CNO Financial Group Inc (CNO) 2014 Q2 法說會逐字稿

Good morning. My name is Bradley and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2014 Earnings Results Conference Call. (Operator Instructions) Mr. Erik Helding, you may begin your conference.

Good morning and thank you for joining us on CNO Financial Group's Second Quarter 2014 Earnings Conference Call. Today's presentation will include remarks from Ed Bonach, Chief Executive Officer; Scott Perry, Chief Business Officer; and Fred Crawford, Chief Financial Officer. Following the presentation, we will also have several other business leaders available for the question and answer period.

During this conference call, we will be referring to information contained in yesterday's press release. You can did obtain the release by visiting the media section of the website at www.cnoinc.com. This morning's presentation is also available in the investor section of our website and was filed in a Form 8-K earlier today. We expect to file our Form 10-Q and post it on our website by August 6.

Let me remind you, that any forward-looking statements we make 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. Today's presentation contains a number of non-GAAP measures which should not be considered as substitutes for the most directly comparable GAAP measures.

You will find a reconciliation of the non-GAAP measures to the corresponding GAAP measures in the appendix. Throughout this presentation, we will be making performance comparisons and unless otherwise specified, any comparisons made will be referring to changes between second quarter 2013 and second quarter 2014. With that, I'll turn the call over to Ed.

Thanks, Erik, and good morning, everyone. CNO posted another strong quarter and our businesses performed well as we continued to deliver growth in sales, collected premiums, annuity account values, and earnings. Consolidated sales were up 3% in the quarter and operating earnings per share excluding significant items increased by 28%. Our financial position remains strong and our key capital ratios are at investment-grade levels.

We continued to return capital to shareholders and repurchased $96 million of common stock in the quarter. Also, we recently increased our 2014 full-year guidance for securities repurchase to $350 million to $400 million.

On July 1, we successfully closed the sale of CLIC. As we have previously discussed, the sale of CLIC is an important milestone for the Company and should significantly reduce our risk profile, further sharpen Management's focus on our three core businesses, and enhance the quality and stability of earnings going forward.

Our consistent performance, strong balance sheet, and proactive approach to derisking our business, continues to be recognized by rating agencies, with S&P upgrading CNO to BB plus earlier this month; the ninth upgrade we have received since 2012. At our investor conference last month, we highlighted some of the investments we are making to increase agent productivity, expand our geographic footprint, introduce new products, expand our worksite platform, increase back office operating efficiencies, and enhance the customer experience.

They are important growth investments that should continue to enable us to drive sales growth above industry averages. While first half sales are below our full-year expectations, there are several metrics supporting our confidence in attaining our sales growth guidance. Scott Perry will go into this in more detail later in the presentation. Despite the slow start, sales over the last 12 months have increased 6%, while collected premiums and annuity account values have increased 2%.

Turning to slide 7, we have had great success in increasing our operating earnings by proactively managing our in-force business and continuing to invest in initiatives to drive growth. For the second quarter, operating earnings, excluding significant items, increased by 24% and operating earnings per share were up 28%, as a result of our continued commitment to return capital to shareholders via stock buybacks.

CNO's capital generation capabilities are compelling. Since 2011, we have generated approximately $1.8 billion in capital and have been thoughtful and balanced in deploying that capital. Earlier this month, we achieved yet another milestone having bought back $1 billion in common stock and equivalents since we implemented our repurchase program in 2011.

With a significant amount of excess capital at the holding company, expectations for continued strength in capital generation, financial metrics at or above investment-grade standards, and leverage of 17%, I can assure you that we are continuously monitoring the key factors that will determine the extent and timing of the recapitalizing. I will turn it over to Scott to discuss our segment results in more detail. Scott?

Thanks, Ed. Bankers Life sales were flat in the quarter with a 13% increase in Life and a 10% increase in annuities, offset by overall lower sales of 15% in health, which was mainly impacted by negative long-term care results. The overall agent force declined by 4% versus last year, but is up 1% from last quarter. The agent force is being impacted by lower recruiting, which was down 9% in the quarter.

Collected premiums for Bankers Life were up 2% in the quarter, due mainly to increases in life and annuity products, which were up 10%. Overall health premiums were down 4%, mainly due to the continued decline in mix shift in long-term care and the decline in Coventry PDP quota share premium, as the program has converted to a fee-only arrangement. Embedded in our results for the quarter are trends that bode well for the long-term economics of the business.

With the mix shift we've seen towards life and annuity products, our average premium per policy increased by 10% and our agent productivity is up 4% in the quarter. In addition, our productive agents increased by 14% versus 2013. While our first year agent numbers are down, the increased productivity of our veteran agents is driving improved retention levels, which we expect to continue and eventually, combined with recruiting results, which we fully expect to revert to historical norms, will lead to a larger, more productive agency force.

Finally, we opened an additional four satellite offices in the quarter and five year-to-date, bringing our total location count to 306. Turning to Washington National, sales were up 9% in the quarter with individual market sales up 11% and worksite sales up 3%. Supplemental health sales were up 12%, primarily driven by sales in the individual market through PMA. Supplemental health collected premiums increased by 6% and PMA-producing agents rose by 17%, benefiting from improved agent retention during the quarter.

Moving on to Colonial Penn, we are pleased with the solid sales recovery that yielded 4% growth in the quarter. This growth was mainly driven by strong sales in both web and digital-generated activities, as well as in the new simplified issued term and whole life products. During the quarter, we also achieved a 5% year-over-year improvement in the marketing cost to sales ratio, as a result of both improvements in our TV costs per lead, as well as good progress made on our sales and regeneration diversification efforts.

