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CNO Financial Group, Inc. 10-Q 2010
form10q.htm





UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ende March 31, 2010

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from          to

Commission File Number 001-31792

Logo
Conseco, Inc.

Delaware
 
75-3108137
State of Incorporation
 
IRS Employer Identification No.
     
11825 N. Pennsylvania Street
   
Carmel, Indiana  46032
 
(317) 817-6100
Address of principal executive offices
 
Telephone
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:  Yes [ X ]  No [   ] 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [   ]  No [  ] 
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer” and  “smaller reporting company” in Rule 12b-2 of the Exchange Act.  Large accelerated filer [   ]  Accelerated filer [ X ] Non-accelerated filer [   ] Smaller reporting company [   ] 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):  Yes [   ] No [ X ]
 
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court:  Yes   [   ]  No [   ]

Shares of common stock outstanding as of April 27, 2010:  250,929,801


 
 

 


TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION
Page
     
Item 1.
Financial Statements
 
     
 
Consolidated Balance Sheet as of March 31, 2010 and December 31, 2009
3
 
Consolidated Statement of Operations for the three months ended March 31, 2010 and 2009
5
 
Consolidated Statement of Shareholders’ Equity for the three months ended March 31, 2010 and 2009
6
 
Consolidated Statement of Cash Flows for the three months ended March 31, 2010 and 2009
7
 
Notes to Consolidated Financial Statements
8
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
     
 
Cautionary Statement Regarding Forward-Looking Statements
47
 
Overview
49
 
Critical Accounting Policies
51
 
Results of Operations
51
 
Premium Collections
66
 
Liquidity and Capital Resources
71
 
Investments
80
 
Investments in Variable Interest Entities
88
 
New Accounting Standards
90
     
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
90
     
Item 4.
Controls and Procedures
90
     
PART II - OTHER INFORMATION
 
     
Item 1.
Legal Proceedings                                                                                                                 
91
     
Item 1A.
Risk Factors                                                                                                                 
91
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds                                                                                                                 
91
     
Item 5.
Other Information                                                                                                                 
92
     
Item 6.
Exhibits                                                                                                                 
92
     




 
2

 


PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)

ASSETS

   
March 31,
   
December 31,
 
   
2010
   
2009
 
   
(unaudited)
       
Investments:
           
Actively managed fixed maturities at fair value (amortized cost:  March 31, 2010 - $18,958.1; December 31, 2009 - $18,998.0)
  $ 18,813.8     $ 18,528.4  
Equity securities at fair value (cost: March 31, 2010 - $30.7; December 31, 2009 - $30.7)
    31.1       31.0  
Mortgage loans
    1,936.6       1,965.5  
Policy loans
    294.0       295.2  
Trading securities
    332.0       293.3  
Investments held by variable interest entities
    511.7       -  
Securities lending collateral
    147.4       180.0  
Other invested assets                                                                                                           
    236.3        236.8  
                 
Total investments                                                                                                        
    22,302.9       21,530.2  
                 
Cash and cash equivalents - unrestricted
    321.1       523.4  
Cash and cash equivalents held by variable interest entities
    24.3       3.4  
Accrued investment income
    334.0       309.0  
Value of policies inforce at the Effective Date
    1,133.2       1,175.9  
Cost of policies produced
    1,788.0       1,790.9  
Reinsurance receivables
    3,444.1       3,559.0  
Income tax assets, net
    1,021.9       1,124.0  
Assets held in separate accounts
    17.0       17.3  
Other assets
     398.4       310.7  
                 
Total assets                                                                                                        
  $ 30,784.9     $ 30,343.8  


(continued on next page)













The accompanying notes are an integral part
of the consolidated financial statements.

 
3

 


CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET,> continued
(Dollars in millions)

LIABILITIES AND SHAREHOLDERS' EQUITY

   
March 31,
   
December 31,
 
   
2010
   
2009
 
   
(unaudited)
       
Liabilities:
           
Liabilities for insurance products:
           
Interest-sensitive products
  $ 13,217.7     $ 13,219.2  
Traditional products
    10,137.6       10,063.5  
Claims payable and other policyholder funds
    969.4       994.0  
Liabilities related to separate accounts
    17.0       17.3  
Other liabilities
    583.6       610.4  
Investment borrowings
    454.5       683.9  
Borrowings related to variable interest entities
    495.4       -  
Securities lending payable
    152.4       185.7  
Notes payable – direct corporate obligations
    1,037.2       1,037.4  
                 
Total liabilities
    27,064.8       26,811.4  
                 
Commitments and Contingencies
               
                 
Shareholders' equity:
               
Common stock ($0.01 par value, 8,000,000,000 shares authorized, shares issued and
outstanding:  March 31, 2010 – 250,929,801; December 31, 2009 – 250,786,216)
    2.5       2.5  
Additional paid-in capital
    4,411.0       4,408.8  
Accumulated other comprehensive loss
    (103.0 )     (264.3 )
Accumulated deficit
    (590.4 )     (614.6 )
                 
Total shareholders' equity
    3,720.1       3,532.4  
Total liabilities and shareholders' equity
  $ 30,784.9     $ 30,343.8  



















The accompanying notes are an integral part
of the consolidated financial statements.

