Finance operations. Certain corporate servicing operations are housed in Saint Paul, Minnesota, in 120,000 square feet of a building owned by the Company. The finance segment operates 45 manufactured housing regional service centers and three commercial finance business centers. Such offices are leased, typically for a term of three to five years, and range in size from 1,700 to 22,000 square feet. We also operate a central servicing center in Rapid City, South Dakota. The lease on this facility has a remaining term of four years, with an option to purchase, and consists of 137,000 square feet. In Rapid City, South Dakota, we have agreed to lease one additional building under construction which will contain approximately 76,000 square feet. The home improvement and consumer product divisions lease their main office in Saint Paul, Minnesota. The lease has a remaining term of four years and consists of 125,000 square feet. The home equity business has operations in six regional locations and 139 regional satellite offices, plus a service center in Tempe, Arizona, which opened in February 1997 (which consists of three buildings totaling approximately 200,000 square feet). The finance operations also lease 4 other administrative offices in Minnesota, New Jersey and Georgia totaling approximately 197,000 square feet; these leases are short-term in length with remaining lease terms ranging from one to five years.
(b) On September 8, 1999, we announced that we would no longer structure the securitizations of the loans we originate in a manner that results in gain-on-sale revenues. For more information on this change, see "Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations -- Finance Segment -- General."
(d) All share and per-share amounts have been restated to reflect the two-for-one stock splits paid on February 11, 1997 and April 1, 1996.
(f) Includes premiums received from universal life products and products without mortality or morbidity risk. Such premiums are not reported as revenues under GAAP and were $3,023.3 million in 1999; $2,585.7 million in 1998; $2,099.4 million in 1997; $1,881.3 million in 1996; and $1,757.5 million in 1995. Also includes deposits in mutual funds totaling $479.3 million in 1999; $87.1 million in 1998; and $19.9 million in 1997.
(g) Represents income before extraordinary charge and net investment gains (losses) of our insurance segment (less that portion of amortization of cost of policies purchased and cost of policies produced and income taxes relating to such gains (losses)). In 1995, operating earnings also excluded income of $87.1 million (net of income taxes) primarily arising from the release of deferred income taxes previously accrued on income related to two affiliates (such deferred tax was no longer required when Conseco reached 80 percent ownership of these companies) and the sale of Conseco's investment in Eagle Credit (a finance subsidiary of Harley Davidson). In 1996, operating earnings also excluded income of $17.4 million (net of income taxes) primarily arising from the sale of Conseco's investment in Noble Broadcast Group, Inc. Operating earnings in 1997 also excluded: (i) an impairment loss in the finance segment of $117.8 million (net of income taxes); (ii) a charge of $40.5 million (net of income taxes) related to premium deficiencies on our Medicare supplement business in the State of Massachusetts; and (iii) a charge of $4.3 million (net of income taxes) related to the death of an executive officer. Operating earnings in 1998 exclude the merger-related and impairment charges of $503.8 million (net of income taxes) described in note (c) above. Operating earnings in 1999 exclude: (i) the impairment charge of $349.2 million (net of income taxes) described in note (c) above; and (ii) the provision for losses on loan guarantees of $11.9 million (net of taxes).
(h) Represents: (i) our assets excluding finance receivables, interest-only securities and servicing assets, of $41.4 billion, $38.9 billion, $37.2 billion, $26.4 billion and $17.9 billion at December 31, 1999, 1998, 1997, 1996 and 1995, respectively; (ii) the total fixed and revolving credit receivables that Conseco Finance manages, including receivables on its balance sheet and receivables applicable to the holders of asset-backed securities sold by Conseco Finance of $45.8 billion, $37.2 billion, $28.0 billion, $20.1 billion and $13.9 billion at December 31, 1999, 1998, 1997, 1996 and 1995, respectively; and (iii) the total market value of the investment portfolios managed by CCM, excluding assets of Conseco's subsidiaries, of $11.4 billion, $11.2 billion, $5.1 billion, $12.6 billion and $10.9 billion at December 31, 1999, 1998, 1997, 1996 and 1995, respectively.
On March 31, 2000, we announced that we plan to explore the sale of Conseco Finance and are hiring Lehman Brothers Inc. to assist in the planned sale. If the planned sale is completed, the Company will no longer have finance operations.
Net income of $467.1 million in 1998, or $1.40 per diluted share, included: (i) net investment losses (net of related costs, amortization and taxes) of $32.8 million, or 10 cents per share; (ii) an extraordinary charge (net of taxes) of $42.6 million, or 13 cents per share, related to early retirement of debt; (iii) the impairment charge (net of taxes) of $355.8 million, or $1.08 per share, to reduce the value of interest-only securities and servicing rights; and (iv) a merger-related charge (net of taxes) of $148.0 million, or $.44 per share, related primarily to costs incurred in conjunction with the Conseco Finance Merger.
Net income of $866.4 million in 1997, or $2.52 per diluted share, included: (i) net investment gains (net of related costs, amortization and taxes) of $44.1 million, or 13 cents per share; (ii) an extraordinary charge of $6.9 million, or 2 cents per share, related to early retirement of debt; (iii) a charge of 4 cents per
share related to the induced conversion of preferred stock (treated as a preferred stock dividend); (iv) an impairment loss totaling $117.8 million or 35 cents per share; (v) charges of $40.5 million, or 12 cents per share, related to premium deficiencies on our Medicare supplement business in the state of Massachusetts; and (vi) charges of $4.3 million, or 1 cent per share, related to the death of an executive officer. The impairment loss represents a charge to reduce the value of interest-only securities and servicing rights generally due to adverse prepayments.
Total revenues included net investment losses of $156.2 million in 1999, and net investment gains of $208.2 million and $266.5 million in 1998 and 1997, respectively. Excluding net investment gains (losses), total revenues were $8.5 billion in 1999, up 12 percent over 1998. Total revenues, excluding net investment gains, were up 14 percent in 1998 over 1997. Increases in total revenues in all three years reflect the impact and timing of acquisitions, as well as growth in both segments.
Premiums and asset accumulation product collections in 1999 were $7.0 billion, up 15 percent over 1998. Premiums and deposits collected in 1998 were $6.1 billion, up 19 percent over 1997. These increases were primarily due to increased production and premium rate increases in 1999 and due to the recent acquisitions and premium rate increases in 1998.
Net investment income related to equity-indexed products based on the S&P 500 Index is substantially offset by a corresponding charge to amounts added to policyholder account balances for equity-indexed products. Such income and related charge fluctuated based on the policyholder account balances subject to this provision and the performance of the S&P 500 Index to which the returns on such products are linked. During 1999, we recorded income from the S&P 500 Options of $142.3 million and added amounts to policyholders' account balances of the equity-indexed products of $141.3 million.
Amortization of cost of S&P 500 Call Options represents the premiums paid to purchase S&P 500 Call Options related to our equity-linked products. We amortize these amounts over the terms of the options. Such amortization has increased because of the increase in our equity-linked product business, changes in the participation rate of such business in the S&P 500 Index, and the cost of the options. Our equity-indexed products are designed in an effort to have the investment income spread earned on the related insurance liabilities are adequate to cover the cost of the S&P 500 Call Options and other costs related to these policies.
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. This amount has increased over the last three years as a result of growth in both of these businesses.
