N-30B-2 1 wnicb.txt N-30B-2 Washington National Insurance Company Consolidated Financial Statements as of December 31, 2000 and 1999, and for the years ended December 31, 2000, 1999 and 1998 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholder Washington National Insurance Company In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, shareholder's equity and cash flows present fairly, in all material respects, the financial position of Washington National Insurance Company (the "Company") at December 31, 2000 and 1999, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. /s/ PricewaterhouseCoopers LLP ------------------------------ PricewaterhouseCoopers LLP April 24, 2001 1
WASHINGTON NATIONAL INSURANCE COMPANY CONSOLIDATED BALANCE SHEET December 31, 2000 and 1999 (Dollars in millions) ASSETS 2000 1999 ---- ---- Investments: Actively managed fixed maturities at fair value (amortized cost: 2000 - $1,560.6; 1999 - $1,780.4)............................................... $1,498.1 $1,670.1 Mortgage loans..................................................................... 77.0 86.0 Policy loans....................................................................... 53.8 55.3 Other invested assets ............................................................. 71.5 64.0 --------- -------- Total investments............................................................ 1,700.4 1,875.4 Cash and cash equivalents.............................................................. 23.7 115.7 Accrued investment income.............................................................. 40.7 35.1 Cost of policies purchased............................................................. 166.9 257.6 Cost of policies produced.............................................................. 32.3 39.2 Reinsurance receivables................................................................ 91.5 91.0 Goodwill............................................................................... 59.4 60.7 Assets held in separate accounts....................................................... 48.6 59.1 Other assets........................................................................... 7.0 7.0 -------- -------- Total assets................................................................. $2,170.5 $2,540.8 ======== ========
(continued on next page) The accompanying notes are an integral part of the financial statements. 2
WASHINGTON NATIONAL INSURANCE COMPANY CONSOLIDATED BALANCE SHEET (Continued) December 31, 2000 and 1999 (Dollars in millions, except per share amount) LIABILITIES AND SHAREHOLDER'S EQUITY 2000 1999 ---- ---- Liabilities: Insurance liabilities.............................................................. $1,663.4 $1,891.7 Liabilities related to separate accounts........................................... 48.6 59.1 Income tax liabilities............................................................. 15.0 17.5 Investment borrowings.............................................................. 17.4 69.7 Other liabilities.................................................................. 72.9 97.3 -------- -------- Total liabilities.......................................................... 1,817.3 2,135.3 -------- -------- Shareholder's equity: Common stock and additional paid-in capital (par value $5.00 per share, 5,250,000 shares authorized, 5,007,370 shares issued and outstanding)..................... 382.5 382.9 Accumulated other comprehensive loss............................................... (20.1) (27.7) Retained earnings (accumulated deficit)............................................ (9.2) 50.3 -------- -------- Total shareholder's equity................................................. 353.2 405.5 -------- -------- Total liabilities and shareholder's equity................................. $2,170.5 $2,540.8 ======== ========
The accompanying notes are an integral part of the financial statements. 3
WASHINGTON NATIONAL INSURANCE COMPANY CONSOLIDATED STATEMENT OF OPERATIONS for the years ended December 31, 2000, 1999 and 1998 (Dollars in millions) 2000 1999 1998 ---- ---- ---- (Dollars in millions) Revenues: Insurance policy income........................................ $151.5 $150.5 $161.1 Net investment income.......................................... 132.4 156.3 148.5 Net gains (losses) from sale of investments.................... (15.7) (6.9) 9.9 Other ......................................................... .1 (.4) 6.2 ------ ------ ------ Total revenues............................................. 268.3 299.5 325.7 ------ ------ ------ Benefits and expenses: Insurance policy benefits...................................... 177.0 168.2 205.1 Amortization of cost of policies produced and purchased ............................................... 23.4 20.8 29.8 Other operating costs and expenses............................. 41.3 24.1 27.7 ------ ------ ------ Total benefits and expenses................................ 241.7 213.1 262.6 ------ ------ ------ Income before income taxes and minority interest........... 26.6 86.4 63.1 Income tax expense................................................ 8.4 30.1 23.2 ------ ------ ------ Income before minority interest............................ 18.2 56.3 39.9 Minority interest................................................. - 3.9 6.3 ------ ------ ------ Net income................................................. $ 18.2 $ 52.4 $ 33.6 ====== ====== ======
The accompanying notes are an integral part of the financial statements. 4
WASHINGTON NATIONAL INSURANCE COMPANY CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY for the years ended December 31, 2000, 1999 and 1998 (Dollars in millions) Retained Common stock Accumulated other earnings and additional comprehensive (accumulated Total paid-in capital income (loss) deficit) ----- --------------- ------------- -------- Balance, December 31, 1997.................................. $282.1 $273.2 $ 6.6 $ 2.3 Comprehensive income, net of tax: Net income............................................... 33.6 - - 33.6 Change in unrealized appreciation (depreciation) of securities (net of applicable income tax benefit of $.5)........................................ (7.5) - (7.5) - ------ Total comprehensive income......................... 26.1 Dividends on common stock................................ (14.0) - - (14.0) ------ ------ ------ ------ Balance, December 31, 1998.................................. 294.2 273.2 (.9) 21.9 Comprehensive income, net of tax: Net income............................................... 52.4 - - 52.4 Change in unrealized appreciation (depreciation) of securities (net of applicable income tax expense of $12.5).............................................. (23.2) - (23.2) - ------ Total comprehensive income......................... 29.2 Cash capital contribution from parent.................... 50.0 50.0 - - Contribution of remaining equity interest in subsidiary by parent.............................................. 56.1 59.7 (3.6) - Dividends on common stock................................ (24.0) - - (24.0) ------ ------ ------ ------ Balance, December 31, 1999.................................. 405.5 382.9 (27.7) 50.3 Comprehensive income, net of tax: Net income............................................... 18.2 - - 18.2 Change in unrealized appreciation (depreciation) of securities (net of applicable income tax expense of $4.1)............................................. 7.6 - 7.6 - ------ Total comprehensive income......................... 25.8 Other.................................................... (.4) (.4) - - Dividends on common stock................................ (77.7) - - (77.7) ------ ------ ------ ------ Balance, December 31, 2000.................................. $353.2 $382.5 $(20.1) $ (9.2) ====== ====== ====== ======
