CNO Financial Group Inc (CNO) 2004 Q2 法說會逐字稿

Thank you for holding and welcome to the Conseco teleconference. We will begin with an address by Tammy Hill, Conseco's Senior Vice President of Investor Relations.

During the presentation, all teleconference participants will be in listen-only mode. A question-and-answer session will follow the presentation. If you need operator assistance at any time during the call, please key star zero and an operator will help you. Thank you for your attention and here is Tammy Hill. Please go ahead.

Thank you. Good afternoon and thanks for joining us for Conseco's second quarter 2004 conference call. Before I turn it over to Bill Shea and Gene Bullis, just a couple of reminders.

We will be referring in the call today to information contained in our second quarter earnings release. You can obtain the earnings release by visiting the News Center section of our Web site at www.conseco.com.

We expect to file our form 10-Q on Monday, August 9th. The 10-Q will also be available through links contained on our Web site.

The forward-looking statements being made today are subject to a number of factors which may cause actual results to be materially different than those contemplated by the forward-looking statement. Please refer to yesterday's earnings release and to our latest Forms 10-K and 10-Q for additional information concerning forward-looking statements and related factors.

And now I'll turn it over to Bill Shea, our CEO. Bill?

Thank you, Tammy. Good afternoon and thank you for joining us on the call.

Gene and I will comment briefly on the quarter, and then we will open it up for your questions.

We are very pleased to have completed a number of significant accomplishments this quarter. We completed our offering of approximately 1.6 billion of common stock and mandatorily convertible preferred.

We redeemed in full 10.5% preferred stock. We reduced our bank debt by 500 million, and completed a new bank debt agreement on the remaining 800 million. And we received the first of what we hope will be a series of rating upgrades from our major rating agencies.

As we have talked about in the past and as we expected, statutory earnings and capital are continuing to grow and generate good cash flow capacity. We are very pleased with our statutory earnings before surplus debenture interest which totaled 125 million for the six months ended June 30th.

We're also pleased with our consolidated risk-based capital ratio which is now up to around 315%. As Gene will comment on it in a little more detail, our results for the second quarter were generally in line with our expectations.

Sales level in our Bankers Life segment was generally on plan and up around 7% from second quarter 2003 in life and supplemental health.

In our Conseco Insurance segment, new sales of life and specified disease were consistent with plan, however, we saw a decline in sales of Medicare supplement through the independent agents and an increase in policy lapses. The lower sales and higher lapses on Medicare supplement sold through independent agents appear to be the result of some aggressive price competition from various regional carriers.

And now I will turn it over to Gene to go over some financial highlights.

Good afternoon. Just a few comments about the quarter's financial results, and then we will open it up for your questions.

As we detailed in yesterday's press release, net income for the second quarter was 44.6 million, including net realized investment losses of 2.4 million. Net income per diluted share was 34 cents, and excluding realized losses net income for diluted share was 36 cents.

The second quarter's results were impacted by the recapitalization which occurred in the middle of the quarter, and by the redemption of our old 10.5% preferred stock, which did not occur until June 11th, due to the 30-day notice period required upon redemption.

As we highlighted in the press release, assuming that the recapitalization and redemption of the old preferred stock occurred at the beginning of the quarter, that would result in pro forma net income per share of 39 cents, or 40 cents excluding the realized investment losses.

Our book value per share at June 30th was $17.89 per share, excluding the accumulated other comprehensive income from FAS 115. During the second quarter, our FAS 115 unrealized gain position at March 31 swung to an unrealized loss at June 30th, as a result of the increasing interest rate environment.

As you will recall, our fresh start accounting at September 1, 2003 required that our investment portfolio be marked to the then current market values, which became our new GAAP book values going forward. If rates continues to rise, we would expect the accumulated other comprehensive loss in shareholders equity to increase in size.

We view this as simply a balance sheet presentation point, and we will continue to report both book value per share and return on equity, excluding the other comprehensive income or loss position.

We expect our insurance earnings over the second half of the year to be generally flat with the second quarter due to several factors: Our margins in long-term care with Bankers are under pressure due to the higher persistency and lower investment deals. This has been experienced by most of the industry.

We have delayed making significant price increases on new long-term care sales, but we anticipate some level of price increase on new sales commencing in 2005, which should help improve margins going forward.

Bankers is also experiencing slightly lower-than-expected margins on senior life and Med Sup business. Margins in both of these businesses are still at or near pricing targets, but are slightly lower than the favorable margins which we experienced in recent years.

The independently distributed Medicare supplement business in our Conseco Insurance segment has experienced higher-than-expected lapses and lower new sales due to fairly aggressive pricing competition from regional carriers.

We are experiencing better persistency in our specified disease business at Conseco Insurance. This is not a negative over the long-term, however, it puts pressure on shorter-term loss ratios because you don't pick up income from early lapses on return of premium policies.

Overall, net investment yields at Bankers and Conseco Insurance are still under some pressure due to the low interest rate environment. If the recent increases in new money investment rates continue, this should gradually improve our portfolio yield. And now we will open it up for questions.

Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer section. If you have a question, you may now press the star followed by one on your phone. If your question has been answered and you wish to withdraw your question, please press the star followed by two. One moment please for first question. Our first question comes from Nigel Dally. Please go ahead, sir.

Great, thank you. First just on guidance. Obviously you've got a lot of moving parts. Your guidance implies EPS of about 40 cents in the back half of the year and $1.60 on an annualized basis. When we look forward to 2005, you then have various additional initiatives like the expense reduction program. So when we put it all together, wondering if you can help us as to what we should think about as a sustainable run rate of earnings per share?

Well, obviously we're not going to be happy with 40 cents a share. We have a whole bunch of things that are teed up. We're going to do, and continue to do a lot of reforecasting in this environment, but we get intensively into what's going to happen in '05 over the next couple of months. Certainly from an overview point of view, we expect more positive news out of closed block long-term care.

As Gene mentioned, repricing or pricing additional, price increases in long-term care at Bankers, better performance because our prices will be more in line in Met Sup and Conseco Insurance. There's a possibility that even though we tried to get our margins up, that we may have just overdid it a little bit in the pricing of Med Sup in that part of our business.

There's certainly the expense reductions that we expect to get for rest the year and also into '05, you know, we believe are very attainable. And we think that our business at Conseco Insurance through our independent agents will come back.

And certainly we're fighting every day to get our "A" rating from A.M. Best, so I think all of that suggests that certainly the 40 cents will improve quite a bit. I don't want to say anything more than that at this point, but management is not happy with a 40-cent run rate. We're not going to live with that, and we expect '05 to really be the beginnings of earnings increases that I think the market will absorb and appreciate.

Okay. Just a couple of other questions as well. First, on the IRS ruling. Just any update there. And if you did get a favorable ruling, will you have you given any thought as to what portion of the DTA you'd likely write back onto the balance sheet?

And then just on the stat results? Obviously stat results were well ahead of plan. Can you discuss your outlook for stat earnings over the remainder of the year as well? At least based on results so far. Just like to get a--

Right. I'll just say that we expect, we certainly expect that the IRS will see it our way in terms of ordinary loss versus capital loss. I really believe that that one is pretty clear, and absolutely going to happen. I think that everything we know has really been positive.

I think that we still believe that the IRS situation will clarify itself certainly at least on the first issue in the August-September time frame, and then it will be certainly a positive benefit to us as we go forward. At least in my opinion I think it's only going to get better.

Gene can address a couple of the other facts that are happening, but, you know, I do think that we've done more work in terms of the size of the NOL itself, and I think we believe that as positive as we were before, we're probably even a little more optimistic. Gene, you want to just hit a couple of --

Nigel, I was trying to remember your third question.

He was asking about the DTA.

Yeah, just adding back to the DTA.

That was the second part. I think, just to reiterate what Bill said, from a specific development point of view, there is no change in our program or our expectations for outcome relative to our NOL situation and getting our returns filed this year. So that situation continues to be as it has been.

On the accounting side, that's really more related to establishment of a pattern of earnings than it is specifically related to the tax NOL issues, because we have lots more deferred taxes even notwithstanding the NOL. We would be expecting to take a look at that after year-end in the context of completing our year-end results and we'll be working with PWC to evaluate all those factors at that point in time. I would expect no sooner than that. Okay. Then the last question is just the outlook for stat earnings. Oh, stat earnings. Well, we're, as you have observed, we're quite pleased and stat earnings are positive for the first half of the year. And we believe that that will continue to be the case.

A little bit of the positive outcome is because of the production is a little bit behind, so you get the lack of strain that does produce results in a favorable way within the Conseco Insurance group. But beyond that, basic statutory benefit ratios are looking quite good.

Certainly in the second quarter reflected the recovery of the mortality issue that we experienced in the first quarter, and we have no reason to believe that that performance won't continue.

That's very helpful. Thank you.

Thank you. And our next question comes from Vanessa Wilson. Please go ahead.

Thank you. Could you talk a little bit about where you are in terms of your yield on your portfolio and what new money rates you're investing at today?

Actually our portfolio, I don't have specific yield, portfolio yield rates right in front of me, but we have improved portfolio rates during the quarter so that the ending portfolio rate is up single digit, several basis points from the beginning of the quarter.

Our new money rates and that's a function of a couple of things, one is what's going on with new rates and what durations are we adding to the portfolio. Within average new money investment rates in the quarter were about 535 or so for the money that we invested during the quarter, and that's obviously affected by, you know, what the mix of cash flows are and what duration we're investing at.

Okay. And could you talk a little bit about your long-term care discount rate on your reserves?

Talk about it in what context? It was mark-to-market at the date of fresh start, and it is what it is. We don't change that.

What is it? As of June 30?

It's, basically it is the appropriate new money rate for the duration of fresh start, so I would guess it's somewhere in the high fives. And we wouldn't change that unless we had a reason to believe that we didn't have margin and we had to unlock assumptions.

