CNO Financial Group, Inc. (CNO) Q1 2015 Earnings Report, Transcript and Summary

Good morning. My name is Benita and I will be your conference operator today. At this time, I would like to welcome everyone to the First Quarter 2015 Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Mr. Helding, you may begin your call.

Thanks, operator. Good morning and thank you for joining us on CNO Financial Group’s first quarter 2015 earnings conference call. Today’s presentation will include remarks from Ed Bonach, Chief Executive Officer; Scott Perry, Chief Business Officer; and Fred Crawford, Chief Financial Officer. Following the presentation, we will also have several other business leaders available for the question-and-answer period. During this conference call, we will be referring to information contained in yesterday’s press release. You can obtain the release by visiting the Media section of our website at www.cnoinc.com. This morning’s presentation is also available in the Investors section of our website and was filed in a Form 8-K last night. We expect to file our Form 10-Q and post it on our website on May 5. Let me remind you that any forward-looking statements we make today are subject to a number of factors which may cause actual results to be materially different than those contemplated by the forward-looking statements. Today’s presentation contains a number of non-GAAP measures, which should not be considered as substitutes for the most directly comparable GAAP measures. You will find a reconciliation of the non-GAAP measures to the corresponding GAAP measures in the appendix. Throughout this presentation, we will be making performance comparisons and unless otherwise specified, any comparisons made will be referring to changes between the first quarter 2014 and first quarter 2015. And with that, I will turn the call over to Ed.

Thanks, Eric and good morning everyone. CNO posted another solid quarter and our business has performed well as we continued to grow sales, our customer reach and earnings per share. Consolidated sales were up 3% in the quarter in line with our 2015 guidance range. Sales at Bankers Life were down slightly, but agent recruiting continued to improve positioning the segment for future growth. Washington National sales were up 3% led by continued strong sales growth at PMA, our wholly owned agency. Colonial Penn sales were up 26%. While we had easier year-over-year comparisons in Q1 for Colonial Penn, our various investments and initiatives in our direct sales platform, including expanded product offerings, more diversified lead generation and increased marketing effectiveness have performed above expectations. Having the vibrant direct sales operation is a key part of serving the needs of the middle market. Our key financial ratios and capital ratios remain at investment grade levels. Our strong financial position and operating performance enables us to continue to return capital to shareholders through dividends and share repurchases. During the quarter, we bought back $86 million of common stock. Operating earnings per share, excluding significant items, were up 11%. Equally important to serving the middle-market is having products and solutions to address the cost at healthcare expenses in retirement. So, let me take a few minutes to tackle out CNO’s long-term care strategy. Out-of-pocket healthcare costs, excluding the cost of long-term care, are estimated at $220,000 through retirement for a 65-year-old couple. This exceeds the retirement savings of 54% of boomers. Middle income boomers on average estimate that the cost of 1 year in a nursing home is $47,000 yet the true cost is nearly double that. Also, half of boomers think long-term care is covered by Medicare, which it is not. So, we continue to offer long-term care products because of their importance to the middle market. That said, we will do so while maintaining pricing discipline and expect the mix of our business to gradually change over time as a result of selling more affordable, primarily shorter benefit products. In the near-term, we will continue to increase and improve the transparency related to the performance and risk of our block. We will pursue rate actions if adverse experience develops. We have been and will remain actively engaged with the reinsurance community to manage the risk to our balance sheet. And finally, we will continue focus on initiatives aimed at improving our overall LTC business performance. In the longer term, we expect to reduce our overall exposure to long-term care by roughly half through a combination of the natural run-off of existing business, reinsurance and proportionately higher growth organic and/or non-organic of other business lines. We will continue to work with industry groups, legislators and regulators to create a sustainable and viable business environment. And we will continue to develop alternative products and solutions that address the critical and growing long-term care needs of the middle-market. With that, I will now turn it over to Scott.

