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Edited Transcript of CNO earnings conference call or presentation 2-Aug-18 5:00pm GMT

Q2 2018 CNO Financial Group Inc Earnings Call

CARMEL Aug 14, 2018 (Thomson StreetEvents) -- Edited Transcript of CNO Financial Group Inc earnings conference call or presentation Thursday, August 2, 2018 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Adam Auvil

CNO Financial Group, Inc. - VP of IR

* Erik Magnus Helding

CNO Financial Group, Inc. - Executive VP & CFO

* Gary Chandru Bhojwani

CNO Financial Group, Inc. - CEO & Director

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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

* Jeffrey Paul Schmitt

William Blair & Company L.L.C., Research Division - Associate

* Randolph Binner

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

* Ryan Joel Krueger

Keefe, Bruyette, & Woods, Inc., Research Division - MD of Equity Research

* 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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Good afternoon. My name is Kim, and I will be your conference operator today. At this time, I would like to welcome everyone to the CNO Financial Group's Second Quarter 2018 Earnings Results Call Conference Call. (Operator Instructions)

Mr. Adam Auvil, you may begin your conference.

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Adam Auvil, CNO Financial Group, Inc. - VP of IR [2]

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Good afternoon, and thank you for joining us on CNO Financial Group's Second Quarter 2018 Earnings Conference Call. Today's presentation will include remarks from Gary Bhojwani, Chief Executive Officer; and Erik Helding, 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 releases. You can obtain the releases 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 our Form 8-K earlier today. We expect to file our Form 10-Q and post it on our website on or before 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'll find a reconciliation of the non-GAAP measures to the corresponding GAAP measures in the appendix. Throughout the presentations, we will be making performance comparisons, and unless otherwise specified, any comparisons made will be referring to changes between second quarter 2017 and second quarter 2018.

And with that, I'll turn the call over to Gary.

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

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Thanks, Adam, and good afternoon. Beginning on Slide 6, I am pleased to announce that CNO has entered into an agreement with Wilton Reassurance Company to cede approximately $2.7 billion of long-term care reserves through 100% indemnity coinsurance. The ceded blocks include 100% of Bankers Life legacy comprehensive and nursing home policies and represent 51% of CNO's statutory long-term care reserves.

Bankers Life will pay an $825 million ceding commission as part of the agreement, which will be funded through existing capital resources. Erik will go into greater detail on the specifics of the transaction during his comments. This transaction represents a material risk reduction to CNO's balance sheet and stress scenarios. It also considerably reduces the possibility of a future reserve strengthening charge. The execution of this agreement is the culmination of a multiyear process to identify a solution that is both fairly priced and enables CNO to realize material risk reduction. We are confident both objectives were achieved with this transaction.

Additionally, we accomplished our goal to transact with the credible, onshore counterparty. A subsidiary of Canada Pension Plan Investment Board, Wilton Re is an established, highly rated and well-capitalized partner, with whom we have a strong relationship, having previously executed 3 transactions together. The trust built through these mutually beneficial transactions contributed to the ability to execute on this agreement. We expect the transaction to close in 2018, subject to regulatory approval.

Finally, derisking marks a step forward in achieving investment-grade ratings by satisfying a consistently referenced catalyst that would lead to an upgrade. On that point, we were very pleased to see the positive actions already taken by Moody's and Fitch in response to the announced transaction.

I'll now turn the call over to Erik to discuss specifics of the transaction. Erik?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [4]

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Thanks, Gary. The transaction announced yesterday encompasses $2.7 billion of legacy nursing home and comprehensive long-term care business in the Bankers Life and Casualty legal entity. You may recall that in our 2017 Investor Day event, we noted that it was these blocks of business that were potentially the most volatile from an earnings and capital perspective. More to come on this in a moment.

The $825 million ceding commission will be funded by approximately $260 million of asset adequacy reserve releases that are no longer required and approximately $150 million of tax benefits as a result of a loss generated by the transaction. $175 million of capital is released as a result of no longer holding the assets and liabilities associated with the blocks, and the remainder will be funded by our $275 million capital contribution from the holding company in order to maintain a 400% RBC ratio at Bankers Life.

It is important to note that the $275 million contribution represents less than 1 year of free cash flow generation for CNO. In conjunction with this announcement, we will move the ceded blocks of business to the LTC in run-off segment starting in the third quarter of 2018. We expect to record an after-tax GAAP loss of approximately $650 million before year-end.

Slide 8 details some of the key terms and conditions of the transaction. Upon closing, Bankers Life will transfer assets backing the statutory liabilities of the ceded blocks, plus the ceding commission, to Wilton Re. A domestic comfort trust will be established to hold the assets backing the statutory liabilities as well as an additional $500 million of over-collateralization.

The over-collateralization amount is subject to step downs of $62.5 million every 5 years. As the ceded block is in run-off, it is our expectation that the over-collateralization, as a percentage of the reserves, will increase over time. The comfort trust will be subject to strict investment guidelines as well as oversight and reporting requirements. CNO will continue to administer the business for the next 36 months, before transitioning over to a third-party to be designated by Wilton Re.

Slide 9 is a graphical depiction of the risk reduction that is achieved with this transaction. The graphs depict projected future cash flows at the inforce block on a pre- and post-transaction basis under the following scenarios. Best estimate, which reflects CNO's current assumptions, current assumptions are adjusted to reflect an immediate and permanent 15% increase in lifetime morbidity. Current assumptions adjusted to reflect an immediate and permanent decrease in the investment portfolio rate from 5.8% to 5.25%, and a compound scenario, which reflects current assumptions adjusted for both the impact of increased morbidity and decreased investment returns.

