CNO Financial Group, Inc. (CNO) Q1 2018 Earnings Report, Transcript and Summary

Good morning. My name is Sara and I will be your conference operator today. At this time, I would like to welcome everyone to the CNO Financial Group First Quarter 2018 Earnings Results Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the conference over to Mr. Adam Auvil. Please go ahead.

Good morning. And thank you for joining us on CNO Financial Group’s first quarter 2018 earnings conference call. Today’s presentation will include remarks from Gary Bhojwani, Chief Executive Officer; and Erik Helding, Chief Financial Officer. Following the presentation, we will also have several other business leaders available for the question-and-answer period. During this conference call, we will be referring to information contained in yesterday’s press release. You could 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 earlier today. We expect to file our Form 10-Q and post it on our website on or before May 3rd. Let me remind you that any forward-looking statements we make today are subject to a number of factors, which may cause actual results to be materially different than those contemplated by the forward-looking statements. Today’s presentation contains a number of non-GAAP measures, which should not be considered as substitutes for the most directly comparable GAAP measures. You’ll find a reconciliation of the non-GAAP measures to the corresponding GAAP measures in the appendix. Throughout this presentation, we will be making performance comparisons. And unless otherwise specified, any comparisons made will be referring to changes between first quarter 2017 and first quarter 2018. And with that, I’ll turn the call over to Gary.

Thanks, Adam. And good morning. First quarter 2018 was another quarter of progress for CNO. We continued to grow key metrics, and our underlying fundamentals are strong. A number of our strategic initiatives are advancing from the pilot phase to implementation to scale. As expected, it will take time for these efforts to demonstrate their full potential. I’ll go into more detail shortly as to why we are encouraged about these initiatives. We posted solid earnings and demonstrated our financial strength. The diversity of our franchise continued to drive consistent and profitable earnings growth. Operating earnings per share were up 29%. Excluding the impact from the change in tax rate, operating earnings per share were up 6%. Book value per diluted share excluding AOCI was $21.94, up 2% sequentially. Although we experienced noise in some key metrics this quarter, our capital position remains strong. Erik will provide details during his remarks. We paid $15 million in common stock dividends this quarter. There were no common stock repurchases in the quarter. Our commitment to deploying 100% of free cash flow over time remains unchanged. Moving to slide six in our segment production results. Bankers Life total collected premiums were down 2%, primarily driven by modestly lower annuity collected premiums. Annuity account values increased 4% due to strong persistency. Life NAP was down 8% for the quarter due in part to fewer producing agents. These results also reflect the impact of new underwriting procedures we implemented late last year to review prescription drug histories on our simplified issue business. Because we anticipate this strategic action will generate long-term improvements in our underwriting margins, we are comfortable with the short-term headwind to sales growth. Health NAP was down 18% for the quarter, driven by a 20% decline in Medicare supplement sales. Fewer producing agents contributed to this result, but it is also reflective of the continued shift to a third-party Medicare advantage plan sales which are not included in our reported NAP figures. Our Medicare advantage inforce policies increased 17%, as a result of higher sales. Fee revenue was up 18% from continued growth in broker dealer and registered investment advisor client assets, and the previously mentioned third-party Medicare advantage offerings. A strong job market coupled with our ongoing strategy to implement a more targeted agent recruiting process contributed to a 7% decline in total average producing agent counts. Several initiatives designed to improve the productivity and retention of our agent force have recently been expanded nationally. While we anticipate that it will take time for these results to impact the overall size of our agent force, our decision to expand these initiatives is a signal of our ongoing commitment to improving sales performance and fundamentally reshaping our agent force. As an example, we’ve piloted increased financial incentives to veteran agents for providing on the job training to help increase the productivity and retention rates of new agents. Based on positive results from the pilot, we expanded the program nationally in late 2017 and have already seen an increase in new agents achieving their production milestones. Moving to Washington National, total collected premiums were up 2% with a 3% increase in supplemental health, partially offset by the continued run-off of the closed Medicare supplement block. Total NAP was down 3% from the year-ago quarter, driven largely by a 4% lower supplemental health sales in the individual channel. The sales results were modestly impacted by weather that reduced the number of active production days. The PMA worksite channel once again posted double-digit growth and was up 15%. Continued recruiting initiatives in this channel contributed to an overall increase of 1% to the PMA average producing agent count. For Washington National, we are seeing early success in a few key growth initiatives. In particular, our efforts to expand our geographic presence generated over $1 million in incremental NAP during the first quarter as part of a 14-state expansion. We are also seeing great progress with initiatives to diversify the product offering and leveraging the breadth of the CNO portfolio in doing so. Life insurance sales grew 5% building off a full year 2017 increase of 15%. Additionally, our pilot to short-term care in the PMA individual channel is gaining traction. And we plan to expand the pilot based on its early success. For Colonial Penn, total collected premiums were up 1% in the first quarter, driven by growth in the block and stable persistency. NAP was down 15% due in part to the deliberate decision to pull back on our marketing investment in the quarter as we remain price disciplined. Lower than anticipated tele sales agent counts also impacted sales. However, we are actively working to resolve the issue and expect the effects to be isolated for the first half of 2018. Due to sales efficiency efforts, web and digital sales saw a 16% increase from recent investments in the platform and user experience enhancements. I will now turn the call over to Erik to discuss our financial results. Erik?