The accompanying notes are an integral part of the financial statements. 5
WASHINGTON NATIONAL INSURANCE COMPANY CONSOLIDATED STATEMENT OF CASH FLOWS for the years ended December 31, 2000, 1999 and 1998 (Dollars in millions) 2000 1999 1998 ---- ---- ---- (Dollars in millions) Cash flows from operating activities: Net income..................................................... $ 18.2 $ 52.4 $ 33.6 Adjustments to reconcile net income to net cash provided (used) by operating activities: Amortization and depreciation.............................. 25.1 22.9 34.3 Income taxes............................................... (6.8) 25.7 5.8 Insurance liabilities...................................... 19.7 (8.4) (28.1) Accrual and amortization of investment income.............. (.4) (1.0) 9.4 Deferral of cost of policies produced and purchased........ (10.1) (20.1) (28.1) Net (gains) losses from sale of investments................ 15.7 6.9 (9.9) Other...................................................... (23.4) (32.9) (18.9) ------- ------- --------- Net cash provided (used) by operating activities....... 38.0 45.5 (1.9) ------- ------- --------- Cash flows from investing activities: Sales of investments........................................... 390.1 702.6 1,568.2 Maturities and redemptions..................................... 10.0 39.5 283.3 Purchases of investments....................................... (263.4) (643.5) (1,748.5) ------- ------- --------- Net cash provided by investing activities.............. 136.7 98.6 103.0 ------- ------- --------- Cash flows from financing activities: Capital contribution........................................... - 50.0 - Deposits to insurance liabilities.............................. 77.6 87.4 119.8 Investment borrowings.......................................... (52.3) 21.6 48.1 Withdrawals from insurance liabilities......................... (260.8) (229.2) (232.8) Dividends paid on common stock................................. (31.2) (24.0) (14.0) ------- ------- --------- Net cash used by financing activities.................. (266.7) (94.2) (78.9) ------- ------- --------- Net increase (decrease) in cash and cash equivalents.................................... (92.0) 49.9 22.2 Cash and cash equivalents, beginning of period.................... 115.7 65.8 43.6 ------- ------- --------- Cash and cash equivalents, end of period.......................... $ 23.7 $ 115.7 $ 65.8 ======= ======= =========
The accompanying notes are an integral part of the financial statements. 6 WASHINGTON NATIONAL INSURANCE COMPANY Notes to Financial Statements ------------------------------ 1. SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation On December 5, 1997, Conseco, Inc. ("Conseco") completed the acquisition of Washington National Insurance Company ("we" or the "Company"). Shareholders of the Company's former parent received $33.25 in cash per common share. The acquisition was accounted for using the push-down purchase method of accounting with an effective date of December 1, 1997. Under this method, the total cost to acquire the Company was allocated to the assets and liabilities based on their fair value, with the excess of the total purchase cost over the fair value of the net assets acquired recorded as goodwill. The Company and its subsidiary are life insurance companies domiciled in Illinois and Indiana, respectively, which develop, market and administer annuity, individual life insurance, individual and group accident and health insurance and other insurance products. Conseco is a financial services holding company with subsidiaries operating throughout the United States. Conseco's insurance subsidiaries develop, market and administer supplemental health insurance, annuity, individual life insurance and other insurance products. Conseco's finance subsidiaries originate, securitize and service manufactured housing, home equity, retail credit and floorplan loans. Conseco's operating strategy is to grow its business by focusing its 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. On June 30, 1999, our parent made a contribution to our capital consisting of the 28.7 percent interest in United Presidential Life Insurance Company ("UPI") we did not previously own. The value contributed of $56.1 million was recorded based on carrying value. Prior to June 30, 1999, the operations of UPI were consolidated in our financial statements, with our parent's ownership interest recorded as minority interest. The following summary explains the accounting policies we use to prepare our financial statements. We prepare our financial statements in accordance with generally accepted accounting principles ("GAAP"). We follow the accounting standards established by the Financial Accounting Standards Board ("FASB"), the American Institute of Certified Public Accountants and the Securities and Exchange Commission. Investments Fixed maturities are securities that mature more than one year after issuance and include bonds, notes receivable and redeemable preferred stock. Fixed maturities that we may sell prior to maturity are classified as actively managed and are carried at estimated fair value, with any unrealized gain or loss, net of tax and related adjustments, recorded as a component of shareholder's equity. Fixed maturity securities that we intend to sell in the near term are classified as trading and are included in other invested assets. We include any unrealized gain or loss on trading securities in net investment gains. Mortgage loans held in our investment portfolio are carried at amortized unpaid balances, net of provisions for estimated losses. Policy loans are stated at their current unpaid principal balances. 