Thanks, Ed. Beginning with Bankers Life, core sales in the quarter were down 2% mainly impacted by 10% lower annuity sales, reflecting the low interest rate environment in the quarter. Life sales were up 2% and long-term care sales were up 15%. This was largely due to increased marketing and sales of our one-year benefit period long-term care products resulting from increased consumer appeal and demand. These shorter duration products have been well received in the market and allow us to balance the risk of our in-force business. Med supp sales were down 7%. However, we expect this trend to reverse as new agents become more productive. We did see an increase in third-party med advantage and PDP production in the quarter, which is not reflected in NAP and expect sales of these and other source products, which leverage our distribution platform, open up new households and generate attractive non-life income to continue to grow going forward as we expand distribution. As result of study sales growth, Med Advantage fee income at $12.6 million was up 28% over last year on a trailing four quarter basis. As we mentioned last quarter, sales in the near-term are being impacted by challenges and recruiting we faced early in 2014, which led to a contraction of our overall agent force. We continue to see positive results from the tactical actions we took to respond to these challenges, with a 6% increase in new recruits in the quarter on top of the 9% increase in the prior quarter. In addition to tactical adjustments, we are investing in a number of initiatives designed to improve recruiting performance, automate field sales processes and improve agent efficiency. We expect these investments to further build on increased retention, higher productivity and an increase in the size of our sales force. As we have previously mentioned, it will take time to re-grow our aging count to prior year levels, but we expect a positive impact throughout 2015. Turning to Washington National, sales were up 3% this quarter. PMA, which makes up 80% of total sales, was up 10% on an average agent force that was up 9%. Our independent channel was down 21% with sales that continue to be adversely impacted by the organizational restructuring of a large independent partner as they work to increase focus on their business. Although the impact of sales continues to be somewhat larger than anticipated, the situation was isolated and the change positions this partner well for steady, profitable growth, albeit with some residual impact on sales through the first half of 2015. When excluding this particular partner, sales were up 9% in the quarter. Lastly, supplemental health collected premiums were up 5% due to continued growth and our in-force. Moving on to Slide 9, Colonial Penn posted a 26% sales increase building on the upward momentum experienced in the second half of 2014. The positive result in the quarter was driven by strong performance across all lead sources, including direct mail and digital and improvements in marketing cost and sales productivity. The first quarter 2015 showed recovery from a weaker first quarter 2014, which was down 1%. Colonial Penn’s first quarter 2015 collective premiums were up 7% year-over-year due to the continued growth in the block and strong first quarter sales performance. Finally, Colonial Penn’s first quarter 2015 total EBIT was negative $5.9 million, which was $300,000 better than first quarter 2014 and favorable to the guided first quarter 2015 projected loss of negative $7 million. We continue to expect Colonial Penn’s EBIT to be slightly positive for the full year 2015. Slide 10 provides an update on our sales outlook for 2015. From a consolidated standpoint, we maintain our growth at 3% to 6%. At Bankers Life, we continue to hold to our expected increase of 3% to 5% in 2015. Although we faced headwinds in the sales of annuities as a result of low crediting rates given the low interest rate environment. And as previously mentioned, it will take time to re-grow our agency count to prior year levels. We will continue to sharpen our focus on recruiting and increased the number of first year agents, which is key to growing our overall agent force. We will also continue to focus on increasing productivity of our veteran agents leading to improved retention levels, which combined with recruiting results returning to historic levels, will lead to a larger and more productive sales force. At Washington National, we still project sales growth of 5% to 7%, along with continued growth in our PMA agency benefiting from greater availability of new products and programs targeted to increase productivity and retention. Worksite sales will benefit from our new group supplemental health products and the one source benefit enrollment and servicing platform. Both of which were introduced on a limited basis late in 2014. For Colonial Penn, we now expect full year 2015 sales growth in the 9% to 12% range, which is up from our initial guidance of 6% to 8% growth. This increase is based on the strong sales results in the quarter and reflecting positive impacts from continued diversification of sales generated through direct mail and digital marketing activities, growth in simplified issue term and whole life products and further improvements in sales productivity and marketing effectiveness initiatives. Finally, across all three of our segments, we have been making investments to improve productivity and drive sales growth. We expect these investments as many are now entering full implementation to accelerate and both impact the sales and expense levels. I will now turn it over to Fred to discuss CNO’s financial results. Fred?

