CNO FINANCIAL GROUP, INC., 10-Q filed on 10/31/2011
Quarterly Report
DOCUMENT AND ENTITY INFORMATION (USD $)
9 Months Ended
Sep. 30, 2011
Oct. 20, 2011
Jun. 30, 2010
Document Information [Line Items]
 
 
 
Entity Registrant Name
CNO Financial Group, Inc. 
 
 
Entity Central Index Key
0001224608 
 
 
Document Type
10-Q 
 
 
Document Period End Date
Sep. 30, 2011 
 
 
Current Fiscal Year End Date
--12-31 
 
 
Document Fiscal Year Focus
2011 
 
 
Document Fiscal Period Focus
Q3 
 
 
Entity Filer Category
Large Accelerated Filer 
 
 
Entity Voluntary Filers
No 
 
 
Entity Well-known Seasoned Issuer
Yes 
 
 
Entity Current Reporting Status
Yes 
 
 
Amendment Flag
FALSE 
 
 
Entity Public Float
 
 
$ 1,225,000,000 
Entity Common Stock, Shares Outstanding
 
234,252,260 
 
CONSOLIDATED BALANCE SHEET (USD $)
In Millions
Sep. 30, 2011
Dec. 31, 2010
Sep. 30, 2010
Dec. 31, 2009
Investments:
 
 
 
 
Fixed maturities, available for sale, at fair value (amortized cost: September 30, 2011 - $21,347.7; December 31, 2010 - $20,155.8)
$ 23,016.7 
$ 20,633.9 
 
 
Equity securities at fair value (cost: September 30, 2011 - $167.0; December 31, 2010 - $68.2)
164.3 
68.1 
 
 
Mortgage loans
1,648.2 
1,761.2 
 
 
Policy loans
279.6 
284.4 
 
 
Trading securities
81.8 
372.6 
 
 
Investments held by variable interest entities
453.5 
420.9 
 
 
Other invested assets
190.9 
240.9 
 
 
Total investments
25,835.0 
23,782.0 
 
 
Cash and cash equivalents - unrestricted
461.9 
571.9 
548.8 
523.4 
Cash and cash equivalents held by variable interest entities
19.7 
26.8 
 
 
Accrued investment income
301.2 
327.8 
 
 
Present value of future profits
714.2 
1,008.6 
 
 
Deferred acquisition costs
1,444.7 
1,764.2 
 
 
Reinsurance receivables
3,131.3 
3,256.3 
 
 
Income tax assets, net
687.2 
839.4 
 
 
Assets held in separate accounts
15.4 
17.5 
 
 
Other assets
314.9 
305.1 
 
 
Total assets
32,925.5 
31,899.6 
 
 
Liabilities for insurance products:
 
 
 
 
Interest-sensitive products
13,168.2 
13,194.7 
 
 
Traditional products
10,444.8 
10,307.6 
 
 
Claims payable and other policyholder funds
985.5 
968.7 
 
 
Liabilities related to separate accounts
15.4 
17.5 
 
 
Other liabilities
576.9 
496.3 
 
 
Investment borrowings
1,509.1 
1,204.1 
 
 
Borrowings related to variable interest entities
405.6 
386.9 
 
 
Notes payable - direct corporate obligations
871.2 
998.5 
 
 
Total liabilities
27,976.7 
27,574.3 
 
 
Commitments and contingencies
 
 
 
 
Shareholders' equity:
 
 
 
 
Common stock ($0.01 par value, 8,000,000,000 shares authorized, shares issued and outstanding: September 30, 2011 – 243,247,260; December 31, 2010 – 251,084,174)
2.4 
2.5 
 
 
Additional paid-in capital
4,379.4 
4,424.2 
 
 
Accumulated other comprehensive income
597.3 
238.3 
 
 
Accumulated deficit
(30.3)
(339.7)
 
 
Total shareholders' equity
4,948.8 
4,325.3 
4,604.3 
3,532.4 
Total liabilities and shareholders' equity
$ 32,925.5 
$ 31,899.6 
 
 
PARENTHETICAL DATA TO THE CONSOLIDATED BALANCE SHEET (USD $)
In Millions, except Share data
Sep. 30, 2011
Dec. 31, 2010
Investments:
 
 
Fixed maturities, available for sale, amortized cost
$ 21,347.7 
$ 20,155.8 
Equity securities amortized cost
$ 167.0 
$ 68.2 
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
243,247,260 
251,084,174 
Common stock, shares outstanding
243,247,260 
251,084,174 
CONSOLIDATED STATEMENT OF OPERATIONS (USD $)
In Millions, except Share data
3 Months Ended
Sep. 30,
9 Months Ended
Sep. 30,
2011
2010
2011
2010
Revenues:
 
 
 
 
Insurance policy income
$ 673.5 
$ 674.5 
$ 2,020.3 
$ 2,007.0 
Net investment income (loss):
 
 
 
 
General account assets
338.2 
326.5 
1,016.5 
962.8 
Policyholder and reinsurer accounts and other special- purpose portfolios
(54.9)
43.3 
(14.4)
44.6 
Realized investment gains (losses):
 
 
 
 
Net realized investment gains, excluding impairment losses
33.5 
28.1 
64.9 
54.7 
Other-than-temporary impairment losses:
 
 
 
 
Total other-than-temporary impairment losses
(2.9)
(22.8)
(26.3)
(69.8)
Portion of other-than-temporary impairment losses recognized in accumulated other comprehensive income
(1.7)
(2.9)
Net impairment losses recognized
(2.9)
(24.5)
(26.3)
(72.7)
Total realized gains (losses)
30.6 
3.6 
38.6 
(18.0)
Fee revenue and other income
4.9 
4.6 
12.5 
11.7 
Total revenues
992.3 
1,052.5 
3,073.5 
3,008.1 
Benefits and expenses:
 
 
 
