Bankers currently leases 300,000 square feet of executive office and administration space in a single facility in downtown Chicago under a 15-year lease agreement. Bankers also leases approximately 100,000 square feet of warehouse space in a second Chicago facility under a 10-year lease agreement. Bankers leases approximately 208 sales offices totaling approximately 340,000 square feet. All of the sales office leases are short-term in length, with remaining lease terms ranging from one to five years.
The following discussion highlights the material factors affecting the results of operations and the significant changes in balance sheet items. This discussion should be read in conjunction with the accompanying consolidated financial statements, the notes thereto and the financial statistics appearing elsewhere herein.
Life insurance companies are included in Conseco's financial statements on a consolidated basis if they are unilaterally controlled by Conseco (i.e., companies that are wholly owned by Conseco, companies that are over 50 percent but less than 100 percent owned by Conseco, and companies that are over 50 percent owned by a partnership in which Conseco is the sole general partner). Life insurance companies are included in Conseco's financial statements on an equity basis if not so controlled (i.e., companies in which Conseco has a significant interest but does not have unilateral control). Refer to Notes 1 and 2 of the consolidated financial statements for a description of changes during the last three years in the composition of the companies included in Conseco's consolidated financial statements.
Various combinations of services, including investment management, mortgage origination and servicing, policy administration, data processing, product marketing and executive management services, are provided to all affiliates and other unaffiliated clients. In addition, subsidiaries of Conseco earn fees by: (i) providing marketing services to financial institutions related to the distribution of insurance and investment products and (ii) distributing property and casualty insurance products through independent agencies.
Of the first seven companies acquired as wholly owned subsidiaries by Conseco, three were subsequently sold and four remained as wholly owned subsidiaries at December 31, 1993. One of the four (Western National) was partially disposed of in February 1994 when Conseco sold 60 percent of its interest in a public offering as described in Note 16 to the consolidated financial statements. The first three companies acquired in the first partnership are now wholly owned subsidiaries of CCP, in which Conseco holds a 40 percent interest. The final acquisition of the first partnership is now a wholly owned subsidiary of BLH, in which Conseco holds a 56 percent interest.
Activities of companies acquired through the first partnership are recorded in the segment related to operations of life insurance companies. Conseco also provides services to those companies resulting in increased income in the fee for service segment. Earnings are reflected in the acquisition and restructuring segment when Conseco, as general partner, earns incentive compensation related to the level of total returns to the partners in excess of prescribed targets, and when restructuring gains are realized from the sale of portions of the acquired entities.
The following table shows the sources of Conseco's net income (after tax and minority interest) for the three years ended December 31, 1993, disaggregated into the three earnings activities described in the preceding section:
The following table further analyzes the changes in fully diluted earnings per share in 1993 compared to 1992 and in 1992 compared to 1991 to identify the increases (decreases) related to changes in income and the decreases related to changes in the number of shares outstanding.
At December 31, 1993, the BLH shares owned by Conseco had a net carrying value of approximately $518.8 million, a market value of approximately $652.8 million and a cost of $313.1 million.
Net investment income. Net investment income increased $48.4 million, or 38 percent, in 1993 over total net investment income in 1992. The increase was due to the growth of invested assets as a result of (i) the recurring operations, (ii) the recapture in 1993 of a reinsurance treaty with related assets totaling $182 million and (iii) the capital transactions in connection with BLH's IPO, as discussed in the accompanying notes to the consolidated financial statements, partially offset by lower yields on the investment portfolio. In addition, during 1993 fixed maturity investments were redeemed prior to their scheduled maturity dates, resulting in additional investment income of approximately $.8 million.
Net realized gains. Bankers sold approximately $2.2 billion of fixed maturity investments in 1993, realizing gains (after applicable expenses, amortization, minority interest and taxes) of $2.9 million. For the ten month period ended October 31, 1992, realized investment losses included writedowns primarily related to Bankers' mortgage-backed security portfolio of derivative collateralized mortgage obligations, which portfolio was transferred to a trust later acquired by ICH or sold to ICH prior to the acquisition of Bankers by the Partnership.
Net realized gains relate to securities sold in response to changes in the investment environment which created opportunities to enhance the risk profile of the investment portfolio by replacing existing securities with alternative securities without adversely affecting the quality of the portfolio or the matching of expected maturities of assets and liabilities. The sales of these securities at a gain followed by reinvestment of the proceeds at lower yields may, absent other management action, tend to decrease future investment yields. The Company believes, however, that the decreases in future investment yields that may result from these sales will not have a significant effect on future net income because: (i) additional amortization of the cost of policies purchased and the cost of policies produced was recognized to reflect reduced future yields (see the following paragraph); (ii) interest rates credited to some products were reduced, diminishing the effect of the yield decrease on the investment earnings spread; and (iii) the investment portfolio increased as a result of reinvesting the realized gains.
The realization of investment gains affects the timing of the amortization of cost of policies purchased and cost of policies produced. As a result of net realized gains from the sales of fixed maturity investments in 1993, amortization of cost of policies purchased and cost of policies produced was increased by $21.0 million and $9.5 million, respectively.
Insurance policy benefits. Total insurance policy benefits (including change in future policy benefits) increased $23.9 million, or 2.8 percent, in 1993 over the total amount in 1992. The increase related primarily to an increase in premiums with mortality and morbidity features written by Bankers. Purchase accounting adjustments were made to insurance liabilities in conjunction with the acquisitions of Bankers made by the Partnership in November 1992 and Conseco in September 1993 (as described in Note 2 to the consolidated financial statements). The impact of these adjustments was that insurance policy benefits (and change in future policy benefits) in 1993 were lower than the amounts which would have been recorded had the accounting basis of insurance liabilities been the same as in 1992. Such decline somewhat offsets the increases described above. Loss ratios did not change significantly.
Interest expense on long-term debt. Interest expense on long-term debt increased $28.6 million in 1993 compared to the total amount in 1992. This interest relates to debt incurred to finance the acquisition of Bankers by the Partnership effective October 31, 1992. Therefore, interest expense was incurred for a full year in 1993 compared to two months in 1992.
Other operating costs and expenses. Other operating costs and expenses decreased $11.1 million, or 6.7 percent, in 1993 compared to the total amount in 1992 as a result of cost reductions realized subsequent to the acquisition of Bankers.
General. Western's increased operating earnings principally reflected the slightly widened spread between investment yields and policy crediting rates on an increasing base of invested assets during the periods presented. The increase in invested assets in 1993 was affected by: (i) the recapture of reinsurance from subsidiaries of Conseco on March 31, 1993, resulting in an increase of $1.3 billion in insurance liabilities and invested assets; and (ii) the recapture of reinsurance from a nonaffiliated company on June 30, 1993, resulting in an increase of $156.5 million in insurance liabilities and invested assets.
Net trading income. The increases in net trading income (after applicable expenses and taxes) in 1993 over the prior two years were primarily due to more favorable market conditions for trading activities.
Net realized gains. Net realized gains (after applicable expenses, amortization, change in future policy benefits and taxes) often fluctuate from year to year. Western sold fixed maturity investments of $3.6 billion, $2.4 billion and $2.9 billion in 1993, 1992 and 1991, respectively.
The effect of sales of fixed maturities on the amortization of cost of policies purchased and cost of policies produced is discussed above under "Bankers." As a result of the net realized gains from the sales of fixed maturity investments in 1993, 1992, and 1991, amortization of the cost of polices purchased was increased by $14.0 million, $42.1 million and $13.1 million, respectively and amortization of the cost of policies produced was increased by $33.2 million, $22.5 million and $11.2 million, respectively. In addition, the realization of investment gains affected the timing of additions to insurance liabilities, resulting in an increase of $37.1 million in 1993.