Thanks, Scott. I will focus my results on earnings development and capital conditions, where we recorded another solid quarter on both fronts. If you adjust for the one significant item in the period, we recorded operating earnings of $0.31 per share an increase of 11% over last year’s normalized quarter. This quarter’s only significant item was the negative impact from a $3 million adjustment to reserves in our Washington National supplemental health business. The adjustment is part of the normal quarterly process of assessing incurred claim development. And in this case, we increased reserves to recognize the modest efficiency. While our insurance earnings drivers performed solidly in aggregate, we experienced somewhat mixed results in our core health margins offset by continued strength in annuity margins, better than expected seasonal earnings from Colonial Penn, and solid corporate investment results. Core capital ratios and holding company liquidity remains strong. We modestly stepped up capital deployment in the quarter and are comfortably on pace to achieve our common stock repurchase guidance for the year. Our press release details two areas of updated guidance for 2015. Scott covered Colonial Penn’s strong sales quarter and we bumped up our guidance accordingly. We also refined our LTC future loss reserve accrual estimates impacting interest adjusted benefit ratios. I will touch on that in a moment. Turning to Slide 12 and our normalized segment earnings, I’ll use this slide as a backdrop to provide a little more detail on the quarter. Bankers’ EBIT benefited from continued strength in Medicare supplement and related health margins and continued solid annuity results. During our fourth quarter call, we discussed the GAAP practice of building reserves when profits are followed by losses or so-called future loss reserves this pertaining to our long-term care business. In the first quarter, we refined our approach related to anticipated rate actions and corresponding policyholder behavior. This refinement resulted in an increased build in the reserve as compared to previous quarters and as compared to estimates embedded in our fourth quarter LTC benefit ratio guidance. We have increased our interest adjusted benefit ratio guidance accordingly to the 84% range. There are varying approaches acceptable under GAAP and we have taken an approach that accrues future loss reserves more quickly. It’s also important to note that we have been accruing for future losses already and entered the first quarter with a $120 million reserve balance, which contributes to our loss recognition testing margins. This change is not the result of any adjustments in our year end actuarial estimates and loss recognition work and we have made no adjustments in our approach to statutory reserving. Washington National’s normalized EBIT was up modestly with growth in supplemental heath premium offset by an elevated benefit ratio in the quarter. After adjusting for the significant item in the quarter, Washington National’s supplemental health benefit ratios were modestly elevated at 55%. We attribute the weaker results to greater persistency on return of premium policies approaching their return of premium maturity, thus building reserves for potential pay-out. We expect benefit ratios will continue to be elevated in the second quarter. At this point, we are maintaining our full year benefit ratio guidance of 54% range and we will be monitoring our performance throughout the year. Colonial Penn reported solid seasonal earnings and sales growth driven by sales productivity and marketing effectiveness. Our overall marketing spend to NAP ratio, a measure of effective lead generation and conversion has been strong in recent quarters. And this is positively impacting earrings results. It’s a bit early to adjust our earnings outlook for 2015, but we are certainly on course for positive earnings years – year in our direct marketing platform. Corporate segment recorded solid investment results as we actively manage our portfolio of investments balancing the economic benefits of non-life investment income with contingent capital strength and maintaining ready liquidity. Turning to Slide 13 and investment results, while rates remain low and spreads are tight, we continue our tactical approach to investing new money flows. Lowering turnover allows us to be selective in finding enhanced deals without sacrificing credit risk. You can see this come through in our new money rates in the period although it’s more instructive to look over the course of a full year, where we expect to be closer to 5.2% on average. Prepayment income was favorable to our full year run-rate expectations, but not out of line with what we have experienced recently. Recognized this income has driven up of a few prepayments that can be isolated and it can be variable. Impairments in the quarter were limited and overall credit conditions remain favorable. We are seeing a modest drag in our risk-based capital ratio, a combination of ratings migration and investing in more capital intensive securities on the margin. As we continue to refine the optimal portfolio design backing our Bankers’ long term care business, we will likely see a modest allotment of capital to this initiative recognizing in the