CNO Financial Group Inc (CNO) 2006 Q3 法說會逐字稿

Good morning. My name is April, and I will be your conference operator today. At this time, I would like to welcome everyone to the Conseco Third Quarter earnings call. [OPERATOR INSTRUCTIONS.] Thank you. I will now turn the call over to Dan Murphy, Senior VP of Investor Relations.

Good morning, and thank you for joining us on Conseco's third quarter earnings conference call. I'm pleased to have several key Conseco executives on the call with me today, including Jim Prieur, Conseco's Chief Executive Officer, Jim Hohmann, Conseco's President and Chief Operating Officer, Gene Bullis, Chief Financial Officer, Mike Dubes, President of Conseco Insurance Group, Scott Perry, Chief Operating Officer of Bankers Life, and Greg Barstead, President of Colonial Penn Life. During the call, we'll be referring to information contained in yesterday's earnings release. You can obtain the release by visiting the Company news section of our website at conseco.com. During the conference call, we will be referring to a presentation that can also be obtained from the Company's website.

This presentation was also filed in a Form 8-K earlier today. The 10-Q will be available through the Investor section of our website when it is filed early next week. Let me remind you that 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 statements. Please refer to yesterday's earnings release and to our latest forms 10-K and 10-Q for additional information concerning the forward-looking statements and related factors.

The presentation we will be referring to today contains a number of non-GAAP measures. These measures should not be considered as substitutes for the most directly comparable GAAP measures. The appendix to the presentation contains a reconciliation of the GAAP measures with the non-GAAP measures. And now I'll turn the call over Conseco's CEO, Jim Prieur. Jim?

Thanks, Dan. On slide 4, you can see that the third quarter had very disappointing results with the impact of poor experience in the run-off long-term care book pulling down the operating income results from -- or to $0.35 a share from $0.44 per share. The balance of the operations were fine. Combined operating earnings from our core segments, Bankers Life which includes Colonial Penn, and Conseco Insurance Group, were up slightly. Operating earnings at Bankers were up substantially, with sales at Bankers and Colonial Penn being up 5% and 10% respectively.

Conseco Insurance Group (CIG) had a decline in earnings year-over-year, reflecting an unusually high level of investment related prepayment activity in the prior year period, as well as normal erosion of its large inforce blocks that are yet to be replaced by new business. But sales were up very dramatically at CIG, and CIG's efforts to add distribution in the market are taking hold. Mike Dubes will be speaking to that shortly.

The long-term care run-off book deserves a lot more explanation, particularly given these results, and we'll be giving you more information on that business in the latter part of this call. On slide 5, you can see a chart showing the growth of consolidated new business production at Conseco. These figures are new annual premium, where single premium life insurance is weighted at 10% and annuity premium is weighted at 6%. The overall 14% growth rate is very attractive for an insurance company, and it speaks to the ability of the Company to produce healthy growth rates with its current ratings.

During the quarter, A.M. Best confirmed the Company's ratings and laid out its metrics for the Company to achieve an upgrade. The Company has continued to attract new talent to its management ranks, hiring a number of health actuaries and specialists and health claim management and administration, and experienced worksite management people as well.

On 6, you can see that Conseco's total collected premium across all business lines has continued to grow, up by 185 million, or 19% on a quarter-over-quarter basis. Next up is our CFO, Gene Bullis, who will discuss the financial highlights of the quarter. Gene?

Good morning, everyone. As detailed in yesterday's press release, net income applicable to common stock for the third quarter was 38.9 million, or $0.26 per diluted common share. This includes 13.9 million of net realized investment losses, or $0.09 per diluted share, resulting in operating income per diluted share of $0.35, as compared to $0.44 in the third quarter of 2005. As discussed in yesterday's release, the current quarter includes a pretax loss of 13 million in the run-off segment, which was approximately 24 million below our expectation, which translates into $0.09 a share after tax.

On slide 8, our operating ROE of 3.8% for the past four quarters reflects the substantial increase in book value that has occurred due to the reduction of our valuation allowance for deferred taxes and the significant litigation related charge recorded last quarter. Excluding the tentative litigation charge and the increase in equity associated with the NOLs, the ROE for the past four quarters is 9.2%.

Slide 9 replicates the EBIT table in the earnings release and highlights the impact of the volatility in the run-off book. Turning to slide 10, book value per share calculated as if the preferred stock had converted, which will occur in May of 2007, decreased slightly from the second quarter to $25.81, reflecting an increase in fully diluted shares outstanding. On the next slide, our debt to total capital calculated excluding accumulated other comprehensive income was approximately 14%. On a pro forma basis for the refinancing that we completed in early October, this ratio will increase to approximately 17%.

On slide 12, risk-based capital at our insurance companies remains strong. Although our statutory financials are not yet completed, we have estimated risk-based capital for the third quarter to be approximately 323. Additionally, when we reflect on a pro forma basis, the RBC for the contribution of the proceeds from our debt offering, we would expect our RBC to be approximately 370.

