CNO FINANCIAL GROUP, INC., 10-K filed on 2/24/2011
Annual Report
CONSOLIDATED BALANCE SHEET (USD $)
In Millions
Year Ended
Dec. 31,
2010
2009
Investments:
 
 
Fixed maturities, available for sale, at fair value (amortized cost: 2010 - $20,155.8; 2009 - $18,998.0)
$ 20,634 
$ 18,528 
Equity securities at fair value (cost: 2010 - $68.2; 2009 - $30.7)
68 
31 
Mortgage loans
1,761 
1,966 
Policy loans
284 
295 
Trading securities
373 
293 
Investments held by variable interest entities
421 
Securities lending collateral
180 
Other invested assets
241 
237 
Total investments
23,782 
21,530 
Cash and cash equivalents - unrestricted
572 
523 
Cash and cash equivalents held by variable interest entities
27 
Accrued investment income
328 
309 
Present value of future profits
1,009 
1,176 
Deferred acquisition costs
1,764 
1,791 
Reinsurance receivables
3,256 
3,559 
Income tax assets, net
839 
1,124 
Assets held in separate accounts
18 
17 
Other assets
305 
311 
Total assets
31,900 
30,344 
Liabilities for insurance products:
 
 
Interest-sensitive products
13,195 
13,219 
Traditional products
10,308 
10,064 
Claims payable and other policyholder funds
969 
994 
Liabilities related to separate accounts
18 
17 
Other liabilities
496 
610 
Investment borrowings
1,204 
684 
Borrowings related to variable interest entities
387 
Securities lending payable
186 
Notes payable - direct corporate obligations
999 
1,037 
Total liabilities
27,574 
26,811 
Commitments and contingencies
 
 
Shareholders' equity:
 
 
Common stock ($0.01 par value, 8,000,000,000 shares authorized, shares issued and outstanding: 2010 - 251,084,174; 2009 - 250,786,216)
Additional paid-in capital
4,424 
4,409 
Accumulated other comprehensive income (loss)
238 
(264)
Accumulated deficit
(340)
(615)
Total shareholders' equity
4,325 
3,532 
Total liabilities and shareholders' equity
$ 31,900 
$ 30,344 
PARENTHETICAL DATA TO THE CONSOLIDATED BALANCE SHEET (USD $)
In Millions, except Share data
Dec. 31, 2010
Dec. 31, 2009
Investments:
 
 
Fixed maturities, available for sale, amortized cost
$ 20,156 
$ 18,998 
Available for sale equity secuities cost
68 
31 
Shareholders' equity:
 
 
Common stock, par value
$ 0.01 
$ 0.01 
Common stock, shares authorized
8,000,000,000 
8,000,000,000 
Common stock, shares issued
251,084,174 
250,786,216 
Common stock, shares outstanding
251,084,174 
250,786,216 
CONSOLIDATED STATEMENT OF OPERATIONS (USD $)
In Millions, except Share data
Year Ended
Dec. 31,
2010
2009
2008
Revenues:
 
 
 
Insurance policy income
$ 2,670 
$ 3,094 
$ 3,254 
Net investment income (loss):
 
 
 
General account assets
1,295 
1,231 
1,255 
Policyholder and reinsurer accounts and other special- purpose portfolios
72 
62 
(76)
Realized investment gains (losses):
 
 
 
Net realized investment gains (losses), excluding impairment losses
180 
135 
(100)
Other-than-temporary impairment losses:
 
 
 
Total other-than-temporary impairment losses
(147)
(385)
(162)
Change in other-than-temporary impairment losses recognized in accumulated other comprehensive income (loss)
(3)
190 
Net impairment losses recognized
(150)
(195)
(162)
Total realized gains (losses)
30 
(61)
(262)
Fee revenue and other income
17 
16 
20 
Total revenues
4,084 
4,341 
4,190 
Benefits and expenses:
 
 
 
Insurance policy benefits
2,724 
3,067 
3,213 
Interest expense
113 
118 
107 
Amortization
444 
433 
368 
(Gain) loss on extinguishment or modification of debt
22 
(21)
Other operating costs and expenses
503 
528 
520 
Total benefits and expenses
3,790 
4,168 
4,186 
Income before income taxes and discontinued operations
294 
174 
Income tax expense:
 
 
 
Tax expense on period income
104 
60 
Valuation allowance for deferred tax assets
(95)
28 
404 
Income (loss) before discontinued operations
285 
86 
(410)
Discontinued operations, net of income taxes
(723)
Net income (loss)
285 
86 
(1,132)
Basic:
 
 
 
Weighted average shares outstanding
250,973,000 
188,365,000 
184,704,000 
Income (loss) before discontinued operations
1.13 
0.45 
(2.22)
Discontinued operations
(3.91)
Net income (loss)
1.13 
0.45 
(6.13)
Diluted:
 
 
 
Weighted average shares outstanding
301,858,000 
193,340,000 
184,704,000 
Income (loss) before discontinued operations
0.99 
0.45 
(2.22)
Discontinued operations
(3.91)
Net income (loss)
$ 0.99 
$ 0.45 
$ (6.13)
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (USD $)
In Millions
Common stock and additional paid-in capital
Accumulated other comprehensive income (loss)
Retained earnings (accumulated deficit)
Total
Balance at Dec. 31, 2007
$ 4,099 
$ (273)
$ 427 
$ 4,252 
Comprehensive income (loss), net of tax:
 
 
 
 
Net income (loss)
 
 
(1,132)
(1,132)
Change in unrealized appreciation (depreciation) of investments (net of applicable income tax benefit (expense))
 
(1,497)
 
(1,497)
Change in unrecognized net loss related to deferred compensation plan (net of applicable income tax benefit)
 
(1)
 
(1)
Total comprehensive income (loss)
 
 
 
(2,630)
Stock option and restricted stock plans
 
 
Balance at Dec. 31, 2008
4,106 
(1,771)
(705)
1,630 
Comprehensive income (loss), net of tax:
 
 
 
 
Net income (loss)
 
 
86 
86 
Change in unrealized appreciation (depreciation) of investments (net of applicable income tax benefit (expense))
 
1,577 
 
1,577 
Noncredit component of impairment losses on fixed maturities, available for sale (net of applicable income tax benefit (expense))
 
(65)
 
(65)
Total comprehensive income (loss)
 
 
 
1,597 
Issuance of common stock, net
296 
 
 
296 
Stock option and restricted stock plans
 
 
Effect of reclassifying noncredit component of previously recognized impairment losses on fixed maturities, available for sale (net of applicable income tax benefit)
 
(5)
 
Balance at Dec. 31, 2009
4,411 
(264)
(615)
3,532 
Comprehensive income (loss), net of tax:
 
 
 
 
Net income (loss)
 
 
285 
285 
Change in unrealized appreciation (depreciation) of investments (net of applicable income tax benefit (expense))
 
441 
 
441 
Noncredit component of impairment losses on fixed maturities, available for sale (net of applicable income tax benefit (expense))
 
68 
 
68 
Total comprehensive income (loss)
 
 
 
793 
Cumulative effect of accounting change
 
(6)
(10)
(16)
Beneficial conversion feature related to the issuance of convertible debentures
 
 
Stock option and restricted stock plans
11 
 
 
11 
Balance at Dec. 31, 2010
$ 4,427 
$ 238 
$ (340)
$ 4,325 
PARENTHETICAL DATA TO THE CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (USD $)
In Millions
Year Ended
Dec. 31,
2010
2009
2008
Comprehensive income (loss), net of tax:
 
 
 
Change in unrealized appreciation (depreciation) of investments, applicable income tax expense (benefit)
$ 242 
$ 880 
$ (834)
Change in unrecognized net loss related to deferred compensation plan, applicable income tax expense (benefit)
 
 
(0)
Noncredit component of impairment losses on fixed maturities, available for sale, applicable income tax expense (benefit)
38 
(36)
 
Effect of reclassifying noncredit component of previously recognized impairment losses on fixed maturities, available for sale, applicable income tax expense (benefit)
 
(3)
 
CONSOLIDATED STATEMENT OF CASH FLOWS (USD $)
In Millions
Year Ended
Dec. 31,
2010
2009
2008
Cash flows from operating activities:
 
 
 
Insurance policy income
$ 2,359 
$ 2,747 
$ 3,141 
Net investment income
1,305 
1,167 
1,340 
Fee revenue and other income
17 
16 
20 
Insurance policy benefits
(1,975)
(2,299)
(2,722)
Interest expense
(108)
(109)
(95)
Policy acquisition costs
(418)
(408)
(459)
Other operating costs
(445)
(496)
(587)
Taxes
(0)
(7)
Net cash provided by operating activities
734 
612 
640 
Cash flows from investing activities:
 
 
 
Sales of investments
8,633 
10,710 
6,833 
Maturities and redemptions of investments
894 
917 
695 
Purchases of investments
(10,739)
(12,540)
(8,194)
Net sales (purchases) of trading securities
(52)
32 
347 
Change in cash and cash equivalents held by variable interest entities
(20)
11 
Change in cash held by discontinued operations
46 
Other
(15)
(11)
(21)
Net cash used by investing activities
(1,299)
(890)
(283)
Cash flows from financing activities:
 
 
 
Issuance of notes payable, net
756 
172 
75 
Issuance of common stock
296 
Payments on notes payable
(794)
(461)
(44)
Expenses related to debt modification and extinguishment of debt
(15)
Amounts received for deposit products
1,730 
1,669 
1,863 
Withdrawals from deposit products
(1,704)
(1,670)
(1,573)
Investment borrowings and borrowings related to variable interest entities
625 
(84)
(146)
Net cash provided (used) by financing activities
613 
(92)
176 
Net increase (decrease) in cash and cash equivalents
49 
(371)
533 
Cash and cash equivalents, beginning of year
523 
895 
362 
Cash and cash equivalents, end of year
$ 572 
$ 523 
$ 895 
BUSINESS AND BASIS OF PRESENTATION
BUSINESS AND BASIS OF PRESENTATION
 

1.       BUSINESS AND BASIS OF PRESENTATION

CNO Financial Group, Inc., a Delaware corporation (“CNO”), (formerly known as Conseco, Inc. prior to its name change in May 2010) is a holding company for a group of insurance companies operating throughout the United States that develop, market and administer health insurance, annuity, individual life insurance and other insurance products.  CNO became the successor to Conseco, Inc., an Indiana corporation (our “Predecessor”), in connection with our bankruptcy reorganization which became effective on September 10, 2003 (the “Effective Date”).  The terms “CNO Financial Group, Inc.”, the “Company”, “we”, “us”, and “our” as used in these financial statements refer to CNO and its subsidiaries or, when the context requires otherwise, our Predecessor and its subsidiaries.  We focus on serving the senior and middle-income markets, which we believe are attractive, underserved, high growth markets.  We sell our products through three distribution channels: career agents, independent producers (some of whom sell one or more of our product lines exclusively) and direct marketing.

Beginning July 1, 2010, management changed the manner in which it disaggregates the Company’s operations for making operating decisions and assessing performance.  As a result, the Company manages its business through the following operating segments: Bankers Life, Colonial Penn and Washington National, which are defined on the basis of product distribution; Other CNO Business, comprised primarily of products we no longer sell actively; and corporate operations, comprised of holding company activities and certain noninsurance company businesses.  Our segments are described below.

·  
Bankers Life, which markets and distributes Medicare supplement insurance, interest-sensitive life insurance, traditional life insurance, fixed annuities and long-term care insurance products to the middle-income senior market through a dedicated field force of career agents and sales managers supported by a network of community-based branch offices.  The Bankers Life segment includes primarily the business of Bankers Life and Casualty Company (“Bankers Life”).  Bankers Life also markets and distributes Medicare Advantage plans primarily through a distribution arrangement with Humana, Inc. (“Humana”) and Medicare Part D prescription drug plans through a distribution and reinsurance arrangement with Coventry Health Care (“Coventry”).
 
·  
Washington National, which markets and distributes supplemental health (including specified disease, accident and hospital indemnity insurance products) and life insurance to middle-income consumers at home and at the worksite.  These products are marketed through Performance Matters Associates, Inc., a wholly owned subsidiary, and through independent marketing organizations and insurance agencies, including worksite marketing.  The products being marketed are underwritten by Washington National Insurance Company (“Washington National”).
 
·  
Colonial Penn, which markets primarily graded benefit and simplified issue life insurance directly to customers through television advertising, direct mail, the internet and telemarketing.  The Colonial Penn segment includes primarily the business of Colonial Penn Life Insurance Company (“Colonial Penn”).
 
·  
Other CNO Business, which consists of blocks of interest-sensitive life insurance, traditional life insurance, annuities, long-term care insurance and other supplemental health products.  These blocks of business are not being actively marketed and were primarily issued or acquired by Conseco Life Insurance Company (“Conseco Life”) and Washington National.
 
We prepare our financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  We follow the accounting standards established by the Financial Accounting Standards Board (“FASB”) and the Securities and Exchange Commission (the “SEC”).

The accompanying financial statements include the accounts of the Company and its subsidiaries.  Our consolidated financial statements exclude the results of material transactions between us and our consolidated affiliates, or among our consolidated affiliates.

When we prepare financial statements in conformity with GAAP, we are required to make estimates and assumptions that significantly affect reported amounts of various assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting periods.  For example, we use significant estimates and assumptions to calculate values for deferred acquisition costs, the present value of future profits, certain investments (including derivatives), assets and liabilities related to income taxes, liabilities for insurance products, liabilities related to litigation, guaranty fund assessment accruals and amounts recoverable from loans to certain former directors and former employees.  If our future experience differs from these estimates and assumptions, our financial statements would be materially affected.

 
TRANSFER OF SENIOR HEALTH INSURANCE COMPANY OF PENNSYLVANIA TO AN INDEPENDENT TRUST
Transfer of Senior Health Insurance Company of Pennsylvania to an Independent Trust


 
2.
TRANSFER OF SENIOR HEALTH INSURANCE COMPANY OF PENNSYLVANIA TO AN INDEPENDENT TRUST

On November 12, 2008, CNO and CDOC, Inc. (“CDOC”), a wholly owned subsidiary of CNO, completed the transfer (the “Transfer”) of the stock of Senior Health Insurance Company of Pennsylvania (“Senior Health”) to Senior Health Care Oversight Trust, an independent trust (the “Independent Trust”) for the exclusive benefit of Senior Health’s long-term care policyholders.  The Transfer was approved by the Pennsylvania Insurance Department.

In connection with the Transfer, the Company entered into a $125.0 million Senior Note due November 12, 2013 (the “Senior Health Note”), payable to Senior Health.  The note has a five-year maturity date; a 6 percent interest rate; and requires annual principal payments of $25.0 million.  As a condition of the order from the Pennsylvania Insurance Department approving the Transfer, CNO agreed that it would not pay cash dividends on its common stock while any portion of the $125.0 million note remained outstanding.

CNO recorded accounting charges totaling $1.0 billion related to the transaction, comprised of Senior Health’s equity (as calculated in accordance with generally accepted accounting principles), an additional valuation allowance for deferred tax assets, the capital contribution to Senior Health and the Independent Trust and transaction expenses.  The accounting charges are summarized as follows (dollars in millions):

      
Recognition of unrealized losses on investments transferred to the Independent Trust
 $380.5 
(a)
       
Gain on reinsurance recapture, net of tax                                                                                                    
  (19.3) 
       
Increase to deferred tax valuation allowance based on recent results which have had a significant impact on taxable income and the effects of the transaction
  298.0  
       
Write-off of remaining shareholder’s equity of Senior Health                                                                                                    
  159.2 
(a)
       
Additional capital contribution and transaction expenses                                                                                                    
  204.4 
(a)
       
Total charges                                                                                                    
 $1,022.8  
_________________
 
(a)
Amount is before the potential tax benefit.  A deferred tax valuation allowance was established for all future potential tax benefits generated by these charges since management had concluded that it is more likely than not that such tax benefits would not be utilized to offset future taxable income.

 


As a result of the Transfer, Senior Health’s long-term care business is presented as a discontinued operation for all periods presented.  The operating results from the discontinued operations are as follows (dollars in millions):

   
2008
 
     
Revenues:
   
Insurance policy income                                                                                 
 $227.9 
Net investment income                                                                                 
  156.9 
Net realized investment losses                                                                                 
  (380.1)
      
Total revenues                                                                             
  4.7 
      
Benefits and expenses:
    
Insurance policy benefits                                                                                 
  311.2 
Amortization                                                                                 
  16.7 
Gain on reinsurance recapture (a)                                                                                 
  (29.7)
Loss on Transfer and transaction expenses                                                                                 
  363.6 
Other operating costs and expenses                                                                                 
  54.0 
      
Total benefits and expenses                                                                             
  715.8 
      
Loss before income taxes                                                                             
  (711.1)
      
Income tax expense (benefit):
    
      
Tax benefit on period income                                                                                 
  (440.7)
      
Valuation allowance for deferred tax assets                                                                                 
   452.3 
      
Net loss from discontinued operations                                                                             
 $(722.7)
_______________
(a)  
In the third quarter of 2008, Senior Health recaptured a block of previously reinsured long-term care business which was included in the business transferred to the Independent Trust.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 
3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The following summary explains the significant accounting policies we use to prepare our financial statements.

Investments

We classify our fixed maturity securities into one of three categories: (i) “available for sale” (which we carry at estimated fair value with any unrealized gain or loss, net of tax and related adjustments, recorded as a component of shareholders’ equity); (ii) “trading” (which we carry at estimated fair value with changes in such value recognized as trading income); or (iii) “held to maturity” (which we carry at amortized cost).  We had no fixed maturity securities classified as held to maturity during the periods presented in these financial statements.

Equity securities include investments in common stock and non-redeemable preferred stock.  We carry these investments at estimated fair value.  We record any unrealized gain or loss, net of tax and related adjustments, as a component of shareholders’ equity.  When declines in value considered to be other than temporary occur, we reduce the amortized cost to estimated fair value and recognize a loss in the statement of operations.

Mortgage loans held in our investment portfolio are carried at amortized unpaid balances, net of provisions for estimated losses.  Interest income is accrued on the principal amount of the loan based on the loan’s contractual interest rate.  Payment terms specified for mortgage loans may include a prepayment penalty for unscheduled payoff of the investment.  Prepayment penalties are recognized as investment income when received.

 


Policy loans are stated at current unpaid principal balances.

Certain of our trading securities are held in an effort to offset the portion of the income statement volatility caused by the effect of interest rate fluctuations on the value of certain embedded derivatives related to our fixed index annuity products and certain modified coinsurance agreements.  See the sections of this note entitled “Accounting for Derivatives” and “Investment Borrowings” for further discussion regarding embedded derivatives and the trading accounts.  In addition, the trading account includes investments backing the market strategies of our multibucket annuity products.  The change in fair value of these securities, which is recognized currently in income from policyholder and reinsurer accounts and other special-purpose portfolios (a component of investment income), is substantially offset by the change in insurance policy benefits for these products.  Our trading securities totaled $372.6 million and $293.3 million at December 31, 2010 and 2009, respectively.

Securities lending collateral primarily consisted of fixed maturities, equity securities and cash and cash equivalents.  We carried these investments at estimated fair value.  We recorded any unrealized gain or loss, net of tax, as a component of shareholders’ equity.  In the third quarter of 2010, the Company discontinued its securities lending program.

Other invested assets include:  (i) certain call options purchased in an effort to hedge the effects of certain policyholder benefits related to our fixed index annuity and life insurance products; and (ii) certain non-traditional investments.  We carry the call options at estimated fair value as further described in the section of this note entitled “Accounting for Derivatives”.  Non-traditional investments include investments in certain limited partnerships, which are accounted for using the equity method, and promissory notes, which are accounted for using the cost method.

We defer any fees received or costs incurred when we originate investments.  We amortize fees, costs, discounts and premiums as yield adjustments over the contractual lives of the investments without anticipation of prepayments.  We consider anticipated prepayments on mortgage-backed securities in determining estimated future yields on such securities.

When we sell a security (other than trading securities), we report the difference between the sale proceeds and amortized cost (determined based on specific identification) as a realized investment gain or loss.

We regularly evaluate our investments for possible impairment as further described in the note to the consolidated financial statements entitled “Investments”.

Cash and Cash Equivalents

Cash and cash equivalents include commercial paper, invested cash and other investments purchased with original maturities of less than three months.  We carry them at amortized cost, which approximates estimated fair value.

Deferred Acquisition Costs

The costs that vary with, and are primarily related to, producing new insurance business subsequent to September 10, 2003 are referred to as deferred acquisition costs.  For universal life or investment products, we amortize these costs in relation to the estimated gross profits using the interest rate credited to the underlying policies.  For other products, we amortize these costs in relation to future anticipated premium revenue using the projected investment earnings rate.

When we realize a gain or loss on investments backing our universal life or investment-type products, we adjust the amortization to reflect the change in estimated gross profits from the products due to the gain or loss realized and the effect on future investment yields.  We also adjust deferred acquisition costs for the change in amortization that would have been recorded if our fixed maturity securities, available for sale, had been sold at their stated aggregate fair value and the proceeds reinvested at current yields.  We limit the total adjustment related to the impact of unrealized losses to the total of costs capitalized plus interest related to insurance policies issued in a particular year.  We include the impact of this adjustment in accumulated other comprehensive income (loss) within shareholders’ equity.

The investment environment during the fourth quarter of 2008 resulted in significant net unrealized losses in our fixed maturity investment portfolio.  The total adjustment to accumulated other comprehensive income (loss)  related to the change in deferred acquisition costs for the negative amortization that would have been recorded if the fixed maturity securities had been sold at their stated aggregate fair value would have resulted in the balance of deferred acquisition costs exceeding the total of

 

costs capitalized plus interest for annuity blocks of business issued in certain years.  Accordingly, the adjustment made to deferred acquisition costs and accumulated other comprehensive income (loss) was reduced by $206 million.

We regularly evaluate the recoverability of the unamortized balance of the deferred acquisition costs.  We consider estimated future gross profits or future premiums, expected mortality or morbidity, interest earned and credited rates, persistency and expenses in determining whether the balance is recoverable.  If we determine a portion of the unamortized balance is not recoverable, it is charged to amortization expense.  In certain cases, the unamortized balance of the deferred acquisition costs may not be deficient in the aggregate, but our estimates of future earnings indicate that profits would be recognized in early periods and losses in later periods.  In this case, we increase the amortization of the deferred acquisition costs over the period of profits, by an amount necessary to offset losses that are expected to be recognized in the later years.

Present Value of Future Profits

The value assigned to the right to receive future cash flows from contracts existing at September 10, 2003 is referred to as the present value of future profits.  We also defer renewal commissions paid in excess of ultimate commission levels related to the existing policies in this account.  The balance of this account is amortized and evaluated for recovery in the same manner as described above for deferred acquisition costs.  We also adjust the present value of future profits for the change in amortization that would have been recorded if the fixed maturity securities, available for sale, had been sold at their stated aggregate fair value and the proceeds reinvested at current yields, similar to the manner described above for deferred acquisition costs.  We limit the total adjustment related to the impact of unrealized losses to the total present value of future profits plus interest.

The discount rate we used to determine the present value of future profits was 12 percent.

The Company expects to amortize the balance of the present value of future profits as of December 31, 2010 as follows:  13 percent in 2011, 11 percent in 2012, 10 percent in 2013, 8 percent in 2014 and 7 percent in 2015.

Assets Held in Separate Accounts

Separate accounts are funds on which investment income and gains or losses accrue directly to certain policyholders.  The assets of these accounts are legally segregated.  They are not subject to the claims that may arise out of any other business of CNO.  We report separate account assets at fair value; the underlying investment risks are assumed by the contractholders.  We record the related liabilities at amounts equal to the separate account assets.  We record the fees earned for administrative and contractholder services performed for the separate accounts in insurance policy income.

Recognition of Insurance Policy Income and Related Benefits and Expenses on Insurance Contracts

For universal life and investment contracts that do not involve significant mortality or morbidity risk, the amounts collected from policyholders are considered deposits and are not included in revenue.  Revenues for these contracts consist of charges for policy administration, cost of insurance charges and surrender charges assessed against policyholders’ account balances.  Such revenues are recognized when the service or coverage is provided, or when the policy is surrendered.

We establish liabilities for investment and universal life products equal to the accumulated policy account values, which include an accumulation of deposit payments plus credited interest, less withdrawals and the amounts assessed against the policyholder through the end of the period.  Sales inducements provided to the policyholders of these products are recognized as liabilities over the period that the contract must remain in force to qualify for the inducement.  The options attributed to the policyholder related to our fixed index annuity products are accounted for as embedded derivatives as described in the section of this note entitled “Accounting for Derivatives”.

Traditional life and the majority of our accident and health products (including long-term care, Medicare supplement and supplemental health products) are long duration insurance contracts.  Premiums on these products are recognized as revenues when due from the policyholders.

We also have a small block of short duration accident and health products.  Premiums on these products are recognized as revenue over the premium coverage period.

We establish liabilities for traditional life, accident and health insurance, and life contingent payment annuity products

 

using mortality tables in general use in the United States, which are modified to reflect the Company’s actual experience when appropriate.  We establish liabilities for accident and health insurance products using morbidity tables based on the Company’s actual or expected experience.  These reserves are computed at amounts that, with additions from estimated future premiums received and with interest on such reserves at estimated future rates, are expected to be sufficient to meet our obligations under the terms of the policy.  Liabilities for future policy benefits are computed on a net-level premium method based upon assumptions as to future claim costs, investment yields, mortality, morbidity, withdrawals, policy dividends and maintenance expenses determined when the policies were issued (or with respect to policies inforce at August 31, 2003, the Company’s best estimate of such assumptions on the Effective Date).  We make an additional provision to allow for potential adverse deviation for some of our assumptions.  Once established, assumptions on these products are generally not changed unless a premium deficiency exists.  In that case, a premium deficiency reserve is recognized and the future pattern of reserve changes are modified to reflect the relationship of premiums to benefits based on the current best estimate of future claim costs, investment yields, mortality, morbidity, withdrawals, policy dividends and maintenance expenses, determined without an additional provision for potential adverse deviation.

We establish claim reserves based on our estimate of the loss to be incurred on reported claims plus estimates of incurred but unreported claims based on our past experience.

Accounting for Long-term Care Premium Rate Increases

Many of our long-term care policies were subject to premium rate increases in the three years ending December 31, 2010.  In some cases, these premium rate increases were materially consistent with the assumptions we used to value the particular block of business at the fresh-start date.  With respect to the 2006 premium rate increases, some of our policyholders were provided an option to cease paying their premiums and receive a non-forfeiture option in the form of a paid-up policy with limited benefits.  In addition, our policyholders could choose to reduce their coverage amounts and premiums in the same proportion, when permitted by our contracts or as required by regulators.  The following describes how we account for these policyholder options:

·  
Premium rate increases – If premium rate increases reflect a change in our previous rate increase assumptions, the new assumptions are not reflected prospectively in our reserves.  Instead, the additional premium revenue resulting from the rate increase is recognized as earned and original assumptions continue to be used to determine changes to liabilities for insurance products unless a premium deficiency exists.

·  
Benefit reductions – A policyholder may choose reduced coverage with a proportionate reduction in premium, when permitted by our contracts.  This option does not require additional underwriting.  Benefit reductions are treated as a partial lapse of coverage, and the balance of our reserves and deferred insurance acquisition costs is reduced in proportion to the reduced coverage.

·  
Non-forfeiture benefits offered in conjunction with a rate increase – In some cases, non-forfeiture benefits are offered to policyholders who wish to lapse their policies at the time of a significant rate increase.  In these cases, exercise of this option is treated as an extinguishment of the original contract and issuance of a new contract.  The balance of our reserves and deferred insurance acquisition costs are released, and a reserve for the new contract is established.

·  
Florida Order – In 2004, the Florida Office of Insurance Regulation issued an order to Washington National, regarding home health care business in Florida.  The order required Washington National to offer a choice of three alternatives to holders of home health care policies in Florida subject to premium rate increases as follows:

·  
retention of their current policy with a rate increase of 50 percent in the first year and actuarially justified increases in subsequent years;
 
·  
receipt of a replacement policy with reduced benefits and a rate increase in the first year of 25 percent and no more than 15 percent in subsequent years; or
 
·  
receipt of a paid-up policy, allowing the holder to file future claims up to 100 percent of the amount of premiums paid since the inception of the policy.
 
Reserves for all three groups of policies under the order were prospectively adjusted using a prospective revision methodology, as these alternatives were required by the Florida Office of Insurance Regulation.  These policies had

 

no insurance acquisition costs established at the Effective Date.

Some of our policyholders may receive a non-forfeiture benefit if they cease paying their premiums pursuant to their original contract (or pursuant to changes made to their original contract as a result of a litigation settlement made prior to the Effective Date or an order issued by the Florida Office of Insurance Regulation).  In these cases, exercise of this option is treated as the exercise of a policy benefit, and the reserve for premium paying benefits is reduced, and the reserve for the non-forfeiture benefit is adjusted to reflect the election of this benefit.

Accounting for marketing and reinsurance agreements with Coventry

Prescription Drug Benefit

The Medicare Prescription Drug, Improvement and Modernization Act of 2003 provided for the introduction of a prescription drug benefit (“PDP”).  In order to offer this product to our current and potential future policyholders without investing in management and infrastructure, we entered into a national distribution agreement with Coventry to use our career and independent agents to distribute Coventry’s prescription drug plan, Advantra Rx.  We receive a fee based on the premiums collected on plans sold through our distribution channels.  In addition, CNO has a quota-share reinsurance agreement with Coventry for CNO enrollees that provides CNO with 50 percent of net premiums and related policy benefits subject to a risk corridor.  The Part D program was effective January 1, 2006.

The following describes how we account for and report our PDP business:

Our accounting for the national distribution agreement

·  
For contracts sold prior to 2009, we recognize distribution and licensing fee income from Coventry based upon negotiated percentages of collected premiums on the underlying Medicare Part D contracts.  For contracts sold in 2009 and thereafter, we recognize distribution income based on a fixed fee per PDP contract.  This fee income is recognized over the calendar year term as premiums are collected.

·  
We also pay commissions to our agents who sell the plans on behalf of Coventry.  These payments are deferred and amortized over the remaining term of the initial enrollment period (the one-year life of the initial policy).

Our accounting for the quota-share agreement

·  
We recognize premium revenue evenly over the period of the underlying Medicare Part D contracts.

·  
We recognize policyholder benefits and ceding commission expense as incurred.

·  
We recognize risk-share premium adjustments consistent with Coventry’s risk-share agreement with the Centers for Medicare and Medicaid Services.

Private-Fee-For-Service

CNO expanded its strategic alliance with Coventry by entering into a national distribution agreement under which our career agents began distributing Coventry’s Private-Fee-For-Service (“PFFS”) plan, beginning January 1, 2007.  The Advantra Freedom product is a Medicare Advantage plan designed to provide seniors with more choices and better coverage at lower cost than original Medicare and Medicare Advantage plans offered through HMOs.  Under the agreement, we received a fee based on the number of PFFS plans sold through our distribution channels.  In addition, CNO had a quota-share reinsurance agreement with Coventry for CNO enrollees that provided CNO with a specified percentage of the net premiums and related profits.  Coventry decided to cease selling PFFS plans effective January 1, 2010.  In July 2009, we announced a strategic alliance under which we would offer Humana’s Medicare Advantage plans to our policyholders and consumers through our career agency force and will receive marketing fees based on sales.  Effective January 1, 2010, we no longer assumed the underwriting risk related to PFFS business.