Insurance policy benefits increased in 1999 as a result of the factors summarized in the explanations for loss ratio fluctuations related to specific products which follows. In 1998, such benefits increased primarily as a result of an increase in the amount of business in force.
The loss ratios for Medicare supplement products have been relatively stable and within our expectations for the last three years. Governmental regulations generally require us to attain and maintain a loss ratio, after three years, of not less than 65 percent.
long-term care products generally result in the accumulation of amounts in the early policy 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, during the asset accumulation phase of these policies, the loss ratio will increase, but the increase in the change in reserve will be partially offset by investment income earned on the assets which have accumulated. The increase in the loss ratio in 1998 also reflects the different characteristics of long-term care policies sold by companies acquired in 1997. In order to improve the profitability of the long-term care product line, we are currently selling products which are expected to be more profitable and we have continued to apply for appropriate rate increases on older blocks of business.
Amounts added to policyholder account balances for annuity products decreased by 8.5 percent, to $666.5 million, in 1999, and increased by 4.5 percent, to $728.6 million, in 1998. The decrease in 1999 was primarily due to a smaller block of this type of annuity business in force, on the average, compared to 1998, while the increase in 1998 was primarily due to a larger block of business in force compared to 1997. The weighted average crediting rates for these annuity liabilities was 4.5 percent, 4.6 percent and 4.8 percent during 1999, 1998 and 1997, respectively.
Net investment gains (losses), net of related costs and amortization fluctuate from period to period. We sell securities and realize net investment gains (losses) in an effort to maximize total return on our portfolio through active investment management. Such securities are sold in response to changes in the investment environment which created opportunities to enhance the total return of the investment portfolio without adversely affecting the quality of the portfolio or the matching of expected maturities of assets and liabilities. Selling securities at a gain, especially when those gains result from reductions in general levels of interest rates, and reinvesting the proceeds at lower yields may, absent other management action, tend to decrease future investment yields. We believe, however, that the following factors mitigate the adverse effect of such lower yields on future net income: (i) we recognize additional amortization of cost of policies purchased and
The change to the structure of our new securitizations will have no effect on the total profit we recognize over the life of each new loan, but it will change the timing of profit recognition. Under the portfolio method (the accounting method required for our securitizations which are structured as secured borrowings), we will recognize: (i) earnings over the life of new loans as interest revenues are generated; (ii) interest expense on the securities which are sold to investors in the loan securitization trusts; and (iii) provisions for losses. As a result, our reported earnings from new loans securitized in transactions accounted for under the portfolio method will be lower in the period in which the loans are securitized (compared to our historical method) and higher in later periods, as interest spread is earned on the loans.
Securitizations of receivables recorded as sales relate to the securitizations structured prior to our September 8, 1999, announcement. The total finance receivables sold in 1999 decreased by 28 percent from 1998 reflecting the change in securitization structure described above.
Net investment income on finance receivables and other consists of: (i) interest earned on finance receivables; and (ii) interest income on short-term and other investments. Such income increased by 119 percent, to $647.1 million, in 1999 and by 34 percent, to $295.5 million, in 1998, consistent with the increases in average on-balance sheet finance receivables. The weighted average yields earned on finance receivables and other investments were 12.2 percent, 10.8 percent and 12.5 percent during 1999, 1998 and 1997, respectively. As a result of the change in the structure of our securitizations, future interest earned on finance receivables should increase as our average on-balance sheet finance receivables increase.
Our gain on sale of finance receivables decreased by 26 percent, to $550.6 million, in 1999 and decreased by 4.4 percent, to $745.0 million, in 1998. The decrease in 1999 primarily reflects our decision to no longer structure our securitizations as sales and to a lesser extent, the lower ratio of gain on sale to loans sold. Our new securitizations are being structured as secured borrowings and no gain on sale is recognized. The gain recognized for our previous securitizations fluctuated when changes occurred in: (i) the amount of loans sold; (ii) market conditions (such as the market interest rates available on securities sold in these securitizations); (iii) the amount and type of interest we retained in the receivables sold; and (iv) assumptions used to calculate the gain. The gain recognized in the first quarter of 1998 was reduced by $47 million for an interest-only security valuation adjustment. In response to higher prepayment rates and higher market yields on publicly traded securities similar to our interest-only securities, we increased the assumed prepayment and discount rates used to calculate the gain on sale of finance receivables for sales completed after June 30, 1998. During 1999, the general level of interest rates increased, causing us to incur higher interest costs on securitizations completed at that time. Accordingly, the amount of gain (before valuation adjustments) as a percentage of closed-end loans sold decreased to 5.4 percent in 1999 from 6.3 percent in 1998 and 7.4 percent in 1997.
severance and other benefits due to certain executives. Other costs included the write-off of computer equipment and related software that will no longer be used, losses for facilities to be vacated, increases to legal expense accruals, and various other costs.
Provision for loss on loan guarantees represents the noncash provision we established in connection with our guarantees of bank loans to approximately 170 directors, officers and key employees and our related loans for interest. The funds from the bank loans were used by the participants to purchase approximately 19.0 million shares of Conseco common stock. In 1999 we established a provision of $18.9 million ($11.9 million after tax) in connection with these guarantees and loans.
Other fixed rate annuity products include single-premium deferred annuities ("SPDAs"), flexible-premium deferred annuities ("FPDAs") and single-premium immediate annuities ("SPIAs"), which are credited with a declared rate. The demand for traditional fixed-rate annuity contracts has decreased in recent years, as relatively low interest rates have made other investment products more attractive. SPDA and FPDA policies typically have an interest rate that is guaranteed for the first policy year, after which we have the discretionary ability to change the crediting rate to any rate not below a guaranteed rate. The interest rate credited on SPIAs is based on market conditions existing when a policy is issued and remains unchanged over the life of the SPIA. Annuity premiums on these products increased by 10 percent, to $958.5 million, in 1999 and decreased by 22 percent, to $868.3 million, in 1998. Fixed annuity collections in 1999 included $208.8 million of premiums on reinsurance contracts entered into during the year. We intend to seek other reinsurance opportunities in the future, although the timing of such transactions is not predictable.
Variable annuities offer contract holders the ability to direct premiums into specific investment portfolios; rates of return are based on the performance of the portfolio. Such annuities have become increasingly popular recently as a result of the desire of investors to invest in common stocks. In 1996, we began to offer more investment options for variable annuity deposits, and we expanded our marketing efforts, resulting in increased collected premiums. Our profits on variable annuities come from the fees charged to contract holders. Variable annuity collected premiums increased by 81 percent, to $603.4 million, in 1999 and by 80 percent, to $332.6 million, in 1998.
Supplemental health products include Medicare supplement, long-term care, specified disease and other insurance products distributed through a career agency force and professional independent producers. Our profits on supplemental health policies depend on the overall level of sales, persistency of in-force business, investment yields, claim experience and expense management.
Premiums collected on specified-disease products were $376.3 million, $392.3 million and $383.6 million in 1999, 1998 and 1997, respectively. During 1999, we curtailed sales of these products in one state due to adverse regulatory decisions, which accounts for most of the decrease.
Other health products include: (i) various health insurance products that are not currently being actively marketed; and (ii) in 1999 and 1998, the specialty health insurance products of a recently acquired company marketed to educators. Premiums collected in 1999 were $121.2 million, up .4 percent over 1998. Premiums collected in 1998 were $120.7 million, up 74 percent over 1997. Since we no longer actively market these products, we expect collected premiums to decrease in future years. The in-force business continues to be profitable.
