Insurance operations. Our supplemental health products are primarily administered from a single facility of 300,000 square feet in downtown Chicago, Illinois, leased under an agreement having a remaining life of nine years. We also lease approximately 130,000 square feet of warehouse space in a second Chicago facility; this lease has a remaining life of four years. Conseco owns an office building in Kokomo, Indiana (100,000 square feet), and two office buildings in Rockford, Illinois (total of 169,000 square feet), which serve as administrative centers for portions of our insurance operations. Conseco owns one office building in Philadelphia, Pennsylvania (127,000 square feet), which serves as the administrative center for our direct response life insurance operations; approximately 60 percent of this space is occupied by the Company, with the remainder leased to tenants. Conseco leases 24,000 square feet of office space in Bensalem, Pennsylvania, with a remaining lease term of one year. Conseco leases 22,000 square feet of office space in Schaumburg, Illinois, for use by our major medical marketing and certain information technology operations. Conseco also leases 220 sales offices in various states totaling approximately 375,000 square feet; these leases are short-term in length, with remaining lease terms ranging from one to five years.
- ------------------------- (a) Comparison of selected supplemental consolidated financial data in the table above is significantly affected by the following business combinations accounted for as purchases: Washington National Corporation (effective December 1, 1997); Colonial Penn Life Insurance Company and Providential Life Insurance Company (September 30, 1997); Pioneer Financial Services, Inc. (April 1, 1997); Capitol American Financial Corporation (January 1, 1997); Transport Holdings Inc. (December 31, 1996); American Travellers Corporation (December 31, 1996); FINOVA Acquisition I, Inc. (December 1, 1996); Life Partners Group, Inc. (July 1, 1996); and American Life Holdings, Inc. (September 29, 1994). All financial data have been restated to give retroactive effect to the merger with Green Tree accounted for as a pooling of interests.
(c) All share and per-share amounts have been restated to reflect the two-for-one stock splits paid on February 11, 1997 and April 1, 1996.
(d) Amounts under this heading are included to assist the reader in analyzing the Company's financial position and results of operations. Such amounts are not intended to, and do not, represent insurance policy income, net income, net income per share, shareholders' equity or book value per share prepared in accordance with generally accepted accounting principles ("GAAP").
(g) Represents: (i) our assets, excluding finance receivables, interest-only securities and servicing assets, of $38.9 billion, $37.2 billion, $26.4 billion, $17.9 billion, and $11.3 billion at December 31, 1998, 1997, 1996, 1995 and 1994, respectively; (ii) the total fixed and revolving credit receivables that Green Tree manages, including receivables on its balance sheet and receivables applicable to the holders of asset-backed securities sold by Green Tree of $37.2 billion, $28.0 billion, $20.1 billion, $13.9 billion, and $9.8 billion at December 31, 1998, 1997, 1996, 1995 and 1994, respectively; and (iii) the total market value of the investment portfolios managed by CCM, excluding assets of Conseco's subsidiaries, of $11.2 billion, $5.1 billion, $12.6 billion, $10.9 billion and $11.7 billion at December 31, 1998, 1997, 1996, 1995 and 1994, respectively.
All statements, trend analyses and other information contained in this report and elsewhere (such as in filings by the Company with the Securities and Exchange Commission, press releases, presentations by the Company or its management or oral statements) relative to markets for the Company's products and trends in the Company's operations or financial results, as well as other statements including words such as "anticipate," "believe," "plan," "estimate," "expect," "intend," and other similar expressions, constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors which may cause actual results to be materially different from those contemplated by the forward-looking statements. Such factors include, among other things: (i) general economic conditions and other factors, including prevailing interest rate levels, stock and credit market performance and health care inflation, which may affect (among other things) the Company's ability to sell its products, its ability to make loans and access capital resources and the costs associated therewith, the market value of the Company's investments, the lapse rate and profitability of policies, and the level of defaults and prepayments of loans made by the Company; (ii) the Company's ability to achieve anticipated synergies and levels of operational efficiencies; (iii) customer response to new products, distribution channels and marketing initiatives; (iv) mortality, morbidity, usage of health care services and other factors which may affect the profitability of the Company's insurance products; (v) changes in the Federal income tax laws and regulations which may affect the relative tax advantages of some of the Company's products; (vi) increasing competition in the sale of insurance and annuities and in the finance business; (vii) regulatory changes or actions, including those relating to regulation of financial services affecting (among other things) bank sales and underwriting of insurance products, regulation of the sale, underwriting and pricing of products, and health care regulation affecting health insurance products; (viii) the ability to achieve Year 2000 readiness for significant systems and operations on a timely basis; (ix) the availability and terms of future acquisitions; and (x) the risk factors or uncertainties listed from time to time in the Company's filings with the Securities and Exchange Commission.
Total revenues included net investment gains of $208.2 million in 1998, $266.5 million in 1997 and $60.8 million in 1996. Excluding net investment gains, total revenues were $7.5 billion in 1998, up 14 percent over 1997. Total revenues, excluding net investment gains, were up 76 percent in 1997 over 1996. Increases in total revenues in all three years reflect the impact and timing of acquisitions, as well as growth in both segments.
Net investment income on general account invested assets (which excludes income on separate account assets related to variable annuities and the income and change in the fair value of S&P 500 Call Options
related to equity-indexed products) increased by 12 percent, to $1,927.0 million, in 1998, and by 37 percent, to $1,715.6 million, in 1997. The average balance of general account invested assets increased by 17 percent in 1998 to $26 billion and by 42 percent in 1997 to $22 billion. General account invested assets increased primarily due to the recent acquisitions. The yield on these assets decreased by .1 percentage point to 7.5 percent in 1998 and increased by .1 percentage point to 7.6 percent in 1997. Such fluctuations reflect the general decreases in investment interest rates over the last three years, offset by the fluctuations in income from limited partnerships and other investments.
Net investment income related to equity-indexed products based on the S&P 500 Index is substantially offset by a corresponding charge to amounts added to policyholder account balances for equity-indexed products. Such income and related charge fluctuated based on the performance of the S&P 500 Index to which the returns on such products are linked. During 1998, we recorded income from the S&P 500 Options of $103.9 million and added amounts to policyholders' account balances of the equity-indexed products of $96.1 million.
Insurance policy benefits increased in 1998 and in 1997 as a result of an increase in the amount of business in force on which benefits are incurred. The amount of business increased primarily as a result of recent acquisitions.
