $1,477.8 $1,573.6 $1,964.8
======== ======== ========
|
Based on current conditions and assumptions as to future events on all policies inforce, the Company expects to amortize approximately 14 percent of the December 31, 2008 balance of the value of policies inforce at the Effective Date in 2009, 12 percent in 2010, 11 percent in 2011, 9 percent in 2012 and 7 percent in 2013. 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, 2008, 2007 and 2006.
In accordance with SFAS 97, we are required to amortize the value of policies inforce in relation to estimated gross profits for universal life products and investment-type products. SFAS 97 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):
2008 2007 2006
---- ---- ----
Balance, beginning of year............................................... $1,423.0 $1,106.7 $ 758.8
Additions............................................................. 459.1 487.6 482.5
Amortization.......................................................... (180.6) (180.6) (147.2)
Cumulative effect of accounting change related to the adoption of
SOP 05-1............................................................ - (1.6) -
Effect of annuity coinsurance transaction............................. - (19.3) -
Amounts related to fair value adjustment of actively
managed fixed maturities............................................ 111.1 30.2 12.6
-------- -------- --------
Balance, end of year..................................................... $1,812.6 $1,423.0 $1,106.7
======== ======== ========
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13. CONSOLIDATED STATEMENT OF CASH FLOWS
The following disclosures supplement our consolidated statement of cash
flows (dollars in millions):
2008 2007 2006
---- ---- ----
Non-cash items not reflected in the investing and
financing activities sections
of the consolidated statement of cash flows:
Stock option and restricted stock plans............................. $ 7.4 $ 11.0 $ 11.4
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 6.7
Change in securities lending collateral............................. 51.6 408.3 460.2
Change in securities lending payable................................ (51.6) (408.3) (460.2)
|
The following reconciles net income to net cash provided by operating activities (dollars in millions):
2008 2007 2006
---- ---- ----
Cash flows from operating activities:
Net income (loss)..................................................... $(1,126.7) $(179.9) $ 106.0
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Amortization and depreciation..................................... 412.0 483.2 501.2
Income taxes...................................................... 432.1 4.2 62.6
Insurance liabilities............................................. 460.6 744.8 493.2
Accrual and amortization of investment income..................... 3.9 73.4 (5.8)
Deferral of policy acquisition costs.............................. (459.1) (545.9) (484.6)
Net realized investment losses.................................... 642.5 155.4 47.2
(Gain) loss on extinguishment of debt............................. (21.2) - .3
Net sales (purchases) of trading securities....................... 346.5 (114.3) 36.0
Loss related to an annuity coinsurance transaction................ - 76.5 -
Loss on Transfer.................................................. 319.9 - -
Gain on reinsurance recapture..................................... (29.7) - -
Other............................................................. 6.0 5.9 175.1
--------- ------- -------
Net cash provided by operating activities....................... $ 986.8 $ 703.3 $ 931.2
========= ======= =======
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Our consolidated statement of cash flows 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, 2008, restricted cash and cash equivalents consisted of $4.8 million held by a VIE.
At December 31, 2007, restricted cash and cash equivalents consisted of:
(i) $16.1 million held by a VIE; (ii) $1.9 million of segregated cash held for
the benefit of the former holders of TOPrS; and (iii) $3.1 million held in an
escrow account pursuant to a litigation settlement.
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):
2008 2007
---- ----
Statutory capital and surplus.................................................................... $1,311.5 $1,336.2
Asset valuation reserve.......................................................................... 55.0 161.3
Interest maintenance reserve..................................................................... 147.7 196.7
-------- --------
Total......................................................................................... $1,514.2 $1,694.2
======== ========
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Statutory capital and surplus included investments in upstream affiliates of $52.2 million and $52.4 million at December 31, 2008 and 2007, 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 $(96.9) million, $(321.3) million and $(232.4) million in 2008, 2007 and 2006, respectively. Included in such net income (loss) were net realized capital gains (losses), net of income taxes, of $(217.1) million, $(38.5) million and $(1.8) million in 2008, 2007 and 2006, respectively. In addition, such net income (loss) included pre-tax amounts for fees and interest to Conseco or its non-life subsidiaries totaling $139.6 million, $162.8 million and $157.6 million in 2008, 2007 and 2006, 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 (excluded from this calculation would be the $61.9 million of additional surplus recognized due to the approval of a permitted practice by insurance regulators related to certain deferred tax assets as further described below); or (ii) 10 percent of statutory capital and surplus as of the end of the preceding year, excluding $61.9 million of additional surplus recognized due to the approval of a permitted practice by insurance regulators 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 2008, our insurance subsidiaries paid cash dividends of $20.0 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, 2008. Accordingly, any dividend payments from these subsidiaries require the approval of the director or commissioner of the applicable state insurance department. During 2009, we are expecting our insurance subsidiaries to pay approximately $60.0 million of extraordinary dividends to CDOC ($25.0 million of which has been approved by the Texas Department of Insurance for payment to CDOC and $35.0 million of which is expected to be approved by the Texas Department of Insurance and paid later in 2009). In addition, we are expecting our insurance subsidiaries to pay interest on surplus debentures of $44.5 million ($21.2 million of which has been approved by the Texas Department of Insurance and $23.3 million of which is expected to be approved by the Texas Department of Insurance and paid later in 2009). Although we believe the dividends and surplus debenture interest payments we are expecting to pay during 2009 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 unlikely. 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 2008, CDOC made capital contributions totaling $79.4 million to Conseco Life Insurance Company of Texas and Washington National Insurance Company.
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 risk-based capital and other capital requirements described below can also limit, in certain circumstances, the ability of our insurance subsidiaries to pay dividends.
Risk-Based Capital ("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, 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.
During 2007 and 2006, we made capital contributions to Senior Health to maintain total adjusted capital in excess of the levels subjecting it to any regulatory action. As a result of losses on the long-term care business, we made capital contributions to Senior Health of $202.0 million (including $56.0 million which was accrued at December 31, 2007, and paid in February 2008) in 2007 and $110.0 million (including $80 million which was accrued at December 31, 2006 and paid in February 2007) in 2006.
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.
The capital and surplus of our insurance subsidiaries has declined in recent periods primarily as a result of the losses recognized as a result of the transaction to transfer Senior Health to an independent trust and net realized investment losses. The Company has taken a number of actions to strengthen the capital position of its subsidiaries, including:
o We requested and obtained approval of a statutory permitted accounting practice as of December 31, 2008 for our insurance subsidiaries domiciled in Illinois and Indiana. The permitted practice modifies the accounting for deferred income taxes by increasing the realization period for deferred tax assets from within one year to within three years of the balance sheet date and increasing the asset recognition limit from 10 percent to 15 percent of adjusted capital and surplus as shown in the most recently filed statutory financial statements. The impact of the permitted practice was to increase the statutory consolidated capital and surplus of our insurance subsidiaries by $61.9 million as of December 31, 2008. In addition, the consolidated risk-based capital ratio increased by 11 percentage points and, as a result, the Company did not need to take additional actions in order to meet the risk-based capital financial covenant requirement at December 31, 2008. The benefit of this permitted practice may not be considered by our insurance subsidiaries when determining surplus available for dividends.
o We have entered into reinsurance agreements which have reduced the aggregate risk-based capital of our insurance subsidiaries. For example, during the fourth quarter of 2008 we entered into two reinsurance transactions which had the effect of increasing our aggregate risk-based capital ratio by 8 percentage points.
o During the fourth quarter of 2008, we completed a transaction pursuant to which our ownership of Senior Health was transferred to an independent trust. The completion of this transaction had the effect of increasing our aggregate risk-based capital ratio by 18 percentage points.
o In the first quarter of 2009, Conseco Insurance Company terminated an existing intercompany commission financing arrangement with a non-life subsidiary of the Company. In connection with the termination of the agreement, Conseco Insurance Company paid $17 million to the non-life subsidiary, representing the present value of the future commissions Conseco Insurance Company would have otherwise paid to the non-life subsidiary over the next several years. The termination of the commission financing agreement had the effect of reducing the statutory capital and surplus of Conseco Insurance Company. However, the current cash available to the holding company increased by the $17 million termination payment.
During 2008, the financial statements of three of our subsidiaries prepared in accordance with statutory accounting practices prescribed or permitted by regulatory authorities reflected the establishment of asset adequacy or premium deficiency reserves primarily related to long-term care and annuity policies. Total asset adequacy and premium deficiency reserves for Washington National, Conseco Insurance Company and Bankers Conseco Life Insurance Company were $53.3 million, $20.0 million and $19.5 million, respectively at December 31, 2008. 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, 2008, the consolidated RBC ratio of our insurance subsidiaries exceeded the minimum risk-based capital requirement included in our Second Amended Credit Facility. 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. Prior to the fourth quarter of 2008, we had a fourth segment comprised of other business in run-off. The other business in run-off segment had included blocks of business that we no longer market or underwrite and were managed separately from our other businesses. Such segment had consisted of: (i) long-term care insurance sold in prior years through independent agents; and (ii) major medical insurance. 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 the long-term care business in the other business in run-off segment is presented as discontinued operations in our consolidated financial statements. Accordingly, we have restated all prior year segment disclosures to conform to management's current view of the Company's operating segments.
We measure segment performance for purposes of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information", 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 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. We may experience realized investment gains (losses), which will affect future earnings levels since our underlying business is long-term 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.
Operating information by segment was as follows (dollars in millions):
2008 2007 2006
---- ---- ----
Revenues:
Bankers Life:
Insurance policy income:
Annuities..................................... $ 49.2 $ 67.6 $ 64.7
Supplemental health........................... 1,795.1 1,456.4 1,240.7
Life.......................................... 187.8 175.4 155.5
Other......................................... 77.8 80.6 84.6
Net investment income (a).......................... 558.2 572.3 525.6
Fee revenue and other income (a)................... 11.0 12.0 6.0
-------- -------- --------
Total Bankers Life revenues............... 2,679.1 2,364.3 2,077.1
-------- -------- --------
Colonial Penn:
Insurance policy income:
Supplemental health........................... 8.4 9.7 11.1
Life.......................................... 175.3 115.0 99.7
Other......................................... 1.1 1.1 1.3
Net investment income (a).......................... 39.6 37.8 38.2
Fee revenue and other income (a)................... 1.8 .7 .6
-------- -------- --------
Total Colonial Penn revenues.............. 226.2 164.3 150.9
-------- -------- --------
Conseco Insurance Group:
Insurance policy income:
Annuities..................................... 14.1 14.3 16.0
Supplemental health........................... 609.4 628.1 655.1
Life.......................................... 325.0 335.3 353.4
Other......................................... 10.4 12.2 14.3
Net investment income (a).......................... 552.5 716.3 757.2
Fee revenue and other income (a)................... 1.7 1.0 1.4
-------- -------- --------
Total Conseco Insurance Group
revenues.............................. 1,513.1 1,707.2 1,797.4
-------- -------- --------
Corporate operations:
Net investment income (a).......................... 28.5 43.4 29.8
Fee and other income............................... 5.2 10.1 11.2
-------- -------- --------
Total corporate revenues.................. 33.7 53.5 41.0
-------- -------- --------
Total revenues............................ 4,452.1 4,289.3 4,066.4
-------- -------- --------
|
(continued on next page)
(continued from previous page)
2008 2007 2006
---- ---- ----
Expenses:
Bankers Life:
Insurance policy benefits.............................. 2,090.4 1,684.7 1,410.6
Amortization........................................... 234.8 264.0 241.0
Interest expense on investment borrowings.............. - - .1
Other operating costs and expenses..................... 182.4 173.8 160.1
-------- -------- --------
Total Bankers Life expenses....................... 2,507.6 2,122.5 1,811.8
-------- -------- --------
Colonial Penn:
Insurance policy benefits.............................. 139.4 102.2 96.4
Amortization........................................... 32.0 20.3 17.3
Other operating costs and expenses..................... 29.6 23.7 15.6
-------- -------- --------
Total Colonial Penn expenses...................... 201.0 146.2 129.3
-------- -------- --------
Conseco Insurance Group:
Insurance policy benefits.............................. 982.7 1,129.0 1,170.6
Amortization........................................... 122.6 178.2 175.1
Interest expense on investment borrowings.............. 22.4 17.6 .8
Costs related to a litigation settlement............... - 32.2 165.8
Loss related to an annuity coinsurance transaction..... - 76.5 -
Other operating costs and expenses..................... 264.1 300.0 288.1
-------- -------- --------
Total Conseco Insurance Group
expenses........................................ 1,391.8 1,733.5 1,800.4
-------- -------- --------
Corporate operations:
Interest expense on corporate debt..................... 59.2 72.3 52.9
Interest expense on variable interest entity........... 16.2 27.4 19.7
Costs related to a litigation settlement............... - 32.2 8.9
Other operating costs and expenses..................... 44.2 42.9 39.5
(Gain) loss on extinguishment of debt.................. (21.2) - .7
-------- -------- --------
Total corporate expenses.......................... 98.4 174.8 121.7
-------- -------- --------
Total expenses.................................... 4,198.8 4,177.0 3,863.2
-------- -------- --------
Income (loss) before income taxes:
Bankers Life...................................... 171.5 241.8 265.3
Colonial Penn..................................... 25.2 18.1 21.6
Conseco Insurance Group........................... 121.3 (26.3) (3.0)
Corporate operations.............................. (64.7) (121.3) (80.7)
-------- -------- --------
Income (loss) before income taxes............. $ 253.3 $ 112.3 $ 203.2
======== ======== ========
--------------------
(a) It is not practicable to provide additional components of revenue by
product or services.
|
A reconciliation of segment revenues and expenses to consolidated revenues and expenses is as follows (dollars in millions):
2008 2007 2006
---- ---- ----
Total segment revenues.......................................... $4,452.1 $4,289.3 $4,066.4
Net realized investment losses.................................. (262.4) (158.0) (46.6)
-------- -------- --------
Consolidated revenues....................................... $4,189.7 $4,131.3 $4,019.8
======== ======== ========
Total segment expenses.......................................... $4,198.8 $4,177.0 $3,863.2
Amortization related to net realized investment losses.......... (21.5) (35.7) (10.1)
-------- -------- --------
Consolidated expenses....................................... $4,177.3 $4,141.3 $3,853.1
======== ======== ========
|
Segment balance sheet information was as follows (dollars in millions):
2008 2007
---- ----
Assets:
Bankers Life.............................................................. $12,927.5 $12,936.9
Colonial Penn............................................................. 916.3 939.1
Conseco Insurance Group................................................... 14,703.7 16,278.9
Corporate operations...................................................... 222.2 263.9
Assets of discontinued operations......................................... - 3,552.4
--------- ---------
Total assets......................................................... $28,769.7 $33,971.2
========= =========
Liabilities:
Bankers Life.............................................................. $12,102.6 $11,310.5
Colonial Penn............................................................. 808.5 797.0
Conseco Insurance Group................................................... 12,370.7 13,366.9
Corporate operations...................................................... 1,868.7 1,189.0
Liabilities of discontinued operations.................................... - 3,071.9
--------- ---------
Total liabilities.................................................... $27,150.5 $29,735.3
========= =========
|
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
------- ---- -------- -----------
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
======== ======== =========
2007
----
Bankers Life................................ $ 781.6 $ 941.6 $10,610.9
Colonial Penn............................... 119.4 130.4 709.7
Conseco Insurance Group..................... 672.6 351.0 12,334.3
-------- -------- ---------
Total.................................... $1,573.6 $1,423.0 $23,654.9
======== ======== =========
|
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).
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. (a)
-------- -------- -------- ------------
2008
----
Revenues.............................................................. $1,027.5 $1,094.7 $1,021.9 $1,045.6
======== ======== ======== ========
Income (loss) before income taxes and discontinued operations......... $(9.8) $ 18.3 $ 7.8 $ (3.9)
Income tax expense (benefit).......................................... (3.5) 307.1 32.4 80.4
----- ------- ------- -------
Loss before discontinued operations................................... (6.3) (288.8) (24.6) (84.3)
Income (loss) from discontinued operations, net of tax................ .5 (198.3) (157.4) (367.5)
----- ------- ------- -------
Net loss.............................................................. $(5.8) $(487.1) $(182.0) $(451.8)
===== ======= ======= =======
Loss per common share:
Basic:
Loss before discontinued operations............................... $(.03) $(1.56) $(.13) $ (.46)
Discontinued operations........................................... - (1.08) (.85) (1.99)
----- ------ ----- ------
Net loss....................................................... $(.03) $(2.64) $(.98) $(2.45)
===== ====== ===== ======
Diluted:
Loss before discontinued operations............................... $(.03) $(1.56) $(.13) $ (.46)
Discontinued operations........................................... - (1.08) (.85) (1.99)
------ ------ ----- ------
Net loss....................................................... $(.03) $(2.64) $(.98) $(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.
|
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.(a)
-------- -------- -------- -----------
2007
----
Revenues.............................................................. $1,004.6 $1,060.4 $1,059.6 $1,006.7
======== ======== ======== ========
Income (loss) before income taxes and discontinued operations......... $ 26.2 $ 23.0 $(68.3) $ 9.1
Income tax expense (benefit).......................................... 9.2 7.8 (26.7) 73.7
------ ------ ------ ------
Income (loss) before discontinued operations.......................... 17.0 15.2 (41.6) (64.6)
Loss from discontinued operations, net of tax......................... (17.5) (70.4) (11.1) (6.9)
------ ------ ------ ------
Net loss.............................................................. $ (.5) $(55.2) $(52.7) $(71.5)
====== ====== ====== ======
Income (loss) per common share:
Basic:
Income (loss) before discontinued operations...................... $ .05 $ .06 $(.22) $(.35)
Discontinued operations........................................... (.12) (.41) (.06) (.03)
----- ----- ----- -----
Net loss....................................................... $(.07) $(.35) $(.28) $(.38)
===== ===== ===== =====
Diluted:
Income (loss) before discontinued operations...................... $ .05 $ .06 $(.22) $(.35)
Discontinued operations........................................... (.12) (.41) (.06) (.03)
----- ----- ----- -----
Net loss....................................................... $(.07) $(.35) $(.28) $(.38)
===== ===== ===== =====
---------
(a) In the fourth quarter of 2007, our net loss reflected the following: (i)
an after tax charge of $10 million as a result of changes in our
estimates of future profits for certain interest-sensitive blocks of
business in our Conseco Insurance Group segment; and (ii) an increase of
$68 million in our valuation allowance for deferred tax assets.
|
17. INVESTMENT IN A VARIABLE INTEREST ENTITY
The Company has an investment in a special purpose entity that is a variable interest entity under FIN 46 (R). 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 will 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 market 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. 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. Also, in 2008, we recognized $10.8 million of writedowns of investments held by Fall Creek resulting from declines in fair values that we concluded were other than temporary. The carrying value of our investment in Fall Creek was $83.8 million and $47.0 million at December 31, 2008 and 2007, respectively. The following tables provide supplemental information about the assets, liabilities, revenues and expenses
of Fall Creek which have been consolidated in accordance with FIN 46 (R), 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,
-------------------
2008 2007
---- ----
Assets:
Actively managed fixed maturities............................ $269.7 $465.9
Cash and cash equivalents - restricted....................... 4.8 16.1
Accrued investment income.................................... 2.8 5.1
Other assets................................................. 7.2 6.9
------ ------
Total assets............................................. $284.5 $494.0
====== ======
Liabilities:
Other liabilities............................................ $ 7.8 $ 12.2
Investment borrowings due to others.......................... 306.5 447.2
Investment borrowings due to the Company..................... 81.9 47.0
------ ------
Total liabilities........................................ 396.2 506.4
------ ------
Equity (deficit):
Capital provided by the Company.............................. 16.6 1.6
Capital provided by others................................... 3.8 4.1
Accumulated other comprehensive loss......................... (118.4) (25.0)
Retained earnings (deficit).................................. (13.7) 6.9
------ ------
Total equity (deficit)................................... (111.7) (12.4)
------ ------
Total liabilities and equity (deficit)................... $284.5 $494.0
====== ======
|
Years ended
December 31,
--------------------------------
2008 2007 2006
---- ---- ----
Revenues:
Net investment income - deposit accounts..................... $ 23.6 $36.8 $25.2
Fee revenue and other income................................. .5 .3 .3
------ ----- -----
Total revenues........................................... 24.1 37.1 25.5
------ ----- -----
Expenses:
Interest expense............................................. 16.2 27.4 19.7
Other operating expenses..................................... .7 .5 .9
------ ----- -----
Total expenses........................................... 16.9 27.9 20.6
------ ----- -----
Income (loss) before net realized investment losses
and income taxes....................................... 7.2 9.2 4.9
Net realized investment losses............................... (24.9) (.4) (.3)
------ ----- -----
Income (loss) before income taxes............................... $(17.7) $ 8.8 $ 4.6
====== ===== =====
|
18. SUBSEQUENT EVENTS
The following significant events occurred after December 31, 2008.
Amendment to our Second Amended Credit Facility
On March 30, 2009, we completed an amendment to our Second Amended Credit
Facility, which provides 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.
The following summarizes the changes to the financial covenant requirements:
Covenant under the
Second Amended Pro Forma margin for
Credit Facility as Balance or adverse development from
amended on ratio as of December 31, 2008
March 30, 2009 December 31, 2008 levels (a)
-------------- ----------------- ------
Aggregate risk-based
capital ratio........... Greater than or equal to 255% Reduction to statutory capital
200% from March 31, 2009 and surplus of approximately
through June 30, 2010 and $290 million, or an increase
thereafter, greater than 250% to the risk-based capital of
(the same ratio required by approximately $145 million.
the facility prior to the
amendment).