Some key observations. First, recognize that the CNO's historical reserve performance has been solid, having not ever taken a charge in this block. That coupled with no assumption for future rounds of premium rate increases, no assumed morbidity improvement, add significant credibility to our best estimate assumption.

Next, volatility or the spread of potential outcomes as a result of adverse deviations and assumptions is materially reduced in all scenarios on a post-transaction basis.

Lastly, post transaction, in the compound scenario, the model decline in cash flow is relative to best estimate can be absorbed without materially impacting free cash flow generation.

Slide 10 highlights the risk reduction achieved with respect to potential loss recognition charges under the stress test scenarios. Focusing on the compound scenario, on a pretransaction basis, CNO would recognize a $1.4 billion reduction in margin, which would result in an $850 million GAAP charge. On a post-transaction basis, the margin impact, while still material, decreases by more than 50% to $640 million and results in a $325 million charge, which approximates 1 year of free cash flow. We view that reduced range of potential impacts is manageable.

Important to note that as a result of the transaction, our Bankers Life loss recognition testing margin as a percentage of net GAAP liabilities doubles from 7% to 14% and that future sales will continue to add positive margin to the retained block. These factors decrease both the probability and the impact of any potential future charges.

Slide 11 details how we expect the transaction to impact our key capital measures, assuming a third quarter 2018 closing. We expect the Bankers Life legal entity to have stand-alone RBC of approximately 400% after giving effect for the capital contribution from the holding company.

Consolidated RBC is expected be approximately 435%. Holding company cash and investments are expected to decrease to $150 million as a result of the contribution to Bankers Life. As a result of the GAAP loss, operating return on equity will improve on an annualized basis by 150 basis points, debt to total capital will increase to approximately 23% and book value per diluted share will decrease to $19.

We expect minimal impact to GAAP earnings in the near term as ceded profits are not significant and will be partially offset by fees paid by Wilton Re to CNO for transition services and administration. Over the longer term, we expect GAAP income to improve as a result of ceding blocks of business that had declining future earnings. As a result of no longer needing to accrue asset adequacy reserves for the ceded blocks, we expect annual free cash flow generation to increase from $300 million to $350 million. We expect to manage consolidated RBC in the 425% to 450% range, maintain minimum holding company liquidity of $150 million at all times and manage leverage in the 22.5% to 25% range. We are committed to maintaining a strong balance sheet, and we feel that our capital ratios are dialed in appropriately and are reflective of the reduced risk profile of the current business.

And with that, I'll turn the call back over to Gary.

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

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Thanks, Erik. Long-term care continues to be a significant health care and retirement challenge for middle-income Americans. Regulators and government officials continue to wrestle with an appropriate public solution. In the private sector, options are contracting and forcing those in need to turn to an already strained public system.

CNO remains committed to offering long-term care insurance and we will continue to focus on providing affordable high-quality insurance, designed with the needs of our middle-income consumers in mind.

Looking at long-term care at CNO moving forward, let me start with our inforce business. The retained business represents a materially reduced risk to the balance sheet. Post-transaction, policies with benefit periods of less than 1 year will represent over 50% of the inforce. Policies with lifetime benefits will fall to under 3%, approximately 5,000 policies down from 11,000 policies. Additionally, long-term care reserves will comprise only 13% of our reserves post transaction, down from 25%.

Turning to new business, CNO will focus on products offering shorter benefit periods. It is clear these are the products that resonate most with our customers as the average benefit period across new sales is currently 10 months. Given current customer preference and our desire for products offering shorter benefit periods, we will discontinue sales of long-term care products with benefit periods longer than 3 years. It is important to note that we expect future sales to contribute to earnings and reserve margins. Additionally, we continue to reinsure 25% of new LTC business, which provides a valuable outside perspective on product design and pricing.

Finally, the transition of the administration of this business allows CNO to undertake a more comprehensive review of our middle and back office infrastructure to identify potential ways to increase operating efficiencies and better serve our customers.

Moving to Slide 13. I'll close this section of our call by highlighting the key benefits and takeaways for this transformative risk-reduction transaction. This transaction successfully reduces CNO's long-term care exposure by ceding the older and more comprehensive business. The retained business has a much better risk profile, which reduces potential future volatility in earnings and reserves. CNO's differentiated long-term care business enabled us to execute the transaction at reasonable economic terms while attaining the necessary risk reduction. We were able to transact with a highly rated and well-capitalized counterparty in Wilton Re. The reduction of tail risks significantly enhances the go-forward balance sheet strength of CNO. Derisking marks a step forward in achieving investment-grade ratings by addressing a key rating agency concern. And again, we are pleased to see the positive actions already taken by Moody's and Fitch.

Lastly, removing this overhang will allow management to focus its time on accelerating profitable growth and serving the needs of the fast-growing and underserved middle-income market.

I'd now like to move on to our second quarter earnings results. Beginning with Slide 15, second quarter 2018 was another strong quarter for CNO. We posted solid earnings and capital results that again demonstrated the strength of our franchise.

Operating earnings per share were $0.49, up 9%, reflecting benefits from tax reform. Book value per diluted share was $22.62, up 3% sequentially. Five of the 7 metrics on the CNO growth scorecard are up this quarter. Although we are pleased with the result, our goal remains to have all 7 metrics grow in a consistent and sustainable way. I'll go into more details on the drivers of this quarter's strong growth later in the presentation.