Thanks, Gary. CNO had another solid quarter of earnings. We reported net income per share of $0.50, up $0.14 or 39%. Operating earnings per share were $0.44, up $0.10 or 29%. Operating earnings per share excluding significant items were $0.43, up $0.08 or 23%. As discussed on our fourth quarter earnings call, because we previously had an effective GAAP tax rate of approximately 36%, we expected an outsized benefit as a result of tax reform. Of the increases in income noted above, approximately 22 points of the improvement was related to having a lower effective tax rate. Operating return on equity was 9.6%, increase from 2017 levels as we are benefiting from higher income and the lower corporate tax rate. Holding company cash and investments were $378 million, down slightly from the fourth quarter due to lower statutory dividends from insurance subsidiaries and the seasonality of expense payments between the holding company and its subsidiaries. Estimated consolidated risk-based capital was 427%. The decline from the fourth quarter is primarily due to opportunistic investments made into several preferred stock and high yield ETFs as well as certain other assets which offered very attractive relative value and incremental yields but had higher capital requirements. These investments are highly liquid and we have the ability to unwind them in a very short period of time, should we wish to. As we have stated in the past, it is our objective to run the company at a consolidated RBC ratio in the 425% to 450% range. As we continue to be within this range, we have not changed our capital management plans. Additionally, there is no change to expected future free cash flow generation or willingness and ability to deploy 100% of free cash flow over time. Turning to slide eight and our segment earnings. Bankers Life earnings reflect lower Medicare supplement margins of $9 million, primarily as a result of the implementation of crossover processing that occurred in the quarter. As a reminder, crossover is an industry-wide claims platform that provides a straight through processing of provider payments. As we have moved portions of our block over to this platform in the past, we typically see an uptick in the volume of small dollar claims and this did occur in the first quarter as expected. Offsetting this were favorable investment income and expenses. Washington National’s earnings in the period reflect significantly higher supplemental health margins as we experienced lower levels of incurred claims. Colonial Penn’s results were slightly ahead of expectations as lower overall advertising spend offset slightly unfavorable mortality. Our LTC in run-off segment reported breakeven results, in line with expectations. Lastly, corporate segment results were lower versus the prior year due primarily to significant outperformance of our COLI asset in the first quarter of 2017. Partially offsetting the decline was lower expense s in the current quarter. Turning to slide nine and our key health benefit ratios. Bankers Life Medicare supplement benefit ratio was 73.3%, in line with our expectations, but higher than the prior year and the prior quarter, as a result of the previously mentioned implementation of crossover claims processing. We continue to expect that the Medicare supplement benefit ratio will be in the 71 to 74% range for the remainder of 2018. Bankers Life long-term care interest adjusted benefit ratio excluding the impact of rate increase related reserve releases was 72.6%, better than expectations, reflecting favorable incurred claims and persistency. We continue to expect the interest adjusted benefit ratio to be in the 75 to 80% range for the remainder of 2018. Washington National supplemental health interest adjusted benefit ratio was 54.4%, significantly better than expectations due to favorable incurred claims as well as a prior period reserve redundancy that was released in the quarter. We continue to expect the interest adjusted benefit ratio to be in the 58 to 61% range for the remainder of 2018. We are encouraged by recent results in our long-term care and supplemental health businesses. And although we are not changing guidance on benefit ratios at this time, we are cautiously optimistic that recent trends will continue and we’ll provide an update on our second quarter call. And with that, I’ll now turn the call back over to Gary.

Thanks Erik. We remain committed to the following three priorities and opportunities. Number one, achieving our growth strategy through implementation and execution on our strategic initiatives. Number two, addressing our legacy long-term care insurance exposure and further derisking the balance sheet. We continue to have active conversations with interested parties and will update the market when appropriate. Number three, deploying 100% of free cash flow generation over time. Areas of deployment include investments to accelerate profitable growth, common stock dividends, share repurchases, and funding potential long-term care risk reduction transactions. The amount and timing of deployment will be based on business and market conditions. Our aim is to deploy capital to its highest and best use over time. Thanks for your ongoing interest in CNO Financial Group. We will now open it up for questions. Operator?

