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Edited Transcript of CNO earnings conference call or presentation 12-Feb-20 4:00pm GMT

Q4 2019 CNO Financial Group Inc Earnings Call

CARMEL Feb 14, 2020 (Thomson StreetEvents) -- Edited Transcript of CNO Financial Group Inc earnings conference call or presentation Wednesday, February 12, 2020 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Eric Ronald Johnson

CNO Financial Group, Inc. - CIO

* Gary Chandru Bhojwani

CNO Financial Group, Inc. - CEO & Director

* Jennifer Childe

CNO Financial Group, Inc. - VP of IR

* Paul Harrington McDonough

CNO Financial Group, Inc. - CFO

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Conference Call Participants

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* Daniel Basch Bergman

Citigroup Inc, Research Division - VP

* Erik James Bass

Autonomous Research LLP - Partner of US Life Insurance

* Humphrey Lee

Dowling & Partners Securities, LLC - Research Analyst

* Randolph Binner

B. Riley FBR, Inc., Research Division - Analyst

* Taylor Alexander Scott

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Thomas George Gallagher

Evercore ISI Institutional Equities, Research Division - Senior MD

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the CNO Financial Group Fourth Quarter 2019 Earnings Results Conference Call. (Operator Instructions) I would now like to hand the conference over to Jennifer Childe, VP, Investor Relations. Please go ahead.

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Jennifer Childe, CNO Financial Group, Inc. - VP of IR [2]

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Thank you, operator. Good morning, and thank you for joining us on CNO Financial Group's Fourth Quarter 2019 Earnings Conference Call. Today's presentation will include remarks from Gary Bhojwani, Chief Executive Officer; and Paul McDonough, 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 obtain the release by visiting the Media section of our website at cnoinc.com. This morning's presentation is also available in the Investors section of our website and was filed in a Form 8-K yesterday. We expect to file our Form 10-K and post it on our website on or before February 25.

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 presentations contain a number of non-GAAP measures, which should not be considered as substitutes for the most directly comparable GAAP measures. You'll find a reconciliation of the non-GAAP measures to the corresponding GAAP measures in the appendix. Throughout the presentation, we will be making performance comparisons and unless otherwise specified, any comparisons made will be referring to changes between fourth quarter 2018 and fourth quarter of 2019.

With that, I'll turn it over to Gary.

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Gary Chandru Bhojwani, CNO Financial Group, Inc. - CEO & Director [3]

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Thanks, Jennifer. Good morning, everyone, and thank you for joining us. 2019 was another productive year for CNO. Operationally, we performed very well. Life and health sales were up 5% for the full year, which included record sales in our worksite and direct-to-consumer businesses. Annuity collected premiums were also up 12% for the full year. Our underwriting results remain stable with all health benefit ratios falling within or better than our provided guidance ranges. Fee revenue was up 76%.

Other key accomplishments in 2019 include our acquisition of Web Benefits Design in April, upgrades from 2 rating agencies so that our debt is now rated investment grade by all 4 rating agencies and the strategic technology partnership we announced in November.

In 2019, we launched several new products, including Medicare Supplement Plan D and Living Insurance. We also piloted Humana Medicare Advantage and our own manufactured Medicare Supplement product through our direct-to-consumer channel. Results from the pilots are preliminary but illustrate the range and types of opportunities we expect to leverage with our industry-leading direct-to-consumer capabilities.

Right now, CNO is organized around 3 operating businesses: Bankers Life, Washington National and Colonial Penn. Last month, we announced a corporate transformation that will consolidate our business segments into 2 divisions that are aligned with the consumers we serve, the consumer division new business. Each one of our 3 businesses have distinctive strengths and characteristics. Bankers Life has a top 5 captive agency force with deep and established customer relationships. Agent distribution of this size and quality is difficult to replicate. Colonial Penn is a top 5 direct-to-consumer insurance business with significant brand awareness and a highly leverageable platform.

Washington National has a fast-growing worksite business, and its niche consumer organization adds breadth and depth to our agency force capabilities.

Today, these segments operate primarily in silos. Brought together, the opportunity is enormous. I am very excited about this transformation in our business and our go-to-market strategy. We'll talk in greater detail about this at our upcoming Investor Day in 2 weeks.

Moving on to the fourth quarter's results on Slide 5. Our fourth quarter performance was strong despite a challenging interest rate environment. Net investment impacts continue to provide significant earnings headwind reducing operating income by $0.08 a share. This reduced income is attributable to both the lower interest rate environment and the up-in-quality portfolio reallocation we completed in the first quarter of 2019.

Despite these headwinds, we grew our operating earnings per share by 4%, excluding significant items in both periods. Our life and health production was strong with sales up 9%. Total insurance policy income was up 1% and all health benefit ratios were within or better than provided guidance. Fourth quarter annuity collected premiums were down 9%, which was attributable to 2 items.

