Conseco needs cash at worst time-WEB ONLY

Without fresh capital-or loosened debt obligations-Carmel-based Conseco could find itself in bankruptcy or looking for a buyer or both.

“It appears that the company will not be able to earn its way out,” wrote Randy Binner, an insurance analyst at Friedman Billings Ramsey & Co., in a note to investors. He estimated that Wall Street’s meltdown will force Conseco to take investment losses of $588 million over the next two years.

But the game’s not up yet for Conseco, Binner and other analysts say. It still has a handful of moves it could make to hang on while it hopes the economy and markets improve.

Conseco CEO Jim Prieur has been cornered into this crisis by a combination of heavy spending to fix old problems and by the worst investment environment since World War II.

The company’s insurance businesses have been improving. But whether they can grow profits fast enough-in a recession, no less-to overcome mounting investment losses is the question now clouding Conseco’s fate.

Those questions also cloud the future of the 1,750 employees working for Conseco in Carmel, as well as nearly 2,000 others around the country. Insurance companies make money by collecting premiums from policyholders and investing those funds, primarily in corporate bonds. They bet that the interest and repayment of those bonds produces enough money to cover claims, pay administrative costs and produce a profit.

Conseco Inc. makes money when the insurance companies it owns-in states like Indiana, Illinois and Pennsylvania-make big enough profits that the states’ regulators allow them to pass up some of those profits, called dividends, to the corporate parent company.

But now Conseco’s auditor, PricewaterhouseCoopers, is questioning whether declines in the value of Conseco’s investments will cause state regulators to block those dividend payments, thus starving Conseco Inc. for cash.

The accounting firm threatened to place a “going concern” warning in Conseco’s annual report, due out March 17, expressing doubt about Conseco’s ability to stay in business.

Such an opinion would automatically violate Conseco’s agreement with its senior-secured creditors. Their loans to the company, administered by Bank of America, total $915 million.

Since Conseco announced its auditor’s concerns March 2, the company’s stock price has lost two-thirds of its alreadydepressed value. The shares closed March 11 at 40 cents apiece.

Other life insurers’ share prices also have swooned as investment losses threaten their survival.

“There continues to be a significant amount of concern and scrutiny on insurance companies and their capital and liquidity constraints, in light of the tough capital markets that we have seen over the last few quarters,” Prieur said on March 2.

Options for action

Conseco’s low stock price makes it virtually impossible for the company to raise money by selling additional shares, as insurance analysts at Keefe Bruyette & Woods envisioned in a January report. They figured Conseco would need to raise $417 million this year or next.

But the battered stock market is no place to raise money now. Nor can Conseco borrow more money-its existing creditors require the company to maintain a certain ratio of debt to capital, and the company already is nearing the threshold.

So what options does Conseco have?

It can shift more blocks of its insurance business to reinsurers. In such a deal, Conseco would pay premiums to another company while giving the reinsurer the responsibility to pay any claims from its policyholders.

The benefit to Conseco would be twofold. It would receive a commission payment from the reinsurer. Also, by unloading the obligation to pay claims, Conseco would free up cash reserves that could then be counted as “excess capital”-a key measurement for its overall financial health.

The downside to such a deal is that Conseco earns lower profits on any blocks of business that are reinsured.

Another option is to negotiate with its lenders. Conseco will be forced to negotiate if it receives a “going-concern” warning from PricewaterhouseCoopers.

But even if it doesn’t, Conseco is perilously close to violating its lenders’ requirements, called debt covenants. And it must make a large payment on the loans-$339 million-in 2010.

Asking for the ability to carry more debt or have lower amounts of excess capital could give Conseco and its managers more breathing room to operate.

In exchange for looser restrictions, Conseco could offer its creditors warrants to buy the company’s stock. Or it might have to pay a higher interest rate on its debt.

National Financial Partners, a New York-based insurer, was in danger of breaking its debt covenants late last year. So it negotiated a temporary increase in the amount of debt the company is allowed to carry in exchange for paying about 2 percentage points more in interest.

Conseco’s lenders might not want to negotiate and instead push the company into bankruptcy reorganization. Conseco already went through bankruptcy in 2003. But finding the financing needed to work through bankruptcy would be extremely difficult right now.

Selling the company would also be difficult, for two reasons. The first is that nearly all life insurers have had as much or more trouble with investment losses as Conseco has, so few have the money to buy Conseco.

The second reason is that selling all or part of Conseco would also force the company to unload investments that are reduced in value but likely to increase. In other words, its investments bought high would be sold low-a cardinal sin.

If Conseco had sold all its investments at the end of 2008, it would have lost $3 billion.

“Why would you want to sell at these levels, particularly if you are in a position to make it through these cycles?” asked Jukka Lipponen, an analyst at Keefe Bruyette & Woods.

Course to a crisis

What’s surprising about Conseco’s crisis is that the company’s insurance businesses are now performing better than they have in years.

Profits have surged at Conseco’s three insurance subsidiaries, Chicago-based Bankers Life & Casualty Co., Philadelphia-based Colonial Penn and Carmel-based Conseco Insurance Group.

Before subtracting interest, taxes and investment losses, those three units grew profits 25 percent last year to nearly $318 million, according to preliminary figures released by Conseco. Total premiums collected surged 12 percent, to $432 million.

Conseco has reported better numbers in the past, said Binner, the Friedman Billings analyst. But they were pumped up due to problems that have been uncovered since the 2006 arrival of CEO Jim Prieur and Chief Financial Officer Ed Bonach.

“Jim and Ed have created a better-functioning Conseco than ever really existed,” Binner said. “They are real, and they’re really fixing the company. But the economic backdrop is just so terrible right now.”

Conseco’s biggest problem was its money-losing long-term-care policies. The company took a charge of $1 billion to transfer most of those policies to an independent trust in November. In just the two years before that, Conseco had spent more than $200 million shoring up reserves for its long-term-care policies.

Those charges, combined with a series of legal and restructuring costs as well as a big restatement of prior years’ earnings, has rapidly dropped Conseco’s total capital level from $5.7 billion to less than $3 billion.

At the end of 2008, Conseco had excess capital of just $59 million. That’s why the company has such little room for error now-in spite of its insurance companies’ growing profits. •