The expansion of several strategic initiatives from the pilot phase to deployment at scale has yielded encouraging early results. We are confident that we are on the right path to achieve steady and sustained growth across the enterprise. As exciting as these results are, it will take several more quarters of positive results until we will comfortably call it a trend. Our commitment to deploying capital into its highest and best use over time remains unchanged. We returned $77 million in capital to shareholders in the quarter, including $60 million in common stock repurchases.

Moving to Slide 16 and our segment production results. Bankers Life total collected premiums were up 2%, primarily driven by a 9% increase in annuity collected premiums. Annuity account values, on which spread income is earned, increased 5%. This is due to both higher new sales and strong persistency of the inforce. Life and health NAP were down 2% and 5% respectively. The life sales decline was primarily driven by higher declination rates on simplified issue business as a result of the new underwriting requirements implemented late last year. Ultimately, this change should improve our future underwriting margins. Offsetting this decline, fully underwriting -- underwritten universal life sales are up 21% year-to-date. Health sales were partially impacted by higher sales of third-party Medicare Advantage plan, which we do not report as NAP.

Growth in our broker-dealer and registered investment adviser businesses, combined with the previously mentioned increase in Medicare Advantage sales, drove our fee revenue up 15% over the comparable quarter. Total producing agent count decreased 6% on an average trailing 12-month basis. On a sequential basis, we materially increased the number of first-year producing agents. This is the result of our recent national rollout of recruiting pilots that led to a higher yield of successful new agents and higher first-year agent retention. While it will take time for these improvements to impact the size of the total agent force, we are encouraged by the progress as it validates that our recruiting and retention initiatives are beginning to take hold. We will continue to emphasize agent retention and productivity.

Moving to Washington National. Total collected premiums were up 3%. This includes a 3% increase in supplemental health, partially offset by the continued run-off of the closed Medicare Supplement block. Total NAP was up 2% from the year-ago quarter, driven by a 31% increase in worksite life sales. These results stem from continued momentum in initiatives to diversify product offerings and build upon 2017 growth of 15%.

Second quarter 2018 PMA worksite sales were up 20% versus the prior year, marking the fifth consecutive quarter of double-digit growth for this channel. The PMA average producing agent count is flat to prior year. New agent recruiting in our individual channel was down slightly. However, it was partially offset by recruiting initiatives in the worksite channel and strong veteran agent retention in both channels.

Washington National's growth initiatives continue to advance with positive results. We are seeing early success in our efforts to expand the Washington National geographic footprint with a 14-state expansion program that has generated nearly $2 million of incremental NAP year-to-date. Our pilot to sell short-term care in the PMA individual channel is gaining traction, and we expanded the distribution across additional territories based on its early success. This pilot is particularly encouraging in that it leverages the breadth of the diverse CNO product portfolio and distribution capabilities. For Colonial Penn, total collected premiums were up 2% in the quarter, driven by growth in the block and stable persistency. NAP was up 5% due to higher cost-effective advertising spend and strong sales efficiency. We also continue to see success with our marketing diversification efforts. A 25% increase in web and digital sales this quarter was driven by investments in the platform and in customer experience enhancements.

I'll now turn the call over to Erik to discuss our financial results. Erik?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [6]

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Thanks, Gary. CNO had another solid quarter of earnings. We reported net income per share of $0.61, up 27% from the prior year. Operating earnings per share were $0.49, up 9%. Excluding the significant items recorded in the second quarter of 2017, operating earnings per share were up 17%.

Operating return on equity was 9.6%, increased from 2017 levels as we are benefiting from lower corporate tax rates. Holding company cash and investments were $376 million, relatively unchanged from the first quarter of 2018. Estimated consolidated risk-based capital was 444%, up from the first quarter of 2018, reflecting higher statutory net income and benefits from some asset reallocation that occurred in the quarter.

Turning to Slide 18 and segment earnings. Bankers Life earnings reflect lower Medicare Supplement margins, primarily as a result of the implementation of Crossover processing that occurred in the first quarter and lower LTC margins, reflecting outperformance versus expectations in the second quarter of 2017. Washington National's earnings in the period reflect higher supplemental health margins as we continue to experience lower levels of incurred claims. Colonial Penn's EBIT was slightly below the prior year, due to some opportunistic investment in direct response television advertising. We continue to expect Colonial Penn's EBIT to be in the $10 million to $20 million range for 2018. Earnings for the LTC and run-off segment were higher, reflecting lower incurred claims. And lastly, corporate segment results were largely flat versus the prior year.

Turning to Slide 19 and our key health benefit ratios. Bankers Life Medicare Supplement benefit ratio was 73.1%, in line with expectations in the first quarter of 2018, but higher than prior year as a result of the previously mentioned implementation of Crossover processing. We continue to expect the Medicare Supplement benefit ratio will be in the 71% to 74% range for the remainder of 2018. Bankers Life long-term care interest-adjusted benefit ratio, excluding the impact of rate increase related reserve releases, was 76.5%. This is in line with expectations, but slightly higher than the past several quarters, due to slightly higher incurred claims. We are temporarily suspending guidance on the LTC interest-adjusted benefit ratio until the recently announced reinsurance transaction closes later this year. Washington National supplemental health interest-adjusted benefit ratio was 56.6%, significantly better than expectations, due to continued favorable incurred claims. As this is the third quarter of favorable experience, we now expect the interest-adjusted benefit ratio to be in the 56% to 59% range for the remainder of 2018.

I'll now turn it back over to Gary.