After a very challenging January, Colonial Penn has started to generate strong sales momentum, achieving a 7% growth since February. This is very relevant since the competitive dynamics have not changed. The positive momentum is a result of multiple internal sales and productivity enhancement initiatives that were launched in February; and we expect that they will continue to generate positive results for the remainder of the year.

Finally, Colonial Penn's collected premium and in-force EBIT were up 6%. Colonial Penn continues to drive solid economic value for the Company.

Turning to slide 11, our business segments are making strategic investments and overall, we are pleased with the progress of those initiatives to help fuel growth in 2014 and beyond. At Bankers, we completed the first phase of work on our new customer relationship management platform, which involves lead and appointment management, and is now being evaluated by several pilot offices.

We also have now released a new two-day live classroom training course on advanced life insurance sales concepts, which has been attended by over 1,000 agents and has become a regular part of our first year agent training. At Washington National, we introduced our new critical illness supplemental health product in the second quarter in 17 states, for sales in the individual market through PMA.

We are seeing strong market receptivity with policy sales exceeding expectations and higher average premium per policy, as compared to the previous product offered in those states. We are also on track to launch three new group products and an enhanced enrollment and benefit servicing platform later this year. Given the timing of product state approvals and enrollment of voluntary benefits, we anticipate the impact of these developments on worksite sales to largely occur in the second half of 2015.

Colonial Penn is making strong progress on its four major initiatives. First, new term and whole life product sales are increasing and now account for close to 10% of total sales. Additionally, we continue with our web and digital efforts, which are improving our marketing cost effectiveness and are a key component of our sales diversification strategy. Lastly, we are capturing benefits in telesales productivity with the full utilization of our new CRM system.

I'll now turn it over to Fred to discuss CNO's financial results. Fred.

Thanks, Scott. CNO recorded another strong quarter on the earnings and capital front. If you adjust for the significant item, we recorded operating earnings of $0.32 per share. This quarter's only significant item impacted corporate expenses and consisted of an adjustment to our agents' deferred compensation liability of approximately $12 million. This adjustment is driven by the material drop in interest rates year-to-date and associated pension index used to value the liabilities.

We take a mark-to-market approach to valuing these liabilities under GAAP and we've experienced periods of gains and losses in the past, which we normalize out of our core results. The majority of our earnings drivers performed at or better than expected, notably annuity margins, overall investment results, health margins in Bankers, and life margins at Colonial Penn. Core capital ratios and holding company liquidity remained strong.

We accelerated capital deployment activities in the quarter. We repurchased approximately $96 million of common stock and in the process, we spent down some of our holding company excess capital. We closed on the CLIC transaction July 1, raising approximately $220 million net of deal expenses, closer to $200 million after completing the recapture of the Bankers Life block from Wilton Re.

Before I leave this slide, it's worth noting that, when comparing our sequential EPS development, we move back to fully diluted shares. The net loss from the sale of CLIC recognized in the first quarter required the use of basic shares in our first quarter EPS calculation.

Turning to slide 13 and our segment earnings, as discussed during our first quarter earnings call, of the roughly $5 million of residual overhead resulting from the sale of CLIC, Bankers and Washington National were each respectively allocated approximately $2 million in the quarter; important when considering year-over-year results.

Bankers EBIT benefited from continued strength in the Medicare supplement and annuity margins, while long-term care benefit ratios improved as compared to recent quarters. In terms of annuities, the combination of strength in indexed annuity sales, solid persistency and spreads continue to fuel strength in earnings. Washington National posted another consistent quarter of sales and collected premium growth in their supplemental health business; however, consistent with recent quarters, benefit ratios were elevated. I'll touch this on more detail in a moment.

Colonial Penn reported solid earnings and a recovery in sales growth driven by cost effective marketing spend. Results also benefited from a modest shift toward direct mail, which allowed us to [DAC] certain acquisition costs. Consistent with guidance provided at our Investor Conference, we anticipate breakeven EBIT for the year as we continue to actively invest in building in-force earnings and value.

Corporate investment results were solid, driven by favorable markets and tactical investment decisions that contributed to the strong performance.

Turning to slide 14, there were a few notable items that require a deeper dive into the performance of our overall health margins. Again, the diversity of med supp, supplemental health, critical illness, and long-term care, effectively ensure a level of stability in our overall margin contribution.

It would be unusual to experience favorable or unfavorable margins in all of our health lines in a given quarter. This quarter was another good example of that. Med supp benefit ratios continued their strong trends, coming in at 69% with continued growth in premium. Long-term care had a favorable quarter relative to recent experience with its interest-adjusted benefit ratio dipping below 80% on better overall claims experience.

It's too early to conclude that the activities we outlined at our Investor Conference are having traction, but we were pleased to see this improvement. Note that premium continues to reduce as we run off more comprehensive and older business and replace with shorter-term and more limited benefit long-term care product. As noted in our press release, Washington National's supplemental health performance was an area of weakness in the quarter.

We have seen, in recent quarters, a slowing of conversion activity, meaning a policyholder who upgrades their policy, resulting in a conversion and resetting of reserve patterns. This activity supported lower near-term benefit ratios, but was not favorable to the long-term economics of our business. Together with related persistency in certain blocks of policies, we see this dynamic continuing into the future and have adjusted our 2014 guidance to the 54% range for interest-adjusted benefit ratios.

Turning to slide 15 and investment results, while rates remain low and spreads are tight, we defended new money rates by remaining tactical in our investment strategy. Tight ALM standards and low turnover creates a manageable flow of assets to invest, allowing us to be selective and nimble in finding opportunity without sacrificing credit risk. As we did last quarter, we highlight on this slide the approximate assets transferred as part of the CLIC sale, overall asset levels in our core businesses continue to grow modestly.

