AGP owns the building housing its principal operations in Des Moines, Iowa, consisting of approximately 107,000 square feet of space. The land underlying the building is subject to a long-term lease expiring in 2016, at which time title to the building will pass to the lessor. AGP owns another building housing its operations in Birmingham, Alabama, consisting of 44,000 square feet.
This discussion should be read in conjunction with the accompanying consolidated financial statements, notes thereto and financial statistics. Changes in 1995, 1994 and 1993 balances in the consolidated financial statements are caused primarily by the transactions described in note 1 "Significant Accounting Policies - Basis of Presentation" and note 2 "Acquisitions/Dispositions" to the consolidated financial statements.
Conseco provides all affiliated and other unaffiliated clients with various services, including investment management, mortgage origination and servicing, policy administration, data processing, product marketing and executive management services. In addition, subsidiaries of Conseco earn fees by: (i) providing marketing services to financial institutions related to the distribution of insurance and investment products; (ii) providing financing services to Partnership II; and (iii) distributing property and casualty insurance products as an independent agency.
Of the first seven companies acquired by Conseco as wholly owned subsidiaries, four were subsequently sold (including WNC through an IPO in February 1994 and the subsequent sale of Conseco's remaining interest in WNC in December 1994, as described in note 2 to the consolidated financial statements). Three remain as wholly owned subsidiaries. The first three companies acquired by Partnership I (two of which were merged at the end of 1994) are now wholly owned subsidiaries of Conseco. The fourth and final acquisition of Partnership I became a wholly owned subsidiary of BLH, in which Conseco currently holds a 90.5 percent interest. In addition, Conseco currently holds a 36 percent interest in the acquisition made by Partnership II. Conseco records the activities of acquired companies in its insurance operations segment. Conseco also provides services to acquired companies, thereby generating income in the fee-based operations segment. Incentive compensation earned by exceeding prescribed returns to the partners and restructuring gains realized from the sale of portions of the acquired entities are reflected in the restructuring segment.
Recently, there has been a change in the financial structure required to acquire life insurance companies while maintaining competitive ratings from A.M. Best and other rating agencies. As a result, Conseco believes it is no longer feasible to acquire life insurance companies through highly leveraged transactions, such as those made in the past by the acquisition partnerships. Conseco, therefore, terminated Partnership II in March 1996. Conseco may accomplish future acquisitions through different financial structures, including acquisitions using its equity capital or other means.
The following table shows the sources of Conseco's net income (after taxes and minority interest) for the last three years:
General. Conseco acquired a 44 percent ownership interest in BLH in November 1992, the date BLH was acquired by Partnership I. In March 1993, BLH completed an IPO of its common stock, thus reducing Conseco's ownership to 31 percent. On September 30, 1993, Conseco acquired 13.3 million additional common shares of BLH, increasing its ownership interest to 56 percent. During 1994, BLH acquired 1.8 million shares of its common stock at a cost of $35.7 million, which increased Conseco's ownership interest in BLH to 58 percent. During 1995, BLH repurchased 2.2 million shares of its common stock at a cost of $42.1 million and Conseco acquired 12.8 million shares of BLH common stock for $262.4 million. As a result of these transactions, Conseco's ownership in BLH increased to 88 percent as of December 31, 1995 (it was 90.5 percent as of March 5, 1996). Conseco's weighted average ownership of BLH during 1995 was 74 percent. At December 31, 1995, the BLH shares owned by Conseco had a net carrying value of approximately $958.9 million and a cost of $575.5 million. All activities of BLH are included in Conseco's financial statements on a consolidated basis since November 1, 1992. Conseco's minority interest adjustment, however, removes the portion of BLH's net income applicable to other owners.
Net investment income increased 13 percent in 1995 and 26 percent in 1994. Average invested assets (amortized cost basis) increased 11 percent in 1995, to $3.4 billion, and 32 percent, to $3.0 billion, in 1994. For 1995 compared to 1994, the percentage increase in net investment income was greater than the percentage increase in average invested assets because the yield earned on average invested assets increased to 7.3 percent in 1995 from 7.2 percent in 1994. For 1994 compared to 1993, the percentage increase in net investment income was less than the percentage increase in average invested assets because the yield earned on average invested assets decreased to 7.2 percent in 1994 from 7.6 percent in 1993.
Selling securities at a gain and reinvesting the proceeds at lower yields may, absent other management action, tend to decrease future investment yields. The Company believes, however, the following factors would mitigate the adverse effect of such decreases on net income: (i) the Company recognizes additional amortization of the cost of policies purchased and the cost of policies produced in the same period as the gain in order to reflect reduced future yields (thereby reducing such amortization in future periods); (ii) the Company can reduce interest rates credited to some products thereby diminishing the effect of the yield decrease on the investment spread; and (iii) the investment portfolio grows as a result of reinvesting the realized gains.
Realized investment gains (losses) affect the timing of the amortization of cost of policies purchased and cost of policies produced. See amortization related to realized gains and losses below.
Insurance policy benefits and change in future policy benefits have increased primarily because of: (i) the higher incidence of medical provider claims in the Medicare supplement line; and (ii) the increased amount of business in force, on which benefits are incurred. The table below summarizes insurance policy income and the ratio of policy benefits to insurance policy income for the Company's individual health and group products.
The ratio of policy benefits to insurance policy income for Medicare supplement policies in 1995 reflects a higher incidence of claims. Additionally, federal legislation regarding the standardization of Medicare supplement plans for policies issued after 1991 (see "Business of Conseco - Regulation"), including the establishment of minimum loss ratios, has had the effect of increasing Medicare supplement loss ratios, since a greater percentage of Bankers' in-force premiums now relate to policies issued after 1991.
Changes in the ratio of policy benefits to insurance policy income for long-term care policies reflect fluctuations in claim experience and reserve development.
The group business consists principally of health insurance products and administrative services. This product effectively shifts most or all of the risks of adverse loss experience to the insured, limiting BLH's underwriting risk over time. These group policies generally permit premiums to be adjusted prospectively to reflect the historical loss experience of the group.
Cost of policies produced represents the cost of producing new business (primarily commissions and certain costs of policy issuance and underwriting) which varies with and is primarily related to the production of new business. Costs deferred may represent amounts paid in the period new business is written (such as underwriting costs and first year commissions) or in periods after the business is written (such as commissions paid in subsequent years in excess of ultimate commissions paid).
Income tax expense fluctuated during the last three years primarily in relationship to pretax income. The effective tax rate of 38 percent for 1995 and 39 percent for 1994 and 1993 exceeded the statutory corporate income tax rate (35 percent) primarily because goodwill amortization is not deductible for federal income tax purposes.
Minority interest declined in each year as Conseco's ownership interest in BLH increased as previously discussed.
Although investment portfolio yields fluctuated during these periods, CCP maintained a comparable level of profitability from investment spreads by adjusting credited interest rates on annuities and financial products to permit the net spread percentage to remain relatively constant.
Net realized gains (losses) often fluctuate from period to period. The annuity operations sold $1.7 billion of fixed maturity securities in 1995, $1.2 billion in 1994 and $2.1 billion in 1993. Net realized gains in 1995 included $6.1 million of investment writedowns taken as a result of conditions which caused the Company to conclude that declines in fair value of certain securities were other than temporary.
The effect of net realized gains (losses) on the amortization of cost of policies purchased and the cost of policies produced is discussed above under BLH. Also see amortization related to net realized gains (losses) below.
Insurance policy benefits and change in future policy benefits relate solely to policies with mortality or morbidity features. The decrease in these amounts correspond with the decrease in the in-force block of such policies.
CCP issued $200 million of 10.5 percent senior notes in December 1994. Proceeds from the notes were used, in part, to repay outstanding debt. Conseco's 1994 earnings included a $2.1 million extraordinary charge related to such prepayment. After the CCP Merger, these notes became direct obligations of Conseco. The interest expense related to the senior notes is recorded in the "Interest and Other" segment after the CCP Merger date.