 
4

 

CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(Dollars in millions, except per share data)
(unaudited)

   
Three months ended
 
   
March 31,
 
   
2010
   
2009
 
             
Revenues:
           
Insurance policy income
  $ 664.6     $ 782.8  
Net investment income (loss):
               
General account assets
    315.4       308.6  
Policyholder and reinsurer accounts and other special- purpose portfolios
    23.8       (18.0 )
Realized investment gains (losses):
               
Net realized investment gains (losses), excluding impairment losses
    15.4       85.1  
Other-than-temporary impairment losses:
               
Total other-than-temporary impairment losses
    (17.7 )     (108.1 )
Change in other-than-temporary impairment losses recognized
in accumulated other comprehensive loss
    (2.6 )     16.1  
Net impairment losses recognized
    (20.3 )     (92.0 )
Total realized gains (losses)
    (4.9 )     (6.9 )
Fee revenue and other income
     3.5       3.0  
                 
Total revenues
    1,002.4       1,069.5  
                 
Benefits and expenses:
               
Insurance policy benefits
    699.0       753.5  
Interest expense
    27.5       23.2  
Amortization
    102.6       120.8  
Loss on extinguishment or modification of debt
    1.8       9.5  
Other operating costs and expenses
    118.4       120.3  
                 
Total benefits and expenses
     949.3       1,027.3  
                 
Income before income taxes
    53.1       42.2  
                 
Income tax expense:
               
Tax expense on period income
    19.2       15.3  
Valuation allowance for deferred tax assets
    -       2.4  
                 
Net income
  $ 33.9     $ 24.5  
                 
Earnings per common share:
               
Basic:
               
Weighted average shares outstanding
    250,788,000       184,754,000  
                 
Net income                                                                                   
  $ .14     $ .13  
                 
Diluted:
               
Weighted average shares outstanding
    292,081,000       184,756,000  
                 
Net income                                                                                   
  $ .13     $ .13  








The accompanying notes are an integral part
of the consolidated financial statements.

 
5

 


CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(Dollars in millions)
(unaudited)

         
Accumulated
   
Retained
       
   
Common stock
   
other
   
earnings
       
   
and additional
   
comprehensive
   
(accumulated
       
   
paid-in capital
   
loss
   
deficit)
   
Total
 
                         
Balance, December 31, 2008                                                          
  $ 4,105.9     $ (1,770.7 )   $ (705.2 )   $ 1,630.0  
                                 
Comprehensive loss, net of tax:
                               
Net income
    -       -       24.5       24.5  
Change in unrealized appreciation (depreciation) of investments (net of applicable income tax benefit of $31.6)
    -       (56.2 )     -       (56.2 )
Noncredit component of impairment losses on actively managed fixed maturities (net of applicable income tax benefit of $4.7)
    -       (8.7 )     -       (8.7 )
                                 
Total comprehensive loss                                                
                            (40.4 )
                                 
Stock option and restricted stock plans
    1.6       -       -       1.6  
Effect of reclassifying noncredit component of previously recognized impairment losses on actively managed fixed maturities (net of applicable income tax benefit of $2.6)
    -       (4.9 )     4.9       -  
                                 
Balance, March 31, 2009
  $ 4,107.5     $ (1,840.5 )   $ (675.8 )   $ 1,591.2  

Balance, December 31, 2009
  $ 4,411.3     $ (264.3 )   $ (614.6 )   $ 3,532.4  
                                 
Comprehensive income, net of tax:
                               
Net income
    -       -       33.9       33.9  
Change in unrealized appreciation (depreciation) of investments (net of applicable income tax expense of $78.0)
    -       146.2       -       146.2  
Noncredit component of impairment losses on actively managed fixed maturities (net of applicable income tax expense of $12.0)
    -       21.3       -       21.3  
                                 
Total comprehensive income
                            201.4  
                                 
Cumulative effect of accounting change
    -       (6.2 )     (9.7 )     (15.9 )
Stock option and restricted stock plans
    2.2       -        -       2.2  
                                 
Balance, March 31, 2010
  $ 4,413.5     $ (103.0 )   $ (590.4 )   $ 3,720.1  

The accompanying notes are an integral part
of the consolidated financial statements.

 
6

 


CONSECO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in millions)
(unaudited)

   
Three months ended
 
   
March 31,
 
   
2010
   
2009
 
             
Cash flows from operating activities:
           
Insurance policy income
  $ 586.3     $ 688.1  
Net investment income
    314.6       279.1  
Fee revenue and other income
    3.5       3.0  
Insurance policy benefits
    (482.3 )     (617.2 )
Interest expense
    (23.5 )     (22.4 )
Policy acquisition costs
    (109.0 )     (105.8 )
Other operating costs
    (106.6 )     (99.9 )
Taxes
    (1.9 )     (2.3 )
                 
Net cash provided by operating activities
    181.1       122.6  
                 
Cash flows from investing activities:
               
Sales of investments
    2,194.5       2,615.2  
Maturities and redemptions of investments
    158.3       117.4  
Purchases of investments
    (2,660.3 )     (2,964.1 )
Net sales (purchases) of trading securities
    (33.8 )     40.8  
Change in cash and cash equivalents held by variable interest entities
    (17.1 )     .3  
Other
    (2.8 )     (8.1 )
                 
Net cash used by investing activities                                                                                     
    (361.2 )     (198.5 )
                 
Cash flows from financing activities:
               
Issuance of notes payable, net
    61.4       -  
Payments on notes payable
    (64.0 )     (3.4 )
Expenses related to debt modification and extinguishment of debt
    -       (9.2 )
Amounts received for deposit products
    375.2       454.1  
Withdrawals from deposit products
    (378.6 )     (481.3 )
Investment borrowings and borrowings related to variable interest entities
    (16.2 )     (9.2 )
                 
Net cash used by financing activities
    (22.2 )     (49.0 )
                 
Net decrease in cash and cash equivalents
    (202.3 )     (124.9 )
                 
Cash and cash equivalents, beginning of period
    523.4       894.5  
                 
Cash and cash equivalents, end of period                                                                                             
  $ 321.1     $ 769.6  
                 
                 





The accompanying notes are an integral part
of the consolidated financial statements.