We had no impairments in the quarter and credit conditions remain very strong. Slide 16 profiles our capital position. We ended the quarter with an RBC ratio of 437%. Our RBC benefited from strong statutory earnings in the quarter of approximately $133 million, which includes the results of CLIC. It's worth noting that we will see reduced statutory income and a modest reduction in RBC, now having sold CLIC.

In addition, we closed on the recapture of the life block from Wilton Re, paying a recapture fee of $28 million and generating additional statutory income in future periods. Leverage dropped 20 basis points the quarter despite more robust capital deployment.

We ended the quarter with over $277 million of liquidity and investments at the holding company and would size our deployable capital at approximately $130 million. The sale of CLIC will increase holding company liquidity and excess capital in the third quarter by approximately $200 million.

We provided updated share repurchase guidance during our Investor Conference. We repurchased $137 million year-to-date maintain our repurchase guidance range of $350 million to $400 million for 2014. We are in a strong capital position and remain dedicated to securing investment-grade ratings over time; a goal we believe is critical to unlocking additional shareholder value.

Turning to slide 17 and ROE development, our normalized operating ROE came in at the mid-8% range. We have been retaining high levels of capital in both the insurance companies and at the holding company. When excluding the impact of the OCB transactions, average equity is up nearly $270 million as compared to this time last year.

This has obviously supported our ratings momentum but challenges ROE progression. In the quarter, the sale of CLIC had a muted impact on ROE given the trailing four quarter basis.

In additional, recognize you're not seeing the benefits of any reinvestment strategy on the proceeds and the life insurance recapture. As Ed noted in his comments, with strength in core capital ratios, the sale of CLIC behind us, continued deleveraging, ratings improvement, and favorable market conditions, we are weighing the value of recapitalizing the balance sheet.

Recognizing that in some cases, we are on positive outlook with the rating agencies, we are looking to drive economic value of our shareholders without sacrificing our desire to achieve investment-grade ratings in time. This requires careful planning and consideration of all the variables outlined at our Investor Conference. We remain focused on a few simple drivers of sustainable shareholder value: investing back in our business to support growth, building ROE while lowering our cost of capital and related beta in our business, and effectively deploying excess capital.

With that, I'll hand back to Ed for closing comments.

Thanks, Fred. At our Investor Day last month, I highlighted some of the reasons why CNO is an attractive opportunity. First, we are market-focused on the middle income market in the US. The middle market is large and underserved, with the at or near retirement portion of that market, in which we specialize, growing rapidly.

Our unique business model and strategic alignments of distribution, products, and back office, give us sustainable competitive advantage to meet the needs of the middle market. We are reinvesting in our business model to continue to drive sales growth above industry averages and to improve operating efficiencies.

We are generating significant amounts of excess capital and have been returning a significant portion of that capital to shareholders, without sacrificing growth or financial strength. We have a strong and proven track record of execution and success, coupled with compelling catalysts to drive future valuation.

With that, we'll now open it up for questions. Operator.

(Operator Instructions) Randy Binner.

Good morning. Thank you. I'm going to try a couple on the potential for a debt recap. I appreciate all your commentary on it so far, but I want to ask a couple specific ones if I can try. The first is on the issue of the make-whole for the senior secured bond, our estimate is that it's something like $20 million economically. The question is, is that $20 million a material amount of money relative to all the other NPV considerations that go into this decision of to how best optimize the capital structure? Is that a big number in that analysis or is that a smaller number in that analysis?

Thanks, Randy. To clarify, the $20 million you're identifying is the difference between the make-whole as it stands today and the call premium, if you will, that's involved once we become callable on October 1, 2015 at 104.7, or what have you. I think that what you're saying is, that's the economic decision point or negative that you're basing your approach on, relative to simply waiting for October 1 of next year. The answer is, it's not insignificant.

I would say that it is, in fact, somewhat of a driver of an NPV analysis. If you were just looking at the economic benefit of just simply refinancing your debt structure, that make-whole premium alone would make the economic outcome tight, unless you did something like go all floating and bank on low floating rates for an extended period of time; which would probably not be wise and definitely would not be favorable to rating agency discussions.

If you sort of assume a natural consistency in the fixed floating mix, that make-whole actually wipes out any economic benefit, even with our ratings progression. Keep in mind, that's in part because we refinanced our leverage loans at literally the low point in the market, from an overall rate and spread standpoint, so we don't enjoy much of an uptick there.

Then, that leads you to all the other economic considerations and non-economic considerations, and really, consistent with what we've been saying, what's happening is that pure refinancing economic decision, which is a tough call, kind of a breakeven net negative, is now starting to become more appealing. As you look at other opportunities for lowering the overall cost of capital of the Company by leveraging a little bit more, being deleveraged while looking at non-financial metrics like extending the maturity, moving to a more covenant life structure, and lowering the amortization, which then frees up additional free cash flow for redeployment at more attractive rates.

The other component of it, of course, that factors in is what's your view of intrinsic value of the stock and what's your view, very importantly, of where that goes, if that's part of the reinvestment strategy which is naturally part of a recap. The answer to your question is its not insignificant, it actually very much hurts the pure economics of the debt structure, but it is very much on our radar because all of the other issues are becoming much more compelling for driving economic benefits over time.

Right, because with the stock at $17, the amount of market cap you could potentially create is, in my mind, it seems like it would be a lot greater than the $20 million, but hear you on the refi side. The other piece is, I think we've tended, or at least I've tended to talk about, maybe there'd be a levered portion of this recap. And you were very clear on that at the June day, that you had a more optimal leverage structure.