end, our investment strategy is designed to support reserve and capital adequacy. Slide 14 profiles our capital position. We ended the quarter with RBC ratio of 428%, down modestly from year end, but in line with our expectations. RBC was dampened a bit by the investment impact I mentioned a moment ago, which add about a 2 to 3 percentage point impact on RBC. Statutory operating earnings in the quarter of $79 million came in as expected and essentially matched the $76 million in dividends we sent to the holding company. Leverage dropped to just under 17% as we amortized $20 million of debt in the quarter. It’s worth noting absent any refinancing we faced $20 million per quarter debt payments through the third quarter of 2016. We ended the quarter with $311 million of liquidity in investments at the holding company. We took advantage of some modest weakness in our share price to push a little harder on repurchase buying back $86 million of stock at a little over $16 per share. We are maintaining our securities repurchase guidance in the range of $250 million to $325 million for 2015. Turning to Slide 15 and returning briefly to the topic of long-term care, Ed provided color on our near and long-term strategic focus. We pulled this slide together to make a simple point than not all long-term care businesses and in-force blocks are alike. In the case of Bankers, there are a few critical characteristics that can have significant impact on the range of potential outcomes for a long duration business like long-term care. First, our target market is essential to understanding our risk profile. The older age and middle-market profile of our market results in a shorter liability duration, less rich benefits and greater transparency into older age claims patterns. Our claims reserves are proven and solid. Of our $4.4 billion in total reserves, roughly $1.2 billion represents claims reserves, where uncertainty over adequacy is considerably lower than active life reserves. On a relative basis, most in the industry have far less policies on claim and are more heavily weighted towards potentially volatile active life reserves. Over 70% of our new business comes from shorter duration policies with benefit periods of a year or less. We have a longstanding reinsurance partnership with RGA to support our approach to pricing and underwriting. We sell this business through the captive Bankers agent model, where long-term care is one of many products sold by a typical Bankers agent and is only sold when the value proposition is there and it meets with our pricing and underwriting standards. These facts then add up to a better overall in-force profile. Only 4.6% of our policies have lifetime benefits and only 17% of our policies have benefit periods greater than 3 years by multiples lower than most participants in the LTC industry. The relatively shorter duration of our liabilities allows us to duration match with assets, where together with relative size and turnover of the portfolio, we have very little only $35 million a quarter subject to reinvestment risk. Finally, we have been successful in achieving several rate increases on our more comprehensive policies, where most of that regulatory uncertainty is behind us and supports our current economics and future estimates. Despite these favorable characteristics, LTC remains a risk we are actively managing each day with several initiatives in motion to defend and improve our position. However, these characteristics do deliver the following, greater confidence in our estimates, and therefore reserves and reserves build accruals. A more narrow spray of outcomes are tail risk thus less disruptive to capital planning. Should we entertain reinsurance solutions, we believe we have a more marketable block of in-force policy mix on balance. Finally, sustainability, in that we can afford to invest in new business knowing its importance to the senior middle-market, while at the same time improving the risk profile of our in-force each and every day. Turning to Slide 16 in ROE redevelopment, on a normalized operating – our normalized operating ROE came in at the 9% range supported by strength in core earnings and capital return to shareholders. During our fourth quarter call, we discussed outlook for ROE in the mid 9% range absent any impact of our recapitalization and this remains our guidance. We noted current headwinds, including new money investment rates, long-term care performance, sales growth and pace of investment in our platform. We do not intend to muddle through persistent low-for-long rates or depressed long-term care margins and are actively investing time and money in initiatives designed to deliver enhanced returns, while improving our ratings and lowering our overall cost to capital. We continue to monitor markets and weigh the value of recapitalizing the balance sheet. Current market conditions are strong. Recognizing our main motivation is to lock in investment grade-like debt structure for greater financial flexibility. As we proceed towards the call date of our bonds in October and balance prepayment penalties with favorable market conditions, it’s important we remain ready and opportunistic as we proceed through the coming months. With that, I will hand back to Ed for some closing comments.