 
7

 
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________


The following notes should be read together with the notes to the consolidated financial statements included in the 2009 Form 10-K of Conseco, Inc.

Conseco, Inc., a Delaware corporation (“CNO”), is a holding company for a group of insurance companies operating throughout the United States that develop, market and administer supplemental health insurance, annuity, individual life insurance and other insurance products.  CNO became the successor to Conseco, Inc., an Indiana corporation (our “Predecessor”), in connection with our bankruptcy reorganization which became effective on September 10, 2003 (the “Effective Date”).  The terms “Conseco”, the “Company”, “we”, “us”, and “our” as used in this report refer to CNO and its subsidiaries or, when the context requires otherwise, our Predecessor and its subsidiaries.  We focus on serving the senior and middle-income markets, which we believe are attractive, underserved, high growth markets.  We sell our products through three distribution channels: career agents, professional independent producers (some of whom sell one or more of our product lines exclusively) and direct marketing.

Conseco’s Board of Directors has made a proposal to change the Company’s name to CNO Financial Group, Inc., which will be subject to a vote by shareholders at the May 11, 2010 annual meeting.

BASIS OF PRESENTATION

Our unaudited consolidated financial statements reflect normal recurring adjustments that, in the opinion of management, are necessary for a fair statement of our financial position, results of operations and cash flows for the periods presented.  As permitted by rules and regulations of the Securities and Exchange Commission (the “SEC”) applicable to quarterly reports on Form 10-Q, we have condensed or omitted certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  We have reclassified certain amounts from the prior periods to conform to the 2010 presentation.  These reclassifications have no effect on net income or shareholders’ equity.  Results for interim periods are not necessarily indicative of the results that may be expected for a full year.

The balance sheet at December 31, 2009, presented herein, has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP in the United States for complete financial statements.

When we prepare financial statements in conformity with GAAP, we are required to make estimates and assumptions that significantly affect reported amounts of various 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 to calculate values for the cost of policies produced, the value of policies inforce at the Effective Date, certain investments (including derivatives), assets and liabilities related to income taxes, liabilities for insurance products, liabilities related to litigation, guaranty fund assessment accruals and amounts recoverable from loans to certain former directors and former employees.  If our future experience differs from these estimates and assumptions, our financial statements would be materially affected.

Our consolidated financial statements exclude the results of material transactions between us and our consolidated affiliates, or among our consolidated affiliates.

OUT-OF-PERIOD ADJUSTMENTS

We recorded the net effects of certain out-of-period adjustments which decreased our net income by $.6 million (or nil cents per diluted share) in the first quarter of 2010.  We evaluated these errors taking into account both qualitative and quantitative factors and considered the impact of these errors in relation to the current period, as well as the materiality to the periods in which they originated.  The impact of correcting these errors in prior years was not significant to any individual period.  Management believes these errors are immaterial to the consolidated financial statements.

 
8

 
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________


ACCOUNTING FOR INVESTMENTS

We classify our fixed maturity securities into one of three categories: (i) “actively managed” (which we carry at estimated fair value with any unrealized gain or loss, net of tax and related adjustments, recorded as a component of shareholders’ equity); (ii) “trading” (which we carry at estimated fair value with changes in such value recognized as trading income); or (iii) “held to maturity” (which we carry at amortized cost).  We had no fixed maturity securities classified as held to maturity during the periods presented in these financial statements.

Certain of our trading securities are held in an effort to offset the portion of the income statement volatility caused by the effect of interest rate fluctuations on the value of the embedded derivatives related to our equity-indexed annuity products and certain modified coinsurance agreements.  See the note entitled “Accounting for Derivatives” for further discussion regarding embedded derivatives and the trading accounts.  In addition, the trading account includes investments backing the market strategies of our multibucket annuity products.  The change in fair value of these securities, which is recognized currently in income from policyholder and reinsurer accounts and other special-purpose portfolios (a component of investment income), is substantially offset by the change in insurance policy benefits for these products.  Our trading securities totaled $332.0 million and $293.3 million at March 31, 2010 and December 31, 2009, respectively.

Accumulated other comprehensive loss is primarily comprised of the net effect of unrealized appreciation (depreciation) on our investments.  These amounts, included in shareholders’ equity as of March 31, 2010 and December 31, 2009, were as follows (dollars in millions):

   
March 31,
   
December 31,
 
   
2010
   
2009
 
             
Net unrealized depreciation on actively managed fixed maturity securities on
which an other-than-temporary impairment loss has been recognized
  $ (91.9 )   $ (133.5 )
Net unrealized losses on all other investments
    (78.3 )     (339.9 )
Adjustment to value of policies inforce at the Effective Date
    2.3       10.7  
Adjustment to cost of policies produced
    16.2       59.8  
Unrecognized net loss related to deferred compensation plan
    (8.1 )     (8.2 )
Deferred income tax asset
    56.8       146.8  
                 
Accumulated other comprehensive loss
  $ (103.0 )   $ (264.3 )


 
9

 
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________



EARNINGS PER SHARE

A reconciliation of net income and shares used to calculate basic and diluted earnings per share is as follows (dollars in millions and shares in thousands):

   
Three months ended
 
   
March 31,
 
   
2010
   
2009
 
Net income for basic earnings per share                                                                                         
  $ 33.9     $ 24.5  
                 
Add:  interest expense on 7.0% Convertible Senior Debentures due 2016 (the “7.0% Debentures”), net of income taxes
    2.6       -  
                 
Net income for diluted earnings per share
  $ 36.5     $ 24.5  
                 
Shares:
               
Weighted average shares outstanding for basic earnings per share
    250,788       184,754  
                 
Effect of dilutive securities on weighted average shares:
               
7% Debentures                                                                                    
    39,533       -  
Stock option and restricted stock plans                                                                                    
    1,760       2  
                 
Dilutive potential common shares                                                                                       
    41,293       2  
                 
Weighted average shares outstanding for diluted earnings per share
    292,081       184,756  

Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding for the period.  Restricted shares (including our performance shares) are not included in basic earnings per share until vested.  Diluted earnings per share reflect the potential dilution that could occur if outstanding stock options were exercised and restricted stock was vested.  The dilution from options and restricted shares is calculated using the treasury stock method.  Under this method, we assume the proceeds from the exercise of the options (or the unrecognized compensation expense with respect to restricted stock) will be used to purchase shares of our common stock at the average market price during the period, reducing the dilutive effect of the exercise of the options (or the vesting of the restricted stock).

