The following is an analysis of the results of operations and financial condition of ICH and its consolidated subsidiaries. The consolidated financial statements and related notes and schedules included elsewhere in this Form 10-K should be read in conjunction with this analysis.
financial reinsurance by in excess of 40%, and began the process of terminating significant reinsurance arrangements with an affiliated company. ICH utilized a portion of the proceeds from its sale of BLHC and cash remaining from its sale of Bankers Life and Casualty Company ("Bankers") in 1992 to further reduce some of the more expensive components of its capital structure. In management's opinion, ICH made significant progress in improving its relationship with regulatory authorities, and continued progress in consolidating the operations of its Texas-based insurance subsidiaries and in further reducing operating expenses. The successes in 1993 were offset, in part, by lower than anticipated earnings from continuing operations and additional losses and writedowns in the Company's investment portfolio. Subsequent to year-end, in February 1994, ICH purchased and retired its Class B Common Stock which had given its previous holders the ability to elect 75% of the members of ICH's Board of Directors. Following is an analysis of these various events and factors, including management's assessment of their impact on the financial position and liquidity of ICH, as well as management's future expectations.
On September 30, 1993, ICH sold its investment in BLHC to Conseco, Inc. ("Conseco") and one of Conseco's subsidiaries for $287.6 million cash. ICH utilized $50 million of the proceeds to redeem $50 million stated value of its Series 1987-A Preferred Stock held by a Conseco subsidiary. The sale of the BLHC shares resulted in a pre-tax gain totaling approximately $197.6 million. For financial reporting purposes, the gains resulting from BLHC's offering and the sale of ICH's remaining interest in BLHC totaling approximately $297.0 million have been reflected as a single line item in the 1993 statement of earnings. ICH continued to reflect its equity in the operating results of BLHC through the date of sale.
Effective March 31, 1993, Bankers and an ICH subsidiary terminated a reinsurance agreement under which Bankers had previously ceded substantially all of its directly underwritten participating life insurance business to ICH's subsidiary. Assets, primarily fixed maturities and cash, with a fair value of approximately $163.6 million were transferred to Bankers and Bankers assumed policy liabilities on the reinsured business totaling approximately $186.2 million. ICH realized a gain on the termination of the reinsurance agreement totaling approximately $22.6 million which has been reflected in other income in the 1993 statement of earnings.
During 1993, ICH completed an exchange offer for a portion of its outstanding debt and significantly reduced some of the more expensive components of its debt and equity structure. Subsequent to year-end, a significant transaction occurred affecting control of the Company.
As discussed above, $50 million stated value of ICH's Series 1987-A Preferred Stock was redeemed in conjunction with the sale of the interest in BLHC. In addition, on December 2, 1993, ICH redeemed for $50 million cash all of its Series 1987-C Preferred Stock at its stated value. These redemptions reduced ICH's annual preferred dividend requirements by $13.5 million.
Utilizing a portion of the proceeds from the sale of BLHC and cash remaining from the sale of Bankers in 1992, ICH retired all of the remaining $124.9 million principal amount of its 16 1/2% Senior Subordinated Debentures due 1994 ("Debentures") during 1993. Approximately $37.5 million of the Debentures were redeemed through a scheduled sinking fund payment in January 1993, an additional $37.5 million were called in March 1993 at a price of 101.84% of the amount redeemed, approximately $4.1 million were exchanged for new debt of the Company in November 1993, and the remaining Debentures were redeemed at par effective for financial reporting purposes as of December 30, 1993. Interest savings on the retired Debentures, excluding the exchanged debt, will approximate $20.2 million annually.
In November 1993, ICH completed an exchange offer whereby $4.1 million of the Debentures and $87.1 million of its 11 1/4% Senior Subordinated Notes due 1996 ("Old Notes") were exchanged for $91.2 million of 11 1/4% Senior Subordinated Notes due 2003 ("New Notes"). See Note 3 of the Notes to Financial Statements for additional information regarding terms of the New Notes. Prior to the exchange offer, ICH and its subsidiaries held $46.8 million of the Old Notes which can, at ICH's option and upon repurchase of the $34.1 million of such Old Notes held by its subsidiaries, be utilized to partially satisfy its first $100 million sinking fund obligation relative to the Old Notes on December 1, 1994. The results of the exchange offer provided ICH additional flexibility in meeting such sinking fund obligation, since the amount of the Old Notes exchanged for New Notes can, also at ICH's option, be taken into consideration in determining what portion, if any, of the Old Notes it wishes to redeem through operation of the sinking fund. Assuming ICH utilizes its available Old Notes and defers sinking fund payments by an amount equivalent to the Old Notes which were exchanged, ICH would not have any sinking fund obligation in 1994 and its obligation in 1995 would total $66.1 million. Alternatively, and assuming its ability to generate the required liquidity, ICH may, at its option, determine to retire up to $100 million of the Old Notes at their par value through operation of the sinking fund in each of 1994 and 1995. ICH also has the option of calling any portion of the Old Notes at a 3% premium through November 30, 1994, and at a 2% premium during the following twelve month period. Thereafter, the Old Notes may be called at their par value.
On February 11, 1994, ICH purchased all of the 100,000 shares of its Class B Common Stock from Consolidated National Corporation ("CNC") for total cash consideration of $500,000. The Class B Common Stock had entitled CNC to elect 75% of ICH's Board of Directors and, by virtue of such voting power, CNC was considered to be ICH's controlling shareholder. The Class B Common Stock was immediately cancelled and retired following ICH's purchase. Concurrently, Stephens Inc. ("Stephens") and Torchmark Corporation ("Torchmark") purchased 4,457,000 shares and 4,667,000 shares, respectively, of ICH Common Stock from CNC. Stephens is an investment banking firm with its principal offices located in Little Rock, Arkansas, and Torchmark is a diversified insurance and financial services company headquartered in Birmingham, Alabama. One officer each from Stephens and Torchmark was elected to fill vacancies on the ICH Board of Directors. In addition, a management and services agreement between ICH and CNC was cancelled, and new ten-year services agreements were entered into with the two principal shareholders of CNC. As a result of these transactions and the transactions with Consolidated Fidelity Life Insurance Company as described below, CNC's ownership in ICH will be reduced to approximately one million shares, or 2%, of ICH's outstanding Common Stock. Management believes these transactions are significant for various reasons. Most importantly, management believes that ICH's access to both debt and equity capital markets has previously been limited because of the control position held by CNC through the Class B stock, and that the retirement of the Class B stock and considerable reduction in CNC's holdings of ICH Common Stock could ultimately enhance ICH's ability to refinance its currently outstanding debt.
Effective June 15, 1993, ICH entered into an agreement (the "Agreement") which initiated the process of terminating certain reinsurance arrangements involving Consolidated Fidelity Life Insurance Company ("CFLIC"), a subsidiary of CNC. The reinsurance arrangements involve certain annuity business with reserves totaling approximately $330.0 million as of December 31, 1993, which was transferred by a subsidiary of ICH, Southwestern Life Insurance Company ("Southwestern"), to an unaffiliated reinsurer in 1990. The unaffiliated reinsurer, in turn, transferred the business to another CNC subsidiary, Marquette National Life Insurance Company ("Marquette"). In 1991, Marquette transferred the annuity business to CFLIC.
The reinsurance arrangements have been under review by the Texas Department of Insurance ("Texas Department") and, in March 1993, ICH and Southwestern agreed with the Texas Department that they would, among other things, develop a plan to enhance and diversify the assets supporting the liabilities reinsured by CFLIC, including possibly recapturing the reinsured annuity business. The recapture is subject to negotiations with the unaffiliated reinsurer and approval by the Texas Department.