Slide 13 relates to net investment income. Net investment income on general account assets for the third quarter reflects earned yields of 5.88%, and in that period, we had new money yield of 6.35%. Yields have improved throughout 2006, as expected, despite below level of prepayments.

On slide 14, shows a break out of our fixed maturities of our investment portfolio by rating category. We continue to maintain a modest 5% amount of our portfolio and below investment grade securities, and overall, a well balanced portfolio.

Slide 15 arrays the most recent five quarters of aggregate health benefit ratios. Despite some volatility within lines, our core business ratios are quite stable. As Jim Hohmann will discuss in a few minutes, our run-off business benefit ratio has become increasingly problematic. Slide 16 reflects how Management tracks its expense initiatives and reflects that we are on our expense plans. And with that I'll turn it back to Jim Prieur.

Thanks, Gene. Now, let's hear from our business leaders beginning with Mike Dubes, President of Conseco Insurance Group.

Thanks, Jim, and good morning, everyone, and thanks for joining us on this call. Slide 17 discusses revenue and pretax operating income. Compared to last year's quarter, CIG's earnings in the third quarter of '06 were affected by the following items -- Lower earned premium and higher incurred claims in our Medicare Supplement business, lost profits from the block of business that is subject to the tentative litigation settlement that we discussed in our second quarter earnings release, improved margins in our specified disease business, and, lastly, net investment income in the third quarter of '05 included 10.5 million of prepayment income on fixed maturity investments and mortgage loans, offset by related additional amortization of $5 million.

In Q3 of '06, we continued to have outstanding results in recruiting distribution partners, new talent, and generating sales. Our recent summit sales conference in Las Vegas showcased Conseco talent and products with a series of well-known industry speakers at workshops. We attracted over 400 participants who paid their own way to attend, a big jump from last year when about 170 attended. Our focus continues to be building out our distribution platform to generate sales to offset the normal erosion of our large inforce block. This, in turn, will improve our operating results.

Slide 18 talks about our benefit ratios for Med Supp. CIG's Med Supp benefit ratio was 66.8% in the third quarter, compared to 56.9% in the second quarter. Persistency did improve in the third quarter. We expected the benefit ratio to increase consistent with our lower -- our expectations of lower lapses.

On slide 19, talks about benefit ratios for specified disease. That was 73.6% compared to 79.9% in Q2. This results reflects lower paid claims in that quarter.

On slide 20, discusses premiums for Med Supp, which was up significantly quarter-over-quarter, and NAP sales for 2006 to-date are well ahead of last year. We will continue the initiative of cross selling final expense and senior cancer products, along with the sale of Med Supp through an extensive training effort. Our new final expense product, which is being released in December, has been designed to be sold at the point-of-sale with Med Supp.

Slide 21 shows premiums for specified disease which were flat quarter-over-quarter, but NAP sales are showing encouraging momentum. Our new senior cancer policy has shown tremendous acceptance in the market, and we are starting to package that product as a combination sale with our Med Supp products, and we have trained over 1,000 agents.

Health agent recruiting remains very strong. We are up 66% for the quarter, and 81% year-to-date. PMA, our wholly owned subsidiary in Dallas, Texas, has had a record year in recruiting.

Slide 22 discusses our life insurance premiums. Our life business is our slowest growth product line, but we have just started to revitalize that product line. Our channel leader was hired in May, and we have now have three seasoned field Vice Presidents to assist him. So far this year, IMO appointments are up 267%, submitted apps are up 6, submitted premium is up 7, and new annual premium is up 11.

On slide 23, our annuity line continues rapid growth both in the qualified and unqualified product lines. First year premiums were up 355% for the quarter, and 266% year-to-date. Our traditional annuity IMO channel had a strong third quarter. With our team of wholesalers, we are finding new opportunities and capitalizing on them. In the third quarter, our application counts rose 12%, and we have realized a corresponding 65% increase in premium.

Q3 saw a major sales contribution from our relationship with Legacy Marketing Group. They have introduced us to 28 IMOs who have been appointed with the Company, and as a result, 900 new agent appointments have occurred.

Last quarter, I advised you that we were working with a new partner in Florida. I'm pleased to announce that early in the fourth quarter of this year, we launched our first annuity product with Actuarial Development Services, and now have ten IMOs representing that product who have already produced business.

Slide 24 sums up a CIG perspective. We will continue to focus in a few areas. We will hire the right people both internally and externally, which will be extremely important. We recently announced a hiring of Luke Bohlman with 20 years experience in the worksite as our sales leader in that channel. Developing the right products in concert with our distribution teams, in order to continue momentum with new products when we come to market, is extremely important.

Next is the continued buildout of our worksite strategy. With the continued evolution of less employer moneys towards benefits, the large number of people in the middle market, and our experience in worksite, I am bullish about our ability to compete in that space. Lastly, it's all about execution and to-date we demonstrated our ability to do that, and I don't anticipate any changes in the future. Jim?

Thanks, Mike. Now I'd like to ask Scott Perry to discuss the results at Bankers Life. Scott?