 
Insurance policy benefits
661.0 
700.0 
2,028.6 
2,050.0 
Interest expense
27.9 
28.4 
86.0 
84.6 
Amortization
87.2 
118.6 
325.4 
317.8 
Loss on extinguishment of debt
1.1 
3.1 
2.7 
Other operating costs and expenses
127.6 
128.2 
367.1 
370.8 
Total benefits and expenses
904.8 
975.2 
2,810.2 
2,825.9 
Income before income taxes
87.5 
77.3 
263.3 
182.2 
Income tax expense:
 
 
 
 
Tax expense on period income
34.5 
27.9 
96.9 
65.8 
Valuation allowance for deferred tax assets
(143.0)
(143.0)
Net income
$ 196.0 
$ 49.4 
$ 309.4 
$ 116.4 
Basic:
 
 
 
 
Weighted average shares outstanding
246,965,000 
251,045,000 
249,673,000 
250,942,000 
Net income
$ 0.79 
$ 0.20 
$ 1.24 
$ 0.46 
Diluted:
 
 
 
 
Weighted average shares outstanding
302,708,000 
306,040,000 
306,085,000 
300,256,000 
Net income
$ 0.66 
$ 0.17 
$ 1.05 
$ 0.42 
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (USD $)
In Millions
Total
Common stock and additional paid-in capital
Accumulated other comprehensive income (loss)
Retained earnings (accumulated deficit)
Balance at Dec. 31, 2009
$ 3,532.4 
$ 4,411.3 
$ (264.3)
$ (614.6)
Comprehensive income (loss), net of tax:
 
 
 
 
Net income
116.4 
116.4 
Change in unrealized appreciation (depreciation) of investments (net of applicable income tax expense)
902.1 
902.1 
Change in noncredit component of impairment losses on fixed maturities, available for sale (net of applicable income tax expense)
56.5 
56.5 
Total comprehensive income (loss)
1,075.0 
 
 
 
Cumulative effect of accounting change
(15.9)
(6.2)
(9.7)
Beneficial conversion feature related to the issuance of convertible debentures
4.0 
4.0 
Stock option and restricted stock plans
8.8 
8.8 
Balance at Sep. 30, 2010
4,604.3 
4,424.1 
688.1 
(507.9)
Balance at Dec. 31, 2010
4,325.3 
4,426.7 
238.3 
(339.7)
Comprehensive income (loss), net of tax:
 
 
 
 
Net income
309.4 
309.4 
Change in unrealized appreciation (depreciation) of investments (net of applicable income tax expense)
355.8 
355.8 
Change in noncredit component of impairment losses on fixed maturities, available for sale (net of applicable income tax expense)
3.2 
3.2 
Total comprehensive income (loss)
668.4 
 
 
 
Cost of shares acquired
(55.7)
55.7 
Stock option and restricted stock plans
10.8 
10.8 
Balance at Sep. 30, 2011
$ 4,948.8 
$ 4,381.8 
$ 597.3 
$ (30.3)
PARENTHETICAL DATA TO THE CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (USD $)
In Millions
9 Months Ended
Sep. 30,
2011
2010
Comprehensive income (loss), net of tax:
 
 
Change in unrealized appreciation (depreciation) of investments, applicable income tax expense
$ 199.0 
$ 497.2 
Change in noncredit component of impairment losses on fixed maturities, available for sale, applicable income tax expense
$ 1.8 
$ 31.6 
CONSOLIDATED STATEMENT OF CASH FLOWS (USD $)
In Millions
9 Months Ended
Sep. 30,
2011
2010
Cash flows from operating activities:
 
 
Insurance policy income
$ 1,791.8 
$ 1,772.9 
Net investment income
1,065.0 
980.5 
Fee revenue and other income
12.5 
11.7 
Insurance policy benefits
(1,555.7)
(1,510.1)
Interest expense
(70.5)
(76.0)
Policy acquisition costs
(328.6)
(315.8)
Other operating costs
(349.9)
(334.4)
Taxes
(2.4)
(4.2)
Net cash provided by operating activities
562.2 
524.6 
Cash flows from investing activities:
 
 
Sales of investments
4,390.5 
6,630.9 
Maturities and redemptions of investments
853.3 
640.1 
Purchases of investments
(6,363.8)
(7,847.1)
Net sales (purchases) of trading securities
307.2 
(52.2)
Change in cash and cash equivalents held by variable interest entities
7.1 
(11.1)
Other
(23.4)
(14.6)
Net cash used by investing activities
(829.1)
(654.0)
Cash flows from financing activities:
 
 
Issuance of notes payable, net
110.8 
Payments on notes payable
(130.7)
(116.5)
Issuance of common stock
0.6 
Payments to repurchase common stock
(55.7)
Amounts received for deposit products
1,285.8 
1,334.7 
Withdrawals from deposit products
(1,272.0)
(1,287.0)
Investment borrowings and borrowings related to variable interest entities
328.9 
112.8 
Net cash used by financing activities
156.9 
154.8 
Net increase (decrease) in cash and cash equivalents
(110.0)
25.4 
Cash and cash equivalents, beginning of period
571.9 
523.4 
Cash and cash equivalents, end of period
$ 461.9 
$ 548.8 
BUSINESS AND BASIS OF PRESENTATION
BUSINESS AND BASIS OF PRESENTATION
BUSINESS AND BASIS OF PRESENTATION

The following notes should be read together with the notes to the consolidated financial statements included in our 2010 Annual Report on Form 10-K.

CNO Financial Group, Inc., a Delaware corporation (“CNO”), 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 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.

Our unaudited consolidated financial statements reflect normal recurring adjustments that, in the opinion of management, are necessary for a fair statement of our financial position, results of operations and cash flows for the periods presented.  As permitted by rules and regulations of the Securities and Exchange Commission (the “SEC”) applicable to quarterly reports on Form 10-Q, we have condensed or omitted certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  We have reclassified certain amounts from the prior periods to conform to the 2011 presentation.  These reclassifications have no effect on net income or shareholders’ equity.  Results for interim periods are not necessarily indicative of the results that may be expected for a full year.