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Gary Chandru Bhojwani, CNO Financial Group, Inc. - CEO & Director [7]

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Thanks, Erik. CNO's objective to significantly reduce our long-term care exposure is nearly complete and continues our strong track record of execution. Next, our sight shifts squarely to accelerating long-term profitable growth. As we have consistently communicated, the diversity of the franchise and the depth and breadth of our product offerings are central to our strategy. However, it is the people behind the execution who ensure our success. To that point, during the second quarter, CNO introduced investments in our workforce through an enhanced compensation program that leverages the benefits of tax reform. Like many companies, we have the opportunity to offer a onetime bonus payout to employees. At CNO, we opted instead to invest in a broader enhanced compensation program that includes an annual cash bonus program, an employee stock purchase plan and a onetime stock option grant. These compensation enhancements will provide a continued incentive over time and therefore, drive the top to bottom associate alignment necessary to achieve sustained success.

It is important to note that there is no change to our stated position to deploy 100% of free cash flow to its highest and best use over time. The timing and amount of future deployment will depend on options for deployment and excess capital levels at that time. The announcement of the transaction to reduce our long-term care risk completes the fixed and focused chapter at CNO. It positions us on a path to continue delivering long-term shareholder return. The post-closing company profile presents a unique investment opportunity in the insurance sector as a well-capitalized company with a path to higher ratings and ROE. We expect additional value to be realized through multiple expansion to a level that is more in line with sector peers as LTC contagion and tail risk fears are materially reduced for CNO.

Thank you for your continued 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 from B. Riley FBR.

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

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So I'm going to try and ask a few high-level questions about what the business might look like after the deal closes in the third quarter. And so I guess, the first is, just to understand this, the business is going to -- the block -- the long-term care block with Wilton, is going to be reinsured out of Bankers, but that reinsured block is going to be reported not in Bankers, but in the run-off segment. So just clarifying that and just trying to understand why it would be moved there instead of just stay resident in Bankers?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [3]

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Yes. Randy, this is Erik. Thanks for the question. So the reinsured block is going to move out of the Bankers Life segment into the LTC and run-off segment because it is just that, it is an LTC block that is in run-off. And so that would be consistent with how we expect to manage it, recognizing that we are moving from managing that business ourselves to managing a counterparty that's going to be managing that business. So that's how we view it, and that's a rationale for moving it to run-off. Now from an income statement and balance sheet perspective, the changes are going to be fairly transparent. Since the income statement is in essence going to be ceded to Wilton, you won't see much by way of financial impact on a quarterly basis running through the income statement. But on a balance sheet basis, you will see some numbers that look a little bit different, basically moving the assets from -- the assets and liabilities from the Bankers Life segment and into the closed block segment.

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

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Right. So this -- you mentioned in your prepared remarks that this business had moderate -- very modest GAAP earnings. So -- I guess, to the extent that's the case, we shouldn't be missing a lot of bottom line at Bankers. But from like a premium and kind of investment income perspective pretax, is there any way you could size kind of what that might look like for the Bankers segment going forward?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [5]

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Yes. I think it's roughly about $180 million of premiums that will leave the system for Bankers. Off hand, I don't know the amount of net investment income, but -- I think the main point is, what you hit on, that the impact to the Bankers Life segment EBIT numbers that we have been reporting is going to be pretty minimal.

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

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I guess for noninvestment income, we would just presume that the assets backing that business no longer are productive. Is that the right way to think of it?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [7]

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Yes. That's right.

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Randolph Binner, B. Riley FBR, Inc., Research Division - Analyst [8]

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Okay. And then in the run-off segment, it's just going to be -- there's just going to be no -- your current run-off produces some policy in net investment income, but because this is 100% quoted share on marginally profitable business that's -- it's really going to be -- you're going to manage this piece of the run-off effectively to a breakeven. Is that fair?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [9]

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That's right. Yes. So what you'll see in the LTC and run-off segment from an income perspective -- income statement perspective is not going to look much different -- or won't actually look any different than it does today.

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Randolph Binner, B. Riley FBR, Inc., Research Division - Analyst [10]

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I'll do one more, and then I'll drop in the queue. So the benefit ratio in Bankers, so -- if I took the premiums that are leaving and assume that they were perfectly unprofitable, is that a decent way to kind of approximate what the benefit ratio would do? And maybe directionally, could you say is the benefit ratio for Bankers overall is going to better after this business leaves?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [11]

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Yes. So we are working on -- really what we're doing is bifurcating the blocks right now in preparation for actually moving it into the LTC and run-off segment. So when you do that, we have to sort of recalculate everything that is retained and in the Bankers Life segment. So we haven't gone all the way through that, but our estimate right now is that, yes, the interest-adjusted benefit ratio would decline by a couple of points on a retained basis in the future.

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Randolph Binner, B. Riley FBR, Inc., Research Division - Analyst [12]

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Just throughout the LTC?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [13]

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Yes. The LTC retained business, yes. That's right.

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Operator [14]

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Your next question comes from Erik Bass from Autonomous Research.

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Erik James Bass, Autonomous Research LLP - Partner of US Life Insurance [15]

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I just had a couple of questions about sort of your capital structure post the transaction. You talk about maintaining holding company liquidity of at least $150 million. I guess, would you be comfortable running close to this level or would you expect to rebuild a bit of a buffer to provide flexibility for other actions? And should we think of that sort of being a use of free cash flow for the next quarter or 2?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [16]

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Erik, yes, this is Erik Helding. Thanks for the question. $150 million is our stated objective as a minimum. I think -- practically speaking, and I think we've said this in the past, we likely would run at something higher than this, just to have some dry powder on hand. I will tell you the way I'm thinking about kind of the LTC risk reduction transaction is that when we've talked about ranges of RBC being 425% to 450%, minimum holding company of $150 million, but wanting to hold more, because we've reduced risk significantly, I have much more confidence in running at the lower end of those ranges than I did previously.

