USAID Situation Report on Kunduz and Takhar Provinces
Conseco tranfer to work-out
1. M E M O R A N D U M
To Olen Honeyman
From Ned McDonnell
Date 28-Feb-02
Re Conseco, Inc. (“Conseco”)
Conclusion. Reassignment of Conseco to the work-out group is now warranted given the
findings presented below. The premise underlying any argument in favor of Conseco is that it has
held embedded value in its insurance reserves to enable the life companies sufficient to bail out
the finance company’s operation. The life operation does not have the wherewithal, as a
continuing operation, to allow for payment of all debt back as scheduled. Conseco is likely to fail.
Purpose. To….
summarize an analysis of the core profitability of underlying operations;
forecast operating performance over the next 10 years if current performance remains
constant or if the life insurance operations are placed into run-off;
assess the ability of the life insurers to assume most or all of the debt issued by Conseco
Finance Corporation (“CFC”); and,
identify the prospect of full and timely repayment of the $11.4bn of debt outstanding.
Please note that, of the $11.4bn of debt, 18% has been provided by Conseco’s relationship banks
while roughly 10% represents repo agreements with investment banks, referenced written against
loans by CFC for mobile homes. For this paper, the credit officer assumes that Conseco has to re-
pay all of the debt and that the collateral underlying the repo lines has little recovery value.
Conseco’s dilemma. If Conseco gradually liquidates itself through a run-off of the insurance
lines, there is a possibility that it can pay down the debt over the next eight to ten years. Barring
financial interventions by outside investors, the outstanding bank lines have less than a 50%
chance of eventual repayment; the loans will almost certainly be extended beyond Dec-05, the
current maturity dates.
The assumptions underlying the projections rely on current performance, which may not be
accurate going-forward. For example, the 7% investment yield forecast over the next few
years may be unrealistically high given low interest rates and a sluggish economy.
There is evidence to suggest that recovery values on defaulted finance receivables,
particularly in the mobile home financing unit, may be overstated.
CFC’s ability to sell assets is limited since its book of business has contracted by one-third
over the past two years.
The forecasts do not assess the impact of adverse selection as the health care books run off;
that is, the people who are most likely to claim under their nursing home policies will likely
hold onto those policies while their healthier compatriots will more likely lapse their policies.
Regulators may not allow Conseco to upstream as $2-4bn of discretionary health insurance
reserves – as policyholders lapse – from the regulated health insurance subsidiaries.
The embedded value of the life reserves has been diminished with weaker asset quality and
the industry-wide erosion of whole life policy sales (where such value typically lies).
Since the Conseco G.A.A.P. statements are unclear about the impact of asset sales on debt
repayment, granting Conseco the benefit of the doubt by adding all proceeds in after-the-fact
may exaggerate the debt reduction attained. These projections grant Conseco the $1.8bn
benefit of the doubt.
The company is under pressure not to re-price “guaranteed renewable” policies at exorbitant
levels to pocket the premiums already paid in by policyholders forced out.
Though the health insurance contracts relieve Conseco of any future obligation upon their
lapsation, recent court settlements and regulatory actions have found Conseco guilty of
2. predatory sales practices; Conseco will have to reinstate previously lapsed long-term care
policies at affordable prices.
Further, for those long-term care customers whom Conseco deliberately priced out of the
market on renewal dates, the company will be required to reimburse them for premiums
previously paid.
Review of forecasts. As detailed in the spreadsheets themselves, the assumptions applied to the
model project the current performance forward through 2010. CFC’s performance, despite efforts
to cut away the ‘old Conseco’, does not appear to be profitable. CFC’s loan book shrinks by 40%
while pre-tax losses exceed $550m through 2007, as indicated by the following data:
$m 2001pro-forma 2002E 2003E 2004E 2005E 2006E 2007E
Pre-tax Inc. 36 -123 -13 -81 -88 -120 -147
Net Worth 1,182 1,040 1,016 965 911 836 745
Non-perform%1
2.5% 2.5% 2.5% 2.5% 2.4% 2.4% 2.4%
In this context of chronic losses at CFC, the projections indicate increasing doubt about
Conseco’s ability to re-pay all of the group’s debt. It is likely that, outside of a bail-out
contractual maturity date of Dec-05. The results presented below include the CFC operations.