Thanks, Jim. As you can see on slide 25, Bankers continued its strong performance with pre-tax operating income coming in at 73 million for the quarter, up 21% from a year ago, and up 4% from the second quarter 2006. This performance reflects many of the actions we implemented in late 2005, early 2006, to improve the fundamentals of our inforce block. The improved earnings is being primarily driven by a lower Medicare Supplement benefit ratio, higher investment income driven principally by higher level of assets backing our annuity and long-term care blocks of business, and lower operating expenses. Pre-tax income on a trailing four-quarter basis indicates consistent growth quarter-to-quarter as these fundamental improvements take hold. In addition, our revenue, both on a current quarter basis and trailing four-quarter basis, is steadily improving quarter-to-quarter, reflecting growth in our life product lines, the re-rate actions we have taken on our long-term care inforce, and the 50% quota share with Coventry Health Care for their prescription drug plan products that both Bankers and CIG are distributing.

Now I'd like to discuss benefit ratios by line. On slide 26, we look at Medicare Supplement. We've experienced a steady decline in the Bankers Medicare Supplement benefit ratio, both on a current quarter and trailing four-quarter basis. This has been fueling a lot of our steady earnings improvement, and is driven by the pricing actions we took last year for 2006, and continued favorable claim experience for 2005 and prior year incurred claims. This resulted in our relooking at our anticipated 2006 loss ratio experienced this quarter, resulting in lowering our anticipated loss ratio experienced for 2006 incurred claims. Slide 27 looks at long-term care benefit ratios. We experienced an increase in our interest adjusted benefit ratio in the third quarter after several quarters of relatively flat benefit ratios. This was primarily driven by an increase in the number of incurred claims for the first two quarters of 2006. This is something we are closely monitoring.

On the re-rate front, approximately 75% of the inforce targeted for re-rates were implemented as of the end of the third quarter 2006, with the balance coming in the fourth quarter 2006 and early 2007. We are extremely pleased with the progress and execution of this process to-date.

Now let me shift to sales, on slide 28. Overall, I am very pleased with our results. For product lines sold by Bankers and Colonial Penn, first year premium collections on insurance products for the quarter was 364 million, up 26% over the comparable time period in 2005 and for the nine months. First year premium collections on insurance products was $1.004 billion, up 17% from the nine months of 2005.

On slide 29, regarding Medicare Supplement, first year premium collections dropped somewhat in the third quarter 2006 from the prior two quarters. If you recall, we have been experiencing very strong sales in Medicare Supplement during the first two quarters of this year, and despite the decline this quarter, first year premium collections are up almost 28% from the third quarter 2005. Also noted on this page is the premium generated through our Part D quota share arrangement from our growing block of PDP customers which, as of the end of September, generated over 140,000 members.

On slide 30, we look at long-term care. As we have discussed in prior quarters, our long-term care sales have been experiencing a steady decline over the past five quarters. With our veteran long-term care agent now back to being focused on selling as opposed to servicing a significant portion of our long-term care policyholders impacted by the inforce re-rate, we are beginning to see some signs that this sales erosion will begin to abate.

As slide 31 shows, we have experienced consistent growth in first year premium collections of our life products, both on a current quarter and trailing four-quarter basis. All life product lines are growing nicely.

And finally, annuities on slide 32. We had a strong showing in first year premium collections of annuities, up 17% from the prior quarter, and up 22% from third quarter 2005. This strong performance was driven principally by the sale of equity indexed annuity products. In third quarter 2006, equity indexed annuities represented almost 30% of first year premium collections of annuities compared to 13% in the third quarter of 2005.

Let me close with a couple of business highlights. First, as you have may noted in our recently issued press release, we are very pleased to officially announce that after lengthy discussions with multiple Medicare Advantage plans, we have entered into a partnership with Coventry Health Care to offer the Advantra Freedom Medicare Advantage Private-Fee-For-Service product in 43 states, covering 73% of the counties we operate in today. This arrangement expands the alliance we formed with Coventry last year to offer Medicare Part D to our policyholders and consumers. And similar to that agreement, we will also be entering into a quota share arrangement, whereby Bankers will share in approximately half of the product economics.

The Private-Fee-For-Service product is designed to provide seniors with more choices and better coverage at lower cost than original Medicare and Medicare Advantage plans offered through HMOs. With Advantra Freedom Private-Fee-For-Service plan, there are no provider restrictions. Policyholders may go to any licensed doctor or hospital in the United States that is willing to provide care and accept the plan's terms of payment.

We are currently in the process of rolling out marketing and training programs to our agents. Sales begin in November, as eligible individuals may enroll in Private-Fee-For-Service plans where available beginning November 15, 2006. As mentioned earlier, our agreement with Coventry is similar to our Part D arrangement, and thereby allows Bankers to earn distribution fees and share in the profitability of our Private-Fee-For-Service sales. In 2007, we expect roughly one out of every four to five Medicare sales to be a Private-Fee-For-Service plan, with Medicare Supplement plans still accounting for the majority of our total Medicare sales.