Interest expense on investment borrowings in the last three years reflected changes in investment borrowing activities and the higher interest rates paid on such borrowings during 1995.
Amortization related to operations was primarily affected by the changes in the amount of business in force on which acquisition costs are capitalized and amortized.
Income tax expense fluctuated in relationship to income before income taxes during the last three years.
Net investment income declined in 1995 as the result of a decrease in invested assets on this segment's closed block of business, as well as decreased yields earned on such assets. The decline in 1994 was primarily a result of the recapture of a block of business by WNC from Conseco's other life insurance subsidiaries on March 31, 1993, which resulted in a decrease of $1.3 billion in insurance liabilities and invested assets. In addition, the redemption of fixed maturity investments prior to their scheduled maturity date resulted in additional investment income (losses) of approximately $(.1) million in 1995, $.1 million in 1994 and $3.7 million in 1993.
Insurance policy benefits and change in future policy benefits relate solely to policies with mortality and morbidity features. These benefits have decreased over the last three years due to the decreased emphasis on generating new premiums from such products.
Interest expense on annuities and financial products decreased over the last three years as a result of the reinsurance recapture by WNC. The average rate credited on all insurance liabilities was approximately 7.0 percent at December 31, 1995, 1994 and 1993.
General. Conseco's earnings reflect its ownership interest in AGP from September 29, 1994, the date AGP was acquired by Partnership II. Immediately after the Acquisition, Conseco, through its direct investment and through its equity interests in the investments made by BLH, CCP and WNC, had approximately a 27 percent ownership interest in AGP. At December 31, 1994, Conseco's ownership interest in AGP decreased to 25 percent as a result of: (i) the sale of Conseco's 40 percent equity interest in WNC on December 23, 1994; and (ii) the sale by a subsidiary of CCP of a portion of its investment in AGP; partially offset by (iii) Conseco's increased ownership percentage in BLH and CCP due to stock repurchases made by BLH and CCP. At December 31, 1995, Conseco's ownership in AGP increased to 36 percent as a result of: (i) Conseco's increased ownership percentage in BLH due to common stock purchases by Conseco and BLH; (ii) Conseco's increased ownership percentage in CCP as a result of the CCP Merger; and (iii) purchases of AGP common stock as a result of AGP's issuance of common stock in a private placement transaction. While all activities of AGP are required to be included in Conseco's financial statements on a consolidated basis for all periods after September 29, 1994, the minority interest adjustment removes from Conseco's net income the portion applicable to other owners so that net income reflects only Conseco's applicable ownership interest. To enhance comparability, the amounts for the year ended December 31, 1993, and for the nine months ended September 29, 1994, (which were prior to the Acquisition) are presented separately.
Insurance policy income, which consists of premiums received on traditional life insurance products and policy fund and surrender charges assessed against investment type products, increased 8 percent in 1995 and 1994, primarily because increased annuity policy withdrawals resulted in higher surrender charges. Surrender charges assessed against annuity withdrawals were $15.4 million, $10.2 million and $6.2 million in 1995, the 1994 periods and 1993, respectively, while annuity policy withdrawals were $750.4 million, $532.8 million and $277.9 million for the same periods, respectively. Surrender charges as a percentage of annuity policy withdrawals declined in 1995 and the 1994 periods as a result of increased withdrawals of a certain policy form whose surrender charge expired in 1995 and 1994 upon such policies reaching their sixth anniversary. In addition, AGP has experienced increases in withdrawals due to: (i) the increased size of AGP'S annuity portfolio; and (ii) competition from other investment products in the second half of 1994, which caused some policyholders to surrender policies and incur a surrender charge to invest funds in higher yielding alternative investments.
The increased level of investment activity in 1995 was the result of more active investment portfolio management since the Acquisition and planned changes in the fixed maturity investment portfolio to reduce the portfolio's duration and exposure to more volatile CMO investments. The declining interest rate environment since the Acquisition date, which increased the market value of fixed maturity investments, contributed to AGP's ability to realize gains on investment sales in 1995.
WNC's operating earnings during the above periods were affected by the growth in invested assets from annuity sales, interest income, and the recapture on March 31, 1993, of a $1.3 billion block of business previously reinsured with subsidiaries of Conseco, offset in part by fluctuations in prepayment income included in net investment income and interest expense on notes payable. WNC's net investment income included prepayment income of $3.1 million in 1994 and $18.0 million in 1993. WNC's net income was affected by these factors, and also changes in realized gains (losses) and trading income.
Conseco's fee revenues include: (i) fees for investment management and mortgage origination and servicing; (ii) commissions earned for insurance and investment product marketing and distribution; (iii) administrative fees for policy administration, data processing, product marketing and executive management services; and (iv) fees for financing services provided to Partnership II. Fees earned from services provided to consolidated entities are eliminated. Such eliminations increased during 1995 as a result of the consolidation of the accounts of CCP effective January 1, 1996, and a full year of revenues from AGP in 1995, compared to only one quarter of such revenues in 1994.
The growth in investment management revenues in 1995 was the result of fee-producing activities provided to AGP, partially offset by a reduction in the rates charged to WNC. Commission revenues include gains of $2.5 million in 1995 and $4.0 million in 1994 related to the buyouts of marketing agreements by banks. Commission revenues decreased in 1995 as compared to 1994 primarily because of the decrease in such gains and the decrease in commissions generated from such marketing agreements before the sales. The increase in commission revenues in 1994 compared to 1993 was primarily due to the acquisition of Bankmark, an insurance marketing company which helps financial institutions provide insurance and investment products to their customers.
Restructuring income was recorded: (a) in 1993 for: (i) incentive earnings allocations from Partnership I, based on the returns resulting from the value of the BLH shares distributed to the partners; and (ii) from the Company's share of the gain realized from the public sale of shares of BLH; (b) in 1994, from the gain realized from the sale of WNC, net of expenses incurred in conjunction with a terminated merger; and (c) in 1995 for: (i) the release of deferred income tax liabilities that were no longer required as a result of the CCP Merger and the purchase of shares of BLH common stock; and (ii) the gain which resulted from the sale of Conseco's investment in Eagle Credit (a finance subsidiary of Harley-Davidson).
Premiums collected by the annuity operations in 1995 were $709.8 million, of which $641.4 million were recorded as deposits to insurance liability accounts. This compared to $522.1 million collected and $450.7 million recorded as deposits to insurance liability accounts in 1994 and $451.0 million collected and $368.5 million recorded as deposits to insurance liability accounts in 1993. The increase in total premiums collected was the result of increased sales of single premium deferred annuities by: (i) professional independent producers ($352.7 million in 1995 versus $201.3 million in 1994 and $48.8 million in 1993), and (ii) educator market specialists ($48.6 million in 1995, $20.5 million in 1994 and $3.8 million in 1993). Total premiums collected through professional independent producers were $413.6 million in 1995, a 58 percent increase over 1994, and comprised 58 percent of collected premiums in 1995. Total premiums collected through educator market specialists were $293.7 million in 1995, a 16 percent increase compared to 1994, and comprised 41 percent of collected premiums in 1995.
Premiums collected in 1993 include $563.0 million of premiums collected by WNC. As previously discussed, Conseco's equity interest in WNC was sold in 1994.
The Company's investment strategy is to: (i) maintain a predominately investment grade fixed income portfolio; (ii) provide adequate liquidity to meet the cash flow requirements of policyholders and other obligations; and (iii) maximize current income total investment return through active investment management. Consistent with this strategy, investments in fixed maturity securities, mortgage loans, credit-tenant loans, policy loans and short-term investments comprised 98 percent of the Company's investment portfolio at December 31, 1995. The remainder of the invested assets were in equity securities and other investments. At December 31, 1995, the Company had invested assets of approximately $14.4 billion.
