Prior to the completion of its IPO, WNC was a wholly owned subsidiary of Conseco. Conseco sold 60 percent of WNC in the IPO. On December 23, 1994, Conseco sold its remaining 40 percent equity interest in WNC. Amounts included in Conseco's accounts for the year ended December 31, 1994, therefore include: (i) all of WNC's earnings from January 1 through February 15, 1994, the date the IPO was completed; and (ii) 40 percent of WNC's earnings for the period from February 15 through December 23, 1994.
Interest expense on annuities and financial products decreased over the last three years as a result of the reinsurance recapture by WNC. The average rate credited on all insurance liabilities was approximately 7.0 percent at December 31, 1994, 1993 and 1992.
A summary of maturity dates and amounts (dollars in millions) of the surplus debenture is shown below. Interest is payable quarterly generally at 2 percent above the prime rate (10.5 percent at December 31, 1994).
Statutory Limitations on Payments by Life Insurance Subsidiaries to Their Parent
As described in the preceding section, Conseco receives funds from its wholly owned insurance subsidiaries from dividends and fees for shared expenses. In connection with its acquisition of certain life insurance subsidiaries, Conseco received surplus debentures from the subsidiaries; the repayment terms were established and approved by the applicable regulatory authorities at the time of each acquisition. All such surplus debentures with Conseco's wholly owned insurance subsidiaries were eliminated by a contribution to the statutory capital of such subsidiaries at December 31, 1992. Annual dividends in excess of maximum amounts prescribed by state statutes (so-called "extraordinary dividends") may not be paid without the approval of the insurance commissioner of each state of domicile.
Insurance departments in the states where the Company's life insurance subsidiaries are domiciled or do business require insurance companies to make annual and quarterly filings. Portions of surplus, called the interest maintenance reserve ("IMR") and the asset valuation reserve ("AVR"), are required to be appropriated and reported as liabilities. The IMR captures all investment gains and losses resulting from changes in interest rates and provides for subsequent amortization of such amounts into statutory net income on a basis reflecting the remaining lives of the assets sold. The AVR captures investment gains and losses related to changes in creditworthiness; it is also adjusted each year based on a formula related to the quality and loss experience of the Company's investment portfolio. These reserves affect the ability of the Company's insurance subsidiaries to reflect investment gains and losses in statutory earnings and surplus.
Credit-tenant loans are loans for commercial properties. When we make these loans: (i) the lease of the principal tenant must be assigned to Conseco; (ii) the lease must produce adequate cash flow to fund substantially all the requirements of the loan; and (iii) the principal tenant or the guarantor of such tenant's obligations must have an investment-grade credit rating when the loan is made. These loans also must be secured by the value of the related property. Our underwriting guidelines take into account such factors as:(i) the lease term of the property; (ii) the borrower's management ability, including business experience, property management capabilities and financial soundness; and (iii) such economic, demographic or other factors that may affect the income generated by the property, or its value. The underwriting guidelines generally require a loan-to-value ratio of 75 percent or less. We carry both credit-tenant loans and traditional mortgage loans at amortized cost.
On November 9, 1992, Partnership I acquired BLH from Southwestern Life Corporation (formerly I.C.H. Corporation, and referred to in this report as "Southwestern Life"). The purchase price of $600.0 million was funded with the net proceeds of the following securities issued by BLH: (i) $175.0 million senior notes to a group of lending banks; (ii) $200.0 million senior subordinated notes; (iii) $45.0 million payment-in-kind junior subordinated notes (including $8.3 million provided by Conseco and $34.7 million provided by Southwestern Life); (iv) $158.3 million of payment-in-kind preferred stock (of which $108.3 million was provided by Conseco and $50.0 million was provided by Southwestern Life); and (v) $66.7 million of common stock of BLH, including $16.7 million directly provided by Southwestern Life and $50.0 million provided by Partnership I (including $25.5 million provided by Conseco and $9.6 million provided by Southwestern Life). None of the BLH notes are direct obligations of Conseco. As a result of this acquisition, Conseco owned approximately 44 percent of the common equity interest in BLH through its direct investments and investments in Partnership I. For accounting convenience, the acquisition was reported as of November 1, 1992, and Conseco made adjustments to reflect financing costs for the period between that date and the actual date of acquisition, November 9, 1992.