We received distribution fees from Coventry and we paid sales commissions to our agents for these enrollments.  In addition, we received a specified percentage of the income (loss) related to this business pursuant to a quota-share agreement with Coventry.

 


The following summarizes our accounting and reporting practices for the PFFS business.

Our accounting for the distribution agreement

·  
We received distribution income from Coventry and other parties based on a fixed fee per PFFS contract.  This income was deferred and recognized over the remaining calendar year term of the initial enrollment period.

·  
We also paid commissions to our agents who sell the plans on behalf of Coventry and other parties.  These payments were deferred and amortized over the remaining term of the initial enrollment period (the one-year life of the initial policy).

Our accounting for the quota-share agreement

·  
We recognized revenue evenly over the period of the underlying PFFS contracts.

·  
We recognized policyholder benefits and ceding commission expense as incurred.

Large Group Private-Fee-For-Service Blocks

During 2007 and 2008, CNO entered into three quota-share reinsurance agreements with Coventry related to the PFFS business written by Coventry under two large group policies.  CNO received a specified percentage of the net premiums and related profits associated with this business as long as the ceded revenue margin (as defined in the quota-share reinsurance agreements) was less than or equal to five percent.  CNO also received a specified percentage of the net premiums and related profits on the ceded margin in excess of five percent.  In order to reduce the required statutory capital associated with the assumption of this business, CNO terminated two group policy quota-share agreements as of December 31, 2008 and terminated the last agreement on June 30, 2009.  Premiums assumed through these reinsurance agreements totaled $47.5 million in 2009.  The income before income taxes related to the assumed business was $14.0 million during the year ended December 31, 2009.

Reinsurance

In the normal course of business, we seek to limit our loss exposure on any single insured or to certain groups of policies by ceding reinsurance to other insurance enterprises.  We currently retain no more than $.8 million of mortality risk on any one policy.  We diversify the risk of reinsurance loss by using a number of reinsurers that have strong claims-paying ratings.  In each case, the ceding CNO subsidiary is directly liable for claims reinsured in the event the assuming company is unable to pay.

The cost of reinsurance on life and health coverages is recognized over the life of the reinsured policies using assumptions consistent with those used to account for the underlying policy.  The cost of reinsurance ceded totaled $258.6 million, $179.4 million and $164.0 million in 2010, 2009 and 2008, respectively.  We deduct this cost from insurance policy income.  Reinsurance recoveries netted against insurance policy benefits totaled $471.6 million, $477.2 million and $536.3 million in 2010, 2009 and 2008, respectively.

From time-to-time, we assume insurance from other companies.  Any costs associated with the assumption of insurance are amortized consistent with the method used to amortize deferred acquisition costs described above.  Reinsurance premiums assumed totaled $92.6 million, $475.5 million and $641.0 million in 2010, 2009 and 2008, respectively. Reinsurance premiums included amounts assumed pursuant to marketing and quota-share agreements with Coventry of $67.2 million, $444.3 million and $609.5 million in 2010, 2009 and 2008, respectively.  Such premiums assumed included group policy quota-share agreements whereby we assumed:  (i) a specified percentage of the PFFS business written by Coventry under a large group policy effective July 1, 2007 (which was terminated on June 30, 2009); and (ii) a specified percentage of the PFFS business written by Coventry under another large group policy effective May 1, 2008 (which was terminated on December 31, 2008).  Coventry decided to cease selling PFFS plans effective January 1, 2010.  In July 2009, Bankers Life entered into an agreement with Humana under which it offers Humana’s Medicare Advantage/PFFS plans to its policyholders and consumers nationwide through its career agency force and receives marketing fees based on sales.  Effective January 1, 2010, the Company no longer assumes the underwriting risk related to PFFS business.

 

See the section of this note entitled “Accounting for Derivatives” for a discussion of the derivative embedded in the payable related to certain modified coinsurance agreements.

In 2008, Bankers Life entered into a reinsurance agreement, as amended, pursuant to which it ceded 70 percent of its new 2008 and 2009 long-term care business, excluding certain business sold in the state of Florida.  The amount reinsured decreased to 50 percent in the first quarter of 2010 and to 25 percent thereafter.  The pre-tax impact of this reinsurance agreement was not significant in 2008.

In September 2009, we completed a transaction under which Washington National and Conseco Insurance Company coinsured, with an effective date of January 1, 2009, about 104,000 non-core life insurance policies in the Other CNO Business segment with Wilton Reassurance Company (“Wilton Re”).  In the transaction, Wilton Re paid a ceding commission of $55.8 million and coinsures and administers 100 percent of these policies.  The CNO insurance companies transferred to Wilton Re $401.6 million in cash and policy loans and $457.4 million of policy and other reserves.  Most of the policies involved in the transaction were issued by companies prior to their acquisition by CNO.  We recorded a deferred gain of approximately $26 million in 2009 which is being recognized over the remaining life of the block of insurance policies coinsured with Wilton Re. We also increased our deferred tax valuation allowance by $20 million in 2009 as a result of reassessing the recovery of our deferred tax assets upon completion of the transaction.

In November 2009, we entered into a transaction under which Bankers Life coinsured, with an effective date of October 1, 2009, about 234,000 life insurance policies with Wilton Re.  In the transaction, Wilton Re paid a ceding commission of $44 million and is 50% coinsuring these policies, which continue to be administered by Bankers Life.  In the transaction, Bankers Life transferred to Wilton Re $73 million in investment securities and policy loans and $117 million of policy and other reserves.  As a result of the transaction, we recorded an increase to our deferred tax valuation allowance of $18 million in 2009, as a result of reassessing the recovery of our deferred tax assets upon completion of the transaction.  We also recorded a pre-tax deferred cost of reinsurance of $32 million in 2009, which, in accordance with GAAP, is being amortized over the life of the block.

Income Taxes

Our income tax expense includes deferred income taxes arising from temporary differences between the financial reporting and tax bases of assets and liabilities, capital loss carryforwards and net operating loss carryforwards (“NOLs”).  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which temporary differences are expected to be recovered or paid.  The effect of a change in tax rates on deferred tax assets and liabilities is recognized in earnings in the period when the changes are enacted.

A reduction of the carrying amount of deferred tax assets by establishing a valuation allowance is required if, based on the available evidence, it is more likely than not that such assets will not be realized.  We evaluate the need to establish a valuation allowance for our deferred income tax assets on an ongoing basis.  In evaluating our deferred income tax assets, we consider whether the deferred income tax assets will be realized, based on the more-likely-than-not realization threshold criterion.  The ultimate realization of our deferred income tax assets depends upon generating sufficient future taxable income during the periods in which our temporary differences become deductible and before our capital loss carryforwards and NOLs expire.  This assessment requires significant judgment.  In assessing the need for a valuation allowance, appropriate consideration is given to all positive and negative evidence related to the realization of the deferred tax assets.  This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, excess appreciated asset value over the tax basis of net assets, the duration of carryforward periods, our experience with operating loss and tax credit carryforwards expiring unused, and tax planning alternatives.

At December 31, 2010, our valuation allowance for our net deferred tax assets was $1.1 billion, as we have determined that it is more likely than not that a portion of our deferred tax assets will not be realized.  This determination was made by evaluating each component of the deferred tax asset and assessing the effects of limitations and/or interpretations on the value of such component to be fully recognized in the future.

Investment Borrowings

Two of the Company’s insurance subsidiaries (Conseco Life and Bankers Life) are members of the Federal Home Loan Bank (“FHLB”).  As members of the FHLB, Conseco Life and Bankers Life have the ability to borrow on a collateralized basis from FHLB.  Conseco Life and Bankers Life are required to hold certain minimum amounts of FHLB

 

common stock as a requirement of membership in the FHLB, and additional amounts based on the amount of the borrowings.  At December 31, 2010, the carrying value of the FHLB common stock was $60.0 million.  As of December 31, 2010, collateralized borrowings from the FHLB totaled $1.2 billion (of which, $750.0 million was borrowed in 2010) and the proceeds were used to purchase fixed maturity securities.  The borrowings are classified as investment borrowings in the accompanying consolidated balance sheet.  The borrowings are collateralized by investments with an estimated fair value of $1.5 billion at December 31, 2010, which are maintained in a custodial account for the benefit of the FHLB.  Such investments are classified as fixed maturities, available for sale, in our consolidated balance sheet.  Interest expense of $20.8 million, $20.3 million and $21.9 million in 2010, 2009 and 2008, respectively, was recognized related to the borrowings.

The following summarizes the terms of the borrowings (dollars in millions):

Amount
 
Maturity
 
Interest rate
borrowed
 
date
 
at December 31, 2010
      
$54.0 
May 2012
 
Variable rate – 0.284%
 13.0 
July 2012
 
Variable rate – 0.349%
 100.0 
October 2013
 
Variable rate – 0.591%
 100.0 
September 2015
 
Variable rate – 0.611%
 100.0 
September 2015
 
Variable rate – 0.588%
 100.0 
October 2015
 
Variable rate – 0.616%
 150.0 
October 2015
 
Variable rate – 0.610%
 146.0 
November 2015
 
Fixed rate – 5.300%
 100.0 
November 2015
 
Fixed rate – 4.890%
 100.0 
December 2015
 
Fixed rate – 4.710%
 50.0 
November 2016
 
Variable rate – 0.573%
 50.0 
November 2016
 
Variable rate – 0.731%
 100.0 
October 2017
 
Variable rate – 0.715%
 37.0 
November 2017
 
Fixed rate – 3.750%
       
$1,200.0     

The variable rate borrowings are pre-payable on each interest reset date without penalty.  The fixed rate borrowings are pre-payable subject to payment of a yield maintenance fee based on current market interest rates.  At December 31, 2010, the aggregate fee to prepay all fixed rate borrowings was $61.2 million.

At December 31, 2010, investment borrowings consisted of:  (i) collateralized borrowings from the FHLB of $1.2 billion; and (ii) other borrowings of $4.1 million.

At December 31, 2009, investment borrowings consisted of:  (i) collateralized borrowings from the FHLB of $450.0 million; (ii) $229.1 million of securities issued to other entities by a variable interest entity (“VIE”) which is consolidated in our financial statements as further discussed in the note to the consolidated financial statements entitled “Investments in Variable Interest Entities”; and (iii) other borrowings of $4.8 million.

Accounting for Derivatives

Our fixed index annuity products provide a guaranteed minimum rate of return and a higher potential return that is based on a percentage (the “participation rate”) of the amount of increase in the value of a particular index, such as the Standard & Poor’s 500 Index, over a specified period.  Typically, on each policy anniversary date, a new index period begins.  We are generally able to change the participation rate at the beginning of each index period during a policy year, subject to contractual minimums.  We typically buy call options (including call spreads) referenced to the applicable indices in an effort to hedge potential increases to policyholder benefits resulting from increases in the particular index to which the policy’s return is linked.  We reflect changes in the estimated fair value of these options in net investment income (classified as investment income from policyholder and reinsurer accounts and other special-purpose portfolios).  Net investment gains (losses) related to fixed index products were $28.2 million, $50.7 million and $(104.3) million in 2010, 2009 and 2008, respectively. These amounts were substantially offset by a corresponding change to insurance policy benefits.  The estimated fair value of these options was $89.4 million and $114.9 million at December 31, 2010 and 2009, respectively.  We classify these instruments as other invested assets.

 


The Company accounts for the options attributed to the policyholder for the estimated life of the annuity contract as embedded derivatives.  The expected future cost of options on fixed index annuity products is used to determine the value of embedded derivatives.  The Company purchases options to hedge liabilities for the next policy year on each policy anniversary date and must estimate the fair value of the forward embedded options related to the policies.  These accounting requirements often create volatility in the earnings from these products.  We record the changes in the fair values of the embedded derivatives in current earnings as a component of policyholder benefits.  Effective January 1, 2008, we adopted authoritative guidance related to fair value measurements which required us to value the embedded derivatives reflecting a hypothetical market perspective for fair value measurement.  We recorded a charge of $1.8 million to net income (after the effects of the amortization of the present value of future profits and deferred acquisition costs (collectively referred to as “amortization of insurance acquisition costs”) and income taxes), attributable to changes in the fair value of the embedded derivatives as a result of adopting such guidance.  The fair value of these derivatives, which are classified as “liabilities for interest-sensitive products”, was $553.6 million and $494.4 million at December 31, 2010 and 2009, respectively.  We maintain a specific block of investments in our trading securities account, which we carry at estimated fair value with changes in such value recognized as investment income (classified as investment income from policyholder and reinsurer accounts and other special-purpose portfolios).  The change in value of these trading securities attributable to interest fluctuations is intended to offset a portion of the change in the value of the embedded derivative.

If the counterparties for the call options we hold fail to meet their obligations, we may have to recognize a loss.  We limit our exposure to such a loss by diversifying among several counterparties believed to be strong and creditworthy.  At December 31, 2010, all of our counterparties were rated “BBB+” or higher by Standard & Poor’s Corporation (“S&P”).

Certain of our reinsurance payable balances contain embedded derivatives.  Such derivatives had an estimated fair value of $(.4) million and $1.6 million at December 31, 2010 and 2009, respectively.  We record the change in the fair value of these derivatives as a component of investment income (classified as investment income from policyholder and reinsurer accounts and other special-purpose portfolios).  We maintain a specific block of investments related to these agreements in our trading securities account, which we carry at estimated fair value with changes in such value recognized as investment income (also classified as investment income from policyholder and reinsurer accounts and other special-purpose portfolios).  The change in value of these trading securities attributable to interest fluctuations is intended to offset the change in value of the embedded derivatives.  However, differences will occur as corporate spreads change.

Multibucket Annuity Product

The Company’s multibucket annuity is an annuity product that credits interest based on the experience of a particular market strategy.  Policyholders allocate their annuity premium payments to several different market strategies based on different asset classes within the Company’s investment portfolio.  Interest is credited to this product based on the market return of the given strategy, less management fees, and funds may be moved between different strategies.  The Company guarantees a minimum return of premium plus approximately 3 percent per annum over the life of the contract.  The investments backing the market strategies of these products are designated by the Company as trading securities.  The change in the fair value of these securities is recognized as investment income (classified as income from policyholder and reinsurer accounts and other special-purpose portfolios), which is substantially offset by the change in insurance policy benefits for these products.  As of December 31, 2010, we hold insurance liabilities of $63.7 million related to multibucket annuity products.

Stock Based Compensation

In December 2004, the FASB issued authoritative guidance which provided additional guidance on accounting for share-based payments and required all such awards to be measured at fair value with the related compensation cost recognized in the statement of operations over the related service period.  CNO implemented the guidance using the modified prospective method on January 1, 2006.  Under this method, the Company began recognizing compensation cost for all awards granted on or after January 1, 2006.  In addition, we are required to recognize compensation cost over the remaining requisite service period for the portion of outstanding awards that were not vested as of January 1, 2006 and were not previously expensed on a pro forma basis pursuant to the guidance.  The guidance also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow rather than as an operating cash flow, as previously required.  During 2010, 2009 and 2008, we did not capitalize any stock-based compensation expense as deferred acquisition costs or any other asset category.

 

Fair Value Measurements

Effective January 1, 2008, we adopted authoritative guidance which clarifies a number of considerations with respect to fair value measurement objectives for financial reporting and expands disclosures about the use of fair value measurements.  The guidance is intended to increase consistency and comparability among fair value estimates used in financial reporting and the disclosure requirements are intended to provide users of financial statements with the ability to assess the reliability of an entity’s fair value measurements.  The initial adoption of the guidance resulted in a charge of $1.8 million to net income (after the effects of the amortization of insurance acquisition costs and income taxes) in the first quarter of 2008, attributable to changes in the liability for the embedded derivatives associated with our fixed index annuity products.  The change resulted from the incorporation of risk margins into the estimated fair value calculation for this liability.

Definition of Fair Value

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date and, therefore, represents an exit price, not an entry price.  We hold fixed maturities, equity securities, trading securities, investments held by variable interest entities, derivatives, separate account assets and embedded derivatives, which are carried at fair value.

The degree of judgment utilized in measuring the fair value of financial instruments is largely dependent on the level to which pricing is based on observable inputs.  Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our view of market assumptions in the absence of observable market information.  Financial instruments with readily available active quoted prices would be considered to have fair values based on the highest level of observable inputs, and little judgment would be utilized in measuring fair value.  Financial instruments that rarely trade would often have fair value based on a lower level of observable inputs, and more judgment would be utilized in measuring fair value.

Valuation Hierarchy

There is a three-level hierarchy for valuing assets or liabilities at fair value based on whether inputs are observable or unobservable.

·  
Level 1 – includes assets and liabilities valued using inputs that are quoted prices in active markets for identical assets or liabilities.  Our Level 1 assets include exchange traded securities.

·  
Level 2 – includes assets and liabilities valued using inputs that are quoted prices for similar assets in an active market, quoted prices for identical or similar assets in a market that is not active, observable inputs, or observable inputs that can be corroborated by market data.  Level 2 assets and liabilities include those financial instruments that are valued by independent pricing services using models or other valuation methodologies.  These models are primarily industry-standard models that consider various inputs such as interest rate, credit spread, reported trades, broker/dealer quotes, issuer spreads and other inputs that are observable or derived from observable information in the marketplace or are supported by observable levels at which transactions are executed in the marketplace.  Financial instruments in this category primarily include:  certain public and private corporate fixed maturity securities; certain government or agency securities; certain mortgage and asset-backed securities; and non-exchange-traded derivatives such as call options to hedge liabilities related to our fixed index annuity products.

·  
Level 3 – includes assets and liabilities valued using unobservable inputs that are used in model-based valuations that contain management assumptions.  Level 3 assets and liabilities include those financial instruments whose fair value is estimated based on non-binding broker prices or internally developed models or methodologies utilizing significant inputs not based on, or corroborated by, readily available market information.  Financial instruments in this category include certain corporate securities (primarily private placements), certain mortgage and asset-backed securities, and other less liquid securities.  Additionally, the Company’s liabilities for embedded derivatives (including embedded derivatives related to our fixed index annuity products and to a modified coinsurance arrangement) are classified in Level 3 since their values include significant unobservable inputs including actuarial assumptions.

At each reporting date, we classify assets and liabilities into the three input levels based on the lowest level of input that is significant to the measurement of fair value for each asset and liability reported at fair value.  This classification is impacted

 

by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established, the characteristics specific to the transaction and overall market conditions.  Our assessment of the significance of a particular input to the fair value measurement and the ultimate classification of each asset and liability requires judgment.

The vast majority of our fixed maturity securities and separate account assets use Level 2 inputs for the determination of fair value.  These fair values are obtained primarily from independent pricing services, which use Level 2 inputs for the determination of fair value.  Substantially all of our Level 2 fixed maturity securities and separate account assets were valued from independent pricing services.  Third party pricing services normally derive the security prices through recently reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information.  If there are no recently reported trades, the third party pricing services may use matrix or model processes to develop a security price where future cash flow expectations are developed and discounted at an estimated risk-adjusted market rate.  The number of prices obtained is dependent on the Company’s analysis of such prices as further described below.

For securities that are not priced by pricing services and may not be reliably priced using pricing models, we obtain broker quotes.  These broker quotes are non-binding and represent an exit price, but assumptions used to establish the fair value may not be observable and therefore represent Level 3 inputs.  Approximately 16 percent and 1 percent of our Level 3 fixed maturity securities were valued using broker quotes or independent pricing services, respectively.  The remaining Level 3 fixed maturity investments do not have readily determinable market prices and/or observable inputs.  For these securities, we use internally developed valuations.  Key assumptions used to determine fair value for these securities may include risk-free rates, risk premiums, performance of underlying collateral and other factors involving significant assumptions which may not be reflective of an active market.  For certain investments, we use a matrix or model process to develop a security price where future cash flow expectations are developed and discounted at an estimated market rate.  The pricing matrix utilizes a spread level to determine the market price for a security.  The credit spread generally incorporates the issuer’s credit rating and other factors relating to the issuer’s industry and the security’s maturity.  In some instances, issuer-specific spread adjustments, which can be positive or negative, are made based upon internal analysis of security specifics such as liquidity, deal size and time to maturity.

Privately placed securities comprise approximately 66 percent of our fixed maturities, available for sale, classified as Level 3.  Privately placed securities are classified as Level 3 when their valuation is based on internal valuation models which rely on significant inputs that are not observable in the market.  Our model applies spreads above the risk-free rate which are determined based on comparison to securities with similar ratings, maturities and industries that are rated by independent third party rating agencies.  Our process also considers the ratings assigned by the National Association of Insurance Commissioners (the “NAIC”) to the Level 3 securities on an annual basis.  Each quarter, a review is performed to determine the reasonableness of the initial valuations from the model.  If an initial valuation appears unreasonable based on our knowledge of a security and current market conditions, we make appropriate adjustments to our valuation inputs.  The remaining securities classified as Level 3 are primarily valued based on internally developed models using estimated future cash flows.  We recognized other-than-temporary impairments on securities classified as Level 3 investments of $75.9 million during 2010 ($72.0 million, prior to the $(3.9) million of impairment losses recognized through accumulated other comprehensive income (loss)).

As the Company is responsible for the determination of fair value, we perform monthly quantitative and qualitative analysis on the prices received from third parties to determine whether the prices are reasonable estimates of fair value.  The Company’s analysis includes:  (i) a review of the methodology used by third party pricing services; (ii) a comparison of pricing services’ valuation to other pricing services’ valuations for the same security; (iii) a review of month to month price fluctuations; (iv) a review to ensure valuations are not unreasonably stale; and (v) back testing to compare actual purchase and sale transactions with valuations received from third parties.  As a result of such procedures, the Company may conclude the prices received from third parties are not reflective of current market conditions.  In those instances, we may request additional pricing quotes or apply internally developed valuations.  However, the number of instances is insignificant and the aggregate change in value of such investments is not materially different from the original prices received.

The categorization of the fair value measurements of our investments priced by independent pricing services was based upon the Company’s judgment of the inputs or methodologies used by the independent pricing services to value different asset classes.  Such inputs include:  benchmark yields, reported trades, broker dealer quotes, issuer spreads, benchmark securities, bids, offers and reference data.  The Company categorizes such fair value measurements based upon asset classes and the underlying observable or unobservable inputs used to value such investments.

 

The classification of fair value measurements for derivative instruments, including embedded derivatives requiring bifurcation, is determined based on the consideration of several inputs including closing exchange or over-the-counter market price quotations; time value and volatility factors underlying options; market interest rates; and non-performance risk.  For certain embedded derivatives, we may use actuarial assumptions in the determination of fair value.

The categorization of fair value measurements, by input level, for our fixed maturity securities, equity securities, trading securities, certain other invested assets, assets held in separate accounts and embedded derivative instruments included in liabilities for insurance products at December 31, 2010 is as follows (dollars in millions):

   
Quoted prices in active markets for identical assets or liabilities (Level 1)
  
Significant other observable inputs (Level 2)
    
Significant unobservable inputs (Level 3)
    
Total
 
Assets:
                
Fixed maturities, available for sale:
                
Corporate securities
 $-  $12,254.7    $2,092.5    $14,347.2 
United States Treasury securities and obligations of United States government corporations and agencies
  10.0   282.2     2.0     294.2 
States and political subdivisions
  -   1,772.1     11.4     1,783.5 
Debt securities issued by foreign governments
  -   .9     -     .9 
Asset-backed securities
  -   638.1     6.0     644.1 
Collateralized debt obligations
  -   -     256.5     256.5 
Commercial mortgage-backed securities
  -   1,363.7     -     1,363.7 
Mortgage pass-through securities
  27.8   -     3.5     31.3 
Collateralized mortgage obligations
  -   1,715.4     197.1     1,912.5 
Total fixed maturities, available for sale 
  37.8   18,027.1     2,569.0     20,633.9 
                      
Equity securities
  -   37.5     30.6     68.1 
                      
Trading securities:
                    
Corporate securities
  3.2   47.5     4.3     55.0 
United States Treasury securities and obligations of United States government corporations and agencies
  -   293.8     -     293.8 
States and political subdivisions
  -   16.1     -     16.1 
Asset-backed securities
  -   .6     -     .6 
Commercial mortgage-backed securities
  -   5.2     -     5.2 
Mortgage pass-through securities
  .3   -     -     .3 
Collateralized mortgage obligations
  -   1.2     .4     1.6 
Total trading securities
  3.5   364.4     4.7     372.6 
Investments held by variable interest entities
  -   414.2     6.7     420.9 
Other invested assets
  -   192.0 
(a)
  -     192.0 
Assets held in separate accounts
  -   17.5     -     17.5 
                      
Liabilities:
                    
Liabilities for insurance products:
                    
Interest-sensitive products
  -   -     553.2 
(b)
  553.2 
_____________
(a)  
Includes company-owned life insurance and derivatives.
(b)  
Includes $553.6 million of embedded derivatives associated with our fixed index annuity products and $(.4) million of embedded derivatives associated with a modified coinsurance agreement.

 


The categorization of fair value measurements, by input level, for our fixed maturity securities, equity securities, trading securities, certain other invested assets, assets held in separate accounts and embedded derivative instruments included in liabilities for insurance products at December 31, 2009 is as follows (dollars in millions):

   
Quoted prices in active markets for identical assets or liabilities (Level 1)
  
Significant other observable inputs (Level 2)
    
Significant unobservable inputs (Level 3)
    
Total
 
Assets:
                
Fixed maturities, available for sale:
                
Corporate securities
 $-  $12,044.3    $2,247.1    $14,291.4 
United States Treasury securities and obligations of United States government corporations and agencies
  19.4   248.0     2.2     269.6 
States and political subdivisions
  -   842.9     10.7     853.6 
Debt securities issued by foreign governments
  -   5.1     -     5.1 
Asset-backed securities
  -   176.3     15.8     192.1 
Collateralized debt obligations
  -   -     92.8     92.8 
Commercial mortgage-backed securities
  -   752.3     13.7     766.0 
Mortgage pass-through securities
  37.1   1.3     4.2     42.6 
Collateralized mortgage obligations
  -   2,003.8     11.4     2,015.2 
Total fixed maturities, available for sale 
  56.5   16,074.0     2,397.9     18,528.4 
                      
Equity securities
  .1   -     30.9     31.0 
                      
Trading securities:
                    
Corporate securities
  3.8   49.4     3.7     56.9 
United States Treasury securities and obligations of United States government corporations and agencies
  -   220.3     -     220.3 
States and political subdivisions
  -   4.4     -     4.4 
Asset-backed securities
  -   .6     -     .6 
Commercial mortgage-backed securities
  -   4.9     -     4.9 
Mortgage pass-through securities
  .5   -     -     .5 
Collateralized mortgage obligations
  -   5.7     -     5.7 
Total trading securities
  4.3   285.3     3.7     293.3 
                      
Securities lending collateral:
                    
Corporate securities
  -   81.0     13.7     94.7 
Asset-backed securities
  -   16.2     22.9     39.1 
Total securities lending collateral
  -   97.2     36.6     133.8 
                      
Other invested assets
  -   192.6 
(a)
  2.4 
(b)
  195.0 
Assets held in separate accounts
  -   17.3     -     17.3 
                      
Liabilities:
                    
Liabilities for insurance products:
                    
Interest-sensitive products
  -   -     496.0 
(c)
  496.0 


 

 
____________
(a)  
Includes company-owned life insurance and derivatives.
(b)  
Includes equity-like holdings in special-purpose entities.
(c)  
Includes $494.4 million of embedded derivatives associated with our fixed index annuity products and $1.6 million of embedded derivatives associated with a modified coinsurance agreement.

 

The following table presents additional information about assets and liabilities measured at fair value on a recurring basis and for which we have utilized significant unobservable (Level 3) inputs to determine fair value for the year ended December 31, 2010 (dollars in millions):
 
   
December 31, 2010
 
Amount of total gains (losses) for the year ended
December 31, 2010 included
in our net
income relating
to assets and liabilities still held as of the reporting date
   
Beginning
balance
as of
December 31,
2009
  
Cumulative
effect of
accounting
change (a)
  
Purchases,
sales,
issuances
and
settlements,
net
  
Total
realized
and
unrealized
gains
(losses)
included
in net
income
  
Total realized
and unrealized
gains (losses)
included in accumulated other
comprehensive
income (loss)
  
Transfers
into
Level 3
(b)
  
Transfers
out of
Level 3
(b) (c)
  
Ending
balance
as of
December 31,
2010
 
Assets:
                            
Fixed maturities, available for sale:
                            
Corporate securities
 $2,247.1  $(5.9) $148.8  $(72.7) $74.5  $19.6  $(318.9) $2,092.5    $-  
United States Treasury securities and obligations of United States government corporations and agencies
  2.2   -   (.1)  -   (.1)  -   -   2.0     -  
States and political subdivisions
  10.7   -   -   -   .4   2.1   (1.8)  11.4     -  
Asset-backed securities
  15.8   -   (12.3)  (11.4)  13.9   -   -   6.0     -  
Collateralized debt obligations
  92.8   (5.7)  160.2   (.3)  9.5   -   -   256.5     -  
Commercial mortgage-backed securities
  13.7   -   -   -   -   -   (13.7)  -     -  
Mortgage pass-through securities
  4.2   -   (.7)  -   -   -   -   3.5     -  
Collateralized mortgage obligations
  11.4   -   174.8   (.8)  5.5   17.3   (11.1)  197.1     -  
Total fixed maturities, available for sale
  2,397.9   (11.6)  470.7   (85.2)  103.7   39.0   (345.5)  2,569.0     -  
Equity securities
  30.9   -   .1   -   (.4)  -   -   30.6     -  
Trading securities:
                                       
 Corporate securities
  3.7   -   -   -   .6   -   -   4.3     .6  
 Collateralized mortgage obligations
   -   -   -   -   .1   .3   -   .4     .1  
Total trading securities
  3.7   -   -   -   .7   .3   -   4.7     .7  
Investments held by variable interest  
  entities:
                                       
Corporate securities
  -   6.9   (1.0)  -   .8   -   -   6.7     -  
Securities lending collateral:
                                       
Corporate securities
  13.7   -   (13.7)  -   -   -   -   -     -  
Asset-backed securities
  22.9   -   (20.9)  -   -   -   (2.0)  -     -  
Total securities lending collateral
  36.6   -   (34.6)  -   -   -   (2.0)  -     -  
Other invested assets
  2.4   (2.4  -   -   -   -   -   -     -  
Liabilities:
                                       
Liabilities for insurance products:
                                       
Interest-sensitive products
  (496.0)  -   (20.0)  (37.2)  -   -   -   (553.2
 
  (37.2
 

 

________
(a)  
Amounts represent adjustments to investments related to a variable interest entity that was required to be consolidated effective January 1, 2010, as well as the reclassification of investments of a variable interest entity which was consolidated at December 31, 2009.
(b)  
Transfers in/out of Level 3 are reported as having occurred at the beginning of the period.
(c)  
Included in the transfers out of Level 3 is approximately $282 million of privately issued securities that were priced using observable market data at December 31, 2010 and were, therefore, transferred to Level 2.