As discussed in the notes to the consolidated financial statements, when Conseco adjusts carrying values of actively managed fixed maturity securities for changes in fair value, the Company also adjusts the cost of policies purchased, cost of policies produced and insurance liabilities. These adjustments are made in order to reflect the change in amortization that would be needed if those fixed maturity investments had actually been sold at their fair values and the proceeds reinvested at current interest rates.
At December 31, 1995, approximately 4.5 percent of Conseco's invested assets and 5.0 percent of fixed maturity investments were rated below investment grade 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). Conseco plans to maintain approximately the present level of below investment grade fixed maturities. These securities generally have greater risks than other corporate debt investments, including risk of loss upon default by the borrower, and are often unsecured and subordinated to other creditors. Below investment grade 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 these risks and monitors its below investment grade securities closely. At December 31, 1995, the Company's below investment grade fixed maturity investments had an amortized cost of $646.8 million and an estimated fair value of $647.2 million.
carrying amount to its net realizable value, which becomes the new cost basis; the amount of the reduction is reported as a realized loss. Conseco recognizes any recovery of such reductions in the cost basis of an investment only upon the sale, repayment or other disposition of the investment. Conseco recorded writedowns of investments of $21.9 million in 1995 as a result of changes in the financial condition of an issuer and changes in the value of the underlying collateral which caused the Company to conclude that the decline in fair value of such investments was other than temporary. The Company's investment portfolio is subject to the risks of further declines in realizable value. The Company, however, attempts to mitigate this risk through the diversification and active management of its portfolio.
The Company's policy is to discontinue the accrual of interest and eliminate all previous interest accruals for defaulted securities, if the Company's assessment is that such amounts will not be ultimately realized in full. Investment income forgone due to defaulted securities was $1.6 million, $3.9 million and $2.7 million for the years ended December 31, 1995, 1994 and 1993, respectively. During 1995, the Company recovered approximately $6.0 million of investment income which was not recognized in prior periods due to defaulted securities.
At December 31, 1995, fixed maturity investments included $4.0 billion of mortgage-backed securities (31 percent of the fixed maturity security portfolio). CMOs are securities backed by pools of pass-through securities and/or mortgages that are segregated into sections or "tranches" which provide for sequential retirement of principal rather than the pro rata share of principal return which occurs through regular monthly principal payments on pass-through securities.
The yield characteristics of mortgage-backed securities differ from those of traditional fixed income securities. Interest and principal payments occur more frequently, often monthly, and mortgage-backed securities are subject to risks associated with variable prepayments. Prepayment rates are influenced by a number of factors which cannot be predicted with certainty, including the relative sensitivity of the underlying mortgages backing the assets to changes in interest rates; a variety of economic, geographic and other factors; and the repayment priority of the securities in the overall securitization structures.
The following table sets forth the par value, amortized cost and estimated fair value of mortgage-backed securities including CMOs at December 31, 1995, summarized by interest rates on the underlying collateral at December 31, 1995:
The amortized cost and estimated fair value of mortgage-backed securities including CMOs at December 31, 1995, summarized by type of security were as follows:
Pass-throughs and sequential and targeted amortization classes have similar prepayment variability. Pass-throughs have historically provided the best liquidity in the mortgage-backed securities market and provide the best price/performance ratio in a highly volatile interest rate environment. This type of security is also frequently used as collateral in the dollar-roll market. Sequential classes pay in a strict sequence; all principal payments received by the CMO are paid to the sequential tranches in order of priority. Targeted amortization classes provide a modest amount of prepayment protection when prepayments on the underlying collateral increase from those assumed at pricing. Thus, they offer slightly better call protection than sequential classes and pass-throughs.
Accrual bonds are CMOs structured such that the payment of coupon interest is deferred until principal payments begin. On each accrual date, the principal balance is increased by the amount of the interest (based upon the stated coupon rate) that otherwise would have been payable. As such, these securities act much the same as zero coupon bonds until cash payments begin. Cash payments typically do not commence until earlier classes in the CMO structure have been retired, which can be significantly influenced by the prepayment experience of the underlying mortgage loan collateral in the CMO structure. Because of the zero coupon element of these securities and the potential uncertainty as to the timing of cash payments, their market values and yields are more sensitive to changing interest rates than other CMOs, pass-through securities and coupon bonds.
During 1995, fixed maturity investments with par values totaling $170 million were redeemed prior to the scheduled maturity date. As a result of such redemptions, Conseco recognized additional income of approximately $3.8 million which was credited to investment income.
Credit-tenant loans are loans on commercial properties where the lease of the principal tenant is assigned to the lender and the principal tenant, or any guarantor of such tenant's obligations, has a credit rating at the time of origination of the loan of at least BBB- or its equivalent. The underwriting guidelines consider such factors as: (i) the lease term of the property; (ii) the mortgagee's management ability, including business experience, property management capabilities and financial soundness; and (iii) such economic, demographic or other factors that may affect the income generated by the property, or its value. The underwriting guidelines also generally require a loan-to-value ratio of 75 percent or less. Credit-tenant loans are carried at amortized cost and were $259.1 million at December 31, 1995, or 2 percent of total invested assets. The total estimated fair value of credit-tenant loans was $258.6 million at December 31, 1995.
At December 31, 1995, the Company held no trading account securities. 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. The net unrealized gain (loss) on trading account securities at December 31, 1995 and 1994, recorded in trading income as a result of adopting SFAS 115, was immaterial.
Short-term investments totaled $189.9 million, or 1.3 percent of invested assets at December 31, 1995, and consisted primarily of commercial paper and repurchase agreements relating to government securities.
Changes in the consolidated balance sheet of 1995 compared to 1994
Changes in Conseco's balance sheet of 1995 compared to 1994 principally reflect the growth through operations, consolidation of CCP as the result of the CCP Merger, changes in the fair value of actively managed fixed maturity investments and the capital and financing transactions discussed below.
In accordance with SFAS 115, Conseco records its actively managed fixed maturity investments at estimated fair value. At December 31, 1995, such investments were increased by $608.2 million as a result of the SFAS 115 adjustment. At December 31, 1994, such investments were decreased by $373.4 million as a result of the SFAS 115 adjustment.
During 1995, insurance liabilities of approximately $70 million resulting from assumed reinsurance were recaptured by a nonaffiliated insurance company. Assets approximately equal to the insurance liabilities were transferred in the reinsurance recapture.
As part of its investment strategy, the Company enters into reverse repurchase agreements and dollar-roll transactions (specialized forms of collateralized lending involving mortgage-backed securities) 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. Conseco had investment borrowings of $298.1 at December 31, 1995, compared with no investment borrowings at December 31, 1994.
Minority interest increased primarily as a result of : (i) the income attributable to minority interest; (ii) adjustments to minority interest as the result of SFAS 115; and (iii) the sale of common stock by AGP, other than amounts purchased by Conseco and its subsidiaries. Such increases were offset by: (i) Conseco's and BLH's purchase of common stock of BLH; and (ii) Conseco's additional ownership interest in CCP, BLH and AGP as a result of the CCP Merger. Changes in minority interest are further described in note 9 to the consolidated financial statements.
Conseco's insurance operating companies generally receive adequate cash flow from premium collections and investment income to meet their obligations. Insurance policy liabilities are primarily long-term and generally are paid from future cash flows. Most of the insurance company assets, other than policy loans, are invested in bonds and other securities, substantially all of which are readily marketable. Although there is no present need or intent to dispose of such investments, the life companies could liquidate portions of their investments if such a need arose. To increase their return on investments and improve liquidity, the life companies from time to time will lend U.S. Treasury securities in reverse repurchase agreements or lend mortgage-backed securities in dollar-roll transactions.