ICH's subordinated debt and preferred stock are rated by various nationally recognized statistical rating organizations, such as Moody's Investors Service, Inc. ("Moody's") and Standard and Poor's Corporation ("S&P"). These agencies, along with Duff & Phelps Credit Rating Company ("Duff & Phelps"), have also rated the claims paying ability of certain of ICH's insurance subsidiaries. In addition, A.M. Best, an agency specializing in the rating of insurance companies, has assigned ratings to each of ICH's insurance subsidiaries. Over the last two years, substantially all of the ratings issued by these agencies have reflected ratings downgrades. Virtually all ratings downgrades experienced by ICH and its subsidiaries were attributed to high or continuing leverage at the parent company level.
Moody's has rated ICH's subordinated debt at "B3" and its preferred stock at "Caa," both of which are below investment grade. S&P has rated ICH's debt at "B-" and its preferred stock at "CCC+," both of which are also below investment grade. Southwestern has been assigned claims paying ratings of "Ba2" by Moody's (questionable financial security), "BBB-" by S&P (adequate financial security, but capacity to meet policyholder obligations susceptible to adverse economic and underwriting conditions) and "A" by Duff & Phelps (high claims paying ability). A.M. Best has assigned "B++" ratings (very good) to all of ICH's significant insurance subsidiaries.
Substantially all of ICH's and its subsidiaries' present ratings were issued prior to ICH's sale of its investment in BLHC, the restructuring of its insurance holding company system, the completion of its debt exchange offer, the retirement of its remaining Debentures, and the redemptions of $100 million in preferred stocks and the Class B Common Stock. Management believes, as a result of these
previously discussed events, that the financial condition of ICH and its insurance subsidiaries has significantly improved and that, as a result, the possibility exists for upgrades in such financial and claims paying ratings. ICH has arranged for meetings with all applicable rating agencies in March 1994, but there can be no assurance that ICH's or its subsidiaries' ratings will be upgraded following such meetings.
ICH's insurance subsidiaries are subject to comprehensive regulation in the various states in which they are authorized to do business. The laws of these states establish supervisory agencies with broad administrative powers, among other things, to grant and revoke licenses for transacting business, to regulate trade practices, reserve requirements, the form and content of policies, and the type and amount of investments, and to review premium rates for fairness and adequacy. These supervisory agencies periodically examine the business and accounts of ICH's insurance subsidiaries and require them to file detailed annual financial statements and reports prepared in accordance with statutory accounting practices. In addition, as an insurance holding company, ICH is also subject to regulatory oversight in the states in which its insurance subsidiaries are domiciled.
During 1992, a special working group (the "Group") of the NAIC, which included the representatives of seven states, conducted an extensive review of the operations and financial condition of ICH and CNC and their respective insurance subsidiaries. Retaining the services of an independent accounting firm, other than ICH's public accountants, the Group placed particular emphasis on reviewing transactions between related parties and major transactions with certain other unaffiliated companies, differences between GAAP and statutory reporting practices, cash flow projections, off-balance sheet risks and non-traditional investments, and the insurance subsidiaries' risk-based capital requirements. In December 1992, based on their review of the findings, the Group advised ICH they had material concerns about asset quality and the cash flow position of ICH. The asset quality concerns were discussed in detail in ICH's 1992 Annual Report on Form 10-K and, as indicated in such discussion, substantially all of the Group's concerns had already been addressed by ICH. Management believes that the Group's concerns regarding ICH's cash flow position were effectively overcome in 1993 by the sale of ICH's investment in BLHC and the successful completion of ICH's debt exchange offer. As a result of these events and the resolution of remaining asset quality concerns, the Group's utilization of other independent accountants to review the affairs of ICH and its subsidiaries has been effectively eliminated and management believes that regulators from the states in which ICH's
insurance subsidiaries are domiciled were significantly more cooperative in granting the required approvals for ICH to accomplish the restructuring of its insurance holding company system. The Group has nevertheless indicated that it will likely continue to monitor, to the extent it deems appropriate, the activities and the operations of ICH and CNC and their respective insurance subsidiaries. However, based on the progress made to date in resolving concerns expressed by the Group, management does not anticipate that ICH will encounter any regulatory difficulty in proceeding with its corporate objective to grow its insurance operations through strategic acquisitions or other means.
Life insurance companies are generally required under statutory accounting rules to maintain an asset valuation reserve ("AVR") which consists of two components: a "default component" to provide for future credit-related losses on fixed income investments and an "equity component" to provide for losses on all types of equity investments, including real estate. Life insurance companies are also required to maintain an interest maintenance reserve ("IMR"), which is credited with the portion of realized capital gains and losses from the sale of fixed maturity investments attributable to changes in interest rates. The IMR is required to be amortized against statutory earnings on a basis reflecting the remaining period to maturity of the fixed income securities sold and there are no limitations as to the amounts which can be accumulated in the IMR. At December 31, 1993, the AVR of ICH's insurance subsidiaries totaled $45.0 million. The IMR of such subsidiaries was insignificant. Increases in the AVR and the IMR do not reduce either statutory or GAAP operating income, but result in a reduction in the statutory surplus of ICH's insurance subsidiaries.
Management believes that the levels of capital in ICH's insurance subsidiaries is sufficient to meet RBC requirements. Based on the NAIC's formulas, the RBC ratios for all but one of ICH's life insurance subsidiaries, based on financial statements as filed with regulatory authorities, exceeded
325% at December 31, 1993. One subsidiary's RBC ratio approximated 250% and management is in the process of evaluating alternatives to achieve at least a 300% RBC ratio for such subsidiary by year-end 1994.
In accordance with applicable insurance laws, ICH's insurance subsidiaries maintain substantial portfolios of investment assets that are held, in large part, to fund their future contractual obligations to policyholders. In structuring these portfolios, ICH has emphasized, and expects to continue to emphasize, investments in fixed maturities. In addition, ICH has maintained significant levels of short-term investments to meet its liquidity needs. Since 1991, fixed maturities and short-term investments have represented more than 75% of ICH's consolidated investments, while no other category of investment represented more than 10%. Additional information regarding the categories and amounts of ICH's investment assets is reflected in Note 5 of the Notes to Financial Statements.
were classified as "actively managed" and adjusted to their fair value through an adjustment to unrealized investment gains and losses in stockholders' equity. Those investments which ICH intended to sell, primarily certain mortgage-backed securities, were classified as "held for sale" and were adjusted to their fair value (if lower than cost) through a charge to earnings. Certain private placement securities which were not readily marketable and which ICH had both the ability and the positive intent to hold to maturity were classified as "held to maturity" and carried at amortized cost.
Investments in noninvestment-grade debt securities generally have greater risks than investment-grade securities. Risk of loss upon default by the borrower is greater with noninvestment-grade securities because these securities are generally unsecured and often are subordinated to other creditors of the issuers, and because the issuers have high levels of indebtedness and are more sensitive to adverse economic conditions, such as recessions or increasing interest rates, than are investment-grade issuers.
As reflected in its year-end 1992 financial statements, ICH held mortgage-backed residual interests and interest-only certificates ("IOs") with a carrying value and fair value of $422.7 million. Such year-end values were reflected net of reserves for anticipated losses in 1993 totaling $34.9 million, which had been provided based on the prepayment experience incurred and expected on the mortgage loans underlying such residual interests and IOs through the first three months of 1993. At June 30, 1993, the carrying value and fair value of such investments had declined to $358.3 million as a result of principal repayments. Based on an analysis of subsequent prepayment experience, management believed that the reserves provided at year-end 1992 had been adequate and, as a consequence, ICH did not incur any significant additional losses on its residual interests and IOs during the first six months of 1993.