The following table presents additional information about assets and liabilities measured at fair value on a recurring basis and for which we have utilized significant unobservable (Level 3) inputs to determine fair value for the year ended December 31, 2009 (dollars in millions):

   
December 31, 2009
   
   
Beginning
balance
as of
December 31,
2008
  
Purchases,
sales,
issuances
and
settlements,
net
  
Total
realized
and
unrealized
gains
(losses)
included
in net
income
  
Total realized
and unrealized
gains (losses)
included in
accumulated other
comprehensive
income (loss)
  
Transfers
into
Level 3
(a)
  
Transfers
out of
Level 3
(a)
  
Ending
balance
as of
December 31,
2009
 
Amount of total gains (losses) for the year ended
December 31, 2009 included
in our net
income relating
to assets and liabilities still held as of the reporting date
 
Assets:
                        
Fixed maturities, available for sale:
                        
Corporate securities
 $1,715.6  $231.1  $(5.2) $284.8  $30.3  $(9.5) $2,247.1  $- 
United States Treasury securities and obligations of United States government corporations and agencies
  2.6   (.1)  -   (.3)  -   -   2.2   - 
States and political subdivisions
  10.5   (.5)  -   (1.1)  1.8   -   10.7   - 
Asset-backed securities
  27.5   (4.4)  (5.2)  2.0   -   (4.1)  15.8   (1.2)
Collateralized debt obligations
  96.7   (36.3)  (4.2)  36.6   -   -   92.8   (2.7)
Commercial mortgage-backed securities
  9.6   (.7)  (.6)  5.4   -   -   13.7   - 
Mortgage pass-through securities
  4.9   (.8)  -   -   .1   -   4.2   - 
Collateralized mortgage obligations
  8.7   10.8   -   .1   -   (8.2)  11.4   - 
Total fixed maturities, available for sale
  1,876.1   199.l  (15.2)  327.5   32.2   (21.8)  2,397.9   (3.9)
Equity securities
  32.4   (.3)  -   (1.2)  -   -   30.9   - 
Trading securities:
                                
Corporate securities
  2.7   -   1.0   -   -   -   3.7   1.0 
Securities lending collateral:
                                
Corporate securities
  34.9   (17.0)  -   .3   -   (4.5)  13.7   - 
Equity securities
  .1   (.1)  (.3)  .3   -   -   -   (.3)
Asset-backed securities
   13.1   -   (.6)  (10.0)  20.4   -   22.9   (.6)
Total securities lending collateral
  48.1   (17.1)  (.9)  (9.4)  20.4   (4.5)  36.6   (.9)
Other invested assets
  2.3   -   (3.4)  3.5   -   -   2.4   (3.4)
Liabilities:
                                
Liabilities for insurance products:
                                
Interest-sensitive products
  (437.2)  (63.8)  5.0   -   -   -   (496.0  7.3 
_________
(a)  
Transfers in/out of Level 3 are reported as having occurred at the beginning of the period.

At December 31, 2010, 86 percent of our Level 3 fixed maturities, available for sale, were investment grade and 81 percent of our Level 3 fixed maturities, available for sale, consisted of corporate securities.

Realized and unrealized investment gains and losses presented in the preceding tables represent gains and losses during the time the applicable financial instruments were classified as Level 3.

 


Realized and unrealized gains (losses) on Level 3 assets are primarily reported in either net investment income for policyholder and reinsurer accounts and other special-purpose portfolios, net realized investment gains (losses) or insurance policy benefits within the consolidated statement of operations or accumulated comprehensive income (loss) within shareholders’ equity based on the appropriate accounting treatment for the instrument.

Purchases, sales, issuances and settlements, net, represent the activity that occurred during the period that results in a change of the asset or liability but does not represent changes in fair value for the instruments held at the beginning of the period.  Such activity primarily consists of purchases and sales of fixed maturity, equity and trading securities, purchases and settlements of derivative instruments, and changes to embedded derivative instruments related to insurance products resulting from the issuance of new contracts, or changes to existing contracts.

We review the fair value hierarchy classifications each reporting period.  Transfers in and/or (out) of Level 3 in 2010 and 2009 were primarily due to changes in the observability of the valuation attributes resulting in a reclassification of certain financial assets or liabilities.  Such reclassifications are reported as transfers in and out of Level 3 at the beginning fair value for the reporting period in which the changes occur.  There were no significant transfers between Level 1 and Level 2 in 2010.

The amount presented for gains (losses) included in our net loss for assets and liabilities still held as of the reporting date primarily represents impairments for fixed maturities, available for sale, changes in fair value of trading securities and certain derivatives and changes in fair value of embedded derivative instruments included in liabilities for insurance products that exist as of the reporting date.

We use the following methods and assumptions to determine the estimated fair values of other financial instruments:

Cash and cash equivalents.  The carrying amount for these instruments approximates their estimated fair value.

Mortgage loans and policy loans.  We discount future expected cash flows for loans included in our investment portfolio based on interest rates currently being offered for similar loans to borrowers with similar credit ratings.  We aggregate loans with similar characteristics in our calculations.  The fair value of policy loans approximates their carrying value.

Other invested assets.  We use quoted market prices, where available.  When quotes are not available, we estimate the fair value based on discounted future expected cash flows or independent transactions which establish a value for our investment.  Investments in limited partnerships are accounted for under the equity method which approximates estimated fair value.

Insurance liabilities for interest-sensitive products.  We discount future expected cash flows based on interest rates currently being offered for similar contracts with similar maturities.

Investment borrowings, notes payable and borrowings related to variable interest entities.  For publicly traded debt, we use current fair values.  For other notes, we use discounted cash flow analyses based on our current incremental borrowing rates for similar types of borrowing arrangements.

 


The estimated fair values of our financial instruments at December 31, 2010 and 2009, were as follows (dollars in millions):

   
2010
  
2009
 
   
Carrying
  
Fair
  
Carrying
  
Fair
 
   
Amount
  
Value
  
Amount
  
Value
 
              
Financial assets:
            
Fixed maturities, available for sale
 $20,633.9  $20,633.9  $18,528.4  $18,528.4 
Equity securities                                                
  68.1   68.1   31.0   31.0 
Mortgage loans                                                
  1,761.2   1,762.6   1,965.5   1,756.8 
Policy loans                                                
  284.4   284.4   295.2   295.2 
Trading securities                                                
  372.6   372.6   293.3   293.3 
Investments held by securitization entities
  420.9   420.9   -   - 
Securities lending collateral                                                
  -   -   180.0   180.0 
Other invested assets                                                
  240.9   240.9   236.8   236.8 
Cash and cash equivalents                                                
  598.7   598.7   526.8   526.8 
                  
Financial liabilities:
                
Insurance liabilities for interest-sensitive products (a)
 $13,194.7  $13,194.7  $13,219.2  $13,219.2 
Investment borrowings                                                
  1,204.1   1,265.3   683.9   677.6 
Borrowings related to securitization entities
  386.9   345.1   -   - 
Notes payable – direct corporate obligations
  998.5   1,166.4   1,037.4   1,041.7 
____________________
(a)  
The estimated fair value of insurance liabilities for interest-sensitive products was approximately equal to its carrying value at December 31, 2010 and 2009.  This was because interest rates credited on the vast majority of account balances approximate current rates paid on similar products and because these rates are not generally guaranteed beyond one year.

Sales Inducements

Certain of our annuity products offer sales inducements to contract holders in the form of enhanced crediting rates or bonus payments in the initial period of the contract.  Certain of our life insurance products offer persistency bonuses credited to the contract holders balance after the policy has been outstanding for a specified period of time.  These enhanced rates and persistency bonuses are considered sales inducements in accordance with GAAP.  Such amounts are deferred and amortized in the same manner as deferred acquisition costs.  Sales inducements deferred totaled $20.0 million, $28.4 million and $47.1 million in 2010, 2009 and 2008, respectively.  Amounts amortized totaled $31.2 million, $30.2 million and $16.7 million in 2010, 2009 and 2008, respectively.  The unamortized balance of deferred sales inducements was $166.4 million and $177.6 million at December 31, 2010 and 2009, respectively.  The balance of insurance liabilities for persistency bonus benefits was $85.3 million and $136.2 million at December 31, 2010 and 2009, respectively.

Out-of-Period Adjustments

We recorded the net effects of certain out-of-period adjustments which decreased our net income by $5.5 million (or two cents per diluted share) in 2010.  We evaluated these errors taking into account both qualitative and quantitative factors and considered the impact of these errors in relation to 2010, as well as the materiality to the periods in which they originated.  Management believes these errors are immaterial to the consolidated annual financial statements.

 


Recently Issued Accounting Standards

Pending Accounting Standards

In October 2010, the FASB issued authoritative guidance that modifies the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal contracts.  The guidance specifies that an insurance entity shall only capitalize incremental direct costs related to the successful acquisition of new or renewal insurance contracts.  The guidance also states that advertising costs should be included in deferred acquisition costs only if the capitalization criteria in the direct-response advertising guidance are met.  The guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011.  The guidance should be applied prospectively upon adoption.  Retrospective application to all prior periods presented upon the date of adoption also is permitted, but not required.  We are in the process of evaluating the impact the guidance will have on our consolidated financial statements and we believe that the guidance will reduce the amount of costs that we can capitalize.

In January 2010, the FASB issued authoritative guidance which requires additional disclosures related to purchases, sales, issuances and settlements in the rollforward of Level 3 fair value measurements.  This guidance is effective for reporting periods beginning after December 15, 2010.  We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

Adopted Accounting Standards

In March 2010, the FASB issued authoritative guidance clarifying the scope exception for embedded credit derivatives and when those features would be bifurcated from the host contract.  Under the new guidance, only embedded credit derivative features that are in the form of subordination of one financial instrument to another would not be subject to the bifurcation requirements.  Accordingly, entities will be required to bifurcate any embedded credit derivative features that no longer qualify under the amended scope exception, or, for certain investments, an entity can elect the fair value option and record the entire investment at fair value.  This guidance is effective for fiscal quarters beginning after June 15, 2010.  The adoption of this guidance did not have a material impact on our consolidated financial statements.

In January 2010, the FASB issued authoritative guidance which requires new disclosures and clarifies existing disclosure requirements related to fair value.  An entity is also required to disclose significant transfers in and out of Levels 1 and 2 of the fair value hierarchy.  In addition, the guidance amends the fair value disclosure requirement for pension and postretirement benefit plan assets to require this disclosure at the investment class level.  The guidance is effective for interim and annual reporting periods beginning after December 15, 2009.  Such disclosures are included in the note to the consolidated financial statements entitled “Fair Value Measurements”.  The adoption of this guidance did not have a material impact on our consolidated financial statements.

In June 2009, the FASB issued authoritative guidance that is intended to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets.  The guidance must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter.  The guidance must be applied to transfers occurring on or after the effective date.  The adoption of this guidance did not have a material impact on our consolidated financial statements.

 


In June 2009, the FASB issued authoritative guidance that requires an entity to perform a qualitative analysis to determine whether a primary beneficiary interest is held in a VIE.  Under the new qualitative model, the primary beneficiary must have both the power to direct the activities of the VIE and the obligation to absorb either losses or gains that could be significant to the VIE.  The guidance also requires ongoing reassessments to determine whether a primary beneficiary interest is held and additional disclosures, including the financial statement effects of the entity’s involvement with VIEs.  The guidance is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter.  The impact of adoption of this guidance is as follows (dollars in millions):

   
January 1, 2010
 
   
Amounts prior to effect of adoption of authoritative
  
Effect of adoption of authoritative
  
As
 
   
guidance
  
guidance
  
adjusted
 
           
Total investments
 $21,530.2  $247.6  $21,777.8 
              
Cash and cash equivalents held by variable interest entities
  3.4   3.8   7.2 
Accrued investment income
  309.0   .9   309.9 
Income tax assets, net
  1,124.0   8.6   1,132.6 
Other assets
  310.7   14.2   324.9 
Total assets
  30,343.8   275.1   30,618.9 
              
Other liabilities
  610.4   8.8   619.2 
Borrowings related to variable interest entities
  229.1   282.2   511.3 
Total liabilities
  26,811.4   291.0   27,102.4 
              
Accumulated other comprehensive income (loss)
  (264.3)  (6.2)  (270.5)
Accumulated deficit
  (614.6)  (9.7)  (624.3)
Total shareholders’ equity
  3,532.4   (15.9)  3,516.5 
              
Total liabilities and shareholders’ equity
  30,343.8   275.1   30,618.9 

On April 9, 2009, the FASB issued authoritative guidance regarding the recognition and presentation of an other-than-temporary impairment and requires additional disclosures.  The recognition provision within this guidance applies only to fixed maturity investments that are subject to the other-than-temporary impairments.  If an entity intends to sell or if it is more likely than not that it will be required to sell an impaired security prior to recovery of its cost basis, the security is other-
than-temporarily impaired and the full amount of the impairment is recognized as a loss through earnings.  Otherwise, losses on securities which are other-than-temporarily impaired are separated into:  (i) the portion of loss which represents the credit loss; and (ii) the portion which is due to other factors.  The credit loss portion is recognized as a loss through earnings while the loss due to other factors is recognized in accumulated other comprehensive income (loss), net of taxes and related amortization.  The guidance requires a cumulative effect adjustment to accumulated deficit and a corresponding adjustment to accumulated other comprehensive income (loss) to reclassify the non-credit portion of previously other-than-temporarily impaired securities which were held at the beginning of the period of adoption and for which we do not intend to sell and it is more likely than not that we will not be required to sell such securities before recovery of the amortized cost basis.  We adopted the guidance effective January 1, 2009.  The cumulative effect of adopting this guidance was a $4.9 million net decrease to accumulated deficit and a corresponding increase to accumulated other comprehensive income (loss).

On April 9, 2009, the FASB issued authoritative guidance which provided additional guidance on estimating fair value when the volume and level of activity for an asset or liability have significantly decreased in relation to normal market activity for the asset or liability and clarifies that the use of multiple valuation techniques may be appropriate.  The guidance also discusses circumstances that may indicate a transaction is not orderly.  The guidance re-emphasizes that fair value continues to be the exit price in an orderly market.  Further, this guidance requires additional disclosures about fair value measurement in annual and interim reporting periods.  The guidance is effective for interim and annual reporting periods ending after June 15, 2009 with early adoption permitted.  We adopted the guidance effective for the period ending March 31,

 

2009, and this guidance did not have a material effect on our consolidated financial statements.

On April 9, 2009, the FASB issued authoritative guidance which requires that the fair value of financial instruments be disclosed in an entity’s financial statements in both interim and annual periods.  The guidance also requires disclosure of methods and assumptions used to estimate fair values.  The guidance is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  We adopted the guidance for the quarter ended June 30, 2009, which did not have a material effect on our consolidated balance sheet or statement of operations.

In May 2008, the FASB issued authoritative guidance that specifies that issuers of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods.  The guidance is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years.  The guidance was applied retrospectively to all periods presented unless instruments were not outstanding during any period included in the financial statements.  In October 2009, the Company reissued its financial statements as December 31, 2008 and 2007, and for the three years ended December 31, 2008, to reflect the adoption of this authoritative guidance on a retrospective basis.  The adoption of the guidance affected the accounting for our 3.5% Convertible Debentures due September 30, 2035 (the “3.5% Debentures”).  Upon adoption of the guidance, the effective interest rate on our 3.5% Debentures increased to 7.4 percent, which resulted in the recognition of a $45 million discount to these notes with the offsetting after tax amount recorded to paid-in capital.  Such discount is amortized as interest expense over the remaining life of the 3.5% Debentures.

Amounts related to the 3.5% Debentures are reflected in our consolidated balance sheet at December 31, 2009, as follows (dollars in millions):

   
December 31,
 
   
2009
 
     
Increase to additional paid-in capital                                                              
 $28.0 
      
Par value of 3.5% Debentures                                                              
 $116.5 
Unamortized discount                                                              
  (3.3)
      
Carrying value of 3.5% Debentures                                                          
 $113.2 

 
Interest expense related to the 3.5% Debentures includes the following at December 31, 2009 and 2008 (dollars in millions):

   
2009
  
2008
 
        
Contractual interest expense                                                              
 $9.4  $11.3 
Amortization of discount                                                              
  9.4   9.5 
Amortization of debt issue costs                                                              
  1.1   1.3 
          
Total interest expense                                                          
 $19.9  $22.1 

 
In January 2009, the FASB issued authoritative guidance which amended certain impairment guidance by removing the exclusive reliance upon market participant assumptions about future cash flows when evaluating the impairment of certain securities.  The guidance permits the use of reasonable management judgment of the probability that the holder will be unable to collect all amounts due.  The guidance is effective prospectively for interim and annual reporting periods ending after December 15, 2008.  The Company adopted the guidance on December 31, 2008 and the adoption did not have a material effect on our consolidated financial statements.

In March 2008, the FASB issued authoritative guidance regarding whether unvested share based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are to be treated as participating securities prior to vesting and, therefore, must be included in the earnings allocation in calculating earnings per share under the two-class method.  The guidance is effective for financial statements issued for fiscal years beginning after December 15,

 

2008, and interim periods within those years and requires retrospective application.  Our adoption of the guidance did not have a material effect on our earnings per share calculations due to the immateriality of unvested restricted shares that are considered to be participating securities.

In March 2008, the FASB issued authoritative guidance which required enhanced disclosures about an entity’s derivative and hedging activities.  The guidance is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.  The adoption of the guidance did not have a material effect on our consolidated financial statements.

In December 2007, the FASB issued authoritative guidance which establishes new standards governing the accounting for and reporting of noncontrolling interests (previously referred to as minority interests).  The guidance establishes reporting requirements which include, among other things, that noncontrolling interests be reflected as a separate component of equity, not as a liability.  It also requires that the interests of the parent and the noncontrolling interest be clearly identifiable.  Additionally, increases and decreases in a parent’s ownership interest that leave control intact shall be reflected as equity transactions, rather than step acquisitions or dilution gains or losses.  The guidance is effective for fiscal years beginning on or after December 15, 2008.  The initial adoption of this guidance had no effect on our consolidated financial statements.

In December 2007, the FASB issued authoritative guidance which requires the acquiring entity in a business combination to recognize all assets acquired and liabilities assumed in a transaction at the acquisition date fair value, with certain exceptions.  Additionally, the guidance requires changes to the accounting treatment of acquisition related items, including, among other items, transaction costs, contingent consideration, restructuring costs, indemnification assets and tax benefits.  The guidance also provides for a substantial number of new disclosure requirements.  The guidance is effective for business combinations initiated on or after the first annual reporting period beginning after December 15, 2008.  We expect that the guidance will have an effect on our accounting for business combinations, if any, that are made in the future.  In addition, the guidance changes the previous requirement that reductions in a valuation allowance for deferred tax assets established in conjunction with the implementation of fresh-start accounting be recognized as a direct increase to additional paid-in capital.  Instead, the revised standard requires that any such reduction be reported as a decrease to income tax expense through the consolidated statement of operations.  Accordingly, any reductions to our valuation allowance for deferred tax assets will be reported as a decrease to income tax expense, after the effective date of the guidance.

In December 2008, the FASB issued authoritative guidance which required public entities to provide additional disclosures about transferors’ continuing involvements with transferred financial assets and to provide additional disclosures about their involvement with VIEs.  The guidance was effective for financial statements issued for fiscal years and interim periods ending after December 15, 2008.  We adopted the guidance on December 31, 2008 and it did not have a material effect on our consolidated financial statements.

In February 2007, the FASB issued authoritative guidance which allows entities to choose to measure many financial instruments and certain other items, including insurance contracts, at fair value (on an instrument-by-instrument basis) that are not currently required to be measured at fair value.  The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.  We adopted the guidance on January 1, 2008.  We did not elect the fair value option for any of our financial assets or liabilities.

In April 2007, FASB issued authoritative guidance which allows fair value amounts recognized for collateral to be offset against fair value amounts recognized for derivative instruments that are executed with the same counterparty under certain circumstances.  The guidance also requires an entity to disclose the accounting policy decision to offset, or not to offset, fair value amounts.  We do not, and have not previously, offset the fair value amounts recognized for derivatives with the amounts recognized as collateral.  All collateral is maintained in a tri-party custodial account.  At December 31, 2008, $11.4 million of derivative liabilities had been offset against derivative assets executed with the same counterparty under master netting arrangements.  There were no such derivative liabilities offset against derivative assets at December 31, 2010 or 2009. We adopted the guidance on January 1, 2008, and it did not have a material effect on our consolidated financial statements.

INVESTMENTS
INVESTMENTS

 
4.
INVESTMENTS

At December 31, 2010, the amortized cost and estimated fair value of fixed maturities, available for sale, and equity securities were as follows (dollars in millions):

      
Gross
  
Gross
  
Estimated
 
   
Amortized
  
unrealized
  
unrealized
  
fair
 
   
cost
  
gains
  
losses
  
value
 
Investment grade (a):
            
Corporate securities
 $12,605.5  $645.2  $(128.6) $13,122.1 
United States Treasury securities and obligations of United States government corporations and agencies
  300.3   5.7   (11.8)  294.2 
States and political subdivisions
  1,871.0   8.5   (99.2)  1,780.3 
Debt securities issued by foreign governments
  .8   .1   -   .9 
Asset-backed securities
  595.3   9.9   (5.1)  600.1 
Collateralized debt obligations
  238.7   3.4   (1.1)  241.0 
Commercial mortgage-backed securities
  1,292.8   76.4   (9.0)  1,360.2 
Mortgage pass-through securities
  29.5   1.8   -   31.3 
Collateralized mortgage obligations
  1,416.7   25.7   (30.1)  1,412.3 
                  
Total investment grade fixed maturities, available for sale
  18,350.6   776.7   (284.9)  18,842.4 
                  
Below-investment grade (a):
                
Corporate securities
  1,241.1   24.4   (40.4)  1,225.1 
States and political subdivisions
  4.7   -   (1.5)  3.2 
Asset-backed securities
  43.7   1.5   (1.2)  44.0 
Collateralized debt obligations
  14.3   1.2   -   15.5 
Commercial mortgage-backed securities
  7.0   -   (3.5)  3.5 
Collateralized mortgage obligations
  494.4   11.2   (5.4)  500.2 
                  
Total below-investment grade fixed maturities, available for sale
  1,805.2   38.3   (52.0)  1,791.5 
                  
Total fixed maturities, available for sale                                                                           
 $20,155.8  $815.0  $(336.9) $20,633.9 
                  
Equity securities                                                                               
 $68.2  $.8  $(.9) $68.1 
______________
 
(a)
Investment ratings – Investment ratings are assigned the second lowest rating by a nationally recognized statistical rating organization (Moody’s Investor Services, Inc. (“Moody’s”), S&P or Fitch Ratings (“Fitch”)), or if not rated by such firms, the rating assigned by the NAIC.  NAIC designations of “1” or “2” include fixed maturities generally rated investment grade (rated “Baa3” or higher by Moody’s or rated “BBB-” or higher by S&P and Fitch).  NAIC designations of “3” through “6” are referred to as below-investment grade (which generally are rated “Ba1” or lower by Moody’s or rated “BB+” or lower by S&P and Fitch).  References to investment grade or below investment grade throughout our consolidated financial statements are determined as described above.

 


At December 31, 2009, the amortized cost and estimated fair value of fixed maturities, available for sale, and equity securities were as follows (dollars in millions):

     
Gross
  
Gross
  
Estimated
 
  
Amortized
  
unrealized
  
unrealized
  
fair
 
  
cost
  
gains
  
losses
  
value
 
Investment grade:
            
Corporate securities
 $13,069.8  $371.9  $(315.4) $13,126.3 
United States Treasury securities and obligations of United States government corporations and agencies
  268.5   4.6   (3.5)  269.6 
States and political subdivisions
  924.2   3.0   (78.4)  848.8 
Debt securities issued by foreign governments
  4.8   .3   -   5.1 
Asset-backed securities
  154.1   1.7   (17.9)  137.9 
Collateralized debt obligations
  84.1   1.2   (.6)  84.7 
Commercial mortgage-backed securities
  867.7   6.2   (108.2)  765.7 
Mortgage pass-through securities
  41.1   1.6   (.1)  42.6 
Collateralized mortgage obligations
  1,801.4   4.2   (81.0)  1,724.6 
                  
Total investment grade fixed maturities, available for sale
  17,215.7   394.7   (605.1)  17,005.3 
                  
Below-investment grade:
                
Corporate securities
  1,275.4   5.8   (116.1)  1,165.1 
States and political subdivisions
  6.9   -   (2.1)  4.8 
Asset-backed securities
  90.9   -   (36.7)  54.2 
Collateralized debt obligations
  12.8   -   (4.7)  8.1 
Commercial mortgage-backed securities
  1.6   -   (1.3)  .3 
Collateralized mortgage obligations
  394.7   -   (104.1)  290.6 
                  
Total below-investment grade fixed maturities, available for sale
  1,782.3   5.8   (265.0)  1,523.1 
                  
Total fixed maturities, available for sale                                                                           
 $18,998.0  $400.5  $(870.1) $18,528.4 
                  
Equity securities                                                                               
 $30.7  $.8  $(.5) $31.0 


 


At December 31, 2010, the amortized cost, gross unrealized gains and losses, other-than-temporary impairments in accumulated other comprehensive income (loss) and estimated fair value of fixed maturities, available for sale, were as follows (dollars in millions):

               
Other-than-
               
temporary
               
impairments
               
included in
      
Gross
  
Gross
     
accumulated other
   
Amortized
  
unrealized
  
unrealized
  
Estimated
  
comprehensive
   
cost
  
gains
  
losses
  
fair value
  
income (loss)
                
Corporate securities
 $13,846.6  $669.6  $(169.0) $14,347.2  $- 
United States Treasury securities and obligations of United States government corporations and agencies
  300.3   5.7   (11.8)  294.2   - 
States and political subdivisions
  1,875.7   8.5   (100.7)  1,783.5   - 
Debt securities issued by foreign governments
  .8   .1   -   .9   - 
Asset-backed securities
  639.0   11.4   (6.3)  644.1   - 
Collateralized debt obligations
  253.0   4.6   (1.1)  256.5   - 
Commercial mortgage-backed securities
  1,299.8   76.4   (12.5)  1,363.7   (.1)
Mortgage pass-through securities
  29.5   1.8   -   31.3   - 
Collateralized mortgage obligations
  1,911.1   36.9   (35.5)  1,912.5   (23.3)
                      
Total fixed maturities, available for sale
 $20,155.8  $815.0  $(336.9) $20,633.9  $(23.4)

At December 31, 2009, the amortized cost, gross unrealized gains and losses, other-than-temporary impairments in other comprehensive loss and estimated fair value of fixed maturities, available for sale, were as follows (dollars in millions):

               
Other-than-
               
temporary
               
impairments
      
Gross
  
Gross
     
included in other
   
Amortized
  
unrealized
  
unrealized
  
Estimated
  
comprehensive
   
cost
  
gains
  
losses
  
fair value
  
loss
                
Corporate securities
 $14,345.2  $377.7  $(431.5) $14,291.4  $- 
United States Treasury securities and obligations of United States government corporations and agencies
  268.5   4.6   (3.5)  269.6   - 
States and political subdivisions
  931.1   3.0   (80.5)  853.6   - 
Debt securities issued by foreign governments
  4.8   .3   -   5.1   - 
Asset-backed securities
  245.0   1.7   (54.6)  192.1   (35.1)
Collateralized debt obligations
  96.9   1.2   (5.3)  92.8   - 
Commercial mortgage-backed securities
  869.3   6.2   (109.5)  766.0   (1.4)
Mortgage pass-through securities
  41.1   1.6   (.1)  42.6   - 
Collateralized mortgage obligations
  2,196.1   4.2   (185.1)  2,015.2   (132.4)
                      
Total fixed maturities, available for sale
 $18,998.0  $400.5  $(870.1) $18,528.4  $(168.9)


 


Accumulated other comprehensive income (loss) is primarily comprised of the net effect of unrealized appreciation (depreciation) on our investments.  These amounts, included in shareholders’ equity as of December 31, 2010 and 2009 were as follows (dollars in millions):

   
2010
  
2009
 
        
Net unrealized appreciation (depreciation) on fixed maturity securities, available for sale, on
which an other-than-temporary impairment loss has been recognized
 $(4.4) $(133.5)
Net unrealized gains (losses) on all other investments                                                                                                             
  476.5   (339.9)
Adjustment to the present value of future profits (a)                                                                                                             
  (17.6)  10.7 
Adjustment to deferred acquisition costs                                                                                                             
  (76.2)  59.8 
Unrecognized net loss related to deferred compensation plan                                                                                                             
  (7.7)  (8.2)
Deferred income tax asset (liability)                                                                                                             
  (132.3)  146.8 
          
Accumulated other comprehensive income (loss)                                                                                                     
 $238.3  $(264.3)
_________
(a)  
The present value of future profits is the value assigned to the right to receive future cash flows from contracts existing at September 10, 2003 (the date our Predecessor emerged from bankruptcy).

 


Concentration of Fixed Maturity Securities, Available for Sale

The following table summarizes the carrying values and gross unrealized losses of our fixed maturity securities, available for sale, by category as of December 31, 2010 (dollars in millions):

            
Percent of
 
         
Gross
  
gross
 
      
Percent of
  
unrealized
  
unrealized
 
   
Carrying value
  
fixed maturities
  
losses
  
losses
 
              
Energy/pipelines                                                         
 $2,001.1   9.7% $14.3   4.2%
Collateralized mortgage obligations
  1,912.5   9.3   35.5   10.5 
Utilities                                                         
  1,826.6   8.9   5.7   1.7 
States and political subdivisions                                                         
  1,783.5   8.6   100.7   29.9 
Commercial mortgage-backed securities
  1,363.7   6.6   12.5   3.7 
Insurance                                                         
  1,227.1   5.9   19.7   5.8 
Food/beverage                                                         
  1,085.2   5.3   9.8   2.9 
Healthcare/pharmaceuticals                                                         
  907.4   4.4   5.7   1.7 
Banks                                                         
  869.1   4.2   44.1   13.1 
Cable/media                                                         
  794.0   3.9   11.5   3.4 
Real estate/REITs                                                         
  760.0   3.7   6.1   1.8 
Asset-backed securities                                                         
  644.1   3.1   6.3   1.9 
Transportation                                                         
  544.6   2.6   3.2   1.0 
Capital goods                                                         
  495.6   2.4   4.0   1.2 
Building materials                                                         
  439.8   2.1   12.4   3.7 
Telecom                                                         
  423.1   2.1   9.1   2.7 
Aerospace/defense                                                         
  349.2   1.7   1.2   .4 
Metals and mining                                                         
  333.5   1.6   2.1   .6 
Chemicals                                                         
  309.5   1.5   2.2   .6 
U.S. Treasury and Obligations                                                         
  294.2   1.4   11.8   3.5 
Paper                                                         
  272.2   1.3   4.8   1.4 
Collateralized debt obligations                                                         
  256.5   1.2   1.1   .3 
Brokerage                                                         
  238.1   1.2   3.0   .9 
Consumer products                                                         
  229.4   1.1   5.0   1.5 
Entertainment/hotels                                                         
  218.5   1.1   .9   .3 
Other                                                         
  1,055.4   5.1   4.2   1.3 
                  
Total fixed maturities, available for sale
 $20,633.9   100.0% $336.9   100.0%

Below-Investment Grade Securities

At December 31, 2010, the amortized cost of the Company’s below-investment grade fixed maturity securities was $1,805.2 million, or 9.0 percent of the Company’s fixed maturity portfolio.  The estimated fair value of the below-investment grade portfolio was $1,791.5 million, or 99 percent of the amortized cost.

Below-investment grade corporate debt securities have different characteristics than investment grade corporate debt securities.  Based on historical performance, probability of default by the borrower is significantly greater for below-investment grade corporate debt securities and in many cases severity of loss is relatively greater as such securities are generally unsecured and often subordinated to other indebtedness of the issuer.  Also, issuers of below-investment grade corporate debt securities frequently have higher levels of debt relative to investment-grade issuers, hence, all other things being equal, are generally more sensitive to adverse economic conditions.  The Company attempts to reduce the overall risk related to its investment in below-investment grade securities, as in all investments, through careful credit analysis, strict investment policy guidelines, and diversification by issuer and/or guarantor and by industry.