Okay. So in your commentary when you're talking about low interest rates pressuring your long-term care loss ratios, were you referring to the discount in the quarter?

No, it's the actual yield that goes into calculating the interest adjusted loss ratio. The actual yield in the quarter, well, for the first half of year was running slightly behind the assumption rate because that was based on new money rates in August.

You're talking about margin erosion on new reserves being added to the mix as opposed to declining margin on existing reserves?

Yes. That's essentially the case. Yes, it's as the portfolio turns and cash flows are reinvested, that's what that's affecting spread or interest credit.

The other piece is that we had a particular phenomenon this year in the low interest rate environment where we were having to amortize our bond discount premium and with prepayments on our ABS securities, that accelerated prepayments and accelerated amortization. We believe that phenomena is essentially behind us, but that effects interests adjusted margins on all lines of business, not just on long-term care.

Okay. And is there anything in the quarter maybe by product, if possible, where you had reserve releases or reserve additions that would have masked the loss ratio and made it either too low or too high?

No.

Okay. Thank you.

Thank you. And our next question comes from Tom Gallagher. Please go ahead, sir.

Hi. First just to start with the follow-up on Vanessa's question. Now I saw you had improvement in the long-term care loss ratio for the run-off book. Were these real cash claim improvements? Or were there any reserve releases imbedded in that, because I know, you know, at least my understanding is the reserve backing that is somewhat conservative. And also, you know, just related to that, what were the statutory results related to that book of business?

We had no particular reserve strengthening or releases so that there is an improvement in current loss ratios as a result of better claims experience, and we're starting to see the beginning of the impact of our claims adjudication programs. It's not significant yet, but we would hope that, you know, gradually over time we would see that impact gradually impact benefit ratios.

Yeah, I think the closed block long-term care business and the team that we have full time on managing and running this block off is, you know, is really doing an excellent job, and it's fundamental improvement in plans of care. We have people on the ground, in the three counties in Florida looking at all the plans of care, evaluating the new plans of care, and we're seeing improvements in the operations related to new claimants and also those on claim.

We also have finished a letter with the Florida Department of Insurance that will give each policyholder 90 days to select Option 1, 2, and 3. Once they're out 90 days, we'll know at least what option they're going to choose, and then obviously that's going to get into our thinking for '05.

Overall, I would say that where we are with the closed block long-term care business is ahead of where we thought it would be when we put the plan together and put management into, you know, independent management in to run off this block. We've got rate increases that we wanted, and I think we understand how this block is operating better and better each day. So I think you'll see continued improvement in the results of that block. Did we answer the question on stats?

Yeah, on the stat basis, we, you know, as I think we have indicated previously, we continue to incur statutory losses on this block, however, this quarter reflected a substantial improvement in stat. If you just ball park, $15 million a quarter, it was kind of in the run rate on a stat basis, and I think we've, we enjoyed a favorable variance this quarter of close to $10 million.

Okay. And then, Bill, just one follow-up on a comment you made. In terms of the letters that have gone out and policyholder elections, when do you expect those to be finalized?

I'm sorry. I guess I didn't clarify it for you. Once the letters go out and are in the hands the policyholders, they have 90 days to select Option 1, 2 and 3. So, you know, let's say they went out the end of July, by the end of October they would have to come back with an answer us to or the default option is Option 1.

Gotcha. Okay. And when, just remind us when those would be implemented after the elections?

Based on, you know, [model] premiums, so whenever they're billed, the first time after the 90 days, so if it's monthly it goes in. The next monthly billing quarterly, annually, so that's the way it's going to break down.

Okay.

And we will have a lot of information on that, and obviously we think that with the selection process and everything else which we've modeled out, certainly it's a fairly big number for us, and we'll fully have it implemented in a year.

Okay. Another question on long-term care as it relates to Bankers. And I know you commented that the loss ratio continues to run a bit high, and it doesn't sound like that's morbidity related it sounds like that's more of a function of surrender rates and interest rates. But, you know, that being said, and I know you commented about potentially getting rate increases on new business. What about your in force book? Is there a chance you'll look to get a rate increase on in force policies?

Yes. It's pretty interesting when you start looking at the dominos here.

It's clear that we want to be at pricing that there's no sense having product out in the market that isn't fairly priced. We're looking intensively at that. It's a situation that we're certainly going to, we're certainly going to make sure we understand what we think we can do with those kinds of increases.

The career distribution is certainly an interested party in this. We've never had a rate increase in that in force block, and I would say that we'll make a decision going into '05, and, you know, I would expect that you'll see some movement in that, but we want to be intelligent about it, we want to make sure we're sensitive to the field and our policyholders, but there's no doubt in our minds that it has to happen.

It's really a question of finishing the analysis and figuring out how we do it best and not lose agents and policyholders, but I think certainly the time has come. And depending on how you think at this point, it certainly isn't a small number.