Combined statutory
capital and surplus..... Greater than $1,100 million $1,366 Reduction to combined
from March 31, 2009 through statutory capital and surplus
June 30, 2010 and thereafter, of approximately $265 million.
$1,270 (the same amount
required by the facility prior
to the amendment).
Debt to total capitalization
ratio................... Not more than 32.5% from 28% Reduction to shareholders'
March 31, 2009 through equity of approximately $615
June 30, 2010 and thereafter, million or additional debt of
not more than 30% (the same $295 million.
ratio required by the facility
prior to the amendment).
Interest coverage ratio..... Greater than or equal to 1.50 2.35 to 1 Reduction in cash flows to
to 1 for rolling four quarters the holding company of
from March 31, 2009 through approximately $45 million.
June 30, 2010 and thereafter,
2.00 to 1 (the same ratio
required by the facility prior
to the amendment).
------------
(a) Calculated as if the amendments made to the financial covenants on
March 30, 2009 (applicable to the period March 31, 2009 through June
30, 2010) were effective on December 31, 2008.
|
Pursuant to its amended terms, the applicable interest rate on the Second Amended Credit Facility (based on either a Eurodollar or base rate) has increased. The Eurodollar rate is now 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 is now 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 requires the Company to pay a fee equal to 1 percent of the outstanding principal balance under the Second Amended Credit Facility, which fee will be added to the principal balance outstanding and will be payable at the maturity of the facility. This 1 percent fee will be reported as non-cash interest expense.
The modifications to the Second Amended Credit Facility also place 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 Second Amended Credit Facility (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 is permitted to issue unsecured indebtedness that is used solely to pay the holders of the Debentures, provided that such indebtedness shall: (i) have a maturity date that is no earlier than October 10, 2014; (ii) contain covenants and events of default that are no more restrictive than those in the Second Amended Credit Facility; (iii) not contain any covenants or events of default based on maintenance of the Company's financial condition; (iv) not amortize; and (v) 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 shall not exceed the $293 million of 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 Debentures, shall not exceed twice the amount of cash interest currently payable on the outstanding Debentures.
The amendment prohibits the Company from redeeming or purchasing the Debentures with cash from sources other than those described in the previous paragraph. The amendment permits the Company to amend, modify or refinance the Convertible Indebtedness so long as such new indebtedness complies with the restrictions set forth in the previous paragraph.
In addition, pursuant to the terms of the amended debt agreement, the lenders have the right to appoint a steering committee which 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.
Pursuant to GAAP, the amendment to the Second Amended Credit Facility is required to be accounted for in accordance with Statement of Financial Accounting Standards No. 15, "Accounting by Debtors and Creditors for Troubled Debt Restructurings". Accordingly, the effects of the modifications will be accounted for prospectively from March 31, 2009, and we will not change the $911.8 million carrying amount of the Second Amended Credit Facility as a result of the modifications. However, the estimated $9.0 million of fees incurred in conjunction with the modifications of the facility will be expensed in the first quarter of 2009.
Ratings changes
A.M. Best, Moody's and S&P recently downgraded the financial strength ratings of our primary insurance subsidiaries as summarized below:
Rating agency Date of change Previous rating New rating Outlook
------------- -------------- --------------- ---------- -------
A.M. Best March 4, 2009 B+ B Under review
with negative
implications
Moody's March 3, 2009 Ba1 Ba2 Negative
S&P February 26, 2009 BB+ BB- Negative
|
On March 2, 2009, S&P placed the financial strength ratings of our primary insurance subsidiaries on credit watch with negative implications. A rating on credit watch with negative implications highlights the potential direction of a rating focusing on identifiable events and short-term trends that cause ratings to be placed under special surveillance by S&P. A "negative" designation means that a rating may be lowered.
Approval of dividends and surplus debenture interest payments
On March 30, 2009, the Texas Department of Insurance approved the payment of $25 million of extraordinary dividends from Conseco Life Insurance Company of Texas to CDOC. In addition, on March 13, 2009, the March 31, 2009 surplus debenture interest payments from Conseco Life Insurance Company of Texas to CDOC totaling approximately $10 million were approved for payment by the Texas Department of Insurance on or after March 31, 2009 and the June 30, 2009 surplus debenture interest payments totaling approximately $11 million were approved for payment on or after June 30, 2009.
Approval of Permitted Practices
In February 2009, we requested and obtained approval of a statutory permitted accounting practice as of December 31, 2008 for our insurance subsidiaries domiciled in Illinois and Indiana. The permitted practice modifies the accounting for deferred income taxes by increasing the realization period for deferred tax assets from within one year to within three years of the balance sheet date and increasing the asset recognition limit from 10 percent to 15 percent of adjusted capital and surplus as shown in the most recently filed statutory financial statements. The impact of the permitted practice was to increase the statutory consolidated capital and surplus of our insurance subsidiaries by $61.9 million as of December 31, 2008. In addition, the consolidated risk-based capital ratio increased by 11 percentage points and, as a result, the Company did not need to take additional actions in order to meet the risk-based capital financial covenant requirement at December 31, 2008. The benefit of this permitted practice may not be considered by our insurance subsidiaries when determining surplus available for dividends.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A. CONTROLS AND PROCEDURES.
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. As a result, Conseco's Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2006, Conseco's disclosure controls and procedures were not effective.
These control deficiencies resulted in the misstatement of our insurance policy benefits, amortization expense, the liabilities for insurance products and the value of policies inforce at the Effective Date and related disclosures in the consolidated financial statements, and in the restatement of our consolidated financial statements for 2006 and 2005, each of the quarters of 2006 and the first three quarters of 2007. Consequently, Conseco's Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2007, Conseco's disclosure controls and procedures were not effective.
Remediation efforts to enhance controls over the actuarial reporting process continued in 2008 under the direction of the Chief Financial Officer. 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. Control deficiencies in the actuarial reporting process related to the design of controls over the completeness and accuracy of certain inforce policies in our Bankers Life and Other Business in Run-off segment (currently classified as discontinued operations) were remediated, and the new controls were determined to be effective.
However, a material weakness relating to the actuarial reporting process in our Conseco Insurance Group segment continued to exist as of December 31, 2008. As a result, the Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2008, 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, 2008. 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 our annual or interim financial statements would not be prevented or detected on a timely basis. Conseco's management has concluded that, as of December 31, 2008, 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, amortization expense, the liabilities for insurance products and the value of policies inforce at the Effective Date. Specifically, the design of controls over the actuarial reporting process to ensure the completeness and accuracy of certain inforce policies in our Conseco Insurance Group segment was not effective. These control deficiencies resulted in an audit adjustment to Conseco's consolidated financial statements during the fourth quarter of 2008. Additionally, these control deficiencies could result in a material misstatement of the aforementioned accounts and disclosures 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, 2008 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, 2008, 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 the actuarial reporting internal control environment and the control deficiencies in our Bankers Life and our former Other Business in Run-off segment were remediated in 2008. Nonetheless, the material weakness related to the design of controls to ensure the completeness and accuracy of certain inforce policies in our Conseco Insurance Group continued to exist as of December 31, 2008. 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 2009. 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 is essential. The most significant remaining weaknesses to be addressed by our remediation efforts relates to the flow of information from the administrative systems to the actuarial processes for specified disease policies in our Conseco Insurance Group segment. Correcting these weaknesses will allow Conseco to reduce its reliance on manual controls and procedures. Conseco intends to continue to develop improved systems and processes which will allow it to rely on front-end preventative controls which will be more sustainable over the long term. Conseco recognizes that further investment is needed to improve the actuarial reporting processes and is committed to making the investments for these improvements.
Changes to Internal Control Over Financial Reporting. Other than 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, 2008, that have materially affected, or are reasonably likely to materially affect, Conseco's internal control over financial reporting.
ITEM 9B. OTHER INFORMATION.
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
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."
ITEM 11. EXECUTIVE COMPENSATION.
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.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
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.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
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.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
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.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) 1. Financial Statements. See Index to Consolidated Financial Statements on page 110 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.
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 31st day of March, 2009.
CONSECO, INC.
By: /s/ C. James Prieur
--------------------
C. James Prieur
Chief Executive Officer
|
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
Signature Title (Capacity) Date --------- ---------------- ---- /s / C. JAMES PRIEUR Director and Chief Executive Officer March 31, 2009 ------------------------------------ (Principal Executive Officer) C. James Prieur /s / EDWARD J. BONACH Executive Vice President March 31, 2009 ------------------------------------ and Chief Financial Officer Edward J. Bonach (Principal Financial Officer) /s / JOHN R. KLINE Senior Vice President March 31, 2009 ------------------------------------ and Chief Accounting Officer John R. Kline (Principal Accounting Officer) /s / R. GLENN HILLIARD Director March 31, 2009 ------------------------------------ R. Glenn Hilliard /s / NEAL SCHNEIDER Director March 31, 2009 ------------------------------------ Neal Schneider /s / PHILIP R. ROBERTS Director March 31, 2009 ------------------------------------ Philip R. Roberts /s / JOHN G. TURNER Director March 31, 2009 ------------------------------------ John G. Turner /s / MICHAEL T. TOKARZ Director March 31, 2009 ------------------------------------ Michael T. Tokarz /s / MICHAEL S. SHANNON Director March 31, 2009 ------------------------------------ Michael S. Shannon /s / DEBRA J. PERRY Director March 31, 2009 ------------------------------------ Debra J. Perry /s / DONNA A. JAMES Director March 31, 2009 ------------------------------------ Donna A. James /s / DOREEN A. WRIGHT Director March 31, 2009 ------------------------------------ Doreen A. Wright |
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 31, 2009 appearing under Item 8 of this Form 10-K also included an audit of the financial statement schedules at December 31, 2008 and 2007 and for the years ended December 31, 2008, 2007 and 2006 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 18 to the consolidated financial statements, certain events occurred subsequent to December 31, 2008, which include an amendment to the Company's Second Amended Credit Facility, certain rating agency downgrades and the obtainment of certain insurance regulatory agency approvals.
/s/ PricewaterhouseCoopers LLP ------------------------------ Indianapolis, Indiana March 31, 2009 |
CONSECO, INC. AND SUBSIDIARIES
SCHEDULE II
Condensed Financial Information of Registrant (Parent Company) Balance Sheet as of December 31, 2008 and 2007
(Dollars in millions)
ASSETS
2008 2007
---- ----
Cash and cash equivalents - unrestricted.................................................. $ 56.5 $ 84.3
Cash and cash equivalents - restricted.................................................... - 1.9
Other invested assets..................................................................... .1 .2
Investment in wholly-owned subsidiaries (eliminated in consolidation)..................... 3,261.6 5,596.9
Receivable from subsidiaries (eliminated in consolidation)................................ .8 6.6
Income tax assets, net.................................................................... - 2.2
Other assets.............................................................................. 23.5 36.4
--------- --------
Total assets.................................................................... $ 3,342.5 $5,728.5
========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable......................................................................... $ 1,328.7 $1,193.7
Payable to subsidiaries (eliminated in consolidation)................................. 261.0 241.5
Income tax liabilities, net........................................................... 69.8 -
Other liabilities..................................................................... 63.8 57.4
--------- --------
Total liabilities............................................................... 1,723.3 1,492.6
--------- --------
Commitments and Contingencies
Shareholders' equity:
Common stock and additional paid-in capital ($.01 par value, 8,000,000,000
shares authorized, shares issued and outstanding: 2008 - 184,753,758;
2007 - 184,652,017) ............................................................... 4,077.9 4,070.5
Accumulated other comprehensive loss.................................................. (1,770.7) (273.3)
Retained earnings (accumulated deficit)............................................... (688.0) 438.7
--------- --------
Total shareholders' equity...................................................... 1,619.2 4,235.9
--------- --------
Total liabilities and shareholders' equity...................................... $ 3,342.5 $5,728.5
========= ========
|
The accompanying notes are an integral part of the condensed financial information.
CONSECO, INC. AND SUBSIDIARIES
SCHEDULE II
Condensed Financial Information of Registrant (Parent Company) Statement of Operations for the years ended December 31, 2008, 2007 and 2006
(Dollars in millions)
2008 2007 2006
---- ---- ----
Revenues:
Net investment income................................................. $ 2.3 $ 3.6 $ 1.9
Net realized investment losses........................................ (25.9) - -
Fee and interest income from subsidiaries (eliminated in
consolidation)...................................................... .7 3.1 .7
--------- ------- ------
Total revenues.................................................... (22.9) 6.7 2.6
--------- ------- ------
Expenses:
Interest expense on notes payable..................................... 59.2 72.3 52.9
Intercompany expenses (eliminated in consolidation)................... 8.3 15.8 15.2
Costs related to a litigation settlement.............................. - 32.2 8.9
Operating costs and expenses.......................................... 34.2 41.2 35.6
(Gain) loss on extinguishment of debt................................. (21.2) - .7
--------- ------- ------
Total expenses.................................................... 80.5 161.5 113.3
--------- ------- ------
Loss before income taxes and equity in
undistributed earnings of subsidiaries............................ (103.4) (154.8) (110.7)
Income tax expense (benefit):
Income tax benefit on period income................................... (36.0) (62.1) (41.7)
Valuation allowance for deferred tax assets........................... 54.1 - -
--------- ------- ------
Loss before equity in undistributed
earnings of subsidiaries and discontinued operations............ (121.5) (92.7) (69.0)
Equity in undistributed earnings of subsidiaries
(eliminated in consolidation)......................................... (282.5) 18.7 174.7
--------- ------- ------
Income (loss) before discontinued operations............................. (404.0) (74.0) 105.7
Discontinued operations, net of income taxes:
Parent company........................................................ (166.3) - -
Subsidiary............................................................ (556.4) (105.9) .3
--------- ------- ------
Net income (loss)................................................. (1,126.7) (179.9) 106.0
Preferred stock dividends................................................ - 14.1 38.0
--------- ------- ------
Income (loss) applicable to common stock.......................... $(1,126.7) $(194.0) $ 68.0
========= ======= ======
|
The accompanying notes are an integral part of the condensed financial information.
CONSECO, INC. AND SUBSIDIARIES
SCHEDULE II
Condensed Financial Information of Registrant (Parent Company)
Statement of Cash Flows
for the years ended December 31, 2008, 2007 and 2006
(Dollars in millions)
2008 2007 2006
---- ---- ----
Cash flows used by operating activities..................................... $(97.4) $(126.6) $(39.4)
------ ------- ------
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) .4
Change in restricted cash................................................ 1.9 (1.8) 1.9
------ ------- ------
Net cash used by investing activities.............................. (48.0) (87.8) 2.3
------ ------- ------
Cash flows from financing activities:
Issuance of notes payable, net........................................... 75.0 200.0 196.7
Issuance of common stock................................................. - 3.4 1.0
Payments to repurchase common stock...................................... - (87.2) -
Payments on notes payable................................................ (44.0) (7.8) (48.0)
Issuance of notes payable to affiliates*................................. 148.0 223.8 324.9
Payments on notes payable to affiliates*................................. (61.4) (110.3) (393.1)
Dividends paid on preferred stock........................................ - (19.0) (38.0)
------ ------- ------
Net cash provided by financing activities.......................... 117.6 202.9 43.5
------ ------- ------
Net increase (decrease) in cash and cash
equivalents...................................................... (27.8) (11.5) 6.4
Cash and cash equivalents, beginning of the year......................... 84.3 95.8 89.4
------ ------- ------
Cash and cash equivalents, end of the year............................... $ 56.5 $ 84.3 $ 95.8
====== ======= ======
* Eliminated in consolidation
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The accompanying notes are an integral part of the condensed financial information.
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. We have reclassified certain amounts in our 2007 and 2006 consolidated financial statements and notes to conform with the 2008 presentation.
CONSECO, INC. AND SUBSIDIARIES
SCHEDULE IV
Reinsurance
for the years ended December 31, 2008, 2007 and 2006
(Dollars in millions)
2008 2007 2006
---- ---- ----
Life insurance inforce:
Direct................................................................ $65,271.1 $67,831.1 $69,674.2
Assumed............................................................... 1,129.8 873.5 860.5
Ceded................................................................. (13,805.9) (14,717.2) (16,583.4)
--------- --------- ---------
Net insurance inforce........................................... $52,595.0 $53,987.4 $53,951.3
========= ========= =========
Percentage of assumed to net.................................... 2.1% 1.6% 1.6%
=== === ===
|
2008 2007 2006
---- ---- ----
Insurance policy income:
Direct................................................................ $2,438.0 $2,445.9 $2,444.1
Assumed............................................................... 641.0 307.8 115.1
Ceded................................................................. (164.0) (202.4) (212.4)
-------- -------- --------
Net premiums.................................................... $2,915.0 $2,551.3 $2,346.8
======== ======== ========
Percentage of assumed to net.................................... 22.0% 12.1% 4.9%
==== ==== ===
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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 17,
2009, incorporated by reference to Exhibit 3.2 of our Current Report
on Form 8-K filed February 23, 2009.
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.
4.4 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.
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 and 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.
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.
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 October 6, 2006
between 40|86 Advisors, Inc. and Eric R. Johnson, incorporated by
reference to Exhibit 10.12 of our Current Report on Form 8-K filed
October 12, 2006, as amended by Amendment dated as of October 14, 2008
filed herewith.
10.13 Conseco, Inc. 2003 Amended and Restated Long-Term Incentive Plan.
10.14 Form of executive stock option agreement under Conseco, Inc. 2003
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. 2003
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.
|
Exhibit
No. Description
--- -----------
10.16 Form of Indemnification Agreement among Conseco, Inc., CDOC, Inc.,
Conseco Services, LLC and each director of Conseco, Inc.
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.
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. 2003
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.
10.27 Employment Agreement dated as of September 8, 2005 between Conseco
Services, LLC and Christopher J. Nickele, incorporated by reference to
Exhibit 10.27 of our Quarterly Report on Form 10-Q for the quarter
ended September 30, 2006.
10.28 Employment Agreement dated as of October 1, 2008 between Conseco
Services, LLC and Scott R. Perry.
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.
10.33 Employment Agreement dated as of May 8, 2007 between Conseco Services,
LLC and Mark E. Alberts incorporated by reference to Exhibit 10.33 of
our Quarterly Report on Form 10-Q for the quarter ended June 30, 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.
|
Exhibit
No. Description
--- -----------
10.35 Employment Agreement effective as of December 10, 2007 between Conseco
Services, LLC and Dan R. Bardin, incorporated by reference to Exhibit
10.35 of our Annual Report on Form 10-K for the year ended December
31, 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.
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 October 6, 2006
between 40|86 Advisors, Inc. and Eric R. Johnson, incorporated by
reference to Exhibit 10.12 of our Current Report on Form 8-K filed
October 12, 2006, as amended by Amendment dated as of October 14, 2008
filed herewith.
10.13 Conseco, Inc. 2003 Amended and Restated Long-Term Incentive Plan.
10.14 Form of executive stock option agreement under Conseco, Inc. 2003
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. 2003
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.
|
Exhibit
No. Description
--- -----------
10.20 Conseco, Inc. Pay for Performance Incentive Plan, as amended.
10.22 Form of performance unit award agreement under the Conseco, Inc. 2003
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.
10.27 Employment Agreement dated as of September 8, 2005 between Conseco
Services, LLC and Christopher J. Nickele, incorporated by reference to
Exhibit 10.27 of our Quarterly Report on Form 10-Q for the quarter
ended September 30, 2006.
10.28 Employment Agreement dated as of October 1, 2008 between Conseco
Services, LLC and Scott R. Perry.
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.
10.33 Employment Agreement dated as of May 8, 2007 between Conseco Services,
LLC and Mark E. Alberts, incorporated by reference to Exhibit 10.33 of
our Quarterly Report on Form 10-Q for the quarter ended June 30, 2007.
10.35 Employment Agreement effective December 10, 2007 between Conseco
Services, LLC and Dan R. Bardin, incorporated by reference to Exhibit
10.35 of our Annual Report on Form 10-K for the year ended December
31, 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.
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.
|
This AMENDMENT TO AMENDED AND RESTATED EMPLOYMENT AGREEMENT is entered into the 14th day of October, 2008, between 40|86 Advisors, Inc. (the "Company") and Eric R. Johnson ("Executive").
A. The Company and Executive entered into an Amended and Restated Employment Agreement dated as of October 6, 2006 and an Amendment to Employment Agreement dated September 25, 2007 (collectively, the "Agreement").
B. The Company and Executive desire to further amend the Agreement to extend its Term (as defined in the Agreement) and to make the other changes set forth herein.
NOW, THEREFORE, in consideration of the foregoing and the mutual covenants contained herein, the receipt and sufficiency of which are hereby acknowledged:
1. Section 2 of the Agreement is hereby amended solely to change the ending date of the Term from September 10, 2008 to September 10, 2009. All other provisions of Section 2 of the Agreement shall remain unchanged.
2. Section 5(b) of the Agreement is hereby amended solely to change "2008 bonus" in the penultimate sentence to "2009 bonus." All other provisions of Section 5(b) of the Agreement shall remain unchanged.
3. A new Section 21 is hereby added to the Agreement to read as follows:
21. Section 409A. Notwithstanding anything to the contrary in the Agreement, if Executive is a "specified employee" within the meaning of Section 409A of the Internal Revenue Code, as amended (the "Code"), at the time of Executive's separation from service, and if any payment or benefit otherwise payable to Executive by the terms of this Agreement is considered to be non-qualified deferred compensation under the Code, then the Company shall delay any such payment or benefit to Executive until the earliest date permitted under Section 409A of the Code without causing Executive to incur excise tax.