Of the companies' total insurance liabilities at December 31, 1995, only 20 percent could be surrendered by the policyholder without a penalty. Approximately 65 percent could be surrendered by the policyholder subject to penalty. Payment characteristics of the insurance liabilities at December 31, 1995, were as follows (dollars in millions):
BLH provided BLI with funds to acquire Bankers Life. In exchange, BLH received a $500 million surplus debenture from BLI. The surplus debenture was approved by the Illinois Department of Insurance ("DOI"). During 1995 and 1994, BLI repaid principal of $30.0 million and $25.0 million, respectively, plus accrued interest on the surplus debenture. BLI may repay principal and interest on the surplus debenture only when the DOI is satisfied that the financial condition of BLI warrants that action; such approval may not be withheld if BLI submits satisfactory evidence of surplus of at least the amount stipulated in the surplus debenture.
At December 31, 1995, BLH had short-term investments of $42.8 million. Conseco believes that BLH could generate additional liquidity, if needed in the future, by issuing equity or debt securities, borrowing additional amounts on its revolving credit facility discussed in note 16 to the consolidated financial statements, or by converting existing assets to cash (such as the sale or transfer of existing blocks of insurance through reinsurance arrangements).
In addition to its debt service obligations, BLH uses cash to pay dividends on its common stock and to pay for administrative services provided by Conseco's wholly owned subsidiaries.
AGP relies on dividends from ALHC and payments under a tax sharing agreement with its subsidiaries to fund its operating expenses, dividends and interest expense. AGP is not expected to pay dividends on its common stock in the near future. Since the Acquisition, AGP's direct obligations for dividends on preferred stock and interest on indebtedness have been substantially reduced as a result of the retirement of certain preferred stock as part of the Acquisition and the conversion of $54.0 million principal amount of the Convertible Debentures. AGP remains obligated to pay interest on the remaining $15.0 million principal balance of the Convertible Debentures as long as such amounts remain outstanding. The former senior term loan required the Company to hold funds in escrow to pay the cash merger consideration to the holders of the Convertible Debentures that remained outstanding. The provisions of the Senior Credit Facility (as discussed hereafter) do not require an escrow account to fund the conversion of the remaining Convertible Debentures outstanding. As such, these funds became available for general corporate purposes on the date the Senior Credit Facility was executed.
AGP is obligated to pay the holders of the Contingent Payment Rights or the holder of the 1988 Series Preferred Stock (depending on the outcome of the Savings Bank Litigation) upon conversion of the 1988 Series Preferred Stock an amount of not less than approximately $30 million. Funds to make these payments are available under the Company's Senior Credit Facility.
AGP has $64.4 million par value 1994 Series Preferred Stock outstanding. Dividends on such preferred stock accrue annually at 13 percent in additional shares through September 2006.
At December 31, 1995, ALHC has $150.0 million principal indebtedness outstanding under its senior subordinated notes and $125.0 million principal indebtedness under the Senior Credit Facility (see note 8 to the consolidated financial statements). ALHC's annual interest payments for 1996 will be: (i) approximately $16.9 million with respect to the senior notes; and (ii) approximately $9.2 million with respect to the Senior Credit Facility (based on rates in effect and amounts outstanding at December 31, 1995).
The parent company (Conseco, Inc.) uses cash primarily to service its debt, pay dividends on preferred and common stock, meet administrative expenses, pay income taxes and invest in affiliates. The wholly owned subsidiaries and BLH provide liquidity to Conseco by paying dividends, tax sharing payments and fees for services provided. The parent company may also issue debt or equity securities, borrow additional amounts under its Credit Agreement with a group of banks as discussed in note 8 to the consolidated financial statements, or sell all or a portion of its investments in subsidiaries or affiliates. These sources have historically provided adequate cash flow to fund: (i) the needs of the parent company's normal operations; (ii) internal expansion, acquisitions and investment opportunities; and (iii) the retirement of debt and equity.
Inflation does not have a significant effect on Conseco's balance sheet; the Company has minimal investments in property, equipment or inventories.
As indicated throughout this report, Conseco intends to continue its strategy of growth through operating life insurance companies and providing services for fees to the affiliated companies and others.
Conseco's life insurance operations include: (i) BLH, in which Conseco had an 88 percent ownership interest at December 31, 1995, and a 90.5 percent ownership interest at March 5, 1996; (ii) Great American Reserve and Beneficial Standard which became wholly owned subsidiaries as a result of the CCP Merger; (iii) the wholly owned life insurance subsidiaries, principally Bankers National and National Fidelity; and (iv) AGP, in which Conseco has a 36 percent ownership interest. Upon completion of the merger with Life Partners Group, Inc. ("LPG"), announced in March 1996, Conseco will have significant in-force business and marketing activity in multiple segments of the life insurance industry, including universal life, ordinary life, term life, single and flexible premium deferred and immediate annuities (including both variable and fixed), Medicare supplement, long-term care and individual and group health insurance. Pro forma collected premiums for 1995 including LPG ($542.6 million), AGP ($825.6 million) and subsidiaries ($2,303.6 million) were as follows (dollars in millions):
BLH's strategy is to continue to grow profitably its individual health and other insurance business while maintaining appropriate levels of capital and surplus. A primary area of focus is expanding and enhancing the productivity of the career agency force, which is BLH's main distribution system. BLH's growth strategy also emphasizes increased cross-selling to existing policyholder households and developing products tailored to meet specific consumer needs. As a result of cross-selling, 1995 annualized new business premiums increased 20 percent for long-term care products. While new sales of Medicare supplement insurance in 1995 were below 1994 levels, total Medicare premiums collected increased 1.0 percent. We believe rate increases effected by BLH in 1995 to offset increased claims costs may have caused the BLH Medicare supplement policy to be less competitive. We believe recently announced rate increases for some competitors' products should improve the BLH price competitiveness in 1996.
The U.S. Congress and state legislatures are currently considering various proposals relating to the country's health care delivery system. BLH is unable to predict what changes will be enacted and, if enacted, their scope and impact. BLH, however, continues to believe that opportunities for its products will grow under any realistic and affordable health care reform scenario.
The annuity operations and AGP have: (i) a sizable and profitable block of in-force business; and (ii) distribution systems that have the potential to generate growth in the SPDA and 403(b) tax sheltered annuity markets.
Conseco continues to provide various services to BLH, AGP, the former subsidiaries of CCP and the other wholly owned subsidiaries. These services include investment management, mortgage origination and servicing, policy and claims administration, data processing, product marketing and executive management services. Conseco also provides such services to unaffiliated clients, principally insurance companies. Conseco intends to expand its service fee revenue by seeking other unaffiliated clients. Such arrangements would take advantage of Conseco's ability to administer products and investments without requiring Conseco to provide additional capital needed to support those products. Because of changes in control at two of Conseco's unaffiliated clients in 1995, it expects to lose those clients during 1996. Fee revenue from those clients in 1995 was $2.2 million for investment management and $4.5 million for administrative services (both amounts are before deduction of direct and indirect expenses). In March 1993, Conseco acquired Bankmark, an insurance marketing company which develops relationships with financial institutions to provide insurance and investment products to their customers. 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.
With the 1996 announcement of the termination of Partnership II, Conseco no longer expects to participate significantly in the process of restructuring life insurance companies in order to realize their increased value through a sale or public offering of the companies. Conseco is currently reviewing alternatives to realize the values represented by AGP. In accordance with the partnership agreement, Partnership II's assets must be distributed within two years of the effective date of dissolution.
Conseco believes it has the resources and capabilities to continue being a successful acquirer of life insurance companies. It also believes that its past record of successfully acquiring, financing and operating life insurance companies will be an advantage compared to others who may attempt to acquire available candidates. As shown in the prior section on liquidity, the pro forma capital structure of Conseco (giving effect to several 1996 events, as if they had occurred at December 31, 1995) includes only 32 percent debt for which Conseco is directly liable to Conseco's capital (40 percent if debt of BLH is included).
