Our Bankers Life segment is primarily administered from a facility in downtown Chicago, Illinois. Bankers Life has approximately 222,000 square feet leased under an agreement which expires in 2018. In addition, Bankers Life leases approximately 114,000 square feet of space in its former location, the Merchandise Mart. Approximately 75 percent of that space is subleased through November 2013, the early termination date of the lease. We also lease 238 sales offices in various states totaling approximately 718,000 square feet. These leases generally are short-term in length, with remaining lease terms expiring between 2010 and 2017.
We manage our business through the following: three primary operating segments, Bankers Life, Colonial Penn and Conseco Insurance Group, which are defined on the basis of product distribution; and corporate operations, which consists of holding company activities and certain noninsurance company businesses that are not part of our other segments. Our segments are described below:
We regularly evaluate our investments for possible impairment based on current economic conditions, credit loss experience and other investee-specific circumstances and developments. When we conclude that a decline in a security’s net realizable value is other than temporary, the decline is recognized as a realized loss and the cost basis of the security is reduced to its estimated fair value. During the year ended December 31, 2009, writedowns of investments included $195.4 million of writedowns of investments for other than temporary declines in fair value recognized through net income.
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.
Coventry as described above under “Accounting for marketing and reinsurance agreements with Coventry”. We began assuming the PDP business on January 1, 2006 and the PFFS business on January 1, 2007. During 2007 and 2008, we entered into new PFFS quota-share reinsurance agreements to assume a specified percentage of the business written by Coventry under three large group policies. During 2008, we recognized a $3 million increase in insurance policy benefits due to changes in our estimates of prior period claim costs on the PFFS business we assume from Coventry. In order to reduce the required statutory capital associated with the assumption of this business, Conseco terminated two group policy quota-share agreements as of December 31, 2008 and terminated the last agreement on June 30, 2009. Coventry has decided to cease selling PFFS plans effective January 1, 2010. On July 22, 2009, Bankers Life announced a strategic alliance under which it will offer Humana’s Medicare Advantage plans to its policyholders and consumers nationwide through its career agency force and will receive marketing fees based on sales. Effective January 1, 2010, the Company will no longer be assuming the underwriting risk related to PFFS business. Insurance margins (insurance policy income less insurance policy benefits) on the PDP and PFFS business were $59.5 million, $24.4 million and $40.3 million in 2009, 2008 and 2007, respectively. The increase in margin in 2009 is primarily due to: (i) increases in our share of risk adjustment premium payments made by the Center for Medicare and Medical Services; and (ii) favorable reserve developments.
Other operating costs and expenses in our Colonial Penn segment increased 1.4 percent, to $30.0 million in 2009 as compared to 2008. Such expenses increased 25 percent, to $29.6 million, in 2008 as compared to 2007 primarily due to: (i) the additional costs incurred following the recapture of the modified coinsurance agreement in the fourth quarter of 2007; and (ii) the growth in this segment in recent periods. Other operating costs and expenses in our Colonial Penn segment in 2007 included $8.4 million of marketing costs associated with a pilot program involving the distribution of Coventry’s PFFS plan through our direct response distribution channel. Such pilot program was discontinued in 2008.
percent and 192.4 percent in 2009, 2008 and 2007, respectively. Benefit ratios are calculated by dividing the product’s insurance policy benefits by insurance policy income. Since the insurance product liabilities we establish for long-term care business are subject to significant estimates, the ultimate claim liability we incur for a particular period is likely to be different than our initial estimate. Our insurance policy benefits reflected reserve redundancies (deficiencies) from prior years of $(2.1) million, $1.1 million and $(6.3) million in 2009, 2008 and 2007, respectively. Excluding the effects of prior year claim reserve redundancies (deficiencies), our benefit ratios would have been 180.1 percent, 172.8 percent and 175.7 percent in 2009, 2008 and 2007, respectively. These ratios reflect the level of incurred claims experienced in recent periods, development on claims incurred in prior periods and changes in policy income. The prior period deficiencies have primarily resulted from the impact of paid claim experience being different than prior estimates.
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.
Collected premiums on Medicare supplement policies in the Conseco Insurance Group segment decreased 13 percent, to $177.8 million, in 2009 and 9.8 percent, to $203.8 million, in 2008. We have experienced lower sales and higher lapses of these products due to premium rate increases implemented in recent periods and competition from companies offering Medicare Advantage products.