The net cash flows from our long-term care products generally result in the accumulation of amounts in the early policy years of a policy (accounted for as reserve increases) which will be paid out as benefits in later policy years (accounted for as reserve decreases). Accordingly, during the asset accumulation phase of these policies, the loss ratio will increase, but the increase in the change in reserve will be partially offset by investment income earned on the assets which have accumulated. The increase in the loss ratio during 1998 reflects such an occurrence; the 1998 and 1997 loss ratios also reflect the different characteristics of long-term care policies sold by recently acquired companies.
The 1998 loss ratio for specified disease products benefited from favorable claim developments. These reduced insurance policy benefits and change in reserves by approximately $10.0 million.
Amounts added to policyholder account balances for interest expense on annuity products increased by 4.5 percent, to $728.6 million, in 1998, and by 12 percent, to $697.1 million, in 1997. The increase in interest expense resulting from a larger block of annuity business in force was partially offset by a reduction in crediting rates. The weighted average crediting rates for these annuity liabilities decreased by .2 percentage points, to 4.6 percent, during 1998, and decreased by .2 percentage points, to 4.8 percent, during 1997.
Amortization related to operations includes amortization of: (i) the cost of policies produced; (ii) the cost of policies purchased; and (iii) goodwill. Balances subject to amortization increased as a result of recent acquisitions and new policies sold.
Interest expense on investment borrowings increased along with our investment borrowing activities. Average investment borrowings were $1,092.4 million during 1998, compared to $719.3 million during 1997. The weighted average interest rate on such borrowings was 5.4 percent during 1998 and 5.8 percent during 1997.
Other operating costs and expenses increased primarily because of recent acquisitions.
Net investment gains (losses), net of related costs and amortization fluctuate from period to period. Selling securities at a gain and reinvesting the proceeds at lower yields may, absent other management action, tend to decrease future investment yields. We believe, however, that the following factors mitigate the adverse effect on net income: (i) we recognize additional amortization of cost of policies purchased and cost of policies produced in order to reflect reduced future yields (thereby reducing such amortization in future periods); (ii) we 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 investment gains. As a result of the sales of fixed maturity investments, our amortization of the cost of policies purchased and the cost of policies produced increased by $236.5 million, $181.2 million and $36.0 million in 1998, 1997 and 1996, respectively.
Manufactured housing contract originations increased by $598.2 million, or 11 percent, during 1998 and by $597.3 million, or 12 percent, during 1997. The increase in 1998 is primarily due to an increase in the average size of the contracts written. The increase in 1997 is due to both an increase in the average size and number of contracts written.
Consumer/credit card contract originations increased by $1.2 billion, or 81 percent, during 1998 and by $531.6 million, or 54 percent, during 1997. The increase is primarily the result of our marketing efforts.
Commercial originations increased by $2.2 billion, or 43 percent, during 1998 and increased by $2.0 billion, or 62 percent, during 1997. The increase reflects higher production in all areas of commercial financing.
Managed receivables include finance receivables we sell through securitizations as well as finance receivables and interests in finance receivables we retain. The average managed receivables increased to $32.4 billion in 1998, up 36 percent over 1997, and to $23.7 billion in 1997, up 44 percent over 1996.
Net investment income on interest-only securities is the accretion recognized on the interest-only securities we retain after we sell finance receivables. Such income increased by 5.6 percent, to $132.9 million, in 1998, and by 63 percent, to $125.8 million, in 1997. The increase was consistent with the change in the average balance of interest-only securities and the increase in the discount rate assumption we use to value our interest-only securities. The weighted average yields earned on interest-only securities were 13.2 percent, 11.2 percent and 9.2 percent during 1998, 1997 and 1996, respectively.
Gain on sale of finance receivables is the difference between the proceeds from the sale of receivables (net of related transaction costs) and the allocated carrying amount of the receivables sold. We determine the allocated carrying amount by allocating the original amount of the receivables between the portion sold and any retained interests (securities classified as fixed maturities, interest-only securities and servicing rights), based on their relative fair values at the time of sale. Assumptions used in calculating the estimated fair value of interest-only securities and servicing rights are subject to volatility that could materially affect operating results. Prepayment rates may vary from expected rates as a result of competition, obligor mobility, general
and regional economic conditions and changes in interest rates. In addition, actual losses incurred as a result of loan defaults may vary from projected performance.
In response to higher prepayment rates and higher market yields on publicly traded securities similar to our interest-only securities, we increased the assumed prepayment and discount rates used to calculate the gain on sale of finance receivables for sales completed after June 30, 1998. Accordingly, the amount of gain as a percentage of closed-end loans sold decreased to 6.27 percent in 1998 from 7.44 percent in 1997 and 7.61 percent in 1996.
Current conditions in the credit markets and the resulting less attractive pricing of certain lower rated securities have caused us to hold, rather than sell, certain securities with corporate guarantee provisions formed in our securitizations. We recognize no gain on the sale of the securities we hold, but we recognize greater interest income, net of related interest expense, over the term we hold them. At December 31, 1998, we held $340.8 million of such securities that are included in actively managed fixed maturities.
Fee revenue and other income includes servicing income, commissions earned on insurance policies written in conjunction with financing transactions, and other income from late fees. Such income increased by 46 percent, to $260.4 million, in 1998 and by 50 percent, to $178.6 million, in 1997. Our servicing portfolio (on which servicing income is earned) grew and our net written insurance premiums grew along with managed receivables.
Impairment charges represent reductions in the value of interest-only securities and servicing rights. During the second quarter of 1998, prepayments on securitized loan contracts continued to exceed our expectations and we concluded that such prepayments were likely to continue to be higher than expected in future periods. As a result, we concluded that an impairment had occurred in the value of the interest-only securities and servicing rights, and we set a new value based on current assumptions. In addition, during the second quarter of 1998, the market yields of publicly traded securities similar to our interest-only securities increased. The new assumptions were based on our internal evaluations and consultation with external investment managers having significant experience in valuing these securities. Compared to the assumptions previously used: (i) we increased prepayment rates; (ii) we increased the discount rate used to determine the present value of future cash flows to 15 percent from 11.5 percent; and (iii) we increased the anticipated future rates of default. We recognized a $549.4 million impairment charge in 1998 to reduce the carrying value of the interest-only securities and servicing rights. In February 1999 we announced that, subject to audit,
Nonrecurring charges include various costs (including investment banking, accounting, legal and regulatory fees and other costs associated with the Green Tree Merger) totaling $148.0 million.