4. All provisions of the Agreement not amended hereby shall remain in full force and effect.
IN WITNESS WHEREOF, the parties have executed this Amendment to Employment Agreement as of the date first above written.
40|86 ADVISORS, INC.
By:/s/ Karl W. Kindig
-------------------------------
Printed: Karl W. Kindig
--------------------------
Title: Assistant Secretary
----------------------------
/s/ Eric R. Johnson
----------------------------------
Eric R. Johnson
|
Exhibit 10.13
CONSECO, INC.
2003 AMENDED AND RESTATED LONG-TERM INCENTIVE PLAN
CONSECO, INC.
2003 AMENDED AND RESTATED LONG-TERM INCENTIVE PLAN
Page
----
1. Purpose....................................................................................................... 3
2. Definitions................................................................................................... 3
3. Administration................................................................................................ 4
4. Stock Subject to Plan......................................................................................... 5
5. Eligibility; Per-Person Award Limitations..................................................................... 6
6. Specific Terms of Awards...................................................................................... 7
7. Performance-Based Compensation............................................................................... 11
8. Certain Provisions Applicable to Awards...................................................................... 13
9. Change in Control............................................................................................ 14
10. Additional Award Forfeiture Provisions....................................................................... 14
11. General Provisions........................................................................................... 16
|
CONSECO, INC.
2003 AMENDED AND RESTATED LONG-TERM INCENTIVE PLAN
1. Purpose. The purpose of this 2003 Amended and Restated Long-Term Incentive Plan (the "Plan") is to aid Conseco Inc., a Delaware corporation (together with its successors and assigns, the "Company"), in attracting, retaining, motivating and rewarding certain employees and non-employee directors of the Company or its subsidiaries or affiliates, to provide for equitable and competitive compensation opportunities, to recognize individual contributions and reward achievement of Company goals, and promote the creation of long-term value for stockholders by closely aligning the interests of Participants with those of stockholders. The Plan authorizes stock based incentives for Participants.
2. Definitions. In addition to the terms defined in Section 1 above and elsewhere in the Plan, the following capitalized terms used in the Plan have the respective meanings set forth in this Section:
(a) "Annual Limit" shall have the meaning specified in Section 5(b).
(b) "Award" means any Option, SAR, Restricted Stock, Restricted Stock Unit, Stock granted as a bonus or in lieu of another award, Dividend Equivalent, Other Stock-Based Award or Performance Award, together with any related right or interest, granted to a Participant under the Plan.
(c) "Beneficiary" means the legal representatives of the Participant's estate entitled by will or the laws of descent and distribution to receive the benefits under a Participant's Award upon a Participant's death, provided that, if and to the extent authorized by the Committee, a Participant may be permitted to designate a Beneficiary, in which case the "Beneficiary" instead will be the person, persons, trust or trusts (if any are then surviving) which have been designated by the Participant in his or her most recent written and duly filed beneficiary designation to receive the benefits specified under the Participant's Award upon such Participant's death.
(d) "Board" means the Company's Board of Directors.
(e) "Code" means the Internal Revenue Code of 1986, as amended. References to any provision of the Code or regulation thereunder shall include any successor provisions and regulations, and reference to regulations includes any applicable guidance or pronouncement of the Department of the Treasury and Internal Revenue Service.
(f) "Committee" means the Human Resources and Compensation Committee of the Board, the composition and governance of which is established in the Committee's Charter as approved from time to time by the Board and subject to Section 303A.05 of the Listed Company Manual of the New York Stock Exchange, and other corporate governance documents of the Company. No action of the Committee shall be void or deemed to be without authority due to the failure of any member, at the time the action was taken, to meet any qualification standard set forth in the Committee Charter or the Plan. The full Board may perform any function of the Committee hereunder except to the extent limited under Section 303A.05 of the Listed Company Manual, in which case the term "Committee" shall refer to the Board.
(g) "Covered Employee" means an Eligible Person who is a Covered Employee as specified in Section 11(j).
(h) "Dividend Equivalent" means a right, granted under this Plan, to receive cash, Stock, other Awards or other property equal in value to all or a specified portion of the dividends paid with respect to a specified number of shares of Stock.
(i)"Effective Date" means the effective date specified in Section 11(p).
(j)"Eligible Person" has the meaning specified in Section 5.
(k) "Exchange Act" means the Securities Exchange Act of 1934, as amended. References to any provision of the Exchange Act or rule (including a proposed rule) thereunder shall include any successor provisions and rules.
(l) "Fair Market Value" means the fair market value of Stock, Awards or
other property as determined in good faith by the Committee or under
procedures established by the Committee. Unless otherwise determined
by the Committee, the Fair Market Value of Stock shall be the
officially-quoted closing selling price of the Stock on the principal
stock exchange or market on which Stock is traded on the day as of
which such value is being determined or, if there is no sale on that
day, then on the last previous day on which a sale was reported. Fair
Market Value relating to the exercise price or base price of any
Non-409A Option or SAR shall conform to requirements under Code
Section 409A.
(m) "409A Awards" means Awards that constitute a deferral of compensation under Code Section 409A and regulations thereunder. "Non-409A Awards" means Awards other than 409A Awards. Although the Committee retains authority under the Plan to grant Options, SARs and Restricted Stock on terms that will qualify those Awards as 409A Awards, Options, SARs exercisable for Stock, and Restricted Stock will be Non-409A Awards unless otherwise expressly specified by the Committee.
(n) "Incentive Stock Option" or "ISO" means any Option designated as an incentive stock option within the meaning of Code Section 422 and qualifying thereunder.
(o) "Option" means a right, granted under the Plan, to purchase Stock.
(p) "Other Stock-Based Awards" means Awards granted to a Participant under
Section 6(h).
(q) "Participant" means a person who has been granted an Award under the Plan which remains outstanding, including a person who is no longer an Eligible Person.
(r) "Performance Award" means a conditional right, granted to a Participant under Sections 6(i) and 7, to receive cash, Stock or other Awards or payments.
(s) "Restricted Stock" means Stock granted under the Plan which is subject to certain restrictions and to a risk of forfeiture.
(t) "Restricted Stock Unit" or "RSU" means a right, granted under the Plan, to receive Stock, cash or other Awards or a combination thereof at the end of a specified deferral period.
(u) "Retirement" means, unless otherwise stated in an applicable Award agreement, Participant's voluntary termination of employment after achieving 65 years of age.
(v) "Rule 16b-3" means Rule 16b-3, as from time to time in effect and applicable to Participants, promulgated by the Securities and Exchange Commission under Section 16 of the Exchange Act.
(w) "Stock" means the Company's Common Stock, par value $0.01 per share, and any other equity securities of the Company that may be substituted or resubstituted for Stock pursuant to Section 11(c).
(x) "Stock Appreciation Rights" or "SAR" means a right granted to a Participant under Section 6(c).
3. Administration.
(a) Authority of the Committee. The Plan shall be administered by the Committee, which shall have full and final authority, in each case subject to and consistent with the provisions of the Plan, to select Eligible Persons to become Participants; to grant Awards; to determine the type and number
of Awards, the dates on which Awards may be exercised and on which the risk of forfeiture or deferral period relating to Awards shall lapse or terminate, the acceleration of any such dates, the expiration date of any Award, whether, to what extent, and under what circumstances an Award may be settled, or the exercise price of an Award may be paid, in cash, Stock, other Awards, or other property, and other terms and conditions of, and all other matters relating to, Awards; to prescribe documents evidencing or setting terms of Awards (such Award documents need not be identical for each Participant), amendments thereto, and rules and regulations for the administration of the Plan and amendments thereto (including outstanding Awards); to construe and interpret the Plan and Award documents and correct defects, supply omissions or reconcile inconsistencies therein; and to make all other decisions and determinations as the Committee may deem necessary or advisable for the administration of the Plan. Decisions of the Committee with respect to the administration and interpretation of the Plan shall be final, conclusive, and binding upon all persons interested in the Plan, including Participants, Beneficiaries, transferees under Section 11(b) and other persons claiming rights from or through a Participant, and stockholders.
(b) Manner of Exercise of Committee Authority. The express grant of any
specific power to the Committee, and the taking of any action by the
Committee, shall not be construed as limiting any power or authority
of the Committee. The Committee may act through subcommittees,
including for purposes of perfecting exemptions under Rule 16b-3 or
qualifying Awards under Code Section 162(m) as performance-based
compensation, in which case the subcommittee shall be subject to and
have authority under the charter applicable to the Committee, and the
acts of the subcommittee shall be deemed to be acts of the Committee
hereunder. The Committee may delegate the administration of the Plan
to one or more officers or employees of the Company, and such
administrator(s) may have the authority to execute and distribute
Award agreements or other documents evidencing or relating to Awards
granted by the Committee under this Plan, to maintain records relating
to Awards, to process or oversee the issuance of Stock under Awards,
to interpret and administer the terms of Awards and to take such other
actions as may be necessary or appropriate for the administration of
the Plan and of Awards under the Plan, provided that in no case shall
any such administrator be authorized (i) to grant Awards under the
Plan, (ii) to take any action that would result in the loss of an
exemption under Rule 16b-3 for Awards granted to or held by
Participants who at the time are subject to Section 16 of the Exchange
Act in respect of the Company or that would cause Awards intended to
qualify as "performance-based compensation" under Code Section 162(m)
to fail to so qualify, (iii) to take any action inconsistent with
Section 157 and other applicable provisions of the Delaware General
Corporation Law, or (iv) to make any determination required to be made
by the Committee under the New York Stock Exchange corporate
governance standards applicable to listed company compensation
committees (currently, Rule 303A.05). Any action by any such
administrator within the scope of its delegation shall be deemed for
all purposes to have been taken by the Committee and, except as
otherwise specifically provided, references in this Plan to the
Committee shall include any such administrator. The Committee (and, to
the extent it so provides, any subcommittee) shall have sole authority
to determine whether to review any actions and/or interpretations of
any such administrator, and if the Committee shall decide to conduct
such a review, any such actions and/or interpretations of any such
administrator shall be subject to approval, disapproval or
modification by the Committee.
(c) Limitation of Liability. The Committee and each member thereof, and any person acting pursuant to authority delegated by the Committee, shall be entitled, in good faith, to rely or act upon any report or other information furnished by any executive officer, other officer or employee of the Company or a subsidiary or affiliate, the Company's independent auditors, consultants or any other agents assisting in the administration of the Plan. Members of the Committee, any person acting pursuant to authority delegated by the Committee, and any officer or employee of the Company or a subsidiary or affiliate acting at the direction or on behalf of the Committee or a delegee shall not be personally liable for any action or determination taken or made in good faith with respect to the Plan, and shall, to the extent permitted by law, be fully indemnified and protected by the Company with respect to any such action or determination.
4. Stock Subject To Plan.
(a) Overall Number of Shares Available for Delivery. The total number of shares of Stock reserved for delivery in connection with Awards under this Plan shall be 10,000,000 shares. The total number of shares available is subject to adjustment as provided in Section 11(c). Any shares of Stock delivered under the Plan shall consist of authorized and unissued shares or treasury shares. No more than 10,000,000 shares may be delivered hereunder as ISOs.
(b) Share Counting Rules. The Committee may adopt reasonable counting procedures to ensure appropriate counting, avoid double counting (as, for example, in the case of tandem or substitute awards) and make adjustments in accordance with this Section 4(b). Shares shall be counted against those reserved to the extent such shares have been delivered and are no longer subject to a risk of forfeiture. To the extent that an Award under the Plan is canceled, expired, forfeited, settled in cash, settled by issuance of fewer shares than the number underlying the award, or otherwise terminated without delivery of shares to the Participant, the shares retained by or returned to the Company will be available under the Plan; and shares that are withheld from such an award or separately surrendered by the Participant in payment of any exercise price or taxes relating to such an award shall be deemed to constitute shares not delivered to the Participant and will be available under the Plan. In addition, in the case of any Award granted in assumption of or in substitution for an award of a company or business acquired by the Company or a subsidiary or affiliate or with which the Company or a subsidiary or affiliate combines, shares issued or issuable in connection with such substitute Award shall not be counted against the number of shares reserved under the Plan.
5. Eligibility; Per-Person Award Limitations.
(a) Eligibility. Awards may be granted under the Plan only to Eligible Persons. For purposes of the Plan, an "Eligible Person" means (i) an employee of the Company or any subsidiary or affiliate, including any person who has been offered employment by the Company or a subsidiary or affiliate, provided that such prospective employee may not receive any payment or exercise any right relating to an Award until such person has commenced employment with the Company or a subsidiary or affiliate, (ii) any non-employee directors of the Company or (iii) other individuals who perform services for the Company or any subsidiary or affiliate. An employee on leave of absence may be considered as still in the employ of the Company or a subsidiary or affiliate for purposes of eligibility for participation in the Plan, if so determined by the Committee. For purposes of the Plan, a joint venture in which the Company or a subsidiary has a substantial direct or indirect equity investment shall be deemed an affiliate, if so determined by the Committee. Holders of awards who will become Eligible Persons granted by a company or business acquired by the Company or a subsidiary or affiliate, or with which the Company or a subsidiary or affiliate combines, are eligible for grants of substitute awards granted in assumption of or in substitution for such outstanding awards previously granted under the Plan in connection with such acquisition or combination transaction, if so determined by the Committee.
(b) Per-Person Award Limitations. In each calendar year during any part of which the Plan is in effect, an Eligible Person may be granted Awards under each of Section 6(b) through (i) relating to up to his or her Annual Limit (such Annual Limit to apply separately to the type of Award authorized under each specified subsection). A Participant's Annual Limit, in any year during any part of which the Participant is then eligible under the Plan, shall equal 1,000,000 shares plus the amount of the Participant's unused Annual Limit relating to the same type of Award as of the close of the previous year, subject to adjustment as provided in Section 11(c). In the case of an Award which is not valued in a way in which the limitation set forth in the preceding sentence would operate as an effective limitation satisfying applicable law (including Treasury Regulation 1.162-27(e)(4)), an Eligible Person may not be granted Awards authorizing the earning during any calendar year of an amount that exceeds the Eligible Person's Annual Limit, which for this purpose shall equal $4 million plus the amount of the Eligible Person's unused cash Annual Limit as of the close of the previous year (this limitation is separate and not affected by the number of Awards granted during such calendar year subject to the limitation in the preceding sentence). For this
purpose, (i) "earning" means satisfying performance conditions so that an amount becomes payable, without regard to whether it is to be paid currently or on a deferred basis or continues to be subject to any service requirement or other non-performance condition, and (ii) a Participant's Annual Limit is used to the extent an amount or number of shares may be potentially earned or paid under an Award, regardless of whether such amount or shares are in fact earned or paid.
6. Specific Terms of Awards.
(a) General. Awards may be granted on the terms and conditions set forth in this Section 6. In addition, the Committee may impose on any Award or the exercise thereof, at the date of grant or thereafter (subject to Sections 11(e) and 11(k)), such additional terms and conditions, not inconsistent with the provisions of the Plan, as the Committee shall determine, including terms requiring forfeiture of Awards in the event of termination of employment or service by the Participant and terms permitting a Participant to make elections relating to his or her Award. The Committee shall retain full power and discretion with respect to any term or condition of an Award that is not mandatory under the Plan, subject to Section 11(k). The Committee shall require the payment of lawful consideration for an Award to the extent necessary to satisfy the requirements of the Delaware General Corporation Law, and may otherwise require payment of consideration for an Award except as limited by the Plan.
(b) Options. The Committee is authorized to grant Options to Participants on the following terms and conditions:
(i) Exercise Price. The exercise price per share of Stock purchasable under an Option (including both ISOs and non-qualified Options) shall be determined by the Committee, provided that, notwithstanding anything contained herein to the contrary such exercise price shall be (A) fixed as of the grant date, and (B) not less than the Fair Market Value of a share of Stock on the grant date. Notwithstanding the foregoing, any substitute award granted in assumption of or in substitution for an outstanding award granted by a company or business acquired by the Company or a subsidiary or affiliate, or with which the Company or a subsidiary or affiliate combines, may be granted with an exercise price per share of Stock other than as required above.
(ii) No Repricing. Without the approval of stockholders, the Committee will not amend or replace previously granted Options in a transaction that constitutes a "repricing," as such term is used in Section 303A.08 of the Listed Company Manual of the New York Stock Exchange.
(iii)Option Term; Time and Method of Exercise. The Committee shall
determine the term of each Option, provided that in no event
shall the term of any Option exceed a period of ten years from
the date of grant. The Committee shall determine the time or
times at which or the circumstances under which an Option may be
exercised in whole or in part. In addition, the Committee shall
determine the methods by which such exercise price may be paid or
deemed to be paid and the form of such payment (subject to
Section 11(k)), including, without limitation, cash, Stock
(including by withholding Stock deliverable upon exercise), other
Awards or awards granted under other plans of the Company or any
subsidiary or affiliate, or other property (including through
broker-assisted "cashless exercise" arrangements, to the extent
permitted by applicable law), and the methods by or forms in
which Stock will be delivered or deemed to be delivered in
satisfaction of Options to Participants.
(iv) ISOs. Notwithstanding anything to the contrary in this Section 6, in the case of the grant of an Option intending to qualify as an ISO: (i) if the Participant owns stock possessing more than 10 percent of the combined voting power of all classes of stock of the Company (a "10% Shareholder"), the purchase price of such Option must be at least 110 percent of the fair market value of the Common Stock on the date of grant and the Option must expire within a period of not more than five (5) years from the date of grant, and (ii) termination of employment will occur when the person to whom an Award was granted ceases to be an employee (as
determined in accordance with Section 3401(c) of the Code and the regulations promulgated thereunder) of the Company and its subsidiaries. Notwithstanding anything in this Section 6 to the contrary, Options designated as ISOs shall not be eligible for treatment under the Code as ISOs to the extent that either (iii) the aggregate fair market value of shares of Common Stock (determined as of the time of grant) with respect to which such Options are exercisable for the first time by the Participant during any calendar year (under all plans of the Company and any Subsidiary) exceeds $100,000, taking Options into account in the order in which they were granted, and (iv) such Options otherwise remain exercisable but are not exercised within three (3) months of termination of employment (or such other period of time provided in Section 422 of the Code).
(c) Stock Appreciation Rights. The Committee is authorized to grant SARs to Participants on the following terms and conditions:
(i) Right to Payment. An SAR shall confer on the Participant to whom it is granted a right to receive, upon exercise thereof, shares of Stock having a value equal to the excess of (A) the Fair Market Value of one share of Stock on the date of exercise (or, in the case of a "Limited SAR," the Fair Market Value determined by reference to the change in control price, as defined under the applicable award agreement) over (B) the exercise or settlement price of the SAR as determined by the Committee. Stock Appreciation Rights may be granted to Participants from time to time either in tandem with or as a component of other Awards granted under the Plan ("tandem SARs") or not in conjunction with other Awards ("freestanding SARs") and may, but need not, relate to a specific Option granted under Section 6(b). The per share price for exercise or settlement of SARs (including both tandem SARs and freestanding SARs) shall be determined by the Committee, but in the case of SARs that are granted in tandem to an Option shall not be less than the exercise price of the Option and in the case of freestanding SARs shall be (A) fixed as of the grant date, and (B) not less than the Fair Market Value of a share of Stock on the grant date.
(ii) No Repricing. Without the approval of stockholders, the Committee will not amend or replace previously granted SARs in a transaction that constitutes a "repricing," as such term is used in Section 303A.08 of the Listed Company Manual of the New York Stock Exchange.
(iii)Other Terms. The Committee shall determine the term of each SAR, provided that in no event shall the term of an SAR exceed a period of ten years from the date of grant. The Committee shall determine at the date of grant or thereafter, the time or times at which and the circumstances under which a SAR may be exercised in whole or in part (including based on future service requirements), the method of exercise, method of settlement, method by or forms in which Stock will be delivered or deemed to be delivered to Participants, and whether or not a SAR shall be free-standing or in tandem or combination with any other Award. Limited SARs that may only be exercised in connection with a change in control or termination of service following a change in control as specified by the Committee may be granted on such terms, not inconsistent with this Section 6(c), as the Committee may determine. The Committee may require that an outstanding Option be exchanged for an SAR exercisable for Stock having vesting, expiration, and other terms substantially the same as the Option, so long as such exchange will not result in additional accounting expense to the Company.
(d) Restricted Stock. The Committee is authorized to grant Restricted Stock to Participants on the following terms and conditions:
(i) Award and Restrictions. Subject to Section 6(d)(ii), Restricted Stock shall be subject to such restrictions on transferability, risk of forfeiture and other restrictions, if any, as the Committee may impose, which restrictions may lapse separately or in combination at such times, under such circumstances, in such installments or otherwise and under such other circumstances as the Committee may determine at the date of grant or thereafter. Except to the extent restricted under the terms of the Plan and any Award document relating to the Restricted Stock, a
Participant granted Restricted Stock shall have all of the rights of a stockholder, including the right to vote the Restricted Stock and the right to receive dividends thereon (subject to any mandatory reinvestment or other requirement imposed by the Committee).
(ii) Forfeiture. Except as otherwise determined by the Committee, upon termination of employment or service during the applicable restriction period, Restricted Stock that is at that time subject to restrictions shall be forfeited and reacquired by the Company; provided that the Committee may provide, by rule or regulation or in any Award document, or may determine in any individual case, that restrictions or forfeiture conditions relating to Restricted Stock will lapse in whole or in part, including in the event of terminations resulting from specified causes.