BUSINESS SEGMENTS

We manage our business through the following:  three primary operating segments, Bankers Life, Colonial Penn and Conseco Insurance Group, which are defined on the basis of product distribution; and corporate operations, which consists of holding company activities and certain noninsurance businesses.

We measure segment performance by excluding realized investment gains (losses) because we believe that this performance measure is a better indicator of the ongoing business and trends in our business.  Our primary investment focus is on investment income to support our liabilities for insurance products as opposed to the generation of realized investment gains (losses), and a long-term focus is necessary to maintain profitability over the life of the business.  Realized investment gains (losses) depend on market conditions and do not necessarily relate to the underlying business of our segments.  Realized investment gains (losses) may affect future earnings levels since our underlying business is long-term in nature and changes in our investment portfolio may impact our ability to earn the assumed interest rates needed to maintain the profitability of our business.



 
10

 
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________



Operating information by segment was as follows (dollars in millions):

   
Three months ended
 
   
March 31,
 
   
2010
   
2009
 
Revenues:
           
Bankers Life:
           
Insurance policy income:
           
Annuities                                                                   
  $ 8.3     $ 10.6  
Supplemental health                                                                   
    345.9       438.7  
Life                                                                   
    42.0       42.2  
Net investment income (a)                                                                       
    185.9       142.2  
Fee revenue and other income (a)                                                                       
    2.3        1.4  
                 
Total Bankers Life revenues                                                               
    584.4        635.1  
                 
Colonial Penn:
               
Insurance policy income:
               
Supplemental health                                                                   
    1.8       2.1  
Life                                                                   
    46.4       45.0  
Net investment income (a)                                                                       
    9.7       9.8  
Fee revenue and other income (a)                                                                       
     .2       .2  
                 
Total Colonial Penn revenues                                                               
     58.1       57.1  
                 
Conseco Insurance Group:
               
Insurance policy income:
               
Annuities                                                                   
    2.5       12.9  
Supplemental health                                                                   
    147.3       149.4  
Life                                                                   
    68.5       79.8  
Other                                                                   
    1.9       2.1  
Net investment income (a)                                                                       
    138.0       134.3  
Fee revenue and other income (a)                                                                       
     .3       .7  
                 
Total Conseco Insurance Group revenues
     358.5       379.2  
                 
Corporate operations:
               
Net investment income                                                                       
    5.6       4.3  
Fee and other income                                                                       
    .7       .7  
                 
Total corporate revenues                                                               
    6.3       5.0  
                 
Total revenues                                                               
    1,007.3       1,076.4  

(continued on next page)


 
11

 
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________


(continued from previous page)

   
Three months ended
 
   
March 31,
 
   
2010
   
2009
 
Expenses:
           
Bankers Life:
           
Insurance policy benefits                                                                            
  $ 416.5     $ 467.2  
Amortization                                                                            
    67.0       75.6  
Other operating costs and expenses                                                                            
    47.7       47.6  
                 
Total Bankers Life expenses                                                                       
    531.2       590.4  
                 
Colonial Penn:
               
Insurance policy benefits                                                                            
    36.7       36.4  
Amortization                                                                            
    8.7       8.4  
Other operating costs and expenses                                                                            
    7.4       7.2  
                 
Total Colonial Penn expenses                                                                       
    52.8       52.0  
                 
Conseco Insurance Group:
               
Insurance policy benefits                                                                            
    245.8       249.9  
Amortization                                                                            
    27.0       36.8  
Interest expense on investment borrowings                                                                            
    5.0       5.2  
Other operating costs and expenses                                                                            
    55.0       56.1  
                 
Total Conseco Insurance Group expenses                                                                       
    332.8       348.0  
                 
Corporate operations:
               
Interest expense on corporate debt
    19.5       13.7  
Interest expense on borrowings of variable interest entities
    3.0       4.3  
Other operating costs and expenses
    8.3       9.4  
Loss on extinguishment or modification of debt
    1.8       9.5  
                 
Total corporate expenses                                                                       
    32.6       36.9  
                 
Total expenses                                                                        
    949.4       1,027.3  
                 
Income (loss) before net realized investment losses (net of related amortization) and income taxes:
               
Bankers Life                                                                            
    53.2       44.7  
Colonial Penn                                                                            
    5.3       5.1  
Conseco Insurance Group                                                                            
    25.7       31.2  
Corporate operations                                                                            
    (26.3 )     (31.9 )
                 
Income before net realized investment losses (net of related amortization) and income taxes
  $ 57.9     $ 49.1  
                 
___________________
(a)
It is not practicable to provide additional components of revenue by product or services.

 
12

 
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________



A reconciliation of segment revenues and expenses to consolidated revenues and expenses is as follows (dollars in millions):

   
Three months ended
 
   
March 31,
 
   
2010
   
2009
 
             
Total segment revenues                                                                    
  $ 1,007.3     $ 1,076.4  
Net realized investment losses                                                                    
    (4.9 )     (6.9 )
                 