But given the ongoing earnings here and upflow to the holding company, if you were to optimize cash and this extra equity that's holding ROE down, would we think that some would come away from your liquidity buffer at the holdco, and some might come away from your RBC, and also, some might come away from the levered portion of the recap?

There's really kind of three buckets that could all be pulled down into whatever category you create to deploying excess capital. Is that the right way of thinking of it? That all of those three areas could give me excess capital to manage?

It absolutely the right way to think about it, but let me give you my editorial comments on all three. First, editorial comments on RBC, yes, we are traveling at a high level of consolidated RBC, at about 437%, no question. Now, as I mentioned in my comments, you have to sort of pro forma for our new RBC, as we roll the CLIC, the legal entity, off of our balance sheet and move forward. We would expect that to drag RBC down by about 5 points, give or take, that's roughly the pro forma estimate.

Then you have to kind of be aware that I give you a nice, neat and tidy consolidated RBC, but the way we, as managers, manage our RBC is on a legal entity by legal entity by basis. I'll just give you, for an example, Bankers, which arguably has the low for long interest rate risk and understandably, the long-term care risk, we run at about 380%, which is a very strong RBC and perfectly adequate; but quite a bit south of the notion of 437%.

We run Washington National higher, in the mid-400%s, we run Colonial Penn similarly in the mid-400%s, and with co-variance benefits that we calculate as if we were one legal entity, it pops up into that 437% range. When we're working with the rating agencies and frankly, just watching our own risk-management techniques, we have to look at both measures, consolidated and legal entity. This is all by way of saying as I would not count on a significant freeing up of excess capital down in the insurance companies.

I think we've guided that will naturally travel down to around the 415% range. Yes, there's a little bit of excess in there, a little bit of cushion and ability to manage some additional money up, but wouldn't count on it.

When you go to liquidity, I think you have it measured right. We talked about our deployable capital today at being about $130 million. Now you bring in net new funds of roughly $200 million after the recapture of the life block and that somewhat sizes the type of available capital you have in liquidity and then it all comes down to leverage capacity.

That, once again, is a cost to capital decision, a rating agency dialogue recognizing we're on positive outlook with Moody's, Fitch, and AM Best, and just good risk-management; what do you think makes sense. What I've tended to guide to is, I feel comfortable, we feel comfortable in the 20% range leverage, but we clearly have pushed that up at times to 22%, 23%. In fact, the last recap we did, we pushed it up a little north of 22%, but it was with the notion of amortizing down into something more comfortable.

What act as the governor on leverage for us is not my earnings and free cash flow, the governor is, I'm below investment grade and I'm saddled with the potential of refinancing risk if I'm not careful. It takes absolutely nothing in term of economic weakness and geopolitical matters to have below investment-grade financial debt gap out, or even at times, freeze out, and I need to be careful about what I'm putting on my balance sheet and what I'm rolling over.

One of the big ways we unlock future value down the road is by being investment-grade, stringing out our maturities, having literally no amortization and more confidence in rolling the debt. That's when I can push leverage up a little bit higher and commensurate with our cash flow.

Right. And I appreciate that, let me ask one more. On the co-variance comment and then just also, on the last piece about the kind of broad basket of covenants you have. Wouldn't the credit market be more likely to take an investment-grade view, if you will, on those issues? I mean, wouldn't they be more likely to look at, give you the ability to have investment-grade covenants now? And on the issue of co-variance, I guess that's not an investment-grade issue, but aren't the credit markets more likely to take in the real benefit that co-variance offers?

Not mixing kind of co-variance and market reception, let me speak to your question. Right now, what we're seeing is relative historic tightness, if you will, between the relative pricing or spread between, particularly BB plus and investment-grade BBB flat or BBB minus. In fact, at historical tightness, which would tell you this is an attractive time to be in that highest end of the below investment-grade range and that's, in fact, contributing to why we are much more interested, despite the make-whole, in looking at whether or not there's an economic benefit to recapitalization.

One, there's that dynamic and we need to be careful about that dynamic going away over time, which it has. Interestingly, historically, it's been as wide as 500 basis points, if you can believe that, during periods of tough credit markets, so we watch that carefully. In terms of structure of the transactions, you are right. It is the case that we're seeing more, what I'd call, covenant-light structures, light is the word used.

It's also the case that it's possible to structure, possible to structure, fall-away provisions that allow you to gain some advantages once you do achieve investment-grade. But these are things that ebb and flow in market conditions. With recent geopolitical news, for example, we've seen a little bit of sell-off in leveraged loans and a little bit of widening and so forth.

So these things ebb and flow over time and we have to be careful to watch those markets. I agree with your comments, but it will never give us, though, is the ability to do those longer dated maturities and really ladder them out, and it will not give us the confidence of being able to refinance at will and that's the challenge.

I appreciate the commentary. Thank you.

Chris Giovanni.

Thanks so much. Good morning. First question, just around the sales environment and maybe a bit soft, telegraphed at your Investor Day and needing to really now get kind of the top end of those long-term targets to fall within the 2014 target. So, based on what you guys are seeing, the recovery and improvement that you guys talked about in your prepared comments, how achievable are some of those targets?

Hey Chris, this is Scott. Yes, I think when we're thinking about guidance, clearly where we are sitting at this point the year, I'd say we tend to guide toward the lower end of our range, but we believe that is still achievable at this point. I think there's a couple of things worth noting.

At Bankers, in particular, one of the things that's causing a little bit of the sluggishness is as we transition to more fully underwritten life insurance, that's a longer process time and so we actually have seen our submitted business, year-to-date, is actually up 6% at Bankers. And we have a building inventory that has to work its way through the underwriting process and that's going on. That's a change from previous periods as we see a larger percentage of our business fall into that fully underwritten category, so I think that's worth noting.