(Exclusion of CFC from the projections does not change results materially since these forecasts
allow for no cash to be upstreamed from CFC).
GOING CONCERN 2001pro-forma 2002E 2003E 2004E 2005E 2006E 2007E
Premiums ($m) 5,718 5,741 5,567 5,590 5,526 5,517 5,554
Revenues 8,544 8,595 8.543 8,274 8,123 8,020 7,991
Net Income -417 247 374 427 430 445 463
Assets (excl. Sep Accts) 49,538 44,609 44,547 44,452 44,382 44,559 44,793
Debt 7,211 6,554 6,252 5,871 5,661 5,329 4,949
G.A.A.P. Net Worth 4,946 2,994 2,485 1,886 1,584 2,085 2,556
run-off 2001pro-forma 2002E 2003E 2004E 2005E 2006E 2007E
Premiums ($m) 5,718 4,409 3,713 3,161 2,704 2,343 2,046
Revenues 8,518 7,263 6,582 5,804 5,204 4,688 4,259
Net Income 434 1,126 1,008 950 910 840 773
Assets (excl. Sep Accts) 49,538 43,691 43,153 41,871 40,568 39,384 38,355
Debt 7,880 6,708 5,838 4,783 3,787 2,788 1,803
G.A.A.P. Net Worth 3,456 4,127 4,393 4,582 4,607 4,525 4,393
Reflections. Despite the unappreciated integrity that the current chairman, Gary Wendt, has
exercised, apologists (e.g., the author of this paper) have run out of excuses for Conseco. There is
substantial cause for pause and questioning:
1. Wendt has consistently brushed off bad new as manifestations of the “old Conseco”. Yet he
has headed the company for 19 months – this refrain is threadbare.
2. Apologists have been arguing that Conseco is at its “lowest of low” points…for five years.
Poor performance for so long indicates a failing business model, not a current issue.
3. While writing down the “I/O” securities is justified, the fact that the larger group has not
written off any goodwill is inconsistent with the actions taken on the “I/O” security.
4. The “A-“ Best rating is pivotal to the viability of Conseco’s life-and-health operations in the
market-place. This rating is increasingly out of harmony with the financial strength
downgrades recently issued by Moody’s, S.&P. and Fitch into the single-B level.
cc M.Cohen; S.Wade; R.Wood; C.Simon; S.Isquith; K.Gidwani; C.Kohler.
1
Historically, this rate has been 1.5%
7. Attachment III; 28-Feb-02
NOTE on Methodology. I have reviewed the statutory statements of the Conseco life insurers (i.e.,
fifteen companies) and modelled the performance of Conseco Finance Corp. (“CFC”). I conducted a
series of four projections: two extending current / actual performance ratioes indefinitely and two
others placing the business into run-off immediately; these scenarioes are further differentiated by
including CNC Finance in two of the projections and excluding finance results in the other two.
There are some implicit assumptions underlying the four scenarioes.
Conseco’s performance during every period in the future will deviate from current results.
If management decides to liquidate any part of Conseco’s life operations, it will liquidate them all
through a run-off of the current books of business and that attrition starts immediately.
That creditors will let Conseco term out debt whenever it wants to do so.
That Conseco’s Best’s rating remains at “A1” at least when it remains a going concern.
There will be no adverse selection of the life / health book.
Conseco will be unable to release discretionary health reserves when it wants to.
None of the sales proceeds have been realized by the company.
The yield curve will remain perfectly flat at all times.
There will be no acceleration of annuity surrenders or lapses no matter what the publicity.