Thanks, Fred. Looking ahead, we are encouraged by the level of sales activity and pleased with the progress we are making to regain momentum on agent recruiting. We will continue to invest in initiatives to increase productivity and operating effectiveness, including leveraging our new strategic partnership with Cognizant to accelerate those activities. We will continue our holistic approach to managing our long-term care business and will begin filing our new round of rate increases this quarter. Our solid operating performance and financial strength coupled with favorable market conditions and continued progress on ratings bodes well for recapitalizing our balance sheet on or before October 1. Lastly, we are actively developing future catalysts and exploring non-organic opportunities to expand and accelerate profitable growth in our business. We will now open it up for questions. Operator?

Thank you. [Operator Instructions] Your first question comes from the line of Erik Bass.

Hi, good morning guys. Thank you. I guess, first just on the future loss reserve accrual for long-term care, just to clarify, is it interest rates that are the main driver of the increased accrual? And then you had said there is no change I guess to the underlying loss ratio and kind of claims experience, but does your guidance factor in any benefit from potential shock lapses as you start re-pricing this quarter?

Thank, Erik. Yes, this is Fred. No, this adjustment is not related to interest rates. And maybe it may serve everyone to step back a little bit and make sure you understand first how we go at this and then I can answer your question in terms of lapse rates. So, we are taking the following approach, where we calculate present value of future losses remembering this is a book of business that has gains followed by losses and the present value of gains. And in our particular case, because we have already built up an FLR of $120 million, you back that off the estimate of present value future losses. That then creates a ratio. You take the ratio of that net loss position to profits and that ratio is then what we applied to the essentially the gross profits going forward to build the FLR. In our particular case, it’s approximately a 50% factor that we are applying to those gross profits. Now, if you may recall back and if we didn’t comment on – and I will comment on it now that back when we are doing loss recognition testing, we did not factor in the potential windfall profits, if you will, from shock lapses related to rate increases, because they can be variable and arguably we think a somewhat consecutive approach, but prudent. Similarly, we don’t take that approach when calculating this accrual either and that gives rise to a slightly higher percentage that we are applying to the gross profits to factor to roll up or accrue the future loss reserve. And so to answer your question, no, we are not taking into account lapse rate profitability, now of course as we install rate increases that may happen. And if that happens, you will see first of all some level of those profits being set aside to build the future loss reserve more aggressively. You will also see some of that dropped to the bottom line to the degree shock lapse changes the trajectory, if you will, of the present value of future profits versus losses it could change that actual factor of 50%, i.e., improving it or bringing it down as well. These are all the types of things we will regularly monitor as we go forward.

Got it. That was helpful. But at this point, we should assume this is a good run-rate kind of level of accrual for this year, but in the future as well?

Yes, but recognizing that again we are in a period, where we are entering into rate increases. And as you go into rate increases, again, the profitability pattern will adjust accordingly and we will have to monitor that. So, while this is – we have estimated profits going forward, those profits can vary as you go through a period of rate increases. Eventually, it will settle down and settle out to a more consistent number.

Got it. And then you had mentioned reinsurance a couple of times and then we also recently saw American Financial Group announced the sale of its long-term care block and some other companies have suggested at least interest in exploring options for their long-term care blocks. What is your view on the appetite of capital for long-term care at this point and as the bid/ask spread narrowed at all?

Yes. It’s – I mean I think it’s a very interesting environment. I think we are absolutely seeing a growing level of interest. I think re-insurers both existing and newly formed re-insurers backed oftentimes by private capital and/or associated particularly with investment vehicles are finding a level of potential attractiveness related to the longer duration of the assets and what maybe their specialized approach to investing those assets. I think what’s also happening is as transparency has picked up considerably in terms of really understanding the nature of the liabilities, the behavior, understanding a little bit better the dynamics of the actuarial risk and issues and variability in the blocks. I think you are gradually finding private capital gaining a level of comfort in attempting to at least understand better the behavior of these liabilities and can a deal be struck? Is there something that they would find attractive to come into the business? The reason I spent some time talking about the makeup of our business is we happen to believe that if you are out there you are a re-insurer and you are looking to dip your toe into the long-term care business and find elements of it attractive. We happen to think the profile of our block of business is uniquely strong and just simply better able to forecast, estimate, appraise and we hope as a result of that, the bid/ask would be more narrow. Now, this of course is our view and we think it’s somewhat has basis based on what I said. We are looking to as Ed mentioned reduce the overall economic exposure to this business in half over the course of the next 4 to 7 years. We know we can’t just simply do that organically. We are going to need to see some level of growth of course in non-organic, non-LTC business. And we also think it’s going to take approaching reinsurance solutions on elements of the Bankers’ block and so we will continue to remain close to the marketplace and monitor that as we go.

Great, thank you very much. Just one quick clarification, you had mentioned on I think the conditions are favorable for recap. Is there anything technical that would preclude you from pursuing a recap now?

No. I mean, it’s really just watching the markets doing what we have been doing, which is balancing what we can achieve in the marketplace with a recognition that there is a penalty we need to pay to go certainly any sooner than the October 1 call date, but even then, there is a call premium required on our bonds. So, it continues to be weighing those economics, but the main point I think I want to drive home is that we have gotten through a year end period. We now are posting a first quarter. And as we discuss our position with rating agencies, as we discuss our situation with bankers and look at the marketplace, we believe CNO continues to be – there continues to be strong demand to invest in CNO, particularly CNO debt if that opportunity were to arise. So, we are watching all those variables right now and have to continue to monitor and be ready if the market hands us an opportunity that we think is a strong NPV for our shareholders.

Perfect. Thank you very much, Scott.

Yes.

Your next question is from the line of Randy Binner.