(iii)Limitation on Vesting. The grant, issuance, retention, vesting and/or settlement of Restricted Stock shall occur at such time and in such installments as determined by the Committee or under criteria established by the Committee. Subject to Section 10, the Committee shall have the right to make the timing of the grant and/or the issuance, ability to retain, vesting and/or settlement of Restricted Stock subject to continued employment, passage of time and/or such performance conditions as deemed appropriate by the Committee; provided that the grant, issuance, retention, vesting and/or settlement of a Restricted Stock Award that is based in whole or in part on performance conditions and/or the level of achievement versus such performance conditions shall be subject to a performance period of not less than one year, and any Award based solely upon continued employment or the passage of time shall vest over a period not less than three years from the date the Award is made, provided that such vesting may occur ratably over the three-year period. The foregoing minimum vesting conditions need not apply (A) in the case of the death, disability or Retirement of the Participant or termination in connection with a Change in Control, (B) with respect to up to an aggregate of 5% of the shares of Stock authorized under the Plan, which may be granted (or regranted upon forfeiture) as Restricted Stock or RSUs without regard to such minimum vesting requirements and (C) with respect to non-employee director awards.
(iv) Certificates for Stock. Restricted Stock granted under the Plan may be evidenced in such manner as the Committee shall determine. If certificates representing Restricted Stock are registered in the name of the Participant, the Committee may require that such certificates bear an appropriate legend referring to the terms, conditions and restrictions applicable to such Restricted Stock, that the Company retain physical possession of the certificates, and that the Participant deliver a stock power to the Company, endorsed in blank, relating to the Restricted Stock.
(v) Dividends and Splits. As a condition to the grant of an Award of Restricted Stock, the Committee may require that any dividends paid on a share of Restricted Stock shall be either (A) paid with respect to such Restricted Stock at the dividend payment date in cash, in kind, or in a number of shares of unrestricted Stock having a Fair Market Value equal to the amount of such dividends, or (B) automatically reinvested in additional Restricted Stock or held in kind, which shall be subject to the same terms as applied to the original Restricted Stock to which it relates. Unless otherwise determined by the Committee, Stock distributed in connection with a Stock split or Stock dividend, and other property distributed as a dividend, shall be subject to restrictions and a risk of forfeiture to the same extent as the Restricted Stock with respect to which such Stock or other property has been distributed.
(e) Restricted Stock Units. The Committee is authorized to grant RSUs to Participants, subject to the following terms and conditions:
(i) Award and Restrictions. Subject to Section 6(e)(ii), RSUs shall be subject to such restrictions on transferability, risk of forfeiture and other restrictions, if any, as the Committee may impose, which restrictions may lapse separately or in combination at such times, under such circumstances (including based on achievement of performance conditions and/or future service requirements), in such installments or otherwise and under such other circumstances as
the Committee may determine at the date of grant or thereafter. A Participant granted RSUs shall not have any of the rights of a stockholder, including the right to vote, until Stock shall have been issued in the Participant's name pursuant to the RSUs, except that the Committee may provide for dividend equivalents pursuant to Section 6(e)(iii) below.
(ii) Limitation on Vesting. The grant, issuance, retention, vesting and/or settlement of RSUs shall occur at such time and in such installments as determined by the Committee or under criteria established by the Committee. Subject to Section 10, the Committee shall have the right to make the timing of the grant and/or the issuance, ability to retain, vesting and/or settlement of RSUs subject to continued employment, passage of time and/or such performance conditions as deemed appropriate by the Committee; provided that the grant, issuance, retention, vesting and/or settlement of an RSU that is based in whole or in part on performance conditions and/or the level of achievement versus such performance conditions shall be subject to a performance period of not less than one year, and any Award based solely upon continued employment or the passage of time shall vest over a period not less than three years from the date the Award is made, provided that such vesting may occur ratably over the three-year period. The foregoing minimum vesting conditions need not apply (A) in the case of the death, disability or Retirement of the Participant or termination in connection with a Change in Control, and (B) with respect to up to an aggregate of 5% of the shares of Stock authorized under the Plan, which may be granted (or regranted upon forfeiture) as Restricted Stock or RSUs without regard to such minimum vesting requirements.
(iii)Dividend Equivalents. Unless otherwise determined by the Committee, dividend equivalents on the specified number of shares of Stock covered by an Award of RSUs shall be either (A) paid with respect to such RSUs at the dividend payment date in cash or in shares of unrestricted Stock having a Fair Market Value equal to the amount of such dividends, or (B) deferred with respect to such RSUs, either as a cash deferral or with the amount or value thereof automatically deemed reinvested in additional RSUs, other Awards or other investment vehicles having a Fair Market Value equal to the amount of such dividends, as the Committee shall determine or permit a Participant to elect.
(f) Bonus Stock and Awards in Lieu of Obligations. The Committee is authorized to grant Stock as a bonus, or to grant Stock or other Awards in lieu of obligations of the Company or a subsidiary or affiliate to pay cash or deliver other property under the Plan or under other plans or compensatory arrangements, subject to such terms as shall be determined by the Committee.
(g) Dividend Equivalents. The Committee is authorized to grant Dividend Equivalents to a Participant, which may be awarded on a free-standing basis or in connection with another Award, provided, however, that if Dividend Equivalents are payable with respect to an Option, such Dividend Equivalents will be payable either as declared or on a specified vesting date, but may not be payable solely with respect to the Participant's date of exercise. The Committee may provide that Dividend Equivalents shall be paid or distributed when accrued or shall be deemed to have been reinvested in additional Stock, Awards, or other investment vehicles, and subject to restrictions on transferability, risks of forfeiture and such other terms as the Committee may specify.
(h) Other Stock-Based Awards. The Committee is authorized, subject to limitations under applicable law, to grant to Participants such other Awards that may be denominated or payable in, valued in whole or in part by reference to, or otherwise based on, or related to, Stock or factors that may influence the value of Stock, including, without limitation, convertible or exchangeable debt securities, other rights convertible or exchangeable into Stock, purchase rights for Stock, Awards with value and payment contingent upon performance of the Company or business units thereof or any other factors designated by the Committee, and Awards valued by reference to the book value of Stock or the value of securities of or the performance of specified subsidiaries or affiliates or other business units. The Committee shall determine the terms and conditions of such Awards. Stock delivered pursuant to an Award in
the nature of a purchase right granted under this Section 6(h) shall be purchased for such consideration, paid for at such times, by such methods, and in such forms, including, without limitation, cash, Stock, other Awards, notes, or other property, as the Committee shall determine. Cash awards, as an element of or supplement to any other Award under the Plan, may also be granted pursuant to this Section 6(h).
(i) Performance Awards. Performance Awards, denominated in cash or in Stock or other Awards, may be granted by the Committee in accordance with Section 7.
7. Performance-Based Compensation.
(a) Performance Awards Generally. Performance Awards may be denominated as a cash amount, number of shares of Stock, or specified number of other Awards (or a combination) which may be earned upon achievement or satisfaction of performance conditions specified by the Committee. In addition, the Committee may specify that any other Award shall constitute a Performance Award by conditioning the right of a Participant to exercise the Award or have it settled, and the timing thereof, upon achievement or satisfaction of such performance conditions as may be specified by the Committee. The Committee may use such business criteria and other measures of performance as it may deem appropriate in establishing any performance conditions, and may exercise its discretion to reduce or increase the amounts payable under any Award subject to performance conditions, except as limited under Sections 7(b) and 7(c) in the case of a Performance Award intended to qualify as "performance-based compensation" under Section 162(m).
(b) Performance Awards Granted to Covered Employees. If the Committee
determines that a Performance Award to be granted to an Eligible
Person who is designated by the Committee as likely to be a Covered
Employee should qualify as "performance-based compensation" for
purposes of Section 162(m), the grant, exercise and/or settlement of
such Performance Award shall be contingent upon achievement of a
pre-established performance goal and other terms set forth in this
Section 7(b).
(i) Performance Goal Generally. The performance goal for such Performance Awards shall consist of one or more business criteria and a targeted level or levels of performance with respect to each of such criteria, as specified by the Committee consistent with this Section 7(b). The performance goal shall be objective and shall otherwise meet the requirements of Code Section 162(m) and regulations thereunder, including the requirement that the level or levels of performance targeted by the Committee result in the achievement of performance goals being "substantially uncertain." The Committee may determine that such Performance Awards shall be granted, exercised and/or settled upon achievement of any one performance goal or that two or more of the performance goals must be achieved as a condition to grant, exercise and/or settlement of such Performance Awards. Performance goals may differ for Performance Awards granted to any one Participant or to different Participants.
(ii) Business Criteria. For purposes of this Plan, a "performance
goal" shall mean any one or more of the following business
criteria, in each case as specified by the Committee: (1) gross
or net revenue, premiums collected, new annualized premiums, and
investment income, (2) any earnings or net income measure,
including earnings from operations, earnings before taxes,
earnings before interest and/or taxes and/or depreciation,
statutory earnings before realized gains (losses), or net income
available to common shareholders, (3) operating earnings per
common share (either basic or diluted); (4) return on assets,
return on investment, return on capital, return on equity, or
return on tangible equity; (5) economic value created; (6)
operating margin or profit margin; (7) net interest margin; (8)
asset quality; (9) stock price or total stockholder return; and
(10) strategic business criteria, consisting of one or more
objectives based on meeting specified market penetration, total
market capitalization, business retention, new product
generation, rate
increase actions, geographic business expansion goals, cost targets (including cost of capital), investment portfolio yield, risk-based capital, statutory capital, Best Capital Adequacy Ratio, tax net operating loss utilization, customer satisfaction, employee satisfaction, agency ratings, management of employment practices and employee benefits, supervision of litigation and information technology, and goals relating to acquisitions or divestitures of subsidiaries, affiliates or joint ventures. The targeted level or levels of performance with respect to such business criteria may be established at such levels and in such terms as the Committee may determine, in its discretion, including in absolute terms, on a per share basis (either basic or diluted), as a goal relative to performance in prior periods, or as a goal compared to the performance of one or more comparable companies or an index covering multiple companies.
(iii)Performance Period; Timing for Establishing Performance Goals. Achievement of performance goals in respect of such Performance Awards shall be measured over a performance period of up to one year or more than one year, as specified by the Committee. A performance goal shall be established not later than the earlier of (A) 90 days after the beginning of any performance period applicable to such Performance Award or (B) the time 25% of such performance period has elapsed.
(iv) Performance Award Pool. The Committee may establish a Performance
Award pool, which shall be an unfunded pool, for purposes of
measuring performance of the Company in connection with
Performance Awards. The amount of such Performance Award pool
shall be based upon the achievement of a performance goal or
goals based on one or more of the business criteria set forth in
Section 7(b)(ii) during the given performance period, as
specified by the Committee in accordance with Section 7(b)(iv).
The Committee may specify the amount of the Performance Award
pool as a percentage of any of such business criteria, a
percentage thereof in excess of a threshold amount, or as another
amount which need not bear a strictly mathematical relationship
to such business criteria.
(v) Settlement of Performance Awards; Other Terms. Settlement of Performance Awards shall be in cash, Stock, other Awards or other property, in the discretion of the Committee. The Committee may, in its discretion, increase or reduce the amount of a settlement otherwise to be made in connection with such Performance Awards, but may not exercise discretion to increase any such amount payable to a Covered Employee in respect of a Performance Award subject to this Section 7(b). Any settlement which changes the form of payment from that originally specified shall be implemented in a manner such that the Performance Award and other related Awards do not, solely for that reason, fail to qualify as "performance-based compensation" for purposes of Section 162(m). The Committee shall specify the circumstances in which such Performance Awards shall be paid or forfeited in the event of termination of employment by the Participant or other event (including a change in control) prior to the end of a performance period or settlement of such Performance Awards.
(vi) Recapture Rights. If at any time after the date on which a
Participant has been granted or becomes vested in an Award
pursuant to the achievement of a performance goal under Section
7, the Committee determines that the earlier determination as to
the achievement of the performance goal was based on incorrect
data and that in fact the performance goal had not been achieved
or had been achieved to a lesser extent than originally
determined and a portion of an Award would not have been granted,
vested or paid, given the correct data, then (i) such portion of
the Award that was granted shall be forfeited and any related
shares (or if such shares were disposed of the cash equivalent)
shall be returned to the Company as provided by the Committee,
(ii) such portion of the Award that became vested shall be deemed
to be not vested and any related shares (or if such shares were
disposed of the cash equivalent) shall be returned to the Company
as provided by the Committee, and (iii) such portion of the Award
paid to the Participant shall be paid by the
Participant to the Company upon notice from the Company as provided by the Committee.
(c) Written Determinations. Determinations by the Committee as to the establishment of performance goals, the amount potentially payable in respect of Performance Awards, the level of actual achievement of the specified performance goals shall be recorded in writing in the case of Performance Awards intended to qualify under Section 162(m). Specifically, the Committee shall certify in writing, in a manner conforming to applicable regulations under Section 162(m), prior to settlement of each such Award granted to a Covered Employee, that the performance objective relating to the Performance Award and other material terms of the Award upon which settlement of the Award was conditioned have been satisfied.
8. Certain Provisions Applicable To Awards.
(a) Stand-Alone, Additional, Tandem, and Substitute Awards. Awards granted under the Plan may, in the discretion of the Committee, be granted either alone or in addition to, in tandem with, or in substitution or exchange for, any other Award or any award granted under another plan of the Company, any subsidiary or affiliate, or any business entity to be acquired by the Company or a subsidiary or affiliate, or any other right of a Participant to receive payment from the Company or any subsidiary or affiliate; provided, however, that a 409A Award may not be granted in tandem with a Non-409A Award. Awards granted in addition to or in tandem with other Awards or awards may be granted either as of the same time as or a different time from the grant of such other Awards or awards. Subject to Section 11(k), the Committee may determine that, in granting a new Award, the in-the-money value or fair value of any surrendered Award or award or the value of any other right to payment surrendered by the Participant may be applied to reduce the exercise price of any Option, grant price of any SAR, or purchase price of any other Award.
(b) Term of Awards. The term of each Award shall be for such period as may be determined by the Committee, subject to the express limitations set forth in the Plan.
(c) Form and Timing of Payment under Awards; Deferrals. Subject to the
terms of the Plan (including Section 11(k)) and any applicable Award
document, payments to be made by the Company or a subsidiary or
affiliate upon the exercise of an Option or other Award or settlement
of an Award may be made in such forms as the Committee shall
determine, including, without limitation, cash, Stock, other Awards or
other property, and may be made in a single payment or transfer, in
installments, or on a deferred basis. The settlement of any Award may
be accelerated, and cash paid in lieu of Stock in connection with such
settlement, in the discretion of the Committee or upon occurrence of
one or more specified events, subject to Section 11(k)). Subject to
Section 11(k), installment or deferred payments may be required by the
Committee (subject to Section 11(e)) or permitted at the election of
the Participant on terms and conditions established by the Committee.
Subject to Section 11(k), payments may include, without limitation,
provisions for the payment or crediting of reasonable interest on
installment or deferred payments or the grant or crediting of Dividend
Equivalents or other amounts in respect of installment or deferred
payments denominated in Stock. In the case of any 409A Award that is
vested and no longer subject to a risk of forfeiture (within the
meaning of Code Section 83), such Award will be distributed to the
Participant, upon application of the Participant, if the Participant
has had an unforeseeable emergency within the meaning of Code Sections
409A(a)(2)(A)(vi) and 409A(a)(2)(B)(ii), in accordance with Section
409A(a)(2)(B)(ii).
(d) Limitation on Vesting of Certain Awards. Subject to Section 8, Restricted Stock will vest over a minimum period of three years except in the event of a Participant's death, disability, or retirement, or in the event of a change in control or other special circumstances. The foregoing notwithstanding, (i) Restricted Stock as to which either the grant or vesting is based on, among other things, the achievement of one or more performance conditions generally will vest over a
minimum period of one year except in the event of a Participant's
death, disability, or retirement, or in the event of a change in
control or other special circumstances, and (ii) up to 5% of the
shares of Stock authorized under the Plan may be granted as Restricted
Stock without any minimum vesting requirements. For purposes of this
Section 8(d)(i), a performance period that precedes the grant of the
Restricted Stock will be treated as part of the vesting period if the
participant has been notified promptly after the commencement of the
performance period that he or she has the opportunity to earn the
Award based on performance and continued service, and (ii) vesting
over a three-year period or one-year period will include periodic
vesting over such period if the rate of such vesting is proportional
(or less rapid) throughout such period.
(e) Cash Settlement of Awards. To the extent permitted by the Committee at the time of grant or thereafter, the Company may deliver cash in full or partial satisfaction, payment and/or settlement upon exercise, cancellation, forfeiture or surrender of any Award.
9. Change in Control. The Committee may set forth in any Award agreement the effect, if any, that a change in control or other, similar transaction shall have on any awards granted under this Plan.
10. Additional Award Forfeiture Provisions.
(a) Forfeiture of Options and Other Awards and Gains Realized Upon Prior Option Exercises or Award Settlements. Unless otherwise determined by the Committee, each Award granted hereunder, other than Awards granted to non-employee directors, shall be subject to the following additional forfeiture conditions, to which the Participant, by accepting an Award hereunder, agrees. If any of the events specified in Section 10(b)(i), (ii), or (iii) occurs (a "Forfeiture Event"), all of the following forfeitures will result:
(i) The unexercised portion of each Option held by the Participant, whether or not vested, and any other Award not then settled will be immediately forfeited and canceled upon the occurrence of the Forfeiture Event; and
(ii) The Participant will be obligated to repay to the Company, in cash, within five business days after demand is made therefor by the Company, the total amount of Award Gain (as defined herein) realized by the Participant upon each exercise of an Option or settlement of an Award that occurred on or after (A) the date that is six months prior to the occurrence of the Forfeiture Event, if the Forfeiture Event occurred while the Participant was employed by the Company or a subsidiary or affiliate, or (B) the date that is six months prior to the date the Participant's employment by the Company or a subsidiary or affiliate terminated, if the Forfeiture Event occurred after the Participant ceased to be so employed. For purposes of this Section, the term "Award Gain" shall mean (i), in respect of a given Option exercise, the product of (X) the Fair Market Value per share of Stock at the date of such exercise (without regard to any subsequent change in the market price of shares) minus the exercise price times (Y) the number of shares as to which the Option was exercised at that date, and (ii), in respect of any other settlement of an Award granted to the Participant, the Fair Market Value of the cash or Stock paid or payable to Participant (regardless of any elective deferral) less any cash or the Fair Market Value of any Stock or property (other than an Award or award which would have itself then been forfeitable hereunder and excluding any payment of tax withholding) paid by the Participant to the Company as a condition of or in connection such settlement.
(b) Events Triggering Forfeiture. The forfeitures specified in Section 10(a) will be triggered upon the occurrence of any one of the following Forfeiture Events at any time during Participant's employment by the Company or a subsidiary or affiliate, or during the one-year period following termination of such employment:
(i) Participant, acting alone or with others, directly or indirectly,
(A) engages, either as employee, employer, consultant, advisor,
or director, or as an owner, investor, partner, or stockholder
unless Participant's interest is insubstantial, in any business
in an area or region in which the Company conducts business at
the date the event occurs, which is directly in competition with
a business then conducted by the Company or a subsidiary or
affiliate; (B) induces any customer or supplier of the Company or
a subsidiary or affiliate, with which the Company or a subsidiary
or affiliate has a business relationship, to curtail, cancel, not
renew, or not continue his or her or its business with the
Company or any subsidiary or affiliate; or (C) induces, or
attempts to influence, any employee of or service provider to the
Company or a subsidiary or affiliate to terminate such employment
or service. The Committee shall, in its discretion, determine
which lines of business the Company conducts on any particular
date and which third parties may reasonably be deemed to be in
competition with the Company. For purposes of this Section
10(b)(i), a Participant's interest as a stockholder is
insubstantial if it represents beneficial ownership of less than
five percent of the outstanding class of stock, and a
Participant's interest as an owner, investor, or partner is
insubstantial if it represents ownership, as determined by the
Committee in its discretion, of less than five percent of the
outstanding equity of the entity;
(ii) Participant discloses, uses, sells, or otherwise transfers, except in the course of employment with or other service to the Company or any subsidiary or affiliate, any confidential or proprietary information of the Company or any subsidiary or affiliate, including but not limited to information regarding the Company's current and potential customers, organization, employees, finances, and methods of operations and investments, so long as such information has not otherwise been disclosed to the public or is not otherwise in the public domain (other than by Participant's breach of this provision), except as required by law or pursuant to legal process, or Participant makes statements or representations, or otherwise communicates, directly or indirectly, in writing, orally, or otherwise, or takes any other action which may, directly or indirectly, disparage or be damaging to the Company or any of its subsidiaries or affiliates or their respective officers, directors, employees, advisors, businesses or reputations, except as required by law or pursuant to legal process; or
(iii)Participant fails to cooperate with the Company or any subsidiary or affiliate in any way, including, without limitation, by making himself or herself available to testify on behalf of the Company or such subsidiary or affiliate in any action, suit, or proceeding, whether civil, criminal, administrative, or investigative, or otherwise fails to assist the Company or any subsidiary or affiliate in any way, including, without limitation, in connection with any such action, suit, or proceeding by providing information and meeting and consulting with members of management of, other representatives of, or counsel to, the Company or such subsidiary or affiliate, as reasonably requested.