 


Contractual Maturity

The following table sets forth the amortized cost and estimated fair value of fixed maturities, available for sale, at December 31, 2010, by contractual maturity.  Actual maturities will differ from contractual maturities because certain borrowers may have the right to call or prepay obligations with or without penalties.  In addition, structured securities (such as asset-backed securities, collateralized debt obligations, commercial mortgage-backed securities, mortgage pass-through securities and collateralized mortgage obligations, collectively referred to as “structured securities”) frequently permit periodic unscheduled payments throughout their lives (dollars in millions):

      
Estimated
 
   
Amortized
  
fair
 
   
cost
  
value
 
        
Due in one year or less                                                               
 $146.4  $146.0 
Due after one year through five years                                                               
  1,146.0   1,202.8 
Due after five years through ten years                                                               
  3,981.4   4,195.0 
Due after ten years                                                               
  10,749.6   10,882.0 
          
Subtotal                                                           
  16,023.4   16,425.8 
          
Structured securities                                                               
  4,132.4   4,208.1 
          
Total fixed maturities, available for sale
 $20,155.8  $20,633.9 

Net Investment Income

Net investment income consisted of the following (dollars in millions):

   
2010
  
2009
  
2008
 
           
Fixed maturities                                                                           
 $1,162.6  $1,083.7  $1,094.4 
Trading income related to policyholder and reinsurer accounts and other special-purpose portfolios
  43.7   11.1   28.6 
Equity securities                                                                           
  .8   1.5   1.4 
Mortgage loans                                                                           
  121.7   130.8   126.1 
Policy loans                                                                           
  18.2   21.2   23.6 
Options related to fixed index products:
            
Option income (loss)                                                                        
  57.3   (63.0)  (71.9)
Change in value of options                                                                        
  (29.1)  113.7   (32.4)
Other invested assets                                                                           
  9.1   10.0   13.8 
Cash and cash equivalents                                                                           
  .5   1.1   11.9 
              
Gross investment income                                                                       
  1,384.8   1,310.1   1,195.5 
Less investment expenses                                                                           
  17.9   17.4   16.7 
              
Net investment income                                                                       
 $1,366.9  $1,292.7  $1,178.8 

The estimated fair value of fixed maturity investments and mortgage loans not accruing investment income totaled $7.9 million and $39.8 million at December 31, 2010 and 2009, respectively.

 

Net Realized Investment Gains (Losses)

The following table sets forth the net realized investment gains (losses) for the periods indicated (dollars in millions):

   
2010
  
2009
  
2008
 
           
Fixed maturity securities, available for sale:
         
Realized gains on sale                                                                                     
 $347.1  $367.9  $110.3 
Realized losses on sale                                                                                     
  (147.7)  (233.9)  (177.3)
Impairments:
            
Total other-than-temporary impairment losses                                                                                   
  (94.8)  (337.8)  (152.7)
Other-than-temporary impairment losses recognized in other comprehensive loss 
  (4.7)   188.3    - 
              
Net impairment losses recognized                                                                               
  (99.5)  (149.5)  (152.7)
              
Net realized investment gains (losses) from fixed maturities
  99.9   (15.5)  (219.7)
              
Equity securities                                                                                         
  .1   -   - 
Commercial mortgage loans                                                                                         
  (16.9)  (13.5)  (19.7)
Impairments of mortgage loans and other investments
  (50.3)  (45.9)  (9.6)
Other                                                                                         
  (2.6)  14.4   (13.4)
              
Net realized investment gains (losses)                                                                               
 $30.2  $(60.5) $(262.4)

During 2010, we recognized net realized investment gains of $30.2 million, which were comprised of $180.0 million of net gains from the sales of investments (primarily fixed maturities) with proceeds of $8.6 billion and $149.8 million of writedowns of investments for other than temporary declines in fair value recognized through net income ($146.8 million, prior to the $(3.0) million of impairment losses recognized through accumulated other comprehensive income (loss)).

During 2009, we recognized net realized investment losses of $60.5 million, which were comprised of $134.9 million of net gains from the sales of investments (primarily fixed maturities) with proceeds of $10.7 billion and $195.4 million of writedowns of investments for other than temporary declines in fair value recognized through net income ($385.0 million, prior to the $189.6 million of impairment losses recognized through other comprehensive loss).

During 2008, we recognized net realized investment losses of $262.4 million, which were comprised of:  (i) $100.1 million of net losses from the sales of investments (primarily fixed maturities); and (ii) $162.3 million of writedowns of investments for other than temporary declines in fair value (no single investment accounted for more than $10 million of such writedowns).

At December 31, 2010, fixed maturity securities in default or considered nonperforming had both an aggregate amortized cost and carrying value of $.6 million.  

During 2010, we recorded an impairment charge of $70.6 million on an investment made by our Predecessor in a guaranteed investment contract issued by a Bermuda insurance company.  We recently decided to pursue the early commutation of this investment in exchange for interests in certain underlying invested assets held by the insurance company.  Current information related to these underlying invested assets obtained in late December 2010 and early 2011 resulted in the recognition of the impairment charge.  The guaranteed investment contract matures in December 2029 and had a projected future yield of 1.33% (the guaranteed minimum rate) immediately prior to the impairment charge.  The estimated fair value of our investment in the guaranteed investment contract was $213 million at December 31, 2010.  Also during 2010, other-than-temporary impairments recorded in earnings included:  (i) $23.6 million of losses related to mortgage-backed and asset-backed securities, primarily reflecting changes related to the estimated future cash flows of the underlying assets and, for certain securities, changes in our intent to hold the securities; (ii) $40.8 million of losses related to commercial mortgage loans reflecting our concerns regarding the issuers’ ability to continue to make contractual payments related to these loans and our estimate of the value of the underlying properties; (iii) $1.6 million related to a home office building which is available for sale; and (iv) $13.2 million of additional losses primarily related to various corporate securities and other invested assets following unforeseen issue-specific events or conditions.

 


During 2010, the $147.7 million of realized losses on sales of $1.4 billion of fixed maturity securities, available for sale, included:  (i) $125.4 million of losses related to the sales of mortgage-backed securities and asset-backed securities; and (ii) $22.3 million of additional losses primarily related to various corporate securities.  Securities are generally sold at a loss following unforeseen issue-specific events or conditions or shifts in perceived risks.  These reasons include but are not limited to:  (i) changes in the investment environment; (ii) expectation that the fair value could deteriorate further; (iii) desire to reduce our exposure to an asset class, an issuer or an industry; (iv) changes in credit quality; or (v) changes in expected liability cash flows.

During 2009, the $195.4 million of other-than-temporary impairments we recorded in earnings included:  (i) $83.6 million of losses related to mortgage-backed and asset-backed securities, primarily reflecting changes related to the performance of the underlying assets and, for certain securities, changes in our intent regarding continuing to hold the securities; (ii) $40.9 million of losses related to commercial mortgage loans reflecting our concerns regarding the issuers’ ability to continue to make contractual payments related to these loans and our estimate of the value of the underlying properties; (iii) $13.8 million of losses related to securities issued by a large commercial lender that recently filed bankruptcy; and (iv) $57.1 million of additional losses primarily related to various corporate securities following unforeseen issue-specific events or conditions and shifts in risks or uncertainty of the issuer.

During 2009, the $233.9 million of realized losses on sales of $1.3 billion of fixed maturity securities, available for sale, included:  (i) $178.3 million of losses related to the sales of mortgage-backed securities and asset-backed securities; (ii) $11.3 million of losses related to the sale of securities issued by providers of financial guarantees and mortgage insurance; and (iii) $44.3 million of additional losses primarily related to various corporate securities.

Our fixed maturity investments are generally purchased in the context of a long-term strategy to fund insurance liabilities, so we do not generally seek to purchase and sell such securities to generate short-term realized gains.  In certain circumstances, including those in which securities are selling at prices which exceed our view of their underlying economic value, or when it is possible to reinvest the proceeds to better meet our long-term asset-liability matching objectives, we may sell certain securities.

The following summarizes the investments (including investments held by the VIEs) sold at a loss during 2010 which had been continuously in an unrealized loss position exceeding 20 percent of the amortized cost basis prior to the sale for the period indicated (dollars in millions):

   
At date of sale
 
   
Number of
  
Amortized
 
Fair
 
Period
 
issuers
  
cost
 
value
 
          
Less than 6 months prior to sale                                                               
  10  $56.9  $44.0 
Greater than or equal to 6 and less than 12 months prior to sale
  2   1.2   .8 
Greater than 12 months                                                               
  43   259.8   174.4 
              
    55  $317.9  $219.2 

During the first quarter of 2009, we adopted newly issued authoritative guidance, which changes the recognition and presentation of other-than-temporary impairments.  Refer to the note to the consolidated financial statements entitled “Summary of Significant Accounting Policies - Adopted Accounting Standards” for additional information.  The recognition provisions within this guidance apply only to our fixed maturity investments.

We regularly evaluate our investments for possible impairment.  Our assessment of whether unrealized losses are “other than temporary” requires significant judgment.  Factors considered include:  (i) the extent to which fair value is less than the cost basis; (ii) the length of time that the fair value has been less than cost; (iii) whether the unrealized loss is event driven, credit-driven or a result of changes in market interest rates or risk premium; (iv) the near-term prospects for specific events, developments or circumstances likely to affect the value of the investment; (v) the investment’s rating and whether the investment is investment-grade and/or has been downgraded since its purchase; (vi) whether the issuer is current on all payments in accordance with the contractual terms of the investment and is expected to meet all of its obligations under the terms of the investment; (vii) whether we intend to sell the investment or it is more likely than not that circumstances will

 

require us to sell the investment before recovery occurs; (viii) the underlying current and prospective asset and enterprise values of the issuer and the extent to which the recoverability of the carrying value of our investment may be affected by changes in such values; (ix) projections of, and unfavorable changes in, cash flows on structured securities including mortgage-backed and asset-backed securities; and (x) other objective and subjective factors.

Future events may occur, or additional information may become available, which may necessitate future realized losses of securities in our portfolio.  Significant losses in the estimated fair values of our investments could have a material adverse effect on our earnings in future periods.

Impairment losses on equity securities are recognized in net income.  The manner in which impairment losses on fixed maturity securities, available for sale, are recognized in the financial statements is dependent on the facts and circumstances related to the specific security.  If we intend to sell a security or it is more likely than not that we would be required to sell a security before the recovery of its amortized cost, the security is other-than-temporarily impaired and the full amount of the impairment is recognized as a loss through earnings.  If we do not expect to recover the amortized cost basis, we do not plan to sell the security, and if it is not more likely than not that we would be required to sell a security before the recovery of its amortized cost, less any current period credit loss, the recognition of the other-than-temporary impairment is bifurcated.  We recognize the credit loss portion in net income and the noncredit loss portion in accumulated other comprehensive income (loss).  Prior to 2009, such other-than-temporary impairments were recognized in their entirety through earnings and the amount recognized was the difference between amortized cost and estimated fair value.

We estimate the amount of the credit loss component of a fixed maturity security impairment as the difference between amortized cost and the present value of the expected cash flows of the security.  The present value is determined using the best estimate of future cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security.  The methodology and assumptions for establishing the best estimate of future cash flows vary depending on the type of security.

For most structured securities, cash flow estimates are based on bond specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity, prepayment speeds and structural support, including excess spread, subordination and guarantees.  For corporate bonds, cash flow estimates are derived from scenario-based outcomes of expected corporate restructurings or the disposition of assets using bond specific facts and circumstances including timing, secured interest and loss severity.  The previous amortized cost basis less the impairment recognized in net income becomes the security’s new cost basis.  We accrete the new cost basis to the estimated future cash flows over the expected remaining life of the security.

The remaining non-credit impairment, which is recorded in accumulated other comprehensive income (loss), is the difference between the security’s estimated fair value and our best estimate of future cash flows discounted at the effective interest rate prior to impairment.  The remaining non-credit impairment typically represents changes in the market interest rates, current market liquidity and risk premiums.  As of December 31, 2010, other-than-temporary impairments included in accumulated other comprehensive income (loss) of $23.4 million (before taxes and related amortization) relate to structured securities.

Mortgage loans are impaired when it is probable that we will not collect the contractual principal and interest on the loan. We measure impairment based upon the difference between the carrying value of the loan and the estimated fair value of the collateral securing the loan less cost to sell.

 


The following table summarizes the amount of credit losses recognized in earnings on fixed maturity securities, available for sale, held at the beginning of the period, for which a portion of the other-than-temporary impairment was also recognized in accumulated other comprehensive income (loss) for the years ended December 31, 2010 and 2009 (dollars in millions):

   
Year ended
 
   
December 31,
 
   
2010
  
2009
 
        
Credit losses on fixed maturity securities, available for sale, beginning of year
 $(27.2) $(.6)
Add:  credit losses on other-than-temporary impairments not previously recognized
  (1.7)  (20.7)
Less:  credit losses on securities sold
  33.3   5.4 
Less:  credit losses on securities impaired due to intent to sell (a)
  1.9   - 
Add:  credit losses on previously impaired securities
  (12.4)  (11.3)
Less:  increases in cash flows expected on previously impaired securities
   -   - 
          
Credit losses on fixed maturity securities, available for sale, end of year
 $(6.1) $(27.2)
__________
(a)  
Represents securities for which the amount previously recognized in accumulated other comprehensive income (loss) was recognized in earnings because we intend to sell the security or we more likely than not will be required to sell the security before recovery of its amortized cost basis.

Investments with Unrealized Losses

The following table sets forth the amortized cost and estimated fair value of those fixed maturities, available for sale, with unrealized losses at December 31, 2010, by contractual maturity.  Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.  Structured securities frequently permit periodic unscheduled payments throughout their lives (dollars in millions):

      
Estimated
 
   
Amortized
  
fair
 
   
cost
  
value
 
        
Due in one year or less                                                                             
 $18.0  $16.4 
Due after one year through five years                                                                             
  204.5   200.2 
Due after five years through ten years                                                                             
  663.7   634.9 
Due after ten years                                                                             
  4,521.5   4,274.7 
          
Subtotal                                                                       
  5,407.7   5,126.2 
          
Structured securities                                                                             
  1,409.3   1,353.9 
          
Total                                                                       
 $6,817.0  $6,480.1 


 


The following summarizes the investments in our portfolio rated below-investment grade which have been continuously in an unrealized loss position exceeding 20 percent of the cost basis for the period indicated as of December 31, 2010 (dollars in millions):

   
Number
  
Cost
  
Unrealized
  
Estimated
 
Period
 
of issuers
  
basis
  
loss
  
fair value
 
              
Less than 6 months                                             
  7  $38.2  $(9.7) $28.5 
Greater than or equal to 6 months and less than 12 months
  1   .4   (.1)  .3 
Greater than 12 months                                             
  4   11.9   (5.0)  6.9 
                  
    12  $50.5  $(14.8) $35.7 

The following table summarizes the gross unrealized losses of our fixed maturity securities, available for sale, by category and ratings category as of December 31, 2010 (dollars in millions):

         
Below investment grade
  
Total gross
 
   
Investment grade
     
B+ and
  
unrealized
 
   
AAA/AA/A
  
BBB
  
BB
  
below
  
losses
 
                 
States and political subdivisions                                                    
 $68.1  $31.1  $1.5  $-  $100.7 
Banks                                                    
  20.3   19.6   4.2   -   44.1 
Collateralized mortgage obligations
  29.5   .6   -   5.4   35.5 
Insurance                                                    
  4.9   11.9   1.0   1.9   19.7 
Energy/pipelines                                                    
  .2   13.9   .1   .1   14.3 
Commercial mortgage-backed securities
  4.2   4.8   3.5   -   12.5 
Building materials                                                    
  -   8.9   3.1   .4   12.4 
U.S. Treasury and Obligations                                                    
  11.8   -   -   -   11.8 
Cable/media                                                    
  -   2.0   3.5   6.0   11.5 
Food/beverage                                                    
  .3   9.0   -   .5   9.8 
Telecom                                                    
  4.3   3.3   1.5   -   9.1 
Asset-backed securities                                                    
  3.0   2.1   .1   1.1   6.3 
Real estate/REITs                                                    
  .1   1.2   3.2   1.6   6.1 
Utilities                                                    
  2.4   2.2   -   1.1   5.7 
Healthcare/pharmaceuticals                                                    
  1.2   4.1   .3   .1   5.7 
Consumer products                                                    
  -   2.4   2.3   .3   5.0 
Paper                                                    
  -   1.3   3.5   -   4.8 
Capital goods                                                    
  .2   .9   2.9   -   4.0 
Transportation                                                    
  .7   1.3   1.2   -   3.2 
Brokerage                                                    
  1.9   1.1   -   -   3.0 
Chemicals                                                    
  -   2.2   -   -   2.2 
Metals and mining                                                    
  -   2.1   -   -   2.1 
Aerospace/defense                                                    
  1.0   .2   -   -   1.2 
Collateralized debt obligations                                                    
  1.1   -   -   -   1.1 
Technology                                                    
  -   .8   .1   .1   1.0 
Entertainment/hotels                                                    
  -   .9   -   -   .9 
Gaming                                                    
  -   -   -   .7   .7 
Textiles                                                    
  -   -   -   .3   .3 
Retail                                                    
  .2   -   -   -   .2 
Other                                                    
  -   1.6   -   .4   2.0 
                      
Total fixed maturities, available for sale
 $155.4  $129.5  $32.0  $20.0  $336.9 


 

    Our investment strategy is to maximize, over a sustained period and within acceptable parameters of quality and risk, investment income and total investment return through active investment management.  Accordingly, we may sell securities at a gain or a loss to enhance the projected total return of the portfolio as market opportunities change, to reflect changing perceptions of risk, or to better match certain characteristics of our investment portfolio with the corresponding characteristics of our insurance liabilities.  While we do not have the intent to sell securities with unrealized losses and it is not more likely than not that we will be required to sell securities with unrealized losses prior to their anticipated recovery, we may sell securities at a loss in the future because of actual or expected changes in our view of the particular investment, its industry, its type or the general investment environment.  If a loss is recognized from a sale subsequent to a balance sheet date due to these unexpected developments, the loss is recognized in the period in which we had the intent to sell the securities before their anticipated recovery.

The following table summarizes the gross unrealized losses and fair values of our investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that such securities have been in a continuous unrealized loss position, at December 31, 2010 (dollars in millions):

   
Less than 12 months
  
12 months or greater
  
Total
 
   
Fair
  
Unrealized
  
Fair
  
Unrealized
  
Fair
  
Unrealized
 
Description of securities
 
value
  
losses
  
value
  
losses
  
value
  
losses
 
                    
United States Treasury securities and obligations of United States government corporations and agencies
 $196.9  $(11.8) $.2  $-  $197.1  $(11.8)
States and political subdivisions
  1,201.9   (54.8)  229.6   (45.9)  1,431.5   (100.7)
Corporate securities                                           
  2,633.0   (80.6)  864.6   (88.4)  3,497.6   (169.0)
Asset-backed securities                                           
  272.2   (2.4)  54.0   (3.9)  326.2   (6.3)
Collateralized debt obligations
  117.0   (.9)  5.8   (.2)  122.8   (1.1)
Commercial mortgage-backed securities
  15.5   -   111.8   (12.5)  127.3   (12.5)
Mortgage pass-through securities
  .3   -   3.4   -   3.7   - 
Collateralized mortgage obligations
   661.0   (29.1)  112.9   (6.4)  773.9   (35.5)
                          
Total fixed maturities, available for sale
 $5,097.8  $(179.6) $1,382.3  $(157.3) $6,480.1  $(336.9)


 


The following table summarizes the gross unrealized losses and fair values of our investments with unrealized losses that were not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that such securities had been in a continuous unrealized loss position, at December 31, 2009 (dollars in millions):

   
Less than 12 months
  
12 months or greater
  
Total
 
   
Fair
  
Unrealized
  
Fair
  
Unrealized
  
Fair
  
Unrealized
 
Description of securities
 
value
  
losses
  
value
  
losses
  
value
  
losses
 
                    
United States Treasury securities and obligations of United States government corporations and agencies
 $157.6  $(3.5) $-  $-  $157.6  $(3.5)
States and political subdivisions
  375.1   (18.0)  291.5   (62.5)  666.6   (80.5)
Corporate securities                                             
  3,707.1   (109.0)  2,919.5   (322.5)  6,626.6   (431.5)
Asset-backed securities                                      
  7.2   (.3)  133.1   (54.3)  140.3   (54.6)
Collateralized debt obligations
  34.5   (.6)  5.7   (4.7)  40.2   (5.3)
Commercial mortgage-backed securities
  211.5   (4.3)  250.8   (105.2)  462.3   (109.5)
Mortgage pass-through securities
  -   -   4.2   (.1)  4.2   (.1)
Collateralized mortgage obligations
  1,301.3   (41.6)  460.3   (143.5)  1,761.6   (185.1)
                          
Total fixed maturities, available for sale
 $5,794.3  $(177.3) $4,065.1  $(692.8) $9,859.4  $(870.1)

Based on management’s current assessment of investments with unrealized losses at December 31, 2010, the Company believes the issuers of the securities will continue to meet their obligations (or with respect to equity-type securities, the investment value will recover to its cost basis).  While we do not have the intent to sell securities with unrealized losses and it is not more likely than not that we will be required to sell securities with unrealized losses prior to their anticipated recovery, our intent on an individual security may change, based upon market or other unforeseen developments.  In such instances, if a loss is recognized from a sale subsequent to a balance sheet date due to these unexpected developments, the loss is recognized in the period in which we had the intent to sell the securities before their anticipated recovery.

Structured Securities

At December 31, 2010, fixed maturity investments included structured securities with an estimated fair value of $4.2 billion (or 20 percent of all fixed maturity securities).  The yield characteristics of structured securities differ in some respects from those of traditional fixed-income securities.  For example, interest and principal payments on structured securities may occur more frequently, often monthly.  In many instances, we are subject to the risk that the amount and timing of principal and interest payments may vary from expectations.  For example, in many cases, partial prepayments may occur at the option of the issuer and prepayment rates are influenced by a number of factors that cannot be predicted with certainty, including:  the relative sensitivity of the underlying assets backing the security to changes in interest rates; a variety of economic, geographic and other factors; the timing and pace of liquidations of defaulted collateral; the amount of loan maturities; and various security-specific structural considerations (for example, the repayment priority of a given security in a securitization structure).  In addition, the total amount of payments for non-government structured securities may be affected by changes to cumulative default rates or loss severities of the related collateral.

In general, the rate of prepayments on structured securities increases when prevailing interest rates decline significantly in absolute terms and also relative to the interest rates on the underlying assets.  The yields recognized on structured securities purchased at a discount to par will increase (relative to the stated rate) when the underlying assets prepay faster than expected.  The yields recognized on structured securities purchased at a premium will decrease (relative to the stated rate) when the underlying assets prepay faster than expected.  When interest rates decline, the proceeds from prepayments may be reinvested at lower rates than we were earning on the prepaid securities.  When interest rates increase, prepayments may decrease.  When this occurs, the average maturity and duration of the structured securities increase, which decreases the yield on structured securities purchased at a discount because the discount is realized as income at a slower rate,

 

and it increases the yield on those purchased at a premium because of a decrease in the annual amortization of the premium.

For structured securities included in fixed maturities, available for sale, that were purchased at a discount or premium, we recognize investment income using an effective yield based on anticipated future prepayments and the estimated final maturity of the securities.  Actual prepayment experience is periodically reviewed and effective yields are recalculated when differences arise between the prepayments originally anticipated and the actual prepayments received and currently anticipated.  For credit sensitive mortgage-backed and asset-backed securities, and for securities that can be prepaid or settled in a way that we would not recover substantially all of our investment, the effective yield is recalculated on a prospective basis.  Under this method, the amortized cost basis in the security is not immediately adjusted and a new yield is applied prospectively.  For all other structured and asset-backed securities, the effective yield is recalculated when changes in assumptions are made, and reflected in our income on a retrospective basis.  Under this method, the amortized cost basis of the investment in the securities is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the securities.  Such adjustments were not significant in 2010.

The following table sets forth the par value, amortized cost and estimated fair value of structured securities, summarized by interest rates on the underlying collateral, at December 31, 2010 (dollars in millions):

   
Par
  
Amortized
  
Estimated
 
   
value
  
cost
  
fair value
 
           
Below 4 percent                                                        
 $370.0  $328.0  $331.8 
4 percent – 5 percent                                                        
  516.5   506.2   484.0 
5 percent – 6 percent                                                        
  2,364.2   2,289.4   2,359.2 
6 percent – 7 percent                                                        
  891.6   841.0   865.4 
7 percent – 8 percent                                                        
  83.3   84.5   85.0 
8 percent and above                                                        
  84.9   83.3   82.7 
              
Total structured securities                                                     
 $4,310.5  $4,132.4  $4,208.1 

The amortized cost and estimated fair value of structured securities at December 31, 2010, summarized by type of security, were as follows (dollars in millions):

      
Estimated fair value
 
         
Percent
 
   
Amortized
     
of fixed
 
Type
 
cost
  
Amount
  
maturities
 
           
Pass-throughs, sequential and equivalent securities
 $1,347.9  $1,354.0   6.6%
Planned amortization classes, target amortization classes and accretion-directed bonds
  568.9   565.4   2.7 
Commercial mortgage-backed securities                                                                 
  1,299.8   1,363.7   6.6 
Asset-backed securities                                                                 
  639.0   644.1   3.1 
Collateralized debt obligations                                                                 
  253.0   256.5   1.2 
Other                                                                 
  23.8   24.4   .2 
              
Total structured securities                                                                 
 $4,132.4  $4,208.1   20.4%

Pass-throughs, sequentials and equivalent securities have unique prepayment variability characteristics.  Pass-through securities typically return principal to the holders based on cash payments from the underlying mortgage obligations.  Sequential securities return principal to tranche holders in a detailed hierarchy.  Planned amortization classes, targeted amortization classes and accretion-directed bonds adhere to fixed schedules of principal payments as long as the underlying mortgage loans experience prepayments within certain estimated ranges.  In most circumstances, changes in prepayment rates are first absorbed by support or companion classes insulating the timing of receipt of cash flows from the consequences of both faster prepayments (average life shortening) and slower prepayments (average life extension).


 

Commercial mortgage-backed securities are secured by commercial real estate mortgages, generally income producing properties that are managed for profit.  Property types include multi-family dwellings including apartments, retail centers, hotels, restaurants, hospitals, nursing homes, warehouses, and office buildings.  Most commercial mortgage-backed securities have call protection features whereby underlying borrowers may not prepay their mortgages for stated periods of time without incurring prepayment penalties.

Commercial Mortgage Loans

At December 31, 2010, the mortgage loan balance was primarily comprised of commercial loans.  Approximately 7 percent, 7 percent, 6 percent, 6 percent, 5 percent and 5 percent of the mortgage loan balance were on properties located in Minnesota, California, Arizona, Florida, North Carolina and Indiana, respectively.  No other state comprised greater than five percent of the mortgage loan balance.  None of the commercial mortgage loan balance was noncurrent at December 31, 2010.  We had no allowance for losses on mortgage loans at both December 31, 2010 and 2009.

The following table provides the weighted average loan-to-value ratio for our outstanding mortgage loans as of December 31, 2010 (dollars in millions):

        
      
Estimated fair
 
Loan-to-value ratio (a)
 
Carrying value
  
value
 
        
Less than 60%                                                                             
 $705.9  $752.5 
60% to 70%                                                                             
  657.2   630.7 
70% to 80%                                                                             
  296.5   286.5 
80% to 90%                                                                             
  46.3   43.9 
Greater than 90%                                                                             
  55.3   49.0 
          
Total                                                                       
 $1,761.2  $1,762.6 
__________
(a)  
Loan-to-value ratios are calculated as the ratio of:  (i) the carrying value of the commercial mortgage loans; to (ii) the estimated fair value of the underlying commercial property.

Securities Lending

The Company participated in a securities lending program whereby certain fixed maturity securities from our investment portfolio were loaned to third parties via a lending agent for a short period of time.  We maintain ownership of the loaned securities.  We required collateral equal to 102 percent of the fair value of the loaned securities.  The collateral was invested by the lending agent in accordance with our guidelines.  The fair value of the loaned securities was monitored on a daily basis with additional collateral obtained as necessary.  In the third quarter of 2010, the Company discontinued its securities lending program.  As of December 31, 2009, the fair value of the loaned securities was $178.5 million.  As of December 31, 2009, the Company had received collateral of $185.7 million.  Income generated from the program, net of expenses is recorded as net investment income and totaled $.2 million, $1.2 million and $2.4 million in 2010, 2009 and 2008, respectively.

Other Investment Disclosures

Life insurance companies are required to maintain certain investments on deposit with state regulatory authorities.  Such assets had aggregate carrying values of $77.7 million and $83.3 million at December 31, 2010 and 2009, respectively.

CNO had no fixed maturity investments that were in excess of 10 percent of shareholders’ equity at December 31, 2010 and 2009 (other than investments issued or guaranteed by the United States government or a United States government agency).

LIABILITIES FOR INSURANCE PRODUCTS
Liability for Insurance Products

5.       LIABILITIES FOR INSURANCE PRODUCTS

These liabilities consisted of the following (dollars in millions):

         
Interest
       
   
Withdrawal
  
Mortality
  
rate
       
   
assumption
  
assumption
  
assumption
  
2010
  
2009
 
                 
Future policy benefits:
               
Interest-sensitive products:
               
Investment contracts                                                    
  N/A   N/A  
(c)
  $9,742.9  $9,676.1 
Universal life contracts                                                    
  N/A   N/A   N/A   3,451.8   3,543.1 
                      
Total interest-sensitive products
              13,194.7   13,219.2 
                      
Traditional products:
                    
Traditional life insurance contracts
 
Company experience
  
(a)
   5%   2,354.3   2,325.4 
                      
Limited-payment annuities                                                    
 
Company experience, if applicable
  
(b)
   4%   873.4   892.8 
                      
Individual and group accident and health
 
Company experience
  
Company
experience
   6%   7,079.9   6,845.3 
                      
Total traditional products                                                
              10,307.6   10,063.5 
                      
Claims payable and other policyholder funds
  N/A   N/A   N/A   968.7   994.0 
Liabilities related to separate accounts
  N/A   N/A   N/A   17.5   17.3 
                      
Total                                                     
             $24,488.5  $24,294.0 
____________________
 
(a)
Principally, modifications of the 1965 - 70 and 1975 - 80 Basic, Select and Ultimate Tables.
 
(b)
Principally, the 1984 United States Population Table and the NAIC 1983 Individual Annuitant Mortality Table.
 
(c)
In 2010 and 2009, all of this liability represented account balances where future benefits are not guaranteed.

The Company establishes reserves for insurance policy benefits based on assumptions as to investment yields, mortality, morbidity, withdrawals, lapses and maintenance expenses.  These reserves include amounts for estimated future payment of claims based on actuarial assumptions.  The balance is based on the Company’s best estimate of the future policyholder benefits to be incurred on this business, given recent and expected future changes in experience.