There will be no inflation of expenses, commission rates, premiums or claims-payments
There will be no regulatory interference when Conseco seeks to upstream dividends from the life
companies or from Conseco Finance.
That Conseco will not seek to spin-off Conseco Finance.
That there is no mis-estimation of recovery values on mobile homes and other assets financed by
Conseco Finance.
That Conseco Finance will have indefinite access to the A.B.S. market.
Obviously, some or even many of these assumption will not manifest themselves over the next
decade. Nevertheless, the uncertainty imposed by not knowing the future does not preclude the
forecasts from accurately assessing the company’s prospects in the years ahead. These several
assumptions yield the following parameters in the scenarioes.
Ongoing Ongoing Run-off Run-off
with CFC without CFC with CFC without CFC
Holding Co. Debt Rate2
7.8% 7.8% 7.8% 7.9%
% of debt o/s in 20103
37% 41% Paid in 2008 Paid in 2008
% debt + Trust Pfd o/s in 2010 50% 53% 8.2% 10.0%
Revenue Growth -5.58% -0.57% -9.66% -9.93%
Lapse Rate 10.9% 10.9% 10.9% 10.9%
Invt Yield 6.9% 6.9% 7.1% 7.1%
Insurance Equity Ratio 6.1% 6.1% 11.8% 11.8%
GAAP Net Worth Ratio 7.2% 8.2% 10.8% 14.1%
On the following pages of this attachment are the templates used to extrapolate the future performance
of the life companies as well as that of Conseco Finance.
2
includes rate on trust preferred stock; S&P declared that it would view deferred payments on trust preferred as
equivalent to defaults on corporate debt.
3
includes trust preferred
8. Attachment III; 28-Feb-02
Conseco computational worksheet; blue cells are inputs without reference to statutories; and, red
cells are manually input based on calculations from Blue-book
Actual Pro-forma Projected
Conseco life & Health Subsidiary FYE 12/2000 2001 2002
Life & Health Premiums : Previous Year $0 $0 $0
Annuity Deposits: Previous Year $0 $0 $0
Life & Health Lapse Rate 0.0% 0.0% 0.0%
Annuity Lapse Rate 0.0% 0.0% 0.0%
Macro-modifier of Lapse Rate 0.0% 0.0% 0.0%
Renewal Premiums $0 $0 $0
New Life & Health Premium Growth Rate 0.0% 0.0% 0.0%
New Deposit Growth Rate 0.0% 0.0% 0.0%
Macro-modifier of New Business Growth Rates 0.0% 0.0% 0.0%
New Life & Health Premiums $0 $0 $0
New Annuity Deposits $0 $0 $0
Investment Income #DIV/0! #DIV/0! #DIV/0!
Other Revenues $0 $0 $0
Total Revenues #DIV/0! #DIV/0! #DIV/0!
Loss Ratio #DIV/0! #DIV/0! #DIV/0!
Mortality Ratio & Morbidity Ratio #DIV/0! #DIV/0! #DIV/0!
Mortality/Morbidity Adverse Selection Modifier 0.0% 0.0% 0.0%
Surrender Rates on Annuities & Deposits 0.0% 0.0% 0.0%
Benefit Payments $0 $0 $0
Surrenders $0 $0 $0
Reserve Changes, including Separate Accounts $0 $0 $0
Commission Rate for New Business 0.0% 0.0% 0.0%
Intermediation Fees for New Annuities 0.0% 0.0% 0.0%
Renewal Commission Rates for Renewing Business 0.0% 0.0% 0.0%
Inflation modifier 0.0% 0.0% 0.0%
Commissions: Life & Health #DIV/0! #DIV/0! #DIV/0!
Commissions: Annuities $0 $0 $0
General Expenses #DIV/0! #DIV/0! #DIV/0!
Other expenses $0 $0 $0
Pre-tax Income #DIV/0! #DIV/0! #DIV/0!