(c) Agreement Does Not Prohibit Competition or Other Participant Activities. Although the conditions set forth in this Section 10 shall be deemed to be incorporated into an Award, a Participant is not thereby prohibited from engaging in any activity, including but not limited to competition with the Company and its subsidiaries and affiliates. Rather, the non-occurrence of the Forfeiture Events set forth in Section 10(b) is a condition to the Participant's right to realize and retain value from his or her compensatory Options and Awards, and the consequence under the Plan if the Participant engages in an activity giving rise to any such Forfeiture Event are the forfeitures specified herein. The Company and Participant shall not be precluded by this provision or otherwise from entering into other agreements concerning the subject matter of Sections 10(a) and 10(b).
(d) Committee Discretion. The Committee may, in its discretion, waive in whole or in part the Company's right to forfeiture under this Section, but no such waiver shall be effective unless evidenced by a writing signed by a duly authorized officer of the Company. In addition, the
Committee may impose additional conditions on Awards, by inclusion of appropriate provisions in the document evidencing or governing any such Award.
11. General Provisions.
(a) Compliance with Legal and Other Requirements. The Company may, to the
extent deemed necessary or advisable by the Committee and subject to
Section 11(k), postpone the issuance or delivery of Stock or payment
of other benefits under any Award until completion of such
registration or qualification of such Stock or other required action
under any federal or state law, rule or regulation, listing or other
required action with respect to any stock exchange or automated
quotation system upon which the Stock or other securities of the
Company are listed or quoted, or compliance with any other obligation
of the Company, as the Committee may consider appropriate, and may
require any Participant to make such representations, furnish such
information and comply with or be subject to such other conditions as
it may consider appropriate in connection with the issuance or
delivery of Stock or payment of other benefits in compliance with
applicable laws, rules, and regulations, listing requirements, or
other obligations.
(b) Limits on Transferability; Beneficiaries. No Award or other right or interest of a Participant under the Plan shall be pledged, hypothecated or otherwise encumbered or subject to any lien, obligation or liability of such Participant to any party (other than the Company or a subsidiary or affiliate thereof), or assigned or transferred by such Participant otherwise than by will or the laws of descent and distribution or to a Beneficiary upon the Participant's death, and such Awards or rights that may be exercisable shall be exercised during the lifetime of the Participant only by the Participant or his or her guardian or legal representative. A Beneficiary, transferee, or other person claiming any rights under the Plan from or through any Participant shall be subject to all terms and conditions of the Plan and any Award document applicable to such Participant, except as otherwise determined by the Committee, and to any additional terms and conditions deemed necessary or appropriate by the Committee.
(c) Adjustments. In the event that any large, special and non-recurring dividend or other distribution (whether in the form of cash or property other than Stock), recapitalization, forward or reverse split, Stock dividend, reorganization, merger, consolidation, spin-off, combination, repurchase, share exchange, liquidation, dissolution or other similar corporate transaction or event affects the Stock such that an adjustment is determined by the Committee to be appropriate, then the Committee shall, in an equitable manner as determined by the Committee, adjust any or all of (i) the number and kind of shares of Stock or other securities of the Company or other issuer which are subject to the Plan, (ii) the number and kind of shares of Stock or other securities of the Company or other issuer by which annual per-person Award limitations are measured under Section 5, including the share limits applicable to non-employee director Awards under Section 5(c), (iii) the number and kind of shares of Stock or other securities of the Company or other issuer subject to or deliverable in respect of outstanding Awards and (iv) the exercise price, settlement price or purchase price relating to any Award or, if deemed appropriate, the Committee may make provision for a payment of cash or property to the holder of an outstanding Option or other Award. In addition, the Committee is authorized to make adjustments in the terms and conditions of, and the criteria included in, Awards (including performance-based Awards and performance goals and any hypothetical funding pool relating thereto) in recognition of unusual or nonrecurring events (including, without limitation, events described in the preceding sentence, as well as acquisitions and dispositions of businesses and assets, or in response to changes in applicable laws, regulations, or accounting principles) affecting any performance conditions; provided that no such adjustment shall be authorized or made if and to the extent that the existence of such authority (i) would cause Options, SARs, or Performance Awards granted under the Plan to Participants designated by the Committee as Covered Employees and intended to qualify as "performance-based compensation" under Code Section 162(m)
and regulations thereunder to otherwise fail to qualify as "performance-based compensation" under Code Section 162(m) and regulations thereunder, or (ii) would cause the Committee to be deemed to have authority to change the targets, within the meaning of Treasury Regulation 1.162-27(e)(4)(vi), under the performance goals relating to Options or SARs granted to Covered Employees and intended to qualify as "performance-based compensation" under Code Section 162(m) and regulations thereunder.
(d) Tax Provisions.
(i) Withholding. The Company and any subsidiary or affiliate is authorized to withhold from any Award granted, any payment relating to an Award under the Plan, including from a distribution of Stock, or any payroll or other payment to a Participant, amounts of withholding and other taxes due or potentially payable in connection with any transaction or event involving an Award, or to require a Participant to remit to the Company an amount in cash or other property (including Stock) to satisfy such withholding before taking any action with respect to an Award, and to take such other action as the Committee may deem advisable to enable the Company and Participants to satisfy obligations for the payment of withholding taxes and other tax obligations relating to any Award. This authority shall include authority to withhold or receive Stock or other property and to make cash payments in respect thereof in satisfaction of a Participant's withholding obligations, either on a mandatory or elective basis in the discretion of the Committee, or in satisfaction of other tax obligations. The Company can delay the delivery to a Participant of Stock under any Award to the extent necessary to allow the Company to determine the amount of withholding to be collected and to collect and process such withholding.
(ii) Required Consent to and Notification of Code Section 83(b)
Election. No election under Section 83(b) of the Code (to include
in gross income in the year of transfer the amounts specified in
Code Section 83(b)) or under a similar provision of the laws of a
jurisdiction outside the United States may be made unless
expressly permitted by the terms of the Award document or by
action of the Committee in writing prior to the making of such
election. In any case in which a Participant is permitted to make
such an election in connection with an Award, the Participant
shall notify the Company of such election within ten days of
filing notice of the election with the Internal Revenue Service
or other governmental authority, in addition to any filing and
notification required pursuant to regulations issued under Code
Section 83(b) or other applicable provision.
(iii)Requirement of Notification Upon Disqualifying Disposition Under
Code Section 421(b). If any Participant shall make any
disposition of shares of Stock delivered pursuant to the exercise
of an ISO under the circumstances described in Code Section
421(b) (i.e., a disqualifying disposition), such Participant
shall notify the Company of such disposition within ten days
thereof.
(e) Changes to the Plan. The Board may amend, suspend or terminate the Plan or the Committee's authority to grant Awards under the Plan without the consent of stockholders or Participants; provided, however, that any amendment to the Plan shall be submitted to the Company's stockholders for approval not later than the earliest annual meeting for which the record date is at or after the date of such Board action:
(i) if such stockholder approval is required by any federal or state law or regulation or the rules of the New York Stock Exchange or any other stock exchange or automated quotation system on which the Stock may then be listed or quoted; or
(ii) if such amendment would materially increase the number of shares reserved for issuance and delivery under the Plan; or
(iii)if such amendment would alter the provisions of the Plan restricting the Company's ability to grant Options or SARs with an exercise price that is not less than the Fair Market Value of Stock; or
(iv) in connection with any action to amend or replace previously granted Options or SARs in a transaction that constitutes a "repricing," as such term is used in Section 303A.08 of the Listed Company Manual of the New York Stock Exchange.
The Board may otherwise, in its discretion, determine to submit other amendments to the Plan to stockholders for approval; and provided further, that, without the consent of an affected Participant, no such Board (or any Committee) action may materially and adversely affect the rights of such Participant under any outstanding Award (for this purpose, actions that alter the timing of federal income taxation of a Participant will not be deemed material unless such action results in an income tax penalty on the Participant). With regard to other terms of Awards, the Committee shall have no authority to waive or modify any such Award term after the Award has been granted to the extent the waived or modified term would be mandatory under the Plan for any Award newly granted at the date of the waiver or modification.
(f) Right of Setoff. The Company or any subsidiary or affiliate may, to the extent permitted by applicable law, deduct from and set off against any amounts the Company or a subsidiary or affiliate may owe to the Participant from time to time (including amounts payable in connection with any Award, owed as wages, fringe benefits, or other compensation owed to the Participant), such amounts as may be owed by the Participant to the Company, including but not limited to amounts owed under Section 10(a), although the Participant shall remain liable for any part of the Participant's payment obligation not satisfied through such deduction and setoff. By accepting any Award granted hereunder, the Participant agrees to any deduction or setoff under this Section 11(f).
(g) Unfunded Status of Awards; Creation of Trusts. To the extent that any Award is deferred compensation, the Plan is intended to constitute an "unfunded" plan for deferred compensation with respect to such Award. With respect to any payments not yet made to a Participant or obligation to deliver Stock pursuant to an Award, nothing contained in the Plan or any Award shall give any such Participant any rights that are greater than those of a general creditor of the Company; provided that the Committee may authorize the creation of trusts and deposit therein cash, Stock, other Awards or other property, or make other arrangements to meet the Company's obligations under the Plan. Such trusts or other arrangements shall be consistent with the "unfunded" status of the Plan unless the Committee otherwise determines with the consent of each affected Participant.
(h) Nonexclusivity of the Plan. Neither the adoption of the Plan by the
Board nor its submission to the stockholders of the Company for
approval shall be construed as creating any limitations on the power
of the Board or a committee thereof to adopt such other incentive
arrangements, apart from the Plan, as it may deem desirable, including
incentive arrangements and awards which do not qualify under Code
Section 162(m), and such other arrangements may be either applicable
generally or only in specific cases.
(i) Payments in the Event of Forfeitures; Fractional Shares. No fractional shares of Stock shall be issued or delivered pursuant to the Plan or any Award. The Committee shall determine whether cash, other Awards or other property shall be issued or paid in lieu of such fractional shares or whether such fractional shares or any rights thereto shall be forfeited or otherwise eliminated.
(j) Compliance with Code Section 162(m). It is the intent of the Company that Options and SARs granted to Covered Employees and other Awards designated as Awards to Covered Employees subject to Section 7 shall constitute qualified "performance-based compensation" within the meaning of Code Section 162(m) and regulations thereunder, unless otherwise determined by
the Committee at the time of allocation of an Award. Accordingly, the terms of Sections 7(b) and (c), including the definitions of Covered Employee and other terms used therein, shall be interpreted in a manner consistent with Code Section 162(m) and regulations thereunder. The foregoing notwithstanding, because the Committee cannot determine with certainty whether a given Participant will be a Covered Employee with respect to a fiscal year that has not yet been completed, the term Covered Employee as used herein shall mean only a person designated by the Committee as likely to be a Covered Employee with respect to a specified fiscal year. If any provision of the Plan or any Award document relating to a Performance Award that is designated as intended to comply with Code Section 162(m) does not comply or is inconsistent with the requirements of Code Section 162(m) or regulations thereunder, such provision shall be construed or deemed amended to the extent necessary to conform to such requirements, and no provision shall be deemed to confer upon the Committee or any other person discretion to increase the amount of compensation otherwise payable in connection with any such Award upon attainment of the applicable performance objectives.
(k) Certain Limitations on Awards to Ensure Compliance with Code Section
409A. For purposes of this Plan, references to an award term or event
(including any authority or right of the Company or a Participant)
being "permitted" under Section 409A mean, for a 409A Award, that the
term or event will not cause the Participant to be liable for payment
of interest or a tax penalty under Section 409A and, for a Non-409A
Award, that the term or event will not cause the Award to be treated
as subject to Section 409A. Other provisions of the Plan
notwithstanding, the terms of any 409A Award and any Non-409A Award,
including any authority of the Company and rights of the Participant
with respect to the Award, shall be limited to those terms permitted
under Section 409A, and any terms not permitted under Section 409A
shall be automatically modified and limited to the extent necessary to
conform with Section 409A. For this purpose, other provisions of the
Plan notwithstanding, the Company shall have no authority to
accelerate distributions relating to 409A Awards in excess of the
authority permitted under Section 409A, and any distribution subject
to Section 409A(a)(2)(A)(i) (separation from service) to a "key
employee" as defined under Section 409A(a)(2)(B)(i), shall not occur
earlier than the earliest time permitted under Section
409A(a)(2)(B)(i).
(l) Governing Law. The validity, construction, and effect of the Plan, any rules and regulations relating to the Plan and any Award document shall be determined in accordance with the laws of the State of Delaware, without giving effect to principles of conflicts of laws, and applicable provisions of federal law.
(m) Awards to Participants Outside the United States. The Committee may modify the terms of any Award under the Plan made to or held by a Participant who is then resident or primarily employed outside of the United States in any manner deemed by the Committee to be necessary or appropriate in order that such Award shall conform to laws, regulations, and customs of the country in which the Participant is then resident or primarily employed, or so that the value and other benefits of the Award to the Participant, as affected by foreign tax laws and other restrictions applicable as a result of the Participant's residence or employment abroad shall be comparable to the value of such an Award to a Participant who is resident or primarily employed in the United States. An Award may be modified under this Section 11(m) in a manner that is inconsistent with the express terms of the Plan, so long as such modifications will not contravene any applicable law or regulation or result in actual liability under Section 16(b) for the Participant whose Award is modified.
(n) Limitation on Rights Conferred under Plan. Neither the Plan nor any action taken hereunder shall be construed as (i) giving any Eligible Person or Participant the right to continue as an Eligible Person or Participant or in the employ or service of the Company or a subsidiary or affiliate, (ii) interfering in any way with the right of the Company or a subsidiary or affiliate to terminate any Eligible Person's or Participant's employment or service at any time (subject to the terms and provisions of any separate written agreements), (iii) giving an Eligible Person or
Participant any claim to be granted any Award under the Plan or to be treated uniformly with other Participants and employees, or (iv) conferring on a Participant any of the rights of a stockholder of the Company unless and until the Participant is duly issued or transferred shares of Stock in accordance with the terms of an Award or an Option is duly exercised. Except as expressly provided in the Plan and an Award document, neither the Plan nor any Award document shall confer on any person other than the Company and the Participant any rights or remedies thereunder.
(o) Severability; Entire Agreement. If any of the provisions of the Plan or any Award document is finally held to be invalid, illegal or unenforceable (whether in whole or in part), such provision shall be deemed modified to the extent, but only to the extent, of such invalidity, illegality or unenforceability, and the remaining provisions shall not be affected thereby; provided, that, if any of such provisions is finally held to be invalid, illegal, or unenforceable because it exceeds the maximum scope determined to be acceptable to permit such provision to be enforceable, such provision shall be deemed to be modified to the minimum extent necessary to modify such scope in order to make such provision enforceable hereunder. The Plan and any agreements or documents designated by the Committee as setting forth the terms of an Award contain the entire agreement of the parties with respect to the subject matter thereof and supersede all prior agreements, promises, covenants, arrangements, communications, representations and warranties between them, whether written or oral with respect to the subject matter thereof.
(p) Plan Effective Date and Termination. The Plan as hereby amended shall become effective if, and at such time as, the stockholders of the Company have approved it in accordance with applicable law and stock exchange requirements. Unless earlier terminated by action of the Board of Directors, the authority of the Committee to make grants under the Plan shall terminate on the date that is ten years after the latest date upon which stockholders of the Company have approved the Plan, and the Plan will remain in effect until such time as no Stock remains available for delivery under the Plan or as set forth above and the Company has no further rights or obligations under the Plan with respect to outstanding Awards under the Plan.
Exhibit 10.16
This INDEMNIFICATION AGREEMENT (the "Agreement") is made as of February 17, 2009 by and among Conseco, Inc., a Delaware corporation (the "Company"), CDOC, Inc., a Delaware corporation and wholly-owned subsidiary of the Company ("CDOC"), and Conseco Services, LLC, an Indiana limited liability company and wholly-owned subsidiary of the Company ("Services"), and ______________________________ ("Indemnitee"). The Company, CDOC and Services are sometimes collectively referred to herein as "Indemnitors."
WHEREAS, the Company desires to attract and retain qualified directors and to provide them with protection against liability and expenses incurred while acting in that capacity;
WHEREAS, the certificate of incorporation and bylaws of the Company contain provisions for indemnifying individuals in connection with their service as members of the board of directors of the Company;
WHEREAS, the bylaws of the Company and applicable state law contemplate that separate contracts may be entered into between the Company with respect to their indemnification by the Company;
WHEREAS, the Company understands that Indemnitee has reservations about serving or continuing to serve the Company without adequate protection against personal liability arising from such service;
WHEREAS, the Company expects to derive substantial direct and indirect benefits from Director's service, and has accordingly agreed to indemnify Director pursuant to this Agreement; and
WHEREAS, CDOC and Services derive substantial direct and indirect benefits from services and other benefits and consideration provided by the Company, and will derive substantial direct and indirect benefits from Director's service to the Company, and have accordingly agreed to indemnify Director pursuant to this Agreement.
NOW THEREFORE, for good and valuable consideration the receipt and sufficiency of which is hereby acknowledged, and in consideration of Indemnitee's service to the Company and the direct and indirect benefits that CDOC and Services will receive from such service, the parties agree as follows:
1. Contractual Indemnity. In addition to the indemnification provisions of the certificate of incorporation and bylaws of the Company, Indemnitors hereby agree, subject to the limitations of Sections 2 and 5 hereof, on a joint and several basis:
(a) To indemnify, defend and hold Indemnitee harmless to the greatest extent possible under applicable law from and against any and all judgments, fines, penalties, amounts paid in settlement and any other amounts reasonably incurred or suffered by Indemnitee (including attorneys' fees) if Indemnitee acted in good faith and in a manner Indemnitee
reasonably believed to be in or not opposed to the best interests of the Company, and, with respect to any criminal action or proceeding, had no reasonable cause to believe Indemnitee's conduct was unlawful, in connection with any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative, including an action by or in the right of the Company (collectively referred to hereafter as a "Claim"), to which Indemnitee is, was or at any time becomes a party, by reason of the fact that Indemnitee is, was or at any time becomes a director, officer, employee or agent of the Company or is or was serving or at any time serves at the request of the Company as a director, officer, employee or agent of another corporation, limited liability company, partnership, joint venture, business organization, trust or other enterprise or association, whether or not arising prior to the date of this Agreement.
(b) To pay any and all expenses reasonably incurred by Indemnitee in defending any Claim (including reasonable attorneys' fees and expenses and other reasonable costs of investigation and defense), as the same are incurred and in advance of a final judicial determination (as to which all rights of appeal therefrom have been exhausted or lapsed) (a "Final Judicial Determination") of any such Claim, upon receipt of a written undertaking by or on behalf of Indemnitee (which shall be unsecured and shall not bear interest) to reimburse such amounts if a Final Judicial Determination determines that Indemnitee (i) is not entitled to be indemnified by Indemnitors under this Agreement, and (ii) is not entitled to be indemnified by the Company under the certificate of incorporation or the bylaws of the Company.
(c) To pay any and all expenses reasonably incurred by Indemnitee in connection with Indemnitee's involvement in (including, without limitation, involvement as a witness or deponent), but not as a party to, any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative, including an action by or in the right of the Company, by reason of the fact that Indemnitee is, was or at any time becomes a director, officer, employee or agent of the Company or is or was serving or at any time serves at the request of the Company as a director, officer, employee or agent of another corporation, limited liability company, partnership, joint venture, business organization, trust or other enterprise or association, whether or not arising prior to the date of this Agreement.
(d) The termination of any action or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that (i) Indemnitee did not act in good faith and in a manner which Indemnitee reasonably believed to be in the best interests of the Company or (ii) with respect to any criminal action or proceeding, Indemnitee had reasonable cause to believe that Indemnitee's conduct was unlawful.
2. Limitations on Contractual Indemnity. Indemnitee shall not be entitled to indemnification or advancement of expenses under Section 1:
(a) if a court of competent jurisdiction, by a Final Judicial Determination, shall determine that such indemnity is not permitted under applicable law; or
(b) on account of any suit in which judgment is rendered for an accounting of profits made from the purchase or sale by Indemnitee of securities of the Company in
violation of the provisions of Section 16(b) of the Securities Exchange Act of 1934; or
(c) with respect to proceedings or claims initiated or brought voluntarily by Indemnitee and not by way of defense, except (i) with respect to proceedings brought in good faith to establish or enforce a right to indemnification under this Agreement or the Company's certificate of incorporation or bylaws or any other statute or law, or (ii) at the Company's discretion, in specific cases if the board of directors of the Company (or a committee thereof) has approved the initiation or bringing of such suit; or
(d) for expenses or liabilities of any type whatsoever which have been paid directly to Indemnitee by an insurance carrier under a policy of liability insurance maintained by the Company; or
(e) for any expenses incurred by the Indemnitee with respect to any proceeding instituted by Indemnitee to enforce or interpret this Agreement, if a court of competent jurisdiction determines that each of the material assertions made by the Indemnitee in such proceeding was not made in good faith or was frivolous.
Notwithstanding any limitations set forth in this Section 2 regarding Indemnitors' obligation to provide indemnification, Indemnitee shall be entitled under Section 4 to receive expense advances hereunder with respect to any such Claim unless and until a court of competent jurisdiction shall have made a Final Judicial Determination that Indemnitee has engaged in acts, omissions or transactions for which Indemnitee is prohibited from receiving indemnification under this Section 2.