These accounts were $180.4 million in 1998, $126.8 million in 1997 and $112.4 million in 1996. Interest expense included in that total was $165.4 million in 1998, $109.4 million in 1997 and $108.1 million in 1996, fluctuating in relationship to the average debt outstanding and the average interest rate.
In accordance with GAAP, insurance policy income as shown in our consolidated statement of operations consists of premiums we receive for policies having life contingencies or morbidity features. For annuity and universal life contracts without such features, premiums collected are not reported as revenues, but as deposits to insurance liabilities. We recognize revenues for these products over time in the form of investment income and surrender or other charges.
In response to consumers' desire for alternative investment products with returns linked to equities, we introduced our first equity-indexed annuity product in 1996. The accumulation value of these annuities is credited with interest at an annual minimum guaranteed rate of 3 percent (or, including the effect of applicable sales loads, a 1.5 percent compound average interest rate over the term of the contracts). The annuities provide for higher returns based on a percentage of the change in the S&P 500 Index during each year of their term. We purchase S&P 500 Call Options in an effort to hedge increases to policyholder benefits that would result from increases in the S&P 500 Index. Total collected premiums for this product increased by 106 percent, to $798.2 million, in 1998 and by 382 percent, to $387.7 million, in 1997.
Variable annuities offer contract holders the ability to direct premiums into specific investment portfolios; rates of return are based on the performance of the portfolio. Such annuities have become increasingly popular recently as a result of the desire of investors to invest in common stocks. In 1996, we began to offer more investment options for variable annuity deposits, and we expanded our marketing efforts, resulting in increased collected premiums. Our profits on variable annuities come from the fees charged to contract holders. Variable annuity collected premiums increased by 80 percent, to $332.6 million, in 1998 and by 104 percent, to $185.2 million, in 1997.
Premiums collected on long-term care policies increased by 9.7 percent, to $728.4 million, in 1998 and by 244 percent, to $663.7 million, in 1997. The increase reflects growth from both recently acquired and previously owned companies.
The following pro forma data present our estimate of our operating earnings (income before extraordinary charge, net investment gains (losses) (less that portion of amortization of cost of policies purchased and cost of policies produced and income taxes relating to such gains (losses), impairment charge (net of income taxes) and nonrecurring charges (net of income taxes)) on a portfolio basis; that is, as if we had accounted for the securitizations of our finance receivables as financing transactions throughout the Company's history rather than as sales. Accordingly, the pro forma data exclude gain on sale of finance receivables, servicing revenues and interest income on interest-only securities. The pro forma data do reflect, over the life of the loans, the spread between: (i) the interest earned on the loans included in the securitization pools; and (ii) the sum of the interest paid to the holders of the debt securities pursuant to the securitizations and credit losses in the portfolio. The pro forma data are intended to assist you in analyzing our operating results; they are not intended to, and do not, represent the results of the Company's operations prepared in accordance with GAAP.
At December 31, 1998, our fixed maturity portfolio had $424.2 million of unrealized gains and $445.2 million of unrealized losses, for a net unrealized loss of $21.0 million. Estimated fair values for fixed maturity investments were determined based on: (i) estimates from nationally recognized pricing services (80 percent of the portfolio); (ii) broker-dealer market makers (7 percent of the portfolio); and (iii) internally developed methods (13 percent of the portfolio).
At December 31, 1998, fixed maturity investments included $6.4 billion of mortgage-backed securities (or 29 percent of all fixed maturity securities). CMOs are backed by pools of mortgages that are segregated into sections or "tranches" that provide for sequential retirement of principal. Pass-through securities receive principal and interest payments through their regular pro rata share of the payments on the underlying mortgages backing the 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. Mortgage-backed securities are subject to risks associated with variable prepayments. Prepayment rates are influenced by a number of factors that 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 discount is realized as income at a slower rate and increases the yield on those purchased at a premium as a result of a decrease in annual amortization of the premium.
The degree to which a mortgage-backed security is susceptible to income fluctuations is influenced by: (i) the difference between its cost and par; (ii) the relative sensitivity of the underlying mortgages backing the security to prepayment in a changing interest rate environment; and (iii) the repayment priority of the security in the overall securitization structure. The Company seeks to limit the extent of these risks associated with mortgage-backed securities in our fixed maturity portfolio by: (i) purchasing securities that are backed by collateral with lower prepayment sensitivity (such as mortgages priced at a discount to par value and mortgages that are extremely seasoned); (ii) avoiding the purchase of securities for our fixed maturity portfolio whose values are heavily influenced by changes in prepayments (such as interest-only and principal-only securities); (iii) investing in securities structured to reduce prepayment risk (such as planned amortization class ("PAC") and targeted amortization class ("TAC") CMOs); and (iv) actively managing the entire portfolio of mortgage-backed securities to dispose of those which are deemed more likely to be prepaid. PAC and TAC instruments represented approximately 28 percent of our mortgage-backed securities at December 31, 1998. The call-adjusted modified duration of our mortgage-backed securities at December 31, 1998, was 4.1 years.
Pass-throughs and sequential and targeted amortization classes have similar prepayment variability. Pass-throughs have historically provided the best liquidity among mortgage-backed securities and also provide the best price/performance ratio in highly volatile interest rate environments. 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.
If we decide to sell an investment held in the actively managed fixed maturity category, we either sell the security or transfer it to the trading account at its fair value and recognize the gain or loss immediately. We transferred securities with a fair value of approximately $350 million into our trading account during 1998: there was no material gain or loss on the transfer.
During 1998, we sold $30.7 billion of investments (primarily fixed maturities), resulting in $459.9 million of investment gains and $149.8 million of investment losses (both before related expenses, amortization and taxes). Such securities were sold in response to changes in the investment environment, which created opportunities to enhance the total return of the investment portfolio without adversely affecting the quality of the portfolio or the matching of expected maturities of assets and liabilities. As discussed in the notes to the consolidated financial statements, the realization of gains and losses affects the timing of the amortization of the cost of policies produced and the cost of policies purchased related to universal life and investment products.
At December 31, 1998, we held mortgage loan investments purchased for our investment portfolio with a carrying value of $1,130.2 million (or 3.9 percent of total invested assets) and a fair value of $1,200.9 million. Mortgage loans were substantially comprised of commercial loans. Noncurrent mortgage loans were insignificant at December 31, 1998. Realized losses on mortgage loans were not significant in any of the past three years. At December 31, 1998, we had a mortgage loan loss reserve of $9.2 million. Approximately 9 percent of the mortgage loans were on properties located in Texas, 8 percent in New York, 8 percent in Florida, 7 percent in Ohio and 7 percent in California. No other state accounted for more than 5 percent of the mortgage loan balance.