Thank you. [Operator Instructions] Your first question comes from the line of Randy Binner from B. Riley. Please go ahead.

Good morning. Thank you. So, I have a question actually just right off on just the nature of the RBC change with the allocation to these preferred ETF investments. I understand, I mean, hearing that you can switch to this because it’s liquid and that it was your kind of a willful move. But, optically, it flattens the RBC trend. And so, I’d like to understand better kind of what the opportunity is with that trade and maybe kind of size it a little bit for us if you could?

Sure. Randy, this is Eric Johnson, and I’ll take that. You will remember that in kind of the middle part of February, there was a kind of a fairly strong shutter in the market and some risk reversion obviously affected equities and fixed income, credit markets as well, spreads widened fairly substantially more in some spaces than in others. And during that dip, we took the opportunity to think about using some cash which has prior been in very short term, highly liquid, basically enhanced cash strategy earning, basically very little and to deploy it tactically into a series of places, some preferred ETFs, a number of them that -- with very diverse underlying constituents, 100, 200, 300 underlying constituents that are predominantly investment grade, also some non-investment grade, a small proportion of non-investment grade ETFs, also some triple B, double Bish CLO paper which widened out very substantially during that time, as well as some high yield corps. If you put that all together, it probably adds up to $300 million with the fixed investment grade constituent preferreds being probably two-thirds of that and the CLO and high yield investments comprising the other third. The economy appears to have another one or two years lags left in the cycle. Corporate earnings continue to be strong, inflation trending up, rates are trending up on a relative value basis. And I think this has played out already relative to say kind of a traditional IT, corporate kind of single A-ish investment. I think, there’s already been a fair amount of tightening of the spreads on for example the ETFs versus IT corps, and that’s playing out pretty well. I can also tell you that on kind of return on capital basis, it has a very pronounced favorable benefit to the company. While I am going to use only -- numbers that are only illustrative, if you believe that our traditional investment basket produces something after default adjustment and after our capital charge, something like 12% ROE, this basket probably produces something 50% higher, which is a fairly significant on a fully adjusted basis for capital allocation as well as default charge. So, it’s a tactical allocation. We’ll revisit it as market conditions change; if the Company’s needs for capital change, we obviously have this and other way to rebalance assets to reduce required capital from investments. It’s on balance I think will prove to be a good earner for the Company, producing good income for the Company, producing good return on capital for the Company, avoiding the longer end of the curve, which is I think when they continue to struggle as rates go higher, so a lot of goods, some risk associated with it. But, it’s -- and even adding the allocation, it fits well within the allocation boundaries that we subscribe to and that we live with, for example high yield -- corporate high yield 4% going into the year; if you include what we did here now, we’re 5%. So, I think we thought about it from a lot of different angles and understand the implications, the risks and the returns and feel good about it.

And then, just kind of housekeeping on forecast in RBC, the required capital went up by I think nominally something like $32 million. And so, all of that’s reflected in the first quarter. There’s no kind of bleed through to the second term. You said that it was mid February. So, that’s all -- the number we got at quarter-end, that’s our new denominator for RBC, correct?

What you’re asking is -- I think we completed that -- this tactical reallocation during the February period. And so, you wouldn’t expect to see it in March and then certainly not in -- I can’t promise what happens from here through the rest of the quarter. But, as of now, you wouldn’t see a similar event.

Okay. And then, just on the -- there’s this kind of a specific mention of LTC risk transfer. Is it one of many potential uses of free capital? I guess, Gary, how should we think about the kind of movement in the tenure and how that affects those discussions, meaning the movement higher belly of the curve?

I think, the short answer, and I’ll let Erik elaborate if he wants to, but I think, the short answer is, we don’t see that affecting how we’re looking at the different opportunities.

I think that’s right. This question has come up in the past. And what we’ve said is, because of a pretty tightly ALN [ph] match that we’re not overly sensitive to move in interest rates. There’s obviously some sensitivity there. But, again because of the match, we’re in pretty good shape there. We’re much more susceptible obviously to the mortality, morbidity, persistency assumptions. And when you look at our stress testing that we’ve discussed and disclosed in the past, that’s really where the bigger impacts are. So, I think higher rates help. But, as we said in the past, higher rates or lower rates aren’t necessarily a barrier to transacting for us.

I think, maybe the only thing I would add to that Randy. So, obviously, we don’t feel like it’s a significant factor in terms of how we think about our options, but I do think that there’re other lot of other folks out there that this move in interest rates increases their appetite.

Yes. I was thinking more like for the counterparty. So, for the counterparty, it would seem this would give them more to work with on the bear side and it seems like you’re echoing that?

Yes. We’ve seen evidence of that.

Your next question comes from Erik Bass from Autonomous Research. Please go ahead.