First, we were up against a difficult comp of 30% growth in the fourth quarter of 2018. Second, we took action during the quarter to proactively manage the participation rates on our annuities in order to balance sales growth and profitability in the current low interest rate environment. As a result of our pricing discipline, we will accept lower sales when market conditions warrant to ensure that we are putting business on our books that meets our return thresholds. We are comfortable with this trade off, and we would do it again in similar circumstances.

We also implemented a new tax planning strategy in the fourth quarter that will allow us to use all of our NOLs that were set to expire in 2023 without being utilized. Our effective management of this asset translates to an incremental $194 million or $1.28 per share benefit to the company. Paul will cover this in more detail.

Turning to Slide 6 for a review of the growth scorecard. In the fourth quarter, both total collected premiums and annuity collected premiums faced tough fourth quarter 2018 comparables of 10% and 30% growth, respectively. You'll note that we circled the 4Q annuity collected premium and total collected premium declines in yellow. We did this to reiterate that these results were expected and by design. That said, both were up nicely for the full year. Our scorecard now reflects 6 consecutive quarters of growth in life and health sales, in client assets in our broker-dealer and in fee revenue.

Turning to Bankers Life on Slide 7. Despite meaningful net investment income headwinds, our Bankers Life adjusted EBIT, excluding significant items, was up 2% year-over-year. We continue to make progress against our strategic initiatives, namely reinvigorate growth, to expand to the right, to reshape the agent force and to optimize productivity. As I mentioned earlier, the fourth quarter was a strong quarter for fee revenue, which was up 123% at Bankers Life year-over-year to $24 million. This reflected growth in our Medicare Advantage enrollments and changes in the assumptions we use to estimate the revenues on these sales.

Life insurance sales at Bankers Life were down 2% year-over-year. We want and expect to see life insurance sales grow to appreciate the improvement as compared to some quarters. We also continue to see a general shift in sales from larger life insurance cases to annuities.

Health NAP was flat. Growth in long-term care and supplemental health was offset by a decrease in Medicare Supplement. As mentioned, our annuity collected premiums were down this quarter but up 12% for the year, which helped drive the account value of our annuities up 5%, which now stands at $9.1 billion. Our average annuity sale is now $90,000, up 3% from last year.

Our broker-dealer and registered investment adviser businesses also continue to grow nicely. Client assets increased 37% over the prior period to $1.5 billion. This sustained growth is significant for our agent force as well as our overall business. Consumer relationships tend to be stronger when we can provide income and retirement solutions as well as insurance products. Our ability to serve the income, retirement and insurance needs of our middle-income consumers is proving to be a key differentiator as evidenced by the growth in our agent retention and productivity metrics.

We generated a 6% increase in our producing agent count, which marks our sixth consecutive quarter of year-over-year growth. This growth is on top of a very strong 4% growth in 4Q '18, and this is especially impressive given that unemployment rates are at historic lows. This also demonstrates that our strategy to recruit fewer but more productive agents continues to deliver positive results.

We increased our adviser count by 7% in the quarter, so that now nearly 1 in 7 of our agents are registered to sell securities. Registered agents partner with our nonregistered agents to provide financial advice to their clients. These efforts result in deeper, more meaningful client relationships and are enabling our producers to be more productive. Not only are we seeing success with first year agent retention, but we are also beginning to see more agents stay with us into their second and third years. Agent growth is an important leading indicator for sales growth, and these trends suggest that our future remains bright.

Moving on to Washington National on Slide 8. Sales were up 32%, a new quarterly record for Washington National that is on top of last year's record fourth quarter. These results reflect our efforts to diversify the product mix, our geographic expansion, and strong growth in worksite consumer markets. Worksite sales were up 7% on top of record growth of 38% in the fourth quarter of 2018.

This was fueled by a 14% increase in worksite producing agent count as well as an 11% increase in life sales. The consumer business saw a marked improvement this quarter with sales up 57% year-over-year, which compares to double-digit declines in recent quarters. This was led in large part by the independent partner channel, which has shown steady and consistent improvement throughout 2019. The combination of increased agent growth along with a strong open enrollment season for supplemental health sales were key factors this past quarter.

Web Benefits Design delivered strong results this quarter with double-digit growth in both employer clients and covered employees. Both revenue and operating income also showed solid growth and were consistent with our expectations. The integration process at WBD continues to run smoothly with back-office consolidation activities proceeding as scheduled. Our focus in 2020 will turn to realizing revenue synergies.

As I mentioned earlier, as part of our corporate transformation, we will organize our operating model into a consumer and worksite division. Creating a separate division for worksite will bring a sharpened management focus to this fast-growing business. We expect these actions to accelerate the growth profile of our worksite business, which already exceeds the growth rate of our peers and the overall industry.