The balance sheet at December 31, 2010, presented herein, has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements.

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 and guaranty fund assessment accruals.  If our future experience differs from these estimates and assumptions, our financial statements would be materially affected.

Our consolidated financial statements exclude the results of transactions between us and our consolidated affiliates, or among our consolidated affiliates.
OUT-OF-PERIOD ADJUSTMENT
OUT-OF-PERIOD ADJUSTMENT
OUT-OF-PERIOD ADJUSTMENT

We recorded the net effect of an out-of-period adjustment which increased our insurance policy benefits by $6.0 million, decreased tax expense by $2.1 million and decreased our net income by $3.9 million (or one cent per diluted share) in the three and nine months ended September 30, 2011. We evaluated this error taking into account both qualitative and quantitative factors and considered the impact of this error in relation to the 2011 periods, as well as the materiality to the periods in which they originated. The impact of correcting this error in prior years was not significant to any individual period. Management believes this error is immaterial to the consolidated financial statements.

INVESTMENTS
INVESTMENTS
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 net investment income (classified as investment income from policyholder and reinsurer accounts and other special-purpose portfolios)); 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.

The trading account includes investments backing the market strategies of our multibucket annuity products and certain reinsurance agreements.  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.  Prior to June 30, 2011, certain of our trading securities were held to offset the income statement volatility caused by the effect of interest rate fluctuations on the value of embedded derivatives related to our fixed index annuity products.  During the second quarter of 2011, we sold this trading portfolio, and invested the proceeds in higher yielding investments. See the note entitled “Accounting for Derivatives” for further discussion regarding these embedded derivatives.  Our trading securities totaled $81.8 million and $372.6 million at September 30, 2011 and December 31, 2010, respectively.

Accumulated other comprehensive income is primarily comprised of the net effect of unrealized appreciation (depreciation) on our investments.  These amounts, included in shareholders’ equity as of September 30, 2011 and December 31, 2010, were as follows (dollars in millions):

 
September 30,
2011
 
December 31,
2010
Net unrealized appreciation (depreciation) on fixed maturity securities, available for sale, on which an other-than-temporary impairment loss has been recognized
$
1.1

 
$
(4.4
)
Net unrealized gains (losses) on all other investments
1,650.0

 
476.5

Adjustment to present value of future profits (a)
(222.6
)
 
(17.6
)
Adjustment to deferred acquisition costs
(488.4
)
 
(76.2
)
Unrecognized net loss related to deferred compensation plan
(9.7
)
 
(7.7
)
Deferred income tax liabilities
(333.1
)
 
(132.3
)
Accumulated other comprehensive income
$
597.3

 
$
238.3

_________
(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).

At September 30, 2011, adjustments to the present value of future profits, deferred acquisition costs and deferred income tax assets included $(188.0) million, $(206.0) million and $141.8 million, respectively, for premium deficiencies that would exist on certain long-term health products if unrealized gains on the assets backing such products had been realized and the proceeds from our sales of such assets were invested at then current yields.

At September 30, 2011, the amortized cost, gross unrealized gains and losses, other-than-temporary impairments in accumulated other comprehensive income and estimated fair value of fixed maturities, available for sale, were as follows (dollars in millions):

 
Amortized
cost
 
Gross
unrealized
gains
 
Gross
unrealized
losses
 
Estimated
fair value
 
Other-than-
temporary
impairments
included in
accumulated other
comprehensive
income
Corporate securities
$
14,439.9

 
$
1,503.1

 
$
(161.1
)
 
$
15,781.9

 
$

United States Treasury securities and obligations of United States government corporations and agencies
410.0

 
12.4

 

 
422.4

 

States and political subdivisions
1,765.4

 
192.5

 
(14.9
)
 
1,943.0

 

Debt securities issued by foreign governments
1.4

 

 

 
1.4

 

Asset-backed securities
904.4

 
23.1

 
(20.8
)
 
906.7

 

Collateralized debt obligations
264.1

 
1.1

 
(5.1
)
 
260.1

 

Commercial mortgage-backed securities
1,388.7

 
65.7

 
(24.4
)
 
1,430.0

 

Mortgage pass-through securities
35.7

 
1.8

 
(.1
)
 
37.4

 

Collateralized mortgage obligations
2,138.1

 
108.9

 
(13.2
)
 
2,233.8

 
(7.3
)
Total fixed maturities, available for sale
$
21,347.7

 
$
1,908.6

 
$
(239.6
)
 
$
23,016.7

 
$
(7.3
)


The following table sets forth the amortized cost and estimated fair value of fixed maturities, available for sale, at September 30, 2011, 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 include provisions for periodic principal payments and permit periodic unscheduled payments.

 
Amortized
cost
 
Estimated
fair
value
 
(Dollars in millions)
Due in one year or less
$
104.8

 
$
106.1

Due after one year through five years
1,259.7

 
1,322.5

Due after five years through ten years
4,460.8

 
4,786.6

Due after ten years
10,791.4

 
11,933.5

Subtotal
16,616.7

 
18,148.7

Structured securities
4,731.0

 
4,868.0

Total fixed maturities, available for sale
$
21,347.7

 
$
23,016.7



Net Realized Investment Gains (Losses)

During the first nine months of 2011, we recognized net realized investment gains of $38.6 million, which were comprised of $64.9 million of net gains from the sales of investments (primarily fixed maturities) with proceeds of $4.4 billion and $26.3 million of writedowns of investments for other than temporary declines in fair value recognized through net income.