Interest expense on annuities and financial products. Interest expense on annuities and financial products has increased over the last three years as a result of increased annuity deposits, offset by reduced interest rates credited on these products. The average rate credited on all insurance liabilities was 6.4 percent, 7.6 percent and 8.1 percent at December 31, 1993, 1992 and 1991, respectively. The decline in credited rates over this period resulted from the lower interest rate environment. The 1993 increase in this expense was largely affected by the reinsurance recapture by Western as discussed under "General" above.
CCP's earnings during the three years ended December 31, 1993, were affected by: (i) a widened spread between investment yields and policy crediting rates on an increasing base of invested assets; (ii) the reduced interest expense resulting from the reduction in CCP's long-term debt through scheduled and unscheduled principal payments and lower interest rates; (iii) the purchase of Beneficial Standard in March 1991; and (iv) the investment of the net proceeds (after prepayment of certain debt) from CCP's IPO in July 1992 and its second public offering in September 1993. Conseco's equity in the earnings of CCP during the three years ended December 31, 1993, was affected by these factors and changes in Conseco's ownership interest in CCP resulting from CCP's IPO and other transactions described in Note 4 to the consolidated financial statements. In addition, in 1992, Conseco's equity in the earnings of CCP included a $3.9 million extraordinary charge related to CCP's prepayment of debt. At December 31, 1993, Conseco owned 40 percent of the common stock of CCP. Such shares owned by Conseco had a net carrying value of $244.3 million, a fair value of approximately $322.1 million and a total cost to Conseco of $102.8 million.
CCP was a partner in the Partnership's investment in Bankers. In conjunction with BLH's IPO, CCP's investment in the Partnership was exchanged for approximately 2.8 percent of the common stock of BLH. Through the date of the IPO, CCP had recognized equity in earnings of Bankers of $1.2 million and $.7 million in 1993 and 1992, respectively. A gain on the sale of stock by BLH of $10.5 million was recognized at the time of the exchange. After the IPO, CCP's investment in BLH is carried at fair value, with any unrealized gain or loss, net of income tax, included directly in shareholders' equity.
Insurance policy income. Insurance policy income related primarily to premiums from products with mortality and morbidity features and the recent declines have resulted from decreased emphasis on generating new premiums from such products.
Net trading income. The increase in net trading income (after applicable expenses and taxes) in 1993 over the prior two years was primarily due to more favorable market conditions for trading activities.
The effect of sales of fixed maturities on the amortization of cost of policies purchased and cost of policies produced is discussed above under "Bankers." As a result of the net realized gains from the sales of fixed maturity investments by Conseco's other wholly owned life insurance subsidiaries in 1993, 1992 and 1991, amortization of the cost of policies purchased was increased by $11.0 million, $7.9 million and $2.4 millon, respectively, and amortization of the cost of policies produced was increased by $.5 million and $7.2 million and $5.7 million, respectively.
Insurance policy benefits. Total insurance policy benefits (including change in future policy benefits) which relate solely to policies with mortality and morbidity features have fluctuated over the last three years due to the decreased emphasis on generating new premiums from such products.
Conseco's ownership interest in Life Re was sold in November 1992, thereby terminating this source of income.
In March 1993, Conseco acquired Marketing Distribution Systems Consulting Group, Inc. and Subsidiaries ("Bankmark"), an insurance marketing company which develops relationships with financial institutions to provide insurance and investment products to their customers. Through Bankmark, financial institutions can offer products from several insurance companies, including Western National. After its acquisition by Conseco, Bankmark began a formal program to actively expand its business by developing relationships with a few large money-center banks to assist them in distributing retail insurance products to their customers. As a result of the costs incurred in conjunction with Bankmark's expansion efforts, Bankmark incurred a net loss of approximately $3.7 million during the period from its acquisition through December 31, 1993.
The incentive earnings allocations were earned when total returns realized by the other partners in the first partnership exceeded prescribed targets. Such amounts were recorded: (i) in 1992 based on the returns resulting from the value of the CCP shares distributed to the partners; and (ii) in 1993, based on the value of BLH shares so distributed. Income from the sale of stock in 1992 resulted from Conseco's sale of its ownership in Life Re and from Conseco's share of the gain realized from the public sale of shares by CCP. The 1993 gain related to the public sale of shares by BLH.
Premiums collected by Bankers. Total premiums collected in 1993 were $1,464.7 million, of which $264.0 million were recorded as deposits to policy liability accounts. This compares to $1,368.9 million collected and $233.3 million recorded as deposits to policy liability accounts in 1992. Bankers amounts in 1992, which are used as a basis of comparison in this discussion, include periods prior to Conseco's acquisition of Bankers in November 1992. Collected premiums by type are provided in the following table for 1993 and 1992:
Total collected premiums of Medicare supplement policies accounted for 39 percent of total collected premiums in 1993 and 38 percent in 1992. During the fourth quarter of 1992, Bankers assumed a block of Medicare supplement policies from an unrelated insurer. Collected premiums in 1993 and 1992 included $16.9 million and $19.4 million, respectively, related to the assumed policies. Bankers' new strategy of pricing Medicare supplement policies on an attained age basis (which produces lower first year premiums which then increase annually) and an increase in the proportion of policies sold with lesser benefits caused annualized new business premiums from such new sales to decrease to $79.6 million in 1993 compared to $83.0 million in 1992. However, even with the new pricing strategy, Bankers' 1993 annualized new business premiums were up 7.1 percent over 1992 sales of $74.3 million.
Long-term care plans accounted for 7.8 percent of total collected premiums in 1993 and 7.6 percent in 1992. The increase was due to growth in new business and a larger base of renewal premiums. Annualized new business premiums were $21.5 million in 1993 and $18.1 million 1992.
Annuity premiums collected increased 28 percent in 1993 over 1992. Virtually all of this increase related to sales of single premium deferred annuities. The increase occurred because of an increased marketing emphasis placed on annuity sales.
Collected premiums for other individual health products decreased 11 percent in 1993 compared to 1992, as anticipated, due to steps taken previously to improve the profitability of the comprehensive major medical product included in this category.
Premiums collected by Western. Total premiums collected were $563.0 million, $840.7 million and $1,267.5 million in 1993, 1992 and 1991, respectively. The decline in total premiums collected was principally due to decreased annuities sold through financial institutions reflecting: (i) increased competition from other carriers (including those with higher ratings); (ii) consumer purchases of alternative investments, such as variable annuities and mutual funds, during these periods of low interest rates; and (iii) Western's focus on maintaining profitability levels on single premium deferred annuities. Western's principal emphasis is to generate profits through adequate pricing of its insurance products and maintaining appropriate investment spreads throughout the life of the policies sold. The operating income of Western is primarily a function of its investment spread, total invested assets and operating expenses. Accordingly, a change in premiums collected in a single period does not directly cause income to change, although continued increases or decreases in premiums may affect the rate of growth of total assets on which investment spread is earned.
During 1993, Western entered into marketing agreements with several large financial institutions who are expected to issue Western annuities in 1994.
Premiums collected by Conseco's wholly owned subsidiaries excluding Western. Total premiums collected were $148.2 million, $82.6 million and $86.6 million in 1993, 1992 and 1991, respectively. During 1993, the Company collected $61.8 million of premiums from guaranteed investment contracts and deposit funds for qualified retirement plans maintained by a subsidiary of the Company.