Taxes #DIV/0! #DIV/0! #DIV/0!
Realized Net Capital Gains or (Losses) $0 $0 $0
Net Income #DIV/0! #DIV/0! #DIV/0!
Eligible Dividend Regulation: if the higher of income or 10% of surplus,
enter "0" to the left; if the lower, enter "1"; and, if uncertain, enter "0"
FYE 12/99 FYE 12/2000 2001 2002
Invested Assets $0 #DIV/0! #DIV/0! #DIV/0!
Affiliated Earning Investments $0 $0 $0 $0
Other Assets $0 #DIV/0! #DIV/0! #DIV/0!
Total Assets $0 #DIV/0! #DIV/0! #DIV/0!
Reserves $0 $0 $0 $0
Other Liabilities $0 #DIV/0! #DIV/0! #DIV/0!
Surplus $0 #DIV/0! #DIV/0! #DIV/0!
(includes asset valuation / interest maintenance reserves)
Reference: Affiliated stocks, already deducted
Eligible Dividends; raw calculation $0 #DIV/0! #DIV/0! #DIV/0!
Eligible Dividends: availability $0 #DIV/0! #DIV/0! #DIV/0!
Contributions to surplus $0 $0 $0 $0
9. Attachment III; 28-Feb-02
Actual Pro-forma Forecast
Conseco Finance Company FYE 12/2000 2001 2002
Interest Rate Earned on Assets 0% 0% 0%
Interest Expense on Assets 0% 0% 0%
Macro-adjustment: change in spreads (in b.p.s) 0.00 0.00
Core Commercial Managed receivables in run-off $0 $0 $0
Owned receivables $0 $0 $0
Growth Rate 0% 0% 0%
Loss Rate 0% 0% 0%
Non-performing Rate 0% 0% 0%
Macro-adjustment; degree of deterioration 0.00% 0.00%
Performing Earning Assets $0 $0 $0
Run-off of Commercial Managed Receivables $0 $0 $0
Owned receivables $0 $0 $0
Growth Rate 0% 0% 0%
Loss Rate 0% 0% 0%
Non-performing Rate 0% 0% 0%
Macro-adjustment; degree of deterioration 0.00% 0.00%
Performing Earning Assets $0 $0 $0
Origination & Other Transaction Fees 0% 0% 0%
Asset Management Fees 0% 0% 0%
Macro-adjustment for Structured Finance Competition
(in basis points)
0.00% 0.00%
Funds for Financing Assets $0 $0 $0
Funds Managed for Third Parties $0 $0 $0
REVENUES
Gross Interest Income $0 $0 $0
Cost of Funds $0 $0 $0
Origination and other fees $0 $0 $0
TOTAL Net FINANCIAL REVENUES $0 $0 $0
SG&A $0 $0 $0
Macro-adjustment for Inflation; degree of acceleration 0.00% 0.00%
Provision for Loan Losses $0 $0 $0
Profit Before Taxes $0 $0 $0
Income Taxes $0 $0 $0
0.0% 0.0% 0.0%
After-tax Securtization Gains; net of one-time charges $0 $0 $0
Net Income $0 $0 $0
Dividend Pay-out % (% of previous year income) 0.00% 0.00%
Operating cash flow $0 $0 $0
BALANCE SHEET FYE 12/2000 2001 2002
Finance Receivables $0 $0 $0
I/0 Securities from Securitization; svcg rights $0 $0 $0
Intangibles (Recbles from CNC; goodwill; svc rites) $0 $0 $0
Cash held as excess collateral for securitizations $0 $0 $0
Other Assets $0 $0 $0
Total Assets $0 $0 $0
NOTE:
Receivables Pledged as collateral $0 $0 $0
Receivables Sold in to off-balance sheet secured debt $0 $0 $0
LIABILITIES & EQUITY
Financing Debt $0 $0 $0
Other Liabilities $0 $0 $0
Equity $0 $0 $0