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. 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.
Below-investment grade securities have different characteristics than investment grade corporate debt securities. 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 creditors of the issuer. Also, issuers of below-investment grade securities usually have higher levels of debt and may be more sensitive to adverse economic conditions, such as recession or increasing interest rates, than are investment grade issuers. The Company attempts to reduce the overall risk 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.
As of December 31, 2005, we have received election notice responses (or policyholders have defaulted to option one due to failure to elect an option) from approximately 15,100 policyholders, 53 percent of whom elected (or defaulted) to option one, 4 percent selected option two and 43 percent selected 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 may 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. In 2005, we did not make any adjustments to the insurance liabilities when these elections were made, although the future profitability of this block is expected to improve. The changes in reserves due to the structural changes arising from such elections are being recognized prospectively over the expected remaining life of the policies pursuant to the lock-in concept of Statement of Financial Accounting Standards No. 60, "Accounting and Reporting by Insurance Enterprises" and related interpretive accounting and actuarial guidance.
o An inability to meet and/or maintain the covenants in our Amended Credit Facility.
In August 2005, we entered into the Amended Credit Facility with a balance of $447.0 million. The proceeds of the Amended Credit Facility were used to repay the remaining principal amount of the Credit Facility. The Amended Credit Facility provided for a one-time increase in the facility or the addition of a new facility of up to $325.0 million. In December 2005, we borrowed an additional $80.0 million pursuant to this provision. The proceeds from the additional borrowing were used to increase the capital and surplus of our insurance subsidiaries. During 2005, we made principal payments totaling $2.4 million on our Amended Credit Facility. Under the terms of the Amended Credit Facility, we are required to make quarterly principal payments of .25 percent (approximately $1.3 million) of the initial principal amount through March 31, 2010. The remaining principal balance is due on June 22, 2010. At December 31, 2005, the interest rate on our Amended Credit Facility was 6.4 percent.
(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 4.6 percent.
(g) The Company establishes reserves for insurance policy benefits based on assumptions as to investment yields, mortality, morbidity, withdrawals and lapses. These reserves include amounts for estimated future payment of claims based on actuarial assumptions. Many factors can affect these reserves, such as economic conditions, inflation, hospital and pharmaceutical costs, changes in doctrines of legal liability and extra contractual damage awards. The fresh-start balance was based on the Company's best estimate (with assistance from a consulting actuarial firm) of the future performance of this business, given recent and expected changes in experience. Adjustments to the Predecessor's liabilities for insurance products are further discussed in the note to the consolidated financial statements entitled "Liabilities for Insurance Products".
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 contingently liable for claims reinsured if the assuming company is unable to pay. The likelihood of a material loss being incurred as a result of the failure of one of our reinsurers is considered remote. The cost of reinsurance 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 $232.2 million in 2005; $255.2 million in 2004; $92.1 million in the four months ended December 31, 2003; and $196.4 million in the eight months ended August 31, 2003. We deduct this cost from insurance policy income. Reinsurance recoveries netted against insurance policy benefits totaled $231.6 million in 2005; $281.8 million in 2004; $94.3 million in the four months ended December 31, 2003; and $199.2 million in the eight months ended August 31, 2003.
In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004) "Share-Based Payment" ("SFAS 123R"), which revises SFAS 123 and supersedes APB 25. SFAS 123R provides additional guidance on accounting for share-based payments and will require 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 will implement SFAS 123R using the modified prospective method on January 1, 2006. Under this method, the Company will begin recognizing compensation cost for all awards granted on or after January 1, 2006. In addition, we will be required to recognize compensation cost over the remaining requisite service period for the portion of outstanding awards that are not vested as of January 1, 2006 and were not previously expensed on a pro forma basis under the fair value method summarized below. 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 currently required. The aggregate value of unvested options at December 31, 2005, as determined using the Black-Scholes option valuation model at the date of grant, was $11.3 million. If compensation cost had been determined based on the fair value at the grant dates for all awards issued after January 1, 1995, the Company's pro forma net income and pro forma earnings per share would have been as follows (dollars in millions, except per share amounts):
The FASB issued FASB Staff Position ("FSP") FAS 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003" ("FSP FAS 106-2") in May 2004. FSP FAS 106-2 provides guidance on accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "Modernization Act"). The Modernization Act provides, among other things, a federal subsidy to plan sponsors who maintain postretirement health care plans that provide prescription drug benefits and meet certain equivalency criteria. FSP FAS 106-2 superseded FSP FAS 106-1, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003". The adoption of FSP FAS 106-2 did not have a significant impact on our consolidated financial statements.
During 2005, we recorded writedowns of equity securities and other invested assets totaling $10.2 million as a result of analysis that led us to conclude that the declines in the values of these investments were other than temporary. This total writedown was comprised of the following: (i) $6.1 million related to an investment in preferred stock of a privately held insurance company which was downgraded by A.M. Best Company ("A.M. Best") in the fourth quarter of 2005; (ii) $1.5 million related to home office buildings which are available for sale, based on the anticipated sales prices; (iii) $1.3 million related to our holdings in a non-operating entity engaged in litigation with the Canadian government; and (iv) $1.3 million related to two real estate investments in retail stores that are vacant and listed for sale, and have recently been re-appraised.
On December 19, 2001, four of the Company's subsidiaries were named in a purported nationwide class action seeking unspecified damages in the District Court of Adams County, Colorado, Jose Medina and others similarly situated v. Conseco Annuity Assurance Company, Conseco Life Insurance Company, Bankers National Life Insurance Company and
Bankers Life and Casualty Company, Cause No. 01-CV-2465, alleging among other things breach of contract regarding alleged non-disclosure of additional charges for those policyholders paying via premium modes other than annual. On November 10, 2003, the court denied the plaintiff's motion for class certification. On January 26, 2004, the plaintiff appealed the trial court's ruling denying class certification, but the Colorado Court of Appeals upheld the trial court's ruling on August 25, 2005. Plaintiffs' counsel indicated that they were going to re-file the case with a smaller proposed plaintiff class. We settled the case to avoid further litigation.
The following assumed health care cost trend rates were used to determine our postretirement benefit obligation:
Brickyard Loan Trust ("Brickyard") was a collateralized debt obligation trust which participated in an underlying pool of commercial loans. The trust was formed by the Predecessor and was fully liquidated in the third quarter of 2003. The initial capital structure of Brickyard consisted of $575 million of senior financing provided by unrelated third party investors and $127 million of notes and subordinated certificates owned by the Company and others. As a result of our 85 percent ownership interest in the subordinated certificates, we were the primary beneficiary of Brickyard. In accordance with ARB 51 "Consolidated Financial Statements", Brickyard was consolidated in our financial statements because our investment management subsidiary, 40|86 Advisors, Inc., was the investment manager and we owned a significant interest in the subordinated certificates.