Other invested assets also include: (i) trading securities; (ii) S&P 500 Call Options; (iii) certain nontraditional investments, including investments in venture capital funds, limited partnerships, mineral rights and promissory notes; and (iv) investments held in a trust for the benefit of the purchasers of certain investment products of our investment management subsidiary.
As part of our investment strategy, we enter into reverse repurchase agreements and dollar-roll transactions to increase our return on investments and improve our liquidity. Reverse repurchase agreements involve a sale of securities and an agreement to repurchase the same securities at a later date at an agreed-upon price. Dollar rolls are similar to reverse repurchase agreements except that the repurchase involves securities that are only substantially the same as the securities sold. We enhance our investment yield by investing the proceeds from the sales in short-term securities pending the contractual repurchase of the securities at discounted prices in the forward market. We are able to engage in such transactions due to the market demand for mortgage-backed securities to form CMOs. Such investment borrowings averaged $1,092.4 million during 1998 and were collateralized by investment securities with fair values approximately
We pool and securitize substantially all of the finance receivables we originate, retaining: (i) investments in interest-only securities that are subordinated to the rights of other investors; (ii) servicing on the contracts; and (iii) in some securitizations, certain securities that are senior to the interest-only securities. In a typical securitization, we sell finance receivables to a special purpose entity which we establish for the limited purpose of purchasing the finance receivables and selling securities representing interests in the receivables. These interest-bearing securities are collateralized by the underlying pool of finance receivables. We receive the proceeds from the sale of the securities in exchange for the finance receivables. The securities are typically sold at the same amount as the principal balance of the receivables sold. We retain a residual interest, which represents the right to receive, over the life of the pool of receivables: (i) the excess of the principal and interest received on the receivables transferred to the special purpose entity over the principal and interest paid to the holders of other interests in the securitization; and (ii) servicing fees.
We service for a fee all of the finance receivables we originate or purchase from other originators. We collect, in the special purpose securitization entity, loan payments, taxes and insurance payments, where applicable, and other payments from borrowers and remit principal and interest payments to holders of the securities backed by the finance receivables we have sold. The cash applicable to the servicing fee and residual interest is remitted from the special purpose entity to the Company.
At December 31, 1998, no single state accounted for more than 8 percent of the contracts we serviced. In addition, no single contractor, dealer or vendor accounted for more than 2 percent of the total contracts we originated.
The following table provides certain information with respect to the 60-days-and-over contractual dollar delinquency, loss experience and repossessed collateral for the Company's managed finance receivables as of December 31, for the years indicated.
- ------------------------- (a) As a percentage of managed finance receivables at period end, excluding receivables already in repossession or foreclosure.
CHANGES IN THE CONSOLIDATED BALANCE SHEET OF 1998 COMPARED WITH 1997
Changes in the consolidated balance sheet at December 31, 1998 compared to 1997, reflect: (i) our operating results; (ii) the previously discussed impairment and nonrecurring charges totaling $503.8 million (net of income taxes of $193.6 million); (iii) our origination and sale of finance receivables; (iv) changes in the fair value of actively managed fixed maturity securities and interest-only securities; and (v) various financing transactions. Financing transactions (described in the notes to the consolidated financial statements) include: (i) common stock issuances and repurchases; (ii) the issuance and repayment of notes payable and commercial paper; and (iii) issuance of Company-obligated mandatorily redeemable preferred securities of subsidiary trusts.
We record our actively managed fixed maturity investments and interest-only securities at estimated fair value in accordance with GAAP. At December 31, 1998, we decreased the carrying value of such investments by $29.2 million as a result of this adjustment. The fair value adjustment resulted in a $519.6 million increase in carrying value at year-end 1997.
Corporate notes payable and commercial paper increased during 1998 with the issuance of debt, the proceeds of which we used to contribute $1.1 billion of additional capital to Green Tree. The increase was partially offset by the repayment of debt using the proceeds from the issuance of Company-obligated mandatorily redeemable preferred securities.
We instituted a commercial paper program in April 1997 to lower our borrowing costs and improve our liquidity. Borrowings under our commercial paper program averaged approximately $808.7 million during 1998 and carried a weighted average interest rate of 5.7 percent.
Company-obligated mandatorily redeemable preferred securities of subsidiary trusts are classified as minority interest in accordance with GAAP. During 1998, we issued $733.6 million of these securities, using the proceeds to repay debt. Refer to the notes in the consolidated financial statements for a description of these securities.
Book value per common share outstanding changed to $16.37 at December 31, 1998, from $16.45 a year earlier. Such change was primarily attributable to the factors discussed in the previous paragraph. Excluding unrealized appreciation (depreciation) of fixed maturity securities, book value per common share outstanding increased to $16.40 at December 31, 1998, from $15.88 a year earlier.
(c) Such ratios exclude the following items from earnings: (i) net investment gains (losses) of our life insurance and corporate segments (less that portion of amortization of cost of policies purchased and cost of policies produced relating to such gains (losses)); (ii) impairment charges; and (iii) nonrecurring charges. Such ratios are not intended to, and do not, represent the following ratios prepared in accordance with GAAP: the ratio of earnings to fixed charges; and the ratio of earnings to fixed charges, preferred dividends and distributions on Company-obligated mandatorily redeemable preferred securities of subsidiary trusts.
(d) Excludes debt of finance segment used to fund finance receivables and investment borrowings of the insurance segment.
(f) Corporate debt is reduced by cash and investments held by non-life companies other than finance companies.
Only a small portion of our insurance liabilities have a time for contractual payment; the majority of such liabilities are payable upon occurrence of the insured event or upon surrender. Of our total insurance liabilities at December 31, 1998, approximately 17 percent could be surrendered by the policyholder without a penalty. Approximately 61 percent could be surrendered by the policyholder subject to penalty or the release of an insurance liability in excess of surrender benefits paid. The remaining 22 percent were not subject to surrender.
Approximately 68 percent of insurance liabilities were subject to interest rates that may be reset annually; the remainder have no explicit interest rate.
We believe that the diversity of our investment portfolio and the concentration of investments in high-quality, liquid securities provides sufficient liquidity to meet foreseeable cash requirements. Our investment portfolio at December 31, 1998, included $1.7 billion of short-term investments and $16.8 billion of publicly traded investment grade bonds. Although there is no present need or intent to dispose of such investments, our life insurance subsidiaries could readily liquidate portions of their investments, if such a need arose. In addition, investments could be used to facilitate borrowings under reverse-repurchase agreements or dollar-roll transactions. Such borrowings have been used by the life companies from time to time to increase their return on investments and to improve liquidity.