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Erik James Bass, Autonomous Research LLP - Partner of US Life Insurance [17]

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That's helpful. That actually was my next question. Just on the RBC and why you think that 425% to 450% is still the right RBC ratio target given the amount of risk reduction that you've done? And also just wanted to clarify whether that contemplates any impact from tax reform or is that sort of what your target is pre any impact?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [18]

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Yes. So maintaining kind of the stated guidance on RBC of 425% to 450%, how we're thinking about running RBC at the Bankers Life legal entity is something closer to 400%, again, which is down from -- it's been about 420%, 425%. And again, that reflects sort of the reduced risk profile and being comfortable running Bankers Life at a slightly lower level. And so mechanically, what happens is when you run your consolidated calculation as a result of running Bankers at 400%, consolidated it's going to be probably about 430%, 435%, so much more towards the lower end of that range. And so that's how we're thinking about kind of RBC going forward. Now to your second question, no, that does not contemplate any impacts from tax reform nor does it contemplate the impacts related to the changes in the C1 charges, which the NAIC is currently debating. So it's really those 2 reasons why I'm kind of hesitant to reduce the RBC ratio guidance range at this particular point in time. I want to see those things get flushed through the system and then kind of see how our balance sheet looks and then see what reactions are sort of externally.

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Erik James Bass, Autonomous Research LLP - Partner of US Life Insurance [19]

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That's helpful. And just finally, last balance sheet question. The investment portfolio, should we expect any change there as a result of the transaction? And assuming you probably are holding some of higher yielding assets and potentially lower-rated assets to back the portfolio. So should we expect any reduction there?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [20]

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I don't think so. I think the pre- and post-transaction portfolios are going to materially look the same. There's going to be some differences. I think the overall asset duration is going to be slightly lower, but I think -- in terms of quality, I think it's going to be largely the same.

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Operator [21]

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Your next question comes from the Ryan Krueger from KBW.

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Ryan Joel Krueger, Keefe, Bruyette, & Woods, Inc., Research Division - MD of Equity Research [22]

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Congrats on the transaction. I was trying to calculate it, but I'm not sure if I'm doing it right. Could you just give us the dollar amount of the reserve margin post transaction on Bankers LTC? And then what the reserve margin was on the block that you are reinsuring?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [23]

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Yes. Ryan, this is Erik. So as of 12/31/2017, on a post-transaction basis, the reserve margin is about $215 million. And on a pre-transaction basis, it was about $100 million higher than that, about $315 million. So we've given up $100 million of margin, but there's a lot of moving pieces behind that. So if you think about the blocks of business that were ceded, the ALR on those blocks of businesses had several $100 million of negative ALR. But as part of the $2.7 billion, we also ceded the claim reserves that were part of that legacy block. And that had slight positive margin, so that netted down to roughly $100 million in negative margin. The other -- so we should have otherwise seen an increase in the dollars margin. But the other thing that we did as part of this transaction was because we ceded the blocks that were projected to lose money, we released the $190 million of FLR. So that's actually what brought the dollars of reserve margin down. But that's a good thing. I think the most important thing from our perspective is the fact that on a percentage of net GAAP liabilities, that number doubled. That's the key.

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Ryan Joel Krueger, Keefe, Bruyette, & Woods, Inc., Research Division - MD of Equity Research [24]

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Got it. And then as you were working through the transaction, certainly makes sense why you did the pre-2013 -- pre-2003 blocks. Just curious why -- was there an opportunity to also do more the 2003 to 2008 block that you had talked about in the past as well or what led to the -- this specific decision?

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Gary Chandru Bhojwani, CNO Financial Group, Inc. - CEO & Director [25]

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That block was never really a priority for us. We were really focused on the pre-2003 business.

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Ryan Joel Krueger, Keefe, Bruyette, & Woods, Inc., Research Division - MD of Equity Research [26]

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Okay. And then last one. Is there any -- should we think about any impact to your tax assets? In other words, now that the loss -- I guess, at present value of tax assets, will that go up after you do this due to new tax assets that are created?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [27]

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Yes. That's correct. So we are creating some new life NOLs. So there will be incremental tax assets. There's an offset though, because we were previously carrying over Life income to cover some of the non-Life NOLs that existed. And so there is an incremental tax benefit, but then there is an increase to the valuation allowance to reflect that we're not going to be using those non-Life NOLs to the extent we previously were. So they net out.

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Operator [28]

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Your next question comes from Jeff Schmitt from William Blair.

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Jeffrey Paul Schmitt, William Blair & Company L.L.C., Research Division - Associate [29]

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So if there's $2.7 billion of reserves and assume you're getting 5% or 6% yield on that, call it $150 million or $160 million of investment income, that's not going off the books, but that's being transferred into the run-off segment? Is that right?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [30]

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No, Jeff. That's not correct. So the assets are moving off the books. The investment income will follow.

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Jeffrey Paul Schmitt, William Blair & Company L.L.C., Research Division - Associate [31]

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Okay. And so if there's minimal impact on GAAP earnings, as you said, what's offsetting that? I mean, obviously, there are some fees from Wilton Re that offsets that.

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [32]

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That's correct. So from an income statement perspective, we're ceding off premiums, net investment income. We are ceding off claims, change in reserve, some commissions and things like that. And so that piece of business generates a small gain, but it largely gets offset by the TSA fees that we get paid by Wilton for the next 3 years.