The following table shows Conseco's investment performance during the last three years, including subsidiaries and Partnership companies from the date each was acquired and including the CCP Companies until the date of deconsolidation.
Conseco's actively managed fixed maturity portfolio at December 31, 1993, was comprised primarily of debt securities of the U.S. government, public utilities and other corporations and mortgage-backed securities. Investments in mortgage-backed securities included collateralized mortgage obligations ("CMO's") and mortgage-backed pass-through securities.
At December 31, 1993, the Company's fixed maturity portfolio (including securities actively managed and held to maturity) had net unrealized gains of $295.7 million (equal to approximately 3.0 percent of the portfolio's carrying value), consisting of $384.3 million of unrealized gains and $88.6 million of unrealized losses. Estimated fair values for fixed maturity investments were determined based on estimates from nationally recognized pricing services, broker-dealer market makers and internally developed methods.
Investments in fixed maturities that were rated below investment-grade as determined by nationally recognized statistical rating organizations (or, if not rated by such firms, with ratings below Class 2 assigned by the National Association of Insurance Commissioners) were 5.1 percent of total invested assets and 6.1 percent of total fixed maturity investments at December 31, 1993. The Company currently plans to maintain approximately the present percentage of its portfolio in fixed maturities that are rated below
investment-grade. Investments in below investment-grade corporate debt securities generally have greater risks than other corporate debt investments. Risk of loss upon default by the borrower is greater with below investment-grade corporate debt securities because these securities generally are unsecured and often are subordinated to other creditors of the issuers, and because the issuers usually have high levels of indebtedness and are more sensitive to adverse economic conditions, such as recession or increasing interest rates, than are investment-grade issuers. The Company is aware of this risk exposure and monitors its below investment-grade securities closely.
The Company limits the extent of these risks by (i) purchasing securities which are backed by collateral with lower prepayment sensitivity (such as mortgages priced at a discount to par value and mortgages that are extremely seasoned), (ii) avoiding securities whose values are heavily influenced by changes in prepayments (such as interest-only and principal-only securities) and (iii) concentrating on securities with prepayment protected structures (such as planned amortization class ("PAC") CMOs. PAC instruments represented approximately 44 percent of the Company's mortgage-backed securities at December 31, 1993. The call-adjusted modified duration of the Company's mortgage-backed securities at December 31, 1993, was 4.7 years.
were no such transfers in 1993. During 1993, the Company sold actively managed fixed maturity securities with a $6.4 billion book value, resulting in $168.3 million of investment gains (before related expenses, amortization and taxes). The sales of fixed maturity securities that result in investment gains may, absent any other management action, tend to decrease future interest yield on the portfolio. The Company believes that the decreases in future interest yields that may result because of these sales will not have a significant effect on future net income because, as explained in Note 11 to the consolidated financial statements, the Company reduced the balances of the cost of policies purchased and cost of policies produced by a total of $89.2 million and increased insurance liabilities $37.1 million to reflect reduced future yields, and because the Company has reduced interest rates credited to products thereby widening the total spread earned on deposits and reserves.
At December 31, 1993, the Company held mortgage loan investments with a carrying value of $158.4 million (or 1.4 percent of total invested assets) and a fair value of $175 million. Approximately 78 percent of the mortgage loan investments were commercial loans.
At December 31, 1993, the Company held trading account securities with a carrying value of $105.8 million. Trading account securities are investments that are purchased with the intent to be traded prior to their maturity or are believed likely to be disposed of in the foreseeable future as a result of market or issuer developments. Effective December 31, 1993, with the Company's adoption of Statement of Financial Accounting Standards No. 115 ("SFAS 115"), trading account securities are carried at estimated fair value, with the changes in fair value reflected in the statement of operations. Prior to the adoption of SFAS 115, unrealized gains or losses on trading account securities were reflected as a component of shareholders' equity and not in the statement of operations. The net unrealized gain on trading account securities at December 31, 1993, recorded in trading income as a result of adopting SFAS 115, was immaterial.
Short-term investments totaled $666.4 million, or 5.7 percent of invested assets at December 31, 1993, and consisted primarily of commercial paper and repurchase agreements relating to government securities.
Changes in the Company's consolidated balance sheet of 1993 compared to 1992 reflected the operations of the Company and the capital and financing transactions discussed below.
The increase in total investments resulted principally from: (i) the net cash flow from operations; (ii) the net proceeds from the public offering of 5.75 million shares of Series D cumulative convertible preferred stock; (iii) the net proceeds received by Bankers from its IPO; (iv) investments received by Bankers related to the recapture of insurance polices ceded in prior years; and (v) an increase in the net unrealized gains on actively managed fixed maturities.
Additionally, as part of its investment strategy, the Company enters into reverse repurchase agreements and dollar roll transactions to increase its return on investments and improve liquidity. These transactions are accounted for as short-term collateralized borrowings and are collateralized by pledged securities with fair values approximately equal to the loan value. The average amount of investment borrowings during 1993 was approximately $410 million compared to $215 million during 1992. The increase in investment borrowings at December 31, 1993, contributed to the increase in the Company's investments.
The investment in CCP increased during 1993 as a result of the Company's equity in CCP's earnings and the purchase of additional shares of common stock of CCP in September 1993, as described in Note 2 to the consolidated financial statements.
Reinsurance receivables, which primarily represent liabilities ceded under reinsurance agreements, decreased as a result of the recapture of insurance policies that had previously been ceded to nonaffiliated companies as described in Note 6 to the consolidated financial statements.
During 1993, goodwill increased as a result of: (i) the purchase of additional shares of common stock of Bankers in September 1993; (ii) the initial public offering of BLH and related transactions completed in March 1993; and (iii) the purchase of Bankmark in the first quarter of 1993. These transactions are further described in Note 2 to the consolidated financial statements.
The $12.6 million decline in common stock and additional paid-in-capital was a result of the repurchase of 450,700 shares of common stock for $25.3 million as part of a stock repurchase program, $9.0 million of costs associated with the public offering of preferred stock (as discussed above) and a $3.8 million increase in the nonvested portion of stock under employee stock and deferred compensation plans. Offsetting these declines, 851,110 shares of common stock were issued pursuant to the Company's stock option and deferred compensation programs for net proceeds and tax benefits of $25.5 million and 274 Series D preferred shares were converted to 215 shares of common stock. As a result of changes in common stock accounts, the number of common shares outstanding increased 400,625 shares.
Of the companies' total insurance liabilities at December 31, 1993, approximately 74 percent may be surrendered by the policyholder, of which 71 percent were subject to penalty if surrendered. Payment characteristics of the insurance liabilities at December 31, 1993, were as follows (dollars in millions):
In connection with the acquisition of Bankers Life, BLH received a $500 million surplus debenture from BLI in exchange for funds provided to acquire Bankers Life. The surplus debenture was approved by the Illinois Department of Insurance ("DOI"). During 1993, BLI repaid principal of $15 million plus accrued interest on the surplus debenture. Payments by BLI of principal and interest on the surplus debenture may be made only when the DOI is satisfied that the financial condition of BLI warrants that action, but such approval may not be withheld if BLI submits satisfactory evidence of surplus of at least the amount stipulated in the surplus debenture.