 


Changes in the unpaid claims reserve (included in claims payable) and disabled life reserves related to accident and health insurance (included in individual and group accident and health liabilities) were as follows (dollars in millions):

   
2010
  
2009
  
2008
 
           
Balance, beginning of the year                                                                        
 $1,444.0  $1,341.3  $1,247.7 
              
Incurred claims (net of reinsurance) related to:
            
Current year                                                                      
  1,505.8   1,616.8   1,729.3 
Prior years (a)                                                                      
  (15.6)  (32.3)  (25.9)
              
Total incurred                                                                  
  1,490.2   1,584.5   1,703.4 
              
Interest on claim reserves                                                                        
  73.4   69.3   61.4 
              
Paid claims (net of reinsurance) related to:
            
Current year                                                                      
  827.0   910.7   1,001.1 
Prior years                                                                      
  694.1   691.6   609.5 
              
Total paid                                                                  
  1,521.1   1,602.3   1,610.6 
              
Net change in balance for reinsurance assumed and ceded
  57.2   51.2   (60.6)
              
Balance, end of the year                                                                        
 $1,543.7  $1,444.0  $1,341.3 
___________
 
(a)
The reserves and liabilities we establish are necessarily based on estimates, assumptions and prior years’ statistics.  Such amounts will fluctuate based upon the estimation procedures used to determine the amount of unpaid losses.  It is possible that actual claims will exceed our reserves and have a material adverse effect on our results of operations and financial condition.

INCOME TAXES
INCOME TAXES

6.      INCOME TAXES

The components of income tax expense were as follows (dollars in millions):

   
2010
  
2009
  
2008
 
           
Current tax expense                                                                       
 $9.7  $9.3  $3.8 
Deferred tax provision                                                                       
  94.2   50.8   5.6 
              
Income tax expense on period income                                                                
  103.9   60.1   9.4 
              
Valuation allowance                                                                       
  (95.0)  27.8   403.9 
              
Total income tax expense                                                                
 $8.9  $87.9  $413.3 


 


A reconciliation of the U.S. statutory corporate tax rate to the effective rate reflected in the consolidated statement of operations is as follows:

   
2010
  
2009
  
2008
 
           
U.S. statutory corporate rate                                                         
  35.0 %  35.0 %  35.0 %
Valuation allowance                                                         
  (32.4 )  16.0   10,916.2 
Other nondeductible expenses (benefits)
  (.3 )  (1.4 )  125.9 
State taxes                                                         
  .8   1.0   78.0 
Provision for tax issues, tax credits and other
  (.1 )  -   15.2 
              
Effective tax rate                                                       
  3.0 %  50.6 %  11,170.3 %

The components of the Company’s income tax assets and liabilities were as follows (dollars in millions):

   
2010
  
2009
 
Deferred tax assets:
      
Net federal operating loss carryforwards attributable to:
      
Life insurance subsidiaries                                                                                         
 $681.7  $745.3 
Non-life companies                                                                                         
  870.6   883.9 
Net state operating loss carryforwards                                                                                             
  17.8   19.1 
Tax credits                                                                                             
  23.4   18.5 
Capital loss carryforwards                                                                                             
  339.7   393.8 
Deductible temporary differences:
        
Investments                                                                                           
  5.3   - 
Insurance liabilities                                                                                           
  738.9   782.1 
Unrealized depreciation of investments                                                                                           
  -   146.8 
Other                                                                                           
  62.8   44.0 
          
Gross deferred tax assets                                                                                        
  2,740.2   3,033.5 
          
Deferred tax liabilities:
        
Investments                                                                                             
  -   (38.1)
Present value of future profits and deferred acquisition costs
  (676.3)  (694.0)
Unrealized appreciation on investments                                                                                             
  (132.3)  - 
          
Gross deferred tax liabilities                                                                                         
  (808.6)  (732.1)
          
Net deferred tax assets before valuation allowance                                                                                         
  1,931.6   2,301.4 
          
Valuation allowance                                                                                                 
  (1,081.4)  (1,176.4)
          
Net deferred tax assets                                                                                         
  850.2   1,125.0 
          
Current income taxes accrued                                                                                                 
  (10.8)  (1.0)
          
Income tax assets, net                                                                                         
 $839.4  $1,124.0 

Our income tax expense includes deferred income taxes arising from temporary differences between the financial reporting and tax bases of assets and liabilities, capital loss carryforwards and NOLs.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which temporary differences are expected to be recovered or paid.  The effect of a change in tax rates on deferred tax assets and liabilities is recognized in earnings in the period when the changes are enacted.

A reduction of the net carrying amount of deferred tax assets by establishing a valuation allowance is required if, based on the available evidence, it is more likely than not that such assets will not be realized.  We evaluate the need to

 

establish a valuation allowance for our deferred income tax assets on an ongoing basis.  In evaluating our deferred income tax assets, we consider whether the deferred income tax assets will be realized, based on the more-likely-than-not realization threshold criterion.  The ultimate realization of our deferred income tax assets depends upon generating sufficient future taxable income during the periods in which our temporary differences become deductible and before our capital loss carryforwards and NOLs expire.  This assessment requires significant judgment.  In assessing the need for a valuation allowance, appropriate consideration is given to all positive and negative evidence related to the realization of the deferred tax assets.  This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, excess appreciated asset value over the tax basis of net assets, the duration of carryforward periods, our experience with operating loss and tax credit carryforwards expiring unused, and tax planning alternatives.

Concluding that a valuation allowance is not required is difficult when there has been significant negative evidence, such as cumulative losses in recent years.  We utilize a three year rolling calculation of actual income before income taxes as our primary measure of cumulative losses in recent years.  Our analysis of whether there needs to be any changes to the deferred tax valuation allowance recognizes that as of December 31, 2010, we have incurred a cumulative loss over the evaluation period, resulting from the substantial loss during 2008 primarily related to the Transfer of Senior Health to an independent trust as described in the note to these consolidated financial statements entitled “Transfer of Senior Health Insurance Company of Pennsylvania to an Independent Trust”.  As a result of the cumulative losses recognized in recent years, our evaluation of the need to increase the valuation allowance for deferred tax assets was primarily based on our historical taxable earnings.  However, because a substantial portion of the cumulative losses for the three-year period ended December 31, 2010, relates to transactions to dispose of blocks of businesses, we have adjusted the three-year cumulative results for the income and losses from the blocks of business disposed of in the past and the business transferred as further described in the note to these financial statements entitled “Transfer of Senior Health Insurance Company of Pennsylvania to an Independent Trust”.  We consider this to be non-recurring and have reflected our best estimates of when temporary differences will reverse over the carryforward periods.

At December 31, 2010, our valuation allowance for our net deferred tax assets was $1.1 billion, as we have determined that it is more likely than not that a portion of our deferred tax assets will not be realized.  This determination was made by evaluating each component of the deferred tax asset and assessing the effects of limitations and/or interpretations on the value of such component to be fully recognized in the future.  We have also evaluated the likelihood that we will have sufficient taxable income to offset the available deferred tax assets based on evidence which we consider to be objective and verifiable. Based upon our analysis completed at December 31, 2010, we believe that we will, more likely than not, recover $850.2 million of our deferred tax assets through reductions of our tax liabilities in future periods.

During 2010, we reduced the valuation allowance established in prior periods by $95 million.  The decrease was primarily attributable to:  revisions to projected future taxable income supported by our increased profitability in the past two years ($47 million); utilization of capital loss carryforwards with current capital gains ($30 million); and utilization of NOL carryforwards with higher taxable income than projected in our previous analysis of the valuation allowance ($18 million).

 


Changes in our valuation allowance are summarized as follows (dollars in millions):

Balance at December 31, 2007                                                                                  
 $672.9  
       
Increase in 2008                                                                               
  856.2 
(a)
Expiration of capital loss carryforwards                                                                               
  (209.7) 
Write-off of capital loss carryforwards related to Senior Health
  (133.2) 
Write-off of certain NOLs related to Senior Health
  (5.5) 
       
Balance at December 31, 2008                                                                                  
  1,180.7  
       
Increase in 2009                                                                               
  27.8 
(b)
Expiration of capital loss carryforwards                                                                               
  (32.1) 
       
Balance at December 31, 2009                                                                                 
  1,176.4  
       
Decrease in 2010                                                                               
  (95.0)
(c)
       
Balance at December 31, 2010                                                                                 
 $1,081.4  
____________________
(a)  
The $856.2 million increase to our valuation allowance during 2008 included increases of:  (i) $452 million of deferred tax assets related to Senior Health, which was transferred to an independent trust during 2008; (ii) $298 million related to our reassessment of the recovery of our deferred tax assets in accordance with GAAP, following the additional losses incurred as a result of the transaction to transfer Senior Health to an independent trust; (iii) $60 million related to the recognition of additional realized investment losses for which we are unlikely to receive any tax benefit; and (iv) $45 million related to the estimated additional future expense following the modifications to our Senior Credit Agreement as described in the note to these consolidated financial statements entitled “Notes Payable - Direct Corporate Obligations.”

(b)  
The $27.8 million increase to our valuation allowance during 2009 included increases of:  (i) $23.0 million related to our reassessment of the recovery of our deferred tax assets following the completion of reinsurance transactions in 2009; and (ii) $4.8 million related to the recognition of additional realized investment losses for which we are unlikely to receive any tax benefit.

(c)  
The $95.0 million reduction to the deferred tax valuation allowance during 2010 resulted from the utilization of NOLs and capital loss carryforwards and higher projections of future taxable income based on evidence we consider to be objective and verifiable.

Recovery of our deferred tax assets is dependent on achieving the projections of future taxable income embedded in our analysis and failure to do so would result in an increase in the valuation allowance in a future period.  Any future increase in the valuation allowance may result in additional income tax expense and reduce shareholders’ equity, and such an increase could have a significant impact upon our earnings in the future.  In addition, the use of the Company’s NOLs is dependent, in part, on whether the Internal Revenue Service (the “IRS”) does not take an adverse position in the future regarding the tax position we have taken in our tax returns with respect to the allocation of a portion of the cancellation of indebtedness income resulting from the bankruptcy of our Predecessor and the classification of the loss we recognized as a result of the transfer of Senior Health to an Independent Trust (as further described below).

The Internal Revenue Code (the “Code”) limits the extent to which losses realized by a non-life entity (or entities) may offset income from a life insurance company (or companies) to the lesser of:  (i) 35 percent of the income of the life insurance company; or (ii) 35 percent of the total loss of the non-life entities (including NOLs of the non-life entities).  There is no similar limitation on the extent to which losses realized by a life insurance entity (or entities) may offset income from a non-life entity (or entities).

Section 382 imposes limitations on a corporation’s ability to use its NOLs when the company undergoes an ownership change.  Future transactions and the timing of such transactions could cause an ownership change for Section 382 income tax purposes.  Such transactions may include, but are not limited to, additional repurchases or issuances of common stock

 

(including upon conversion of our outstanding 7.0% Convertible Senior Debentures due 2016 (the “7.0% Debentures”), or acquisitions or sales of shares of CNO stock by certain holders of our shares, including persons who have held, currently hold or may accumulate in the future five percent or more of our outstanding common stock for their own account.  Many of these transactions are beyond our control.  If an additional ownership change were to occur for purposes of Section 382, we would be required to calculate an annual restriction on the use of our NOLs to offset future taxable income.  The annual restriction would be calculated based upon the value of CNO’s equity at the time of such ownership change, multiplied by a federal long-term tax exempt rate (3.67 percent at December 31, 2010), and the annual restriction could effectively eliminate our ability to use a substantial portion of our NOLs to offset future taxable income.  We regularly monitor ownership change (as calculated for purposes of Section 382) and, as of December 31, 2010, we were below the 50 percent ownership change level that would trigger further impairment of our ability to utilize our NOLs.

On January 20, 2009, the Company’s Board of Directors adopted a Section 382 Rights Agreement which is designed to protect shareholder value by preserving the value of our tax assets primarily associated with tax NOLs under Section 382.  The Section 382 Rights Agreement was adopted to reduce the likelihood of this occurring by deterring the acquisition of stock that would create “5 percent shareholders” as defined in Section 382.

Under the Section 382 Rights Agreement, one right was distributed for each share of our common stock outstanding as of the close of business on January 30, 2009.  Effective January 20, 2009, if any person or group (subject to certain exemptions) becomes a “5 percent shareholder” of CNO without the approval of the Board of Directors, there would be a triggering event causing significant dilution in the voting power and economic ownership of that person or group.  Existing shareholders who currently are “5 percent shareholders” will trigger a dilutive event only if they acquire additional shares exceeding one percent of our outstanding shares without prior approval from the Board of Directors.

The Section 382 Rights Agreement will continue in effect until January 20, 2012, unless earlier terminated or redeemed by the Board of Directors.  The Company’s Audit Committee will review our NOLs on an annual basis and will recommend amending or terminating the Section 382 Rights Agreement based on its review.  The Section 382 Rights Agreement was approved by a vote at the annual meeting of shareholders on May 12, 2009.

On May 11, 2010, our shareholders approved an amendment to CNO’s certificate of incorporation designed to prevent certain transfers of common stock which could otherwise adversely affect our ability to use our NOLs (the “Section 382 Charter Amendment”).  Subject to the provisions set forth in the Section 382 Charter Amendment, transfers of our common stock would be void and of no effect if the effect of the purported transfer would be to:  (i) increase the direct or indirect ownership of our common stock by any person or public group (as such term is defined in the regulations under Section 382) from less than 5% to 5% or more of our common stock; (ii) increase the percentage of our common stock owned directly or indirectly by a person or public group owning or deemed to own 5% or more of our common stock; or (iii) create a new public group.  The Section 382 Charter Amendment will continue in effect until December 31, 2013.

As of December 31, 2010, we had $4.4 billion of federal NOLs and $1.0 billion of capital loss carryforwards, which expire as follows (dollars in millions):

Year of expiration
 
Net operating loss carryforwards (a)
 
Capital loss
  
Total loss
 
   
Life
 
Non-life
 
carryforwards
  
carryforwards
 
                  
2011
 $-    $.1    $-  $.1 
2013
  -     -     942.0   942.0 
2014
  -     -     28.7   28.7 
2018
  1,713.9 
(a)
  -     -   1,713.9 
2021
  29.6     -     -   29.6 
2022
  204.1     -     -   204.1 
2023
  -     1,999.3 
(a)
  -   1,999.3 
2024
  -     3.2     -   3.2 
2025
  -     118.8     -   118.8 
2027
  -     216.8     -   216.8 
2028
  -     .5     -   .5 
2029
   -     148.7     -   148.7 
                      
Total
 $1,947.6    $2,487.4    $970.7  $5,405.7 

 

____________________
(a)  
The allocation of the NOLs summarized above assumes the IRS does not take an adverse position in the future regarding the tax position we plan to take in our tax returns with respect to the allocation of cancellation of indebtedness income.  If the IRS disagrees with the tax position we plan to take with respect to the allocation of cancellation of indebtedness income, and their position prevails, approximately $631 million of the NOLs expiring in 2018 would be characterized as non-life NOLs.

We had deferred tax assets related to NOLs for state income taxes of $17.8 million and $19.1 million at December 31, 2010 and 2009, respectively.  The related state NOLs are available to offset future state taxable income in certain states through 2015.

As more fully discussed below, the Company’s interpretation of the tax law, as it relates to the application of the cancellation of indebtedness income to its NOLs, is an uncertain tax position.  Since all other life NOLs must be utilized prior to this portion of the NOL, it has not yet been utilized nor is it expected to be utilized within the next twelve months.  As a result, an uncertain tax position has not yet been taken on the Company’s tax return.

Although authoritative guidance allowed a change in accounting, the Company has chosen to continue its past accounting policy of classifying interest and penalties as income tax expense in the consolidated statement of operations.  No such amounts were recognized in 2010, 2009 or 2008.  The liability for accrued interest and penalties was not significant at December 31, 2010 or December 31, 2009.

Tax years 2007 through 2009 are open to examination by the IRS, and tax year 2002 remains open only for potential adjustments related to certain partnership investments.  The Company does not anticipate any material adjustments related to these partnership investments.  The Company’s various state income tax returns are generally open for tax years 2007 through 2009 based on the individual state statutes of limitation.

In July 2006, the Joint Committee of Taxation accepted the audit and the settlement which characterized $2.1 billion of the tax losses on our Predecessor’s investment in Conseco Finance Corp. as life company losses and the remaining $3.8 billion as non-life losses prior to the application of the cancellation of indebtedness attribute reductions described below.

The Code provides that any income realized as a result of the cancellation of indebtedness in bankruptcy (cancellation of debt income or “CODI”) must reduce NOLs.  We realized $2.5 billion of CODI when we emerged from bankruptcy.  Pursuant to the Company’s interpretation of the tax law, the CODI reductions were all used to reduce non-life NOLs.  However, if the IRS were to disagree with our interpretation and ultimately prevail, we believe $631 million of NOLs classified as life company NOLs would be re-characterized as non-life NOLs and subject to the 35% limitation discussed above.  Such a re-characterization would also extend the year of expiration as life company NOLs expire after 15 years whereas non-life NOLs expire after 20 years.  Due to uncertainties with respect to the ultimate position the IRS may take and limitations on our ability to utilize NOLs based on projected life and non-life income, we have considered the $631 million of CODI to be a reduction to life NOLs when determining our valuation allowance.  If we determine the IRS agrees with our position that the $631 million of CODI is a reduction to non-life NOLs, our valuation allowance would be reduced by approximately $140 million based on the income projection used in our valuation allowance at December 31, 2010.

We recognized a $742 million loss on our investment in Senior Health which was worthless when it was transferred to an Independent Trust in 2008.  We have treated the loss as a capital loss when determining the deferred tax benefit we may receive.  We also established a full valuation allowance as we believe we will not generate capital gains to utilize the benefit.  However, due to uncertainties in the tax code, we have reflected this loss as an ordinary loss in our tax return, contrary to certain IRS rulings.  If classifying this loss as ordinary is ultimately determined to be correct, our valuation allowance would be reduced by approximately $160 million based on income projections used in our valuation allowance at December 31, 2010.

In accordance with GAAP, we are precluded from recognizing the tax benefits of any tax windfall upon the exercise of a stock option or the vesting of restricted stock unless such deduction resulted in actual cash savings to the Company.  Because of the Company’s NOLs, no cash savings have occurred.  NOL carryforwards of $.6 million related to deductions for stock options and restricted stock will be reflected in additional paid-in capital if realized.

NOTES PAYABLE - DIRECT CORPORATE OBLIGATIONS
NOTES PAYABLE - DIRECT CORPORATE OBLIGATIONS

7.       NOTES PAYABLE - DIRECT CORPORATE OBLIGATIONS

The following notes payable were direct corporate obligations of the Company as of December 31, 2010 and 2009 (dollars in millions):

   
2010
  
2009
 
        
3.5% Debentures                                                                      
 $-  $116.5 
7.0% Debentures                                                                      
  293.0   176.5 
New senior secured credit agreement                                                                      
  375.0   - 
9.0% Senior Secured Notes                                                                      
  275.0   - 
Previous senior credit agreement                                                                      
  -   652.1 
6% Senior Health Note                                                                      
  75.0   100.0 
Unamortized discount on 3.5% Debentures                                                                      
  -   (3.3)
Unamortized discount on 7.0% Debentures                                                                      
  (14.8)  (4.4)
Unamortized discount on new senior secured credit agreement
  (4.7)  - 
          
Direct corporate obligations                                                                  
 $998.5  $1,037.4 

3.5% Debentures

In August 2005, we completed the private offering of $330 million of 3.5% Debentures.  During 2008, we repurchased $37.0 million par value of such 3.5% Debentures for $15.3 million plus accrued interest.  On November 13, 2009, we completed a cash tender offer (the “Tender Offer”) for $176.5 million aggregate principal amount of the 3.5% Debentures.  The aggregate consideration for the 3.5% Debentures accepted by us in the Tender Offer, plus accrued and unpaid interest thereon, was $177.2 million.  This amount was funded primarily from the net proceeds from the issuance of 7.0% Debentures as described below.

In February 2010, we repurchased $64.0 million aggregate principal amount of our 3.5% Debentures in a privately-negotiated transaction.  In connection with the repurchase of the 3.5% Debentures, we completed a second closing of $64 million aggregate principal amount of our 7.0% Debentures.  The net proceeds from the issuance of the 7.0% Debentures were used to fund a substantial portion of the consideration payable in connection with the repurchase of the 3.5% Debentures.  The purchase price for the $64.0 million of 3.5% Debentures was equal to 100 percent of the aggregate principal amount plus accrued and unpaid interest.

In May 2010, we repurchased $52.5 million aggregate principal amount of our 3.5% Debentures in a privately-negotiated transaction.  In connection with the repurchase of the 3.5% Debentures, we completed a third closing of $52.5 million aggregate principal amount of our 7.0% Debentures.  The net proceeds from the issuance of the 7.0% Debentures were used to fund a substantial portion of the consideration payable in connection with the repurchase of the 3.5% Debentures.  The purchase price for the $52.5 million of 3.5% Debentures was equal to 100 percent of the aggregate principal amount plus accrued and unpaid interest.

7.0% Debentures

On November 13, 2009, we issued $176.5 million aggregate principal amount of our 7.0% Debentures in the initial closing of our private offering of 7.0% Debentures to Morgan Stanley & Co. Incorporated, as the initial purchaser of the 7.0% Debentures.  The net proceeds from the initial closing of the offering of our 7.0% Debentures, after deducting the initial purchaser’s discounts and commissions and  before other offering expenses, totaled $172.0 million.  The Company used the net proceeds to fund a substantial portion of the consideration payable in connection with the Tender Offer for the 3.5% Debentures.

In February 2010, we completed a second closing of $64 million aggregate principal amount of our 7.0% Debentures and in May 2010, we completed a third closing of $52.5 million aggregate principal amount of our 7.0% Debentures.  These issuances were made pursuant to the purchase agreement that we entered into in October 2009 relating to the private offering of up to $293 million of 7.0% Debentures.  We received aggregate net proceeds (after taking into account the discounted

 

offering price less the initial purchaser’s discounts and commissions, but before expenses) of: (i) $61.4 million in the second closing of the 7.0% Debentures; and (ii) $49.4 million in the third closing of the 7.0% Debentures.  At December 31, 2010 and 2009, unamortized issuance costs (classified as other assets) related to the 7.0% Debentures were $1.9 million and $2.1 million, respectively, and are amortized as an increase to interest expense over the term of the 7.0% Debentures.

The 7.0% Debentures rank equally in right of payment with all of the Company’s unsecured and unsubordinated obligations.  The 7.0% Debentures are governed by an Indenture dated as of October 16, 2009 (the “7.0% Indenture”) between the Company and The Bank of New York Mellon Trust Company, N.A., as trustee (“Mellon”).  The 7.0% Debentures bear interest at a rate of 7.0% per annum, payable semi-annually on June 30 and December 30 of each year, commencing on the interest payment date immediately succeeding the issuance date of such series.  The 7.0% Debentures will mature on December 30, 2016, unless earlier converted.  The 7.0% Debentures may not be redeemed at the Company’s election prior to the stated maturity date and the holders may not require the Company to repurchase the 7.0% Debentures at any time.  The 7.0% Debentures are not convertible prior to June 30, 2013, except under limited circumstances.  Commencing on June 30, 2013, the 7.0% Debentures will be convertible into shares of our common stock at the option of the holder at any time, subject to certain exceptions and subject to our right to terminate such conversion rights under certain circumstances relating to the sale price of our common stock.  If the holders elect to convert their 7.0% Debentures upon the occurrence of certain changes of control of CNO or certain other events, we will be required, under certain circumstances, to increase the conversion rate for such holders of the 7.0% Debentures who convert in connection with such events.  Initially, the 7.0% Debentures will be convertible into 182.1494 shares of our common stock for each $1,000 principal amount of 7.0% Debentures, which is equivalent to an initial conversion price of approximately $5.49 per share.  The conversion rate is subject to adjustment following the occurrence of certain events in accordance with the terms of the 7.0% Indenture.

The 7.0% Debenture provides for customary events of default (subject in certain cases to customary grace and cure periods), which include nonpayment, breach of covenants in the 7.0% Debenture, failure to pay at maturity or acceleration of other indebtedness and certain events of bankruptcy and insolvency.  Generally, if an event of default occurs, Mellon or holders of at least 50% in principal amount of the then outstanding 7.0% Debentures may declare the principal of, and accrued but unpaid interest on all of the 7.0% Debentures to be immediately due and payable.

The 7.0% Indenture provides that on and after the date of the 7.0% Indenture, the Company may not:  (i) consolidate with or merge into any other person or sell, convey, lease or transfer the Company’s consolidated properties and assets substantially as an entirety to any other person in any one transaction or series of related transactions; or (ii) permit any person to consolidate with or merge into the Company, unless certain requirements set forth in the 7.0% Indenture are satisfied.

In accordance with GAAP, we are required to consider on each issuance date whether the 7.0% Debentures issued on such date are issued with a beneficial conversion feature.  A beneficial conversion feature will exist if the 7.0% Debentures may be convertible into common stock at an effective conversion price (calculated by dividing the proceeds from the issuance of 7.0% Debentures issued on that date (per $1,000 principal amount of debentures) by the then effective conversion rate) that is lower than the market price of a share of common stock on the date of issuance.  When a beneficial conversion feature exists, we are required to separately recognize the beneficial conversion feature at issuance by allocating a portion of the proceeds to the intrinsic value of that feature.  The value of the beneficial conversion feature is recorded, net of taxes, as an increase to additional paid-in capital.  If a beneficial conversion feature exists on the actual date(s) of issuance, a discount equal to the intrinsic value of the beneficial conversion feature will be recorded against the carrying value of the 7.0% Debentures.  Such discount will be amortized from the actual date(s) of issuance to the stated maturity date of the 7.0% Debentures using the effective interest method.  Accordingly, the interest expense we recognize related to the 7.0% Debentures will be dependent upon whether a beneficial conversion feature exists on the actual date(s) of issuance and the amount by which the market price(s) of our common stock exceeds the effective conversion price on such actual date(s) of issuance.

The closing market price of our common stock on May 4, 2010 (the last closing price prior to the issuance of $52.5 million of the 7.0% Debentures) was $5.81.  Because this amount was higher than the effective conversion price of $5.17 on that date, a beneficial conversion feature existed with respect to the 7.0% Debentures we issued.  The beneficial conversion feature related to the 7.0% Debentures issued on May 5, 2010 of $4.0 million, net of tax, was recorded as an increase to additional paid-in capital.


 

New Senior Secured Credit Agreement

On December 21, 2010, the Company entered into a $375 million senior secured term loan facility maturing on September 30, 2016, pursuant to an agreement among the Company, Morgan Stanley Senior Funding, Inc., as administrative agent (the “Agent”), and the lenders from time to time party thereto (the “New Senior Secured Credit Agreement”).  The net proceeds of $363.6 million were used to repay a portion of the amount outstanding under our Second Amended and Restated Credit Agreement dated as of October 10, 2006 among CNO, Bank of America, N.A. as agent, J.P. Morgan Chase Bank, N.A., as Syndication Agent and other parties (the “Previous Senior Credit Agreement”).

The interest rate applicable to the New Senior Secured Credit Agreement is, at our option (in most instances), a Eurodollar rate of Libor plus 6.00 percent (subject to a Libor “floor” of 1.5 percent) or a Base Rate plus 5.00 percent (subject to a Base Rate “floor” of 2.5 percent).  The pricing terms for the New Senior Secured Credit Agreement included upfront fees of 1.25 percent paid to the lenders.  At December 31, 2010, the interest rate on our New Senior Secured Credit Agreement was 7.5 percent.  The New Senior Secured Credit Agreement is guaranteed by our primary non-insurance company subsidiaries, as defined in the New Senior Secured Credit Agreement (collectively, the “Subsidiary Guarantors”) and secured by substantially all of our and the Subsidiary Guarantors’ assets.

The New Senior Credit Agreement contains covenants that limit the Company’s ability to take certain actions and perform certain activities, including (each subject to exceptions as set forth in the New Senior Credit Agreement):

·  
limitations on debt (including, without limitation, guarantees and other contingent obligations);

·  
limitations on issuances of disqualified capital stock;

·  
limitations on liens and further negative pledges;

·  
limitations on sales, transfers and other dispositions of assets;

·  
limitations on transactions with affiliates;

·  
limitations on changes in the nature of the Company’s business;

·  
limitations on mergers, consolidations and acquisitions;

·  
limitations on dividends and other distributions, stock repurchases and redemptions and other restricted payments;

·  
limitations on investments and acquisitions;

·  
limitations on prepayment of certain debt;

·  
limitations on modifications or waivers of certain debt documents and charter documents;

·  
investment portfolio requirements for insurance subsidiaries;

·  
limitations on restrictions affecting subsidiaries;

·  
limitations on holding company activities; and

·  
limitations on changes in accounting policies.

In addition, the New Senior Secured Credit Agreement requires the Company to maintain:  (i) a debt to total capitalization ratio of not more than 30 percent (such ratio was 19.99 percent at December 31, 2010); (ii) an interest coverage ratio of not less than 2.00 to 1.00 for each rolling four quarters (or, if less, the number of full fiscal quarters commencing after the effective date of the New Senior Secured Credit Agreement) (such ratio was not applicable for the period ended December 31, 2010); (iii) an aggregate ratio of total adjusted capital to company action level risk-based capital for the Company’s insurance subsidiaries of not less than 225 percent on or prior to December 31, 2011 and 250 percent thereafter

 

(such ratio was 332 percent at December 31, 2010); and (iv) a combined statutory capital and surplus for the Company’s insurance subsidiaries of at least $1,200.0 million (combined statutory capital and surplus at December 31, 2010, was $1,596.4 million).

We may prepay, in whole or in part, the New Senior Secured Credit Agreement, together with any accrued and unpaid interest, with prior notice but without premium or penalty in minimum amounts of $1.0 million or any multiple thereof.

Mandatory prepayments of the New Senior Secured Credit Agreement will be required in an amount equal to: (i) 100 percent of the net cash proceeds from certain asset sales or casualty events; (ii) 100 percent of the net cash proceeds received by the Company or any of its subsidiaries from certain debt issuances; (iii) 50 percent of the net cash proceeds received from certain equity issuances; and (iv) 100 percent of the amount of certain restricted payments made (including any common stock dividends and share repurchases) as defined in the New Senior Secured Credit Agreement.
 
Notwithstanding the foregoing, no mandatory prepayments pursuant to items (i) or (iii) in the preceding paragraph shall be required if: (x) the debt to total capitalization ratio is equal or less than 20 percent; and (y) either (A) the financial strength rating of certain insurance subsidiaries is equal or better than A- (stable) from A.M. Best Company or (B) the New Senior Secured Credit Agreement is rated equal or better than BBB- (stable) from S&P and Baa3 (stable) by Moody’s.
 
In connection with the execution of the New Senior Secured Credit Agreement, the Company and the Subsidiary Guarantors entered into a guarantee and security agreement, dated as of December 21, 2010 (the “Guarantee and Security Agreement”), by and among the Company, the Subsidiary Guarantors and the Agent, pursuant to which the Subsidiary Guarantors guaranteed all of the obligations of the Company under the New Senior Secured Credit Agreement and the Company and the Subsidiary Guarantors pledged substantially all of their assets to secure the New Senior Secured Credit Agreement, subject to certain exceptions as set forth in the Guarantee and Security Agreement.

9.0% Senior Secured Notes

On December 21, 2010, we issued $275.0 million aggregate principal amount of 9.00% Senior Secured Notes due 2018 (the “9.0% Senior Secured Notes”).  The net proceeds of $267.0 million were used to repay a portion of the amount outstanding under the Previous Senior Credit Agreement.

The 9.0% Senior Secured Notes were issued pursuant to an Indenture, dated as of December 21, 2010 (the “Indenture”), by and among the Company, the Subsidiary Guarantors and Wilmington Trust FSB, as trustee and collateral agent (“Wilmington”).