Turning to Colonial Penn on Slide 9. Colonial Penn, our direct-to-consumer business, delivered record full year sales, which were up 7% year-over-year. This is attributable to our cost-effective marketing spend that we accelerated during the first 9 months of the year when television advertising rates were more attractive. During 2019, we also benefited from strong increases in our sales productivity and our ongoing lead and sales diversification efforts.

Fourth quarter sales were down 8%. It was attributable to 2 items. First, we were up against a difficult comp of 17% growth in the fourth quarter of 2018. Second, we faced a challenging television advertising environment and pulled back on our marketing spend, which dampened growth. We have a price-disciplined and thoughtful approach to growing the business. When market conditions warrant, we will accept a lower sales to ensure we are putting business on our books that meets our return hurdles. We are comfortable with the trade-off, and we would do it again in similar circumstances.

One of the most attractive features of this business is its predictability. We can increase or decrease our marketing spend and predict our sales results within a narrow range.

Due to GAAP accounting treatment, dialing back our advertising spend in the fourth quarter had the effect of boosting our earnings. The strength of our industry-leading direct-to-consumer business is a core capability that we will invest in and advance in our new operating model. This year alone, this business had 2.4 million unique visitors to the colonialpenn.com website, carried out 1.2 million telesales interactions and completed 34,000 web chat sessions since May or roughly 5,000 per month.

Ultimately, we intend to enhance our customer experience so that consumers can seamlessly move between our brands and sales channels to buy a product how and when they wish to purchase it. Direct-to-consumer is a key component of this experience.

Moving on to capital deployment on Slide 10. I'd like to remind you of our capital allocation strategy. We are committed to deploying 100% of our excess capital to its highest and best use over time. Our goal remains unchanged, to maximize return on invested capital over the long run. We will continue to weigh our options accordingly.

Our capital position remains strong. With our shares trading at an average discount to book value of approximately 18% during the quarter, we maintained our accelerated pace of buybacks. We repurchased $75 million in the fourth quarter on top of $75 million in the third quarter. This brings our full year capital return to $319 million, including $252 million spent on share repurchases. This was nearly double the amount we spent on buybacks in 2018. It is the most we've deployed on share repurchases since 2015.

As long as our stock remains highly undervalued and trades at a significant discount to book value, we intend to use share repurchases as our primary vehicle for excess capital deployment.

Before turning it over to Paul, I would like to make a final point. While interest rate movements are outside of our control, we are not being complacent. We will continue to take proactive and decisive action to mitigate the impact. The technology partnership we announced in November is expected to deliver $20 million in savings over 5 years, ultimately leading to run rate savings of $8 million per year in 2024.

The transformation we recently announced, which will consolidate our 3 business segments to 2 divisions, is expected to reduce gross annual run rate spending by approximately $22 million by the end of 2020 before investing approximately $11 million of net savings to support various technology and growth initiatives.

Together, these savings initiatives will dampen the impact from the challenging rate environment, while providing a solid base for our future. We are laser-focused on generating stronger operating leverage and we'll continue to seek other opportunities to reduce our structural costs and minimize our expenses.

With that, I'll now turn it over to Paul to discuss the financials. Paul?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [4]

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Thanks, Gary, and good morning, everyone. Turning to the financial highlights on Slide 11. Operating income per diluted share was up 44% to $0.52 in the fourth quarter. Excluding significant items in both periods, operating income per diluted share was up 4% from $0.45 to $0.47 despite a decline in net investment income of $0.08.

Contributing to the increase in earnings per share in the quarter were improved underwriting margins and increased fee income. For the full year, excluding significant items, operating earnings per diluted share declined 2% or $0.03 to $1.80 despite net investment income declining $0.24 per share. The headwind from lower net earned rates was mostly offset by a higher level of invested assets, improved margins and higher fee income.

Earnings per share for both the quarter and the year benefited from reduced share count due to share repurchases. The comprehensive annual actuarial review of assumptions had a fairly modest $10 million unfavorable impact on pretax operating earnings, driven by a reduction in earned investment rates, reflecting our up-in-quality trade in Q1 '19 and lower interest rates generally. It compares to a $1 million unfavorable impact in the prior year period. Consistent with past practice, we've included these as significant items.

Our long-term care business continued to perform as expected. Margin increased modestly as new business gains outpaced earned rate reductions. There were no material long-term care assumption changes as experience continues to align very well with expectations. We did reduce our ultimate new money rate assumption now targeting an ultimate 10-year treasury rate of 4%, which is down 25 basis points from the assumption last year. Within nonoperating income, we recorded a $14 million charge related to our previously announced corporate transformation and strategic IT partnership. This was comprised of both severance and costs associated with our outsourcing arrangement.