Okay. And then just one last question. I know there's still, there's been for the last couple of quarters, a fairly high level of surplus node debenture payments going to the holding company and I think there's some catch-up in there. Can you remind us when the high level of that's going to come down a bit and when you'd be able to start accumulating capital, you know, from higher stat earnings?

Well I think we're accumulating capital pretty well now, but we had a, we brought, cumulatively we brought 96 million down, I think we had a total of 184 to take. So that will bleed out over time as we need it.

And in the context we're still building RBCs. So we've added 17 points or 18 points of RBC just in the quarter, and 25 points so far this year. So the capital is all relative.

So Gene, was that from, was the RBC enhancement from some addition of equity from or cash from your capital rates? Or was that from natural build-up within the sub?

Mostly related to reduced required capital, and some marginal capital build-up in the subs, but reducing required capital partially effected by one thing we did with the proceeds is, we redeemed some immediate holding company preferred stock that was sitting inside the insurance companies, and you do get a different hit on required capital when you make that redemption. So that had some impact on RBC, but the rest is just continued improvement in the asset quality, investment risk, and business risk reflected in the RBC calculation.

And we expect RBC to go up from here until the end of the year, and it could go up, you know, quite a few basis points, at least that certainly is our expectation at this point given production and all the rest. We also are generating, you know, a fair amount of cash flow.

At some point, certainly by the end of the year, we'll have enough cash flow at the holding company, way beyond what we need for debt service, and just having a few bucks up there, and then the question becomes, you know, what do we do with it.

The conundrum we're in right now is, we believe that we're an "A"-rated company, and the biggest drag on this business now and growing the business is, frankly, getting production up at Conseco Insurance. And certainly given what we believe the independent agents need, not that it won't give a boost to our captive agent force at Bankers, is to get that A rating.

And if you look at certainly debt-to-total capital, which is 19%, and certainly could trend lower if we decide to pay down more of the debt, an "A" rating would give not only a psychological boost to the independent distribution, but really get some of these people back that we've been working with, but they need to see that increase in rating.

So I think if you look at the balance sheet, cash flow, our basic ratios, we're in great shape. We just need to put some octane behind getting production up at Conseco Insurance, and you never know how fast it's going to come back, but hopefully we can get our ratings up a little bit more and really get back in that business. Because you may remember our NAP that production before this company went in the tank was somewhere around $200 million at Conseco Insurance.

And that easily we believe we can get back to, and we certainly have a strong enough company and a strong enough balance sheet to get there. We just can't wait to get there. We're going to push very, very hard to get not only our A.M. Best rating up but also our debt ratings up.

Okay. Thanks.

Thank you. Our next question comes from Andrew Kligerman. Please go ahead.

Thank you. Let me ask you a few one-off questions. Just first, could you give us an update with respect to your reporting systems integration? How many reporting systems do you have, and where would you like to be in 12 months?

I am not quite sure how to map reporting systems to policy admin systems which is really what our focus is, is reducing the number of policy admin systems. Reporting is a function of a ledger process that maps to those systems where basically we have a single ledger.

We, the short answer is that we're relatively on track in making our system simplification strategy work. In terms of how that will play out over the next several quarters, the one thing that is affecting the schedule and our thinking about it is the companion process that we're going through for compliance with SOx 404.

As a result of that, to some extent, we've accelerated a couple of conversions and also delayed some so that we're creating a window in the fourth quarter where we're not doing any actual platform conversions because we have to go through this whole process of testing and remediation to make sure that our control systems pass 404 muster at year-end, and there isn't any opportunity to fix it if you wait until year-end to be able to demonstrate that.

So that's kind of a longer answer to your question, but we're essentially on track, and we would expect in, around the first quarter of '05 to have achieved our target of reducing policy admin systems from in the mid-30s to the mid-teens.

I see. And so what, right now are you in the low 20s?

I would guess high 20s.

Okay. And then a quick update on mortality and prepays, which were big issues in the first quarter. How did you fair on life mortality and what were some of the prepay figures?

Life mortality was essentially on plan or, in fact, very slightly favorable. So actual-to-expected overall was fine. It wasn't problematic. It wasn't, there wasn't any significant mortality gain, but it was nice to be a little favorable.

So that really is an issue that seems to have been a one-off for Q1. It remains to be seen whether or not we'll be generating mortality gains, so over a longer period we would be back on plan to recover that negative experience in Q1 and there's really no way to predict that, it happens. The other question was on --

Prepay activity. What were some of, were there losses? Was it in line?

On amortization? It was very much in line with what our plans and business models reflect. We continue to have some ABS prepayments as you would expect and we had some in the plan. So for the quarter, it was very much in line with our expectations.

Okay. And then just lastly, I think long-term care was covered, but with regard to Med Sup. With the loss ratio a little high at Bankers at 69 and a little low at CIG at about, a little under 63, I've been modeling for 66.5, so is there likely to be a convergence on both where they both kind of gravitate?