Consolidated revenues                                                               
  $ 1,002.4     $ 1,069.5  
                 
Total segment expenses                                                                    
  $ 949.4     $ 1,027.3  
Amortization related to net realized investment losses
    (.1 )     -  
                 
Consolidated expenses                                                               
  $ 949.3     $ 1,027.3  
                 

ACCOUNTING FOR DERIVATIVES

Our equity-indexed annuity products provide a guaranteed base rate of return and a higher potential return that is based on a percentage (the “participation rate”) of the amount of increase in the value of a particular index, such as the Standard & Poor’s 500 Index, over a specified period.  Typically, on each policy anniversary date, a new index period begins.  We are generally able to change the participation rate at the beginning of each index period during a policy year, subject to contractual minimums.  We typically buy call options (including call spreads) referenced to the applicable indices in an effort to hedge potential increases in policyholder benefits resulting from increases in the particular index to which the policy’s return is linked.  We reflect changes in the estimated fair value of these options in net investment income (classified as investment income from policyholder and reinsurer accounts and other special-purpose portfolios).  Net investment gains (losses) related to equity-indexed products were $15.0 million and $(15.7) million in the three months ended March 31, 2010 and 2009, respectively.  These amounts were substantially offset by a corresponding change to insurance policy benefits.  The estimated fair value of these options was $106.0 million and $114.9 million at March 31, 2010 and December 31, 2009, respectively.  We classify these instruments as other invested assets.

The Company accounts for the options attributed to the policyholder for the estimated life of the annuity contract as embedded derivatives.  The expected future cost of options on equity-indexed annuity products is used to determine the value of embedded derivatives.  The Company purchases options to hedge liabilities for the next policy year on each policy anniversary date and must estimate the fair value of the forward embedded options related to the policies.  These accounting requirements often create volatility in the earnings from these products.  We record the changes in the fair values of the embedded derivatives in current earnings as a component of policyholder benefits.  The fair value of these derivatives, which are classified as “liabilities for interest-sensitive products”, was $496.4 million at March 31, 2010 and $494.4 million at December 31, 2009.  We maintain a specific block of investments in our trading securities account, which we carry at estimated fair value with changes in such value recognized as investment income (classified as investment income from policyholder and reinsurer accounts and other special-purpose portfolios).  The change in value of these trading securities attributable to interest fluctuations is intended to offset a portion of the change in the value of the embedded derivative.

If the counterparties for the call options we hold fail to meet their obligations, we may have to recognize a loss.  We limit our exposure to such a loss by diversifying among several counterparties believed to be strong and creditworthy.  At March 31, 2010, substantially all of our counterparties were rated “BBB+” or higher by Standard & Poor’s Corporation (“S&P”).

Certain of our reinsurance payable balances contain embedded derivatives.  Such derivatives had an estimated fair value of $.8 million and $1.6 million at March 31, 2010 and December 31, 2009, respectively.  We record the change in the fair value of these derivatives as a component of investment income (classified as investment income from policyholder

 
13

 
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________

 
and reinsurer accounts and other special-purpose portfolios).  We maintain a specific block of investments related to these agreements in our trading securities account, which we carry at estimated fair value with changes in such value recognized as investment income (also classified as investment income from policyholder and reinsurer accounts and other special-purpose portfolios).  The change in value of these trading securities attributable to interest fluctuations is intended to offset the change in value of the embedded derivatives.  However, differences will occur as corporate spreads change.

REINSURANCE

The cost of reinsurance ceded totaled $64.6 million and $43.7 million in the first three months of 2010 and 2009, respectively.  We deduct this cost from insurance policy income.  Reinsurance recoveries netted against insurance policy benefits totaled $119.9 million and $126.7 million in the first three months of 2010 and 2009, respectively.

From time-to-time, we assume insurance from other companies.  Any costs associated with the assumption of insurance are amortized consistent with the method used to amortize the cost of policies produced.  Reinsurance premiums assumed totaled $24.2 million and $131.1 million in the first three months of 2010 and 2009, respectively.  Reinsurance premiums included amounts assumed pursuant to marketing and quota-share agreements with Coventry Health Care (“Coventry”) of $17.9 million and $122.6 million in the first three months of 2010 and 2009, respectively.  Coventry decided to cease selling Private-Fee-For-Service (“PFFS”) plans effective January 1, 2010.  On July 22, 2009, Bankers Life and Casualty Company (“Bankers Life”) announced a strategic alliance with Humana, Inc. (“Humana”) under which it offers Humana’s Medicare Advantage plans to its policyholders and consumers nationwide through its career agency force and receives marketing fees based on sales.  Effective January 1, 2010, the Company no longer assumes the underwriting risk related to PFFS business.

See the note entitled “Accounting for Derivatives” for a discussion of the derivative embedded in the payable related to certain modified coinsurance agreements.

In September 2009, we completed a transaction under which two insurance companies in our Conseco Insurance Group unit coinsured, with an effective date of January 1, 2009, about 104,000 non-core life insurance policies with Wilton Reassurance Company (“Wilton Re”).  In the transaction, Wilton Re paid a ceding commission of $55.8 million and
coinsures and administers 100 percent of these policies.  The Conseco companies transferred to Wilton Re $401.6 million in cash and policy loans and $457.4 million of policy and other reserves.  Most of the policies involved in the transaction were issued by companies prior to their acquisition by Conseco.  Approximately 70 percent of the policies that were coinsured were from Washington National Insurance Company (“Washington National”); the remainder were from Conseco Insurance Company.  We recorded a deferred gain of approximately $26 million in 2009 which is being recognized over the remaining life of the block of insurance policies coinsured with Wilton Re.