Lastly, we continue to make progress in our efforts to enter the state of New York. This is an important move for Bankers as New York is the only state that we do not have a presence. We will open our first branch in Syracuse, New York, later this month, with plans to add at least four more in 2007. Jim?

Thanks, Scott. Now, I'd like to ask Greg Barstead to discuss the results at Colonial Penn. Greg?

Thanks, Jim. Conseco's direct response group at Colonial Penn continues to demonstrate solid sales growth in its core life insurance marketing program. As you can see on slide 33, Colonial Penn has achieved five consecutive quarters of steady growth in its key sales metric first year collected premium. During the third quarter of 2006, we were up 16% over the comparable quarter of 2005.

This growth can largely be attributed to four components. First, in a targeted manner, we have increased our advertising spend in our core TV based lead generation campaigns. Second, we have undertaken efforts to broaden our overall customer acquisition activities by introducing several new direct mail-based lead programs this year. Third, we have been successful in expanding sales volumes in our recurring direct mail campaigns that are directed to prior responders to our advertising, as well as our existing customer base. These campaigns are benefiting now from the increased lead activity in recent quarters, and will continue to benefit from this expanded activity in the future. And finally, we have been successful at improving the overall sales productivity of our telemarketing staff. Now I'll turn it back over to Jim.

Thanks, Greg. Now we would like our COO, Jim Hohmann, to give you a report on our closed block health business. Jim?

Thanks, Jim. As Jim Prieur mentioned, this has been a very disappointing quarter in the LTC closed block. Let me take you through some of the specifics.

If you turn to slide number 34, you will see a display of interest adjusted benefit ratios for the last five quarters. For the first three quarters, the ratio, although it is influenced by several moving parts, has been relatively flat at around 50% or less; however, in the second quarter of this year, the ratio exceeded 64% and in the third quarter, it has risen to 83%. Over this same period, premiums have declined modestly from the low $90 million level to the mid $80 million level.

As you can see from the slide, and as noted during the earnings call for the second quarter, the increased loss ratio in the second quarter appeared to be caused by one-time fluctuation rather than a trend. Accordingly, when we revised our outlook for the balance of the year, we anticipate that the loss ratio would be somewhat elevated from recent history, but that it would fall from the spike in the second quarter.

In the third quarter, the loss ratio has increased again and the book of business under performed our expectation by about $24 million. The overwhelming majority of the shortfall stems from two phenomena. Roughly speaking, about 9 million comes from higher than expected persistency, and about 13 million comes from increased claims incurred.

Beginning with persistency, it is important to realize that a small variance can have a fairly substantial impact. With roughly $2.5 billion of active life reserve, a ratable 40 basis point difference in persistency can create roughly a $10 million financial variance. Even a smaller variation can cause that difference if the mix of persisting business has changed, and less reserve intensive business is lapsing, and more reserve intensive business is persisting. This will happen from time to time, and it's not necessarily a trend.

On the claim side, one of the items that we track is inventory adjusted claims paid. This is not a financial statement measure, but takes paid claims and adjusts them to reflect an estimate of the change in claims inventory. For the four quarters ending with the first quarter of 2006, that is, the last quarter before the loss ratios increased, inventory adjusted claims paid had been averaging about $95 million per quarter. In the second quarter of this year, inventory adjusted paid claims were estimated at nearly $103 million, and in the third quarter it fell, but only slightly to about 102 million.

Most of our incurred claim variance was caused directly by paid claim experience. In addition, because we've had two successive quarters of adverse experience, the claim reserve calculations are reflecting higher expected future payments, which has bolstered reserves on existing claims. Having described the experience of the quarter and its financial effects, let's turn to the business improvement initiatives we outlined during our call last quarter.

If you look at slide 35, you will will recall that we had initiatives involving premium re-rates, talent and organizational design, technology, and claims management. If you turn to slide 36, you'll see that the re-rates are being filed across the country. As stated on last quarter's call, on an annualized inforce basis, the estimated impact of these re-rate requests would be about $50 million; however, we noted that rate approvals and execution would reduce the actual annualized figure.

Since last quarter, we have completed additional work to estimate the effective approvals and implementation. We expect roughly $35 million of annualized net revenue enhancement will be derived from the first round of rate increases. This figure accounts for the expected approval level as well as policyholder decisions regarding acceptance of the rate increase. Some policyholders will choose to reduce benefits, and, therefore, their premiums. The annualized net revenue enhancement is the primary financial metric against which we are measuring our progress on the re-rates. In addition, we will be closely monitoring benefit reduction elections because the financial benefit of these reductions may well exceed the financial benefit of a corresponding rate increase.

To measure progress on re-rating, you need to begin with the fact that a total of 357 rate filings must be prepared, filed, negotiated, approved, and then implemented. As of October 13, we have 85 of these requests on file, and we have received 22 approvals. While the 22 approvals represent only about 6% of the total filings, they capture over 22% of the annualized net revenue enhancement because we prioritize the filings by financial impact. So in dollar terms, roughly 8 million of of the 35 million has already been approved.