Well over time, that's exactly right. The question is they could fluctuate in any given quarter, but because there is essentially a statutory soft point here that over time you tend to solve for, you're always running a little ahead or a little behind because it's really not a given period test. But you're right, I think that's, the question is, what kind of fluctuations might you see in any given quarter and that's just kind of it is what it is.

And to get the Bankers ratio in line, you're just going to implement some more immediate rate increases? Would that be the strategy?

Well you don't really, you rerate pretty much annually so we wouldn't expect to have any pricing changes for the rest of the period. And the rest is essentially what happens with morbidity.

I -- wait. So you're saying that for the balance of the year you've kind of locked in, but when you start next year, you're going --

Well, we've locked in terms of price.

Right.

And then there is the normal fluctuation of morbidity that might occur on any given quarter up or down.

Right, but when these policies come up for, you know, renewal, will you be able to charge more on them?

Sure.

Okay. Great.

Thank you, our next question comes from Jukka Lipponen. Please go ahead.

Good morning. Just going back to the guidance. Can you help me map how these numbers relate to your previous guidance which was up, basically let's call it 175 million which was the low end of your range for the 12-month period ending at the end of the third quarter, and if I add to that the cost saves from the, or the savings from the recapitalization, I get to number that will be, like, 220. And then when I take your actual net income for first half of 85 and I add the low end of your guidance of 126, I get to 210, which seems to be lower than what the previous guidance was, which did not include the fourth quarter, which, my understanding was, that you were going to have some, a significant portion of the 20 million cost saves perhaps in the fourth quarter. So, can you talk about that?

Well, I guess I can talk briefly about the underlying arithmetic and then I won't comment too much more on trying to revise guidance that we just put out this morning.

The, if you just take the range that's in the guidance at 126 to 136, you annualize that, and you subtract the impact of the recap, which I would say on an annualized basis is $90 million. You have sort of annualized revised guidance of, that tops out at around 182, and I think the bottom is around 165, 160, something like that at the low end. So I think the midpoint pretty much maps to where we had originally intended to reflect our expectations, and that's how we put it together.

And in terms of the cost saves, are we still on plan in terms of the $20 million to be realized this year?

Yes.

And is that mostly in the third and the fourth quarters?

No. Actually we're somewhat favorable in, so far. So we've already achieved some of that cost reduction.

Okay. And looking at just this quarter's numbers, the operating expense at Bankers Life were 44 million compared to like 35 in the first quarter, and 41 million in the fourth quarter. Is that cost relating to opening up new offices or what's playing into that number?

I think it's a combination of costs, opening up new offices in the quarter, as well as the Q1 number. I think it is a little low than, was above, in terms of execution and performance, it was above expectations. So I think it's a relatively low number in the first quarter that came back more in balance in the second quarter.

Okay. And what's the size of your, the deferred tax asset at 630?

$2.4 billion.

And that's the net?

Yes.

And then last, did, was there any improvement in spreads in the quarter, and did that help earnings?

Annuity spreads?

Right.

Slight improvement. So that I think annuity performance on a spread basis was mildly better in the second quarter than the first quarter.

And if we stay, sort of rates stay where we are roughly at this point, would you expect further improvement or sort of steady?

Steady to slightly improved.

Okay. Thank you.

Thank you. The next question comes from Felice Gilman. Please go ahead.

Hi. I can see and it certainly makes sense to me that your focus is on stat earnings, because you're still in the recovery stage, and that's, you know, how you're going to get the upgrades that you need to really start to grow. I wonder if you could just give me an idea of, if you can, of whether there are any trade-offs for you in terms of stat earnings and GAAP earnings when you're, you know, in terms of decisions you're making and how much that's affecting your GAAP earnings because it's, of course, it's always a little bit unusual for a company to have so much higher stat earnings than GAAP earnings.

Well, I'll respond a little bit. I think there is some tension on the asset side. You know, we have worked very hard to improve our asset qualities and we've gotten our below investment grade down to 3.3%.

We will continue to maintain a, I say a heavily investment grade-weighted investment portfolio until we get our rerates, because asset quality is a significant component of a rating process. And I think you would have to conclude, therefore, that we're sacrificing some yield as a result of that.

Beyond that, from an operating point of view, I think that our decisions are very much aligned with doing the right things for the GAAP income statement is also producing the right outcomes on the stat side.

Thanks.

Thank you. Our next question comes from Beth Malone. Please go ahead.

Yes, thank you. My question has to do with the market that you talked about competition and the Med Sup market especially and some competitors out there. Could you give us an idea of who those competitors are, at least describe them if you don't want to give us the names?

And also maybe you could talk about why it is that we're starting to see so much competition in these markets. Is this new or is it building? And what factors outside of Conseco's situation is causing this competitive environment for your business?

Beth, this is Tammy. I think what the marketing crews are seeing is most of that pretty aggressive competition is coming from the smaller regional carriers, and why they've decided to do it, you can only guess that, other than one of the critical things in Med Sup is critical mass as we've talked about in the past. We fortunately has that and I'm sure some of the smaller guys don't feel like they do, so that could be one thing that's allowing them to be what we view as a little aggressive.