In November 2009, we entered into a transaction under which Bankers Life coinsured, with an effective date of October 1, 2009, about 234,000 life insurance policies with Wilton Re.  In the transaction, Wilton Re paid a ceding commission of $44 million and is 50% coinsuring these policies, which continue to be administered by Bankers Life.  In the transaction, Bankers Life transferred to Wilton Re $73 million in investment securities and policy loans and $117 million of policy and other reserves.  We also recorded a pre-tax deferred cost of reinsurance of $32 million in 2009, which, in accordance with GAAP, is being amortized over the life of the block.


 
14

 
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________


INCOME TAXES

The components of income tax expense were as follows (dollars in millions):

   
Three months ended
 
   
March 31,
 
   
2010
   
2009
 
             
Current tax expense                                                                       
  $ 1.0     $ 2.0  
Deferred tax provision                                                                       
    18.2       13.3  
                 
Income tax expense on period income                                                                
    19.2       15.3  
                 
Valuation allowance                                                                       
    -       2.4  
                 
Total income tax expense                                                                
  $ 19.2     $ 17.7  

A reconciliation of the U.S. statutory corporate tax rate to the effective rate reflected in the consolidated statement of operations is as follows:

   
Three months ended
 
   
March 31,
 
   
2010
   
2009
 
             
U.S. statutory corporate rate
    35.0 %     35.0 %
Valuation allowance
    -       5.7  
Other nondeductible expenses
    (.7 )     -  
State taxes
    .9       1.2  
Provision for tax issues, tax credits and other
    1.0       -  
                 
Effective tax rate                                                       
    36.2 %     41.9 %

 
15

 
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________



The components of the Company’s income tax assets and liabilities were as follows (dollars in millions):

   
March 31,
   
December 31,
 
   
2010
   
2009
 
Deferred tax assets:
           
Net federal operating loss carryforwards attributable to:
           
Life insurance subsidiaries                                                                                         
  $ 739.1     $ 745.3  
Non-life companies                                                                                         
    882.6       883.9  
Net state operating loss carryforwards
    19.1       19.1  
Tax credits
    19.0       18.5  
Capital loss carryforwards
    390.5       393.8  
Deductible temporary differences:
               
Insurance liabilities                                                                                           
    777.7       782.1  
Unrealized depreciation of investments                                                                                           
    56.8       146.8  
Other                                                                                           
     50.9       44.0  
                 
Gross deferred tax assets                                                                                        
    2,935.7       3,033.5  
                 
Deferred tax liabilities:
               
Actively managed fixed maturities
    (43.2 )     (38.1 )
Value of policies inforce at the Effective Date and cost of policies produced
    (694.1 )     (694.0 )
                 
Gross deferred tax liabilities                                                                                         
    (737.3 )     (732.1 )
                 
Net deferred tax assets before valuation allowance
    2,198.4       2,301.4  
                 
Valuation allowance                                                                                                 
    (1,176.4 )     (1,176.4 )
                 
Net deferred tax assets                                                                                         
    1,022.0       1,125.0  
                 
Current income taxes accrued                                                                                                 
    (.1 )     (1.0 )
                 
Income tax assets, net                                                                                         
  $ 1,021.9     $ 1,124.0  

Our income tax expense includes deferred income taxes arising from temporary differences between the financial reporting and tax bases of assets and liabilities, capital loss carryforwards and net operating loss carryforwards (“NOLs”).  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which temporary differences are expected to be recovered or paid.  The effect of a change in tax rates on deferred tax assets and liabilities is recognized in earnings in the period when the changes are enacted.

A reduction of the net carrying amount of deferred tax assets by establishing a valuation allowance is required if, based on the available evidence, it is more likely than not that such assets will not be realized.  We evaluate the need to establish a valuation allowance for our deferred income tax assets on an ongoing basis.  In evaluating our deferred income tax assets, we consider whether the deferred income tax assets will be realized, based on the more-likely-than-not realization threshold criterion.  The ultimate realization of our deferred income tax assets depends upon generating sufficient future taxable income during the periods in which our temporary differences become deductible and before our capital loss carryforwards and NOLs expire.  This assessment requires significant judgment.  In assessing the need for a valuation allowance, appropriate consideration is given to all positive and negative evidence related to the realization of the deferred tax assets.  This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, excess appreciated asset value over the tax basis of net assets, the duration of carryforward periods, our experience with operating loss and tax credit carryforwards expiring unused, and tax planning alternatives.

 
16

 
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________


Concluding that a valuation allowance is not required is difficult when there has been significant negative evidence, such as cumulative losses in recent years.  We utilize a three year rolling calculation of actual income before income taxes as our primary measure of cumulative losses in recent years.  Our analysis of whether there needs to be further increases to the deferred tax valuation allowance recognizes that as of March 31, 2010, we have incurred a cumulative loss over the evaluation period, resulting from the substantial loss during the year ended December 31, 2008 primarily related to the transfer of Senior Health Insurance Company of Pennsylvania (“Senior Health”) to an independent trust.  As a result of the cumulative losses recognized in recent years, our evaluation of the need to increase the valuation allowance for deferred tax assets was primarily based on our historical earnings.  However, because a substantial portion of the cumulative losses for the three-year period ended March 31, 2010, relates to transactions to dispose of blocks of businesses, we have adjusted the three-year cumulative results for the income and losses from the blocks of business disposed of in the past and the business transferred in 2008.  In addition, we have adjusted the three-year cumulative results for a significant litigation settlement and the worthlessness of certain loans made by our Predecessor.  We consider these to be non-recurring matters and have reflected our best estimates of when temporary differences will reverse over the carryforward periods.