Also within nonoperating income, we recorded a $194 million tax benefit in the quarter. As Gary mentioned, we initiated a tax planning strategy, which allows us to utilize over $900 million of net operating losses that would otherwise expire unused in 2023. As a result, we reversed the related valuation allowance. This added $1.29 to year-end book value per share and contributed to a 13% increase for the full year.

Operating return on equity, excluding significant items, was 10.4% in the 12 months ended December 31, 2019, compared to 10.3% in the prior year period.

For the full year, we generated about $330 million in free cash flow before capital retained to fund organic growth. Net of this capital strain, free cash flow was about $290 million. This compares to operating income, excluding significant items, of $282 million, which reflects free cash flow conversion of 116% before capital strain or slightly above 100% after.

As Gary stated, we returned $319 million to shareholders during the year, which reflects more than 10% of our market cap as of the beginning of 2019. We also reduced our share count by 9%.

At year-end, statutory capital was $1.7 billion. Our estimated consolidated risk-based capital ratio was 408% and holding company cash and investments were $187 million. As I've mentioned in previous quarters, we have been reviewing our capital and liquidity targets and intend to share our conclusions during our Investor Day on February 26.

Turning to Slide 12 and segment earnings. The decline in investment income in the quarter impacted each of our operating segments. In addition to that, some things worth noting. In our Bankers Life segment, earnings reflect improved underwriting, an increase in fee revenue and other income and an increase in operating expenses, driven largely by continued spending on growth initiatives.

Fee revenues in the quarter more than doubled to $24 million, which reflects growth in our Medicare Advantage enrollments and includes changes in the assumptions we use to estimate the revenue on these sales. Washington National's earnings reflect favorable interest-sensitive life results in the prior year period and a slightly higher interest adjusted benefit ratio this quarter. Colonial Penn's earnings were up $1.4 million or 29% to $6.2 million due to growth in the block and lower marketing spend. As a reminder, a majority of Colonial Penn's advertising expense is not capitalized, which impacts short-term earnings.

In-force earnings, which excludes the impact from the ad spend, grew 6% over the prior year to $18.8 million. Full year EBIT was $14.3 million, slightly above the [midpoint] of the guidance and was down 3% year-over-year, reflecting increased marketing spend. Notably, full year in-force EBIT was up 7% to $72 million.

Turning to Slide 13 in our key health benefit ratios. Bankers Life Medicare Supplement benefit ratio was 74.2%, down from 76% from the prior period and in line with our 2019 guidance of 73% to 77%. Bankers Life long-term care interest adjusted benefit ratio for the retained block of business was 75%, generally in line with the same period last year and within our 2019 guided range of 74% to 79%.

Washington National supplemental health interest adjusted benefit ratio was 54.2%, also generally in line with the same period last year and slightly better than our 2019 guidance of 55% to 58%.

Turning to Slide 14 in our investment results for the quarter. Net investment income in the fourth quarter was down $18.4 million or 6% year-over-year despite a 3.5% increase in average invested assets. This is attributable to the following: number one, a decline in the book and earn yields, which reflects the up-in-quality repositioning of the portfolio in the first quarter of 2019 as well as lower rates and tighter spreads generally; number two, reduced prepayment income, which declined $6.3 million year-over-year; and third, an increase in impairments, which remain well within an expected range.

The new money rate of 4.08%, which was down 58 basis points sequentially, reflects lack of new investments and alternatives in the fourth quarter. Relative to treasury rates and investment-grade spreads, the 4.08% new money rate certainly reflects a healthy outcome. We did not undertake any significant additional repositioning of the overall portfolio in the fourth quarter.

Before turning it over, I'd like to mention that we will be rolling out a new reporting structure at our Investor Day on February 26, and we'll be providing the revised presentation of our historical financial information at that time.

And with that, I'll turn it back to Gary.

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Gary Chandru Bhojwani, CNO Financial Group, Inc. - CEO & Director [5]

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Thanks, Paul. I'm proud of the progress we made in 2019. We executed well against our playbook, posting solid operational and financial results. We allocated capital prudently returning $319 million to shareholders in the same year we completed the acquisition of Web Benefits Design to invest in our fast-growing worksite business.

Growth initiatives that we implemented over the past few years and our ongoing investments in technology are paying off. We took a hard look at our cost structure and identified significant savings opportunities that will dampen the impact from the low interest rate environment and strengthen our ability to execute on our strategy.

The organizational changes we recently announced to transform our business are also expected to generate meaningful revenue synergies and boost our growth rate. As we enter 2020, we expect to build on our momentum and deliver another year of profitable growth. We are creating a leaner, more integrated and customer-centric organization that positions us well for the long-term success and shareholder value creation.