During the first nine months of 2010, we recognized net realized investment losses of $18.0 million, which were comprised of $54.7 million of net gains from the sales of investments (primarily fixed maturities) with proceeds of $6.6 billion and $72.7 million of writedowns of investments for other than temporary declines in fair value recognized through net income ($69.8 million, prior to the $(2.9) million of impairment losses recognized through accumulated other comprehensive income (loss)).

At September 30, 2011, fixed maturity securities and mortgage loans in default or considered nonperforming had an aggregate amortized cost of $4.4 million and a carrying value of $4.5 million.

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 generate short-term realized gains through the purchase and sale of such securities.  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 objectives, we may sell certain securities.

During the nine months ended September 30, 2011, we sold $.9 billion of fixed maturity investments which resulted in gross investment losses (before income taxes) of $57.1 million.  We sell securities at a loss for a number of reasons including, but not limited to:  (i) changes in the investment environment; (ii) expectation that the market 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.

There was one investment sold at a loss during the first nine months of 2011 that had been continuously in an unrealized loss position exceeding 20 percent of the amortized cost basis for more than 12 months prior to the sale of the investment. This investment had an amortized cost and estimated fair value of $4.0 million and $2.7 million, respectively.

We regularly evaluate all of our investments with unrealized losses 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; (x) the value of any collateral; and (xi) 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 consolidated financial statements 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).

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 September 30, 2011, other-than-temporary impairments included in accumulated other comprehensive income of $7.3 million (before taxes and related amortization) related to structured securities.

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 for the three and nine months ended September 30, 2011 and 2010 (dollars in millions):
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2011
 
2010
 
2011
 
2010
Credit losses on fixed maturity securities, available for sale, beginning of period
$
(1.6
)
 
$
(24.0
)
 
$
(6.1
)
 
$
(27.2
)
Add:  credit losses on other-than-temporary impairments not previously recognized

 

 

 
(1.3
)
Less:  credit losses on securities sold
.7

 
14.5

 
5.2

 
28.0

Less:  credit losses on securities impaired due to intent to sell (a)

 

 

 
1.1

Add:  credit losses on previously impaired securities

 
(1.7
)
 

 
(11.8
)
Less:  increases in cash flows expected on previously impaired securities

 

 

 

Credit losses on fixed maturity securities, available for sale, end of period
$
(.9
)
 
$
(11.2
)
 
$
(.9
)
 
$
(11.2
)
__________
(a)
Represents securities for which the amount previously recognized in accumulated other comprehensive income 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.

Gross Unrealized Investment Losses

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 income or 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.

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 September 30, 2011 (dollars in millions):

 
 
Less than 12 months
 
12 months or greater
 
Total
Description of securities
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
United States Treasury securities and obligations of United States government corporations and agencies
 
$
.1

 
$

 
$
.2

 
$

 
$
.3

 
$

States and political subdivisions
 
2.1

 
(.2
)
 
179.6

 
(14.7
)
 
181.7

 
(14.9
)
Corporate securities
 
1,598.7

 
(72.0
)
 
520.1

 
(89.1
)
 
2,118.8

 
(161.1
)
Asset-backed securities
 
437.3

 
(18.6
)
 
21.5

 
(2.2
)
 
458.8

 
(20.8
)
Collateralized debt obligations
 
213.1

 
(5.1
)
 

 

 
213.1

 
(5.1
)
Commercial mortgage-backed securities
 
329.1

 
(22.2
)
 
35.6

 
(2.2
)
 
364.7

 
(24.4
)
Mortgage pass-through securities
 
2.9

 

 
3.1

 
(.1
)
 
6.0

 
(.1
)
Collateralized mortgage obligations
 
516.5

 
(12.9
)
 
19.4

 
(.3
)
 
535.9

 
(13.2
)
Total fixed maturities, available for sale
 
$
3,099.8

 
$
(131.0
)
 
$
779.5

 
$
(108.6
)
 
$
3,879.3

 
$
(239.6
)
Equity securities
 
$
27.2

 
$
(3.7
)
 
$
.4

 
$
(.1
)
 
$
27.6

 
$
(3.8
)


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
Description of securities
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
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
)
Equity securities
 
$
.4

 
$

 
$
6.1

 
$
(.9
)
 
$
6.5

 
$
(.9
)


Based on management’s current assessment of investments with unrealized losses at September 30, 2011, 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 security before its anticipated recovery.
EARNINGS PER SHARE
EARNINGS PER SHARE
EARNINGS PER SHARE

A reconciliation of net income and shares used to calculate basic and diluted earnings per share is as follows (dollars in millions and shares in thousands):
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2011
 
2010
 
2011
 
2010
Net income for basic earnings per share
$
196.0

 
$
49.4

 
$
309.4

 
$
116.4

Add:  interest expense on 7.0% Convertible Senior Debentures due 2016 (the “7.0% Debentures”), net of income taxes
3.7

 
3.7

 
11.1

 
9.7

Net income for diluted earnings per share
$
199.7

 
$
53.1

 
$
320.5

 
$
126.1

Shares:
 

 
 

 
 

 
 

Weighted average shares outstanding for basic earnings per share
246,965

 
251,045

 
249,673

 
250,942

Effect of dilutive securities on weighted average shares:
 

 
 

 
 

 
 

7% Debentures
53,367

 
53,364

 
53,367

 
47,563

Stock option and restricted stock plans
2,353

 
1,631

 
2,712

 
1,751

Warrants
23

 

 
333

 

Dilutive potential common shares
55,743

 
54,995

 
56,412

 
49,314

Weighted average shares outstanding for diluted earnings per share
302,708

 
306,040

 
306,085

 
300,256



Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding for the period.  Restricted shares (including our performance shares) are not included in basic earnings per share until vested.  Diluted earnings per share reflect the potential dilution that could occur if outstanding stock options and
warrants were exercised and restricted stock was vested.  The dilution from options, warrants and restricted shares is calculated using the treasury stock method.  Under this method, we assume the proceeds from the exercise of the options and warrants (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). 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% Debentures.