I don't think we think it's unique to Conseco. I think, you know, everybody is seeing it, and when you distribute through independent agents, they, on behalf of their policyholders, go after the lowest rate possible, because it's a completely regulated and federally mandated program, so it's very easy to price shop.

Okay. One other thing. Are these other competitors, are they "A"- rated? Do you think it's the fact that you're a "B"-plus plus that's making it tougher for you to hang on to this market share?

I think most of them are at least "A"-minus rated. As we've said in the past, you almost have to be "A"-minus rated to be a long-term competitor. But it's really premium rate driven more than ratings, we think.

Okay. And, you know, how are you responding to this competition? Is it because you have to remain disciplined in your pricing? You're not going to meet them in the market on terms of pricing so that's why you're starting to see some pressure?

There's a couple of things that we expect to do strategically. We will be commencing in '05, we'll be issuing new Med Sup policies from Conseco Insurance Company, which is not where we are currently producing most of our Med Sup policies which are in Conseco Health. That will give us a little more pricing flexibility than we would otherwise have. So pricing is an opportunity for us.

And the other is conservation. You know, clearly when you have disappointing persistency, you figure out what you can do to conserve. So there are some programs on the conservation side that we're trying to put together that may produce some results, but it becomes a little difficult. Things like trying to get more of the block on ACH helps it stay in force longer because people have to actually, you know, affirmatively call their bank and change the automatic transfer.

Okay. One last question. In terms of marketing, are there any plans now that you've your "B"-plus-plus rating and you're starting to stabilize your core business to enhance or expand your marketing strength in terms of either resources or management team additions?

Yeah, we're always, Beth, we're always looking at that. Certainly that's been something that has been thought about and actually we've done some hiring in that area.

We've also focused on what we think are the premiere IMOs that have worked with Conseco over a period of time, and have spent a lot more time and effort with them. As you remember, some parts of the business that Conseco Insurance was virtually shut down when we had very limited capital. So bringing back life and annuities still is going to take some time.

But in terms of what we're doing with the life side of the business, we're focused on communicating much more actively now since the "B" double plus rating. We actually started a little bit earlier and we assumed we were going to get our ratings upgrade.

We very much believed we were going to get two notches up, so we started focusing on what can you deliver to us and how much money do we need to spend with you to become, you know, one of your top insurance companies again, and we believe it's starting to work. The frustrating part is, because we only get the "B" double plus rating, not that long ago, we're not seeing it in the numbers yet, and it will probably be more in the fourth quarter before we'll see production start to improve.

We're seeing a little bit of it in life, a little bit of it in annuities and I think Med Sup frankly, will take care of itself as we get into '05 and pricing certainly is more in line with the competition.

But people are spending a lot of time trying to make sure that we have the right IMOs. We're paying the most that, we're paying the right amount of attention to them, we're actively seeking them out. We're visiting them all the time.

And I think because we're targeting IMOs and not just having IMOs all over the place, the ones that can sell our products, we're going to see some real benefit out of it. It's a program we thought a lot about before we ever imagined, you know, a double notch upgrade from A.M. Best.

But I've got to tell you, the real fight here is to get the "A" rating back. We still get resistance from some of our IMOs that have done business with us in the past. They want the "A" rating, it's much easier for them. So we are talking to them about the things we have to do as a company to get that "A" rating back, and frankly, we're still getting some resistance because we don't have an "A" rating.

Now the fact we don't need an "A" rating to sell all of the products, I think it's become almost a, you know, just a bone of contention because we don't have an "A" rating. They want it, and they're going to hold back some business from us until we get it. But we believe that we have the right IMOs who are pursuing the right IMOs, and I think the amount of money we're spending now is targeted where we think we can get the most benefit, and we get out of relationships where we didn't think in the future there'd be any value added.

In terms of anything that would be kind of a large national campaign, that's not where we're going.

Okay. Thank you.

Thank you. And the next question comes from Richard Hayden. Please go ahead, sir.

Hi. Bill, what sort of free cash flow do you think you'll generate this year and some sort of framework for next?

Well, I mean, obviously, Richard, we're above 250, and, you know, we believe that that number is going to increase, and it's the kind of thing that we had talked about before and we had ballparked it there, but certainly it's growing for a whole bunch of reasons, and it's going to continue to grow. So I would say, you know, you can target a number that's a bit higher than that right now, and I think that it's only going in a positive direction.

I'm sure everybody in this hall is going to think this is part heresy, but has a company in the insurance industry ever with your sort of rating initiated a dividend in order to convey to the rating agencies the confidence the management has?

Not that I am aware of. I don't know of any. If someone on the call does, we'd be happy to talk about it, but we're in this situation now that given where we are with operations and frankly the tax position that I truly believe we're going to sustain and all of that, that we're going to have significant cash flow.