I wanted to come back to the investment portfolio changes and just see if I am thinking about this correctly. I mean, it seems like what you’re doing is taking some excess capital that was kind of reflected in your RBC, and you’re just deploying it at a way to pick up a higher yield on that excess capital. But, it would be tactical in the sense that if you needed that capital to either do a long-term care transaction or something else, you could easily unwind and get back. So, it’s -- I think if it’s right that it’s really yield enhancing mechanism on excess capital that you plan to hold for a period?

So, I think, what you’re describing is fairly accurate. I think, the way I think about it is, we manage the Company’s consolidated RBC in a range of 425% to 450%. And so, I’d say anything within that range, anything above the loan at that range isn’t necessarily excess capital, but I get your meaning. I think, the notion of using that perceived excess capital, I guess would be correct, if we felt like coming off the first quarter that we had to immediately rebuild the 450%. And that’s somehow caused a disruption of dividends from the insurance subs at the holding company. And that’s just not the way that we’re looking at this. In my prepared remarks, I specifically said, no change in capital management strategy or free cash flow generation.

Got it. And then, I guess as we think about the deployment of excess capital, you hadn’t mentioned the general account as a potential bucket. So, that’s really the general account kind of dealing with your existing RBC, the free cash flow you generate would be used for the buckets that Gary laid out in terms of the organic growth, buybacks, dividends, M&A et cetera. Is that correct?

Yes. Again, the way I think about it is, sort of anything in the 425 to 450% range in terms of statutory working capital is not from my perspective considered excess capital. What I consider excess capital is future of free cash flow generated above and beyond that and everything above $150 million at the holding company which is currently $230 million. And so, for those things yes, I would say, they’re more geared towards the things that Gary mentioned in his remarks.

Got it. And the dividend paid to the holding company was lower than normal, I guess this quarter but it’s also something we’ve seen in the first quarter in the past. So, is that why the cash position really didn’t or declined slightly quarter-over-quarter?

Yes. That’s one of the contributors. It’s true that our first quarter earnings on a statutory basis as well as GAAP tend to be a little bit lower, and that was the case. And so, we did by design, dividend up less to the holding company. The other issue -- it wasn’t necessarily an issue, it’s actually something -- it’s seasonality that we have between the holding company and its insurance subs. The holding company pays expenses on behalf of the insurance subs. And it’s the case that in the first quarter, one of those big payments is made. And that’s the incentive compensation that’s paid to the directors and officers. And so, that happened in the first quarter. If you look back historically, you could see that that has happened and that net settlement amount tends to be a negative number for us. That was the case here again this quarter. It was a little bit larger this time because there were some other payments that were made on behalf of the insurance subs. Now, what should happen is -- what we’re expecting to happen is that in the second quarter, the holding company is going to basically get some of that back. And so, I would expect that net settlement number in the second quarter to be kind of in the 10 to $20 million positive range.

Got it, thank you. And if I could just ask one last one. What are the implications of the sale of Tennenbaum Capital Partners to BlackRock? And will this -- maybe without giving specific numbers, but will this free-up capital for you? And I think you’re stake was held in the general accounts. So, should we expect an RBC lift there?

So, I think the answer is to be determined. So, obviously, first, there is a process that has to play out, which is the approval process and actually closing, which I think has been disclosed but we expect that to happen in the third quarter. And then, from there, it all depends on what the proceeds are reinvested in. So, there could be potential capital lift; there may not be, again depending on if we invest in something similar, then there likely wouldn’t be a capital lift. Now, where you might see change in capital is when proceeds are actually paid out, we expect to do fairly well on that investment. The financial terms haven’t been disclosed. And so, we can’t comment beyond that. But, we are very pleased with how that’s played out and we do expect to benefit as a result of the sale.

Your next question comes from the line of Ryan Krueger from KBW. Please go ahead.

Hi, thanks. Good morning. My first question was just about the RBC. I think, in the past, you talked about more targeting the 450 range, and then kind of closer to 425, if you were to do a long-term care de-risking transaction. It sounds like now you view 425 to 450 as an appropriate range as is. So, I am just curious what led to the change in general there.

So, I think, you make a good point. I think, in the past and it’s been a while, we have guided to the 425 to 450 range. Now, in the recent, in several -- recent several quarters, it’s true that we actually have been running at 450%. So, when asked about that level, I think what I’ve said is that this is about the appropriate level, given the risk profile of the company. And so, I was sort of confirming that 450% was the level that we intended to run at. But, I wasn’t necessarily saying that we wouldn’t be comfortable running at 425%. So, I think, the general statement is, the way we think about it and manage capital is really more 425 to 450. Now, adding on to your second comment, yes, absolutely, we believe in a post LTC transaction world that we can and should potentially run at a lower level of capital now. Is that 425%, is that 400%? That remains to be determined.