3. Continuation of Contractual Indemnity. For the avoidance of doubt, Indemnitee's right to indemnification and advancement of expenses provided under this Indemnification Agreement shall (i) vest at the time that such Indemnitee became a director of the Company and (ii) continue as to the Indemnitee even though he or she may have ceased to be a director of the Company. All agreements and obligations of Indemnitors contained herein shall continue for so long as Indemnitee shall be subject to, or involved in, any possible action, suit, proceeding or other assertion of a Claim or Claims.
4. Expenses; Indemnification Procedure. Indemnitors shall, on a joint and several basis, advance all expenses incurred by Indemnitee in connection with the investigation, defense, settlement or appeal of any action, suit, proceeding or other Claim referenced in Section 1 hereof. Indemnitee hereby undertakes to repay such amounts advanced if, and to the extent that, a Final Judicial Determination determines that Indemnitee is not entitled to be indemnified by Indemnitors as authorized hereby. The advances to be made under Section 1(b) hereunder shall be paid by Indemnitors to Indemnitee within twenty (20) days following delivery of a written request therefor by Indemnitee to Indemnitors as provided in Section 17.
5. Notification and Defense of Claim. If any action, suit, proceeding or other Claim is brought against Indemnitee in respect of which indemnity may be sought under this Agreement:
(a) Indemnitee will promptly notify Indemnitors in writing of the
commencement thereof, and Indemnitors will be entitled to participate therein at
their own expense or to assume the defense thereof and to employ counsel
reasonably satisfactory to Indemnitee, provided however, that failure to provide
such notice in accordance with this Section 5(a) shall not affect Indemnitee's
rights to receive any expenses or expense advances hereunder unless and except
to the extent that Indemnitors did not otherwise learn of such Claim and such
failure of Indemnitee to provide such notice results in the forfeiture by
Indemnitors of substantial rights and defenses. Notice to Indemnitors shall be
made in accordance with Section 17. If Indemnitors do not assume the defense of
a Claim or Indemnitee reasonably determines that there may be a conflict between
the positions of Indemnitors and Indemnitee in conducting the defense of a
Claim, then counsel to Indemnitee shall be entitled to conduct the defense as
reasonably determined by such counsel to be necessary or desirable to protect
the interests of the Indemnitee and Indemnitors shall not have the right to
assume the defense of such Claim and the reasonable fees and expenses of such
counsel to the Indemnitee shall be borne by Indemnitors, on a joint and several
basis, upon delivery to the Company of the undertaking referred to in Section
1(b). However, in no event will Indemnitors be obligated to pay the fees or
expenses of more than one firm of attorneys representing Indemnitee and any
other agents of Indemnitors in connection with any one Claim or separate but
substantially similar or related Claims in the same jurisdiction arising out of
the same general allegations or circumstances, unless Indemnitee reasonably
determines that representation of Indemnitee and other agents of Indemnitors by
the same firm of attorneys would present a conflict of interest that materially
prejudices the interests of Indemnitee.
(b) Indemnitors shall not be liable to indemnify Indemnitee for any amounts paid in settlement of any Claim effected without Indemnitors' written consent, and Indemnitors shall not settle any Claim in a manner which would impose any penalty or limitation on Indemnitee or require the admission of guilt or responsibility without Indemnitee's written consent, provided, however, that neither Indemnitors nor Indemnitee shall unreasonably withhold its consent to any proposed settlement and, provided further, that if a Claim is settled by Indemnitee with Indemnitors' written consent, or if there is a Final Judicial Determination for the plaintiff in connection with the Claim by a court of competent jurisdiction, Indemnitors shall indemnify and hold harmless Indemnitee from and against any and all losses, costs, expenses and liabilities incurred by reason of such settlement or judgment in accordance with Section 1.
(c) Indemnitee shall give Indemnitors such information in the possession of, or reasonably obtainable by, Indemnitee, and cooperation as Indemnitors may reasonably require and as shall be within Indemnitee's power and control.
(d) Any indemnification provided for in Section 1 shall be made promptly, and in any event within forty-five (45) days (or in the case of advance of expenses, twenty (20) days) after receipt of the written request of Indemnitee. If a claim for indemnification under this Agreement, under any statute, or under any provision of the Company's certificate of incorporation or bylaws providing for indemnification, is not paid in full by Indemnitors within forty-five (45) days after a written request for payment thereof has first been received by Indemnitors, Indemnitee may, but need not, at any time thereafter bring an action against Indemnitors to recover the unpaid amount of the claim and, subject to Section 13 of this Agreement, Indemnitee shall also be entitled to be reimbursed for the expenses (including attorneys' fees) of bringing such action. It shall be a defense to any such claim (other than an
action brought to enforce a claim for expenses incurred in connection with any action or proceeding in advance of its final disposition) that Indemnitee has not met the standards of conduct which make it permissible under applicable law for Indemnitors to indemnify Indemnitee for the amount claimed, but the burden of proving such defense shall be on Indemnitors, and Indemnitee shall be entitled to receive interim payments of expenses pursuant to Section 4 unless and until there is a Final Judicial Determination with respect to such defense. It is the parties' intention that if Indemnitors contest Indemnitee's right to indemnification, the question of Indemnitee's right to indemnification shall be for the court to decide, and neither the failure of Indemnitors (including their respective board of directors, board of managers, any committee or subgroup thereof, or independent legal counsel) to have made a determination that indemnification of Indemnitee is proper in the circumstances because Indemnitee has met the applicable standard of conduct required by applicable law, nor an actual determination by Indemnitors (including their respective board of directors, board of managers, any committee or subgroup thereof, or independent legal counsel) that Indemnitee has not met such applicable standard of conduct, shall create a presumption that Indemnitee has or has not met the applicable standard of conduct.
(e) If, at the time of the receipt of a notice of a Claim, the Company has director and officer liability insurance in effect, the Company shall give prompt notice of the commencement of such proceeding to the insurers in accordance with the procedures set forth in the applicable policies. The Company shall thereafter take all necessary or desirable action to cause such insurers to pay, on behalf of the Indemnitee, all amounts payable as a result of such proceeding in accordance with the terms of such policies, provided however, that nothing contained in this Section 5(e) shall excuse Indemnitors from their joint and several obligation to pay expense advances to Indemnitee, or indemnify Indemnitee, as provided herein.
6. Scope. Notwithstanding any other provision of this Agreement, Indemnitors, on a joint and several basis, hereby agree to indemnify Indemnitee against any Claim to the fullest extent permitted by law, notwithstanding that such indemnification is not specifically authorized by the other provisions of this Agreement or the Company's certificate of incorporation or bylaws or by applicable law. In the event of any change, after the date of this Agreement, in any applicable law, statute or rule which expands the right of a Delaware corporation to indemnify a member of its board of directors, an officer or other corporate agent, such change shall be, ipso facto, within the purview of Indemnitee's rights and Indemnitors' obligations, under this Agreement. In the event of any change in any applicable law, statute, or rule which narrows the right of a Delaware corporation to indemnify a member of its board of directors, an officer, or other corporate agent, such change, to the extent not otherwise required by applicable law to be applied to this Agreement, shall have no effect on this Agreement or the parties' rights and obligations hereunder.
7. Partial Indemnification. If Indemnitee is entitled under any provision of this Agreement to indemnification by Indemnitors for some or a portion of the expenses, judgments, fines or penalties actually or reasonably incurred by him in the investigation, defense, appeal or settlement of any civil or criminal action or proceeding, but not, however, for the total amount thereof, Indemnitors, on a joint and several basis, shall nevertheless indemnify Indemnitee for the portion of such expenses, judgments, fines or penalties to which Indemnitee is entitled.
8. Director and Officer Liability Insurance. The Company shall use reasonable best efforts to obtain and at all times maintain, for the benefit of Director, coverage under a director and officer liability insurance policy at a level that is reasonable and customary for similarly situated companies.
9. Public Policy. The parties acknowledge that in certain instances, federal law or applicable public policy may prohibit the Company from indemnifying its directors and officers under this Agreement or otherwise. Indemnitee understands and acknowledges that the Company has undertaken or may be required in the future to undertake with the Securities and Exchange Commission to submit the question of indemnification to a court in certain circumstances for a determination of the Company's right under public policy to indemnify Indemnitee.
10. No Restrictions. The rights and remedies of Indemnitee under this Agreement shall not be deemed to exclude or impair any other rights or remedies to which Indemnitee may be entitled under the certificate of incorporation or bylaws of the Company or under any other agreement, provision of law or otherwise, nor shall anything contained herein restrict the right of Indemnitors to indemnify Indemnitee in any proper case even though not specifically provided for in this Agreement, nor shall anything contained herein restrict Indemnitee's right to contribution as may be available under applicable law. The indemnification provided under this Agreement shall continue as to Indemnitee for any action Indemnitee took or did not take while serving as a director, officer, employee or agent of the Company or any of its subsidiaries even though Indemnitee may have ceased to serve in such capacity.
11. Severability. Each of the provisions of this Agreement is a separate and distinct agreement and independent of the others, so that if any provision hereof shall be held to be invalid or unenforceable for any reason, such invalidity or unenforceability shall not affect the validity or enforceability of the other provisions hereof. Furthermore, to the fullest extent possible, the provisions of this Agreement (including, without limitations, each portion of this Agreement containing any provision held to be invalid, void or otherwise unenforceable, that is not itself invalid, void or unenforceable) shall be construed so as to give effect to the intent manifested by the provision held invalid, illegal or unenforceable.
12. No Construction as Employment Agreement. Nothing contained herein shall be construed as giving Indemnitee any right to be retained as a director of the Company or in the employ of the Company.
13. Attorneys' Fees. In the event of any litigation or other action or proceeding to enforce or interpret this Agreement, the prevailing party as determined by the court shall be entitled to an award of its reasonable attorneys' fees and other costs, in addition to such relief as may be awarded by a court or other tribunal.
14. Further Assurances. The parties will do, execute and deliver, or will cause to be done, executed and delivered, all such further acts, documents and things as may be reasonably required for the purpose of giving effect to this Agreement and the transactions contemplated hereby.
15. Acknowledgment. Indemnitors expressly acknowledge that they have entered into this Agreement and assumed the obligations imposed on them hereunder in order to induce Indemnitee to serve or to continue to serve Indemnitors, and further acknowledge that Indemnitee is relying on this Agreement in serving or continuing to serve in such capacity.
16. Counterparts. This Agreement may be executed (including by facsimile) in one or more counterparts, each of which shall constitute an original and together shall constitute one instrument.
17. Notice. All notices, requests, or other communications provided for in this Agreement shall be in writing and shall be delivered personally or by reputable overnight courier service (delivery charges prepaid) to any party at the address herein or such other address as indicated by written notice. Any such notice, request, or other communication shall be deemed to have been given pursuant to this Agreement when delivered personally or on the second business day after deposit with a reputable overnight courier service, as the case may be. Addresses for notice to Indemnitee is shown on the signature page to this Agreement. Address for notice to Indemnitors shall be to Conseco, Inc., 11825 N. Pennsylvania Street, Carmel, Indiana, 46032, Attention: Chief Executive Officer.
18. Subrogation. In the event of payment under this Agreement, Indemnitors shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee, who shall execute all documents required and shall do all acts that may be necessary to secure such rights and to enable Indemnitors effectively to bring suit to enforce such rights.
19. Governing Law; Binding Effect; Amendment.
(a) This Agreement shall be interpreted and enforced in accordance with the laws of the State of Delaware (without regard to any conflict of law provisions thereof).
(b) This Agreement shall be binding upon Indemnitee, the Company, CDOC and Services, their successors and assigns, and shall inure to the benefit of Indemnitee, his heirs, personal representatives and assigns and to the benefit of the Company, CDOC, Services and their respective successors and assigns.
(c) No amendment, modification, termination or cancellation of this Agreement shall be effective unless in writing signed by each party hereto.
* * * * *
IN WITNESS WHEREOF, the parties have executed this Indemnification Agreement as of the date first written above.
CONSECO, INC.
By: ------------------------------------- Name: C. James Prieur Title: Chief Executive Officer |
CDOC, INC.
By: ------------------------------------- Name: Edward J. Bonach Title: President |
CONSECO SERVICES, LLC
By: ------------------------------------- Name: Edward J. Bonach Title: President |
AGREED AND ACCEPTED:
Address:
Exhibit 10.20
Page
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1. General........................................................................ 1
2. Definitions.................................................................... 1
3. Participation.................................................................. 3
4. Incentive Plan Awards.......................................................... 4
5. Administration................................................................. 6
6. Miscellaneous.................................................................. 6
|
1. GENERAL
(a) Purpose. This Conseco, Inc. 2005 Pay for Performance Incentive Plan (the "Plan" or "P4P") is intended to assist Conseco, Inc., a Delaware corporation (the "Company"), and its Affiliated Corporations in attracting, retaining, motivating and rewarding employees who occupy key positions and contribute to the growth and profitability of the Company and its Affiliated Corporations through the award of certain incentives. The Plan also is intended to enable the Committee to preserve the tax deductibility of incentive awards under Section 162(m) of the Code, and to advance the interests of the shareholders of the Company by providing performance-based incentives to eligible individuals.
(b) Effective Date. The Plan shall become effective as of the date of its
adoption by the Board of Directors of the Company, subject to stockholder
approval, and shall continue in effect until terminated by the Board pursuant to
Section 6(a). No payment may be made hereunder prior to stockholder approval of
the Plan.
2. DEFINITIONS
(a) "Affiliated Corporations" shall include members of the controlled group of corporations within the meaning of Section 1504 of the Code determined without regard to Section 1504(b).
(b) "Board" means the Board of Directors of the Company.
(c) "Code" means the Internal Revenue Code of 1986, as amended from time to time, including regulations thereunder and successor provisions and regulations thereto.
(d) "Committee" means the committee designated by the Board to administer the P4P. With respect to Covered Employees for whom the P4P is intended to provide "qualified performance-based compensation" within the meaning of Section 162(m) of the Code, any Committee must consist solely of two or more persons each of whom are "outside directors" within the meaning of Section 162(m) of the Code. To the extent the Committee delegates authority pursuant to Section 5(b), references to the Committee in the P4P shall, as appropriate, be deemed to refer to the Committee's delegate.
(e) "Company" means Conseco, Inc.
(f) "Comparison Group" means the peer group of companies designated by the Committee as the Comparison Group relative to a given Performance Cycle, as described in Section2(o).
(g) "Covered Employee" has the meaning given such term under Section 162(m) of the Code.
(h) "Employer" means the Company and any Affiliated Corporation that employs a Participant.
(i) "Fiscal Year" means the 12-month period beginning on each January 1 and ending on December 31 of the same calendar year.
(j) "Incentive Percentage" means the number determined by the Committee as the percentage of a Participant's annual rate of salary in effect for the last full payroll period of the Performance Period to be paid as an Incentive Plan Award if the specified Performance Goals are achieved. The Committee may establish different Incentive Percentages for individual Participants or different classes of Participants, and/or the achievement of different levels of the Performance Goals.
(k) "Incentive Plan Award" means an incentive compensation award under the P4P, payment of which is contingent and based upon the attainment of the Performance Goals with respect to a Performance Period.
(l) "Participant" means an employee of an Employer participating in the Plan for a Performance Period as provided in Section 3.
(m) "P4P" means the Conseco, Inc. Pay For Performance Incentive Plan, as it may be amended from time to time.
(n) "Performance Goals" means the pre-established objective performance goals established by the Committee for each Performance Period. Solely with respect to Covered Employees for any Performance Period for which the P4P is intended to provide Qualified Performance-based Compensation, Performance Goals shall be established by the Committee no later than 90 days after the beginning of the Fiscal Year to which the Performance Goals relate (and in the case of a Performance Period shorter than a Fiscal Year, no later than the date on which 25% of the Performance Period has elapsed) and while the attainment of the Performance Goals is substantially uncertain. The Performance Goals may be based upon the performance of the Company, of any Affiliated Corporation, of a division thereof, and/or of an individual Participant, using one or more of the Performance Measures selected by the Committee. Separate Performance Goals may be established by the Committee for the Company or an Affiliated Corporation, or division thereof, or an individual. With respect to Participants who are not Covered Employees, the Committee may establish other subjective or objective goals, including individual Performance Goals, which it deems appropriate. The preceding sentence shall also apply to Covered Employees with respect to any Incentive Plan Award not intended at the time of grant to be Qualified Performance-based Compensation. Performance Goals may be set at a specific level, or may be expressed as a relative percentage to the comparable measure at comparison companies or a defined index.
(o) "Performance Measure" means one or more of the following criteria, on
which Performance Goals may be based, subject to Section 4(a): (1) gross or net
revenue, premiums collected, new annualized premiums, and investment income, (2)
any earnings or net income measure, including earnings from operations, earnings
before taxes, earnings before interest and/or taxes and/or depreciation,
statutory earnings before realized gains (losses), or net income available to
common shareholders, (3) operating earnings per common share (either basic or
diluted); (4) return on assets, return on investment, return on capital, return
on equity, or return on tangible equity; (5) economic value created; (6)
operating margin or profit margin; (7) net interest margin; (8) asset quality;
(9) stock price or total stockholder return; and (10) strategic business
criteria, consisting of one or more objectives based on meeting specified market
penetration, total market capitalization, business retention, new product
generation, rate increase actions, geographic business expansion goals, cost
targets (including cost of capital), investment portfolio yield, risk-based
capital, statutory capital, BCAR, tax net operating loss utilization, customer
satisfaction, employee satisfaction, agency ratings, management of employment
practices and employee benefits, supervision of litigation and information
technology, and goals relating to acquisitions or divestitures of subsidiaries,
affiliates or joint ventures. The targeted level or levels of performance with
respect to such business criteria may be established at such levels and in such
terms as the Committee may determine, in its discretion, including in absolute
terms, on a per share basis (either basic or diluted), as a goal relative to
performance in prior periods, or as a goal compared to the performance of one or
more comparable companies or an index covering multiple companies.
(p) "Performance Period" means a Fiscal Year or other period of time (which may be longer or shorter than a Fiscal Year) set by the Committee.
(q) "Qualified Performance-based Compensation" has the meaning given such term under Section 162(m) of the Code and the regulations promulgated thereunder.
3. PARTICIPATION
Individuals eligible to participate in the P4P shall consist of officers and other employees of an Employer whom the Committee determines have the potential to contribute significantly to the success of the Company and its Affiliated Corporations. For each Performance Period the Committee shall determine which officers and other employees shall participate in the P4P. For any Performance Period for which Incentive Plan Awards are intended to be Qualified Performance-based Compensation, the Committee shall designate the Covered Employees eligible to participate in the P4P no later than the 90th day of the Fiscal Year (or, in the case of a Performance Period shorter than a Fiscal Year after no later than the date on which 25% of the Performance Period has elapsed), so long as the attainment of the Performance Goals is still substantially uncertain.
4. INCENTIVE PLAN AWARDS
(a) Determination of Incentive Plan Awards.
The Committee shall, promptly after the date on which the necessary financial, individual or other information for a particular Performance Period becomes available, determine and certify in writing the degree to which each of the Performance Goals has been attained. Performance Goals shall, to the extent applicable, be based upon generally accepted accounting principles. The Committee may adjust Performance Goals to take into account the effect of the following, subject to Section 6(j): Changes in accounting standards that may be required by the Financial Accounting Standards Board, the Securities and Exchange Commission or any other rulemaking body after the Performance Goal is established; realized investment gains and losses; extraordinary, unusual, non-recurring or infrequent items; currency fluctuations; acquisitions; divestitures; litigation losses; financing activities; expenses for restructuring or productivity initiatives; other non-operating items; new laws, cases or regulatory developments that result in unanticipated items of gain, loss, income or expense; executive severance arrangements; and other items as the Committee determines to be required so that the operating results of the Company, division, or an Affiliated Corporation shall be computed on a comparative basis from Performance Period to Performance Period. Determination by the Committee or its designee shall be final and conclusive on all parties, but shall be based on relevant objective information or financial data. The Committee may also, in its discretion, adjust a P4P Award based on other factors it deems relevant and appropriate; provided, however, that the Committee may only exercise such discretion to reduce, and not to increase, a P4P Award unless such award was not intended to be Qualified Performance- based Compensation.
(b) Eligibility and Amount of Incentive Plan Award.
(i) To be eligible for payment of any P4P Award, the Participant must:
(x) have performed the Participant's duties to the satisfaction of the
Committee; (y) have not engaged in any act deemed by the Committee to be
inimical to the best interest of the Company or an Affiliated Corporation; and
(z) otherwise complied with Company and Employer policies at all times prior to
the date the P4P Award is actually paid. No P4P Award shall be paid to any
Participant who does not satisfy each of the above. In addition, unless the
Committee determines otherwise, the Participant must be employed by the Company
or an Affiliated Corporation on the day on which the P4P Award is scheduled to
be paid in accordance with Section 4(c), except in the event termination is due
to the Participant's death, disability (as defined in Section 422(c) of the
Code) or retirement (after attainment of age 55), or a separate agreement
entered into between the Participant and his or her Employer specifically
provides otherwise; provided however, that no Participant shall receive such a
P4P Award upon retirement or pursuant to a separate agreement entered into
between the Participant and his or her Employer unless such award was not
intended to be Qualified Performance-based Compensation. In the event of a
Participant's death, disability or retirement, the P4P Award shall be prorated
based upon the period of
employment during the Performance Period. The Committee may, in its sole discretion, reduce, eliminate or increase any P4P Award for any individual or group, except that the amount of any P4P Award intended to be Qualified Performance-based Compensation may not be increased above the amount determined under Section 4(a) hereof.