The 9.0% Senior Secured Notes will mature on January 15, 2018.  Interest on the 9.0% Senior Secured Notes accrues at a rate of 9.0% per annum and is payable semiannually in arrears on January 15 and July 15 of each year, commencing on July 15, 2011.  The 9.0% Senior Secured Notes and the guarantees thereof (the “Guarantee”) are senior secured obligations of the Company and the Subsidiary Guarantors and rank equally in right of payment with all of the Company’s and the Subsidiary Guarantor’s existing and future senior obligations, and senior to all of the Company’s and the Subsidiary Guarantors’ existing and future subordinated indebtedness.  The 9.0% Senior Secured Notes are secured by substantially all of the assets of the Company and the Subsidiary Guarantors, subject to certain exceptions.  The 9.0% Senior Secured Notes and the Guarantees are pari passu to all of the Company’s and the Subsidiary Guarantors’ existing and future secured indebtedness under the New Senior Secured Credit Agreement.

The Company may redeem all or part of the 9.0% Senior Secured Notes beginning on January 15, 2014, at the redemption prices set forth in the Indenture.  The Company may also redeem all or part of the 9.0% Senior Secured Notes at any time and from time to time prior to January 15, 2014, at a price equal to 100% of the aggregate principal amount of the 9.0% Senior Secured Notes to be redeemed plus a “make-whole” premium and accrued and unpaid interest.  In addition, prior to January 15, 2014, the Company may redeem up to 35% of the aggregate principal amounts of the 9.0% Senior Secured Notes with the net cash proceeds of certain equity offerings at a price equal to 109.000% of the aggregate principal amount of the 9.0% Senior Secured Notes to be redeemed plus accrued and unpaid interest.

Upon the occurrence of a change of control (as defined in the Indenture), each holder of the 9.0% Senior Secured Notes may require the Company to repurchase all or a portion of the 9.0% Senior Secured Notes in cash at a price equal to 101% of the aggregate principal amount of the 9.0% Senior Secured Notes to be repurchased, plus accrued and unpaid interest, if any, to the date of repurchase.

 

The Indenture contains covenants that, among other things, limit (subject to certain exceptions) the Company’s ability and the ability of the Company’s Restricted Subsidiaries (as defined in the Indenture) to:

·  
incur or guarantee additional indebtedness or issue preferred stock;
 
·  
pay dividends or make other distributions to shareholders;
 
·  
purchase or redeem capital stock or subordinated indebtedness;
 
·  
make investments;
 
·  
create liens;
 
·  
incur restrictions on the Company’s ability and the ability of the Restricted Subsidiaries to pay dividends or make other payments to the Company;
 
·  
sell assets, including capital stock of the Company’s subsidiaries;
 
·  
consolidate or merge with or into other companies or transfer all or substantially all of the Company’s assets; and
 
·  
engage in transactions with affiliates.
 
The Indenture provides for customary events of default (subject in certain cases to customary grace and cure periods), which include nonpayment, breach of covenants in the Indenture, failure to pay at maturity or acceleration of other indebtedness, a failure to pay certain judgments and certain events of bankruptcy and insolvency.  Generally, if an event of default occurs, Wilmington or holders of at least 25% in principal amount of the then outstanding 9.0% Senior Secured Notes may declare the principal of and accrued but unpaid interest, including any additional interest, on all of the 9.0% Senior Secured Notes to be due and payable.

In connection with the issuance of the 9.0% Senior Secured Notes and execution of the Indenture, the Company and the Subsidiary Guarantors entered into a security agreement, dated as of December 21, 2010 (the “Security Agreement”), by and among the Company, the Subsidiary Guarantors and Wilmington Trust FSB, as collateral agent, pursuant to which the Company and the Subsidiary Guarantors pledged substantially all of their assets to secure their obligations under the Indenture, subject to certain exceptions as set forth in the Security Agreement.

Intercreditor Agreement

In connection with the issuance of the 9.0% Senior Secured Notes and entry into the New Senior Secured Credit Agreement, the Agent and Wilmington, as collateral agent and authorized representative with respect to the 9.0% Senior Secured Notes, entered into an Intercreditor Agreement, dated as of December 21, 2010 (the “Intercreditor Agreement”), which sets forth agreements with respect to the first-priority liens granted by the Company and the Subsidiary Guarantors pursuant to the Indenture and the New Senior Secured Credit Agreement.

Under the Intercreditor Agreement, any actions that may be taken with respect to the collateral that secures the 9.0% Senior Secured Notes and the New Senior Secured Credit Agreement, including the ability to cause the commencement of enforcement proceedings against such collateral, to control such proceedings and to approve amendments to releases of such collateral from the lien of, and waive past defaults under, such documents relating to such collateral, will be at the direction of the authorized representative of the lenders under the New Senior Secured Credit Agreement until the earlier of:  (i) the Company’s obligations under the New Senior Secured Credit Agreement (or refinancings thereof) are discharged; (ii) the date on which the outstanding principal amount of loans and commitments under the New Senior Secured Credit Agreement is less than $25.0 million; and (iii) 180 days after the occurrence of both an event of default under the Indenture and the authorized representative of the holders of the 9.0% Senior Secured Notes making certain representations as described in the Intercreditor Agreement, unless the authorized representative of the lenders under the New Senior Secured Credit Agreement has commenced and is diligently pursuing enforcement action with respect to the collateral or the grantor of the security interest in that collateral (whether the Company or the applicable Subsidiary Guarantor) is then a debtor under or with respect to (or otherwise subject to) any insolvency or liquidation proceeding.

 


Previous Senior Credit Agreement

In December 2010, we repaid the $652.1 million outstanding principal balance under our Previous Senior Credit Agreement using:  (i) the proceeds from the New Senior Secured Credit Agreement and the issuance of the 9.0% Senior Secured Notes; and (ii) available cash.

On March 30, 2009, we completed Amendment No. 2 to our Previous Senior Credit Agreement, which provided for, among other things:  (i) additional margins between our then current financial status and certain financial covenant requirements through June 30, 2010; (ii) higher interest rates and the payment of a fee; (iii) new restrictions on the ability of the Company to incur additional indebtedness; and (iv) the ability of the lender to appoint a financial advisor at the Company’s expense.

Pursuant to its amended terms, the applicable interest rate on the Previous Senior Credit Agreement (based on either a Eurodollar or base rate) was increased.  The Eurodollar rate was equal to LIBOR plus 4 percent with a minimum LIBOR rate of 2.5 percent (such rate was previously LIBOR plus 2 percent with no minimum rate).  The base rate was equal to 2.5 percent plus the greater of: (i) the Federal funds rate plus .50 percent; or (ii) Bank of America’s prime rate.  In addition, the amended agreement required the Company to pay a fee equal to 1 percent of the outstanding principal balance under the Senior Credit Agreement, which fee was added to the principal balance outstanding and was payable at the maturity of the facility.  This 1 percent fee was reported as non-cash interest expense.

On December 22, 2009, the Company entered into Amendment No. 3 to our Previous Senior Credit Agreement, which provided for, among other things:

·  
the minimum risk-based capital ratio requirement was 200% through December 31, 2010 and was to increase to 225% for 2011 and 250% for 2012 (the risk-based capital requirement was previously scheduled to return to 250% after June 30, 2010);

·  
the required minimum level of statutory capital and surplus was $1.1 billion through December 31, 2010 and was to increase to $1.2 billion for 2011 and $1.3 billion for 2012 (the required minimum level of statutory capital and surplus was previously scheduled to return to $1.27 billion after June 30, 2010);

·  
the interest coverage ratio requirement was 1.50 through December 31, 2010 and was to increase to 1.75 for 2011 and 2.00 for 2012 (the interest coverage ratio requirement was previously scheduled to return to 2.00 after June 30, 2010); and

·  
the debt to total capital ratio requirement was 32.5% though December 31, 2009 and decreased to 30% thereafter (the debt to total capital ratio requirement was previously scheduled to return to 30% after June 30, 2010).

The Company also agreed to pay $150 million of the first $200 million of net proceeds from its public offering of common stock (as further discussed below) to the lenders and, in addition, to pay 50% of any net proceeds in excess of $200 million from the offering.  The credit facility previously required the Company to pay 50% of the net proceeds of any equity issuance to the lenders.

The amendment modified the Company’s principal repayment schedule and eliminated any principal payments in 2010.  There were no changes to the maturity date of October 10, 2013.  The Company was previously required to make principal repayments equal to 1% of the initial principal balance each year, subject to certain adjustments, and to make additional principal repayments from excess cash flow.

The amendment also provided that the 1% payment in kind, or PIK, interest that had accrued since March 30, 2009 as an addition to the principal balance under the Previous Senior Credit Agreement was replaced with a payment of an equal amount of cash interest.  The amount of accrued PIK interest ($6.3 million) was paid in cash when the amendment became effective.  The deletion of the 1% PIK interest and the payment of an equal amount of cash interest did not impact reported interest expense.

On November 13, 2009, we repaid $36.8 million of outstanding principal on the Previous Senior Credit Agreement from the proceeds of the issuance of common stock and warrants to Paulson & Co. Inc. (“Paulson”).  On December 22, 2009,

 

the Company repaid $161.4 million of outstanding principal on the Previous Senior Credit Agreement from proceeds of an equity offering.  Such transactions are further discussed in the note to the consolidated financial statements entitled “Shareholders’ Equity.”

During 2009 and 2008, we made scheduled principal payments totaling $5.3 million and $8.7 million, respectively, on our Previous Senior Credit Agreement.  Also, during 2009, we made a mandatory prepayment of $1.2 million based on the Company’s excess cash flows at December 31, 2008 as defined in the Previous Senior Credit Agreement.  There were $5.4 million of unamortized issuance costs (classified as other assets) related to our Previous Senior Credit Agreement at December 31, 2009.

In accordance with Amendment No. 3 to our Previous Senior Credit Agreement, the applicable interest rate on the Previous Senior Credit Agreement, payable at least quarterly, was based on either a Eurodollar rate or a base rate.  The Eurodollar rate was equal to LIBOR plus 5 percent with a minimum LIBOR rate of 2.5 percent.  The base rate was equal to 4 percent plus the greater of:  (i) the Federal funds rate plus .50 percent; or (ii) Bank of America’s prime rate.

The Previous Senior Credit Agreement included an $80.0 million revolving credit facility that could be used for general corporate purposes.  In October 2008, the Company borrowed $75.0 million under the revolving credit facility to assure the future availability of this additional liquidity given our concerns with the ability of certain financial institutions to be able to provide funding in the future.  In December 2008, we repaid $20.0 million of the revolving facility and reduced the maximum amount available under the revolving facility to $60.0 million.  In April 2009, we repaid the remaining $55.0 million that was outstanding under the revolving facility portion of our Previous Senior Credit Agreement.  The Company paid a commitment fee equal to .50 percent of the unused portion of the revolving credit facility on an annualized basis.

Senior Health Note

In connection with the Transfer, the Company issued the Senior Health Note payable to Senior Health.  The Senior Health Note is unsecured and bears interest at a rate of 6.0 percent per year payable quarterly, beginning on March 15, 2009. We are required to make annual principal payments of $25.0 million beginning on November 12, 2009.  The Company made a $25.0 million scheduled payment on the Senior Health Note in both 2010 and 2009.  The Company may redeem the Senior Health Note, in whole or in part, at any time by giving the holder 30 days notice (unless a shorter notice is satisfactory to the holder).  The redemption amount is equal to the principal amount redeemed plus any accrued and unpaid interest thereon.  Any outstanding amount under the Senior Health Note will be due and payable immediately if an event of default (as defined in the Senior Health Note) occurs and continues without remedy.  As a condition of the order from the Pennsylvania Insurance Department approving the Transfer, we agreed that we would not pay cash dividends on our common stock while any portion of the Senior Health Note remained outstanding.

Gain (Loss) on Extinguishment or Modification of Debt

In 2010, we recognized an aggregate loss on the extinguishment of debt totaling $6.8 million representing the write-off of unamortized discount and issuance costs associated with:  (i) the repurchases of 3.5% Debentures; and (ii) the repayment of the Previous Senior Credit Agreement, each as previously described above.

In 2009, we recognized an aggregate loss on the extinguishment or modification of debt totaling $22.2 million resulting from expenses incurred and the write-off of unamortized discount or issuance costs related to the following transactions which are described above:  (i) the Tender Offer; (ii) repayment of principal amounts on the Previous Senior Credit Agreement from the issuance of common stock; and (iii) modifications to our Previous Senior Credit Agreement in March 2009 and December 2009.

In 2008, we repurchased $37.0 million par value of the 3.5% Debentures for $15.3 million plus accrued interest and recognized a gain on the extinguishment of debt of $21.2 million related to such repurchases.

 


Scheduled Debt Repayments

The scheduled repayment of our direct corporate obligations is as follows (dollars in millions):

2011                                                                         
 $55.0 
2012                                                                         
  65.0 
2013                                                                         
  80.0 
2014                                                                         
  75.0 
2015                                                                         
  85.0 
2016                                                                         
  383.0 
2018                                                                         
  275.0 
      
   $1,018.0 

COMMITMENTS AND CONTINGENCIES
COMMITMENTS AND CONTINGENCIES

8.  
COMMITMENTS AND CONTINGENCIES

Litigation and Other Legal Proceedings

The Company and its subsidiaries are involved in various legal actions in the normal course of business, in which claims for compensatory and punitive damages are asserted, some for substantial amounts.  Some of the pending matters have been filed as purported class actions and some actions have been filed in certain jurisdictions that permit punitive damage awards that are disproportionate to the actual damages incurred.  The amounts sought in certain of these actions are often large or indeterminate and the ultimate outcome of certain actions is difficult to predict.  In the event of an adverse outcome in one or more of these matters, the ultimate liability may be in excess of the liabilities we have established and could have a material adverse effect on our business, financial condition, results of operations and cash flows.  In addition, the resolution of pending or future litigation may involve modifications to the terms of outstanding insurance policies or could impact the timing and amount of rate increases, which could adversely affect the future profitability of the related insurance policies.  Although there can be no assurances, at the present time the Company does not anticipate that the ultimate liability from either pending or threatened legal actions, after consideration of existing loss provisions, will have a material adverse effect on the financial condition, operating results or cash flows of the Company.

In the cases described below, we have disclosed any specific dollar amounts sought in the complaints.  In our experience, monetary demands in complaints bear little relation to the ultimate loss, if any, to the Company.  However, for the reasons stated above, it is not possible to make meaningful estimates of the amount or range of loss that could result from some of these matters at this time.  The Company reviews these matters on an ongoing basis.  When assessing reasonably possible and probable outcomes, the Company bases its assessment on the expected ultimate outcome following all appeals.

Securities Litigation

After our Predecessor announced its intention to restructure on August 9, 2002, eight purported securities fraud class action lawsuits were filed in the United States District Court for the Southern District of Indiana.  The complaints named us as a defendant, along with certain of our former officers.  These lawsuits were filed on behalf of persons or entities who purchased our Predecessor’s common stock on various dates between October 24, 2001 and August 9, 2002.  The plaintiffs allege claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and allege material omissions and dissemination of materially misleading statements regarding, among other things, the liquidity of our Predecessor and alleged problems in Conseco Finance Corp.’s manufactured housing division, allegedly resulting in the artificial inflation of our Predecessor’s stock price.  These cases were consolidated into one case in the United States District Court for the Southern District of Indiana, captioned Franz Schleicher, et al. v. Conseco, Inc., Gary Wendt, William Shea, Charles Chokel and James Adams, et al., Case No. 02-CV-1332 DFH-TAB.  The complaint seeks an unspecified amount of damages.  The plaintiffs filed an amended consolidated class action complaint with respect to the individual defendants on December 8, 2003.  Our liability with respect to this lawsuit was discharged in our Predecessor’s plan of reorganization and our obligation to indemnify individual defendants who were not serving as an officer or director on the Effective Date is limited to $3 million in the aggregate under such plan.  Our liability to indemnify individual defendants who were serving as an officer or director on the Effective Date, of which there is one such defendant, is not limited by such plan.  The parties to this case have reached a settlement, which was approved by the court.  The Company did not incur any additional liability in connection with the settlement.

 

On August 6, 2009, a purported class action complaint was filed in the United States District Court for the Southern District of New York, Plumbers and Pipefitters Local Union No. 719 Pension Trust Fund, on behalf of itself and all others similarly situated v. Conseco, Inc., et al., Case No. 09-CIV-6966, on behalf of purchasers of our common stock during the period from August 4, 2005 to March 17, 2008 (the “Class Period”).  The complaint charges CNO and certain of its officers and directors with violations of the Securities Exchange Act of 1934.  On June 2, 2010, the plaintiff filed a second amended complaint.  The amended complaint alleges that, during the Class Period, the defendants issued numerous statements regarding the Company’s financial performance. As alleged in the complaint, these statements were materially false and misleading because the defendants misrepresented and/or failed to disclose the following adverse facts, among others: (i) that the Company was reporting materially inaccurate revenue figures; (ii) that the Company’s reported financial results were materially misstated and did not present the true operating performance of the Company; (iii) that the Company’s shareholders’ equity was materially overstated during the Class Period, including the overstatement of shareholders’ equity by $20.6 million at December 31, 2006; and (iv) as a result of the foregoing, the defendants lacked a reasonable basis for their positive statements about the Company, its corporate governance practices, its prospects and earnings growth.  On August 2, 2010, we filed a motion to dismiss the amended complaint.  We believe the action is without merit and intend to defend it vigorously.  The ultimate outcome of the action cannot be predicted with certainty.

On June 2, 2010, a purported shareholder derivative complaint was filed in the Marion County Circuit/Superior Court, Indiana, William T. Carter, derivatively on behalf of CNO Financial Group, Inc. v. R. Glenn Hilliard, Donna A. James, R. Keith Long, Debra J. Perry, C. James Prieur, Neal C. Schneider, Michael T. Tokarz, John G. Turner, William Kirsch, Eugene Bullis, Michael Dubes, James Hohmann, Edward Bonach, Ali Inanilan, and John Wells, and CNO Financial Group, Inc., Cause No. 49D10 10 06 PL 024523, on behalf of nominal defendant CNO Financial Group, Inc. against certain current and/or former members of its Board of Directors and executive officers seeking to remedy defendant’s alleged breaches of fiduciary duties and unjust enrichment from August 2005 to the present.  On November 1, 2010, the plaintiffs filed an amended complaint.  The allegations in the complaint are similar to those described in the preceding paragraph.  On December 17, 2010, we filed a motion to dismiss the amended complaint.  We believe the action is without merit, and intend to defend it vigorously.  The ultimate outcome of the action cannot be predicted with certainty.
 
    Cost of Insurance Litigation

Two lawsuits are pending in Hawaii captioned AE Ventures for Archie Murakami, et al. v. Conseco, Inc., Conseco Life Insurance Company; and Doe Defendants 1-100, Case No. CV05-00594 and Clifford S. Arakaki et al. v. Conseco Life Insurance Company, Doe Defendants 1-100, Case No. CV05-00026 (United States District Court, District of Hawaii).  These suits involve an aggregate of approximately 700 plaintiffs all of whom purport to have opted out of the previously settled In Re Conseco Life Insurance Co. Cost of Insurance Litigation multi-district action.  The complaints allege nondisclosure, breach of fiduciary duty, violations of HRS 480 (unfair and/or deceptive business practices), declaratory and injunctive relief, insurance bad faith, punitive damages, and seeks to impose alter ego liability.  A settlement in principle has been reached.  The ultimate outcome of these lawsuits cannot be predicted with certainty and an adverse outcome could exceed the amount we have accrued and could have a material adverse impact on the Company’s consolidated financial condition, cash flows or results of operations.

Other Litigation

On November 17, 2005, a complaint was filed in the United States District Court for the Northern District of California, Robert H. Hansen, an individual, and on behalf of all others similarly situated v. Conseco Insurance Company, an Illinois corporation f/k/a Conseco Annuity Assurance Company, Cause No. C0504726.  Plaintiff in this putative class action purchased an annuity in 2000 and is claiming relief on behalf of the proposed national class for alleged violations of the Racketeer Influenced and Corrupt Organizations Act; elder abuse; unlawful, deceptive and unfair business practices; unlawful, deceptive and misleading advertising; breach of fiduciary duty; aiding and abetting of breach of fiduciary duty; and unjust enrichment and imposition of constructive trust.  On January 27, 2006, a similar complaint was filed in the same court entitled Friou P. Jones, on Behalf of Himself and All Others Similarly Situated v. Conseco Insurance Company, an Illinois company f/k/a Conseco Annuity Assurance Company, Cause No. C06-00537.  Mr. Jones had purchased an annuity in 2003.  Each case alleged that the annuity sold was inappropriate and that the annuity products in question are inherently unsuitable for seniors age 65 and older.  On March 3, 2006 a first amended complaint was filed in the Hansen case adding causes of action for fraudulent concealment and breach of the duty of good faith and fair dealing.  In an order dated April 14, 2006, the court consolidated the two cases under the original Hansen cause number and retitled the consolidated action:  In re Conseco Insurance Co. Annuity Marketing & Sales Practices Litig.  A settlement in principle has been reached in this case, and the hearing for preliminary approval of the settlement is set for March 25, 2011.

 


On March 4, 2008, a complaint was filed in the United States District Court for the Central District of California, Celedonia X. Yue, M. D. on behalf of the class of all others similarly situated, and on behalf of the General Public v. Conseco Life Insurance Company, successor to Philadelphia Life Insurance Company and formerly known as Massachusetts General Life Insurance Company, Cause No. CV08-01506 CAS.  Plaintiff in this putative class action owns a Valulife universal life policy insuring the life of Ruth S. Yue originally issued by Massachusetts General Life Insurance Company in 1995.  Plaintiff is claiming breach of contract on behalf of the proposed national class and seeks injunctive and restitutionary relief pursuant to California Business & Professions Code Section 17200 and declaratory relief.  The putative class consists of all owners of Valulife and Valuterm universal life insurance policies issued by either Massachusetts General or Philadelphia Life and that were later acquired and serviced by Conseco Life.  Plaintiff alleges that members of the class will be damaged by increases in the cost of insurance (a non-guaranteed element) that are set to take place in the twenty first policy year of Valulife and Valuterm policies. No such increases have yet been applied to the subject policies.  During 2010, Conseco Life voluntarily agreed not to implement the cost of insurance rate increase at issue in this litigation and is following a process with respect to any future cost of insurance rate increases as set forth in the regulatory settlement agreement described below.  Plaintiff filed a motion for certification of a nationwide class and a California state class.  On December 7, 2009, the court granted that motion.  On October 8, 2010, the court dismissed the causes of actions alleged in the California state class.  On January 19, 2011, the court granted the plaintiff’s motion for summary judgment as to the declaratory relief claim and on February 2, 2011, the court issued an advisory opinion, in the form of a declaratory judgment, as to what, in its view, Conseco Life could consider in implementing future cost of insurance rate increases related to its Valulife and Valuterm block of policies.  On February 17, 2011, Conseco Life filed notice that it is appealing the court’s decision.  We believe the action is without merit, and intend to defend it vigorously.  The ultimate outcome of the action cannot be predicted with certainty.

On December 8, 2008, a purported Florida state class action was filed in the U.S. District Court for the Southern District of Florida, Sydelle Ruderman individually and on behalf of all other similarly situated v. Washington National Insurance Company, Case No. 08-23401-CIV-Cohn/Selzer. In the complaint, plaintiff alleges that the inflation escalation rider on her policy of long-term care insurance operates to increase the policy’s lifetime maximum benefit, and that Washington National breached the contract by stopping her benefits when they reached the lifetime maximum.  The Company takes the position that the inflation escalator only affects the per day maximum benefit.  Plaintiffs filed their motion for class certification, and the motion has been fully briefed by both sides.  The court has not yet ruled on the motion or set it for hearing.  Additional parties have asked the court to allow them to intervene in the action, and on January 5, 2010, the court granted the motion to intervene and granted the plaintiff’s motion for class certification.  The court certified a (B) (3) Florida state class alleging damages and a (B) (2) Florida state class alleging injunctive relief.  The parties have reached a settlement in principle of the (B) (3) class.  The plaintiffs filed a motion for summary judgment as to the (B) (2) class which was granted by the court on September 8, 2010.  The Company filed a notice of appeal on October 6, 2010.  We believe the action is without merit, and intend to defend it vigorously.  The ultimate outcome of the action cannot be predicted with certainty.

On December 24, 2008, a purported class action was filed in the U.S. District Court for the Northern District of California, Cedric Brady, et. al. individually and on behalf of all other similarly situated v. Conseco, Inc. and Conseco Life Insurance Company Case No. 3:08-cv-05746.  The plaintiffs allege that Conseco Life and Conseco, Inc. committed breach of contract and insurance bad faith and violated various consumer protection statutes in the administration of various interest sensitive whole life products sold primarily under the name “Lifetrend” by requiring the payment of additional cash amounts to maintain the policies in force and by making changes to certain non-guaranteed elements in their policies.  On April 23, 2009, the plaintiffs filed an amended complaint adding the additional counts of breach of fiduciary duty, fraud, negligent misrepresentation, conversion and declaratory relief.  On May 29, 2009, Conseco, Inc. and Conseco Life filed a motion to dismiss the amended complaint.  On July 29, 2009, the court granted in part and denied in part the motion to dismiss.  The court dismissed the allegations that Conseco Life violated various consumer protection statutes, the breach of fiduciary duty count, and dismissed Conseco, Inc. for lack of personal jurisdiction.  On October 15, 2009, Conseco Life filed a motion with the Judicial Panel on Multidistrict Litigation (“MDL”), seeking the establishment of an MDL proceeding consolidating this case and the McFarland case described below into a single action.  On February 3, 2010, the Judicial Panel on MDL ordered this case be consolidated for pretrial proceedings.  On July 7, 2010, plaintiffs filed an amended motion for class certification of a nationwide class and a California state class.  The Company filed its motion in opposition on July 21, 2010.  On October 6, 2010, the court granted the motion for certification of a nationwide class and denied the motion for certification of a California state class.  Trial is set for May 7, 2012.  The Company believes the action is without merit and intends to defend it vigorously.  The ultimate outcome of the action cannot be predicted with certainty.


 

On July 2, 2009, a purported class action was filed in the U.S. District Court for the Middle District of Florida, Bill W. McFarland, and all those similarly situated v. Conseco Life Insurance Company, Case No. 3:09-cv-598-J-32MCR.  The plaintiff alleges that Conseco Life committed breach of contract and has been unjustly enriched in the administration, including changes to certain non-guaranteed elements, of various interest sensitive whole life products sold primarily under the name “Lifetrend.”  The plaintiff seeks declaratory and injunctive relief, compensatory damages, punitive damages and attorney fees.  As described in the preceding paragraph, on February 3, 2010, the Judicial Panel on MDL ordered this case be consolidated with the Brady case for pretrial proceedings in the Northern District of California Federal Court.  On July 7, 2010, plaintiffs filed an amended motion for class certification of a nationwide class and a California state class.  The Company filed its motion in opposition on July 21, 2010.  On October 6, 2010, the court granted the motion for certification of a nationwide class and denied the motion for certification of a California state class.  Trial is set for May 7, 2012.  The Company believes the action is without merit and intends to defend it vigorously.  The ultimate outcome of the action cannot be predicted with certainty.

On January 26, 2009, a purported class action complaint was filed in the United States District Court for the Northern District of Illinois, Samuel Rowe and Estella Rowe, individually and on behalf of themselves and all others similarly situated v. Bankers Life & Casualty Company and Bankers Life Insurance Company of Illinois, Case No. 09CV491.  The plaintiffs are alleging violation of California Business and Professions Code Sections 17200 et seq. and 17500 et seq., breach of common law fiduciary duty, breach of implied covenant of good faith and fair dealing and violation of California Welfare and Institutions Code Section 15600 on behalf of the proposed national class and seek injunctive relief, compensatory damages, punitive damages and attorney fees.  The plaintiff alleges that the defendants used an improper and misleading sales and marketing approach to seniors that fails to disclose all facts, misuses consumers’ confidential financial information, uses misleading sales and marketing materials, promotes deferred annuities that are fundamentally inferior and less valuable than readily available alternative investment products and fails to adequately disclose other principal risks including maturity dates, surrender penalties and other restrictions which limit access to annuity proceeds to a date beyond the applicants actuarial life expectancy.  Plaintiffs have amended their complaint attempting to convert this from a California only class action to a national class action.  In addition, the amended complaint adds causes of action under the Racketeer Influenced and Corrupt Organization Act (“RICO”); aiding and abetting breach of fiduciary duty and for unjust enrichment.  On September 13, 2010, the court dismissed the plaintiff’s RICO claims.  On October 25, 2010, the plaintiffs filed a second amended complaint re-alleging their RICO claims.  A hearing date on the motion for class certification has not been set.  We believe the action is without merit, and intend to defend it vigorously.  The ultimate outcome of the action cannot be predicted with certainty.

In addition, the Company and its subsidiaries are involved on an ongoing basis in other lawsuits, including purported class actions, related to their operations.  The ultimate outcome of all of these other legal matters pending against the Company or its subsidiaries cannot be predicted, and, although such lawsuits are not expected individually to have a material adverse effect on the Company, such lawsuits could have, in the aggregate, a material adverse effect on the Company’s consolidated financial condition, cash flows or results of operations.

Regulatory Examinations and Fines

Insurance companies face significant risks related to regulatory investigations and actions.  Regulatory investigations generally result from matters related to sales or underwriting practices, payment of contingent or other sales commissions, claim payments and procedures, product design, product disclosure, additional premium charges for premiums paid on a periodic basis, denial or delay of benefits, charging excessive or impermissible fees on products, changing the way cost of insurance charges are calculated for certain life insurance products or recommending unsuitable products to customers.  We are, in the ordinary course of our business, subject to various examinations, inquiries and information requests from state, federal and other authorities.  The ultimate outcome of these regulatory actions cannot be predicted with certainty.  In the event of an unfavorable outcome in one or more of these matters, the ultimate liability may be in excess of liabilities we have established and we could suffer significant reputational harm as a result of these matters, which could also have a material adverse effect on our business, financial condition, results of operations or cash flows.

The states of Pennsylvania, Illinois, Texas, Florida and Indiana led a multistate examination of the long-term care claims administration and complaint handling practices of Senior Health and Bankers Life, as well as the sales and marketing practices of Bankers Life.  On May 7, 2008, we announced a settlement among the state insurance regulators and Senior Health and Bankers Life.  This examination covered the years 2005, 2006 and 2007.  More than 40 states are parties to the settlement, which included a Senior Health fine of up to $2.3 million, with up to an additional $10 million payable, on the part of either Senior Health and/or Bankers Life, in the event the process improvements and benchmarks are not met.  The

 

process improvement plan is being monitored by the lead states and pursuant to the settlement agreement, the lead states are conducting a re-examination of Bankers Life to confirm compliance with the process improvements and benchmarks.

In late October 2008, Conseco Life mailed notice to approximately 12,000 holders of its “Lifetrend” life insurance products to inform them of:  (i) changes to certain “non-guaranteed elements” (“NGEs”) of their policies; and (ii) the fact that certain policyholders who were not paying premiums may have failed to receive a notice that their policy was underfunded and that additional premiums were required in order for the policyholders to maintain their guaranteed cash values.  In December 2008, Conseco Life mailed notice to approximately 16,000 holders of its CIUL3+ universal life policies to inform them of an increase in certain NGEs with respect to their policies.  Prior to or around the time that the notices were sent, Conseco Life had informed the insurance regulators in a number of states, including among others Indiana, Iowa and Florida, of these matters and the planned communication with the impacted policyholders.  Several states initiated regulatory actions and inquiries after the notices were sent by Conseco Life, and Conseco Life agreed to take no further actions with respect to those policies during the pendency of a market conduct examination.