Individual and group major medical products include major medical health insurance products sold to individuals and groups. Group premiums decreased by 5.1 percent, to $526.0 million, in 1999 and increased by 5.3 percent, to $554.4 million, in 1998. Individual health premiums collected in 1999 were comparable to 1998 and increased in 1998 compared to 1997 as a result of our recent acquisitions. Our efforts to secure rate increases and emphasize only profitable major medical business restrict our ability to grow these premiums.
Mutual fund sales were very strong in 1999, reflecting our expanded distribution and new marketing programs. We also believe that these sales have been positively impacted by the recent investment performance of our funds.
In this section, we present our estimate of our operating earnings (income before extraordinary charge and net investment gains (losses) (less that portion of amortization of cost of policies purchased and cost of policies produced and income taxes relating to such gains (losses))) on a portfolio basis; that is, as if we had accounted for the securitizations of our finance receivables as financing transactions, rather than as sales, throughout the Company's history. Accordingly, the pro forma data exclude gain on sale of finance receivables, servicing revenues and interest income on interest-only securities. The pro forma data do reflect, over the life of the loans, the spread between: (i) the interest earned on the loans included in the securitization pools; and (ii) the sum of the interest paid to the holders of the debt securities pursuant to the securitizations and credit losses in the portfolio. The provision for credit losses represents the amount which management believes is sufficient to maintain the allowance for credit losses at a level that adequately provides for potential losses. This section is intended to assist you in analyzing our operating results. It is not intended to, and does not, represent the results of the Company's operations prepared in accordance with GAAP.
This presentation assumes that the Company had been a portfolio lender since its inception. Although we intend to account for all future financings that support our lending activities under the portfolio method, our actual earnings will initially be substantially lower than the pro forma earnings presented here since the portion of our managed portfolio accounted for under the portfolio method will initially be small.
(a) Excludes the effect of reporting fixed maturities at fair value as described in note 1 to the consolidated financial statements.
Our actively managed fixed maturity portfolio at December 31, 1999, included primarily debt securities of the United States government, public utilities and other corporations, and mortgage-backed securities. Mortgage-backed securities included collateralized mortgage obligations ("CMOs") and mortgage-backed pass-through securities.
We periodically evaluate the creditworthiness of each issuer whose securities we hold. We pay special attention 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. Information reviewed may include the recent operational results and financial position of the issuer, information about its industry, recent press releases and other information. Conseco employs a staff of
Pass-throughs and sequential and targeted amortization classes have similar prepayment variability. Pass-throughs historically provide the best liquidity in the mortgage-backed securities market. Pass-throughs are also used frequently in the dollar roll market and can be used as the collateral when creating collateralized mortgage obligations. Sequential classes are a series of tranches that return principal to the holders in sequence. Targeted amortization classes offer slightly better structure in return of principal than sequentials when prepayment speeds are close to the speed at the time of creation.
Commercial mortgage-backed securities ("CMBS") are bonds secured by commercial real estate mortgages. Commercial real estate encompasses income producing properties that are managed for economic profit. Property types include multi-family dwellings including apartments, retail centers, hotels, restaurants, hospitals, nursing homes, warehouses, and office buildings. The CMBS market currently offers high yields, strong credits and call protection compared to similar rated corporate bonds. Most CMBS have strong call protection features where borrowers are locked out from prepaying their mortgages for a stated period of time. If the borrower does prepay any or all of the loan, they will be required to pay prepayment penalties.
Subordinated and mezzanine tranches are classes that provide credit enhancement to the senior tranches. The rating agencies require that this credit enhancement not deteriorate due to prepayments for a period of time, usually five years of complete lockout followed by another period of time where prepayments are shared pro rata with senior tranches. The credit risk of subordinated and mezzanine tranches is derived from owning a small percentage of the mortgage collateral, while bearing a majority of the risk of loss due to property owner defaults. Subordinated bonds can be anything rated "AA" or lower, while typically we do not buy anything lower than "BB".
If we decide to sell an investment held in the actively managed fixed maturity category, we either sell the security or transfer it to the trading account at its fair value and recognize the gain or loss immediately. There were no material transfers into our trading account during 1999.
At December 31, 1999, we held mortgage loan investments with a carrying value of $1,274.5 million (or 4.7 percent of total invested assets) and a fair value of $1,188.0 million. Mortgage loans were substantially comprised of commercial loans. Noncurrent mortgage loans were insignificant at December 31, 1999. Realized losses on mortgage loans were not significant in any of the past three years. At December 31, 1999, we had a mortgage loan loss reserve of $3.8 million. Approximately 8 percent of the mortgage loans were on properties located in Ohio, 8 percent in New York, 7 percent in Texas, 7 percent in Florida, 7 percent in Pennsylvania and 7 percent in California. No other state accounted for more than 5 percent of the mortgage loan balance.
At December 31, 1999, we held $51.8 million of trading securities; they are included in other invested assets. Trading securities are investments we intend to sell in the near term. We carry trading securities at estimated fair value; changes in fair value are reflected in the statement of operations.
As part of our investment strategy, we enter into reverse repurchase agreements and dollar-roll transactions to increase our return on investments and improve our liquidity. Reverse repurchase agreements
On September 8, 1999, we announced that we would no longer structure our securitizations in a manner that results in recording a sale of the loans. Our new securitizations are structured to include provisions that entitle the Company to repurchase assets transferred to the special purpose entity when the aggregate unpaid principal balance reaches a specified level. Until these assets are repurchased, however, the assets are the property of the special purpose entity and are not available to satisfy the claims of creditors of the Company. Pursuant to Financial Accounting Standards Board Statement No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, such securitization transactions are accounted for under the portfolio method, whereby the loans and the securitization debt remain on our balance sheet, rather than as sales.
The securitizations structured prior to our September 8, 1999, announcement met the applicable criteria to be accounted for as sales. We sold $9.7 billion of finance receivables during 1999 and recognized gains of $550.6 million. At the time the loans were securitized and sold, we recognized a gain and recorded our residual interest in the securitization. The residual interest represents the right to receive, over the life of the pool of
receivables: (i) the excess of the principal and interest received on the receivables transferred to the special purpose entity over the principal and interest paid to the holders of other interests in the securitization; and (ii) servicing fees. In some of those securitizations, we also retained certain lower-rated securities that are senior in payment priority to the interest-only securities. Such retained securities had a par value, fair market value and amortized cost of $769.8 million, $694.3 million and $712.6 million, respectively, at December 31, 1999, and were classified as actively managed fixed maturity securities.
At December 31, 1999, no single state accounted for more than 8 percent of the contracts we serviced. In addition, no single contractor, dealer or vendor accounted for more than one percent of the total contracts we originated.
(b) As a percentage of average managed finance receivables during the period, net of recoveries.
Interest-only securities represent interests we retained in securitization transactions structured prior to our September 8, 1999, announcement and are carried at estimated fair value. On a quarterly basis, we estimate the fair value of these securities by discounting the projected future cash flows using current assumptions. If we determine that the differences between the estimated fair value and the book value of these securities is a temporary difference we adjust shareholders' equity. At December 31, 1999, this adjustment decreased the carrying value of the interest-only securities by $11.2 million to $905.0 million. Declines in value are considered to be other than temporary when the present value of the estimated future cash flows discounted at a risk free rate using current assumptions is less than the book value of the interest-only securities. When this occurs, we reduce the amortized cost to the estimated fair value and recognize a loss in the statement of operations.