Hey, good morning everyone. I have had some technical difficulties. So, I am going to ask a couple of questions and I hope that I am not being redundant, but just back on the FLR, I just want to make sure I understand that right, so it’s not an interest rate change, it’s a behavior change – and the behavior change and the assumptions would be in response to how behavior would react to higher rates that are being put through on the block? Is that a good layman’s way of describing it?

I wouldn’t describe it that way. Again let’s kind of level set here. So, first, last year, 2014, we had been building a future loss reserve at a rate of about $5.5 million a quarter. And we have been doing that for quite a while. And as I said we ended the year with a future loss reserve balance of about $120 million. As we entered into 2015, we adjusted our approach to the build of the FLR. We had been building the FLR on more of a percentage of premium basis and we move to more of a percentage of gross profit basis. And in doing that, we also needed to of course reset our expectations for gross profits coming off of all the loss recognition testing work being done at year end. And so we reset that process and had an estimate for what that was going to mean to the build in the FLR, i.e., a higher build in FLR and that factored into our 81% roughly long-term care interest adjusted benefit ratio range. Now, fast forward to first quarter, what’s changed? Well, what’s changed is in refining that calculation, that percentage of gross profit approach, we took a hard look at not just the rate increases, which of course have been embedded in our estimates all along. They were part of the year end work, but the more tactical and technical dynamic of how should we be estimating policyholder behavior after rate increases are installed, most notably lapse rates. And so in looking at that, we made the decision that it would not be in our view prudent and perhaps modestly conservative, but would be more prudent to not include the profits associated with shock lapse in that present value profit calculation thus driving down the ratio, driving down that 50% ratio applied to gross profits, so in making that decision, that naturally resulted in a slightly elevated accrual for FLR. To give you some numbers around it in the first quarter, for example, we accrued about $9 million in our FLR. So, again, last year a pace of $5.5 million a quarter, first quarter, we accrued $9 million. What are we seeing going forward that factors into the 84% interest adjusted benefit ratio roughly a range of $9 million to $11 million again depending on the quarterly timing of gross profits and applying that factor. Does that help?

Yes, thank you. That absolutely helps. Sorry, I got dropped from the call, so I didn’t get all of the explanation, that’s more conservative, that makes sense. So, couple of follow-ups. One, what caused you to reevaluate that decision to not anticipate the benefit of – the benefit from higher price increases? Was it an internal decision? Was it an external decision? Was it, I mean, an auditor decision? What changed?

Yes. No, it was not an auditor decision although we work actively with our auditors on this approach. GAAP is interesting, right. GAAP says hey, if you have profits followed by losses, you must develop a future loss reserve accrue, but then it falls a little short and precisely what methodologies one would use. And so we as a management team and as an actuarial and accounting team need to come up with a supportable, viable, sensible, practice of building that reserve. And that’s what we did. Nothing really changed dynamically in the way we think of the business. It was really a matter of further refining as we were entering into that very first quarter of posting the FLR into our financial statements. And in doing that, we simply made the call that it made sense for us to be careful about including too much in the way of shock lapse related benefits.

Okay. And just is there any shock lapse benefit or is it zero?

We have assumed zero. That’s both in our loss recognition testing and in the establishing of this 50% factor. Now, what do we expect? Hard to tell. Of course, historically, we have seen that benefit. And one of the things I would tell you that I did not like about the percentage of premium approach and this happened actually to me when I first arrived at the company, we are in the tail end of installing rate increases. And we actually saw what I would call kind of windfall profitability related to shock lapses. And of course we would get on the call with you and say hey, that’s a notable item, adjust that out of your numbers when it comes to our run-rate. In the whole time you are thinking to yourself, wouldn’t it be more prudent or wouldn’t it be a better practice or helpful for us to start the process of building that reserve by applying more of a gross profit percentage, right, certainly more prudently establishing your balance sheet as you go forward for the potential risk based on your estimates. And so I think this is just a very good approach. I think it’s become a more customary approach of how to do this. And so what will happen is if we do see shock lapses we will be setting some of that aside to build future loss reserves, but it’s likely that some of that would also flow through as is naturally the case.

Okay, got it. And then if you haven’t already quantified the next round of rate increases kind of what percentage of rate increase is targeted on what percentage of the block?