Before we open it up for questions, I want to remind you that the CNO Investor Day is on February 26, 2020, in New York. Please note that pre-registration is required. We issued a press release a few weeks ago with registration instructions. If you have any questions, please e-mail Jennifer at ir@cnoinc.com. Thank you for your interest in CNO Financial Group. We will now open it up for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Randy Binner with B. Riley FBR.

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Randolph Binner, B. Riley FBR, Inc., Research Division - Analyst [2]

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I wanted to ask a few questions about the tax improvement on the valuation allowance. So I guess, first, could you describe maybe in a little bit more detail the nature of the tax planning strategy that allowed you to have that recovery of the valuation allowance?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [3]

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Sure. Randy, it's Paul. So we're changing a tax method of accounting, which allows us to allocate certain indirect costs, so overhead, to improvements that we make on our buildings and facilities. And so essentially, we allocate those costs. We then capitalize those costs, which increases our taxable income in the period '20 to '23 and allows us to utilize NOLs that we previously thought would expire unused in 2023 and, therefore, reverse the valuation allowance that we had against those, roughly $900 million or so of NOLs we thought would expire unused. We had a valuation allowance against it. With this tax strategy, we're able to reverse that allowance.

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Randolph Binner, B. Riley FBR, Inc., Research Division - Analyst [4]

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And is that strategy -- was that -- was the use of that something that changed with the tax change -- tax law changes a few years ago?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [5]

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No, it's not a function of those changes. So the tax strategy would have been available to us and others at other times. But our fact set didn't really align with it until now, which is the reason that we're adopting it now as opposed to some previous period.

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Randolph Binner, B. Riley FBR, Inc., Research Division - Analyst [6]

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Okay, great. And then just to make sure we have the numbers right. So on Slide 25 of your presentation, so that now shows $532 million of NOLS. Is that -- is there any more valuation allowance? Or is it just this $532 million of NOLs now?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [7]

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That's exactly right. So $532 million of DTAs related to $2.5 billion of NOLS. And no valuation now against any of those NOLS.

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Operator [8]

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Your next question comes from Erik Bass with Autonomous Research.

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Erik James Bass, Autonomous Research LLP - Partner of US Life Insurance [9]

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Given the acceleration in business growth, the actions you're taking on expenses and the fact that we're now close to anniversary-ing the up-in-quality trade, do you think we're at the point where you would expect the EBIT for the operating businesses to show consistent year-on-year growth ex disclosed items?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [10]

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So Erik, very high level, I'd say a couple of things. Number one, we'll continue to face an earnings headwind from net investment income through 2020, driven by the combination of the impact of the up-in-quality and continued low rates and tighter spreads. So that dynamic will persist, not as pronounced in 2019 but will nevertheless persist.

Our intention, and you've seen some of this already, is to offset that through expense management.

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Gary Chandru Bhojwani, CNO Financial Group, Inc. - CEO & Director [11]

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I think one other thing I would add to that, Erik, we'll be talking more about this at Investor Day, but the type of visibility we provide, I think, will be greater in terms of the operating earnings because of the reorganization. So we're using the reorganization as an opportunity to change the way we report. Paul mentioned that. So I think you'll get a greater sense of visibility. And the rest of the comments, I certainly agree with what Paul shared.

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Erik James Bass, Autonomous Research LLP - Partner of US Life Insurance [12]

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Got it. And then I know you also plan to give a more detailed update on capital at the Investor Day, but is it reasonable to assume that you could sustain the level of capital deployment from the past 2 quarters on a near-term basis just based on your free cash flow and current excess capital?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [13]

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Sure. So, Erik, what I'd say is that relative to revisiting our target capital levels, I think we're landing in a good place there. And again, we'll give you specifics on the Investor Day. And what that means for share repurchase, I think I'd prefer to punt that to Investor Day as well when we expect to give sort of more fulsome guidance broadly with respect to capital as well as across the business.

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Erik James Bass, Autonomous Research LLP - Partner of US Life Insurance [14]

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Got it. Okay. No, that's fair. I guess I was just looking at it even based on your existing targets, it looks like you still have excess capital, and as you said, are generating pretty material free cash flow?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [15]

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Yes, that's certainly fair.

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Operator [16]

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Your next question comes from Humphrey Lee with Dowling & Partners.

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Humphrey Lee, Dowling & Partners Securities, LLC - Research Analyst [17]

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Paul, you mentioned that you continue to see the investment income headwinds in throughout 2020 because of the environment and also the repositioning that you've done. Should we anticipate that kind of similar 5 to 6 basis point kind of quarterly decline in your book yield as kind of as a run rate assuming kind of the environment stay the same?

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Eric Ronald Johnson, CNO Financial Group, Inc. - CIO [18]

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Humphrey, this is not Paul. This is Eric Johnson, and let me -- if you don't mind, I'll answer that for you. I want to answer it on a couple of levels. I mean, one is kind of I'll give you a rule of thumb so you can think about your model, and then the other is to be perhaps a little more specific relating to the quarter, which just passed.