Moving ahead expeditiously with our re-rate program will continue to be a top priority. By the end of the fourth quarter, our target is to have approximately one-third of the annualized net revenue enhancement approved. The financial effect of these rate increases will come on line throughout 2007, and impact the business in all future durations. Finally, it is important to note that our rate filings are requesting rate increases at this level for each of the next three years. A handful of regulators will approve these all at once, while others will simply note that we will be requesting more in each of the trailing two years. Turning to slide 37, you can see that on the talent and organizational front, we have added exceptional talent to our team since the last earnings call, and we've created a more specialized LTC organization. Collectively, we've added almost 35 years of LTC experience. Overseeing the re-rate activity, we have Dick Garner who is an actuary and has joined us from American Republic. Dick has over 35 years of health-related experience, and has been working with LTC for over 20 years, quite frankly, since the inception of the product category in the industry.

We've also hired Brian Wegner. Brian has about 22 years of overall industry experience, with about seven focused on LTC. Among his former employers are Fortis and American Republic.

We've also hired David Vega. David joins us from the long-term care group. He has about 14 years of overall industry experience, with about seven of that focused on LTC. Organizationally, we've introduced more specialization into our front line claims teams. Specifically, we have realigned our claims teams to better address the variation of LTC policy forms and benefits by state or multi-state region. This increased specialization will improve our claims management and compliance.

Extending the specialization theme, we have moved the LTC call center from a centralized environment into the LTC unit where we have specialists trained exclusively on our run-off LTC book. In that setting, we are also able to establish a close connection between that team and the legal team within LTC that we referenced during our last earnings call.

From slide 38, you can see that we have launched several IT related initiatives to better support the LTC operation and improve claims management. We are implementing a new work flow system this month. Not only will that allow us to more efficiently distribute our work, but it will also improve our quality control and our claims metrics. Longer term systems initiatives involve improving electronic access to policy benefit and claim history. Today, we continue to address deficiencies in the historically acquired platforms through manual processes.

Turning to slide 39, we have retained LifePlans to attack claim leakage. LifePlans is a national LTC services firm with a 20 year track record in LTC claims management and product development. We have worked with LifePlans successfully in the past at Bankers Life & Casualty. Beyond the leakage study, we have asked a major actuarial consulting firm, Milliman, to review our claims information to ensure that we capture and share all of the qualitative, as well as quantitative, information that would be helpful with establishing our claim reserves. Both of these projects are expected to run through the fourth quarter.

Finally, I turn your attention to slide 40. As noted during the call last quarter, it is important to realize that while we've improved performance in the LTC book -- that while improved performance in the LTC book is going to be a logical consequence of these actions I've described, it will take time to materialize. The fourth quarter of 2006 will be a period where our new leaders will be focused on managing the changes noted earlier, while they also work with LifePlans and Milliman to develop even more recommendations and improvements.

Moving into 2007, we expect that to be a transformational year where accelerating process and financial improvements can be expected. Jim?

Thanks, Jim. Turning to slide 41, I wanted to share a couple of observations with you. I've now been with the Company for 50 days and have spent quite a bit of time with the distributors. I believe that one of the strengths of Conseco is its distribution. The Bankers Life business has a strong and unique culture that's ideally suited to serving the senior middle market in America. Colonial Penn is an important and successful direct marketing franchise that should be able to grow in excess of 20% per year. CIG has established itself as a supplier to a number of national partners and IMOs and, of course, also as a wholly-owned subsidiary selling directly into the market. These distribution systems are, for the most part, not particularly rating sensitive, which makes Conseco somewhat unusual in the insurance marketplace. While we continue to look forward to the time that the ratings improve, our ratings improvement alone is unlikely to have a huge impact on the sales results of the Company. Aside from the distribution strength of Conseco, the other observation I would make is that the Company has opportunities to run a much tighter operation. There are some parts of the Company that need much more focus. There are parts of the business which are producing unacceptably low returns, which we will not feel compelled to keep. The Company has to be focused on creating shareholder value. That's the primary reason that the Board hired me.

Capital management needs to be improved. The Company, this Company, generates excess capital, and if we can't use it, we will return it to shareholders. Compensation for executives will also be changed to align interest more closely with shareholders. For example, ROE per business units will become a primary measure of performance. So I'm here today to tell you that everything is on the table.

To summarize, on slide 42, in the third quarter, we had some positive developments with good profitability at Bankers and solid sales, some profit slippage at CIG but outstanding sales results there. These core businesses are fine, not that they can't do better, of course, and I'm sure that the staff and salesforces can and will improve these core businesses even further. The run-off block of LTC business, however, has produced very poor results. Jim Hohmann has described the various steps that we're taking to improve performance in this business, and we'll be aggressively working on this block going forward. This is the second disappointing quarter in a row, and this isn't acceptable to senior management or to the Board. We're in the middle of our annual planning process, and I can assure you that the business plans for the Company will be adjusted to take into account the current circumstances and the recent results. I'd like to emphasize that this will not be a business as usual plan. Conseco is focused on the senior middle market in America, the fastest growing major segment in the market. Conseco has a unique sales machine dedicated to this market, whether it's through agents, direct, worksites, or through brokers. We're committed to growing this business successfully in the future. Thank you for your attention, and we will open it up for questions. Operator?