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Jeffrey Paul Schmitt, William Blair & Company L.L.C., Research Division - Associate [33]

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Okay. And then just looking at the producing agents, I guess, surprised to see that much of a drop in Bankers Life, particularly those with 3-plus years of experience. Can you give us sort of a status update on your efforts to increase retention there?

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Gary Chandru Bhojwani, CNO Financial Group, Inc. - CEO & Director [34]

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Yes. We've been really focused on, as we've talked about before, driving the yield from our recruiting efforts. So we've been much less focused on the front door metrics per se and more focused on getting agents to convert past that first year. So our first-year retention numbers are -- as we said verbally, we didn't indicate that in the data. But as we said verbally, our -- we're very pleased with. In terms of the plus-3 year, I think we're looking at -- what is it -- the number went from -- 1,847 to 1,835. So you're talking about less than a 1% move. So if I understood the question correctly, that's not been as much the point of focus. I shouldn't say it that way. A 1% move -- I don't know that I would draw a lot of conclusions around that. It's -- we've really been focused on a longer-term retention and I think that's just a -- it's a blip.

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Jeffrey Paul Schmitt, William Blair & Company L.L.C., Research Division - Associate [35]

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Got it. Okay.

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Gary Chandru Bhojwani, CNO Financial Group, Inc. - CEO & Director [36]

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Can -- I want to clarify a question that you asked and I want to make sure because -- I want to make sure we responded to it correctly. You were asking about the offset in investment income due to the $2.7 billion. And it's true that we're getting money from Wilton in the form of a transition services agreement to support certain activities, but those payments don't offset all of that investment income.

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [37]

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No. No.

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Gary Chandru Bhojwani, CNO Financial Group, Inc. - CEO & Director [38]

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That's a small piece of it. What's really offsetting that investment income is other things that we would have been accruing because that's a loss-producing block. So when you net out what we would have been accruing and some fees and other things, that's together what's offsetting the $100-and-some-odd million of investment income. I just wanted to make sure we didn't give you the impression that it's the TSA payments that are offsetting that. I don't know if we already lost him.

Jeff, if you're still there, we can't hear you, but I guess we'll go on to the next caller.

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Operator [39]

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Your next question comes from Dan Bergman from Citi.

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Daniel Basch Bergman, Citigroup Inc, Research Division - VP [40]

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To start, I was hoping you could provide a little more detail on the mechanics of the trust account that Wilton is setting up. I mean, it sounds like initially it's funded with assets equal to the statutory liabilities plus $500 million. I just wanted to see how this would work if there's kind of future deterioration in the block. In other words, for example, if statutory reserves had to be increased by $250 million earned after the deal closed, would Wilton then be required to put an additional $250 million into that trust? Just any color there and in general, any comments around the structuring. How you got comfortable with the counterparty risk would be very helpful?

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Gary Chandru Bhojwani, CNO Financial Group, Inc. - CEO & Director [41]

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Yes. Dan, this is Gary. I'm going to make a couple of general comments, and then I'll ask Erik to weigh in with the specifics. I think when you look at that over-collateralization account, there's a few things that I want to make sure are clearly understood. The first thing is, please remember that this is a 100% coinsurance. This is not a Stop Loss treaty. So the trigger for this is not simply if there's adverse claims development. The second point I want to make, I think it's important to look at our history of reserve adequacy and not having to take charges. Typically when we set up the reserves, if you look back at our history, thankfully we've been pretty accurate about that. The third thing I'd point out, remember the policies are also running off. So if something happens x number of years from now, there are number of the policies that will run-off over time. It's actually, relatively speaking, quite quick. But I think the main thing to remember, this trust gets put into play not simply when there's adverse development on the reserves of the claims, but rather if there's adverse development and Wilton is unable to meet those financial requirements. It's not simply in the case of just adverse claims development or the loss -- or where this collateral account kicks in. So I don't know Erik, if you want to add some details to that, perhaps some numbers.

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [42]

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Yes. I think it's well said. I mean -- so we'll get transferred in the trust the statutory liabilities, which are the reserves plus IMR that's created as part of the transaction, and then the additional $500 million. I think one thing I want to clarify is Wilton is obligated to maintain the trust and make sure that it's always adequately funded. So I think that's a key point. If there's deterioration for one reason or another, it's not our obligation to top off the trust. So I think that's one point of clarification. I made mention in my prepared remarks about there is a gradual drawdown of $62.5 million every 5 years and so that was done very specifically to mimic at a slower pace the run-off of the reserves as Gary mentioned. The run-offs or -- the reserves are running off fairly quickly because it's an aged block. So what will happen is over time, the collateral that's in the account, even though it's going to be getting pulled down every 5 years, it is actually going to be a greater proportion of the reserves and really growing until essentially the end the life of this block. So I think that's an important distinction. I think one other thing I'd mention is if there is adverse deterioration -- if it's significant and there's actuarial justification, the first thing that we would do is -- or that Wilton would do, is go out and seek premium rate increases to offset any of that. So that's kind of the first line of defense. And to Gary's point, whatever can't be made up from that is then the obligation of Wilton and its capital structure.

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Daniel Basch Bergman, Citigroup Inc, Research Division - VP [43]

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Got it. That's very helpful. I appreciate the color. And if I could -- moving to RBC, I was hoping you could give a little bit more details on the drivers of the quarter-over-quarter increase in the RBC ratio [per] quarter. I was just trying to get a sense is there any portion of that, that came from portfolio repositioning? And kind of was there any unwind of some of the changes that you guys had made in the portfolio last quarter?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [44]

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Yes. Dan, I made mention of it in my prepared remarks. We did have higher statutory income, and we did -- as we were moving towards having better clarity about a deal materializing in the second half of the quarter, we did proactively move some stuff around in order to kind of regenerate some of the RBC that we had used up in the first quarter for some of those trades that we talked about. So -- yes, so that was about 12 points of the improvement from the first quarter came from that reallocation exercise.