7 WASHINGTON NATIONAL INSURANCE COMPANY Notes to Financial Statements ------------------------------ Other invested assets include trading securities and certain non-traditional investments. Non-traditional investments include investments in certain limited partnerships, mineral rights and promissory notes; we account for them using either the cost method, or for investments in partnerships over whose operations the Company exercises significant influence, the equity method. We defer any fees received or costs incurred when we originate investments (primarily mortgage loans). We amortize fees, costs, discounts and premiums as yield adjustments over the contractual lives of the investments. We consider anticipated prepayments on mortgage-backed securities in determining estimated future yields on such securities. When we sell a security (other than a trading security), we report the difference between the sale proceeds and amortized cost (determined based on specific identification) as an investment gain or loss. We regularly evaluate all of our investments based on current economic conditions, credit loss experience and other investee-specific developments. If there is a decline in a security's net realizable value that is other than temporary, we treat it as a realized loss and reduce our cost basis of the security to its estimated fair value. Cash and Cash Equivalents Cash and cash equivalents include commercial paper, invested cash and other investments purchased with original maturities of less than three months. We carry them at amortized cost, which approximates estimated fair value. Assets Held in Separate Accounts Separate accounts are funds on which investment income and gains or losses accrue directly to certain policyholders. The assets of these accounts are legally segregated. They are not subject to the claims that may arise out of any other business of the Company. We report separate account assets at market value; the underlying investment risks are assumed by the contract holders. We record the related liabilities at amounts equal to the market value of the underlying assets. We record the fees earned for administrative and contractholder services performed for the separate accounts in insurance policy income. Cost of Policies Produced 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. When we realize a gain or loss on investments backing our universal life or investment-type products, we adjust the amortization to reflect the change in estimated gross profits from the products due to the gain or loss realized and the effect of the event on future investment yields. We also adjust the cost of policies produced for the change in amortization that would have been recorded if actively managed fixed maturity securities had been sold at their stated aggregate fair value and the proceeds reinvested at current yields. We include the impact of this adjustment in accumulated other comprehensive income (loss) within shareholder's equity. Each year, we evaluate the recoverability of the unamortized balance of the cost of policies produced. We consider estimated future gross profits or future premiums, expected mortality or morbidity, interest earned and credited rates, persistency and expenses in determining whether the balance is recoverable. If we determine a portion of the unamortized balance is not recoverable, it is charged to amortization expense. 8 WASHINGTON NATIONAL INSURANCE COMPANY Notes to Financial Statements ------------------------------ Cost of Policies Purchased The cost assigned to the right to receive future cash flows from contracts existing at the date of an acquisition is referred to as the cost of policies purchased. We also defer renewal commissions paid in excess of ultimate commission levels related to the purchased policies in this account. The balance of this account is amortized, evaluated for recovery, and adjusted for the impact of unrealized gains (losses) in the same manner as the cost of policies produced described above. The discount rate we use to determine the value of the cost of policies purchased is the rate of return we need to earn in order to invest in the business being acquired. In determining this required rate of return, we consider many factors including: (i) the magnitude of the risks associated with each of the actuarial assumptions used in determining expected future cash flows; (ii) the cost of our capital required to fund the acquisition; (iii) the likelihood of changes in projected future cash flows that might occur if there are changes in insurance regulations and tax laws; (iv) the acquired company's compatibility with other Company activities that may favorably affect future cash flows; (v) the complexity of the acquired company; and (vi) recent prices (i.e., discount rates used in determining valuations) paid by others to acquire similar blocks of business. Goodwill Goodwill is the excess of the amount paid to acquire the Company over the fair value of its net assets. Our analysis indicates that the anticipated ongoing cash flows from the earnings of the Company extends beyond the maximum 40-year period allowed for goodwill amortization. Accordingly, we amortize goodwill on the straight-line basis generally over a 40- year period. The total accumulated amortization of goodwill was $4.9 million and $3.6 million at December 31, 2000 and 1999, respectively. 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 our earnings over the remaining amortization period. At December 31, 2000, goodwill is also recoverable from projected net cash flows from estimated earnings (including earnings on projected amounts of new business consistent with the Company's business plan), discounted at rates we believe are appropriate for the business. If we were to determine that changes in undiscounted 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). Recognition of Insurance Policy Income and Related Benefits and Expenses on Insurance Contracts Generally, we recognize insurance premiums for traditional life and accident and health contracts as earned over the premium-paying periods. We establish reserves for future benefits on a net-level premium method based upon assumptions as to investment yields, mortality, morbidity, withdrawals and dividends. We record premiums for universal life-type and investment-type contracts that do not involve significant mortality or morbidity risk as deposits to insurance liabilities. Revenues for these contracts consist of mortality, morbidity, expense and surrender charges. We establish reserves for the estimated present value of the remaining net costs of all reported and unreported claims. Reinsurance In the normal course of business, we seek to limit our exposure to loss on any single insured or to certain groups of policies by ceding reinsurance to other insurance enterprises. We currently retain no more than $.3 million of mortality risk on any one policy. We diversify the risk of reinsurance loss by using a number of reinsurers that have strong claims-paying ratings. If any reinsurer could not meet its obligations, the Company would assume the liability. The likelihood of a material loss being incurred as a result of the failure of one of our reinsurers is considered remote. The cost of reinsurance is recognized over the life of the reinsured policies using assumptions consistent with those used to account for the underlying policy. The cost of reinsurance ceded totaled $46.9 million, $50.4 million and $41.7 million for the years ended December 31, 2000, 1999 and 1998, respectively. A receivable is recorded for the reinsured portion of insurance policy benefits paid and liabilities for insurance products. Reinsurance recoveries netted against insurance policy benefits totaled $16.8 million, $21.7 million and $29.5 million in 2000, 1999 and 1998, respectively. 