We recognized impairment charges of $554.3 million ($349.2 million after tax) in 1999 and $549.4 million ($355.8 million after tax) in 1998 to reduce the book value of interest-only securities and servicing rights as described above under "Finance Operations."
Shareholders' equity, excluding accumulated other comprehensive loss, increased by $1.0 billion in 1999, to $6.3 billion. Significant components of the increase included: (i) net income of $595.0 million; (ii) the issuance of convertible preferred stock with net proceeds of $478.2 million; (iii) the issuance of $209.6 million of common stock; and (iv) the tax benefit of $25.0 million related to the issuance of shares under stock option plans. These increases were partially offset by: (i) repurchases of $89.5 million of common stock; and (ii) $192.7 million of common and preferred stock dividends. The accumulated other comprehensive loss increased by $743.2 million principally related to the decreasing fair value of our insurance companies' investment portfolio as interest rates rose.
Goodwill (representing the excess of the amounts we paid to acquire companies over the fair value of net assets acquired in transactions accounted for as purchases) was $3,927.8 million and $3,960.2 million at December 31, 1999 and 1998, respectively. Goodwill as a percentage of shareholders' equity was 71 percent and 75 percent at December 31, 1999 and 1998, respectively. Goodwill as a percentage of total capital, excluding other comprehensive loss, was 34 percent and 38 percent at December 31, 1999 and 1998, respectively. We believe that the life of our goodwill is indeterminable and, therefore, have generally amortized its balance over 40 years as permitted by generally accepted accounting principles. Amortization of goodwill totaled $110.1 million, $106.2 million, and $84.5 million during 1999, 1998 and 1997, respectively. If we had determined the estimated useful life of our goodwill was less than 40 years, amortization expense would have been higher.
(c) Such ratios exclude the following items from earnings: (i) net investment gains (losses) (less that portion of amortization of cost of policies purchased and cost of policies produced relating to such gains (losses)); (ii) impairment charges; and (iii) charges that are considered to be unusual. Such ratios are not intended to, and do not, represent the following ratios prepared in accordance with GAAP: the ratio of earnings to fixed charges; and the ratio of earnings to fixed charges, preferred dividends and distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts.
(d) Excludes debt of the finance segment used to fund finance receivables and investment borrowings of the insurance segment. In 1995, excludes debt of affiliates of $584.7 million which was not a direct obligation of Conseco.
(f) Total Company-obligated mandatorily redeemable preferred securities of subsidiary trusts exclude, and total capital includes: (i) amounts related to FELINE PRIDES which require the holders to purchase a number of shares of the Company's common stock under the terms specified in the stock purchase contracts; and (ii) amounts related to RHINOS. In April 2000, the Company and the holder of the RHINOS agreed to the repurchase by the Company of the RHINOS. In connection with the RHINOS repurchase, the Company is entering into a bank credit facility of $125.0 million.
Only a small portion of our insurance liabilities have a time for contractual payment; the majority of such liabilities are payable upon occurrence of the insured event or upon surrender. Of our total insurance liabilities at December 31, 1999, approximately 20 percent could be surrendered by the policyholder without a penalty. Approximately 56 percent could be surrendered by the policyholder subject to penalty or the release of an insurance liability in excess of surrender benefits paid. The remaining 24 percent do not provide a surrender benefit.
(a) Includes liabilities related to our equity-indexed annuity product of $2,306.1 million. The accumulation value of these annuities is credited with interest at an annual guaranteed minimum rate of 3 percent (or, including the effect of applicable sales loads, a 1.7 percent compound average interest rate over the term of the contract). These annuities provide for potentially higher returns based on a percentage of the change in the S&P 500 Index during each year of their term. We purchase S&P 500 Call Options in an effort to hedge increases to insurance liabilities resulting from increases in the S&P 500 Index.
The most significant source of liquidity for our finance operations has been our ability to finance the receivables we originate in the secondary markets through loan securitizations. Under certain securitization structures, we have provided a variety of credit enhancements, which generally take the form of corporate guarantees, but have also included bank letters of credit, surety bonds, cash deposits and over-collateralization or other equivalent collateral. When choosing the appropriate structure for a securitization of loans, we analyze the cash flows unique to each transaction, as well as its marketability and projected economic value. The structure of each securitized transaction depends, to a great extent, on conditions in the fixed-income markets at the time the transaction is completed, as well as on cost considerations and the availability and effectiveness of the various enhancement methods.
The market for securities backed by receivables is a cost-effective source of funds. In recent periods, conditions in the credit markets have resulted in less-attractive pricing of certain lower rated securities typically included in loan securitization transactions. As a result, we have chosen to hold rather than sell some of the securities in the securitization trusts, particularly securities having corporate guarantee provisions. Accordingly, we must finance a portion of the loans we originate through sources other than the securitization markets. We believe there are adequate sources of liquidity other than securitizations to finance a portion of the loans we originate while still maintaining planned levels of loan originations.
Market conditions in the credit markets for loan securitizations change from time to time. For example, liquidity in the credit markets became extremely limited for many issuers during the third and fourth quarters of 1998. In addition during certain periods of 1999, the general levels of interest rates increased on securities issued in securitizations, causing us to incur higher interest costs on securitizations completed during those periods. Changes in market conditions in the securitization markets could affect the interest rate spreads we earn on the loans we originate and the cash provided by our finance operations. We have increased interest rates on our lending products as we strive to maintain our targeted spread regardless of the interest rate environment.
We continually investigate and pursue alternative and supplementary methods to finance our lending operations. In late 1998, we began issuing certificates of deposit through our bank subsidiary. At December 31, 1999, we had $870.5 million of such deposits outstanding which are recorded as liabilities related to certificates of deposit. The average rate paid on these deposits was 5.8 percent during 1999.
Our finance segment generated cash flows from operating activities of $624.0 million during 1999, compared to $349.2 million in 1998. Such cash flows include cash received from the securitization trusts of $618.3 million in 1999 and $517.9 million in 1998, representing distribution of excess interest and servicing fees.
On September 8, 1999, we announced that, although we plan to continue to finance the receivables we originate through loan securitizations, we will no longer structure future securitizations in a manner that results in gain-on-sale revenues. This change is not expected to have any material effect on the amount or timing of cash flows we receive, but the change required us to classify certain activities differently on our cash flow statement (e.g., certain cash flows recorded as "operating cash flows" under the gain-on-sale method must be recorded as "investing activities" under the portfolio method and vice versa).
At December 31, 1999, we had $6.9 billion in master repurchase agreements and commercial paper conduit facilities (subject to the availability of eligible collateral) with various banking and investment banking firms for the purpose of financing our consumer and commercial finance loan production. These agreements generally provide for annual terms, some of which are extended each quarter by mutual agreement of the parties for an additional annual term based upon receipt of updated quarterly financial information. At December 31, 1999, we had $2.9 billion borrowed under the repurchase agreements.