Effective July 30, 1993, ICH and its subsidiaries, along with CFLIC, entered into a transaction designed to substantially reduce their exposure to the prepayment risks associated with their investments in residual interest and IO mortgage-backed securities, including liquidating a substantial portion of such investments. ICH's subsidiaries and CFLIC sold directly-owned residual interests and IOs with a carrying value of approximately $137.7 million and $26.5 million, respectively, to an unaffiliated third party, Fund America Investors Corporation II ("Fund America"). In addition, ICH and CFLIC sold to Fund America 75% of their rights with respect to residual interests in certain mortgage-backed securities which were acquired in conjunction with the sale of Bankers and are held in a special-purpose trust (the "Trust") to collateralize certain mortgage note obligations (see Note 3 of the Notes to Financial Statements included elsewhere in this Report). CFLIC had acquired its interest in the Trust as previously discussed under "Transactions With Consolidated Fidelity Life Insurance Company." Because ICH was deemed to be the Trust's sponsor and, with CFLIC, retained a majority ownership in the residual interest, the accounts of the Trust were included in ICH's consolidated balance sheet at year-end 1992 and at June 30, 1993. Following is a summary of the various accounts of the Trust as reflected in ICH's balance sheet at June 30, 1993, and ICH's net residual interest in the Trust (in millions):
The net carrying value of the 75% interests in the Trust sold by ICH and CFLIC to Fund America approximated $7.0 million and $33.7 million, respectively, at the date of sale.
Fund America sponsored the formation of a new trust (the "New Trust") into which it deposited the purchased securities. Interests in the New Trust aggregating $217 million, or 68.4% of its total outstanding securities, were sold to other unaffiliated parties. A portion of the sales proceeds were utilized to acquire additional securities which were deposited into the New Trust, including certain securities maturing in 2030 designed to assure the ultimate return of principal on the interests in the New Trust retained by ICH, its subsidiaries and CFLIC. The remaining proceeds, after underwriting expenses, were utilized to pay a portion of the purchase price for the securities purchased from ICH and its subsidiaries and CFLIC. The remainder of the purchase price was paid by issuing participation certificates representing residual interests in the pool of $101.0 million principal amount of securities placed in the New Trust. The participation certificates received in the transaction were valued for financial reporting purposes at their fair value, assuming an 11% annual return to maturity.
Real estate investments totaling $67.5 million and home office real estate totaling $13.3 million represented 2.5% and .5% of ICH's investment portfolio, respectively, at December 31, 1993. ICH has a stated policy of not directly making real estate investments, except for foreclosures on its existing mortgage loans. Mortgage loan foreclosures totaled $3.2 million, $5.7 million and $20.9 million for the three years 1993, 1992 and 1991, respectively. During 1993, ICH completed its obligation to purchase certain real estate from former subsidiaries for approximately $19 million. In addition, in conjunction with the sale of Bankers in 1992, ICH purchased all of the real estate held by Bankers, primarily its home office real estate, for $9 million. Bankers has entered into a long-term lease for a portion of the property sold to ICH and ICH is attempting to sell the remaining properties. The Bankers real estate has been independently appraised at a value in excess of ICH's carrying value.
public offering of shares of CCP Insurance common stock. ICH's subsidiaries received 1,764,439 shares of CCP Insurance in exchange for their investment in Predecessor CCP and ICH's subsidiaries acquired an additional 525,000 shares of CCP Insurance through its offering. In September 1993, CCP Insurance completed an underwritten primary and secondary offering of shares of its common stock. ICH's subsidiaries sold all of their 1,764,439 shares of CCP insurance common stock in the offering and realized investment gains totaling $27.8 million. In addition, during 1993, ICH's subsidiaries sold 455,375 of the 525,000 shares of CCP Insurance acquired in its initial public offering and realized additional investment gains totaling $5.3 million.
Included in the limited partnership investments at year-end 1992 and 1991 was ICH's investment in the HMC/Life Partners, L.P. with a carrying value of approximately $5.0 million. During March 1993, Life Partners Group, Inc. ("LPG"), the holding company formed to acquire certain subsidiaries from ICH in 1990, completed an initial public offering of 15.2 million shares of its common stock, or a 58.5% interest in LPG, at $17 per share. ICH had acquired a 31% interest in the HMC/Life Partners, L.P. at the time of the sale of such subsidiaries and the partnership, in turn, directly owned 5.1 million shares of the LPG common stock. Based on an assumed liquidation of the partnership and distribution of shares under provisions of the partnership agreement, the holder of ICH's partnership interest would be entitled to receive shares of LPG common stock with a fair value at December 31, 1993, of approximately $21.3 million, or $16.3 million more than the adjusted cost of ICH's investment in the partnership. As discussed earlier under "Transactions With Consolidated Fidelity Life Insurance Company," the investment in the HMC/Life Partners, L.P. was transferred to CFLIC in exchange for preferred stock as the first step in a series of transactions to terminate certain reinsurance arrangements involving CFLIC and Southwestern.
At December 31, 1993, ICH had pre-tax unrealized investment gains totaling $33.9 million, consisting of $21.4 million of unrealized gains related to available for sale fixed maturities, $7.2 million of unrealized gains attributable to equity securities, and $5.3 million of unrealized gains attributable to investments in limited partnerships. Such unrealized investment gains are reflected in stockholders' equity, net of a $10.4 million adjustment in deferred policy acquisition costs and other policy liabilities, a $5.2 million adjustment for the minority interest in certain unrealized investment losses and $8.2 million in deferred income tax effects. At December 31, 1992, pre-tax unrealized investment gains totaled $28.5 million, of which $24.1 million was attributable to ICH's equity investment in CCP Insurance, and were reflected in stockholders' equity, net of $9.7 million in deferred income tax effects. The unrealized gains related to available for sale fixed maturities are primarily as a result of declines in market interest rates between the two dates. Except as may be required to meet its liquidity requirements, ICH has no current plans over the near-term to liquidate a significant portion of such available for sale fixed maturities to realize such gains.
The following table sets forth, for the periods indicated, certain ratio data regarding the operations of ICH and its consolidated subsidiaries. Pro forma ratio data is presented as if the sale of Bankers and ICH's investment in BLHC had occurred as of the beginning of each period presented and is based on the same assumptions utilized in preparing the pro forma results of operations reflected in Note 2 of the Notes to Financial Statements, including elimination of the after-tax gains on the sales of Bankers in 1992 and the Company's investment in BLHC in 1993.
Realized investment losses (resulting primarily from writedowns) reduced operating earnings by $119.1 million and $26.4 million for 1992 and 1991, respectively. See "Insurance Operations" following for additional information regarding items of an infrequent and non-recurring nature which have affected ICH's operating results.
As previously discussed, the claims-paying ratings assigned to certain of ICH's subsidiaries by various nationally recognized statistical ratings organizations were lowered during 1992 and 1993. Except for withdrawals made by certain GIC holders, management believes ICH's subsidiaries have not experienced more than normal policy surrenders and withdrawals as a result of these ratings downgrades. For the year ended December 31, 1993, policyholder contract withdrawals, principally GICs, exceeded policyholder contract deposits by approximately $207.4 million. Withdrawals by GIC
holders totaled $329.0 million. Approximately $184.3 million of such withdrawals represented scheduled maturities of GICs which were not reinvested with an ICH subsidiary. In addition, as a result of the previously discussed restructuring of ICH's holding company system, the surplus of such subsidiary was significantly reduced and, as a consequence, some policyholders became entitled to an early withdrawal of their GICs. The subsidiary also voluntarily offered certain other GIC holders the right of early withdrawal. Unscheduled and early GIC withdrawals totaled $144.7 million. Because of its available liquidity and readily marketable securities, the subsidiary has not encountered, and management does not anticipate that the subsidiary will encounter, any difficulty in meeting its obligations relative to such withdrawals. The substantial withdrawal of GICs during 1993 is expected to have a positive effect on ICH's future results of operations because the rates of interest being credited to such GICs exceeded the rates ICH's subsidiary was earning on the related invested assets.