9 WASHINGTON NATIONAL INSURANCE COMPANY Notes to Financial Statements ------------------------------ At December 31, 2000, 1999 and 1998, approximately 38 percent, 34 percent and 51 percent, respectively, of our total reinsurance recoverables were from subsidiaries of Conseco. Income Taxes Our income tax expense includes deferred income taxes arising from temporary differences between the tax and financial reporting bases of assets and liabilities. In assessing the realization of deferred income tax assets, we consider whether it is more likely than not that the deferred income tax assets will be realized. The ultimate realization of deferred income tax assets depends upon generating future taxable income during the periods in which temporary differences become deductible. If future income is not generated as expected, deferred income tax assets may need to be written off (no such write-offs have occurred). Minority Interest Prior to June 30, 1999, our consolidated financial statements included all of the assets, liabilities, revenues and expenses of UPI, even though we did not own all of UPI's common stock. We made a charge against consolidated income for the share of earnings allocable to minority interests. We recorded the equity of UPI allocable to the minority interest separately on our consolidated balance sheet. On June 30, 1999, our parent made a contribution to our capital consisting of the 28.7 percent interest in UPI we did not previously own. Accordingly, there was no need for the minority interest charge in periods after that date. Investment Borrowings As part of our investment strategy, we may enter into reverse repurchase agreements and dollar-roll transactions to increase our investment return or to improve our liquidity. We account for these transactions as collateral borrowings, where the amount borrowed is equal to the sales price of the underlying securities. 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, with dollar rolls, the repurchase involves securities that are only substantially the same as the securities sold. Such borrowings averaged approximately $25.1 million during 2000 and $53.0 million during 1999. These borrowings 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 6.3 percent and 6.1 percent in 2000 and 1999, respectively. The primary risk associated with short-term collateralized borrowings is that a counterparty will be unable to perform under the terms of the contract. Our exposure is limited to the excess of the net replacement cost of the securities over the value of the short-term investments (such excess was not material at December 31, 2000). We believe the counterparties to our reverse repurchase and dollar-roll agreements are financially responsible and that the counterparty risk is minimal. Use of Estimates When we prepare financial statements in conformity with GAAP, we are required to make estimates and assumptions that significantly affect various reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting periods. For example, we use significant estimates and assumptions in calculating values for the cost of policies produced, the cost of policies purchased, goodwill, insurance liabilities, liabilities related to litigation, guaranty fund assessment accruals and deferred income taxes. If our future experience differs materially from these estimates and assumptions, our financial statements could be affected. Fair Values of Financial Instruments We use the following methods and assumptions to determine the estimated fair values of financial instruments: Investment securities. For fixed maturity securities (including redeemable preferred stocks) and for equity and trading securities, we use quotes from independent pricing services, where available. For investment securities for which such quotes are not available, we use values obtained from broker-dealer market makers or by discounting expected future 10 WASHINGTON NATIONAL INSURANCE COMPANY Notes to Financial Statements ------------------------------ cash flows using a current market rate appropriate for the yield, credit quality, and (for fixed maturity securities) the maturity of the investment being priced. Cash and cash equivalents. The carrying amount for these instruments approximates their estimated fair value. 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. The market value of policy loans approximates their carrying value. Other invested assets. We use quoted market prices, where available. When quotes are not available, we estimate the fair value based on: (i) discounted future expected cash flows; or (ii) independent transactions which establish a value for our investment. When we are unable to estimate a fair value, we assume a market value equal to carrying value. Insurance liabilities for interest-sensitive products. We discount future expected cash flows based on interest rates currently being offered for similar contracts with similar maturities. Investment borrowings. Due to the short-term nature of these borrowings (terms generally less than 30 days), estimated fair values are assumed to approximate the carrying amount reported in the balance sheet. Here are the estimated fair values of our financial instruments:
2000 1999 ----------------------- ------------------------- Carrying Fair Carrying Fair Amount Value Amount Value ------ ----- ------ ----- (Dollars in millions) Financial assets: Actively managed fixed maturities............................ $1,498.1 $1,498.1 $1,670.1 $1,670.1 Mortgage loans............................................... 77.0 78.1 86.0 86.7 Policy loans................................................. 53.8 53.8 55.3 55.3 Other invested assets........................................ 71.5 71.5 64.0 64.0 Cash and cash equivalents.................................... 23.7 23.7 115.7 115.7 Financial liabilities: Insurance liabilities for interest-sensitive products (1).... 1,318.9 1,318.9 1,531.6 1,531.6 Investment borrowings........................................ 17.4 17.4 69.7 69.7 -------------------- (1) The estimated fair value of the liabilities for interest-sensitive products was approximately equal to its carrying value at December 31, 2000 and 1999. This was because interest rates credited on the vast majority of account balances approximate current rates paid on similar products and because these rates are not generally guaranteed beyond one year. We are not required to disclose fair values for insurance liabilities, other than those for interest-sensitive products. However, we take into consideration the estimated fair values of all insurance liabilities in our overall management of interest rate risk. We attempt to minimize exposure to changing interest rates by matching investment maturities with amounts due under insurance contracts.