Okay. Thanks. And then, just on the lack of buyback in the quarter. Was that more related to your valuation of alternatives such as LTC de-risking and potential M&A or I guess how much of it has to do with your view of valuation in your stock as well?

Hey, Ryan. This is Gary. Thanks for the question. There’s not really a simple short answer for you because I would tell you that at least the way I think about it, there’s not one driving issue. And so, maybe I can just talk at a high level as to how I look at this. The first thing I want to say is none of our shareholders should walk away thinking that buybacks are off the table. That is absolutely not the case. We continue to regard buybacks as a viable potential use of that capital. However, as you’ll recall, after the 2017 results, we made a point of not providing a specific range of buybacks, and we’ve done that in the past, as you know, and we are not doing that presently. And the main reason we’re not doing that right now, the simplest way I can explain it is, I have bias to want to grow the business. So, we have strong support from our Board of Directors. And we really want to carefully consider all of the opportunities that are out there whether it has to do with risk reduction or investing more on organic growth or investing more in inorganic growth. There is of course also a factor we look at where the stock is trading during the period in time when we are looking to deploy those funds. And when we look at everything, the potential opportunities coming at us, where the stock was trading, where we are in the year, meaning still the first quarter, when we looked at all that we felt like we were comfortable not deploying those funds into share buybacks. But, I want to emphasize two major points. Number one, buybacks remain a viable option for us. Everyone should be very clear about that. I’m stopping short of committing to a specific range because of point number two, we have a bias to want to grow the business and really maximize the opportunity here. I think, we have some very unique opportunities before us and I think there are some really strong reasons why we should grow this business. I am happy to talk about that separately if you want. But, we think there’s an opportunity here and we want to keep our powder dry.

Just one follow-up. In terms of inorganic potential growth, what are the types of properties or businesses that are most interesting to you; are they more around distribution or kind of full businesses?

To be honest, we’ve looked at a variety of different things. Some have to -- would be described purely as distribution, some are manufacturers and distributors, some are somewhere in between, some take us in a different direction, some build on existing strengths. What I really want more than anything else is first, what’s going to help us grow the business? Second, what’s going to help us grow the business specifically with the middle market that we’re focused on? And once we can find things that meet those two basic criteria, we’re pretty open to a number of different opportunities. And frankly, I’ve been very pleased with what I’ve seen in the marketplace in terms of people talking to us.

Your next question comes from the line of Humphrey Lee from Dowling and Partners. Please go ahead.

Gary, in your prepared remarks you talked about some of the pilots have been rolled out on national basis. Can you talk about how -- like, in those pilots, like for example, the productivity enhancement, how much did that help your sales force in terms of productivity enhancements, and how should we think about that being rolled out to a bigger stage? And same thing on the short term care in PMA, how should we think about that pilot as well?

Sure. Okay. So, first of all, let me state the obvious. None of the pilots are working as fast as I want. And that is the nature of these. I think when you try things out, you try five things, and two of them don’t work and one works kind of well and the other two don’t work so great, and so. That’s the nature of pilots experimentation. But, I would love for all of it to move faster. A couple of the things that you touched upon. I was really very pleased with what I saw in terms of the short-term care pilot. Our PMA business has historically focused pretty much on one line of business. So, to take that distribution force that’s otherwise very talented and get them to learn and really get excited about a new product, as you might imagine, that takes a little bit of pushing to get those distribution folks to get excited about that. But, we’ve crossed the threshold. It’s off of a very small base. So, we don’t talk a lot about it. But, I’m very pleased with that. I happen to think that that distribution channel that we have there is capable of much, much more. And I’m really hoping the leaders of that channel are listening because they’re constantly getting this push from me, but I think they can do a lot more. And I think the short-term care is just one such example. So, I’m very pleased with that. I would also point to the life insurance business. That channel has also done very well that historically didn’t sell life. So, we’ve taken a channel that’s been historically committed to supplemental health, they’ve now started to sell life, they’ve now started to sell short term care. And I would point out that one of the reasons they’ve been able to even get access to those things is because of our diversified model. Recall that within the CNO family, we manufacture those products either by Bankers Life or Colonial Penn or what have you. And we have our brands right now selling one another’s products, and that’s something that we’re excited about. Am I willing to give you a specific number that it’s going to result the next $1 million more sale next quarter? No. I am not willing to do that yet. I’m telling you that we continue to pilot these things and I’ve been very pleased with that. In the case of Bankers Life, our biggest challenge there is reshaping the agent force. We’ve got an agent force that’s captive to us, that depending on how you measure it is the fifth or sixth largest captive distribution force in the country. We think there’s an opportunity to find the way we bring folks in and refine how many of them we’ll keep. We have historically brought in a very significant number of agents. But, then, when you wind the clock forward two or three years, we haven’t kept many of them. There is a lot of churn. And so, our opportunity there, and I’ve talked about this before, instead of bringing in 7,000 or 8,000 and then three years later having a 100 of them left, our goal is to bring in 3,000 and hopefully have 2,00 or 300 left. And that’s what we’re trying to do. We’re doing it with different pilots that have to do with referrals, that have to do with giving veteran agents incentives, and all the while, trying to drive productivity. That’s a high level of what we’re trying to do. I know, you would like a target. I don’t have one to give you. I can tell you that we recognize we’ve got to reshape that agent force, and that’s what we’re doing.