The parent company (Conseco, Inc.) needs liquidity primarily to service its debt, pay dividends on preferred and common stock and meet administrative expenses. The wholly owned insurance subsidiaries (excluding Western), Bankers, Western and CCP provide liquidity to the parent company by paying dividends and fees for services provided. These operations generate adequate cash flow to meet the needs of the parent company's normal operations.
The parent company also may issue debt or equity securities periodically to fund internal expansion, acquisitions, investment opportunities and for the retirement of debt and equity. Such transactions during 1993 included the following:
- In February 1993, the Company completed a public offering of $200 million of 8.125 percent senior notes due in 2003. Proceeds from the offering of $195.6 million (after original issue discount and underwriting and other associated costs) were used to redeem all of the Company's outstanding 12.75 percent senior subordinated notes and for other general corporate purposes.
- In connection with Conseco's acquisition of additional shares of Bankers common stock on September 30, 1993, a new $200 million senior term loan was executed, with net proceeds to Conseco of $197.8 million (after fees and other associated costs). This senior term loan was repaid with proceeds from the IPO of WNC on February 15, 1994.
The following table shows the cash flow activity of the parent company and its non-life subsidiaries from 1991 through 1993.
Statutory Limitations on Payments by Life Insurance Subsidiaries to their Parent
As described in the preceding section, Conseco receives funds from its wholly owned insurance subsidiaries from dividends and fees for shared expenses. In connection with its acquisition of certain life insurance subsidiaries, Conseco received surplus debentures from the subsidiaries and the repayment terms were established and approved by the applicable regulatory authorities at the time of each acquisition. All such surplus debentures with Conseco's wholly owned insurance subsidiaries were eliminated by a contribution to the statutory capital of such subsidiaries at December 31, 1992. Annual dividends in excess of maximum amounts prescribed by state statutes (so-called "extraordinary dividends") may not be paid without the approval of the insurance commissioner of each state in which a life subsidiary is domiciled.
Inflation does not have a significant effect on Conseco's balance sheet due to the minimal dollars invested in property and equipment and the absence of inventories.
Medical cost inflation has had a significant impact on Bankers' operations. These costs have continued to increase in recent years in excess of the Consumer Price Index and similar increases will likely continue although recently the rate of increase has declined. The impact on Bankers' operations is dependent upon its ability to charge higher premium rates, which are subject to approval by the insurance departments of each state in which Bankers sells its products. Prior to the standardization of Medicare supplement plans, approximately two-thirds of the states permitted rate plans with automatic escalation clauses. This permitted Bankers, in periods following initial approval, to adjust premium rates for changes in Medicare deductibles and increases in medical cost inflation without refiling with the regulators. Currently, all rate changes for the standardized plans must now be individually approved by each state. Bankers' pricing of its new standardized supplement plans reflects the impact of these filings and the lengthening of time required to implement rate increases.
The Company adopted several new accounting standards during 1993. Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan" ("SFAS 114"), requires that an impaired loan be revalued at the present value of expected future cash flows discounted at the loan's effective interest rate when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. The adoption of SFAS 114 had an immaterial impact on the Company's financial position and results of operations.
In November 1992, the Financial Accounting Standards Board's Emerging Issues Task Force concluded that for acquisitions after November 19, 1992, the amortization method for cost of policies purchased should use an interest rate comparable to the rates credited to the underlying products. Such method was employed by the Company for the acquisition of 13.3 million common shares of Bankers (as described in Note 2 to the consolidated financial statements) and will be employed by the Company in future acquisitions.
As indicated throughout this report, Conseco intends to continue its strategy of growth through its three principal sources of earnings: operations of life insurance companies, provision of services for fees to the affiliated companies and others, and acquisition and restructuring of life insurance companies.
At December 31, 1993, Conseco owned 100 percent of Western. On February 15, 1994, Conseco sold a majority interest in Western through an IPO of 60 percent of the common stock of WNC. The offering of WNC generated net pretax proceeds to Conseco of $537.9 million, which were used to repay a $200 million senior unsecured loan and for other general corporate purposes. Conseco will record, in the first quarter of 1994, a one-time, after-tax gain of approximately $43 million as a result of the IPO. At February 15, 1994, the WNC shares owned by Conseco had a fair value of approximately $330.6 million (based on the closing price of $13.25 per share) and a net carrying value of approximately $270.0 million.
Conseco also owns 11.6 million shares, or 40 percent, of CCP's common shares outstanding. At December 31, 1993, the CCP shares owned by Conseco had a net carrying value of approximately $244.3 million, a fair value of approximately $322.1 million (based on the closing price of $27.875 per share) and a cost of $102.8 million. CCP has (i) a sizable and profitable block of in-force business and (ii) a distribution system that has the potential to generate growth in the 403(b) tax sheltered annuity market. Further, CCP believes it has the financial strength to pursue an acquisition to complement its internal growth.
On February 2, 1994, Conseco announced the closing of CCP II, a partnership which will invest in acquisitions of specialized annuity, life and accident and health insurance companies and related businesses, in which 36 investors committed a total of $624 million of capital to the new partnership. Commitments to the new partnership include $100 million from Conseco, $25 million from Bankers, $25 million from CCP, $50 million from Western and $36 million from executive officers and directors of Conseco and its affiliates. A subsidiary of Conseco is the sole general partner.
The Company believes that a number of life insurance companies will be available to be acquired in the next 10 years as a result of strategic posturing and consolidation within the life industry. The Company expects to participate in such acquisitions through CCP II using the capital provided by the partnership, mezzanine capital that may be provided by the individual partners of CCP II and others, and debt capital from various sources.
Consolidated Balance Sheet at December 31, 1993 and 1992. . . . . . 48
Consolidated Statement of Operations for the years ended December 31, 1993, 1992 and 1991. . . . . . . . . . . . . . . . . 50
Management of Conseco, Inc. is responsible for the reliability of the financial information in this annual report. The financial statements are prepared in accordance with generally accepted accounting principles and the other financial information in this annual report is consistent with that of the financial statements.
CONSOLIDATED BALANCE SHEET (Continued) December 31, 1993 and 1992 (Dollars in millions)
Conseco, Inc. ("Conseco" or the "Company") is a specialized financial services holding company which primarily makes controlling strategic investments in insurance companies and related businesses, manages the operations of those businesses to increase their value, provides services to acquired companies and other businesses, and seeks to realize the increase in value that its management brings to such companies through sale or restructuring. The insurance companies in which Conseco has made investments develop, market, issue and administer primarily annuity, individual health insurance and life insurance products. Conseco provides administrative, data processing and investment management services to affiliated and nonaffiliated companies. The Company's principal wholly owned life insurance subsidiaries are Western National Life Insurance Company ("Western National"), Bankers National Life Insurance Company ("Bankers National") and National Fidelity Life Insurance Company ("National Fidelity"). A majority interest of Western National was sold on February 15, 1994 (see Note 16).
During 1990, Conseco formed the Partnership, which raised and invested $99.5 million of capital, of which approximately half was provided by the Company and the balance by other investors. A wholly owned subsidiary of Conseco was the sole general partner of the Partnership. The Partnership was the Company's vehicle for effecting the following acquisitions of insurance companies: Great American Reserve Insurance Company ("Great American Reserve") in June 1990, Jefferson National Life Insurance Company ("Jefferson National") in November 1990, Beneficial Standard Life Insurance Company ("Beneficial Standard") in March 1991 and Bankers Life and Casualty Company and its subsidiary, Certified Life Insurance Company (collectively, "Bankers Life") in November 1992. All acquisitions were accounted for as purchases and were reflected in operations as of their effective dates. As sole general partner, Conseco exercised unilateral control over the Partnership; therefore, the accounts of the Partnership and its majority-owned subsidiaries were included in the consolidated financial statements of Conseco and its wholly owned subsidiaries in the periods prior to the Partnership's liquidation as of March 31, 1993. Intercompany accounts and transactions were eliminated.