Recently Issued Accounting Standards Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), as amended by Statement of Financial Accounting Standards No. 137, "Deferral of the Effective Date of FASB Statement No. 133" and Statement of Financial Accounting Standards No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities" ("SFAS 138") 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 11 WASHINGTON NATIONAL INSURANCE COMPANY Notes to Financial Statements ------------------------------ transaction and, if it is, on the type of hedge transaction. We will adopt SFAS 133 as of January 1, 2001. Because of our minimal use of derivatives, we do not anticipate that the adoption of the new standard and implementation guidance approved by FASB prior to December 31, 2000, will have a material impact on the Company's financial position or results of operations. 2. INVESTMENTS: At December 31, 2000, the amortized cost and estimated fair value of actively managed fixed maturity securities were as follows:
Gross Gross Estimated Amortized unrealized unrealized fair cost gains losses value ---- ----- ------ ----- (Dollars in millions) Investment grade: Corporate securities................................................ $ 908.4 $1.1 $52.1 $ 857.4 United States Treasury securities and obligations of United States government corporations and agencies................ 22.6 .3 - 22.9 States and political subdivisions................................... 11.1 .3 - 11.4 Debt securities issued by foreign governments....................... 11.7 .1 .3 11.5 Mortgage-backed securities ......................................... 514.2 2.8 5.3 511.7 Below-investment grade (primarily corporate securities)................ 92.6 - 9.4 83.2 --------- ---- ----- -------- Total actively managed fixed maturities........................... $1,560.6 $4.6 $67.1 $1,498.1 ======== ==== ===== ========
At December 31, 1999, the amortized cost and estimated fair value of actively managed fixed maturity securities were as follows:
Gross Gross Estimated Amortized unrealized unrealized fair cost gains losses value ---- ----- ------ ----- (Dollars in millions) Investment grade: Corporate securities................................................ $1,092.9 $.3 $ 81.4 $1,011.8 United States Treasury securities and obligations of United States government corporations and agencies................ 21.9 - .5 21.4 States and political subdivisions................................... 11.9 - .1 11.8 Debt securities issued by foreign governments....................... 12.3 - .9 11.4 Mortgage-backed securities ......................................... 547.3 .1 26.2 521.2 Below-investment grade (primarily corporate securities)................ 94.1 .3 1.9 92.5 -------- --- ------ -------- Total actively managed fixed maturities........................... $1,780.4 $.7 $111.0 $1,670.1 ======== === ====== ========
12 WASHINGTON NATIONAL INSURANCE COMPANY Notes to Financial Statements ------------------------------ Accumulated other comprehensive loss is primary comprised of unrealized losses on actively managed fixed maturity investments. Such amounts, included in shareholder's equity as of December 31, 2000 and 1999, were summarized as follows:
2000 1999 ---- ---- (Dollars in millions) Unrealized losses on investments..................................................................... $(63.7) $(109.1) Adjustments to cost of policies purchased and cost of policies produced.............................. 32.1 65.8 Deferred income tax benefit.......................................................................... 11.5 15.6 ------ ------- Accumulated other comprehensive loss.......................................................... $(20.1) $ (27.7) ====== =======
The following table sets forth the amortized cost and estimated fair value of actively managed fixed maturities at December 31, 2000, by contractual maturity. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Most of the mortgage-backed securities shown below provide for periodic payments throughout their lives.
Estimated Amortized fair cost value ---- ----- (Dollars in millions) Due in one year or less........................................................................ $ 29.6 $ 29.6 Due after one year through five years.......................................................... 235.5 227.9 Due after five years through ten years......................................................... 207.2 197.5 Due after ten years............................................................................ 565.4 522.9 -------- -------- Subtotal.................................................................................. 1,037.7 977.9 Mortgage-backed securities (a)................................................................. 522.9 520.2 -------- -------- Total actively managed fixed maturities ............................................... $1,560.6 $1,498.1 ======== ======== -------------------- (a) Includes below-investment grade mortgage-backed securities with an amortized cost and estimated fair value of $8.7 million and $8.5 million, respectively.