I think the second thing worth noting is Washington National is right smack on their target in the higher end of their range and Colonial Penn, as I mentioned in my comments upfront, after January, we've seen solid sales of 7% and we see some real positive trends there. Our conversion rates are strong and our television lead costs and clearance looks very good and we expect that to continue in the second half of the year.

Clearly, getting to that range is going to assume that we get recruiting back to norm at Bankers. It also assumes a strong second half with med supp, especially a strong open enrollment period, and then continued progress in the areas that we've noted that have already shown strength.

Okay and then what's causing you to capture a greater portion of the fully underwritten business?

I think that is a very kind of purposeful move that we've made around agent training and development. It somewhat had a negative impact on our recruiting. We've rolled out a number of training and promotional programs, starting in the second half of last year, that our managers have had to spend a great deal of their time and energy focusing on. Those are largely rolled out and the systems are now running and so we're expecting that our management focus can return to a more balanced focus between recruiting and ongoing sales management.

Okay. At Colonial Penn, you talked about, in the press release, about the shift towards deferrable marketing expenses, which looked to reduce some of the new business strain. I was wondering, can you talk a little bit more about some of those shifts? I think you talked about higher TV marketing conversion, but sort of the sustainability of that, and given the build out of the in-force, are we possibly at a point where Colonial Penn, at least on a GAAP basis, could be an earnings contributor as early as next year?

I don't want to get too far ahead of ourselves, but clearly we have made a purposeful shift to drive more web and digital lead generation activity and those can be more closely related to the sale and ultimately, allow for deferability. Now that is an initiative that has been going on for about 12 months in earnest. We expect that to continue and over time, we expect more balance and a shift from heavy reliance on TV lead gen to less heavy reliance on lead gen supplemented by web and digital activity and thus an increase in deferability.

Chris, just a couple of comments on EBIT at Colonial Penn. We did have a very good quarter. I would say the combination of some favorable investment results that are allocated Colonial Penn, a little bit of favorable mortality, and the deferability, and the deferability was maybe a $0.5 million-ish type contributor to the EBIT in the quarter; that the combination of those things probably helped out earnings in the quarter by about $1 million, maybe a tick over $1 million before tax, just to give you some color on that. Again, as we mentioned, we're adhering to the breakeven concept for the year.

Third quarter, you should note, is seasonally a quarter where we tend to run at breakeven to a small loss, then recovering to breakeven or a small profit in the fourth quarter and therein lies driving towards breakeven for the year. As we go forward, that notion of in force earnings build should continue in a steady and predictable rate. That's where we are focused in driving economic value, but the ebb and flow of our investment in the business will really, then, dictate the EBIT in any particular year and that's subject to our strategic view of whether we like what is progressing.

Understood. Last one, Fred, just for you, thoughts on the valuation allowances, I believe the third quarter is when you do your annual review of the of valuation allowance pertaining to the earnings outlook and the likelihood of utilizing the tax assets.

Yes, I don't want to front run our process, but what we have been saying, particularly after an extremely active year of releasing valuation allowance and generating economics last year, is that we would expect the traditional annual review, as prescribed under GAAP, to really, really calm down in terms of the valuation releases as we go forward. We have a natural assumed level of growth rate in earnings, including non-life income, in our current estimate. I can't predict for you whether or not we'll see something, but I would suggest to you my expectation would be if we did, it would be very modest in the way of adjustments.

Understood, very helpful. Thanks so much.

Tom Gallagher.

Good morning. First question is just on Bankers and what kind of spread you've been earning on the indexed annuity, fixed annuity portion, of that business. Fred, is there a way we can think about where spreads have been trending, what the ROA is in that business, and how big of a contributor that is to the $87 million of EBIT?

Yes, it's a strong contributor to Bankers' EBIT for sure and has been for a while, in part because we've been growing those assets overall in our annuity block; both EIA sales, as well as persistency, has been tracking favorable. Keep in mind, Tom, that the type of distribution model that we have is quite beneficial in that regard. We're not on shelf space, so to speak, nor are we where you get competitive issues and exchanges and moving money around, nor are we selling into an investment-oriented group of individuals.

These folks are really focused in on the protection orientation of the product, as well as investment returns. It's a very sticky, predictable, good high-quality business. That being said, to answer your question, we have been traveling in a range of about 325 to 350 basis points of spread overall when combining the product's traditional fixed annuity, deferred annuity, and indexed annuity. We have been traveling at, we think, a high level of spread.

This is due to some very good investment results and somewhat to do, although I would say modest, the low volatility environment and related option costs, et cetera. There are some things that are allowing us to enjoy a bit wider, so I would suspect that we're at the high end of that range and would probably normalize. In fact, I can't recall if I mentioned this at the investor conference, but I'm happy to mention it here, and that is we gave some forward projections on things like ROE build and EPS build and in those projections, we have a modest calming down, if you will, of spreads over time, which we would expect to normalize.

That gives you a little bit of color. I think our assets under management, if you want to call it, or account value under management is traveling around $7.8 billion when combining both products.

That's helpful, Fred. With that wide of a spread, I'm assuming that's going to yield something like an after-tax ROA in the low 100s? Does that sound reasonable or would you make any adjustments to that?

Yes, I'll let you do those calcs only because I haven't been tracking it that way, plus I would need to kind of think through everything I want in there and not in there, relative to expense load. For example, that spread I mentioned is not including any sort of provision for default expectations and so forth, which I would normally do when thinking about longer-term ROAs. I'd also have to think about distribution expense and other dynamics that we have incorporated in our spread expectations. Tom, I don't mean to avoid the question, but I would suggest that you could do some of your own calcs and come up with an idea of how that's working.