CONSOLIDATED STATEMENT OF OPERATIONS for the years ended December 31, 1995, 1994 and 1993 (Dollars in millions, except per share data)
The following summary explains the accounting policies we use to arrive at some of the more significant numbers in our financial statements. We have restated all share and per share amounts for the April 1, 1996 two-for-one stock split. 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.
Consolidation issues. During 1990, Conseco formed Conseco Capital Partners, L.P. ("Partnership I"), which raised and invested $99.5 million of capital. Approximately half of this capital was provided by Conseco; the balance was provided by other investors. A wholly owned subsidiary of Conseco was the sole general partner of Partnership I. Partnership I was the Company's vehicle for acquiring four insurance companies: Great American Reserve in June 1990, Jefferson National Life Insurance Company ("Jefferson National") in November 1990 (it was merged with Great American Reserve in 1994), Beneficial Standard in March 1991 and Bankers Life in November 1992. We accounted for all of these acquisitions as purchases, reflecting the acquired operations in our financial statements beginning with the acquisition dates. As sole general partner, Conseco exercised unilateral control over Partnership I. We were therefore required to include the accounts of Partnership I and its majority-owned subsidiaries in our consolidated financial statements until Partnership I was liquidated on March 31, 1993. See note 2 for a description of the activities of Partnership I.
We were required to use step-basis accounting when we acquired the shares of CCP common stock in various transactions . As a result, the assets and liabilities of CCP included in our December 31, 1995, consolidated balance sheet represent the following combination of values: (i) the portion of CCP's net assets acquired by Conseco in the initial acquisitions of CCP's subsidiaries made by Partnership I is valued as of those respective acquisition dates; and (ii) the portion of CCP's net assets acquired in the CCP Merger is valued as of August 31, 1995.
Partnership II was organized to invest in privately negotiated acquisitions of specialized annuity, life and accident and health insurance companies and related businesses. Partnership II acquired AGP on September 29, 1994 (as further described in note 2). Partnership II owns 80 percent of the outstanding shares of AGP's common stock. Because Conseco is the sole general partner of Partnership II, Conseco controls Partnership II and AGP even though its ownership interest is less than 50 percent. Because of this control, Conseco's consolidated financial statements are required to include the accounts of Partnership II and AGP. Immediately after the acquisition of AGP, Conseco, through its direct investment and through its equity interests in the investments made by BLH, CCP and WNC, had approximately a 27 percent ownership interest in AGP.
We accounted for the acquisition of AGP using the purchase method of accounting. Under purchase accounting, we allocated the total purchase cost of AGP to the assets and liabilities acquired based on their fair values, with the excess of the total purchase cost over the fair value of the net assets acquired recorded as goodwill.
Neither "consolidation" nor "non-consolidation" changes the net income or shareholders' equity we report. Our consolidated financial statements do not include the results of material transactions between us and our consolidated affiliates, or among our consolidated affiliates. We reclassified some figures in our 1994 and 1993 consolidated financial statements and notes to conform with the 1995 presentation.
Fixed maturities are securities that mature more than one year after issuance. They include bonds, notes receivable and preferred stocks with mandatory redemption features.
Equity securities include investments in common stocks and non-redeemable preferred stock.
We implemented Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115") as of December 31, 1993. We classify our fixed maturity and equity securities into three categories:
Actively managed - fixed maturity and equity securities that we may sell prior to maturity in response to changes in interest rates, issuer credit quality or our liquidity requirements. We carry actively managed securities at fair value. We record any unrealized gain or loss, net of tax and the related adjustments described below, as a component of shareholders' equity.
We consider the anticipated returns from investing policyholder balances, including realized gains and losses, in determining the amortization of the cost of policies purchased and the cost of policies produced. When we state actively managed fixed maturities at fair value, we also adjust the cost of policies purchased and the cost of policies produced to reflect the change in cumulative amortization that we would have recorded if we had sold these securities at their fair value and reinvested the proceeds at current yields. If future yields on such securities decline, it may be necessary to increase certain of our insurance liabilities. We are required to adjust such liabilities when their balances and future net cash flows (including investment income) are insufficient to cover future benefits and expenses.
For a transfer from the trading category - we do not reverse the unrealized gain or loss already recognized in earnings.
Credit-tenant loans are loans for commercial properties. When we make these loans: (i) the lease of the principal tenant must be assigned to Conseco; (ii) the lease must produce adequate cash flow to fund substantially all the requirements of the loan; and (iii) the principal tenant or the guarantor of such tenant's obligations must have an investment-grade credit rating when the loan is made. These loans also must be secured by the value of the related property. Our underwriting guidelines take into account such factors as: (i) the lease term of the property; (ii) the borrower's management ability, including business experience, property management capabilities and financial soundness; and (iii) such economic, demographic or other factors that may affect the income generated by the property, or its value. The underwriting guidelines generally require a loan-to-value ratio of 75 percent or less. We carry both credit-tenant loans and traditional mortgage loans at amortized cost.
We regularly evaluate all our credit-tenant loans, mortgage loans and other investments based on current economic conditions, credit loss experience and other investee-specific developments. If there is a decline in a security's net realizable value that is other than temporary, we treat it as a realized loss and we reduce our cost basis of the security to its estimated fair value. If a loan becomes impaired (i.e., it becomes probable that we will be unable to collect all amounts due according to the contractual terms of the agreement), we revalue the loan at the present value of expected cash flows, discounted at the loan's effective interest rate. We accrue interest thereafter on the net carrying amount of impaired loans.
- Identify the rate of return that we must earn in order to accept these risks, based on consideration of the factors summarized below.
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 the following factors:
After we determine the cost of policies purchased, we amortize that amount based on the incidence of the expected cash flows. For acquisitions we made on or before November 19, 1992, we amortize the asset 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 AGP and the acquisitions of additional ownership interests in BLH and CCP in 1995 and 1994), we amortize this asset using the interest rate credited to the underlying policies.
If renewal premiums collected, investment spread, investment gains or losses, mortality and morbidity costs or other factors differ from our expectations, we adjust our amortization of the cost of policies purchased. For example, the sale of a fixed maturity investment may result in a gain (or loss). If the sale proceeds are reinvested at a lower (or higher) earnings rate, there may also be a reduction (or increase) in our future investment spread. We must then increase (or decrease) amortization to reflect the change in the incidence of expected cash flows. For acquisitions made on or before November 19, 1992, we adjust amortization in the current and future years to reflect: (i) our revised estimate of future cash flows; and (ii) the revised interest rate at which the
The costs which vary with and are primarily related to producing new business are referred to as cost of policies produced. They consist primarily of commissions, bonus interest and certain costs of policy issuance and underwriting, net of fees charged to the policy in excess of ultimate fees charged. To the extent that they are recoverable from future profits, we defer these costs and amortize them with interest as follows:
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 either Conseco or the insured to make changes in the contract terms (such as single- premium whole life and universal life), we record premium deposits and benefit payments as increases or decreases in a liability account, rather than as revenue and expense. We record as revenue any amounts charged against the liability account for the cost of insurance, policy administration and surrender penalties. We record as expense any interest credited to the liability account and any benefit payments which exceed the contract liability account balance.
For contracts with mortality risk, but with premiums paid for only a limited period (such as single premium immediate annuities with benefits paid for the life of the annuitant), our accounting treatment is similar to that used for traditional contracts. An exception is that we defer the excess of the gross premium over the net premium and recognize it in relation to the present value of expected future benefit payments (when accounting for annuity contracts) or in relation to insurance in force (when accounting for life insurance contracts).
For participating policies, we determine annually the amount of dividends to be paid. We include as an insurance liability the portion of the earnings allocated to participating policyholders.
In the normal course of business, Conseco seeks to limit its exposure to loss on any single insured and to recover a portion of the benefits paid over such limits. We do this by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage and coinsurance contracts. We limit how much risk per policy we will retain. This retention limit does not exceed $.8 million on any of our policies.