Certain of ICH's insurance subsidiaries have ceded blocks of insurance to unaffiliated reinsurers to provide funds for financing acquisitions and other purposes. These reinsurance transactions, or so-called "surplus relief reinsurance," represent financing arrangements and, in accordance with generally accepted accounting practices, are not reflected in the accompanying financial statements except for the risk fees paid to or received from reinsurers. Net statutory surplus provided by such treaties before tax effects totaled $51.5 million at December 31, 1993, or approximately 41% less than the $87.5 million of surplus relief at December 31, 1992. These arrangements are expected to terminate over the next several years through the recapture of the ceded blocks of business and such recaptures will result in a charge to the statutory earnings of the recapturing companies. During 1993, a treaty that had provided approximately $22.2 million of surplus relief for an ICH subsidiary as of year-end 1992 was recaptured in conjunction with ICH's restructuring of its insurance holding company system.
The primary sources of liquidity for ICH have historically included dividends and loans from its insurance subsidiaries and payments of principal and interest on surplus debentures issued by certain insurance subsidiaries. As previously discussed, in 1993, the sale of ICH's investment in BLHC provided a substantial amount of liquidity for the parent company.
The unpaid principal balance of surplus debentures issued to ICH by its insurance subsidiaries totaled $247.6 million at December 31, 1992 and $607.2 million at December 31, 1991. Of the 1992 amount, surplus debentures in the aggregate unpaid principal amount of $141.8 million was payable by Southwestern and $105.8 million was payable by Modern American. In 1993, Southwestern repaid the remaining balance on its surplus debenture utilizing proceeds from its 1992 sale of Bankers. In the restructuring of ICH's insurance holding company system in 1993, the surplus debenture from Modern American was retired and added to ICH's investment in its subsidiaries. At December 31, 1993, there were no remaining surplus debentures due ICH by its subsidiaries.
State insurance laws generally restrict the ability of insurance companies to make loans to affiliates or to pay cash dividends in excess of the greater of such companies' net gains from operations during the preceding year or 10% of their policyholder surplus determined in accordance with accounting practices prescribed by such states. These regulatory restrictions historically have not affected the ability of ICH to meet its liquidity requirements. However, certain states in which ICH's subsidiaries are domiciled, including New York and Kentucky, have adopted laws that have restricted the payment of cash dividends to the lesser of such companies' net gains from operations or 10% of their policyholder surplus. Other states may consider similar legislation in future periods or may consider legislation that would base the level of cash dividends which may be paid to the maintenance of specified risk-based capital levels. The adoption of such laws could significantly reduce the level of cash dividends that could be paid without regulatory approval.
ICH received cash dividends from Modern American totaling $149 million in 1991, but received no cash dividends from its insurance subsidiaries in either 1993 or 1992. In 1992, Modern American agreed with the Missouri Department of Insurance that it would not pay any dividends without obtaining the prior approval from the Missouri Department and, in 1993, Southwestern agreed with the Texas Department that it would not pay any dividend without giving it thirty days prior notice.
The restructuring of ICH's insurance holding company system in 1993 substantially reduced the size of Modern American and it no longer holds title to the common stock of any of ICH's insurance subsidiaries. Therefore, the restrictions on Modern American's ability to pay dividends are not expected to have a significant affect on future dividends to ICH from ICH's subsidiaries. In addition, as a result of the restructuring, all of ICH's insurance subsidiaries, other than Constitution Life Insurance Company and Bankers Life and Casualty Company of New York, are aligned horizontally beneath ICH and, as a consequence, are expected to be able to make direct payments of dividends to ICH in future periods.
ICH's principal needs for liquidity are debt service and, to a lesser extent, preferred dividend requirements. ICH's consolidated indebtedness totaled approximately $418.0 million at December 31, 1993, compared to $543.3 million at December 31, 1992, and $706.1 million at December 31, 1991. Substantially all indebtedness of ICH was incurred in the connection with acquisitions of subsidiaries in periods prior to 1987, including collateralized senior debt and unsecured subordinated debt, a portion of which was exchanged for new debt in 1993. See Note 3 of the Notes to Financial Statements for additional information regarding ICH's consolidated indebtedness, including annual maturities.
Primarily as a result of the sale for cash of ICH's interest in BLHC in 1993, ICH believes that it has adequate resources to meet its existing commitments, including preferred stock dividends, for all of 1994. The following table reflects ICH's cash sources and requirements on a projected basis for 1994 and on an actual basis for 1993.
Cash available at the end of 1993 includes approximately $60.3 million of readily marketable fixed maturity investments which were acquired for the purpose of obtaining higher yields than could be achieved through holdings in short-term investments. The 1994 projected cash requirements assume no sinking fund payments relative to ICH's Old Notes. See "Changes in Capital Structure" for a discussion of ICH's options relative to sinking fund requirements in 1994. In addition, the 1994 projections assume that the CFLIC transactions with ICH will be effected during the 1994 second quarter, including the redemption of CFLIC's preferred stock by the return to ICH of its $30 million senior secured loan and ICH's Series 1986-A and Series 1987-B preferred stocks. See "Transactions With Consolidated Fidelity Life Insurance Company."
As a result of the acquisition and retirement of ICH's Class B Common Stock in early 1994, management now believes that ICH has improved its ability to refinance its presently outstanding debt at substantially reduced interest rates. Such a refinancing is, of course, dependent on numerous factors, such as an improvement in the ratings assigned by nationally recognized statistical rating organizations, market interest rates, a successful underwriting, and other factors. ICH intends to monitor these factors closely over the next several months to determine whether such a refinancing is possible. There can be no assurance that ICH will, in fact, attempt to restructure its presently outstanding debt; however, in the event that it does, the 1994 projected cash sources and requirements as reflected above could materially change.
ICH's actual cash sources in 1993 were approximately $295.6 million more than were previously projected for 1993, substantially all of which were attributable to ICH's sale of its investment in BLHC for $287.6 million. Actual cash requirements in 1993 exceeded projected requirements by approximately $174.3 million. Significant items that were not included in the 1993 projections and that accounted for a substantial portion of the increase in cash requirements include ICH's redemption of $100 million of its outstanding preferred stock, an additional $45.9 million redemption of its Debentures, and intercompany income tax allocation payments to ICH's insurance subsidiaries totaling $15.0 million. The increase in tax allocation payments was a result of the BLHC transaction which resulted in a taxable gain and reimbursement to ICH's subsidiaries for utilization by ICH of their tax loss carryforwards. Primarily as a result of the increase in cash sources, which was not completely offset by an increase in cash requirements, available cash and marketable securities at the end of 1993 was approximately $121.3 million more than originally projected.
The decline in pre-tax operating earnings from $59.6 million in 1991 to $47.7 million in 1992 was attributable, in part, to including Bankers' results for only the first ten months of 1992 compared to the full year in 1991. ICH was unable to effectively redeploy the proceeds from the sale of Bankers during the last two months of 1992 to replace the reduction in operating earnings resulting from such sale. In addition, a reduction in yields on invested assets between 1991 and 1992 contributed to a narrowing of the spreads between earnings on invested assets and interest credited to policyholders' accounts or required to meet policyholder obligations and further contributed to the reduction in operating earnings. The decline in the pre-tax operating earnings of $47.7 million to a pre-tax operating loss of $6.6 million in 1993 reflects, in part, the exclusion of Bankers' results for all of 1993. ICH did reflect its equity in the operating results of BLHC for the first nine months of 1993 totaling $29.1 million. However, ICH was still unable in 1993 to redeploy proceeds from the sale to fully replace the earnings of Bankers. Following the sale of its interest in BLHC in September 1993, ICH has methodically proceeded to utilize its available liquidity to further reduce the costs of its capital structure, but during the interim period has had to maintain larger than desirable amounts invested in lower-yielding short-term investments. In addition, interest spreads relative to ICH's insurance operations further narrowed in 1993 resulting in reduced operating earnings, and ICH incurred sizeable losses in its group health operations.