Understood. Your comment on the margins or the spreads coming down a bit in the future, is that more of an intermediate term expectation or is any reason to think that might happen over the next few quarters?

Yes, I would say, generally, we feel okay about sustainability of spreads throughout 2014, but I would expect it to start to calm down, as you get into 2015 and 2016, to more normal levels, which would be more around the low end of the range I mentioned.

Okay. Then shifting gears to some of the other areas within Bankers, the med supp, I know the 69.5% benefit ratio result this quarter is roughly in line with your expectations, but a bit higher than it's been running at lately. Anything in particular driving that, and is the expectation still there around the 70% level going forward?

Yes, we've stuck to that guidance of 70% range and feel like, of course, this quarter is very consistent with that. You've seen, in previous quarters, that we have been traveling lower than that and really what had been going on in previous quarters, although not outside the norm, we've seen these levels before, is a level of redundancy in the number where we reflect on the current performance and then past reserving standards and make adjustments to the reserves according to how we see the pattern of performance.

Those redundancies, although small in any particular quarter, can contribute to a better benefit ratio or favorable benefit ratio and that's how we've tended to describe it in the last few quarters as being favorable. We would describe this quarter as being essentially in alignment with our long-term expectations, so no real deterioration, if you will, in terms of say, claims activity or something going on that's causing deterioration. It was really more about favorability in previous quarters, due, in part, to little redundancy factors that have taken into the numbers.

Okay. The delta on long-term care this quarter, how you got some improvement there, and anything, if you peel back the onion, was it claims, was it better NII, what was the driver there?

Yes, better claims activity and then also, slightly better persistency in nursing home inflation. As I've mentioned before, Tom, on previous calls, it does not take too much in the way of movement and persistency on particularly, the more comprehensive product that was sold historically in past years. We bucket that in nursing home inflation. Nursing home inflation is in and around, a little north of $2 billion of our overall reserves in long-term care and it is the most sensitive to those dynamics.

We saw that improve just a little bit in the quarter and that will make a difference. But together, and somewhat coupled with that, is better claims experience. Now what I would guard against is, for the same reason when traveling at 81%, I said not to worry, we're sticking with our guidance, is the same reason traveling at 79%, I would say, not to worry we're sticking with our guidance. And that is, we should experience quarters that are favorable and unfavorable on the margin given this business, but that was the driver this quarter.

Okay. If I could just sneak one more in on the Washington National, the supplemental health and other, what was driving the interest-adjusted benefit ratio? Can you comment a bit further on the product that was a drag there? Is that something that we should be just thinking about from an earnings standpoint? Is there any potential balance sheet implications there?

Yes, I would not be concerned over balance sheet implications, in part because this particular business, both stat and gap, carries significant loss recognition testing and cash flow testing margins relative to the product expectation, so I would not be concerned about that dynamic. This is really, once again, more about net favorability historically, historically meaning even previous to the quarters that we show on the slide here, going back into 2012 and early part of 2013 where we are enjoying a level of conversion activity.

This is where we had certain incentives out there for agents to go back to policyholders, where we had previously sold them a critical illness policy, and working them to upgrade the policy based on their needs. If the policyholder were to take these upgrades, it would trigger a conversion, if you will, and in doing so, actuarially, you reset, if you will, the pattern of reserves going forward under the fresh policy.

That resetting has the effect of releasing a level of reserves, even though it's not really an item that matters to, what I'd call, the long-term economics or lifetime benefit ratio, if you will, of the product. It had the effect of more near-term benefits in the benefit ratio and near-term quarter to quarter earnings benefits, but it was not a good long-term economic approach to the business. We then pulled back on incenting that kind of behavior because, obviously, we want agents to create new households, new clients, and be oriented around that.

That's what we are trying to capitalize on, the middle market. That is, in fact, happening now, which we're quite excited about, armed with a new product and incented to really drive new households. Conversion activity has slowed and this ratio has creeped up and we think that's going to be sustainably at these levels, which is why we're re-guiding.

Importantly, it's not as if the product has misbehaved and now, all of a sudden, we're not generating the returns we anticipated when we first structured the product. It's really more returning back to the kind of policyholder behavior we would otherwise expect in the product.

Understood. Thanks.

Erik Bass.

Thank you. What is the timing for reviewing your GAAP interest rate assumptions for the long-term care block? If you could just talk about where new money rates are running today and what is your methodology for projecting future new money rates?

Yes, first, under GAAP, Erik, we actually are required to take a look at what interest rates are doing and our best estimates each quarter and so we do watch what's going on. But your question is appropriate and from a practical standpoint, because you wouldn't typically, on best estimate actuarial assumptions, move with every tick and tie of interest rates. You tend to make a deeper annual look at it and we tend to look at it, particularly interest rate-oriented look in the third quarter.

We do a little bit of work on assumptions in the fourth quarter, as well, but historically, interest rates, in particular, have been in the third quarter period. The timing of that has to do with, really, the timing of building up our long-term investment strategy to support our financial planning process. We use that same material and that same view of the world that goes into our financial plan, goes into influencing our long-term assumptions for loss recognition testing and cash flow testing.

So it tends to be third quarter and that's where we've made those adjustments. What I'm seeing now, and you can see it in our results, is that we've been able to achieve new money rates that are at or better than the assumption we had in place for this year. Interestingly, we're also seeing really decent portfolio yields overall, as some of our investment strategies in past years, particularly around beaten down or discounted RMBS are starting to drive a little bit of energy in portfolio yields, as well. We seem to be hanging in there.