The parent company is a legal entity, separate and distinct from its subsidiaries, and has no business operations. The parent company uses cash for: (i) principal and interest payments on debt; (ii) dividends on preferred and common stock; (iii) payments to subsidiary trusts to be used for distributions on the Company-obligated mandatorily redeemable preferred securities of subsidiary trusts; (iv) holding company administrative expenses; (v) income taxes; and (vi) investments in subsidiaries. The primary sources of cash to meet these obligations are payments from our subsidiaries, including the statutorily permitted payments from our life insurance subsidiaries in the form of: (i) fees for services provided; (ii) tax sharing payments; (iii) dividend payments; and (iv) surplus debenture interest and principal payments. The parent company may also obtain cash by: (i) issuing debt or equity securities; (ii) borrowing additional amounts under its revolving credit agreement, as described in the notes to the consolidated financial statements; or (iii) selling all or a portion of its subsidiaries. These sources have historically provided adequate cash flow to fund the needs of the parent company's: (i) normal operations; (ii) internal expansion, acquisitions and investment opportunities; and (iii) the retirement of debt and equity.
Cash provided by operating activities at the parent company, including dividends received from subsidiaries, totaled $282.8 million, $163.0 million and $156.9 million in 1999, 1998 and 1997, respectively. The Company followed the practice in those years of retaining capital in its operating subsidiaries by limiting dividends paid to the parent company. Consistent with our discussions with rating agencies, we modified that practice for future years. At the parent company, we have announced a target of receiving cash from operating activities, including dividends, interest and fees received from the subsidiaries, of twice the parent's cash requirement for interest, dividends and distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts.
company for any 12-month period in amounts equal to the greater of (or in a few states, the lesser of): (i) net gain from operations for the prior year; or (ii) 10 percent of surplus as of the end of the preceding year. Any dividends in excess of these levels require the approval of the director or commissioner of the applicable state insurance department. After deduction of $274.3 million of fees and interest paid to Conseco in 1999, the remaining statutory earnings of our insurance subsidiaries permit distributions to Conseco in 2000 of approximately $204.6 million without the permission of regulatory authorities. In addition, our finance subsidiary had operating cash flows of $601.0 million in 1999.
Following our announcement on March 31, 2000, that we plan to explore the sale of Conseco Finance, the ratings described in the previous paragraph were placed on review as the agencies analyze the impact of the developing transaction. In addition, S&P reduced its ratings of our senior debt securities from "BBB+" to "BBB-" and changed its ratings outlook to negative. These rating actions are expected to increase the cost of capital to the Company.
In September 1999, $1.0 billion of our bank credit facility expired. This borrowing capacity was replaced by a new bank credit line of $766 million (allowing us to borrow up to $2,266 million under our bank credit facilities), a $50 million extendible commercial note, and a $200 million increase in amounts which are available under a credit facility collateralized by interest-only and other securities (allowing us to borrow up to $700 million under such facility). In February 2000, we issued $800.0 million of 8.75 percent notes due 2004. Also, in February 2000, the credit facility collateralized by interest-only and other securities was extended for an additional one-year term in the amount of $500.0 million.
Inflation does not have a significant effect on our balance sheet; we have minimal investments in property, equipment or inventories. To the extent that interest rates may change to reflect inflation or inflation expectations, there would be an effect on our balance sheet and operations. Lower interest rates experienced in periods prior to 1999 have increased the value of our investment in fixed maturities and may have increased the amount of new finance receivables originated. These lower rates may also have made it more difficult to issue new fixed rate annuities and may have accelerated prepayments of finance receivables. Rising interest rates experienced in 1999 decreased the value of our investments in fixed maturities and may have slowed the issuance of new finance receivables and the prepayment of existing finance receivables. Changes in interest rates can also affect the value of the finance receivables we hold. It is not possible to calculate the effect of these changes on our operating results.
The profitability of many of our products depends on the spreads between the interest yield we earn on investments and the rates we credit on our insurance liabilities. Although substantially all credited rates on our annuity products may be changed annually (subject to minimum guaranteed rates), changes in competition and other factors, including the impact of the level of surrenders and withdrawals, may limit our ability to adjust or to maintain crediting rates at levels necessary to avoid narrowing of spreads under certain market conditions. Approximately 60 percent of our insurance liabilities were subject to interest rates that may be reset annually; the remainder have no explicit interest rates. As of December 31, 1999, the average yield, computed on the cost basis of our investment portfolio, was 7.2 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 5.0 percent.
incorporate numerous assumptions, require significant estimates and assume an immediate change in interest rates without any management of the investment portfolio in reaction to such change. Consequently, potential changes in value of our financial instruments indicated by the simulations will likely be different from the actual changes experienced under given interest rate scenarios, and the differences may be material. Because we actively manage our investments and liabilities, our net exposure to interest rates can vary over time.
The operations of the Company are subject to risk resulting from fluctuations in market prices of our equity securities and venture-capital investments. 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 and venture-capital investments to a relatively small portion of our total investments.
We manage the ratio of borrowed capital to total capital and the portion of our outstanding capital subject to fixed and variable rates, taking into consideration the current interest rate environment and other market conditions. Our borrowed capital at December 31, 1999, included notes payable and Company-obligated mandatorily redeemable preferred securities of subsidiary trusts totaling $5.1 billion ($4.6 billion of which is at fixed rates and $.5 billion of which is at floating rates). Based on the interest rate exposure and prevalent rates at December 31, 1999, a relative 10 percent decrease in interest rates would increase the fair value of our fixed-rate borrowed capital by approximately $47 million. This compares to a $90 million increase based on our borrowed capital and prevalent rates at December 31, 1998. Our interest expense on floating-rate debt will fluctuate as prevailing interest rates change.
We periodically enter into interest rate swap agreements which effectively exchange a fixed rate of interest on a notional amount ($2.4 billion at December 31, 1999) for a floating rate. At December 31, 1999, such interest rate swap agreements were scheduled to mature in various years through 2008 and had an average remaining life of 3.5 years (the average call date is 1.9 years). If the counterparties of these interest rate swaps do not meet their obligations, Conseco could have a loss. Conseco limits its exposure to such a loss by diversifying among several counterparties believed to be financially sound and creditworthy. At December 31, 1999, all of the counterparties were rated "A" or higher by Standard & Poor's Corporation. Based on the interest rate exposure and prevalent rates at December 31, 1999, a relative 10 percent increase in interest rates would cause the value of our interest rate swaps to decrease by $35 million. This compares to a $25 million decrease based on prevalent rates at December 31, 1998.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY, CONTINUED FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (DOLLARS IN MILLIONS)
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (DOLLARS IN MILLIONS)
CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (DOLLARS IN MILLIONS)
The following summary explains the accounting policies we use to arrive at the more significant numbers in our financial statements. We prepare our financial statements in accordance with generally accepted accounting principles ("GAAP"). We follow the accounting standards established by the Financial Accounting Standards Board, the American Institute of Certified Public Accountants and the Securities and Exchange Commission. We have restated all share and per-share amounts for the two-for-one stock split distributed February 11, 1997.
Conseco, Inc. ("we", "Conseco" or the "Company" ) is a financial services holding company operating throughout the United States. Our life insurance segment develops, markets and administers supplemental health insurance, annuity, individual life insurance, individual and group major medical insurance and other insurance products. This segment also includes other asset accumulation products such as mutual funds. Our finance segment originates, purchases, sells and services consumer and commercial finance loans. Conseco's operating strategy is to grow its businesses by focusing on the development and expansion of profitable products and strong distribution channels, to seek to achieve superior investment returns through active asset management and to control expenses. Conseco has supplemented its growth by acquiring companies with profitable niche products and strong distribution systems.