One kind of rule of thumb you could think about, at least in terms of new money rates, would be something in the order in a quarter of 10-year treasuries plus 200, maybe 225 basis points. So that's something you can externally keep an eye on. And so for example, last quarter, if you had an average tenure of roughly 180 and the new money rate landed at around 4.08%, that's pretty much in line with that rule of thumb. So that would be a way of thinking about it going forward.

Now you will also probably then ask me, well, the prior quarter, the new money rate was much higher. It was roughly 55 basis points higher in the third quarter. Well, what happened? Did you fall off a cliff or something? No, we didn't fall off a cliff. It is a measure that's highly sensitive to a fairly small number of events. We had one investment in the third quarter not replicated in the fourth quarter that generated -- carried a very high book yield. And it generated roughly 45 basis points of that 58 basis point difference, one investment. So we'd like to have one investment like that every quarter, and we certainly look for them. But what you should expect is something in line with the rule of thumb I gave you affected by, from time to time, specific individual opportunities that may drive that number upward in a given quarter. I hope that helps you with that question.

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Gary Chandru Bhojwani, CNO Financial Group, Inc. - CEO & Director [19]

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Eric, we've in the past talked about what The Street should expect in terms of overall book yield. Do you want to share that again as well, too, please?

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Eric Ronald Johnson, CNO Financial Group, Inc. - CIO [20]

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Yes, happy to do that. I said now this will be the third quarter in a row I said that you should all think of book yield in the current environment, trading at a rate somewhere between 3 and 8 basis points a quarter. This quarter was, I think, roughly 6. I'll take it down a level.

At Washington National, the book yield was down 2 basis points. Bankers Life, it was down 9 basis points. Bankers came off a little bit more because there's more new money coming through the system in Bankers. And it has a little more LIBOR floating rate exposure, floating rates came down a little bit in the quarter. So a little higher delta in the quarter. But you should expect applying the rule of thumb I gave you on new money rates that, that would produce roughly something between 3 and 5 basis point erosion in today's market in book yield, plus whatever noise factors that will emerge from -- as I just described.

So interestingly enough, when you factor all that into core income, meaning repeatable book yield and earnings, core income for the quarter was -- investment income was quite stable. It was down maybe $4 million or $5 million at Bankers and basically down about $0.5 million at Washington National. Most of the noise in the quarter really came from prepayments being down $6 million and alternatives being down year-over-year, down about $8 million, although up a little bit quarter-over-quarter. And so when you have one-timers come off like prepayments being down $6 million, that $6 million change in prepayments affected earned yield for the quarter by 12 basis points. The earned yield for the quarter was down 14 basis points. So 12 of the 14 came from the reduction in prepayment. Core income was quite stable. There's some noise around the edges that we have to do a better job, I think, of articulating and giving you rules of thumb to understand. And I think we'll be able to do some of that at Investor Day so you can see through that noise. And Gary can spend the earnings call talking about sales and efficiencies and all the good things happening at the company.

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Gary Chandru Bhojwani, CNO Financial Group, Inc. - CEO & Director [21]

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Thanks, Eric. Humphrey, did you want to -- do you have a follow-up? Or are you good?

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Humphrey Lee, Dowling & Partners Securities, LLC - Research Analyst [22]

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Yes, I have a second question. So looking at your fee income, like you pointed out, was very good. Obviously, there's some corresponding expenses related to those fee business. Given the growth that you have in these kind of fee businesses, like how should we think about the margin for the business as we kind of modeling the top line and the expenses going forward?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [23]

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Humphrey, it's Paul. I'll take a crack at that. In the context of trying to stay true to our principle of not providing guidance, I guess, I'd say, number one, that the margins were quite stable, in line with expectations. I guess, the only thing I'd call out is sort of noise in the quarter relative to your modeling relates to the change in assumptions that we made for the accounting of our Medicare Advantage business. So this is ASC 606. I'm sure you're familiar with that, which was effective in January 1 of '18, and requires that we estimate the lifetime revenue and expenses or net revenue for that business. We didn't feel that we had sufficient data to make that estimate until the fourth quarter of this year.

And now that we have sufficient data, we booked an estimate for that lifetime net revenue, and that increased both our revenue and our expenses in the quarter. The net impact of that was about $6.5 million.

Away from that, I'd say that our margins were consistent with our expectations and stable relative to recent periods.

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Operator [24]

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Your next question comes from Thomas Gallagher with Evercore ISI.