Yes. So, if you recall from last quarter when we sort of discussed our approach to rate increases, we are going at rate increases state by state largely concentrated in the more comprehensive buckets of policies that we have. And we are on average looking at filing as low as 20% and as high as 40% rate increases. However, for purposes of our estimates, we have assumed only a 40% success rate on those increases, that then resulting in 9% or roughly $50 million of premium. And so what we are doing right now is we are in the process of starting those filings and we will be starting the kind of the first wave, if you will, of those filings here in the second quarter. There will be a level of continued filings as we move throughout the year. It’s quite a process. As I think by now you know it’s state-by-state, it’s complex, there are separate calculations and packages that are performed for each state based on what they need and want to support any rate filing. And so we tend to go at it in a graduated phased way throughout the reminder of the year, but starting in the second quarter.

Okay, understood. And then one more if I can sneak it in. I think maybe Erik Bass get into this, but I mean, there has been re-insurers, you have looked at it long-term care books, is there other institutional interests that you have seen out there and potentially take in these liabilities?

Is there other than re-insurers?

Right. Yes, is there anything outside there any other structures that are developing?

Yes, I mean, it’s a good question. I would say, we tend to as part of generalizing say re-insurers or reinsurance, but there are players out there working through I guess I will call it more synthetic structures to transfer the risk. This is not new. This has been under development, if you will, among various banks, bank-owned re-insurers etcetera, for a while. My view Randy is that those types of structures are first, they tend to be loaded with boxes and arrows, which typically means there could be challenges with really holistically transferring the risk. And so I am skeptical of those types of structures working. However, we want to remain open to it and look at it. So, there are alternative structures out there, but they usually involve the primary company retaining a level of risk and/or stop loss if you will where risk can come back at you. And my big rule of thumb here is if I transfer risk, but keep elements of the tail, I probably haven’t done much for myself. So, if you are going to come at us with reinsurance solutions, but come at us with an idea. However, if you could keep detail that would be great, that ain’t going to work.

Understood. Thanks for the response.

Your next question is from the line of Dan Bergman.

Hi, good morning. You mentioned the goal of reducing your, I think with the relative economic exposure to long-term care by roughly 50%. First, can you give you a little more color on how you are measuring or defining relative economic exposure and how we should think about that decline? And secondly, is there any sense you can give of how much of this should come from the natural run-off of the book versus what would need to come from reinsurance or similar non-organic sorts?

So, let’s talk about this notion of cutting our exposure in half and kind of what the elements are, that drive that. And then I will answer your question specifically. So, what we are talking about here is first of all growing the 85% of non-LTC business that makes up CNO disproportionately to long-term care, right and that’s both organically and non-organically, okay. And so that’s why the longer range associate, because we would expect it to happen over longer range. The second is just the natural run-on and run-off of the block itself. We are bringing on naturally shorter duration as we have mentioned and lower premium per policy, policies on to our books. And what is naturally running off, because it’s much older, where mortality comes into play and other forms of lapsation is generally the more comprehensive long-term care business that has to happen. They will also be the business that when we install rate increases if you are going to see a level of lapsation, you would see it there as well. So, what I would call the natural run-on and run-off of the actual block of business itself. And then last but not the least is well, is there something non-organic you can do with the long-term care block itself, i.e., re-insurers. And that’s where we would see reinsurance playing a role in possibly reducing our exposure through a transaction and thus the reinsurance discussion. Now, your question of what do you mean by economic exposure? I think of economic exposure in a couple of different ways, okay. One simple way is to look at the amount of reserves as compared to the total reserves on your balance sheet. And as you might know, that’s closer to in fact even a little bit north of 20%, so what brings it down to 15%, we will realize we are a large med supp player and med supp drives an awful lot of economic benefits and cash flows, particularly when you are in the mid supp business and the long-term care business, yet does not carry much in the way of reserves on your balance sheet. So, you almost have to take sort of a reserve equivalent economic value of the supplemental health business, load that on our balance sheet and that starts driving the reserve percentage down. The better and more technical way for I think an investor to think about the economic value and the better way for us as a management team is to essentially cut in half the capital at risk. I think it would really make the most sense in terms of driving value, because what we are trying to do here is really by lowering the beta or risk profile of the company, a couple of things are going to happen. One of course we drive down the cost of equity. We probably get a booster shot by ratings moving in the right directions. If you do it right and execute on it, that gives you another little kicker on cost of debt and cost of equity, you could probably add a little more dose of leverage to your balance sheet, because you reduce that risk file. So, it all comes together and all of those things would be factored in and thinking about the economics frankly of a reinsurance transaction. So, I think about waking up 4 to 7 years from now and saying, not only are the reserves left as a percentage of our total company, but if I think about what the capital at risk for a given variable was back then and what it is today it’s half the dollar amount.