INDIVIDUAL LIFE. Revenues of the individual life insurance segment accounted for approximately 37.8% of consolidated revenues excluding corporate revenues and realized investment gains and losses in 1993, as compared to 20% in 1992 and 21% in 1991. Such increase in 1993 is directly attributable to the sale of Bankers in 1992. Bankers revenues had been derived predominantly from sales of individual health insurance products and, as a result of the sale, the relative proportion of ICH's revenues attributable to the individual life insurance segment increased significantly. Most individual life insurance sales over the last three years were of universal and interest-sensitive life insurance products, although several new traditional whole life products were introduced into the marketplace during 1993. Exclusive of sales by Bankers, individual life sales have declined from $21.0 million in 1991 to $14.0 million in 1992 to $13.1 million in 1993. Management believes these declines are attributable to the downgrade in the claims-paying rating of ICH's most significant life insurance subsidiary, Southwestern, and to slow market acceptance of several new products introduced during 1991. However, as a result of changes in marketing strategies to target sales in the senior citizen marketplace and the new products introduced in 1993, sales of individual life insurance products increased significantly in the latter half of 1993, exceeding sales during the comparable period in 1992.
Management expects to continue to emphasize growth in its individual life insurance segment and, barring a further decline in investment yields, believes the changes made in its marketing strategies and the introduction of new products in 1993 will result in increased sales of individual life insurance products and an improvement in the operating results of this segment in 1994.
INDIVIDUAL HEALTH. Sales and revenues in the individual health segment declined significantly in 1993 as a result of the sale of Bankers. Individual health premiums earned by Bankers represented approximately 74.8% of total individual health premiums in 1992 and 75.7% in 1991. The individual health premiums earned in 1993 and the remaining premiums earned in each of 1992 and 1991 were primarily attributable to Union Bankers Insurance Company ("Union Bankers") and Bankers Multiple Line Insurance Company ("Bankers Multiple"), former Bankers subsidiaries which were retained by ICH when Bankers was sold. Union Bankers has emphasized the sale of Medicare supplement products through brokerage agencies. Bankers Multiple specializes in the sale of comprehensive health products through a large general agency. Another ICH subsidiary, Integrity National Life Insurance Company, sells individual health insurance products, primarily Medicare supplement business, in the home service market.
Exclusive of Bankers in 1992, new sales of individual health products increased from $60.3 million in 1992 to $63.6 million in 1993 and premiums earned increased from $216.2 million in 1992 to $220.3 million in 1993. The ratio of policy benefits to premiums earned (exclusive of Bankers) declined from 68.4% in 1992 to 62.3% in 1993, resulting in an approximately $15.0 million improvement in the gross operating margins of ICH's insurance subsidiaries.
Management expects to continue to emphasize growth in the individual health segment, primarily in the senior citizens market through the sales of Medicare supplement and long-term care, or nursing home, products.
While sales of new group business declined during 1993 as compared to 1992, earned premiums of this segment (excluding Bankers) increased from $103.8 million in 1992 to $136.5 million in 1993 as a result of sales in 1992. The related ratio of policy benefits to earned premiums of the group segment increased dramatically from 62.9% in 1992 to 74.8% in 1993 and contributed to a pre-tax operating loss of $12.9 million in 1993, as compared to pre-tax operating earnings of $5.1 million in 1992. During the last half of 1993, Philadelphia American encountered an unexpected increase in claim costs driven by an upswing in the utilization and cost of physician services and several large individual claims covered under group plans. Additionally, in the course of evaluating Philadelphia American's results for the fourth quarter of 1993, management determined that errors had been made in the second and third quarters of 1993 in accounting for certain reinsurance activities and had resulted in an approximate $7.4 million overstatement of Philadelphia American's pre-tax operating earnings for such periods. These errors contributed to an inadequate assessment of the need for premium rate increases on certain of Philadelphia American's group health cases, which, in turn, contributed to the adverse claims experience on these cases which continued into the 1993 fourth quarter. Management has taken several actions which are expected to rapidly reduce losses and return this segment to profitability in 1994. These actions include 1) terminating several large, but unprofitable group cases at or near the end of 1993, 2) identifying several additional group cases which will not be renewed during the first six months of 1994, and 3) implementing substantial rate increases to restore profitability to its remaining group business. In addition, internal controls at Philadelphia American have been strengthened and personnel changes have been made to prevent a future reoccurrence of accounting errors in reported results.
Preferred dividend requirements totaled $28.8 million in 1993 and $30.8 million in each of 1992 and 1991. As the result of the redemption of $100 million stated value of ICH's preferred stocks in 1993, preferred dividend requirements are expected to be reduced to approximately $17.3 million in 1994. Assuming the completion of the transactions with CFLIC by March 31, 1994, as previously discussed under "Transactions With Consolidated Fidelity Life Insurance Company," ICH's preferred dividend requirements in 1994 would be reduced by an additional $2.5 million.
In 1993, income tax expense represented approximately 31% of consolidated operating earnings before income taxes, or 4% less than the expected corporate income tax rate. During 1993, the corporate income tax rate was increased from 34% to 35%, retroactive to January 1, 1993. The effect of such rate increase on ICH's deferred income tax asset as of the beginning of 1993, a benefit totaling $3.5 million, has been included in the 1993 income tax provision. Other significant items affecting the
1993 effective income tax rate included a reduction in the valuation allowance for ICH's deferred income tax asset based on the utilization of available loss carryforwards to offset income taxes otherwise payable as a result of the BLHC sale and other investment gains and the utilization of capital loss carryforwards which had previously not been reflected for financial reporting purposes. In 1992, ICH reported an income tax credit totaling $69.2 million on a consolidated operating loss before income taxes of $18.4 million. This unusual relationship was primarily attributable to the significant tax basis gain on the sale of Bankers and a reduction in the Company's valuation allowance for its deferred tax asset as a result of utilizing available capital loss carryforwards to reduce taxes otherwise payable as a result of such gain. In 1991, income tax expense represented 24% of consolidated operating earnings before income taxes. The effective rate was approximately 10% lower than the expected rate, substantially all of which was attributable to a reduction in the deferred tax asset valuation allowance based on tax planning strategies for the utilization of a portion of ICH's capital loss carryforwards. See Note 13 of the Notes to Financial Statements for an analysis of the various components affecting ICH's income tax provisions.
Management has periodically assessed the ability of ICH's insurance subsidiaries to produce taxable income in future periods sufficient to fully utilize their operating book/tax temporary differences and tax loss carryforwards. These assessments have included actuarial projections under alternative scenarios of future profits on the existing insurance in force of ICH's insurance subsidiaries, including provisions for adverse deviation, adjusted to reflect ICH's anticipated debt service costs. While management believes that there will be sufficient future taxable income to realize substantially
all of the benefit of ICH's remaining temporary differences, valuation allowances totaling $16.3 million and $24.2 million were provided against ICH's deferred tax assets at December 31, 1993 and 1992, respectively, to reflect the uncertainties of realizing all of the benefits of available tax loss carryforwards.
Alternative minimum tax ("AMT") credit carryforwards result from the acceleration of income taxes under certain circumstances and can be carried forward for an indefinite period. The $13.9 million and $11.7 million component of ICH's deferred income tax assets at December 31, 1993 and 1992, respectively, represents taxes incurred under AMT provisions which are expected to be recovered through reduced income tax payments over the next several years.