Our finance operations require continued access to the capital markets for the warehousing and sale of finance receivables. To satisfy these needs, we use a variety of capital resources.
During the third and fourth quarters of 1998, liquidity in the credit markets became extremely limited for many issuers. We believe the liquidity in this market has improved significantly since then. This market is very large and fills a need for many investors and therefore we believe it is unlikely to disappear. We have been able to sell finance receivables even under the tough market conditions which existed during the latter half of 1998. In addition, we have access to bank credit, master repurchase agreements and securitization lines that would enable us to continue production of loans for some time, even if the asset-backed markets were temporarily not available.
Cash received by the Company from the special purpose securitization entities in 1998 in the form of servicing fees and payments on the residual interest securities increased to $517.9 million compared to $395.2 million in 1997. This growth is the result of our growing servicing portfolio. Interest on unsold loans also increased during 1998 as a result of the increase in the outstanding finance receivables.
At December 31, 1998, the parent company and its non-life subsidiaries had short-term investments of $57.7 million, of which $51.9 million was expended in January 1999 for accrued interest and dividends. The parent company and its non-life subsidiaries had additional investments in fixed maturities, equity securities
and other invested assets of $245.8 million at December 31, 1998, which, if needed, could be liquidated or contributed to the insurance subsidiaries.
Our debt agreements require us to maintain minimum working capital and RBC ratios, and limit our ability to incur additional indebtedness. They also restrict the amount of retained earnings that is available for dividends and require Conseco to maintain certain minimum ratings at its insurance subsidiaries.
Inflation does not have a significant effect on our balance sheet; we have minimal investments in property, equipment or inventories. To the extent that interest rates may change to reflect inflation or inflation expectations, there would be an effect on our balance sheet and operations. Lower interest rates experienced in recent periods have increased the value of our investment in fixed maturities and may have increased the amount of new finance receivables originated. These lower rates may also have made it more difficult to issue new fixed rate annuities and may have accelerated prepayments of finance receivables. It is not possible to calculate the effect of these changes on our operating results. It is likely that rising interest rates would have the opposite effect. Changes in interest rates can also affect the value of the finance receivables we hold.
Many computer programs were originally designed to identify each year using two digits. If not corrected, these computer programs could cause system failures or miscalculations in the year 2000, with possible adverse effects on our operations. In 1996, we initiated a comprehensive corporate-wide program designed to ensure that our computer programs function properly in the year 2000. A number of our employees (including several officers), as well as external consultants and contract programmers, are working on various year-2000 projects. Under the program, we are analyzing our application systems, operating systems, hardware, networks, electronic data interfaces and infrastructure devices (such as facsimile machines and telephone systems). We also have been working with vendors and other external business relations to help avoid year-2000 problems related to the software or services they provide to us.
Our year-2000 projects are currently on schedule. We are conducting our year-2000 projects in three phases: (i) an audit and assessment phase, designed to identify year-2000 issues; (ii) a modification phase, designed to correct year-2000 issues; and (iii) a testing phase, designed to test the modifications after they have been installed. We have completed the audit and assessment phase for all critical systems. The modification phase of our program is substantially complete for our insurance subsidiaries' projects. We expect to substantially complete our finance subsidiaries' modification projects by the end of the second quarter of 1999. The testing phase of our program is expected to be completed by the end of the third quarter of 1999.
We believe that we have provided for sufficient time in order to complete any additional modifications, if necessary, before December 31, 1999.
Our year-2000 projects are the highest priority for our information technology and many other employees. Other systems projects continue while our year-2000 projects are being completed, however, in many cases, we have accelerated system upgrades when the new systems address year-2000 issues.
The profitability of many of our products depends on the spreads between the interest yield we earn on investments and the rates we credit on our insurance liabilities. Although substantially all credited rates on our annuity products may be changed annually (subject to minimum guaranteed rates), changes in competition and other factors, including the impact of the level of surrenders and withdrawals, may limit our ability to adjust or to maintain crediting rates at levels necessary to avoid narrowing of spreads under certain market conditions. Approximately 68 percent of our insurance liabilities were subject to interest rates that may be reset annually: the remainder have no explicit interest rates. As of December 31, 1998, the average yield, computed on the cost basis of our investment portfolio, was 7.3 percent, and the average interest rate credited or accruing to our total insurance liabilities was 5.1 percent, excluding interest bonuses guaranteed for the first year of the annuity contract only.
We use computer models to simulate the cash flows expected from our existing business under various interest rate scenarios. These simulations enable us to measure the potential gain or loss in fair value of our interest rate-sensitive financial instruments. With such estimates, we seek to closely match the duration of our assets to the duration of our liabilities. When the estimated durations of assets and liabilities are similar, exposure to interest rate risk is minimized because a change in the value of assets should be largely offset by a change in the value of liabilities. At December 31, 1998, the adjusted modified duration of our fixed maturity securities and short-term investments was approximately 5.8 years and the duration of our insurance liabilities was approximately 6.7 years. We estimate that our fixed maturity securities and short-term investments (net of corresponding changes in the value of cost of policies purchased, cost of policies produced and insurance liabilities) would decline in fair value by approximately $490 million if interest rates were to increase by 10 percent from their December 31, 1998 levels. This compares to a decline in fair value of $540 million based on amounts and rates at December 31, 1997. The calculations involved in our computer simulations incorporate numerous assumptions, require significant estimates and assume an immediate change in interest rates without any management of the investment portfolio in reaction to such change. Consequently, potential changes in value of our financial instruments indicated by the simulations will likely be different from the actual changes experienced under given interest rate scenarios, and the differences may be material. Because we actively manage our investments and liabilities, our net exposure to interest rates can vary over time.
We retain interests in the finance receivables sold through investments in interest-only securities that are subordinated to the rights of other investors. Interest-only securities do not have a stated maturity or amortization period. The expected amount of the cash flow as well as the timing depends on the performance of the underlying collateral supporting each securitization. The actual cash flow of these instruments could vary substantially if performance is different from our assumptions. We develop assumptions to value these investments by analyzing past portfolio performance, current loan characteristics, current market conditions and the expected effect of our actions to mitigate adverse performance. Assumptions used as of December 31, 1998, are summarized in the notes to the consolidated financial statements.