BUSINESS SEGMENTS
BUSINESS SEGMENTS
BUSINESS SEGMENTS

The Company manages its business through the following operating segments: Bankers Life, Washington National and Colonial Penn, 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) and fair value changes in embedded derivative liabilities 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) and fair value changes in embedded derivative liabilities depend on market conditions and do not necessarily relate to the underlying business of our segments.  Realized investment gains (losses) and fair value changes in embedded derivative liabilities 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):
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2011
 
2010
 
2011
 
2010
Revenues:
 
 
 
 
 
 
 
Bankers Life:
 
 
 
 
 
 
 
Insurance policy income:
 
 
 
 
 
 
 
Annuities
$
9.6

 
$
11.7

 
$
26.7

 
$
30.7

Health
334.0

 
343.9

 
1,017.1

 
1,032.2

Life
61.0

 
49.5

 
170.4

 
139.1

Net investment income (a)
158.0

 
208.5

 
564.5

 
554.9

Fee revenue and other income (a)
3.6

 
3.6

 
9.2

 
8.6

Total Bankers Life revenues
566.2

 
617.2

 
1,787.9

 
1,765.5

Washington National:
 

 
 

 
 

 
 

Insurance policy income:
 

 
 

 
 

 
 

Health
141.2

 
139.6

 
423.1

 
418.6

Life
3.9

 
4.0

 
11.8

 
12.7

Other
.8

 
1.3

 
3.0

 
3.7

Net investment income (a)
47.3

 
46.4

 
140.3

 
137.7

Fee revenue and other income (a)
.4

 
.3

 
.9

 
.8

Total Washington National revenues
193.6

 
191.6

 
579.1

 
573.5

Colonial Penn:
 

 
 

 
 

 
 

Insurance policy income:
 

 
 

 
 

 
 

Health
1.4

 
1.8

 
4.5

 
5.2

Life
49.4

 
47.0

 
147.5

 
141.1

Net investment income (a)
10.1

 
9.9

 
30.9

 
29.3

Fee revenue and other income (a)
.2

 
.2

 
.6

 
.5

Total Colonial Penn revenues
61.1

 
58.9

 
183.5

 
176.1

Other CNO Business:
 

 
 

 
 

 
 

Insurance policy income:
 

 
 

 
 

 
 

Annuities
3.4

 
3.8

 
8.6

 
8.7

Health
6.9

 
7.5

 
21.3

 
22.7

Life
61.7

 
63.9

 
184.9

 
190.4

Other
.2

 
.5

 
1.4

 
1.9

Net investment income (a)
74.6

 
96.5

 
256.0

 
269.5

Total Other CNO Business revenues
146.8

 
172.2

 
472.2

 
493.2

Corporate operations:
 

 
 

 
 

 
 

Net investment income
(6.7
)
 
8.5

 
10.4

 
16.0

Fee and other income
.7

 
.5

 
1.8

 
1.8

Total corporate revenues
(6.0
)
 
9.0

 
12.2

 
17.8

Total revenues
961.7

 
1,048.9

 
3,034.9

 
3,026.1


(continued on next page)

(continued from previous page)
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2011
 
2010
 
2011
 
2010
Expenses:
 
 
 
 
 
 
 
Bankers Life:
 
 
 
 
 
 
 
Insurance policy benefits
$
360.6

 
$
402.1

 
$
1,174.3

 
$
1,201.3

Amortization
67.2

 
76.4

 
238.8

 
214.0

Interest expense on investment borrowings
1.2

 

 
3.5

 

Other operating costs and expenses
45.8

 
43.2

 
131.3

 
137.5

Total Bankers Life expenses
474.8

 
521.7

 
1,547.9

 
1,552.8

Washington National:
 

 
 

 
 

 
 

Insurance policy benefits
119.0

 
112.4

 
349.5

 
341.6

Amortization
13.9

 
14.4

 
44.0

 
42.3

Interest expense on investment borrowings
.2

 

 
.2

 

Other operating costs and expenses
38.4

 
37.6

 
115.4

 
113.7

Total Washington National expenses
171.5

 
164.4

 
509.1

 
497.6

Colonial Penn:
 

 
 

 
 

 
 

Insurance policy benefits
36.0

 
36.4

 
112.7

 
108.5

Amortization
9.3

 
7.0

 
26.9

 
24.5

Other operating costs and expenses
7.7

 
7.7

 
22.8

 
22.4

Total Colonial Penn expenses
53.0

 
51.1

 
162.4

 
155.4

Other CNO Business:
 

 
 

 
 

 
 

Insurance policy benefits
111.5

 
149.1

 
358.2

 
398.6

Amortization
11.3

 
20.7

 
30.3

 
36.5

Interest expense on investment borrowings
5.3

 
5.1

 
15.2

 
15.1

Other operating costs and expenses
16.7

 
21.7

 
54.6

 
60.5

Total Other CNO Business expenses
144.8

 
196.6

 
458.3

 
510.7

Corporate operations:
 

 
 

 
 

 
 

Interest expense on corporate debt
18.7

 
20.0

 
58.6

 
59.3

Interest expense on borrowings of variable interest entities
2.4

 
3.3

 
8.4

 
10.2

Interest expense on investment borrowings
.1

 

 
.1

 

Loss on extinguishment of debt
1.1

 

 
3.1

 
2.7

Other operating costs and expenses
19.0

 
18.0

 
43.0

 
36.7

Total corporate expenses
41.3

 
41.3

 
113.2

 
108.9

Total expenses
885.4

 
975.1

 
2,790.9

 
2,825.4

Income (loss) before net realized investment losses and fair value changes in embedded derivative liabilities (net of related amortization) and income taxes:
 

 
 
 
 

 
 