At March 31, 2010, our valuation allowance for our net deferred tax assets was $1.2 billion, as we have determined that it is more likely than not that a portion of our deferred tax assets will not be realized.  This determination was made by evaluating each component of the deferred tax asset and assessing the effects of limitations and/or interpretations on the value of such component to be fully recognized in the future.  We have also evaluated the likelihood that we will have sufficient taxable income to offset the available deferred tax assets based on evidence which we consider to be objective and verifiable.  Based upon our analysis completed at March 31, 2010, we believe that we will, more likely than not, recover $1.0 billion of our deferred tax assets through reductions of our tax liabilities in future periods.  There were no changes to our valuation allowance for deferred tax assets during the three months ended March 31, 2010.

Recovery of our deferred tax assets is dependent on achieving the projections of future taxable income embedded in our analysis and failure to do so would result in an increase in the valuation allowance in a future period.  Any future increase in the valuation allowance may result in additional income tax expense and reduce shareholders’ equity, and such an increase could have a significant impact upon our earnings in the future.  In addition, the use of the Company’s NOLs is dependent, in part, on whether the Internal Revenue Service (the “IRS”) does not take an adverse position in the future regarding the tax position we have taken in our tax returns with respect to the allocation of cancellation of indebtedness income.

The Internal Revenue Code (the “Code”) limits the extent to which losses realized by a non-life entity (or entities) may offset income from a life insurance company (or companies) to the lesser of:  (i) 35 percent of the income of the life insurance company; or (ii) 35 percent of the total loss of the non-life entities (including NOLs of the non-life entities).  There is no similar limitation on the extent to which losses realized by a life insurance entity (or entities) may offset income from a non-life entity (or entities).

Section 382 imposes limitations on a corporation’s ability to use its NOLs when the company undergoes an ownership change.  Future transactions and the timing of such transactions could cause an ownership change for Section 382 income tax purposes.  Such transactions may include, but are not limited to, additional repurchases or issuances of common stock (including upon conversion of our outstanding 3.5% Convertible Debentures due September 30, 2035 (the “3.5% Debentures”) or 7.0% Debentures), or acquisitions or sales of shares of Conseco stock by certain holders of our shares, including persons who have held, currently hold or may accumulate in the future five percent or more of our outstanding common stock for their own account.  Many of these transactions are beyond our control.  If an additional ownership change were to occur for purposes of Section 382, we would be required to calculate an annual restriction on the use of our NOLs to offset future taxable income.  The annual restriction would be calculated based upon the value of Conseco’s equity at the time of such ownership change, multiplied by a federal long-term tax exempt rate (4.03 percent at March 31, 2010), and the annual restriction could effectively eliminate our ability to use a substantial portion of our NOLs to offset future taxable income.  We regularly monitor ownership change (as calculated for purposes of Section 382) and, as of March 31, 2010, we were below the 50 percent ownership change level that would trigger further impairment of our ability to utilize our NOLs.

 
17

 
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________



As of March 31, 2010, we had $4.6 billion of federal NOLs and $1.1 billion of capital loss carryforwards, which expire as follows (dollars in millions):

Year of expiration
 
Net operating loss carryforwards (a)
 
Capital loss
   
Total loss
 
   
Life
 
Non-life
 
carryforwards
   
carryforwards
 
                             
2010
  $ -       $ .1       $ -     $ .1  
2011
    -         .1         -       .1  
2012
    -         -         54.2       54.2  
2013
    -         -         1,034.2       1,034.2  
2014
    -         -         27.3       27.3  
2018
    1,878.0  
(a)
    -         -       1,878.0  
2021
    29.6         -         -       29.6  
2022
    204.1         -         -       204.1  
2023
    -         2,055.6  
(a)
    -       2,055.6  
2024
    -         3.2         -       3.2  
2025
    -         118.8         -       118.8  
2026
    -         .5         -       .5  
2027
    -         216.3         -       216.3  
2028
    -         1.2         -       1.2  
2029
     -         125.9         -       125.9  
                                     
Total
  $ 2,111.7       $ 2,521.7       $ 1,115.7     $ 5,749.1  
____________________
(a)  
The allocation of the NOLs summarized above assumes the IRS does not take an adverse position in the future regarding the tax position we plan to take in our tax returns with respect to the allocation of cancellation of indebtedness income.  If the IRS disagrees with the tax position we plan to take with respect to the allocation of cancellation of indebtedness income, and their position prevails, approximately $631 million of the NOLs expiring in 2018 would be characterized as non-life NOLs.

We had deferred tax assets related to NOLs for state income taxes of $19.1 million at both March 31, 2010 and December 31, 2009.  The related state NOLs are available to offset future state taxable income in certain states through 2015.

Tax years 2006 through 2009 are open to examination by the IRS, and tax year 2002 remains open only for potential adjustments related to certain partnership investments.  The Company does not anticipate any material adjustments related to these partnership investments.  The Company’s various state income tax returns are generally open for tax years 2006 through 2009 based on the individual state statutes of limitation.

 
18

 
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________



NOTES PAYABLE - DIRECT CORPORATE OBLIGATIONS

The following notes payable were direct corporate obligations of the Company as of March 31, 2010 and December 31, 2009 (dollars in millions):

   
March 31,
   
December 31,
 
   
2010
   
2009
 
             
3.5% Debentures                                                                      
  $ 52.5     $ 116.5  
7.0% Debentures                                                                      
    240.5       176.5  
Secured credit agreement                                                                      
    652.1       652.1  
Senior Note due November 12, 2013 (the “Senior Note”)
    100.0       100.0  
Unamortized discount on 3.5% Debentures                                                                      
    (1.0 )     (3.3 )
Unamortized discount on 7.0% Debentures                                                                      
    (6.9 )     (4.4 )
                 
Direct corporate obligations                                                                  
  $ 1,037.2     $ 1,037.4  

In February 2010, we repurchased $64.0 million aggregate principal amount of our 3.5% Debentures in a privately-negotiated transaction.  In connection with the repurchase of the 3.5% Debentures, we completed a second closing of $64 million aggregate principal amount of our 7.0% Debentures as part of our previously-announced private offering of 7.0% Debentures.  The first closing of $176.5 million of the 7.0% Debentures was completed on November 13, 2009, upon settlement of a tender offer for the 3.5% Debentures.