Our consolidated financial statements exclude the results of material transactions between us and our consolidated affiliates, or among our consolidated affiliates. We reclassified certain amounts in our 1998 and 1997 consolidated financial statements and notes to conform with the 1999 presentation. These reclassifications have no effect on net income or shareholders' equity.
securitization in excess of the sum of the principal and interest to be paid on the securities sold and contractual servicing fees. We carry interest-only securities at estimated fair value. We determine fair value by discounting the projected cash flows over the expected life of the receivables sold using current prepayment, default loss and interest rate assumptions. Estimates for prepayments, defaults, and losses for manufactured housing loans are determined based on a macroeconomic model developed by the Company with the assistance of outside experts. We record any unrealized gain or loss determined to be temporary, net of tax, as a component of shareholders' equity. Declines in value are considered to be other than temporary when the present value of estimated future cash flows discounted at a risk free rate using current assumptions is less than the book value of the interest-only securities. 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. The assumptions used to determine new values are based on our internal evaluations and consultation with external advisors having significant experience in valuing these securities. See note 4 for additional discussion of gain on sale of receivables and interest-only securities.
When we sell a security (other than trading securities, venture capital investments or S&P 500 Call Options), we report the difference between our sale proceeds and its amortized cost (determined based on specific identification) as an investment gain or loss.
We defer fees received and costs incurred when we originate finance receivables. We amortize deferred fees, costs, discounts and premiums over the contractual lives of the receivables, giving consideration to anticipated prepayments. We include such deferred fees or costs in the amortized cost of finance receivables.
The provision for credit losses charged to expense is based upon an assessment of current and historical loss experience, loan portfolio trends, prevailing economic and business conditions, and other relevant factors. In management's opinion, the provision is sufficient to maintain the allowance for credit losses at a level that adequately provides for losses inherent in the portfolio.
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 current realized gain or loss and the effect of the event 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 include the impact of this adjustment in accumulated other comprehensive income (loss) within shareholders' equity. CONSECO, INC. AND SUBSIDIARIES
The discount rate we use to determine the value of the cost of policies purchased is the rate of return we need to earn in order to invest in the business being acquired. In determining this required rate of return, we consider many factors including: (i) the magnitude of the risks associated with each of the actuarial assumptions used in determining expected future cash flows; (ii) the cost of our capital required to fund the acquisition; (iii) the likelihood of changes in projected future cash flows that might occur if there are changes in insurance regulations and tax laws; (iv) the acquired company?s compatibility with other Conseco activities that may favorably affect future cash flows; (v) the complexity of the acquired company; and (vi) recent prices (i.e., discount rates used in determining valuations) paid by others to acquire similar blocks of business.
Goodwill is the excess of the amount we paid to acquire a company over the fair value of its net assets. Our analysis of acquired insurance businesses indicates that the anticipated ongoing cash flows from the earnings of the purchased businesses extend significantly beyond the maximum 40-year period allowed for goodwill amortization. Accordingly, we amortize goodwill on the straight-line basis generally over a 40-year period. At December 31, 1999, the total accumulated amortization of goodwill was $391.2 million. We continually monitor the value of our goodwill based on our estimates of future earnings. We determine whether goodwill is fully recoverable from projected undiscounted net cash flows from earnings of the subsidiaries over the remaining amortization period. If we were to determine that changes in such projected cash flows no longer support the recoverability of goodwill over the remaining amortization period, we would reduce its carrying value with a corresponding charge to expense or shorten the amortization period (no such changes have occurred). Cash flows considered in such an analysis are those of the business acquired, if separately identifiable, or the product line that acquired the business, if such earnings are not separately identifiable.
investment risks are assumed by the contract holders. We record the related liabilities at amounts equal to the market value of the underlying assets. We record the fees earned for administrative and contractholder services performed for the separate accounts in insurance policy income.
In addition, we hold investments in a trust for the benefit of the purchasers of certain products of our asset management subsidiary; this amount is offset by a corresponding liability account, the value of which fluctuates in relation to changes in the values of these investments. Because we hold the residual interests in the cash flows from the trust and actively manage its investments, we are required to include the accounts of the trust in our consolidated financial statements. We record the fees earned for investment management and other services provided to the trust as fee revenue.
These liabilities relate to the certificates of deposits issued by our bank subsidiary. The liability and interest expense account are also increased for the interest which accrues on the deposits. The weighted average interest crediting rate on these deposits was 5.8 percent during 1999.
In the normal course of business, we seek to limit our exposure to loss 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. If any reinsurer could not meet its obligations, the Company would assume the liability. 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 $418.6 million, $541.3 million and $499.0 million in 1999, 1998 and 1997, respectively. A receivable is recorded for the reinsured portion of insurance policy benefits paid and liabilities for insurance products. Reinsurance recoveries netted against insurance policy benefits totaled $392.0 million, $484.3 million and $587.5 million in 1999, 1998 and 1997, respectively.
Our income tax expense includes deferred income taxes arising from temporary differences between the tax and financial reporting bases of assets and liabilities. In assessing the realization of deferred income tax assets, we consider whether it is more likely than not that the deferred income tax assets will be realized. The ultimate realization of deferred income tax assets depends upon generating future taxable income during the
periods in which temporary differences become deductible. If future income is not generated as expected, deferred income tax assets may need to be written off (no such write-offs have occurred).
Our equity-indexed annuity products provide a guaranteed base rate of return and a higher potential return linked to the performance of the Standard & Poor's 500 Index ("S&P 500 Index"). We buy S&P 500 Call Options in an effort to hedge potential increases to policyholder benefits resulting from increases in the S&P 500 Index to which the product's return is linked. We include the cost of the S&P 500 Call Options in the pricing of these products. Policyholder account balances for these annuities fluctuate in relation to changes in the values of these options. We reflect changes in the value of these options in net investment income. During 1999, 1998 and 1997, net investment income included $142.3 million, $103.9 million and $39.4 million, respectively, related to these changes. Such investment income was substantially offset by increases to policyholder account balances. The value of the S&P 500 Call Options was $129.2 million at December 31, 1999. We classify such instruments as other invested assets. We defer the premiums paid to purchase the S&P 500 Call Options and amortize them to investment income over their terms. Such amortization was $96.3 million, $52.0 million and $14.6 million during 1999, 1998 and 1997, respectively. The unamortized premium of the S&P 500 Call Options was $59.5 million at December 31, 1999.
We periodically use interest-rate swaps to hedge the interest rate risk associated with our borrowed capital. At December 31, 1999, we held instruments having an aggregate notional principal amount of $2.4 billion that effectively convert a portion of our fixed-rate borrowed capital into floating-rate instruments
for specified periods of time. The agreements mature in various years through 2008 and have an average remaining life of 3.5 years (the average call date is 1.9 years). We record the difference between the rates as an adjustment to interest expense. During 1999, interest expense was reduced by $6.4 million as a result of these interest-rate swap agreements. At December 31, 1999, such agreements had a fair value of $(48.2) million.