Effective January 1, 1993, ICH adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other than Pensions," and incurred a charge for the cumulative effect of the adoption of the accounting change as of that date totaling $1.8 million, after tax effects. In addition, effective December 31, 1993, ICH adopted SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" and incurred a charge for the cumulative effect of the adoption of the accounting change as of that date totaling $4.9 million, after tax effects. Effective January 1, 1991, ICH adopted SFAS No. 109, "Accounting for Income Taxes," and the benefit of the cumulative effect of the adoption of the accounting change as of that date totaled $8.8 million.
President Clinton has targeted health care reform as a top domestic priority of his administration, and has proposed to Congress legislation, the American Health Security Act, that would significantly change the manner in which the entire health care industry operates. The reform legislation proposed by the Clinton administration would ultimately guarantee universal access to health care coverage and create purchasing alliances for government established health care plans. Alternative legislative proposals that have been developed to reform the health care system have goals ranging from universal access to health care coverage through managed competition to health care cost containment through, among other things, health insurance reform. ICH currently cannot predict what impact health care reform proposals will have on the health insurance industry, whether any health insurance measures will be adopted in the foreseeable future or, if adopted, whether such reform proposals or measures will have a material effect on its operations.
AND FINANCIAL STATEMENT SCHEDULES OF I.C.H. CORPORATION AND SUBSIDIARIES (ITEMS 8, 14(A), AND 14(C))
We have audited the consolidated financial statements and financial statement schedules of I.C.H. Corporation and Subsidiaries as listed in the index on page 47 of this Form 10-K. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
As more fully described in Notes 14 and 5 to these consolidated financial statements, effective January 1, 1993 and December 31, 1993, the Company adopted Statements of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" and No. 115, "Accounting for Certain Investments in Debt and Equity Securities," respectively.
I.C.H. CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (IN THOUSANDS)
The Company's insurance subsidiaries maintain their accounts in conformity with accounting practices prescribed or permitted by state insurance regulatory authorities. In the accompanying financial statements such accounts have been adjusted to conform with generally accepted accounting principles (GAAP).
Fixed maturity investments include bonds and preferred stocks with mandatory redemption features. The Company classifies all fixed maturity investments into two categories as follows:
- Available for sale securities, representing securities that are readily marketable and 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 Company's management of its income tax position, its general liquidity needs, increases in loan demand, the need to increase regulatory capital, changes in foreign currency risk, or similar factors. Available for sale securities are carried at fair value.
Investments in limited partnerships and 20% to 50% interests in the common stocks of other entities, whose affairs are not controlled by the Company (equity investees), are reflected on the
(D) EXCESS COST OF INVESTMENT IN SUBSIDIARIES OVER NET ASSETS ACQUIRED
The excess cost of investments in subsidiaries over net assets acquired is being amortized on the straight-line basis over a 40-year period. The Company periodically assesses the recoverability of its excess cost through an actuarial projection of undiscounted future earnings of the Company's insurance subsidiaries (excluding excess cost amortization) over the remaining life of such excess cost. Such projections are prepared under various interest rate scenarios, with anticipated levels of new business production for only a five-year period.
(E) DEFERRED POLICY ACQUISITION COSTS AND PRESENT VALUE OF FUTURE PROFITS OF ACQUIRED BUSINESS
Recoverability of deferred policy acquisition costs and the present value of future profits of acquired business is evaluated annually by comparing the current estimate of discounted expected future cash flows 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 cash flows from the business, will not be sufficient to recover the unamortized asset balance, the difference is charged to expense. Amortization is adjusted in future years to reflect the revised estimate of future profits.
Separate accounts represent segregated assets whose values directly determine the amounts of the liabilities for variable products and separate account pension deposits. The insurance company does not have an investment risk with these assets and liabilities. The risk lies solely with the holder of the contract.
Policy and contract claims include provisions for reported claims in process of settlement, valued in accordance with the terms of the related policies and contracts, as well as provisions for claims incurred and unreported based on prior experience of the Company.
MORTGAGE AND COLLATERAL LOANS: The fair values for mortgage and collateral loans are estimated using discounted cash flow analyses, based on 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.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INVESTMENTS IN LIMITED PARTNERSHIPS: Fair values for the Company's investments in limited partnerships are based on the estimated fair values of the partnership assets and liabilities, assuming a liquidation of the partnership and distribution of proceeds to the partners.
INVESTMENT CONTRACTS: Fair values for the Company's liabilities under investment-type insurance contracts are estimated 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.
Primary earnings per share are computed by dividing earnings, less preferred dividend requirements, by the weighted average number of common shares outstanding. In computing fully diluted earnings per share, the weighted average number of common shares outstanding is adjusted to reflect common stock equivalents resulting from stock options and the assumed conversion of the Company's Series 1984-A and 1986-A Preferred Stock into common shares, and preferred dividend requirements are adjusted to eliminate dividends on the shares assumed to have been converted. The computation of fully diluted earnings per share excludes the assumed conversion of such preferred shares for each period in which the assumed conversion would be antidilutive.
Effective March 31, 1993, BLHC completed an initial public offering (Offering) of 19.55 million shares of its common stock, or an approximate 35.8% interest in BLHC at $22 per share. Proceeds of the Offering, after underwriting expenses, approximated $405 million. Effective the same day, CCP announced a plan of dissolution and BLHC shares held by CCP were subsequently distributed to the respective partners in accordance with that plan. The Company received 2,917,318 shares of BLHC common stock as a result of such distribution, increasing its direct ownership in BLHC common stock to 13,316,168 shares, or approximately 24.4% of BLHC's outstanding common shares following the Offering. The Company reflected a gain on the BLHC Offering totaling $99,376,000, primarily representing the Company's 24.4% equity in the net proceeds of such Offering. BLHC utilized a portion of the Offering proceeds to redeem certain of its outstanding securities, including the $50 million stated value of BLHC preferred stock and the $34.7 million principal amount of BLHC Junior Subordinated Notes held by the Company. Because a portion of the purchase price paid for such investments had been allocated to the Company's common equity investments in BLHC, such redemptions resulted in additional gains totaling $8,252,000, which have been included as a component of realized investment gains.
On September 30, 1993, the Company sold its remaining investment in BLHC to Conseco and one of Conseco's subsidiaries for $287,639,000 cash. The Company utilized $50 million of the proceeds to redeem $50 million stated value of the Series 1987-A Preferred Stock of the Company from a Conseco subsidiary. The sale of the BLHC shares resulted in a gain totaling $197,665,000. The gains resulting from BLHC's Offering and the sale of the Company's remaining interest in BLHC totaling $297,041,000 have been reflected as a single line item in the consolidated statement of earnings for the year ended December 31, 1993. The Company continued to reflect its equity in the earnings of BLHC through the date of sale.
In addition to the sales of Bankers and the Company's interest in BLHC and the subsequent application of the proceeds from such sales, other transactions occurred during 1993 or are expected to occur in 1994 that have had or are expected to have a significant effect on the Company's results of operations, including 1) the sale in 1993 of a 75% interest in a special purpose trust holding certain mortgage-backed securities and the deconsolidation of the accounts of such trust (see Note 3), 2) the sale in 1993 of the Company's investment in the common stock of CCP Insurance, Inc. (CCP Insurance) (see Note 6) and the reinvestment of the proceeds from such sale, and 3) the assumed completion in 1994 of the recapture of certain annuity business ceded to an affiliate under a reinsurance agreement and the related retirement of certain of the Company's debt and preferred stock upon completion of the recapture (see Note 4). Following is unaudited pro forma results of the Company with reported results adjusted to reflect the effects on operations of the above described transactions. The approximate after-tax gains realized on the sale of Bankers totaling $73.1 million in 1992 and the Company's interest in BLHC totaling $193.1 million in 1993 are included in the Company's historical results, but have been eliminated from the pro forma results. The $600 million of proceeds from the sale of Bankers in 1992 was utilized 1) to retire $75 million of the Company's 16 1/2% Senior Subordinated Debentures due 1994 (Debentures), 2) to retire $85 million of the Company's senior secured debt, 3) to purchase $84.7 million of BLHC debt and preferred stock, 4) to purchase $26.3 million of BLHC and CCP equity investments, and 5) to purchase assets from Bankers for $280.5 million. The remaining $48.5 million of proceeds from the sale of Bankers, along with the remaining proceeds from the sales of the Company's investments in BLHC and CCP Insurance, is assumed to have been invested at a new money rate of 6 1/4%. The Company utilized $100 million of the proceeds from the sale
2. ACQUISITIONS AND DISPOSITIONS (CONTINUED) of BLHC to redeem the Company's Series 1986-A and 1986-C preferred stocks and approximately $45.9 million of its Debentures, and the remaining proceeds totaled approximately $141.7 million. The pro forma results further assume that all of the transactions occurred as of the first day of each period persented. Such pro forma results may not represent what the Company's results would have been had the assumed transactions occurred at the beginning of such periods and do not purport to project the Company's results for any future period.