(ii) The P4P Award shall be determined by multiplying the Incentive Percentage applicable to the Participant by the Participant's annual rate of salary in effect for the last full payroll period of the Performance Period to which the P4P Award pertains. In no event, however, will a P4P Award for a Covered Employee exceed $5,000,000 for a Fiscal Year Performance Period (or in the case of a Performance Period other than a Fiscal Year, an amount that bears the same ratio to $5,000,000 as the Performance Period bears to a Fiscal Year).
(iii) The Committee shall have the discretion and authority to make
adjustments to any P4P Award in circumstances where, during the Performance
Period: (1) a Participant leaves the Employer and is rehired as a Participant;
(2) a Participant is hired, promoted or transferred into a position eligible for
P4P participation; (3) a Participant transfers between eligible P4P positions
with different Incentive Percentages or Performance Goals; (4) a Participant
transfers to a position not eligible to participate in the P4P; (5) a
Participant becomes eligible for an incentive from another incentive plan
maintained by the Company or Affiliated Corporation; (6) a Participant is on a
leave of absence; and (7) similar circumstances deemed appropriate by the
Committee, consistent with the purpose and terms of the P4P; provided however,
that the Committee shall not be authorized to increase the amount of the P4P
Award payable to a Covered Employee if the amount was intended to be Qualified
Performance-based Compensation.
(c) Payment of Award. Unless the Committee provides otherwise, P4P Awards will be paid in cash or cash equivalent within 75 days of the end of the applicable Performance Period to which the award pertains, but in no event prior to certification by the Committee as provided in Section 4(a) and in no event past the date that would otherwise qualify the P4P Award as a "short-term deferral" as that term is defined in Treasury Regulation 1.409A-1(b) promulgated under Section 409A of the Code. If any portion of a P4P Award payable to a Covered Employee that is intended to be Qualified Performance-based Compensation for any reason is not deductible, payment of that portion shall, at the Committee's discretion, be deferred until the earliest date it may be paid and deducted; provided however, that any such deferral shall be made in compliance with a plan designed to comply with the requirements of Section 409A of the Code. Further, if the Participant is on administrative suspension at the time payment would otherwise be made, payment shall be delayed until the matter is resolved by the Employer. No payment shall be made if the Committee determines the qualification requirements of Section 4(b)(i) have not been satisfied by the Participant.
5. ADMINISTRATION
(a) General. The P4P shall be administered by the Committee. Subject to the
provisions of the P4P, the Committee shall have full discretionary authority to
administer and interpret the P4P, to exercise all powers either specifically
granted to it under the P4P or as are necessary or advisable in the
administration of the P4P, to decide the facts in any case arising under the
P4P, to prescribe, amend and rescind rules and regulations relating to the P4P,
to require performance reports on which it can base its determinations under
Section 4(a), and to make all other determinations necessary or advisable for
the administration of the P4P, all of which shall be binding on all persons,
including the Company, Affiliated Corporations, the Participants (or any person
claiming any rights under the P4P from or through any Participant), and any
shareholder of the Company. A majority of the Committee shall constitute a
quorum, and, provided a quorum is present (or unanimous written consent is
otherwise obtained), the Committee shall act pursuant to a majority vote of
those present. No member of the Board or the Committee shall be liable for any
action taken or determination made in good faith with respect to the P4P or any
Plan Award.
(b) Delegation. Except to the extent prohibited by applicable law or the applicable rules of a stock exchange, the Committee may allocate all or any portion of its responsibilities and powers to any one or more of its members, may delegate all or any part of its responsibilities and powers for administering the P4P to one or more persons as the Committee deems appropriate, and at any time revoke the allocation or delegation; provided however, the Committee may not delegate its responsibilities under the Plan relating to any Covered Employee's P4P Award intended to be Qualified Performance-based Compensation to the extent delegation is prohibited under Section 162(m) of the Code.
6. MISCELLANEOUS
(a) Amendment and Termination.
(i) The Board may at any time amend or terminate the P4P (in whole or in part) without the approval of the shareholders of the Company, except as otherwise provided in this Section 6(a). Neither the Company nor any Affiliated Corporation is obligated to continue this P4P.
(ii) Unless terminated earlier by the Committee, the Plan shall terminate on the fifth anniversary of the effective date. No further P4P Awards may be granted under the Plan following the termination date, but outstanding P4P Awards for Performance Periods begun prior to the Plan termination date shall continue in accordance with their terms.
(iii) Any amendment to the P4P that changes the class of individuals of an Employer eligible to participate, changes the Performance Measures or the formula used or increases the maximum dollar amount that may be paid to a Participant for a Performance Period shall not be effective with respect to Plan Awards to Covered Employees intended to be Qualified Performance-based Compensation unless the amendment is approved by shareholders before the Plan Award is paid.
(b) Effect of Incentive Plan Awards on Other Compensation.
(i) Plan Awards shall not be considered eligible pay under other plans, benefit arrangements, or fringe benefit arrangements of the Company or an Affiliated Corporation, unless otherwise provided under the terms of other plans.
(ii) To the extent provided in the applicable benefit plan or benefit arrangement of the Company or an Affiliated Corporation, amounts payable as Plan Awards will be reduced in accordance with the Participant's compensation reduction election, if any, in effect under other plans at the time the Plan Award is otherwise payable.
(c) No Guarantee, No Funding. The payment of a Plan Award for any Performance Period does not guarantee any person eligibility for or payment of a Plan Award for any other Performance Period. Plan Awards shall be paid solely from the general assets of the Participant's Employer, to the extent the payments are attributable to services for the Employer. To the extent any person acquires a right to receive payments from an Employer under the P4P, the right is no greater than the right of any other unsecured general creditor.
(d) Tax Withholding. The Participant's Employer shall have the right to deduct from all payments made under the P4P any federal, state or local taxes required by law to be withheld with respect to the payments.
(e) Governing Law. The provisions of the P4P shall be interpreted, construed, and administered in accordance with the referenced provisions of the Code and with the laws of the State of Delaware.
(f) Awards Not Transferable. Subject to Section 6(h), no amount payable to, or held under the P4P for the account of, any Participant, spouse or beneficiary shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, or charge, and any attempt to so anticipate, alienate, sell, transfer, assign, pledge, encumber, or charge the same shall be void; nor shall any amount payable to, or held under the P4P for the account of, any Participant be in any manner liable for such Participant's debts, contracts, liabilities, engagements, or torts, or be subject to any legal process to levy upon or attach.
(g) No Contract. This P4P shall not be deemed a contract of employment with any Participant, nor shall any provision hereof affect the right of the Company or any Affiliated Corporations to terminate a Participant's employment.
(h) Payments to Minors and Incompetents; Death. If any Participant, spouse or beneficiary entitled to receive any benefits hereunder is a minor or is deemed by the Committee or is adjudged to be legally incapable of giving valid receipt and discharge for such benefits, they will be paid to such person or institution as the Committee may designate or to the duly
appointed guardian. Such payment shall, to the extent made, be deemed a complete discharge of any such payment under the Plan. In the event of a Participant's death prior to payment of any Plan Award to which Participant is otherwise entitled, payment shall be made to the Participant's then-effective beneficiary or beneficiaries in accordance with the beneficiary designation on file with the Company. If no such beneficiary designation is in effect, payments shall be made to the Participant's estate.
(i) Nonexclusivity of the Plan. Neither the adoption of the Plan by the Board nor its submission of any terms of the Plan to the stockholders of the Company for approval shall be construed as creating any limitations on the power of the Board or a committee thereof to adopt such other incentive arrangements, apart from the Plan, as it may deem desirable, including incentive arrangements and awards which do not qualify under Section 162(m) of the Code, and such other arrangements may be either applicable generally or only in specific cases.
(j) Compliance with Section 162(m) of the Code. It is the intent of the
Company that compensation under the Plan payable to Covered Employees shall
constitute Qualified Performance-based Compensation unless otherwise determined
by the Committee at the time of allocation of an award. Accordingly, the terms
of Section 4 and other provisions of the Plan, including the definitions and
other terms used therein, shall be interpreted in a manner consistent with
Section 162(m) of the Code. If any provision of the Plan or any document
relating to an award that is designated as intended to comply with Section
162(m) of the Code does not comply or is inconsistent with the requirements of
Section 162(m) of the Code, such provision shall be construed or deemed amended
to the extent necessary to conform to such requirements, and no provision shall
be deemed to confer upon the Committee or any other person discretion to
increase the amount of compensation otherwise payable in connection with any
such award upon attainment of the applicable performance objectives.
Notwithstanding the foregoing, however, whenever the Committee determines that
it is advisable to grant or pay Plan Awards that do not qualify as Qualified
Performance-based Compensation, the Committee may make grants or payments
without satisfying the requirements of Section 162(m) of the Code, provided,
however, that any such determination must be made prior to the time that any
such grant or payment is made.
(k) Severability; Entire Agreement. If any of the provisions of this Plan or any award document is finally held to be invalid, illegal or unenforceable (whether in whole or in part), such provision shall be deemed modified to the extent, but only to the extent, of such invalidity, illegality or unenforceability, and the remaining provisions shall not be affected thereby; provided, that, if any of such provisions is finally held to be invalid, illegal, or unenforceable because it exceeds the maximum scope determined to be acceptable to permit such provision to be enforceable, such provision shall be deemed to be modified to the minimum extent necessary to modify such scope in order to make such provision enforceable hereunder. The Plan and any award documents contain the entire agreement of the parties with respect to the subject matter thereof and, unless specified
otherwise, supersede all prior agreements, promises, covenants, arrangements, communications, representations and warranties between them, whether written or oral, with respect to the subject matter thereof.
(l) Captions. The captions contained in the P4P are inserted only as a matter of convenience and for reference and in no way define, limit, enlarge or describe the scope or intent of the Plan, nor do they in any way affect the construction of any provision of the Plan.
(m) For purposes of this Plan, references to an award term or event
(including any authority or right of the Company or a Participant) being in
compliance with Section 409A shall mean, for an award that is a "deferral" under
Section 409A (a "409A Award"), that the term or event will not cause the
Participant to be liable for payment of interest or a tax penalty under Section
409A and, for an award that is not considered a "deferral" under Section 409A (a
"non-409A Award"), that the term or event will not cause the award to be treated
as a deferral subject to Section 409A. Other provisions of the Plan
notwithstanding, the terms of any 409A Award and any Non-409A Award, including
any authority of the Company and rights of the Participant with respect to the
Award, shall be limited to those terms permitted under Section 409A, and any
terms not permitted under Section 409A shall be automatically modified and
limited to the extent necessary to conform with Section 409A. For this purpose,
other provisions of the Plan notwithstanding, the Company shall have no
authority to accelerate distributions relating to 409A Awards in excess of the
authority permitted under Section 409A, and any distribution subject to Section
409A(a)(2)(A)(i) (separation from service) to a "key employee" as defined under
Section 409A(a)(2)(B)(i), shall not occur earlier than the earliest time
permitted under Section 409A(a)(2)(B)(i).
Exhibit 10.28
This AMENDED AND RESTATED EMPLOYMENT AGREEMENT, dated as of the 1st day of October, 2008, is between Conseco Services, LLC, an Indiana limited liability company ("Company"), and Scott R. Perry ("Executive").
WHEREAS, the Company and Executive entered into an Employment Agreement dated as of October 1, 2004, and an Amendment thereto dated December 18, 2006, and they now desire to amend and restate such agreement.
WHEREAS, the continued services of Executive and his managerial and professional experience are of value to the Company.
WHEREAS, the Company desires to have the benefit and advantage of the services of Executive to assist the Company and Conseco, Inc. ("Conseco") upon the terms and conditions set forth herein.
NOW, THEREFORE, in consideration of the foregoing and the mutual covenants contained herein, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows:
1. Employment. The Company hereby employs Executive and Executive hereby accepts employment upon the terms and conditions hereinafter set forth.
2. Term. The effective date of this agreement (the "Agreement") shall be the date set forth above (the "Effective Date"). Subject to the provisions for termination as provided in Section 10 hereof, the term of Executive's employment under this Agreement shall be the period beginning on the Effective Date and ending on September 30, 2010 (the "Term"). The Term shall not be automatically renewed and shall end upon any earlier termination of Executive's employment with the Company.
3. Duties. During the Term, Executive shall be engaged by the Company in the capacity of President, Bankers Life and Casualty Company, or in such other senior executive capacity as the Chief Executive Officer of Conseco shall specify. Executive shall report to the Chief Executive Officer of Conseco or such other senior executive officer as the Chief Executive Officer of Conseco may specify regarding the performance of his duties.
4. Extent of Services. During the Term, subject to the direction and control of the Chief Executive Officer of Conseco, Executive shall have the power and authority commensurate with his executive status and necessary to perform his duties hereunder. Executive shall devote his entire employable time, attention and best efforts to the business of the Company and, during the Term, shall not, without the consent of the Company, be actively engaged in any other business activity, whether or not such business activity is pursued for gain, profit or other pecuniary advantage; provided, however, that this shall not be construed as preventing Executive from serving on boards of professional, community, civic, education,
charitable and corporate organizations on which he presently serves or may choose to serve or investing his assets in such form or manner as will not require any services on the part of Executive in the operation of the affairs of the companies in which such investments are made (to the extent not in violation of the non-competition and non-solicitation provisions of Section 9 hereof); provided, however, that corporate organizations shall be limited to those mutually agreed upon by Executive and the Company.
5. Compensation. During the Term:
(a) As compensation for services hereunder rendered during the Term hereof, Executive shall receive a base salary ("Base Salary") of Four Hundred Forty-One Thousand Dollars ($441,000) per year payable in equal installments in accordance with the Company's payroll procedure for its salaried executives. Salary payments and other payments under this Agreement shall be subject to withholding of taxes and other appropriate and customary amounts. Executive may receive increases in his Base Salary from time to time, based upon his performance, subject to approval of the Company.
(b) In addition to Base Salary, Executive will have an opportunity to earn a bonus each year, as determined by the Company, with a target annual bonus equal to 100% of Executive's Base Salary (the "Target Bonus") and a maximum annual bonus of 200% of Executive's Base Salary with respect to any calendar year, with such bonus payable at such time that other similar payments are made to other Company executives but in no event later than March 15 of the year following the year with respect to which such bonus was payable, unless the bonus amounts to be paid cannot be confirmed and paid on or before March 15, in which event the bonuses will be paid within 15 days after the bonus amounts have been confirmed by the Company. For purposes of clarification, annual executive bonuses are payable on or before March 15 of the year following the year with respect to which such bonuses are payable, if Executive remains employed with the Company through such date or as otherwise payable under Section 11 of this Agreement. Notwithstanding the above, a pro-rata portion of the 2010 bonus will be paid at the same time that similar payments are made to other Company executives if Executive remains employed through the end of the Term. The performance requirements for Target Bonuses will be based on financial and other objective targets that the Conseco Board of Directors (the "Board") or the Human Resources and Compensation Committee of the Board (the "Compensation Committee") believes are reasonably attainable at the time that they are set.
(c) Executive shall be eligible to participate in and receive future grants under any Conseco stock or equity-based program offered to senior executives, subject to the discretion of the Board or the Compensation Committee.
6. Fringe Benefits. During the Term:
(a) Executive shall be entitled to participate in such existing executive benefit plans and insurance programs offered by the Company, or which it may adopt from time to time, for its executive management or supervisory personnel generally, in accordance with the eligibility requirements for participation therein. Nothing herein shall be construed so as to prevent the Company from modifying or terminating any executive benefit plans or programs, or executive fringe benefits, that it may adopt from time to time.
(b) Executive shall be entitled to four weeks of vacation with pay each year.
(c) Executive may incur reasonable expenses for promoting the Company's business, including expenses for entertainment, travel, and similar items. The Company shall reimburse Executive for all such reasonable expenses upon Executive's periodic presentation of an itemized account of such expenditures in accordance with the Company's policies and procedures; provided, however, that any such reimbursement will be made no later than March 15 of the year following the year in which the expense was incurred. The Company agrees to pay Executive an additional amount to cover the incremental additional income taxes incurred by Executive, if any, with respect to payment or reimbursement of any reasonable business expenses pursuant to this subsection (c); provided, however, that any such payment will be made no later than March 15 of the year following the year in which the income tax was incurred.
(d) Executive shall be permitted to make elective contributions to any Company-sponsored, non-qualified deferred compensation plan in accordance with the terms of such plan.
7. Disability.
(a) If Executive shall become physically or mentally disabled during
the Term to the extent that his ability to perform his duties and services
hereunder is materially and adversely impaired, his Base Salary, bonus and
other compensation provided herein shall continue while he remains employed
by the Company; provided, that if such disability (as determined in the
Company's reasonable judgment, exercised in good faith) continues for at
least three (3) consecutive months, the Company may terminate Executive's
employment hereunder, in which case the Company within 10 business days
shall pay Executive a cash payment equal to (i) his annual Base Salary as
provided in Section 5(a) hereof to the extent earned but unpaid as of the
date of termination ("Unpaid Salary"), (ii) the bonus payable pursuant to
Section 5(b) for the fiscal year of the Company ending prior to the date of
termination (to the extent earned based on performance under the goals and
objectives of the applicable plan but not previously paid) ("Unpaid
Bonus"), (iii) Executive's then accrued but unused vacation ("Unpaid
Vacation") (the Unpaid Salary, Unpaid Bonus and Unpaid Vacation referred to
sometimes together as the "Accrued Amounts") and (iv) a pro-rata portion of
the Target Bonus for the year in which the termination for disability
occurs. All options, restricted stock and/or other awards held by Executive
on the date of termination for disability shall vest only through the date
of termination according to the normal vesting schedule applicable to such options or restricted stock and Executive shall be treated in accordance with the applicable award agreements.
(b) No payments or vesting under this Section 7 will be made if such disability arose primarily from (a) chronic use of intoxicants, drugs or narcotics (other than drugs prescribed to Executive by a physician and used by Executive for their intended purpose for which they had been prescribed) or (b) intentionally self-inflicted injury or intentionally self-induced illness.
8. Disclosure of Information. Executive acknowledges that, in and as a result of his employment with the Company, he has been and will be making use of, acquiring and/or adding to confidential information of the Company and its affiliates of a special and unique nature and value. As a material inducement to the Company to enter into this Agreement and to pay to Executive the compensation stated in Section 5, as well as any additional benefits stated herein, Executive covenants and agrees that he shall not, at any time while he is employed by the Company or at any time thereafter, directly or indirectly, divulge or disclose for any purpose whatsoever, any confidential information (whether or not specifically labeled or identified as "confidential information"), in any form or medium, that has been obtained by or disclosed to him as a result of his employment with the Company and which the Company or any of its affiliates has taken appropriate steps to safeguard, except to the extent that such confidential information (a) becomes a matter of public record or is published in a newspaper, magazine or other periodical available to the general public, other than as a result of any act or omission of Executive, (b) is required to be disclosed by any law, regulation or order of any court or regulatory commission, department or agency, in which event Executive shall give prompt notice of such requirement to the Company to enable the Company to seek an appropriate protective order or confidential treatment, (c) must be disclosed to enable Executive properly to perform his duties under this Agreement or (d) was developed by Executive prior to his employment by the Company. Upon the termination of Executive's employment, Executive shall return such information (in whatever form) obtained from or belonging to the Company or any of its affiliates which he may have in his possession or control.
9. Covenants Against Competition and Solicitation. Executive acknowledges that the services he is to render to the Company and its affiliates are of a special and unusual character, with a unique value to the Company and its affiliates, the loss of which cannot adequately be compensated by damages or an action at law. In view of the unique value to the Company and its affiliates of the services of Executive for which the Company has contracted hereunder, because of the confidential information to be obtained by, or disclosed to, Executive as set forth in Section 8 above, and as a material inducement to the Company to enter into this Agreement and to pay to Executive the compensation stated in Section 5 hereof, as well as any additional benefits stated herein, and other good and valuable consideration, Executive covenants and agrees that throughout the period Executive remains employed or compensated hereunder and for one year thereafter, Executive shall not, directly or indirectly, anywhere in the United States of America (i) render any services, as an agent, independent contractor, consultant or otherwise, or become employed or compensated by any other corporation, person or entity that derives a non-incidental portion of its revenue from the business of selling or providing annuity,
life, accident or health insurance products or services; (ii) in any manner compete with the Company or any of its affiliates with respect to lines of business that the Company and its affiliates derive more than a non-incidental portion of their revenue from or with respect to which the Company and its affiliates have made a significant investment in; (iii) solicit or attempt to convert to other insurance carriers or other corporations, persons or other entities providing these same or similar products or services provided by the Company and its affiliates, any customers or policyholders of the Company or any of its affiliates; or (iv) solicit for employment or employ any individual who was employed by the Company or any of its affiliates during the term of Executive's employment with the Company. Should any particular covenant or provision of this Section 9 be held unreasonable or contrary to public policy for any reason, including, without limitation, the time period, geographical area, or scope of activity covered by any restrictive covenant or provision, the Company and Executive acknowledge and agree that such covenant or provision shall automatically be deemed modified such that the contested covenant or provision shall have the closest effect permitted by applicable law to the original form and shall be given effect and enforced as so modified to whatever extent would be reasonable and enforceable under applicable law.