See Note 2 for a description of the activities of the Partnership and its acquired companies. As a result of the public offering in July 1992 by CCP Insurance, Inc. ("CCP"), a newly organized holding company for the Partnership's first three acquisitions, Conseco no longer had unilateral control over those entities and ceased including the accounts of those companies in its consolidated financial statements. CCP and its subsidiaries are included in Conseco's financial statements on the equity basis since July 1, 1992.
Because its former owner continued to own 40 percent of BLH following the Partnership's acquisition of Bankers Life in 1992, it was necessary for the Partnership and Conseco to account for that acquisition as a "step acquisition transaction" in accordance with the guidance provided in Issue Number 88-16 of the Emerging Issues Task Force of the Financial Accounting Standards Board entitled "Basis in Leveraged Buyout Transactions." The step acquisition accounting was also used by Conseco to account for its increased ownership in Bankers acquired in September 1993. As a result, the assets and liabilities of Bankers included in Conseco's 1993 consolidated balance sheet represent the following combination of values: (i) the portion of Bankers' net assets acquired by Conseco in the November 1992 acquisition made by the Partnership is valued as of that acquisition date, (ii) the portion of Bankers' net assets acquired in September 1993 is valued as of that date, and (iii) the portion of Bankers' net assets owned by minority interests is valued based on Bankers' consolidated financial statements.
The cost of Conseco's September 1993 purchase of BLH shares was allocated to the assets and liabilities acquired based on a preliminary determination of their fair values; accordingly, this allocation may be adjusted upon final determination of such values. In management's opinion, however, any adjustments to fair values are not expected to be material.
Certain amounts from prior periods were reclassified to conform to the 1993 presentation.
Fixed maturity investments are securities that mature more than one year after they are issued and include bonds, notes receivable and preferred stocks with mandatory redemption features. Equity securities include investments in common stocks and non-redeemable preferred stock. Effective December 31, 1993, the Company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"), and, accordingly, classifies its fixed maturity and equity securities into the following three categories:
- Actively managed fixed maturity and equity securities are securities that may be sold prior to maturity due to changes that might occur in market interest rate risks, changes in the security's prepayment risk, the management of income tax position, general liquidity needs, and increase in loan demand, the need to increase regulatory capital, changes in foreign currency risk or similar factors. Actively managed securities are carried at fair value and the unrealized gain or loss is recorded to shareholders' equity, net of tax and the related adjustments described in the second following paragraph.
- Trading account securities are fixed maturity and equity securities that are bought and held principally for the purpose of selling them in the near term. Trading account securities are carried at estimated fair value and the unrealized gain or loss is included as a component of net trading income.
- All other fixed maturity securities are those securities which the Company has the ability and positive intent to hold to maturity, and are carried at amortized cost. The Company may dispose of such securities under certain unforeseen circumstances, such as issuer credit deterioration or regulatory requirements.
The above categories for classifying fixed maturity and equity securities are consistent with the Company's policy prior to the adoption of SFAS 115, with one exception that net unrealized gains and losses on trading account securities, which had previously been recorded as an adjustment to shareholders' equity, are now recognized as trading income under the provisions of SFAS 115. The net unrealized gain on trading account securities at December 31, 1993, recorded in trading income as a result of adopting SFAS 115 was immaterial.
Unrealized gains and losses and the related adjustments described in the preceding paragraph have no effect on earnings, but are recorded, net of tax, to shareholders' equity. The following table summarizes the effect of these adjustments as of December 31, 1993:
- For transfers from the trading category, the unrealized gain or loss already recognized in earnings is not reversed;
- For transfers to actively managed from held to maturity, the unrealized gain or loss is recognized in shareholders' equity; and
Credit-tenant loans are loans for commercial properties which require (i) the lease of the principal tenant to be assigned to the Company and to produce adequate cash flow to fund substantially all the requirements of the loan and (ii) the principal tenant or the guarantor of such tenant's obligations to have an investment-grade credit rating at the time of origination of the loan. These loans are also secured by the value of the related property. The underwriting guidelines take into account such factors as the lease term of the property; the borrower's management ability, including business experience, property management capabilities and financial soundness; and such economic, demographic or other factors that may affect the income generated by the property or its value. The underwriting guidelines also require a loan-to-value ratio of 75 percent or less.
Policy loans are stated at their current unpaid principal balance. Short-term investments include commercial paper, invested cash and other investments purchased with maturities less than three months and are carried at amortized cost, which approximates estimated fair value. The company considers all short-term investments to be cash equivalents. Mortgage and credit-tenant loans are stated at amortized cost.
Fees received and costs incurred in connection with origination of investments, principally mortgages and credit-tenant loans are deferred. Fees, costs, discounts and premiums are amortized as yield adjustments over the contractual life of the investments. Anticipated prepayments on mortgage-backed securities are taken into consideration in determining estimated future yields on such securities.
Separate accounts represent funds for which investment income and gains or losses accrue directly to certain policyholders. The assets of these accounts are legally segregated and are not subject to the claims which may arise out of any other business of the Company. Separate account assets are reported at market value since the underlying investment risks are assumed by the contract holders. The related liabilities are recorded at amounts equal to the underlying assets and the fair value of those liabilities is equal to their carrying amount.
The cost of policies purchased represents the portion of the cost to acquire a subsidiary that is attributable to the right to receive future cash flows from insurance contracts existing at the date of acquisition of the subsidiary. The value of cost of policies purchased is the actuarially determined present value of the projected future cash flows from the acquired policies.
- Identify the risks inherent in realizing those cash flows (i.e., what is the probability that the cash flows will be realized).
- Identify the rate of return that the Company believes it must earn in order to accept the risks inherent in realizing the cash flows, based on consideration of the factors summarized below.
- Determine the value of the policies purchased by discounting the expected future cash flows by the discount rate the Company requires.
Expected future cash flows used in determining such value are based on actuarially determined projections of future premium collections, mortality, surrenders, operating expenses, changes in insurance liabilities, investment yields on the assets held to back the policy liabilities and other factors. These projections take into account all factors known or expected at the valuation date based on the collective judgment of the management of the Company. Actual experience on purchased business may vary from projections due to differences in renewal premiums collected, investment spread, investment gains or losses, mortality and morbidity costs and other factors. These variances from original projections, whether positive or negative, are included in net income as they occur. To the extent that these variances indicate that future cash flows will differ from those reflected in the scheduled amortization of the cost of policies purchased, current and future amortization is adjusted. For example, sales of fixed maturity investments that result in a gain (or loss), but also reduce (or increase) the future investment spread because the sale proceeds are reinvested at a lower (or higher) earnings rate, cause amortization to increase (or decrease) reflecting the change in the incidence of cash flows.
- The magnitude of the risks associated with each of the actuarial assumptions used in determining expected future cash flows as described in the preceding paragraphs.
- The perceived likelihood of changes in projected future cash flows that might occur if there are changes in insurance regulations and tax laws.
- The compatibility with other Company activities that may favorably affect future cash flows.
- Recent purchase prices (i.e., discount rates used in determining valuations) on similar blocks of business.