And I mentioned earlier in the call that, you know, for lack of other things to do, we could pay the debt down significantly. It's at 790 now, and, you know, if you're looking around for places to use your cash by the end of the year, that's a decision that certainly is going to be confronting us because we'll have way too much money at the holding company. I know that didn't answer your question, but I guess I wasn't intending to.

If you had to prioritize usage of that cash, would debt be the number one priority?

No. Growing the business profitably would certainly be what we have to do, and we have to figure out how to do it.

And so if you ask me, you know, right now, getting that "A" rating back. When I look at competition, there might be one or two companies that are rated "B' plus, "B" double plus, everyone else is "A" minus and some of them are "A" plus "A" double plus.

So one of the theories we had that may or may not be totally valid now, is that we wanted to make sure our ratios, our balance sheet, and everything we could control with a "B"-type rating, we did. We believe we've done that. What we can't control is independent agents giving us good quality business with a "B"-type rating.

And when you talk to the rating agencies, they say show us new NAP, show us growth and revenues, and frankly, it's not impossible to grow the business on the health side, but we have, you know, we have other lines of business, and it's kind of like the chicken and the egg. I would like to deploy the capital in really good, quality business.

The IMOs on the independent side are waiting for the "A" rating, and on the captive side, I think we'd do better with an "A" rating because that's in fact where Bankers has been for a long time, and I happen to think that production would improve significantly with the "A" rating. The question is how to get there from here.

I don't think there's been a situation in the insurance industry, certainly not in the health insurance industry, where you go down to a "B" and come back to an "A" and you have a company with a very strong balance sheet, great cash flow, and you need the "A" rating to get production up. Our operating problems we're solving every day, I'm not as concerned about that as taking more time to get an "A" rating and putting our distribution at risk that I don't think we should have to take.

Would we consider a dividend? I can't imagine it, to tell you the truth.

Can I follow up on that? Yeah, I think that, you know, on that same point, I think we have to be aware of what the realities are. Certainly over time, that is something that would make imminent sense, but in the short-term, we have a secure loan agreement that doesn't allow us to pay dividends anyway.

So when you talk about what's the smartest use of the capital from a financial gearing point of view, it's whatever use that will provide the fastest path to financial strength rating in the "A" category from A.M. Best and an investment grade rating on the debt. That's our primary objective here. Both that will enable us to grow our business and the best gear the financial and capital structure of the business.

Thank you. And our next question comes from Dan Lipshitz. Please go ahead, sir.

Yes, hi. This is Dan Lipshitz from Furtree Partners. You guys may have gone over this before, but just in terms of the cost savings you're talking about, how much do you expect to be down in '05 versus '04?

Our original plan was $30 million and I have no reason to believe that isn't executable.

Got it. Thanks a lot.

And our next question comes from Howard Amster. Please go ahead, sir.

I wanted to ask you two questions. The first is, if you downstream money to the insurance subs, are you saying that could increase your probability of getting the "A" rating? And I guess the question is, why isn't that being done now as opposed to, like, four, three or four months where I think you alluded to before.

And then the other question was the deferred tax asset. I'm looking at your balance sheet, I just wonder under what category it is because I didn't see, I think you said it was $1.2 billion was the deferred tax asset unless it is reserved against.

Well, on the first question, our RBC ratios at 315, and based on our calculations, something called the BCAR, the Best Capital Adequacy Ratio, is well in excess of an A-plus minimum ratio, so putting more capital in the insurance companies is really not going be a recipe for an increased A.M. Best rating. Really, their focus now is on franchise value and underlying performance of the insurance companies.

It is an interesting point that you make, because when Gene mentioned the BCAR rating, we're already within just a couple of points of being at the "B" double plus. I'm sorry, "A" double plus level which is the highest, which is the highest rating for what Best calls BCAR.

And the same with risk-based capital. We expect that to go up just by the passage of a couple more quarters by quite a few basis points. So we're clearly in the "A" category, "A"-plus category, whatever, so now you're faced with cash at the holding company and I just threw out that we would pay down debt. We haven't made any decision along those lines, but we certainly will be sitting with, by anybody's definition, excess cash at the holding company by year-end.

So the, you get, you receive that cash from tax treaties with the insurance companies because your NOL basically and also because you upstream money just in dividends. Is that correct?

It's not much in the way of dividends. There is some modest dividend component, but we have fee arrangements with the insurance companies as well surplus debenture interest that produces cash flow.

I see.

Your question on the deferred taxes is, there is deferred tax asset is $2.4 billion, and it has 100% valuation allowance provided against it.

That's what I thought. When one looks at the balance sheet you provided there's no, it's at zero. You wouldn't find it there.

Right. That's right.

Okay. That makes sense.

You'll see all the details in the Q.

Okay. And then, I guess, so what you're saying is you have more than enough capital adequacy as your insurance company's --

I would say it's stronger than that but given the type of insurance company we are, if you would had to asked management where they think we'd have to have RBC to run the company given our product suite and all of that, it certainly wouldn't have to be at 300% risk-based capital and as Gene said, we're at 315.