10. Termination. During the Term:
(a) Either the Company or Executive may terminate his employment at any time for any reason upon written notice to the other. The Company may terminate Executive's employment for Just Cause pursuant to Section 10(b) below or in a Control Termination pursuant to Section 10(c) below. Executive's employment shall also terminate (i) upon the death of Executive or (ii) after disability of Executive pursuant to Section 7 hereof.
(b) The Company may terminate Executive's employment at any time for Just Cause. For purposes of this Agreement, "Just Cause" shall mean:
(i) (A) material breach by Executive of this Agreement not cured within 15 days after written notice to Executive by the Company, (B) a material breach of Executive's duty of loyalty to the Company or its affiliates not cured within 15 days after written notice to Executive by the Company, or (C) willful malfeasance or fraud or dishonesty of a substantial nature in performing Executive's services on behalf of the Company or its affiliates, which in each case is willful and deliberate on Executive's part and committed in bad faith or without reasonable belief that such breach or action is in the best interests of the Company or its affiliates;
(ii) Executive's use of alcohol or drugs (other than drugs prescribed to Executive by a physician and used by Executive for their intended purposes for which they had been prescribed) or other repeated conduct which materially and repeatedly interferes with the performance of his duties hereunder, which materially compromises the integrity or the reputation of the Company or its affiliates, or which results in other substantial economic harm to the Company or its affiliates;
(iii) Executive's conviction by a court of law, admission that he is guilty, or entry of a plea of nolo contendere with regard to a felony or other crime involving moral turpitude;
(iv) Executive's unscheduled absence from his employment duties other than as a result of illness or disability, for whatever cause, for a period of more than three (3) consecutive days, without consent from the Company prior to the expiration of the three (3) day period;
(v) Executive's failure to take action or to abstain from taking action, as directed in writing by a member of the Board or a higher ranking executive of the Company or Conseco, where such failure continues after Executive has been given written notice of such failure and at least five (5) business days thereafter to cure such failure; or
(vi) Any intentional wrongful act or omission by Executive that results in the restatement of Conseco's financial statements due to a violation of the Sarbanes-Oxley Act of 2002.
No termination shall be deemed to be a termination by the Company for Just Cause if the termination is as a result of Executive refusing to act in a manner that would be a violation of applicable law or where Executive acts (or refrains from taking action) in good faith in accordance with directions of a member of the Board or higher ranking executive but was unable to attain the desired results because such results were inherently unreasonable or unattainable.
(c) The Company may terminate Executive's employment in a Control Termination. A "Control Termination" shall mean any termination by the Company (or its successor) of Executive's employment for any reason within six months in anticipation of or within two years following a Change in Control.
The term "Change in Control" shall mean the occurrence of any of the following:
(i) the acquisition (other than an acquisition in connection with a "Non-Control Transaction") by any "person" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended (the "1934 Act")) of "beneficial ownership" (as such term is defined in Rule 13d-3 promulgated under the 1934 Act), directly or indirectly, of securities of Conseco or its Ultimate Parent representing 51% or more of the combined voting power of the then outstanding securities of Conseco or its Ultimate Parent entitled to vote generally with respect to the election of the Board or the board of directors of Conseco's Ultimate Parent; or
(ii) as a result of or in connection with a tender or exchange offer or contest for election of directors, individual board members of Conseco (identified as of the date of commencement of such tender or exchange offer, or the
commencement of such election contest, as the case may be) cease to constitute at least a majority of the Board; or
(iii) the consummation of a merger, consolidation or reorganization with or into Conseco unless (x) the stockholders of Conseco immediately before such transaction beneficially own, directly or indirectly, immediately following such transaction securities representing 51% or more of the combined voting power of the then outstanding securities entitled to vote generally with respect to the election of the board of directors of Conseco (or its successor) or, if applicable, the Ultimate Parent and (y) individual board members of Conseco (identified as of the date that a binding agreement providing for such transaction is signed) constitute at least a majority of the board of directors of Conseco (or its successor) or, if applicable, the Ultimate Parent (a transaction to which clauses (x) and (y) apply, a "Non-Control Transaction").
For purposes of this Agreement, "Ultimate Parent" shall mean the parent corporation (or if there is more than one parent corporation, the ultimate parent corporation) that, following a transaction, directly or indirectly beneficially owns a majority of the voting power of the outstanding securities entitled to vote with respect to the election of the board of directors of Conseco (or its successor).
(d) At Executive's option, he may terminate employment with the Company "With Reason" provided one or more of the following conditions are met: (i) any reduction in Executive's Base Salary or Target Bonus without his consent, or (ii) there is a "Change in Control" as defined in Section 10(c) and, following Executive's written request made prior to the Change in Control, the ultimate parent entity or entities directly or indirectly gaining control of a majority of the Board or outstanding securities entitled to vote with respect to the Board fails to affirm and guarantee the Company's current and future obligations under this Agreement.
(e) Upon termination of Executive's employment with the Company for any reason (whether voluntary or involuntary), Executive shall be deemed to have voluntarily resigned from all positions that Executive may then hold with the Company and any of its affiliates; provided that such deemed resignation shall not adversely affect Executive's rights to compensation or benefits under this Agreement and shall not affect the determination of whether Executive's termination was for Just Cause or With Reason.
11. Payments Following Termination.
(a) In the event that Executive's employment is terminated by the Company for Just Cause or if Executive voluntarily resigns, then (i) the Company within 10 business days shall pay Executive a cash payment of his Base Salary as provided in Section 5(a) hereof that was earned but unpaid as of the date of termination and (ii) no bonus for the year of termination will be earned or paid to Executive. All stock options, restricted stock and/or other awards held by Executive on the date of termination shall be treated in accordance with the applicable award agreements.
(b) In the event Executive's employment is terminated by the death of Executive, then the Company shall pay Executive's estate within 30 days (i) the Accrued Amounts and (ii) a pro-rata portion of the Target Bonus for the year in which his death occurs. All stock options, restricted stock and/or other awards held by Executive on the date of termination shall be treated in accordance with the applicable award agreements.
(c) In the event that Executive is terminated by the Company without Just Cause (and other than a termination due to expiration of the Term, death, disability or a Control Termination) or by Executive With Reason, then the Company shall pay Executive within 30 days (i) the Accrued Amounts, (ii) a pro-rata portion of the Target Bonus for the year in which his termination occurs and (iii) a cash lump sum equal to his Base Salary and Target Bonus. All stock options, restricted stock and/or other awards held by Executive on the date of termination shall be treated in accordance with the applicable award agreements.
(d) In the event that Executive is terminated by the Company (or its
successor) in a Control Termination as so defined, then the Company shall
pay Executive within 30 days (i) the Accrued Amounts, (ii) a cash lump sum
equal to his Target Bonus and one and one-half times his Base Salary and
(iii) a cash lump sum equal to a pro-rata portion of the Target Bonus for
the year in which the date of termination occurs. All stock options,
restricted stock and/or other awards held by Executive upon the occurrence
of the Change in Control shall be treated in accordance with the applicable
award agreements.
(e) Notwithstanding anything to the contrary, payment of any severance under this Agreement is conditioned upon the execution by Executive of a separation and release agreement in a form acceptable to the Company and the observation of such waiting or revocation periods, if any, before and after execution of the agreement by Executive as are required by law, such as, for example, the waiting or revocation periods required for a waiver and release to be effective with respect to claims under the Age Discrimination in Employment Act, provided that the Company delivers to Executive such agreement within seven days of the date of his termination.
12. Character of Termination Payments. The amounts payable to Executive upon any termination of his employment shall be considered severance pay in consideration of past services rendered on behalf of the Company and his continued service from the date hereof to the date he becomes entitled to such payments and shall be the sole amount of severance pay to which Executive is entitled from the Company and its affiliates upon termination of his employment during the Term. Executive shall have no duty to mitigate his damages by seeking other employment and, should Executive actually receive compensation from any such other employment, the payments required hereunder shall not be reduced or offset by any such other compensation.
13. Representations of the Parties.
(a) The Company represents and warrants to Executive that (i) this Agreement has been duly authorized, executed and delivered by the Company and constitutes valid and binding obligations of the Company; and (ii) the employment of Executive on the terms and conditions contained in this Agreement will not conflict with, result in a breach or violation of, constitute a default under, or result in the creation or imposition of any lien, charge or encumbrance upon any property or assets of the Company pursuant to: (A) the certificate of formation, (B) the terms of any indenture, contract, lease, mortgage, deed of trust, note, loan agreement or other agreement, obligation, condition, covenant or instrument to which the Company is a party or bound or to which its property is subject, or (C) any statute, law, rule, regulation, judgment, order or decree applicable to the Company, or any regulatory body, administrative agency, governmental body, arbitrator or other authority having jurisdiction over the Company.
(b) Executive represents and warrants to the Company that: (i) this Agreement has been duly executed and delivered by Executive and constitutes a valid and binding obligation of Executive; and (ii) neither the execution of this Agreement by Executive nor his employment by the Company on the terms and conditions contained herein will conflict with, result in a breach or violation of, or constitute a default under any agreement, obligation, condition, covenant or instrument to which Executive is a party or bound or to which his property is subject, or any statute, law, rule, regulation, judgment, order or decree applicable to Executive of any court, regulatory body, administrative agency, governmental body, arbitrator or other authority having jurisdiction over Executive or any of his property.
14. Arbitration of Disputes; Injunctive Relief.
(a) Arbitration. Except as provided in subsection (b) below, any controversy or claim arising out of or relating to this Agreement or the breach thereof shall be settled by binding arbitration in the City of Indianapolis, Indiana, in accordance with the laws of the State of Indiana by three arbitrators, one of whom shall be appointed by the Company, one by Executive, and the third of whom shall be appointed by the first two arbitrators. If the first two arbitrators cannot agree on the appointment of a third arbitrator, then the third arbitrator shall be appointed by the Chief Judge of the United States District Court for the Southern District of Indiana. The arbitration shall be conducted in accordance with the rules of the American Arbitration Association, except with respect to the selection of arbitrators, which shall be as provided in this Section. Judgment upon the award rendered by the arbitrators may be entered in any court having jurisdiction thereof. All reasonable costs and expenses (including fees and disbursements of counsel) incurred by Executive pursuant to this Section 14 shall be paid on behalf of or reimbursed to Executive promptly by the Company; provided, however, that in the event the Company prevails in such proceedings, Executive shall immediately repay all such amounts to the Company.
(b) Executive acknowledges that a breach or threatened breach by Executive of Sections 8 or 9 of this Agreement will give rise to irreparable injury to the Company
and that money damages will not be adequate relief for such injury. Notwithstanding paragraph (a) above, the Company and Executive agree that the Company may seek and obtain injunctive relief, including, without limitation, temporary restraining orders, preliminary injunctions and/or permanent injunctions, in a court of proper jurisdiction to restrain or prohibit a breach or threatened breach of Section 8 or 9 of this Agreement. Nothing herein shall be construed as prohibiting the Company from pursuing any other remedies available to the Company for such breach or threatened breach, including the recovery of damages from Executive.
15. Notices. Any notice required or permitted to be given under this Agreement shall be sufficient if in writing and if sent by registered mail to his residence, in the case of Executive, or to the business office of its Chief Executive Officer, in the case of the Company.
16. Waiver of Breach and Severability. The waiver by either party of a breach of any provision of this Agreement by the other party shall not operate or be construed as a waiver of any subsequent breach by either party. In the event any provision of this Agreement is found to be invalid or unenforceable, it may be severed from the Agreement, and the remaining provisions of the Agreement shall continue to be binding and effective.
17. Entire Agreement. Other than any equity award agreements entered into pursuant to the Conseco, Inc. 2003 Amended and Restated Long-Term Incentive Plan or any subsequent incentive plan, this instrument contains the entire agreement of the parties and, as of the Effective Date, supersedes all other obligations of the Company and its affiliates under other agreements or otherwise. The compensation and benefits to be paid under the terms of this Agreement are in lieu of all other compensation or benefits to which Executive is entitled from Conseco, the Company, and its affiliates, and upon termination of Executive's employment with the Company Executive will not be entitled to receive any severance or other payments beyond those specified in this Agreement. This Agreement may not be changed orally, but only by an instrument in writing signed by the party against whom enforcement of any waiver, change, modification, extension or discharge is sought.
18. Binding Agreement and Governing Law; Assignment Limited. This Agreement shall be binding upon and shall inure to the benefit of the parties and their lawful successors in interest (including, without limitation, Executive's estate, heirs and personal representatives) and, except for issues or matters as to which federal law is applicable, shall be construed in accordance with and governed by the laws of the State of Indiana. This Agreement is personal to each of the parties hereto, and neither party may assign or delegate any of its rights or obligations hereunder without the prior written consent of the other.
19. Indemnification. If Executive was or is made a party or is threatened to be made a party to or is otherwise involved (including involvement as a witness) in any action, suit or proceeding, whether civil, criminal, administrative or investigative (a "Proceeding"), by reason of the fact that he or she is or was an officer or employee of the Company or any of its affiliates, Executive shall be indemnified and held harmless by the Company to the fullest extent authorized by the Delaware General Corporation Law, as the same exists or may hereafter be amended (but, in the case of any such amendment, only to the extent that such amendment permits the Company to provide broader indemnification rights than permitted prior thereto), against all expense, liability and loss (including attorneys' fees, judgments, fines, excise taxes or
penalties and amounts paid in settlement) reasonably incurred or suffered by Executive in connection therewith and such indemnification shall continue as to Executive if he ceases to be an officer or employee and shall inure to the benefit of Executive's heirs, executors and administrators; provided, however, that the Company shall indemnify Executive in connection with a proceeding (or part thereof) initiated by Executive only if such Proceeding (or part thereof) was authorized by the managing member of the Company. The right to indemnification conferred in this paragraph shall include the obligation of the Company to pay the expenses incurred in defending any such proceeding in advance of its final disposition (an "Advance of Expenses"); provided, however, that, if and to the extent that the Delaware General Corporation Law requires, an Advance of Expenses incurred by Executive in his capacity as an officer or employee shall be made only upon delivery to the Company of an undertaking, by or on behalf of Executive, to repay all amounts so advanced if it shall ultimately be determined by final judicial decision from which there is no further right to appeal that Executive is not entitled to be indemnified for such expenses under this paragraph or otherwise.
20. No Third Party Beneficiaries. The terms and provisions of this Agreement are intended solely for the benefit of each party hereto and their respective successors or permitted assigns, and it is not intended to confer third-party beneficiary rights upon any other person.
21. Section 409A. Notwithstanding anything to the contrary in this
Agreement, if Executive is a "specified employee" within the meaning of Section
409A of the Internal Revenue Code, as amended (the "Code"), at the time of
Executive's separation from service, and if any payment or benefit otherwise
payable to Executive by the terms of this Agreement is considered to be
non-qualified deferred compensation under the Code, then the Company shall delay
any such payment or benefit to Executive until the earliest date permitted under
Section 409A without causing Executive to incur excise tax.
22. Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed to be an original, but all of which together shall constitute one and the same instrument.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written, effective as of the Effective Date.
COMPANY:
CONSECO SERVICES, LLC
/s/ Edward J. Bonach ------------------------------------ Edward J. Bonach President |
EXECUTIVE:
/s/ Scott R. Perry ------------------------------------ Scott R. Perry |
CONSECO, INC. AND SUBSIDIARIES
Exhibit 12.1
Computation of Ratio of Earnings to
Fixed Charges and Preferred Dividends
(Dollars in millions)
2008 2007 2006 2005 2004
---- ---- ---- ---- ----
Pretax income (loss) from operations:
Net income (loss)..................................... $(1,126.7) $(179.9) $106.0 $312.7 $289.7
Add income tax expense (benefit)...................... 416.4 64.0 61.0 144.1 132.5
Add discontinued operations........................... 722.7 105.9 (.3) (51.1) (44.3)
--------- ------- ------ ------ ------
Pretax income (loss) from operations.................. 12.4 (10.0) 166.7 405.7 377.9
--------- ------- ------ ------ ------
Add fixed charges:
Interest expense on corporate debt.................... 59.2 72.3 52.9 48.1 71.5
Interest expense on investment borrowings............. 38.6 45.0 20.6 10.2 8.0
Interest added to policyholder account balances....... 330.5 399.5 426.8 419.9 410.4
Portion of rental (a)................................. 13.4 13.7 13.2 12.6 13.5
--------- ------- ------ ------ ------
Fixed charges..................................... 441.7 530.5 513.5 490.8 503.4
--------- ------- ------ ------ ------
Adjusted earnings (loss).......................... $ 454.1 $ 520.5 $680.2 $896.5 $881.3
========= ======= ====== ====== ======
Ratio of earnings to fixed charges............. 1.03X (b) 1.32X 1.83X 1.75X
===== = ===== ===== =====
Fixed charges................................................ $ 441.7 $ 530.5 $513.5 $490.8 $503.4
Add dividends on preferred stock, including
dividends on preferred stock of subsidiaries
(divided by the ratio of income to pretax income).... - 23.5 59.9 58.9 100.9
--------- ------- ------ ------ ------
Fixed charges plus preferred dividends............ $ 441.7 $ 554.0 $573.4 $549.7 $604.3
========= ======= ====== ====== ======
Adjusted earnings (loss).......................... $ 454.1 $ 520.5 $680.2 $896.5 $881.3
========= ======= ====== ====== ======
Ratio of earnings to fixed charges and
preferred dividends.......................... 1.03X (c) 1.19X 1.63X 1.46X
===== = ===== ===== =====
--------------------
(a) Interest portion of rental is estimated to be 33 percent.
(b) For such ratio, earnings were $10.0 million less than fixed charges.
(c) For such ratio, earnings were $33.5 million less than fixed charges.
|
Exhibit 21
Subsidiaries of Conseco, Inc.
Name State or Other Jurisdiction ---- --------------------------- 40|86 Advisors, Inc. Delaware Design Benefit Plans, Inc. Illinois NAL Financial Group, Inc. Delaware CDOC, Inc. Delaware Conseco Securities, Inc. Delaware K. F. Insurance Agency of Massachusetts, Inc. Massachusetts K. F. Agency, Inc. Illinois Administrators Service Corporation Illinois Hawthorne Advertising Agency, Incorporated Pennsylvania Geneva International Insurance Company, Inc. Turks and Caicos General Acceptance Corporation Reinsurance Limited Turks and Caicos American Life and Casualty Marketing Division Co. Iowa 40|86 Mortgage Capital, Inc. Delaware Conseco Management Services Company Texas Conseco Services, LLC Indiana Conseco Marketing, L.L.C. Indiana Conseco Data Services (India) Private Limited India Codelinks, LLC Indiana Conseco Health Services, Inc. Pennsylvania Performance Matters Associates, Inc. Delaware Performance Matters Associates of Texas, Inc. Texas Erie International Insurance Company, Inc. Turks and Caicos Association Management Corporation Illinois Conseco Life Insurance Company of Texas Texas Colonial Penn Life Insurance Company Pennsylvania C.P. Real Estate Services Corp. New Jersey Conseco Health Insurance Company Arizona Bankers Conseco Life Insurance Company New York Washington National Insurance Company Illinois Conseco Life Insurance Company Indiana Conseco Insurance Company Illinois Bankers Life and Casualty Company Illinois BLC Financial Services, Inc. Illinois Carmel Fifth, LLC Delaware ResortPort Holding of Delaware, Inc. Delaware 3037953 Nova Scotia Company Nova Scotia |
Exhibit 23.1
We hereby consent to the incorporation by reference in this Registration Statement on Form S-8 (File No. 333-108835) of Conseco, Inc of our report dated March 31, 2009 relating to the financial statements and the effectiveness of internal control over financial reporting, which appears in this Form 10-K. We also consent to the incorporation by reference of our report dated March 31, 2009 relating to the financial statement schedules, which appear in this Form 10-K.
/s/ PricewaterhouseCoopers LLP ------------------------------ Indianapolis, Indiana March 31, 2009 |
Exhibit 31.1
CONSECO, INC. AND SUBSIDIARIES
CERTIFICATION
I, C. James Prieur, certify that:
1. I have reviewed this annual report on Form 10-K of Conseco, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the year covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the years presented in this annual report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the year in which this annual report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;
(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the year covered by this annual report; and
(d) Disclosed in this annual report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: March 31, 2009 /s/ C. James Prieur ------------------- C. James Prieur, Chief Executive Officer |
Exhibit 31.2
CONSECO, INC. AND SUBSIDIARIES
CERTIFICATION
I, Edward J. Bonach, certify that:
1. I have reviewed this annual report on Form 10-K of Conseco, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the year covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the years presented in this annual report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the year in which this annual report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;
(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the year covered by this annual report; and
(d) Disclosed in this annual report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: March 31, 2009 /s/ Edward J. Bonach -------------------- Edward J. Bonach, Executive Vice President and Chief Financial Officer |
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Conseco, Inc. (the "Company") on Form 10-K for the year ending December 31, 2008 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, C. James Prieur, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my actual knowledge:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
/s/ C. James Prieur ------------------- C. James Prieur Chief Executive Officer March 31, 2009 |
A signed original of this written statement required by Section 906 has been provided to Conseco, Inc. and will be retained by Conseco, Inc. and furnished to the Securities and Exchange Commission upon request.
Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Conseco, Inc. (the "Company") on Form 10-K for the year ending December 31, 2008 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Edward J. Bonach, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my actual knowledge:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
/s/ Edward J. Bonach -------------------- Edward J. Bonach Executive Vice President and Chief Financial Officer March 31, 2009 |
A signed original of this written statement required by Section 906 has been provided to Conseco, Inc. and will be retained by Conseco, Inc. and furnished to the Securities and Exchange Commission upon request.