[OPERATOR INSTRUCTIONS.] Your first question is from Andrew Kligerman with UBS.

Just to get started to make sure I'm clear on the run-off long-term care block, where Jim Hohmann said progress will take time to materialize. If I understand it, you've got 25% of the approvals in action right now, and then the rate increases are going to come over three years. So the question is: How does this 136% benefits ratio work it's way down? Is it very gradual, and where can we expect it to be in say two years time?

Well, a couple things. I think first of all, to start with the rate increases themselves. Specifically, we're talking about approvals of rate increases, and obviously, we need to continue to get approvals, and then we need to implement and get those out to the policyholders, and then see what choices they make. That's one of the reasons why it takes time.

And that's only a quarter done?

It's a quarter approved.

Okay.

From a financial perspective. So this will be work that will be ongoing through the whole of next year.

The second thing is that with respect to the particular loss ratio, there's lots of factors that go into that, and that loss ratio, in the same way that it changed in this particular quarter when we had a difference in persistency that was only modest that had a substantial financial effect, could go the other way next quarter, or it could stay where it is. That's not as much of a pure rate increase item as that particular piece of the puzzle could be more of a fluctuation. But over time, you would expect by adding more premium to the book that we would be managing to the lower loss ratio.

And what would that lower loss ratio be, Jim?

Well, I've actually got one of the actuaries in the room, a gentlemen named Mark Albert, and perhaps, Mark, you can address that particular item? We need to move the mic over though.

Yeah, as Jim indicated, the many factors drove the 136% loss ratio, or the 83% interest adjusted loss ratio, and we focus a lot on the interest adjusted number because that's the more accurate financial measure. And we would expect that to normalize back to a 50-60% range more in line with what we have seen in historical periods.

And time wise, when do you think that happens?

Probably in a full cycle.

Again, that's going to be driven by, largely by these other non-rate increase factors that impacted results for the quarter. We still expect a normalization of results over the next several quarters to occur.

Just to add to that, I think in that context, the path won't be linear, and when it gets there, the experience will continue to be volatile. It's the nature of the business.

Okay. And then just shifting over to the fact that you had a loss in that run-off block and AM Best, one of their prerequisites to an upgrade in 18 to 24 months would be $50 million of earnings in that run-off business. Clearly, that doesn't seem to be the trajectory this year or next year, so does it look like you just won't, what are the -- does that just take all bets off the AM Best upgrade even in 18 to 24 months?

Well, I would say that's principally a question to AM Best, but from our point of view, as we view the rating process, financial strength ratings and credit ratings, our prospective, this is a process that we will continue to work through. Whether or not we achieve the hurdle at this point, I think, is certainly too early to call today. There is embedded margin in this business that we would expect to emerge over time, and the AM Best review will occur at a point in the future, and then the performance of the book will be evaluated at that point.

Okay, and then just lastly, Jim Prieur had indicated that you would not necessarily be compelled to keep businesses with unacceptable returns. How might you divest of them, particularly this run-off block? Is a securitization an alternative, is reinsurance an alternative? Is there a market for long-term care insurance to be seeded away?

Andrew, I wasn't necessarily referring to this block, and I think the message I was trying to leave with people was that everything is on the table rather than getting into the specifics.

Okay. That's fair, and just if you could get specific about the long-term care, if you had wanted to, if that were, if you were considering that, do you think that there's a market out there to seed it away?

I think when a business is accepting short-term, what could be short-term, negative fluctuations, negative trends, that probably is not an ideal time to either sell it or re-insure it.

Good point. Interesting point. Thank you very much.

You're welcome.

Your next question is from Joan Zief with Goldman. Sachs.

Hi. Thank you, I have two questions. First is how do you balance the ratings issue and your desire for a growing distribution and growing sale? Because how do you decide whether the business that you're getting is the quality that you want to get, given your ratings, and the distributors that you want to get are the quality, given your ratings.

Well, I think that -- I've been trying to make the point that the business that we currently have is not particularly credit ratings sensitive, and with respect to the balance, many of the credit rating agencies seem to want growth, in any event. But the business that we're currently in is business of a B double-plus company and can do quite comfortably, and we seem to be achieving quite a bit of growth. And I don't see this as being a big trade off.

My next question is you mentioned that you do want to use your excess capital for shareholder value, but is that really realistic for the next several years? You have restrictions on the covenants and things like that. Is that really just a long-term goal, or is there really something immediate that can be done?

Well, first of all, there are rooms within the debt covenant that would provide room right now, and then as we make changes in the company and focus more on this, I think that it is a realistic thing, and it's realistic in 2007.

And when you're thinking realistic, are you thinking dividends, or are you thinking buyback?

I think we will review the dividend policy as we approach 2007, and either or both.