That’s very helpful. Thanks. Maybe just to follow-up of the buckets you mentioned, I mean any sense of how much might need to come from reinsurance to hit that 50% target or is it – do you have any moving piece?

Yes, it’s going to be moving. And I would say this that the really nice thing right, okay. So, as I mentioned earlier, so we have $4.4 billion of reserves. And as I mentioned $1.2 billion of it is claims reserves, which are very well in hand. We feel very comfortable with the quality of those reserves and how they performed particularly strongly about that when you realize the mix of our business and that there is far less risk of things like the sort of the continuation of claims, if you will, related to lifetime benefits. We just simply don’t have that type of risk. So, you then start to look at the remaining active life reserves of roughly 3.2. And so when you think of the size of our business, it’s not like we have to go to market with a $3 billion long-term care reinsurance transaction. I think what makes a lot of sense is quite honestly a little bit of what we just did here more recently albeit with a closed block, look at $0.5 billion, $600 million perhaps in the high side $1 billion transactions, which are easier for the perspective market to absorb and dip their toe in water, really move the dial for us. And I also like the idea of not putting all of our eggs in one basket. I think it’s likely the case that you would look at one or two different types of structures over time to get it done right. Now, remember all of this is essentially assuming that the bid/ask works for us. Because if I may ask comfortable with the dynamics of the in-force as I am and where I see the economics going, I am going to be more demanding on what I expect to see in the way of pricing in bid/ask. I am not in some position of desperation here. And so I think we are in good shape, but we are going to do what you would expect us to do and that is negotiate and move when it makes sense in balance for our shareholders.

Great, thanks. Maybe just one last one, shift gears to sales, it looks like one driver of the Bankers sales decline was depressed annuity sales due to the low rate environment. Is there any sense you can provide about what level of interest rate or even just annuity sales is embedded in your 3% to 5% 2015 guidance? I mean, I guess asked another way, if rates remain near 2% through the rest of the year, could that drag on annuity sales cause you to miss the Bankers segment sales guidance or would the pickup in overall sales over the course of the year from recruiting be enough to offset that?

So, we did assume some level of continued pressure and interest rate in our forecast. So, it’s still at risk, but more to your last point, Dan, we would expect that the agency force still has to make a living and we see a product shift and offsets in other areas. There is the second half of the year – there is a – we have made an assumption of a modest improvement or leveling out of crediting rates. And so to the degree that doesn’t happen that presents some risk, but we would expect to be able to pivot and shift to other product lines.

Great, thanks.

And this question is from the line of Humphrey Lee.

Good morning, guys. Just to follow-up on Bankers sales, so my understanding is for last quarter, you have a pretty good recruitment growth and [indiscernible] again for this quarter. Just remind me kind of the ramp-up period for new recruit, was it like 180 days? So, if so the first batch of the stronger recruit should come through to production in the second quarter, is that the right way to think about that?

Humphrey, that’s correct. It’s about a 6 to 9 month ramp up depending upon obviously when they came on in the quarter. So, yes, we would expect the second quarter to start to begin to see some benefit of those fourth quarter recruits come through and then in the third quarter some benefit of the first quarter of this year recruits come through, correct. And they are likely going to come through in those product lines like traditional life, critical illness and med supp, so simplified issue, smaller premium per policy type business.

Okay. And then in terms of that in Washington National that one producer restructuring like how much of the impact was it in kind of – in this quarter and how should we think about it for the balance of the year?

Sure. It was a significant impact for that 20%. So, let me just step back and remind everyone that the 80% of Washington National production comes from our captive wholly-owned agency, PMA. The partner channel contributes today 20% and this was one of our larger partners for sure. So, backing that out, it had a significant impact, sales went from up 3 to up 9, so it was significant. We expect the second half of the year that, that partner will stabilize, but we aren’t expecting growth from that particular partner. So, we have spent and continue to spend time building on the other partnerships, that we have and expanding into additional partnerships. So, we become less dependent on one large organization, but we would expect that to continue to impact us in the second quarter and with some improvement in stabilization in the second half of the year.

And Humphrey, that was considered in our guidance and that’s why we have reiterated our guidance.

Okay, got it. Thank you.

And there are no further questions. Are there any closing remarks?

No, just thank you everyone for your interest in CNO.

And this concludes today’s conference call. Thank you for your participation. You may now disconnect.