After the cost of purchased policies is determined using the methods described above, the amount is amortized based on the incidence of the expected cash flows. For acquisitions made on or before November 19, 1992, the asset is amortized with interest at the same rate used to determine the discounted value of the asset. For acquisitions after November 19, 1992, including the acquisition of additional shares of Bankers on September 30, 1993, the asset is amortized using an interest rate comparable to the rate credited to the underlying products. This amortization methodology is in accordance with the conclusions reached by the Emerging Issues Task Force of the Financial Accounting Standards Board in their November 19, 1992, meeting.
Recoverability of the cost of policies purchased is evaluated annually by comparing the current estimate of expected future cash flows (discounted at the rate of interest earned on invested assets) to the unamortized asset balance by line of insurance business. If such current estimate indicates that the existing insurance liabilities, together with the present value of future net cash flows from the blocks of business purchased, will not be sufficient to recover the cost of policies purchased, the difference is charged to expense. Amortization is also adjusted for the current and future years to reflect (i) the revised estimate of future cash flows and (ii) the revised interest rate (but not greater than the rate initially used and not lower than the rate of interest earned on invested assets) at which the discounted present value of such expected future profits equals the unamortized asset balance.
- For universal life-type contracts and investment-type contracts, in relation to the present value of expected gross profits from these contracts, discounted using the interest rate credited to the policy.
Recoverability of the unamortized balance of the cost of policies produced is evaluated regularly. For universal life-type contracts and investment-type contracts, the accumulated amortization is adjusted (whether an increase or a decrease) whenever there is a material change in the estimated gross profits expected over the life of a block of business in order to maintain a constant relationship between cumulative amortization and the present value (discounted at the rate of interest that accrues to the policies) of expected gross profits. For most other contracts, the unamortized asset balance is reduced by a charge to income only when the present value of future cash flows, net of the policy liabilities, is not sufficient to cover such asset balance.
Property and equipment are carried at cost, net of accumulated depreciation. Depreciation expense was $6.0 million, $3.7 million and $4.0 million for 1993, 1992 and 1991, respectively, computed using the straight-line method over the estimated useful lives of the assets, which range from 3 to 50 years.
For investment contracts without mortality risk (such as deferred annuities and immediate annuities with benefits paid for a period certain) and for contracts that permit the Company or the insured to make changes in the contract terms (such as single-premium whole life and universal life), premium deposits and benefit payments are recorded as increases or decreases in a liability account rather than as revenue and expense. Amounts charged against the liability account for the cost of insurance, policy administration and surrender penalties are recorded as revenues. Interest credited to the liability account and benefit payments made in excess of the contract liability account balance are charged to expense.
For traditional insurance contracts, premiums are recognized as income when due or, for short duration contracts, over the period to which the premiums relate. Benefits and expenses are recognized as a level percentage of earned premiums. Such recognition is accomplished through the provision for future policy benefits and the amortization of deferred policy acquisition costs.
For participating policies, the amount of dividends to be paid is determined annually by the Company. The portion of the earnings allocated to participating policyholders is included as an insurance liability.
Assets and liabilities related to insurance contracts are reported before the effects of reinsurance. Reinsurance receivables and prepaid reinsurance premiums (including amounts related to insurance liabilities) are reported as assets. Estimated reinsurance receivables are recognized in a manner consistent with the liabilities related to the underlying reinsured contracts. Such amounts have been presented in accordance with Statement of Financial Accounting Standards No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts."
The consolidated financial statements include all of the assets, liabilities, revenues and expenses of the Partnership, its subsidiaries and Bankers. A charge is made against consolidated income representing the share of the earnings of these partially-owned entities allocable to the minority interests. Shareholders' equity of such entities allocable to the minority interests is shown separately on the consolidated balance sheet.
Investment securities: The estimated fair values for fixed maturity securities (including redeemable preferred stocks) are based on quoted market prices, where available. For fixed maturity securities not actively traded, the estimated fair values are determined using values obtained from independent pricing services or, in the case of private placements, are determined by discounting expected future cash flows using a current market rate applicable to the yield, credit quality and maturity of the investments. The estimated fair values for equity securities and trading account securities are based on quoted market prices.
Mortgage loans, credit-tenant loans and policy loans: The estimated fair values of these loans are determined by discounting future expected cash flows using interest rates currently being offered for similar loans to borrowers with similar credit ratings. Loans with similar characteristics are aggregated for purposes of the calculations.
Off-balance sheet interest rate guarantee and swaps: The estimated fair value of the Company's interest rate guarantee contract and swap agreements are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standings.
Insurance liabilities for investment contracts: The estimated fair values of the Company's liabilities under investment-type insurance contracts are determined using discounted cash flow calculations based on interest rates currently being offered for similar contracts with maturities consistent with those remaining for the contracts being valued.
As of March 31, 1991, the Partnership completed the acquisition of all of the outstanding stock of Beneficial Standard for a purchase price of $141.1 million, including $.9 million of fees and other costs. The acquisition was funded with $27.0 million of capital contributions from the Partnership and the net proceeds of the following: a $79.5 million senior secured loan from lending banks; a $9.5 million senior secured loan provided by the Company and $40.0 million of preferred stock (including $17.9 million provided by the Company).
In September 1993, CCP completed a public offering in which CCP sold 3.0 million shares of its common stock and certain shareholders sold 6.5 million shares of CCP common stock. Proceeds of approximately $80.9 million from the offering of common shares by CCP (after underwriting and issuance costs) were added to CCP's funds for general corporate purposes. CCP received no proceeds from the sale of shares by the selling shareholders. In a separate transaction, Conseco purchased 2.0 million shares of CCP common stock from the selling shareholders for $53.6 million. In addition, Conseco purchased .3 million shares of CCP common stock in open market transactions for $5.9 million during 1993. After these transactions, Conseco owns 40 percent of the common stock of CCP.
The Partnership agreement provided incentive compensation to the general partner in the form of transfers from the limited partners of a portion of their returns in excess of prescribed targets. The distribution of CCP shares to the limited partners in 1992 caused such targets to be exceeded, resulting in incentive compensation of $6.1 million, net of tax of $3.2 million, to Conseco. In addition, income in 1992 included $1.9 million, net of tax of $7.3 million, representing Conseco's percentage share in the increase in CCP's shareholders' equity account attributable to the proceeds from the IPO.
In March 1993, Conseco acquired 95 percent of the outstanding common stock of Bankmark for $6.1 million. Bankmark is an insurance marketing company which develops marketing relationships with financial institutions to provide insurance and investment products to their customers.
The acquisitions of CCP, Bankers and Bankmark described above were recorded in the consolidated statement of cash flows as follows:
The amortized cost, estimated fair value and carrying value of fixed maturities were as follows at December 31, 1993:
The following table sets forth the amortized cost and estimated fair value of fixed maturities as of December 31, 1993, based upon the source of the estimated fair value:
Below investment grade fixed maturity investments, summarized by the amount their amortized cost exceeds fair value, were as follows at December 31, 1993:
The amortized cost and estimated fair value of fixed maturities at December 31, 1993, by contractual maturity, are shown below. 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 and because most mortgage-backed securities provide for periodic payments throughout their lives.
The proceeds from sales of fixed maturity investments were $6.5 billion, $4.2 billion and $4.8 billion for the years ended December 31, 1993, 1992 and 1991, respectively. The proceeds from the sales of trading account securities were $10.0 billion, $6.7 billion and $5.6 billion for the years ended December 31, 1993, 1992 and 1991, respectively. In 1993, there were no sales of fixed maturities classified as held to maturity, although some were called by the issuer.