Net investment income consisted of the following:
2000 1999 1998 ---- ---- ---- (Dollars in millions) Actively managed fixed maturity securities........................ $118.0 $125.0 $121.6 Mortgage loans.................................................... 7.8 10.0 16.7 Policy loans...................................................... 3.7 3.7 3.8 Other invested assets............................................. 3.1 16.2 7.2 Cash and cash equivalents......................................... 1.3 2.4 2.9 ------ ------ ------ Gross investment income........................................ 133.9 157.3 152.2 Investment expenses............................................... 1.5 1.0 3.7 ------ ------ ------ Net investment income........................................ $132.4 $156.3 $148.5 ====== ====== ======
13 WASHINGTON NATIONAL INSURANCE COMPANY Notes to Financial Statements ------------------------------ The Company had no significant fixed maturity investments or mortgage loans that were not accruing investment income in 2000, 1999 and 1998. Investment gains (losses), net of investment expenses, were included in revenue as follows:
2000 1999 1998 ---- ---- ---- (Dollars in millions) Fixed maturities: Gross gains.................................................... $ 1.7 $ 3.7 $17.1 Gross losses................................................... (10.0) (5.0) (3.7) Other than temporary decline in fair value..................... (3.0) - - ------ ----- ----- Net investment gains (losses) from fixed maturities before expenses................................................. (11.3) (1.3) 13.4 Other............................................................. (.6) .4 - ------ ----- ----- Net investment gains (losses) before expenses.............. (11.9) (.9) 13.4 Investment expenses............................................... 3.8 6.0 3.5 ------ ----- ----- Net investment gains (losses).............................. $(15.7) $(6.9) $ 9.9 ======= ===== ======
At December 31, 2000, the mortgage loan balance was primarily comprised of commercial loans. Approximately 22 percent, 13 percent, 8 percent, 6 percent and 6 percent of the mortgage loan balance were on properties located in California, Illinois, Indiana, Tennessee and Texas, respectively. No other state comprised greater than 5 percent of the mortgage loan balance. Noncurrent mortgage loans were insignificant at December 31, 2000. Our allowance for loss on mortgage loans was $2.0 million at both December 31, 2000 and 1999. Life insurance companies are required to maintain certain investments on deposit with state regulatory authorities. Such assets had an aggregate carrying value of $12.0 million at December 31, 2000. At December 31, 2000, the Company had investments in Carmel Fifth LLC, a real estate investment company, with an amortized cost and carrying value of $47.8 million and $47.7 million, respectively. The Company also holds preferred stock issued by a subsidiary of Conseco which has an amortized cost and carrying value of $40.0 million. The Company had no other investments in any single entity in excess of 10 percent of shareholder's equity at December 31, 2000, other than investments issued or guaranteed by the United States government or a United States government agency. 14 WASHINGTON NATIONAL INSURANCE COMPANY Notes to Financial Statements ------------------------------ 3. INSURANCE LIABILITIES: These liabilities consisted of the following:
Interest Withdrawal Mortality rate assumption assumption assumption 2000 1999 ---------- ---------- ---------- ---- ---- (Dollars in millions) Future policy benefits: Interest-sensitive products: Investment contracts............................ N/A N/A (b) $ 591.3 $ 771.1 Universal life-type contracts................... N/A N/A (b) 727.6 760.5 -------- -------- Total interest-sensitive products............. 1,318.9 1,531.6 -------- -------- Traditional products: Limited-payment contracts....................... Company (a) 4.8% 99.3 103.9 experience, if applicable Other traditional products...................... N/A N/A N/A 174.6 169.0 -------- -------- Total traditional products.................... 273.9 272.9 -------- -------- Claims payable and other policyholder funds ........ N/A N/A N/A 70.6 87.2 -------- -------- Total......................................... $1,663.4 $1,891.7 ======== ======== ------------- (a) Principally modifications of the 1965 - 70 Basic Tables. (b) This balance represents account balances because future benefits are not guaranteed.
4. INCOME TAXES: Income tax liabilities were comprised of the following:
2000 1999 ---- ---- (Dollars in millions) Deferred income tax liabilities (assets): Investments (primarily actively managed fixed maturities).................................. $ 7.2 $ 12.7 Cost of policies purchased and cost of policies produced................................... 51.0 74.6 Insurance liabilities...................................................................... (41.2) (58.6) Unrealized depreciation.................................................................... (11.5) (15.6) Other...................................................................................... (.8) - ------ ------ Deferred income tax liabilities....................................................... 4.7 13.1 Current income tax liabilities................................................................. 10.3 4.4 ------ ------ Income tax liabilities................................................................ $ 15.0 $ 17.5 ====== ======
Income tax expense was as follows:
2000 1999 1998 ---- ---- ---- (Dollars in millions) Current tax provision..................................... $ 21.0 $14.6 $17.2 Deferred tax provision (benefit).......................... (12.6) 15.5 6.0 ------ ----- ----- Income tax expense................................. $ 8.4 $30.1 $23.2 ====== ===== =====
15 WASHINGTON NATIONAL INSURANCE COMPANY Notes to Financial Statements ------------------------------ A reconciliation of the U.S. statutory corporate tax rate to the effective rate reflected in the statement of operations is as follows:
2000 1999 1998 ---- ---- ---- (Dollars in millions) U.S. statutory corporate rate............................... 35.0% 35.0% 35.0% Other....................................................... (3.4)% (.2)% 1.8% ---- ---- ---- Income tax expense................................. 31.6% 34.8% 36.8% ==== ==== ====