We manage the ratio of borrowed capital to total capital and the portion of our outstanding capital subject to fixed and variable rates, taking into consideration the current interest rate environment and other market conditions. Our borrowed capital at December 31, 1998, included commercial paper, notes payable and Company-obligated mandatorily redeemable preferred securities of subsidiary trusts totaling $5.0 billion ($1.5 billion of which is at floating rates and $3.5 billion of which is at fixed rates). Based on the interest rate exposure and prevalent rates at December 31, 1998, a relative 10 percent decrease in interest rates would increase the fair value of our fixed-rate borrowed capital by approximately $90 million. This compares to a $75 million increase based on our borrowed capital and prevalent rates at December 31, 1997. Our interest expense on floating-rate debt will fluctuate as prevailing interest rates change.
STEPHEN C. HILBERT Chairman of the Board, President and Chief Executive Officer ROLLIN M. DICK Executive Vice President and Chief Financial Officer
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion.
CONSOLIDATED BALANCE SHEET DECEMBER 31, 1998 AND 1997 (DOLLARS IN MILLIONS)
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (DOLLARS IN MILLIONS)
CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (DOLLARS IN MILLIONS)
Conseco, Inc. ("we", "Conseco" or the "Company" ) is a financial services holding company operating throughout the United States. Our life insurance subsidiaries develop, market and administer supplemental health insurance, annuity, individual life insurance, individual and group major medical insurance and other insurance products. Our finance subsidiaries originate, purchase, sell and service consumer and commercial finance loans. Conseco's operating strategy is to grow its businesses by focusing our resources on the development and expansion of profitable products and strong distribution channels, to seek to achieve superior investment returns through active asset management and to control expenses.
Our consolidated financial statements exclude the results of material transactions between us and our consolidated affiliates, or among our consolidated affiliates. We reclassified certain amounts in our 1997 and 1996 consolidated financial statements and notes to conform with the 1998 presentation.
present value of estimated future cash flows discounted at a risk free rate using current assumptions is less than the carrying value of the interest-only securities. When declines in value considered to be other than temporary occur, we reduce the amortized cost to estimated fair value and recognize a loss in the statement of operations. See note 4 for additional discussion of gain on sale of receivables and interest-only securities.
Finance receivables consist of: (i) lease, commercial finance and revolving credit receivables; and (ii) loans held for securitization. Lease receivables are generally direct financing leases; the carrying value of these receivables represents the present value of both the future minimum lease payments and related residual values. Commercial finance receivables generally represent dealer floorplan; asset-based financial arrangements with dealers, manufacturers and other commercial entities; and commercial real estate loans. Revolving credit receivables consist of retail credit card arrangements with merchants, dealers and their customers. Loans held for sale generally consist of recent originations of manufactured housing, home equity, home improvement and consumer and equipment contracts which we expect to sell in the near term. We carry loans held for sale at the lower of amortized cost or market as determined in the aggregate for both commercial and other products. There was no valuation allowance as of December 31, 1998 or 1997. We state finance receivables net of allowance for expected losses.
We defer fees received and costs incurred when we originate finance receivables. We amortize fees, costs, discounts and premiums over the contractual lives of the receivables, giving consideration to anticipated prepayments. We include such deferred fees or costs in the cost of finance receivables sold upon the sale.
The costs that vary with, and are primarily related to, producing new insurance business are referred to as cost of policies produced. We amortize these costs using the interest rate credited to the underlying policy; (i) in relation to the estimated gross profits for universal life-type and investment-type products; or (ii) in relation to future anticipated premium revenue for other products.
The cost assigned to the right to receive future cash flows from contracts existing at the date of an acquisition is referred to as cost of policies purchased. This balance is amortized, evaluated for recoverability, and adjusted for the impact of unrealized gains (losses) in the same manner as the cost of policies produced described above.
Goodwill is the excess of the amount we paid to acquire a company over the fair value of its net assets. We amortize goodwill on the straight-line basis generally over a 40-year period. At December 31, 1998, the total accumulated amortization of goodwill was $281.1 million. We continually monitor the value of our goodwill based on our estimates of future earnings. We determine whether goodwill is fully recoverable from projected undiscounted net cash flows from earnings of the subsidiaries over the remaining amortization period. If we were to determine that changes in such projected cash flows no longer support the recoverability of goodwill over the remaining amortization period, we would reduce its carrying value with a corresponding charge to expense or shorten the amortization period (no such changes have occurred). Cash flows considered CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
in such an analysis are those of the business acquired, if separately identifiable, or the product line that acquired the business, if such earnings are not separately identifiable.
STANDARD & POOR'S 500 INDEX CALL OPTIONS AND INTEREST RATE SWAP AGREEMENTS
Our equity-indexed annuity products provide a guaranteed base rate of return, and a higher potential return linked to the performance of the S&P 500 Index. We buy S&P 500 Index Call Options in an effort to hedge potential increases to policyholder benefits resulting from increases in the S&P 500 Index. We include the cost of the S&P 500 Call Options in the pricing of the equity-indexed annuity products. We reflect changes in the values of the S&P 500 Call Options, which fluctuate in relation to changes in policyholder account balances for these annuities, in net investment income. We defer the premiums paid to purchase these instruments and amortize them to investment income over their term. Such amortization was $52.0 million in 1998 and $14.6 million in 1997.
Net investment income included $103.9 million and $39.4 million during 1998 and 1997, respectively, related to changes in the value of the S&P 500 Call Options. There was no such income in 1996. Such investment income was substantially offset by amounts added to policyholder account balances for annuities and financial products. The value of the S&P 500 Call Options (with a notional amount of approximately $1.2 billion) was $107.9 million at December 31, 1998. We classify such instruments as other invested assets.
For investment purposes, we entered into various interest rate swap agreements having an aggregate notional principal amount of $1.7 billion at December 31, 1998. Such agreements are marked to market, with the related gain (loss) classified as investment income in the statement of operations. The agreements effectively exchange a fixed rate of interest on the notional amount into a floating rate. At December 31, 1998, our swap agreements had a fair value of $20.7 million. We received $5.0 million in cash from these investments during 1998. The agreements mature in various years through 2008 and have an average remaining life of five years (the average call date is 2.7 years).
Interest-only securities. We discount future expected cash flows over the expected life of the receivables sold using prepayment, default, loss and interest rate assumptions that we believe market participants would use to value such securities.
Mortgage loans and policy loans. We discount future expected cash flows for loans included in our investment portfolio based on interest rates currently being offered for similar loans to borrowers with similar credit ratings. We aggregate loans with similar characteristics in our calculations.
Finance receivables. For loans held for securitization, we use market values realized in recent sales of loans in securitization transactions. For other loans, we use carrying value.