Got it. Just to touch on the agent force a little more. I understand the over aging [ph] force kind of coming down at Bankers as expected as you kind of focus more on the veteran agents. But, I thought that you were hoping to kind of maintain a third year plus agents, at least steady or kind of -- or maybe even grow a little bit. But, the 2% decline kind of this quarter was a little bit of a surprise. Are you doing some pruning as well in this in the veteran agents group as well?

There is always some of that going on. And, Humphrey, look, you make a very fair point. We would have liked that three-year plus number to keep growing, okay. And we went from if you look at the data that we have at Bankers Life from 1,863, down to 1,847. So, what is that? 16 headcount. And the distribution force is 1,800 strong. While I wanted that to go up, not down, it’s hard for me to draw too many conclusions to a change of 16 headcount against the denominator of over 1,800. So, some of it has to do with pruning, some of it has do with folks doing other things, some of it has to do with time. This is just going to take a few quarters to play itself out. But, in fairness Humphrey, we did not want that number to go down, and that’s not what we would have hoped, but I’m also not sounding the alarm bells, given the relatively small fluctuation.

Yes. I guess, it’s just the kind of many companies now offering higher hourly salary above the minimum wage. Does that have an impact to kind of your agent retention?

Look, any macro trends in the employment market impact us. Because as you’ll recall, our agents are commission-only. They are not employees, they’re 1099 producers, and they work strictly on a commission basis. And you have more folks willing to try a career change like that when you’re talking about an 8% unemployment world than you are when you’re talking about a 3% unemployment, and that’s just the reality. So, certainly, we’re impacted by that, absolutely. What I’d be willing to say that that three-year swing of 16 bodies is driven because of that. I wouldn’t be willing to say that. Maybe two or three of those 16 folks are driven because of that but I wouldn’t be able to say that all of them are driven because of that. I think, we’re working through this. And I would also point out that recognizing what’s happening in the employment market, that’s also been one of the things we’ve done with the pilots in terms of when folks -- when some of these agents reach a certain threshold, we provide more support than we historically have and on a selected basis based on certain criteria. So, those are the types of things we’re trying to navigate through.

Your next question comes from the line of Sean Dargan from Wells Fargo Securities. Please go ahead.

Thank you. I have a question, if I just take a step back at a high level, I just want to make sure I understand the relationship between RBC, holding company resources, and your ability to do an LTC transaction. So, the incremental investments you made, which brought down RBC through buying preferred share ETFs was done at the insurance sub level. If you were to do an LTC transaction, would it be holding company cash that would be contributed to counterparty, or would it be capital any insurance sub? I am just trying to figure out what the relationship is.

Yes, Sean, this is Erik Helding. So, maybe just a general comment. So, any potential LTC transaction would be done between -- and this is particularly one we’re talking about, the Bankers Life and casualty, statutory legal entity and the counter party. And so, the transfer of assets and liabilities in consideration will happen between those two entities. So, it first starts with the capital level and wherewithal of the legal entity to transact. Now, if the legal entity doesn’t have sufficient capital on hand to transact and maintain adequate risk-based capital on a standalone basis, it would then be up to the holding company to help fund the transaction. So, that’s kind of how it works.

Okay. And the LTC block is not a discrete sub stack under Bankers Life. So, any transaction has to be a reinsurance transaction, is that correct?

Yes. You are actually correct. The LTC business that we are discussing is within the Bankers Life and casualty legal entity. It’s not in the subsidiary company. So that is correct.

Your next question comes from the line of Alex Scott from Goldman Sachs. Please go ahead.

Thanks. First question I have is just on the long-term care. You mentioned cautiously optimistic that some of the trends can continue. Just wondering, what you are seeing in the performance of the block that would give you the confidence to say something like that? Is there anything around persistency or claims, the way that morbidity, mortality is coming in that’s driving those comments?