Bankers Life
91.4

 
95.5

 
240.0

 
212.7

Washington National
22.1

 
27.2

 
70.0

 
75.9

Colonial Penn
8.1

 
7.8

 
21.1

 
20.7

Other CNO Business
2.0

 
(24.4
)
 
13.9

 
(17.5
)
Corporate operations
(47.3
)
 
(32.3
)
 
(101.0
)
 
(91.1
)
Income before net realized investment losses and fair value changes in embedded derivative liabilities (net of related amortization) and income taxes
$
76.3

 
$
73.8

 
$
244.0

 
$
200.7

___________________
(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):

 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2011
 
2010
 
2011
 
2010
Total segment revenues                                                                                            
$
961.7

 
$
1,048.9

 
$
3,034.9

 
$
3,026.1

Net realized investment gains (losses)                                                                                            
30.6

 
3.6

 
38.6

 
(18.0
)
Consolidated revenues                                                                                       
$
992.3

 
$
1,052.5

 
$
3,073.5

 
$
3,008.1

 
 
 
 
 
 
 
 
Total segment expenses                                                                                            
$
885.4

 
$
975.1

 
$
2,790.9

 
$
2,825.4

Insurance policy benefits - fair value changes in embedded derivative liabilities
33.9

 

 
33.9

 

Amortization related to fair value changes in embedded derivative liabilities
(19.4
)
 

 
(19.4
)
 

Amortization related to net realized investment gains (losses)
4.9

 
.1

 
4.8

 
.5

Consolidated expenses                                                                                       
$
904.8

 
$
975.2

 
$
2,810.2

 
$
2,825.9

ACCOUNTING FOR DERIVATIVES
ACCOUNTING FOR DERIVATIVES
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 $(25.7) million and $(9.7) million in the nine months ended September 30, 2011 and 2010, respectively. These amounts were substantially offset by a corresponding change to insurance policy benefits.  The estimated fair value of these options was $30.1 million and $89.4 million at September 30, 2011 and December 31, 2010, 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 insurance policy benefits.  The fair value of these derivatives, which are classified as “liabilities for interest-sensitive products”, was $638.6 million at September 30, 2011 and $553.6 million at December 31, 2010. Prior to June 30, 2011, we maintained a specific block of investments in our trading securities account (which we carried at estimated fair value with changes in such value recognized as investment income from policyholder and reinsurer accounts and other special-purpose portfolios) to offset the income statement volatility caused by the effect of interest rate fluctuations on the value of embedded derivatives related to our fixed index annuity products.  During the second quarter of 2011, we sold this trading portfolio, which will result in increased volatility in future earnings since the volatility caused by the accounting requirements to record embedded options at fair value will no longer be offset.

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 September 30, 2011, substantially 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 $3.3 million and $(.4) million at September 30, 2011 and December 31, 2010, 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 the 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 offsets the change in value of the embedded derivatives.

REINSURANCE
REINSURANCE
REINSURANCE

The cost of reinsurance ceded totaled $58.3 million and $62.9 million in the third quarters of 2011 and 2010, respectively, and $176.3 million and $194.6 million in the first nine months of 2011 and 2010, respectively.  We deduct this cost from insurance policy income.  Reinsurance recoveries netted against insurance policy benefits totaled $45.4 million and $118.7 million in the third quarters of 2011 and 2010, respectively, and $160.2 million and $352.2 million in the first nine months of 2011 and 2010, 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.  Reinsurance premiums assumed totaled $18.1 million and $25.0 million in the third quarters of 2011 and 2010, respectively, and $64.6 million and $75.8 million in the first nine months of 2011 and 2010, respectively.  Reinsurance premiums included amounts assumed pursuant to marketing and quota-share agreements with Coventry Health Care (“Coventry”) of $12.8 million and $18.8 million in the third quarters of 2011 and 2010, respectively, and $47.6 million and $56.1 million in the first nine months of 2011 and 2010, respectively. Coventry decided to cease selling Private-Fee-For-Service (“PFFS”) plans effective January 1, 2010.  In July 2009, Bankers Life and Casualty Company (“Bankers Life”) entered into an agreement with Humana, Inc. (“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 note entitled “Accounting for Derivatives” for a discussion of the derivative embedded in the payable related to certain modified coinsurance agreements.

INCOME TAXES
INCOME TAXES
INCOME TAXES

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

 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2011
 
2010
 
2011
 
2010
Current tax expense
$
2.3

 
$
3.0

 
$
7.2

 
$
5.5

Deferred tax provision
32.2

 
24.9

 
89.7

 
60.3

Income tax expense on period income
34.5

 
27.9

 
96.9

 
65.8

Valuation allowance
(143.0
)
 

 
(143.0
)
 

Total income tax expense (benefit)
$
(108.5
)
 
$
27.9

 
$
(46.1
)
 
$
65.8



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

Nine months ended

September 30,
 
2011
 
2010
U.S. statutory corporate rate
35.0
 %
 
35.0
 %
Valuation allowance
(54.3
)
 

Other nondeductible benefits
1.4

 
(.2
)
State taxes
.9

 
.9

Provision for tax issues, tax credits and other
(.5
)
 
.4

Effective tax rate
(17.5
)%
 
36.1
 %


The components of the Company’s income tax assets and liabilities were as follows (dollars in millions):
 
September 30,
2011
 
December 31,
2010
Deferred tax assets:
 
 
 
Net federal operating loss carryforwards attributable to:
 
 
 
Life insurance subsidiaries
$
614.8

 
$
681.7

Non-life companies
869.5

 
870.6

Net state operating loss carryforwards
17.7

 
17.8

Tax credits
29.8

 
23.4

Capital loss carryforwards
353.1

 
339.7

Deductible temporary differences:
 

 
 

Investments

 
5.3

Insurance liabilities
749.5

 
738.9

Other
43.2

 
62.8

Gross deferred tax assets
2,677.6

 
2,740.2

Deferred tax liabilities:
 