After working with various state insurance regulators to review the terms of the Lifetrend and CIUL3+ policies, Conseco Life reached a settlement in principle with the regulators regarding issues involving these policies. During this regulatory review process, Conseco Life had been allowed to move forward with implementing the NGE changes in its CIUL3+ policies while the regulators continued their review.  Conseco Life had also resumed the administration of its Lifetrend policies with administrative changes in place but did not implement the NGE changes pending execution of the final settlement agreement with the regulators.  On June 30, 2010, we announced that Conseco Life had finalized a regulatory settlement agreement that requires the establishment of a $10 million fund for certain owners of its Lifetrend life insurance products and the payment of a $1 million assessment to participating jurisdictions.  Over 45 jurisdictions, representing almost 98 percent of the Lifetrend policyholders, have signed the settlement agreement.  Conseco Life is in the process of notifying consumers of the settlement and the increase in their non-guaranteed elements.  As previously disclosed, we accrued for the financial impact of the settlement in our consolidated financial statements for year-end 2009.

Guaranty Fund Assessments

The balance sheet at December 31, 2010, included: (i) accruals of $21.8 million, representing our estimate of all known assessments that will be levied against the Company’s insurance subsidiaries by various state guaranty associations based on premiums written through December 31, 2010; and (ii) receivables of $16.2 million that we estimate will be recovered through a reduction in future premium taxes as a result of such assessments.  At December 31, 2009, such guaranty fund assessment accruals were $22.1 million and such receivables were $16.9 million.  These estimates are subject to change when the associations determine more precisely the losses that have occurred and how such losses will be allocated among the insurance companies.  We recognized expense for such assessments of $2.4 million, $.3 million and $3.1 million in 2010, 2009 and 2008, respectively.

Guarantees

We held bank loans made to certain former directors and employees that enabled them to purchase common stock of our Predecessor.  These loans, with a principal amount of $481.3 million, had been guaranteed by our Predecessor.  We received all rights to collect the balances due pursuant to the original terms of these loans.  In addition, we held loans to participants for interest on the loans.  The loans and the interest loans are collectively referred to as the “D&O loans.”  At December 31, 2010, we had reached settlements with the former directors and employees and had collected the remaining amounts outstanding related to the D&O loan settlements.

Pursuant to the settlement that was reached with the Official Committee of the Trust Originated Preferred Securities (“TOPrS”) Holders and the Official Committee of Unsecured Creditors in the Plan, the former holders of TOPrS (issued by our Predecessor’s subsidiary trusts and eliminated in our reorganization) who did not opt out of the bankruptcy settlement, were entitled to receive 45 percent of any net proceeds from the collection of certain D&O loans in an aggregate amount not to exceed $30 million.  As of December 31, 2010, we had paid $20.5 million to the former holders of TOPrS and we have established a liability of $2.0 million (which is included in other liabilities), representing the final amount which will be paid to the former holders of TOPrS pursuant to the settlement.

In accordance with the terms of the employment agreements of two of the Company’s former chief executive officers, certain wholly-owned subsidiaries of the Company are the guarantors of the former executives’ nonqualified supplemental retirement benefits.  The liability for such benefits was $22.6 million and $22.0 million at December 31, 2010 and 2009,

 

respectively, and is included in the caption “Other liabilities” in the consolidated balance sheet.

Leases and Certain Other Long-Term Commitments

The Company rents office space, equipment and computer software under noncancellable operating lease agreements.  In addition, the Company has entered into certain sponsorship agreements which require future payments.  Total expense pursuant to these lease and sponsorship agreements was $42.8 million, $42.3 million and $44.1 million in 2010, 2009 and 2008, respectively.  Future required minimum payments as of December 31, 2010, were as follows (dollars in millions):

2011                                                                                               
 $45.0 
2012                                                                                               
  33.8 
2013                                                                                               
  27.0 
2014                                                                                               
  20.7 
2015                                                                                               
  17.4 
Thereafter                                                                                               
  45.6 
      
Total                                                                                         
 $189.5 

OTHER DISCLOSURES
Other Disclosures

9.  
OTHER DISCLOSURES

Agent Deferred Compensation Plan

For our agent deferred compensation plan and postretirement plans, it is our policy to immediately recognize changes in the actuarial benefit obligation resulting from either actual experience being different than expected or from changes in actuarial assumptions.

One of our insurance subsidiaries has a noncontributory, unfunded deferred compensation plan for qualifying members of its career agency force.  Benefits are based on years of service and career earnings.  The actuarial measurement date of this deferred compensation plan is December 31.  The liability recognized in the consolidated balance sheet for the agents’ deferred compensation plan was $114.4 million and $106.3 million at December 31, 2010 and 2009, respectively.  Costs incurred on this plan were $13.0 million, $11.9 million and $7.7 million during 2010, 2009 and 2008, respectively (including the recognition of gains (losses) of $(3.6) million, $(3.3) million and $.6 million in 2010, 2009 and 2008, respectively, resulting from actual experience being different than expected or from changes in actuarial assumptions).  The estimated net loss for the agent deferred compensation plan that will be amortized from accumulated other comprehensive income (loss) into the net periodic benefit cost during 2011 is $.8 million.  In 2006, we purchased Company-owned life insurance (“COLI”) as an investment vehicle to fund the agent deferred compensation plan.  The COLI assets are not assets of the agent deferred compensation plan, and as a result, are accounted for outside the plan and are recorded in the consolidated balance sheet as other invested assets.  The carrying value of the COLI assets was $102.7 million and $78.0 million at December 31, 2010 and 2009, respectively.  Changes in the cash surrender value (which approximates net realizable value) of the COLI assets are recorded as net investment income.

We used the following assumptions for the deferred compensation plan to calculate:

   
2010
  
2009
 
        
Benefit obligations:
      
Discount rate
  5.50 %  5.75 %
          
Net periodic cost:
        
Discount rate
  5.75 %  6.03 %

The discount rate is based on the yield of a hypothetical portfolio of high quality debt instruments which could effectively settle plan benefits on a present value basis as of the measurement date.  At December 31, 2010, for our deferred compensation plan for qualifying members of our career agency force, we assumed a 5 percent annual increase in compensation until the participant’s normal retirement date (age 65 and completion of five years of service).


 

The benefits expected to be paid pursuant to our agent deferred compensation plan as of December 31, 2010 were as follows (dollars in millions):

2011                                                   
 $4.7 
2012                                                   
  4.8 
2013                                                   
  5.4 
2014                                                   
  5.8 
2015                                                   
  6.3 
2016 – 2020                                                   
  36.5 

The Company has qualified defined contribution plans for which substantially all employees are eligible.  Company contributions, which match certain voluntary employee contributions to the plan, totaled $4.1 million, $4.2 million and $4.4 million in 2010, 2009 and 2008, respectively.  Employer matching contributions are discretionary.

Reclassification Adjustments Included in Accumulated Other Comprehensive Income (Loss)

The changes in unrealized appreciation (depreciation) included in accumulated other comprehensive income (loss) are net of reclassification adjustments for after-tax net gains (losses) from the sale of investments included in net income (loss) of approximately $(175) million, $(593) million and $(19) million for the years ended December 31, 2010, 2009 and 2008, respectively.

SHAREHOLDERS' EQUITY
Shareholders' Equity

 
10.
SHAREHOLDERS’ EQUITY

In December 2009, we completed the public offering, including underwriter over-allotments, of 49.5 million shares of our common stock at an offering price of $4.75 per share.  The net proceeds to the Company from the offering, after deducting underwriting commissions and discounts and offering expenses totaled $222.7 million.  The Company used $161.4 million of the net proceeds from the offering to reduce its indebtedness under its Previous Senior Credit Agreement and the remaining net proceeds were used for general corporate purposes.

In November 2009, we completed the private sale of 16.4 million shares of our common stock and warrants to purchase 5.0 million shares of our common stock to Paulson on behalf of several investment funds and accounts managed by Paulson. The net proceeds to the Company from the private placement, after deducting financial advisory fees and other offering expenses, totaled $73.6 million.  The Company used $36.8 million of the net proceeds from the private placement to reduce its indebtedness under its Previous Senior Credit Agreement and used $10.5 million to fund the portion of the settlement of the Tender Offer that was not funded by the issuance of the 7.0% Debentures, as further described in the note to the consolidated financial statements entitled “Notes Payable – Direct Corporate Obligations”.  The remaining proceeds were used:  (i) to pay a portion of the purchase price of the 3.5% Debentures that were repurchased by us in 2010; and (ii) for general corporate purposes.

In November 2009, concurrently with the completion of the private placement of our common stock and warrants, we entered into an investor rights agreement with Paulson, pursuant to which we granted to Paulson, among other things, certain registration rights with respect to certain securities and certain preemptive rights, and Paulson agreed to, among other things, certain restrictions on transfer of certain securities, certain voting limitations and certain standstill provisions.

The warrants have an exercise price of $6.50 per share of common stock, subject to customary anti-dilution adjustments. Prior to June 30, 2013, the warrants are not exercisable, except under limited circumstances. Commencing on June 30, 2013, the warrants will be exercisable for shares of our common stock at the option of the holder at any time, subject to certain exceptions.  The warrants expire on December 30, 2016.

Prior to completing the private placement with Paulson, our board of directors deemed Paulson an “Exempted Entity” and therefore not an “Acquiring Person” for purposes of our Section 382 Rights Agreement, with respect to the 16.4 million shares of common stock, any shares of common stock issued upon exercise of the warrants, any common stock issued upon conversion of the 7.0% Debentures owned by Paulson, as well as the shares of common stock Paulson owned prior to the private placement.  See the note to the consolidated financial statements entitled “Income Taxes” for more information on the Section 382 Rights Agreement.


 

Pursuant to the Plan, we issued warrants to purchase 6.0 million shares of our common stock (the “Series A Warrants”) entitling the holders to purchase shares of CNO common stock at a price of $27.60 per share.  The Series A Warrants expired on September 10, 2008.

Changes in the number of shares of common stock outstanding were as follows (shares in thousands):

   
2010
    
2009
  
2008
  
              
Balance, beginning of year                                                                               
  250,786     184,754   184,652  
Issuance of common stock                                                                           
  -     65,900   -  
Shares issued under employee benefit compensation plans
  265 
(a)
  132   102 
(a)
Stock options exercised                                                                           
  33     -    -  
                 
                 
Balance, end of year                                                                               
  251,084     250,786   184,754  
____________________
(a)  
In 2010 and 2008, such amount was reduced by 74 thousand shares and 16 thousand shares, respectively, which were tendered for the payment of federal and state taxes owed on the issuance of restricted stock.

The Company has a long-term incentive plan which permits the grant of CNO incentive or non-qualified stock options, restricted stock awards, stock appreciation rights, performance shares or units and certain other equity-based awards to certain directors, officers and employees of the Company and certain other individuals who perform services for the Company.  In April 2009, the shareholders of the Company approved an increase in the number of shares authorized to be issued under the plan to a maximum of 25.8 million shares from 10 million shares.  As of December 31, 2010, 9.3 million shares remained available for issuance under the plan.  Our stock option awards are generally granted with an exercise price equal to the market price of the Company’s stock on the date of grant.  For options granted in 2006 and prior years, our stock option awards generally vest on a graded basis over a four year service term and expire ten years from the date of grant.  Our stock option awards granted in 2007 through 2009 generally vest on a graded basis over a three year service term and expire five years from the date of grant.  Our stock options granted in 2010 vest on a graded basis over a three year service term and expire seven years from the date of grant.  The vesting periods for our restricted stock awards range from immediate vesting to a period of four years.

A summary of the Company’s stock option activity and related information for 2010 is presented below (shares in thousands; dollars in millions, except per share amounts):

      
Weighted
 
Weighted
  
      
average
 
average
 
Aggregate
      
exercise
 
remaining
 
intrinsic
   
Shares
  
price
 
life
 
value
            
Outstanding at the beginning of the year
  8,560  $11.65        
                 
Options granted                                                           
  1,849   6.43        
                 
Exercised                                                           
  (33)  2.83       $-  
                    
Forfeited or terminated                                                           
  (622)  8.81           
                    
Outstanding at the end of the year                                                           
  9,754   10.87    
3.6 years
 $38.3  
                   
Options exercisable at the end of the year
  4,374       
2.9 years
 $24.1  
                   
Available for future grant 
  9,326              


 

A summary of the Company’s stock option activity and related information for 2009 is presented below (shares in thousands; dollars in millions, except per share amounts):

      
Weighted
 
Weighted
   
      
average
 
average
 
Aggregate
 
      
exercise
 
remaining
 
intrinsic
 
   
Shares
  
price
 
life
 
value
 
             
Outstanding at the beginning of the year
  5,864  $16.94      
               
Options granted                                                           
  3,219   2.64      
               
Exercised                                                           
  -   -    $- 
                
Forfeited or terminated                                                           
  (523)  15.52       
                
Outstanding at the end of the year                                                           
  8,560   11.65 
4.1 years
 $31.6 
                
Options exercisable at the end of the year
  2,992     
4.4 years
 $19.4 
                
Available for future grant                                                           
  12,565           

A summary of the Company’s stock option activity and related information for 2008 is presented below (shares in thousands; dollars in millions, except per share amounts):

      
Weighted
 
Weighted
   
      
average
 
average
 
Aggregate
 
      
exercise
 
remaining
 
Intrinsic
 
   
Shares
  
price
 
life
 
Value
 
             
Outstanding at the beginning of the year
  4,828  $19.82      
               
Options granted                                                           
  1,863   10.27      
               
Exercised                                                           
  -   -    $- 
                
Forfeited or terminated                                                           
  (827)  18.69       
                
Outstanding at the end of the year                                                           
  5,864   16.94 
4.8 years
 $27.9 
                
Options exercisable at the end of the year
  2,412     
5.5 years
 $16.6 
                
Available for future grant                                                           
  1,154           

We recognized compensation expense related to stock options totaling $7.1 million ($4.6 million after income taxes) in 2010, $6.9 million ($4.5 million after income taxes) in 2009 and $6.0 million ($3.9 million after income taxes) in 2008.  Compensation expense related to stock options reduced both basic and diluted earnings (loss) per share by 2 cents in 2010, 2009 and 2008.  At December 31, 2010, the unrecognized compensation expense for non-vested stock options totaled $9.8 million which is expected to be recognized over a weighted average period of 1.8 years.  Cash received from the exercise of stock options was $.1 million, nil and nil during 2010, 2009 and 2008, respectively.

 


The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option valuation model with the following weighted average assumptions:

   
2010 Grants
  
2009 Grantss
  
2008 Grantss
 
           
Weighted average risk-free interest rates
  2.5%  1.6%  2.5%
Weighted average dividend yields                                                            
  0.0%  0.0%  0.0%
Volatility factors                                                            
  105%  108%  24%
Weighted average expected life                                                            
 
4.7 years
  
3.8 years
  
3.7 years
 
Weighted average fair value per share
 $4.90  $1.89  $2.25 

The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant.  The dividend yield is based on the Company’s history and expectation of dividend payouts.  Volatility factors are based on the weekly historical volatility of the Company’s common stock equal to the expected life of the option or since our emergence from bankruptcy in September 2003.  The expected life is based on the average of the graded vesting period and the contractual terms of the option.

The exercise price was equal to the market price of our stock for all options granted in 2010, 2009 and 2008.

The following table summarizes information about stock options outstanding at December 31, 2010 (shares in thousands):

    
Options outstanding
  
Options exercisable
 
   
Number
  
Remaining
  
Average exercise
  
Number
  
Average exercise
 
Range of exercise prices
  
outstanding
  
life (in years)
  
price
  
exercisable
  
price
 
                 
$1.13   647   3.3  $1.13   -  $- 
$2.83 - $3.11   2,213   3.4   3.05   -   - 
$4.79 - $6.45   1,788   6.2   6.41   -   - 
$8.91 - $12.96   1,531   2.2   10.58   799   10.61 
$14.78 - $21.67   3,098   2.9   19.32   3,098   19.32 
$22.42 - $25.45   477   4.8   23.18   477   23.18 
                       
     9,754           4,374     

During 2010, 2009 and 2008, the Company granted 1.0 million, .8 million and .1 million restricted shares, respectively, of CNO common stock to certain directors, officers and employees of the Company at a weighted average fair value of $6.28 per share, $1.67 per share and $9.75 per share, respectively.  The fair value of such grants totaled $6.2 million, $1.4 million and $.8 million in 2010, 2009 and 2008, respectively.  Such amounts are recognized as compensation expense over the vesting period of the restricted stock.  A summary of the Company’s non-vested restricted stock activity for 2010 is presented below (shares in thousands):

      
Weighted
 
      
average
 
      
grant date
 
   
Shares
  
fair value
 
        
Non-vested shares, beginning of year                                                                                   
  748  $2.15 
Granted                                                                               
  985   6.28 
Vested                                                                               
  (340)  3.89 
Forfeited                                                                               
  (74)  4.61 
          
Non-vested shares, end of year                                                                                   
  1,319   4.65 

At December 31, 2010, the unrecognized compensation expense for non-vested restricted stock totaled $4.4 million which is expected to be recognized over a weighted average period of 2.0 years.  At December 31, 2009, the unrecognized compensation expense for non-vested restricted stock totaled $1.1 million.  We recognized compensation expense related to

 

restricted stock awards totaling $2.5 million, $.9 million and $1.4 million in 2010, 2009 and 2008, respectively.  The fair value of restricted stock that vested during 2010, 2009 and 2008 was $1.3 million, $.8 million and $1.9 million, respectively.

Authoritative guidance also requires us to estimate the amount of unvested stock-based awards that will be forfeited in future periods and reduce the amount of compensation expense recognized over the applicable service period to reflect this estimate. We periodically evaluate our forfeiture assumptions to more accurately reflect our actual forfeiture experience.

The Company does not currently recognize tax benefits resulting from tax deductions in excess of the compensation expense recognized because of NOLs which are available to offset future taxable income.

As further discussed in the footnote to the consolidated financial statements entitled “Income Taxes”, the Company’s Board of Directors adopted the Section 382 Rights Agreement on January 20, 2009, which is designed to protect shareholder value by preserving the value of our tax assets primarily associated with NOLs.  As a result, the Company declared a dividend of one preferred share purchase right (a “Right”) for each outstanding share of common stock.  The dividend was payable on January 30, 2009, to the shareholders of record as of the close of business on that date.  Each Right entitles the shareholder to purchase from the Company one one-thousandth of a share of Series A Junior Participating Preferred Stock, par value $.01 per share (the “Junior Preferred Stock”) of the Company at a price of $20.00 per one one-thousandth of a share of Junior Preferred Stock.  The description and terms of the Rights are set forth in the Section 382 Rights Agreement.  The Rights would become exercisable in the event any person or group (subject to certain exemptions) becomes a “5 percent shareholder” of CNO without the approval of the Board of Directors or an existing shareholder who is currently a “5 percent shareholder” acquires additional shares exceeding one percent of our outstanding shares without prior approval from the Board of Directors.

A reconciliation of net income (loss) and shares used to calculate basic and diluted earnings (loss) per share is as follows (dollars in millions and shares in thousands):

   
2010
  
2009
  
2008
 
           
Income (loss) before discontinued operations
 $284.6  $85.7  $(409.6)
Discontinued operations
  -   -   (722.7)
              
Net income (loss) for basic earnings per share
  284.6   85.7   (1,132.3)
              
Add:  interest expense on 7.0% Debentures, net of income taxes
  13.3   1.1   - 
Net income (loss) for diluted earnings per share
 $297.9  $86.8  $(1,132.3)
              
Shares:
            
Weighted average shares outstanding for basic earnings per share
  250,973   188,365   184,704 
              
Effect of dilutive securities on weighted average shares:
            
7% Debentures
  49,014   4,281   - 
Stock option and restricted stock plans
  1,871   694    - 
              
Dilutive potential common shares
  50,885   4,975    - 
              
Weighted average shares outstanding for diluted earnings per share
  301,858   193,340   184,704 

There were no dilutive common stock equivalents during 2008 because of the net loss recognized by the Company during such period.  Therefore, all potentially dilutive shares are excluded in the weighted average shares outstanding for diluted earnings per share.

 


The following summarizes the equivalent common shares for securities that were not included in the computation of diluted earnings per share, because doing so would have been antidilutive in such periods (shares in thousands).

   
2008
 
     
Equivalent common shares that were antidilutive during the year:
   
Stock option and restricted stock plans                                                                              
  32 
      
Antidilutive equivalent common shares                                                                            
  32 

In August 2005, we completed the private offering of the 3.5% Debentures.  For periods in which the 3.5% Debentures were outstanding, the conversion feature of the 3.5% Debentures did not have a dilutive effect because the weighted average market price of our common stock did not exceed the initial conversion price of $26.66.  Therefore, the 3.5% Debentures had no effect on our diluted shares outstanding or our diluted earnings per share in 2010, 2009 or 2008.

Basic earnings (loss) per common share is computed by dividing net income (loss) applicable to common stock by the weighted average number of common shares outstanding for the period.  Restricted shares (including our performance shares) are not included in basic earnings (loss) per share until vested.  Diluted earnings (loss) per share reflect the potential dilution that could occur if outstanding stock options were exercised and restricted stock was vested.  The dilution from options and restricted shares is calculated using the treasury stock method.  Under this method, we assume the proceeds from the exercise of the options (or the unrecognized compensation expense with respect to restricted stock) will be used to purchase shares of our common stock at the average market price during the period, reducing the dilutive effect of the exercise of the options (or the vesting of the restricted stock).

In 2010, 2009 and 2008, the Company granted performance shares totaling 686,900, 620,225 and 645,100, respectively, pursuant to its long-term incentive plan to certain officers of the Company.  The criteria for payment for such awards are based on certain company-wide performance levels that must be achieved within a specified performance time, each as defined in the award.  Unless antidilutive, the diluted weighted average shares outstanding would reflect the number of performance shares expected to be issued, using the treasury stock method.

A summary of the Company’s performance shares is presented below (shares in thousands):

   
Total shareholder
  
Operating return
  
Pre-tax operating
 
   
return awards
  
on equity awards
  
income awards
 
           
Awards outstanding at December 31, 2007
  218   146   - 
              
Granted in 2008
  387   258   - 
Forfeited
  (54 )  (37 )  - 
              
Awards outstanding at December 31, 2008
  551   367   - 
              
Granted in 2009
  -   620   - 
Forfeited
  (220 )  (162 )  - 
              
Awards outstanding at December 31, 2009
  331   825   - 
              
Granted in 2010
  -   -   687 
Forfeited
  (331 )  (270 )  (35 )
              
Awards outstanding at December 31, 2010
  -   555   652 

The grant date fair value of the total shareholder return awards was $1.6 million in 2008.  The grant date fair value of the operating return on equity awards was $1.9 million and $2.7 million in 2009 and 2008, respectively.  The grant date fair value of the pre-tax operating income awards was $4.4 million in 2010.  We recognized compensation expense of $2.2 million, $1.3 million and $.1 million in 2010, 2009 and 2008, respectively, related to the performance shares.

 
OTHER OPERATING STATEMENT DATA
Other Operating Statement Data

11.       OTHER OPERATING STATEMENT DATA

Insurance policy income consisted of the following (dollars in millions):

   
2010
  
2009
  
2008
 
Traditional products:
         
Direct premiums collected                                                                        
 $4,252.0  $4,128.1  $4,313.5 
Reinsurance assumed                                                                        
  99.4   476.5   642.8 
Reinsurance ceded                                                                        
  (264.7)  (185.7)  (164.3)
              
Premiums collected, net of reinsurance                                                                   
  4,086.7   4,418.9   4,792.0 
              
Change in unearned premiums                                                                        
  2.9   (2.1)  (13.5)
Less premiums on universal life and products without mortality and morbidity risk which are recorded as additions to insurance liabilities
  (1,730.1)  (1,668.9)  (1,863.5)
Premiums on traditional products with mortality or morbidity risk
  2,359.5   2,747.9   2,915.0 
Fees and surrender charges on interest-sensitive products
  310.5   345.7   338.6 
              
Insurance policy income                                                                   
 $2,670.0  $3,093.6  $3,253.6 

The four states with the largest shares of 2010 collected premiums were Florida (7.8 percent), California (7.2 percent), Texas (6.1 percent) and Pennsylvania (6.1 percent).  No other state accounted for more than five percent of total collected premiums.

Other operating costs and expenses were as follows (dollars in millions):

   
2010
  
2009
  
2008
 
           
Commission expense                                                             
 $96.8  $114.3  $128.2 
Salaries and wages                                                             
  175.6   173.5   160.5 
Other                                                             
  230.5   240.5   231.6 
              
Total other operating costs and expenses
 $502.9  $528.3  $520.3 

Changes in the present value of future profits were as follows (dollars in millions):

   
2010
  
2009
  
2008
 
           
Balance, beginning of year                                                                               
 $1,175.9  $1,477.8  $1,573.6 
Amortization
  (139.0)  (177.5)  (187.3)
Effect of reinsurance transactions
  -   (24.1)  - 
Amounts related to fair value adjustment of actively managed fixed maturities
  (28.3)  (100.3)  92.7 
Other
  -   -   (1.2)
              
Balance, end of year                                                                               
 $1,008.6  $1,175.9  $1,477.8 


 

Based on current conditions and assumptions as to future events on all policies inforce, the Company expects to amortize approximately 13 percent of the December 31, 2010 balance of the present value of future profits in 2011, 11 percent in 2012, 10 percent in 2013, 8 percent in 2014 and 7 percent in 2015.  The discount rate used to determine the amortization of the present value of future profits averaged approximately 5 percent in the years ended December 31, 2010, 2009 and 2008.

In accordance with authoritative guidance, we are required to amortize the present value of future profits in relation to estimated gross profits for universal life products and investment-type products.  Such guidance also requires that estimates of expected gross profits used as a basis for amortization be evaluated regularly, and that the total amortization recorded to date be adjusted by a charge or credit to the statement of operations, if actual experience or other evidence suggests that earlier estimates should be revised.

Changes in deferred acquisition costs were as follows (dollars in millions):

   
2010
  
2009
  
2008
 
           
Balance, beginning of year
 $1,790.9  $1,812.6  $1,423.0 
Additions
  424.8   407.5   459.1 
Amortization
  (304.8)  (255.2)  (180.6)
Effect of reinsurance transactions
  -   (79.0)  - 
Amounts related to fair value adjustment of fixed maturities, available for sale
  (136.0)  (95.0)  111.1 
Other adjustments
  (10.7)  -   - 
              
Balance, end of year
 $1,764.2  $1,790.9  $1,812.6 

CONSOLIDATED STATEMENT OF CASH FLOWS
CONSOLIDATED STATEMENT OF CASH FLOWS

12.       CONSOLIDATED STATEMENT OF CASH FLOWS

The following disclosures supplement our consolidated statement of cash flows:

Non-cash items not reflected in the investing and financing activities sections of the consolidated statement of cash flows (dollars in millions):

   
2010
  
2009
  
2008
 
           
Stock option and restricted stock plans                                                                      
 $11.4  $9.1  $7.4 
Change in securities lending collateral                                                                      
  103.7   223.1   51.6 
Change in securities lending payable                                                                      
  (103.7)  (223.1)  (51.6)

The following reconciles net income (loss) to net cash provided by operating activities (dollars in millions):

   
2010
  
2009
  
2008
 
Cash flows from operating activities:
         
Net income (loss)
 $284.6  $85.7  $(1,132.3)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
            
Amortization and depreciation
  465.3   460.9   420.7 
Income taxes
  8.5   80.7   429.0 
Insurance liabilities
  437.6   421.4   460.6 
Accrual and amortization of investment income
  (62.0)  (125.4)  3.9 
Deferral of policy acquisition costs
  (418.2)  (407.5)  (459.1)
Net realized investment (gains) losses
  (30.2)  60.5   642.5 
(Gain) loss on extinguishment of debt
  6.8   22.2   (21.2)
Loss on Transfer
  -   -   319.9 
Gain on reinsurance recapture
  -   -   (29.7)
Other
  41.6   13.2   6.0 
              
Net cash provided by operating activities                                                                                   
 $734.0  $611.7  $640.3 

 

Our consolidated statement of cash flows for 2008 combines the cash flows from discontinued operations with the cash flows from continuing operations within each major category (operating, investing and financing) of the cash flow statement.

At December 31, 2010, restricted cash and cash equivalents consisted of $26.8 million held by VIEs.

At December 31, 2009, restricted cash and cash equivalents consisted of $3.4 million held by a VIE.

STATUTORY INFORMATION (BASED ON NON-GAAP MEASURES)
Statutory Information (Based on Non-Gaap Measures)

13.       STATUTORY INFORMATION (BASED ON NON-GAAP MEASURES)

Statutory accounting practices prescribed or permitted by regulatory authorities for the Company’s insurance subsidiaries differ from GAAP.  The Company’s insurance subsidiaries reported the following amounts to regulatory agencies, after appropriate elimination of intercompany accounts among such subsidiaries (dollars in millions):

   
2010
  
2009
 
        
Statutory capital and surplus                                                       
 $1,525.1  $1,410.7 
Asset valuation reserve                                                       
  71.3   28.2 
Interest maintenance reserve                                                       
  428.1   290.6 
          
Total                                                       
 $2,024.5  $1,729.5 

Statutory capital and surplus included investments in upstream affiliates of $52.4 million at both December 31, 2010 and 2009, which was eliminated in the consolidated financial statements prepared in accordance with GAAP.

Statutory earnings build the capital required by ratings agencies and regulators.  Statutory earnings, fees and interest paid by the insurance companies to the parent company create the “cash flow capacity” the parent company needs to meet its obligations, including debt service.  The consolidated statutory net income (loss) (a non-GAAP measure) of our insurance subsidiaries was $181.9 million, $77.5 million and $(96.9) million in 2010, 2009 and 2008, respectively.  Included in such net income (loss) were net realized capital losses, net of income taxes, of $79.6 million, $186.5 million and $217.1 million in 2010, 2009 and 2008, respectively.  In addition, such net income (loss) included pre-tax amounts for fees and interest to CNO or its non-life subsidiaries totaling $132.4 million, $137.1 million and $139.6 million in 2010, 2009 and 2008, respectively.

Insurance regulators may prohibit the payment of dividends or other payments by our insurance subsidiaries to parent companies if they determine that such payment could be adverse to our policyholders or contract holders.  Otherwise, the ability of our insurance subsidiaries to pay dividends is subject to state insurance department regulations.  Insurance regulations generally permit dividends to be paid from statutory earned surplus of the insurance company without regulatory approval for any 12-month period in amounts equal to the greater of (or in a few states, the lesser of): (i) statutory net gain from operations or statutory net income for the prior year; or (ii) 10 percent of statutory capital and surplus as of the end of the preceding year, excluding $76.1 million of additional surplus recognized due to temporary modifications in statutory prescribed practices related to certain deferred tax assets.  This type of dividend is referred to as “ordinary dividends”.  Any dividends in excess of these levels require the approval of the director or commissioner of the applicable state insurance department.  This type of dividend is referred to as “extraordinary dividends”.  During 2010, our insurance subsidiaries paid extraordinary dividends of $166.0 million to CDOC (which is the immediate parent of Washington National, Conseco Life and Conseco Life Insurance Company of Texas).