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Operator [45]

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

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Humphrey Lee, Dowling & Partners Securities, LLC - Research Analyst [46]

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A question related to Bankers annuity sales. Looking at the sales growth this quarter, definitely a good development. I was just wondering like -- can you give us some color in terms of what drove the stronger production in annuities? And how should we think about the trajectory from here?

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Gary Chandru Bhojwani, CNO Financial Group, Inc. - CEO & Director [47]

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Humphrey, this is Gary. Thanks for the question. The growth in annuities, we were pleased with it. I think it's fantastic progress. But frankly, I think we're capable of doing even better. And really what's driving it is a combination of a couple of factors. First of all, a little over a year ago, we launched a new annuity product that's had great reception. So we've been very pleased with that. Number two, it's been part of our stated strategy as we move to the right to move where more and more of our advisers are getting their securities license and being able to give consumers real assistance around accumulation income and longevity, as opposed to just straight up morality or health products like Life and Med Supp. So it's been part of that concerted effort. And as more of our producers have gotten their securities licenses, they've been getting into more households and offering more of those types of planning services. So I would tell you it's a combination of the product. It's a combination of -- part of our distribution strategy with the broker-dealer, and it's also a function of consumer need as more and more middle-income Americans retire -- and we all know that there's 10,000 Americans retiring a day. As more folks retire, they need these types of products. So we are pleased with it. We think we're capable of even more.

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Humphrey Lee, Dowling & Partners Securities, LLC - Research Analyst [48]

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So on the licensing, can you remind us like one of -- what number of Bankers' agents now are licensed to sell securities?

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Gary Chandru Bhojwani, CNO Financial Group, Inc. - CEO & Director [49]

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We disclosed -- I'm not sure we've disclosed that -- we started out with 1 out of 12. We said that our stated goal was to have 1 out of 5. I can tell you that we continue to make progress every quarter, and we expect -- we're still working through some of this, but we expect that with the Q3 results, our broker-dealer will then officially be 2 years old and the results will be at a point where it makes sense to start sharing more disclosures. So we'll be giving you more visibility beginning next quarter. But to directly answer the question, we continue to make very good progress on those ratios and are very pleased with how many of our agents are taking that next step and getting their securities license.

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Humphrey Lee, Dowling & Partners Securities, LLC - Research Analyst [50]

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Got it. Additional color on the broker-dealers would be helpful. And then shifting gear on the TSA fee. Would that be going through it in Bankers or going through it in run-off LTC?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [51]

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The -- Yes. Humphrey, this is Erik. Let me make sure I got my gymnastics correct. Yes, to the extent, the ceded profit -- yes, the ceded P&L has actually been moved over to the run-off segment, then -- yes, it should run through there. That's correct.

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Humphrey Lee, Dowling & Partners Securities, LLC - Research Analyst [52]

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Okay. And then because this is an administration fee, would that be qualified as non-Life income.

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [53]

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I believe so, yes.

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Humphrey Lee, Dowling & Partners Securities, LLC - Research Analyst [54]

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Okay. So in reality, the earnings amount, you're talking about the limited impact between kind of losing the block of business versus getting the TSA fees. So it's somewhat augmented because of the tax benefits coming through? Is that the way to think about that? Like I'm just trying to get a sense, after 3 years, how should we think about the net earnings impact from the transaction?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [55]

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Yes. So the answer to your question, I'm not thinking of it that way in terms of -- Life, non-Life income and how that's offsetting and some benefit, not at all. Really what happens is the ceded block of business makes a little bit of money now and that's getting -- and that's on a fully allocated sort of income statement basis. And that is going off the books and over to Wilton Re. So that loss of income here in the next couple of years is going to get offset by what Wilton is going to pay us to administer the business for the transition period. Now kind of beyond 3 years, what happens is the profits on this block of business are declining every year. And so what we are giving up is a smaller number and it actually, from a projection perspective, turns into a positive for us. So it's something we're trying to talk about in the prepared remarks was this is a positive for earnings growth and ROE trajectory because the blocks of business are projected to lose more and more money over time. By moving those off our income statement and our balance sheet, we have sort of more of a tailwind to earnings and ROE growth rather than a headwind.

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Operator [56]

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Your next question comes from Tom Gallagher from Evercore.

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Thomas George Gallagher, Evercore ISI Institutional Equities, Research Division - Senior MD [57]

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A few questions on long-term care and the deal. The -- can you just explain what was behind the trust structure? Was that something the regulators wanted? Was that something that you wanted? What's the -- is that to avoid having to put up reinsurance recoverables? Can you provide a little perspective on that?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [58]

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Tom, this is Erik. No. There was no regulatory requirement. This is an onshore trust with an onshore reinsurance partner, so trust was not required to secure reserve credit. This was something that Wilton and us agreed to sort of jointly.

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Thomas George Gallagher, Evercore ISI Institutional Equities, Research Division - Senior MD [59]

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Okay. So just that's where the structure went. Nothing -- no one pushing you to do it that way. That was just mutually agreed upon.

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [60]

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Correct.