 
 

Investments
(26.1
)
 

Present value of future profits and deferred acquisition costs
(677.0
)
 
(676.3
)
Unrealized appreciation on investments
(333.1
)
 
(132.3
)
Gross deferred tax liabilities
(1,036.2
)
 
(808.6
)
Net deferred tax assets before valuation allowance
1,641.4

 
1,931.6

Valuation allowance
(938.4
)
 
(1,081.4
)
Net deferred tax assets
703.0

 
850.2

Current income taxes accrued
(15.8
)
 
(10.8
)
Income tax assets, net
$
687.2

 
$
839.4



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 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. In assessing the need for a valuation allowance, all available evidence, both positive and negative, shall be considered to determine whether, based on the weight of that evidence, a valuation allowance for deferred tax assets is needed. This assessment requires significant judgment and considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of carryforward periods, our experience with operating loss and tax credit carryforwards expiring unused, and tax planning strategies. We evaluate the need to establish a valuation allowance for our deferred income tax assets on an ongoing basis. The 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.

Concluding that a valuation allowance is not required is difficult when there has been 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. As a result of the cumulative losses recognized in recent years, our evaluation of the valuation allowance was primarily based on historical taxable earnings. However, because a substantial portion of the cumulative losses included in historical taxable earnings related to transactions to dispose of blocks of businesses, we considered them to be non-recurring and 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 of Senior Health Insurance Company of Pennsylvania ("Senior Health") transferred in 2008.

As of September 30, 2011, we are no longer in a three-year cumulative loss position. We have achieved taxable income in each of the last twelve quarters and our deferred tax valuation model reflects increased levels of taxable income in the future which will allow us to further utilize our deferred tax assets. Based on our assessment, it appears more likely than not that $917 million of our deferred tax assets will be realized through future taxable earnings. Accordingly, we have reduced our deferred tax valuation allowance by $143.0 million. We will continue to assess the need for a valuation allowance in the future. If future results are less than those reflected in our model, a valuation allowance may be required to reduce the deferred tax asset, which could have a material impact on our results of operations in the period in which it is recorded.
 
Our analysis at September 30, 2011, reflected revisions to future taxable income used in our deferred tax valuation model. Our deferred tax valuation model reflects future taxable income based on a normalized average annual taxable income for the last three years, plus 5% growth for the next five years and no growth thereafter. Taxable income used in the deferred tax valuation model for future periods through 2023 (the year in which significant non-life NOLs expire) includes $3,375 million of life taxable income and $250 million of non-life taxable income. We have evaluated each component of the deferred tax asset and assessed the effect of limitations and/or interpretations on the value of each component to be fully recognized in the future.

Recovery of our deferred tax assets is dependent on achieving the future taxable income used in our deferred tax valuation model 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”) takes an adverse position in the future regarding the tax position we have taken in our tax returns with respect to the allocation of cancellation of indebtedness income resulting from the bankruptcy of our Predecessor.

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% 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 (3.86 percent at September 30, 2011), 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 September 30, 2011, we were below the 50 percent ownership change level that would trigger further impairment of our ability to utilize our NOLs.

As of September 30, 2011, we had $4.2 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
 

 
 
 

 
 
 
941.5

 
941.5

2014
 

 
 
 

 
 
 
28.6

 
28.6

2016
 

 
 
 

 
 
 
38.8

 
38.8

2018
 
1,522.8

 
(a)
 

 
 
 

 
1,522.8

2021
 
29.6

 
 
 

 
 
 

 
29.6

2022
 
204.1

 
 
 

 
 
 

 
204.1

2023
 

 
 
 
1,996.0

 
(a)
 

 
1,996.0

2024
 

 
 
 
3.2

 
 
 

 
3.2

2025
 

 
 
 
118.8

 
 
 

 
118.8

2027
 

 
 
 
216.8

 
 
 

 
216.8

2028
 

 
 
 
.3

 
 
 

 
.3

2029
 

 
 
 
149.0

 
 
 

 
149.0

Total
 
$
1,756.5

 
 
 
$
2,484.2

 
 
 
$
1,008.9

 
$
5,249.6

 
_________________________
(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 $17.7 million and $17.8 million at September 30, 2011 and December 31, 2010, respectively.  The related state NOLs are available to offset future state taxable income in certain states through 2019.

Tax years 2008 through 2010 are open to examination by the IRS.  The Company’s various state income tax returns are generally open for tax years 2008 through 2010 based on the individual state statutes of limitation.
NOTES PAYABLE - DIRECT CORPORATE OBLIGATIONS
NOTES PAYABLE - DIRECT CORPORATE OBLIGATIONS
NOTES PAYABLE - DIRECT CORPORATE OBLIGATIONS

The following notes payable were direct corporate obligations of the Company as of September 30, 2011 and December 31, 2010 (dollars in millions):

 
September 30,
2011
 
December 31,
2010
7.0% Debentures
$
293.0

 
$
293.0

Senior Secured Credit Agreement
269.3

 
375.0

9.0% Senior Secured Notes due January 2018 (the “9.0% Senior Secured Notes”)
275.0

 
275.0

Senior Health Note due November 12, 2013 (the “Senior Health Note”)
50.0

 
75.0

Unamortized discount on 7.0% Debentures
(13.4
)
 
(14.8
)
Unamortized discount on Senior Secured Credit Agreement
(2.7
)
 
(4.7
)
Direct corporate obligations
$
871.2

 
$
998.5



In May 2011, we amended our Senior Secured Credit Agreement. Pursuant to the amended terms, the applicable interest rate on the Senior Secured Credit Agreement was decreased. The new interest rate is, at our option (in most instances): (i) a Eurodollar rate of LIBOR plus 5.00 percent subject to a LIBOR "floor" of 1.25 percent (previously LIBOR plus 6.00 percent with a LIBOR floor of 1.50 percent); or (ii) a Base Rate plus 4.00 percent subject to a Base Rate "floor" of 2.25 percent (previously a Base Rate plus 5.00 percent with a Base Rate floor of 2.50 percent). The interest rate on the Senior Secured Credit Agreement was 6.25 percent at September 30, 2011. Other changes to the Senior Secured Credit Agreement included:

(i)
a reduction in the mandatory prepayments resulting from certain restricted payments (including share repurchases). Pursuant to the amended terms, the amount of the mandatory prepayment is: (a) 100 percent of the amount of certain restricted payments made if the debt to total capitalization ratio, as defined in the agreement, is greater than 17.5 percent (such ratio was 18.0 percent at September 30, 2011); (b) 50 percent of the amount if such ratio is equal to or less than 17.5 percent but greater than 12.5 percent; or (c) if the ratio is equal to or less than 12.5 percent at the time of the restricted payment, then there is no prepayment requirement. Previously, we were required to make mandatory prepayments equal to 100 percent of the amount of certain restricted payments regardless of the level of the debt to total capitalization ratio;

(ii)
revisions to the covenants related to investment activity to allow the Company to make certain investments which were previously only permitted to be made by our insurance subsidiaries; and

(iii)
an increase in the cap on non-investment grade investments to 12 percent from 10 percent.

In the first nine months of 2011, as required under the terms of the Senior Secured Credit Agreement, we made mandatory prepayments totaling $55.7 million due to our repurchase of $55.7 million of our common stock. As a result of the repayments, we recognized a loss on the extinguishment of debt totaling $1.7 million representing the write-off of unamortized discount and issuance costs associated with the Senior Secured Credit Agreement.

In September 2011, we made an early payment of $25.0 million on the Senior Health Note, in satisfaction of the scheduled payment due in November 2011.

In March 2011, we made a voluntary prepayment of $50.0 million on our outstanding principal balance under the Senior Secured Credit Agreement using available cash.  As a result of the repayment, we recognized a loss on the extinguishment of debt totaling $1.4 million representing the write-off of unamortized discount and issuance costs associated with the Senior Secured Credit Agreement.

The scheduled repayment of our direct corporate obligations was as follows at September 30, 2011 (dollars in millions):
Year ending September 30,
 
2012
$
10.0

2013
76.2

2014
95.0

2015
82.5

2016
55.6

Thereafter
568.0

 
$
887.3

INVESTMENT BORROWINGS
INVESTMENT BORROWINGS
INVESTMENT BORROWINGS

Three of the Company’s insurance subsidiaries (Conseco Life Insurance Company (“Conseco Life”), Washington National Insurance Company and Bankers Life) are members of the Federal Home Loan Bank (“FHLB”).  As members of the FHLB, Conseco Life, Washington National Insurance Company and Bankers Life have the ability to borrow on a collateralized basis from the FHLB.  Conseco Life, Washington National Insurance Company and Bankers Life are required to hold certain minimum amounts of FHLB common stock as a condition of membership in the FHLB, and additional amounts based on the amount of the borrowings.  At September 30, 2011, the carrying value of the FHLB common stock was $72.5 million.  As of September 30, 2011, collateralized borrowings from the FHLB totaled $1.5 billion 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 $1.9 billion at September 30, 2011, 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 $18.9 million and $14.9 million in the first nine months of 2011 and 2010, respectively, was recognized related to the borrowings.

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

Amount
 
Maturity
 
Interest rate at
borrowed
 
date
 
September 30, 2011
 
 
 
 
 
$
100.0

 
October 2013
 
Variable rate – 0.565%
67.0

 
February 2014
 
Fixed rate – 1.830%
50.0

 
August 2014
 
Variable rate – 0.416%
100.0

 
September 2015
 
Variable rate – 0.553%
150.0

 
October 2015
 
Variable rate – 0.579%
100.0

 
November 2015
 
Fixed rate – 4.890%
146.0

 
November 2015
 
Fixed rate – 5.300%
100.0

 
December 2015
 
Fixed rate – 4.710%
100.0

 
June 2016
 
Variable rate – 0.675%
75.0

 
June 2016
 
Variable rate – 0.406%
75.0

 
August 2016
 
Variable rate – 0.392%
50.0

 
November 2016
 
Variable rate – 0.599%
50.0

 
November 2016
 
Variable rate – 0.705%
100.0

 
June 2017
 
Variable rate – 0.742%
50.0

 
August 2017
 
Variable rate – 0.486%
100.0

 
October 2017
 
Variable rate – 0.679%
37.0

 
November 2017
 
Fixed rate – 3.750%
$
1,450.0

 
 
 
 


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 September 30, 2011, the aggregate fee to prepay all fixed rate borrowings was $66.2 million.

In 2011, as part of our investment strategy, we entered into repurchase agreements to increase our investment return. We account for these transactions as collateralized borrowings, where the amount borrowed is equal to the sales price of the underlying securities. Repurchase agreements involve a sale of securities and an agreement to repurchase the same securities at a later date at an agreed-upon price. Such borrowings totaled $57.1 million at September 30, 2011. These borrowings were collateralized by investment securities with fair values approximately equal to the loan value. The primary risks associated with short-term collateralized borrowings are: (i) a substantial decline in the market value of the margined security will occur; and (ii) that a counterparty will be unable to perform under the terms of the contract or be unwilling to extend such financing in future periods especially if the liquidity or value of the margined security has declined. Exposure is limited to the excess of the net replacement cost of the related securities.

At September 30, 2011, investment borrowings consisted of:  (i) collateralized borrowings from the FHLB of $1.5 billion; (ii) repurchase agreements of $57.1 million; and (iii) other borrowings of $2.0 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.
CHANGES IN COMMON STOCK
CHANGES IN COMMON STOCK
CHANGES IN COMMON STOCK

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