Okay. I just have actually one last question.

Oh, sure.

That is your solutions to the long-term care closed block seem to be a very traditional approach. Go in for the rate increases, and get that implemented, and take care of the way you manage claims, and things like that. But do you think at this point in time, it may be more appropriate to think about some sort of non-traditional approach to walling that off so that you're not sort of throwing good money after bad?

Well, as I said, I think everything is on the table; however, there's a reason why people take traditional approaches. It's that they work, and so we're definitely going to look at it in a traditional way. And the two things that you can do with a block is manage the claims to the best of your ability, and improve the revenue. Jim, if you'd like to add something?

Well, I think the traditional approach I think is the undeniable in terms of the action that we would take, and whether or not there's something that can be done, in addition to that. I don't view traditional and the alternatives you're talking about as necessarily mutually exclusive, so I think we have a set of undeniables here that certainly should be effective, and so we're going to be driving those.

Okay. Thank you.

Next question, Operator?

I'm sorry, your next question is from Yaron Shashoua With Fox-Pitt, Kelton.

Thank you, and good morning. Just a couple of questions. The first, if things continue to get worse in the run-off business, is there any risk that you'll have to bolster reserves?

Well, there is, I would say, understanding how the reserving works, you have active life reserves, and then you have claim reserves. There are several $100 million of margin built into the existing act of life reserves, so before one would have to make any adjustments, that would have to erode significantly. With respect to claim reserves, that tends to be more volatile and relates to claims specifically that have been incurred to-date, and we could have fluctuations in those claim reserves as experience related to how those claims run-off on already incurred claims develop over the next several quarters. Our average claim reserve is, typically our average duration period is 24 to 30 months.

Maybe one thing I could add to that is one of the reasons that you see the financial effects that we talked about is because reserving system is dynamic by it's nature. So it has been adjusting as we go. So as a result, there's certainly that particular aspect ongoing, and that provides some additional protection against what you described.

Okay, great. Second question is on if you still see volatility and earnings continue to decline, how does that affect actually your valuation on the deferred tax asset?

The valuation of the deferred tax asset is a function of projections that involves a very long period, so we would pretty much cover the same period that the end force does. So one would map against the other relative to the basic assumptions that are in the reserves. The bright line accounting issues would be crossed if, in fact, on the aggregate we're generating a loss. Then we have different accounting rules that come into play relative to the presumption on the recoverability of the deferred tax asset. That's not a conceivable outcome for me.

Okay, and my last question is actually to Jim Prieur. I realize you have only been there for a short time, but could you at least give us a sense for the kind of timeline you and the Board are thinking in terms of enhancing the company's ROE?

Well, I think we're aiming to improve it as quickly as we can, so why don't I just leave it at that.

I mean, I understand timing is as quick as possible, but can you elaborate on options of what you can do to actually improve the ROE?

Well, there are a whole number of things, but in terms of managing capital, the earlier question was about the company will consider reviewing dividend policy, and will be doing that relatively soon.

Okay. Thank you very much.

Your next question is from Jukka Lipponen with KBW.

Good morning. Jim Prieur, first to you. Could you give us some color on what attracted you to Conseco? How do you view Conseco persisting in the marketplace, and what are the opportunities that you see for Conseco?

Sure. I'd spent an awful long time at Sun Life Financial, and I had a lot of different roles at Sun, and I think I was in 15 different jobs, and my last job I think I had for about six and a half years, and I felt it was time for a change. Sun Life had done very, very well, and I saw Conseco, I continue to see Conseco focused on a part of the market that very few insurance companies are focused on, and I think it's a company that has the potential to become a really big and strong company in the marketplace. So that was the basic attraction.

And the opportunities?

The opportunity is to fulfill my vision and make sure that Conseco does succeed in the middle market, American insurance market, and continue to grow at a very fast pace. And if you'll permit the comment on value, it also strikes me as being a fairly inexpensive stock at this point.

And can you give us an update on where are we as far as the systems upgrades and systems integration, etc?

Sure. Why don't I give a very brief comment, and then I'll pass it over to Russ Bostick who runs our systems area. But Conseco has opportunities to invest in systems. Quite a few opportunities to invest in systems improvement simply because of it's history. It's legacy of having acquired so many different companies, and so there are opportunities to improve the operational effectiveness of the company by continuing to invest in systems. And with that broad comment, I'll pass it over to Russ. Russ?