Hi, Alex. This is Eric. So, I’d say, it’s just general favorability that we’ve seen for at least four or five quarters in a row here. If you roll back to 2017, you probably remember that we were towards the low end, if not better than the low end of the guidance that we’d given. In fact, I think during the middle of the year, we actually lowered guidance on the interest, benefit ratio. So, in general, what we are seeing is yes, favorability in credit claims and slight favorability in persistency. So, persistency being a little bit lower than we were expecting, which when that happens, when people lights [ph] off, you’re releasing reserves and that contributes to the lower benefit ratio. But there’s nothing sort of acute. We have been discussing for a while that we have been looking at ways to improve things, management practices and we continue to do things like that. And we think that is benefiting; it’s hard to quantify, but we certainly think that that’s benefiting us.

Okay. And the other question I had was just around potential LTC transaction. You mentioned in the event that there is not enough OpCo [ph] to fund it, potentially a HoldCo would help out. Would you -- how do you guys think about debt capacity? On the other side of LTC transaction, if you’ve unloaded enough risk, is there an ability to take leverage out there?

Yes. Alex, so, I think maybe to clarify. I don’t recall same, as there wasn’t enough capital at the holding company to fund the potential LTC transaction. So, I just want to clarify that.

Then, I mean -- sorry…

Yes, okay. That’s fine. That’s where I was going next is, whether or not the Bankers Life and casualty legal entity has enough capital on its own or it needs capital from the holding company, whether capital -- the holding company has enough capital is going to depend on the size of the transaction, which blocks are transacted on and a number of different factors. So, I just wanted to get that out there. So, that -- does that make sense?

Yes. Okay.

And did you have -- I am sorry, did you have a follow-up question on that?

No. That’s it. Thanks.

Your next question comes from the line of Tom Gallagher from Evercore. Please go ahead.

First just a follow-up on the risk trends for long term care theme. I think, you guys had talked about mainly focusing on highly rated counterparties, insurance companies when thinking about risk transfer. But, we’ve definitely seen a change in the market. I know it’s on the variable annuity side. But, you’ve had investment consortium’s alternative managers getting involved now in terms of risk transfer. Is that on the table for you guys when you’re thinking about alternatives here or is it really still insurance companies, highly rated counterparties are the main ones under consideration?

Look, the short answer for me on this question is, we’re willing to look at a number of different opportunities, but we are highly, highly sensitive to how it will look to our shareholders and what the credibility of the counterparty is. And you can tell, I’m hedging little bit on my response because the point that I want to make sure our shareholders understand is, we will be very sensitive to the quality of the counterparty, the structure of the deal and so on. We are very particular about that. The reason I’m hedging though is, I’ve been surprised by the number of as you put consortiums and other market opportunities that are out there right now. If you would ask me a year ago, are people going to be taking a run at variable annuity business? I would have said, no way. And you’ve seen some of the same things happen that I am seeing right now. So, I am very surprised by the number and nature of parties that are out there, looking to do things. And I don’t want to rule out something that I haven’t thought of today that that would be quite compelling. But the quality and financial strength of the counterparty that we do any type of deal with, will be a paramount consideration.

Got you. That’s pretty clear, Gary. The other related question to that is, in addition to the counterparties, I think you’ve also seen some changes in the way state regulators are dealing with businesses that are housed within the same legal entities and potentially approving transactions which would carve out those legal entities, which could change the nature of some of these types of transactions, if you know what I mean. So, I’m curious if you think, is that also a possibility here because in a vacuum if it’s only a reinsurance transaction that could be done, it’s more limiting. But, if there is possibility or opportunity to get regulators to approve a carve-out of a sale instead of the reinsurance deal, I think that’s a very big difference in terms of the economics for you. But anyway that’s -- curious your thoughts on that.

Yes. So, obviously, the nature of the question is purely speculative, I want to first tell you to make sure I keep our attorneys happy with me. I think that the movement we’ve seen in the marketplace, the growing flexibility by regulators, the growing amount of capital and the growing number of parties that are interested in transactions like this, I think all of that is good for a company like CNO. And I’ll come back to what I said before, there are a lot of things that if you would have asked me just 12 months ago, would they potentially be happening in the marketplace, I would have said, absolutely not, never going to happen. And here we are today, people buying variable annuity blocks and regulators allowing carve-outs and all sorts of stuff. So, I think that’s a good thing for us, I think that’s a good thing for the optionality it gives an organization like ours. I’m not at a point where I can predict how we would react because it’s so issue specific. But again, I want to emphasize the credit quality, the strength, the character, the nature of the deal we do, we understand how important that is.

Okay. And then, just on another topic, Gary. If you were to really try and distill what’s happening on the sales front here, because I know organic growth and turning around sales momentum sounds like a big strategic priority. You were sort of highlighting how the improving jobs picture makes it harder. Is that really the biggest challenge for you in terms of why we’re seeing the results today or maybe if you could sort of drill down and explain why you think it’s happening, why you believe you can improve it.