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 is dependent upon the generation of future taxable income during the periods in which temporary differences become deductible. If future income does not occur as expected, deferred income taxes may need to be written off.
Short-term investments. We use quoted market prices. The carrying amount reported on our consolidated balance sheet for these instruments approximates their estimated fair value.
Redeemable preferred stock of a subsidiary of AGP (a component of minority interest). The estimated fair value of redeemable preferred stock which is publicly-traded is based on quoted market prices. The estimated fair value of the privately placed redeemable preferred stock is determined by discounting expected future cash flows using assumed incremental dividend rates for similar duration securities.
In early 1994, CCP announced a program to repurchase up to 2.0 million shares of its common stock in the open market or through negotiated transactions. In October 1994, CCP expanded the repurchase program to 4.0 million shares. During 1994, CCP acquired 3.5 million shares of its common stock under this program at a cost of $71.8 million. CCP's repurchases increased Conseco's ownership interest in CCP to 45 percent at December 31, 1994. In early 1995, CCP repurchased an additional 2.2 million shares under this program for $44.5 million increasing Conseco's ownership interest to 49 percent.
We funded the CCP Merger (including the repayment of our existing $250.0 million revolving credit facility ) with available cash and borrowings from a new $600.0 million credit facility (the "Credit Agreement"). The sources and uses of the financing to complete the CCP Merger are summarized below (dollars in millions):
The effect of the CCP Merger on the consolidated balance sheet as of the CCP Merger date was as follows (dollars in millions):
On November 9, 1992, Partnership I formed BLH to acquire Bankers Life from I.C.H. Corporation ("ICH"). The purchase price of $600.0 million was funded with the net proceeds of the following securities issued by BLH: (i) $175.0 million senior notes to a group of lending banks; (ii) $200.0 million senior subordinated notes; (iii) $45.0 million payment-in-kind junior subordinated notes (including $8.3 million provided by Conseco and $34.7 million provided by ICH); (iv) $158.3 million of payment-in-kind preferred stock (of which $108.3 million was provided by Conseco and $50.0 million was provided by ICH); and (v) $66.7 million of common stock of BLH, including $16.7 million directly provided by ICH and $50.0 million provided by Partnership I (including $25.5 million provided by Conseco and $9.6 million provided by ICH). None of the BLH notes are direct obligations of Conseco. As a result of this acquisition, Conseco owned approximately 44 percent of the common equity interest in BLH through its direct investments and investments in Partnership I. For accounting convenience, the acquisition was reported as of November 1, 1992, and Conseco made adjustments to reflect financing costs for the period between that date and the actual date of acquisition, November 9, 1992.
On September 30, 1993, Conseco acquired 13.3 million shares of BLH common stock from ICH for $287.6 million. The shares purchased represented 25 percent of BLH's outstanding shares. Conseco paid for these shares by surrendering for redemption $50.0 million stated value of ICH preferred stock, and by paying $237.6 million in cash. Conseco funded the cash payment using available cash and the net proceeds from a $200.0 million senior unsecured loan. As described below, the loan was repaid in February 1994, using the proceeds from the IPO of WNC. The transaction with ICH increased Conseco's ownership of BLH to 56 percent.
In April 1994, BLH announced a program to repurchase up to 2 million of its common shares in open-market or negotiated transactions. During 1994, BLH acquired 1.8 million shares of its common stock under this program at a cost of $35.7 million. BLH's repurchases increased Conseco's ownership interest in BLH to 58 percent.
On June 28, 1995, we completed the program to acquire additional shares of BLH common stock. A total of 12.8 million shares were purchased for $262.4 million in open market and negotiated transactions during 1995. The shares purchased represented 24 percent of the then outstanding shares of BLH common stock increasing our ownership of BLH to 82 percent (85 percent including shares of BLH owned by CCP) as of June 30, 1995. We funded the acquisition with available cash, proceeds from our revolving credit agreements and a $32.0 million loan from CCP. Income tax expense was reduced by $66.5 million in the second quarter of 1995 as a result of the release of deferred income taxes previously accrued on income related to BLH. Such deferred tax is no longer required since we are permitted to file a consolidated tax return with BLH and the income this tax relates to can be distributed to Conseco without the payment of tax. In addition, BLH repurchased 2.2 million shares of its common stock during 1995 at a cost of $42.1 million, increasing our ownership interest in BLH to 88 percent as of December 31, 1995 (90.5 percent as of March 5, 1996).
The closing price of BLH's shares on the New York Stock Exchange on December 31, 1995, was $20.25 per share, indicating a total fair value of Conseco's investment in BLH of $904.4 million. Conseco's cost of these shares was $575.5 million. Shares held by Conseco are not freely tradable, and sale of such shares may require a registration statement with the Securities and Exchange Commission.
In connection with the organization of WNC and the transfer of the stock of Western National to WNC by Conseco, WNC issued 60 million 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 15, 1994, WNC completed the IPO of 37.2 million shares of its common stock. Of these shares, 2.3 million were new shares sold by WNC and 34.9 million were sold by Conseco. In addition, Conseco sold .2 million shares to the president of WNC at the IPO price, less underwriting discounts and commissions. On February 22, 1994, WNC completed a public offering of $150.0 million aggregate principal amount of 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 offering expenses) together with some of the proceeds from WNC's IPO of common stock, were used to repay the Conseco Note.
The disposition of WNC as a result of the IPO was recorded in the consolidated statement of cash flows as follows (dollars in millions):
On September 29, 1994, Partnership II completed the acquisition of AGP (the "Acquisition"). Under an Agreement and Plan of Merger dated May 1, 1994, AGP merged with a subsidiary of Partnership II. AGP's former stockholders received $15.25 in cash per common equivalent share. They also received a contingent payment right to receive up to another $2.00 in cash per common equivalent share (the "Contingent Consideration"), based on the outcome of AGP's pending litigation against the U.S. Government concerning AGP's former savings bank subsidiary (the "AGP Litigation").
In accordance with the Partnership II agreement, Conseco earned fees of $2.5 million (net of taxes of $1.3 million) for services related to the financing of the Acquisition.
The acquisitions of CCP, BLH, Bankmark and AGP described above were recorded in the consolidated statement of cash flows as follows:
The following table sets forth the amortized cost and estimated fair value of actively managed fixed maturities as of December 31, 1995, based upon the pricing source used to determine estimated fair value:
The following table sets forth fixed maturity investments at December 31, 1995, classified by rating categories. The category assigned is the highest rating by a nationally recognized statistical rating organization or, as to $282.9 million fair value of fixed maturities not rated by such firms, the rating assigned by the National Association of Insurance Commissioners ("NAIC"). For purposes of the table, NAIC Class 1 is included in the "A" rating; Class 2, "BBB-"; Class 3, "BB-"; and Classes 4-6, "B+ and below."
The carrying value of fixed maturity investments and mortgage loans not accruing investment income totaled $1.5 million, $11.2 million and $19.6 million at December 31, 1995, 1994 and 1993, respectively.
Trading income (losses) from sales of trading account securities, net of investment expenses, were included in revenue as follows:
At December 31, 1995, net appreciation of equity securities (before income tax) was $2.0 million, consisting of $3.2 million of appreciation and $1.2 million of depreciation.
The following table sets forth the par value, amortized cost and estimated fair value of investments in mortgage-backed securities including CMOs at December 31, 1995, summarized by interest rates on the underlying collateral at December 31, 1995:
The amortized cost and estimated fair value of mortgage-backed securities including CMOs at December 31, 1995, summarized by type of security were as follows (dollars in millions):
At December 31, 1995, approximately 91 percent of the estimated fair value of Conseco's mortgage-backed securities was determined by nationally recognized pricing services and 9 percent was determined by broker-dealer market makers.
Life insurance companies are required to maintain certain investments on deposit with state regulatory authorities. Such assets had an aggregate carrying value of $70.4 million at December 31, 1995.