Hello, this is Russ Bostick. There are a couple of distinct areas where we're seeking systems improvements, and they will roughly fall into the category of the front office where staff has to process the business, and how much consistency can we give them in their work experience so that they are able to be more productive and process accurately. In that area, as noted before for long-term care, we're distributing the automated work distributor system so that we're improving the consistency and depth of automated workflow throughout the organization, and that's a multi-year plan. We're well into it and have achieved significant successes, particularly in the Conseco operation, and as you note, we are now applying it this month in long-term care. Those same capabilities are going into Colonial Penn and Bankers over the next year. We also are standardizing our processing of new business on a system from NaviSys that will be deployed in the first quarter in both Conseco and Bankers, and that system will provide us with a much stronger and consistent ability to respond to spikes and volume ,and locations for insurance do arrive at very different rates, different days of the month based on sales incentives and the like. We'll be able to be responsive to distributors with that. On the back end, or the back office, if you will, which has been the more traditional place for us to talk about systems and their simplification, we've standardized on a system called LifePro from a company based here in Carmel, Indiana, PDMA. We've got over 20 people with greater than seven years experience on that platform deploying it, and we are introducing new products rapidly beginning this fall on the latest version of that software. We are studying whether to restart the further simplification of systems, and that is to say conversion of policies from one section to another with LifePro as the target platform for most of that work. At the same time, we continue to improve IT practice, driving out production quality issues, improving the state of practice in IT, and improving the use of our owned Conseco, India, IT organization.

And then last question to Gene. Is there any reason why you couldn't put this run-off long-term care block and start reporting it as a discontinued operation and eliminate some of the earnings volatility as far as the rest of the business goes?

I think that the rules around discontinued operations are very difficult to apply to something that has a contractual committment that might last for 20 years. So in fact, we did consider that earlier, and we were able at one point earlier in our history to put our major med business into a category of discontinued because that would more reasonably qualify the accounting standards. But it's very difficult, and I think many insurance companies with close blocks would love to call them discontinued. It's just not -- doesn't pass mustard from an accounting point of view.

Great. Thank you.

Your next question is from Eugene Chen with Sutton Brook Capital.

Thanks for taking the call. Let me first start off by saying we've been patient long-term and supportive shareholders for some time, we have endured multiple CEO changes, and we have seen multiple promises by management that have been continually unmet. My question today is: Given the increased risk profile of the long-term care book and what seems to be basically an unattainable AM Best target that they put out for you, why is it not the right time today to be proactive and explore strategic alternatives?

Thanks for the question, Eugene. Well, I think companies always have to be thinking about what their value is on an ongoing basis. In other words, it should be automatic that companies are thinking about strategy and alternatives to their current strategy all the time. And the breakup value or the value in the sale pretty much has to be in the mind of every Board member and every senior executive if they are doing their job. It's sort of a shadow value that you got to be aware of, and sometimes it is greater than the Stock Market value, and the question then is do you think you can improve the company enough that you will move both the Stock Market value and that shadow value up by more than the value get in a sale. I guess as I was saying earlier, Conseco is in the midst of it's regular planning process with the Board, and we will be presenting the plan to the Board at the next board meeting in December, and it will not be business as usual. Conseco is also organized on a very shareholder-friendly basis. There are no special takeover defenses in the case of Conseco, and we will be looking at everything.

So I'm sorry. Are you saying that you are undertaking in conjunction with your annual planning a proactive strategic review or not? And will we be given a report or some kind of feedback from your, the plan that you present to the Board in December?

Undoubtedly, we'll be sharing the plan once the plan has been approved the Board. I think we have time for one more question.

Yes. One more question, please, Operator?

Your last question is from Tom Gallagher with Credit Suisse.

Good morning. Two quick ones for you. One is, I don't know if this was asked earlier, but your deferred tax asset, I guess this is for Gene. Is there any risk here that if the run-off long-term care loss ratio stays where it is for awhile that we could have had DTA impairment type situation, that's the first question. And then second one is my understanding is that in past years, you've also done rerate on the run-off book. Why is it going to be different this time, and why do you have confidence that you can actually improve things? Thanks.

Well, on the first question, the financial projections that we use to both establish and evaluate our deferred tax assets and related valuation allowances have a level of sensitivity exposure to downside risk in them, which I think wouldn't be significantly different from the kinds of thing that we currently experience, so I don't see any immediate issue relative to recoverability. So I'll leave it at that, so I don't think so. Relative to the rerate question, Jim?

Sure. A couple thoughts on that. There has been some rerating in the book in the past, and I think that by it's nature, I would conclude that's successful to have done that. Those rerates are embedded in the book. It is a fact, however, that with the Florida consent orders around a portion of the book, an awful lot of attention was diverted to the Florida consent orders, and the bulk of that book has not been rerated in some time. And so as far as rerating being successful, I think we already have momentum on the rerating. We certainly have the infrastructure to implement it, and we have a plan that brings the rerates in over time so that we properly manage the book to make sure that the absorption of rerates is as best as it could possibly be.

And Jim, is it fair to say that the rerate plan that you have in place now is much more substantial than what's been done in the past, or does this look and feel similarly?

Certainly it's much more substantial than anything in the recent past, and it's important to realize that it has three stages to it, all of which are substantial. The $35 million that was referenced in the script is only the first round.

Okay, thanks.

Operator? Thank you very much for all of the questions, and undoubtedly we'll be getting some more afterwards. I'd just like to reiterate that Conseco is focused on the right part of the market., the senior middle market in America, and we do have a unique sales machine. I think that we are proving that we can grow the business with the current credit ratings, and we are committed to growing this business successfully in the future. Thank you all very much.

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