Accumulated net appreciation of equity securities before tax as of December 31, 1993, was $.1 million consisting of $.1 million of appreciation and no depreciation.
The carrying value and fair value of fixed maturity investments in default as to the payment of principal or interest totaled $25.3 million at December 31, 1993, net of total recorded writedowns of $16.8 million. During 1991, the Company recorded $18.7 million of writedowns of fixed maturity investments as a result of changes in conditions which caused the Company to conclude the issuer may be unable to comply with the terms of the investment. During 1992, the Company recorded no such writedowns. During 1993, the Company recorded $7.9 million of such writedowns.
Investments in mortgage-backed securities at December 31, 1993, included collateralized mortgage obligations ("CMOs") of $2,193.9 million and mortgage-backed pass-through securities of $962.5 million. At December 31, 1993, the par value, amortized cost and estimated fair value of investments in mortgage-backed securities summarized by interest rates on the underlying collateral were comprised of the following:
As part of its investment strategy, the Company enters into repurchase agreements and dollar roll transactions to increase its return on investments and improve liquidity. These transactions generally terminate after 30 days and are accounted for as short-term collateralized borrowings. Such borrowings averaged approximately $410 million during 1993 (compared to $215 million during 1992) and were collateralized by mortgage-backed securities with fair values approximately equal to the loan value.
Life insurance companies are required to maintain certain amounts of assets on deposit with state regulatory authorities. Such assets had an aggregate carrying value of $27.0 million at December 31, 1993.
Investments in any entity in excess of 10 percent of shareholders' equity at December 31, 1993, other than investments in affiliates and investments issued or guaranteed by the U.S. government, substantially all of which were actively managed fixed maturities, were as follows:
Participating policies represented approximately 11 percent, 12 percent and 14 percent of total life insurance in force at December 31, 1993, 1992 and 1991, respectively, and approximately 3 percent, 8 percent and 18 percent of premium income for 1993, 1992 and 1991, respectively. Dividends on participating policies amounted to $16.0 million, $11.1 million and $14.6 million in 1993, 1992 and 1991, respectively.
As described in Note 1, an adjustment was made to increase insurance liabilities by $39.1 million related to recording unrealized gains on actively managed fixed maturities.
The estimated fair value of the liabilities for investment contracts was approximately equal to its carrying value at December 31, 1993 and 1992, because interest rates credited on the vast majority of account balances approximate current rates paid on similar investments and are not generally guaranteed beyond one year. Fair values for the Company's insurance liabilities other than those for investment contracts are not required to be disclosed. However, the estimated fair values of liabilities for all insurance contracts are taken into consideration in the Company's overall management of interest rate risk, which minimizes exposure to changing interest rates through the matching of investment maturities with amounts due under insurance contracts.
The Company has ceded blocks of insurance under reinsurance transactions which represent financing arrangements and, in accordance with generally accepted accounting principles, are not reflected in the accompanying consolidated financial statements except for the risk fees paid to reinsurers. Net statutory surplus provided by such treaties totaled $2.9 million and $11.2 million at December 31, 1993 and 1992, respectively. Risk fees paid to reinsurers generally ranged from 2 percent to 4 percent of the net amount of surplus provided.
The Company has also ceded policy liabilities under assumption reinsurance agreements where all obligations under the insurance contracts have been ceded to another company. Accordingly, insurance liabilities related to such policies were not reported in the balance sheet. The Company believes the assuming companies are able to honor all contractual commitments under the assumption reinsurance agreements based on periodic reviews of financial statements, insurance industry reports and reports filed with state insurance departments.
At December 31, 1992, insurance liabilities of approximately $182.0 million, were reinsured by Bankers with a subsidiary of ICH. During the first quarter of 1993, Bankers recaptured the reinsured business with assets approximately equal to the insurance liabilities. Recapture fees of $15.5 million were capitalized as a component of cost of policies purchased.
At December 31, 1993, federal income tax loss carryforwards of $94.9 million were available (subject to various statutory restrictions) for use on future tax returns, portions of which begin expiring in 1999. Of the loss carryforwards, $24.5 million may be used to offset income from the non-life insurance companies only. None of the carryforwards are available to reduce the tax provision for financial reporting purposes.
The Company's subsidiaries have deducted approximately $12.9 million on their tax returns allocated to policyholders' surplus for which no provision has been made for income taxes that may be payable if such amounts are used to pay dividends to the shareholder or for certain other purposes.
The IRS has completed its examination of the Company for years through 1990. All amounts due have been paid or accrued.
Notes payable that are direct obligations of the Company at December 31, 1993 and 1992, were as follows:
On September 30, 1993, the Company executed a $200 million senior unsecured loan due to a group of banks as financing for Conseco's purchase of common shares of Bankers as described in Note 2. As discussed in Note 16, on February 15, 1994, the loan was repaid in full, resulting in an extraordinary charge of $1.2 million (net of a $.6 million tax benefit) in the first quarter of 1994.
In February 1993, the Company completed a public offering of $200 million of its 8.125 percent senior notes due in 2003. Proceeds from the offering of approximately $195.6 million (after original issue discount and other associated costs) were used to repurchase in open market transactions or redeem the remaining outstanding 12.75 percent senior subordinated notes issued in July 1987 and for general corporate purposes. The repurchase and redemption of the senior subordinated notes resulted in an extraordinary charge of $8.4 million, net of a $4.3 million tax benefit, in 1993. The 8.125 percent senior notes bear interest payable semi-annually on February 15 and August 15. The notes are unsecured and rank pari passu with all other unsecured and unsubordinated indebtedness of the Company. The notes are not redeemable prior to maturity.
In June 1989, the Company, as partial acquisition financing for National Fidelity, executed a senior promissory note payable in the amount of $34.0 million. The note was subsequently rewritten into two notes - one for $24.0 million and one for $10.0 million. The $10.0 million note was held by Great American Reserve at the time Great American Reserve was acquired by the Partnership in 1990. In March 1993, the Company redeemed the note held by Great American Reserve at its current par value of $7.0 million, resulting in an extraordinary charge of $.4 million (net of a $.3 million tax benefit). In March 1994, the $24 million note was repaid in full resulting in an extraordinary charge of $.8 million (net of a $.4 million tax benefit) in the first quarter of 1994.
During 1992 and 1991, the Company purchased in the market or called $20.0 million and $92.4 million, respectively, par value of senior subordinated notes. These redemptions resulted in extraordinary charges of $1.4 million, net of a $.7 million tax benefit, in 1992 and $5.0 million, net of a $2.6 million tax benefit, in 1991.
The $175.0 million senior term loan is due to a group of banks with principal due in varying amounts from 1994 through 1999. The interest rate is based on either LIBOR plus an applicable margin or prime rate plus an applicable margin for periods of one, two, three or six months as selected by Bankers from time to time (such rate was 5.5 percent at December 31, 1993). The applicable margin for the rate based on a prime rate will vary from .75 percent to 1.5 percent depending on the principal amount of the senior term loan outstanding and a defined cash coverage ratio based generally on cash flows relative to certain fixed charges. The applicable margin for the LIBOR rate will vary from 2.0 percent to 2.75 percent depending on such principal amount and ratio. Under the provisions of the note agreement, the subsidiaries of Bankers are limited in the amount of dividends they may pay on common stock and Bankers must comply with other covenants, including the maintenance of specific financial ratios. The senior term loan has as collateral the majority of the common stock of Bankers and the common stock and surplus debentures issued by its life insurance subsidiary to BLH.