Investments (all of which were actively managed fixed maturities) in any single entity in excess of ten percent of shareholders' equity at December 31, 1995, other than asset-backed securities and investments issued or guaranteed by the United States government or a United States government agency, were as follows:
In 1994, the Company received fees totaling $16.3 million for services provided by Conseco to WNC. Conseco also received dividends on WNC common stock totaling $3.0 million in 1994.
The sale of fixed maturity investments during 1993 reduced the expected future yields on the investment of policyholder balances to the extent that projected future cash flows on certain products were insufficient to cover future benefits and expenses. Accordingly, Conseco established additional estimated insurance liabilities of $37.1 million by a charge to change in future policy benefits related to realized gains.
At December 31, 1995, Conseco's largest reinsurer accounted for less than .06 percent of total insurance liabilities and less than 9 percent of total reinsurance receivables.
In August 1995, the Company executed a $600 million Credit Agreement with a group of banks to finance the CCP Merger and to repay the $250.0 million principal amount outstanding under another credit agreement (which amount was borrowed in 1995 primarily to finance the purchase of BLH common stock by Conseco). The Credit Agreement has two tranches. One tranche permits maximum principal borrowings of $350.0 million ("Tranche A") and the other tranche permits maximum principal borrowings of $250.0 million ("Tranche B"). On the CCP Merger date, the Company borrowed $280.0 million under Tranche A and $250.0 million under Tranche B.
Mandatory prepayments are required as follows: (i) from 50 percent of excess cash flow as defined commencing for the year 1997; (ii) upon the sale or disposition of any significant assets other than in the ordinary course of business; and (iii) upon the sale or issuance of debt or equity securities of Conseco or any of its subsidiaries. The Credit Agreement also requires that any mandatory prepayments shall reduce the maximum borrowings permitted under the Credit Agreement by the amount of such prepayment. The Credit Agreement has as collateral, among other things, pledges of the capital stock of Conseco's subsidiaries.
In the fourth quarter of 1995, we repaid $50 million principal amount of borrowings under the Credit Agreement. On January 23, 1996, we repaid $245 million principal amount of borrowings under the Credit Agreement using the proceeds of the sale of convertible preferred stock (see note 16) and the maximum amount which may be borrowed under Tranche A was reduced to $250 million and future reductions were changed to: 1997 - $21.4 million; 1998 - $35.7 million; 1999 - $46.4 million; 2000 - $46.5 million; and 2001 - $100.0 million.
As the result of the CCP Merger, CCP's $200 million 10.5 percent senior notes due in 2004 became direct obligations of Conseco. The notes are unsecured and rank pari passu with all other unsecured and unsubordinated indebtedness of Conseco. The notes are not redeemable prior to maturity and are publicly traded on the New York Stock Exchange.
At December 31, 1995, notes payable of BLH, which are not direct obligations of Conseco, were as follows:
As part of its planned debt restructuring, BLH entered into a $110.0 million bridge loan facility in December 1995. Borrowings under the facility bear interest based on a Base Rate or LIBOR Rate, as defined. Such rate in effect at December 31, 1995 was 6.75 percent. BLH used proceeds from the bridge facility to repay and retire the senior term loan. Conseco recognized an extraordinary charge of $1.0 million (net of a $.5 million tax benefit) related to such repayments. In February 1996, the bridge facility was replaced by a new credit agreement (see note 16).
BLH's $200.0 million senior subordinated notes bear interest at 13 percent. The notes are due November 1, 2002, and may be redeemed, at BLH's option, on or after November 1, 1997, at a redemption price initially at 106.5 percent and declining thereafter. In December 1993, BLH repurchased $20.0 million of the notes in open market transactions for $24.0 million, resulting in an extraordinary charge of $3.1 million, net of tax benefit. Conseco's share of this charge ($1.0 million) was included as an extraordinary charge in the consolidated financial statements. In March 1996, BLH redeemed $148.0 million principal amount of these notes pursuant to a tender offer (see note 16).
BLH issued $36.7 million of paid-in-kind ("PIK") subordinated notes in connection with its acquisition by Partnership I. In 1993, BLH retired all of its PIK subordinated notes totaling $38.3 million and prepaid $55.0 million of its senior term loan. Repayment of this debt resulted in an extraordinary charge for BLH of $4.8 million, net of a $2.5 million tax benefit, in 1993. Conseco's share of this charge ($2.1 million) was included as an extraordinary charge in the consolidated financial statements.
In connection with the financing of the Acquisition, a subsidiary of AGP executed a $200 million senior term loan with a group of banks. In 1995, the AGP subsidiary made a $15.0 million scheduled payment and a $30.0 million unscheduled payment on the senior term loan. The $30.0 million unscheduled payment was made using the proceeds from the issuance of additional shares of AGP common stock. In addition, the AGP subsidiary executed a $225 million credit facility (the "Senior Credit Facility") and simultaneously borrowed $125.0 million. Such proceeds were used for the repayment in full of the remaining principal balance under the existing senior term loan. Conseco recognized an extraordinary charge of $1.1 million (net of $1.0 million income tax benefit) related to such repayments.
The Senior Credit Facility provides $225 million comprised of two tranches: the first providing maximum borrowings of $105 million ("Tranche One"), and the second providing maximum borrowings under a term loan of $20 million and a revolving credit facility of $100 million ('Tranche Two"). ALHC borrowed $105.0 million under the Tranche One facility and $20.0 million under the Tranche Two facility. No amounts were drawn under the revolving credit facility during 1995.
Tranche One and Tranche Two borrowings bear interest based on a Base Rate or an Offshore Rate, as defined, plus an applicable margin which varies based on the AGP subsidiary's long-term senior debt rating. Such rates selected at December 31, 1995 were 7.32 percent for Tranche One and 7.82 percent for Tranche Two.
The Senior Credit Facility provides for mandatory prepayments under certain conditions and is collateralized by, among other things: (i) pledges of the capital stock of AGP's subsidiaries and a surplus note issued by American Life and Casualty Insurance Company ("American Life," AGP's primary operating subsidiary) held by an AGP subsidiary; and (ii) the assignment of investment advisory agreements among AGP's principal subsidiaries and a subsidiary of Conseco. Borrowings under the credit agreement are unconditionally guaranteed by AGP and a non-insurance subsidiary of AGP.
In connection with the financing of the Acquisition, the AGP subsidiary issued $150 million of senior subordinated notes in a public offering. The senior subordinated notes bear interest at 11.25 percent and will mature in September 2004. Such notes are unsecured and will be subordinated in the right of payment to the prior payment in full of all senior indebtedness, including the AGP subsidiary's obligations under the Senior Credit Facility. The senior subordinated notes are redeemable at the option of the AGP subsidiary, in whole or in part, at any time on and after September 15, 1999, initially at 105.625 percent of their principal amount, plus accrued interest, declining to 100 percent of their principal amount, plus accrued interest, on and after September 15, 2001.
On the Acquisition date, AGP's notes payable included $69.0 million par value convertible subordinated debentures ("Debentures") due 2003. The Debentures bear interest at 6.25 percent. Prior to the Acquisition, the Debentures were convertible into shares of AGP's common stock at a conversion ratio of 65.625 shares of common stock for each $1,000 principal amount of Debentures. As a result of the Acquisition, holders of the Debentures are entitled to receive at their option the same consideration given to the holders of AGP common stock for each share of AGP common stock into which such securities were convertible prior to the Acquisition. Through December 31, 1995, Debentures with a principal amount of $54.0 million have been redeemed. The Debentures are redeemable, in whole or in part, at the option of AGP, at any time, on or after May 1, 1996, initially at 106 percent of the principal amount and declining to 100 percent of the principal amount on or after May 1, 1999. The requirement to hold funds in escrow for the conversion of the outstanding convertible debentures was eliminated upon execution of the Senior Credit Facility and repayment of the senior term loan.