3. NOTES PAYABLE AND COLLATERALIZED MORTGAGE NOTE OBLIGATION The carrying amount of notes payable at December 31, 1993 and 1992, and the fair value of notes payable at December 31, 1993, are summarized as follows:
Immediately prior to its sale, Bankers held certain mortgage-backed securities and other related securities used as hedges with a carrying value of $252,049,000. In conjunction with the sale of Bankers, these securities were placed in a special purpose trust (the Trust), organized by a new special purpose subsidiary, I.C.H. Funding Corporation (ICH Funding). Bankers was issued a $159,162,000 bond collateralized by the securities placed in the Trust. The Company retained a residual interest in the Trust totaling $91,797,000. All of the receipts on the securities placed in the Trust were to be applied first to repay the principal and interest on the bond retained by Bankers of 8.5%. The bond to Bankers with a carrying value of $157,231,000 at December 31, 1992, was reflected in the accompanying balance sheet as a collateralized mortgage note obligation. The Company was granted an option to purchase Bankers' interest in the bond at its remaining carrying value within ninety days following the sale of Bankers. On February 5, 1993, the Trust completed the sale to unaffiliated parties of interests in the trust totaling $171,000,000 and utilized $142,092,000 of the proceeds to retire the remaining obligation due Bankers. On July 30, 1993, the Company and its affiliate, CFLIC, sold 75% of their rights with respect to the Trust to an unaffiliated party and the accounts of the Trust, including the collateralized mortgage note obligations, were eliminated from the consolidated financial statements of the Company for periods subsequent to that date.
Experience refunds received from CFLIC under the Southwestern reinsurance arrangement totaled $4,851,000, $2,068,000 and $10,788,000 for the years ended December 31, 1993, 1992 and 1991, respectively. The Bankers business reinsured by CFLIC was not profitable in 1992 and 1991 due primarily to a loss incurred relative to certain reinsurance recoverables and, as a consequence, Bankers was not entitled to an experience refund in either 1992 or 1991.
Bankers was a party to a service agreement with Marquette and CFLIC whereby it provided investment management, administrative, data processing, and general supervisory and management services related to business reinsured with CFLIC, in exchange for annual fees equal to .45% of reserves on the reinsured policies. Fees earned from providing such services totaled $1,593,000 for the ten months ended October 31, 1992 and $2,043,000 for the year ended December 31, 1991. Such fees were taken into consideration in the determination of profitability of the reinsured business. In addition, a subsidiary entered into a service agreement effective January 1992, whereby the subsidiary provided administrative services for Marquette. Fees earned from providing such services totaled $449,000 and $2,016,000 for the years ended December 31, 1993 and 1992, respectively.
Prior to 1992, all of the Company's fixed maturities were carried at amortized cost because management had stated its intent and believed ICH had the ability to hold all such investments to
The amortized cost of investments in fixed maturities, the cost of equity securities and the estimated values of such investments at December 31, 1993 and 1992 by categories of securities are as follows:
Excluding scheduled maturities and sales related to reinsurance transactions, proceeds from sales of investments in debt securities during 1993, 1992 and 1991 and the related gross gains and gross losses realized on such sales were as follows:
6. INVESTMENTS IN EQUITY INVESTEES AND LIMITED PARTNERSHIPS At December 31, 1992, the Company owned a 39.9% indirect equity interest in Bankers, consisting of a 29.7% equity interest in BLHC and 10.2% equity interest through its limited partnership investment in CCP. In addition, the Company owned $34.7 million principal amount of BLHC 11% Junior Subordinated Debentures due 2003 and $50.0 million of a BLHC 11% preferred stock. The 1992 sale of Bankers was accounted for as a "step transaction" in accordance with GAAP. Accordingly, gain recognition was limited to the 60.1% interest deemed to have been sold. The excess of the sales price over the Company's basis in Bankers on the 39.9% portion of the investment deemed to have been retained by the Company (excess of sales price over basis in retained interest) was reflected as a reduction in the carrying value of the Company's investments in BLHC and CCP. Effective March 31, 1993, the Company's ownership interest in BLHC was reduced to 24.4% as a result of BLHC's offering and on September 30, 1993, the Company sold its investment in BLHC (see Note 2).
6. INVESTMENTS IN EQUITY INVESTEES AND LIMITED PARTNERSHIPS (CONTINUED) At December 31, 1992, CCP had no assets or liabilities, other than its investment in BLHC. Financial information of BLHC and the Company's carrying value and equity in earnings of BLHC as of and for the two months ended December 31, 1992, and the Company's equity in the earnings of BLHC for the nine months ended September 30, 1993, is as follows (in thousands):
Included in the limited partnership investments at December 31, 1991, was the Company's 21.4% interest in CCP (Predecessor CCP). On July 21, 1992, Predecessor CCP formed a new insurance holding company, CCP Insurance, Inc. and completed an initial public offering (IPO) of common stock in CCP Insurance. Predecessor CCP was liquidated and the Company received 1,764,439 shares of CCP Insurance common stock in exchange for its 21.4% interest in Predecessor CCP. At the date of exchange, the Company's carrying value in Predecessor CCP totaled $19,509,000, which became the Company's basis in the shares of CCP Insurance common stock. The Company subsequently reflected its investment in CCP Insurance, along with 525,000 shares of CCP Insurance purchased in the IPO, as marketable equity securities. Effective September 29, 1993, CCP Insurance completed an underwritten primary and secondary offering of shares of its common stock. The Company sold all of the 1,764,439 shares of the common stock of CCP Insurance in conjunction with the offering for $47,272,000 and realized investment gains totaling $27,758,000. In addition, during 1993, the Company sold 455,375 shares of CCP Insurance common stock in open market transactions and realized gains totaling $5,310,000. At December 31, 1993, the Company continues to hold 69,625 shares of CCP Insurance common stock with a fair value of approximately $1.9 million.
7. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK Certain of the Company's subsidiaries have entered into interest rate swap arrangements to convert the interest rate characteristics of certain investments to match those of related insurance liabilities. The agreements expire from 1994 to 1997 and exchange fixed-rate payments ranging from 5.45% to 8.44% for three month LIBOR-based interest payments on notional amounts of $43.9 million. The interest rate differential to be received or paid is recognized over the lives of the agreements as an adjustment to interest expense. The subsidiaries are exposed to credit risk in the event of default by counterparties to the extent of any amounts that have been recorded in the balance sheet and market risk as a result of potential future increases in LIBOR. The fair value of interest rate swap arrangements at December 31, 1993, approximated $2.5 million.