A summary of the maturity dates of the various notes is as follows:
Certain notes payable, not direct obligations of Conseco, were issued by subsidiaries of the Partnership to finance portions of the purchase prices of Great American Reserve, Jefferson National and Beneficial Standard. In connection with the IPO and recapitalization of CCP, a significant portion of CCP's debt was retired, resulting in an extraordinary charge for CCP of $8.8 million, net of a $4.8 million tax benefit, in 1992. Conseco's share of this charge ($3.9 million) was included as an extraordinary charge in the consolidated financial statements in 1992. The remaining outstanding debt was no longer consolidated in the Company's consolidated financial statements as described in Note 1.
During March of 1994, the Company's Board of Directors approved a Performance-Based Compensation Bonus Plan (the "Bonus Plan") for certain officers of the Company. This Bonus Plan is intended to comply with the recently enacted Internal Revenue Code Section 162(m), which potentially limits the deductibility of amounts paid to officers of public companies. The Bonus Plan provides for the payment of bonuses based upon the Company's return on equity and pretax profits. This Bonus Plan, to meet Section 162(m), must be ratified by the Company's shareholders.
Bankers has a qualified defined contribution plan in which substantially all of its employees are eligible to participate. Company contributions, which match certain voluntary contributions to the plan, totaled $1.1 million and $.1 million in 1993 and 1992, respectively.
Bankers has a noncontributory unfunded deferred compensation plan for qualifying members of its career agency force. Benefits are based on years of service and career earnings. The amounts recognized in the consolidated balance sheet for the agents deferred compensation plan were as follows:
The weighted-average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 7 percent and 5 percent, respectively, at December 31, 1993, and 8 percent and 5 percent, respectively, at December 31, 1992.
The Company's 1983 employee stock option plan was authorized to grant options to purchase up to 12.0 million shares of the Company's common stock at a price not less than its market value on the date the option is granted. The 1983 stock option plan expired in December 1993. A new plan was adopted in 1994, subject to shareholder approval, which authorizes the granting of options to purchase up to 6.0 million shares of the Company's common stock at a price not less than its market value on the date the option is granted. The options are exercisable for up to 10 years from date of grant and may become exercisable immediately or over a period of time. The plan also permits granting of stock appreciation rights.
In February 1994, Conseco implemented an option exercise program under which its chief executive officer and four of its executive vice presidents exercised outstanding options to purchase approximately 3.6 million shares of the Company's common stock. The options would otherwise have remained exercisable until the years 1999 and 2000. As a result of the exercise, the Company will be able to realize a tax deduction of approximately $200 million, equal to the aggregate tax gain recognized by the executives as a result of the exercise. The tax benefit together with the proceeds from exercise of the options will be reflected as an increase to paid-in capital. The Company withheld sufficient shares to cover federal and state taxes owed by the executives as a result of the exercise transaction. Net of withheld shares, the Company issued approximately 1.8 million shares of common stock to the executives. The Company also granted to the executive officers new options to purchase a total of 3,016,000 shares of the Company's common stock at $59.25 per share under the 1994 Stock Option and Incentive Plan to replace the shares surrendered for taxes and the exercise price on this and other recent option exercises and as the 1994 incentive grant to six executives.
In addition to the 1.8 million shares retired in February as described in the preceding paragraph, the Company repurchased approximately 1.1 million shares of its common stock for $65.5 million between January 1 and March 25, 1994, as part of its previously announced stock repurchase program.
The five states with the largest shares of the subsidiaries' premiums collected in 1993 were Illinois (15 percent), Texas (7.6 percent), Michigan (6.7 percent), Indiana (5.8 percent) and New Jersey (5.8 percent). No other state accounted for more than 5 percent of total collected premiums. Premiums on reinsurance assumed of $6.0 million, $2.2 million and $15.2 million for the years 1993, 1992 and 1991, respectively, were included in direct premiums in the preceding table.
Based on current conditions and assumptions as to future events on all policies in force, the Company expects to amortize in 1994 approximately 13 percent of the cost of policies purchased balance at December 31, 1993, 11 percent in 1995, 10 percent in 1996, 9 percent in 1997, and 9 percent in 1998. The average discount rate used to determine the amortization of the cost of policies purchased prior to November 19, 1992, ranged from 15 percent to 20 percent during the three-year period ended December 31, 1993. The discount rate for the cost of policies purchased thereafter is 7.5 percent.
The following table compares the consolidated pretax income determined on a statutory accounting basis with such income reported herein in accordance with generally accepted accounting principles:
State insurance laws generally restrict the ability of insurance companies to pay dividends or make other distributions. Net assets of the Company's wholly owned life insurance subsidiaries, determined in accordance with generally accepted accounting principles, aggregated approximately $1.0 billion at December 31, 1993, of which approximately $18.7 million is available for distribution to Conseco in 1994 without the permission of state regulatory authorities.
Conseco's earnings result from three different activities: (i) the operation of life insurance companies; (ii) services provided to both affiliates and others for fees; and (iii) the acquisition and restructuring of life insurance companies. Conseco's life insurance operations are primarily conducted through BLH (which distributes Medicare supplement policies and other life and health products to the senior citizens market through career agents, most of whom sell only Bankers' products), Western National (which distributes single premium deferred annuities through financial institutions and other annuity products through personal producing general agents), CCP (which distributes: (i) tax qualified annuities and certain employee benefit-related products primarily to school teachers and administrators through educator market specialists; and (ii) annuities and life insurance products through other diversified cost effective distribution channels) and Conseco's other wholly owned subsidiaries (which have profitable blocks of in-force life business, although new sales are currently not being emphasized).
On February 2, 1994, Conseco announced the closing of Conseco Capital Partners II, L.P., a partnership which will invest in privately negotiated acquisitions of specialized annuity, life and accident and health insurance companies and related businesses, in which 36 investors committed a total of $624 million of capital. Commitments to the new partnership include $100 million from Conseco, $25 million from Bankers, $25 million from CCP, $50 million from Western and $36 million from executive officers and directors of Conseco and its affiliates.
On February 15, 1994, Western National Corporation ("WNC") completed the initial public offering of 37,202,500 shares of common stock, of which 2,300,000 shares were sold by WNC and 34,902,500 shares were sold by Conseco. In addition, Conseco sold 150,000 shares to the President of WNC at the initial public offering price less underwriting discounts and commissions. Prior to the initial public offering, Western National and WNC were wholly owned subsidiaries of Conseco. WNC was formed in October 1993 as a Delaware corporation to be the holding company for Western National. In connection with the organization of WNC and the transfer of the stock of Western National to WNC by Conseco, WNC issued 60,000,000 shares of its common stock and a $150.0 million, 6.75 percent senior note due March 31, 1996 (the "Conseco Note") to Conseco. On February 22, 1994, WNC completed a public offering of $150.0 million aggregate principal amount of its 7.125 percent senior notes due February 15, 2004. The net proceeds from the offering of $147.5 million (after original issue discount, underwriting discount and estimated offering expenses) and certain proceeds from WNC's initial public offering of common stock were used to repay the Conseco Note.
The following summarizes selected account balances of Western National that are consolidated with the accounts of the Company in the accompanying consolidated financial statements:
The following unaudited pro forma balance sheet data are presented as if the IPO of WNC and related transactions had occurred on December 31, 1993. The pro forma statement of operations data are presented as if such transactions had occurred on January 1, 1993 and assumes the net proceeds to Conseco from the IPO and related transactions were invested to earn 3 percent per year before income tax.