The purchase price for the $64.0 million of 3.5% Debentures was equal to 100 percent of the aggregate principal amount plus accrued and unpaid interest.  As a result of the repurchase, we realized a loss on the extinguishment of debt of $1.8 million, representing the write-off of unamortized discount and issuance costs associated with 3.5% Debentures that were repurchased.

The issuance of the $64.0 million of 7.0% Debentures was made pursuant to the purchase agreement that we entered into in October 2009 relating to the private offering of up to $293 million of 7.0% Debentures.  We received aggregate net proceeds of $61.4 million in the second closing of the 7.0% Debentures (after taking into account the discounted offering price less the initial purchaser’s discounts and commissions, but before expenses).  An aggregate of $52.5 million of the 3.5% Debentures remain outstanding.

In May 2010, as further discussed in the note to the consolidated financial statements entitled “Subsequent Events”, we repurchased $52.5 million aggregate principal amount of the 3.5% Debentures and issued $52.5 million aggregate principal amount of the 7.0% Debentures.

During the first three months of 2010, there was no scheduled principal payment on our secured credit agreement (“Senior Credit Agreement”).  There were $5.1 million and $5.4 million of unamortized issuance costs (classified as other assets) related to our Senior Credit Agreement at March 31, 2010 and December 31, 2009, respectively.

 
19

 
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________


The following chart summarizes:  (i) the most significant financial ratios and balances we must maintain pursuant to our Senior Credit Agreement; (ii) the current ratios and balances as of March 31, 2010; and (iii) the margins for adverse developments before such ratio or balance requirement is not met (dollars in millions):

     
Balance or
   
     
ratio as of
 
Margin for adverse
 
Covenant under the
 
March 31,
 
development from
 
Senior Credit Agreement
 
2010
 
March 31, 2010 levels
           
Aggregate risk-based capital ratio
Greater than or equal to 200% through December 31, 2010; greater than or equal to 225% from March 31, 2011 through December 31, 2011; and thereafter, greater than 250%.
    319%  
Reduction to total adjusted capital (defined as combined statutory capital and surplus plus the asset valuation reserve and 50 percent of the balance of the provision of policyholder dividends) of approximately $547 million, or an increase to required risk-based capital of approximately $273 million.
             
Combined statutory capital and surplus
Greater than $1,100 million through December 31, 2010; greater than $1,200 million from March 31, 2011 through December 31, 2011; and thereafter, $1,300 million.
 
$1,464 million
 
Reduction to combined statutory capital and surplus of approximately $364 million.
             
Debt to total capitalization ratio
Not more than 30%.
    22%  
Reduction to shareholders’ equity of approximately $1.4 billion or additional debt of $587 million.
             
Interest coverage ratio
Greater than or equal to 1.50 to 1 for rolling four quarters through December 31, 2010; greater than or equal to 1.75 to 1 for rolling four quarters from March 31, 2011 through December 31, 2011; and thereafter, 2.00 to 1.
 
1.71 to 1
 
Reduction in cash flows to the holding company of approximately $15 million.


 
20

 
CONSECO, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________



The scheduled repayment of our direct corporate obligations was as follows at March 31, 2010 (dollars in millions):

Remainder of 2010                                                                         
  $ 77.5  
(a)
2011                                                                         
    60.0    
2012                                                                         
    65.0    
2013                                                                         
    602.1    
2016                                                                         
    240.5  
(b)
           
    $ 1,045.1    
_____________
(a)  
Includes $52.5 million of the 3.5% Debentures.  In May 2010, as further discussed in the note to the consolidated financial statements entitled “Subsequent Events”, we repurchased $52.5 million of the 3.5% Debentures and issued $52.5 million of the 7.0% Debentures.  Less than $.1 million of the 3.5% Debentures remain outstanding.
(b)  
Excludes the $52.5 million of 7.0% Debentures issued in May 2010 as described in (a) above.

INVESTMENT BORROWINGS

One of the Company’s insurance subsidiaries (Conseco Life Insurance Company, “Conseco Life”) is a member of the Federal Home Loan Bank of Indianapolis (“FHLBI”).  As a member of the FHLBI, Conseco Life has the ability to borrow on a collateralized basis from FHLBI.  Conseco Life is required to hold a certain minimum amount of FHLBI common stock as a requirement of membership in the FHLBI, and additional amounts based on the amount of the borrowings.  At March 31, 2010, the carrying value of the FHLBI common stock was $22.5 million.  Collateralized borrowings from the FHLBI totaled $450.0 million as of March 31, 2010, and the proceeds were used to purchase fixed maturity securities.  The borrowings are classified as investment borrowings in the accompanying consolidated balance sheet.  The borrowings are collateralized by investments with an estimated fair value of $517.0 million at March 31, 2010, which are maintained in a custodial account for the benefit of the FHLBI.  Such investments are classified as actively managed fixed maturities in our consolidated balance sheet.  Conseco Life recognized interest expense of $4.9 million and $5.1 million in the first three months of 2010 and 2009, respectively, related to the borrowings.

The following summarizes the terms of the borrowings (dollars in millions):

Amount