During the second quarter of 1998, prepayments on securitized loan contracts continued to exceed expectations and management concluded that such prepayments were likely to continue to be higher than expected in future periods as well. As a result of these developments, we concluded that the value of the interest-only securities and servicing rights had been impaired, and we determined a new value using current assumptions. In addition, the market yields of publicly traded securities similar to our interest-only securities also increased during the second quarter. The new assumptions were based on our internal evaluations and consultation with external investment managers having significant experience in valuing these securities. The new assumptions reflect the following changes from the assumptions previously used: (i) an increase in prepayment rates; (ii) an increase (to 15 percent from 11.5 percent) in the discount rate used to determine the present value of future cash flows; and (iii) an increase in anticipated default rates. We recognized a $549.4 million impairment charge in 1998 to reduce the carrying value of the interest-only securities and servicing rights.
CONSECO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
We recognized a $148.0 million nonrecurring charge in the second quarter of 1998 related to the Green Tree Merger consisting of: $45.0 million transaction costs; $71.0 million severance and other employment related costs; and $32.0 million other costs. Transaction costs included expenses related to the Green Tree Merger such as fees paid for investment bankers, attorneys, accountants and printers. Severance and other employment related costs included contractual severance and other benefits due to certain executives. Other costs included the write-off of computer equipment and related software that will no longer be used, losses for facilities to be vacated, increases to legal expense accruals, and various other costs.
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") was issued in June 1998. SFAS 133 requires all derivative instruments to be recorded on the balance sheet at estimated fair value. Changes in the fair value of derivative instruments are to be recorded each period either in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, on the type of hedge transaction. SFAS 133 is effective for year 2000. We are currently evaluating the impact of SFAS 133; at present, we do not believe it will have a material effect on our consolidated financial position or results of operations.
On June 30, 1998, we completed the Green Tree Merger. We issued a total of 128.7 million shares of Conseco common stock (including 5.0 million common equivalent shares issued in exchange for Green Tree's outstanding options), exchanging .9165 of a share of Conseco common stock for each share of Green Tree common stock. The Green Tree Merger constituted a tax-free exchange and was accounted for under the pooling of interests method. We restated all prior period consolidated financial statements to include Green Tree as though it had always been a subsidiary of Conseco.
The results of operations for Conseco and Green Tree, separately and combined, for periods prior to the merger were as follows:
On a pro forma basis, assuming the acquisitions and financing transactions we completed in 1996 had been completed at the beginning of 1996, our total revenues, income before extraordinary charge, basic income before extraordinary charge per share, and diluted income before extraordinary charge per share for the year ended December 31, 1996, would have been $4,690.3 million, $552.5 million, $1.88 and $1.69, respectively. The pro forma data are not necessarily indicative of our results of operations had these transactions occurred on January 1, 1996, nor the results of future operations. We have not presented pro forma data for the 1997 acquisitions because, in accordance with the disclosure requirements of the Securities and Exchange Commission, such acquisitions are not significant, either individually or in the aggregate.
At December 31, 1998, the amortized cost and estimated fair value of actively managed fixed maturities and equity securities were as follows:
At December 31, 1997, the amortized cost and estimated fair value of actively managed fixed maturities and equity securities were as follows:
Net unrealized gains (losses) on actively managed fixed maturity investments included in shareholders' equity as of December 31, 1998 and 1997, were as follows:
The carrying value of fixed maturity investments and mortgage loans not accruing investment income totaled $50.1 million, $3.1 million and $2.1 million at December 31, 1998, 1997 and 1996, respectively.
Life insurance companies are required to maintain certain investments on deposit with state regulatory authorities. Such assets had an aggregate carrying value of $191.9 million at December 31, 1998.
collateralized by the underlying pool of finance receivables. We in turn, receive the proceeds from the sale of the securities, which are typically sold at the same amount as the principal balance of the receivables sold. We retain a residual interest, which represents the right to receive, over the life of the pool of receivables: (i) the excess of the principal and interest received on the receivables transferred to the special purpose entity over the principal and interest paid to the holders of other interests in the securitization; and (ii) servicing fees.
As explained in note 1, the interest-only security is initially recorded at a value representing an allocated portion of the cost basis of the finance receivables being sold. The account value was adjusted to estimated fair value at December 31, 1998, using the following assumptions. The difference between this estimated fair value and the security's book value is insignificant and is included in unrealized depreciation of other investments.
- --------------- (a) Excludes finance receivables sold in revolving trust securitizations.
- ------------------------- (a) Principally modifications of the 1965 -- 70 and 1975 -- 80 Basic, Select and Ultimate Tables.
(b) Principally the 1984 United States Population Table and the NAIC 1983 Individual Annuitant Mortality Table.
A reconciliation of the income tax provisions based on the U.S. statutory corporate tax rate to the provisions reflected in the consolidated statement of operations is as follows:
At December 31, 1998, Conseco had federal income tax loss carryforwards of $1.0 billion available (subject to various statutory restrictions) for use on future tax returns. Portions of these carryforwards begin expiring in 2002. The following restrictions exist with respect to the utilization of portions of the loss carryforwards: (i) $64.4 million may be used only to offset income from our non-life insurance companies; (ii) $94.4 million (attributable to acquired companies) may be used only to offset the income from those companies; and (iii) $841.2 million is available to offset income from certain life insurance subsidiaries and all the non-life insurance subsidiaries. None of the carryforwards are available to reduce the tax provision for financial reporting purposes.
Corporate notes payable and commercial paper at December 31, 1998 and 1997, were as follows (interest rates as of December 31, 1998):
The Company's current bank credit facilities allow us to borrow up to $2.5 billion, of which $1.5 billion may be borrowed until 2003 and $1.0 billion may be borrowed until 1999. Actual borrowings at December 31, 1998, totaled $1,250.0 million (of which $877.7 million was used to finance the purchase of finance receivables classified as finance notes payable -- See "Finance Notes Payable and Commercial Paper"). The credit facility requires us to maintain various financial ratios, as defined in the agreement, including: (i) a debt-to-total capitalization ratio less than .45:1 (such ratio was .39:1 at December 31, 1998); and (ii) an interest coverage ratio greater than 2.0:1 during the period October 1, 1998 through September 30, 1999, greater than 2.25:1 for the period October 1, 1999 through September 30, 2001 and greater than 2.50:1 thereafter (such ratio was 5.40:1 for the period ended December 31, 1998). Our unsecured bank credit facilities are used to support our commercial paper program.