As I mentioned at the conference, and I'm sure my friend Eric Johnson, who's sitting next to me, would say the same thing, code yellow with a tinge of orange on the overall investment in yield environment for the same reason we're exploring, or at least thinking through the dynamics of recapitalizing, are the same reason of why we're challenged on the investment side. Spreads are in and rates are low, certainly year-to-date and so we have to be very tactical to maintain these yields as we go forward. But so far, through the first half of this year, we've been hanging in there with our assumptions.

Okay, thank you. If I could circle back to your response to Randy's question and get a kind of nuance in terms of how you were talking about the view of the rating agencies and wanting to certainly preserve the kind of long-term upward bias in your ratings progression towards investment-grade. Am I interpreting it right? It sounds like you are a little bit less convicted around that being the governor in terms of the timing of a potential recap, given some of the other factors you're looking at.

You'd mentioned the upgrade from S&P, but they obviously moved to stable outlook and provided several targets for you to achieve, which all look achievable but will take time, so how do you think about that variable?

Sure, I'd break it into, really, two comments. One is sort of a longer-term perspective on it, on investment-grade, which is, I don't fundamentally believe that the ratios we're operating at, the pure credit ratios we're operating at, are somehow holding us back from getting to investment-grade. I think if you were to look at the combination of our RBC, our leverage, our cash flow coverage, which has to be among the best in the industry, and the credit conditions that we have been producing in the general account, you have to sort of conclude, I would hope, that we are safely in the investment-grade category on those ratios. Particularly when you realize we don't do anything synthetically on our RBC like the use of captives and letters of credit and securitization.

We don't have hybrid securities in our capital structure that are debt, but get equity credit. We don't have any of that kind of stuff, what you see is what you get. I think that bodes well for our ratios. It's not really about dialing in ratios, which means it's really about franchised progress, stability, growth, certainly calming down and building a fence, if you will, around the risk profile of long-term care. It has to do with those dynamics, in my view, in terms of driving toward investment grade.

Why would I hold up the efficient use of capital or the efficient capital structure for a rating agency outcome, if it has more to do with franchise dynamics and risk profile of that business? So, that's my long-term point of view and I think you're going to find rating agencies that are going to naturally want to take that much more time when we're making the move to investment-grade that would be, to me, understandable that they would take some time and some deep thought as they move that direction. In other words, that's not holding us back.

The near-term issue to be careful about is that we're on positive outlook with some of these agencies and you have to think about that for a second. You have an agency that, sometime in the last six months, has made the proactive move to put you on positive outlook, with an intention that your capital structure is going to be managed in a certain way, and if so, they will make a move on your rating in some measurable timeline; typically something like a year.

That just means, by definition, we have to be careful to really work actively with the agencies, all of them, even if not on positive outlook. But particularly, for those that have us on outlook, to make sure that they understand we are settling into ratios that remain very consistent with an otherwise strong investment-grade company. That's really what I mean by deep consideration and working with the agencies. It's just that nuance of being on positive and not really wanting to cause disruption in that progress.

Got it. Thank you.

Humphrey Lee.

Thank you. Good morning. Just want to follow up on the Washington National supplemental health product. What percentage of the block has this conversion or premium features and what is the average lifecycle for this product? How much has this elevated the ratio?

At my fingertips, I don't have the percentage of the block, if you will, that has been subject to conversion activity, albeit I know that once upon a time, when looking at our new sales in a particular period, let say pull back to the 2010 - 2011 time period, we would have as much as a little more than 30% of our sales related to just conversion activity. More recently, because of the adjustments we've made, that's, I think, sub-10% in terms of its contribution of sales. These are approximate figures.

I can answer that way in terms of the recent years and the amount of that activity taking place. I can't really answer and simply don't have the data in front of me on the percentage of the block. Your second question, though, is interesting to understand and that is that this dynamic is taking place on a critical illness product, supplemental health product, with a return of premium feature.

It's typically the case on return of premium that there is a maturity date, at which time that return of premium, you now become eligible to take advantage of that return of premium dynamic and that is quite a long duration. I'm going to look to my partners here, but I believe it's in the 20 year category. I'm getting nodding heads so around 20 years or so. What you have going on here is not just a slowing down of conversion activity, but very likely a slowing down of that activity and therefore, more persistency on products that are reaching those dates closer to that maturity date.

As you could expect, as you reach closer to return of premium, your reserves start to accelerate and build in readiness, if you will, for that maturity date. So that's kind of the dynamic that's happening. When we talk about persistency in certain blocks of business, it's literally the vintage of those policies creeping closer to those anniversary dates where the reserve build starts to naturally pick up a little more steam as we get closer.

If those policies persist more, you'll see some elevated reserving and therefore, weighing down on the benefit ratio. This is, again, over the lifetime of the policy, this isn't necessarily a problem in that it was anticipated, that if you offer a feature like this, this should be the dynamic or the policyholder behavior. It's less about return dynamics and more about the near-term quarter to quarter earnings dynamic.

That's helpful. I wanted touch on sales a little bit. I think Scott was saying, in terms of the achieving the (inaudible) target, (inaudible) sales growth targets for 2014, but I'm looking at Bankers and Colonial Penn, it seems that if you want to get to the low end of the target, you'd probably have to grow roughly 10% year-over-year for the second half of the year. Scott mentioned that, in the pipeline, there are some kind of policies (inaudible) that haven't really been underwritten, so there could be some tick up in the second half of the year. But in general, are there any initiatives that you're planning to do that may help you get to that closer to 10% in the second half the year?