On September 8, 1999, we announced that we would no longer structure our securitizations in a manner that results in recording a sale of the loans. Instead, we are using the portfolio method (the accounting method required for securitizations which are structured as secured borrowings) to account for securitization transactions structured after that date. Our new securitizations are structured to include provisions that entitle the Company to repurchase assets transferred to the special purpose entity when the aggregate unpaid principal balance reaches a specified level. Until these assets are repurchased, however, the assets are the property of the special purpose entity and are not available to satisfy the claims of creditors of the Company. Pursuant to Financial Accounting Standards Board Statement No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" ("SFAS 125"), such securitization transactions are accounted for under the portfolio method, whereby the loans and securitization debt remain on our balance sheet, rather than as sales.
Venture capital investments. We carry these investments at estimated fair value based on quoted market prices or estimates of fair value if the securities are not publicly traded. In certain situations, including thinly traded securities, limited partnership structures, large-block holdings, restricted shares or other special situations, we adjust quoted market prices to produce an estimate of the attainable fair values.
- ------------------------- (1) The estimated fair value of the liabilities for interest-sensitive products was approximately equal to its carrying value at December 31, 1999 and 1998. 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. We are not required to disclose fair values for insurance liabilities, other than those for interest-sensitive products. However, we take into consideration the estimated fair values of all insurance liabilities in our overall management of interest rate risk. We attempt to minimize exposure to changing interest rates by matching investment maturities with amounts due under insurance contracts.
During the second quarter of 1998, prepayments on securitized loan contracts continued to exceed expectations and management concluded that such prepayments were likely to continue to be higher than
We recognized a $148.0 million merger-related charge in the second quarter of 1998 related to the Merger consisting of: $45.0 million transaction costs; $71.0 million severance and other employment related costs; and $32.0 million other costs. Transaction costs included expenses related to the Merger such as fees paid for investment bankers, attorneys, accountants and printers. Severance and other employment related costs included contractual severance and other benefits due to certain executives. Other costs included the write-off of computer equipment and related software that will no longer be used, losses for facilities to be vacated, increases to legal expense accruals, and various other costs.
We implemented Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1") on January 1, 1999. SOP 98-1 defines internal use software and when the costs associated with internal use software should be capitalized. The implementation of SOP 98-1 did not have a material effect on our consolidated financial position or results of operations.
The results of operations for Conseco and Conseco Finance, separately and combined, for periods prior to the merger were as follows:
At December 31, 1999, the amortized cost and estimated fair value of actively managed fixed maturities and equity securities were as follows:
The following table sets forth the amortized cost and estimated fair value of actively managed fixed maturities at December 31, 1999, 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. Most of the mortgage-backed securities shown below provide for periodic payments throughout their lives.
Life insurance companies are required to maintain certain investments on deposit with state regulatory authorities. Such assets had an aggregate carrying value of $210.0 million at December 31, 1999.
Our venture capital investments had an estimated fair value of $527.5 million at December 31, 1999, and include equity and equity-type investments made by our subsidiary which engages in venture capital investment activities. Venture capital investment income will fluctuate from period-to-period based on changes in estimated market values of our venture capital investments. During 1999, we invested $53.2 million in a company in the wireless communication business. The market values of many companies in this sector increased significantly in 1999. In the fourth quarter of 1999, our investee sold shares of common stock to the public in an initial public offering. As a result, an ascertainable market value was established for our investment, which we adjusted to recognize liquidity restrictions. In 1999, we recognized venture capital income of $354.8 million related to this investment.
On September 8, 1999, we announced that we would no longer structure our securitizations in a manner that results in recording a sale of the loans. Instead, we are using the portfolio method to account for securitization transactions structured after that date. Our new securitizations are structured to include provisions that entitle the Company to repurchase assets transferred to the special purpose entity when the aggregate unpaid principal balance reaches a specified level. Until these assets are repurchased, however, the assets are the property of the special purpose entity and are not available to satisfy claims of creditors of the Company. Pursuant to SFAS 125, such securitization transactions are accounted for under the portfolio method, whereby the loans and securitization debt remain on our balance sheet, rather than as sales.
We classify the finance receivables transferred to the securitization trusts and held as collateral for the notes issued to investors as finance receivables-securitized. We are generally able to repurchase these receivables from the trust when the aggregate unpaid principal balance reaches 20 percent of the initial principal balance of the finance receivables. The average interest rate earned on these receivables at December 31, 1999, was approximately 11.7 percent. We classify the notes issued to investors in the securitization trusts as "notes payable related to securitized finance receivables structured as collateralized borrowings".
Finance receivables-securitized, summarized by type, were as follows at December 31, 1999 (dollars in millions):
The changes in the allowance for credit losses included in finance receivables were as follows:
The securitizations structured prior to our September 8, 1999, announcement met the applicable criteria to be accounted for as sales. At the time the loans were securitized and sold, we recognized a gain and recorded our retained interest represented by the interest-only security. The interest-only security represents the right to receive, over the life of the pool of receivables, the excess of the principal and interest received on the receivables transferred to the special purpose entity over the sum of: (i) principal and interest paid to the holders of other interests in the securitization; and (ii) contractual servicing fees. In some of those securitizations, we also retained certain lower-rated securities that are senior in payment priority to the interest-only securities. Such retained securities had a par value, fair market value and amortized cost of $769.8 million, $694.3 million and $712.6 million, respectively, at December 31, 1999, and were classified as actively managed fixed maturity securities.
During 1999, 1998 and 1997, the Company sold $9.7 billion, $13.4 billion and $10.7 billion, respectively, of finance receivables in various securitized transactions and recognized gains of $550.6 million, $745.0 million and $779.0 million, respectively.
(a) The valuation of interest-only securities is affected not only by the projected level of prepayments of principal and net credit losses, but also by the projected timing of such prepayments and net credit losses. Should such timing differ materially from our projections, it could have a material effect on the valuation of our interest-only securities. Additionally, such valuation is determined by discounting cash flows over the entire expected life of the receivables sold.
(b) The valuation of interest-only securities is affected not only by the projected level of prepayments of principal and net credit losses, but also by the projected timing of such prepayments and net credit losses. Should such timing differ materially from our projections, it could have a material effect on the valuation of our interest-only securities.
Activity in the interest-only securities account during 1999 and 1998 is as follows:
(a) Principally, modifications of the 1965 -- 70 and 1975 -- 80 Basic, Select and Ultimate Tables.
(c) In 1999 and 1998: (i) approximately 96 percent and 95 percent, respectively, of this liability represented account balances where future benefits are not guaranteed; and (ii) approximately 4 percent and 5 percent, respectively, represented the present value of guaranteed future benefits determined using an average interest rate of approximately 6 percent.
Borrowings under our commercial paper program averaged $1,058.3 million during 1999, at a weighted average interest rate of 5.3 percent.
Notes payable due 2003 bear interest at LIBOR plus .5 percent. Such notes are putable by the holder prior to the maturity date at a 1 to 3 percent discount to par. The notes and accrued interest thereon are secured by standby letters of credit.
As of December 31, 1999, we had $6.9 billion of master repurchase agreements and commercial paper conduit facilities (of which $2.9 billion was outstanding) with various banking and investment banking firms, subject to the availability of eligible collateral. The agreements generally provide for one year terms, some of which can be extended each quarter by mutual agreement of the parties for an additional year, based upon the financial performance of our finance subsidiary.