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Thomas George Gallagher, Evercore ISI Institutional Equities, Research Division - Senior MD [25]

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Paul, just a follow-up to the Humphrey's question you just answered, the $6.5 million net impact, would that have been a pretax earnings benefit for Bankers? And would you expect some of that or none of that to recur as you head into 1Q?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [26]

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Sure. So it's pretax. And as you said, it's all in Bankers. And so on Page 7 of our supplement, you'll see it flowing through the revenue line and the commission expense and distribution line. As far as what it looks like next year, because of the seasonality of the business and the timing of booking the related revenue and expense, I would expect that the -- both the revenue and the expense in '20 to mirror very much the timing in 2019 because much of it gets booked in the fourth quarter.

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Thomas George Gallagher, Evercore ISI Institutional Equities, Research Division - Senior MD [27]

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Got it. So you -- we should see a similar $6.5 million pretax earnings uplift, but it should be more of a 4Q '20 event? Is that a fair way to think about it?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [28]

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Yes.

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Thomas George Gallagher, Evercore ISI Institutional Equities, Research Division - Senior MD [29]

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Okay. But not -- and will the much higher level of fee income you had at Bankers in 4Q, will that also come down just from a revenue standpoint as we roll into 1Q? Because I think seasonally, 1Q in '19 was also high. So I was just curious how we should think about seasonality for fee income or fee revenue?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [30]

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You're right. So 1Q '19 was high. I'd expect to see something very comparable in 1Q '20 and the same for Q2 and Q3. And then Q4, the dynamic you saw in Q4 '19 should be repeated in Q4 '20.

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Thomas George Gallagher, Evercore ISI Institutional Equities, Research Division - Senior MD [31]

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Got you. And then just to kind of close the loop on your net investment income comment. The -- just taking your prepared remarks, the $0.08 a share interest rate related headwind, I mean, that's 17% of earnings. Now I -- you clearly have produced some other nice offsets against that. But as we think about the actual earnings headwind related to interest rates, just taking Eric's comments and doing some back of the envelope math, I get something significantly less than that from an ongoing earnings -- from an EPS headwind standpoint, I get something around 6% to 8% range of an EPS headwind. Does that sound about directionally right in terms of -- when you quantify it and just overlay it against EPS expectations?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [32]

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Yes, I don't think there's anything wrong with your math, Tom. The only thing I would point out is that you're always going to have some volatility from the variable components of NII. So I think the math you're doing relates to the headwind from just the sequential decline in our book yield. Then you have to factor in the plus or minus that may occur that in every quarter almost will occur. You just don't know whether it's going to be plus or minus from the variable components, faults, prepays primarily.

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Eric Ronald Johnson, CNO Financial Group, Inc. - CIO [33]

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Yes, Tom, this is Eric. And maybe I can -- I gave you a rule of thumb around the new money rate, which I think may be useful to you, and I'll give you a rule of thumb also, which may be useful to you around alternatives and prepays as well. And I think Paul is exactly correct to say there's going to be variability in these 2 items that is more significant than in new money and book yield. And so the one thing that is certain is that the exact rule of thumb won't produce an exact result but just as a frame of reference. Alternative investments, we like alternatives that -- I use the term pay rent that have a carry as opposed to that are market directional and pure equity content. And so the way I think about that portfolio is I want to produce a carry of around between 8% and 10%.

And so if you want to think about, let's say, let's use 8% as a rule of thumb for kind of the quarter-on-quarter income from alternatives. I think that is reasonable, recognizing that there are going to be quarters where that is going to have a bell curve that's going to start at minus 5% and go up to plus 20% in terms of return based on market conditions. And then when you look at prepayments, I'm just looking back here, Tom. And we've had prepayments on a quarterly basis everywhere from $2 million to $10 million in a given quarter over the last 3 years. That number is very, very hard to -- as you know, it's not a number we can manage, and it's very difficult to predict going into a quarter. But if you want to kind of pick an average number of $6 million, I think that would be a rule of thumb that you could apply recognizing that it's going to actualize somewhere north or south of that, depending on the given quarter.

So when I think I've now given you 3 rules of thumb you can apply, that will help you understand how to think about investment income here. There's going to be -- listen, this is a $21 million -- $21 billion, excuse me, portfolio and all kinds of moving parts. And there's going to be $3 million items going this way and that way in a given quarter. And I don't think we're going to ever -- whether rates are high or low, we're not going to get around that. Having said that, I think that's -- this will be a way of producing a normalized over the term of things view.

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Operator [34]

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Your next question comes from Alex Scott with Goldman Sachs.

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Taylor Alexander Scott, Goldman Sachs Group Inc., Research Division - Equity Analyst [35]

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First question I had was on, I guess, just the growth that you're getting on new annualized premiums, fees, et cetera, and how it's going to translate to top line and earnings growth. Have we kind of set aside the LTC and runoff and set aside the NII pressure that's been discussed? I guess, maybe even said another way, how much growth in the NAP and the fee revenue do you need to sort of offset the runoff? Like what's the lapse trend? How do I think about the dynamics there? And how much growth you can actually get from the kind of sales growth that you're seeing?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [36]

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Alex, it's Paul. I guess, well, it's kind of hard for me to answer that question without giving you earnings guidance. I think those are assumptions you have to build into your model, just trending our historical data.