Yes, I think the two things that are going on, one I alluded to, the very positive trends that we're seeing at Colonial Penn that we just expect to continue. We have more spend planned for the second half of the year and we are experiencing rates that would bode well for that spend. The other thing we're seeing is a tick up in conversion rates and converting those leads to sales and then this continued trend of pick up on the term and whole life.

We expect those positive trends that are driving sales in the 8% range, in the last few months here of the quarter, to continue the second half of the year at Colonial Penn combined with the additional spend we have planned; that's why we're feeling pretty confident about our ability to get to that range. At Bankers, I would point to two things: one is we are confident that the open enrollment season will have a positive impact on both, obviously our Medicare Advantage activity, which allows us to open a lot of new households; and then Medicare supplement activity tends to follow strong in the second half of the year.

We had a relatively soft half med supp activity in the first half and we expect that to reverse. I think secondly, the recruiting activity we expect to pick up and help generate a positive open enrollment. Most of the decline that we saw, or actually, all of the decline that we saw, and the softness in the Medicare supplement, came from first-year agent production. Actually 2-plus year agent production was up quarter-over-quarter so we expect, as recruiting gets back to historic norms, that med supp will benefit and then med supp will also benefit from the annual election periods.

Okay, that's very helpful. Just one last question, on the operating earnings were very strong this quarter. Was there anything special happening and how should we think about it on a run rate basis?

Yes, there were some special things happening in statutory earnings. Statutory earnings of $133 million would be quite elevated from what we would normally experience, even in a strong quarter, and there's a few basic things going on. One is Banker's statutory earnings benefited somewhat from movement in the equity markets, including equity markets and volatility.

I have mentioned this in the past, we experienced this in a quarter maybe a little over a year ago or so once before, and that is there's a difference under statutory accounting, in the accounting for indexed annuities on the options versus the benefit and the accounting for it. In other words, the liability's accounted for under one methodology and the asset under another and because of that difference in approach, you can have noise in your financial statements if the market moves more sharply.

With the S&P up around 4.7% or so in the quarter alone and volatility moving around, Bankers earnings benefited overall by the markets of about $10 million. Again, this largely driven by statutory accounting dynamics, not necessarily carrying through to our GAAP results for Bankers. So I would take $10 million out of that.

In addition, then, and equally as important, is we had various unusual items or one-time items, including items that were part of preparing for the sale of CLIC, and the accounting, if you will, for various internal reinsurance transactions that served to pump the actual reported statutory earnings in the period by about $12 million.

There is an offsetting entry that runs through capital, but it just has the optical illusion of pumping your statutory earnings up a little higher. So I would place the normalized statutory earnings at closer to the $110 million in the quarter. Now you need to do one more step, which is back to my prepared comments on the call, and that is, you actually have to remove the actual earnings of the legal entity that we've sold to Wilton Re as we go forward.

We'd again, put that in and around the $10 million territory and therefore, we would say pro forma normalized earnings is more in that $100 million range. Hopefully, that's helpful.

Got it thanks.

Sean Dargan.

Thanks, good afternoon. Going back to Bankers LTC, the rate of your decline in earned premiums is a little greater or has been a little greater than the 4% that was guided to. How should we think about that trending over the rest of the year?

Best I can tell, Sean, is that it's going to trend similar to the way it has been. As I mentioned in my prepared remarks, and this has been going on for a while now, is we simply have more comprehensive product rolling off; the combination of voluntary persistency which is quite low, and then mortality which is a more meaningful component to our runoff, given the average age of our policyholders, tends to be quite a bit elevated compared to the industry.

We have a natural rolling off of more comprehensive product and what we're putting on our books is shorter-term and therefore, less premium per policy product. Also, of note, of course, is as we've said we are relatively weaker year over year in the sale of long-term care insurance, even the short-term care category, and that has a lot to do with just simply the challenging market dynamics of selling long-term care business that meets our return expectations. So it's the combination of those two things that may be causing a bit more of a tick up in runoff of premium, but it's really the same story.

Got it. Just as we think about the noise in the corporate segment regarding the fair value of liabilities, if we had an uptick in interest rates would the impact be roughly the same as it was this quarter on the way down or how should we think about that?

Not too far off from of magnitude perspective up or down, but let me give you some color on what we're doing here. We take what's called a fair value approach to the liability, I use the term mark-to-market, but it's really more technically a fair value approach. We use an actual Citigroup pension liability index to establish a corridor. That corridor tends to be in and around 60 or 70 basis points wide where we watch that index and how that index is moving, how that corridor moves relative to our valuation rate.

Think of it this way, each quarter, we mark-to-market, if you will, or update that corridor and if we fall outside of it, up or down, we'll make an economic adjustment or a fair value adjustment to the liability. The reason I walk you through that, is that you should not anticipate that every 10 basis points of move in the Treasury and therefore, presuming a 10 basis move in the index, is somehow going to result in a gain or loss in any given quarter.

We set it up so as not to be overly noisy, yet still be consistent with what we believe GAAP and the FASB and others expect you to do on these liabilities, which is be more fair value-oriented. So we more conventionally look at this annually. That's really when we look at it hard and at year-end, typically, as part of fourth quarter review.

But what we have is a corridor that says hey, if any interim, however, rates move to a point of busting through corridor, then we really need to move more quickly to adjust our liability, which we believe is what GAAP and FASB would want us to do. That's what happened. Fifty basis point drop in the Treasury, the index dropped accordingly, it busted outside the corridor and we market to market.

Okay, great. Thank you.

There are no further questions at this time.

Thanks, Operator. Thanks for all the questions and thanks to everyone on the call for your interest in CNO Financial Group.

Ladies and gentlemen, this does conclude today's conference call. You may now disconnect.