Notes payable and commercial paper related to our financing activities were as follows (interest rates as of December 31, 1998):
As of December 31, 1998, we had $4.0 billion of master repurchase agreements with various investment banking firms, subject to the availability of eligible collateral. The agreements generally provide for terms of one year, which can be extended each quarter by mutual agreement of the parties for an additional year, based upon the review of updated quarterly financial information of the finance segment.
The Company has qualified defined contribution plans for which substantially all employees are eligible. Company contributions, which match certain voluntary employee contributions to the plan, totaled $6.2 million in 1998, $6.3 million in 1997, and $3.3 million in 1996. Matching contributions may be made either in cash or in Conseco common stock.
Green Tree has been served with various related lawsuits which were filed in the United States District Court for the District of Minnesota. These lawsuits were filed as purported class actions on behalf of persons or entities who purchased common stock or options of Green Tree during the alleged class periods that generally run from February 1995 to January 1998. One such action did not include class action claims. In addition to Green Tree, certain current and former officers and directors of Green Tree are named as defendants in one or more of the lawsuits. Green Tree and other defendants have obtained an order from the United States District Court for the District of Minnesota consolidating the lawsuits seeking class action status into two actions: one which pertains to a purported class of common stockholders and the other which pertains to a purported class of stock option traders. Plaintiffs in the lawsuits assert claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. In each case, plaintiffs allege that Green Tree and the other defendants violated federal securities laws by, among other things, making false and misleading statements about the current state and future prospects of Green Tree (particularly with respect to prepayment assumptions and performance of certain loan portfolios of Green Tree) which allegedly rendered Green Tree's financial statements false and misleading. The Company believes that the lawsuits are without merit and intends to defend such lawsuits vigorously. The ultimate outcome of these lawsuits cannot be predicted with certainty. Green Tree has filed motions, which are pending, to dismiss these lawsuits.
The balance sheet at December 31, 1998, includes: (i) accruals of $31.5 million, representing our estimate of all known assessments that will be levied against the Company's insurance subsidiaries by various
state guaranty associations based on premiums written through December 31, 1998; and (ii) receivables of $12.8 million that we estimate will be recovered through a reduction in future premium taxes as a result of such assessments. These estimates are subject to change when the associations determine more precisely the losses that have occurred and how such losses will be allocated among the insurance companies. We recognized expense for such assessments of $16.2 million in 1998, $3.7 million in 1997 and $4.0 million in 1996.
We have provided guarantees of approximately $1.8 billion at December 31, 1998, in conjunction with certain sales of finance receivables. In conjunction with our investment in certain consumer financing companies, we have guaranteed approximately $70 million of such companies' indebtedness. We believe a significant loss from any such guarantee is remote.
Certain wholly owned subsidiary trusts have issued preferred securities in public offerings. The trusts used the proceeds from these offerings to purchase subordinated debentures from Conseco. The terms of the preferred securities parallel the terms of the debentures, which account for substantially all trust assets. The preferred securities are to be redeemed on a pro rata basis, to the same extent as the debentures are repaid. Under certain circumstances involving a change in law or legal interpretation, the debentures may be distributed to the holders of the preferred securities. Our obligations under the debentures and related agreements, taken together, provide a full and unconditional guarantee of payments due on the preferred securities. The debentures issued to the subsidiary and the common securities purchased by Conseco from the subsidiary are eliminated in the consolidated financial statements.
(ii) will receive a contract adjustment payment equal to .25 percent of the value of the security; and (b) a beneficial ownership of a 6.75 percent trust originated preferred security. Each holder will receive aggregate cumulative cash distributions at the annual rate of 7 percent of the $50 stated amount per security, payable quarterly. The applicable distribution rate on the trust originated preferred securities that remain outstanding during the period February 16, 2001, through February 16, 2003, will be reset so that the market value of the trust originated preferred securities will be equal to 100.5 percent of the par value. Conseco may limit the market rate reset to be no higher than the rate on the two-year benchmark Treasury plus 200 basis points.
Changes in the number of shares of common stock outstanding during the years ended December 31, 1998, 1997 and 1996 were as follows:
Dividends declared on common stock for 1998, 1997 and 1996, were $.530, $.313 and $.083 per common share, respectively. Our accrual for declared but unpaid dividends was $44.2 million at December 31, 1998. Such dividends were paid in January 1999.
The stock option activity and related information includes the combined activity and information of both Conseco and Green Tree for all periods. On March 1, 1998, prior to the time a merger was contemplated, Green Tree repriced certain of its employee stock options to the current market price. A summary of the Company's stock option activity and related information for the years ended December 31, 1998, 1997 and 1996, is presented below (shares in thousands):
We estimated the fair value of each option grant used to determine the pro forma amounts summarized above using the Black-Scholes option valuation model with the following weighted average assumptions for 1998, 1997 and 1996:
The five states with the largest shares of 1998 collected premiums were Florida (9.5 percent), California (9.2 percent), Illinois (8.5 percent), Texas (7.5 percent) and Michigan (4.5 percent). No other state accounted for more than 4 percent of total collected premiums.
Based on current conditions and assumptions as to future events on all policies in force, the Company expects to amortize approximately 11 percent of the December 31, 1998, balance of cost of policies purchased in 1999, 10 percent in 2000, 9 percent in 2001, 8 percent in 2002 and 7 percent in 2003. The discount rates used to determine the amortization of the cost of policies purchased averaged 7 percent in 1998, 7 percent in 1997 and 10 percent in 1996.
Statutory accounting practices prescribed or permitted by regulatory authorities for the Company's insurance subsidiaries differ from GAAP. Our life insurance subsidiaries reported the following amounts to regulatory agencies, after appropriate elimination of intercompany accounts:
The statutory capital and surplus shown above included investments in non-life affiliates, all of which were eliminated in the consolidated financial statements prepared in accordance with GAAP, of $809.0 million at December 31, 1998 and $513.1 million at December 31, 1997.
Insurance and fee-based segment. Our insurance and fee-based segment provides supplemental health, annuity, life, and individual and group major medical products to a broad spectrum of customers through multiple distribution channels, each focused on a specific market segment. These products are primarily marketed through career agents, professional independent producers and direct marketing.
Our quarterly results of operations are based on numerous estimates, principally related to policy reserves, amortization of cost of policies purchased, amortization of cost of policies produced, valuation of the interest- only securities and income taxes. We revise all such estimates each quarter and we ultimately adjust them to year-end amounts. When we determine that revisions are necessary, we report them as part of operations in the current quarter.