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Taylor Alexander Scott, Goldman Sachs Group Inc., Research Division - Equity Analyst [37]

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Okay. Maybe as a follow-up on cash flow. I was just interested if you had any thoughts on the -- what I think the last time you guys gave is $300 million to $350 million or so. I was wondering if you could provide any color on that? Like I appreciate that the excess capital part of the conversation and whatever you're going to do on RBC ratio is maybe separate, and you don't want to talk about that yet, but just maybe the ongoing business, if there's any color on how that's trending? And how much you plan to use behind new business growth in 2020?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [38]

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Sure. So Alex, I'll first just kind of level set with respect to 2019. As I mentioned in the prepared remarks, for the year, our gross free cash flow is about $303 million net of the capital to support our organic growth free cash flow, about $290 million. I think I'll punt to the Investor Day to give forward-looking statements, but I would say now that given that the business is very stable, you wouldn't expect that gross free cash flow number to change materially.

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Taylor Alexander Scott, Goldman Sachs Group Inc., Research Division - Equity Analyst [39]

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Got it. And so the impact of this DTA change, in particular, that would have just a modest benefit from year-to-year? Or is that more front-end loaded, the impact that it has?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [40]

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You're talking about the tax strategy, whether that impacts free cash flow?

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Taylor Alexander Scott, Goldman Sachs Group Inc., Research Division - Equity Analyst [41]

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Yes. Yes. Yes, just like what it would -- if I should think about that as just being like a level benefit over time? Or because of the years it impacted and the way it's being utilized, if it has a bigger impact on near-term cash flow?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [42]

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Yes. So the tax strategy actually has no impact on our cash taxes through 2023. During that period, we're simply recording higher taxable income, strictly for tax purposes not affecting our GAAP or stat books but higher taxable income, which allows us to utilize the NOLs. In '24, we would expect to reverse the method of accounting that's allowing us to do this, which will actually create a new NOL that we would utilize in '25 to '29. So the cash benefit is really in the '25 to '29 period.

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Operator [43]

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(Operator Instructions) Your next question comes from Dan Bergman with Citi.

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Daniel Basch Bergman, Citigroup Inc, Research Division - VP [44]

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I believe you said you lowered the assumed long-term new money rate by about 25 basis points to a 4% 10-year treasury yield as part of the annual review. I was just hoping to get a little more color on that assumption. How long is the grade-up period to that 4% level? And I was just hoping you could remind us what is the sensitivity of the long-term care margin to any changes in that assumption?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [45]

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Sure. Dan, it's Paul. So yes, we reduced the ultimate new money rate assumption by 25 basis points. And the grade up to that is 5 years. As far as the impact, I think, to give sort of a fulsome picture of that, I would refer you to the disclosure in our 10-K and our risk factors. We provide 4 scenarios, interest rate scenarios and the impact that, that has. So that, I think, gives you a context and obviously, that's a bit dated now. We'll be filing our 2019 K right before Investor Day, and so you'll have that updated context. Our intention is to repeat the same type of disclosure. But you also saw in real time this year the impact of that assumption, along with other changes and assumptions on our long-term care book, and there was no income statement impact from that. And the margin of our long-term care business actually improved slightly with the unfavorable impact from lower earned rates, offset by the margin created by the new business.

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Daniel Basch Bergman, Citigroup Inc, Research Division - VP [46]

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Got it. And then maybe moving just to the runoff long-term care block, I think earnings on that business has remained positive, I think, at least in the past 6 quarters or so. So I just wanted to see if there's any additional color you could give on what you're seeing in terms of how that block has developed. What's driven the strong recent results and whether we should continue to expect that to fall back down to breakeven going forward.

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [47]

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Sure. So our experience there has been very much in line with slightly better than expectations. And so I guess, that's the first point. The second point is, as you know from our disclosures, there's very little margin in the closed block. And so there's a lot -- there's not much margin for error but the experience has been very good. So that hasn't been an issue.

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Daniel Basch Bergman, Citigroup Inc, Research Division - VP [48]

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Got it. But in terms of earnings, still kind of thinking about breakeven as we move forward?

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Paul Harrington McDonough, CNO Financial Group, Inc. - CFO [49]

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Yes, for modeling purposes, I think breakeven is what you should model.

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Operator [50]

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There are no further questions queued up at this time. I'll turn the call back over to Jennifer Childe.

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Jennifer Childe, CNO Financial Group, Inc. - VP of IR [51]

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Thanks very much for your interest in CNO and look forward to seeing you at our Investor Day on February 26.

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Operator [52]

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This concludes today's conference call. You may now disconnect.