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Thomas George Gallagher, Evercore ISI Institutional Equities, Research Division - Senior MD [61]

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The -- and I guess, Gary, I heard your comment about your priority was this older block because -- I think from what I heard or what I saw it -- from a stress test stand point, it had more risk in it than what remains. But did you contemplate reinsuring your whole long-term care exposure? And is there any reason why down the road you might not consider that?

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Gary Chandru Bhojwani, CNO Financial Group, Inc. - CEO & Director [62]

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I guess, I wouldn't want to try and predict what we might consider in the future. What I would tell you is that the block that remains, we are very, very comfortable with. In particular, the business after 2008 is profitable. So I -- never say never, but at this point, there's certainly no compelling force to part with that. And in terms of the '03 to '08, we just -- we didn't see the kind of upside from it. To a large extent, we undertook this transaction to give our shareholders more comfortable and visibility, and we did that by getting rid of the block that had the greatest potential volatility as respect to earnings and reserves. Any of the other blocks that we have don't have those characteristics. And really, there was no compelling need. And again, particularly when you look at the business issued after 2008, that's profitable and we don't want to give that up.

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Thomas George Gallagher, Evercore ISI Institutional Equities, Research Division - Senior MD [63]

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Got it. And then final question, I know you don't disclose it this way exactly, but can you give at least a rough approximation of what percent of your earnings going forward will be long-term care?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [64]

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Yes. I mean, we don't -- Tom, this is Erik. Yes, we don't disclose that. So I'm going to have to pass on that for now. What we're doing as part of the bifurcation on this block and moving over to the closed block or rather the LTC and run-off block is thinking about incremental ways that we can kind of enhance disclosure around the retained block. And so I think that's something that we'll take into consideration.

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Operator [65]

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Your next question comes from Alex Scott from Goldman Sachs.

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Taylor Alexander Scott, Goldman Sachs Group Inc., Research Division - Equity Analyst [66]

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My first question was just around the process a little bit, if you're able to talk about it. I mean, you've worked with Wilton in the past. I mean, is this something you just worked on sort of exclusively with them or were there sort of a number of interested reinsurance counterparties that looked at this deal?

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Gary Chandru Bhojwani, CNO Financial Group, Inc. - CEO & Director [67]

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Alex, thanks for the question. We are really pleased to have transacted on this deal with Wilton. As you know, we've done 3 other transactions with them. We think the world of them, have a good relationship with them and are very pleased to have done this deal with them. We were in conversations with others. And as you know -- I suspect you know pretty well, there are often NDAs in situations like this and there are other parties with whom we may want to transact the future. So the short answer is, we're not doing any kissing and telling right now.

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Taylor Alexander Scott, Goldman Sachs Group Inc., Research Division - Equity Analyst [68]

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Got it. Okay, understood. And then just -- when I think about ROE going forward, I saw the slides and heard your comments, I mean -- when I think about that 11%, sort of what you printed, plus the 150 basis points that was mentioned, I mean, how much upside do you see is kind of roll forward over the next few years? Like how much higher can you get that ROE and what would be the drivers of that?

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Gary Chandru Bhojwani, CNO Financial Group, Inc. - CEO & Director [69]

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Well, for the moment, our position is that we're not providing ROE guidance, so I'm going to stay with that. I will share with you a couple other comments though. We feel pretty bullish about the business. I really like what I see. And both our board and our management team recognize it's a priority to continue to increase that ROE. And we think we're capable of driving it higher, but we are stopping short of providing any specific guidance.

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Operator [70]

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Your next question comes from Randy Binner from B. Riley FBR.

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Randolph Binner, B. Riley FBR, Inc., Research Division - Analyst [71]

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So no ROE guide, but can we presume it would be better from this transaction?

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Gary Chandru Bhojwani, CNO Financial Group, Inc. - CEO & Director [72]

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Well, we're certainly not aiming to make it worse, Randy.

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Randolph Binner, B. Riley FBR, Inc., Research Division - Analyst [73]

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Good. And then on the NOL, this is I think in follow-up to Humphrey's question. Just to get that right, the net impact to NOL, the offset is complete on that piece. There is no net change to the NOL or no material net change expected?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [74]

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Randy, it's Erik. Thanks for the follow-up question because I realized I had misstated that. There is a positive benefit on a net basis of about $60 million.

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Randolph Binner, B. Riley FBR, Inc., Research Division - Analyst [75]

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$60 million, good guy. And that good guy is in the Life NOL or the non-Life NOL?

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [76]

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Yes, the Life NOL.

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Randolph Binner, B. Riley FBR, Inc., Research Division - Analyst [77]

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Okay. So that's like that adds a little bit of value there. And then one more, if I can. And this may -- just try this -- the sort of RBC ratio pro forma, which you shared on Page 11 or Slide 11 of your slide deck, that is estimate of RBC post-closing, so the ratio itself doesn't change. How should we think about that kind of numerator and denominator change that gets to that 435% pro forma RBC ratio of 435%.

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Erik Magnus Helding, CNO Financial Group, Inc. - Executive VP & CFO [78]

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So in the Bankers Life legal entity, what ends up happening is that their required capital drops by about $45 million. And so what was essentially -- I've got it actually here in front of me. What was capital of -- roughly $1.6 billion at the end of the second quarter for Bankers would end up coming out to somewhere around $1.4 billion after getting effect for the capital contribution. And the denominator goes from about $380 million down to about $340 million.

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Operator [79]

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This ends the Q&A session. I now hand it back over to the presenters for closing remarks.

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Adam Auvil, CNO Financial Group, Inc. - VP of IR [80]

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Thank you, operator, and thank you all for joining us on today's call.

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Operator [81]

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This ends today's call. You may now disconnect.