Bank credit facilities, commercial paper, master repurchase agreements and similar credit facilities that are used for short-term funding:
compensation increase of 5.5 percent in both 1999 and 1998. For measurement purposes, we assumed a 9.0 percent annual rate of increase in the per capita cost of covered health care benefits for 2000, decreasing gradually to 5.0 percent in 2011 and remaining level thereafter. During 1999, we amended the pension plans of recently acquired companies to reduce future benefits accruing under such plans. These changes resulted in the actuarial, settlement and curtailment gains summarized above.
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 $10.3 million in 1999, $6.2 million in 1998, and $6.3 million in 1997. Matching contributions are required to be made either in cash or in Conseco common stock.
Conseco, Inc. and its subsidiaries, Conseco Life Insurance Company, and Wabash Life Insurance Company, are currently named defendants in a certified nationwide class action lawsuit in the Superior Court for Santa Clara County (California, cause number CV768991) and captioned "John P. Dupell and the John P. Dupell 1992 Insurance Trust vs. Massachusetts General Life Insurance Company: Life Partners Group, Inc., Wabash Life Insurance Company, Conseco, Inc., Donovan R. Bolton, et al." The class, approximately 345,000 in number, consists of all persons who purchased universal life insurance policies from Conseco Life Insurance Company, formerly named Massachusetts General Life Insurance Company, between January 1, 1984 and July 23, 1999 (excluding policies where death benefits were paid). The claims involve the changing interest rate climate between the 1980's and the comparatively lower rates in the 1990's, and the resulting lower rates credited to universal life products. The plaintiffs asserted claims of fraud, breach of the covenant of good faith and fair dealing, negligence, negligent misrepresentation, unjust enrichment and related matters. Conseco believes this lawsuit is without merit and is defending it vigorously. The ultimate outcome of this lawsuit cannot be predicted with certainty.
We have provided guarantees of approximately $1.6 billion at December 31, 1999, in conjunction with certain sales of finance receivables. We believe the likelihood of a significant loss from such guarantees is remote.
collateral for the loans. The bank loans we have guaranteed are scheduled to mature as follows: $150.0 million on May 31, 2000 and $425.8 million on August 30, 2001. The Company expects the banks to extend the maturity dates of these loans when they become due. At December 31, 1999, the guaranteed bank loans exceeded the value of the common stock collateralizing the loans by $281.0 million. All participants have agreed to indemnify Conseco for any loss incurred on their loans. In addition, we have provided loans to participants for interest on the bank loans totaling $44.8 million. We regularly evaluate these guarantees and loans in light of the collateral and the creditworthiness of the participants. In 1999 we established a noncash provision of $18.9 million ($11.9 after tax) in connection with these guarantees and loans, which was included as a component of the provisions for losses.
Certain wholly owned subsidiary trusts have issued preferred securities in public offerings. The trusts used the proceeds from these offerings to purchase subordinated debentures from Conseco. The terms of the preferred securities parallel the terms of the debentures, which account for substantially all trust assets. The preferred securities are to be redeemed on a pro rata basis, to the same extent as the debentures are repaid. Under certain circumstances involving a change in law or legal interpretation, the debentures may be distributed to the holders of the preferred securities. Our obligations under the debentures and related agreements, taken together, provide a full and unconditional guarantee of payments due on the preferred securities. The debentures issued to the subsidiary trusts and the common securities purchased by Conseco from the subsidiary trusts are eliminated in the consolidated financial statements.
(a) Each RHINOS security pays cash distributions at a floating rate equal to the three-month LIBOR plus 225 basis points, payable quarterly (such rate was 8.35 percent at December 31, 1999). In April 2000, the Company and the holder of the RHINOS agreed to the repurchase by the Company of the RHINOS. In connection with the RHINOS repurchase, the Company is entering into a bank credit facility of $125.0 million.
(b) These securities may be redeemed anytime at: (i) the principal balance; plus (ii) a premium equal to the excess, if any, of the sum of the discounted present value of the remaining scheduled payments of principal and interest using a current market interest rate over the principal amount of securities to be redeemed.
We are authorized to issue up to 20 million shares of preferred stock. On December 15, 1999, we issued $500.0 million (2.6 million shares) of Series F Common-Linked Convertible Preferred Stock (the "Series F Preferred Stock") to Thomas H. Lee Company and affiliated investors. The Series F Preferred Stock is convertible into Conseco common stock at a common equivalent rate of $19.25 per share. The Series F Preferred Stock pays a 4 percent dividend, of which an amount at least equal to the common dividend will be payable in cash, and the remainder may be paid in additional Series F shares valued at $19.25 per share.
On June 30, 1999, we sold 3.1 million shares of our common stock to an unaffiliated party (the "Buyer") at the then-current market value of $29.0625 per share. Simultaneous with the issuance of the common stock, we entered into a forward transaction with the Buyer to be settled at $29.0625 per share in a method of our choosing (i.e., we may select cash settlement, transfer of net shares to or from the Buyer, or transfer of net cash to or from the Buyer). We make payments to the Buyer equivalent to a total fixed return of LIBOR plus 65 basis points for the length of time the forward transaction is outstanding. We settled the contract in March 2000 by repurchasing the shares held by the Buyer.
The stock option activity and related information includes the combined activity and information of both Conseco and Conseco Finance for all periods. On March 1, 1998, prior to the time the Merger was contemplated, Conseco Finance repriced certain of its employee stock options to the current market price. A summary of the Company's stock option activity and related information for the years ended December 31, 1999, 1998 and 1997, is presented below (shares in thousands):
The following reconciles net income to net cash provided by operating activities:
Statutory accounting practices prescribed or permitted by regulatory authorities for the Company's insurance subsidiaries differ from GAAP. Our insurance subsidiaries reported the following amounts to regulatory agencies, after appropriate elimination of intercompany accounts:
State insurance laws generally restrict the ability of insurance companies to pay dividends or make other distributions. In addition to fees and interest described above, our insurance subsidiaries may pay dividends to Conseco in 2000 of $204.6 million without permission from state regulatory authorities. Net assets of the Company's wholly owned insurance subsidiaries, determined in accordance with GAAP, aggregated approximately $7.8 billion at December 31, 1999.
We manage our business operations through two segments, based on the products offered.
Insurance and fee-based segment. Our insurance and fee-based segment provides supplemental health, annuity, life, and individual and group major medical products to a broad spectrum of customers through multiple distribution channels, each focused on a specific market segment. These products are primarily marketed through career agents, professional independent producers and direct marketing. This segment also includes our venture capital investment activity.
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.
(iv) adjusting loan origination cost deferrals. These changes decreased previously reported net income by $9.3 million ($.03 per diluted share), $84.2 million ($.26 per diluted share) and $37.8 million ($.11 per diluted share) in the first, second and third quarters, respectively.
(c) The selected quarterly financial data give retroactive effect to the merger with Conseco Finance in a transaction accounted for as a pooling of interests which was completed on June 30, 1998 (see note 2). The pooling of interests method of accounting requires the restatement of all periods presented as if the companies had always been combined. Accordingly, amounts previously reported differ from the amounts presented here.
On March 31, 2000, we announced that we plan to explore the sale of Conseco Finance and is hiring Lehman Brothers to assist in the planned sale. If the planned sale is completed, the Company will no longer have finance operations.