The agreements described above also include provisions pursuant to which the employee may elect to receive, in the event of a termination of the agreement following a change in control of the Company (as defined), a severance allowance equal to 60 months' salary, bonus and other benefits. The employee also may elect to have the Company purchase all Conseco stock and all options to purchase Conseco stock, without deduction of the applicable exercise prices, held by such person at a price per share equal to the highest market price in the preceding six months.
BLH also provides certain health care and life insurance benefits for eligible retired employees. Benefits are provided under a contributory unfunded plan which includes cost-sharing features determined at the discretion of management. During 1994 and 1993, several modifications were made to postretirement benefit plans that: (i) established cost-sharing for certain future retirees; (ii) established maximum annual costs and benefits; and (iii) revised certain other benefits. Such changes made in 1993 resulted in a $45.0 million decrease in the accumulated postretirement benefit obligation ("APBO"). As a result, the APBO was reduced $27.6 million, goodwill was reduced by $17.9 million and deferred income tax liability was increased by $9.7 million. The remaining 1993 changes resulted in an unrecognized net reduction in prior service costs of $11.9 million and an unrecognized gain of $2.0 million. Such changes made in 1994 resulted in a $9.2 million amendment gain and $5.2 million curtailment gain. The amendment gain is amortized over the remaining service period of active plan participants. The curtailment gain is included in other income. Amounts related to the postretirement benefit plan consisted of the following:
From time to time, mandatory assessments are levied on the Company's insurance subsidiaries by life and health guaranty associations of most states in which these subsidiaries are licensed. These assessments are to cover losses to policyholders of insolvent or rehabilitated insurance companies. The associations levy assessments (up to prescribed limits) on all insurers in a particular state in order to pay claims on the basis of the proportionate share of premiums written by insurers in the lines of business in which the insolvent or rehabilitated insurer is engaged. These assessments may be deferred or forgiven in certain states if they would threaten an insurer's financial strength and, in some states, these assessments can be partially recovered through a reduction in future premium taxes. The balance sheet at December 31, 1995, includes accruals of $16.6 million, which approximate the Company's estimate of all known assessments that will be levied against the Company's insurance subsidiaries by various state guaranty associations based on premiums that have been written through December 31, 1995. Such estimate is subject to change as the associations determine more precisely the losses that have occurred and how such losses will be allocated to insurance companies. The Company's cost for such assessments incurred by its insurance company subsidiaries and equity investees was $3.2 million in 1995, $8.0 million in 1994 and $2.9 million in 1993.
Minority interest represents the interest of investors other than Conseco in BLH and Partnership II and its subsidiaries. Minority interest at December 31, 1995, included: (i) $73.4 million interest in the common stock of BLH; (ii) $99.0 million interest in the redeemable preferred stock of a subsidiary of AGP; (iii) $11.7 million interest in the AGP 1994 Series PIK Preferred Stock; and (iv) $219.2 million interest in the limited partnership and common stock of Partnership II and its subsidiaries.
Dividends declared on common stock for 1995, 1994 and 1993, were $.093, $.25 and $.15 per common share, respectively. A liability was accrued for dividends declared but unpaid at December 31, 1995, totaling $.4 million. Such dividends were paid in January 1996.
The Company was authorized under its 1983 employee stock option plan to grant options to purchase up to 24 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 continues to govern options granted thereunder, but expired in all other respects in December 1993. A new plan was adopted in 1994 which authorizes the granting of options to purchase up to 12 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 and certain other awards.
Statutory accounting practices require the asset valuation reserve ("AVR") and the interest maintenance reserve ("IMR") be reported as liabilities. The purpose of these reserves is to stabilize statutory surplus against fluctuations in the market value of investments. The IMR captures all realized investment gains and losses, net of income tax, on debt instruments resulting from changes in interest rates and provides for subsequent amortization of such amounts into statutory net income on a basis reflecting the remaining lives of the assets sold. The AVR captures all realized, net of income tax, and unrealized investment gains and losses related to changes in creditworthiness and is also adjusted each year based on a formula related to the quality and loss experience of the Company's investment portfolio.
Our quarterly results of operations are based on numerous estimates, principally related to policy reserves, the amortization of cost of policies purchased, the amortization of cost of policies produced and income taxes. We revise all such estimates each quarter and we ultimately adjust them to year-end amounts. When we determine revisions are necessary, we report them as part of operations of the current quarter.
Each share of PRIDES will pay dividends at the annual rate of 7 percent of the $61.125 liquidation preference per share (equivalent to an annual amount of $4.279 per share), payable quarterly. On February 1, 2000, unless either previously redeemed by Conseco or converted at the option of the holder, each share of PRIDES will mandatorily convert into two shares of Conseco common stock, subject to adjustment in certain events. Shares of PRIDES are not redeemable prior to February 1, 1999. During the period February 1, 1999 through February 1, 2000, the Company may redeem any or all of the outstanding shares of PRIDES. Upon such redemption, each holder will receive, in exchange for each share of PRIDES, the number of shares of Conseco common stock equal to (A) the sum of (i) $62.195, declining to $61.125 after February 1, 1999, and (ii) accrued and unpaid dividends divided by (B) the market price of Conseco common stock at such date, but in no event less than 1.71 shares of Conseco common stock. Pro forma fully diluted earnings per share for the year ended December 31, 1995, assuming: (i) the issuance of the PRIDES; and (ii) the use of such proceeds to reduce notes payable of Conseco, would have been $3.71, rather than reported fully diluted earnings per share of $4.22.
In March 1996, BLH completed a tender offer pursuant to which it repurchased $148 million principal balance of its 13 percent senior subordinated notes for $172 million. In the first quarter of 1996, Conseco will report an extraordinary charge of approximately $9 million (after applicable income tax) as a result of the repurchase. The repurchase was made using the proceeds from a revolving credit facility entered into in February 1996. Maximum principal amounts which can be borrowed under the agreement total $400 million (including a competitive bid facility in the aggregate principal amount of up to $100 million). Amounts borrowed under the new facility are due in 2001 and accrue interest at a rate of LIBOR plus an applicable margin of between 50 and 75 basis points, depending on BLH's ratio of consolidated net worth (such interest rate was 6.3 percent at March 6, 1996). Proceeds of $30 million were borrowed under the agreement to refinance the existing $110 million principal balance due under the bridge loan facility.
In conjunction with the tender offer, holders of a majority of the senior subordinated notes consented to amendments which eliminated substantially all of the restrictive covenants of the senior subordinated notes, including covenants which limited BLH's ability to pay dividends, incur additional indebtedness, repurchase its common stock, and make certain investments.
During the first quarter of 1996, BLH repurchased 1.3 million shares of its common stock at a cost of $27.5 million, increasing Conseco's ownership interest in BLH to 90.5 percent.
In February 1996, Conseco's Board of Directors authorized a two-for-one split of Conseco's common stock. The stock split will be paid April 1, 1996, to the holders of record at the close of business on March 20, 1996. The split will be effected by issuing one additional share of common stock for each share outstanding on the record date. All share data and per share amounts have been restated to reflect the effect of the stock split. The Board of Directors also authorized a quarterly cash dividend to be paid April 1, 1996, of 2 cents per post-split share; an increase of 1 cent over the prior rate.
In March 1996, Conseco announced that Partnership II would be dissolved. Accordingly, the partners (including Conseco and its subsidiaries) have no further commitment to make additional contributions of capital to Partnership II. In accordance with the partnership agreement, all of Partnership II's assets (primarily its investment in AGP) will be distributed to its partners subject to the conditions contained in the partnership agreement. In any event, Partnership II's assets must be distributed within two years of the effective date of dissolution. In the first quarter of 1996, Conseco will report a one-time loss of approximately $6 million (net of applicable income taxes) as a result of the dissolution.