The estimated fair value of guaranteed investment contracts approximated their carrying value at December 31, 1993 because it is expected that substantially all of such contracts will be terminated during 1994. The estimated fair value of the liabilities for other investment contracts is approximately equal to their carrying value at December 31, 1993, because interest rates credited to account balances approximate current rates paid on similar investments and are generally not guaranteed beyond one year. Fair values for the Company's insurance liabilities other than those for investment-type insurance contracts are not required to be disclosed. However, the fair values of liabilities under 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.
9. STOCKHOLDERS' EQUITY AND RESTRICTIONS At December 31, 1993, substantially all of consolidated stockholders' equity represented net assets of the Company's insurance subsidiaries that cannot be transferred to the Company in the form of dividends, loans or advances. Generally, the net assets of the Company's insurance subsidiaries available for transfer to the Company are limited to the greater of the subsidiaries' net gain from operations during the preceding year or 10% of the subsidiaries' net surplus as of the end of the preceding year as determined in accordance with accounting practices prescribed or permitted by insurance regulatory authorities. Payment of dividends in excess of such amounts would generally require approval by the regulatory authorities. At December 31, 1993, approximately $34.0 million was available under existing laws for the payment of dividends by insurance subsidiaries to the
10. CAPITAL STOCK At December 31, 1993, the Company had three classes of capital stock, including Series Preferred Stock (no par value), Common Stock ($1.00 par value) and Class B Common Stock ($1.00 par value).
The Series 1987-B Preferred Stock has a stated value of $50 per share, provides for cash liquidating distributions of up to such stated value and provides for cumulative annual dividends of $4.50 per share. Dividends and liquidating distributions on the 1987-B Preferred Stock are payable in preference to those payable on the Common Stock and Class B Common Stock, but are subordinated in right of payment to dividends and liquidating distributions payable on the Series 1986-A Preferred Stock. The 1987-B Preferred Stock ranks on parity with the Series 1984-A Preferred Stock. The 1987-B Preferred Stock is neither convertible nor entitled to any voting rights, except as required by law. The Company may redeem shares of the 1987-B Preferred Stock at any time at the $50 stated value.
12. COMMITMENTS, LITIGATION AND CONTINGENT LIABILITIES At December 31, 1993, the Company and its subsidiaries had long-term leases covering certain of their facilities and equipment. The net minimum rental commitments under noncancellable operating leases with lease terms in excess of one year are $6.3 million, $5.9 million, $.7 million, $.3 million and $.3 million for the years 1994, 1995, 1996, 1997, and 1998, respectively, and $.1 million for subsequent years. In addition, as a result of a judgement involving a mortgage loan foreclosure, a subsidiary is obligated under a real property lease for payments totaling $120,000 annually through November 2082.
At December 31, 1993, the Company had an outstanding commitment to make limited partnership investments of up to $25 million in Conseco Capital Partners II, L.P. The partnership was formed to make corporate acquisitions of specialized annuity, life and health insurance companies and related businesses.
The Company and its subsidiaries have been under examination by the Internal Revenue Service (IRS) for the tax years 1983 through 1992. The IRS has completed its examination for the years 1983 through 1985 and had previously issued Preliminary Notices of Deficiencies totaling approximately $17.5 million, before interest. The Company protested such assessed deficiencies and subsequently has tentatively reached an agreement with the IRS under which the Company and certain of its subsidiaries will incur approximately $4.6 million of additional taxes and interest. The IRS has not completed its examination for the years 1986 through 1992 and therefore has not issued Notices of Deficiencies for those years. Management believes that the ultimate liability for additional taxes and interest for these later years will not exceed amounts recorded in the Company's financial statements.
In the course of their examination of the income tax returns of the Company and its subsidiaries for the years 1986 through 1989, the examining agent involved has submitted a Request for Technical Advice to the IRS Chief Counsel's Office regarding the deductibility of interest expense on the surplus debentures issued by the Company's insurance subsidiaries. The issue involves approximately $444 million of interest deductions claimed by the Company's subsidiaries during the periods under examination and, if disallowed as deductions, would result in additional income tax expense, before interest, of approximately $163 million. For years subsequent to the periods under examination, the Company's subsidiaries have claimed additional interest deductions totaling $190 million which, if likewise disallowed, would result in additional income tax expense, before interest, totaling approximately $65 million. Management believes the surplus debentures in question were legally enforceable debt instruments, as opposed to equity contributions, and that the related interest was properly deductible. In addition, the appropriate domiciliary states of the Company's insurance subsidiaries recognized such surplus debentures as valid debt instruments. Further, all existing case law has held in the favor of taxpayers with regard to the issue of whether surplus debentures represent debt, as opposed to equity and, as a consequence, management believes that the Company and its subsidiaries do not have significant exposure to additional taxes as a result of this Request for Technical Advice.
From time to time, assessments are levied on the Company's insurance subsidiaries by life and health guaranty associations in states in which they are licensed to do business. Such assessments are made primarily to cover the losses of policyholders of insolvent or rehabilitated insurers. In some states, these assessments can be partially recovered through a reduction in future premium taxes. The Company's insurance subsidiaries paid assessments of $3.2 million, $2.8 million and $2.9 million in
Various other lawsuits and claims are pending against the Company and its subsidiaries. Based in part upon the opinion of counsel as to the ultimate disposition of the above discussed and other matters, management believes that the liability, if any, will not be material.
The provision for income taxes is included in the statements of earnings as follows:
15. EXTRAORDINARY LOSSES For the years 1993 and 1992, the Company incurred extraordinary losses, all related to early extinguishment of debt, as follows:
For the quarter ended March 31, 1993, the Company reported a non-operating gain totaling $79,459,000, net of tax effects, representing the Company's equity in the proceeds of BLHC's initial public offering. As a result of the Company's subsequent sale of its remaining interest in BLHC, such non-operating gain was reclassified as a component of revenues and operating earnings. Revenues and results of operations for the 1993 first quarter have accordingly been adjusted to reflect such reclassification.
The results of operations for the quarters ended June 30, 1993 and September 30, 1993, have been restated to correct for accounting errors determined in the course of preparation of the Company's year-end financial statements. The errors involved the incorrect accounting for certain group
16. QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED) health reinsurance activities and the correction of income tax provisions for a special purpose subsidiary which can no longer be included in the Company's consolidated income tax return. Following is a summary of the effect of these corrections on the reported results (in thousands, except per share amounts):
17. INDUSTRY SEGMENT DATA The Company and its subsidiaries are principally engaged in the sale and underwriting of individual life and health insurance, group insurance and accumulation products. Total revenues by segment reflect sales to unaffiliated customers. Operating earnings (loss) equal total revenues less operating expenses.
Premium income and other considerations includes premium income, mortality and administration charges, surrender charges and amortization of deferred policy initiation fees. Net investment income and other income are allocated to the segments based on rates ranging from 6% to 10% related to reserves generated by each of the four insurance segments. Corporate revenues and operating earnings include gains (losses) on the sales of subsidiaries, equity in earnings (losses) of unconsolidated affiliates and limited partnerships, and the remaining net investment income considered to be income applicable to the investment of capital and surplus funds. Operating expenses are allocated to each segment based on a ratio of operating expenses to premiums and premium equivalents.
18. SUPPLEMENTAL DATA TO CONSOLIDATED STATEMENTS OF CASH FLOWS Cash payments (receipts) for interest expense and income taxes were as follows:
I.C.H. CORPORATION AND SUBSIDIARIES AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (IN THOUSANDS)
I.C.H. CORPORATION CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED) STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (IN THOUSANDS)
I.C.H. CORPORATION CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED) NOTES TO CONDENSED FINANCIAL STATEMENTS
Prior to the sale of Bankers, the parent company acquired certain assets from Bankers at their fair value. The tax attributes related to such assets were likewise transferred to ICH and the income tax consequences which had been reflected for financial purposes have been reflected as a deemed dividend to the parent company.
SCHEDULE VIII I.C.H. CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (IN THOUSANDS)