Investments in mortgage-backed securities at December 31, 1994, included collateralized mortgage obligations ("CMOs") of $2,042.7 million and mortgage-backed pass-through securities of $516.4 million. The following table sets forth the par value, amortized cost and estimated fair value of investments in mortgage-backed securities at December 31, 1994, summarized by interest rates on the underlying collateral at December 31, 1994:
As part of its investment strategy, the Company enters into reverse repurchase agreements and dollar-roll transactions to increase its return on investments and improve its liquidity. These transactions are accounted for as short-term collateralized borrowings. Such borrowings averaged approximately $208.0 million during 1994 (compared to an average of $431.0 million during 1993) and were collateralized by investment securities with fair values approximately equal to the loan value. The weighted average interest rate on short-term collateralized borrowings was 3.7 percent in 1994 and 2.4 percent in 1993.
The Company has ceded certain policy liabilities under assumption reinsurance agreements. Since all of Conseco's obligations under the insurance contracts have been ceded to another company, insurance liabilities related to such policies were not reported in the balance sheet. Conseco believes the assuming companies are able to honor all contractual commitments under the assumption reinsurance agreements, based on its periodic reviews of financial statements, insurance industry reports and reports filed with state insurance departments.
At December 31, 1994, Conseco had federal income tax loss carryforwards of $314.2 million were available (subject to various statutory restrictions) for use on future tax returns. Portions of these carryforwards begin expiring in 1999. Of the loss carryforwards, $50.3 million may be used to offset income only from the non-life insurance companies. None of the carryforwards are available to reduce the tax provision for financial reporting purposes.
On the Acquisition date, Statesman's notes payable included $69.0 million par value Convertible Subordinated Debentures ("Debentures") due 2003. Interest on the Debentures is payable semiannually on May 1 and November 1. Prior to the Acquisition, the Debentures were convertible into shares of Statesman's common stock at a conversion ratio of 65.625 shares of common stock for each $1,000 principal amount of Debentures. As a result of the Acquisition, holders of the Debentures are entitled to receive at their option the same consideration given to the holders of Statesman common stock for each share of Statesman common stock into which such securities were convertible prior to the Acquisition. Through December 31, 1994, Debentures with a principal amount of $44.8 million have been redeemed. Cash required to pay all outstanding Debentures, including the optional conversion consideration is held in escrow until the Debentures are converted, redeemed or mature. The Debentures are redeemable, in whole or in part, at the option of Statesman, at any time, on or after May 1, 1996, initially at 106 percent of the principal amount and declining to 100 percent of the principal amount on or after May 1, 1999.
Prior to the Acquisition, Statesman entered into several contracts to hedge interest rate risks. At the date of the Acquisition, these contracts had ceased to effectively hedge the risks and were recorded at their fair value pursuant to purchase accounting. Conseco accounts for these contracts at estimated fair value with changes in fair value reflected in earnings as they occur.
- As to $250 million notional amount, at the amount of the LIBOR increase in excess of .50 percent every six months,
In February 1994, Conseco implemented an option exercise program under which its chief executive officer and four of its executive vice presidents exercised outstanding options to purchase approximately 3.6 million shares of the Company's common stock. The options would otherwise have remained exercisable until the years 1999 and 2000. As a result of the exercise, the Company realized a tax deduction equal to the aggregate tax gain recognized by the executives. The tax benefit of $67.8 million (net of payroll taxes incurred of $2.9 million) and the proceeds from the exercise of these options of $15.4 million were reflected as increases to common stock and paid-in capital. The Company withheld sufficient shares to cover federal and state taxes owed by the executives as a result of the exercise transactions. Net of withheld shares, the Company issued approximately 1.8 million common shares to the executives. The Company also granted to the executive officers new options to purchase a total of 3,016,000 shares of the Company's common stock at $59.25 per share (the market price at the date of such grant) under the 1994 Stock and Incentive Plan to replace the shares surrendered for taxes and the exercise price on these and other recent option exercises and as the 1994 incentive grant to the executives.
The following non-cash items were not reflected in the consolidated statement of cash flows in 1994: (i) recapture of insurance liabilities and invested assets totaling $390.2 million and $371.0 million, respectively, described in note 6; (ii) redemption of Debentures of a subsidiary with principal amount of $44.8 million using segregated cash; and (iii) the tax benefit of $69.2 million related to issuance of Conseco's common stock under employee benefit plans. The following non cash-items were not reflected in 1993: (i) the surrender for redemption $50.0 million stated value of Southwestern Life preferred stock in exchange for common shares of BLH (as described in note 2 to the consolidated financial statements); (ii) recapture of insurance liabilities and invested assets each totaling approximately $338.5 million in connection with the recapture of reinsurance as described in note 6 to the consolidated financial statements; and (iii) the tax benefit of $15.3 million related to issuance of Conseco's common stock under employee benefit plans.