So one the things we were trying to do is make a point that we have a very strong balance sheet, debt-to-capital ratios that's at the "A" level or investment grade level, and risk-based capital that's at the "A", " A"-plus levels or beyond that, and do everything we can in our power to make sure that we're able to get our "A" rating back as fast as we can.

So I guess the question is, if capital isn't what's going to drive it, is it just mere passage of time? Because it sounds like you're saying your metrics are strong enough to be a single "A"-rated company.

Yeah, I'd say, and let me just answer that. I'd say yes, passage of time and another two quarters may be of reasonable earnings. On the other hand, you know, the double-edge sword is that I don't like a day to pass without an "A" rating because of our independent distribution.

I don't assume anything in terms of how fast it'll take to get our business back, and let's say back to the starting point, $200 million of new annualized premium. That, to me, is just the beginning point.

And so every day that passes, you know, I worry about our independent distribution and how long it's going to take us to do better than we're doing now, and once we get an "A" rating, how long is it going to take us to really get back in action. That's the kind of thing that's the imponderable for this company right now. So we go back and certainly after every major event, earnings or what have you, we go back and talk to our regulators and hopefully they'll see it our way very soon.

You mean rating agencies as opposed to regulators?

Oh I'm sorry, I meant to say rating agencies, I apologize.

Oh, that's okay. With this excess, can you give us a sense of the excess cash at the parent? And, also, is the 790, is that debt at the parent? Is that 790 parent company debt?

Yeah, the 790 is, well, actually it's the parent company and an intermediate holding company that are guarantors, but it's essentially, it's outside the insurance companies.

Okay.

And cash flow, well, right now there is not a significant amount of excess cash flow, but we are continuing to grow cash, and our existing expectations are that that cash position would continue to grow, you know, in the $100 million a year range, sufficient to accumulate enough to pay off that debt at maturity.

Pay off the 790 at maturity? Could you comment, let's say, as of let's say year-end '04 how much excess cash you would feel you'd be carrying at the holding company? Because that will lead to my next question.

I mean, I'll answer it. It's anywhere from as much as or as little as 100 to maybe 150 million.

Okay.

And that's, you know, and that's just ballpark right now, but it's a good starting point.

So that's 150 million that you have already established doesn't belong at the, you know, in the insurance company so you're going to have more than enough capital there. I guess my question --

That's right, and we're still going to be, as I mentioned, we're still going to be growing capital for the next couple of quarters to get to year-end so the risk-based capital of 315 easily can go up by quite a few more points.

Right. So then getting back to the other gentleman's question, and I agree that dividend makes no sense, but if you have 150 million of capital growing at, or excess cash growing at 100 million a year, is there any, is there, how does buying back the trust preferreds compare to, for example, buying in the debt? What kind of rate could you receive by buying in the debt based, you know, the call premiums you'd have to pay, et cetera, as compared to the 5.5%, you know --

Well, the debt's got a one-year non-call at 101, so that goes away pretty quickly. But we're still carrying 800, and that will still allow us to do some prepayments without having to incur any call premium on the debt.

Okay. So the whole 790 after a year becomes, there's no call premium you're saying?

Right.

And what's the approximate rate on that please?

Well, right now, it's LIBOR plus 400, but we expect it to go to LIBOR plus 350 as soon as we complete this quarter's process and we get and increase in our Moody's rating from B3 to B2.

So there's another 4 million of savings.

Okay. So I guess the question is, in comparing this to, let's say either buying some of that back and buying some of the trust preferred back, what becomes a better, you know, alternative?

When you say trust preferred, you mean our existing Series B preferred stock?

Right. The 5.5%.

The lower grade wouldn't allow you to do that.

Would not allow it. Okay. So the issue is you really have to pay them. That's the only place--

You know, it's their collateral. It is a secured loan.

Gotcha. Okay. Thank you very much.

Operator, I think we have time for one more question if anyone's in queue.

Thank you, ma'am. Our final question from Tom Gallagher. Please go ahead. Please go ahead with your question, sir, your line is open.

Are we finished?

Mr. Gallagher, go ahead with your question. Your line is open, sir.

Hello, can you hear me? Hello, can you hear me?

Yes. Yes, we can.

Okay, good.

Is that you, Tom?

Yes it is. Sorry.

We didn't hear you at first. Go ahead.

Just a quick follow-up, the 125 million in stat earnings. Does that, now that, that's exclusive completely of the inner company fees that are paid to the holding company, correct?

Right.

Or should I think of that being additional free cash flow? And what would that number have been in the first half of the year?

Yeah, you should, and it runs about 20 million a quarter.

Okay. So the real free cash flow number for the first half of the year would have been 40 plus 125? Roughly?

Yeah.

Okay, thanks.

Which is why we said we're above the 250 run rate right now because it's really more like 325 or so.

Okay. Thanks a lot.

Thank you, everyone.

Thank you, sir. Thank you, ladies and gentlemen today for your participation. This concludes your conference call. You may now disconnect. Have a great day.