Sure, let me -- I definitely want to talk about the challenges because we have challenges and it’s not turning as quick as I want. So, I want to be clear about that, so no one thinks I’m [indiscernible]. But I also want to thank about some of the things that are going well. I mean, I have just been really, really pleased with the progress of our broker dealer. And I know, we don’t yet have enough quarters under our belt to where we’re demonstrating results to, but I can tell you, we’ve been extremely pleased by the number of our insurance agents that are taking that step and really stepping into the securities world and committing to this business as a true career and really are helping our middle market consumers in a way that they hadn’t been able to. I’m really, really pleased with how folks at Washington National have grabbed on to new products way outside of things that they’ve never sold before and making hay with life insurance products and short-term care and so on. So, there are really some very strong pockets of encouragement on the sales front. The biggest challenge though clearly for us on the sales front is at Bankers Life. Some of that is impacted by bringing agents into this career that work on a commission basis and the employment picture impacts that. There is no question about that. That’s a significant challenge for us. Some of it is where the consumer preference is right now. I mean, if we think -- you’ve seen all the stats I have in terms of how many boomers are going into retirement. We know that if people go into retirement and there -- the houses are paid for, the kids college is on or whatever it is, from a sheer financial planning standpoint, their need for life insurance goes down but their need for wealth management products and other things that provide income for life, goes up. We’re seeing some of that. And I don’t think we’re alone. I think there are other folks in our business that have seen life insurance sales come under pressure. So, we’re seeing some of those things. So, I think the short answer in terms of what I would say is I’m -- we’re facing some headwinds relative to bringing agents into commission nature. [Ph] There’s no question about that. We are facing some headwinds in terms of the consumer and the fundamental demand picture for products like life insurance. However, we are facing -- not facing, we have some significant tailwinds in terms of there aren’t a million other people down here competing for our middle market consumer. We’ve got some tailwinds in terms of our insurance agents are really embracing the opportunity that becoming a securities licensed professional offers. We are seeing some tailwinds in terms of the ability to cross sell our products and grow our franchises within operations like Washington National. So, there’s a lot of different factors that work here. There’s no one thing that’s driving at all. And you’re right, as anybody that’s ever run a business, knows the hardest thing to do is change momentum. And it’s going to take us some time and we are pushing through that.

Your next question comes from the line of Dan Bergman from Citi. Please go ahead.

I guess to start, following up on the asset allocation change. Could you talk a little bit more about the decision to make much of the investments through ETF? Is that mainly for liquidity purposes and does the use of ETFs draw a higher capital charge than the underlying assets otherwise would to start?

This is Eric Johnson. Happy to answer that for you. But, I don’t want to do an advertisement here for BlackRock or Invesco or anybody else who happens to do ETF. But, I will say that if you are looking at like a power shares or something that has 200, 250 underlying constituents, it would be very difficult for us to get in and out of those, efficiently pay a lot of money on a bid offer. And it would be a very difficult task. So, what you are getting in your wrapper is in essence you are getting broad and diversified exposure on a defined basis that has a greater liquidity as a sum than the sum of the underlying components. The price you are paying for that is the underlying components in this one particular case I just mentioned are roughly 90% investments grade, NAIC rated, the wrapper it had before of rating. This is reverse R there. So, you are paying a price for the administrative convenience and liquidity. On the other hand, you are getting a very high return on capital. At the end of the day, the distribution rate on something like what I just described to you is north of 6% on the invested dollar, which is very high. So, there are trade-offs in other words. And we unfortunately with the curve the way it is being so flat and rates headed where they’re headed which it seems terminal rates are going higher, there are no easy buckets. There was -- in order to achieve the Company’s needs, we are not going to simply be able to run a very -- a simple model that by single A bonds has long end of the curve that probably is not going to be the way to get the periodic earnings we need or the long-term value we need. So, we are going to have to be smart and opportunistic within boundaries that are appropriate for capital and risk. So, I think you should look at this in that context. We are not going to have a portfolio that don’t have this. [Ph] There are a lot of reasons that that’s not going to be the case. But I think there are on a limited basis and carefully thought out cases where a passive allocation can add value to a portfolio. Particularly a good example is the case where you have something like we had in the first quarter we had fairly sharp, even discontinuous change in relative value and blow out in spreads. And to capture it -- a quick way of capturing that obviously is something that gives you a broad exposure like in ETF. So, you can grab that change in relative value very quickly and then you can modify it over time.

And maybe just quickly -- quick follow-up on the Bankers long term care business. Was there any notable benefit that you saw from kind of the elevated -- potentially elevated mortality of adverse flu season in the favorable one quarter results?

No, not really. I mean, mortality in the quarter was generally fairly benign and we saw a little bit of an uptick in Colonial Penn a little bit and our traditional Life business and Bankers Life, but it was very marginal investment and really sort of benign in the quarter.

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

Thank you operator, and thanks for joining us on today’s call.

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