As of December 31, 2009, we had investments in substantive default (i.e., in default due to nonpayment of interest or principal) that had an estimated fair value of $39.8 million. 40|86 Advisors employs experienced professionals to manage
At December 31, 2009, we held commercial mortgage loan investments with a carrying value of $1,965.5 million (or 9 percent of total invested assets) and a fair value of $1,756.8 million. Noncurrent commercial mortgage loans were insignificant at December 31, 2009. During 2009, we recognized $40.9 million of writedowns of commercial mortgage loans resulting from declines in fair value that we concluded were other than temporary. During 2008, we recognized $5.8 million of writedowns of commercial mortgage loans for other-than-temporary declines in fair value and recognized losses of $22.1 million from the liquidation of several delinquent commercial mortgage loans. Realized losses on commercial mortgage loans were not significant in 2007. We had no allowance for loss on mortgage loans at both December 31, 2009 and 2008. Approximately 7 percent, 7 percent, 7 percent, 6 percent and 6 percent of the mortgage loan balance were on properties located in Indiana, Minnesota, Ohio, California and Arizona, respectively. No other state comprised greater than five percent of the mortgage loan balance.
The following table shows our commercial mortgage loan portfolio by loan size as of December 31, 2009 (dollars in millions):
In accordance with GAAP, we record our actively managed fixed maturity investments, equity securities and certain other invested assets at estimated fair value with any unrealized gain or loss (excluding impairment losses, which are recognized through earnings), net of tax and related adjustments, recorded as a component of shareholders’ equity. At December 31, 2009, we decreased the carrying value of such investments by $.5 billion as a result of this fair value adjustment.
On October 16, 2009, A.M. Best affirmed the financial strength rating of “B” of our primary insurance subsidiaries and the ratings outlook as negative. Also, A.M. Best removed the ratings from under review with negative implications. On March 4, 2009, A.M. Best downgraded the financial strength ratings of our primary insurance subsidiaries to “B” from “B+” and such ratings had been placed under review with negative implications. The “B” rating is assigned to companies that have a fair ability, in A.M. Best’s opinion, to meet their current obligations to policyholders, but are financially vulnerable to adverse changes in underwriting and economic conditions. A.M. Best ratings for the industry currently range from “A++ (Superior)” to “F (In Liquidation)” and some companies are not rated. An “A++” rating indicates a superior ability to meet ongoing obligations to policyholders. A.M. Best has sixteen possible ratings. There are six ratings above our “B” rating and nine ratings that are below our rating.
As calculated pursuant to the state insurance department of each company’s domiciliary state.
The following chart summarizes: (i) the most significant financial ratios and balances we must maintain pursuant to our Senior Credit Agreement; (ii) the current ratios and balances as of December 31, 2009; and (iii) the margins for adverse developments before such ratio or balance requirement is not met (dollars in millions):
certain asset dispositions; (vi) affiliate transactions; (vii) certain investment activities; (viii) change in business; and (ix) prepayment of indebtedness (other than the Senior Credit Agreement). The obligations under our Senior Credit Agreement are guaranteed by Conseco’s current and future domestic subsidiaries, other than: (i) its insurance companies; (ii) subsidiaries of the insurance companies; or (iii) certain immaterial subsidiaries as defined in the Senior Credit Agreement. This guarantee was secured by granting liens on substantially all the assets of the guarantors, including the capital stock of Conseco Life of Texas, Washington National and Conseco Health.
there can be no assurance that management will be successful in implementing such strategies and achieving adequate investment spreads.
Our investment in options backing our equity-linked products is closely matched with our obligation to equity-indexed annuity holders. Fair value changes associated with that investment are substantially offset by an increase or decrease in the amounts added to policyholder account balances for equity-indexed products.
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.
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.
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.
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.
Our fixed maturity investments are generally purchased in the context of a long-term strategy to fund insurance liabilities, so we do not generally seek to purchase and sell such securities to generate short-term realized gains. In certain circumstances, including those in which securities are selling at prices which exceed our view of their underlying economic value, or when it is possible to reinvest the proceeds to better meet our long-term asset-liability matching objectives, we may sell certain securities.
Impairment losses on equity securities are recognized in net income. The manner in which impairment losses on actively managed fixed maturity securities are recognized in the financial statements is dependent on the facts and circumstances related to the specific security. If we intend to sell a security or it is more likely than not that we would be required to sell a security before the recovery of its amortized cost, the security is other-than-temporarily impaired and the full amount of the impairment is recognized as a loss through earnings. If we do not expect to recover the amortized cost basis, we do not plan to sell the security and if it is not more likely than not that we would be required to sell a security before
Pass-throughs, sequentials and equivalent securities have unique prepayment variability characteristics. Pass-through securities typically return principal to the holders based on cash payments from the underlying mortgage obligations. Sequential securities return principal to tranche holders in a detailed hierarchy. Planned amortization classes, targeted amortization classes and accretion-directed bonds adhere to fixed schedules of principal payments as long as the underlying mortgage loans experience prepayments within certain estimated ranges. Changes in prepayment rates are first absorbed by support or companion classes insulating the timing of receipt of cash flows from the consequences of both faster prepayments (average life shortening) and slower prepayments (average life extension).