Each of the immediate subsidiaries of CDOC have negative earned surplus at December 31, 2010.  Accordingly, any dividend payments from these subsidiaries require the approval of the director or commissioner of the applicable state insurance department.  During 2011, we are expecting our insurance subsidiaries to pay approximately $215 million of extraordinary dividends to CDOC (subject to approval by the applicable state insurance department) and CDOC expects to make capital contributions to our insurance subsidiaries totaling $160.0 million.  In addition, we are expecting our insurance subsidiaries to pay interest on surplus debentures of $48.7 million in 2011, which will not require additional approval provided the risk-based capital (“RBC”) ratio of Conseco Life Insurance Company of Texas exceeds 100 percent (but will require prior written notice to the Texas state insurance department).  Dividends and other payments from our non-insurance subsidiaries to CNO or CDOC do not require approval by any regulatory authority or other third party.  Also, during 2010, CDOC made capital contributions of $114.4 million to our insurance subsidiaries.


 

In accordance with an order from the Florida Office of Insurance Regulation, Washington National may not distribute funds to any affiliate or shareholder without prior notice to the Florida Office of Insurance Regulation.  In addition, the RBC and other capital requirements described below can also limit, in certain circumstances, the ability of our insurance subsidiaries to pay dividends.

RBC requirements provide a tool for insurance regulators to determine the levels of statutory capital and surplus an insurer must maintain in relation to its insurance and investment risks and the need for possible regulatory attention.  The RBC requirements provide four levels of regulatory attention, varying with the ratio of the insurance company’s total adjusted capital (defined as the total of its statutory capital and surplus, AVR and certain other adjustments) to its RBC (as measured on December 31 of each year) as follows:  (i) if a company’s total adjusted capital is less than 100 percent but greater than or equal to 75 percent of its RBC, the company must submit a comprehensive plan to the regulatory authority proposing corrective actions aimed at improving its capital position (the “Company Action Level”); (ii) if a company’s total adjusted capital is less than 75 percent but greater than or equal to 50 percent of its RBC, the regulatory authority will perform a special examination of the company and issue an order specifying the corrective actions that must be taken; (iii) if a company’s total adjusted capital is less than 50 percent but greater than or equal to 35 percent of its RBC, the regulatory authority may take any action it deems necessary, including placing the company under regulatory control; and (iv) if a company’s total adjusted capital is less than 35 percent of its RBC, the regulatory authority must place the company under its control.  In addition, the RBC requirements provide for a trend test if a company’s total adjusted capital is between 100 percent and 125 percent of its RBC at the end of the year.  The trend test calculates the greater of the decrease in the margin of total adjusted capital over RBC:  (i) between the current year and the prior year; and (ii) for the average of the last 3 years.  It assumes that such decrease could occur again in the coming year.  Any company whose trended total adjusted capital is less than 95 percent of its RBC would trigger a requirement to submit a comprehensive plan as described above for the Company Action Level.

In addition, although we are under no obligation to do so, we may elect to contribute additional capital to strengthen the surplus of certain insurance subsidiaries.  Any election regarding the contribution of additional capital to our insurance subsidiaries could affect the ability of our insurance subsidiaries to pay dividends to the holding company.  The ability of our insurance subsidiaries to pay dividends is also impacted by various criteria established by rating agencies to maintain or receive higher ratings and by the capital levels that we target for our insurance subsidiaries.

At December 31, 2010, the consolidated RBC ratio of our insurance subsidiaries exceeded the minimum RBC requirement included in our New Senior Secured Credit Agreement.  See the note to the consolidated financial statements entitled “Notes Payable - Direct Corporate Obligations” for further discussion of various financial ratios and balances we are required to maintain.  We calculate the consolidated RBC ratio by assuming all of the assets, liabilities, capital and surplus and other aspects of the business of our insurance subsidiaries are combined together in one insurance subsidiary, with appropriate intercompany eliminations.

BUSINESS SEGMENTS
BUSINESS SEGMENTS

14.  
BUSINESS SEGMENTS

Beginning July 1, 2010, management changed the manner in which it disaggregates the Company’s operations for making operating decisions and assessing performance.  As a result, the Company manages its business through the following operating segments: Bankers Life, Colonial Penn and Washington National, which are defined on the basis of product distribution; Other CNO Business, comprised primarily of products we no longer sell actively; and corporate operations, comprised of holding company activities and certain noninsurance company businesses.

We measure segment performance by excluding realized investment gains (losses) because we believe that this performance measure is a better indicator of the ongoing business and trends in our business.  Our primary investment focus is on investment income to support our liabilities for insurance products as opposed to the generation of realized investment gains (losses), and a long-term focus is necessary to maintain profitability over the life of the business.  Realized investment gains (losses) depend on market conditions and do not necessarily relate to the underlying business of our segments.

 

Realized investment gains (losses) may affect future earnings levels since our underlying business is long-term in nature and changes in our investment portfolio may impact our ability to earn the assumed interest rates needed to maintain the profitability of our business.

Operating information by segment was as follows (dollars in millions):

   
2010
  
2009
  
2008
 
           
Revenues:
         
Bankers Life:
         
Insurance policy income:
         
Annuities
 $39.5  $41.4  $49.2 
Health
  1,366.0   1,711.7   1,872.9 
Life
  190.7   206.1   187.8 
Net investment income (a)
  758.9   678.1   558.2 
Fee revenue and other income (a)
  12.8   10.2    11.0 
              
Total Bankers Life revenues
  2,367.9   2,647.5   2,679.1 
              
Washington National:
            
Insurance policy income:
            
Health
  559.3   563.2   574.8 
Life
  16.8   29.4   35.3 
Other
  4.9   5.3   7.1 
Net investment income (a)
  185.4   188.9   197.3 
Fee revenue and other income (a)
  1.1   1.5   .7 
              
Total Washington National revenues
  767.5   788.3    815.2 
              
Colonial Penn:
            
Insurance policy income:
            
Health
  6.8   8.1   9.5 
Life
  188.1   188.0   175.3 
Net investment income (a)
  39.3   38.7   39.6 
Fee revenue and other income (a)
  .7   .9   1.8 
              
Total Colonial Penn revenues
  234.9   235.7    226.2 
              
Other CNO Business:
            
Insurance policy income:
            
Annuities
  12.9   29.5   14.1 
Health
  29.9   32.1   34.6 
Life
  252.5   275.8   289.7 
Other
  2.6   3.0   3.3 
Net investment income (a)
  364.6   371.9   355.2 
Fee revenue and other income (a)
  -    -   1.0 
              
Total Other CNO Business revenues
  662.5   712.3   697.9 
              
Corporate operations:
            
Net investment income
  18.7   15.1   28.5 
Fee and other income
  2.2   3.0    5.2 
              
Total corporate revenues
  20.9   18.1    33.7 
              
Total revenues
  4,053.7   4,401.9   4,452.1 

(continued on next page)


 

(continued from previous page)

   
2010
  
2009
  
2008
 
Expenses:
         
Bankers Life:
         
Insurance policy benefits
 $1,607.3  $1,905.0  $2,090.4 
Amortization
  290.5   267.9   234.8 
Interest expense on investment borrowings
  1.0   -   - 
Other operating costs and expenses
  185.0   196.6   182.4 
              
Total Bankers Life expenses
  2,083.8   2,369.5   2,507.6 
              
Washington National:
            
Insurance policy benefits
  450.6   467.0   473.2 
Amortization
  56.9   53.9   54.0 
Other operating costs and expenses
  155.4   156.5   166.9 
              
Total Washington National expenses
  662.9   677.4   694.1 
              
Colonial Penn:
            
Insurance policy benefits
  144.8   143.0   139.4 
Amortization
  33.3   33.3   32.0 
Other operating costs and expenses
  30.3   30.0   29.6 
              
Total Colonial Penn expenses
  208.4   206.3   201.0 
              
Other CNO Business:
            
Insurance policy benefits
  521.0   551.7   509.5 
Amortization
  51.6   81.6   68.6 
Interest expense on investment borrowings
  20.0   20.5   22.4 
Other operating costs and expenses
  81.4   102.1   97.2 
              
Total Other CNO Business expenses
  674.0   755.9   697.7 
              
Corporate operations:
            
Interest expense on corporate debt
  79.3   84.7   67.9 
Interest expense on variable interest entities
  12.9   12.7   16.2 
Other operating costs and expenses
  50.8   43.1   44.2 
(Gain) loss on extinguishment or modification of debt
  6.8   22.2   (21.2)
              
Total corporate expenses
  149.8   162.7   107.1 
              
Total expenses
  3,778.9   4,171.8   4,207.5 
              
Income (loss) before net realized investment losses (net of related amortization), income taxes and discontinued operations:
            
Bankers Life
  284.1   278.0   171.5 
Washington National
  104.6   110.9   121.1 
Colonial Penn
  26.5   29.4   25.2 
Other CNO Business
  (11.5)  (43.6)  .2 
Corporate operations
  (128.9)  (144.6)  (73.4)
              
Income before net realized investment losses (net of related amortization), income taxes and discontinued operations
 $274.8  $230.1  $244.6 
              
___________________
(a)
It is not practicable to provide additional components of revenue by product or services.

 


A reconciliation of segment revenues and expenses to consolidated revenues and expenses is as follows (dollars in millions):
   
2010
  
2009
  
2008
 
           
Total segment revenues                                                                    
 $4,053.7  $4,401.9  $4,452.1 
Net realized investment gains (losses)                                                                    
  30.2   (60.5)  (262.4)
              
Consolidated revenues                                                               
 $4,083.9  $4,341.4  $4,189.7 
              
Total segment expenses                                                                    
 $3,778.9  $4,171.8  $4,207.5 
Amortization related to net realized investment gains (losses)
  11.5   (4.0)  (21.5)
              
Consolidated expenses                                                               
 $3,790.4  $4,167.8  $4,186.0 

Segment balance sheet information was as follows (dollars in millions):

   
2010
  
2009
 
Assets:
      
Bankers Life                                                                                
 $16,150.0  $14,503.8 
Washington National                                                                                
  4,033.7   4,070.7 
Colonial Penn                                                                                
  999.3   971.4 
Other CNO Business                                                                                
  8,999.5   9,254.6 
Corporate operations                                                                                
  1,717.1   1,543.3 
          
Total assets                                                                            
 $31,899.6  $30,343.8 
          
Liabilities:
        
Bankers Life                                                                                
 $14,074.3  $12,832.4 
Washington National                                                                                
  3,170.7   3,325.0 
Colonial Penn                                                                                
  733.9   763.3 
Other CNO Business                                                                                
  8,152.1   8,564.2 
Corporate operations                                                                                
  1,443.3   1,326.5 
          
Total liabilities                                                                            
 $27,574.3  $26,811.4 

The following table presents selected financial information of our segments (dollars in millions):

   
Present
  
Deferred
    
   
value of
  
acquisition
  
Insurance
 
Segment
 
future profits
  
costs
  
liabilities
 
           
2010
         
Bankers Life                                              
 $467.2  $1,149.5  $13,065.8 
Washington National                                              
  426.9   212.3   2,979.2 
Colonial Penn                                              
  81.7   226.5   717.8 
Other CNO Business                                              
  32.8   175.9   7,725.7 
              
Total                                              
 $1,008.6  $1,764.2  $24,488.5 
              
2009
            
Bankers Life                                              
 $569.5  $1,179.1  $12,384.8 
Washington National                                              
  455.1   185.4   3,117.2 
Colonial Penn                                              
  92.4   199.8   713.8 
Other CNO Business                                              
  58.9   226.6   8,078.2 
              
Total                                              
 $1,175.9  $1,790.9  $24,294.0 

QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly Financial Data (Unaudited)


15.       QUARTERLY FINANCIAL DATA (UNAUDITED)

We compute earnings per common share for each quarter independently of earnings per share for the year.  The sum of the quarterly earnings per share may not equal the earnings per share for the year because of: (i) transactions affecting the weighted average number of shares outstanding in each quarter; and (ii) the uneven distribution of earnings during the year.  Quarterly financial data (unaudited) were as follows (dollars in millions, except per share data).

2010
 
1st Qtr.
  
2nd Qtr.
  
3rd Qtr.
  
4th Qtr.
 
              
Revenues                                                                              
 $1,002.4  $953.2  $1,052.5  $1,075.8 
                  
Income before income taxes                                                                              
 $53.1  $51.8  $77.3  $111.3 
Income tax expense (benefit)                                                                              
  19.2   18.7   27.9   (56.9)
                  
Net income                                                                              
 $33.9  $33.1  $49.4  $168.2 
                  
Income per common share:
                
Basic:
                
Net income                                                                      
 $.14  $.13  $.20  $.67 
                  
Diluted:
                
Net income                                                                      
 $.13  $.12  $.17  $.56 

2009
 
1st Qtr.
  
2nd Qtr.
  
3rd Qtr.
  
4th Qtr.
 
              
Revenues                                                                             
 $1,069.5  $1,095.6  $1,118.6  $1,057.7 
                  
Income before income taxes                                                                             
 $42.2  $49.6  $64.1  $17.7 
Income tax expense (benefit)                                                                             
  17.7   22.0   48.7   (.5)
                  
Net income                                                                             
 $24.5  $27.6  $15.4  $18.2 
                  
Income per common share:
                
Basic:
                
Net income                                                                        
 $.13  $.15  $.08  $.09 
                  
Diluted:
                
Net income                                                                        
 $.13  $.15  $.08  $.09 

INVESTMENTS IN VARIABLE INTEREST ENTITIES
INVESTMENTS IN VARIABLE INTEREST ENTITIES

 
16.
INVESTMENTS IN VARIABLE INTEREST ENTITIES

Effective January 1, 2010, the Company adopted authoritative guidance that requires an entity to perform a qualitative analysis to determine whether a primary beneficiary interest is held in a VIE.  The guidance also requires ongoing reassessments to determine whether a primary beneficiary interest is held.  Based on our assessment, we concluded that we were the primary beneficiary with respect to two VIEs which are consolidated in our financial statements.  One of the VIEs was consolidated prior to 2010.  The following is a description of our significant investments in VIEs:

Fall Creek CLO Ltd. (“Fall Creek”) and Eagle Creek CLO Ltd. (“Eagle Creek”) are collateralized loan trusts that were established to issue securities and use the proceeds to principally invest in corporate loans and other permitted investments.  The assets held by the trusts are legally isolated and not available to the Company.  The liabilities of Fall Creek and Eagle Creek are expected to be satisfied from the cash flows generated by the underlying loans, not from the assets of the Company.  Repayment of the remaining principal balance of the borrowings of Fall Creek and Eagle Creek are based on available cash flows from the assets and such borrowings mature in 2017 and 2018, respectively.  The Company has no further commitments to Fall Creek or Eagle Creek.

Certain of our subsidiaries are noteholders of the VIEs and, as a result, could absorb part of the losses of the VIEs.  Another subsidiary of the Company is the investment manager for both Fall Creek and Eagle Creek.  As such, it has the power to direct the most significant activities of the VIEs which materially impacts the economic performance of the VIEs.

The following table provides supplemental information about the assets and liabilities of Fall Creek and Eagle Creek which have been consolidated in accordance with authoritative guidance (dollars in millions):

   
December 31, 2010
 
           
   
Fall Creek
     
Net effect on
 
   
and
     
consolidated
 
   
Eagle Creek
  
Eliminations
  
balance sheet
 
           
Assets:
         
Investments held by variable interest entities
 $420.9  $-  $420.9 
Notes receivable of VIEs held by insurance subsidiaries
  -   (96.8)  (96.8)
Cash and cash equivalents held by variable interest entities
  26.8   -   26.8 
Accrued investment income
  1.4   (4.8)  (3.4)
Income tax assets, net
  20.9   (6.5)  14.4 
Other assets
  15.9   -   15.9 
              
Total assets                                                                   
 $485.9  $(108.1) $377.8 
              
Liabilities:
            
Other liabilities
 $22.0  $(4.6) $17.4 
Borrowings related to variable interest entities
  386.9   -   386.9 
Notes payable of VIEs held by insurance subsidiaries
  115.6   (115.6)  - 
              
Total liabilities                                                                   
 $524.5  $(120.2) $404.3 


 


   
December 31, 2009
 
           
         
Net effect on
 
         
consolidated
 
   
Fall Creek
  
Eliminations
  
balance sheet
 
           
Assets:
         
Fixed maturities, available for sale
 $268.0  $-  $268.0 
Notes receivable of VIE held by insurance subsidiaries
  -   (81.9)  (81.9)
Cash and cash equivalents – restricted
  3.4   -   3.4 
Accrued investment income
  1.2   (3.0)  (1.8)
Income tax assets, net
  19.3   (5.3)  14.0 
Other assets
  8.0   -   8.0 
              
Total assets                                                                  
 $299.9  $(90.2) $209.7 
              
Liabilities:
            
Other liabilities
 $7.7  $(3.2) $4.5 
Investment borrowings
  229.1   -   229.1 
Notes payable of VIE held by insurance subsidiaries
  99.2   (99.2)  - 
              
Total liabilities                                                                  
 $336.0  $(102.4) $233.6 

The following table provides supplemental information about the revenues and expenses of Fall Creek and Eagle Creek which have been consolidated in accordance with authoritative guidance, after giving effect to the elimination of our investment in Fall Creek and Eagle Creek and investment management fees earned by a subsidiary of the Company (dollars in millions):

   
2010
  
2009
  
2008
 
           
Revenues:
         
Net investment income – policyholder and reinsurer accounts and other special-purpose portfolios
 $20.1  $13.4  $23.6 
Fee revenue and other income
  .6   .3   .5 
              
Total revenues
  20.7   13.7   24.1 
              
Expenses:
            
Interest expense
  12.9   12.7   16.2 
Other operating expenses
  .6   .2   .7 
              
Total expenses
  13.5   12.9   16.9 
              
Income (loss) before net realized investment losses
and income taxes
  7.2   .8   7.2 
              
Net realized investment losses
  (3.7)  (14.2)  (24.9)
              
Income (loss) before income taxes
 $3.5  $(13.4) $(17.7)

The investment portfolio held by the VIEs is primarily comprised of corporate fixed maturity securities which are almost entirely rated as below-investment grade securities.  At December 31, 2010, such securities had an amortized cost of $428.0 million; gross unrealized gains of $3.7 million; gross unrealized losses of $10.8 million; and an estimated fair value of $420.9 million.

 

The following table sets forth the amortized cost and estimated fair value of the investments held by the VIEs at December 31, 2010, by contractual maturity.  Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

      
Estimated
 
   
Amortized
  
fair
 
   
cost
  
value
 
   
(Dollars in millions)
 
        
Due in one year or less                                                                               
 $11.9  $12.1 
Due after one year through five years                                                                               
  328.4   320.1 
Due after five years through ten years                                                                               
  87.7   88.7 
          
Total                                                                         
 $428.0  $420.9 

The following table summarizes the carrying values of the investments held by the VIEs by category as of December 31, 2010 (dollars in millions):

            
Percent of
 
      
Percent
  
Gross
  
gross
 
      
of fixed
  
unrealized
  
unrealized
 
   
Carrying value
  
maturities
  
losses
  
losses
 
              
Cable/media                                                         
 $70.7   16.8% $2.3   21.5%
Healthcare/pharmaceuticals                                                         
  60.0   14.2   1.0   9.2 
Chemicals                                                         
  23.6   5.6   .4   3.4 
Retail                                                         
  20.9   5.0   .3   2.7 
Entertainment/hotels                                                         
  19.6   4.7   .5   4.4 
Autos                                                         
  18.6   4.4   .1   1.4 
Gaming                                                         
  18.4   4.4   1.1   10.3 
Utilities                                                         
  18.4   4.4   1.5   14.0 
Capital goods                                                         
  16.1   3.8   .3   2.6 
Consumer products                                                         
  16.0   3.8   .4   3.9 
Food/beverage                                                         
  15.9   3.8   .1   1.0 
Aerospace/defense                                                         
  15.8   3.8   -   .5 
Paper                                                         
  14.2   3.4   .1   .6 
Energy/pipelines                                                         
  12.1   2.8   1.0   9.1 
Technology                                                         
  11.0   2.6   .2   2.2 
Insurance                                                         
  7.1   1.7   -   - 
Other                                                         
  62.5   14.8   1.5   13.2 
                  
Total                                                    
 $420.9   100.0% $10.8   100.0%

The following table sets forth the amortized cost and estimated fair value of those investments held by the VIEs with unrealized losses at December 31, 2010, by contractual maturity.  Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

      
Estimated
 
   
Amortized
  
fair
 
   
cost
  
value
 
   
(Dollars in millions)
 
        
Due in one year or less                                                                             
 $4.0  $3.9 
Due after one year through five years                                                                             
  234.4   224.0 
Due after five years through ten years                                                                             
  28.2   27.9 
          
Total                                                                       
 $266.6  $255.8 

 

The following summarizes the investments in our portfolio held by the VIEs rated below-investment grade which have been continuously in an unrealized loss position exceeding 20 percent of the cost basis for the period indicated as of December 31, 2010 (dollars in millions):
   
Number
  
Cost
  
Unrealized
  
Estimated
 
   
of issuers
  
basis
  
loss
  
fair value
 
              
Less than 6 months
  1  $2.0  $( .5) $1.5 
Greater than or equal to 6 and less than 12 months
  5   10.4   (2.6)  7.8 
Greater than 12 months
  1   2.0   (.8)  1.2 
                  
    7  $14.4  $(3.9) $10.5 

During 2010, we recognized net realized investment losses on the VIE investments of $3.7million, which were comprised of $.4 million of net losses from the sales of fixed maturities, and $3.3 million of writedowns of investments for other than temporary declines in fair value recognized through net income.  During 2009, we recognized net realized investment losses on the VIE investments of $14.2 million, which were comprised of $.7 million of net losses from the sales of fixed maturities, and $13.5 million of writedowns of investments for other than temporary declines in fair value recognized through net income.

At December 31, 2010, investments held by the VIEs that were in default had an aggregate amortized cost of $6.8 million and a carrying value of $7.3 million, of which $2.3 million (carrying value) were subsequently sold.

During 2010, $36.1 million of investments held by the VIEs were sold which resulted in gross investment losses (before income taxes) of $4.2 million.  The following summarizes the investments sold at a loss during 2010 which had been continuously in an unrealized loss position exceeding 20 percent of the amortized cost basis prior to the sale for the period indicated (dollars in millions):

   
At date of sale
 
   
Number
  
Amortized
  
Fair
 
   
of issuers
  
cost
  
value
 
           
Less than six months prior to sale                                                                               
  2  $.1  $.1 
Greater than or equal to 6 and less than 12 months prior to sale
  2   1.2   .8 
Greater than 12 months prior to sale                                                                               
  2   1.3   .4 
              
    6  $2.6  $1.3 

At December 31, 2010, the VIEs held:  (i) investments with a fair value of $26.7 million and gross unrealized losses of $.8 million that had been in an unrealized loss position for less than twelve months; and (ii) investments with a fair value of $229.1 million and gross unrealized losses of $10.0 million that had been in an unrealized loss position for greater than twelve months.

The investments held by the VIEs are evaluated for other-than-temporary declines in fair value in a manner that is consistent with the Company’s fixed maturities, available for sale.

In addition, the Company, in the normal course of business, makes passive investments in structured securities issued by VIEs for which the Company is not the investment manager.  These structured securities include asset-backed securities, collateralized debt obligations, commercial mortgage-backed securities, residential mortgage-backed securities and collateralized mortgage obligations.  Our maximum exposure to loss on these securities is limited to our cost basis in the investment.  We have determined that we are not the primary beneficiary of these structured securities due to the relative size of our investment in comparison to the total principal amount of the individual structured securities and the level of credit subordination which reduces our obligation to absorb gains or losses.

At December 31, 2010, we hold investments in various limited partnerships, in which we are not the primary beneficiary, totaling $20.7 million (classified as other invested assets).  At December 31, 2010, we had unfunded commitments to these partnerships of $14.7 million.  Our maximum exposure to loss on these investments is limited to the amount of our investment.

Schedule II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
Condensed Financial Information of Registrant



CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES

SCHEDULE II

Condensed Financial Information of Registrant (Parent Company)
Balance Sheet
as of December 31, 2010 and 2009
(Dollars in millions)

ASSETS
   
2010
  
2009
 
        
Cash and cash equivalents - unrestricted                                                                                                          
 $160.0  $145.3 
Other invested assets                                                                                                          
  .2   .2 
Investment in wholly-owned subsidiaries (eliminated in consolidation)
  5,362.0   4,902.4 
Receivable from subsidiaries (eliminated in consolidation)                                                                                                          
  2.3   .9 
Other assets                                                                                                          
  20.5   16.1 
          
Total assets                                                                                              
 $5,545.0  $5,064.9 
          
          
 
          
Liabilities:
        
Notes payable                                                                                                     
 $998.5  $1,037.4 
Payable to subsidiaries (eliminated in consolidation)                                                                                                     
  78.3   360.2 
Income tax liabilities, net                                                                                                     
  87.2   76.2 
Other liabilities                                                                                                     
  55.7   58.7 
          
Total liabilities                                                                                              
  1,219.7   1,532.5 
          
          
Commitments and Contingencies
        
          
Shareholders’ equity:
        
Common stock and additional paid-in capital ($.01 par value, 8,000,000,000 shares authorized, shares issued and outstanding:  
    2010 – 251,084,174; 2009 – 250,786,216)                                                                                                  
 $4,426.7   4,411.3 
Accumulated other comprehensive income (loss)                                                                                                     
  238.3   (264.3)
Accumulated deficit                                                                                                     
  (339.7)  (614.6)
          
Total shareholders’ equity                                                                                              
  4,325.3   3,532.4 
          
Total liabilities and shareholders’ equity                                                                                              
 $5,545.0  $5,064.9 







The accompanying notes are an integral part
of the condensed financial information.

 


CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE II

Condensed Financial Information of Registrant (Parent Company)

Statement of Operations
for the years ended December 31, 2010, 2009 and 2008
(Dollars in millions)

   
2010
  
2009
  
2008
 
           
Revenues:
         
Net investment income                                                                                        
 $-  $-  $2.3 
Net realized investment losses                                                                                        
  -   (.2)  (25.9)
Fee and interest income from subsidiaries (eliminated in consolidation)
  -   -   .7 
              
Total revenues                                                                                   
  -   (.2)  (22.9)
              
Expenses:
            
Interest expense on notes payable
  79.3   84.7   67.9 
Intercompany expenses (eliminated in consolidation)
  1.3   2.4   8.3 
Operating costs and expenses
  49.3   45.6   34.2 
(Gain) loss on extinguishment or modification of debt
  6.8   22.2   (21.2)
              
Total expenses                                                                                   
  136.7   154.9   89.2 
              
Loss before income taxes and equity in undistributed earnings of subsidiaries
  (136.7)  (155.1)  (112.1)
              
Income tax expense (benefit):
            
Income tax benefit on period income                                                                                        
  (50.8)  (57.8)  (39.1)
Valuation allowance for deferred tax assets                                                                                        
  -   -   54.1 
              
Loss before equity in undistributed earnings of subsidiaries and discontinued operations
  (85.9)  (97.3)  (127.1)
              
Equity in undistributed earnings of subsidiaries (eliminated in consolidation)
  370.5   183.0   (282.5)
              
Income (loss) before discontinued operations                                                                                          
  284.6   85.7   (409.6)
Discontinued operations, net of income taxes:
            
Parent company                                                                                        
  -   -   (166.3)
Subsidiary                                                                                        
  -   -   (556.4)
              
Net income (loss)                                                                                   
 $284.6  $85.7  $(1,132.3)












The accompanying notes are an integral part
of the condensed financial information.

 

CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE II

Condensed Financial Information of Registrant (Parent Company)

Statement of Cash Flows
for the years ended December 31, 2010, 2009 and 2008
 (Dollars in millions)

   
2010
  
2009
  
2008
 
           
Cash flows used by operating activities                                                                                        
 $(119.1) $(110.7) $(97.4)
              
Cash flows from investing activities:
            
Sales of investments                                                                                    
  -   -   13.9 
Purchases of investments                                                                                    
  -   -   (39.8)
Investments and advances to consolidated subsidiaries*
  26.6   -   (24.0)
Change in restricted cash                                                                                    
  -   -   1.9 
              
Net cash used by investing activities                                                                              
  26.6   -   (48.0)
              
Cash flows from financing activities:
            
Issuance of notes payable, net                                                                                    
  756.1   172.0   75.0 
Issuance of common stock                                                                                    
  -   296.3   - 
Payments on notes payable                                                                                    
  (793.6)  (461.2)  (44.0)
Expenses related to debt modification or extinguishment of debt
  -   (14.7)  - 
Issuance of notes payable to affiliates*                                                                                    
  177.0   266.9   148.0 
Payments on notes payable to affiliates*                                                                                    
  (32.3)  (59.8)  (61.4)
              
Net cash provided by financing activities                                                                              
  107.2   199.5   117.6 
              
Net increase (decrease) in cash and cash equivalents
  14.7   88.8   (27.8)
              
Cash and cash equivalents, beginning of the year                                                                                        
  145.3   56.5   84.3 
              
Cash and cash equivalents, end of the year                                                                                        
 $160.0  $145.3  $56.5 

*  Eliminated in consolidation




















The accompanying notes are an integral part
of the condensed financial information.

 

CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE II

Notes to Condensed Financial Information

1.         Basis of Presentation

The condensed financial information should be read in conjunction with the consolidated financial statements of CNO Financial Group, Inc.  The condensed financial information includes the accounts and activity of the parent company.

Schedule IV - REINSURANCE
Reinsurance

 

CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES

SCHEDULE IV

Reinsurance
for the years ended December 31, 2010, 2009 and 2008
 (Dollars in millions)

   
2010
  
2009
  
2008
 
Life insurance inforce:
         
Direct                                                                         
 $59,388.5  $61,814.4  $65,271.1 
Assumed                                                                         
  374.2   403.5   1,129.8 
Ceded                                                                         
  (14,800.9)  (16,461.5)  (13,805.9)
              
Net insurance inforce                                                                     
 $44,961.8  $45,756.4  $52,595.0 
              
Percentage of assumed to net                                                                     
  .8%  .9%  2.1%
              
              

   
2010
  
2009
  
2008
 
Insurance policy income:
         
Direct                                                                         
 $2,525.5  $2,451.8  $2,438.0 
Assumed                                                                         
  92.6   475.5   641.0 
Ceded                                                                         
  (258.6)  (179.4)  (164.0)
              
Net premiums                                                                     
 $2,359.5  $2,747.9  $2,915.0 
              
Percentage of assumed to net                                                                     
  3.9%  17.3%  22.0%


Document Information
Year Ended
Dec. 31, 2010
Document Type
10-K 
Amendment Flag
FALSE 
Document Period End Date
2010-12-31 
Entity Information
Year Ended
Dec. 31, 2010
Feb. 11, 2011
Jun. 30, 2010
Entity Registrant Name
CNO Financial Group, Inc. 
 
 
Entity Central Index Key
0001224608 
 
 
Current Fiscal Year End Date
12/31 
 
 
Entity Well-known Seasoned Issuer
Yes 
 
 
Entity Voluntary Filers
No 
 
 
Entity Current Reporting Status
Yes 
 
 
Entity Filer Category
Large Accelerated Filer 
 
 
Entity Public Float
 
 
1,225,000,000 
Entity Common Stock, Shares Outstanding
 
251,084,174 
 
Document Fiscal Year Focus
2010 
 
 
Document Fiscal Period Focus
FY