The Company is currently being examined by the Internal Revenue Service for the 1995 through 1998 tax years. The Company believes that the outcome of this examination will not have a material impact on its financial position or results of operations. 5. OTHER DISCLOSURES: Leases The Company rents office space, equipment and computer software under noncancellable operating leases. As a result of the sale of the Company's health insurance business in 1996 and the acquisition by Conseco, the Company entered into an agreement to sublease its home office building to ACCO, a subsidiary of American Brands. The building was leased from a joint venture partnership in which the Company has a one-third interest. ACCO took possession of approximately 80 percent of the building at the beginning of August 1997. A portion of the Company's operations occupied the remaining 20 percent of the building through February 15, 1998. Total rental expense was $1.1 million in 2000, $1.2 million in 1999 and $1.3 million in 1998. Future required minimum rental payments as of December 31, 2000, were as follows (dollars in millions): 2001........................................................ $ 3.7 2002........................................................ 3.6 2003........................................................ 3.6 2004........................................................ 3.7 2005........................................................ 3.7 Thereafter.................................................. 30.0 ----- Total....................... $48.3 =====
16 WASHINGTON NATIONAL INSURANCE COMPANY Notes to Financial Statements ------------------------------ Postretirement Plan The Company provides health care and life insurance benefits for certain eligible retired employees under a partially funded plan. Such postretirement benefit plan is contributory, with participants' contributions adjusted annually. Amounts related to the postretirement benefit plan was as follows:
2000 1999 ---- ---- (Dollars in millions) Benefit obligation, beginning of year......................................... $ 16.0 $ 19.5 Interest cost............................................................. 1.2 1.2 Plan participants' contributions.......................................... .3 .4 Actuarial gain............................................................ (.2) (3.4) Benefits paid............................................................. (1.8) (1.7) ------ ------ Benefit obligation, end of year............................................... $ 15.5 $ 16.0 ====== ====== Fair value of plan assets, beginning of year.................................. $ 4.3 $ 5.1 Actual return on plan assets.............................................. .4 .3 Plan participants' contributions.......................................... - .4 Benefits paid............................................................. (1.7) (1.5) ------ ------ Fair value of plan assets, end of year........................................ $ 3.0 $ 4.3 ====== ====== Funded status................................................................. $(12.5) $(11.7) Unrecognized net actuarial gain............................................... (12.0) (12.3) ------ ------ Accrued benefit liability.............................................. $(24.5) $(24.0) ====== ======
We used the following weighted average assumptions to calculate benefit obligations for our 2000 and 1999 valuations: discount rate of approximately 7.8 percent and 7.5 percent, respectively; and an expected return on plan assets of approximately 4.6 percent and 4.6 percent, respectively. For measurement purposes, we assumed a 8.6 percent annual rate of increase in the per capita cost of covered health care benefits for 2001, decreasing gradually to 5.0 percent in 2010 and remaining level thereafter. Components of the cost we recognized related to the postretirement plan were as follows:
2000 1999 1998 ---- ---- ---- (Dollars in millions) Interest cost.................................................. $1.2 $1.2 $1.3 Expected return of plan assets................................. (.2) (.2) (.2) Amortization of prior service cost............................. (.8) (.5) (.5) Recognized net actuarial loss.................................. - - (.1) ---- ---- ---- Net periodic benefit cost............................... $ .2 $ .5 $ .5 ==== ==== ====
A one-percentage-point change in the assumed health care cost trend rates would have an insignificant effect on the net periodic benefit cost of our postretirement benefit obligation. 17 WASHINGTON NATIONAL INSURANCE COMPANY Notes to Financial Statements ------------------------------ Litigation The Company and UPI are currently named defendants in a lawsuit filed in the Circuit Court of Claiborne County, Mississippi, Cause No. CV-99-0106, and captioned "Carla Beaugez, Lois Dearing, Lee Eaton and all other persons identified in the lawsuit v. Conseco, Inc., Conseco Services, Inc., Washington National Company, United Presidential Life Insurance Company and Larry Ratcliff." The claims of the eighty-seven plaintiffs arise out of allegedly wrongful increases of the cost of insurance and decrease in the credited interest rates on universal life policies issued to the plaintiffs by UPI. The plaintiffs asserted claims including negligent and intentional misrepresentation, fraudulent concealment, fraudulent inducement, common law fraud, and deceptive sales practices. The Company believes this lawsuit is without merit and is defending it vigorously. The ultimate outcome of this lawsuit cannot be predicted with certainty. In addition, the Company is involved on an ongoing basis in lawsuits related to its operations. Although the ultimate outcome of certain of such matters cannot be predicted, such lawsuits currently pending against the Company are not expected, individually or in the aggregate, to have a material adverse effect on the Company's financial condition, cash flows or results of operations. Guaranty Fund Assessments The balance sheet at December 31, 2000, includes: (i) accruals of $4.6 million, representing our estimate of all known assessments that will be levied against the Company by various state guaranty associations based on premiums written through December 31, 2000; and (ii) receivables of $.9 million that we estimate will be recovered through a reduction in future premium taxes as a result of such future and prior assessments. At December 31, 1999, such guaranty fund assessment related accruals were $6.4 million and such receivables were $2.2 million. 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 $.9 million in 2000, $.2 million in 1999 and $.3 million in 1998. Related Party Transactions The Company operates without direct employees through management and service agreements with subsidiaries of Conseco. Fees for such services (including data processing, executive management and investment management services) are based on Conseco's direct and directly allocable costs plus a 10 percent margin. Total fees incurred by the Company under such agreements were $27.6 million in 2000, $33.1 million in 1999 and $20.7 million in 1998. The Company holds $40.0 million of preferred stock issued by a subsidiary of Conseco, which is classified as "other invested assets" in the accompanying balance sheet for both 2000 and 1999. During 2000, the Company recorded dividends on common stock totaling $77.7 million. Such dividends to our parent consisted of: (i) cash dividends of $31.2 million; and (ii) the transfer of actively managed fixed maturity securities with a carrying value of $46.5 million. During 1999, the Company's parent made a $50.0 million cash contribution to the Company. 18 WASHINGTON NATIONAL INSURANCE COMPANY Notes to Financial Statements ------------------------------ 6. OTHER OPERATING STATEMENT DATA: Insurance policy income consisted of the following:
2000 1999 1998 ---- ---- ---- (Dollars in millions) Traditional products: Direct premiums collected............................................ $205.1 $214.7 $250.1 Reinsurance ceded.................................................... (46.9) (50.4) (41.7) ------ ------ ------ Premiums collected, net of reinsurance........................... 158.2 164.3 208.4 Less premiums on universal life and products without mortality and morbidity risk which are recorded as additions to insurance liabilities........................................................ 77.6 87.4 119.8 ------ ------ ------ Premiums on traditional products with mortality or morbidity risk, recorded as insurance policy income............................ 80.6 76.9 88.6 Fees and surrender charges on interest-sensitive products............... 70.9 73.6 72.5 ------ ------ ------ Insurance policy income.......................................... $151.5 $150.5 $161.1 ====== ====== ======
The five states with the largest shares of 2000 collected premiums were New Jersey (15 percent), Texas (10 percent), California (5 percent), Pennsylvania (5 percent) and Florida (5 percent). No other state accounted for more than 4 percent of total collected premiums. Changes in the cost of policies purchased were as follows:
2000 1999 1998 ---- ---- ---- (Dollars in millions) Balance, beginning of year................................ $257.6 $207.2 $218.5 Amortization........................................... (17.4) (17.5) (26.6) Amounts related to fair value adjustment of actively managed fixed maturities.................... (31.8) 66.1 3.2 Amount transferred to affiliate pursuant to modified coinsurance agreement................................ (33.8) - - Other ................................................. (7.7) 1.8 12.1 ------ ------ ------ Balance, end of year...................................... $166.9 $257.6 $207.2 ====== ====== ======
Based on current conditions and assumptions as to future events on all policies in force, the Company expects to amortize approximately 12 percent of the December 31, 2000, balance of cost of policies purchased in 2001, 10 percent in 2002, 8 percent in 2003, 7 percent in 2004 and 6 percent in 2005. The discount rates used to determine the amortization of the cost of policies purchased ranged from 4 percent to 7 percent and averaged 5.6 percent. 19 WASHINGTON NATIONAL INSURANCE COMPANY Notes to Financial Statements ------------------------------ Changes in the cost of policies produced were as follows:
2000 1999 1998 ---- ---- ---- (Dollars in millions) Balance, beginning of year................................ $39.2 $22.2 $ 2.7 Additions.............................................. 8.7 18.4 22.7 Amortization........................................... (6.0) (3.3) (3.2) Amounts related to fair value adjustment of actively managed fixed maturities.................... (1.9) 1.9 - Amount transferred to affiliate pursuant to modified coinsurance agreement................................ (7.7) - - ----- ----- ------ Balance, end of year...................................... $32.3 $39.2 $22.2 ===== ===== =====
7. STATEMENT OF CASH FLOWS: Income taxes paid totaled $14.5 million in 2000, $5.2 million in 1999 and $16.8 million in 1998. 8. STATUTORY INFORMATION: Statutory accounting practices prescribed or permitted by regulatory authorities for insurance companies differ from GAAP. The Company reported the following combined amounts to regulatory agencies:
2000 1999 ---- ---- (Dollars in millions) Statutory capital and surplus.................................................. $154.7 $209.3 Asset valuation reserve........................................................ 9.8 19.1 Interest maintenance reserve................................................... 28.0 39.4
Our combined statutory net income was $31.7 million, $46.2 million and $29.6 million in 2000, 1999 and 1998, respectively. During 2000, the Company recaptured previously ceded yearly renewable term reinsurance. The cumulative contribution to statutory basis capital and surplus from this reinsurance was nil, $3.7 million and $5.5 million for the years ended December 31, 2000, 1999 and 1998, respectively. These transactions did not materially impact the Company's GAAP financial statements. State insurance laws generally restrict the ability of insurance companies to pay dividends or make other distributions. During 2000, the Company paid dividends to its parent totaling $77.7 million, of which $59.0 million was considered an extraordinary dividend and was approved by the Illinois Department of Insurance. We may pay dividends to our parent in 2001 of $31.7 million without permission from state regulatory authorities. However, under State of Illinois insurance regulations, dividends may be paid only from earned surplus without prior approval. Therefore, the Company's unassigned surplus deficit must be eliminated before the Company can pay any dividends without prior approval. In 1998, the National Association of Insurance Commissioners adopted codified statutory accounting principles in a process referred to as codification. Such principles are summarized in the Accounting Practices and Procedures Manual. The revised manual is effective January 1, 2001. The revised manual has changed, to some extent, prescribed statutory accounting practices and will result in changes to the accounting practices that we use to prepare our statutory-basis financial statements. However, we believe the impact of these changes to our statutory-based capital and surplus as of January 1, 2001, will not be significant. 20 The registrant hereby incorporates by reference the March 15, 2001 Fundamental Investors Prospectus, file number 811-00032, filed with the Commission on March 8, 2001.