Commercial mortgage-backed securities are secured by commercial real estate mortgages, generally income producing properties that are managed for profit. Property types include multi-family dwellings including apartments, retail centers, hotels, restaurants, hospitals, nursing homes, warehouses, and office buildings. Most commercial mortgage-backed securities have call protection features whereby underlying borrowers may not prepay their mortgages for stated periods of time
Section 382 imposes limitations on a corporation’s ability to use its NOLs when the company undergoes an ownership change. Future transactions and the timing of such transactions could cause an ownership change for Section 382 income tax purposes. Such transactions may include, but are not limited to, additional repurchases or issuances of common stock (including upon conversion of our outstanding 3.5% Debentures or 7.0% Debentures), or acquisitions or sales of shares of Conseco stock by certain holders of our shares, including persons who have held, currently hold or may accumulate in the future five percent or more of our outstanding common stock for their own account. Many of these transactions are beyond our control. If an additional ownership change were to occur for purposes of Section 382, we would be required to calculate an annual restriction on the use of our NOLs to offset future taxable income. The annual restriction would be calculated based upon the value of Conseco’s equity at the time of such ownership change, multiplied by a federal long-term tax exempt rate (4.16 percent at December 31, 2009), and the annual restriction could effectively eliminate our ability to use a substantial portion of our NOLs to offset future taxable income. We regularly monitor ownership change (as calculated for purposes of Section 382) and, as of December 31, 2009, we were below the 50 percent ownership change level that would trigger further impairment of our ability to utilize our NOLs.
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.
If an event of default occurs and is continuing with respect to the 3.5% Debentures, either the trustee or the holders of at least 25 percent of the aggregate accreted principal amount of the 3.5% Debentures then outstanding may declare the accreted principal amount, plus accrued and unpaid interest, including additional interest and contingent interest, if any, on the 3.5% Debentures to be due and payable immediately. If an event of default relating to certain events of bankruptcy, insolvency or reorganization occurs, the accreted principal amount plus accrued and unpaid interest, including additional interest and contingent interest, if any, on the 3.5% Debentures will become immediately due and payable. The following are events of default with respect to the 3.5% Debentures:
The Company was permitted to issue unsecured indebtedness that is used solely to pay the holders of the 3.5% Debentures, provided that such indebtedness: (i) had a maturity date that is no earlier than October 10, 2014; (ii) contained covenants and events of default that are no more restrictive than those in the Senior Credit Agreement; (iii) did not contain
On November 13, 2009, we repaid $36.8 million of outstanding principal on the Senior Credit Agreement from the proceeds of the issuance of common stock and warrants to Paulson. On December 22, 2009, the Company repaid $161.4 million of outstanding principal on the Senior Credit Agreement from proceeds of an equity offering. Such transactions are further discussed in the note to the consolidated financial statements entitled “Shareholders’ Equity.”
In 2008, we repurchased $37.0 million par value of the 3.5% Debentures for $15.3 million plus accrued interest and recognized a gain on the extinguishment of debt of $21.2 million related to such repurchases.
Includes $116.5 million of the 3.5% Debentures. The holders of our 3.5% Debentures have the right to require the Company to repurchase their 3.5% Debentures for cash on September 30, 2010. This amount assumes that all remaining holders of our 3.5% Debentures exercise that right. In February 2010, as further discussed in the note to the consolidated financial statements entitled “Subsequent Events”, we repurchased $64 million of the 3.5% Debentures and issued $64 million of the 7.0% Debentures.
In late October 2008, Conseco Life mailed notice to approximately 12,000 holders of its “Lifetrend” life insurance products to inform them of: (i) changes to certain “non-guaranteed elements” (“NGEs”) of their policies; and (ii) the fact that certain policyholders who were not paying premiums may have failed to receive a notice that their policy was underfunded and that additional premiums were required in order for the policyholders to maintain their guaranteed cash values. In December 2008, Conseco Life mailed notice to approximately 16,000 holders of its CIUL3+ universal life policies to inform them of an increase in certain NGEs with respect to their policies. Prior to or around the time that the notices were sent, Conseco Life had informed the insurance regulators in a number of states, including among others Indiana, Iowa and Florida, of these matters and the planned communication with the impacted policyholders. Conseco Life received a cease and desist order from the Iowa Department of Insurance dated December 9, 2008, directing that it cease any further activity with respect to the matters that had been communicated in the notice to the Lifetrend policyholders. In December 2008, in response to communications received from certain regulators and policyholders, Conseco Life unilaterally agreed to enter into a nationwide temporary moratorium through March 31, 2009 with regard to the proposed Lifetrend changes. Conseco agreed to extend that moratorium to June 30, 2009. In addition, Conseco Life entered into a stipulation and standstill with the Iowa Department of Insurance pursuant to which Conseco Life also agreed to take no further action with respect to the Lifetrend and CIUL3+ policyholders in Iowa.
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.